UNIT 6
BANKS:
Meaning:
A commercial bank is an institution that operates for profit. It accepts deposits from the general public and extends loans to the households, the firms and the Government. The essential characteristics of commercial banking include
(1) Acceptance of deposits from the public.
(2) For the purpose of lending or investment.
(3) Withdrawal by means of an instrument whether a cheque, draft, order, etc.
Definition:
According to Cairns Cross, “A bank is an institution which deals in money and credit.”
According to Sayers, “Banks are institutions whose debts are usually referred to as ‘bank deposits’ and commonly accepted in final settlement of other people debts.”
FUNCTIONS OF COMMERCIAL BANKS
Modern commercial banks perform a variety of functions and help the industrialists, businessmen and traders. They keep the wheels of commerce, trade and industry always revolving. Modern commercial banks perform mainly two types of functions i.e. primary or banking functions and secondary or subsidiary functions.
Functions of commercial bank
Primary Function Secondary Functions
(Banking Function) (Non Banking Function)
Accepting Deposits Granting Advance Agency Functions General Utility Functions
(A) Primary Functions:
The primary functions of a bank are also known as banking functions. They are the main functions of a bank. They are as follows –
Accepting Deposits: Accepting Deposits from the public is the most important function of a modern commercial bank offering various types of deposit accounts; banks mobilize the savings of the community. People who have surplus money deposit it with a bank for safety. The commercial banks protect the deposits and give interest on such deposits. There are four types of accounts:
Saving Deposits Accounts: It is a deposit account which is operated by individuals for the purpose of saving a part of their income. Its main objective is to promote savings. It encourages saving habits among the salary earners and others. There is no restriction on the number and amount of deposits. But withdrawals are subject to certain restrictions. Banks pay a certain percentage of interest on this deposit. At present it is 4 % p.a. The money can be withdrawn either by cheque or withdrawal slip.
Fixed Deposits Accounts: Fixed deposits are kept in a bank for fixed period varying from 30 days to several years. A certain sum of money is deposited for a fixed period. A higher rate of interest is paid. The rate may vary from bank to bank Withdrawals are not allowed before the maturity of period. In case of emergency, if the depositor wants to withdraw money before the maturity date, he will have to lose some interest. The depositor is given a fixed deposit receipt which he has to produce at the time of maturity. The deposit can be renewed for further period. Fixed deposit account is also known as time deposit.
Current Deposits Accounts: These accounts are also known as demand deposits because the amount can be withdrawn on demand. This type of account is opened by businessmen who have a number of regular transactions with the bank, both deposits and withdrawals. There, is no restriction on the number and amount of deposits. There are also no restrictions on the withdrawals. Bank does not pay any rate of interest on such accounts. The bank provides overdraft facility to current account holder. Banks charge incidental commissions on such accounts. It facilitates the industrial progress.
Recurring Deposits Account: Under this account, regular income earners deposit a certain amount of money at regular intervals for a certain period of time. For example, an individual can deposit, say Rs 500 every month for a certain period say, 2 years. Its main objective is to develop regular savings habits among the public. The period of deposit is minimum 6 months and maximum 10 years. The rate of interest is higher. At the end of the maturity period, the account holder can get substantial amount, which can be utilized for the purchase of consumer durables or some other investment such as land, machinery, etc.
Granting Advances (Loans):
The second important function of a commercial bank is to extend loans and advances. The money which is received by banks by way of deposits is utilized for granting loans and advances to worthy borrowers. The profit earning capacity of a bank mainly depends upon the performance of the function. This function is also important in the context of economic development in general and development of trade, industry and commerce.
Overdraft Facility: An overdraft facility is granted by the bank only to those persons who have their current accounts in the bank. To meet the temporary needs of the customer, the bank may permit the customer to overdraw the amount from the bank in excess of his balance. The bank may grant such advance on the personal security. The interest is charged only on the actual amount used. The overdraft is granted only occasionally and for short periods. A certain amount is sanctioned as overdrafts which can be withdrawn within a certain period of time say three months or so. It is sanctioned to traders, partnership firms and joint stock companies. The overdraft facility can be renewed from time to time.
Cash Credit: It is a short-term credit given by the bank to any businessman to meet regular working capital needs. The bank opens a separate account in respect of cash credit. The borrower is allowed to draw from that account upto a certain ‘limit against a bond signed by securities or any other eligible securities. Interest is charged only on the actual amount withdrawn by the customer. It can be availed by current account holders as well as other businessmen. Most industrial concerns and business houses borrow money in this form.
