Chapter 1 - Introduction To Banking

Chapter 1 Introduction to Banking
Foundation Certificate in Banking

For Associates
Page 1 of 28
Confidentiality statement
This document should not be carried outside the physical and virtual boundaries of TCS and
its client work locations. The sharing of this document with any person other than TCSer
would tantamount to violation of confidentiality agreement signed by you while joining TC
Notice
The information given in this course material is merely for reference. Certain third party
terminologies or matter that may be appearing in the course are used only for contextual
identification and explanation, without an intention to infringe.
Certificate in Hospital Management
TCS Business Domain Academy
Chapter 1- Introduction to Banking

Introduction
Banking plays an important role in the development of an economy. This chapter provides
an overview of the Banking industry from its start and takes the reader through the basic
banking concepts, functions, characteris
characteristics and classification of banks.
Learning Objective
At the end of this chapter, you would have learnt about:
History of Banks
Evolution of Currency notes
Classification of banks
Characteristics of Banks
Table of Contents
Chapter 1- Introduction to Banking.......................................................................................
....................... 3
1.1
Introduction to Banking.........................................................................................
......................... 4
1.2
Functions and Characteristics of a Bank ..............................................................
.............................. 10
1.3
Classification of Banks .........................................................................................
......................... 19
Summary ................................
........................................................................................................................
........................ 27
Page 3 of 28
1.1
Introduction to Banking
A bank is an entity that provides banking services with a profit making intent. The main
function of a bank is to mobilize the savings i.e. to direct the deposits and savings of the
economy towards investment.
In addition to the primary activities of acceptin

accepting
g deposits and lending, Banks offer ancillary
financial services to make additional profits. These ancillary services include selling
insurance products, investment products or stock brokering, renting safe deposit boxes,
etc.
Banks are able to offer benefits

efits and services on account of their risk
risk-taking
taking and usage of
financial leverage. Leverage is primarily through deposit acceptance. Leverage also helps
banks perform the critical function of financial intermediation, through which depositors
have greaterr investment choices and borrowers have a wider range of sources of credit. This
results in more efficient resource allocation and has been the key driver in the development
of the economic systems.
In Renaissance time, goldsmiths lent gold to gain signi

significant
ficant profits. Many banks offer
ancillary financial services to make additional profits, for example, selling insurance
products, investment products or stock brokering, renting safe deposit boxes, etc. Thus, we
can say that banking plays an important rol
role in the development of an economy
The French and Italians can be credited with coining the term Bank. In French language,
Banque means a chest for safekeeping. In Italian, La Banca refers to a bench where
transactions were conducted. Thus, it came
ca
to be called as Bank as it iss associated with
safekeeping and transactions.
1.1.1
Origin of Banking
Banking services originated from areas with thriving trade and commerce activities such as
ancient China, Lydia, Phoenica and Greece. Banking existed as back into the past as 2000
BC, when Babylonian temples offered loans from their properties/treasures.
Page 4 of 28
However, before going into the details of history of banking, one needs to understand
Barter System. Barter system is defined as the system in which goods are eexchanged
xchanged for
other goods. This system then gave way to risk
risk-taking
taking activities, since there was no medium
of exchange.
First Modern Banks:
The first bank to provide basic banking functions emerged in Spain in 1401. It was called the
Bank of Barcelona. Some
me of the other banks that served as foundations of modern banking
were:
Bank of Venice (1587)
Bank of Amsterdam (1609)
Bank of Hamburg (1619)
Other key developments in Europe were:
Bank of France set up by Napoleon in 1800.
Stock-issuing
issuing banks set up in the 19th century in Germany.
London goldsmiths were the originators of banking in the British isles.
Did You Know?
The key media of exchange before Banks came in were - wampum, tobacco, fur skins, corn,
and livestock.
1.1.2
Banking in the US
The evolution of banking in the US went through different phases.
Chartered Banking
The period 1781-1838

