Introduction to Banking

Meaning and origin of word Bank& Banking Evolution of Banking

Definition of Banking
Posted On : 20.02.2016 10:59 pm

Dr.L. Herber and L. Hart define the banker, as one who in the ordinary course of business honours cheques
drawn upon him by persons from and for whom he receives money on current accounts

Definition of Banking

On account of multifarious activities of modern banks, the Bank or Banking has

been defined by several economists as follows:

Dr.L. Herber and L. Hart define the banker, as one who in the ordinary course of
business honours cheques drawn upon him by persons from and for whom he
receives money on current accounts.
Chambers Twentieth century Dictionary defines a bank as and, institution for the
keeping, lending and exchanging etc. of money.

According to Crowther, The bankers business is to take the debts of other people
to offer his own in exchange, and thereby create money.

Prof. Kent defines a bank as, an organization whose principal operations are
concerned with the accumulation of the temporarily idle money of the general
public for the purpose of advancing to others for expenditure.
It is evident from the above definitions that a bank is an institution which accepts
deposits from the public and in turn advances loans by creating credit.
History of Banking

The name bank is usually used in the sense of commercial bank. The word bank
seems to have originated from the Germanic world banck which means a joint
stock fund or heap. It is possible that the word has also been derived from the
French word banque and the Italian word banco. The Italian word banco refers to
a bench at which the money changers or mediaeval bankers used to change one
kind of money into another and transact their banking business. Thus, the early
banking was associated with the business of money changing.

The first public banking institution was The Bank of Venice, founded in 1157. The
Bank of Barcelona and the bank of Genoa were established in 1401 and 1407
respectively. These are the recognized forerunners of modern commercial banks.
Exchange banking was developed after the installation of the Bank of Amsterdam
in 1609 and Bank of Hamburg in 1690.

The credit for laying the foundation of modern banking in England goes to the
Lombards of Italy who had migrated to other European countries and England.
The bankers of Lombardy developed the money lending business in England. The
Bank of England was established in 1694. The development of joint stock
commercial banking started functioning in 1833. The modern banking system
actually developed only in the nineteenth century. In India, the first modern bank
Bank of Bengal was established in 1806 in the Bengal presidency.
Commercial Banks and Functions of
Commercial Banks
Posted On : 20.02.2016 11:07 pm

A commercial bank is an institution that operates for profit. The traditional functions of a commercial bank
relate to the acceptance of deposits from the public and provision of credit to different sectors of the
economy.

Commercial Banks

A commercial bank is an institution that operates for profit. The traditional

functions of a commercial bank relate to the acceptance of deposits from the
public and provision of credit to different sectors of the economy. However, with
the evolution of modern banking and growth of banking system as an integral
part of the national economy, there has been a perceptible change in the attitude
and outlook of the commercial banks. These banks have started providing a host
of banking services to their customers. Nevertheless, the basic character of
commercial banking remains unchanged. In the early days, commercial banks are
organized as a joint stock company to earn profit. They cater to the needs of
short-term, medium term credit and provide capital to businessmen and
industrialists. In the recent days, the banks lend long term funds to businessmen
and industrialists.

Functions of Commercial Banks

The various functions performed by commercial banks can be classified as

follows:

1) Accepting or attracting deposits

 Commercial banks accept deposits by mobilizing the savings of the people.
These deposits can be of three forms.

Savings deposits: It is a kind of safety vault for the people with idle cash. These
deposits are kept under savings account. Deposits in this account earn interest at
nominal rates and the banks are entitled to release deposits on demand by the
deposit holder. In practice, the bank imposes a limit on the number and amount
of withdrawals during a period. Cheque facilities are also given to the deposit
holder.

Demand deposits: Demand deposits are kept under current account. The
depositor can withdraw the money on demand. But, the account holder should
specify the amount and the number of withdrawals. Banks do not pay any interest
on these accounts. On the contrary, bank imposes service charges on maintaining
these accounts.

Fixed deposits: These are also known as time deposits. The amount deposited
cannot be withdrawn before the maturity period for which they have contracted.
These deposits carry interest at higher rates varying with the length of the
contract.

2) Advancing of loans

Banks adopt several ways for granting loans and advances. These
operations take different forms.
a) Cash credit: The bank sanctions loans to individuals or firms against some
collateral security. The loan money is credited in the account of the borrower and
he can withdraw the amount as and when it is required. The ceiling of the loan
amount is determined by the bank on the basis of the stock value of the borrower
which in turn becomes Bankers possession. The borrower can withdraw the cash
within or upto the credit limit. The bank charges interest for the amount
withdrawn only.

b) Provision of overdraft facilities

The respectable and reliable customers enjoy these facilities. The customer
can issue cheques and overdraw the money in times of need, even if there
is no adequate balance in his account. The customer will pay the interest to
the bank for the amount overdrawn.

c) Discounting bills of exchange

This operation is done through discounting of commercial papers,

promissory notes and bills of exchange, usually for three months. The banks
after deducting interest charges and collection charges from the face value
of the bills, give the balance amount to the customer. When the exchange
bill matures, the banks collect the payment from the party.

3) Creation of money or credit

Every loan sanctioned by the banker creates a deposit. Because, when a bank
sanctions loan to a customer, an account is opened in his name and the loan
amount is credited into his account. The borrower withdraws money whenever
 the amount is required. The creation of such deposits leads to increase in the
money stock of the economy and through its circulation creates new money.

4) Other functions

Some of the other important functions performed by these banks are as

follows:

a) Transfer of funds

In the complexity of trade and commerce in the modern days, the transfer
of funds from one place to another becomes difficult. Banks help in
eliminating this difficulty through the use of various credit instruments like
cheques, bank drafts and pay orders, traveller cheques, etc. This process is
called clearing and it is efficiently done by bank operations.

b) Agency functions

Commercial banks are increasingly acting as financial agents for their

clients. They make all sorts of payments on behalf of their clients like
insurance premium, pension claims, dividend claims or capital demands
etc. Likewise, they buy and sell gold, silver and securities on behalf of their
clients.

c) General utility services

 A commercial bank performs general utility services such as providing
safety lockers for the safer custody of valuables of the customers.

Issuing of letter of credit to the customers.

Under-writing loans to be raised by public bodies and corporations.

Compiling statistics and information relating to trade, commerce and industry.

Thus, commercial banks render valuable services to the community.
Developed banking system ensures industrial and economic progress. It
constitutes the lifeblood of an advanced economic society. In developing
countries like India, commercial banking may be described as development
banking. It plays a critical developmental role in making their funds
available to the priority sectors, weaker sections and employment-oriented
schemes.

The word bank is used in the sense of a commercial bank. It is of Germanic origin
though some persons trace its origin to the French word Banqui and the Italian
word Banca. It referred to a bench for keeping, lending, and exchanging of money
or coins in the market place by money lenders and money changers. There was no
such word as banking before 1640, although the practice of safe-keeping 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, and advanced loans and issued
hundis (letters of transfer). The Jain scriptures mention the names of two bankers
who built the famous Dilware Temples of Mount Abu during 1197 and 1247 A.D.
The first bank called the Bank of Venice was established in Venice, Italy in 1157 to
finance the monarch in his wars. The bankers of Lombardy were famous in England.
But modern banking began with the English goldsmiths 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.

Thus the commercial banks contribute much to the growth of a developing economy
by granting loans to agriculture, trade and industry, by helping in physical and human
capital formation and by following the monetary policy of the country.

Role of Commercial banks in economic development of a

country
1. Capital Formation:

Banks play an important role in capital formation, which is essential for the
economic development of a country. They mobilize the small savings of the
people scattered over a wide area through their network of branches all over the
country and make it available for productive purposes. Now-a-days, banks offer
very attractive schemes to attract the people to save their money with them and
bring the savings mobilized to the organized money market. If the banks do not
perform this function, savings either remains idle or used in creating assets, which
are low in scale of plan priorities.

2. Creation of Credit:
Banks create credit for the purpose of providing more funds for development
projects. Credit creation leads to increased production, employment, sales and
prices and thereby they cause faster economic development.

3. Channelizing the Funds to Productive Investment:

Banks invest the savings mobilized by them for productive purposes. Capital
formation is not the only function of commercial banks. Pooled savings should be
distributed to various sectors of the economy with a view to increase the
productivity of the nation. Then only it can be said to have performed an
important role in the economic development of the nation.

4. Fuller Utilization of Resources:

Savings pooled by banks are utilized to a greater extent for development

purposes of various regions in the country. It ensures fuller utilization of
resources.

5. Encouraging Right Type of Industries:

The banks help in the development of the right type of industries by extending
loan to right type of persons. In this way, they help not only for industrialization
of the country but also for the economic development of the country. They grant
loans and advances to manufacturers whose products are in great demand.

6. Bank Rate Policy:

Economists are of the view that by changing the bank rates, changes can be
made in the money supply of a country. In our country, the RBI regulates the rate
of interest to be paid by banks for the deposits accepted by them and also the
rate of interest to be charged by them on the loans granted by them.

