What is Banking ?
Banking institutions are a group of financial intermediaries which are engaged in the business of carrying out the banking activities after getting necessary approval from the Central Bank of the country, viz. Reserve Bank of India under the provisions of Banking Regulation Act, 1949.
The word 'bank' has derived from German language, which has the literal meaning 'to collect'. Initially the basic function of a bank was to collect money from public in the form of deposits. Banks entered into other areas of function like lending of money, etc. in the next stage of their evolution. In the current context, they are one of the most significant constituents of our country's economic framework. Consequent upon the nationalization of major banks in 1960, they have played a vital role as agents and facilitators of achieving the social objectives set forth by the Government of India.
Definition of Banking
According to Justice Homes :
"The real business of a banker is to obtain deposits of money which he may use for his own profit by lending it out again".
According to R.S. Meyers :
"Banks are institutions whose debts are referred to as bank deposits and they are commonly accepted in final settlement of other people's debts"
Section 5(1)(b) of the Banking Regulation Act, 1949 defines banking as :
"The accepting for the purpose of lending or investment, of deposits from the public, repayable on demand or otherwise and withdrawal by cheque, draft, order or otherwise".
Section 5(1)(c) defines a banking company as :
"Any company which transacts the business of banking in India".
Basically banks are financial intermediaries, which are engaged in the business of (i) acting as a 'payment agent' on behalf of their customers, and (ii) borrowing and lending of money. Their functions include receiving, keeping and lending money (in the expectation of repayment).
Features of Banking
Characteristics of Banking can be depicted as following :
- Dealing in various types of financial instruments, like bills of exchange, hundies, promissory notes, coupons, drafts, bills of lading, railway receipts, warrants, debentures, certificates, scrips, etc. by way of drawing, accepting, discounting, buying, selling and collecting them on behalf of their customers. Such instruments may be negotiable or non negotiable and transferable or non-transferable.
- Acceptance of deposits and borrowing / raising of money.
- Lending of money either against appropriate tangible securities or without any security.
- Issuing of letters of credit (LC), traveler's cheques, drafts, circular notes, etc. on behalf of their customers.
- Buying and selling of foreign exchange and different forex currencies.
- Buying and selling of various commodities like metals, agricultural produce, etc.
- Receiving of important documents and other valuables from their constituents for safe custody.
- Dealing in various financial instruments like stocks funds, shares, debentures, bonds, obligations, securities and other investments on their own and on behalf of their customers, through their acquisition, holding, issuing on commission, underwriting, etc
- Buying and selling of different forms of securities like bonds, equities, derivative instruments, etc. on behalf of their regular customers or non customers, and the negotiating of loans and advances.
Functions of Banking
Banks perform a key role in the overall sustenance and development of a country's financial system. Working and Functions of Bank/Banking are as follows :
Payment System
Banks operating in the system play an important role in providing a payment framework of the financial system of any country. Now-a-days, most of the transactions pertaining to transfer of funds take place in cashless mode, i.e. modes other than cash. Such cashless transactions may be effected Gran Cast e through cheques, credit debit cards, National Electronic Funds Transfers (NEFT), Real Time Gross Settlements (RTGS), Immediate Payments Systems (IMPS), prepaid cards, etc. in all the above mentioned methods used for transfer of funds, financial intermediaries. especially the banks and technology play a crucial role.
The basic objective of putting a national payment system in place is to ensure smooth flow of money from one end of the economy to the other. A robust, result-oriented, and safe payment system facilitates development of various economic activities in country. in a It is a platform not only for ensuring accurate and timely payments, but also transmission of a country's monetary policy framed by its Central Bank. World over, the payment systems of different countries have evolved by overcoming various challenges faced by them from time to time, and continuously bringing about the desired changes necessary for their existence and growth. The foundation stone of a payment system has four pillars, viz. safety, security, soundness, and efficiency. These pillars are also referred to as 'Triple S+E' principle. Components of this principle are linked with each other in a coordinated manner.
