EDUCATION IS

LEARNING WHAT YOU

DIDN'T EVEN KNOW

YOU DIDN'T KNOW 

BANKING &
FINANCIAL
INSTITUTIONS
PREPARED BY :- MOHIT SHARMA  
 CONTENTS
CONTENTS

Sr. No. Title Page No.

1. OVERVIEW OF INDIAN FINANCIAL SYSTEM 1-6

2. TYPES OF BANKS 7-20

3. RESERVE BANK OF INDIA (RBI) 21-28

4. BANKING SECTOR REFORMS 29-41

5. FINANCIAL MARKET 42-48

6. NON-BANKING FINANCIAL COMPANIES 49-56

7. REGULATORS OF BANKS AND FINANCIAL INSTITUTIONS

IN INDIA 57-59

8. FINANCIAL SECTOR REFORMS INCLUDING FINANCIAL INCLUSION

60-61

9. E-BANKING 62-68

10. INSURANCE 69-82

 CHAPTER :1 OVERVIEW OF INDIAN FINANCIAL SYSTEM

Introduction
The financial system of a country is an important tool for economic development of the
country as it helps in the creation of wealth by linking savings with investments. It
facilitates the flow of funds from the households (savers) to business firms (investors) to
aid in wealth creation and development of both the parties. The institutional
arrangements include all condition and mechanism governing the production,
distribution, exchange and holding of financial assets or instruments of all kinds.
There are four main constituents of the financial system as follows:
1. Financial Services
2. Financial Assets/Instruments
3. Financial Markets
4. Financial Intermediaries

Financial Services
Financial Services is concerned with the design and delivery of financial instruments,
advisory services to individuals and businesses within the area of banking and related
institutions, personal financial planning, leasing, investment, assets, insurance etc.
These services include
o Banking Services: Includes all the operations provided by the banks including to
the simple deposit and withdrawal of money to the issue of loans, credit cards etc.
o Foreign Exchange services: Includes the currency exchange, foreign exchange
banking or the wire transfer.
o Investment Services: It generally includes the asset management, hedge fund
management and the custody services.
o Insurance Services: It deals with the selling of insurance policies, brokerages,
insurance underwriting or the reinsurance.

1
o Some of the other services include advisory services, venture capital, angel
investment etc.

Financial Instruments/Assets
Financial Instruments can be defined as a market for short-term money and financial
assets that is a substitute for money. The term short-term means generally a period of
one year substitutes for money is used to denote any financial asset which can be
quickly converted into money. Some of the important instruments are as follows:
o Call /Notice-Money: Call/Notice money is the money borrowed on demand for a
very short period. When money is lent for a day it is known as Call Money. Intervening
holidays and Sunday are excluded for this purpose. Thus money borrowed on a day and
repaid on the next working day is Call Money. When the money is borrowed or lent for
more than a day up to 14 days it is called Notice Money. No collateral security is required
to cover these transactions.
o Term Money: Deposits with maturity period beyond 14 days is referred to as the
term money. The entry restrictions are the same as that of Call/Notice Money, the
specified entities not allowed to lend beyond 14 days.
o Treasury Bills: Treasury Bills are short-term (up to one year) borrowing
instruments of the union government. It‘s a promise by the Government to pay the
stated sum after the expiry of the stated period from the date of issue (less than one
year). They are issued at a discount off the face value and on maturity, the face value is
paid to the holder.
o Certificate of Deposits: Certificates of Deposits is a money market instrument
issued in dematerialised form or as a Promissory Note for funds deposited at a bank,
other eligible financial institution for a specified period.
o Commercial Paper: CP is a note in evidence of the debt obligation of the issuer. On
issuing commercial paper the debt is transformed into an instrument. CP is an unsecured
promissory note privately placed with investors at a discount rate of face value
determined by market forces.

Financial Markets
The financial markets are classified into two groups:
A capital market is an organised market which provides long-term finance for business.
Capital Market also refers to the facilities and institutional arrangements for borrowing
and lending long-term funds. Capital Market is divided into three groups:
o Corporate Securities Market: Corporate securities are equity and preference
shares, debentures and bonds of companies. The corporate security market is a very
sensitive and active market. It can be divided into two groups: primary and secondary.
o Government Securities Market: In this market government securities are bought
and sold. The securities are issued in the form of bonds and credit notes. The buyers of
such securities are Banks, Insurance Companies, Provident funds, RBI and Individuals.
o Long-Term Loans Market: Banks and Financial institutions that provide long-term
loans to firms for modernization, expansion and diversification of business. Long-Term
Loan Market can be divided into Term Loans Market, Mortgages Market and Financial
Guarantees Market.

Money Market is the market for short-term funds. The money market is divided into
two types: Unorganised and Organised Money Market.

2
o Unorganized Market: It consists of Moneylenders, Indigenous Bankers, Chit Funds,
etc.
o Organized Money Market: It consists of Treasury Bills, Commercial Paper,
Certificate Of Deposit, Call Money Market and Commercial Bill Market. Organised Markets
work as per the rules and regulations of RBI. RBI controls the Organized Financial Market
in India.
Financial Intermediaries
A financial intermediary is an institution which connects the deficit and surplus money.
The best example of an intermediary is a bank which transforms the bank deposits to
bank loans. The role of the financial intermediary is to distribute funds from people who
have an extra inflow of money to those who don‘t have enough money to fulfil the
needs. Functions of Financial Intermediary are as follows:
o Maturity transformation: Deals with the conversion of short-term liabilities to
long-term assets.
o Risk transformation: Conversion of risky investments into relatively risk-free ones.
o Convenience denomination: It is a way of matching small deposits with large
loans and large deposits with small loans.

Financial Intermediaries are divided into two types:

Depository institutions: These are banks and credit unions that collect money from
the public and use that money to advance loans to financial customers.
Non-Depository institutions: These are brokerage firms, insurance and mutual funds
companies that cannot collect money deposits but can sell financial products to financial
customers.

Conclusion
Indian Financial System accelerates the rate and volume of savings through the
provision of various financial instruments and efficient mobilization of savings. It aids in
increasing the national output of the country by providing funds to corporate customers
to expand their respective business. It helps economic development and raising the
standard of living of people and promotes the development of the weaker section of
society through rural development banks and co-operative societies.

1.1 OVERVIEW OF INDIAN FINANCIAL SYSTEM

> A financial system is a complex, well-integrated set of sub-systems of financial
institutions, markets, instruments and services which facilitates the transfer and
allocation of funds, efficiently and effectively.
> The financial systems of most developing countries are characterized by
coexistence and cooperation between the formal and informal financial sectors.
> Formal financial systems consist of four segments or components: financial
institutions, financial markets, financial instruments and financial services.
> Financial institutions are intermediaries that mobilize savings and facilitate the
allocation of funds in an efficient manner. Financial institutions can be classified into
banking and nonbanking, term finance, specialized, sectoral, investment and
state-level: Banking institutions are creators and purveyors of credit while non-banking
financial institutions are purveyors of credit. In India, non-banking financial institutions,
namely, the Developmental Financial Institutions (DFIs) and non-banking financial
companies (NBFCs) as well as Housing Finance Companies (HFCs) are the major

3
institutional purveyors of credit.
> Financial institutions can also be classified as term-finance institutions such
as: Industrial Development Bank of India (IDBI), the Industrial Credit and Investment
Corporation of India (ICICI), the Industrial Financial Corporation of India (IFCI), the
Small Industries Development Bank of India (SIDBI) and the Industrial Investment Bank
of India (IIBI).
> Financial institutions can be specialized finance institutions such as: the
Export Import Bank of India (EXIM), the Tourism Finance Corporation of India (TFCI),
ICICI Venture, the Infrastructure Development Finance Company (IDFC), and sectoral
financial institutions such as the National Bank for Agricultural and Rural Development
(NABARD) and the National Housing Bank (NHB).
> Investment institutions in the business of mutual funds are Unit Trust of India (UTI),
public sector and private sector mutual funds and insurance activity of Life Insurance
Corporation (LIC), General Insurance Corporation (GIC) and its subsidiaries are classified
as financial institutions.
> There are state-level financial institutions such as the State Financial Corporations
(SFCs) and State Industrial Development Corporations (SIDCs) which are owned and
managed by the State governments.

> Financial markets are a mechanism enabling participants to deal in financial claims.
The markets also provide a facility in which their demands and requirements interact to
set a price for such claims.
> The main organized financial markets in India are the money market and the
capital market. The money market is a market for short-term securities while the
capital market is a market for longterm securities, i.e. securities having a maturity
period of one year or more.
> Financial markets are also classified as primary and secondary markets. The
primary market deals in new issues, the secondary market is meant for trading in
outstanding'or existing securities. There are two components of the secondary market:
over-the-counter (OTC) market and the exchange traded market. The government
securities market is' an OT€jpnarket in which spot trades are negotiated and traded for
immediate delivery and payment while in the exchange-traded market, trading takes
place over a trading cycle in stock exchanges. Recently, the derivatives market
(exchange traded) has come into existence.
> Financial instruments are a claim against a person or an institution for payment,
at a future date, of a sum of money and/or a periodic payment in the form of interest or
dividend.
> Financial services are those that help with, borrowing and funding, lending and
investing, buying and selling securities, making and enabling payments and settlements
and managing risk exposures in financial markets.
> The RBI regulates the money market and the SEBI regulates the capital market.
> The four segments are financial systems are interdependent and interact
continuously with each other. Their interaction leads to the development of a smoothly
functioning financial system.
> The functions of a financial system include:
❖ Mobilizing and allocating savings;
❖ Monitoring corporate performance;
❖ Providing payment and settlement systems;

4
♦> Optimum allocation of risk-bearing and reduction;
❖ Disseminating price-related information;
❖ Offering portfolio adjustment facility;
❖ Lowering the cost of transactions and
❖ Promoting the process of financial deepening and broadening.
> The basic elements of a well-functioning financial system are:
❖ A strong legal and regulatory environment;
❖ Stable money;
❖ Sound public finances and public debt management;
❖ Central bank;
❖ A sound banking system;
❖ An information system and
❖ A well-functioning securities market. -'
> The two types of financial system designs are: bank-based and market-based.
> The bank-dominated system such as in Germany, where a few large banks play a
dominant role and the stock market is not that important. The market-dominated
financial system as in the USA, where financial markets play an important role while the
banking industry is much less concentrated.
Why is maintaining a CIBIL score important?
A CIBIL score is like a fingerprint. It clearly gives a picture of a person's financial health
and how responsibly he uses his money. Most people are not even aware of the credit
scoring process until they apply for a loan! And then it dawns on to the small steps that
could have been taken in everyday life to have a good CIBIL rating. But that might be
too late as the person‘s loan application would have already been rejected and he would
be left on to a loan path to rebuilding or improving his CIBIL score.
What is a Good CIBIL Score?
A Good CIBIL score is defined as a score at or above which you should be able to get a
loan easily at the lowest interest rates, subject to your eligibility and other documents
check. Typically, banks in India consider a score of 700 and above as a Good CIBIL
Score. Further, banks may ask for a higher score for unsecured loans as compared to
secured loans such as home loans.
CIBIL Score Range

Credit Bureaus Score Range

CIBIL Score 300-900

Experian Score 300-900

Equifax Score 300-850

Highmark Score 300-900

5
Good CIBIL Rating in India

Loan Type Good CIBIL Score

Home Loan Above 650

Personal Loan Above 700

Loan against Property Above 650

Business Loan Above 700

Car Loan Above 700

Gold Loan Not required

 CIBIL Score in India is a three digit number ranging from 300 to 900, which signifies
the creditworthiness of an individual based on his credit profile and past repayment track
record.
 All four credit scoring agencies in India; CIBIL, Experian, Equifax and Highmark use
their proprietary calculations and algorithms to estimate your score.
 Banks check your CIBIL score before taking a decision to sanction you a loan. Hence,
a Good Score is one the most important factor that can help you get the best loan at
cheapest rates.

6
 CHAPTER :2 TYPES OF BANKS

Banking and Financial Institutions and some basic concepts

―Banking‖ means the accepting, for the purpose of lending or investment, of deposits
of money from the public, repayable on demand or otherwise, and withdrawable by
cheque, draft, order or otherwise;
―Banking company‖ means any company which transacts the business of banking 4
[in India]; Explanation.—Any company which is engaged in the manufacture of goods or
carries on any trade and which accepts deposits of money from the public merely for the
purpose of financing its business as such manufacturer or trader shall not be deemed to
transact the business of banking within the meaning of this clause;

Use of words ―bank‖, ―banker‖, ―banking‖ or ―banking company‖.—(1) No

company other than a banking company shall use as part of its name [or in
connection with its business] any of the words ―bank‖, ―banker‖ or ―banking‖
and no company shall carry on the business of banking in India unless it uses
as part of its name at least one of such words.
No firm, individual or group of individuals shall, for the purpose of carrying on
any business, use as part of its or his name any of the words ―bank‖, ―banking‖
or ―banking company‖.

What is net demand and time liability (NDTL)?

―demand liabilities‖ means liabilities which must be met on demand, and ―time liabilities‖
means liabilities which are not demand liabilities;
As the name suggest there are three broad components to NDTL.
1. Demand Liabilities 2. Time Liabilities; and 3. A Netting Amount that is
reduced from the Demand and Time Liabilities.

Demand Liabilities
Demand Liabilities of a bank are liabilities which are payable on demand. These
include :-
current deposits; demand liabilities portion of savings bank deposits; margins
held against letters of credit / guarantees;
balances in overdue fixed deposits; cash certificates and cumulative/recurring
deposits;
outstanding Telegraphic Transfers (TTs); Mail Transfer (MTs); Demand Drafts
(DDs);
unclaimed deposits; credit balances in the Cash Credit account; and deposits
held as security for advances which are payable on demand.

Time Liabilities
Time Liabilities of a bank are those liabilities that are payable other than on
demand. :-
These include fixed deposits; cash certificates; cumulative and recurring
deposits; time liabilities portion of savings bank deposits; staff security
deposits; margin held against letters of credit, if not payable on demand;

7
deposits held as securities for advances which are not payable on demand;and
gold deposits.

Other demand and time liabilities (ODTL)

ODTL includes: interest accrued on deposits; bills payable; unpaid dividends;
suspense account balances representing amounts due to other banks or public;
net credit balances in branch adjustment account;
Cash collaterals received under collateralized derivative transactions.

Banks: The term bank is being used since long term but there is no clear conception
regarding its beginning. Origin of the word bank belongs to the word Banchior to the
Greek word Banque. Both these words refer to the same kind of banking. Casa De San
Giorgiowas the first bank to be established in 1148. The first public bank was Bank of
Venice. It was established in 1157. In simple words, bank refers to an institution that
deals in money. The institution accepts deposits from the people and gives loans to
those who are in need. Beside dealing in money, banks these days perform various other
functions, such as credit creation, agency job and general service. Bank, therefore is
such an institution which accepts deposits from the people, gives loan, create credit and
undertakes agency work.
A bank is a financial institution which deals with deposits and advances and other related
services. It receives money from those who want to save in the form of deposits and it
lends money to those who need it.
Characteristics/Features of a Bank:
 Dealing in money
 Individual/Firm/Company
 Acceptance of deposit
 Giving advance
 Payments and withdrawal
 Agency and Utility services
 Profit and Services Orientation (a bank is an profit seeking institution having service
oriented approach)
 Ever increasing function
 Connecting link between borrowing &lending of money.
 Banking Business
 Name identity always add the word ―Bank‖ to its name,

Types of Banks:
Banks are classified on various basis, as under:
Classification on the basis of Ownership: On the basis of ownership, banks are of
the following types:
 Public sector banks: Public sector banks are those banks (In 2011 IDBI Bank, 2014
BhartiyaMahila bank were notified with a min.) which are owned by the Government. The
Government runs these banks. In India 20 banks (14+6) were nationalised in 1969 and
1980 respectively. All these banks now belong to the public sector category. Social
welfare is their principal objective.
 Private sector banksThese are those banks which are owned and run by the private
sector. Various banks in the country such as Vijaya bank belong to this category. An
individual has control over these banks in proportion to the shares of the banks held by
him.26 private sector banks,

8
 Co-operative banks: Co-operative banks are those banks which are jointly run by a
group of individuals. Each individual has an equal share in these banks. The affairs of the
bank are managed by its shareholders. Profits are equally distributed among the
shareholders. Mutual help of the members of co-operative banks is the principal
objective of these banks.

Classification According to Law:

Banks are classified into the following two categories on the basis of Reserve Bank Act,
1934:
 Scheduled banks:These are the banks having paid up capital of at least Rs.5 lacs.
These are a joint stock company or a cooperative organisation. These banks are mention
in the second schedule of the Reserve Bank.
 Non-Scheduled banks also called LAB(Local Area Bank): registered as a public
limited Co. act 2013. However they are licensed under the banking regulation
act,1949.These banks are not mentioned in the Second Schedule of Reserve Bank. Paid-
up capital of these banks is less than Rs. 5 lacs. The number of such banks is gradually
falling in India. There are only ‗4‘ such banks at present.
1. Coastal Local Area bank ltd.
2. Capital Local Area bank ltd.
3. Krishna BhimaSamruddhi Local Area bank ltd.
4. Subhadra Local Area bank ltd.

Classification According to Functions:

 Commercial Banks: Total of 93 Commercial banks in India; commercial banks refers

to both scheduled &non-scheduled commercial banks regulated under the Banking
Regulation Act,1949.
Commercial banks are the most important constituents of banking system. These are the
banks which do banking which do banking business to earn profit. According to
Goldfield and Chandler the term ‗Commercial‘with regard to these banks refers to
Commercial Loan Theory. According to this theory, in the assets of banks are included
short term loans for short period. In the words of Culbertson, ‗Commercial Banks are
the institutions that make short term loans to business and in the process create
money‘. According to Reed and Gill, ‗A commercial bank is a financial institution that
accepts demand deposits and makes commercial loans and is regulated by a bank
regulatory agency‘.
According to Goldfield and Chandler it is wrong as well as confusing to call these banks
as commercial banks. This is because of two reasons. First, these banks also give long
period loans to agriculture and industry. Second, many other institutions have also come
up which give only short-period loans. The principal functions like money as a medium of
exchange. These banks do not issue notes but create credit on the basis of their cash

9
deposits. Credit creation is the principal function of these banks. Chandler therefore,
maintains that it would be more appropriate to call these banks as Cheque Deposits
Banks. But their current and popular name is Commercial Banks. Thus, a commercial
bank is a bank which deals in money and credit for the purpose of earning profit. The
State Bank of India, Punjab National Bank, Indian Bank, Canara Bankare some of
the examples of Commercial Banks.
 Foreign BanksForeign Banks are those banks which are incorporated in a foreign
country. They have set up their branches in India. Their principal function is to make
credit arrangement for the export and imports of the country and these banks deal in
foreign exchange. These banks convert the country‘s currency into currencies of other
countries, and likewise foreign currencies are converted into domestic currency. To
perform this function of currency – banks have their head offices in foreign countries.
Most of the exchange banks in India are foreign banks;Grindlays Bank, Chartered
Bank, Hong-kong Bank, Bank of America are example of these banks in India.
 Industrial Banks: Industrial Banks are those banks which offer long term and
medium term loans to the industries and also work for their development. These banks
help industries in the sale of their debentures, bonds and shares. Banks themselves
purchase the shares as well as underwrite the debentures of the industries. Industrial
Banks give loans to the industries for purchase of land and machinery. In India many
industrial banks have been established after independence, viz. Industrial
Development Bank of India, Industrial Finance corporation, State Finance
Corporations and others.
 Agricultural Banks: Agricultural Banks are those banks which give credit to
agricultural sector of the economy Short period loans are given to the farmers for the
purchase of seeds, fertilizers and other inputs. Long period loans are given for making
permanent improvement land. Agricultural Co-operative Banks and Regional Rural Banks
deal in short period loans while long period loans are advanced by Land Development
Banks. At the village level Primary Agricultural Co-operative Societies, at the tehsil level
Co-operative Unions, at the district level Central Co-operative Banks and at the state
level State Co-operative Banks function in India. to fulfil agricultural credit needs at the
national level, National Bank for Agriculture in India. To fulfil agriculture credit needs at
the national level, National Bank for Agriculture and Rural Development (NABARD) has
been established.
 Saving Banks: The principal function of these banks is to collect small savings
across the country and put them to the productive use. These Banks have shown marked
development in Germany and Japan. Saving Banks were first established in Hamberg
city of Germany in 1765. In India a department of Post Offices functions as Saving
Banks.
 Indigenous Banks: These Banks found their origin in India. These banks made a
significant contribution to the development of agriculture and industry before
independence. Mahajans, rural money lenders and jewellers have been the fore-runners
of these banks in India. These agencies do their banking business with their own funds.
Even these days nearly 40% of agricultural loans are offered by the indigenous bank in
India.
 Central Bank: Central Bank is the Apex bank of the banking system of the country.
It issues currency notes and acts as banker‘s bank. It controls credit and regulates the
banking system of the country. Central Bank occupies an important status in monetary
and banking system of a country. Economic stability is the principal function of these
banks. The Central Bank issues all type all types of currency, controls all other banks in
the country and functions as the bank of the Government. This Bank also controls and
regulates the flow of credit. The Reserve Bank of India, Bank of England and
Federal Reserve System are the Central Banks respectively of India, England and
U.S.A. Though the first Central bank in the world was established in 1668 in Sweden, but
the true beginning of Central banking system is marked with the establishment of Bank
of England in 1694.
In short, Central Bank is an institution that controls and regulates the banking system of
the country.