7. Bank Monetize Debt:

Commercial banks transform the loan to be repaid after a certain period into
cash, which can be immediately used for business activities. Manufacturers and
wholesale traders cannot increase their sales without selling goods on credit
basis. But credit sales may lead to locking up of capital.

8. Finance to Government:

Government is acting as the promoter of industries in underdeveloped countries

for which finance is needed for it. Banks provide long-term credit to Government
by investing their funds in Government securities and short-term finance by
purchasing Treasury Bills.

9. Bankers as Employers:

After the nationalization of big banks, banking industry has grown to a great
extent. Banks branches are opened in almost all the villages, which leads to the
creation of new employment opportunities. Banks are also improving people for
occupying various posts in their office.

10.Banks are Entrepreneurs:

In recent days, banks have assumed the role of developing entrepreneurship

particularly in developing countries like India. Developing of entrepreneurship is a
complex process. It includes the formation of project ideas, identification of
specific projects suitable to local conditions, inducing new entrepreneurs to take
up these well-formulated projects and provision of counseling services like
technical and managerial guidance.

Role of Banks in economic development

Banks play a very useful and crucial role in the economic life of every nation. They
have control over a large part of the supply of money in circulation, and they can
influence the nature and character of production in any country.
Role of Banks in economic development

Banks play a very useful and crucial role in the economic life of every nation. They
have control over a large part of the supply of money in circulation, and they can
influence the nature and character of production in any country. In order to study
the economic significance of banks, we have to review the general and important
functions of banks.

1) Removing the deficiency of capital formation

In any economy, economic development is not possible unless there is an

adequate degree of capital accumulation (or) formation. Deficiency of capital
formation is the result of low saving made by the community. The serious capital
deficiency in developing economies is reflected in small amount of capital
equipment per worker and the limited knowledge, training and scientific advance.
At this juncture, banks play a useful role. Banks stimulate saving and investment
to remove this deficiency. A sound banking system mobilizes small savings of the
community and makes them available for investment in productive enterprises.
The important implications of this activity include Banks mobilise deposits by
offering attractive rates of interest and thus convert savings into active capital.
Otherwise that amount would have remained idle.

Banks distribute these savings through loans among productive enterprises

which are helpful in nation building.

It facilitates the optimum utilization of the financial resources of the community.

2) Provision of finance and credit

Banks are very important sources of finance and credit for industry and trade. It is
observed that credit is the lubricant of all commerce and trade. Hence, banks
become nerve centers of all trade activities and therefore commerce and trade
could function in the presence of sound banking system.

The banks cover foreign trade transactions also. Big banks also undertake foreign
exchange business. They help in concluding deferred payments, arrangements
between the domestic industrial undertakings and foreign firms to enable the
former import machinery and other essential equipment.

3) Extension of the size of the market

Commercial bankers help commerce and industry in yet another way. With the
sound banking system, it is possible for commerce and industry for extending
their field of operation. Commercial banks act as an intermediary between buyers
and the sellers. Goods are supplied on bank guarantees, making it viable for
industry and commerce to cultivate and locate markets for their products. The
risks are undertaken by the bank. When the risks have been set free by the banks,
the industry can look forward to derive economies of the large size of the market.

4) Act as an engine of balanced regional development

Commercial banks help in proper allocation of funds among different regions of

the economy. The banks operate primarily for profits. When the banks lend their
funds for more productive uses, their profits will be maximized. Introduction of
branch banking makes it possible to choose between different regions. A region
with growth potential attracts more bank funds. But in recent years, the approach
of banks towards regional growth has been undergoing a change. Banks help
create infrastructure essential for economic development. Thus banks are engines
of balanced regional development in the country.

5) Financing agriculture and allied activities

The commercial bank helps the farmers in extending credit for agricultural
development. Farmers require credit for various purposes like making their
produce, for the modernization and mechanization of their agriculture, for
providing irrigation facilities and for developing land.

The banks also extend their financial assistance in the areas of animal husbanding,
dairy farming, sheep breeding, poultry farming and horticulture.

6) For improving the standard of living of the people

The standard of living of the people is estimated on the basis of the consumption
pattern. The banks advance loans to consumers for the purchase of consumer
durables and other immovable property, which will raise the standard of living of
the people.

Central bank - Definition, Functions

Posted On: 20.02.2016 11:09 pm

The banking system of a country can work systematically in coordinated manner, only if there is an apex
institution to direct the activities of the banks. Such apex institution is popularly known as central bank.

Central Banks
 The banking system of a country can work systematically in coordinated
manner, only if there is an apex institution to direct the activities of the
banks. Such apex institution is popularly known as central bank. The central
bank of the country is an autonomous institution, entrusted with powers of
control and supervision. It controls the monetary and banking system of the
country. After World War II, the International Monetary conference held at
Brussels in 1929 recommended the setting up of a central bank in every
country. The central bank of our country, known as Reserve Bank of India was
set up in 1935. The central bank of England called Bank of England was
established in 1694. It is known as the mother of central banks, since it
provides the fundamentals of the art of central banking.

The central bank of France called Bank of France was founded in 1800. The
USA established a central banking system in the form of Federal Reserve
Banks in 1914.

Definition of a central bank

A central bank has been defined in terms of its functions. The following are some
of the definitions given by economists.

According to Smith, the primary definition of central banking is a banking system

in which a single bank has either complete control or a residuary monopoly of
note issue.

H.A. Shaw defines a central bank, as a bank which controls credit.

In the words of Haw trey a central bank is that which is the lender of the last
resort.
According to Samuelson, a central bank is a bank of bankers. Its duty is to
control the monetary base and through control of high-powered money to
control the communitys supply of money.

Distinction between central banks and commercial banks

The central bank is basically different from commercial banks in the following
respects.

The central bank is the apex institution of the monetary and banking system of
the country. A commercial bank is only a constituent unit of the banking system
and a subordinate to the central bank.

While the central bank possesses the monopoly of note-issue, commercial

banks do not have this right.

The central bank is not a profit making institution. Its aim is to promote the
general economic policy of the government. But, the primary objective of
commercial banks is to earn profit for their shareholders.

The central bank maintains the foreign exchange reserves of the country. The
commercial banks only deal in foreign exchange under the directions of the
central bank.
The central bank is an organ of the government and acts as its banker and the
financial advisor, whereas commercial banks act as advisors and bankers to the
general public only.

Functions of Central bank

The main functions of a central bank are common all over the world. But the
scope and content of policy objectives may vary from country to country and from
period to period depending on the economic situations of the respective country.
Generally all the central banks aim at achieving economic stability along with a
high growth rate and a favorable external payment position through proper
monetary management. The common functions of central banks are discussed
below.

Regulator of currency

The issue of paper money is the most important function of a central bank. The
central bank is the authority to issue currency for circulation, which is a legal
tender money. The issue department of the central bank has the responsibility to
issue notes and coins to the commercial banks. The central bank regulates the
credit and currency according to the economic situation of the country. In the
methods of note issue, the central bank is required to keep a certain amount or a
fixed proportion of gold and foreign securities against the total notes issued. The
Reserve Bank of India is required to keep Rs.115 crore in gold and Rs.85 crore in
foreign securities, but there is no limit to the issue of notes.

Having the monopoly of note issue, central bank gains advantages as

Ensuring uniformity of the notes issued and a proper control over the supply of
money can be exercised.

Bring stability in the monetary system and creates confidence among the public.

Government is able to earn profits from printing currencies.

Banker, Agent and Adviser to the Government

The central bank of the country acts as the banker, fiscal agent and advisor to the
government. As a banker, it keeps the deposits of the central and state
governments and makes payments on behalf of governments. It buys and sells
foreign currencies on behalf of the government. It keeps the stock of gold of the
country. As a fiscal agent, the bank makes short-term loans to the government for
a period not exceeding 90 days. It floats loans and advances to the State
governments and local bodies. It manages the entire public debt on behalf of the
government. As an adviser, the bank gives useful advice to the governments on
important monetary and economic problems like devaluation, foreign exchange
policy and budgetary policy.

Custodian of cash Reserves of commercial banks

Commercial banks are required to keep a certain percentage of cash reserves with
the central bank. On the basis of these reserves, the central bank transfers funds
from one bank to another to facilitate the clearing of cheques.
Custodian and Management of Foreign Exchange reserves

The central bank keeps and manages the foreign exchange reserves of the
country. It fixes the exchange rate of the domestic currency in terms of foreign
currencies. If there are any fluctuations in the foreign exchange rates, it may have
to buy and sell foreign currencies in order to minimize the instability of exchange
rates.

Lender of the last resort

By giving accommodation in the form of re-discounts and collateral advances to

commercial banks, bill brokers and their financial institutions, the central bank
acts as the lender of the last resort. The central bank lends to such institutions in
order to help them when they are faced with difficult situations so as to save the
financial structure of the country from collapse.

Clearing Function

The central bank acts as a clearing house for other banks and mutual obligations
are settled through the clearing system. Since it holds cash reserves of
commercial banks, it is easier for the central bank to act as a clearing house.