Loans: When a banker makes a lump-sum advance to the customers, it is called 'loan'. Interest is charged on the entire amount sanctioned irrespective of whether the complete amount is used or not by the customer. Loans are of various types i.e. Term loans, participation loans, personal loans, call loans, collateral loans etc.
Call Loans or Money at call: are loans repayable at short notice. They are called call loans, as they can be called back at any time. These loans are given to for a period of 7 to 15 days for investment in stock market. The rate of interest is the lowest.
Short term Loans: are provided by commercial bank for a period not more than two years. The rate of interest is higher. They are given to businessmen to satisfy their working capital requirement.
Medium term Loans: The loans are sanctioned for a period of two to five years period. The rate of interest charged for this type of loan is more than the short term loans. Such loans are useful to industries to introduce innovations or for introduction of new method of production.
Long term Loans: Loans which are sanctioned for five years are known as long term loans. The rate of interest charged is higher than other loans. Such loans help businessmen to introduce permanent changes in the methods of production.
Discounting Bills of exchange: Another important function that the modern banks perform is the discounting of bills of exchange. Advances are made by discounting the bills of exchange. These advances are given for short periods only. When the holder of the bill is not in a position to wait till the maturity of the bill and requires the cash urgently, he sells the bill of exchange to the bank. The bank purchases the instrument at a discount. This type of business is very common in advanced countries.
(B) Secondary Functions:
Secondary functions are also known as non-banking functions or subsidiary functions or subsidiary functions. They are classified into two main categories
Agency functions General utility Functions
Agency Functions: Bank also act as agents for their customers and in that capacity perform certain functions, which are known as agency functions. For these services, the bank charges certain commission from the customers. Some of the agency functions are as follows:
Collection: The commercial banks collect cheque, bills, draft interest, dividends on behalf of their customers and credit them into their accounts. This service is provided on the standing instructions from customers.
Payments: Banks also pay bills, insurance premium interest, loan installments, electricity bills, telephone bills, etc. on behalf of their customers as per their direction.
Purchase and Sale of Securities: Banks purchase or sell shares, bonds and securities of private companies on behalf of their clients.
Acts as Trustee: Banks acts as the trustee and the executor of the wills of their customers after their death.
E-Banking (Electronic Banking): A customer can operate his bank account through internet. Money can be transferred from one place to another for their customers. E-banking helps businessmen, traders, merchants in transacting business.
Dematerialization Account (De-mat Account): Some banks provide De-mat facility. De-mat account is useful to investors who deal in shares. The transactions related to buying and selling of shares are recorded in a separate De-mat account. Periodically statements regarding shares transactions are given to each investor.
General Utility Functions:
Safe Deposit Vault (Lockers): This facility is available to the general public to enable them to keep their valuables and securities like ornaments, jewels, documents, deeds, etc. There is a separate section in banks where lockers are provided in various sizes on payment of fixed rates.
Remittance of Funds: Banks remit money from one place to another or even from one country to another. Remittance of fund is done by telegraphic transfer, mail transfer, demand draft, etc.
Letter of credit: Commercial banks also issue letters of credit, to enable the traders to buy goods from foreign countries on credit. Through this letter of credit, the bank in one country authorizes another bank in foreign country to honour the draft or cheque of the person named in the document. The payment is limited to the amount shown in the letter and the amount is chargeable to the bank which issues the letter.
Referee: As a referee a bank authenticates the credit worthiness of its customers. This enables the customers to run their business smoothly and also obtain goods and services on credit.
Underwriter: Banks provide underwriting facility to the joint stock companies especially new business enterprises and also to the government in order to help them in raising funds. It guarantees the purchase of certain portion of shares if not sold in the market. Later they are free to sell these shares in the market whenever they want to do so. This is all done by the banks on a small commission from the company.
Dealings in Foreign Exchange: By keeping separate foreign exchange department, commercial banks offer services for converting one currency into another.
ATM facility (Automated Teller machine): Now-a-day banks also provide ATM facility to their customers. AS a result they can withdraw money at any time of the day, at their convenience, whenever they need it.
Collects statistics: The modern banks also collect statistics about money, banking, trade, commerce and publish them in form of pamphlets and hand outs. This helps their customers in acquiring knowledge about the latest economic situation.