1838 was an era of Chartered Banking in the US. Reputation was the
primary edge in the bygone days, with market placing a premium on institutions with high
integrity. Public trust was the key factor for a bank to circulate notes and redeem them on
demand. When the trust in a bank was less, its notes tend to exchange at a lower rate when
Page 5 of 28
compared to those of more reputed banks. This was visible in Boston in late 1790s where
there were a large number of notes in circulation. Boston banks deci
decided
ded to accept some
banks notes in 1799, but at 0.5% discount. After some years, they refused to accept these
notes even at a discount.
Private money brokers
Private money brokers, who were the early arbitrageurs, arrived on the scene in the 1800s.
These
e brokers purchased the notes at a lower rate and sent them back to the issuing bank
seeking the original redemption price for the notes.
Suffolk Bank System
Following such redemption problems, American banking came up with a significant

cooperative self-regulation
regulation called the Suffolk Bank System. Chartered in 1818, the Suffolk
Bank started country bank notes collection from 1819. This was in essence a regional
clearing system. This restricted the supply of notes and facilitated notes circulation at their
th
face value.
Though a large number of chartered banks emerged, very few failed thanks to the discipline
implemented by the Suffolk Bank.
Free Banking
The period of 1837-63

63 was referred to as Free Banking period (which meant lack of any
restriction on new bank formation and services offered). Banking regulation was under
intense scrutiny following renewal of the Second Bank of the United States and several
banking failures.
New York introduced a new concept in 1838 called Free Banking which was adopted
ad
by
several other states. After the 1837 panic, public realized that banks may not be able to
honor their notes and discounting (ie. trading at was highly prevalent). Some note brokers
started publishing regular periodicals known as Bank Note Reporters
Reporters that listed discounts.
Page 6 of 28
National Banking
Next important phase was National Banking from 1863

1863-1913.
1913. The Congress passed an Act
to establish the National Banking System in 1863, which had certain key free banking
elements such as free entry and collateralized
collateralized bank notes (notes or credit memos backed by
assets).
However, in contrast to the state laws, federal laws regulated market forces by enforcing
limit on notes issue and establishing geographic allocations. The limit was removed in 1875,
but the need for collateral continued which restricted money supply growth. This resulted in
price deflation and low economic growth. To resolve this issue, private markets took
innovative steps.
Important milestones for the US were:
Bank of North America First important bank to be set up in the US in 1781 and was
the first to be chartered by the US government.
Several banks were chartered during the 1780s primarily to issue bank notes, large
to supplement the coins in circulation.
Banks of the time were also allowed deposit

deposit-loans activity
Bank of the United States was set up in 1791 and was the first bank to serve the
government as well as the general public.
1.1.3
The History of Indian Banking
Banking in India has origins in the Vedic period. Manu has talked at length about money
lending, commerce and foreign trade financing in Manusmriti. He also set interest rate
rules. Another major period for banking was the Mughal reign, when there were bankers
active in money lending and foreign trade. Agency houses conducted banking operations
during the East India Company rule.
The first joint stock company called, the General Bank of India was set up in the year 1786.
Other key banks were the Bank of Hindustan and Bengal Bank. Except for Bank of
Hindustan which lasted until 1906, other two failed.
Presidency Banks:
Page 7 of 28
The 19th century witnessed the genesis of three banks, also called the Presidency banks:
The Bank of Bengal, 1809
Bank of Bombay, 1840
Bank of Madras, 1843
Though they began as independent units, they were merged in 1920 and a new bank called
the Imperial Bank of India came into being in 1921. Post-independence,
Post independence, this bank was taken
over by the newly set up State Bank of India in 1955.
The Reserve Bank of India

dia was created in 1935 by the passing of Reserve Bank of India Act
1934.There were several banks with Indian management, set up during the Swadeshi
movement, such as:
Punjab National Bank
Bank of Baroda
The Central Bank of India, etc.
Fourteen major banks were nationalized in 1969 and six more in 1980.
Did you know?
Allahabad Bank is the oldest public sector bank in India and Bank of Bengal was previously
called as Bank of Calcutta.
1.1.4
Evolution of Bank Notes
Bank Notes:: A bank note is a negotiabl

negotiable
e promissory note issued by a bank and payable to
the bearer on demand. The amount payable is stated on the face of the note.
Bank notes are backed only by the government. Generally, the Central Bank is the only
bank that can create bank notes. In India, RBI has the sole authority to issue bank notes.
Similarly, Federal Reserve Bank is the only bank that can issue bank notes in the United
States.
Now, let us see how bank notes have evolved as a medium of exchange.
Page 8 of 28
Bills and drafts were the two ancient fforms

