Banking & Insurance

Banking

1 Lesson 1 Banking Sector in India

UNIT I
LESSON 1
BANKING SECTOR IN INDIA
Dr. Pooja Goel
Shaheed Bhagat Singh College
University of Delhi
Objectives
After going through this lesson you should be able to:

Understand the Concept of Banking

Describe the Development of Banking in India

Explain the Functions of Bank

Differentiate Among Banking Sectors

Structure
1.1 Concept of Banking
1.2 Development of Banking in India
1.3 Functions of Bank

1.4 Banking Sectors

1.5 Summary
1.6 Test Question
1.7 Further Readings
The banking sector is the lifeline of any modern economy. It is one of the
important 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
mobilization of deposits and disbursement of credit to various sectors of the
economy. The banking sector is dominant in India as it accounts for more
than half the assets of the financial sector.
1.1 Concept of Banking
Banks are institutions that accept various types of deposits and use those
funds for granting loans. The business of banking is that of an intermediary
between the saving and investment units of the economy. It collects the
surplus funds of millions of individual savers who are widely scattered and
channelize them to the investor. According to section 5(b) of the Banking
Regulation Act, 1949, banking means 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, and order or
otherwise. Banking company means any company which transacts the
business of banking in India. No company can carry on the business of
banking in India unless it uses as part of its name at least one of the words
bank, banker or banking. The essential characteristics of the banking
business as defined in section 5(b) of the Banking Regulation Act are:
Acceptance of deposits from the public, For the purpose of lending or
investment
a)

Withdraw able by means of any instrument whether a cheques or

otherwise.
1.2 Development of Banking in India
The history of banking dates back to the thirteenth century when the
first bill of exchange was used as money in medieval trade. There was no
such word as banking before 1640, although the practice of safekeeping and savings flourished in the temple of Babylon as early as 2000

B.C. Chanakya in his Arthashastra written in about 300 B.C. mentioned

about the existence of powerful guilds of merchant bankers who received
deposits, advanced loans and issued hundis (letters of transfer). The Jain
scriptures mention the names of two bankers who built the famous
Dilwara Temples of Mount Abu during 1197 and 1247 A.D.
The first bank called the Bank of Venice was established in
Venice, Itlay in 1157 to finance the monarch in his wars. The bankers of
Lombardy were famous in England. But modern banking began with the
English goldsmith only after 1640. The first bank in India was the Bank of
Hindustan started in 1770 by Alexander & Co. an English agency house in
Calcutta which failed in 1782 with the closure of the agency house. But
the first bank in the modern sense was established in the Bengal
Presidency as the Bank of Bengal in 1806.
History apart, it was the merchant banker who first evolved the
system of banking by trading in commodities than money. Their trading
activities required the remittances of money from one place to another.
For this, they issued hundis to remit funds. In India, such merchant
bankers were known as Seths.
The next stage in the growth of banking was the goldsmith. The
business of goldsmith was such that he had to take special precautions
against theft of gold and jewellery. If he seemed to be an honest person,
merchants in the neighborhood started leaving their bullion, money and
ornaments in his care. As this practice spread, the goldsmith started
charging something for taking care of the money and bullion. As evidence
for receiving valuables, he issued a receipt. Since gold and silver coins
had no marks of the owner, the goldsmith started lending them. As the
goldsmith was prepared to give the holder of the receipt an equal
amount of money on demand, the goldsmith receipts became like
cheques as a medium of exchange and a means of payment.
The next stage in the growth of banking is the moneylender. The
goldsmith found that on an average the withdrawals of coins were much
less than the deposits with him. So he started advancing the coins on loan
by charging interest. As a safeguard, he kept some money in the reserve.
Thus the goldsmith-money-lender became a banker who started
performing the two functions of modern banking that of accepting
deposits and advancing loans.
In India our historical, cultural, social and economic factors have
resulted in the Indian money market being characterized by the existence
of both the unorganized and the organized sectors.