10
 Classification of Commercial Banks on the basis of their Organization:
On the basis of their organisation, commercial banks may be classified as under:
 Unit banking: According to Kent, ‗Under unit banking system, the banking
operations are carried through a single banking office rather than through a network of
branches. Each banking company is a separate company, separately licensed having its
own capital, Board of Directors and shareholders.‘
In this banking system a particular bank functions in a limited area. Bank is of small size
and generally it has no branch office. Such a bank deposits its money in some big bank,
called Correspondent Bank. The control and ownership of these banks is generally in the
hands of local individuals. This banking system is popular in U.S.A.
 Branch Banking: Branch banking refers to that system of banking in which a bank
establishes its head office in some big city and operates the various branches all over the
country. Some of its branches may also be in foreign countries. Branch Banking System
is popular in India, Britain, Canada, France, Germany and various other countries. In the
worlds of Goldfield and Chandler, ‗A branch bank is a banking corporation that directly
owns two or more banking agencies.‘
Branch Banking is a system in which:
I. A bank renders its banking services at two or more places.
II. Head office has the overall control over the working of various branches.
III. Branches can be opened in the same town, state or the country in which the
concerned head office is located or at different places.
IV. Overall control of all the branches is done by one central authority, viz. Board of
Directors.
Functions of Commercial Banks:
Functions of commercial banks can be divided into three parts:

A. Primary Functions
Commercial Banks perform three primary functions:
 Accepting of Deposit:A bank accepts deposits from public. People can deposit their
cash balances in either of the following accounts as per their convenience.
I. Fixed or Time Deposit Account: Cash is deposited in this account for a fixed
period. The depositor gets receipts for the amount deposited. It is called Fixed Deposit
Receipt. It compromises the name of the depositor, amount of the deposit, rate of
interest and the period of deposit. This receipt is not transferable. If the depositor stands
in need of the amount before the expiry of the fixed period, he can withdraw the same
after paying the discount of the bank. This type of deposit attracts high rate of interest.
Longer the period of deposit higher is the rate of interest. It is so because bank can use
this amount for a longer period. It is also called Time Liability of the bank.
II. Current or Demand Deposit Account: A depositor can deposit his funds any
number of times he likes and can also withdraw the same any number of times he
wishes. Ordinarily, businessmen deposit their funds in this account. Generally, no

11
 interest is paid by the bank on demand deposit account. Rather the bank demands some
charges from the depositors if the amount lying in account falls below the minimum
limit. The amount from this account is withdrawn through cheques. This type of account
is also called Demand Liability. In America, it is called Chequing Account
III. Saving Deposit Account: This account is meant for encouraging small savings.
Restrictions are imposed by the bank on the amount to be withdrawn by the depositor. If
the latter wants to withdraw more money than is allowed then he has give prior notice to
the bank. Bank pays interest on this account although its rate is less than the rate of
interest paid on fixed account.
IV. Home Safe Saving Account: This account has been introduced recently by the
banks. A small portable safe is provided to the depositor at his place. Key of safe is kept
by Bank. Depositor put his small savings in it as convenient to him and after some time
hands the same over to bank and gets it entered in his account. Many banks collect the
saved amount by deputing an agent to the place of the depositor. Interest paid on this
account is less than the one paid on saving account.
V. Recurring Deposit Account: Under this account a specified amount is deposited
every month for a specific, say 12, 24, 36 or 60 months. This amount cannot be
withdrawn before the expiry of the given period expect under exceptional circumstances.
Interest on the amount deposited is also credited to the account of the depositor. Like
time-deposit account, interest paid on this account is higher than other account.
 Advancing of Loans: Another primary function of the commercial banks is to
advances loans. A certain part of the cash received by the banks as deposits kept in the
reserve and the rest is given as loan. Banks advance loans mostly for productive
purposes, on approved security. The amount of loan is generally less than the value of
the security. Banks advance following types of loans:
I. Cash Credit: The debtor is allowed to withdraw a certain amount on a given
security. The debtor withdraws the amount within this limit, as per his requirement and
also repays it. Interest is charged by the bank on the amount actually withdrawn.
II. Over-Draft: Clients who have current account with the bank get the sanction to
withdraw more money than is lying in the said account. It is called over draft. This
facility is available for short-term to reliable persons. Supposing a person has Rs. 10,000
lying in current account. If the bank allows him to issue cheques uptoRs. 12,000, then
the amount of Rs. 2,000 will be called over-draft.
III. Loans and Advances: These loans are given in the form of a fixed amount. Bank
enters the name amount of loan in the account books of debtor. The latter can withdraw
it any time. The interest is chargeable on the whole amount from the day the loan is
sanctioned irrespectively of the fact that the debtor withdraws the whole amount or the
part of it.
IV. Discounting of the Bill of Exchange: It is another method of giving advance by
the banks. Under this method, bank gives advance to their clients on the basis of their
bills of exchange before the maturity of such bills. A deduction is made out of the face
value of bill for the period the bill is yet to run. This reduction is called discounting of the
bill. The bank =s discount only the trade bills. The bills are discounted at the market rate
of interest. On the expiry of the maturity period, the amount mentioned in the bill is
collected from the party concerned by the bank.
V. Investment in Government Securities: Purchasing of Government securities by
the banks tantamount to advancing loans by them to the government. Banks prefer to
buy government securities as these are considered to be the safest investment.
 Credit Creation: One of the main functions of bank these days is to create credit.
Banks creates credit by giving more loans than their primary deposits.
B. Secondary Functions
Besides the above primary functions, banks also perform many secondary functions such
as agency functions, general utility and social functions.
 Agency Function:Banks act as agents to their customers in different ways:

12
 I. Collection and Payment of Various Items: Banks collect cheques, rent, interest
etc. on behalf of their customers and also make payment of taxes, insurance premia etc.
on their behalf.
II. Purchase and Sale of Securities: Banks normally are more knowledgeable with
regard to stock and share business. As such they buy, sell and keep in safe custody the
securities on behalf of their customers.
III. Trustee and Executor: Banks also act as trustees and executors of the property of
their customers on their advice.
IV. Remitting of Money: Banks also remit money from one place to another through
bank draft.
V. Purchase and Sale of Foreign Exchange: Banks buy and sell foreign exchange
and thus promote international trade and foreign traders to their customers.
VI. Letter of References: Bank also give information about economic position of their
customers to domestic & foreign traders to their customers.
 General Utility Services:Commercial banks also provide certain services of general
utility to the society:
I. Locker Facilities: Banks provide locker facilities to their customers. People can
keep their gold and silver jewellery or other important documents in these lockers. Their
annual rent is very nominal.
II. Traveller‘s Cheque and Letters of Credit: Banks issue traveller‘s cheque and
letters of credit to their customers so that they may be spared from the risk of carrying
cash during their journey.
III. Business Information And Statistics: Being familiar with the economic situation
of the country, the banks give advice to their customers on financial matters on the basis
of business information and statistical data collected by them.
IV. Help in transportation of Goods: Big businessmen and industrialists after
consigning goods to their retailers send the Railway Receipt (Consignment Note) to the
bank. The retailers get this Receipt from bank on payment of the value of the
consignment to it. Having obtained the Railway Receipt from the bank they get delivery
of the consignment from the Railway Goods Office. In this way banks help in the
transportation of goods from the production centres to the consumption centre.
C. Developmental Functions
In modern times, banks also perform following significant functions relating to economic
development and social welfare of the country.
1. Banks collect idle savings of the people and invest the same in productive activities.
Thus, they help in accelerating the rate of capital formation.
2. Banks are also taking part in capital market. They have been giving long-term
advances to industry, agriculture, small-scale industry, traders, transporters etc. they
also finance export trade.
3. Banks give loans to weaker sections of the society on low rate of interest. Small
artisans, landless agricultural labourers and poor classes get cheap loans from the
banks.
4. Commercial banks have opened their branches in rural areas and small towns to
provide banking facilities to the people living therein.
5. Since banks do not give loans for speculative and unproductive activities, bank credit
can be used productively.
6. Banks also give credit at low rate of interest to finance such programmes as are
meant for rural development and removal of unemployment.
7. The commercial bank either of their own or through their subsidiaries, perform
several financial functions. These include mutual funds, Merchant banking, Housing
finance, Factory Leasing Factoring, Stock Investment etc.
In short, a modern bank performs several functions which are of great significance to the
economic growth of a country. A bank is no longer an institution required to accept
deposits and advance loans. It plays a significant role in the economic development and
social welfare of a country.

13
Form ‗B‘

A universal bank participates in many kinds of banking activities and is both

a commercial bank and an investment bank as well as providing other financial

14
services such as insurance. These are also called full-service financial firms, although
there can also be full-service investment banks which provide wealth and asset
management, trading, underwriting, researching as well as financial advisory.

These are the sectors in which FDI is allowed in India

FDI
Sector Entry Route & Remarks
Limit
Asset Reconstruction
100% Automatic
Companies
Automatic up to 49% Above 49% & up to 74%
Banking- Private Sector 74%
under Government route
Banking- Public Sector 20% Government
Credit Information
100% Automatic
Companies (CIC)

Meaning of Cooperative Bank:

Cooperative bank is an institution established on the cooperative basis and dealing in
ordinary banking business. Like other banks, the cooperative banks are founded by
collecting funds through shares, accept deposits and grant loans.
The cooperative banks, however, differ from joint stock banks in the following manner:
(i) Cooperative banks issue shares of unlimited liability, while the joint stock banks issue
shares of limited liability.
(ii) In a cooperative bank, one shareholder has one vote whatever the number of shares
he may hold. In a joint stock bank, the voting right of a shareholder is determined by
the number of shares he possesses.
(iii) Cooperative banks are generally concerned with the rural credit and provide financial
assistance for agricultural and rural activities. Joint stock companies are primarily
concerned with the credit requirements of trade and industry.
(iv) Cooperative banking in India is federal in structure. Primary credit societies are at
the lowest rung. Then, there are central cooperative banks at the district level and state
cooperative banks at the state level. Joint stock banks do not have such a federal
structure.
(v) Cooperative credit societies are located in the villages spread over entire country.
Joint stock banks and their branches mainly concentrate in the urban areas, particularly
in the big cities

15
History of Cooperative Banking in India:
Cooperative movement in India was started primarily for dealing with the problem of
rural credit. The history of Indian cooperative banking started with the passing of
Cooperative Societies Act in 1904. The objective of this Act was to establish cooperative
credit societies ―to encourage thrift, self-help and cooperation among agriculturists,
artisans and persons of limited means.‖
Many cooperative credit societies were set up under this Act. The Cooperative Societies
Act, 1912 recognised the need for establishing new organisations for supervision,
auditing and supply of cooperative credit. These organisations were- (a) A union,
consisting of primary societies; (b) the central banks; and (c) provincial banks.
Although beginning has been made in the direction of establishing cooperative societies
and extending cooperative credit, but the progress remained unsatisfactory in the pre-
independence period. Even after being in operation for half a century, the cooperative
credit formed only 3.1 per cent of the total rural credit in 1951-52.

Structure of Cooperative Banking:

There are different types of cooperative credit institutions working in India. These
institutions can be classified into two broad categories- agricultural and non-agricultural.
Agricultural credit institutions dominate the entire cooperative credit structure.
Agricultural credit institutions are further divided into short-term agricultural credit
institutions and long-term agricultural credit institutions.
The short-term agricultural credit institutions which cater to the short-term financial
needs of agriculturists have three-tier federal structure- (a) at the apex, there is the
state cooperative bank in each state; (b) at the district level, there are central
cooperative banks; (c) at the village level, there are primary agricultural credit societies.

List of Scheduled Commercial Banks in India

Sr. No. Category of Banks Total Number
1 Public Sector Bank 1
2 Nationalized Banks 17
3 Private Sector Banks 22
4 Foreign Banks 46
5 ... Regional Rural Banks 53

16
Sr. Name of Acts
No.
1 The Enforcement of Security Interest and Recovery of Debts Laws and
Miscellaneous Provisions(Amendment) Act, 2016 (NO. 44 OF 2016)

2 Negotiable Instruments (Amendment) Act, 2015

3 Payment and Settlement Systems (Amendment) Act, 2015

4 Banking Law Amendment Act to come into force, 2013

5 Banking Laws Amendment Act 2012

6 The Factoring Regulation Act, 2011

7 Enforcement of Security Interest and Recovery of DEBTS Law (Amendment) Act,

2012

8 The Sick Industrial Companies (Special Provisions) Repeal Act, 2003

9 Industrial Development Bank (Transfer of Undertaking & Repeal) Act, 2003

10 The Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002

11 Industrial Reconstruction Bank (Transfer of Undertaking & Appeal) Act, 1997^: $;/
12 Recovery of Debts Due to Banks and Financial Institutions Act, 1993

13 The Industrial Finance Corporation (Transfer of Undertakings and Repeal) Act,

1993

14 The Special Court (trial of Offences relating to Transactions in Securities) Act, 1992

15 SIDBI Act, 1989

16 The National Housing Bank Act, 1987

17 Sick Industrial Companies (Special Provisions) Act, 1985.

18 Shipping Development Fund Committee (Abolition) Act, 1985

19 Chit Fund Act 1982

20 The National Bank for Agriculture and Rural Development Act, 1981

21 The Export-Import Bank of India Act, 1981

22 The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980

23 The Regional Rural Banks Act, 1976 '

24 The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970

25 The Deposit Insurance and Credit Guarantee Corporation Act, 1961

26 The Subsidiary Banks General Regulation, 1959

17
27 The State Bank of India (Subsidiary Banks) Act, 1959

28 The State Bank of India Act, 1955

29 The Industrial Disputes (Banking Companies) Decision Act, 1955

30 The Reserve Bank of India (Amendment and Misc. Provisions) Act, 1953

31 The State Financial Corporations Act, 1951

32 The Banking Regulation Act, 1949

33 The Industrial Disputes (Banking and Insurance Companies) Act, 1949

34 The Banking Companies (Legal Practitioner Clients' Accounts) Act, 1949

35 The Industrial Finance Corporation of India Act, 1948

36 The Reserve Bank of India Act, 1934

37 The Bankers' Books Evidence Act, 1891

38 Negotiable Instrument Act, 1881

Insurance Acts
1 The Insurance Laws (Amendment) Act, 2015
2 The Securities and Insurance Laws (Amendment and Validation) Act, 2012
3 Actuaries Act, 2006
4 General Insurance Business (Nationalisation) Amendment Act, 2002
5 Insurance Regulatory and Development Authority Act, 1999

6 General Insurance Business (Nationalization) Act, 1972

7 Life Insurance Act, 1956

8 Insurance Act, 1938

Pension Reforms
1 The Pension Fund Regulatory and Development Authority Act, 2013
The Indian Banking Companies Act, 1949:
“Banking means the acceptance for the purpose of lending or investment, of
deposits of money from the
public repayable on demand or otherwise, and withdrawal by cheque, draft,
order or otherwise
Stages of Evolution of Banking in India
1. Agency Houses: One agency house established the first bank in India called the
Bank of Hindustan in 1770.
2. Presidency Banks: Bank of Bengal, Bank of Bombay and Bank of Madras were
established in 1806,1840 and 1943 respectively.

18
3. Joint Stock Banks: In 1884, banks were allowed to be established on the principle
of limited liability. Punjab National Bank, Allahabad Bank, Bank of Baroda are some of
the banks then established.
4. Imperial Bank of India: established in 1921; nationalised in July 1, 1955; today‘s
State Bank of India.
5. Establishment of the Reserve Bank of India: Hilton Young Commission.
Accordingly, the RBI was established in 1935.
6. Nationalisation of the RBI and the Banking Regulation Act in 1949.
7. Nationalisation of Banks in 19th July, 1969 and 1980.
8. Local Area Banks: Local Area Banks with operations in two or three contiguous
districts were conceived in the 1996 Union budget to mobilise rural savings and make
them available for investments in local areas. The Raghuram Rajan Committee had
envisaged these local area banks as private, well governed, deposit-taking small-finance
banks.

LEAD BANK SCHEME

In 1969, the RBI implemented the recommendation of the Study Group headed by Prof.
D.R. Gadgil. It was called the ‗ Gadgil Study Group‟1, it was based on the organization
framework for implementation of the social objectives. The study group found that the
commercial banks did not have adequate presence in rural areas and also lacked the
required rural orientation and hence recommended an „Area Approach‘ to evolve plans
and programmes for the development of an adequate banking and credit structure in the
rural areas. Later on, the Nariman Committee recommended that each public sector
bank should concentrate on certain districts where it should act as a „Lead Bank‟. The
‗Lead Bank Scheme‘ is administered by the RBI since 1969. The scheme aims at
coordinating the activities of banks and other developmental agencies through various
forums in order to achieve the objective of enhancing the flow of bank finance to priority
sector and other sectors and to-promote the banks‘ role in overall
development of the rural sector.
Local Area Banks
These banks are set up in private sector to cater to the credit needs of the local people
and to provide efficient and competitive financial intermediation services in their area of
operation. The RBI issuedguidelines for the setting up of local area banks in August
1996. The banks are registered as a public limited company under the Companies Act,
1956 and are issued licenses under the Banking Regulation Act, 1949. They are also
eligible for inclusion in the Second Schedule of the RBI Act, 1934. The minimum paid up
capital for such a bank is Rs. 5 crore and the promoters‘ contribution for such a bank is
at least Rs. 2 crore. There are four local area banks operating in certain places such as
Coastal Local Area Bank Ltd. in Andhra Pradesh, Krishna Bhima Samruddhi Local Area
Bank Ltd. which operates in Mahbub Nagar district of Andhra Pradesh, Gulbarga and
Raichur districts in Karnataka and Subhadra

19
Mobilization Lending Investment
Deposit Resources of bank ■ Lending to agriculture ■ Investment in SLR
and non- SLR
■ Deposit Mobilization: Time ■ Lending to priority sector
securities.
and demand.
■ Lending to industry
■ Investment of
■ Time deposits are short,
■ Infrastructure financing banks in government
medium and long-term.
securities and other
■ Lending to household sector
■ Demand deposits: current approved securities is
and savings. ■ Lending to sensitive sectors known as SLR
securities.
■ Certificate of deposits are ■ Financing of Non-banking
short-term time deposits. finance companies ■ Investment in
commercial paper,
■ Foreign deposits mobilization ■ Financing to factoring
units of mutual funds,
include: (a) Non-Resident companies.
shares and debentures
External Rupee Account [NR(E)
of PSUs and private
RA] introduced in February 1970;
corporate sector are
Foreign Currency Non-Resident
known as non-SLR
(Account) in November 1975;
securities.
Non-resident External Rupee
Account in April 2002. >
Non-Deposit Resources of
bank
■ Through public issues in the
capital market.
■ By borrowing in the
call/notice money market, repo
market and Collateralized
borrowing and lending obligation
(CBLO) market.
■ Through private placement
■ Through External Commercial
Borrowings and inter-bank
borrowings.

