Banking and non banking institutions

Banking institutions
The banking sector is the lifeline of any modern economy. It is one of the important financial
pillars of the financial system which plays a vital role in the success/failure of an economy.
Banks are one of the oldest financial intermediaries in the financial system. They play an
important role in the mobilisation of deposits and disbursement of credit to various sectors of
the economy. The banking system is the fuel injection system which spurs economic
efficiency by mobilising savings and allocating them to high return investment. Research
confirms that countries with a well- developed banking system grow faster than those with a
weaker one. The banking system reflects the economic health of the country. The strength of
economy of any country basically hinges on the strength and efficiency of the financial
system, efficiently deploys mobilised savings in productive sectors and a solvent banking
system ensures that the bank is capable of meeting its obligation to the depositors. The
banking sector is dominant in India as it accounts for more than half the assets of the
financial sector.
Section 5(1) (b) of the Banking Regulation Act defines banking as the accepting, for the
purpose of lending or investment, of deposits of money from the public, repayable on demand
or otherwise and withdrawable by cheque, draft, order or otherwise. Section 5(I) (c) defines
banking company as any company which transacts the business of banking in India.
However , the acceptance of deposits by companies for the purpose of financing their own
business is not regarded as banking within the meaning of the act. The essential
characteristics of the banking business as defined in Section 5(b) of the Banking Regulation
Act are as follows.
Acceptance of deposits from the public
For the purpose of lending or investment
Repayable on demand or otherwise
Withdrawable by means of any instrument whether a cheque or otherwise
From the definition, two important functions of commercial banks emerge: acceptance of
deposits and lending of funds. For centuries, banks have burrowed and lent money to
business, trade, and people, charging interest on loans and paying interest on deposits. These
two functions are the core activities of banking.

FUNCTIONS OF BANK
Deposits
Deposits are the main source of funds for commercial banks. The amount mobilised as
deposits is then lent in the form of advances. The higher the amount of deposits mobilised,

the higher is the amount of funds lent. The growth of deposits on savings. Savings held in the
form of currency or gold and jewellery are unproductive. For economic growth to take place,
it is essential that these savings are mobilised and channelized for capital formation which, in
turn, accelerates economic growth. Banks are important financial intermediaries between
savers and borrowers. Banks mobilise savings by accepting deposits. Deposits may be
categorised into (i) demand deposits and (ii) time deposits.
Demand deposits are deposits which can be withdrawn without notice and can be repaid on
demand. Current accounts and savings accounts are classified as demand deposits.
Time deposits are deposits which are repayable after a fixed date or after a period of notice.
Fixed deposits, recurring/cumulative deposits, miscellaneous deposits, and cash certificates
are classified as time deposits.
A significant proportion of funds is contributed by deposits which account for more than 80
percent liabilities of scheduled commercial banks(SCBs)
Credit creation
Bank are a special type of financial intermediaries which not only accept and deploy large
amounts of uncollateralised deposits in a fiduciary capacity, but also leverage such finds
through credit creation. Banks are creators of credit. The creation of credit is an important
function of a bank and this function distinguishes banks from the non-banking institutions.
Banks create deposits in the process of their lending operation. When banks mobilise savings,
it lends the amount that remains after providing for reserves. The amount lent is either
deposited in the same bank or in some other bank. For instance, when a banks extends
overdraft facility or discounts a bill of exchange, the banks first of all credits this amount in
the account of the customer, who creates a deposits. The bank, after keeping aside a certain
portion of this deposits in the form of reserves, lends this amount. This process continues and
repeats in all the banks or in the banking system as a whole. This leads to the creation of
credit, which in turn, increases the liabilities and assets in the banking system.
For instance, a bank receives Rs. 1,000 in the form of deposits. The bank after keeping aside,
say, 10 percent in the from of reserves, lends the remaining amount, i.e., Rs. 900. The amount
lent is either deposited in the same bank or in some other bank. The bank again, after keeping
aside reserves of 10 per cent, lends the remaining amount, i.e., Rs 810. This process continues
and repeats in all banks simultaneously leading to creation of credit. Credit creation leads to
an increase in the total amount of money for circulation.
Lending of funds
Commercial banks mobilise savings from the surplus- spending sector and lend these funds to
the deficit-spending sector. They facilitate not only flow of funds but also flow of goods and
services from producers to consumers through this function of lending. Commercial banks
facilitate the financial activities of not only the private sector but also of the government.
Funds are lent in the form of cash credit, overdraft, and loan system. Banks discount bill of