(a)

Unorganized Sector: The unorganized sector comprises moneylenders and

indigenous bankers which cater to the needs of a large number of people
especially in the rural areas. They have been meeting the financial
requirements of the rural populace since times immemorial. Their
importance can be gauged from the fact that Jagat Seths, hereditary
bankers of the Nawab of Bengal, were recognized even by Aurangzeb and
the East India Company who were compelled to borrow from them also
publicly honored them.
The indigenous bankers are different from the proper banks in a
number of ways. For instance, they combine banking activities with trade
whereas trading is strictly prohibited for banks in the organized sector.
They do not believe in formalities or paper work for making deposits or
withdrawing money. In fact, since a substantial percentage of their
clientele is illiterate, they frequently take a thumb impression of their
customers on a blank paper. Even if they use a Hundi as a negotiable
instrument yet it will not be indicated on its face whether the
transaction is supported by valuable consideration or it is merely as a
result of mutual accommodation. The rate of interest charged by them
fluctuates directly with the need of the borrower and may sometimes be
as high as 300 percent! They are insulated from all type of monetary and
credit controls as they fall outside thy purview of RBI. Though they are
still the major source of funds for small borrowers, but now their market
has started shrinking because of the fast expansion of branches of banks
in the unorganized sectors.
1.3 Functions of Bank
According to section 6 of the Banking Regulation Act, 1949, the primary
functions of a bank are: acceptance of deposits and lending of funds. For
centuries, banks have borrowed 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. Besides these two
functions, a commercial bank performs a variety of other functions which
can be categorized in two broad categories namely (a) Agency or
Representative functions (b) General Utility functions.

(a)

Agency or Representative functions:

Collection and Payment of Various Items: Banks carry out

the standing instructions of customers for making payments;
including subscriptions, insurance premium, rent, electricity and
telephone bills, etc.

Undertake government business like payment of pension,

collection of direct tax (e.g. income tax) and indirect tax like
excise duty.

Letter of Reference: Banks buy and sell foreign exchange

and thus promote international trade. This function is normally
discharged by Foreign Exchange Banks.

Purchase and Sale of Securities: Underwrite and deal in

stock, funds, shares, debentures, etc.

Governments Agent: Act as agents for any government or

local authority or any other person or persons; also carry on
agency business of any description including the clearing and
forwarding of goods, giving of receipts and discharges, and
otherwise acting as an attorney on behalf of customers, but
excluding the business of a managing Agent or Secretary and
treasurer of a company.

Purchase and Sale of Foreign Exchange: Banks buy and sell

foreign exchange and thus promote international trade. This
function is normally discharged by Foreign Exchange Banks.

Trustee and Executor: Banks also act as trustees and

executors of the property of their customers on their advice.

Remittance of Money: Banks also remit money from one

place to the other through bank drafts or mail or telegraphic
transfers.

(a) General Utility functions:

Locker facility: Banks provide locker facilities to their

customers. People can keep their gold or silver jewellery or other

important documents in these lockers. Their annual rent is very

nominal.

Business Information and Statistics: Being familiar with the

economic situation of the country, the banks give advice to their
customers on financial matters on the basis of business information
and statistical data collected by them.

Help in Transportation of Goods: Big businessmen or

industrialists after consigning goods to their retailers send the
Railway Receipt to the bank. The retailers get this receipt from the
bank on payment of the value of the consignment to it. Having
obtained the Railway Receipt from the bank they get delivery of
the consignment from the Railway Goods Office. In this way banks
help in the transportation of goods from the production centers to
the consumption centers.

Acting as a Referee: If desired by the customer, the bank can

be a referee i.e. who could be referred by the third parties for
seeking information regarding the financial position of the
customer.

Issuing Letters of Credit: Bankers in a way by issuing letters of

credit certify the credit worthiness of the customers. Letters of
credit are very popular in foreign trade.

Acting as Underwriter: Banks also underwrite the securities

issued by the government and corporate bodies for commission.
The name of a bank as an underwriter encourages investors to have
faith in the security.