20
 CHAPTER :3 RESERVE BANK OF INDIA (RBI)

The Reserve Bank of India is the central bank of the country. Central banks are a
relatively recent innovation and most central banks, as we know them today, were
established around the early twentieth century.
The Reserve Bank of India was set up on the basis of the recommendations of the Hilton
Young Commission. The Reserve Bank of India Act, 1934 (II of 1934) provides the
statutory basis of the functioning of the Bank, which commenced operations on April 1,
1935.
Establishment The Reserve Bank of India was established on April 1, 1935 in
accordance with the provisions of the Reserve Bank of India Act, 1934.The Central Office
of the Reserve Bank was initially established in Calcutta but was permanently moved to
Mumbai in 1937. The Central Office is where the Governor sits and where policies are
formulated.Though originally privately owned, since nationalisation in 1949, the Reserve
Bank is fully owned by the Government of India.
PreambleThe Preamble of the Reserve Bank of India describes the basic functions of the
Reserve Bank as:"...to regulate the issue of Bank Notes and keeping of reserves with a
view to securing monetary stability in India and generally to operate the currency and
credit system of the country to its advantage."
Mgt. &ControL RBI:

21 Member Central Board of Director

1 4 Deputy 2 Officer 10 Appoint by GOI 4 Local boards

Governor Governors Appoint by governors
जो देश के structure
Finance
पर अपनी राय व्यक्त कोrepresentकरने
Ministry
करते है| के लिए
CGनेappoint ककये
थे|

Central board  Mumbai. Governor Dr. Urjit Patel

Central board केअतिरिक्त 4 Local board भीहै : Mumbai, Calcutta, Chennai, New Delhi.
 अबिक 24 persons नेइसे Govern तकयाहै |
1st Governor Sir Osborne Smith, 3rd Indian Governor Sir C.D. Deshmukh, 23rd Governor
Raguram G Rajan AND 24THDr. Urjit Patel
Central Board
The Reserve Bank's affairs are governed by a central board of directors. The board is
appointed by the Government of India in keeping with the Reserve Bank of India Act.
Appointed/nominated for a period of four years
Constitution:
Official Directors

21
Full-time : Governor and not more than four Deputy Governors
Non-Official Directors
Nominated by Government: ten Directors from various fields and two government
Official
Others: four Directors - one each from four local boards
Functions : General superintendence and direction of the Bank's affairs
Names and addresses of the Central Board of Directors of the Reserve Bank of India
1. Dr. Urjit R. Patel Governor
2. Shri R. Gandhi Deputy Governor
3. Shri S. S. Mundra Deputy Governor
4. Shri N. S. Vishwanathan Deputy Governor
5. Dr. Viral V. Acharya Deputy Governor

Dr. 4th 4th

23 Raghuram September September
G. Rajan 2013 2016

4th
Dr. Urjit R.
24 September Till Date
Patel
2016

Financial Supervision:-
The Reserve Bank of India performs this function under the guidance of the Board for
Financial Supervision (BFS). The Board was constituted in November 1994 as a
committee of the Central Board of Directors of the Reserve Bank of India.
Offices Has 19 regional offices, most of them in state capitals and 9 Sub-offices.
Subsidiaries Fully owned: Deposit Insurance and Credit Guarantee Corporation of
India(DICGC), Bharatiya Reserve Bank Note Mudran Private Limited(BRBNMPL), National
Housing Bank(NHB)
Objective Primary objective of BFS is to undertake consolidated supervision of the
financial sector comprising commercial banks, financial institutions and non-banking
finance companies.
Constitution The Board is constituted by co-opting four Directors from the Central
Board as members for a term of two years and is chaired by the Governor. The Deputy
Governors of the Reserve Bank are ex-officio members. One Deputy Governor, usually,
the Deputy Governor in charge of banking regulation and supervision, is nominated as
the Vice-Chairman of the Board.
BFS meetingsThe Board is required to meet normally once every month. It considers
inspection reports and other supervisory issues placed before it by the supervisory
departments.BFS through the Audit Sub-Committee also aims at upgrading the quality of
the statutory audit and internal audit functions in banks and financial institutions. The
audit sub-committee includes Deputy Governor as the chairman and two Directors of the
Central Board as members.The BFS oversees the functioning of Department of Banking
Supervision (DBS), Department of Non-Banking Supervision (DNBS) and Financial
Institutions Division (FID) and gives directions on the regulatory and supervisory issues.

22
The Reserve Bank of India is the central bank of India it was established as a
shareholder‘s bank on 1st April 1935. Its share capital was Rs. 5 crore, divided
in to 5 lakhs fully paid up shares of Rs. 100 each. On 1st January 1949 it was
nationalized. Its headquarters is at Mumbai. RBI, like any other bank performs
almost all traditional Central banking functions. Due to country‘s development
it has also undertaken developmental and promotional functions.
A. FUNCTIONS OF RBI :-
RBI performs many functions, some of them are:-
1. Issue Of Currency Notes :-
Under section 22 of RBI Act, the bank has the sole right to issue currency notes of all
denominations except one rupee coins and notes. The one-rupee notes and coins and
small coins are issued by Central Government and their distribution is undertaken by RBI
as the agent of the government. The RBI has a separate issue department which is
entrusted with the issue of currency notes.
2. Banker To The Government :-
The RBI acts as a banker agent and adviser to the government. It has obligation to
transact the banking business of Central Government as well as State Governments.
E.g.:- RBI receives and makes all payments on behalf of government, remits its funds,
buys and sells foreign currencies for it and gives it advice on all banking matters. RBI
helps the Government – both Central and state – to float new loans and manage public
debt. The bank makes ways and meets advances of the government. On behalf of
central government it sells treasury bills and thereby provides short-term finance.
3. Banker‘s bank And Lender Off Last Resort :-
RBI acts as a banker to other banks. It provides financial assistance to scheduled banks
and state co-operative banks in form of rediscounting of eligible bills and loans and
advances against approved securities.
RBI acts as a lender of last resort. It provides funds to bank when they fail to get it from
other sources. It also acts as a clearing house. Through RBI, banks make interbanks
payments.
4. Controller Of Credit :-
RBI has power to control the volume of credit created by banks. The RBI through its
various quantitative and qualitative techniques regulates total supply of money and bank
credit in the interest of economy. RBI pumps in money during busy season and
withdraws money during slack season.
5. Exchange control And Custodian Of Foreign Reserve :-
RBI has the responsibility of maintaining fixed exchange rates with all member countries
of IMF. For this, RBI has centralized all foreign exchange reserves (FOREX). RBI
functions as custodian of nations foreign exchange reserves. It has to maintain external
valu of Rupee. RBI achieves this aim through appropriate monetary fiscal and trade
policies and exchange control.
6. Collection And Publication Of Data :-
The RBI collects and complies statistical information on banking and financial operations
of the economy. The Reserve Bank Of India‘ Bulletian is a monthly publication. It not
only provides information, but also results of important studies and investigations
conducted by reserve bank are given. ‗The Report on currency and finance‘ is an annual
publication. It provides review of various developments of economic and financial
importance.
7. Regulatory And Supervisory Functions :-

23
The RBI has wide powers of supervision and control over commercial and co-operative
banks, relating to licensing, establishment, branch expansion, liquidity of Assets,
management and methods of working, amalgamation, re-construction and liquidation.
The supervisory functions of RBI have helped a great in improving the standard of
banking in India to develop on sound lines and to improve the methods of their
operation.
8. Clearing House Functions :-
The RBI acts as a clearing house for all member banks. This avoids unnecessary transfer
of funds between the various banks.
9. Development And Promotional Functions :-
The RBI has helped in setting up Industrial Finance Corporations of India (IFCI), State
Financial Corporations (SFCs), Deposit Insurance Corporation, Agricultural Refinance and
Development Corporation (ARDC), units Trust of India (UTI) etc. these institutions were
set up to mobilize savings, promote saving habits and to provide industrial and
agricultural finance.
RBI has a special Agricultural Credit Department (ACD) which studies the problems of
agricultural credit. For this Regional Rural banks, Co-operative, NABARD etc. were
established. The RBI has also taken measures to promote organized bill market to create
elasticity in Indian Money Market in order to satisfy seasonal credit needs.
Thus RBI has contributed to economic growth by promoting rural credit, industrial
financing, export trade etc.
MONETARY POLICY OF RBI :-
The Monetary Policy of RBI is not merely one of credit restriction, but it has also the duty
to see that legitimate credit requirements are met and at the same time credit is not
used for unproductive and speculative purposes RBI has various weapons of monetary
control and by using them, it hopes to achieve its monetary policy.
I) General I Quantitative Credit Control Methods :-
In India, the legal framework of RBI‘s control over the credit structure has been provided
Under Reserve Bank of India Act, 1934 and the Banking RegulationAct, 1949.
Quantitative credit controls are used to maintain proper quantity of credit o money
supply in market. Some of the important general credit control methods are:-
1. Bank Rate Policy :-
Bank rate is the rate at which the Central bank lends money to the commercial banks for
their liquidity requirements. Bank rate is also called discount rate. In other words bank
rate is the rate at which the central bank rediscounts eligible papers (like approved
securities, bills of exchange, commercial papers etc) held by commercial banks. Bank
rate is important because it is the pace setter to other market rates of interest. Bank
rates have been changed several times by RBI to control inflation and recession. By
2003, the bank rate has been reduced to 6% p.a
2. Open market operations :-
It refers to buying and selling of government securities in open market in order to
expand or contract the amount of money in the banking system. This technique is
superior to bank rate policy. Purchases inject money into the banking system while sale
of securities do the opposite. During last two decades the RBI has been undertaking
switch operations. These involve the purchase of one loan against the sale of another or,
vice-versa. This policy aims at preventing unrestricted increase in liquidity.
3. Cash Reserve Ratio (CRR):-
The Gash Reserve Ratio (CRR) is an effective instrument of credit control. Under the RBl
Act of, l934 every commercial bank has to keep certain minimum cash reserves with

24
RBI. The RBI is empowered to vary the CRR between 3% and 15%. A high CRR reduces
the cash for lending and a low CRR increases the cash for lending. The CRR has been
brought down from 15% in 1991 to 7.5% in May 2001. It further reduced to 5.5% in
December 2001. It stood at 5% on January 2009. In January 2010, RBI increased the
CRR from 5% to 5.75%. It further increased in April 2010 to 6% as inflationary
pressures had started building up in the economy. As of March 2011, CRR is 6%.
4. Statutory Liquidity Ratio (SLR)
Under SLR, the government has imposed an obligation on the banks to maintain a
certain ratio to its total deposits with BANK ITSELF in the form of liquid assets like cash,
gold and other securities. The RBI has power to fix SLR in the range of 25% and 40%
between 1990 and 1992 SLR was as high as 38.5%. Narasimham Committee did not
favour maintenance of high SLR. The SLR was lowered down to 25% from 10thOctober
1997.It was further reduced to 24% on November 2008. At present it is 25%.
5. Repo and Reverse Repo Rates
In determining interest rate trends, the repo and reverse repo rates are becoming
important. Repo means Sale and Repurchase Agreement. Repo is a swap deal involving
the immediate Sale of Securities and simultaneous purchase of those securities at a
future date, at a predetermined price. Repo rate helps commercial banks to acquire
funds from RBI by selling securities and also agreeing to repurchase at a later date.
Reverse repo rate is the rate that banks get from RBI for parking their short term excess
funds with RBI. Repo and reverse repo operations are used by RBI in its Liquidity
Adjustment Facility. RBI contracts credit by increasing the repo and reverse repo rates
and by decreasing them it expands credit. Repo rate was 6.75% in March 2011 and
Reverse repo rate was 5.75% for the same period. On May 2011 RBI announced
Monetary Policy for 2011-12. To reduce inflation it hiked repo rate to,7.25% and Reverse
repo to 6.25%.
Current Rates provided by RBI as on 03-10-2019(4th bi monthly monetary
policy)
Policy Rates Reserve Ratios Lending/Deposit Rates

Policy Repo Rate: 5.15% Cash Reserve Ratio: 4% Base Rate: 8.95% - 9.40%

Reverse Repo Rate: Statutory Liquidity Ratio: MCLR (overnight): 8.05% - 8.50%
4.90% 18.75%

Marginal Standing Facility Saving Deposit Rate: 3.50% - 4.00%

Rate: 5.40%

Bank Rate: 5.40% Term Deposit Rate > 1 year: 6.25% -

7.50%
CPI(INFLATION )4% WITH A BAND OF +\- 2

II) SELECTIVE / QUALITATIVE CREDIT CONTROL METHODS

Under Selective Credit Control, credit is provided to selected borrowers for selected
purpose, depending upon the use to which the control try to regulate the quality of credit
- the direction towards the credit flows. The Selective Controls are :-
1. Ceiling on Credit
The Ceiling on level of credit restricts the lending capacity of a bank to grant advances
against certain controlled securities.
2. Margin Requirements :-

25
A loan is sanctioned against Collateral Security. Margin means that proportion of the
value of security against which loan is not given. Margin against a particular security is
reduced or increased in order to encourage or to discourage the flow of credit to a
particular sector. It varies from 20% to 80%. For agricultural commodities it is as high
as 75%. Higher the margin lesser will be the loan sanctioned.
3. Discriminatory Interest Rate (DIR)
Through DIR, RBI makes credit flow to certain priority or weaker sectors by charging
concessional rates of interest. RBI issues supplementary instructions regarding granting
of additional credit against sensitive commodities, issue of guarantees, making advances
etc.
4. Directives:-
The RBI issues directives to banks regarding advances. Directives are regarding the
purpose for which loans may or may not be given.
5. Direct Action
It is too severe and is therefore rarely followed. It may involve refusal by RBI to
rediscount bills or cancellation of license, if the bank has failed to comply with the
directives of RBI.
6. Moral Suasion
Under Moral Suasion, RBI issues periodical letters to bank to exercise control over credit
in general or advances against particular commodities. Periodic discussions are held with
authorities of commercial banks in this respect.
Monetary policy is a regulatory policy by which the central bank or monetary authority of
a country controls the supply of money, availability of bank credit and cost of money,
that is, the rate of Interest.
Monetary policy / monetary management is regarded as an important tool of economic
management in India. RBI controls the supply of money and bank credit. The Central
bank has the duty to see that legitimate credit requirements are met and at the same
credit is not used for unproductive and speculative purposes. RBI rightly calls its credit
policy as one of controlled expansion.

The Monetary Policy Committee (MPC):

Composition and Objectives
The 6 member Monetary Policy Committee (MPC) constituted by the Central
Government as per the Section 45ZB of the amended RBI Act, 1934. The first
meeting of the MPC was held on October 3 and 4, 2016. This committee decides various
policy rates like Repo rate, Reverse repo rate, MSF and Liquidity Adjustment Facility etc.
Reserve Bank of India (RBI) is the highest monetary authority of India. RBI is authorised
to maintain the money supply in the economy as per the requirement of the economy.
RBI releases bimonthly monetary policy of the country.
What is Monetary Policy
Monetary policy refers to the policy of the Reserve Bank of India with regard to the use
of monetary instruments under its control to achieve the goals of GDP growth and lower
inflation rate. The RBI is authorised to made monetary policy under the Reserve
Bank of India Act, 1934.Hence monetary policy refers to the credit control measures
adopted by the Central Bank of a country.
Objectives of the Monetary Policy: Key decisions pertaining to benchmark interest
rates used to be taken by the Governor of Reserve Bank of India alone prior to the
establishment of the committee. The Governor of RBI is appointed and can be

26
disqualified by the Government anytime. This led to uncertainty and resulted in friction
between the Government and the RBI, especially during the times of low growth and
high inflation. Before the constitution of the MPC, a Technical Advisory Committee (TAC)
on monetary policy with experts from monetary economics, central banking, financial
markets and public finance advised the Reserve Bank on the stance of monetary policy.
However, its role was only advisory in nature.
The setting up of a committee to decide on Monetary Policy was first proposed by
the Urjit Patel Committee. The Committee suggested a five-member MPC - three
members from the RBI and two nominated by the Government. The Government initially
proposed a seven-member committee - three from the RBI and four nominated by it.
Subsequent negotiations led to the current composition of the committee, with the
external members having a four-year term.
The Reserve Bank‘s Monetary Policy Department (MPD) assists the MPC in formulating
the monetary policy. Views of key stakeholders in the economy, and analytical work of
the Reserve Bank contribute to the process for arriving at the decision on the policy repo
rate. The Financial Markets Operations Department (FMOD) operationalises the monetary
policy, mainly through day-to-day liquidity management operations. The Financial
Markets Committee (FMC) meets daily to review the liquidity conditions so as to ensure
that the operating target of monetary policy (weighted average lending rate) is kept
close to the policy repo rate. Monetary Policy Committee came into force on 27th June
2016.
Suggestions for setting up a Monetary policy committee is not new and goes back to
2002 when YV Reddy committee proposed to establish a MPC, then Tarapore committee
in 2006, Percy Mistry committee in 2007, Raghuram Rajan committee in 2009 and then
Urjit Patel Committee in 2013.

The Chakravarty committee has emphasized that price stability, economic growth,
equity, social justice, promoting and nurturing the new monetary and financial
institutions have been important objectives of the monetary policy in India.
RBI tries always tries to reduce rate of inflation or keep it within a sustainable limit while
on the other hand government of India focus to accelerate the GDP growth of the
country.
What is Monetary Policy Committee?
The Monetary Policy Committee (MPC) constituted by the Central Government under
Section 45ZB.The MPC determines the policy interest rate required to achieve the
inflation target.
The Reserve Bank‘s Monetary Policy Department (MPD) assists the Monetary Policy
Committee (MPC) in forming the monetary policy. The Monetary Policy Committee
determines the policy rates required to achieve the inflation target.
Composition of Monetary Policy Committee
The 6 member Monetary Policy Committee (MPC) constituted by the Central
Government as per the Section 45ZB of the amended RBI Act, 1934. The first
meeting of the Monetary Policy Committee (MPC) was held on in Mumbai on
October 3, 2016.
The composition of the MPC as on April 2019 is as follows;
1. Governor of the Reserve Bank of India – Chairperson, ex officio; (Shri
Shaktikanta Das)
2. Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy –
Member, ex officio; (Dr. Viral V. Acharya).

27
3. One officer of the Reserve Bank of India to be nominated by the Central Board –
Member, ex officio; (Dr. Michael Debabrata Patra)
4. Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad –
Member
5. Professor Pami Dua, Director, Delhi School of Economics – Member
6. Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member
Except ex-officio members all members will hold the office for a period of 4 years or until
further orders, whichever is earlier.

RATING OF BANKS:-
What is the 'CAMELS Rating System'FOR DOMESTIC BANKS
.RBI‘s 1995 working group headed by S. Padmanabham suggested method of rating.
.RBI rates the Bank on a 5 Point Scale of A to E, widely on the lines of international.
CAMELS ratings model for domestic banks and CALCS for foreign Banks.

CAMELS Rating for Domestic Banks –

C- CAPITAL ADEQUACY RATIO
A -ASSET QUALITY
M -MANAGEMENT EFFECTIVENESS
E- EARNINGS
L- LIQUIDITY
S- SYSTEM AND CONTROLS

Each of these 6 components is calculated on a scale of 1 to 100.

CALCS Rating for Foreign Banks –
C CAPITAL ADEQUACY RATIO
AASSET QUALITY
L LIQUIDITY
C COMPLIANCE
S SYSTEM AND CONTROLS

28
 CHAPTER :4 BANKING SECTOR REFORMS

Since nationalization of banks in 1969, the banking sector had been dominated by the
public sector. There was financial repression, role of technology was limited, no risk
management etc. This resulted in low profitability and poor asset quality. The country
was caught in deep economic crises. The Government decided to introduce
comprehensive economic reforms. Banking sector reforms were part of this package. In
august 1991, the Government appointed a committee on financial system under the
chairmanship of M. Narasimhan.
FIRST PHASE OF BANKING SECTOR REFORMS or NARASIMHAN COMMITTEE REPORT –
1991 :-
SUBMISSION OF REPORT ON 17 DEC 1991 IN PARLIAMENT
RECOMMENDATIONS OF NARASIMHAN COMMITTEE :-
On the recommendations of Narasimhan Committee, following measures were
undertaken by government since 1991 :-
1. Lowering SLR And CRR
The high SLR and CRR reduced the profits of the banks. The SLR has been reduced from
38.5% in 1991 to 25% in 1997. This has left more funds with banks for allocation to
agriculture, industry, trade etc.
The Cash Reserve Ratio (CRR) is the cash ratio of a banks total deposits to be
maintained with RBI. The CRR has been brought down from 15% in 1991 to 4.1% in
June 2003. The purpose is to release the funds locked up with RBI.
2. Prudential Norms :-
Prudential norms have been started by RBI in order to impart professionalism in
commercial banks. The purpose of prudential norms include proper disclosure of income,
classification of assets and provision for Bad debts so as to ensure hat the books of
commercial banks reflect the accurate and correct picture of financial position.
Prudential norms required banks to make 100% provision for all Non-performing Assets
(NPAs). Funding for this purpose was placed at Rs. 10,000 croresphased
over 2 years.
3. Capital Adequacy Norms (CAN) :-
Capital Adequacy ratio is the ratio of minimum capital to risk asset ratio. In April 1992
RBI fixed CAN at 8%. By March 1996, all public sector banks had attained the ratio of
8%. It was also attained by foreign banks.
4. Deregulation Of Interest Rates :-
The Narasimhan Committee advocated that interest rates should be allowed to be
determined by market forces. Since 1992, interest rates has become much simpler and
freer.
a) Scheduled Commercial banks have now the freedom to set interest rates on their
deposits subject to minimum floor rates and maximum ceiling rates.
b) Interest rate on domestic term deposits has been decontrolled.
c) The prime lending rate of SBI and other banks on general advances of over Rs. 2
lakhs has been reduced.
d) Rate of Interest on bank loans above Rs. 2 lakhs has been fully decontrolled.
e) The interest rates on deposits and advances of all Co-operative banks have been
deregulated subject to a minimum lending rate of 13%.
5. Recovery Of Debts :-

29
The Government of India passed the ―Recovery of debts due to Banks and Financial
Institutions Act 1993‖ in order to facilitate and speed up the recovery of debts due to
banks and financial institutions. Six Special Recovery Tribunals have been set up. An
Appellate Tribunal has also been set up in Mumbai.
6. Competition From New Private Sector Banks :-
Now banking is open to private sector. New private sector banks have already started
functioning. These new private sector banks are allowed to raise capital contribution
from foreign institutional investors up to 20% and from NRIs up to 40%. This has led to
increased competition.