exchange, give venture capital, and guarantees. Loans and advances form around 50 per cent
of the aggregate deposits of SCBs.
Ancillary functions
Besides the primary function of mobilising deposits and lending funds, banks provide a range
of ancillary services, including transfer of funds, collection, foreign exchange, safe deposit
locker, gift cheques, and merchant banking, thus banks provide a wide variety of banking and
ancillary services.
Banks are distinct entities as they have fiduciary responsibility, are highly leveraged and the
future of any one bank can threaten the integrity of the payments system which is the
backbone of any modern economy.
DEVELOPMENT OF BANKING IN INDIA
The history of banking dates back to thirteenth century when the first bill of exchange was
used as money in medieval trade.
Banking has its origin in Vedic times, i.e., 2000 to 1400 BC. Indigenous bankers and money
lenders have played a vital role for centuries. Modern banking in India emerged between the
eighteenth and the beginning of the nineteenth centuries when European agency houses
erected a structure of European controlled banks with limited liability. In 1683, the first bank
was set up in Madras by the officers of East India Company. The first joint stock bank was
Bank of Bombay , established in 1720 in Bombay, followed by Bank of Hindustan in
Calcutta, which was established in 1770 by an agency house. The principal of limited
liability, which was first applied to joint stock companies in 1860, was a landmark in Indian
banking.
Schedule commercial banks
Schedule commercial banks are those included in the second schedule of the Reserve Bank of
India Act, 1934. In terms of ownership and function, commercial banks can be classified into
four categories: public sector banks, foreign banks in India, and regional rural banks.
Public sector banks
Public sectors banks are banks in which the government has a major holding. These can be
classified into two groups: (i) the State Bank of India and its associates and (ii) nationalised
banks.
State Bank of India.
The State Bank of India was initially known as the Imperial Bank. Imperial Bank was formed
in 1921 by the amalgamation of three presidency banks- the Bank of Bengal, the Bank of
Bombay, and the Bank of Madras. These presidency banks were created as a charter to deal in
bills of exchange payable in India and were an integral part of the Indian treasury.

The State Bank of India has five subsidiaries:

The State Bank of Bikaner and Jaipur
The State Bank of Hyderabad
The State Bank of Mysore
The State Bank of Patiala
The State Bank of Travancore
SBI has three foreign subsidiaries: SBI International (Mauritius) Limited, SBI (California),
SBI (Canada), and INMB Bank Ltd. (Lagos). SBI is also planning to substantially increase its
international operations by entering into Bangladesh, Middle East, Israel, Moscow markets.
Nationalised Banks
The nationalised banks are a dominant segment in commercial banking. The bulk of the
banking business in the country is in the public sector. Public sector banks have expanded
their branch network and catered to the socio-economic needs of a large mass of the
population, especially the weaker section and in the rural areas. Public sector banks dominate
with 75 per cent of deposits and 71 per cent of advances in the industry.
Private Sector Banks.
New private sector Banks to withstand the competition from public sector banks came up
with innovative products and superior service. They withstand new markets such as retailing ,
capital markets, bancassurance and tie-ups with automobile dealers for vehicle finance. They
accessed low-cost NRI funds and managed the associated forex risk for them.
New private sector Banks
Axis Bank Ltd
Developmental Credit Bank Ltd
HDFC Bank Ltd
ICICI Bank Ltd
IndusInd Bank Ltd
Kotak Mahindra Ltd
Yes Bank Ltd

Foreign Bank in India

The foreign bank in India has benefitted the financial system by enhancing competition,
transfer of technology and specialised skills resulting in higher efficiency and greater
customer satisfaction. They have also enabled large Indian companies to access foreign
currency resources from their overseas branches in times of foreign currency constraint.
They are active players in the money market and foreign exchange market which has
contributed to enhancing the liquidity and deepening of these markets in terms of both
volumes and products.
Characteristics of foreign Bank in India
Enhanced competition
State of art technology
Strong retail presence
Active player in money market and foreign exchange market
Some Foreign Banks in India
ABN-Amro Bank
American express Banking Corp
Bank International Indonesia
Bank of America
Bank of Bahrain and Kuwait
BNP Paribas
Calyon Bank
City Bank NA
HSBC Ltd
JP Morgan Chase Bank
Standard Chartered Bank
State Bank of Mauritius Ltd
UBS AG
Standard Chartered Bank is the undisputed leader among the foreign banks with assets of
over Rs 30,000 crore followed by City bank which is a distant second.