Issuing of Travellers Cheques and Credit Cards: Banks have

been rendering great service by issuing travellers cheques, which
enable a person to travel without fear of theft or loss of money.
Now, some banks have started credit card system, under which a
credit card holder is allowed to avail credit from the listed outlets
without any additional cost or effort. Thus a credit card holder
need not carry or handle cash all the time.

Issuing Gift Cheques: Certain banks issue gift cheques of

various denominations e.g some Indian banks issue gift cheques of
the denomination of Rs. 101, 501, 1001 etc. These are generally
issued free of charge or a very nominal fee is charged.

Dealing in Foreign Exchange: Major branches of commercial

banks also transact business of foreign exchange. Commercial banks
are the main authorized dealers of foreign exchange in India.

Merchant Banking Services: Commercial banks also render

merchant banking services to the customers. They help in availing
loans from non-banking financial institutions.

1.4 Banking Sectors

The spectrum of needs and requirements of individuals, organizations and
sectors of the economy is very vast and diverse. Banks have come up with a
whole range of banking products and services to suit the requirements of
their clients. Banking sectors include corporate banking, international
banking and rural banking.
Corporate Banking: Cooperative banking typically serves the
financial needs of large corporate houses- both domestic and
multinational-public sectors and governments. However, traditionally
banks had primarily been focusing on production based activities and
financed working capital requirements as well as term loans to
corporates due to following reasons:

From the beginning till the pre-reform era, business houses

were heavily dependent on banks for their financial needs. The
capital markets were not well developed, joint ventures norms
had not been liberalized, mergers and acquisitions were not the
preferred route and numerous restrictions were placed on
raising finance from overseas markets.

The banking institutions too showed a preference for

providing credit to the corporates. This way their paper work
was markedly reduced as the numbers of clients were less. Not
only the workload was eased but also the risk involved was
considerably less as corporate borrowings were made against
collaterals after verifying their capacity for repayment.

The government had also earmarked priority sectors, and as

such banks had to comply with the targets allotted to them.
After liberalization, many corporates could not face the
competition and went into the red. Economic downturn and
recessionary environment resulted in poor performance of many

borrowers. As a direct consequence of all these, the NPAs of banks

started mounting. However, according to the RBI annual report of
2005-06, the credit demand by the corporate sector has turned robust
on the back of strong industrial performance. Furthermore, banks are
expected to have greater financing opportunities in the area of
project finance, especially in the infrastructure sector, given the
conversion of two major financial institutions into banks. Banks have
been focusing mainly on syndication of debt to ensure wider
participation in project finance and wholesale leading segment.
Features
Corporate banking serves the need of corporates, those having a legal
entity. They offer business current accounts, make commercial loans,
participate in syndicated lending and are active in inter-bank markets
to borrow/lend from/ to other banks. Many banks offer structured
products, capital market services and corporate solutions. Corporate
banking involves comparatively fewer borrowers and the account size
is usually large and sometimes it can turn into billions of dollars.
Services
I.

Corporate banking services include:

II.

Working capital and terms loans, overdrafts,

bill discounting, project financing.

III.

Cash management both short term holdings of

cash as well as funds held for longer periods.

IV.

Financing of exports and imports including

export credit arrangements.

V.
VI.
VII.

Project finance
Transmission and receipt of money.
Handling foreign currency and hedging against
changes in value.

