Banking and Finance

An overview
Historical Evolution

Introduction 1/2
Banks accept deposits and use funds to grant loans Pools savings of widely scattered economically surplus units-social capital Helps in capital formation and capital accumulation Reservoir of resources necessary for economic growth

Introduction 2/2
Infrastructure finance, finance to basic industries, modernization of agriculture, domestic and international trade Plays a pivotal role in accelerating pace of economic development Through them monetary and fiscal policies implemented. Viable, safe and sound banking system essential

Banking History 1/2

Word bank derived from bancus or banque that is a bench as Jews in Lombardy, transacted their business on benches in market place. When a banker failed, his banco was broken up by the people whence the word bankrupt

Banking History 2/2

Babylonians had developed a banking system in as early as 2000 B.C. Temples of Babylon were used as banks. Spread of irreligion destroyed public sense of depositing money. In ancient Greece and Rome practice of granting loans prevalent. The Bank of Venice established in 1157 considered to be most ancient Aristotle's dictum that the charging of interest was unnatural and consequently immoral was adhered to. Mohammedans refuse to accept interest on money loans.
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British Banking

Royal exchanger for the benefit of the Crown. (reign of Edward III) Goldsmiths 17th century. Money was held in the form of gold/silver. People started keeping money in goldsmiths strong rooms for a fee. Receipts were issued which later on became transferable and used for settlement of debt. Gold smiths started giving loans against surplus money. King Charles II stopped. Bank of England in 1694. Issue and Deposit banking Business of different types of banks. Specialized in one activity, issuing and discounting houses. Functions of commercial banks: Deposits, issuing notes, lending money, transferring money from place 6 to place.

Historical Background (India)1/2

Banker was integral part of India even before advent of Banking concept. Debts were raised for dicing, payment of old debts. Manu A sensible man should deposit his money with a person of good family, good conduct, well acquainted with the law, veracious having many relations wealthy and honorable.

Historical Background (India)2/2

Chanakyas Arthshastra (300 B.C) says powerful guild of merchant bankers who received deposits, advanced loans Loans were granted to kings and persons acted as treasures and bankers to the State. Hundi from the word hund to collect:Darshani, Maidi, Shah Jog hundies. Bastupal Tejpal drew a hundi for Rs 10 crore on the Nagar Seth of Ahmedabad for Dilwara temple.

Banking History 2/2

J.B.Tavernier said that every village had a money changer called the shroff or seth who acted as a banker and made remittance of money. Banking developed during Buddhist and Moghul period. During British period an agency house called as M/s. Alexander & Co., M/S Fergusson & Co took to banking. First bank to start was The Bank of Hindustan. Mere appendage to agency Houses. closed1829-32

Fall of Joint Stock Banks

Banking incompatible with any other type of business proved in 1829-32. Disaster Bank of Hindustan failed in 1832 Sholapur bank failed in 1918 due to such fatal combination. Indian Companies Act 1913 segregated banking from other trade. Use of word bank banker restricted.

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Presidency Banks

Bank of Bengal in 1809 obtained a charter with a capital of Rs 50 lacs, one fifth by Government Bank of Bombay 1840. Capital 52.25 Bank of Madras 1843. Capital Rs 30 lacs In 1860 principle of limited liability was first applied to banks Crisis of 1862-65. Bank of Bombay went into liquidation and restarted in 1868
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Imperial bank and SBI

Many banks opened 1906-13 period Crash of 1913-17 for Indian joint stock banks Presidency banks amalgamated into the Imperial Bank of India by an Act in 1920 No power to issue notes, Government banker Reserve Bank of India established in 1935 In 1955 SBI Act was passed. 1959 SBI (subsidiry bank) Act was passed

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Growth of Banking in India

Money Lender
Deposit Agency House Joint Stock Company Hundi Loan

Presidency Banks
Imperial Bank of India State Bank of India
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Organized and unorganized sectors

Moneylenders (Unorgani) Own savings Banking and trading High rate of interest Minimum formalities Money to be returned after fixed period Provides no other service Hardly any procedure or technology Banks (organized) Lend from deposits Prohibited from trading Interest rates lower Stringent formalities Money to be returned as per contract Provides a number of other services also Computerized

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Banking and other business

1.
2. 3. 4. 5.

Banking Deals in money Banks create credit Controlled by RBI Requirements of SLR/CRR Balance profitability with social justice

1.
2. 3. 4. 5.

