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Banking in India - Short Notes

Published on Thursday, March 27, 2014
Bank = financial institution = accepts deposits and lends money as well as allows the depositor to withdraw money.
Non-Banking Financial Companies(NBFCs)= financial institution = accepts deposits and lends money but does not allow to withdraw money from deposits.

Reserve Bank of India(RBI)

·         Setup in 1935(by RBI Act,1934) as a private bank with two extra functions. (why?)

To regulate & control bank in India. (how?)

By two tools – CRR & SLR

Cash Reserve Ratio (CRR) (currently 4%)

Informally – Bank has Rs 100, Rs 4(4%) goes to RBI
Formal Definition – Ratio of total deposits of the bank in India which is kept with the RBI in cash form.

Statutory liquidity ratio (SLR) (currently 23%)

Informally – RBI says to bank, after collecting CRR I have a lot of money so I don’t need more money give me deposit in gold or government approved securities etc

Formal Definition - ratio of total deposits of a bank which is to be maintained by the bank in non –cash form.

To act as banker of the government. (how?)

Revenue collection as well as payments on behalf of Government across the country
  • After nationalization in 1949, RBI emerged as the central banking body of India and government handed different functions to it from time to time such as- 
  • Issuing agency of currency and coins other than rupee one currency and coin(which are issued by the Ministry of Finance itself with the signature of the Revenue Secretary on the note.) 

Ques - Why RBI doesn't issue Rupee 1 currency and coins?

Because it is a fundamental currency.

Ques - Which is the fundamental Rate of RBI?
 Repo rate is the fundamental rate because all the rates are related to it.
  • Distributing agency of currency and coins issued by Government 
  • Banker of the Government(how?) (discussed above) 

Banker of the banks (how?)

As discussed above bank have to keep CRR with RBI, thus necessitating a need for maintaining accounts with RBI. Bank maintain a account with RBI where CRR is deposited hence RBI act as Banker of the banks.

Bank of the last resort (how?)

Informally - You need loan, you go to bank, it asks you for security. You go to your friend, he gives you loan without security

Similar case is with the banks: Either they borrow from other banks (known as Interbank Call Money Market) but what if other bank don’t have money to lend? Then the bank can borrow from RBI on the basis of eligible securities. Hence RBI act as Bank of the last resort.

Announces the credit and monetary policy for the economy
  • The policy by which the desired level of money flow and its demand is regulated. 
  • Tools RBI use to regulate the desired/required kind of the credit and monetary policy- 

CRR,SLR (both discussed above), Bank rate, repo rate, reverse repo rate

Repo rate:-

  • Informal- bank need loan, they borrow from RBI.
  • Fundamental rate i.e. all other rates are related to it.
  • Rate of repurchase = Repo rate
  • Rate of interest the RBI charges from its clients on their short term borrowing.

Reverse repo rate:-

  • Informal - Bank has excess money they deposit it with RBI and earn interest. (NOTE:- NO INTEREST IS PAID ON CRR)
  • Always 1% less than Repo rate
  • Rate of interest the RBI pays to its clients who offer short term loan to it.

Bank rate :-

  • The rate of interest which the RBI charges its clients on their long-term borrowing.

Marginal Standing Facility (MSF)

MSF is a window for banks to borrow from RBI in emergency situations when inter-bank liquidity dries up completely. Banks borrow from the RBI by pledging government securities at a rate higher than the repo rate under Liquidity Adjustment Facility (LAF)

Liquidity Adjustment Facility (LAF)

LAF helps banks to adjust their daily liquidity mismatches. LAF has two components – repo and reverse repo.