orms of paper money. The former were basically
receipts for certain value, while the latter were a promise to convert to certain value at a
later date. Drafts in the form of metals were used as far as 1 BC in Ptolemaic Egypt. Paper
money came into being to make up for coin shortages.
China issued local paper currency in the 600s. In the 10th century, a form of bank note
named as Jiaozi appeared in Sichuan, China to counter the lack of copper. This was during
the period of Chinese Song Dynasty (960
(960-1279 AD). Most numismatists generally consider
this as the first paper money in the history.
The first bank notes in Europe were issued in 1660 by Stockholms Banco, a predecessor of
the Bank of Sweden. The Bank of England was the first to issue permanently circulating
notes in the year 1694. The practice of printed bank notes and fixed denominations came
into being in the 18th century. Another power center in Italy was Florence, famed for its gold
coin called florin, which was the first hard currency of the
th time.
Did you know?
The Bank of England has been issuing bank notes since 1694. These notes were originally
hand-written.
written. Although they were partially printed from 1725 onwards, cashiers still had to
sign each note and make it payable to someone. To
Totally
tally printed notes were put in
circulation from 1855.
All over the world, only a few central banks do not perform this function. A prime example
of this is the Monetary Authority of Singapore (MAS).
The paper money in India traces its origin back to the 18th century. Private and semi
semigovernment banks started issuing paper money. The Paper Currency Act of 1861 brought an
end to the notes issue by the Private and Presidency banks. The act conferred the monopoly
of Notes issue upon Government of India and it continued issuing of currency notes till the
establishment of Reserve Bank of India.
Page 9 of 28
1.2
Functions and Characteristics of a Bank
Banks have certain key roles to perform in any economy

economy. They are active players in money
supply by raising funds through deposit mobilization; inter bank borrowings and issue of
financial instruments in capital or money markets. A portion of these raised funds is lent to
the borrowers.
off money from public for the purpose of
Banking is defined as Acceptance of deposits o
Lending or Investment, repayable on demand or otherwise and withdrawable by cheque,
draft, or otherwise (Banking Regulations Act of India, 1949)
The essential functions of a bank are accepting of deposits and lendin

lending
g or investing. A
banking company must perform the
these essential functions: If the purpose of accepting of
deposits is not to lend or invest, then the business will not be called as a banking business.
1.2.1
Primary Functions of a Bank
Accepting deposits: Banks accept deposits from its customers. Banks pay interest on these
deposits. There are different types of deposits.
Savings deposits:: These are time deposits. These are interest bearing accounts
(Example, Employee Salary Account)
Fixed deposits: Its a savings account which pays a fixed rate of interest until the
maturity date (Example, Certificate of Deposit)
Current deposits:: This is a deposit account without a specified maturity date. The
customer can withdraw the money at any point of time. ((Example: The
he checking
account or the current account used by business men for their daily business
transactions.)
Recurring deposits:: This is a type of term deposit which allows the customers to
deposit a fixed amount every month. Its almost similar to a FD ac
account
count in which the
Page 10 of 28
customers can deposit a certain amount as monthly installments. For example,

1000 per month or 5,000 per month)
Lending:: Banks lend money to its customers and charge interest on these
borrowings.
Cash credit:: its the total amount of cash that can be obtained from certain type of
credit line. (Example: The cash credit limit in a credit card)
Bank overdrafts: This is a credit facility given to its customers by a bank. This
allows a customer to write checks and withdraw cash, even when there is no
balance in the account.
Loans: Lending of money for a specific purpose in exchange of future repayment