Other business Deals goods/services No such power No controls No such condition regarding liquidity Greater freedom to organize business

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Pre-Independence Period
Imperial Bank of India (1921) All Central bank functions. RBI (1935): (a) To regulate issue of bank notes; and (b) Monetary stability. Banks established in major cities. Traditional finance of tea, jute, sugar etc. Banks were under influence of business houses.

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Banking Definition

Section 5 of the Banking Regulation Act 1949 defines a banking Company as any company which transacts the business of banking in India. Banking means accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdraw able by cheque, draft, order or otherwise. Any company which is engaged in the manufacture of goods or carrries on any trade and which accepts deposits of money from the public for the purpose of financing its business, such manufacturer or trader shall not be deemed to transact the business of banking
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Post Independence Period

Banking Regulation Act, 1948 to regulate banking system. No priority sector. Banking Co.s. 620 Branches 4263 No term lending F.I. & Deposits 9978 AVD 5188 capital market. Investment 3768 High bank failure in 1949: 55 banks went under liquidation

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Position in December 2007

Total domestic deposits:- Rs 25,41,201 crores Domestic Credit:- Rs 28,62,491 Crores

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Social Control Nationalization and After

Social control from 01-02-1968 - Composition of board by Government - Priority sector lending Nationalization of 14 banks in 1969 and 6 more banks in 1980. - Flow of credit to priority sector - Branch expansion in non banked areas - Social banking: poverty alleviation program - Rural banking: 1833 in 1969 to 35206 by 1991 - Semi urban 3342 in 1969 to 11,344 in 1991
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Regime of reform (1992-2002)

Background Excessive regulation in all areas, interest rates, policies, directed credit Inadequate capital base of banks High level of NPAs Low profitability Poor customer service Rising inflation, high level of fiscal deficit, low GDP growth and unsustainable C/A deficit.
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Narasimhan Committee, 1991

Functions Examination of existing financial structure Improving the organizational systems, procedures and policies Measures infusing greater competitive vitality into financial systems Cost, composition and adequacy of capital structure of banks and financial institutions Review role of different types of financial institutions and their balanced growth Review existing supervisory arrangements of various financial entities. Review legislative framework and suggest changes
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N C.I Twin Principles

Operational Flexibility Functional Autonomy

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Cont
Recommendations Reduction of SLR/CRR Public debt by fiscal measures Interest at market rate on SLR/CRR (one year deposit rate) Directed credit be phased out redefine priority sector, down to 10% Deregulation of interest rates: Prime rate to be floor rate Capital adequacy: Basel Standards of 8%; (Capital (T1+T2+T3)/risk weighted assets).
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Cont

Income recognition and classification of assets: (a) No Income on NPAs; (b) 90 days (Income recognition) Transparency of bank balance sheets: (a) Full disclosures for stake holders (equity holders, investors and depositors) Alignment with income tax rules Creation of asset reconstruction fund Proposed structure of banking system: - International banks, 8/10 National banks, Regional banks.
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Cont

Removal of dual control i.e. from RBI and Ministry of Finance to only RBI Depoliticisation of appointment of CMDs, rather based on merit based upon committee recommendations Consortium lending be changed to syndication or participative lending; banks to do term finance; and F.Is/W.C.advance State level financial institutions
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Cont

Setting up of rural banking subsidiaries Entry of private/new banks Branch licensing should be stopped and banks to be given full authority/autonomy Entry of foreign banks; to be treated at par with domestic banks Freedom from RBI/GOI directive (a) Complete autonomy to banks in day to day affairs; and (b) Internal administration Supervision over banks: prudential norms
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Cont.
Rehabilitation programme of sick units Setting up of one or more subsidiaries of banks abroad. Permission of establishing new banks in private sector Foreign banks operating in India should be subjected to provisions applicable to domestic banks

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Strengthening Capital adequacy

In addition to credit risk, Consider Market risk and off balance sheet risks (Basel II). Government securities be marked to market. No special treatment to Government Guaranteed accounts. PSBs to access Capital Market. Forex open position,100% risk. CAR be increased to 9% by 00 &10% by 02

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Asset Quality
NPA norms be made more rigorous Govt. guaranteed accounts be treated at par with any other commercial advance Establish Asset Reconst. Company ARC and issue NPA Swap Bonds, ABS Element of Interest subsidy be removed from Priority Sector lending

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Prudential Norms and disclosure requirements

Reduce Asset to be NPA to 90 days. Provide General Provision of 1% on Standard Assets also. Tax benefits be given on NPA provision

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Systems and Methods in Banks

Independent Loan Review mechanism to determine NPAs Banks should be permitted hire skilled manpower from the market Remuneration to Bankers as per Market norms Management Information System in Banks Computerization