Now suppose I am a relative of a senior employee of a bank so I could get a loan with very less interest rate as compared to other persons. How do you stop this? Comes Bank Rate

Bank rate

Replaced Benchmark Prime Lending Rate(BPLR). Introduced in 1972. Bank finance at a concessional rate of 4% pa to the weaker sections of the community for engaging in productive and gainful activities so that they could improve their economic condition.
  • Under BPLR, banks could lend under BPLR.
  • With effective from July 1,2010
  • Basically a floor rate below which bank cannot lend
Exceptions (i.e. conditions in which bank can lend below Bank rate-
  1. Loans to bank’s own employees including retired employees.
  2. Loan to bank’s depositors against their own deposits.
  3. Differential Rate of Interest (DRI Advances)

Nationalization of Banking

State Bank of India

  • Three Imperial Banks were merged by SBI Act, 1955 and were named State bank of India.
  • 8 more private bank were partially nationalized by SBI (Associates) Act, 1959 and named as Associates of SBI.
  • State bank of Bikaner and the State Bank of Jaipur merged and named State bank of Bikaner and Jaipur. Hence SBI group has 8 banks – SBI being one and seven of its Associates.
Through Banking Nationalization Act, 1969, government nationalized 20 private banks-
  • 14 banks having deposits more than Rs 50 crore nationalized in July 1969
  • 6 banks having deposits more than Rs 200 crore nationalized in April 1980
  • However loss making New Bank of India was merged with Punjab National Bank in September, 1993. Hence total number of nationalized bank is 19. technically speaking NATIONALIZED BANK=100% GOVERNMENT STAKE so there is only 1 nationalized bank i.e. Bhartiya Mahila Bank (BMB).
Question - Why the government went for the nationalization of the banks?
Answer - Banks were managed by private and hence had narrow reach. Banking before nationalization was CLASS BANKING NOT MASS BANKING only elites had bank accounts so government went for nationalization.

Regional Rural Banks (RRBs)

  • First set up on October 2, 1975
  • Aim – to provide banking services to the doorsteps of the rural masses who previously depended on private money lenders.

Priority Sector Lending(PSL):

Priority sector

Priority sectors refer to those sectors of the economy which may not get timely and adequate credit in the absence of this special dispensation. Typically, these are small value loans to farmers for agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low income groups and weaker sections.

Categories under priority sector

  1. Agriculture
  2. Micro and Small Enterprises
  3. Education
  4. Housing
  5. Export Credit
  6. Others
  • Indian banks have to lend 40% to priority sector .
  • Out of 40% or Sub-target – 18% to agriculture and 10% to weaker sections
  • Private banks have to lend 32% to priority sector
  • No sub-target

Non- performing assets (NPA)

A non-performing asset shall be a loan or an advance where:-

1. Interest and/or installment of principal remain overdue for a period of more than 90 days in respect of Term Loan.
2. The account remains ‘ out of order’ for a period of more than 90 days in respect of an overdraft/cash credit(OD/CC).
3. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

4. A loan granted for short duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for two crop seasons.

5. A loan granted for long duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for one crop season.

Types of NPA

1. Sub-standard Assets - An asset is classified as sub-standard if it remained NPA for a period less than or equal to 12 month.

2. Doubtful Assets - An asset is required to be classified as doubtful, if it has remained NPA for more than 12 months.

3. Loss Assets – A loss asset is one where loss has been identified by the bank or internal or external auditors or by the co-operation department or by RBI, but the amount has not been written off wholly or partly. In other words such an asset is considered un-collectible and of such little value that its continuance as an bankable asset is not warranted although there may be some salvage or recovery value.

Consider a scenario:-

I took a loan from the bank but I didn't repaid it back. When bank asked me to repay the loan I filed a frivolous case against the bank, the case went for years and years. In this situation banks were at lose so to remove this situation in 1993 Government of India came with Debt Recovery Tribunals (DRTs) , it went well for some time but in years DRTs were clogged up with many cases.

Main Problem with DRTs – sale of property could be done by bank only by courts order

Hence DRTs failed to bring the desired changes so government of India came up with SARFAESI Act, 2002 (Secularization and Reconstruction of Financial Assets and Enforcement of Security Interest Act ,2002).This act gave powers to the banks concerning NPAs.

Under SARFAESI banks can now take possession of security or take over the management of the borrowing concern.

If bank evoked SARFAESI Act = defaulter cannot go to court

This article is written by Yogesh Tiwari and it's a part of March article writing contest.

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Ramandeep Singh, your guide to banking and insurance exams. With 14 years of experience and 5000+ selections, Ramandeep understands the path to success, having transitioned himself from Dena Bank and SBI. He's passionate about helping you achieve your banking and insurance dreams.

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