Controller of credit

The most important function of the central bank is to control the credit creation
power of commercial banks in order to control inflationary and deflationary
pressures within the economy. For this purpose, the central bank adopts
Quantitative methods and Qualitative (selective) methods. Quantitative methods
aim at controlling the cost and quantity of credit by adopting i) bank rate policy ii)
open market operations iii) variations in reserve ratios of commercial banks.
Qualitative methods control the use and direction of credit. It involves i)
regulation of margin requirements ii) regulation of consumer credit, iii) rationing
of credit, iv) direct action by the central bank, and v) moral suasion

Besides the above functions, the central bank performs many additional
functions. It has to study all problems relating to i) credit, ii) fluctuations in price
level iii) fluctuations in foreign exchange value. It has to collect monetary and
financial statistics, conduct research and provide information. It has to look after
the matters relating to IMF and the World Bank. All together, the central bank is
the financial and monetary guardian of the nation.

BANKING STRUCTURE IN INDIA

Reserve Bank of India (RBI)
The country had no central bank prior to the establishment of the RBI. The RBI is
the supreme monetary and banking authority in the country and controls the
banking system in India. It is called the Reserve Bank as it keeps the reserves of
all commercial banks.
Scheduled & Non scheduled Banks
A scheduled bank is a bank that is listed under the second schedule of the RBI Act,
1934. In order to be included under this schedule of the RBI Act, banks have to
fulfill certain conditions such as having a paid up capital and reserves of at least
0.5 million and satisfying the Reserve Bank that its affairs are not being conducted
in a manner prejudicial to the interests of its depositors. Scheduled banks are
further classified into commercial and cooperative banks. Non- scheduled banks
are those which are not included in the second schedule of the RBI Act, 1934. At
present these are only three such banks in the country.
Commercial Banks
Commercial banks may be defined as, any banking organization that deals with
the deposits and loans of business organizations.Commercial banks issue bank
checks and drafts, as well as accept money on term deposits. Commercial banks
also act as moneylenders, by way of installment loans and overdrafts.Commercial
banks also allow for a variety of deposit accounts, such as checking, savings, and
time deposit. These institutions are run to make a profit and owned by a group of
individuals.
Scheduled Commercial Banks (SCBs):
Scheduled commercial banks (SCBs) account for a major proportion of the
business of the scheduled banks. SCBs in India are categorized into the five groups
based on their ownership and/or their nature of operations. State Bank of India
and its six associates (excluding State Bank of Saurashtra, which has been merged
with the SBI with effect from August 13, 2008) are recognised as a separate
category of SCBs, because of the distinct statutes (SBI Act, 1955 and SBI Subsidiary
Banks Act, 1959) that govern them. Nationalised banks and SBI and
associates together form the public sector banks group IDBI ltd. has been
included in the nationalised banks group since December 2004. Private sector
banks include the old private sector banks and the new generation private sector
banks- which were incorporated according to the revised guidelines issued by the
RBI regarding the entry of private sector banks in 1993.
Foreign banks are present in the country either through complete
branch/subsidiary route presence or through their representative offices.

Classification of Banks in India: 2 Types

This article throws light upon the two types of banks that operate in India.
The types are: 1. Central Bank 2. Commercial Banks.
Type # 1. Central Bank:
The bank is called the apex bank in a country. This bank is also known as
central bank entrusted with the task of controlling, guiding and regulating
the entire banking system and structure in the country. It is owned by the
Govt. and help in deciding the monetary and credit policies in the best
interest of the country.

The central Bank is Government Banker, maintains revenue and

expenditure records of Govt. under different heads, helps govt. to decide
rate of interest. The central bank regulates and issues currency performs
banking services to all other banks and in case of need extends loans to
banks on reasonable rates.

As such it functions like a bankers bank also. Like Central Govt. it provides
agency services to State Govts. Also. It keeps international currency and
manages all necessary action relating to foreign exchange. Foreign exchange
reserves are held by the central bank. Cash Reserves of all the commercial
banks are held by the central bank.

ADVERTISEMENTS:

It is empowered to inspect the functioning of all banks including credit

control. The central bank collects returns and financial statements
mandatory to be submitted by all the banks. In case of default central bank
can levy penalty on defaulting banks. The Reserve Bank of India is the
Central Bank of India. It does not deal directly as banker with the public.

Type # 2. Commercial Banks:

As is clear from the name a commercial bank is one that functions like
commercial company with a view to earn profits. Usually a commercial bank
is an establishment which deals in money, receiving it as deposits from
customers, honouring customers drawings against such deposits on
demand. Collecting cheques for customers and lending or investing surplus
deposits until they are required for repayment.

Normally these banks perform all kinds of functions as have been prescribed
under banking regulation and other Acts. Excepting deposits, lending money
(both short time and long time). They also perform agency functions and
correspondent banks. In fact all the commercial banks are joint stock
companies and they work like that.
Different Types of Commercial Banks:
ADVERTISEMENTS:

a) Nationalised Banks:
The Nationalised Banks are also known as Public Sector Banks. Majority of
Stake in these banks is held by the government. Government of India in
consultation with the Reserve Bank of India prescribes functioning norms for
these banks. Previously the entire equity was held by the government but
over a period of time it was reduced but still the majority is held by the
Govt. Some strong banks have been allowed to reach the capital market and
raise the additional capital.

b) State Bank of India and Its Associate Banks:

These banks are also nationalized bank. In addition to working as
commercial banks they also work as the agent of RBI.

ADVERTISEMENTS:

c) Private Sector Banks:

All the banks working under private sectors are also Joint Stock companies.
These banks are registered as companies with limited liability. Previously
before independence it was mandatory for any private bank that at least
one of its Director should have unlimited liability to safe guard the
customers interest.

In Private banks majority of share capital is held by private individuals where

as in Public Sector Banks it is held with government. All the banking norms
and regulations prescribed by RBI are applicable on these banks also.
Followed by several banking reforms in India banks started enjoying some
operational freedom. With the result more and more private banks are
coming up. Moreover Private Sector Banks are better capitalized compared
to PSB.

d) Foreign Banks:
ADVERTISEMENTS:
Foreign Banks working in India are also Private banks but these banks have
their Headquarters in a foreign country and not in India. They have opened
their branches in India to work as registered banks. Lately these banks have
been allowed to expand their functions including through subsidiaries and
off shore banking.

e) Specialised Banks:
Under this category those banks can be covered which do not perform
ordinary banking functions but have been established to fulfill certain
specific goals.

Cooperative Banks
Cooperative banking is retail and commercial banking organized on
a cooperative basis. Cooperative banking institutions take deposits and lend
money in most parts of the world.

Cooperative banking, as discussed here, includes retail banking carried out

by credit unions, mutual savings banks, societies and cooperatives, as well as
commercial banking services provided by mutual organizations (such
as cooperative federations) to cooperative businesses.

Types of Banking

Types of Banking

When we talk about banks, we are talking about several different types of financial institutions,
conducting different kinds of business. Some banks are very large and carry out many different
functions, others are more specialised. Some have operated for hundreds of years and some have
taken on new kinds of business quite recently.

Not all banks carry out the same range of activities. Banking activities can be generally divided into
the following types:
Central Banking
The duty of central banks is to maintain financial stability, otherwise a country's economy will not
operate properly. Central banks act as regulators of their country's interest rates by controlling the
amount of money in circulation and buying and selling currencies. They amass reserves and act as
lenders of last resort, should another bank get into trouble. They exist as a separate entity from all
the other banks.

Reserve Bank of India

The Reserve Bank of India (RBI) is India's central banking institution, which
controls the monetary policy of the Indian rupee. It commenced its
operations on 1 April 1935 during the British Rule in accordance with the
provisions of the Reserve Bank of India Act, 1934.

The original share capital was divided into shares of 100 each fully paid,
which were initially owned entirely by private shareholders. Following
India's independence on 15 August 1947, the RBI was nationalized on 1
January 1949.

The RBI plays an important part in the Development Strategy of

the Government of India.

It is a member bank of the Asian Clearing Union. The general

superintendence and direction of the RBI is entrusted with the 21-member
Central Board of Directors: the Governor, 4 Deputy Governors, 2 Finance
Ministry representatives, 10 government-nominated directors to represent
important elements of India's economy, and 4 directors to represent local
boards headquartered at Mumbai, Kolkata, Chennai and New Delhi. Each of
these local boards consists of 5 members who represent regional interests,
the interests of co-operative and indigenous banks.

The Reserve Bank of India (RBI) is India's central banking institution.

It was established on 1 April 1935 during the British Raj in accordance with
the provisions of the Reserve Bank of India Act, 1934 after the
recommendation from Hilton-Young commission.
The Reserve Bank of India was nationalized in 1949 under the Reserve Bank
(Transfer of Public Ownership) Act, 1948.

The headquarters of the Reserve Bank of India are located in Mumbai. RBI
has 19 regional offices most of them in state capitals and 9 sub-offices.

