A textbook of Banking and Finance

TEXT BOOK OF

BANKING AND FINANCE

TEXT BOOK OF

BANKING AND FINANCE

DR. N.K. SHARMA

SUNRISE

PUBLISHERS & DISTRIBUTORS

E-566. Vaishali Nagar. Jaipur - 302021 (Raj.)

Published by :

SUNRISE PUBLISHERS & DISTRIBUTORS

E-566, Vaishali Nagar,

Jaipur - 302021 (Raj.)

Ph.:9413156675,9772299149

Email: [email protected]

First Published - 2009

©Reserved

ISBN: 978-93-80207-00-1

All rights reserved. No part of this book may be reproduced in any

form or by any mean without permission in writing from the publisher.

Printed at : Jaipur

PREFACE

The study of money and banking is very mush useful in modern

business and commerce because modern trade, commerce and

industry's problems have become so complex that decision maker's

personal experience is no danger adequate to provide an appropriate

solution. It has, therefore, becomes essential for persons associated

with decision making to process at least a working knowl~dge of

the relevant tools of analysis. The purpose of this book is to provide

in one volume, the various money and banking which are deemed

to constitute the subject matter of this book. This book is intended to

explain in non-technical language, the money and banking concepts,

tools of analysis, their relevance in business decision making and

also the influences of banking environment on business and

commerce decisions. The scope of money and banking is still in a

state of flux and it may remain so in a computer based dynamic

economy with modern outlook of management.

It gives me great pleasure to place this book before the students,

learned teachers, professionals and business executives. This book

has been designed especially for the students of B.Com., B.A., BBA,

M.Com., M.A., MBA, etc., of various Indian Universities.

I shall be thankful to the readers and teachers for pointing out

discrepancies and errors in the text, which I hope to rectify further

improvement of this book, will be highly appreciated.

Author

CONTENTS

1. Introduction 1

2. Banking Regulation Act - 1949 17

3. Banker-Customer Relationship 35

4. Requisites of a Cheque 61

5. Promissory Notes 72

6. Endorsements and Crossings 83

7. Reserve Bank of India and Its Role 104

8. E-Banking and Innovative Banking 113

9. Regional Rural Banks 137

10. Credit Creition by Commercial Banks 147

11. Credit to Priority and Neglected Sectors 167

12. Other Borrowers in Priority Sector 179

13. Guarantee of Loans for Small-Scale Industries 195

14. Credit Guarantee for Service Co-Operatives 209

15. Commercial Banking in India 222

16. Nationalised Commercial Banks 237

17. Regional Rural Banks 263

18. Role of Development Banking

19. Development Banking in India an Assessment

20. Importance of Money

21. Circular Flow of Money

22. Value of Money

23. Kinds of Money

24. Failure of Monetarism

25. Theory of Money

26. India's Development Finance

27. State Finances

28. Local Governments Finance in India

29. Public Enterprises in India

30. Co-operative Banks

275

294

304

315

329

347

368

383

405

419

438

444

462

CHAPTER

INTRODUCTION

The British East India Company established "The Hindustan

Bank" in Kolkata and Mumbai in 1770 and later in 1785 established

other banks. In early nineteenth century three Presidency Banks,

i.e., Bank of Bengal, Bank of Bombay and Bank of Madras were

established. The first important event in the history of banking in

India took place in 1919 when the Presidency Banks were

amalgamated and Imperial Bank of India was set up. Banking

Companies (Inspection Ordinance) was passed in January 1946,

and in February 1946, Banking Companies (Restriction of Branches)

Act was passed. In 1949, the Banking Companies Act was passed

which was later amended to read as Banking Regulation Act.

On 19 July, 1969 an ordinance was issued by the central

government acquiring ownership and control of 14 major banks in

our country. This was done to bring commercial banks into the

mainstream of economic development with definite social

obligations and objectives. Two major aspects of nationalization

were: (1) rapid branch expansion and (2) channelling of credit

according to plan priorities. Later, on 5 April 1980, six more

commercial banks were nationalised. After the submission of

recommendations of the Committee headed by Chairman Shri M.

