Principles and Practices of Banking

PRINCIPLES AND PRACTICES OF BANKING
A financial system means the structure that is available in an economy to mobilize

the capital from various surplus sectors of the economy and allocate and distribute
the same to the various needy sectors.

The transformation of Savings into Investment consumption is facilitated by the
active role played by the financial system.

The process of transformation is aided by various types of financial assets suiting
the individual needs and demands of both the investors and splendors

The offering of these diverse types of financial assets is supported by role of
financial intermediaries who invariably intermediate between these two segments
of investors and spenders. Intermediaries are banks, financial institutions, mutual
funds etc.
FINANCIAL SYSTEMS OVERVIEW
Various segments of Financial Markets are:

Money Market

Debt Capital Market

Forex Market

Equity Capital Market
FINANCIAL SYSTEMS OVERVIEW
CENTRAL BANKING AUTHORITY: It has two roles in Monetary control including:

Controlling Inflation

Bank supervision

ROLES AND FUNCTIONS OF RBI (CENTRAL
BANKING AUTHORITY)
BANKING AUTHORITY)
Financial System

CBA Capital Markets Regulatory Authority Insurance and Pension Regulators
Monetary Control Equity and Debt market control Regulatory Framework for insurance companies
Supervision over Banks/F.I. Super vision over Super of insurance companies
Management of Government Debt Stock exchanges regulating pricing structure of insurance firms
Banker to Government brokers framing rules for pension funds
Lender of last resort to banks equity and debt raisers regulating pension funds
Regulator investment bankers
mutual funds
listed companies

Monetary Control: prime rates of lending are controlled by

Is ensured through CRR (cash reserve ratio)

Statutory Liquidity Ratio mechanism

Bank and repo rates- the rate at which RBI Lends money to Banks.

Open Market Operations

Selective Credit Control

BANKING AUTHORITY)
CRR (Cash Reserve Ratio)

The Cash Reserve Ratio (CRR) refers to this liquid cash that banks have to maintain
with the Reserve Bank of India (RBI) as a certain percentage of their demand and time
liabilities. For example if the CRR is 10% then a bank with net demand and time
deposits of Rs 1,00,000 will have to deposit Rs 10,000 with the RBI as liquid cash.

CRR was introduced in 1950 primarily as a measure to ensure safety and liquidity of
bank deposits, however over the years it has become an important and effective tool for
directly regulating the lending capacity of banks and controlling the money supply in the
economy.
When the RBI feels that the money supply is increasing and causing an upward
pressure on inflation, the RBI has the option of increasing the CRR thereby reducing
the deposits available with banks to make loans and hence reducing the money supply
and inflation.

BANKING AUTHORITY)
Statutory liquidity ratio is the amount of liquid assets such as precious metals (gold) or
other approved securities (AAA-Rated risk free bonds), that a financial institution must
maintain as reserves other than the cash with the Central Bank. The statutory liquidity
ratio is a term most commonly used in India.

The objectives of SLR are
expansion of bank credit.

To augment the investment of the banks in government securities.
To ensure solvency of banks. A reduction of SLR rates looks eminent to support
the credit growth in India

BANKING AUTHORITY)
Bank and repo rates:

Bank rate, also referred to as the discount rate, is the rate of interest which a central
bank charges on the loans and advances that it extends to commercial banks and
other financial intermediaries. Changes in the bank rate are often used by central
banks to control the money supply.

BANKING AUTHORITY)
Open Market Operations:

This refers to sale or purchase of government securities by RBI in the open market
with a view to increase or decrease the liquidity in the banking system and there by
affect the loanable funds with banks.

For example, quantitative easing:
A government monetary policy occasionally used to increase the money supply by
buying government securities or other securities from the market. Quantitative easing
increases the money supply by flooding financial institutions with capital, in an effort
to promote increased lending and liquidity.

BANKING AUTHORITY)
Selective credit control:

RBI issues directive under sector 21 and 35 A of the banking regulation act,
stipulating certain restrictions on bank advances against specified sensitive
commodities.

RBIs selective credit control directives is to prevent speculative holding of
essential commodities (oils, oilseeds, sugar, gur, vanaspati etc. and the resultant
rise their prices.