Travellers’ Cheques: Banks help customers by issuing internal or international travellers’ cheques. When people travel within the country or between countries traveller’s cheques are used as most convenient method of carrying funds.
Meaning:
The Central Bank is the most important banking institution in the banking structure of every country. It is the ‘apex’ (highest) banking institution and is rightly treated as the ‘Lender of the money market’. It guides and regular the activities of all the banks in the country. The Central Bank acts as an agent, banker and adviser to the government in economic and financial matters. Their main objective is to regulate currency and credit system and to ensure economic stability and growth in the country. Today almost all the countries of the world have their own Central Banks.
The Reserve Bank of India, which is the Central Bank of our country, was established on 1st April, 1935 under the RBI Act, 1934.
Definition:
According to Prof. R. P. Kent, Central Bank is “An institution charged with the responsibility of managing the expansion and contraction of the volume of money in the interest of the general public welfare”.
Functions of Central Bank: The functions are divided into two parts:
A) Monetary Function B) Non-Monetary Function
A) Monetary Function:
Monopoly of notes issue: The main function of the Central Bank is the issue of notes. Central Bank has been authorized to print and issue currency notes. No bank other than the Central Bank enjoys the right of note issue. As the Central Bank is the only authority of note issue, its notes enjoys a distinctive prestige. There is uniformity in the issue of notes and over-issue can avoid. Moreover, it creates confidence among people.
In India, the Reserve Bank of India acts as the Central Bank which enjoys the monopoly of note issue. It has been authorized to print and issue all currency notes except one rupee notes and coins. The RBI adopts what is known as minimum reserve system to print notes. As per 1957 Reserve Bank of India (amendment) Act, the RBI keeps a minimum reserve of Rs. 200crores in gold and foreign securities. Out of this, Rs. 115 crores must be in gold and Rs. 85 crores in foreign securities. The notes issued in excess of Rs. 200 crores are backed by the government rupee securities.
Banker to the Government: It acts as the banker, advisor and agent of the government.
As a banker to the government: As a banker of the government it carries out all banking requirements of the government. It accepts deposits and makes payments of all government workers. It transfers funds from one place to another or from one use to another use for the government. It collects taxes on behalf of the government and advances loans to the government. It manages public debts, interest on loans, repayments of loan from International organizations etc. Central Bank advises the government on monetary problems and implemented the monetary policy of the nation. In India the Reserve Bank of India performs all these functions. Since, its operation is spread all over India. The RBI has appointed the State Bank of India as its sole agent for transaction government business.
As an advisor to the Government: The central bank has complete knowledge about the functioning of the economy and can therefore advice the government on various economic and monetary matters. It advices the government on various financial matters such as framing the budget, controlling inflation, foreign exchange policy, managing fiscal deficit, Monetary policy, etc.
Bankers Bank: The Central Bank is the apex body of the banking system. It supervises co-ordinates and controls the operations and activities of the commercial banks. It is the legal tradition that all commercial banks should keep a certain proportion of the demand and time deposits with the Central Bank of the country. This proportion is called cash reserve ratio (CRR).
The Reserve Bank of India also rediscount bill and provides financial assistance to commercial banks. The RBI grants loans to the scheduled banks for a period 90days against eligible bills. The RBI has been empowered to control the activities of all commercial banks under Reserve Bank of India Act 1934 and Banking Regulation Act, 1949.
Custodian of Nation’s Foreign Exchange / Determination of Exchange rate:
All foreign exchange reserve of the country is kept by the Central Bank of the country. It enables the Central Bank to exercise control over the foreign exchange. All foreign exchange transaction is done through the Central Bank. The Reserve Bank of India maintains the stability of the rate of exchange, section 40 of the RBI with this function.
It is obligatory for the RBI to buy and sell currencies of the members of the IMF. The Foreign Exchange Regulation Act (FERA) passed in 1947 to give wide powered to RBI to exercise control over foreign exchange. Over the years the act has been amended many times and currently, it is known as Foreign Exchange & Management Act (FEMA).
Lender of the last resort: The Central Bank helps the commercial banks when they face a financial crisis. When all the sources are closed, commercial banks can rely (depend) upon the Central Bank as the last resort (option) for securing financial assistance. That is why the Central Bank is called the Lender of the last resort. Sometimes cash reserve of the commercial banks gets exhausted. During such situations, Commercial banks can approach the Central Bank to come to their rescue. The Reserve Bank of India provides the necessary funds and relieves from their burden.