Its present governor is Duvvuri Subba Rao.

The basic functions of the Reserve Bank of India are to regulate the issue of
Bank notes and the keeping of reserves with a view to securing monetary
stability in India and generally to operate the currency and credit system of
the country to its advantage.( From the Preamble of the Reserve Bank of
India Act, 1934)

The chief objective of such recommendation were twofold:

To separate the control of currency and credit from the government

To augment banking facilities throughout the country.

Origin of the Reserve Bank of India

Origin of the RBI:

Strategic efforts were made to establish a central bank in India. Warren

Hastings made the earliest attempt, when he was acting as the Governor of
Bengal in 1773. He recommended for the formation of General Bank in
Bengal and Bihar. The Chamberlin Commission report in 1913 also raised
the issue of the founding of a central bank for the country. Based on this
report, Professor J.M. Keynes formulated the first comprehensive plan for
an Indian central bank. However, Keynes plan did not come into effect, on
account of the outbreak of the First World War.

There has been a long series of efforts to establish a central bank in our
country. The earliest attempt may be traced back to 1773, when Warren
Hastings, the Governor of Bengal (later Governor-General), felt the need for
a central bank in the country and recommended that a General Bank in
Bengal and Bihar be founded.

The Report of the Chamberlain Commission in 1913 also raised the issue of
the founding of a central bank in the country. As a supplement to this
report, Professor J.M. Keynes chalked out the first comprehensive plan for
an Indian central bank. Keynes plan, however, did not come into effect,
owing to the outbreak of the First World War.

In 1921, the Imperial Bank of India was set-up by the amalgamation of the
three Presidency Banks, which performed a few central banking functions,
though primarily it remained as a commercial bank. Specifically, the Imperial
Bank served as a banker to the government and in some capacity as
bankers bank till the establishment of the Reserve Bank of India in 1935.

The founding of a central bank in India was again stressed by the Royal
Commission on Indian Currency and Finance (popularly known as the Hilton-
Young Commission) in 1926. The Commission suggested the name Reserve
Bank of India for the countrys central bank. In January 1927, a bill to this
effect was introduced in the Legislative Assembly, but was dropped on
constitutional grounds. In 1931 the Indian Central Banking Enquiry
Committee made a strong recommendation for the establishment of a
Reserve Bank.

Objects and Functions of Reserve Bank of India

Major functions of the RBI are as follows:

Monetary authority
Issuer of currency
Banker, Agent and Financial Advisor to the government
Banker to the Banks
Regulation and supervision of the banking and financial system
Management of Foreign Exchange
Regulation and Supervision of the Payment and Settlement Systems
Developmental role

1. Issue of Bank Notes:

The Reserve Bank of India has the sole right to issue currency notes except one rupee
notes which are issued by the Ministry of Finance. Currency notes issued by the
Reserve Bank are declared unlimited legal tender throughout the country.
2. Banker to Government:
As banker to the government the Reserve Bank manages the banking needs of the
government. It has to-maintain and operate the governments deposit accounts. It
collects receipts of funds and makes payments on behalf of the government. It
represents the Government of India as the member of the IMF and the World Bank.

3. Custodian of Cash Reserves of Commercial Banks:

The commercial banks hold deposits in the Reserve Bank and the latter has the
custody of the cash reserves of the commercial banks.

4. Custodian of Countrys Foreign Currency Reserves:

The Reserve Bank has the custody of the countrys reserves of international
currency, and this enables the Reserve Bank to deal with crisis connected with
adverse balance of payments position.

5. Lender of Last Resort:

The commercial banks approach the Reserve Bank in times of emergency to tide over
financial difficulties, and the Reserve bank comes to their rescue though it might
charge a higher rate of interest.

6. Central Clearance and Accounts Settlement:

Since commercial banks have their surplus cash reserves deposited in the Reserve
Bank, it is easier to deal with each other and settle the claim of each on the other
through book keeping entries in the books of the Reserve Bank. The clearing of
accounts has now become an essential function of the Reserve Bank.

7. Controller of Credit:
Since credit money forms the most important part of supply of money, and since the
supply of money has important implications for economic stability, the importance of
control of credit becomes obvious. Credit is controlled by the Reserve Bank in
accordance with the economic priorities of the government.

Objectives of the Reserve Bank of India

The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives of
the Reserve Bank as:

To regulate the issue of Bank notes and the keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and
credit system of the country to its advantage.

Besides it has other objectives, which can be listed out as below.

1. To remain free from political influence and be in successful operation for

maintaining financial stability and credit.

2. To discharge purely central banking functions in the Indian money market, such
as acting as the note-issuing authority, bankers bank and banker to Government,
and to promote the growth of the economy.
3. To assist the planned process of development of the Indian economy.

To manage the monetary and credit system of the country.

*To stabilizes internal and external value of rupee.
* For balanced and systematic development of banking in the country.
* For the development of organized money market in the country.
* For proper arrangement of agriculture finance.
* For proper arrangement of industrial finance.
* For proper management of public debts.
* To establish monetary relations with other countries of the world and international
financial institutions.
* For centralization of cash reserves of commercial banks.
* To maintain balance between the demand and supply of currency.

RBI & its role in the economy

1. Acts as the currency authority The Reserve Bank manages currency in India.
The Government, on the advice of the Reserve Bank, decides on the various
denominations. The Reserve Bank also co-ordinates with the Government in the
designing of bank notes, including the security feature. The Reserve Bank
estimates the quantity of notes that are likely to be needed denomination-wise
and places the indent with the various presses through the Government of India.

The Reserve Bank derives its role in currency management on the basis of the
Reserve Bank of India Act, 1934. All the currency notes except one rupee note are
issued by RBI. The RBI act permits RBI to issue notes in the denominations of
rupees 2, 5, 10, 20, 50, 100, 500, 1000, 5000, 10000. Currently 5000 and 10000
rupee notes are not in circulation.

2. Controls money supply and credit RBI controls the supply of money in the
economy by exercising its control over interest rates in order to maintain price
stability and achieve high economic growth. RBI takes into account the following
monetary policies to control money supply and credit

a) Open Market Operations

b) Cash Reserve Ratio

c) Statutory Liquidity Ratio

d) Bank Rate Policy

e) Repo Rate and Reverse Repo Rate

Each of the five points will be discussed in detail in a separate post.

3. Manages foreign exchange RBI ensures that short term fluctuations in trade
do not affect the exchange rate. In order to maintain stability in exchange rates,
RBI enters into foreign exchange transactions

4. Serves as a banker to the government RBI acts as the banker, agent and
advisor to the Government of India. It accepts payment for the account of the
union and also makes payment on the behalf of government.

5. Acts as the banker of banks As the bankers bank, RBI holds a part of the cash
reserves of banks, lends the banks funds for short periods, and provides them
with centralized clearing and cheap and quick remittance facilities.

6. Supervises banks RBI exercises powers of supervision, regulation and control

over commercial banks. The banks regulatory functions relating to banks cover
their establishment (i.e. licensing), branch expansion, liquidity of their assets,
management and methods of working, amalgamation, reconstruction and
liquidation.
 Banker Customer Relationship

