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March 20th, 2009
Significance of Banks
The importance of a bank to modern economy, so as to enable them to develop, can be stated as follow:
(i) The banks collect the savings of those people who can save and allocate them to those who need it. These savings would have remained idle due to ignorance of the people and due to the fact that they were in scattered and oddly small quantities. But banks collect them and divide them in the portions as required by the different investors.
(ii) Banks preserve the financial resources of the country and it is expected of them that they allocate them appropriately in the suitable and desirable manner.
(iii) They make available the means for sending funds from one place to another and do this in cheap, safe and convenient manner.
(iv) Banks arrange for payments by changes, order or bearer, crossed and uncrossed, which is the easiest and most convenient, Besides they also care for making such payments as safe as possible.
(v) Banks also help their customers, in the task of preserving their precious possessions intact and safe.
(vi) To advance money, the basis of modern industry and economy and essential for financing the developmental process, is governed by banks.
(vii) It makes the monetary system elastic. Such elasticity is greatly desired in the present economy, where the phase of economy goes on changing and with such changes, demand for money is required. It is quite proper and convenient for the government and R.B.I. to change its currency and credit policy frequently, This is done by RBI, by changing the supply of money with the changing the supply of money with the changing needs of the public.
Although traditionally, the main business of banks is acceptance of deposits and lending, the banks have now spread their wings far and wide into many allied and even unrelated activities.
Banking as an Ancestral Service
For the history of modern banking in India, a reference to the English Agency Houses in the days of East India Company is necessary. Those agency houses, with no capital of their own and depending entirely on deposits, were in fact trading firms carrying on banking as a part of their business and vanished form the scene in the crises of 1829-32. In the first half of the 19th century, the East India company established 3 banks The Bank of Bengal in 1809, the Bank of Bombay in 1840 and the Bank of Madras in 1843.
The Bank of Bengal was given Charter with a capital of Rs.50 Lakhs. This bank was given powers in different years as to:
(i) Rate of interest was limited to 12%.
(iii) Power to issue currency notes was given in 1824.
(iii) Power to open new branches given in 1839.
(iv) Power to deal in inland exchange was given in 1839.
These 3 banks were also known as Presidency Banks. The currency notes issued by presidency banks were not popular, those were replaced by Government Paper Money in 1862. In 1860, the principle of limited liability was introduced in India in Joint Stock banks, to avoid mushroom growth of banks, which failed mostly due to speculation, mismanagement and fraud. During the .crises in between 1862-75, numerous banks failed, including
Bank of Bombay. The Bank of Bombay was later restarted in the same year; with the same name. Due to failure of banks, during 1862-75 only only one bank was established in 1865 i.e. the Allahabad Bank Ltd. Indian banks were restarted functioning in the year 1894, when the Indian mints were closed to the free coinage of silver. The only important bank registered after the closure of the mints was the Punjab National Bank Ltd. with its head office at Lahore in 1895.
In the Swadeshi movement, number of banks were opened by Indians during 1906-13. Those new banks were:
• Peoples Bank of India Ltd.
• Bank of India Ltd.
• Central Bank of India Ltd.
• Indian Bank Ltd.
• Bank of Baroda Ltd.
This boom of opening new banks was overturned by the most severe crises of 1913-17. Therefore the period of amalgamation started. All the three presidency banks were amalgamated on 27th. Jan. 1921 and the Imperial Bank of India was established This bank was allowed to hold Government balances and to manage the public debt and clearing houses till the establishment of the RBI in 1935. With the passing of the State Bank of India Act, 1955, the undertaking of Imperial bank of India, was taken over by the newly constituted SBI. It had the largest number branches, which gave it the privilege of conversion into Government business institution of the country
Pursuant to the provisions of the State Bank of India (Subsidiary Bank) Act, 1959,
The following banks were constituted as subsidiary of SBI :
• State Bank of Bikaner & Jaipur
• State Bank of Indore
• State Bank of Travancore
• State Bank of Hydrabad
• State Bank of Patiala
• State Bank of Saurashtra
• State Bank of Mysore
In 1960, the Palai Central Bank in Kerala failed and that gave suspicion to the depositors. As such Deposit Insurance of Credit Guarantee Corporation (DIGGC) was established to guarantee repayment of deposits up to Rs. 10,000 to each depositor in case of failure of banks. On 19th July, 1969, 14 Joint Stock banks were nationalized which were having minimum depositors of Rs.50 crores and above. This brought into its fold 50% of banks' operations Again in April, 1980, 6 more banks were brought under area of nationalised banks, to total business of 95% in its fold. These 6 banks were giving tough competition to nationalized bankers and were indulged into irregularities causing concern to depositors.