Clearing house facility: Central Bank provides clearing facility for the smooth functioning of commercial bank. It is a fact that there are large numbers of commercial banks opening in the economy. Each bank will have claims and counter claims over other. This is not possible for all commercial bank to meet personally to settle their claims. Central Bank solves this problem smoothly by debiting and crediting each bank concerned.
B) Non-Monetary Function:
Control & supervisory function: The Central Bank of India also takes the responsibility of supervising the activities for all commercial banks. It issues licenses to banking companies. It can take direct action against the erring commercial banks. It can suspend the activities of such commercial banks or may refuse to renew the license. In India the RBI controls, supervises the functions of all commercial banks.
The Reserve Bank of India Act, 1934 & Banking Regulation Act, 1949 have given RBI the power of supervision and control over commercial and co-operative bank.
Promotional & Development function:
a) To promote banking habits: The Central Bank has been playing a more responsible role towards the economic development of our country. Its functions are not confirmed to control of money market alone. In India, RBI exercises its power over commercial banks and puts them under pressure to open branches in the rural sector. This has contributed a lot towards rural banking and to cultivate banking habits among the poor people.
b) Agricultural finance: As a significant step towards rural credit, the RBI created various agencies and institutions for weaker sections under the various schemes for rural development. The arrival of NABARD in India has created a history in the field of rural finance.
c) Industrial finance: Central Bank takes several steps to meet the long term requirements of the industrial finance. The financial institutions like IFCA, SFCA, ICICI, LIC, IDBI, IRCI, SIOBI, etc. play a vital role in boosting the growth in industrial sector in India.
d) Export-Import finance: RBI played a responsible role in the establishment of the Export-Import Bank (EXIM Bank) to provide finance towards export and import activities. The EXIM Bank was establishing in January, 1982 to provide refinance to the commercial banks and financial institutions against their export-import financing activities.
e) Encouraging small savings: To provide opportunities of investment and better returns for small savers, the RBI played an active role in the establishment of UNIT TRUST OF INDIA in 1963.
Methods of Credit control by Central Bank:
Credit control also means that monetary management or Instrument of monetary policy. Central Bank controls the credit by using two methods –
a) Quantitative Method b) Qualitative Method.
A) Quantitative Method: It refers to the steps aimed at controlling credit by checking the quantity of money in circulation.
Bank rate policy: Bank rate is the rate at which Central Bank rediscount bill of commercial Banks and provides financial assistance to commercial bank.
During inflation Central Bank follows the Dear money policy. It increases the bank rate & thereby makes borrowing costly. This will discourage the commercial bank from the obtaining funds from the Central Bank. When Bank rate increases, the rate of interest prevailing in the money market will also increase. The borrowers will have to pay high rate of interest and their tendency to demand credit will decline. It leads to contraction of supply of credit money and reduces investment. Such reduction in business activities results in contraction of factor rewards which in turn in brings the effective demand down. As demand declines price will fall and inflation is controlled.
During deflation the bank will follow, Cheap money policy and the bank rate will be reduced. As a result the rate of interest collected by the Commercial Banks will also fall. This encourages the business community to demand more loans and it leads to expansion of credit. This would put deflation under check.
Open market policy: It refers to buying and selling of securities and other eligible papers by central bank in the open Market.
Central Bank can create contraction and expansion of credit selling and buying securities. It can control the credit money by selling securities and eligible papers in the open market. When it sells securities money flows to Central Bank. It reduces the volume of deposit received by the commercial banks and contracts credit. It expands credit by buying securities from the market. It results in large volume of circulation of money among commercial banks.
Open market policy technique is superior to Bank rate policy. First of all bank need not depend upon commercial banks for the success of open market operation. By knowing their reserve position. Central Bank of India can directly influence the commercial banks. Secondly, Open market operations successful when government borrows money from public debt has been expanding, Government can successfully sell its securities to the public.
Varying cash reserve ratio: This is another weapon used by the Central Bank to control credit. Cash reserve is the ratio upon which all commercial bank. It is a legal tradition which every commercial bank has to follow. The reserves left with commercial banks after meeting minimum reserve is known as excess reserves. Thus has a direct impact on the capacity of banks to create credit. When the Central Bank raises the cash reserve ratio, the ability of the commercial banks to create credit. When the cash reserve ratio is brought down, the ability of commercial banks to create credit widens.
