Unit I

Introduction to Banking
Origin:

The growth and development of the term ‘bank’ is a gradual and evolutionary process. There is no single
answer to the question for the term bank or banking. According to some, the English word ‘bank’ is derived
from the Italian word ‘banco’, the Latin word ‘bancus’ and the French word ‘banque’, which mean a bench. In
olden days the European merchants, transacted their businesses on benches in market places by displaying the
money of different denominations and the bench resembled the banking counter and it is assumed bank may be
derived from the word ‘bench’. Again if the banker failed his obligation to pay money, the bench was broken up
by the people and hence the word ‘bankrupt’ came in to existence.

Evolution of banking:

Banking made its first appearance as a public Enterprise in the year 1157 in Italy with the establishment of
Bank of Venice. The bank of Barcelona was started in 1401, the bank of Genova in 1401 and the bank of
Amsterdam in 1609. However the banking act of 1833 in England has encouraged the growth of joint stock
commercial banking.

In India the East India company established the presidency Bank of Bengal 1806 the presidency Bank of
Bombay 1840 and the presidency Bank of Madras 1843 with function as independent units. This Swadeshi
Movement in the early 20th century has induced to establish a large number of banks under Indian
Management. These developments increased a large number of Indian banks to come up in the economy. Likely
the Punjab National Bank Limited came into existence in 1895, Bank of India in 1906 the Canara Bank Limited
in 1906 etc.

Ancestors of modern banking

Modern banking origin can be traced by considering the three important sources. They are the merchant
bankers, money lenders and goldsmiths.

1. The merchant bankers: They are originally traders in both internal and international trade. In addition to
trading activity they financed foreign trade businesses due to this reason they are called as merchant bankers.
The contribution of merchant bankers to modern banking are financing foreign trade and using bills of
exchange.

2. Money lenders: They are the persons who lend their surplus money to the needy people at a higher rate of
interest. In addition to their lending they also accept deposits at a low rate of interest from the public and
offered loans at higher rate of interest. The difference between borrowing rate and lending rate of the interest is
profit for the money lenders. The contribution of money lenders to the growth of modern banking are accepting
deposits and lending funds.

3. Goldsmiths: They are the persons of honesty integrity and reliability as such most of the people deposited
their surplus money with the goldsmiths. In addition to that they also offer safety lockers facility for

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maintaining valuable like gold and other ornaments. For the money deposited they issued deposit receipt. The
deposit receipt are acknowledge as debt instrument which issued by Goldsmith to depositors. However the
customer can withdraw their money or valuables by producing deposit receipt. The contribution of goldsmiths
to the modern banking system are issue of banks more handling cheque system and creation of money.

Evolution of Banking in India:

Money lending was an existence for a very long time right from the vedic period. The British government
brought modern banking into India with the establishment of Bank Of Bengal in 1806, bank of Bombay in
1840, bank of Madras in 1843. Together these were called the presidency banks which were acting as banker to
the government apart from carrying on general banking. All these three Presidency banks were amalgamated in
1921 to create a single Imperial Bank of India. In 1935 Reserve Bank of India was created as the central bank of
the country. Meanwhile a large number of joint stock banks were established by lending business houses and
Indigenous bankers. In 1955 Imperial Bank of India was renamed as State Bank of India to shake out the image
of British monarchy.

In 1969 14 major banks were Nationalised opening up and era of social banking. Realising the need to develop
rural areas through recognising banks as development agents the Nationalised banks together with SBI and its
associate went in for a major expansion of branch network in rural areas. In 1980 name the reach of public
sector bank. The benefit of social banking was the available of Banking facilities even in remote villages the
Profit ability of the banks was thrown to the winds resulting in severe shortage of funds in the 1980s.

In 1990's, Narasimham committee recommended major steps for banking reforms. Following this Bank started
improving their Profitability. Many new generation banks like ICICI Bank, in the slant Bank Global Trust
Bank, HDFC Bank et cetera were established starting as total computerised branches of services and remittance
of funds electronically. Naturally all the old generation banks went in for computerisation initially and
networking a little later on introduction of ATM (automated teller machine) brought down the cost of operation
of the Indian Bank.

