Introduction to Banking

1. Introduction to Banking MishuTripathi

2. History of Banking in India-Phase I • Three presidency banks were established in Calcutta (1806) in Bombay (1840) and in Madras (1843) • In the early part of 20th century, on account of the Swadeshi movement a number of joint stock banks were established by Indians like Bank of India, Bank of Baroda and Central Bank of India. • In 1921 the three presidency banks were merged and the Imperial Bank of India was created

3. During the period 1900 to 1925 many banks failed, and hence a Central Banking Enquiry Committee formed in 1929 to trace the reasons for the failure of such banks. • The Reserve Bank of India Act was passed in 1934 and the RBI came into existence in 1935 and RBI was nationalised in 1949 • The Banking Regulation Act,1949 gave wide powers to RBI to act as the regulator for banks in India

4. Phase II • In 1955 State Bank of India became the successor to the Imperial Bank of India ,under the State Bank of India Act,1955. • In 1959 State Bank of India (Subsidiary Banks) Act was passed to enable SBI to take over State Associated banks as SBI’s subsidiaries

5. In 1969 the Government of India nationalised 14 major commercial banks having deposits of Rs.50 crore or more • In 1975 Regional Rural Banks were established under RRB Act 1976, which was preceded by RRB Ordinance in 1975 • In 1980 six more commercial banks were nationalised, with a deposit of Rs.200 crore or more

6. Banking Progress in India-Phase III • In the liberalised, privatised and globalised environment, banks operating in India have diversified their banking activities by offering Banking facilities like: • Merchant banking • ATMs/Credit Cards/Internet banking/Mobile Banking • Factoring • Third Party Services *Time is more important than money

7. What is Banking and its functions???

8. Definition of a Bank • The banking is defined as “accepting for the purpose of lending or investment, of deposit of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft and order or otherwise”

9. Features of the Bank • Accepting money/deposits from the public • Lending or investing the money so collected. If the purpose of accepting of deposit is not to lend or invest, the business is not called banking business. The money so accepted is repayable on demand. The money so deposited can be withdrawn by the approved modes as specified by bank.

10. Accepting deposits Accepting deposits is the prime function of a commercial bank. They generally accept 3 types of deposits • Current Deposits • Savings Deposits • Term Deposits

11. Current Deposits/Current Account • Current Deposits/Current Account is also known as demand deposit as any amount can be withdrawn at any time by drawing a cheque or giving the chequefavouring the payee. • No interest is allowed on these.

12. In fact bank charges incidental charges depending on the volume of transactions, which was earlier, calculated on the basis of number of folios used.  • If the depositor keeps huge balance in the account, the bank is ready to waive the charges, as it is costless deposit for the bank. • The bank also charges cheque book issuing charges on per leaf basis.

13. Who can open Current Account • Individuals of sound mind and who have attained majority. • Two or more individuals in their joint names. • Proprietary Concerns (Sole Proprietorships) • Partnerships Firms • Hindu Undivided Families • Companies

14. 7. Clubs, Societies, Associations, Committees, Schools etc 8. Trusts 9. Executors 10. Administrators 11. Government and Semi-Government Bodies, Local Authorities etc. • Based on the current account variant you choose, you will be eligible for a host of services at free/concessional rates.  • Companies, firms and other business entities primarily use this account.

15. KNOW YOUR CUSTOMER- KYC • Know your customer norms are applicable to all customer accounts. It deals with not only to identify the customer but also to understand the activities of the customer, to ensure that the operations in the customer account/s is/are for genuine purpose

16. KYC RULES The main rules are – • Customer identification • Ceiling and monitoring of cash transactions • Internal Control Systems • Prevention of Terrorism Finance • Identification and Reporting of Suspicious Transactions • Adherence to Foreign Contribution Regulation Act (FCRA), 1976 • Record Keeping • Training of staff and management

17. Savings deposits/Savings Bank Account • This account is designed to promote savings among the households. • This is mainly for non-commercial transactions. • Companies, firms and other business entities are prohibited to open such accounts.

18. Who can open Savings Account • An individual in his/her own name • Individuals in their joint names with suitable repayment instructions • Minor represented by parent/guardian • Minor students above 10 years • Clubs, Societies, Associations, Trusts, Executors, Educational Institutions, Administrators, HUF, etc.

19. Documentation Required • One passport size photograph • Identity Proof • Address Proof • PAN number or form 60/61 is a must for opening the account.

20. Savings Account • The depositor earns interest, which at present is 4%, and the rate of interest is governed by RBI directive and is same in all the banks. • Earlier interest is paid on the minimum balance in the account from 10th of the month to last day of the month. • From 1st of April 2010 the interest is paid based on daily balance in the account. • There are restrictions on number of withdrawals in a year. • Banks issue certain cheque leaves free: 60 cheque leaves free in a year and Rs 5 per cheque leaf beyond that. 