Debtor-creditor relationship

Banker as an agent

Creditor demanding payment

Banker as a Bailee

Banker as a trustee

Proper place & time of demand

Not time barred

Bank as an executor

Bank as an attorney

Banker has a right to combine account

A banker has no right to close the account

A banker as a creditor
Assurance and Insurance
The two words were used synonymously at one time, but there is fine
distinction between the two. Assurance is used in those contracts which guarantee
the payment of a certain sum on the happening of a specified event which is bound
to happen sooner or later, for example attaining a certain age or death. Thus life
policies comes under assurance.
Insurance, on the other hand, contemplates the granting of agreed compensation of
the happening of certain events stipulated in the contract which are not expected
but which may happen, for example risk relating to fire, accident or marine.
1. Principle of utmost good faith: A contract of insurance is a contract of
Uberrimae Fidei i.e., of utmost good faith. Both insurer and insured should
display the utmost good faith towards each other in relation to the contract.
In other words, each party must reveal all material information to the other
party whether such information is asked or not. There should not be any
fraud, non-disclosure or misrepresentation of material facts.
Example in case of life insurance, the insured must revel the true age and
details of the existing illness/diseases. If he does not disclose the true fact
while getting his life insured, the insurance company can avoid the contract.
Similarly, in case of the insurance of a building against fire, the insured must
disclose the details of the goods stored, if such goods are of hazardous nature
A material fact means important facts which would influence the judgment of
the insurer in fixing the premium or deciding whether he should accept the
risk, on what terms. All material facts should be disclosed in true and full form
2. Principle of Insurable Interest: This principle requires that the insured must
have a insurable interest in the subject matter of insurance. Insurance interest
means some pecuniary interest in the subject matter of contract of insurance.
Insurance interest is that interest, when the policy holders get benefited by
the existence of the subject matter and loss if there is death or damage to the
subject matter.
For example In life insurance, a man cannot insured the life of a stranger as he
has no insurable interest in him but he can get insured the life of himself and
of persons in whose life he has a pecuniary interest. So in the life insurance
interest exists in the following cases:-
 - Husband in the life of his wife and wife in the life of her husband
- Parents in the life of a child if there is pecuniary benefit derived from the
life of a Child
- Creditor in the life of debtor
- Employer in the life of an employee
- Surety in the life of a principle debtor
In life insurance, insurable interest must be present at the time when the
policy is taken. In fire insurance, it must be present at the time of insurance and at
the time if loss if subject matter. In marine insurance, it must be present at the time
of loss of the subject matter.
3. Principle of Indemnity: This principle is applicable in case of fire and marine
insurance only. It is not applicable in case of life, personal accident and
sickness insurance. A contract of indemnity means that the insured in case of
loss against which the policy has been insured, shall be paid the actual cost of
loss not exceeding the amount of the insurance policy. The purpose of
contract of insurance is to place the insured in the same financial position, as
he was before the loss.
Example A house is insured against fire for Rs. 50000. It is burnt down and found
that the expenditure of Rs. 30000 will restore it to its original condition. The
insurer is liable to pay only Rs. 30000.
In life insurance, principle of indemnity does not apply as there is no question
of actual loss. The insurer is required to pay a fixed amount upon in advance in
the event of accident, death or at the expiry of the fixed term of the policy.
Thus, a contract of a life insurance is a contingent contract and not a contract
of indemnity.
4. Principle of Contribution: The principle of contribution is a corollary to the
doctrine of indemnity. It applies to any insurance which is a contract of
indemnity. So it does not apply to life insurance. A particular property may be
insured with two or more insurers against the same risks. In such cases, the
insurers must share the burden of payment in proportion to the amount insured
by each. If one of the insurer pays the whole loss, he is entitled to contribution
from other insurers
Example B gets his house insured against fire for Rs. 10000 with insurer P and for
Rs. 20000 with insurer Q. a loss of Rs. 15000 occurs, P is liable to pay for Rs.
 5000 and Q is labile to pay Rs 10000. If the whole amount pf loss is paid by Q,
then Q can recover Rs. 5000 from P. The liability of P &Q will be determined as
under:

Sum insured with Individual insurer (i.e. P or Q) x Actual Loss = Total sum
insured

Liability of P = 10000 x 15000 = Rs.5000

30000

Liability of Q = 20000 x 15000 = Rs.10000

30000
The right of contribution arises when:
(a) There are different policies which related to the same subject matters;
(b) The policies cover the same period which caused the loss;
(c) All the policies are in force at the time of loss; and
(d) One of the insurer has paid to the insured more than his share of loss.
5. Principle of Subrogation : The doctrine of subrogation is a collorary to the
principle of indemnity and applies only to fire and marine insurance.
According to doctrine of subrogation, after the insured is compensated for the
loss caused by the damage to the property insured by him, the right of
ownership to such property passes to the insurer after settling the claims of
the insured in respect of the covered loss.
Example Furniture is insured for Rs. 1 lacs against fire, it is burnt down and
the insurer pays the full value of Rs. 1 Lacs to the insured, later on the damage
Furniture is sold for Rs. 10000. The insurer is entitled to receive the sum of Rs.
10000.
A loss may occur accidentally or by the action or negligence of third party. If
the insured suffer a loss because of action of third party and he is in a position
to recover the loss from the insurer then insured can not take action against
third party, his right is subrogated (substituted) to the insurer on settlement
 of the claim. The insurer, therefore, can recover the claim from the third
party.
If the insured recovers any compensation for the loss (due to third party),
from the third party, after he has already been indemnified by the insurer, he
holds the amount of such compensation as the trustee if the insurer.
The insurer is entitled to the benefits out of such rights only to the extent of
the amount he has paid to the insured as compensation
6. Principle of Causa Proxima : Causa proxima, means proximate cause or cause
which, in a natural and unbroken series of events, is responsible for a loss or
damage. The insurer is liable for loss only when such a loss is proximately
caused by the peril insured against. The cause should be the proximate cause
and can not the remote cause. If the risk insured is the remote cause of the
loss, then the insurer is not bound to pay compensation. The nearest cause
should be considered while determining the liability of the insured. The
insurer is liable to pay if the proximate cause is insured.

Example In a marine insurance policy, the goods were insured against

damage by sea water, some rats on the board made a hole in a bottom of the
ship causing sea water to pour into the ship and damage the goods. Here, the
proximate cause of loss is sea water which is covered by the policy and the
hole made by the rats is a remote cause. Therefore, the insured can recover
damage from the insurer
Example A ship was insured against loss arising from collision. A collision
took palce resulting in a few days delay. Because of the delay, a cargo of
oranges becomes unsuitable for human consumption. It was held that the
insurer was not liable for the the loss because the proximate cause of loss was
delay and not the collision of the ship.
7. Principle of Mitigation of Loss: An insured must take all reasonable care to
reduce the loss. We must act as if the property was not insured.
Example If a house is insured against fire, and there is accidental fire, the
owner must take all reasonable steps to keep the loss minimum. He is
supposed to take all steps which a man of ordinary prudence will take under
the circumstances to save the insured property.
Benefits of Insurance or Role and Importance of Insurance
Benefit of insurance can be divided into these categories -
1. Benefits to Individual
2 Benefits to Business or Industry
3. Benefits to the Society
It can be explained as under -
1. Benefits to Individual
(a) Insurance provides security & safety : Insurance gives a sense of security to
the policy holder. Insurance provide security and safety against the loss of
earning at death or in old age, against the loss at fire, against the loss at
damage, destruction of property, goods, furniture etc.
Life insurance provides protection to the dependents in case of death of
policyholders and to the policyholder in old age. Fire insurance insured the
property against loss on a fire. Similarly other insurance provide security
against the loss by indemnifying to the extent of actual loss.
(b) Encourage Savings : Life insurance is best form of saving. The insured person
must regularly save out of his current income an amount equal to the
premium to be paid otherwise his policy get lapsed if premium is not paid on
time.
(c) Providing Investment Opportunity : Life insurance provide different policies
in which individual can invest smoothly and with security; like endowment
policies, deferred annuities etc. There is special exemption in the Income Tax,
Wealth Tax etc. regarding this type of investment
2 Benefits to Business or Industry
(a) Shifting of Risk : Insurance is a social device whereby businessmen shift
specific risks to the insurance company. This helps the businessmen to
concentrate more on important business issues.
(b) Assuring Expected Profits : An insured businessman or policyholder can enjoy
normal expected profits as he would not be required to make provisions or
allocate funds for meeting future contingencies.
(c) Improve Credit Standing : Insured assets are easily accepted as security for
loans by the banks and financial institutions so insurance improve credit
standing of the business firm
 (d) Business Continuation With the help of property insurance, the property of
business is protected against disasters and chance of closure of business is
reduced
3. Benefits to the Society
(a) Capital Formation : As institutional investors, insurance companies provide
funds for financing economic development. They mobilize the saving of the
people and invest these saving into more productive channels
(b) Generating Employment Opportunities : With the growth of the insurance
business, the insurance companies are creating more and more employment
opportunities.
(c) Promoting Social Welfare : Policies like old age pension scheme, policies for
education, marriage provide sense of security to the policyholders and thus
ensure social welfare.
(d) Helps Controlling Inflation : The insurance reduces the inflationary pressure in
two ways, first, by extracting money in supply to the amount of premium
collected and secondly, by providing funds for production narrow down the
inflationary gap.
3. Social Insurance: Social insurance provide protection to the weaker sections
of the society who are unable to pay the premium. It includes pension plans,
disability benefits, unemployment benefits, sickness insurance and industrial
insurance.
II Risk Points of View
The insurance can be classified into three categories from Risk point of view
1. Property Insurance
2. Liability Insurance
3. Other forms of Insurance
1. Property Insurance: Property of the individual and business is exposed to risk
of fire, theft marine peril etc. This needs insurance. This is insured with the
help of:-
(i) Fire Insurance
(ii) Marine Insurance
(iii) Miscellaneous Insurance
 (i) Fire Insurance: Fire insurance covers risks of fire. It is contract of
indemnity. Fire insurance is a contract under which the insurer agrees to
indemnify the insured, in return for payment of the premium in lump sum
or by instalments, losses suffered by the him due to destruction of or
damage to the insured property, caused by fire during an agreed period of
time. It includes losses directly caused through fire or ignition. There are
various types of fire insurance policies.
- Consequential loss policy
- Comprehensive policy
- Valued policy
- Valuable policy
- Floating policy
- Average policy
(ii) Marine Insurance: Marine insurance is an arrangement by which the
insurer undertakes to compensate the owner of the ship or cargo for
complete or partial loss at sea. So it provides protection against loss
because of marine perils. The marine perils are collisions with rock, ship
attack by enemies, fire etc. Marine insurance insures ship, cargo and
freight.
The following kinds of marine policies are -
- Voyage policy
- Time policy
- Valued policy
- Hull Policy
- Cargo Policy
- Freight Policy
(iii) Miscellaneous Insurance: It includes various forms of insurance including
property insurance, liability insurance, personal injuries are also insured.
The property, goods, machine, furniture, automobile, valuable goods etc.
can be insured against the damage or destruction due to accident or
disappearance due to theft.
Miscellaneous insurance covers
 - Motor
- Disability
- Engineering and aviation risks
- Credit insurance
- Construction risks
- Money Insurance
- Burglary and theft insurance
- All risks insurance
2. Liability Insurance: The insurer is liable top pay the damage of the property or
to compensate the loss of personal injury or death. It includes fidelity
insurance, automobile insurance and machine insurance.
The following are types of liability Insurance:-
- Third party insurance
- Employees insurance
- Reinsurance
3. Other forms of Insurance: It include export credit insurance, state employee
insurance etc. whereby the insurer guarantees to pay certain amount at the
happening of certain events.
The following are other form of Insurance-
- Fidelity Insurance
- Credit Insurance
- Privilege Insurance