Under selective credit control bank should not allow customers dealing in SCC
commodities any credit facilities (including loan against stock, receivables, real
estate etc.
BANKING AUTHORITY)
in sharp contrast to the situation before 1991, since then, apart from a transparent
communications policy and a broad based consultative approach to policy making,
Governors speeches and appearances on the electronic media and the press have
been substantial, having significant influence on markets and opinions. In the
process, the RBI has gained reputational bonus and public credibility.

financial and external sectors in India have also become relatively more efficient and
resilient.

while the effectiveness of monetary policy has improved significantly to meet the
evolving demands, some constraints are persisting, which impact the choice and
effectiveness of our policy framework.

RECENT DEVELOPMENTS IN INDIAN
FINANCIAL SYSTEM

The market in which shares are issued and traded, either through exchanges or
over-the-counter markets. Also known as the stock market, it is one of the most
vital areas of a market economy because it gives companies access to capital and
investors a slice of ownership in a company with the potential to realize gains
based on its future performance.

This market can be split into two main sectors: the primary and secondary market.
The primary market is where new issues are first offered. Any subsequent trading
takes place in the secondary market.
INTRODUCTION TO EQUITY MARKET

An amount of money borrowed by one party from another. Many
corporations/individuals use debt as a method for making large purchases that
they could not afford under normal circumstances. A debt arrangement gives the
borrowing party permission to borrow money under the condition that it is to be
paid back at a later date, usually with interest.

Bonds, loans and commercial paper are all examples of debt. Loans can be short
term and/or long term depending upon the financing need of specific company.
Also the loans can be secured, unsecured and convertible in nature. The
convertible loans can be converted from debt to equity on pre-specified maturity
date.

INTRODUCTION TO DEBT MARKET
The RBI institution was established on 1 April 1935 during the British Raj in
accordance with the provisions of the Reserve Bank of India Act, 1934.

The Reserve Bank of India was set up on the recommendations of the Hilton-
Young Commission. The commission submitted its report in the year 1926, though
the bank was not set up for another nine years.

The Preamble of the Reserve Bank of India describes the basic functions of the
Reserve Bank as to regulate the issue of bank notes, to keep reserves with a view
to securing monetary stability in India and generally to operate the currency and
credit system in the best interests of the country.
The Central Office of the Reserve Bank was initially established in Kolkata,
Bengal, but was permanently moved to Mumbai in 1937.

HISTORICAL ASPECTS OF BANKING INDIA
the Indian government developed a centrally planned economic policy and focused on
the agricultural sector. The administration nationalized commercial banks and
established, based on the Banking Companies Act, 1949 (later called Banking
Regulation Act) a central bank regulation as part of the RBI. Furthermore, the central
bank was ordered to support the economic plan with loans.

the Indian government nationalized 6 more commercial banks, following 14 major
commercial banks being nationalized in 1969

The regulation of the economy and especially the financial sector was reinforced by the
Government of India in the 1970s and 1980s. The central bank became the central
player and increased its policies for a lot of tasks like interests, reserve ratio and visible
deposits. The measures aimed at better economic development and had a huge effect
on the company policy of the institutes. The banks lent money in selected sectors, like
agri-business and small trade companies

HISTORICAL ASEPCTS OF BANKING
Debtor-Creditor Relationship

BANKER CUSTOMER RELATIONSHIP
Debtor (loan taker) Loan provider
Loan amount approved by
creditor and paid to debtor
Interest expense paid to creditor by
debtor. When loan expires principal
amount is also paid to creditor by debtor
Creditor:

An entity (person or institution) that extends credit by giving another entity permission
to borrow money if it is paid back at a later date. Creditors can be classified as either
"personal" or "real".

Those people who loan money to friends or family are personal creditors. Real
creditors (i.e. a bank or finance company) have legal contracts with the borrower
granting the lender the right to claim any of the debtor's real assets (e.g. real estate or
car) if he or she fails to pay back the loan.

Creditor:

When creditors are notified of bankruptcy proceedings, they have a couple of options
with respect to their claim against the debtor:

they can share in any distribution from the bankruptcy estate according to the
priority of their claim. Most unsecured, non-wage claims come low on the priority
list.

They can take the debtor to court and challenge a debtor's discharge (the right not
to pay back) due to bankruptcy protection.
Debtor:
A company or individual who owes money. If the debt is in the form of a loan from a
financial institution, the debtor is referred to as a borrower. If the debt is in the form of
securities, such as bonds, the debtor is referred to as an issuer.