21. There is a restriction for maintaining minimum balance in the account, which is fixed at the discretion of the bank. • Quarterly Average Balance - Rs 250/- at Rural Branches and Rs 500/- at semi urban Branches and Rs 1,000 in Metro and urban branches. • Non-maintenance of QAB attracts a service charge of Rs 75/- per quarter.

22. The balance can be withdrawn by issuing cheques or one can have ATM/Debit Card. • Depositor can give standing instructions to transfer funds from the account to his other accounts like recurring deposit every month for which the charges have to be paid. •  Banks have the system of transferring any sum above the stipulated amount to a term deposit of the desired period to enable the depositor to avail of higher rate of interest.

23. Term deposit • While opening the term deposit one has to state the period for which the deposit is required and the rate of interest on deposit is dependent on period of deposit. • At present the deposit rate varies from 8.25-9.10% • The minimum period at present is 7 days and maximum is 10 years. • The bank prescribes the rules for premature withdrawals and charges penalty for premature withdrawal.

24. If the depositor wants funds for short term, temporarily or the maturity of deposit is just near, he can opt for a loan against the security of such deposit. • The quantum of loan can be 90% of deposit inclusive of interest. • While the depositor continues to earn interest on his deposits, he has to pay interest on the loan raised, which is higher than the rate of deposit.

25. Different schemes of term deposits • Monthly interest scheme. • Half yearly interest scheme. • Reinvestment plan wherein the interest earned on deposit at the end of each quarter /half year is deemed to be invested and the depositor earns interest on principal and interest.

26. Recurring deposit • It is classified as term deposit and the depositor opts for depositing a fixed amount every month for a stated number of months. The rate of interest is same as in the case of fixed deposit. • At the request of depositor the bank will debit the customers operative account for the credit of recurring deposit every month. • The depositor can withdraw the balance prematurely or can raise a loan at the security of recurring deposit.

27. Tax deduction at source on interest (TDS) • Banks are statutorily required to deduct income tax (@ 10%+ 3 % education cess on tax so calculated) if the interest paid or accrued in all the deposits of a particular depositor exceeds Rs 10000/ in a financial year. • If the depositor does not furnish his PAN, in that case the bank will deduct TDS at 20% + 3% education cess on tax deducted. • There is no TDS on Savings Bank Account. •  Banks will not deduct TDS in case the depositor gives a declaration in Form 15 G (15 H for senior citizens) in duplicate stating that the tax on estimated income of the recipient for the financial year will be NIL. 

28. Introduction for opening a bank account • For opening an account particularly operating account in a bank, bank requires the customers to bring introduction from a customer known to the bank. •  Banks incur great risk if they open an account without proper introduction. • Nomination is also encouraged.

29. Advancing of Loans • The second most primary function of a commercial bank is to ‘Lend’. • In fact lending and accepting deposit are bread and butter of a commercial banks.

30. Loans are given for • Consumption • Trade and Commerce • Agriculture • Small Scale Industries (SSIs) • Industrial Loans • Export or Imports • Vehicle • Housing and • you name and bank will tailor make the scheme to suit the class of borrowers

31. Loans may be fund based or non-fund based (wherein bank guarantee or LC is issued) • Loan may be fixed duration- term loans In this case a fixed amount is given. • These loans are given to acquire some assets like, machinery, land and buildings, car, house etc. • This is repayable in equated monthly/quarterly/yearly installments along with monthly interest • The assets purchased out of bank finance are taken as security. 

32. Loans may be in the form of running account - cash credit or overdraft. • “Working capital needs” means funds required to meet day to day working of the borrower like buying raw materials, day – to- day expenses, wages and salaries etc.   • Therefore to meet the needs of working capital (day to day requirement) amount given by a bank is in the form of running account. •  The bank fixes the limit of the borrower.The borrower can withdraw the amount as per his requirements mainly for purchasing of goods, payment of expenses and sale proceeds is deposited by him. • The bank charges interest on the balance drawn by the borrower and not on the limit fixed.This way the borrower will be paying interest forthe amount withdrawn and for the period it iswithdrawn.

33. Bills Discounting/Cheque Discounting • A trader receives bill of exchange or cheque in settlement of his claim from the debtor.  • The banker discounts or purchases the bills or cheques of their customers and provide him with funds which can be used by the borrower for meeting his working capital requirements.

34. Bills Discounting/Cheque Discounting • Example: • ‘A’ a trader has sold goods to a trader ‘B’ at Delhi for Rs 1 lac. •  B’ has given a cheque to ‘A’ for Rs 1 lac for settlement of his dues. The cheque is drawn at Delhi. •  If ‘A’ deposits the same in his account it will take about 10 to 15 days for the cheque to be cleared as the cheque will be treated as outstation. •  If ‘A’ is in urgent need of funds he can request his banker to purchase the cheque. •  The bank depending on the nature of dealing of ‘A’ will purchase the cheque and after deducting bank’s charges known as discount charges, give credit to ‘A’. •  Bank will send the cheque to Delhi for collection and after it is realized, clears its entry. •  If the cheque is returned, bank will recover from ‘A’. • This way the trader gets credit against their outstandings.