along with principal amount and interest is termed as loan. (Examples: Housing
loan, Vehicle loan, Agricultural loan, etc.)
Discounting bills: discounting bill is cashing a bill at less than its actual value before
its maturity date.
(Example, a bill has a value of Rs. 1,000 and the maturity date is 31st March. The bill
can be issued to the holder at a value of Rs.900 before 31st March. W
When
hen the bill
matures, that is, on 31st March, the holder receives Rs.1,000)
1.2.2
Secondary Functions of a Bank
Banks do perform certain secondary functions apart from the primary functions.
The secondary functions performed by a bank can be classified as below:
Agency Functions:
Banks act as agent to its clients. These agency functions include:
Page 11 of 28
Funds Transfer:: Fund transfer refers to transfer of fund from one account to
another. (Example, transfer of funds from customers account to customers credit
card
rd for credit card payment)
Cheques Collection: Collecting cheques on behalf of its client is a function of bank.
Periodic Payments/collection: Collection of interest, dividend, rent according to

the customers instructions.
Portfolio Management: Professional management of securities and other assets

for the customers. (Example, wealth management, estate planning and
administration)
Other functions: act as a trustee to the client, Advisor to the client, etc.
Utility Functions:
Banks offer utility
ty services as a secondary function. Some of the utility functions performed
by banks are given below:
Drafts & letter of credit: Issue of drafts, Letter of Credits, etc.
Locker facility: Providing locker facility for keeping valuables
Underwriting: Underwriting of shares and debentures
Foreign Exchange: Assisting

ssisting in foreign trade through dealing in foreign exchange
transactions.
Social welfare programs: Distributing

istributing Social Security card as a part of welfare
program.
Other Utility Functions: Other functions such as collection and publishing of

economic data related to the banking industry
industry.
Page 12 of 28
Did You Know?
In the 17th century, UK Goldsmiths and scriveners, who performed research on land titles,
had begun to accept deposits, on which they paid interest, suggesting that the funds were
loaned out.
1.2.3
Sources of Income for a Bank
As we have already discussed, bank is a profit making entity. The main business of banking
is borrowing and lending money. Hence, the main source of income for a bank comes from
these two activities. Bank receives additional income from the secondary services as well.
The various sources

ces of income for a bank are discussed below:
Spread / Margin:
Banks pay interest on the deposits made by the customers. In turn, they charge interest on
the loans availed by the customers. The difference between the interest earned and paid is
called as Spread or Margin. Banks generally borrows at a lower rate of interest and lends at
a higher rate of interest. The yields from the loans make the major portion of the banks
income.
Fee Based Income:

Banks provide their customers a wide variety of services
services in addition to the primary lending
and deposit facility they provide. They charge commissions for these services. These are the
secondary sources of income for a banking organization. The income generated through
these services is also referred to as Exchange, Commission and Brokerage based income.
Few examples for these kinds of services are listed below
Exchange transaction:
Exchange transaction income is the income earned out of the dealings of a bank in Forex
market.
Page 13 of 28
Sale of investments:
Sale
e of investment income is derived out of the investment activities carried out by the
banks.
1.2.4
Characteristics of a Bank
Banks have certain characteristics which are discussed below:
Deals in Money: Banks deal with depositors money. In addition to this, any
transaction which takes place in a bank is in terms of money.
Stores Money: Provide a safe place for investors valuables. Vaults that banks have
are fireproof and nearly impenetrable. Moreover banks have insurance against
losses as a result of theft.
Saving Money/Accept Deposits: They offer various means of saving money

(current account, saving account etc). They pay interest as a percentage of money
in these accounts.
Lend Money/Offer Loans: Like they receive deposits, they lend money to those
who need as well and charge interest and fees. They can however issue only certain
amount of loan due to Fractional Reserve System, which states banks should keep
certain % of value of loans in form of deposits.
Establishes a connecting link: It acts as a link between those who need money and
those who have surplus funds.
Profit/Service oriented: Just like any other business, banks are also profit oriented.
They earn profit by charging interest on loans and fees on various banking services
servi
they provide.
Business: The business of banking cannot function as a subsidiary to any business.
Name: In order to enable people to understand that xyz is a bank and transacts in
money, it must add bank to its name.
Page 14 of 28
Banking as an Integral Part of the Financial System: Banking system is an integral

component of the financial system.
The financial system in a country involves several institutions and agencies. They include:
Capital Market
Capital market brings both the investors and the people wh
who
o are in need of capital
together. There are two types of markets: primary and secondary markets.
The primary market is where fresh capital is directly accepted from investors by an
entrepreneur.
Investors can trade (buy or sell) their investments in existing companies with other
investors in the secondary market
market.
Stock exchanges provide a convenient mechanism for this.
Securities Market
Securities market is the market where securities such as sstocks,