The reverse merger of ICICI into ICICI Bank revolutionized Indian banking in 2003. All the development
functions of the erstwhile ICICI became the business of ICICI Bank. This opened many windows of
opportunities to the Indian banks. With the huge number of branches that are network electronically has made
banks to be the partner in progress of insurance companies Mutual Funds capital markets public utilities
government etc ATM are also emerging as multi task computer interface offerings that services as sale and
purchase of mutual fund units Railway Booking, payment of insurance premium and host of other services
banks in 2006 – 07 have become one joint financial mechanism for the whole country.

Definition of term bank and banking:

Oxford dictionary defines a bank as “An organization that provides various financial services, for example
keeping or lending money”.

Dr. H.L. Hart defines a bank as “One who is ordinary course of his business, honours cheques drawn upon him
by persons from and for whom he receives money on current accounts”.

The Banking Regulation Act has defines the term ‘bank’ and ‘banking company’ as follows:

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Term banking company – sec. 5(1)(c) – “Any company which transacts the business of banking in India” is
known as a banking company.

Term bank – sec. 5(1)(b) – “Accepting for the purpose of lending or investment of deposit of money from the
public, repayable on demand or otherwise and with drawable by cheques, drafts, order or otherwise.”

Functions of banks:

I Primary functions:

They are the fundamental functions which have to be undertaken by any bank in a country to be called as a
commercial bank or banking. No institution can be called as a Bank unless they perform these principal
functions of accepting deposits from the public and learning advances to the needy public. It can be further
classified into the following

1. Accepting deposits- deposits constitute a major source of funds for a commercial bank. Generally
commercial banks accept deposits in different forms according to the needs, interests and economic conditions
of the society. For instance small and medium income group deposits in a savings bank account for the safety
and reasonable return to the funds. While business community and traders current or demand deposits for the
convenience of payment or settlement of business obligations as such commercial banks accepts following
types of deposits.

● Current accounts: current accounts are generally open by trading or business communities. It is a running
account in which there are no restrictions for any number of deposits and withdrawals in a given period of time.
Generally the current account holder is not entitled to any interest on his credit balance held in the account and
there is no maximum limit to the amount that can be deposited to the account.

● Savings accounts: savings accounts are opened by middle and low income groups with banks to save a part of
their income for future needs. Savings accounts also earn some reasonable interest on the deposits and earn
some income to account holders.

● Fixed deposit account: fixed deposit is opened by small and medium savers as a form of investment and to
avoid risks in other alternative forms of investments. A fixed deposit can be defined as an account open for a
fixed amount of money at a fixed rate of interest and for a fixed period of time fixed deposits enjoy an attractive
rate of interest on funds invested in the amount.

● Recurring deposit accounts: recurring deposit is a term deposit which is opened by regular income groups by
depositing a certain sum of money at regular intervals, 6 quarterly or monthly basis for a predetermined period.
It allows customers with an opportunity to build up their savings through regular monthly or quarterly deposits
of fixed some over a fixed period of time. The amount of deposited repayable along with interest to the account
holder in cash or by crediting to the savings bank account on maturity.

2. Lending of funds: lending of funds constitute the main business of a commercial bank. A major portion of
funds are employed in loan and advances on profitable bases by commercial banks to individuals and
institutions are formed. Most of the loans of commercial banks are secured either against Collateral security or
by way of personal guarantee. Commercial banks after keeping a certain portion of deposits or funds as cash

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reserves the balance is linked to needy persons for interest. This interest is the main source of income to the
commercial banks. Commercial bank provides the following types of loans and advances.

● Direct loans: loan is a financial arrangement between banks and borrowing customers on a
separate account called a loan account. When loan is sanctioned the entire loan amount is
transferred to the borrowed account in one lump sum. If such interest is payable by the borrower
on the entire amount of the loan sanction. However the borrower can repair the loans in one
installment or a regular interval as per prior agreement. Loans sanction for individuals and forms
and even for customer credit.