License
1st Round → 1993 → 10 6 working [HDFC, ICICI, IDBI, Including, UTI, DCB]
Banks
4 Closed [Global Trust Bank, Bank of Punjab, Centurial Bank,
Times Bank]
2nd Round → 2001 → 2 Kotak
Banks
Yes Bank
3rd Round → 2013 → 23 banks apply for license but only 2 banks get license. i.e., Bandhan
financial service (2014) & IDFC (2015)
There are some in-principle conditions:
(i) Net worth exceeds Rs. 1000 Cr.
(ii)25% of branches in un-bank area.
23 Banks
2 Banks 11 Banks 10 Banks
Called Universal Bank Payment Bank Small finance Bank

7. Phasing Out Of Directed Credit :-

The committee suggested phasing out of the directed credit programme. It suggested
that credit target for priority sector should be reduced to 10% from 40%. It would not
be easy for government as farmers, small industrialists and transporters have powerful
lobbies.
8. Access To Capital Market :-
The Banking Companies (Acquisition and Transfer of Undertakings) Act was amended to
enable the banks to raise capital through public issues. This is subject to provision that
the holding of Central Government would not fall below 51% of paid-up-capital. SBI has
already raised substantial amount of funds through equity and bonds.
9. Freedom Of Operation :-
Scheduled Commercial Banks are given freedom to open new branches and upgrade
extension counters, after attaining capital adequacy ratio and prudential accounting
norms. The banks are also permitted to close non-viable branches other than in rural
areas.
10. Local Area banks (LABs) :-
In 1996, RBI issued guidelines for setting up of Local Area Banks and it gave Its
approval for setting up of 7 LABs in private sector. LABs will help in mobilizing rural
savings and in channeling them in to investment in local areas.

30
11. Supervision Of Commercial Banks :-
The RBI has set up a Board of financial Supervision with an advisory Council to
strengthen the supervision of banks and financial institutions. In 1993, RBI established a
new department known as Department of Supervision as an independent unit for
supervision of commercial banks.
SECOND PHASE OF REFORMS OF BANKING SECTOR (1998) / NARASIMHAN
COMMITTEE REPORT 1998 :-
On the recommendations of committee following reforms have been taken :-
1) New Areas: New areas for bank financing have been opened up, such as :-
Insurance, credit cards, asset management, leasing, gold banking, investment banking
etc.
2) New Instruments: For greater flexibility and better risk management new
instruments have been introduced such as :- Interest rate swaps, cross currency forward
contracts, forward rate agreements, liquidity adjustment facility for meeting day-to-day
liquidity mismatch.
3) Risk Management :-Banks have started specialized committees to measure and
monitor various risks. They are regularly upgrading their skills and systems.
4) Strengthening Technology :-For payment and settlement system technology
infrastructure has been strengthened with electronic funds transfer, centralized fund
management system, etc.
5) Increase Inflow Of Credit :-Measures are taken to increase the flow of credit to
priority sector through focus on Micro Credit and Self Help Groups.
6) Increase in FDI Limit :-In private banks the limit for FDI has been increased from
49% to 74%.
7) Universal banking :-Universal banking refers to combination of commercial
banking and investment banking. For evolution of universal banking guidelines have
been given
8) Adoption Of Global Standards :-RBI has introduced Risk Based Supervision of
banks. Best international practices in accounting systems, corporate governance,
payment and settlement systems etc. are being adopted.
9) Information Technology :-Banks have introduced online banking, E-banking,
internet banking, telephone banking etc. Measures have been taken facilitate delivery of
banking services through electronic channels.
10) Management Of NPAs:-RBI and central government have taken measures for
management of non-performing assets (NPAs), such as corporate Debt Restructuring
(CDR), Debt Recovery Tribunals (DRTs) and LokAdalts.
11) Mergers And Amalgamation :-In May 2005, RBI has issued guidelines for merger
and Amalgamation of private sector banks.
12) Guidelines For Anti-Money Laundering :-In recent times, prevention of money
laundering has been given importance in international financial relationships. In 2004,
RBI revised the guidelines on know your customer (KYC) principles.
13) Managerial Autonomy :- In February, 2005, the Government of India has issued a
managerial autonomy package for public sector banks to provide them a level playing
field with private sector banks in India.
14) Customer Service:-In recent years, to improve customer service, RBI has taken
many steps such as :- Credit Card Facilities, banking ombudsman, settlement off claims
of deceased depositors etc.
15) Base Rate System Of Interest Rates:-In 2003 the system of Benchmark Prime

31
Lending Rate (BPLR) was introduced to serve as a benchmark rate for banks pricing of
their loan products so as to ensure that it truly reflected the actual cost. However the
BPLR system tell short of its objective. RBi introduced the system of Base Rate since 1st
July, 2010. The base rate is the minimum rate for all loans. For banking system as a
whole, the base rates were in the range of 5.50% - 9.00% as on 13th October, 2010.
Approach to calculate Base Rate: Marginal Cost of Funds Based Lending Rate
(MCLR)
Last year, RBI has directed banks to calculate their respective base rate based on
marginal cost of lending funds which was previously calculated on other factors as per
bank ease.
Firstly what is base rate?
Base rate is the rate which is decided by respective banks below which they cannot lend
credits to individuals or businesses except in the cases allowed by RBI. It is different for
each bank. RBI does not decide the base rate for banks, but banks themselves decide
the base rate following a certain methodology.
Before 2010, there was Benchmark Prime Lending Rate (BPLR) system. Under this banks
were allowed to lend loans to their most trust worthy customers at a low rate. But this
system was not transparent. Banks used to lend to big businesses in order to increase
their business and the low income people could not have the credits easily.
So in 2010, banks were advised by RBI to apply the system of base rate i.e. below this
rate banks will not be able to lend credits, except in the cases allowed by RBI. Banks
were provided with various parameters to calculate their respective base rates. These
parameters include average cost of funds, marginal cost of funds or any other
methodology which seemed reasonable.
This was a good step by RBI which allowed transparency in the loan credit system. But
then banks used to change their methodology as when they wanted and which provided
them with more ease and convenience.
Whenever the RBI cuts the repo rate, same has to be done by banks also in their base
rates, but they lower the base rate in small because most banks currently follow average
cost of funds based calculation for arriving at respective base rates. This is the main
reason for changing the policy to Marginal Cost of Funds based Lending Rates (MCLR).
Now again changing the policy, RBI had directed banks to change their methodology to
Marginal cost of Funds to calculate the base rate.
What is marginal cost of funds?
They are the funds which banks have to give to its customers and RBI instead of
investing them in other ways.
The main components of MCLR are:
Marginal Cost of Funds: Customers deposit money in savings account, fixed deposits,
recurring deposits and foreign currency accounts and banks have to give interest on
these amounts. Interest given on short term borrowings from RBI in the form of repo
rate
Negative carry on account of CRR: Banks have to keep a part of their deposits with
RBI which is known as Cash Reserve Ratio (CRR). RBI does not give any interest for
these deposits, banks can use these funds to provide loans and earn interests.
Operating Costs: Operating costs associated with ATMs, providing loans, infrastructure,
raising funds, etc.
Tenor premium: The loans which are given for longer terms or have longer tenor
period. MCLR would be based on these longs terms rate also.
These 4 parameters decide the funds which could have have been invested by banks

32
other than giving to the customers and RBI. In new system also, like base rate, banks
can not lend below a certain benchmark.
Some of the guidelines on MCLR
Loans covered by government schemes, where banks have to charge interest rates as
per the scheme are exempted from being linked to MCLR.
Like base rate, banks are not allowed to lend below MCLR, except for few categories like
loans against deposits, loans to bank‘s own employees.
Fixed Rate home loans, personal loans, auto loans etc., will not be linked to MCLR.
MCLR would be effective after April 1, 2016, so all new loans will be given based on the
new system after April 1, 2016.
Existing customers will also have an option to shift to the new regime with some
conditions.
Banks have to review and publish their MCLR of different maturities every month on a
pre-announced date.
The new measures will add further transparency in the methodology followed by banks
for determining interest rates on advances.

Recent development in Banking

■S The Banks Board Bureau has its genesis in the recommendations of The Committee
to Review Governance of Boards of Banks in India, May 2014. Thereafter, on February
28, 2016, the Government of India announced the constitution, and composition of the
Bureau. The Bureau started functioning from April 01, 2016 as an autonomous
recommendatory body.
■S Capital for Public Sector Banks (PSBs): Under the Indradhanush Plan, action
related to (i) Appointment (ii) Bank Board Bureau (iii) Capitalization (iv) De-stressing
PSBs (v) Empowerment (vi) Framework of Accountability (vii) Governance Reforms has
been initiated by the Government.
S Merger of SBI Associates with State Bank of India (SBI): The merger has come in
effect from 1st April, 2017.
S BRICS Interbank Co-operation Mechanism: EXIM Bank is the nominated member
development bank from India under the BRICS Interbank Co-operation Mechanism.
■S Conversion of Kisan Credit Card (KCC) into RuPay KCCs
S The Negotiable Instruments (Amendment) Act, 2015
S The Payment and Settlement Systems (Amendment) Act, 2015: The Payment and
Settlement Systems Act, 2007 was enacted with a view to providing a sound legal basis
for the regulation and supervision of payment systems in India by Reserve Bank of India.
S Regional Rural Banks (Amendments) Act, 2015: RRBs are jointly owned by
Government of India, the concerned State Government and Sponsor Banks.
S Card acceptance infrastructure
■S Debt Recovery Tribunals

33
BASEL NORMS

Bank for International Settlements

The Bank for International Settlements (BIS) is an international financial
institution owned by central banks which "fosters international monetary and
financial cooperation and serves as a bank for central banks". The BIS carries
out its work through its meetings, programmes and through the Basel Process
– hosting international groups pursuing global financial stability and facilitating
their interaction. It also provides banking services, but only to central banks
and other international organizations. It is based in Basel, Switzerland, with
representative offices in Hong Kong and Mexico City. The BIS was established
in 1930 by an intergovernmental agreement between Germany, Belgium,
France, the United Kingdom, Italy, Japan, the United States and Switzerland. It
opened its doors in Basel, Switzerland on 17 May 1930.

Basel Committee on Banking Supervision

The Basel Committee on Banking Supervision (BCBS) is a committee of banking
supervisory authorities that was established by the central bank governors of
the Group of Ten countries in 1974. It provides a forum for regular cooperation
on banking supervisory matters. Its objective is to enhance understanding of
key supervisory issues and improve the quality of banking supervision
worldwide. The Committee frames guidelines and standards in different areas –
some of the better known among them are the international standards on
capital adequacy, the Core Principles for Effective Banking Supervision and the
Concordat on cross-border banking supervision.The Committee's Secretariat is
located at the Bank for International Settlements (BIS) in Basel, Switzerland.
However, the BIS and the Basel Committee remain two distinct entities
This incident prompted the G-10 nations to form the Basel Committee on
Banking Supervision in late 1974, under the auspices of the Bank for
International Settlements (BIS) located in Basel, Switzerland.

BASEL NORMS

Introduction

Basel is a city in Switzerland which is also the headquarters of Bureau of

International Settlement (BIS).
 BIS fosters co-operation among central banks with a common goal of financial
stability and common standards of banking regulations.
 The Bank for International Settlements (BIS) established on 17 May 1930, is the
world's oldest international financial organisation. There are two representative offices in
the Hong Kong and in Mexico City. In total BIS has 60 member countries from all over
the world and covers approx 95% of the world GDP.

Objective

 The set of the agreement by the BCBS (BASEL COMMITTEE ON BANKING

SUPERVISION), which mainly focuses on risks to banks and the financial system are
called Basel accord.
 The purpose of the accord is to ensure that financial institutions have enough capital
on account to meet the obligations and absorb unexpected losses.

34
 India has accepted Basel accords for the banking system.
 BASEL ACCORD has given us three BASEL NORMS which are BASEL 1,2 and 3.

Before coming to that we have to understand following terms-

 CAR/CRAR- Capital Adequacy Ratio/ Capital to Risk Weighted Asset Ratio
 RWA- Risk Weighted Assets
⇒Formulae for CAR=Total Capital/RWA*100

⇒ Now here, Total Capital= Tier1+ Tier2 capital

Risk Weighted Assets

RWA means assets with different risk profiles; it means that we all know that is much
larger risk in personal loans in comparison to the housing loan, so with different types of
loans the risk percentage on these loans also varies.

BASEL-I

 In 1988, The Basel Committee on Banking Supervision (BCBS) introduced capital

measurement system called Basel capital accord, also called as Basel 1.
 It focused almost entirely on credit risk, It defined capital and structure of risk
weights for banks.
 The minimum capital requirement was fixed at 8% of risk-weighted assets (RWA).
 India adopted Basel 1 guidelines in 1999.

BASEL-II

In 2004, Basel II guidelines were published by BCBS, which were considered to be the
refined and reformed versions of Basel I accord.

The guidelines were based on three parameters which are as follows

 Banks should maintain a minimum capital adequacy requirement of 8% of risk
assets.
 Banks were needed to develop and use better risk management techniques in
monitoring and managing all the three types of risks that is credit and increased
disclosure requirements.
 The three types of risk are- operational risk, market risk, capital risk.
 Banks need to mandatory disclose their risk exposure, etc to the central bank.
 Basel II norms in India and overseas are yet to be fully implemented.
The three pillars of BASEL-3 can be understood from the following figure

BASEL-3

35
Basel III

 In 2010, Basel III guidelines were released. These guidelines were introduced in
response to the financial crisis of 2008.
 In 2008, Lehman Brothers collapsed in September 2008, the need for a fundamental
strengthening of the Basel II framework had become apparent.
 Basel III norms aim at making most banking activities such as their trading book
activities more capital-intensive.
 The guidelines aim to promote a more resilient banking system by focusing on four
vital banking parameters viz. capital, leverage, funding and liquidity.
 Presently Indian banking system follows Basel II norms.
 The Reserve Bank of India has extended the timeline for full implementation of the
Basel III capital regulations by a year to March 31, 2019.

Important Points Regarding Implementation of Basel III

 The government of India is scaling disinvesting their holdings in PSBs to 52 per cent.
 The government will soon infuse Rs 6,990 crore in nine public sector banks including
SBI, Bank of Baroda (BoB), Punjab National Bank (PNB) for enhancing their capital and
meeting global risk norms.
 This is the first tranche of capital infusion for which the government had allocated Rs
11,200 crore in the Budget for 2014-15.
 The government has infused Rs 58,600 crorebetween 2011 to 2014 in the state-
owned banks.
 Finance Minister ArunJaitley in the Budget speech had said that "to be in line with
Basel-III norms there is a requirement to infuse Rs 2,40,000crore as equity by 2018 in
our banks. To meet this huge capital requirement we need to raise additional resources
to fulfil this obligation.

36
Basel Norms
Basel I Basel II Basel III
 Introduction in 1988 2004 2010
 India start 1992 2009 Amendment in 2011
implementation
 Fully implement by 1999 31.3.2015 31.3.2019
India
 Recommendation CAR=8% 3 Pillars 3 Pillars
(i) CAR=8% But India (i) CAR=9% (Public +
9%. Private Banks) But for
new private banks CAR
(ii) Supervision
would be 10% and local
review (i.e., How to
area banks has to
maintain risk)
maintain 15%
(iii) Mkt. Discipline
(ii) Enhanced Supervision
(i.e., How to disclose) review
(iii) Enhanced mkt.
discipline

The ―Indradhanush‖ plan for Public Sector Banks

Finance minister ArunJaitley launched a seven pronged plan called Indradhanush in
August 2015. The mission is also known as A2G for public sector banks.
Mission of the plan: To revamp or improve the functioning of public sector banks.
Indradhanush mainly focuses on systemic changes in state-run lenders, including a fresh
look at hiring, a comprehensive plan to de-stress bloated lenders, capital infusion,
accountability incentives with higher rewards including stock options and cleaning up
governance.
The plan is called Indradhanush because it contains seven elements as
1.Appointments: Executives from the private sector have been hired to run state-
owned banks. Separate post of CMDs and MD & CEO in PSU. Private sector candidates
can also apply for the position of MD & CEO.
2.Bank Board Bureau: It will replace existing appointments board. Click here to read
about Bank Board Bureau.
3.Capitalization: Under recapitalization plans for Public Sector Banks, 13 banks would
get Rs 20,058 crore this financial year. The rest Rs 5,000 crore would be allocated based
on efficiency criteria. SBI will get the highestRs 5,511 cr, followed by Bank of India at
Rs 2,455 cr, IDBI at Rs 2,229 cr, PNB at Rs 1732 cr and IOB at Rs 2009 cr.
4.De-stressing: The focus will be on de-stressing the banks from their Non-Performing
Assets or Bad Loans. Asset reconstruction companies would also be strengthened to deal
with the bad loan situation.
5.Empowerment: Under this, the government will make it easier for PSBs to hire. The
government is looking at introducing Employee Stock Ownership Plan (ESOPs) for the
PSU bank managements.
6.Framework of Accountability: The government also announced a new framework of
key performance indicators for state-run lenders to boost efficiency in functioning while
assuring them of independence in decision making on purely commercial considerations.
7.Governance Reforms: The process of governance reforms started with
―GyanSangam‖ – a conclave of PSBs and Financial Institutions organized at the
beginning of 2015 in Pune which was attended by all stake-holders including Prime
Minister, Finance Minister, MoS (Finance), Governor, RBI and CMDs of all PSBs and FIs.
The GyanSangam recommendations included strengthening of risk management

37
practices. Each bank agreed to nominate a senior officer as Chief Risk Officer of the
bank.
The Basel-I defined two tiers of the Capital in the banks to provide a point of view to the
regulators. The Tier-I Capital is the core capital while the Tier-II capital can be said to be
subordinate capitals. The following info shows the 2 tiers of the Capital Fund under the
Basel II.

Tier-I Capital
 Paid up Capital
 Statutory Reserves
 Other disclosed free reserves
 Capital Reserves which represent surplus arising out of the sale proceeds of the
assets.
 Investment Fluctuation Reserves
 Innovative Perpetual Debt Instruments (IPDIs)
 Perpetual Noncumulative Preference Shares.
Minus:
 Equity Investment in subsidiaries.
 Intangible assets.
 Losses (Current period + past carried forward)
Tier-II Capital
 Undisclosed reserves and cumulative perpetual preference shares.
 Revaluation Reserves
 General Provisions and loss reserves
 Hybrid debt capital instruments such as bonds.
 Long term unsecured loans
 Debt Capital Instruments.
 Redeemable cumulative Preference shares
 Perpetual cumulative preference shares.