In recent times, there has been a marked shift from corporate to

retail banking. The major reason for avoiding corporate accounts is
the mounting non-performing corporate accounts. Difficulty in pricing
the services and high risks involved are some of the other reasons for
overlooking corporate accounts. However this is very lucrative

segment provided care is taken in identifying and focusing on selected

business segments and catering to their requirements, e.g. for the SME
segment, credit is paramount whereas for big corporates, customized
solutions are needed. Systematic account planning process can help to
identify the profitable customers, and pricing of services can help the
bank to get rid of asset quality problem. Most developed nations
banks have separate corporate bank divisions which help them to
avoid
the
pitfalls
of
one
size
fits
all
policies.
(B) Retail Banking: With a jump in the Indian economy from
a manufacturing sector, that never really took off, to a
nascent service sector, Banking as a whole is undergoing a
change. A larger option for the consumer is getting
translated into a larger demand for financial products and
customization of services is fast becoming the norm than a
competitive advantage. With the Retail banking sector
expected to grow at a rate of 30% players are focusing
more and more on the Retail and are waking up to the
potential of this sector of banking. At the same time, the
banking sector as a whole is seeing structural changes in
regulatory frameworks and securitization and stringent NPA
norms expected to be in place by 2004 means the faster
one adapts to these changing dynamics, the faster is one
expected to gain the advantage. In this article, we try to
study the reasons behind the euphemism regarding the
Retail-focus of the Indian banks and try to assess how much
of it is worth the attention that it is attracting. Retail
banking is typical mass-market banking in which individual
customers use local branches of larger commercial
banks. Retail banking is banking that provides direct services to
consumers. Many people with bank accounts have their accounts at
a retail bank and banks that offer retail banking services may also
have merchant and commercial branches that work with
businesses. For people with high net worth and special banking
needs, private retail banking services may be pursued. These offer
a high level of service with a number of options that are not
available to average members of the public. Services offered
include savings and checking accounts, mortgages, personal

loans, debit/credit cards and certificates of deposit

(CDs).The most basic retail banking services include savings
and checking accounts. Most retail banks, however, try to make
themselves into a one stop shop for banking customers. This
increasescustomer retention and loyalty, ensuring that the bank has
a steady supply of customers. Expanding banking services also
provides more opportunities for the bank to turn a profit.
Characteristics of Retail Banking
1.

Large Number of Small Customers: Retail banking is

characterized by the existence of a large number of small
customers, who consumes personal banking and small business
services. The essential prerequisite of retail banking is its
orientation towards the consumer whether it is in size, price,
delivery channels or product profile.

2.

Multiple Products: A basket of products including flexi deposits,

cards, insurance, medical expenses, auto loans are offered to the
consumers. Besides these, there are a number of value added
services like de-mat accounts, issue of free ATM cards, portfolio
management, payment of water, electricity and telephone bills.

3.

Multiple Delivery Channels: To increase penetration and access

banks are not limiting themselves to branches but are making
extensive use of internet, call centres, kiosks, etc.

Origin of Retail Banking: Origin of retail banking in India can be traced

to a number of developments.
1.

Financial Sector Reforms and Liberalization: Before opening up of the

economy during the decade of the nineties, corporate banking had been the
preferred goal for bankers. However, after the reforms it no longer
remained so. Corporates could now go in for external commercial
borrowings from any internationally recognized bank, export credit agency,
international capital market or supplier of equipment. They could also opt
for mergers and acquisitions. So banks had to look for other avenues than
the corporate sector for growth and expansion.

2.

Spreading of Risk: Another consequence of liberalization was industrial

recession, economic downturn, industrial sickness which resulted in failure
of many big corporates. Mounting non-performing assets made banks more
cautious about lending to business houses, and diverting their funds into the

retail segment, as retail banking has the advantage of minimizing the risk
and maximizing the returns. The returns from retail segment are three to
four percent as compared to one to two percent from the corporate
segment.
3.

Growth in Banking Technology and Automation of Banking Processes:

Technology has opened up new vistas for the banking industry and redefined
its nature, scope and extent. State-of-the-art electronic technology has
helped to increase penetration through ATMs without opening more
branches. Internet has made possible banking to be done from home.
Telebanking and phone banking are some other new technologies which have
revolutionized banking.

4.