● Cash credits: it is a financial arrangement between banker and trader custom of short term in
which borewell can avail cash credit up to a certain limit fixed by the bank. It is given again
sufficiency security of the customer that is inventory et cetera. Usually businesses or traders
customers receive this facility and continuously draw from the bank up to a certain specified
amount called cash credit limit.

● Overdraft: an overdraft occurs when money is withdrawn from a bank account and the available
balance goes below zero. In such situations the account is said to be overdrawn. An overdraft is a
financial arrangement between a Banker and the current account holder in which a current
account holder is allowed to draw money over and above the credit balance in his account under
prior arrangements.

● Discounting of bills: the banker discounts eligible Trade bills and extends financial facility to the
trader customer for a short period of 60 days to 90 days. In discounting the bills the bank credits
the customer current accounts with net proceeds after deducting discount charges which is an
income for a bank. Bills act as security for the bank and the same time banks enjoy financial
assistance from the apex bank through rediscounting through financial agency.

3.Investment of funds

It is the statutory obligation for every financial institution to invest its funds in government securities or
government guaranteed securities. Banks invest a considerable proportion of their fund in investments as per
legal obligation. Indian banks invest up to 25% of their deposits in government securities. Government
securities include both Central and state governments such as treasury bills, national saving certificates of local
bodies etc. Such investments have the prime objective of Financing the economic development and
infrastructure development of a nation.

4.Creation of money

When Bank accepts deposits, command the advance of such funds as loans and advances to customers in order
to earn profits. But such advances or loans are not given in the form of cash to the borrow response. Banks open
the current account in the names of the borrowers and credit such funds to their accounts. The borrower is
allowed to withdraw the required funds by checks whenever he needs. Such loan advances create additional
deposits or bank money. These additional bank money or deposits created by banks are known as creation of
money. In other words, when banks lends advances they create additional purchasing power in the economy and
such additional purchasing power is called the creation of money.

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II Secondary functions:

Commercial banks perform a number of subsidiary services to customers. Those functions are not obligatory
but to retain existing customers and to attract new customers they perform the services. Banks normally charge
a small proportion of charges in the form of commission from the customers for the services. Subsidiary
functions can be classified into

1. Agency services: agency services are undertaken for and on behalf of customers. This function is of
immense use to the customers in their day to day financial transactions. Any bank account holder Can
obtain the services with some prior arrangements with the bank. They are

 Collection facilities: banks collect cheques, bills, drafts, interest and dividends on securities and rents on
behalf of their customers and credit the collection proceeds to customers' accounts.

 Payment services: banks peoples Life Insurance Premium subscriptions to journals and newspapers,
electricity bills etc on behalf of the customers according to standing instructions and debit the customers
account against such payments.

 Assistance in purchase and sale of security: banks have wide contact with a large number of stock
brokers and due to their contact we can help the customers in buying and selling of securities in the
stock market at the right time, price and place.

 Purchase and sale of foreign exchange: banks are authorized members of foreign exchange dealers
association and they have wide information on Foreign Exchange. This enables the banks to secure best
prices to customers in dealing on Foreign Exchange.

 Investment advice: banks collect information of stock market investments and other forms of alternative
investments and advise the customers in the right type of Investments.

 Remittance of funds: banks arrange for remittance of funds from one place to another or from one
country to another on behalf of the customers through Bank Draft, male transfers or NEFT etc.

 Acting as a Trustee executors and attorney: Banks Act as Trusty to manage trust property as per the
instructions of property owners. Banks required to follow the instructions of trusted and manage the
property and their by hand over the benefits to the customers. As an executor the banker settles is the
property of the disease person as per the will of such customers. Banks as an attorney of customer
receives interest and dividends on behalf of customers and issue a valid receipt for such income. Again
he is authorized to sign the transfer form of sale and purchase of security on behalf of the customers.

 Income Tax consultancy: commercial banks act as text consultants to his customers. The commercial
banks prepare general sales tax return, income tax return et cetera and file the same with the tax
authorities.

 Correspondent and representatives: banks access representatives in obtaining passports, Traveller's

tickets on behalf of customers even they secure air and sea passes for their customers.