Please note that banks have to follow the following minimum requirements of
Capital Fund:
 Minimum Total CRAR (Basel II Recommendations) : 8%
 Minimum Total CRAR (RBI Guidelines) : 9%
 For New Private Sector Banks : 10%
 The banks that undertake insurance business: 10%
 Local Area Banks : 15%
 For dividend declaration by banks 9%

38
Risk Management in Banks
Risk may be defined as an exposure to a transaction with loss, which occurs with some
probability and which can be expected, measured and minimized. Thus, risk
management is necessary to ensure sound, stable and efficient banking system. Risk
management involves identification, measurement, monitoring and controlling risks to
optimize risk-reward trade-off. -N--
Steps in Risk Management Process
Risk Analysis: It implies a backroom exercise of looking at the entire gamut of risks.
Thus, risk analysis includes risk identification and risk measurement. ; >
Risk Identification: The banking system faces different types of risks such as credit
risk, market risk, interest rate risk, foreign exchange risk, operational risk, technological
risk, liquidity risk, strategic risk and contingent risk.
RiskMeasurement Risk Control and Risk Monitoring.
Risk Management Tools: (i) Asset liability management [ALM] (it is a process of
planning, organizing and controlling asset and liability volume maturities, rates and
yields so as to match the structure of liabilities with structure of assets) and (ii) stress
testing i.e. sensitivity tests and scenario tests. The ALM guidelines mainly address
liquidity, currency and interest rate risks.
NPA Management
A non-performing asset (NPA) is a loan or advance for which the principal or interest
payment remained overdue for a period of 90 days. An asset, including a leased asset,
becomes non-performing when it ■ ceases to generate income for the bank. A ‗non-
performing asset‘ (NPA) was defined as a credit facility in respect of which the interest
and/ or instalment of principal has remained ‗past due‘ for a specified period of time.
Description: Banks are required to classify NPAs further into Substandard, Doubtful and
Loss assets.
1. Substandard assets: Assets which has remained NPA for a period less than or equal
to 12 months.
2. Doubtful assets: An asset would be classified as doubtful if it has remained in the
substandard category for a period of 12 months.
3. Loss assets: As per RBI, ―Loss asset is considered uncollectible and of such little
value that its continuance as a bankable asset is not warranted, although there may be
some salvage or recovery value.‖
1. 5/25 Refinancing scheme. ^
2. Asset Reconstruction Companies. , \;/
3. Strategic Debt Restructuring.
4. Asset Quality review.
5. S4A (Scheme for Sustainable Structuring of Stressed Assets) introduced in
June 2016. Resolution of Stressed Assets — Revised Framework dated February
12, 2018
Lenders shall identify incipient stress in loan accounts, immediately on default, by
classifying stressed assets as special mention accounts (SMA) as per the following
categories:

39
SMA Sub-categories Basis for classification - Principal or interest payment or
any other amount wholly or partly overdue between
SMA-0 1-30 days
SMA-1 31 -60 days
SMA-2 61-90 days

Hon‘ble Supreme Court, vide its order dated April 2, 2019, had held the RBI circular
dated February 12, 2018 on Resolution of Stressed Assets as ultra vires. In light of the
same, the Statement on Framework for Resolution of Stressed Assets issued by the
Governor on April 4, 2019 had clarified that the Reserve Bank of India will take
necessary steps, including issuance of a revised circular, as may be necessary, for
expeditious and effective resolution of stressed assets.
Accordingly, the Reserve Bank has today placed on its website the prudential framework
for resolution { of stressed assets by banks in the wake of the judgement of the Hon‘ble
Supreme Court of India. Prudential Framework for Resolution of Stressed Assets
on June 7.2019.
Introduction: In exercise of the powers conferred by the Banking Regulation Act, 1949
and the Reserve Bank of India Act, 1934, the Reserve Bank, being satisfied that it is
necessary and expedient in the public interest so to do, hereby, issues the directions
hereinafter specified.
Short title and^commencement
1. These directions shall be called the Reserve Bank of India (Prudential Framework for
Resolution of Stressed Assets) Directions 2019.
2. These directions shall come into force with immediate effect.
Applicability
3. The provisions of these directions shall apply to the following entities:
(i) Scheduled Commercial Banks (excluding Regional Rural Banks);
(ii) All India Term Financial Institutions (NABARD, NHB, EXIM Bank, and SIDBI);
(iii) Small Finance Banks; and,
(iv)Systemically Important Non-Deposit taking Non-Banking Financial Companies
(NBFC-ND-SI) and Deposit taking Non-Banking Financial Companies (NBFC-D).
Purpose
4. These directions are issued with a view to providing a framework for early
recognition; reporting and time bound resolution of stressed assets.
5. These directions are issued without prejudice to issuance of specific directions, from
time to time, by the Reserve Bank to banks, in terms of the provisions of Section 35AA
of the Banking Regulation Act, 1949, for initiation of insolvency proceedings against
specific borrowers under the Insolvency and Bankruptcy Code, 2016 (IBC).
The RBI today issued a revised circular for resolving stressed assets by offering lenders a
30-day period to label an account an NPA.
Here are all the key details of the new RBI circular:
. Under the new Prudential framework for resolution of stressed assets', lenders will have
complete discretion to design, implement resolution plan.
.Banks may start resolution, IBC process within 30 days of default.
. Once a borrower is reported to be in default by any lenders, they may review of the
borrower .'account within 30 days from the day of default.

40
 . Lenders should follow a board-approved policy for resolution of bad loans.
.Mandatory to sign inter-creditor agreement (ICA) by all lenders, which will provide for a
majority decision making criteria.
RBI changed its earlier norm of 100 percent approval from creditors. ICA shall now
provide any decision agreed by lenders representing 75 percent by value of total
outstanding credit facilities and 60 percent of lenders helping speed up the resolution
process.
4- Lenders must resolve over Rs 2000 crore NPA account within 180 days.
^ Higher provisioning for delay in resolution. L enders will have to make 35 percent
provisions- first 20 percent for 180 days and then an additional 15 percent if no
resolution is found within 365 days.
4* The joint lenders' forum (JLF) as mandatory inslilutional mechanism for resolution
also stands discontinued. - 4'
4s- The accounts would be classified according to this time table:
SMA Sub-categories Basis for classification - Principal or interest payment or any
other amount wholly or partly overdue between < ||
SMA-0 1-30 days
SMA-1 31 -60 days
SMA-2 61-90 days
In the case of revolving credit facilities like cash credit, the SMA sub-categories will be as follows:

SMA Sub-categories Basis for classification — Outstanding balance remains

continuously in excess of the sanctioned limit or drawing
power, whichever is lower, for a period of:

SMA-1 31 -60 days

SMA-2 61-90 days
4*- In addition, the lenders shall submit a weekly report of instances of default by all borrowers (with
aggregate exposure of Rs 50 million and above) by close of business on every Friday, or the
preceding working day if Friday happens to be a holiday," RBI said in its circular.

^ For borrowers with exposure between Rs 1,500 crore and Rs 2,000 crore, the new
norms will be applicable from January 1, 2020, while for loans up to Rs 1,500 crore will
be announced in due course.
RBI also warned that any action by lenders to conceal the actual status of accounts or
evergreening the stressed accounts, will be subjected to stringent
supervisory/enforcement actions.

41
 CHAPTER :5 FINANCIAL MARKET

Financial Market: A financial market is a market for the creation and exchange of
financial assets or
to carry out financial transactions in the form of financial assets such as fresh issue of
shares and debentures by a firm or the trading (i.e. buying and selling) of existing
financial assets like equity shares, debentures and bonds.
Functions of Financial Market
Financial markets play significant role in the allocation of scarce and limited resources
(especially capital) in an economy by performing the following functions:
1. Mobilisation of Savings and Channeling them into the most Productive Uses
2. Facilitating Price Discovery
3. Provide Liquidity to Financial Assets
4. Reducing the Cost of Transactions
Types of Financial Markets: On the basis of type of financial claim ‘ v
The debt market is the financial market for fixed claims (debt securities) and the equity
market is the
financial market for residual claims-(equity shares). „.---
Types of Financial Markets: On the basis of maturity of financial instruments and claims
The market for short-term financial claims (upto one year) is called money market and
the market for
long-term financial claims (more than one year) is called the capital market.
Types of Financial Markets: On the basis of seasoning of claim (new or
outstanding) issues The market where issuers sell new claims is called primary market
and the market where investors trade outstanding securities is called the secondary
market.
Types of Financial Markets: On the basis of timing of delivery
A cash or spot market is one where the delivery takes place immediately and a forward
or futures market is one where the delivery takes place at a predetermined time in
future.
Types of Financial Markets: On the basis of organizational structure
An exchange-traded market is characterized by a centralized organisation with
standardized procedures. An over-the-counter market is a decentralized market with
customized procedures.
Types of Financial Markets: On the basis of maturity of financial instruments
The financial markets can broadly be divided into money and capital market on the
basis of the maturity of financial instruments traded in them. Financial instruments with
a maturity of less than one year are traded in money market-whereas financial
instruments with longer maturity period (i.e. more than one year) are traded in the
capital market.
Money Market: Features
1. The money market is a market for short term funds which deals in monetary assets
whose period of maturity is upto one year. These assets are close substitutes for money.
2. It is a market where low risk, unsecured and short term debt instruments including
treasury bills, commercial paper, call money, certificate of deposit and commercial bill
that are highly liquid are issued and actively traded every day. The Discount Finance

42
House of India (DFHI) has been established for the specific objective of providing a ready
market for money market instruments.
3. It has no physical location, but is an activity conducted over the telephone and
through the internet. ----- -z-r-r
4. It enables the raising of short-term funds for meeting the temporary shortages of
cash and obligations and the temporary deployment of excess funds for earning returns.
5. The major participants are the Reserve Bank of India (RBI), Commercial Banks, Non-
Banking Finance Companies (NBFC), State Governments, Large Corporate Houses and
Mutual Funds.
Money Market Instruments 1. Treasury Bill: Features
1. A Treasury bill is basically an instrument of short-term borrowing by the Government
of India maturing in less than one year.
2. They are also known as Zero Coupon Bonds issued by the Reserve Bank of India on
behalf of the Central Government to meet its short-term requirement of funds.
3. Treasury bills are issued in the form of a promissory note.
4. They are highly liquid and have assured yield and negligible risk of default.
5. They are issued at a price which is lower than their face value and repaid at par.
6. The difference between the price at which the treasury bills are issued and their
redemption value is the interest receivable on them and is called discount.
7. Treasury bills are available for a minimum amount of Rs 25,000 and in multiples
thereof.
8. The RBI which issues T-bills on behalf of the GOI, auctions 14-days and 91-days T-
bills every Friday and 184-days and 364 - days T-bills every alternative Wednesday.
9. T-bills are sold through a uniform price auction (Dutch auction).
2. Commercial Paper: Features
1. Commercial paper is a short-term unsecured promissory note, negotiable and
transferable by endorsement and delivery with a fixed maturity period.
2. It is issued by large and creditworthy companies to raise short-term funds at lower
rates of interest than market rates.
3. It usually has a maturity period of 90 to 180 days to one year.
4. The issuance of commercial paper is an alternative to bank borrowing for large
companies that are generally considered to be financially strong.
5. It is sold at a discount from its face value and redeemed at par.
6. The original purpose of commercial paper was to provide short-terms funds for
seasonal and working capital needs. For example, companies use this instrument for
purposes such as bridge financing.
Example: Suppose a company needs long-term finance to buy somefmachinery.Mn
order to raise the long term funds in the capital market the company will have to incur
floatation costs (costs associated
%
with floating of an issue are brokerage, commission, printing of applications and
advertising etc.). Funds raised through commercial paper are used to meet the
floatatiorucosts. This is known as Bridge Financing.

43
3. Call Money: Features
1. Call money is short-term finance repayable.on demand, with a maturity period of one
day to fifteen days, used for inter-bank transactions.
2. Commercial banks have to maintain a minimum cash balance known as cash reserve
ratio. The Reserve Bank of India changes the cash reserve ratio from time to time which
in turn affects the amount of funds available to be given as loans by commercial banks.
3. Call money is a method by which banks borrow from each other to be able to
maintain the cash reserve ratio. •‘
4. The interest rate paid on call money loans is known as the call rate. It is a highly
volatile rate that varies from day-to-day and sometimes even from hour-to-hour.
5. There is an inverse relationship between call rates and other short-term money
market instruments such as certificates of deposit and commercial paper.
6. A rise in call money rates makes other sources of finance such as commercial paper
and certificates of deposit cheaper in comparison for banks raise funds from these
sources.
4. Certificate of Deposit: Features
1. Certificates of deposit (CD) are unsecured, negotiable, short-term instruments in
bearer form, issued by commercial banks and development financial institutions.
2. They can be issued to individuals, corporations and companies during periods of tight
liquidity when the deposit growth of banks is slow but the demand for credit is high.
3. They help to mobilise a large amount of money for short periods.
5. Commercial Bill: Features
1. A commercial bill is a bill of exchange used to finance the working capital
requirements of business firms. * vw
2. It is a short-term, negotiable, self-liquidating instrument which is used to finance the
credit sales of firms.
3. When goods are sold on credit, the buyer becomes liable to make payment on a
specific date in future. The seller could wait till the specified date or make use of a bill of
exchange.
4. The seller (drawer) of the goods draws the bill and the buyer (drawee) accepts it. On
being accepted, the bill becomes a marketable instrument and is called a trade bill.
These bills can be discounted with a bank if the seller needs funds before the bill
matures.
5. When a trade bill is accepted by a commercial bank it is known as a commercial bill.
Capital Market: Features
1. The capital market refers to facilities and institutional arrangements through which
long-term funds, both debt and equity are raised and invested.
2. It consists of a series of channels through which savings of the community are made
available for industrial and commercial enterprises and for the public in general.
3. It directs mobilised savings into their most productive use leading to growth and
development of the economy.
4. The capital market consists of development banks, commercial banks and stock
exchanges.
5. The capital market can be divided into primary and secondary markets.

44
Difference between Money Market and Capital Market
Sr. Point of Difference Money Market Capital Market
No.
1. Participants Institutional participants such as Financial institutions,
RBI, Mutual Funds, Commercial Development and commercial
Banks, Non Banking Finance banks, corporate firms, foreign
Companies (NBFC), State investors, general public as retail
Governments, investors.

and Large Corporate Houses.

2. Financial Treasury Bill, Commercial Paper, Equity Shares, Preference
Call Money, Certificate of Shares, Debentures, Bonds.
Instruments
Deposits and Commercial Bill
3. Investment Outlay Large amount of money required Small amount of money invested
to invest into financial into financial , instruments.
instruments.
4. Duration One day to one year (short Medium to long term (more than
duration) one year)
5. Liquidity High degree of liquidity with Low degree of liquidity.
formal arrangement in the form-
of- the Discount Finance House of
India (DFHI).
6. Safety Highly safe with minimum risk of High risky with returns and
default. default risk.
7. Expected Return Low return High return in the form of
dividends and bonus shares.

Primary Market
The primary market is also called the new issues market. It deals with new securities in the
form of equity shares, preference shares, debentures, loans and deposits being issued for the
first time. The main function is to facilitate the transfer of investible funds from savers to
entrepreneurs seeking to establish new enterprises/projects or expansion, diversification,
modernization of existing projects, mergers and takeovers etc. The investors are banks, financial
institutions, insurance companies, mutual funds and individuals.

45
Methods of Floatation
There are various methods of floating new issues in the primary market:
1. Offer through Prospectus
2. Offer for Sale
3. Private Placement.
4. Rights Issue
5. e-IPOs .
SECONDARY MARKET
• The secondary market is also known as the stock market or stock exchange.
• It is a market for the purchase and sale of existing securities after being initially
offered to the public in the primary market.
• It helps existing investors to disinvest and fresh investors to enter the market.
• It also provides liquidity and marketability to existing securities.
• It also contributes to economic growth by channelizing funds towards the most
productive investments through the process of disinvestment and reinvestment.
• Securities are traded, cleared and settled within the regulatory framework prescribed
by SEBI. Advances in information technology have made trading through stock
exchanges accessible from anywhere in the country through trading terminals.
• It comprises of equity and debt markets.
• Secondary market could be either auction or dealer market. While stock exchange is
the part of an auction market, Over-the-Counter (OTC) is a part of the dealer market.
• For the general investor, the secondary market provides an efficient platform for
trading of his securities. For the management of the company, Secondary, equity
markets serve as a monitoring and control conduit—by facilitating value-enhancing
control activities, enabling implementation of incentive-based management contracts,
and aggregating information (via price discovery) that guides management decisions.
Government Securities Market
The G-Secs market has witnessed significant changes during the past decade.
Introduction of an electronic screen based trading system, dematerialized holding,
straight through processing, establishment of the Clearing Corporation of India Ltd.
(CCIL) as the Central Counter Party (CCP) for guaranteed settlement, new instruments,
and changes in the legal environment are some of the major aspects that have
contributed to the rapid development of the G-Sec market.
Major participants in the G-Sccs market historically have been large institutional
investors. With the various measures for development, the market has also witnessed
the entry of smaller entities such as co-operative banks, small pension, provident and
other funds etc. These entities are mandated to invest in G-Secs through respective
regulations.
What is a Government Security (G-Sec)?
A Government Security (G-Sec) is a tradeable instrument issued by the Central
Government or the State Governments. It acknowledges the Government‘s debt
obligation. Such securities are short term (usually called treasury bills, with original
maturities of less than one year) or long term (usually called Government bonds or
dated securities with original maturity of one year or more). In India, the Central
Government issues both, treasury bills and bonds or dated securities while the State

46
Governments issue
only bonds or dated securities, which are called the State Development Loans (SDLs). G-
Secs carry
practically no risk of default and, hence, are called risk-free gilt-edged instruments.
a. Treasury Bills (T-bills)
Treasury bills or T-bills, which are money market instruments, are short term debt
instruments issued by the Government of India and are presently issued in three tenors,
namely, 91 day, 182 day and 364 day. Treasury bills are zero coupon securities and pay
no interest. They are issued at a discount and redeemed at the face value at maturity.
b. Cash Management Bills (CMBs) *-
In 2010, Government of India, in consultation with RBI introduced a new short-term
instrument, known as Cash Management Bills (CMBs), to meet the temporary
mismatches in the cash flow of the Government of India. The CMBs have the generic
character of T-bills but are issued for maturities less than 91 days.
c. Dated G-Secs
Dated G-Secs are securities which carry a fixed or floating coupon (interest rate) which
is paid on the face value, on half-yearly basis. Generally, the tenor of dated securities
ranges from 5 years to 40 years. Instruments:
Fixed Rate Bonds - These are bonds on which the coupon rate is fixed for the entire life
(i.e. till maturity) of the bond. Most Government bonds in India are issued as fixed rate
bonds. For example - 8.24% GS2018 was issued on April 22, 2008 for a tenor of 10
years maturing on April 22, 2018. Floating Rate Bonds (FRB) - FRBs are securities
which do not have a fixed coupon rate. FRBs were first issued in September 1995 in
India.
Zero Coupon Bonds - Zero coupon bonds are bonds with no coupon payments.
However, like T- Bills, they are issued at a discount and redeemed at face value.
Capital Indexed Bonds - These are bonds, the principal of which is linked to an
accepted index of inflation with a view to protecting the Principal amount of the investors
from inflation.
Inflation Indexed Bonds (IIBs) - IIBs are bonds wherein both coupon flows and
Principal amounts are f protected against inflation. The inflation index used in IIBs may
be Whole Sale Price Index (WPI) or Consumer Price Index (CPI).
Bonds with Call/ Put Options - Bonds can also be issued with features of optionality
wherein the issuer can have the option to buy-back (call option) or the investor can
have the option to sell the bond (put option) to the issuer during the currency of the
bond.
Special Securities - Under the market borrowing programme, the Government of India
also issues, from time to time, special securities to entities like Oil Marketing Companies,
Fertilizer Companies, the Food Corporation of India, etc. (popularly called oil bonds,
fertiliser bonds and food bonds respectively) as compensation to these companies in lieu
of cash subsidies.
STRIPS - Separate Trading of Registered Interest and Principal of Securities:-
STRIPS are the securities created by way of separating the cash flows associated with a
regular G-Sec i.e. each semiannual coupon payment and the final principal payment to
be received from the issuer, into separate securities. They are essentially Zero Coupon
Bonds (ZCBs
Sovereign Gold BoncL(SGB): SGBs are unique instruments, prices of .which are linked
to commodity price viz Gold. SGBs are denominated in multiples of gram(s) of gold with
a basic unit of l gram,

47
d. State Development Loans (SDLs)
State Governments also raise loans from the market which are called SDLs. SDLs are
dated securities issued through normal auction similar to the auctions conducted for
dated securities issued by the Central Government.
Fiiiancial Institutions: Development Finance Institutions (DFIs); Non-Banking Financial
Companies (NBFCs); Mutual Funds; Pension Funds.