Types of Payment System Offered by Banks
Currently, there are following kinds of payment systems offered by banks to their constituents :
1) National Electronic Funds Transfer (NEFT) :
NEFT is a national level payment system, which envisages transfer of funds electronically from the constituent of one bank branch account to the constituent of the same or another bank branch account. The word 'constituent' include individuals, firms. companies. or other incorporated bodies (like trusts, societies, etc.).
2) Electronic Funds Transfer (EFT) :
Under the Electronic Funds Transfer (EFT) money is transferred or exchanged, through the use of computer-based systems, from one account/ multiple accounts to another account / multiple accounts, either within a single FI or across multiple FIs. Some of the activities undertaken under the EFT system are as following:
- Transactions initiated by a debit or credit cardholder, while making payments.
- Direct deposits (credits) by a business entity to its employees, using a 'payroll service bureau'.
- Direct payments (debits), also referred to as electronic cheques, under which a bank customer's account is debited directly on account of payment / EMI of goods delivered or services rendered.
- Payment of various bills electronically through online banking in respect of different services like telephone, electricity, and other utilities.
- Transfer of funds through stored value of electronic money, e.g. pre-paid cards, electronic wallets, etc. and wire transfer through an international banking network.
- Electronic Benefit Transfer, especially in respect of Government subsidies like cooking gas, fertilizers, and other social benefit schemes.
3) Negotiated Dealing System (NDS) :
NDS refers to a system which was put in place by Reserve Bank of India in February, 2002 with a view to provide a safe and efficient infrastructure for facilitating smooth secondary market operations in Government of India securities. It is a screen-based platform, which offers real-time trading facilities (i.e. quotations and negotiations) to various market participants. All the transactions pertaining to a deal are settled directly through the system without any human intervention and without any requirement of furnishing physical transfer form by the participants. In addition to the above, NDS also helps the participants in discovering the level of price and volume by providing electronic reporting of trades and data distribution.
4) Real Time Gross Settlement (RTGS) :
RTGS refers to a system which envisages on-going settlement of transactions (transfer of funds) on a real-time basis. A series of settlements take place on individual transaction basis without effecting netting of such transactions. It means, if there are a large number of transactions involving a single entity, some of which being credit transactions and others being debit transactions, they would be settled separately, and not netted. Each individual transaction would be treated as a separate transaction and settled accordingly. Of course the final result would be the same, whether the settlement is done on gross basis (individually) or on a net basis, but the hallmark of RTGS is settlement of transactions on gross basis. As the settlements under RTGS take place in the books of RBI, they are final and cannot be revoked.
Inter-mediation
Inter-mediation may be defined as the process of mobilizing funds from the savers (who are having surplus thereof) of the economy and diverting the same to the entrepreneurs (who are in the need thereof). Financial inter-mediation is a key factor in the economic development of any country. Financial intermediaries like banks, NBFCs, and other entities are generally companies incorporated under the Indian Companies Act, which are engaged in the business of accepting deposits (borrowings) from savers for onward lending to the business entities in the need of funds for their day to day operations or expansion of business or venturing into new fields of business. In brief, they act as a conduit for channelizing funds from the net savers to the net borrowers of the system in an organized manner.
In addition to the deposits which form the basic source of funds for onward lending, the financial intermediaries have the benefit of getting floating funds which may also be used for lending operations. Floating funds are those funds, which remain with the financial intermediaries (especially banks) during the process of transfer of funds from one branch of a bank to another branch or from one bank to another bank.
Maturity Inter-mediation
Maturity inter-mediation is a phenomenon which denotes a bank's lending of funds (on long-term), which were raised for a short-term tenure. Banks and other financial intermediaries borrow funds in the form of demand deposits or certificate of deposits, which are used for short term lending as well as for long term lending. Maturity inter-mediation places a bank / other FIs in a vulnerable spot due to maturity mismatches. Financial markets are impacted by maturity inter-mediation in the following manner :
- Investors as well as borrowers have multiple choices as regards the maturity pattern of their investments / borrowings.