B) Qualitative Method:
It refers to the step aimed at controlling credit by checking the allocation of credit. Such steps check the purpose for which credit money is used. They encourage credit money for socially desirable purposes and restrict the same towards undesirable and non productive areas.
Issuing directives: a) Purposes on which advances can be granted. b) Margin requirements against securities. c) Maximum limit regarding advances granted to any borrower. d) Terms and conditions including the rate of interest for granting loans.
Margin requirements: A bank requires security such as gold, shares, property against loan sanction. No bank gives loan equal to the market value of the property, if a person produces security worth Rs. 30,000, he may be got a loan of Rs. 25,000. Thus, difference between the value of security and the actual amount loan is taken as margin. It may direct the commercial bank to keep higher margin towards loan against stock of food grains, equity shares, etc.
Regulation of consumer credit: Commercial bank often advance loan to consumer for durable luxury goods like Television, Refrigerator, etc. Central Bank can regulate consumer loans by minimum down payment and increase the period of repayment i.e. installment may be reduce.
Rationing of credit: Central bank can also regulate the volume of credit by imposing ceiling on different type of loans provided by the commercial banks, It check the flow of money into undesirable uses.
Moral situation: It refers to the general appeal or request made by the central bank persuading the commercial bank to co-operative in controlling credit, Central bank may request the commercial bank to seek further accommodation or not to speculative activities.
Direct action: The Central bank also applying to hard measure to control the erring commercial bank. Such as commercial bank refusal of renewal suspending of license, refusing financial assistance to commercial bank etc.
The world bank is an international organization dedicated to provide finance, advice and research to developing nations. Conventionally it is not a bank. Instead, it comprises two institutions namely the international bank for reconstruction and development (IBRD) and the International Development Association (IDA). As on date 189 member countries share ownership of the bank. The bank works closely with three other organizations:
- The International Finance Corporation.
- The Multilateral Guarantee Agency
- The International Centre for the settlement of investment Disputes.
All five organizations are collectively known as the World Bank Group.
The International Bank for reconsideration and development (IBRD) provides debt financing to governments that are considered middle income. The International Development Association (IDA) gives interest- free loans to the governments of poor countries. The World Bank is the Multilateral Investment Guarantee Agency (MIGA), an organization that promotes foreign direct investment in developing countries. The International Centre for settlement of investment disputes (ICSID) provides arbitration on international investment disputes.
Features of World Bank
Organization and Structure:
The organization of the bank consist of the board of Governors, the board of executive directors and the advisory committee, the loan committee and the president and other staff members. All the powers of the bank are vested in the Board of Governors which is the supreme policy making body of the bank. The board consist of one Governor and one Alternative governor appointed for five years by each member country.
Goals:
The world bank group has set two goals to be achieved by 2030.
- End extreme poverty by decreasing the percentage of people living on less than $1.90 a day to no more than 3%.
- Promote shared prosperity by fostering the income growth of the bottom 40% for every country.
The world bank is a vital source of financial and technical assistance to developing countries around the world.
Financial Products and Services:
World bank provides low-interest loans ,zero to low- interest credits, and grants to developing countries. It supports in areas such as education, health, public administration, infrastructure, financial and private sector development, agriculture and envoirnmental and natural resource management.
Innovative Knowledge Sharing:
World bank offers support to developing countries through policy advice, research and analysis and technical assistance. Analytical works of world bank often helps developing countries. It also helps in capacity development of the developing countries. World bank also sponsors, host or participates in many conferences and forums on issues of development.
Innovative and Entrepreneurship:
In the competitive economy, innovation and entrepreneurship plays an important role in the growth of the business. It helps in higher productivity which leads to increased economic growth. It helps in creation of employment to eradicate poverty. Young and growth- oriented companies contribute in employment growth. They help in enhancing competitiveness and productivity by introducing new products, developing novel business models and opening new markets. Innovation allow firms to specialize, meet international best-practice standards and upgrade quality.
Social Development:
Social development focuses on the need to “put people first” in development processes. The world bank work with governments, communities, civil societies, the private sector and the marginalized for the cause of social development. Social development promotes economic growth and leads to a higher quality of life. The world bank’s work on social development brings voices of the poor and vulnerable into development processes. World bank is also undertaking timely social risk analysis, including poverty and social impact analysis.