Changing profile of Customers: An ever-increasing middle class, with

more disposable income, higher education and a desire for higher standard
of living have fuelled the demand for retail banking services. More and more
people seemed to have embraced the credit culture, and are demanding
consumer goods, holidays, education and a host of other value added
banking services.
(C) Rural Banking: On the birth anniversary of Mahatma Gandhi on
October 2, 1975, Rural Banks were established with a view to stepping up
rural credit. In 1975, the Government of India appointed a working group
under the Chairmanship of M. Narasimham, the Deputy Governor of the
Reserve Bank of India to review the flow of institutional credit to the
people in rural areas. The committee was to study the availability of
institutional credit to the weaker section of the rural population and to
suggest alternative agencies for this purpose. The committee concluded
that the commercial banks would not be able to meet the credit
requirements of the weaker sections of the rural areas in particular and
rural community in general. The Government accepted the
recommendations of the working group and passed an ordinance in
September 1977 to establish Regional Rural Banks.
Need to Establish Regional Rural Banks
The main need and objective of the RBBs was to provide credit and other
facilities to the small and marginal farmers, agricultural laborers and
artisans, who had, by and large, not been adequately served by the existing
credit institutions namely, cooperative banks and commercial banks:

1.

Co-operative Banks: So far as the co-operative credit structure is

concerned, it lacks the managerial talent, post credit supervision and the
loan recovery. They are also not in a position to mobilize necessary
resources.

2.

Commercial Banks: These banks are mostly centralized in urban areas

and are urban-oriented. Although these can play a crucial role as far as the
rural credit is concerned. For this they have to adjust their methods,
procedures, training and orientation in accordance with the rural
environment. Further, due to high salary structure, staffing pattern and high
establishment expenses their operational cost is also higher. Thus, under
these circumstances, the commercial banks cannot provide credit, to the
weaker sections of the rural areas, at a cheap rate.

3.

Need of a New Institution: Thus in accordance with the rural

requirements, the necessity was felt to establish such an institution i.e. a
rural oriented bank which may fulfill credit needs of the rural people
particularly the weaker section. It may also combine the merits of the above
two mentioned institutions, keeping aside their drawbacks. The RRBs, as
subsidization to nationalized banks, are expected in the long run not only to
provide credit to farmers and village industries but also to mobilize deposits
from rural households. They may form an integral part of the rural financial
structure in India.
Difference Between RRBs and Commercial Banks
Although the RRBs are basically the scheduled commercial banks, yet they
differ from each other in the following respects

1.

The area of the RRB is limited to a specified region comprising one or

more districts of a state.

2.

The RRBs grant direct loans and advance only to small and managerial
farmers, rural artisans and agricultural laborers and others of small having
small means for productive purposes.

3.

The lending rates of RRBs are not higher than the prevailing lending
rates of co-operative societies, in any particular state. The sponsoring banks
and the Reserve bank of India provide many subsidies and concessions to
RRBs to enable it to function effectively.
Organisation

The RRBs have been established by Sponsor bank usually a public sector
bank. The steering committee on RRBs identifies the districts requiring
these banks. Later, the Central Government sets up RRBs with the
consultation of the state government and the sponsor bank. Each RRBs
operates within local limits with such as name as may be specified by the
Central Government. The bank can establish its branches at any place within
the notified areas.
Capital
The authorized capital of each RRBs is Rs. 5 crore which may be increased or
reduced by the Central Government but not below its paid up capital of Rs.
25 lakh. Of this fifty percent is subscribed by the Central Government, 15
percent by the State Government and 35 percent by the sponsor bank. At
present the formula for subscription to RRBs has been fixed at 60:20:20
between central government, state government and the sponsor
bank. The Central Governments contribution is made through NABARD.
Management
Each RRB is managed by a Board of Directors. The general superintendence,
direction and management of the affairs and business of RRBs vests with the
nine member Board of Directors. The Central Government nominates 3
directors. The chairman, usually an officer of the sponsor bank but is
appointed by the central Government. The Board of Directors is required to
act on business principles and in accordance with the directives and
guidelines issued by the Reserve Bank. At the State Level, State Level
Coordination Committee have also been formed to have uniformity of
approach of different RRBs.
Functions
The RRB are required to perform the following functions or operations:
1.

