FBM 1202- COOPERATION, MARKETING & FINANCE

Lecture 10 BANKING

Introduction:
You know people earn money to meet their day to day expenses on food, clothing,
education of children etc. They also need money to meet future expenses on marriage,
higher education of children housing building and social functions. These are heavy
expenses, which can be met if some money is saved out of the present income. With this
practice, savings were available for use whenever needed, but it also involved the risk of loss
by theft, robbery and other accidents.
Thus, people were in need of a place where money could be saved safely and would
be available when required. Banks are such places where people can deposit their savings
with the assurance that they will be able to with draw money from the deposits whenever
required.
Meaning of a bank:
A bank is an institution which accepts deposits from the general public and extends
loans to the households, the firms and the government. Banks are that institutions which
operates in money. Thus, they are money traders. With the process of development,
functions of banks are also increasing and diversifying. Now, the banks are not nearly the
traders of money, they also create credit. Their activities are increasing and diversifying.
Banks, therefore, is such an institution which accepts deposits from the people, give
loans, creates credit and undertakes agency work.
According to the Banking Companies Act of 1949, Banking is defined as, accepting
for the purpose of lending or investment of deposit money from the public, repayable on
demand or otherwise and withdrawable by cheque draft, order or otherwise. It also defines
Bank as an institution dealing in money and credit. It safeguards the savings of the public
and gives loans and advances.
According to Prof. Kinley, “A bank is an establishment which makes to individuals
such advances of money as may be required and safely made, and to which individuals
entrust money when it required by them for use”.
A banking sector performs 3 Primary functions in an economy:
– The operation of the payment system,
– The mobilization of savings and

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– The allocation of savings to investment projects.

Types of banks

Functions of a Bank
The various functions of banks can be seen from the following figure:

Commercial Banks
Commercial Banks are very important component of the money market. They play a
very important role in Indian Financial system. Indian banking industry is regulated by
Reserve Bank of India. Commercial Bank act as Intermediaries because they accept deposits
from savers and lend these funds to borrowers.
Commercial Bank is financial Institution that accepts deposits for the purpose of
lending. In other words, commercial Banks provide services such as accepting deposits,
giving business loans and also allow for variety of deposit accounts. They collect money

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from those who have it to spare and lend to those who require it. Commercial Bank is a
banker to the general public. Commercial Banks registered under Indian companies Act,
1936 and are also governed by the Indian Banking Regulation Act, 1949.
Structure of Commercial Banks
Commercial banks are basically of two types.
1. Scheduled banks
2. Non- scheduled banks
Scheduled Banks
Scheduled banks are those which have been in II schedule of Reserve Banks of India
act, 1934 and following criteria should be satisfied.
1. Minimum paid up capital Rs 5 lakh.
2. It must be a corporation as co-operative society.
3. Any activity of bank will not adversely affect the interest of depositors
Scheduled banks consists public sector banks, private sector banks, foreign banks, and
regional rural banks.
1) Public Sector Banks: Public banks are those in which 50% of their capital is provided by
Central Government, 15% by concerned State Government and 35% by sponsored
commercial banks. Public sector banks are mostly situated in rural area than urban area.
In India, there are 21 public sector banks. They include the State Bank of India, Bank of
India, PNB, Syndicate Bank, Union bank of India, etc.
2) Private Sector Banks: Private Banks are those in which majority of share capital kept by
business house and individual. After the nationalization, entry of private sector banks is
restricted. Ex: Federal Bank, South Indian Bank, ICICI bank
3) Foreign Banks: Foreign banks are those which incorporated outside India and open their
branches in India. Foreign banks performed all the function like other commercial banks
in India. Foreign banks are superior in technology and management than India banks.
They offer different types of products and services such as offshore banking, online
banking, personal banks etc. They provide loans for automobiles, small and large
businesses. Foreign banks also provide special types of credit card which are nationally
and internationally accepted. Example: HSBC Bank, Barclays Bank, Deutsche Bank etc.
4) Regional Rural Banks: Regional rural banks established 1975 with mandate to ensure
sufficient credit for agriculture and rural sector. RRB’s are jointly owned by government

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of India, concerned state government and sponsor bank with capital share of 50 %, 15%
and 35% respectively. There are 14,475 regional rural banks in India. NABARD control
and prepare the policies for Regional Rural Banks. The basic objective of establishing
RRB’s in India was to provide the credit to rural sector especially the small and medium
farmers, artisans, agricultural labour and even small entrepreneurs.
Non Scheduled Banks
Non-scheduled banks in India define in clause (C) of section 5 of Banks regulation
Act 1949. Non- scheduled banks are those which are not a schedule bank and their paid up
capital and reserves is less than Rs.5 lakh and are not included in the 2 nd schedule of the
Reserve Bank of India Act, 1934.