It is not a crime to fail to pay a debt. Except in certain bankruptcy situations, debtors can
choose to pay debts in any priority they choose. But if you've failed to pay a debt, you have
broken a contract or agreement between you and a creditor. Generally, most oral and
written agreements for the repayment of consumer debt - debts for personal, family or
household purposes secured primarily by a person's residence - are enforceable.

However, most debts for business or commercial purposes must be in writing to be
enforceable. If the agreement requires the debtor to pay a certain amount of money, then
the creditor does not have to accept a lesser amount. Also, if there was no actual
agreement but the creditor has loaned money, performed services or provided the debtor
with a product, that debtor must pay the creditor.

When Bank is debtor and customer is creditor

This happens when a customer opens can account with the bank. The money is
handed over to the bank in a form of debt.

In this case money is lent to the bank and the bank is free to use it in a way most
beneficial to it. The bank is not liable to return money in same denominations (type
of notes like 50, 100, 500, 1000 are denominations).

Demand of the payment should be made by the customer. The banker is not
required to repay the debt voluntarily.

The demand should be made in written by the customer.
When a customer deposits money with the bank a debtor-creator relationship is
established under which the bank acquires the beneficial title to the funds. The bank is
entitled to use the funds in any manner it deems fit. The customer does not acquire
any interest or charge over the banks general assets and the deposit account is
merely an acknowledgement and record of the credit balance standing to customers
account.[iii]

When a bank undertakes to act a trustee and holds deposits on trust, the bank has
no power to use those deposits as a part of general assets unless the trust instrument
expressly authorizes to do so. In such circumstances the trust money may solely be
applied to the benefit of the beneficiaries of the trust account. The bank, therefore, in
such cases cannot discharge its obligation with respect to the trust property by
giving an account of the credit balance.

BANK AS TRUSTEE
The word money laundering refers to the use of the financial system to hide the
source of funds gained from illegal activity such as drug trafficking, bribery, extortion,
embezzlement, theft or other criminal activity, as the criminals try to make their ill
gotten gains appear genuine.

Anti Money Laundering is the term used by banks and other financial institutions to
describe the variety of measures they have to combat this illegal activity and to
prevent criminals from using individual banks and the financial system in general as
the conduit for their Proceeds of Crime.
In all major jurisdictions around the world, criminal legislation and regulation make it
mandatory for banks and financial institutions to have arrangements to combat Money
Laundering, with harsh criminal penalties for non-compliance.

ANTI MONEY LAUNDERING (AML)
Money laundering is traditionally done in three stages, called Placement, Layering and
Integration.

Placement is the physical depositing of the cash.

Layering describes the process of transactions, some very simple, some more
complicated and often involving transactions within and between banks and across
borders, which seek to confuse the trail back to the original cash.

Integration is the process by which the money is brought back into use by the
criminal in the normal economy, often by the purchase of assets (houses, cars,
works of art) but which make it appear legitimate.

ANTI MONEY LAUNDERING (AML)
Anti money laundering can be implemented by using following

KYC (know your customer)

Due diligence

ANTI MONEY LAUNDERING
KYC (Know your customer)

RBI has instructed all Banks to adopt a KYC/AML Policy
to prevent criminal elements from using the Banking system for money laundering
activities
To enable the Bank to know/understand the customers and their financial dealings
better, which in turn would help the Bank to manage risks prudently.
To put in place appropriate controls for detection and reporting of suspicious
activities in accordance with applicable laws/laid down procedures.
To comply with applicable laws and regulatory guidelines.
To take necessary steps to ensure that the concerned staff is adequately trained in
KYC/AML procedures.
KYC (Know your customer)

For identity of individuals: passport, pan card, voter id card, driving license and/or
letter from authorized public authority.

For companies: Certificate of incorporation and MOA (Memorandum of association) &
AOA (articles of association), resolution of the board of directors to open an account
and identification of those who have authority to operate account.

For partnerships: registrars certificate, partnership deednames of all partners,
power of attorney granted to partner or employee of the firm to transact business on
its behalf.

For trusts and foundations: certificate of registration, power of attorney granted to
transact business on its behalf-names and addresses of founder, the
manager/directors and beneficiaries.

Due diligence

The words Due Diligence in the financial sense describe the process by which a bank
or financial institution checks the identity, background and other aspects of the source
of wealth of potential and existing customers.