Operations Related to Agricultural Activities: To grant loans and

advances to small and marginal framers and agricultural laborers, whether
individually or in groups or to cooperative societies including agricultural
marketing societies, agricultural processing societies, cooperative farming
societies, primary agricultural societies for agricultural purposes or for other
related purposes.

2.

Operations Related to Non-Agricultural Activities: Granting of loans and

advances to artisans, small entrepreneurs and persons of small means

engaged in trade, commerce and industry or other productive activities

within its area of operation.
(D) Micro-Credit: In spite of the phenomenal outreach of formal credit
institutions, the rural poor still depend upon the informal sources of credit.
Two major causes for this are the large number of small borrowers with
small and frequent needs. Also the ability of these borrowers to provide
collateral is very limited. Besides, the long and cumbersome bank
procedures and their risk perception have also been limiting factors. Microcredit has emerged as the most suitable and practical alternative to
conventional banking in reaching the hitherto untapped poor population.
Micro-credit or micro-finance means providing very poor families with very
small loans to help them engage in productive activities or grow their tiny
businesses. Over time, the concept of micro-credit been broadened to
include a whole range of financial and non-financial services like credit,
equity and institution building support, savings, insurance etc. Micro-finance
institution is an organization that provides financial services to people with
limited income who have difficulty in accessing the formal banking sector.
The objective of micro finance is to provide appropriate financial services to
significant numbers of low-income, economically active people in order to
finance micro-enterprises and non-farm income generating activities
including agro-allied activities and ultimately improve their condition as
well as that of local economies.
As per RBI micro-finance is the provision of thrift, credit and other
financial services and products of very small amount to the poor in rural,
semi-urban and urban areas for enabling them to raise their income levels,
and improve their living standard. Micro-credit institutions are those that
provide these facilities. The micro-finance approach has emerged as an
important development in banking for channelizing credit for poverty
alleviation directly and effectively. The micro-credit extended by banks to
individual borrowers directly or through any agency is regarded as a part of
banks priority sector loans.
(E ) Self-Help Groups: SHGs have been launched to combat the
problem of growing poverty at the grass roots level. Small, cohesive and
participative groups of the poor are formed who regularly pool their savings
to make small interest bearing loans to its members. In the process, they
lean the nuances of financial discipline. Initially bank credit is not primary
objective. It is only after the group stabilizes and gains ability to undertake
productive activity and bear risk that micro-credit comes into play.

The SHG bank linkage programme has proved to be the major

supplementary credit delivery system with a wide acceptance by banks,
NGOs and various government departments. It encourages the rural poor to
build their capacity to manage their own finances, and then negotiate bank
credit on commercial terms. Certain norms have to be observed in the
formation of SHGs. To become a member, a person has to be below the
poverty line. Only one member of a family can become a member and that
person cannot become a member of more than one SHG. There is no limit of
maximum number of members can be between 10 and 20. Members of SHGs
are supposed to meet regularly, that is, once a week or once a fortnight.
However, registration is optional and left to the discretion of the members.
(F) Non-Banking Financial Intermediaries: Non-Banking financial
Intermediaries are a heterogeneous group of financial institution, other than
commercial and cooperative banks. These institutions are an integral part of
the Indian financial system. A wide variety of financial institutions is
included in it. These institutions raise funds from the public, directly and
indirectly, to lend them to ultimate spenders. The Development Banks (such
as the IDBI, IFCI, ICICI, SFCs, SIDCs, etc.) fall in this category. They
specialize in making term loans to their borrowers. LIC, GIC and its
subsidiaries and the UTI are its other all India big term-lending institutions.
Out of these three, only UTI is a pure non-banking financial intermediary,
the others raise funds in the shape of premium from the sale of insurance.
Besides this, there are provident funds and post offices who mobilize public
savings in a big way for onward transmission to ultimate borrowers or
spenders. A large number of small NBFs such as investment companies loan
companies, hire purchase finance companies and the equipment leasing
companies, these are private sector companies with only a few exceptions.
Functions of Non-Banking Financial Intermediaries: The main
functions performed by NBFs are as under:
1.