Insurance since Ancient times

In India, Insurance has well established history of more than thousand years. In Rigveda, there is a
concept called Yogakshema, which means prosperity, well being and security of people. Also
Insurance was mentioned in Manusmrithi, Dharmashastra and Arthashastra. In those times
insurance refers to pooling of resources that could be re-distributed in times of natural calamities
such as fire, floods, epidemics and famine. This was probably a pre-cursor to modern day insurance.
Modern Day Insurance

The modern form of Life Insurance came to India from England in the year 1818. Oriental Life
Insurance Company started by Europeans in Calcutta was the first life insurance company on Indian
Soil.

The insurance companies established during that period were brought up with the purpose of
looking after the needs of European community and Indian natives were not being insured by these
companies. However, later with the efforts of eminent people like Babu Muttylal Seal, the foreign
life insurance companies started insuring Indian lives. But Indian lives were being treated as sub-
standard lives and heavy extra premiums were being charged on them.

Bombay Mutual Life Assurance Society heralded the birth of first Indian life insurance company in
the year 1870, and covered Indian lives at normal rates. Bharat Insurance Company (1896) was also
one of such companies inspired by nationalism. The Swadeshi movement of 1905-1907 gave rise to
more insurance companies such as The United India in Madras, National Indian and National
Insurance in Calcutta and the Co-operative Assurance at Lahore.

Life Insurance Companies Act, 1912

In the year 1912, the Life Insurance Companies Act, and the Provident Fund Act were passed. The
Life Insurance Companies Act, 1912 made it necessary that the premium rate tables and periodical
valuations of companies should be certified by an actuary. But the Act discriminated between
foreign and Indian companies on many accounts, putting the Indian companies at a disadvantage.

Insurance Act 1938

From 44 companies with total business-in-force as Rs.22.44 Crores, it rose to 176 companies with
total business-in-force as Rs.298 Crores in 1938. With a view to protect the interests of the Indian
Insurance companies, the earlier legislation was amended with the enactment of the Insurance Act
1938, which consists comprehensive provisions for effective control over the activities of insurers or
insurance organizations.
The Insurance Act 1938 was the first legislation governing the life insurance and non-life insurance
and to provide strict state control over insurance business.

Birth of Life Insurance Corporation of India

On 19th of January, 1956, that life insurance in India was nationalized. About 154 Indian insurance
companies, 16 non-Indian companies and 75 provident were operating in India at the time of
nationalization. Nationalization was accomplished in two stages; initially the management of the
companies was taken over by means of an Ordinance, and later, the ownership too by means of a
comprehensive bill.

The Parliament of India passed the Life Insurance Corporation Act on June 1956, and the Life
Insurance Corporation of India was created on September 1956, with the objective of spreading life
insurance much more widely and in particular to the rural areas with a view to reach all insurable
persons in the country, providing them adequate financial cover at a reasonable cost.

The LIC had monopoly till the late 90s when the Insurance sector was reopened to the private
sector.

History of General (non-life) Insurance

The history of general insurance dates back to the Industrial Revolution in the west during the 17th
century. General Insurance in India has its roots in the establishment of Triton Insurance Company
Ltd. at Kolkata in the year 1850 by the Britishers. In 1907, the Indian Mercantile Insurance Ltd. was
established and was the first company to transact all classes of general insurance business.

In 1957, General Insurance Council (GIC), a wing of the Insurance Associaton of India was
established The General Insurance Council framed a code of conduct for ensuring fair conduct and
sound business practices across Non-Life or General insurance sector.

In 1968, the Insurance Act was amended to regulate investments and set minimum solvency
margins. The Tariff Advisory Committee was also established in the same year.
With the passing of the General Insurance Business (Nationalization) Act in 1972, general insurance
business was nationalized. A total of 107 insurers were amalgamated and grouped into four
companies namely National Insurance Company Ltd. at Kolkata, the New India Assurance Company
Ltd. at Mumbai, the Oriental Insurance Company Ltd at New Delhi and the United India Insurance
Company Ltd at Chennai.

Malhotra Committee

The Government set up a committee in 1993 under the chairmanship of R.N. Malhotra, former
Governor of RBI (Reserve Bank of India), to propose recommendations for initiation and
implementation of reforms in the Indian insurance sector. The objective of setting up this
committee was to complement the pace of reforms initiated in the financial sector.

The aforesaid committee submitted its report in 1994 wherein it was recommended that the
private sector be permitted to enter the Indian insurance sector. It also recommended the
participation of foreign companies by allowing them to enter into an MOU (Memorandum of
Understanding) by floating Indian companies, preferably a joint venture with Indian partners.

Birth of IRDA

Following the recommendations of the Malhotra Committee report, the Insurance

Regulatory and Development Authority (IRDA) Act, in 1999 was passed by the
Indian Parliament.

The IRDA opened up the Indian insurance market in August 2000 by inviting
application for registration proposals. Foreign companies were allowed entry into
Indian insurance sector with an upper ceiling on ownership of up to 26%
participation. The IRDA has been granted the powers to frame regulations under
Section 114A of the Insurance Act, 1938.

From 2000 onwards, IRDA has framed various regulations for carrying on
insurance business to protection of Indian policyholders interests including the
registration of Life & Non-Life (General) Insurance companies.
Insurance a thriving sector

At present there are 28 general insurance companies including the ECGC and Agriculture Insurance
Corporation of India and 24 life insurance companies operating in the country.
The insurance sector is a massive one and is thriving at a speedy rate of 15-20%. Together with
banking services, insurance services add about 7% to the countrys GDP. A well-developed and

Banker and a Customer Relationship

The relationship between a banker and a customer depends on the type of

transaction.

These relationships confer certain rights and obligations both on the part of
the banker and on the customer.

Bank customers can be categorized in to four broad categories

Those who maintain account relationship with banks i.e. existing

customers.

Those who had account relationship with bank i.e. Former Customers

Those who do not maintain any account relationship with the bank but
frequently visit branch of a bank for availing banking facilities such as for
purchasing a draft, en-cashing a cheque, etc. Technically they are not
customers, as they do not maintain any account with the bank branch.

Prospective/ Potential customers

Classification of Relationship

1. General Relationship
 2. Special Relationship

1. General Relationship

Debtor-Creditor

CreditorDebtor

2. Special Relationship

Bank as a Trustee

Termination of relationship between a banker and a customer

The death, insolvency, lunacy of the customer.

The customer closing the account i.e. Voluntary termination.

Liquidation of the company.

The closing of the account by the bank after giving due notice.

The completion of the contract or the specific transaction.

Duties of a banker

Duty to maintain secrecy/confidentiality of customers' accounts.

Duty to honor cheques drawn by customers on their accounts and collect

cheque, bills on his behalf.

Duty to pay bills etc., as per standing instructions of the customer.

Duty to provide proper services.

 Duty to act as per the directions given by the customer. If directions are not
given the banker has to act according to how he is expected to act.

Duty to submit periodical statements i.e. informing customers of the state

of the account

Articles/items kept should not be released to a third party without due

authorization by the customer.

Types of Bank Accounts in India

Current deposits / accounts

Saving bank / saving fund deposits / accounts

Recurring deposits / accounts

Fixed deposits / accounts or term deposits

Development of Insurance in India

To understand the Development of Insurance in India we have to look into the

development of Insurance Laws in India, since its a necessity and compulsion on
Business Doers to evolve-conceptualize-amend their policies/strategies in
accordance with the Law of the Land to do hassle-free business.
In the following manner the Indian Insurance Scenario has changed gradually-
1938 This is the year when a comprehensive Act called The Insurance Act,
1938 has been introduced.

1939 In this year the Insurance Rules were framed for effectuating the
Insurance Act.

1956 This year has witnessed a huge change in the Indian Insurance Sector since
the Government of India took over all life insurance companies.

1968 In 1968 The Insurance Act, 1938 was amended to provide for social
control, minimum solvency margin and a Tariff Advisory Committee (TAC) has also
been established.