Business Position of scheduled banks as on 29/4/05
Deposits Rs. 17,81,580 Crore
Credits Rs. 11,27,433 Crore
Bank Rate 6% (even in Oct 2005)
Prime Lending Rate (PLR) in between 10.5% -11.50%
CRR 4.50%
SLR 25%
Presently, as a part of deregulation many new generation private sector banks have been permitted viz. ICICI 1 (IDBI) HDFC and the nationalized banks are being privatized to the extent of 49%.
INTRODUCTION OF COMMERCIAL BANK
Commercial banks are the oldest, biggest, and fastest growing intermediaries in India. they are also the most important depositories of public saving and the most important disburses of finance. commercial banking in India is a unique systems, the like of which exist nowhere in the world. the truth of this statement becomes clear as one studies the philosophy and approaches that have contributed to the evolution of the banking policy, programmes and operation in India.
The banking systems in India works under the constraints that go with social control and public ownership. the public ownership of banks has been achieved in three stages:1955,July1969, and April 1980. Not only the private sector and foreign banks are required to meet targets in respect of sectoral development of credit, regional distribution of branches, and regional credit- deposits ratios. the operations of banks have been determined by Lead Bank Scheme, Differential Rate of Interest Scheme, Credit Authorisation Scheme, inventory norms and lending systems prescribed by the authorities, the formulation of the credit plans, and Service Area Approach.
Balancing Profitability with Liquidity Management
Commercial banks ordinarily are simple business or commercial concerns which provide various types of financial services to 'customers in return for payments in one form or another, such as interest, discounts, fees, commission, and so on. Their objective is to make profits. However; what distinguishes them from other business concerns (financial as well as manufacturing) is the degree to which they have to balance the principle of profit maximization with certain other principles.
In India especially, banks are required to mod their performance in profit-making if that clashes with their obligations in such areas as 'social welfare, social justice, and promotion of regional balance in development. In any case, compared to other business concerns, banks in general have to pay much more attention to balancing profitability with liquidity/It is true that all business concerns face liquidity constraint in various areas of their decision-making and, therefore, they have to devote considerable attention to liquidity management. But with banks, the need for maintenance of liquidity is much greater because of the nature of their liabilities. Banks deal in other people's money, a substantial part of which is repayable on demand.- That is why for banks, unlike other business concerns, liquidity management is as important as profitability management
This is reflected in the management and control of reserves of commercial banks.
MANAGEMENT OF RESERVES
The banks are expected to hold voluntarily a part of their deposits in the form of ready cash which is known as cash reserves; and the ratio of cash reserves to deposits is known as the (cash) reserve ratio. As banks are likely to be tempted not to hold adequate amounts of reserves if they are left to guide themselves on this point, and since the temptation may have extremely destabilising effect on the economy in general, the Central Bank in every country is empowered to prescribe the reserve ratio that all banks must maintain. The Central Bank also undertakes, as the lender of last resort, to supply reserves to banks in times of genuine difficulties. It should be clear that the function of the legal reserve requirements is two-fold:
(a) to make deposits safe and liquid, and
(b) to enable the Central Bank to control the amount of checking deposits or
bank money which the banks can create.
Since the banks are required to maintain a fraction of their deposit liabilities as reserves, the modern banking system is also known as the fractional reserve banking.
CREATION OF CREDIT
Another distinguishing feature of banks is that while they can create as well as transfer money (funds), other financial institutions can only transfer funds. In other words, unlike other financial institutions, banks are not merely financial intermediaries. This aspect of bank operations has been variously expressed. Banks are said to create deposits or credit or money, or it can be said that every loan given by banks creates a deposit. This has given rise to the important concept of deposit multiplier or credit multiplier or money multiplier.
The import of this is that banks add to the money supply in the economy, and since money supply is an important determinant of prices, nominal national income, and other macro-economic variables, banks become responsible in a major way for changes in economic activity. Further, as indicated in Chapter One, since banks can create credit, they can encourage investment for some time without prior increase in saving.