48
 CHAPTER :6 NON-BANKING FINANCIAL COMPANIES

Development Finance Institutions (DFIs)

The vehicle for extending development finance is called development financial institution
(DFI) or development bank. A DFI is defined as "an institution promoted or assisted by
Government mainly to provide development finance to one or more sectors or sub-
sectors of the economy. The . institution distinguishes itself by a judicious balance as
between commercial norms of operation, as adopted by any private financial institution,
and developmental obligations; it emphasizes the "project approach" - meaning the
viability of the project to be financed - against the "collateral approach"; apart from
provision of long-term loans, equity capital, guarantees and underwriting functions, a
development bank normally is also expected to upgrade the managerial and the other
operational pre-requisites of the assisted projects. Its insurance against default is the
integrity, competence and resourcefulness of the management, the commercial and
technical viability of the project and above all the speed of implementation and efficiency
of operations of the assisted projects. Its relationship with its clients is of a continuing
nature and of being a "partner" in the project than that of a mere "financier" (Scharf and
Shetty, 1972).
Thus, the basic emphasis of a DFI is on long-term finance and on assistance for activities
or sectors of the economy where the risks may be higher than that the ordinary financial
system is willing to bear. DFIs may also play a large role in stimulating equity and debt
markets by (i) selling their own stocks and bonds; (ii) helping the assisted enterprises
float or place their securities and (iii) selling from their own portfolio of investments.
Non-Banking Financial Companies
A Non-Banking Financial Company (NBFC) is a company registered under the Companies
Act, 1956 engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or
other marketable securities of a like nature, leasing, hire-purchase, insurance business,
chit business but does not include any institution whose principal business is that of
agriculture activity, industrial activity, purchase or sale of any goods (other than
securities) or providing any services and sale/purchase/construction of immovable
property. A non-banking institution which is a company and has principal business of
receiving deposits under any scheme or arrangement in one lump sum or in installments
by way of contributions or in any other manner, is also a non-banking financial company
(Residuary non-banking company).
A Non-Banking Financial Company (NBFC) is a company registered under the Companies
Act, 1956 engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or
other marketable securities of a like nature, leasing* hire-purchase, insurance business,
chit business but does not include any institution whose principal business is that of
agriculture activity, industrial activity, purchase or sale of any goods (other than
securities) or providing any services and sale/purchase/construction of immovable
property. A non-banking institution* which is a company and has principal business of
receiving deposits under any scheme or arrangement in one lump sum or in installments
by way of contributions or in any other manner, is also a non-banking financial company
(Residuary non-banking company). .
NBFCs are companies registered under the Company Law, engaged in the
business of loans and advances, acquisition of shares, stock, bonds, hire-
purchase, insurance business, or chit business: but does not include any
institution whose principal business is agriculture or industrial activity; or the
sale, purchase or construction of immovable property.
What does conducting financial activity as ―principal business‖ mean?
Financial activity as principal business is when a company‘s financial assets constitute

49
more than 50 per cent of the total assets and income from financial assets constitute
more than 50 per cent of the gross income. A company which fulfils both these criteria
will be registered as NBFC by RBI. The term 'principal business' is not defined by the
Reserve Bank of India Act. The Reserve Bank has defined it so as to ensure that only
companies predominantly engaged in financial activity get registered with it and are
regulated and supervised by it. Hence if there are companies engaged in agricultural
operations, industrial activity, purchase and sale of goods, providing services or
purchase, sale or construction of immovable property as their principal business and are
doing some '< financial business in a small way, they will not be regulated by the
Reserve Bank. Interestingly, this test is popularly known as 50-50 test and is applied to
determine whether or not a company is into financial business. NBFCs are doing
functions similar to banks. What is difference between banks & NBFCs?
NBFCs lend and make investments and hence their activities are akin to that of banks;
however there are a few differences as given below:
i. NBFC cannot accept demand deposits;
ii. NBFCs do not form part of the payment and settlement system and cannot issue
cheques drawn on itself;
iii. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is
not available to depositors of NBFCs, unlike in case of banks.
Is it necessary that every NBFC should be registered with RBI?
In terms of Section 45-IA of the RBI Act, 1934, no Non-banking Financial company can
commence or carry on business of a non-banking financial institution without a)
obtaining a certificate of registration from the Bank and without having a Net Owned
Funds of ? 25 lakhs (f Two crore since April 1999). However, in terms of the powers
given to the Bank, to obviate dual regulation, certain categories of NBFCs which are
regulated by other regulators are exempted from the requirement of registration with
RBI viz. Venture Capital Fund/Merchant Banking companies/Stock broking companies
registered with SEBI, Insurance Company holding a valid Certificate of Registration
issued by IRDA, Nidhi companies as notified .under Section 620A of the Companies Act,
1956, Chit companies as defined in clause (b) of Section 2 of the Chit Funds Act,
1982,Housing Finance Companies regulated by National Housing Bank, Stock Exchange
or a Mutual Benefit company.
What are the requirements for registration with RBI?
A company incorporated under the Companies Act, 1956 and desirous of commencing
business of non-banking financial institution as defined under Section 45 1(a) of the RBI
Act, 1934 should comply with the following:
i. it should be a company registered under Section 3 of the companies Act, 1956
ii. It should have a minimum net owned fund of ? 200 lakh. (The minimum net owned
fund (NOF) required for specialized NBFCs like NBFC-MFIs, NBFC-Factors, CICs is
indicated separately in the FAQs on specialized NBFCs)
What are systemically important NBFCs?
NBFCs whose asset size are of 500 cr. or more as per last audited balance sheet are
considered as systemically important NBFCs. The rationale for such classification is that
the activities of such NBFCs will have a bearing on the financial stability of the overall
economy.
What are the different types/categories of NBFCs registered with RBI?
NBFCs are categorized a) in terms of the type of liabilities into Deposit and Non-Deposit
accepting NBFCs, b) non deposit taking NBFCs by their size into systemically important
and other non-deposit holding companies (NBFC-NPSI and NBFC-ND) and c) by the kind
of activity they conduct. Within this broad categorization the different types of NBFCs are

50
as follows:
1. Asset Finance Company (AFC) : An AFC is a company which is a financial institution
carrying on as its principal business the financing of physical assets supporting
productive/economic activity, such as automobiles, tractors, lathe machines, generator
sets, earth moving and material handling equipments, moving on own power and
general purpose industrial machines. Principal business for this purpose is defined as
aggregate of financing real/physical assets supporting economic activity and income
arising therefrom is not less than 60% of its total assets and total income respectively.
2. Investment Company (IC) : IC means any company which is a financial institution
carrying on as its principal business the acquisition of securities,
3. Loan Company (LC): LC means any company which is a financial institution
carrying on as its principal business the providing of finance whether by making loans or
advances or otherwise for any activity other than its own but does not include an Asset
Finance Company.
4. Infrastructure Finance Company (IFC): IFC is a non-banking finance company a)
which deploys at least 75 per cent of its total assets in infrastructure loans, b) has a
minimum Net Owned Funds of ? 300 crore, c) has a minimum credit rating of‗A ‗or
equivalent d) and a CRAR of 15%.
5. Systemically Important Core Investment Company (CIC-ND-SI): CIC-ND-SI is
an NBFC carrying on the business of acquisition of shares and securities which satisfies
the following conditions:-
a. it holds not less than 90% of its Total Assets in the form of investment in equity
shares, preference shares, debt or loans in group companies;
b. its investments in the equity shares (including instruments compulsorily convertible
into equity shares within a period not exceeding 10 years, from the date of issue) in
group companies constitutes not less than 60% of its Total Assets;
c. it does not trade in its investments in shares, debt or loans in group companies
except through block sale for the purpose of dilution or disinvestment;
d. it does not carry on any other financial activity referred to in Section 451(c) and
451(f) of the RBI act, 1934 except investment in bank deposits, money market
instruments, government securities, loans to and investments in debt issuances of group
companies or guarantees issued on behalf of group companies.
e. Its asset size is ? 100 crore or above and
f. It accepts public funds
6. Infrastructure Debt Fund: Non- Banking Financial Company (IDF-NBFC) : IDF-
NBFC is a company registered as NBFC to facilitate the flow of long term debt into
infrastructure projects. IDF-NBFC raise resources through issue of Rupee or Dollar
denominated bonds of minimum 5 year maturity. Only Infrastructure Finance Companies
(IFC) can sponsor IDF-NBFCs.
/. Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI):
NBFC-MFI is a nondeposit taking NBFC having not less than 85% of its assets in the
nature of qualifying assets which satisfy the following criteria:
Loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not
exceeding ? 1,00,000 or urban and semi-urban household income not exceeding ?
1,60,000;
i. loan amount does not exceed ? 50,000 in the first cycle and ? 1,00,000 in
subsequent cycles;
ii. total indebtedness of the borrower does not exceed ? 1,00,000;

51
iii. tenure of the loan not to be less than 24 months for loan amount in excess of ?
15,000 with prepayment without penalty;
iv. loan to be extended without collateral;
v. aggregate amount of loans, given for income generation, is not less than 50 per cent
of the total loans given by the MFIs;
vi. loan is repayable on weekly, fortnightly or monthly instalments at the choice of the
borrower
8. Non-Banking Financial Company - Factors (NBFC-Factors): NBFC-Factor is a non-
deposit taking NBFC engaged in the principal business of factoring. The financial assets
in the factoring business should constitute at least 50 percent of its total assets and its
income derived from factoring business should not be less than 50 percent of its gross
income.
9. Mortgage Guarantee Companies (MGC) - MGC are financial institutions for which
at least 90% of the business turnover is mortgage guarantee business or at least 90% of
the gross income is from mortgage guarantee business and net owned fund is ? 100
crore.
10. NBFC- Non-Operative Financial Holding Company (NOFHC) is financial
institution through which promoter / promoter groups will be permitted to set up a new
bank .It‘s a wholly-owned Non-Operative Financial Holding Company (NOFHC) which will
hold the bank as well as all other financial services companies regulated by RBI or other
financial sector regulators, to the extent permissible under the applicable regulatory
prescriptions.
Mutual Fund
A mutual fund is a financial instrument that collects money from several small investors
and invests it in various investment options like shares, bonds, etc. This fund is
managed by experts. A Mutual Fund is an investment vehicle that is made up of a pool of
funds collected from many investors for the purpose of investing in securities such as
stocks, bonds, money market instruments and similar assets. One of the main
advantages of mutual funds is that they give small investors access to professionally
managed, diversified portfolios of equities, bonds and other securities, which would be
quite difficult (if not impossible) to create with a small amount of capital.
Types of Mutual Funds
Mutual funds can be classified into three types: Equity, Debt and Hybrid. Equity
mutual funds invest in shares of companies listed on the stock exchange. Debt mutual
funds invest in bonds of reputed companies and government bonds. Hybrid mutual funds
invest in both, shares and bonds.
Benefits of Investing in Mutual Funds
The major benefits on investing in a mutual fund are: - Diversification - Professional
management - Convenience - Liquidity - Variety of schemes and types - Tax benefits
NFO: NFO stands for a New Fund Offer. When a new fund is launched for investors, it is
known as a NFO. A JNhO could also be the launch of additional units of a close-ended
fund.'
Fund of Funds: A fund of fund is a kind of mutual fund that invests in a variety of
mutual funds.
Equity mutual funds: Equity mutual funds collect money from several investors like
you, and invest this amount in shares of various companies. The primary objective of
equity mutual funds is to invest in shares of different companies and generate good
returns. A '
Debt mutual funds: Debt mutual funds collect money from.several-investors like you,

52
and invest this amount in bonds of reputed companies and government bonds.
Hybrid mutual funds: Hybrid mutual funds invest both, in shares and bonds. The
portion invested in shares helps grow your wealth, while the portion invested in bonds
offers stability to your portfolio. Systematic Investment Plan (SIP): A Systematic
Investment Plan (SIP) is a convenient method of investing in mutual funds. Under this
plan, an investor contributes a fixed amount towards the mutual fund scheme at regular
intervals, and gets units at the prevailing NAV.
Benefits of investing in a SIP: Investing in SIP offers two major benefits: - You can
start investing with a small amount - You can average out your investment, as SIP
involves buying units at different points of time and at different NAV levels
Systematic Withdrawal Plan (SWP): Under a Systematic Withdrawal Plan (SWP), an
investor redeems a fixed number of mutual fund units at regular intervals.
Exchange Traded Funds: Exchange Traded Funds (ETFs) are funds that can be traded
on a stock exchange, just like shares. These funds invest in shares, indexes or
commodities.
Index funds: Index funds are mutual funds that invest in shares of companies
comprising a particular index. These funds intend to replicate the performance of a
particular index.
NAV: NAV stands for Net Asset Value of a mutual fund. This is basically the price of one
unit of a mutual fund.
Gilt funds: A gilt fund is a kind of mutual fund that invest your money only in
government securities. These funds are considered to be safe as they bear no default
risk.
Sectoral mutual funds: Sectoral mutual funds invest your money in shares of
companies of one particular sector. The main objective of these funds is to provide high
returns from one particular sector that has the potential to grow.
Liquid funds: Liquid funds are mutual funds that offer high liquidity. This means, the
units of these funds can be sold immediately, and the invested amount can be redeemed
quickly.
Capital protection funds: Capital protection funds are mutual funds designed to
protect yanr'capital. These funds put a major portion of the investment in bonds, and a
small portion in shares. Over time, the portion invested in bonds grows to the size of
your original investment. So even if the portion invested in shares does not do well, your
capital is still protected.
Open-ended mutual fund: Open-ended funds can be bought and sold at any time;
they have no fixed tenure.
Close-ended mutual fund: Investors can buy units of close-ended mutual funds only
when a mutual fund company launches the fund. Once investors buy them, investors
have to hold investment for a fixed tenure.
Redemption price: Redemption price is the price that you receive on selling each unit
of your mutual fund investment.
Mutual Fund Service System (MFSSV
Mutual Fund Service System (MFSS) is an online order collection system provided by
NSE to its eligible members for placing subscription or redemption orders on the MFSS
based on orders received from the investors. NSE launched India's first Mutual Fund
Service System (MFSS) on November 30, 2009 through which an investor can
subscribe or redeem units of a mutual fund scheme.
Trading
NSE's automated screen based trading, modem, fully computerized trading system

53
designed to offer investors across the length and breadth of the country a safe and easy
way to invest. The NSE trading
!'■
system called 'National Exchange for Automated Trading' (NEAT) is a fully automated
screen based trading system, which adopts the principle of an order driven market.
Clearing & Settlement
The settlement for Mutual Funds Service System is carried out by NSCCL through the
depository and bank interface. The clearing and settlement mechanism provides for
settlement of funds and mutual fund units in case of subscription and redemption orders.
The settlement for Mutual Funds Service System is carried out by NSCCL through the
depository and bank interface. The clearing and settlement mechanism provides for
settlement of funds and mutual fund units in case of subscription and redemption orders.
The transfer of funds and units in respect of redemptions and subscriptions, respectively,
is effected to the broker/Clearing Members' settlement / pool account. Investors receive
redemption amount (if units are redeemed) and units (if units are purchased) through
broker/clearing members'pool account. /'>
All requests for subscription and redemption are settled on individual^ig and only to the
extent of the funds/units paid in by participants/clients on the settlement day.
Receipfand transfer of funds and units for subscription are done on a T+l day basis. .
Receipt and transfer of mutual fund units for redemption
✓ -Pi
is done on T day and is conducted for units in dematerialised form' only. The transfer of
funds for redemption is carried out on a T+l, T+2 and T+3 basis depending upon the
category of funds.
The settlement cycles are in accordance with the settlement schedules issued by NSCCL
from time to time. NSCCL is only a facilitator and not a counter party for the subscription
and redemption of units. ORGANISATION OF A MUTUAL FUND
There are many entities involved in the organisational set up of a mutual fund:
Unit Holders: It is a person or institution which invest their funds in the mutual fund
Sponsors: The sponsor initiates the idea to set-up a mutual fund. It could be a registered
company, scheduled bank or financial institution. The sponsor appoints the trustees,
AMC and the custodian. Once the AMC is formed, the sponsor is just a stakeholder.
However, sponsors could play a key role in bailing out an AMC during a crisis.
Trustees: Trustees protect the interests of unit holders. Sometimes trustees and
sponsors are the same. Trustees float and market schemes, and secure necessary
approvals. They check if the AMC's investments are within defined limits, whether fund's
assets are protected, and also ensure that unit holders get their due returns. For major
decisions concerning the fund, they have to take unit holders consent. They submit
reports every six months to SEBI (Securities Exchange Board of India).
AMC: The AMC manages your money. It takes investment decisions, compensates
investors through dividends, maintains proper accounting and information for pricing of
units, calculates the NAV, and provides information on listed schemes and secondary
market transactions.
Transfer Agent: A transfer agent is employed by a mutual fund to conduct
recordkeeping and related functions. Transfer agents maintain records of shareholder
accounts, calculate and disburse dividends, and prepare and mail shareholder account
statements, federal income tax information and other shareholder notices. Some transfer
agents prepare and mail statements confirming shareholder transactions and account
balances and maintain customer service departments to respond to shareholder
inquiries.

54
Custodian: Mutual funds are required by law to protect their securities by placing them
with a custodian. Nearly all mutual funds use qualified bank custodians. The SEBI
requires mutual fund custodians to segregate mutual fund portfolio securities from other
bank assets.
Mutual Fund in India: History
The mutual fund industry in India started in 1963 with the formation of Unit Trust of
India, at the initiative of the Government of India arid Reserve Bank of India. The history
of mutual funds in India can be broadly divided into four distinct phases:
First Phase -1964-1987
Unit Trust of India (UTI) was established in 1963 by an Act of Parliament. It was set up
by the Reserve Bank of India and functioned under the Regulatory and administrative
control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the
Industrial Development Bank of India (IDBI) took over the regulatory and administrative
control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the
end of 1988 UTI had Rs. 6,700 crores of assets under management. Second Phase -
1987-1993 (Entry of Public Sector Funds)
1987 marked the entry of non-UTI, public sector mutual funds set up by public sector
banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation
of India (GIC). SBI Mutual Fund was the first non-UTI Mutual Fund established in June
1987 followed by Canbank Mutual Fund

(Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov
89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its
mutual fund in June 1989 while GIC had set up its mutual fund in December 1990.
At the end of 1993, the mutual fund industry had assets under management of Rs.
47,004 crores.
Third Phase - 1993-2003 (Entry of Private Sector Funds)
With the entry of private sector funds in 1993, a new era started in the Indian mutual
fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was
the year in which the first Mutual Fund Regulations came into being, under which all
mutual funds, except UTI were to be registered and governed. The erstwhile Kothari
Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund
regi stered in July 1993.
The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive
and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI
(Mutual Fund) Regulations 1996.
The number of mutual fund houses went on increasing, with many foreign mutual funds
setting up funds in India and also the industry has witnessed several mergers and
acquisitions. As at the end of January
2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit
Trust of India with Rs. 44,541 crores of assets under management was way ahead of
other mutual funds.
Fourth Phase - since February 2003
In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was
bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust
of India with assets under management of Rs. 29,835 crores as at the end of January
2003, representing broadly, the assets of US 64 scheme, assured return and certain
other schemes. The Specified Undertaking of Unit Trust of India, functioning under an
administrator and under the rules framed by Government of India and does not come
under the purview of the Mutual Fund Regulations.

55
The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered
with SEBI and functions under the Mutual Fund Regulations. With the bifurcation of the
erstwhile UTl which had in March 2000 more than Rs. 76,000 crores of assets under
management and with the setting up of a UTI Mutual Fund, conforming to the SEBI
Mutual Fund Regulations, and with recent mergers taking place among different private
sector funds, the mutual fund industry has entered its current phase of consolidation and
growth.
Regulation of Mutual Funds in India
Mutual Funds in India are governed by the SEBI (Mutual Fund) Regulations 1996 as
amended from
time to time [i.e. SEBI (Mutual Funds) (Amendment Regulations 2014],
Risk may be represented as:
(BLUE) investors understand that their principal will be at low risk.
(YELLOW) investors understand that their principal will be at medium risk. ;
(BROWN) investors understand that their principal will be at high risk.

56
CHAPTER :7 REGULATORS OF BANKS AND FINANCIAL INSTITUTIONS
IN INDIA

Regulators of Banks and Financial Institutions In India

The financial system in India is regulated by independent regulators in the field of
banking, insurance, capital market, commodities market, and pension funds. However,
Government of India plays a significant role in controlling the financial system in India
and influences the roles of such regulators at least to some extent.
The following are five major financial regulatory bodies in India
(A) Statutory Bodies via parliamentary enactments:
1. Reserve Bank of India :
Reserve Bank of India is the apex monetary Institution of India. It is also called as the
central bank of the country. The Reserve Bank of India was established on April 1, 1935
in accordance with the provisions of the Reserve Bank of India Act, 1934. The Central
Office of the Reserve Bank was initially established in Calcutta but was permanently
moved to Mumbai in 1937. The Central Office is where the Governor sits and where
policies are formulated. Though originally privately owned, since nationalization in
1949, the Reserve Bank is fully owned by the Government of India.
It acts as the apex monetary authority of the country. The Central Office is where the
Governor sits and is where policies are formulated. Though originally privately owned,
since nationalization in 1949, the Reserve Bank is fully owned by the Government of
India. The preamble of the reserve bank of India is as follows:
―…to regulate the issue of Bank Notes and keeping of reserves with a view to securing
monetary stability in India and generally to operate the currency and credit system of
the country to its advantage.‖
2. Securities and Exchange Board of India:-
SEBI Act, 1992 : Securities and Exchange Board of India (SEBI) was first established in
the year 1988 as a non-statutory body for regulating the securities market. It became an
autonomous body in 1992 and more powers were given through an ordinance. Since
then it regulates the market through its independent powers. SEBI is an authority to
regulate and develop the Indian capital market and project theinterest of
investors in the capital market. Controller of Capital Issues has been replaced by the
SEBI, an authority under Capital Issue (Control) Act, 1947.
1. Formatted on 30th Jan, 1992. 2. Replaced Capital issue control Act, 19747
3. Head office is in Mumbai 4. Branch offices: Deli, Kolkata & Chennai
3. Insurance Regulatory and Development Authority:
The Insurance Regulatory and Development Authority (IRDA) is a national agency of the
Government of India and is based in Hyderabad (Andhra Pradesh) . It was formed by an
Act of Indian Parliament known as IRDA Act 1999, which was amended in 2002 to
incorporate some emerging requirements. Mission of IRDA as stated in the act is ―to
protect the interests of the policyholders, to regulate, promote and ensure orderly
growth of the insurance industry and for matters connected therewith or incidental
thereto.‖
(B) Part of the Ministries of the Government of India :
4. Forward Market Commission India (FMC):
Forward Markets Commission (FMC) headquartered at Mumbai, is a regulatory authority
which is overseen by the Ministry of Consumer Affairs, Food and Public Distribution,
Govt. of India. This Commission allows commodity trading in 22 exchanges in India, out
of which three are national level.