 Letter of references: banks provide information about economic and financial positions of their
customers to traders and provide similar information about other traders to their customers.
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 2. General utility services: general utility services are ended for both customers and non-customers of a
bank. Even the general public who does not have a bank account are also entitled to the services. They
are

 Safety locker facility banks provide locker facilities to their customers. The customers can keep the
valuables like gold and silver ornaments, title deeds and other important documents like shares and
debentures in these Lockers for safe custody. This has minimized the risk of loss due to theft and other
risks.

 Traveller's cheques: it is a printed check of a specific denominations which are purchased by the person
from a bank after making necessary payments. Customers can carry on traveling and such checks are
accepted in banks, hotels and other business establishments. This helps a customers to travel within
India or abroad without any fear of theft or loss of money.

 Transferring money: money can be transferred from one place to another. In the same manner banks
collect funds of their customers from other banks and credit the same to the customer’s account.

 Merchant banking: commercial banks provide merchant banking services to the investors and business
forms. Merchant banking activity includes project advisory services and loan syndication corporate
advisory services like mergers and acquisitions, equity valuation, disinvestment, project identification
etc. Such services are provided through their subsidiaries which are quite useful for business units.

 Automatic teller machines the ATMs are machines for quick withdrawal of cash. ATM facilities now
covered almost all the areas irrespective of Urban and rural areas. The account holders with debit cards
can we draw cash from ATM for their urgent needs without entering Bank branches or offices.

 Credit cards: credit cards are another important means of making payments. The Visa and master cards
are operated by the commercial banks. The card holder can use credit cards for withdrawal of cash from
ATMs and also to settle payments for any purchases made in trade establishments without direct cash
payments.

 Letter of credit: letter of credit are issued by the banks to their customers who are involved in
international trade. This letter certifies the credit worthiness and enables them to import goods on credit
terms from the exporter extreme of letter of credit.

 Collection of statistics: Bank collect data and Statistics relating to trade commerce industry agriculture
and banking etc these data are published in journals and bulletins which are quite useful for Research
and economic planning of a nation.

 Gift checks some banks issue give checks of various denominations of Rupees 501 Rupees 1001 etc
which can be used for providing gives on occasions like birthdays, weddings etc.

 Accepting bills on behalf of customers in some occasions banks accept bills of exchange relating to
internal or foreign trade on behalf of their customers. This and shows more security and enables the
customers to do business without risk.

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  Advise on financial matters banks give advice to their customers on the financial matters in respect of
trade business Trends and other economic activities.

 Socio economic services banks undertake social initiative and as a part of corporate social
responsibilities they help in development of backward areas and encourage self-employment, Micro
Finance for achieving balanced regional economic development.

 Underwriting: they underwrite the shares and debentures issued by joint stock companies and assist in
raising finance of Corporate bodies. They also under ride the loans floated by the government bodies.

 Factoring services commercial banks provide factoring services to their customers since banks are
experts in financial dealings. Factoring services help in ascertaining cash inflows and administration of
book debts of business units. Through factoring banks take responsibility for collection of book depth
and relieve the business units from the process of collection of deaths. This services is provided by a
separate subsidiary under SEBI regulations.

 Lease finance the commercial banks extend leaving finance for acquiring huge and costly capital
equipment or assets. In leasing finance banks provide financial assistance to purchase costly equipment
for production purposes and assist them in procuring capital assets without making lump sum payments
which will stop repayment of credit that can be made in periodical installments.

 When your capital finance when you capital refers to high risk equity capital. Under the scheme of
assistance the finance is extended by banks through a separate subsidiary to highly risky ventures where
there is no guarantee of success or Returns. In other words finance is extended to new generations and
highly risky new ventures in the economy.

 Bancassurances: bancassurances refer to selling insurance products through banks. Banks and insurance
companies come up in a partnership where in the bank sells the tied insurance companies insurance
products to its customers. Selling insurance products benefits both the bank and insurance companies.
Banks on in the form of fees and insurance companies increase its market reach and customer base.