tocks, bonds, debentures, etc.
are traded. The government issues Bonds and Treasury Bills for the public to buy.
Similarly, local self-government
government entities (such as municipalities) and companies also
issue bonds and debentures. These securities can further be traded in the securities
market.
Financial Institutions
These are specialized institutions, whose business is to provide loans to persons who
need it. They do it out of their own capital as well as by taking deposits from the public.
They basically provide
vide long term finance. Apart from institutions, an informal market of
moneylenders and their clients are also a part of the system.
Money Market
Money markets enable participants to borrow and lend for short term spanning from
several days to not more than a year. Generally, financial instruments with high
liquidity and very short maturity are traded in these markets. Certificate of deposits,
bankers acceptances, treasury bills, commercial paper, repos, etc. are examples for
money market securities.
Page 15 of 28
Foreign Exchange Market
This market enables the participants to buy, sell and exchange currencies. These
markets are believed to be the most efficient market among all the financial markets in
the whole system because of its size and liquidity.
Insurance Companies
While the business of insurance companies is to provide insurance cover, they also
invest the large amount of money they collect as premium so that they become
important players in the financial system.
Banks
The
he Banks accept deposits from the public in the form of Current Accounts and Savings
Bank Accounts that are repayable on demand and Fixed Term Deposits. They provide
loans to individuals, industry and commerce, both as long term loans and short term
loans, and extend overdraft facilities where
where a customer has to make a payment in
excess of his available funds.
They also:
provide facility to make payments to third parties through cheques, and participate
in clearing and payment systems, both inland and international, enabling payment
through other Banks
provide facility for remittance of money from one place to another
maintain automated teller machines and maintain credit and debit card systems
accept valuables for safekeeping and rent out safe deposit lockers
act as agents for collec

collection
tion of cheques and commercial bills, buying and selling
securities, and make payments on behalf of the customer
convert money from one currency to another
provide guarantees and letters of credit
do leasing business
manage investment portfolios of custome

customers
act as trustees and executors

Page 16 of 28
provide trade intelligence on parties and market.
All Banks may not do all these activities. But the minimum services a Bank has to render are
to accept demand deposits in accounts that are operated by cheques or withdrawal
withdrawa forms,
accept other deposits, and lend or invest the collected money.
With so many activities, Banks become very useful and influential, especially for industry
and commerce. Banks have been traditionally called handmaiden of commerce.
In India, Banks act as agents of the government for collection of various taxes and payment
of pensions. They also assist in developing credit plans for development of the economy
economy.
Other characteristics of banks are discussed below:
Banks are leveraged
This means that a bank conducts its business while exposing other peoples money to risk. A
bank uses funds in various investments, but there is always a risk that it may not be able to
return these funds to their owners (who are mostly the depositors). There are two mai
main
implications to bank leverage.
Firstly, capital acts as a cushion that prevents bankruptcy. In essence it is a buffer stock.
However, this buffer is very small and is not adequate to prevent insolvency. Yet it is very
important and this amount requires being determined based on the banks environment
and regulatory conditions.
Secondly, managers acting for shareholders can take up risky investment

can do this due to the combined effect of leverage and limited
Shareholders benefit from positive outcomes, but for
avenues. They
liability for shareholders.

sharehold
bad outcomes its the debtors who
pay the price.
Banks are illiquid
Page 17 of 28
Generally, banks hold long term assets and comparatively short term deposit liabilities.
Loans appear as short-term
term contrac
contracts,
ts, however in reality they are longer term
commitments as companies expect the resources to continue. If such loans do not continue,
companies may need to take abrupt steps which may hurt their profitability, operations and
reputation. It would also hurt the banks loan quality. In this sense the banking system is
illiquid if it rapidly liquidates its investments and businesses, value of its assets would fall
sharply.
Banks manage information problems
Banks play a major role in solving information prob

problems
lems that affect global financial markets.
They gather a lot of information to understand their borrowers using various techniques.
Its a banks business to gather private information about a borrower.
However, this puts depositors as well as regulator