57
FMC is a regulatory authority for commodity futures market in India. FMC is the chief
regulator of forward and futures markets in India. FMC comes under the Ministry of
Consumer Affairs, Food and Public Distribution because futures traded in India are
traditionally in food commodities.
FMC is a legal body set up under Forward Contracts (Regulation) Act 1952. The Act
provides that the Commission should consist of minimum two and maximum four
members appointed by the Central Government. The chairman of the FMC is nominated
by the central government.
5. PFRDA under the Finance Ministry:
Pension Fund Regulatory and Development Authority:
PFRDA was established by Government of India on 23rd August, 2003. The Government
has, through an executive order dated 10th October 2003, mandated PFRDA to act as a
regulator for the pension sector. The mandate of PFRDA is development and regulation
of pension sector in India.
Pension Fund Regulatory and Development Authority (PFRDA) is mandated to regulate
the ‗National Pension System‘ (NPS) for government employees as well as other citizens
of India, through its registered intermediaries, such as Central Recordkeeping Agency
(CRA), Pension Fund Managers (PFMs) for professional management and investment of
subscriber funds, Points of Presence (POP‘s) for distribution of the product, Trustee
Bank, Custodians, NPS Trust, and aggregators as per the agreement with these entities.
The PFRDA was originally established by the Government of India through a resolution
dated l Oth October, 2003 & 14th November, 2008, has since attained a statutory status
post the passage of Pension Fund Regulatory and Development Authority Act, 2013.
The housing finance companies are regulated by National Housing Bank (NHB). The
Department of Company Affairs (DCA), Government of India regulates deposit taking
activities of companies (other than NBFCs) registered under Companies Law.
Pension fund
―Pension fund‖ means an intermediary which has been granted a Certificate of
Registration by the Authority as a Pension Fund for receiving contributions, accumulating
them and making payments to the subscriber in the manner as may be specified by the
Authority.
Appointed and registered Pension Funds manages pension corpus through various
schemes under National Pension System. Pension Funds use their access codes to
confirm receipt of netted assets and instructions regarding fund allocation, confirm
allocation of funds and communicate the NAV of each scheme to CRA and the custodian
on a regular basis.
Pension Funds also acts as a bridge between the various intermediaries under NPS
architecture and PFRDA in order to protect the interests of the subscribers by providing
the information and data as is required by the Regulator.
Pension Fund Regulatory and Development Authority (Pension Fund) Regulations, 2015
were notified on 14th May, 2015 and the Pension Funds had to abide by these
regulations.
Roles and responsibilities of PFs
Pension Funds are generally responsible for receiving contributions and managing
pension corpus through various schemes under National Pension System in accordance
with the provisions of the PFRDA Act, rules and regulations made there under,
agreements executed with the National Pension System Trust and other intermediaries
under NPS architecture.
1. Pension Funds are required to adhere to the PFRDA Act 2013, PFRDA (Pension Fund)
Regulations and PFRDA (National Pension System Trust) Regulations 2015. The

58
management of pensions schemes shall be carried in accordance with the objects of the
schemes, provisions of the Act, Trust Deed, rules, regulations, guidelines and circulars
issued by the Authority from time to time and within the time lines as specified by the
Authority or the National Pension System Trust.
2. Pension Fund shall take all; reasonable steps and exercise due diligence to ensure
that the investment of funds, management of assets pertaining to any scheme is not
contrary to the provisions of PFRDA Act 2013, the rules, Regulations and guidelines
/directions or any law in force and are as per the norms of management of corpus of
pension fund, including investment guidelines as approved by the Authority from time to
time.
3. Pension Funds shall carry out its operations as directed by the PFRDA/NPS Trust and
having regard to obligations enunciated in PFRDA (Pension Fund) Regulations, 2015
Securities shall be held on behalf of, and in the name of the NPS Trust. The Trust shall
be the registered owner of these securities and funds. However, individual subscribers
under NPS shall remain beneficial owners of these assets and funds.
4. Pension Fund shall exercise SI due diligence and vigilance in carrying out its duties
and in protecting the rights and interests of the subscribers.
5. To furnish periodic reports, information and documents as specified.
6. Should comply with the disclosure requirements and code of conduct for the benefit
of subscribers.
7. To maintain absolute confidentiality of records/ data/ information including
subscriber‘s data/ information.
8. The Pension Fund shall, at all times render high standards of service, exercise
reasonable care, prudence, professional skill, promptness, diligence and vigilance while
discharging its duties in the best interests of the subscribers. The Pension Funds shall
avoid speculative investments or transactions.
9. The Pension Fund shall adopt best governance practices for investments and. risk
management viz. constitution of Investment Committee and Risk Committee, its
composition, functions, policy contents and other like matters.
Functions
The pension fund functions in accordance with the terms of its Certificate of Registration
arid the Regulations issued by Authority from time to time. PF is mandated to invest and
manage the1 pension; assets of the subscribers covered under NPS, which is inclusive of
but not confined to the following-
1. Investment of contributions as per investment guidelines prescribed by the.Authority.
2. Scheme portfolio construction.
3. Maintains books and records of its operations.
4. Reporting to the Authority at periodical intervals.
5. Public disclosure.
Regulations
Pension Fund Regulatory and Development Authority (Pension Fund) Regulations, 2015
Pension Fund Regulatory and Development Authority (Pension Fund) (First Amendment)
Regulations, 2016
Pension Fund Regulatory and Development Authority (Exits and Withdrawals under the
NPS) (Fourth
Amendment) Regulations, 2018

59
 CHAPTER :8 Financial Sector Reforms including Financial Inclusion

The Indian Government introduced the policy of liberalization and globalization in the
real sector of the economy in a very big way in June 1991. Therefore, on August 14,
1991, a nine-member High Level Committee on the Financial System was set up "to
examine all aspects relating to the structure, organization, functions, and
procedures of the financial system." The Committee headed by Mr. Narasimham,
submitted a summary Report to the Government of India on November 8, 1991, and
the Main Report on November 16, 1991 (RBI, 1991).
India‘s reform program included wide-ranging reforms in the banking system, the capital
markets and with reforms in insurance sector.
The recommendations of the Committee on Financial System (CFS) Narasimham
Committee I was aimed at: (i) ensuring a degree of operational flexibility, (ii)
internal autonomy for public sector banks in their decisionmaking and (iii) greater
degree of professionalism in banking operation.
Banking Sector Reforms
The Eighth Plan period saw the start of reforms in the banking sector consisting of
financial liberalisation in the form of reduced direct Government control over interest
rates and credit allocation mechanisms combined with efforts to strengthen the
regulatory framework by improving prudential norms, capital adequacy standards and
external supervision.
Capital Market Reforms '
. Establishing a modem regulatoiy framework covering the major participants in the
capital market.
.The technology of trading and settlements in the stock exchanges has been modernized.
Insurance Sector Reforms
The insurance sector (including pension schemes), was a public sector monopoly at
the start of the reforms. The need to open the sector to private insurance companies
was recommended by an expert committee (the Malhotra Committee) in 1994, but
there was strong political resistance. It was only in 2000 that the law was finally
amended to allow private sector insurance companies, with foreign equity allowed up to
26 percent, to enter the field. An independent Insurance Development and
Regulatory Authority have now been established and ten new life insurance companies
and six general insurance companies, many with well-known international insurance
companies as partners, have started operations. The development of an active insurance
and pensions industry offering attractive products tailored to different types of
requirements could stimulate long term savings and add depth to the capital markets.
Financial Inclusion
The Government of India (GOI) and the Reserve Bank of India (RBI) have been making
intensive efforts to promote financial inclusionasone of the important national objectives
of the country. Some of the major efforts made in the last five decades include -
nationalization of banks, building up of robust branch network of scheduled commercial
banks, co-operatives and regional rural banks, introduction of mandated priority sector
lending targets, lead bank scheme, formation of self-help groups, permitting Banking
Correspondents (BCs) to be appointed by banks to provide door step delivery of banking
services, zero balance BSBD accounts, etc. The fundamental objective of all these
initiatives is to reach the large sections of the hitherto financially excluded Indian
population.
Meaning of Financial Inclusion

60
1. Financial inclusion may be defined as the process of ensuring access to
financial services and timely and adequate credit where needed by vulnerable
groups such as weaker sections and low income groups at an affordable cost
(The Committee on Financial Inclusion, Chairman: Dr. C. Rangarajan).
2. Financial Inclusion, broadly defined, refers to universal access to a wide
range of financial services at a reasonable cost. These include not only banking
products but also other financial services such as insurance and equity
products (The Committee on Financial Sector Reforms, Chairman: Dr. Raghuram
G. Rajan).
Financial Inclusion is an important priority of the Government. The objective of Financial
Inclusion is to extend financial services to the large hitherto un-served population of the
country to unlock its growth potential. In addition, it strives towards a more inclusive
growth by making financing available to the poor in particular. Progress of Financial
Inclusion _
1. Position of households availing banking services as per Census2011: 58.7 percent.
2. Expansion of bank branch networks and ATMs.
3. RBI Branch Authorization policy.
4. Expansion of Business Correspondent Agent Network.
5. Swabhimann Scheme.
6. Direct Benefit Transfer and Direct Benefit Transfer for LPG.
7. RuPay Card.
8. Unstructured Supplementary Service Data (USSD) based Mobile Banking.
9. Pradhan Mantri Jan-Dhan Yojana(PMJDY) was formally launched on 28th August,
2014.

61
 CHAPTER :9 E-BANKING

Comm Metallic Money Paper Bank money Crypto/

odity Money Encrypt
Money /Fiat ed
Conce money
pt
• Has Full Bodied Token • has no Paper Digital Money
intrinsic coin intrinsic Money
I.V > F.V.
value value
I.V. < Che Dem Real Delayed
Metal
• E.g. F.V • Also que and time time
Tabbac base called Draf
ca legal t
process tender
↓ IMPS RTGS NEFT NA NE Card
CH CS Syst
Debasemen 2010 2004 2005
em
t process ↓ 201
6
Thomas
Grisham‘s • Available • •
law said → workin work
Bad money 24×7×365 g ing
dripes out hours hour
• Min. Limit
good s
Rs. 1 • 2
money. (12
lakh
• Max. limit Batc
→ 10,000 to • 500 hes)
200,000 cr.
• No
(depend on
• 25 – limit
IFSC)
55
• 10
• Charges
• RBI lakh
→Rs. 5 – Rs.
15 •
2.5
• Operator
– 25
→ NPCI
•
RBI

E-Banking
Internet banking, also known as online banking, e-banking or virtual banking, is an
electronic payment system that enables customers of a bank or other financial institution
to conduct a range of financial transactions through the financial institution's website
The two successive Committees on Computerization (Rangarajan Committees) were
responsible for bank computerization in India. Some important areas where the IT plays
important roles are:
^4 Funds Transfer mechanism: Electronic Clearing System (ECS), EFT, Real Time Gross
Settlement, National Electronic Funds Transfer "4 Clearing House operations: MICR, CTS
Innovative on line e- banking services: Tele banking, Mobile banking, SMS banking,
Credit/ Debit Cards, ATMs, Internet banking, Core Banking Solutions, etc.
Mobile Banking
―Mobile banking refers to provision and obtaining of banking and financial services with

62
the help of mobile telecommunication devices.‖
Mobile banking refers to send money, receive money, check account balance, pay bills,
access account, e- passbook, account statement, branch locator, ATM locator, requests
using mobile phones.
Types of Mobile Banking Services
S Mobile Banking over Wireless Application Protocol (WAP)
S Mobile Banking over SMS (also known as SMS Banking)
S Mobile Banking over Unstructured Supplementary Service Data (USSD)
Communication Networks in Banking System
As per the recommendations of the Saraf Committee, the Reserve Bank of India has
set up a country wide data communication network for banks linking major centers of
the country, known as EVFINET (Indian Financial Network) and this network use
satellite communication with very small aperture terminals (VSATs) as earth stations.
VSAT network is a .single closed user group network for the exclusive use of banks and
other financial institutions. The VSATs are owned by individual banks and the RBI. The
hub is owned by the RBI and the Institute for Development and Research in Banking
Technology (IDRBT).
Automated Clearing System
Clearing House Inter-bank Payment System (CHIPS): run by New York clearing
house.
Clearing House Automated Paymeni System (CHAPS): set up in UK.
Clearing House Automated Transfer System (CHATS): Hong Kong based.
❖ Electronic Cleaning System
❖ ECS is a retail.funds transfer system to effect payments (utility bills, dividends,
interest, etc) ECS helps corporates, government departments, public sector
undertakings, utility service providers to receive and/or pay bulk payments. ECS is
divided into ECS (credit) and ECS (debit).
❖ Real Time Gross Settlement System implemented by RBI.
❖ National Electronic Funds Transfer System (NEFT) handles smaller size
transactions.
♦> Indian Financial System Code: IFSC is an alpha-numeric code that identifies a bank-
branch participating in the RTGS/NEFT system. IFSC has ll digit code and the first four
alpha characters represents the bank, the 5th code is 0 (zero), which is reserved for
future use and the last six digits are numeric characters represents the branch.
❖ ATMs: ATMs are used as a channel for cash management of individual customers.
ATMs can be accessed by ATM card, debit or credit cards. White Label ATMs- RBI has
vide notifications dated 20th
June, 2012, permitted non-banking entities to set up or start ATMs which are called
White Label ATMs (WLA).
❖ NPCI: National Payments Corporation of India (NPCI), an umbrella organisation for
operating retail payments and settlement systems in India, is an initiative of Reserve
Bank of India (RBI) and Indian Banks‘ Association (IBA) under the provisions of the
Payment and Settlement Systems Act, 2007, for creating a robust Payment & Settlement
Infrastructure in India.
❖ RuPay:

63
❖ RuPay Contactless: It is an open loop EMV based payment product from NPCI and
aims at providing an efficient and hassle-free experience to the customer.
❖ BHIM: Bharat Interface for Money (BHIM) is an app that lets you make simple, easy
and quick payment transactions using Unified Payments Interface (UPI).
❖ Unified Payments Interface (UPI)
❖ Bharat Bill Pay- The One stop destination for Bill Payment
❖ *99#: a USSD based mobile BANKing service of NPCI was initially launched in
November 2012.
❖ National Financial Switch: National Financial Switch (NFS) ATM network having 37
members and connecting about 50,000 ATMs was taken over by NPCI from Institute for
Development and Research in Banking Technology (IDRBT) on December 14, 2009.
❖ Aadhaar Enabled Payment System
❖ Bharat QR
❖ BHIM Aadhaar Pay
USSD: USSD Unstructured Supplementary Service Data (USSD) is a channel of the
Mobile Operators. NUUP (National Unified USSD Platform) uses this channel for Mobile
Payments in India. This was initiated by the MPFI (Mobile Payment Forum of India) with
the support of IDRBT, DoT, TRAI and RBI and has been implemented by the NPCI
(National Payment Corporation of India).
FinTech and Financial Market disruptions
The term ―FinTech‖ is a contraction of the words ―finance‖ and ―technology‖. It refers to
the technological start-ups that are emerging to challenge traditional banking and
financial players and covers an array of services, from crowd funding platforms and
mobile payment solutions to online portfolio management tools and international money
transfers.
Some of the major FinTech products and services currently used in the market place are
Peer to Peer (P2P) lending platforms, crowd funding, block chain technology, distributed
ledgers technology, Big Data, smart contracts, Robo advisors, E-aggregators, etc. These
FinTech products are currently used in international finance, which bring together the
lenders and borrowers, seekers and providers of information, with or without a nodal
intermediation agency.
FinTechs are attracting interest both from users of banking services and investment
funds, which see them as the future of the financial sector. Even retail groups and
telecom operators are looking for ways to offer financial services via their existing
networks. This fluny of activities raises questions over what kind of financial landscape
will emerge in the wake of the digital transformation.
Financial institutions are seeking to increase their knowledge in relation to technological
innovation, both through partnerships with tech companies and by investing in or
acquiring such companies. Despite this, there are wide differences in the preparedness
of market participants for these changes in practice.
What is FinTech?
FinTech is an umbrella term coined in the recent past to denote technological innovation
having a bearing on financial services. FinTech is a broad term that requires definition
and currently regulators are working on bringing out a common definition.
According to Financial Stability Board (FSB), of the BIS, ―FinTech is technologically
enabled financial innovation that could result in new business models, applications,
processes, or products with an associated material effect on financial markets and
institutions and the provision of financial services‖. This definition aims at encompassing

64
 the wide variety of innovations in financial services enabled by technologies, regardless
the type, size and regulatory status of the innovative firm. The broadness of the FSB
definition is useful when assessing and anticipating the rapid development of the
financial system and financial institutions, and the associated risks and opportunities.
FinTech innovations have the potential to deliver a range of benefits, in particular
efficiency improvements and cost reductions. Technological developments are also
fundamentally changing the way people access financial services and increasing financial
inclusion.
Categorization of major FinTech Innovations
Payments, Deposits, Lending Market Investment Data Analytics &
Clearing & & capital raising Risk Management
provisioning management
Settlement

Mobile and web- Crowd-funding Peer Smart contracts Robo advice Smart Big data
based payments to peer lending Cloud computing e- contracts e-Trading Artificial
Digital currencies Digital currencies Aggregators Intelligence &
Distributed ledger Distributed Ledger Robotics

• Block chain is a distributed ledger in which transactions (e.g. involving digital

currencies or securities) are stored as blocks (groups of transactions that are performed
around the same point in time) on computers that are connected to the network.
• Crowd funding is a way of raising debt or equity from multiple investors via an
internet-based platform.
• ―Robo-advice‖ is the provision of financial advice by automated, money
management" providers, thereby disintermediating human financial advisors and
reducing costs.
• Crypto currency
• India being a more conservative market where cash transactions - still dominate,
usage of digital financial currency such as ‗bitcoin‘ has not seen much traction when,
compared to international markets. There are, however, a few bitcoin exchange startups
present in India - Unocoin, Coinsecure, and Zebpay.
Indian FinTech Industry
Payments Online Financial Products
• Payment Banks • Lending
• Mobile wallets • Insurance
• Payment gateway e-NPS
• Payment infrastructure: ATM, mPOS • MF/Broking

Banking Initiatives by Department of Financial Services (Government of India)

1. Bank Board Bureau: With a view to improve the Governance of Public Sector Banks
(PSBs), the Government had decided to set up an autonomous Banks Board Bureau. The
Bureau will recommend for selection of heads of Public Sector Banks and help Banks in
developing strategies and capital raising plans. The Banks Board Bureau has three ex-
officio members and three expert members in addition to Chairman. Except ex-officio
members, all the Members and Chairman are part time. The BBB has started functioning
from 01.04.2016.
2. Capital for Public Sector Banks (PSBs): Under the Indradhanush Plan, action related
to (i) Appointment (ii) Bank Board Bureau (iii) Capitalization (iv) De-stressing PSBs (v)
Empowerment (vi) Framework of Accountability (vii) Governance Reforms has been

65
initiated by the Government. Further, the Government of India had proposed to make
available Rs.70,000 crore out of budgetary allocations for four years. The Government
has infused a sum of Rs. 25,000 crore in 19 PSBs during financial year 2015-16, and in
FY 2016-17, Rs. 22,915 crore was allocated to 13 PSBs. An amount of Rs. 10,000 crore
has been proposed for
Re-capitalization-of PSBs for the Financial Year 2017-18. Further, the Government has
allowed all PSBs to raise capital from Public markets through Follow-on Public Offer
(FPO) based on specific criteria.
3. Merger of SBI Associates with State Bank of India (SBI): Government has
approved the proposal for merger of (i) State Bank of Bikaner & Jaipur (SBBJ), (ii) State
Bank of Hyderabad (SBH), (iii) State Bank of Mysore (SBM), (iv) State Bank of Patiala
(SBP) and (v) State Bank of Travancore (SBT) with State Bank of India (SBI) and the
same has been notified in the Gazette of India on 22.02.2017. The merger has come in
effect from 1st April, 2017. Subsequent to merger, the existing customers of Subsidiary
Banks will have access to SBI‘s global network which spans across all the time zones.
4. Merger of Bhartiya Mahila Bank (BMB) with State Bank of India (SBI):
Government has approved the proposal for merger of Bhartiya Mahila Bank (BMB) with
SBI and the same has been notified in the Gazette of India on 20.03.2017. The merger
has come into effect from 1st April, 2017.
5. BRICS Interbank Co-operation Mechanism: EXIM Bank is the nominated member
development bank from India under the BRICS Interbank Co-operation Mechanism. The
Bank entered into a multilateral general co-operation agreement with the New
Development Bank, along with other development banks of the BRICS nations. India was
the Chairman of the BRICS Forum for 2016. Having assumed the Presidency of the
BRICS Interbank Co-operation Mechanism, Exim Bank organized a series of events and
seminars in 2016. The Annual Meeting of the BRICS Interbank Cooperation Mechanism,
and the Annual Financial Forum were organised in Goa on October 15, 2016.
6. Conversion of Kisan Credit Card (KCC) into RuPay KCCs: The Government has
been closely monitoring the progress of conversion of Kisan Credit Cards (KCCs) to
RuPay ATM cum Debit Kisan Credit Cards (RKCCs). NABARD will coordinate the
conversion of operative/live KCCs into RKCCs by Cooperative Banks and Regional Rural
Banks (RRBs) in a mission mode.
7. Producer‟s Development and Upliftment (PRODUCE): In compliance to the
announcement made in the Union Budget, 2014-15, an amount of Rs. 200 crore has
been released to NABARD. The Scheme, is under implementation by NABARD, under
which 800 Producers Organizations (POs) have to be promoted during 2014-15 and
1,200 POs during 2015-16. Against the target for forming 2,000 Farmers Producers
Organisations (FPOs), NABARD has sanctioned 2,172 FPOs as on 31st December, 2016.
8. The Negotiable Instruments (Amendment) Act, 2015: The Negotiable
Instruments (Amendment) Act, 2015 has been notified in the Gazette of India,
Extraordinary on 29th December, 2015. The provisions of this Amendment Act came into
force on the 15th Day of June, 2015. The Amendment Act is focused on clarifying the
jurisdiction related issues for filing cases for offence committed under section 138 of the
Negotiable Instruments Act (NI Act). The Amendment Act 29.12.2015 facilitates filing of
cases only in a court within whose local jurisdiction the bank branch of the payee, where
the payee delivers the cheque for payment through his account, is situated, except in
case of bearer cheques, which are presented to the branch of the drawee bank and in
that case the local Court of that branch would get jurisdiction. The Amendment Act,
provides for retrospective validation for the new scheme of determining the jurisdiction
of a court to try a case under section 138 of the N.I. Act. The Amendment Act, also
mandate centralization of cases against the same drawer. The clarification of
jurisdictional issues may be desirable from the equity point of view as this would be in
the interests of the complainant and would also ensure a fair trial.