1972 This year witnessed the Nationalization of General Insurance Companies

and for this General Insurance Business (Nationalization) Act, 1972 was passed.

1973 The General Insurance Corporation of India (GIC) came into existence as a
Government Company.

1974 A year later 107 insurers practicing General Insurance business were
grouped and merged to form four subsidiaries of GICs namely National
Insurance Co. Ltd. The New India Assurance Co. Ltd. The Oriental Insurance Co.
Ltd. United India Insurance Co. Ltd.

1991 The Public Liability Insurance Act 1991 and Public Liability Insurance Rules
1991 were introduced as another milestone in the series of Public Welfare Laws in
India.1994 The Malhotra Committee submitted its report in January 1994 (set
up by Govt. in 1993 under Chairmanship of Shri R.N. Malhotra, former Governor
of RBI, to examine potential reforms that could be undertaken in the insurance
sector and complement them with reforms initiated in the other sectors)
submitted its report in January 1994 and recommended establishment of a strong
and effective insurance regulatory authority.
1998 Insurance Ombudsman Redressed of Public Grievances Rules, 1998 were
issued to provide Consumers a Forum with minimal formalities to get their
grievances resolved.

1999 This year has the great relevance in the history of Indian Insurance Sector
since based on the Malhotra Committee Report the Insurance Regulatory and
Development Authority (IRDA) was established to regulate, promote and ensure
orderly growth of the insurance and reinsurance business in India.

2001 The year of 2001 brought another transformation in the Insurance

Business of India because in addition to the existing Government insurance
companies, Private Sector Companies were also licensed by IRDA to conduct
general insurance business in India.

General Insurance Companies in India (Image Credit: www.insurancemags.com)

2002 General Insurance Business (Nationalization) Amendment Act, 2002 was

passed in which the important amendment was that the subsidiaries of GIC were
restructured as independent companies and GIC was converted into National Re-
insurer.

2003 This year witnessed the introduction of Broker for first time in Indian
Insurance Market to boost up the business in more widened manner.
2015 The Insurance Laws (Amendment) Act, 2015 was passed to increase the
Ceiling of 26% FDI to 49% and in this manner the Insurance Business in India has
been widely opened for Foreign Giants of Insurance.

The other kind of classification divides the economy into only two broad
categories:
ADVERTISEMENTS:

(a) Priority sectors and

(b) Non-priority sectors.

This kind of classification was adopted for policy purposes for the first time in
1968. The highlights of the sectoral allocation of commercial bank credit over
the two sub-periods and the two schemes of sectoral classification are
discussed in the sub-section below.
A. Pre-Nationalisation Period (1951-68):
The highlights of this period are summed up below:
ADVERTISEMENTS:

1. Dramatic Increase in the Share of Industry and Decline in that of Trade

and Others:
The share of industry in scheduled commercial banks credit rose rapidly over
the period. From 34 per cent in 1951 it raised to 51 per cent in 1961 and to
67.5 per cent in 1968, thereby doubling itself in a span of 17 years. There was
a corresponding decline in the share of trade from 36 per cent to 19 per cent
and that of the miscellaneous category from 28 per cent to 11 per cent. Within
the industrial sector, the bulk (about 80 per cent) of bank credit went to the
corporate sector and only a small fraction to the small-scale industry. Of the
incremental bank credit to the industrial sector, the main beneficiaries were
newer industries such as engineering, iron and steel, and chemicals.

The factors responsible for the aforesaid shift in the advances pattern
operated on both the demand and supply sides of bank credit. On the one
hand, the state policy, under the framework of a mixed economy and five-year
plans initiated in 1951, sought the industrial development of the country
largely through the promotion of large industries in the corporate sector.

To that end, it entailed several supportive measures, which offered new profit
opportunities to large industry and encouraged greatly its demand for bank
credit. On the other hand, large industry and established business houses,
because of their ownership or control of big commercial banks, could claim
easily an increasing proportion of the incremental bank credit and banks
themselves were perfectly happy to fall in line.

2. Heavy Concentration of Bank Credit:

Another feature of the pattern of bank advances to industry is its highly
skewed distribution in favour of large borrowers. According to one source, the
size distribution of borrowal accounts of commercial banks (in mid-sixties)
showed that 70% of total industrial advances went to only 1% of the total
number of borrowal accounts, each with credit outstanding of over Rs. 5
lakhs, whereas 12% of the accounts with outstanding of less than Rs. 10,000
each received barely 4% of the total.

A similar concentration was observed in the case of guarantees (in respect of

deferred payments) issued by banks. The number of borrowal accounts itself
had stayed nearly stagnant during the sixties till 1968, increasing from 10.78
lakhs in April 1961 to only 11.27 lakhs in March 1968.

What factors were responsible for such heavy concentration of bank credit for
industry in favour of a few large borrowers? It will explain how and why the
security-oriented credit in search of safety against risk of default tends to
favour large borrowers in general. This will be so even when banks are free
from effective control by big borrowers. This will be all the more so if banks
are owned and controlled by big borrowers. And this was the situation before
the nationalisation of 14 major banks in July 1969, at least so as far as the
ownership was concerned.

A few facts are worth noting. The commercial banks in India had a very low
capital base. The ratio of paid-up capital to deposits was too low and was
going down over time. The low capital base facilitated concentration of
controlling of bank shares in a few hands and gave them command over the
deployment of rapidly growing deposits. This represented concentration of
enormous economic power. Understandably, therefore, all proposals from the
RBI for the strengthening of the capital base of banks by new issues of share
capital (which would have led to some dilution of ownership and control) met
with stiff opposition from the chambers of commerce and the Indian Banks
Association.

Another institutional mechanism used for exercising control over the credit
policy of banks has been the interlocking of directorship. An official survey of
directorships of 20 leading banks, conducted in 1963, had brought out that
188 persons, who had been serving on the Boards of these 20 banks, had
1,452 directorships of other companies also. The total number of companies
(excluding non-profit making organizations) under these directors was 1,100.
It was further revealed that through common directors, banks were connected
with insurance companies, finance companies, investment trusts,
manufacturing and trading companies and non-profit organizations.

Yet another institutional device used by large industrial borrowers for

appropriating the bulk of bank credit going to industry was by cornering
industrial licenses and on their bases obtaining long-term financial assistance
and underwriting (of new issues) facility from development banks and other
term-lending institutions.

These arrangements are usually treated as good indicators of the soundness

of projects for which commercial banks willingly provided working capital. The
rediscounting and refinance facilities offered to banks by the IDBI for industrial
loans of various kinds and at concessional rates of interest further encouraged
commercial banks to advance industrial credit liberally.

3. Low Share of Agriculture:

Throughout the period (1951-68), agriculture continued to command a very
low proportion (a little more than 2%) of total commercial bank credit, firstly
because commercial banks were reluctant to provide such credit and so were
not geared to that end and secondly because, as a matter of deliberate policy
(of functional specialisation), the needs of agricultural credit were supposed to
be met by the co-operative credit system. But from about the mid-sixties, the
latter was finding it increasingly difficult to meet the credit requirements of
both large farmers adopting new technology under the HYVP (High-Yield-
Variety Programme) and the weaker sections.
Against the background of severe shortage of food grains production in the
country and the consequent need for promoting the HYVP and to support also
the weaker sections on political considerations, pressures came to be exerted
on the RBI to provide adequate refinance to the co-operative credit system.

Since the RBI as the central banking authority considered it inadvisable to

stretch its help beyond a reasonable limit and since there were inherent
organizational and structural limitations on the co-operative banking system in
raising its own resources, a multi-agency approach for the provision of
agricultural credit with commercial banks as the other source of credit came to
be initiated. To start with, the SBI was assigned the role of providing credit to
agricultural marketing and processing societies.

As these societies were dominated primarily by big cultivators and traders with
semi-urban and urban contacts and as agriculture became more paying under
the new technology, the demand for more of agricultural credit from
commercial banks became stronger over time. Things started changing in this
direction soon after the nationalisation of 14 major banks in July 1969.

4. Miscellaneous Category:
In March 1951 about 28% of total commercial bank credit went to such parties
as non-bank financial companies, including indigenous bankers (12.7%),
private persons in the form of personal loans (6.8%) and others. With the
steep rise in credit to industry, the share of this residual category had declined
to about 11%.
B. Post-Nationalisation Period:
The key feature of the post-nationalisation period in the field of allocation of
credit has been growing functional diversification with increasing emphasis on
credit to priority sectors and emergence of food credit (that is, credit for the
procurement of food grains) as an important item. These twin developments
have led to reallocation of sectoral credit from what it was in the pre-
nationalisation period.

1. Priority Sectors:
The concept of priority sectors for the allocation of commercial bank credit
took definite shape during the brief period of the Social Control of Banks
(1968). Initially, at the recommendation of the National Credit Council, three
sectors, namely, agriculture, small industries, and exports, were officially
recognized as priority sectors. Later, a few more categories came to be added
to the list, namely, road and water transport operators, professional and self-
employed persons, retail trade and small business, and education.