regulatorss at a disadvantage when compared to
the banks. While banks can monitor their borrowers, depositors (who in essence are lenders
to banks) cannot monitor bank managers. Regulators do get information, but it is very less
when compared to the information avai
available with bank managers.
There are two main implications to bank leverage It largely relies on market conditions.
When funds are freely available, a borrower may borrow from another bank to repay debt.
During strong economic conditions, even weaker com
companies
panies may appear strong due to easy
access to credit. That means during lending booms banks may not be able to say which of
their loans are bad. And if banks have a hard time in this, their regulators also will.
Bank depositors are protected
Depositors are vulnerable as not only do banks handle their funds but also their private
information. Small depositors may not recover due to losses from mismanagement.
Hence regulators worldwide offer deposit protection subject to a limit. Also corporate
governance initiatives are being mandated.
Banks manage the payments mechanism
Page 18 of 28
A smooth functioning payment system is in the interests of the banking system since the
failure of one bank may have impact on other banks.
Payment mechanisms are important for a banks liabilities. Banks need to make regular
payments to depositors or gain payments from creditors. This in essence is the vehicle
through which payment mechanism
mecha
operates.
Banks improve credit quality
Banks are high quality borrowers. This comes from diversification of banks assets and
capital, which in-turn
turn secure them against their obligations.
1.3
Classification of Banks
Banks can be classified according to

to the functions they perform and the services they offer.
Banks can be further classified as per the ownership.
1.3.1
Scheduled and Non-Scheduled

Scheduled banks
Scheduled banks
Banks which are authorized to provide banking services in India, and those are included in
the second schedule of the RBI Act, 1934. The banks operate under Scheduled banks are
licensed to carry out extensive banking operations including foreign exchange operations.
Scheduled banks in India include:
Scheduled Commercial banks State bank of India and its Associates
Nationalized Banks Bank of India, Andra Bank,
Foreign Banks Bank of A

America, Citi Bank N.A.
Private sector banks ICICI Bank Ltd, HDFC Bank Ltd, federal Bank Ltd.
Cooperative banks - Bharat Co

Co-operative Bank (Mumbai) Ltd., Mumbai, Andhra
Pradesh State Co-operative
operative Bank Ltd. Hyderabad
Regional rural banks Andra Pradesh Grameena Vikas Bank

Bank.
Page 19 of 28
Non-Scheduled banks
Banks those do not come under the purview of RBI Act, 1934, those are not included in the
schedule of RBI. Non-scheduled
eduled banks can carry out limited banking operations. For
example, a non-scheduled
scheduled bank cannot deal with foreign exchange operations.
Non-scheduled
cheduled banks in India include:
The Mahila Vikas Co-operative

operative Bank Ltd., Ahmedabad.
Government Employees Co
Co-operative Bank Ltd, Dharwad.
Jagruti Co-operative
operative Bank Ltd., Belgaum
Swarna Co-Operative
Operative Urban Bank Ltd., Hyderabad
Hyderabad.
Banks in India can be further classified on the basis of ownership, functions and services.
1.3.2
Public and Private Banks
Banks in India can be classified

assified on the basis of ownership as public or nationalized banks and
private banks.
Public / Nationalized Banks:
Majority stake of these banks are is held by the government. Shares of these banks are
listed on stock exchanges. Example: Allahabad Bank, Bank of Baroda, State Bank of India,
etc.
Private Banks:
Majority stake of these banks are held by private stakeholders.

Examples:
Federal Bank
Karur Vysya Bank
Lakshmi Vilas Bank, etc.