Functions of Commercial Banks

1. Accepting Deposits:
Accepting deposits is one of major function of commercial bank. It is the business of
bank to accept deposits so that he can lend it to other and earn interest. Basically, the money
is accepted as deposit for safe keeping. Banks also pay interest on these deposits. To attract
depositors banks maintain different types of accounts. These are as following.
a) Fixed Deposit Accounts: The account which is opened for fixed period by
depositing amount is known as fixed deposit account. The money deposited in this
account cannot be withdrawn before expiry of period. A high rate of interest is paid on
fixed deposits.
b) Current Deposit Account: Current deposit accounts are mostly opened by
businessmen and traders who withdraw money number of times a day. Banks does not
pay interest on these types of account. The bank collects certain charges from depositors
for services rendered by it.
c) Saving Account: Saving account is most suited for those people who want to save
money for future needs. This type of account can be opened with a minimum initial
deposit. A minimum balance has to be maintained in account as prescribed by bank.
Some restrictions are imposed on depositor regarding number of deposit withdrawal
and amount to be withdrawn in given period.
d) Recurring Deposit Account: The purpose of these accounts is to encourage public
for regular saving, particularly by fixed income group. Fixed amount is deposit is
deposited at regular intervals for a fixed term and repaid on maturity.

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2. Grant of Loans and Advances

Besides accepting deposit, the second most important function of commercial bank is
advancing of loan to the public. After keeping a certain part of deposits received by bank as
reserve, the rest of balance is given as loan. The different types of loan and advances are
given by bank as follow.
a) Call Money: There are generally short term credits that range from one day to fort
night. The rate of interest depends upon the conditions prevailing in money market.
b) Overdraft: In overdraft, a customer can withdraw money from his current account
even when the available balance is zero. When the amount withdrawn is within the
authorized limit, then rate of interest is charged at agreed rate. Overdraft is allowed
normally against the security of negotiable Instrument and credit worthy customers
without security.
c) Cash Credit: In cash credit, Bank advance loan against the customer current asset or
personal guarantee. The borrower has option to withdraw the funds as and when
required to extent of his needs but he cannot exceed the credit limit allowed to him. The
cash credit limit depends on the debtor’s need and as agreed with the bank. The bank
charges interest only on money withdrawn from by them.
d) Discounting of Bills: Under this type of lending, Bank pay amount before due date of
bill after deducting certain rate of discount or commission. The holder of bill gets money
immediately without waiting for the date of maturity.
e) Direct Loan: A loans granted for a fixed maturity period more than one year. Loans
are usually secured against some collateral security. The borrower can withdraw entire
money through cheque. The interest is charged on entire amount of loan. Repayment of
loan is either in installments or in lump sum.
3. Credit Creation
Credit creation is also an important function of commercial Bank. The process of
credit creation automatically performed when bank accept deposits and provide loans
In this process, customers deposit their money in bank. Bank keeps certain amount
of deposit as cash reserve and rest of balance is given as loan and advances. Banks are not
required to keep the entire deposits in cash. The amount of loan is not given directly to
borrower instead deposit their money in that account. Here, bank’s lends money and
process of credit creation starts.