Many foreign banks such as the common wealth Bank of Australia , the Royal Bank of
Scotland, and UBS are planning to start their operation in India.

Non banking Financial companies

Non banking financial companies(NBFCs) constitute and important segment of the financial
system. NBFCs are financial intermediaries engaged primarily in the business of accepting
deposits and delivering credit. They play an important role in channelizing the scarce
financial resources to capital formation. NBFCs supplement the role of the banking sector in
meeting the increasing financial needs of the corporate sector, delivering credit to the
unorganised sector and to small local burrowers. But they differ from banks in many ways.
An NBFCs can accept deposit but not demand deposits and hence, they cannot raise low cost
funds through savings or current accounts. Moreover, it is not a part of the payment and
settlement system, cannot issue cheques drawn on itself and cannot burrow from the RBI.
NBFCs have a more flexible structure than banks. As compared to banks, they can take quick
decisions, assume greater risks, and tailor-make services and charges according to the needs
of the clients. Their flexible structure helps in broadening the market by providing the saver
and investor a bundle of services on a competitive basis.
NBFCs provide a range of services such as hire purchase finance, equipment lease finance,
loans, and investments. Due to the rapid growth of NBFCs and a wide variety of services
provided by them, there has been a gradual blurring of distinction of banks and NBFCs
except that commercial banks have the exclusive privilege in the issuance of cheques.

Types of NBFCs
NBFCs can be classified in different segments depending on the type of activities they
undertake.
1. Asset Finance Company (AFC)
2. Investment Company (IC)
3. Loan Company (LC)
Types of Non-Banking Financial Entities (Regulated by the RBI)
1. Non-Banking financial Company
a) Equipment leasing company (EL)
b) Hire purchase finance company (HP)
c) Investment company (IC)
This are now known as Asset finance company (AFC)
Principal business

Principal business is that of receiving deposits or that of a financial institution, such as

lending, investment in securities, hire purchase or equipment leasing.
d) Loan company (LC)
Principal business
Providing finance by making loans or advances, or otherwise for any activity other than its
own; Excludes EL/HP/Housing finance companies(HFCs).
e) Residuary Non-Banking Company (RNBC)
Principal business
Company which receives deposits under any scheme or arrangements, by whatever name
called, in one lump-sum or in instalments by way of contributions or subscriptions or by sale
of units or certificates or other instruments, or in any manner.
The RNBCs are the only class of NBFCs for which the floor rate of interest for deposits is
specified by the RBI while there is no upper limit prescribed for them.
II. Mutual Benefit Financial Companies (MBFC) i.e., Nidhi Company.
Mutual benefit financial companies (Nidhis) are NBFCs notified under section 620 A of the
companies Act, 1956, and primarily regulated by the department of company affairs (DCA)
under the directions/guidelines issued by them under section 637A of the of the company Act,
1956. The Sabanayagam committee in Nidhis defines Nidhis as a company formed with the
exclusive object of cultivating the habit of thrift, savings and functioning for the mutual
benefit of members by receiving only from individuals enrolled as members and by lending
only to individuals, also enrolled as members, and which functions as per notification and
guidelines prescribed by the DCA.
These companies are exempt from the core provisions of the RBI Act and NBFC directions
relating to acceptance of public deposits. However, the Reserve Bank is empowered to issue
directions relating to deposits acceptance activities and directions relating to ceiling on
interest rate. They are also required to maintain register of deposits, furnish receipt to
depositors, and submit returns to the RBI.
III. Mutual Benefit Company (MBC) i.e., Potential Nidhi Company.
A company which is working on the lines of a Nidhi company but has not yet been so
declared by the central government, has minimum Net Owned Fund (NOF) of Rs. 10 lakh,
has applied to the RBI for CoR and also to Department of Company Affairs (DCA) for being
notified as Nidhi Company and has not contravened directions/regulations of the RBI/DCA.
Growth of NBFCs
NBFCs in India have existed since long. They came into limelight in the second half of the
1980s and in the first half of the 1990s.

NBFCs flourished during the stock market boom of the early 1990s. In the initial years of
liberalisation, they not only became prominent in a wide range of activities but they outpaced
banks in deposit raising owing to their customised services. They have backed many small
entrepreneurs. They have also lent small- ticket personal loans of size Rs. 25000 to customers
and thereby fuelled the consumption boom.