Segment banking – Meaning:

Segment banking refers to Section or portion of the whole form of banking business will stop it segment bank
has some common features behavior or preferences in delivering its financial products or services. For instance,
banks offering only Microfinance products and services, a special bank for infrastructure finance for project
finance mortgage banking banks for industrial finance, banks for women sections and payments banks etc.

Segment banking is a niche banking for different segments that allows for the creation of a variety of small
specialized banks that target specific regions or populations or financial products. It includes mortgage banks,
banks for infrastructure finance, banks for agriculture, banks for small and medium enterprises etc.

Merits:

 Segment banks concentrate on niche area and thereby provide services mainly to chosen areas which
helps higher productivity of funds.

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  Segment banks have limited norms and regulations of the RBI then universal banking, which can
increase optimum utilisation of resources and reduce underutilization of funds.

 Universal banks have to follow the direct lending policy of the RBI especially in the priority sector
advances in which Indian banks and even for in banks find it difficult to choose the right financial
products. Segment banks are exempted from such regulations and have flexibility to provide specialised
services in their identified core competencies. This will reduce intermination cost and achieve better
price Discovery and improved allocative efficiency.

 Segment banks has risk management expertise and significance scope for specialisation. Such
expectives helps in risk assessment and infrastructure Financing.

 Segment banks can find easy way to provide no frills facilities to economically disadvantaged people.
Segment banking as an initiative of financial inclusion can help society to come under the main streams
of the banking system.

 Segment banks reduce conflict interest of multiple functions performed by same or single bank and their
by can offers specialized financial products to their customers in most cost effective manner.

 During 2014 RBI has identified nearly 4.9 lakhs villages having population of less than 2000 are under
banked or unbanked. Segment banks can take the challenge of extending banking facilities to such areas
as a part of financial inclusion.

 Management method and cause control is easy and effective in segment banking. This is because of cash
flow based learning, operating leases and factoring which will lower the cost of transactions.

Demerits:

 When compared to Universal banks the segment banks narrow business model may suffer from the
liability of concentrated risk. Such bags cannot diverse if I the risk due to lack of portfolio investment
policy.

 Universal banks have the option of cross subsidizing across different sectors in which it extends
financial products that result in optimum allocation and better profitability of banks. Such cross
subsidization to different sectors cannot be enjoyed by segment Bank.

 Segment Bank sometimes non viable and increase cost of banking services as banking business in
concentrated for particular product or service.

 Segment banking is not a new concept but it is too early to say it's effectiveness as suggested by State
Bank of India because it may overlock the current stipulation on priority sector norms.

Retail banking - meaning:

Retail banking, also known as consumer banking or personal banking, is banking that provides financial
services to individual consumers rather than businesses. Retail banking is a way for individual consumers to
manage their money, have access to credit, and deposit their money in a secure manner. Services offered by

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retail banks include checking and savings accounts, mortgages, personal loans, credit cards, and certificates of
deposit (CDs).

Retail banks come in a variety of types and sizes, from local community banks, which are small, locally run
banks to the retail banking services of large, global corporate banks such as JPMorgan Chase and Citibank.

Retail Banking is a form of commercial banking wherein service is provided to the retail (individual) customers
for non-entrepreneurial purposes. In banking, the term ‘retail’ signifies, that the consumer avails banking
products for personal use, wherein the consumer is the customer of the bank and the products are the services
that a bank offers to its customers. It is also known as consumer banking.

As of March 31, 2021, the top five largest U.S. commercial banks by assets were:

 JPMorgan Chase

 Bank of America

 Wells Fargo

 Citibank

 U.S. Bank

Retail banking is intended to help consumers manage their money by giving them access to basic banking
services, a source of credit, and financial advice. The general public can access a variety of services through a
retail bank, including checking and savings accounts, mortgages, credit cards, foreign currency and remittance
services, and automobile financing.