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4. Secondary Functions:
 Sale and Purchase of Securities: On the behalf of customer, commercial bank
sale and purchase of the securities of private companies as well as government
securities.
 Transfer of Funds: Commercial Bank also provide facilities to transfer funds
from one place to another place in form Bank draft, cheques, mail transfer etc.
 Collection and Payment of Credit Instrument: Commercial Bank collects and
makes payment on behalf of their customers. Commercial Bank collects and pay
negotiable instruments and also pay rent, income tax fees, insurance premium
etc.
 Locker Facility: Commercial Banks provides locker facility to their customers.
We can keep gold, silver and important documents in locker.
 Letter of Credit: Letter of credit certified the credit worthiness of their customers
which issued by commercial banks.
 Collection of Information: Commercial Banks also collect the information
relating to Industry, trade, commerce which made available to their customers.
 Travellers Cheque ad Credit Card: Commercial Banks issue traveller’s cheques
and credit cards to their customers. They can travel without fear of theft and loss
of money. Credit card is used to make payment for purchases so that individual
does not have to carry cash.
 Foreign Exchange: Commercial banks provide facility to their customers dealing
in foreign exchange. Commercial Banks are authorized dealers in India.
 Issuing of Gift Cheques: Commercial Banks issues the gift cheques like Rs 11,
51, 101,501 etc.
 Educational Loans: Commercial Banks also provide educational loan to student
for higher studies at reasonable rate of interest.
 Consumer Finance: Commercial Banks provide consumer finance facility for
purchase consumer durables like televisions, refrigerators etc.
 Automated Teller Machine: Nowadays with the help of ATM, we can deposit or
withdraw money from our account any time.

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 FBM 1202- COOPERATION, MARKETING & FINANCE

NATIONALIZATION OF COMMERCIAL BANKS

According to the IMF - Nationalisation is defined as “government taking control
over assets and over a corporation, usually by acquiring the majority stake or the whole
stake in the corporation”.
Nationalisation of banks means to take the banks under government undertaking.
Banks after nationalisation comes directly under Banking Regulation Act 1949.
• On 1st Jan 1949, RBI was nationalised first.
• In 1955, the Imperial Bank of India was nationalized and was given the name SBI, to act
as the principal agent of RBI and to handle banking transactions all over the country.
• Despite the progress in 1950s and 1960s, it was felt that the creation of SBI was not far
reaching enough since the banking needs of small scale industries and the agricultural
structure was still not covered sufficiently.
• Nationalisation was done in 2 phases:
• In 19 July 1969, GOI nationalised 14 commercial banks whose national wise deposits
were greater than Rs. 500 million under the prime minister ship of Smt Indira Gandhi.

1. Central Bank of India 8. Dena Bank

2. Bank of India 9. Union Bank of India
3. Punjab National Bank 10. Allahabad Bank
4. Bank of Baroda 11. Syndicate Bank
5. United commercial Bank 12. Indian Bank
6. Canara Bank 13. Bank of Maharashtra
7. United Bank of India 14. Indian Overseas Bank

 6 more commercial banks were nationalised in April 1980.

1. Punjab and Sind bank
2. Andhra Bank
3. New Bank of India (In 1993, the govt merged New Bank of India with PNB)
4. Vijaya Bank
5. Oriental Bank of Commerce
6. Corporation Bank.

At present, there are 19 nationalised banks in india.

Need for Nationalization of Commercial Banks:

The needs for nationalization of Commercial Banks are given below.
1. Commercial Banks were provide loans to large scale Industries and neglected priority
sectors.

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2. Before the nationalization financially strong Bank ignored RBI Directives which
adversely effected RBI monetary policy.
3. To remove the fear of bank failures from the minds of people.
4. To keep means of generating wealth in public control.
5. To remove regional imbalances and ensure even distribution of banking facilities.
6. To prevent unfair credit distribution by commercial banks

Advantages of Nationalization of Commercial Banks:

1. To Check on Creation of Industrial Monopoly: Before nationalization of commercial
banks credit was concentrated to few hands and this formed Industrial Monopoly. No
person except big Industrialist could get loan and advances. This neglected the other
smaller industrialist. So, commercial banks were nationalized to curb the monopolizing
tendencies.
2. Credit Facility to Priority Sector: Agriculture sector is backbone of India. This sector
was neglected at that time. There was no credit facility available to agriculture sector
before nationalization.
3. Reduction of Regional Imbalance: Regional imbalances had existed in India for a long
time in area of banking facilities. After nationalization, branches opened in backward
states like Assam, Bihar, Uttar Pradesh than in developed states like Gujarat, Tamil
Nadu etc. These banks reduced the Regional Imbalances.
4. Collection of Saving: Before the Nationalization, the banks did not attract more saving
from public as people did not trust banking system. But After nationalization of
commercial Banks, the deposits were increased as public started believing in public
sector Bank than private sector banks.
5. To check on Black Money: In order to avoid income tax, people kept money with banks.
For the solution of this problem the banks were nationalized.
6. Economic Growth: Before nationalization of banks, economy of country was not
growing due to anti-social practices, speculation and hoarding. The country’s economy
suffered badly. In order to solve this problem banks were nationalized.
7. Export Promotion: Commercial Banks also promotes export. Because there is need to
promote export for earn Foreign exchange. So, Banks give Finance to Exporter at
concessional rates.

