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Banking System in India

Banking System in India is dominated by nationalized


banks. The nationalization of 14 privately owned banks
in India took place on 19th of July 1969 by Mrs. Indira
Gandhi the then prime minister, with an another
installment of nationalization of 6 banks on 15.04.1980.
The major objective of nationalization was to ensure
mass banking as against class banking with banking
infrastructure aimed at hilly tracts and terrains of the
country. Prior to 1969, State Bank of India (SBI) was the
only public sector bank in India. SBI was nationalized in
1955 under the SBI Act of 1955.
Banking System in India
Classification of Banks in India
A. Central Bank:
The Reserve Bank of India is the Central Bank. It is fully
owned by the government. It is governed by a central
board and headed by a Governor, who is appointed by the
Central Government. It issues guidelines for the
functioning of all banks operating within the country.
B. Public Sector Banks:
(a) The State Bank Group: the State Bank of India and its
associate banks
(b) 20 other nationalized banks
(c) Regional rural banks: they are sponsored by public
sector banks
C. Private Sector Banks:
(a) Private Banks
(b) Foreign Banks Operating in India
(c) Scheduled Cooperative Banks
(d) Non-scheduled Banks
D. Cooperative Banks:
The cooperative sector banks are related with
rural areas and serve rural people mainly. The
cooperative banking sector is divided into the
following categories:
(a) State Cooperative Banks
(b) Central Cooperative Banks
(c) Primary Agriculture Credit Societies
Some Financial Institutions
1. National Bank for Agriculture and Rural Development
(NABARD)
2. Export Import Bank of India (EXIM Bank
3. National Housing Bank (NHB)
4. Housing and Urban Development Corporation Ltd.
(HUDCO)
5. Industrial Investment Bank of India (erstwhile Industrial
Reconstruction Bank of India)
6. Industrial Credit and Investment Corporation of India Bank
(ICICI)
7. Small Industries Development Bank of India (SIDBI)
8. Infrastructure Development Finance Co. (IDFC)
9. Power Finance Corporation (PFC)
Reserve Bank of India
Commercial Banks
Nationalised Bank,
Private Bank,
RRB
Co-operative Banks
Rural (Short Term Structure, Long Term
Structure),
Urban
Development Banks
NABARD, SIDBI, EXIM, IDBI
Reserve Bank of India: Role and Functions
Traditional Central Banking Functions (Monetary
Functions)
a. Bank of Issue – The Minimum Reserve System
b. Banker to Government
c. Banker's Bank and Lender of the Last Resort
d. Controller of Credit
e. Custodian of Foreign Reserves
Supervisory Functions
Promotional Functions
Miscellaneous Functions
a. a. Interest Rate Intervention
b. b. Monetary Policy Instruments
Traditional Central Banking Functions
(Monetary Functions)
• Bank of Issue — The Minimum Reserve
System
• Banker to Government
• Bankers’ Bank and Lender of the Last Resort
• Controller of Credit
• Custodian of Foreign Reserve
Supervisory Functions (Non-monetary
Functions
The Reserve Bank of India Act, 1934, and the Banking
Regulation Act, 1949 have given the RBI wide powers.
The RBI has to supervise and control commercial and
co-operative banks in relation to licensing and
establishments, branch expansion, liquidity of their
assets, management and methods of working,
amalgamation, reconstruction, and liquidation.
The RBI is authorized to carry out periodical
inspections of the banks and to call for returns and
necessary information from them.
The nationalization of 14 major Indian scheduled
banks in July 1969 imposed new responsibilities
on the RBI for directing the growth of banking
and credit policies towards more rapid
development of the economy and realization of
certain desired social objectives.
The supervisory functions of the RBI have helped
a great deal in improving the standard of banking
in India to develop on sound lines and to improve
the methods of their operation.
Promotional Functions (Non-monetary
Functions)
Since Independence, with economic growth, the range of the
Reserve Bank’s functions has steadily widened. The Bank now
performs a variety of developmental and promotional functions,
which, at one time, were regarded as outside the normal scope of
central banking.
1. The Reserve Bank promotes the banking habit.
2. Extends banking facilities to rural and semi-urban areas.
3. Establishes and promotes new specialized financing agencies i.e.,
Industrial Development Banks.
4. Development of the co-operative credit movement to encourage
savings and to eliminate moneylenders from the villages and to route
its short-term credit to agriculture.
Miscellaneous Functions
Following are the miscellaneous functions
of RBI:
• Interest Rate Interventions
• Monetary Policy Instruments
Departments of RBI
Capital requirements – Capital
Adequacy
Reserve Requirements (CRR, SLR)
Cash Reserve Ratio (CRR)
CRR–A tool of credit control
Statutory Liquidity Ratio (SLR)
Treasury management
Treasury management (or treasury operations) includes management of an
enterprise's holdings,
with the ultimate goal of maximizing the firm's liquidity and mitigating its
operational, financial
and reputational risk. Treasury Management includes a firm's collections,
disbursements,
concentration, investment and funding activities. In larger firms, it may also
include trading in
bonds, currencies, financial derivatives and the associated financial risk
management.
Objectives of Treasury Management
To exploit potentials in markets which are becoming integrated and consequently volatile.
To manage funding costs and efficient resource allocation.
To optimisation of profitability through improving rate of return on portfolio, securities
trading and achieving moderate capital gain.
To controlling and minimizing market and credit risks.
To use information technology for the entire gamut of activities.
Comply with the requirements of regulators.
Adhere to internal policy guidelines on money market and investments.
To achieve above objectives, individual banks have to have following policies linked to
overall business strategies and plans.
Specific treasury policies and goals.
Specific guidelines for managing various risks.
Specific guidelines to build I.T. and analytical capabilities.
Specify earning targets on ROE & ROA and acceptable risk levels and limits.