1. Small Banks: They function in a small range via branch banking with nearly all facilities offered by the
large banks and hence are quite known among the populace. Nevertheless, they possess lower market
shares and lesser deposits compared to them.
2. Large Banks: These prominent banks operate in big cities with numerous branches and certainly have
more personnel than small banks. Also, several retail clients choose them because of their huge
popularity.
3. Online Banks: As the name suggests, online banks work electronically with no tangible offices.
Moreover, they operate through an official website accessible from even the remotest parts of the world.
Now that a majority of people prefer to avail banking services from the comfort of their homes, it is a
lucrative option for people with hectic schedules.

Advantages of Retail Banking

 The deposits from retail customers are stable and form core deposits. Such deposits are interest
insensitive with less bargaining for additional interest. Also, they constitute low-cost funds for the
banks.

 An effective customer relationship management helps in developing a vast and strong customer base.

 Retail banking also assists in increasing subsidiary businesses of the banks like insurance, etc.

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  It amounts to better yield and profitability.

 It contributes to the economic development and economic revival of the country, through increased
production.

 Helps in improving the lifestyle of consumers by providing loans at affordable rate of interest.

 Involves minimum marketing efforts.

 Due to its large customer base, they have a diversified portfolio, which reduces the bank’s dependence
on a single borrower.

Disadvantages of Retail Banking

 Monitoring and follow-up of a large number of loan accounts induce banks to spend heavily on
manpower.

 Banks invest heavily in technology for better services however, they are not utilized to that extent.

 Nowadays, most customers are interested in other financial products such as mutual funds.

 Long-term loans may turn into Non-Performing Asset (NPA) if they are not monitored and followed up
properly.

Co-operative banking:

Cooperative Banks are organised by members Belonging to a particular region caste, community or employees.
In India cooperative banks are established under the cooperative societies act of 1912. The main objective of
cooperative banks is to extend credit to the agriculturist and relieving them from the clutches of village money
lenders.

Features of cooperative banks:

 Structure of the banks: Cooperative banks are operated in three tier structure or Federal structure. at the
top state level Cooperative Bank, at the district level Central Cooperative Bank and at the village
primary Cooperative Bank perform the banking activities.

 Purpose of credit: mainly extend credit to rural areas and provide credit to agricultural and rural
activities.

 Management and voting rights: Voting rights Usually one member one board and shareholders or
members appoint direct day to day management of cooperative.

 interest rate: Usually charge low rate of interest on the loans and advances. but in case of deposit they
offer higher interest than commercial bank.

 Borrowers: Generally the members are the main Borrowers Cooperative Bank.

The cooperative Structure is sub classified

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 1. Primary Cooperative Bank: A primary Cooperative Bank is an association of members of a particular
locality whose primary objective is mutual help and support to each other residing in that region. As
Membership is particularly open to all sections of people in the locality people of different status and
brought together into the Common organisation. The day-to-day affair of the society is managed by
honorary secretary presently called as the chief executive officer and President through the assistance of
board of directors who are elected by the members on the one member one vote. The Co-operatives
operate under limited liability and fund are raised through share Capital, Reserve fund, deposits from
members and non-members, loans from Central Cooperative Bank.

2. Central Cooperative Bank: A Central Cooperative Bank is a Federation of primary cooperative banks in
specified area say at a district level. The membership of the Central Cooperative Bank are sometime
restricted to members of primary Cooperative Bank which are known as pure Central Cooperative Bank.
Now other individual are also educated and number of almost all Central Cooperative Bank and they are
called mixed Central Cooperative Bank. The funds of Central Cooperative Bank consists of Share
Capital, Reserve funds, deposits from member and non member, loans from state cooperative Bank and
sometime the primary Cooperative deposit their surplus Fund with Central Cooperative Bank.

3. State Cooperative Bank: State Cooperative Bank are operating at top of the Cooperative credit structure.
They are also known as Apex bank as it functions like a leader of Central Cooperative Bank. They are
located in the concerned state headquarters. The membership comprises from the Representative of
Central Co operative Bank and individual share holder. State Cooperative stuff as a channel Between
Cooperative movement and commercial bank and attracting deposits from the rich urban classes. Nabard
maintains contact with the State Cooperative Bank and assists in rediscounting facilities, collects and
disseminate Useful information regarding Cooperative movement.

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