Exports came to be treated separately in their own right. Targets of priority

sector credit for public sector banks were set and revised from time to time as
a matter of government policy. The targets were set in terms of percentages
of bank credit outstanding.

For example, it was put as 40% to be attained by March 1985. In most cases,
the targets were exceeded. Sub-targets were also set. For example, it was
said that at least 15% of total credit must go to agriculture by way of direct
finance and that at least 25% of priority-sector advances (or 10% of total
credit) must go to the weaker sections.
The data on the priority sector credit outstanding are presented in Table 6.2.

Credit to agriculture and other priority sectors are discussed below.

Credit given to agriculture is of two types:

(a) Direct finance and

(b) Indirect finance.

More than 80% of it is direct finance and the rest in indirect finance. The
former comprises the following:
(i) Short-term loans (including crop loans) given for the purchase of production
inputs such as seeds, fertilizers, pesticides and to meet the cost of cultivation.
These loans are generally repayable within a period of 12 months and in
certain cases within 15 to 18 months. The repayment schedule is related to
the harvesting and marketing of particular crops;

(ii) Medium/long-term loans granted for the development of agriculture, such

as development of small irrigation (tube wells and other wells), purchase of
tractors and other agricultural implements and machinery, improvement of
land. The period of repayment of these loans is generally 3 to 10 years. It may
be longer where refinance is available from the NABARD and such refinance
is quite substantial. More than half of direct finance is in the form of term
loans, also called investment or development finance.
Such finance, no doubt, is very helpful for asset formation in (and
development of agriculture. But we must also recognize that its main
beneficiaries have been and are likely to be relatively large farmers (with more
than 10- acre holdings), whereas small farmers have fared better with short-
term loans; and

(iii) Loans for allied agricultural activities such as dairying, poultry farming,
piggeries, pisciculture, etc. Indirect finance to agriculture is finance given to
agencies or individuals engaged in the marketing of agricultural commodities,
supply production inputs and other services for agriculture, like credit for
financing the distribution of fertilisers, pesticides, and other inputs, loans to
State Electricity Boards for financing their programmes tube-well energization,
loans to primary agricultural credit societies, investment in debentures issued
by land development banks, etc. Since nationalisation, advances to
agriculture have recorded a substantial increase and so have the advances
outstanding to it. At the end of June 1995, the latter had stood at Rs. 22,200
crores (see Table 6.2).

Yet 60% of the assisted families could not cross the poverty line. So, under
the 7th plan, in addition to covering 10 million families as new beneficiaries,
supplementary assistance was given to deserving 10 million families that had
been assisted during the 6th plan period.

2. Fall in the Share of Bank Credit to Large and Medium Industry and
Rise in that of the Small-Scale Industry:
There has been a persistent decline in the share of bank credit from
scheduled commercial banks to industry as a whole and to large and medium
industry in particular. This share of industry decreased from 67.5% in March
1968 to 48.8% in March 1986. The share of large and medium industry
declined from 60.6% in March 1968 to 34.7% and that of small industry rose
from 6.9 (in March 1968) to 14.1% in March 1986.

Some part of the measured changes in relative shares as between March

1968 and later dates might have arisen due to changes in the classification of
data a purely measurement (or statistical) phenomenon. However, a major
part of the measured changes is genuine and the shifts in the sectoral
allocation of credit are mainly the result of policy changes. With the increased
diversification in industry, the structure of industry-wise allocation of bank
credit has also undergone changes: the relative shares of textiles, engineering
and sugar have declined and those of newer industry groups have improved.

3. Rise in the Share of Food Advances:

With rising trend in the domestic output of food grains, market surpluses of
food, public distribution of food grains, public procurement of food, and the
size of buffer stocks of food, a rising share of bank credit has taken the form
of food advances. For example, in March 1968, the amount outstanding of
food advances of Rs. 109 crore constituted only 3.5% of total advances of
scheduled commercial banks; by March 1995, these advances had increased
to Rs- 12,300 crore, constituting about 6.2% of total advances.

In order to encourage banks to meet this new and growing demand, the RBI
not only issued appropriate guidelines to banks, but also offered them its
refinance facilities against increases in such advances. Over time as the food
advances grew, the RBI has been tightening the conditions of refinance from
time to time and made the commercial banks to finance larger amounts of
such advances from their internal resources.

4. Bank Credit to Public Sector Units:

Apart from providing funds to the Central and State governments through
investment in government bonds and bills, and investments in market bonds
issued by State Electricity Boards, Port Trusts, and other quasi-government
bodies. Commercial banks also make loans and advances to public sector
units. These units include the Food Corporation of India and similar state
government units.

The main factors responsible for the increasing share of the public
sector units in bank credit are:
(a) The increasing relative importance of such units in the non-financial sector
of the economy. With the expansion of economic activities of such units, it is
legitimate for such units to claim their share, along with others in bank credit;
(b) low profitability, on average, of public sector units, so that they generate
less of internal funds for financing their growth and depend relatively more on
borrowed funds; and

(c) privileged position of public sector unitsboth the government and the RBI
advise and expect preferential treatment of public sector units from banks,
especially public-sector banks.

The consequence of the above development has been relative decline in the
share in bank credit of both large and medium industry and wholesale trade in
the private corporate sector. The latter has, therefore, been exerting pressure
for more bank credit.

The resolution has come about mostly in the form of excessive annual
increases in total bank credit, so that, at least in nominal terms, the absolute
incremental demands for bank credit from several powerful pressure groups
can be satisfied. The RBI has also permitted, and at times actively co-
operated with banks in, such excessive increases in bank credit.

5. Export Credit:
In view of the paramount need to promote exports to earn sufficient foreign
exchange to be able to meet the countrys large mind growing foreign
exchange obligations, the government, in recent years, has adopted several
fiscal and credit policy measures.

To induce banks Jo increase their credit for exports, the RBI has been
providing increasingly liberal refinance to them for such credit and at low
concessional rate of interest. The refinance rule for increase in export credit
has also been received upward from time to time. In 1994-95, the export credit
of banks as more than Rs. 25,400 crore or 12.8 per cent of the net bank
credit.

Financial Diversification by Banks:

The commercial banks have made significant strides in their diversification
activities through their subsidiaries into new areas like merchant banking,
mutual funds, housing finance, hire purchase/equipment leasing and factoring
services.

Insurance Sector Reforms :

Insurance Sector Reforms In 1993, Malhotra Committee - headed
by former Finance Secretary & RBI Governor R.N. Malhotra.

Objective - to create more efficient & competitive financial

system. Key recommendations of the reform;

1 Structure: a government stake 50% in insurance companies.

2 Competition:

Private Companies with a minimum paid up capital of Rs.1bn

should be allowed to enter the sector.

No Company should deal in both life and general insurance

through a single entity.

Foreign companies may be allowed to enter the industry in

collaboration with the domestic companies.

Regulatory Body:

The insurance act should be changed. An insurance regulatory

body should be set up.

Controller of insurance-a part of the Finance Ministry should be

made independent.
Investments :

Mandatory Investments of LIC Life Fund in government securities

to be reduced from 75% to 50%.

GIC and its subsidiaries are not to hold more than 5% in any
company.

Customer Service: LIC should pay interest on delay on payment

beyond 30 days. Insurance companies must be encouraged to set
up unit link pension plans.

Insurance Regulatory and Development Authority (IRDA) is an autonomous apex

statutory body which regulates and develops the insurance industry in India. It
was constituted by a Parliament of India act called Insurance Regulatory and
Development Authority Act, 1999 and duly passed by the Government of India.
The IRDA Act, 1999 was passed as per the major recommendation of
the Malhotra Committee report (7 Jan, 1994) which recommended
establishment of an independent regulatory authority for insurance sector
in India
As stated in the act mission of IRDA is "to protect the interests of the
policyholders, to regulate, promote and ensure orderly growth of the
insurance industry and for matters connected therewith or incidental
thereto.
As per current guidelines issued by IRDA, Insurance Companies are not
permitted to invest in Indian Depository Receipts (IDR), while they are
permitted to invest in Equity shares/ Bonds/ Debentures.

TYPES OF INSURANCE
Insurance occupies an important place in the modern world because the
risk, which can be insured, have increased in number and extent owing to
the growing complexity of the present day economic system. It plays a vital
role in the life of every citizen and has developed on an enormous scale
leading to the evolution of many different types of insurance. In fact, now a
day almost any risk can be made the subject matter of contract of
insurance. The different types of insurance have come about by practice
within insurance companies, and by the influence of legislation controlling
the transacting of insurance business. Broadly, insurance may be classified
into the following categories:
(1) Classification on the basis of nature of insurance
(a) Life Insurance
(b) Fire Insurance
(c) Marine Insurance
(d) Social Insurance
(e) Miscellaneous Insurance
(2) Classification from business point of view:
(a) Life Insurance
(b) General Insurance
(3) Classification from risk point of view:
(a) Personal Insurance
(b) Property Insurance
(c) Liability Insurance
(d) Fidelity Guarantee Insurance