Specify internal structure and decision-making roles.
Techniques of Credit Control
Quantitative or General Methods
Bank Rate Policy
Adjusting with CRR and SLR
Lending Rate
Repo Rate
Reverse Repo Rate
Qualitative or Selective Methods
Marginal Requirements
Regulation of Consumer Credit
Credit Rationing
Moral Suasion
Direct Action
Publicity
Risk Management and Central Bank
The survey of central bank risk managers
confirms that a high proportion of central banks is
currently restructuring their risk management
operations. This survey reveals:
1. Increasing integration of risk management
2. Recognition of the importance of operational
risk
3. A need for clear objectives for the various
departments involved in risk management
Central banks need to interpret the concept of risk in a very broad sense. Risk includes not
only the identification and control of financial market risks and payment systems risks, but
also reputation risks, political risks, regulatory risks, technological risks and moral hazards.
Thus:
1. The key tasks of all central banks – monetary and exchange rate policy, oversight of
payment systems, supervision, and crisis management – all require central banks to
manage risk.
2. Central bankers need to identify and manage political and reputation risks.
3. Organize a risk management department so that it can work effectively with the
internal audit department, the external auditors and the financial control department.
4. Larger central banks are leading the way in developing risk management procedures
and translating this into corporate governance in the central bank.
5. For smaller banks with limited resources, setting up a separate risk management
department is often not feasible. In these circumstances, risk has to be assessed and
controlled by departmental heads.
6. Rising “risk awareness” is widely recognized as an important step to reducing
operational risk for the organization as a whole. In nutshell, a risk identification and
management culture has to be developed in a central bank.
Functions of Treasury Management
The various functions of domestic treasury are—
(a)Maintenance of CRR/SLR
(b)Deployment of surplus money in S.T. or L.T.
instruments - Liquidity Management
(c)Drawls of refinance limits - Liquidity
Management
(d)Maximizing returns through trading and retailing
in securities -Investment Management
Maintenance of CRR
1. Section 42(1) of the RBI Act empowers the RBI to stipulate ratio to be
maintained - presently 4.75% w.e.f. 02.08.2012.
2. Can be any ratio between 3 and 20%.
3. Ratio is required to be maintained on the Demand and Time liabilities of
banks excluding inter-bank dealings.
4. Balances with the RBI and also those in currency chests are eligible for
computation but not balances with other banks and liquid cash held by
individual banks.
5. Required to be maintained on 14 days period on a fortnightly average
basis.
6. 70% on daily average basis to be maintained throughout the fortnight.
7. Defaulting banks are not allowed access to refinance/rediscounting
facilities.
Maintenance of SLR
1. RBI has authority to stipulate SLR up to 40% of
NDTL of banks - presently 23% w.e.f. 02.08.2012.
2. Investments in approved liquid assets are eligible
for computation.
3. Required to be maintained on daily basis but
amount calculated on the basis of NDTL of second
preceding fortnight.
4. Cash held by banks in their safes, other banks and
held by them with RBI in excess of CRR
requirements are eligible for SLR requirements.
Liquidity Management
1. Treasury branch/department works out the liquidity requirements
on a day to day basis taking into account the likely inflows and
outflows which can be as under: Inflows Outflows
2. (a) Refinance availed Refinance repaid
3. (b) Currency chest deposits Currency chest withdrawals
4. (c) Net Clearing receipts Net Clearing payments
5. (d) Food Credit repayment Food credit disbursal
6. (e) Remittance received in RBI A/cs Remittances made out of RBI
A/cs
7. (f) Call lending's repaid Call borrowings repaid
8. (g) Proceeds of investment sales Investments made
9. (h) Interest on investments (i) Other receipts in RBI A/cs Other
drawings in RBI A/c
Depending on whether the net position needs
borrowings or lendings, treasurer has to choose
the option from following alternatives:
(a)Interbank Call money market
(b)Liquidation of investments
(c)Repos
(d)Refinance/Rediscounting Window
Call money sources has the following limitations:
(i) Any indication to market regarding illiquidity -
which is indicated when this market is tapped
frequently - would increase costs.
(ii)Since the lenders being competitors, they may
not be prepared always to lend.
(iii)Illiquidity may suddenly emerge in the market
due to sudden developments.
Liquidity management should be governed by a
well laid out policy covering
(i) Control of cash flows
(ii)Monitoring of undrawn limits
(iii)Control of short term borrowing capacity
(iv)Management of portfolio of liquid assets
(v)Contingency plan
Investment Management
Deposits mobilized by banks are required to be deployed
either in loans & advances or in investments.
While doing this every bank has to take care of credit risk,
market risk.
The portion of such deposits which are not lent are
invested either in SLR securities and non-SLR securities.
Since SLR securities are more risk free and there is a
compulsion to invest their return is generally low.
Non-SLR and SLR security investments are to be shuffled
both within and between themselves taking into account
the interest rate movements and connected price
movements.
Investments are therefore required to be invested in a
professional manner keeping in mind the RBI's and
the bank's own policy directives and operative
guidelines. Functions of the investment department
can be mentioned as:
1. Maintenance of SLR
2. Maximisation of yield on investment
3. Matching maturities of investments with those of
deposits and borrowings
• Prediction of interest rate movements and
analysis of their impact on investment portfolio
• Managing SLR/Non-SLR investment portfolio
for profit maximization
• Managing investments in capital markets
• Optimisation of interest costs through repos in
case of sudden shortages.

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