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8. Credit Card Facility Credit card facility is provided by these Banks which has made our
life easy. People can buy necessary things through credit card and make payment later
on.
9. Promote Small Scale Industry: Nationalized commercial Banks encouraged small scale
Industry by granting Loans. These banks grant short term and long term loan to
purchase machinery and equipment.
Disadvantages of Nationalization of Commercial Banks:
1. Low performance: The biggest problem of nationalized banks has been their low
performance. Banks are required to keep minimum capital to risk asset ratio which
known as capital adequacy ratio. It should be 9%.Most of public sector banks had
negative ratio.
2. Favouritism: Another limitation of commercial banks was favouritism in granting loan.
They harass certain small industrialist and at the same time banks grant loan to big
industrialist on easy terms and conditions. They follow the policy of partiality which
affected the trust of client in banks working.
3. Unbalanced Distribution of Credit: In initial years, Agriculture sector got priority and
other sector were neglected. Bank do not advance loan to weaker section such as
labourers, worker and small trader due to lack of security.
4. Financial Crisis: After nationalization, some banks were operating under losses. This is
because banks advance loan without adequate security. Banks grant non-performing
loans which interest has not been received for 180 days. The recovery of loan was poor
which lead to losses. This is main reason for failure of banks.
5. Political Interference: Another limitation of nationalized commercial banks was
increasing the political interference in granting loans, appointment of banks personnel,
opening of new branches etc.
6. Inadequate Facilities: Nationalized commercial banks have failed to provide adequate
facilities and services to population living in rural and sub urban area. Banks failed to
mobilize rural deposit.

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 FBM 1202- COOPERATION, MARKETING & FINANCE

LEAD BANK SCHEME

The study group appointed by National Credit Council (NCC) in 1969 under the
chairmanship of Prof. D.R.Gadgil recommended “Service Area Approach” for the
development of financial structure. Under SAA, each bank branch in rural and semi-urban
area was designated to serve an area of 15 to 25 villages and the branch was responsible for
meeting the needs of bank credit of its service area. The primary objective of SAA was to
increase productive lending and forge effective linkages between bank credit, production,
productivity and increase in income levels in rural and semi-urban areas.
In the same year i.e., 1969, RBI appointed Sri. F.K.F Nariman committee to
examine recommendations of Prof. Gadgil’s study group. The Nariman committee also
endorsed the views of the Gadgil committee on “Service Area Approach” and
recommended the formulation of “Lead Bank Scheme”. The RBI accepted the Nariman’s
committee recommendations and lead bank scheme came into force from 1969 to provide
lead roles to individual banks (both in public sector and private sector) for the districts
allotted to them.
The Lead Bank Scheme was introduced by RBI on the basis of the
recommendations of both the Gadgil Study Group and Banker’s Committee (Nariman
Committee). The studies by the committees found that the rural areas were not able to enjoy
the benefits of banking. Commercial banks did not have adequate presence in rural areas
and also lacked the required rural orientation. So a bank (public or private) was given some
area in which that bank had to play a lead role in providing financial services to the people,
making them aware about the banks and various benefits of banks and also generating trust
among people so that they deposit their money without any fear of loss or fraud in rural
areas. So in this way, all the districts in the country have been allotted to various banks. The
lead bank also acts as a leader for coordination activities and services of all financial
institutions in that area.
Under the lead bank scheme, specific districts are allotted to each bank, which would
take the lead role in identifying the potential areas for banking and expanding credit
facilities. Lead bank is the leading bank among the commercial banks in a district i.e. having
maximum number of bank branches in the district.
The activities of lead bank can be dealt under two important phases:

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Phase I: Survey of the lead district

 The RBI has mentioned the following functions of lead bank under phase-I
 Surveying the potential areas for banking in the district.
 Identifying the business establishments which are so far dependent on non –
institutional agencies for credit and financing them so as to raise their income
 Examining the available marketing facilities for agricultural and industrial products
and linking credit with marketing.
 Invoking cooperation among different banks in opening new bank branches.
 Estimating the credit gaps in various sectors of district economy.
 Developing contacts and maintaining liaison with the Government and other
agencies.
Phase II-Preparation of credit Plans:
RBI emphasized that the lead bank should
 Formulate the bankable loaning schemes involving intensive use of labour, so as to
generate additional employment.
 Disburse loans to increase the productivity of land in Agriculture and allied
activities, so as to increase the income level.
 Give maximum credit to weaker sections of the society mainly for productive
purposes.
Therefore lead bank scheme expects the banker to become an important participant in
the developmental process in the area of its operation in rural areas, and the service area
approach put the banker in the position of implementing the development plans.

REGIONAL RURAL BANKS (RRBS)

All India Rural Credit Review Committee (AIRCRC) under chairmanship of Sri. B.
Venkatappaiah during the year 1969 was of the opinion that over large parts of the country
the marginal and small farmers were deprived of having access to the cooperative credit
both for production and investment purposes. This stressed the establishment of institutional
financial agencies under public sector. Consequently the first spell of nationalization of
banks was done with greater expectations, but the situation had not changed as per the
expectations.

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Hence, the Government of India appointed a working committee under the

chairmanship of Sri. M. Narasimham to study the financial assistance rendered to the
weaker sections in the rural areas. This working committee recommended the setting up of
rural based institutional agencies called “Regional Rural Banks” after identifying
shortcomings in the functioning of commercial banks and cooperatives.
The Government of India accepted the recommendations of Sri. Narsimham
committee and regional rural banks came in to existence through Regional Rural Banks
Ordinance on 26th September, 1975 with the aim of developing rural economy in all areas
like agriculture, trade, commerce, industry and other productive activities in the rural areas,
credit and other facilities, particularly to small and marginal farmers, agricultural labourers,
artisans and small entrepreneurs, etc..
Initially only 5 RRBs were set up on pilot basis with sponsorship of commercial
banks on October 2nd, 1975. This ordinance of 1975 was replaced by the Regional Rural
Banks Act, 1976.
Objectives of RRBs are:
 To develop rural economy.
 To provide credit for agriculture and allied activities.
 To encourage small scale industries, artisans in the villages.
 To reduce the dependence of weaker sections (Marginal farmers, small farmers and
rural artisans) on private money lenders.
 To fill the gap created by the moratorium on borrowings from private money lenders.
 To make backward and tribal areas economically better by opening new bank
branches.
 To help the financially poor people in their consumption needs.
Functioning of RRBs:
 Each RRB is being sponsored by a scheduled commercial bank.
 The operational area of each RRB is one or two districts. Each branch of RRB can
serve a population of roughly 20,000 people.
 Authorized share capital of each RRB is Rs. one crore, contributed by central
government, state government and sponsoring commercial bank in the ratio of
50:15:35. Issued capital for each RRB is Rs. 25 lakhs.

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 The rate of interest charged by RRBs on the loans is same as that of Primary
Agriculture Credit Societies (PACS), but they are allowed to offer 0.5 per cent
interest more than that of commercial banks on its deposits.
 RRBs have simplified procedural formalities in giving agricultural finance on
recommendations of Sri. Baldev Singh’s working group.
 RRBs use local languages in their transactions.
 The cost of operation i.e. user charges are low as compared to that of commercial
banks.

Some Facts about RRBs:

 RRBs were set up on the recommendations of the Narasimham Working Group.