BASIS AND PROCESS OF CREDIT CREATION
Creation of money by banks. In modern economies, almost all exchanges are effected by money. Money is said to be a medium of exchange, a store of value, a unit of account. There is much controversy as to what, in practice in a given year, is the measure of supply of money in any economy. We do not need to go into that controversy here. Suffice it to say that everyone agrees that currency and demand deposits with banks are definitely to be included in any measure of money supply. Thus, apart from the currency issued by the government and the Central Bank, the demand or current or checkable deposits with banks are accepted by the public as money. Therefore, since the loan operations of banks lead to the creation of checkable deposits, they add to the supply of money in the economy. To recapitulate, the money-creating power of banks stems from the fact that modern banking is a fractional reserve banking, and that certain liabilities of banks are accepted (used) by the public as money.
Credit Ratio
Non-food credit grew at a high rate during 2004-05.Normally, the rate of credit is higher than the rate of growth of deposits due to the base effect- the outstanding deposits is much higher than the outstanding credit. For instance, while the outstanding deposits at end-March 2005 were Rs,18,19,900 crore, the outstanding credit was Rs, 11,04,913 crore. Also, in any given year, the accretion to credit has generally remained lower than the accretion to deposits. During 2004-05, however, incremental credit and deposits were more or less of the same magnitude, while incremental investments in relation to deposits during the year were much lower than in the previous year. This resulted in some unusual behaviour of the credit-deposit (C-D) ratio and investment-deposit (I-D) ratio Among bank-groups, the new private sector banks had the highest C-D ratio, followed by foreign banks, old private sector and public sector banks
Bank Credit
Volume of Credit Commercial banks are a major source of finance to industry and commerce. Outstanding bank credit has gone on increasing from Rs 727 crore in 1951 to Rs 19,124 crore in 1978, to Rs 69,713 crore in 1986, Rs 1,01,453 crore in 1989-90, Rs 2,82,702 crore in 1997, and to Rs 6,09,053 crore in 2002. Banks have introduced many innovative schemes for the disbursement of credit. Among such schemes are village adoption, agricultural development branches and equity fund for small units. Recently, most of the banks have introduced attractive educational loan schemes for pursuing studies at home or abroad. They have moved in the direction of bridging certain defects or gaps in their policies, such as giving too much credit to large scale industrial units and commerce, and giving too little credit to agriculture, small industries, and so on.
Types of Credit Banks in India provide mainly short-term credit for financing working capital needs although, as will be seen subsequently, their term loans have increased over the years. The various types of advances provided by them are:
(a) loans, (b) cash credit, (c) overdrafts (0D), (d) demand loans, (e) purchase and discounting of commercial bills, and (h) installment or hire-purchase credit.
Cash Credit and Overdraft
Cash credits and overdrafts are said to be running accounts, from which the borrower can withdraw funds as and when needed up to the credit limit sanctioned by his banker. Usually, while cash credit is given against the security of commodity stocks, overdrafts are allowed on personal or joint current accounts. Interest is charged on the outstanding amount borrowed and not on the credit limit sanctioned. In order to curb the misuse of this facility, banks used to levy a commitment charge on unutilised portion of the credit limit sanctioned. However, this practice has now been discontinued. Although these advances are mostly secured and of a self-liquidating character, banks are known to provide them on 'clean basis' in certain cases. Technically, these advances are repayable on demand, and are of a short-term nature. Actually, the widespread prevalent practice is to roll over these advances from time to time.
As a result, cash credits actually become long-term advances in many cases. Although, technically these advances are highly liquid, it has been pointed out that it is a myth to regard them so because even the most profitable borrower would hardly be in a position to repay them on demand.
Purchasing and Discounting of Bills
Purchasing and discounting of bills-internal and foreign-is another method of advancing credit by banks. It is adopted mainly to finance trade transactions and movement of goods. Bill finance is either repayable on demand or after a period not exceeding 90 days. It has been observed that bills traded in India are often fake bills created out of book debts of industrial and business units. Bill financing has certain favourable features. Banks can raise funds in the secondary markets by rediscounting bills with the RBI and financial institutions like IDBI and Discount and Finance House of India (DFHI).
They can also earn some money if the rediscount rate is lower than the discount rate. Further, the buying and selling of bills expand the banks' business more quickly by the faster recycling of funds.
Among these different systems of bank credit, cash credit/overdraft system remains the most important one. The shift away from it has been slow. Of the total bank credits, the outstanding cash credit and overdrafts accounted for about 66 per cent in 1935, 69 per cent in 1949, 57 per cent in 1973, 52 per cent in 1976, 45 per cent in 1986 and 48 per cent in 1994, and 36 per cent in 2002.
MONETARY AND CREDIT POLICY
The policy Statements of the Reserve Bank provide a frame work for the monetary, structural and prudential measures that are initiated from time to time consistent with the overall objectives of growth, price stability and financial stability. |
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