Page 20 of 28
1.3.3
Classification on the basis

asis of functions and services
Banks can be classified on the basis of functions and services as follows:
Commercial banks:
Commercial banks are the institutions that accept deposits and provide credit to the
customers, generally used to describe a normal retail bank as opposed to an investment
bank. However, it is now common to give this name to a bank or a bank division that
transacts with corporations. These banks are owned by private investors or
stockholders. Commercial
cial banks can also be any other category of for-profit banks.
Private Banks:
These are generally not incorporated and are owned by partners or individuals. The primary
function of these banks is asset management of wealthy clients (known as High Net
N Worth
clients)
Example
JP Morgan Private Bank
Goldman Sachs
UBS
Retail banks:
A retail bank is a service oriented bank, where individual customers access services of larger
commercial banks. It is a typical mass
mass-market bank where, individual customers use local
branches of larger commercial banks. The key services offered by a retail bank include
savings, checking accounts, mortgages, personal loans, debit cards and credit cards. In
addition to above facilities, retail banks also provide bill payment services, mutual funds and
advisory services.
Page 21 of 28
Citibank is the worldss largest retail bank. Some other banks which practice retail banking
are:
Bank of America
Lloyds TSB
ICICI
HDFC, etc.
Investment banks:
These Banks helps corporations and governments in raising capital, primarily by drawing
funds from the public through the capital market by acting as underwriters and agents in
issuing securities.
An investment bank does not take deposits. They are highly involved in consulting
companies regarding mergers and acquisitions, divestitures, private placements, etc.
Other secondary functions include

include:
sales and trading of derivatives research to review companies
global transaction banking
merchant banking
risk management
investment management
corporate strategy, etc.
There are two types of investment banks
Investment Banks
These are basic investment banks which deal with the issuing of stocks and bonds
to the clients for a specific amount of money and invest this money in various ways.
These
e are also involved in advising corporations regarding mergers and acquisitions
and other corporate activities.
Page 22 of 28
Merchant banks
These banks are involved mainly in trade finance. But they provide capital to firms
in the form of shares rather than loans. They avoid investing in new companies.
They offer services of advice on financial structuring, management of capital issue,

syndication of loans, portfolio management of investments, advice on mergers and
acquisitions, etc. They are called Accepting Hou
Houses
ses in the UK and Investment Banks
in the USA.
Several Indian Banks do different types of business across the segments a Bank
may have Retail Banking, Corporate Banking, Private Banking, a Leasing Division, a
Merchant Banking Division, etc all in house.
Rural banks:
These are the banks which cater to the financial needs of the rural public. Regional Rural
Banks in India are the examples for these types of banks.
Co-operative banks:
Co-operative
operative banks carry out the functions of both retail and commercial banking. They
operate on a co-operative
operative basis.
Industrial banks:
Industrial banks grant loans and advances to individuals and companies which belong to
specific industry types. Industrial banks are generally owned by Non-Banking
Non Banking Financial
Institutions.
Example IDBI (industrial Development Bank of India)

Banks accept deposits from the public with the promise that the money will be returned to
them either on demand or at the expiry of the contract.
However, the money thus collected is deployed

deployed by them for providing loans or for
investment. This means that all the depositors' money at any point of time would not be
Page 23 of 28
available with the Bank for repayment of deposits. The system works because in practice, all
depositors do not come and ask for their money at the same time.
A loan given by a Bank would be used by the borrower in making a certain payment. The
beneficiary of the payment may again deposit the money in the same or another Bank.
Such a deposit is used by the Bank again to make a fresh
fresh loan. This cycle implies that Banks
can create new deposits out of loans and again make further loans, thus multiplying the
availability of money. Banks make loans available to businessmen and others for industry
and commerce.
The sectors for which Banks make such loans thrive in the economy. These activities of
Banks affect availability of money with the general public and have a profound effect on the
economy. Because of such factors that affect the wellbeing of national economies, the
activities off Banks are supervised by designated national authorities. The Central Bank
referred to in Frame 2.3 of Inter
Inter-America
America development bank report discharge this function.
They derive their authority from national legislation of their countries.
Central Banks regulate the functioning of Banks by setting up rules regarding the liquidity
and cash reserves that Banks have to maintain, sectorial credit flows, determining rates of
interest, intervening in money and securities markets, etc. They specify rules aabout
bout when
defaulted loans have to be provided for, and the amount of capital Banks need to maintain
in relationship to the size and type of their operations.
They also set up monitoring mechanisms to ensure that Banks follow the rules. Central
Banks act ass regulators. Monitoring is achieved in two different ways. Off-site
site monitoring
is done by making it mandatory for Banks to report to the regulators by way of periodic
returns and statements on various aspects of their functioning.
Regulators also conduct on-site