Narasimham, a comprehensive reform of the banking system was

2 Introduction

introduced in 1992-93. The main aim of the reform measures was-to

ensure that the balance sheets of banks must reflect their actual

financial health.

In 1993 new private sector banks were allowed to be set up in

the Indian Banking System to increase productivity and efficiency

of our banking system. A committee headed by Shri M. Narasimham,

to examine the record of implementation of financial system reforms

recommended by the CFS in 1991 was constituted in December

1997. In 2001 the revised guidelines for entry of new banks in private

sector were issued. Subsequently, for the conversion of Non Banking

Financial Corporations into Scheduled Banks, guidelines were also

issued.

Role of Banking Sector:

According to Prof. M.s. Chhikara, "Banking sector, managing

the demand and supply functions of money, plays an important

role fo~ promoting a healthy, balanced and sustainable development

of a country. It is considered as the most important segment

responsible for accelerating as well as slowing down the national

and global economies. Movements in this sector have almost one￾to-one relationship with the growth of an economy. A strong

financial and banking sector gives the necessary support to the

economic system to fundion effectively and vice versa, so, a sound,

systematic and dynamic banking system occupies a pivotal position

in the economy "world over and supports them to emerge as business

leaders."

With the intensification of the pace of the ongoing economic

and financial sector reforms for more liberalization and

globalization of the Indian economy, the Indian banking industry

is undergoing a paradigm change in scope, content, structure,

functions and governance. The information and communication

technology revolution is radically and perceptibly changing the

operational environment of the Banks, in our country.

Banks offer following services to their account holders at their

specified branches:

• Multi-city / payable at par (PAP) cheque facility.

Introduction 3

• Any where banking facility and internet banking facility.

• Credit card, debit/ ATM card, mobile banking and Real￾Time Gross Settlement (RTGS).

• Gradually, foreign banks are expanding the number of

production offer, their complexity such as derivatives,

leverage financing, etc.

• Doorstep banking facilities are being offered by some of

these banks to cater to convenience lifestyle of its customers.

• Private banks are extending services including wealth

management and equity trading apart from credit cards.

Emerging Trends:

The traditional distinctions between banking and other

financial services like insurance on one side and between

commercial banking, developmental banking and investment

banking are getting blurred. The emergence of universal banking

and bank assurance are clearly pointers. This global convergence

of financial services may gather further momentum in the years to

come.

The banking and insurance sector reforms have encouraged

private sector players to make forays into the business in

collaboration with major international companies. This new

scenario will witness financially sound and experienced players

transforming the industry with best practices in product

development, operational efficiency, marketing capability, service

focus, and tech-savvy orientation. Thus, there is a need for intensive,

futuristic and career-oriented programs in these two areas: Banking

and Insurance. These developments in Banking and Insurance

industry call for competent and professionally trained managers.

As observed Dr. A.B.C. Raj, Chancellor, the ICFAI University, in one

of his recent messages.

Increasing competition, thinner spreads and introduction of

new technology driven products are some of the trends that the

Indian banking system is experiencing. "Recent trends in Indian

banking have reflected the efforts of the major players to adapt to a

rapidly liberalizing and globalising environment. While the impact

4 Introduction

of these changes is possibly a subject of debate, there is one group

which is not complaining - the customers, the beneficiaries of the

process of liberalization", observed Amitabh Guha, State Bank of

Travancore.

Further, the technology oriented banking has become one of the

latest mantras of success in the market, especially to win over the

customers. To this, says SBI Chairman AK Purwar, "Indian banks

need to fuel the market by bringing new products at par with the

international standards, extending ATM facility to rural areas and

vibrant networking countrywide to compete with the new generation

and the MNC banks in India".

As T.5. Anantharaman, Financial Analyst, mentioned, "The

savings and investments scenario in our country has undergone

total change in the past decade, since the country embarked on a

course of liberalization and globalization of its economy. With the

increasing sophistication of our economy, the variety and type of

investments options available to us today have multiplied. Also,

with the economy getting mOle and more integrated with the world

economy, rapid changes in the options, instruments, rate of return

etc. have become the order of the day." Such a change is visible in

respect of shares, mutual funds, fixed income, bank deposits, life

insurance, pension plans etc. Since change and innovation is

involved in this process, one can legitimately expect an exciting

and lucrative career scenario in the banking, finance and insurance

sector.