Brokers of Loanable Funds: NBFs act as brokers of loanable funds and in

this capacity they intermediate between the ultimate saver and the
ultimate investor. They sell indirect securities to the savers and purchase
primary securities from investors. Thus, they change debt into credit. By
doing so, they take risk on themselves and reduce the risk of ultimate
lenders. Not only that, by diversifying their financial assets they spread
their risk widely and thus reduce their own risk because low returns on some
assets are offset by high return on others.

2.

Mobilization of Savings: These institutions mobilize savings for the

benefit of the economy. By providing expert financial services like easy
liquidity, safety of the principal amount and ready divisibility of savings into
direct securities of different values they are able to mobilize more funds
and attract larger share of public savings.

3.

Channelization of Funds into Investment The NBFs, by mobilizing savings,

channelize them into productive investments. Each intermediary follows its
own investment policy. For instance, savings and loan associations invest in
mortgages; insurance companies invest in bonds and securities etc. Thus this
channelization of public savings into investment helps capital formation and
economic growth.

4.

Stabilize the Capital Market These institutions trade in the capital

market in a variety of assets and liabilities, and thus equilibrate the demand
for and supply of assets. Since they function with a legal framework and
rules and they protect the interests of the savers and bring stability to the
capital market.

5.

Provide Liquidity Since the main functions of the NBFs convert a

financial asset into cash easily, quickly and without loss in the capital value,
they provide liquidity. They are able to do so, because they advance shortterm loans and finance them by issuing claims against themselves for long
periods and they diversify loans among different types of borrowers.
Types of Non Banking Financial Institutions: The main types of
non-banking financial institutions/intermediaries are as under:
The Life Insurance Companies: Life Insurance Corporation of India enjoys
near monopoly of life insurance in India. It is the biggest institutional
investor. The LIC was established in 1 September, 1956 by nationalizing all
the life insurance companies operating in India. Prior to nationalization of
insurance companies, 245 private insurance companies operate from 97
centres. The main objectives of LIC are (i) To carry on Life Insurance
business in India. Life insurance is a very important form of long term
savings. (ii) The LIC aims in promoting savings. (iii) To invest profitability the
savings collected in the form of payments received from life insurers. The
LIC has two tier of capital structure- the initial capital, and premium
capital. The initial capital of LIC is Rs. 5 crore provided by the Government
of India. The premium paid by policy holders are the principal source of
funds by LIC. Besides, the LIC receives interest, dividends, repayments and
redemptions which add to its investible resources. The LIC is required to