 The first RRB to be set up was the Prathama Bank, sponsored by Syndicate Bank on
October 2, 1975 in Uttar Pradesh. The head office is at Moradabad, UP.
 At that time, Mrs Indira Gandhi was the Prime Minister of India.
 The regulatory authority of these RRBs is NABARD.
 All the RRBs are on Core Banking platform like other commercial banks.
 The area of operation of the RRBs is limited to few districts in a State.
 The percentage shares of the Government of India, the concerned State Government
and the bank, which had sponsored the RRB is in the proportion of 50%, 15% and
35%.
 Sponsor bank can be any Nationalized Commercial Bank.
 The sources of funds of RRBs comprise of owned fund, deposits, borrowings from
NABARD, Sponsor Banks and other sources including SIDBI and National Housing
Bank.
 RBI has allowed the RRBs to maintain a lower level of SLR than commercial banks.
 The Chakrabarty Committee reviewed the financial position of all RRBs in 2010 and
recommended for recapitalization.
 Under the Dr Vyas Committee Recommendations, amalgamation of RRBs took
place in 2013.
 As a result of amalgamation, number of the RRBs reduced from 196 to 64 as on 31
March 2013. On 31 March 2016, there were 56 RRBs (post-merger) covering 525
districts with a network of 14,494 branches.

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 All states in India have RRBs, except Sikkim and Goa.

CROP LOAN SYSTEM:

Even though All India Rural Credit Survey Committee (AIRCSC) under the
chairmanship of Sri. Gorwala during 1954 and V.L. Mehra Committee on Co-operative
credit in 1960 recommended the adoption of crop loan system in all states; it was not
implemented due to several reasons.
The twin objectives of crop loan system are:
1. Treating the crop as security instead of immovable property like land.
2. Fixing the scale of finance depending up on the actual farm expenditure i.e. based on
cost of cultivation.
Salient features of the crop loan system:
 The credit requirements of the farmers are to be estimated based on the cost of
cultivation of the crops cultivated by them.
 The eligibility to receive the loan by the farmer is not measured by the ownership of
land but by the fact that he is a real farmer who needs credit for cultivation.
 The crop loans should be advanced on the hypothecation of the crop.
 The disbursement and recovery of the loans are to be made in accordance with the
crop production schedule.
 The loans should include both cash and kind components.
 The quantum of loan should be fixed according to the variety (local, imp. variety or
HYV), the season in which it is grown and the type of crop i.e. whether it is irrigated
or rainfed crop.
 Crop loan is fixed by the District Level Technical Committee (DLTC) consisting of
experts from the fields of agriculture, animal husbandry, banking etc.

SCALE OF FINANCE
Scale of finance is an indicative cost taken as base cost depending on which the
amount to be financed to a farmer is fixed. Normally scale of finance is given in a range, as
the cost of cultivation for a farmer practicing traditional methods of farming and that of a
progressive farmer practicing modern methods of cultivation differs. The lower value of the

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range corresponds to the requirement of the former while the upper value corresponds to the
latter.
Scale of finance is fixed for annual, perennial crops and livestock also. Livestock will
have fixed costs of finance and they are termed as unit costs. The unit varies with the type of
livestock. Ex: for milch cattle the unit refers to two animals, for sheep and goat a minimum
of 10 animals and for poultry a minimum of 500 birds.
Factors influencing the scale of finance:
1. Type of the crop: It varies from crop to crop.
2. Nature of the crop: With in the same crop between the improved varieties and high
yielding varieties (HYVs) the scale of finance differs.
3. Season: Scale of finance differs with season for the same crop.
4. Type of land: Based on the type of the land i.e. irrigated or dry the scale of finance
differs with the same crop.
5. District/Area: For the same crop the scale of finance varies from district to district.
How Scale of Finance is fixed:
Scale of finance is fixed for each district by a committee known as District Level
Technical Committee (DLTC).The members of DLTC constitute representatives of lead
bank of that district, NABARD, local co-operative banks and commercial banks, officials of
department of agriculture& animal husbandry etc. The meetings of DLTC are chaired by
district magistrate/ district collector and convened by respective lead bank district manager.
DLTC compiles technical survey report with the information obtained from NABARD.
NABARD in turn obtains information from the state agricultural department every year,
which will have the necessary details like what are crops grown, their extent etc. By using
the above details a potential map is prepared. By using this one can list out the priority
activities to be financed in each part of the district and extent to which these are to be
financed. Finally cost of cultivation is estimated based on the market trends & needs. The
finance scale is not fixed and keeps on changing every year.

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