Electronic Banking:

Now with the advanced technologies setting trends in the

banking sector, most banks are increasingly opting for the mode of

Electronic Banking, the reason being that the technology enables

the bank to be easily accessible to a large number of consumers and

that too at a very low cost. Further, Electronic Banking or Banking

facilitates the banking operations much faster than the traditional

method.

"To most people, electronic banking means 24 hour access to

cash through an Automated Teller Machine (ATM) or pay cheques

deposited directly into savings accounts. Electronic Banking, also

Introduction 5

known as Electronic Fund Transfer (EFT), uses computer and

electronic technology as a substitute for cheques and other paper

transactions. Many financial institutions use an Automated Teller

Machine (ATM) card and a personal identitication number (PIN)

for this purpose.

On online banking advantages, he further pointed out, "In

general, you will find lower fees and higher interest rates for deposits

due to the reduced cost of operating online and no need for

. numerous physical bank branches. You will have easy access to

account information and transactions, due to the fact that any

internet enabled computer can become your bank terminal. You

will generally have up to the minute current bank account

information due to the automation of most systems. In many cases,

online banks offer free bill pay, which can he a big saving in both

money and time. You can transfer funds electronically between

.accounts. Since online banks are marketing for new customers, there

are many special offers available. Some US banks offer initial

amount of say $20 to open your first account with them and some

offer free overdraft protection on their interest checking accounts

with a minimum balance."

Moreover, in improvement in the quality of services, the

development and use of communication networks have also helped

the banking industry to a larger extent. The design, management

and regulation of electronically based payments system are

becoming focus of policy deliberations.

According to Chairman and MD, Dr. K. Ramakrishna, "When

you speak of inclusive growth, the human force of banking is

essential. In the last 10 to 15 years, technology has become a big

component. A human force is always needed. While that is so,

convenience is essential too. With 24 hours banking and all other

delivery channels such as ATM's and concepts such as e-banking,

things have become very easy. Bu t even in the long run, I can't see

the importance ofbrick-n-mortar and human interaction changing

in India.

For example, WI: see the very human and personal aspect of

credit counselling coming to our country in a big way. Moral and

6 Introduction

emotional support is an often unseen but important aspect of

banking. People in banking do have to have great personal values.

That does not come to light in a big way, as bankers don't showcase

all tha t and generally talk numbers. Bu t then, values are the core of

this profession. Ethical banking is the core.

In our country after a slow start, there has been an explosive

growth in mobile phones with its number reaching 80 million now,

growing at the rate of more than three million per month. The mobile

handset has emerged as an inevitable accessory not only for

communications, but for entertainment, doing online transactions

which include banking as well.

Driven by competition and transaction cost control, banks have

been effectively embracing the mobile technology to add value to

their customers. To attract new business and sustain customer

loyalty, bank should be able to reach them through convenient

delivery channels. The Internet banking was one of the true

anywhere, anytime channels introduced by most of the banks.

However, it needs a web connection to access the website of the

bank and do transaction. As against this, mobile banking was found

much more easy and convenient to use by the customers. Current

estimates show that about 5 million customers using mobile banking

in India.

Banking Industry (Vision 2020) :

Consequent to nationalization in 1969 and economic

liberalization in 1991, banks in India are on fast track growth in

size, technology and deliverables to customers.

Every aspect of banking will be transformed by new. technology

by 2020. Customer friendly products, delivery channels, relationship

banking, dependency on IT systems and competitive pricing would

be the driving forces, but a pressure cooker atmosphere cannot be

avoided. The most successful institutions will be those that combine

visionary technology and very competitive pricing with strong

relationships and brands built on trust with previous in-depth

experience of the client business. Ranks would have adopted the

following strategies to move to hi-tech banking as a necessity of e￾commerce, e-banking etc. :