High quality due diligence requires careful and persistent effort by a financial
institution to find out about the background and source of wealth of a customer. This
provides two key benefits for the risk-aware financial business first, comfort that the
firm is not exposing itself to excessive risk of being used by criminals to launder the
Proceeds of Crime; and second (and equally important), sufficiently detailed
knowledge of the customer's source of wealth and financial position to be able to sell
products which are appropriate and which help the customer and the firm to make
money.

Section 12, of Prevention of money laundering act, 2002 casts the following reporting
obligation for banking companies to director, financial intelligence unit-India

Cash Transactions:

all cash transactions of value more than 10 lacks or its equivalent in foreign
currency.

Al series of cash transactions integrally connected to each other where series of
transaction value adds up to be more than 10 lacks in Indian currency.

All cash transactions where fake currency notes have been used as genuine and
where any forgery of valuable security has taken place.

The major functions of bank are to mobilize deposits from the public and to invest
and/or lend these deposits to individuals, firms and corporate institutions.

Types of Deposits

Demand deposits

Time deposits
DEPOSIT PRODUCTS OR SERVICES
Demand deposits:

Payable on demand

Low interest rates or no interest rate

It includes current, savings, overdue deposits and unclaimed deposits.

Interest is paid on half yearly basis in saving accounts
Time deposits:

Repaid after expiry of the deposit period

High interest rates, which vary according to period

Time deposits from 7 days to 120 months period with or without reinvestment
plans.

Interest is paid on quarterly rests and is cumulative every quarter.
Features of demand deposits:

Current deposits: current deposit accounts are opened to meet the transactions of
business and trade and hence are not entitled to any interest from the bank. On
the contrary bank levy charges for maintaining the accounts in the form of per
page fees, per cheque leaf debit charges, minimum balance fees.

Saving deposits: its purpose is to inculcate a habit of saving. It is opened by
individual/trusts et. Interest is paid at a rate as demanded by RBI.
Time deposits:

Accounts may be opened by individuals or firms or corporates or by designated institutions.

Amount is repayable on maturity. Banks issues deposits with maturity from seven days to one
hundred and twenty months.

Rate of interest is fixed by each bank for different periods.

Deposits are kept for fixed period but could be withdrawn before maturity at a reduced rate of
interest.

Tax deducted at source by banks, if the interest paid on deposits is more than 10,000 or more at a
time.
A banker is under a statutory obligation to make payment of a cheque drawn on an
account, if there are sufficient funds in the account properly applicable for making
payment.

Negotiable Instruments ACT 1881

this act deals with three kinds of instruments which are widely used in commercial
transactions.

Promissory notes
Bills of exchange
Cheque

PAYMENT AND COLLECTION OF CHEQUES
AND OTHER NEGOTIABLE INSTRUMENTS
Definition of Cheque:

A cheque is a bill of exchange drawn on a specified banker and not expressed to
be payable otherwise than on demand and it includes the electronic image of
truncated cheque and a cheque form.

Cheque contrains instruction in writing given by the account holder to his bank for
payment of money from his account.
There is statutory obligation on part of the banker to make payment of cheque
if the cheque is properly drawn,
there is sufficient balance in the account and
there is no legal restraint on the banks duty to pay.

Order or bearer cheque

Order cheque means that the words after the name in the payto column "bearer " is
struck off and/or the words order is written. In that case it is an instruction to the bank
to pay the amount of the cheque to the person mentioned in the cheque after
identification or to anyone authorised by the person mentioned in the cheque, that too
after verification. The bank will ask the person tendering order cheque to provide proof
that the person is the same as mentioned in the cheque.

Before making payment, it should be ensured that the amount stated in words and
figure talliers.

Cross Cheque

Any cheque crossed with two parallel lines means that the cheque can only be
deposited directly into an account with a bank and cannot be immediately cashed by a
bank over the counter. By using crossed cheques, cheque writers can effectively
protect the cheques they write from being stolen and cashed.
Payment in due course

Forgery in order cheque Under section 85(1) , forgery in a bear cheque under section
85(2) and in case of crossed cheque under section 128.

Before making the payment of cheque, the bank should ensure that it is made in due
course to enable it to get protection under various provisions act of N.I. Act
(negotiable instruments act).

Principles and Practices of Banking

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Principles and Practices of Banking

Uploaded by

Copyright:

Available Formats

PRINCIPLES AND PRACTICES OF BANKING

A financial system means the structure that is available in an economy to mobilize

You might also like