invest atleast 50% of its funds in government and other approved securities.
LIC has to invest 10% of its funds in other investments which include loans to
state governments for housing and water supply schemes, to Municipal
Corporation, and corporation, and cooperative sugar companies, loans to
policy holders, fixed deposits with banks and cooperatives societies. The
main principle involved is security of funds rather than maximization of
return on investment.
General Insurance Companies: General Insurance Corporation of India was
established in January 1973, when General Insurance Companies were
nationalized. At the time of nationalization, there were 68 Indian companies
and 45 non-Indian companies in the field. Their business was nationalized
and vested in the General Insurance Company and its four subsidiaries viz.,
National Insurance Company Ltd. and United India Insurance Company Ltd.
The GIC is the holding company and its direct business is restricted only to
aviation insurance; general insurance is handled by the subsidiaries of GIC
and they operate various types of policies to suit the diverse needs of
various segments of the society. They derive their income from insurance
premia and invest the funds in various types of securities as well as in the
form of loans. GIC has thus emerged as an important investment institution
operating in Indian capital market.
Unit Trust of India: The UTI is an investment institution which offers the
small investor a share in Indias industrial growth and productive investment
with minimum risk and reasonable returns. The UTI was established as a
Statutory Corporation in February 1964 under the UTI Act 1964. It
commenced its operations from 1 July, 1964. The UTI was established with
the objective of mobilizing the savings of the community and channeling
them into productive investment. Its objective is to encourage widespread
and diffused ownership of industry by affording investors particularly the
small investors, a means of acquiring shares assured of a reasonable return
with minimum risk. Thus, the primary objective of the Unit Trust in two fold
(i) To stimulate and pool the savings of the middle and low income groups
(ii) To enable the unit holders to share the benefits and prosperity of the
rapidly growing industrialization in the country. The UTI is managed by a
board of trustees. It consists of a chairman and 9 other trustees. The
chairman is appointed by the government of India in consultation with the
IDBI, 4 trustees nominated by the IDBI, one trustee each nominated by the
RBI, LIC and SBI and 2 trustees selected by other institutions which
contributed to the initial capital of the UTI. The head office of UTI is in
Mumbai. It has four zonal offices at Mumbai, Kolkata, Chennai and New
Delhi. It has 51 branch offices in various parts of the country.

(G) Mutual Funds: A mutual fund is a trust that pools the savings of a
number of investors who share a common financial gain. Anybody with an
investible surplus of as little as a few thousand rupees can invest in mutual
funds. These investors buy units of a particular Mutual Fund Scheme that has
defined investment objective and strategy. The money thus collected is then
invested by the fund manager in different type of securities. The income
earned through investments and the capital appreciation realized by the
scheme is shared by its unit holders in proportion to the number of units
owned by them. In India, the mutual fund industry started with the setting
up of Unit Trust of India in 1964. Public sector banks and financial
institutions began to establish mutual funds in 1987. The private sector and
financial institutions were allowed to set up mutual funds in 1993.
(H) Provident/ Pension Funds: These funds represent the most
significant form of long-term contractual saving of the household sector. At
present the annual contribution to these funds is running at double the rate
than the rate of annual contribution to life insurance. In the financial year
1999-2000, about Rs. 69.695 crore had accumulated in the provident fund
and other accounts with the Government of India. The resources mobilized
by the funds during the same year were Rs. 1,465 crore. The provident funds
scheme practically started in the post-independence period. Under the
legalization, provident funds have been made compulsory in the organized
sector of industry, coal mining, plantation and services (such as government,
banking, insurance, teaching, etc.) There is a separate P.F. Legislation for
coal mining, industries and Assam tea plantations. With the growth of the
organized sector of the economy and in wage employment, savings
mobilizations through PFs will growth further. The wage- earners are
encouraged to join, P.F. schemes and make contributions to them, because
thereby alone they are able to earn employers matching contribution to the
fund.
(I) Post Offices: Post offices serve as the vehicle for mobilizing small
savings of the public for the government. These have been established with
the sole motive of collecting peoples small savings in urban, semi-urban and
rural areas. They are generally known as Savings Banks. In rural areas
where majority of the population live, do not have such commercial banks.
To create banking habit among them and to collect their scattered small
savings, the savings banks have been opened. In India where there are no
commercial banks, the Post-Office perform the functions of commercial
banks, they collect the deposits of the people, open their deposit accounts
and pay interest for the deposited money.

1.5 Conclusion
In simple words, bank refers to an institution that deals in money. This
institution accepts deposits from the people and gives loans to those who
are in need. Besides dealing in money, banks these days perform various
other functions, such as credit creation, agency job and general service. The
spectrum of needs and requirements of individuals, organizations and
sectors of the economy is very vast and diverse. Banks have come up with a
whole range of banking products and services to suit the requirements of
their clients. Banking sectors include corporate banking, international
banking and rural banking.
1.6 Test Questions
Q1. What is a Bank? Explain the main functions of a Bank.
Q2. Explain the various types of retail banking services offered by banks.
Q3. Give an overview of different banking sectors in India.