site inspections of Banks to audit their books and business
activities. They are usually statutorily armed with penal powers to enforce compliance by
Banks.
The Basel Committee on Banking Supervision, under the aegis of the Bank for International
Settlements
lements at Basel, Switzerland, formulates principles and standards of Bank supervision.
Page 24 of 28
They do not have legal authority to enforce these. National governments and Central Banks
usually adapt the standards and practices to suit their national priorities and
and environment
and enforce them.
Banking Organization
Typical commercial Banks operate with a large network of offices. Some of these are for
their internal administrative functions, but most of the offices are called Branches.
Branches
A Branch of a Bank is where customers visit for the purpose of opening accounts, depositing
and withdrawing money in their accounts and making other transactions. A Branch would
be headed by a Manager and may have several sections or departments that perform the
various activities such as
Deposits,
Loans and Advances,
Remittances,
Safe Deposit Vault, and so on
Sections may also be based on functional segments such as a Private Banking section,
Corporate Credit section, etc.
etc
The Branches may directly report to their Head O

Office.
ffice. More often, a group of Branches
report to a regional office. Depending on the Bank, such groupings may be done at more
than one level, leading to a tiered structure, with the Head Office at the top of the reporting
pyramid. The Head Office would int
interact with the regulators.
In the case of a Bank having operations in more than one country, a country level office
would be set up to deal with this. Banks usually set up the tiers on a geographical basis, to
provide uniformity of operational environmen
environment.
t. At the head office level and also within the
administrative offices and Branches, functional groups for business segments may be
established.
Page 25 of 28
Banks in India have been establishing specialized Branches for customer segments and
special functions.
Examples are:
Service Branches that deal with interbank clearing operations, customer money
transfers, etc for Branches in a geographical area
Agricultural Development Branches, Corporate Banking Branches and Small and

Medium Enterprises Branches for the respective customer segments
Capital Market Branches, Leasing Finance Branches

Branches, Overseas Business
Branches etc that handle the particular business segments alone
Asset Recovery Branches that specialize in dealing with defaulted loans
The administrative offices in various tiers deal with back end operations such as
assessment of borrowers, supervision and audit of Branch operations, coordinating,
reporting, etc.
Page 26 of 28
Summary
A bank is an entity that provides banking services with a profit making intent.
The
he Bank term can be traced to Italian and French languages - In French, Banque
means - chest (for safekeeping). In Italian, Banca means bench (for conducting
transactions)
Banking services originated from areas with thriving trade and commerce activiti
activities
such as ancient China, Lydia, Phoenica and Greece.
Barter system is the system in which goods are exchanged for other goods.
The first bank, Bank of Barcelona, emerged in Spain in 1401.
Some of the other banks that served as foundations of modern banking

banking were Bank
of Venice, Bank of Amsterdam, and Bank of Hamburg.
The evolution of banking in the US went through different phases: Chartered

Banking, Private money brokers, Suffolk Bank System, Free Banking, National
Banking
The 19th century witnessed the g

genesis
enesis of three banks, also called the Presidency
banks in india
A bank note is a negotiable promissory note issued by a bank and payable to the
bearer on demand. The amount payable is stated on the face of the note.
The primary functions of a bank are accepting of deposits and lending or investing
and the secondary functions are Agency Functions and Utility Functions:
Spread / Margin, Exchange, Commission and Brokerage based income, Exchange

transaction, Sale of investments
inve
are the sources of income for a bank
Characteristics of a bank are dealing in Money, Storing Money, Saving Money,

Lending Money, Establishing a connecting link, Profit/Service oriented, Business,
Name
Banking is an Integral Part of the financial sy

system.
Banks can be classified according to the ownership, functions they perform and the
services they offer as Scheduled, Non
Non-scheduled,
scheduled, Nationalized Banks, Private
Banks, Commercial banks:, Private Banks, Retail banks, Investment banks, Rural
banks, Co-operative
operative banks, Industrial banks.
Page 27 of 28
Page 28 of 28

Chapter 1 - Introduction To Banking

Uploaded by

Copyright:

Available Formats

Chapter 1 - Introduction To Banking

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 1 - Introduction To Banking

Uploaded by

Copyright:

Available Formats

Chapter 1 Introduction to Banking

Foundation Certificate in Banking

Certificate in Hospital Management

TCS Business Domain Academy