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Structural Issues

Conversion of DFIs into banks Mergers between banks/banks/DFIs RBI should reduce its shareholding in PSBs Deposit Insurance as per RBI CAMELS rating. Bank Boards be independent, responsive to enhancing share holder value. Non Banking parties allowed access to Bill Discounting, CPs, treasury Bills ,Money Market Mutual Funds
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Response by RBI
SLR brought down-25 37.4%in 92 to 25%in 01 CRR brought down-5 15% in 92 to 5.5 % in 01

Bank Rate reduced

12% in 91

to 6.5 % in 01

Gross

NPA to G.adv

23% in 92

to 2.4% in 01

Net Profit (SCB5194)

4,705 cr (Loss)

2095 cr in 01

Deposits

and Advance Int. Rate deregulated Re capitalized weak banks by Rs 20,000 cr Risk Based Supervision

Increased 4 times

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Nara II Report dated 22nd April 1998 Implementation done

SLR and CRR reduced and interest on them Directed credit - discouraged Interest rate structure - autonomy Capital adequacy- accepted Income recognition, asset classification-done Transparency of financial statements Tax treatment of provisions

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Nara II Report dated 22nd April 1998 Implementation done

Debt recovery tribunal established Entry of Private sector banks permitted Branch Licensing Foreign banks-liberalized Autonomy measures Supervisory Authority Board for Financial Supervision (BFS) Appointment of CEOs/Board members Development Financial Institutions Capital Market regulations
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Not implemented
Asset Reconstruction Fund Regional Rural Banks Foreign operations of Indian banks

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Recommendations of Nara II

RBI should withdraw from 91 days T bill market. Inter-bank and call money and term money market be restricted to banks and primary dealers Minimum shareholding of Government and RBI be brought down to 33%. RBI to withdraw from bank boards. Providing 5 % market risk for Government and approved securities Providing of risk weight for Government guaranteed accounts. Treat as NPAs if sticky.
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Recommendations of Nara II

Providing of risk weight for forex open position limits Accrual of interest for interest income 90 days CRR 9% by 2000 and 10% by 2002 Start up capital for foreign banks be increased to $ 25 m from $10 m Bank Chairman to have a three year term NPAs be identified and transferred to ARC Systems and methods in banks Issues related to Technology
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Recommendations of Nara II
Electronic funds transfer, ATM, Structural Issues Rural and small industrial credit Regulation and supervision Legal and legislative framework

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Challenges to banking in 2008

Retail credit which was growing at 30% y-o-y now in 10-15% and may end in single digit (Kamath). Tapering off. Criticism for strong arm tactics for recovery of bank loans Rising Non-performing loans (NPL). 10 year effort seems to be coming to end. Floating rate home loans, EMIs increasing and so default. Banks earnings are down Real estate accounts for 90% of credit growth of 100,000 crores of last two years- current melt down
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Challenge of 2009
From April 2009, entry of foreign banks easier. Issues relating to resources, capital, consolidation, talent and scale. Indian banks have to put their house in order to face the challenge.

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Other Important Committees1/3

Chore Committee (1979) and Tandon(1974) Committees on system of bank finance. Gave three methods of lending. Recommended second method. Bifurcation of loan limits into cash credit and loan (core). Peak and non-peak level be separate. Encourage bills. Fixed Inventory norms for raw material, goods in process, finished goods and receivables. 1991 Naik Committee Report on the adequacy of institutional credit to SSI sector. Bank finance to be 20 % of turnover. 1993. Shetty Committee on lending under consortium arrangements. Rs 5 Cr. to 20 Cr. 5 to10 banks
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Other important committees 2/3

1. 2.

3. 4.

1996 Shere Committee on Electronic Funds Transfer and other electronic payments:Defined scope of EFT and liabilities Defined finality and irrevocability of transfer of funds at different stages sender, settlement and receiver finality. Measures to ensure security, integrity and efficiency of net work linkages Consequence of fraud, paper documents, bank failures, evidence in courts, cheque truncation

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Other important committees 2/3

1. 2. 3.

1977 Marathe Committee on Urban Cooperative Banks (UCBs). Registration and licensing of new UCBs Primary credit societies Area of operation, rehabilitation and regulatory mechanism. 1986 Khusro Committee Report on Review of the Agricultural Credit System in India
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Areas of Concern for Indian Banking

Special protection to depositors interests Deposit Insurance Protection from Fraud Credit Rating Legal Reforms Best Practices and Best Practice Code (BPC ) Asset quality
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