- As the investors prefer to commit their funds for a short duration, the funds for a longer duration are made available to a borrower at a comparatively higher rate of interest. However, a financial intermediary is still in a position to offer long term loans at a lower rate of interest as compared to an individual investor, as it has the benefit of inflow of funds in the shape of successive deposits until the maturity, albeit with some risks.
Thus, the financial intermediaries plays an important role in the overall development of financial system of a country by bringing together two significant groups, viz. those who have surplus funds and are ready to part with them, and those who are in the need of funds and are willing to borrow. Maturity and risk transformation are two significant outcomes of the maturity inter-mediation process.
Financial Services
Financial services include all those services, which act as an intermediary between an investor on one hand and a borrower on the other. For an investor, they offer an opportunity to invest in a safe and profitable manner, and for a borrower they act as a reliable source of raising funds in a secure and hassle-free environment. The financial service industry has been aptly defined as "the collection of organizations which intermediate and facilitate financial transactions of individual and institutional investors resulting from their resource allocation activities through time".
The financial services encompass all the activities associated with the conversion of savings into investment. Of late, besides providing the traditional banking services, banks as financial intermediaries. have started to offer their customers a wide-range of financial services, such as investment banking, services relating to the fields of insurance, Government business, forex, wealth management. etc. Venturing into such novel businesses has improved bottom-lines of the banks offering such services. Financial services offered by banks involve both capital market and money market activities. Traditional banking activities may be broadly divided into two categories, viz. fund-based activities and non-fund based activities.
Types of Financial Services Offered by Banks
Financial services offered by banks may be classified into following categories :
1) Asset-based Financial Services:
They are the services in which funds are used for the creation of assets.
2) Fee-based Financial Services:
They do not create assets directly instead they act as facilitators for creation of assets. They charge fees for the services rendered by them.
Banking Structure in India
Types of banking / Organizational set-up of the banking industry in India has been depicted through the following chart :
Scheduled Banks
Scheduled banks are those banks, the names of which are included in the second schedule to the Reserve Bank of India Act, 1934. Banks desirous of being included in the above schedule are required to fulfill following basic requirements :
- Their paid-up capital should not be less than Rs.5 lakh.
- Their business activities should not be detrimental to their depositors interests.
Once a bank's name is included in the second schedule ibid, certain facilities (borrowing, re-discounting, refinancing) are extended to them by Reserve Bank of India and they are put under certain obligations by the Central Bank. All the scheduled banks are required to comply with various statutory provisions (contained in RBI Act, 1934, and BR Act, 1949) and guidelines/directions issued by RBI from time to time. Requirements in respect of Cash Reserve Ratio (CRR), Statutory Reserve Ratio (SLR), capital adequacy ratio, Priority Sector Lending, etc. are some of the examples of such requirements. Scheduled banks may be further categorized into following two groups :
1) Commercial Bank :
Commercial banks may be defined as the financial intermediaries engaged in the business of acceptance of deposits, extending various types of loan and advances (business, housing, auto, personal, etc.) and investment activities.
2) Co-operative Banks :
Co-operative banks are also financial intermediaries like commercial banks, engaged in the business of acceptance of deposits, extending various types of loans and advances (business, housing, auto, personal, etc.) and investment activities. However, they differ from the commercial banks, inasmuch as they are established and function on co-operative principles.
Non-Scheduled Banks
Non-scheduled banks are the banks not included in the Second Schedule of the RBI, Act, 1934. They do not enjoy the facilities from RBI as scheduled banks enjoy in the form of borrowing, re-discounting, refinancing. etc. from the Central Bank. However, as far as control of RBI over their activities is concerned, the RBI is fully empowered to exercise control over them. They are required to comply with statutory provisions (contained in RBI Act, 1934, and BR Act, 1949) and various directions issued by RBI from time to time, e.g. compliance with CRR/SLR requirements, preparation of annual accounts and balance sheets as required in terms of Section 29 of the Banking Regulation Act. 1949, etc.