35. Loans given by the banks are classified as secured, unsecured or partly secured.  • If the banks have not taken any security then it is called unsecured (clean loan). Examples of unsecured loans are: • Agriculture loans • Educational loans etc

36. In the case of unsecuredloans the banker relies on the credit worthiness of the borrower and take one or more guarantor to ensure safety of the advance. • Secured loans are those loans against which the banker holds some security.  • Partly secured loans are those where the value of security does not fully cover the amount of loan taken

37. Bankers generally do not finance the full amount of the asset to be purchased but asks the borrower to bring a margin which varies from 10 to 15% depending on the type of security and the credit worthiness of the borrower. • The purpose of taking margin is to cover the fall in the value of security and also the increase in the amount of outstanding of the borrower on account of interest, if the borrower does not pay any amount.

38. Some Examples of Secured Loans

39. Bank Guarantee • In the case of Bank Guarantee the bank undertakes to pay the stated amount to the beneficiary of bank guarantee in case of default in meeting the obligation. • Example: Suppose ‘A’ wants to get a machine manufactured from ‘B’ for Rs 10 lac. • They are not regularly dealing with each other as machines are not bought everyday. The machine is suitable only for ‘A’ and may not be of any use to any body else. • If ‘B’ asks ‘A’ to pay the cost of machine of Rs 10 lac before ‘B’ starts manufacturing the machine. • ‘A’ may not give because of fear if ‘B’ does not manufacture or delay he will lose the money and have to litigate the matter for recovery.

40. On the other hand if ‘B’ starts manufacturing and later on ‘A does not take delivery and does not pay, ‘B’ will suffer a great loss. • To mitigate the hardship ‘B’ asks ‘A’ to arrange for a bank guarantee in his favour for Rs 10 lacs. • In the Bank guarantee the bank will undertake to make payment to ‘B’ if he delivers the machine to ‘A’ • In Bank Guarantee document, the conditions and date of delivery etc will be clearly written.  • Bank will charge its commission for issuing bank guarantee. • Bank is not parting with the funds when they issue bank guarantee. • But bank has to part with the funds if ‘A’ does not pay when the machine is delivered.   • Banks issue Bank guarantee to their credit worthy borrowers and after taking suitable security. 

41. Letter of Credit (L/C) • M/s ABC Ltd. an exporter of shirts to USA receives and order from M/s XYZ from USA. •  In the normal course they have two options: • One is to ask M/s XYZ to send the money in advance so that the shirt may be sent. • This may not be accepted by the importer i.e. M/s XYZ as if M/s ABC does not send the shirts, they will suffer. There is risk on the part of importer. • Second option is to send the shirts and wait for the payment. • The importer M/s XYZ may delay or not send the payment or may even reject the goods leading to litigation in USA. • The risk is on the part of exporter. 

42. To mitigate the problem the exporter will request the importer to send a letter of credit from a reputed bank who will guarantee payment if the export is made and all the conditions governing the export is complied with. • This way the bank is undertaking to make payment.Bank is substituting the credit of borrower with his own credit. • This way neither the exporter will suffer due to lack of clarity on the credit worthiness of the importer nor the importer will suffer as the payment will be made only after the export has been done and all the conditions are complied with. • This is called non-fund based facility.

43. Principles of Lending

44. “Lending is an art not a science.” • This maxim indicates that there are no set rules or formulae to appraise loan applications providing cent percent results. •  Appraisal, by whatever methods, can never be an exact or automatic process. •  It will always remain more of an art than a science and it is through experience that a person becomes proficient in the art of lending.

45. Factors in Lending Systematic study of various factors shall help a banker in working out the feasibility of the project and evaluating credit worthiness of the borrower although the risk can never be fully eliminated in lending.

46. 5Ms • Man • Material • Market • Machine and • Money Under these five heads we shall examine various other aspects related to them.

47. Man The foremost and the most important aspect of appraisal is the man behind the scene i.e., the management. • The Character • Competence and • Capital

48. Character: Will he repay the loan? • In banking parlance, character is usually associated with the record of past payments of the party with the banker other creditors. • If past financial record is not good, it is better to drop the proposal even if good security is available. • A banker can bear with borrower who is not able to pay because of circumstances beyond his control but he cannot do with a borrower who is not willing to pay.

49. In the absence of past record one has to see other traits of a borrower like frankness, reasonableness, patience, attitude towards risk and other entrepreneurial qualities. • An experienced banker can draw conclusions during the course of an interview.

50. Competence: Can he repay the loan?1. Managerial Competence • It is a decisive factor influencing the failure or success of an enterprise. • Fluctuating availability of supplies, changing technology, rising prices, shifting tastes and stiff competition enlarge the role of management decision in success.