66
9. The Payment and Settlement Systems (Amendment) Act, 2015: The Payment
and Settlement Systems (Amendment) Act, 2015 was enacted by Parliament and
received the assent of President on 13.05.2015. The Amendment Act, inter-alia, sought
to introduce reforms to increase transparency and stability of Indian financial markets in
line with globally accepted norms. The Payment and Settlement Systems Act, 2007 was
enacted with a view to providing a sound legal basis for the regulation and supervision of
payment systems in India by Reserve Bank of India.
10. Regional Rural Banks (Amendments) Act, 2015: Regional Rural Banks (RRBs)
were established under Regional Rural Banks Act, 1976 (the RRB Act) to create an
alternative channel to the cooperative credit structure and to ensure sufficient
institutional credit for the rural and agriculture sector. RRBs are jointly owned by
Government of India, the concerned State Government and Sponsor Banks. In view of
the growing role of RRBs in extending banking services in rural areas, a need to amend
the Regional Rural Banks Act, 1976 was felt.
11. Card acceptance infrastructure: To augment card acceptance infrastructure for
use of debit cards, a major drive was undertaken between December 2016 and March
2017, resulting in an increase in the number of card acceptance terminals at Point of
Sale (PoS) by an additional 12.54 lakh, up from 15.19 lakh as on 30.11.2016. Further,
to improve such infrastructure in villages, 2.04 lakh PoS terminals have been sanctioned
from the Financial Inclusion Fund by NABARD.
12. BIFR/AAIFR: The Gazette notification^ regarding bringing into force the Sick
Industrial Companies (Special Provisions) Repeal Act, 2003 under section 1 (2) of the
Act and provisions regarding abetment of cases with BIFR/AAIFR under section 4(b) of
the Act have been issued, dated 25.11.2016. Both the notifications come into force with
effect from 01.12.2016 resulting into winding up of BIFR and AAIFR and abetment of
cases. In order to maintain the continuity, the winding up of BIFR/AAIFR is to coincide
with constitution of the National Company Law Tribunal (NCLT)/ National Company Law
Appellant Tribunal (NCLAT), as per the provisions of companies (second Amendment)
Act, 2002.
13. Debt Recovery Tribunals: The Recovery of Debts Due to Banks and Financial
Institutions (RDDB & FI) Act, 1993 and Securitisation and Reconstruction of Financial
Assets and Enforcement of Security <• Interest Act (SARFAESI Act), 2002 were
amended by the Enforcement of Security Interest and Recovery
of Debts Laws & Miscellaneous Provisions (Amendment) Act, 2016 to rationalize the
procedures and timelines followed by these Tribunals for expeditious adjudication and
speedier resolution of defaulted loans in time bound manner.
Insurance Initiatives by Department of Financial Services (Government of
India)
1. The Insurance Laws (Amendment) Bill, 2015: The Insurance Laws
(Amendment) Bill, 2015 was passed by the Lok Sabha on 4th March, 2015 and by the
Rajya Sabha on 12th March, 2015, thus paving the way for major reform related
amendments in the Insurance Act, 1938, the General Insurance Business
(Nationalization) Act, 1972 and the Insurance Regulatory and Development Authority
(IRDA) Act, 1999. The Insurance Laws (Amendment) Act 2015 notified on 23rd March,
2015 has seamlessly replaced the Insurance Laws (Amendment) Ordinance, 2014, which
came into force on 26th December 2014. The amendment Act removes archaic and
redundant provisions in the legislations and incorporates certain provisions to provide
Insurance Regulatory and Development Authority of India (IRDAI) with the flexibility to
discharge its functions more effectively and efficiently. It also provides for enhancement
of the foreign investment cap in an Indian Insurance Company from 26% to an explicitly
composite limit of 49% with the safeguard of Indian ownership and control.
2. Listing of Public Sector General Insurance Companies: To promote the
objective of achieving higher levels of transparency and accountability, government has

67
approved listing of the following five Government owned General Insurance Companies
on the stock exchanges namely The New India Assurance Company Ltd., United India
Insurance Company Ltd., Oriental Insurance Company Ltd., National Insurance Company
Ltd. and General Insurance Corporation of India.
The shareholding of these Public Sector General Insurance Companies (PSGICs) will be
divested from 100 percent to 75 percent in one or more tranches over a period of time.
During the process of disinvestment, existing rules and regulations of Securities and
Exchange Board of India (SEBI) and Insurance Regulatory and Development Authority of
India (IRDAI) will be followed.

68
 CHAPTER : 10 Insurance

Insurance is a contract between two parties, where one promises the other to indemnify
or make good any financial loss suffered by the latter (the insured) in consideration for
an amount received by way of „premium‟. In other words, the party agreeing to pay for
the losses is the „insurer‟. The party whose loss makes the ‗insurer‘ pay the claim is the
„insured‟. The consideration involved in the contract or what the insured pays to the
‗insurer‘ is called premium. The contract of insurance is referred to as the „policy‟. An
insurance contract is based on mathematical prediction; guided by the principle of
utmost good faith and enforceable by law. Insurance is a case of financial globalisation
as insurance is a service and a matter of solicitation.
Features of Insurance ________
1. Pooling of Economic Losses and Risk Reduction
Pooling of losses means the spreading of losses incurred by the few over the entire
group, so that in the process, average loss is substituted for actual loss. In simple
words, pooling in an insurance context implies two things:
(i) sharing of losses by the entire group and (ii) using the law of large numbers to predict
future losses.
The law of large numbers states that the greater the number of exposures, the more
closely will the actual results approach the probable results that are expected from an
infinite number of exposures.
This can be well understood by an example. While the probability of getting heads 5 out
of JO times by tossing a coin in the air is exactly half, it is not necessary that heads will
appear 5 times only; it can appear 8 times also. However, as the number of tosses
increases, the probability of heads and tails appearing equal number of times increases.
Insurance is a business based on the previous experience of damage and loss. Actual
loss comes close to estimated loss where the number of assets/individuals exposed to
similar risk is large.'The law of large numbers gains importance here since the amount of
premium to be charged depends upon the expected loss, which should enable the insurer
to meet all the expenses and claims that arise and also allow for reasonable profit. The
conclusion is by application of law of large numbers, the insurer can reduce the
risk.
2. Payment of accidental and unintentional losses:
Insurance deals with covering of all unexpected and unforeseen losses which occurs at
random; accidental in nature and a result of chance and not deliberately caused. _
3. Transferred Risk:
Insurance is a contract in which the risk of one party is transferred to the other, who is
usually in a stronger position financially and can easily make good the loss of the
insured. Risks of death, illness, theft, etc. are all examples where the risk of the insured
can be transferred to the insurer. Thus the most commonly adopted form of risk transfer
is insurance i.e. the risk that can be transferred in insurance is insurable risk.
4. Principle of Indemnity :
Life insurance is not a contract of indemnity. But property or personal accident insurance
contracts are contracts of ‗indemnity‘. Indemnity means to make good any financial
loss suffered by the insured and to put him or her back in the same financial
position as he or she was before the occurrence of the loss. An example is the
Householders Insurance policy where the insurer pays the actual loss to the policyholder
in case of any theft or damage that has been caused to his household appliances or
gadgets covered under the policy. In accordance with this principle, the insured cannot

69
claim more than the actual loss caused to an insured risk.
Features of a Contract
A contract is defined as an agreement between two or more parties to perform or
abstain from an act with an intention to create a legally binding relationship. An
enforceable contract must have the following requisites:
(i) offer and acceptance; (ii) consideration; (iii) legal capacity to contract (applicant must
not be a minor, mentally incompetent, an enemy alien and intoxicated); (iv) prior
consent of all the parties and (v) legality of object.
Features of Insurance Contracts
1. Insurance contract is characterized as one of adhesion - terms and provisions are
fixed by one party [the insurer] and, with minor exceptions, must be accepted or
rejected en totale by the other party [prospective
policy owner],
2. Insurance contract is also conditional - insurer‘s obligation to pay a claim depends
upon the performance
of certain acts, such as payment of premiums and furnishing proof of death. [This is
designed to protect insurer from moral hazard]. '
3. Insurance contract is unilateral in nature - only one party, the insurer, gives a legally
enforceable promise.
4. Insurance contract is an aleatory contract - involves the element of-chance, and one
party may receive more in value than the other.
Principles of Insurance
1. Utmost goods faith
Insurance contracts are the contract of mutual trust and confidence. Both parties to the
contract i.e., the insurer and the insured must disclose all relevant information to each
other. For example, while entering into a contract of life insurance, the insured must
declare to the insurance company if he is suffering from any disease that may be life
threatening.
2. Insurable interest
It means financial or pecuniary interest in the subject matter of insurance. A person has
insurable interest in the property or life insured if he stands to gain from its existence or
loose financially from its damage or destruction. In case of life insurance, a person
taking the policy must have insurable interest at the time of taking the policy. For
example, a man can take life insurance policy on the name of his wife and if later they
get divorced this: will not affect the insurance contract because the man had insurable
interest in the life of his wife at the time of entering into the contract. In case of marine
insurance insurable interest must exist at the time of loss or damage to the property. In
contract of fire insurance, it must exist both at the time of taking the policy as well as at
the time of loss or damage to the property.
3. Indemnity
The word indemnity means to restore someone to the same position that he/she was in
before the event concerned took place. This principle is applicable to the fire and marine
insurance. It is not applicable to life insurance, because the loss of life cannot be
restored. The purpose of this principle is that the insured is not allowed to make any
profit from the insurance contract on the happening of the event that is insured against.
Compensation is paid on the basis of amount of actual loss or the sum insured,
whichever is less.

70
4. Contribution
The same subject matter may be insured with more than one insurer. In such a case,
the insurance claim to be paid to the insured must be shared or contributed by all
insurers.
5. Subrogation
In the contract of insurance subrogation means that after the insurer has compensated
the insured, the insurer gets all the rights of the insured with regard to the subject
matter of the
insurance. For example, suppose goods worth Rs. 20,000/- are partially destroyed by
fire and the insurance company pays the compensation to the insured, then the
insurance company can take even these partially destroyed goods and sell them in the
market.
6. Mitigation
In case of a mishap the insured must take all possible steps to reduce or mitigate the
loss or damage to the subject matter of insurance. This principle ensures that the
insured does not become negligent about the safety of the subject matter after taking an
insurance policy. The insured is expected to act in a manner as if the subject matter has
not been insured.
7. Causa-proxima (nearest cause)
According to this principle the insured can claim compensation for a loss only if it caused
by the risk insured against. The risk insured should be,nearest cause (not a remote
cause) for the loss. Then only the insurance company is liable to pay the compensation.
For example a ship carrying orange was insured against losses arising form accident. The
ship reached the port safely and there was a delay in unloading the oranges from the
ship. As a result the oranges got spoilt. The insurer did not pay any compensation for
the loss because the proximate cause of loss was delay in unloading and not any
accident during voyage. Historical background: (a) Insurance Act 1938 concerning
insurance business in India; (b) Nationalisation of Life insurance business and set up of
―LIC‖ on 1st September 1956; (c) General insurance industry in India was nationalised
and a government company known as General Insurance Corporation of India was
formed by the central government in November, 1972; (d) Liberalising India‟s
Insurance: As a part of comprehensive reform process initiated in the year 1991,
central government has setup a committee on reforms in insurance sector headed by Mr.
R. N. Malhotra. (e) FDI in insurance: With the enactment of ―Insurance Regulatory and
Development Authority Act, 1999‖ private participation in the Indian insurance market
was allowed though foreign equity in any insurance company being restricted to 26%
and currently 49%.
Types of insurance-Life and Non-life insurance;
Life Insurance
□ Life Insurance is a financial cover for a contingency linked with human life, like
death, disability, accident, retirement etc. Human life is subject to risks of death and
disability due to natural and accidental
causes. When human life is lost or a person is disabled permanently or temporarily,
there is loss of income to the household.
□ Though human life cannot be valued, a monetary sum could be determined based on
the loss of income in future years. Hence, in life insurance, the Sum Assured ( or the
amount guaranteed to be paid in the event of a loss) is by way of a ‗benefit‘. Life
Insurance products provide a definite amount of money in case the life insured dies
during the term of the policy or becomes disabled on account of an accident.
All of us face the following risks-

71
■ Dying too soon
■ Living too long Life Insurance is needed:
To ensure that your immediate family has some financial support in the event of your
demise.
To finance your children‘s education and other needs
To have a savings plan for the future so that you have a constant source of income after
retirement.
To ensure that you have extra income when your earnings are reduced due to serious
illness or accident.
To provide for other financial contingencies and life style requirements.
Who needs life Insurance?
□ Primarily, anyone who has a family to support and is an income earner needs Life
Insurance.
□ In view of the economic value of their contribution to the family, housewives too
need life insurance cover.
□ Even children can be considered for life insurance in view of their future income
potential being at risk.
□ Non-Life Insurance
S Fire Insurance S Marine Insurance S Motor Insurance ■S Burglary Insurance ■S
Fidelity Insurance S Property Insurance S Travel Insurance V Fisal Bima

Risk classification and management;

Uncertainty and Risk
An uncertainty refers to a ―state of mind or psychological reaction, characterized by
doubt, based on a lack of knowledge about what will or will not happen in the future‖.
Uncertainty is the opposite of certainty. Certainty
is a conviction or absolute about a particular situation. Uncertainty falls into two
categories'. In the category first, uncertainties for which the probability of occurrence is
measurable either on a priority grounds or through the statistical analysis of a series of
similar events that have occurred in the past. These measurable uncertainties are known
as risks. In the second category, we have non-measurable uncertainties because their
occurrence follows no set pattern or because they are unique events. In the words of
John Maynard Keynes: A situation of uncertainty has an element of surprise and the
significance of uncertainty arises from its influence on the process of decision-making
by individuals, businesses and society at large.
There is no generally or universally accepted definition of risk. It suggests different
things; to different people. People use the term “risk” for (i) an insured items (e.g.
this building is a poor risk); (ii) the chance of loss (e.g. the risk of loss in business or
investment is high); (iii) the cause of loss (e.g. insurance is available against the risk
of burglary or risk of fire). '
In viewpoint of economists and statisticians
Risk is associated with “variability” (e.g. variability of return on investment in an
equity share of a company). Therefore, risk is defined as “variation in the range of
possible outcomes”. The greater the potential variation, greater is the risk.
Bernstein observers risk as:
―When we take a risk, we are betting on an outcome that will result from a decision

72
we have made, though we do not know for certain what the outcome will be‖.
An another look at the-meaning of risk
• Risk is measurable uncertainty concerning the occurrence of a loss or events
which might produce a loss. The losses are measured in monetary/financial terms. The
management of risk involves decision-making under uncertainty. The losses can be
analyzed according to: (i) probability or chance - how likely? (ii) Peril - immediate
cause of a loss (e.g. fire, theft, death); (iii) Frequency - how often? (iv) Severity - how
much in financial terms when it occurs; (v) Total rupee loss in a time period.
• Risk includes an outcome of loss or danger. It is measurable uncertainty concerning a
potential loss. It is a situation in which we are not sure whether there will be a loss of a
certain kind or how much will be lost. It is this uncertainty and undesirable element
found with risk that creates the need for insurance.
• The potential loss can be divided into (i) financial loss which is measurable in
monetary terms (e.g. loss of a ( camera by theft); (ii)physical loss (e.g. death or
personal injuries often having financial results for the person or
family; (iii) emotional loss (e.g. feelings of grief and sorrow).
• Insurable risks cover financial and physical loss.
• Risk is defined as the relative variation of the actual outcome from the anticipated or
expected outcome. For example, in case of a manufacturing firm, the development of
new product is risky as the profits from the sale
of product in the market are uncertain before the actual sale. Another example, the
development of new drugs by a pharmaceutical company is characterized by risk
because of the range of possible outcomes with regard to the market reception of the
new drug.
• In some definitions, risk focuses only on the probability of an event occurring. The
broader meaning includes both the probability of the event occurring and the
consequences of the event. For example, the probability of a severe earthquake may be
very low but the consequences are so catastrophic that it would be called a high-risk
event.
Definitions
Risk means uncertainty about future loss or an inability to predict the
occurrence or size of a loss. Risk can be classified as pure or speculative risk -
Frederick G. Crane. ''
Risk is a condition in which there is a possibility of an adverse deviation, from a
desired outcome that is expected or hopedfor - Emmett J. Vaughan and Therese
Vaughan.
Risk is defined as uncertainty concerning the occurrence of a loss -^George E.
Rejda.
Characteristics of Risk
1. Absence of knowledge of happening of any event.
2. Uncertainty: It refers to a state of mind characterized by doubt, based on lack of
knowledge about what will or will not happen in the future.
3. Occurrence of Loss.
4. Probability of loss.
5. Problem and opportunity for business.
6. Exposure to perils.

73
A peril is the cause of a loss. The common examples of insured perils include fire, theft,
burglary, explosion, natural calamities; hear attacks, illness or terrorist attacks. The
insurance companies provide policies to provide financial protection against losses
caused by perils.
How Risk is different from ‗‗Peril‖ and ―Hazard‖
The concept of risk is to be distinguished from the terms „peril‟ and „hazard‟.
„Peril‟ is defined as the cause of loss. Perils that cause damage to property include
theft, burglary, fire, hailstorm, windstorm, lightning and earthquakes. An example of
peril is: if Amit‘s car is damaged in a collision with Ramesh‘s car, collision is the peril or
cause of loss.
„Hazard‟ is a condition that creates the chance of loss or increases the chance of a loss.
Three major types of hazards are usually distinguished.
a) Physical hazard
b) Moral hazard and
c) Morale hazard
Physical hazard: A physical condition that increases the chance of loss is called
physical hazard. A large number
of examples of physical hazard from our daily life can be cited, such as defective
electrical wiring in a cinema hall
which increases the chance of fire, bad and poorly maintained roads that increase the
chance of motor accidents and defective locking system on the main door of an
apartment that increases the chance of theft.
Moral Hazard: Moral hazard is a condition characterized by defects in the character of
an individual such as
dishonesty that increases the frequency of loss or severity of loss or both. Moral hazard
is a common occurrence in insurance and is not easy to control. Examples: making a
fraudulent insurance claim, submitting an insurance
claim for an inflated amount and setting fire to an insured godown stocked with
inventory in order to lay claim to the insurance amount. With a view to controlling moral
hazard, insurers take a NO OF steps such as careful underwriting practices, and by
including a number of provisions in the insurance:y such as exclusions,
deductibles and riders.
Conclusion: Moral hazard refers to a deliberate dishonesty resulting in increasing the
frequency-or severity of
loss.
Morale Hazard: Morale hazard refers to carelessness or indifference to loss because of
the presence of insurance. Examples include leaving the main door of a house open to
make entry of a burglar easy, leaving car keys in an unlocked car door, and carelessness
in regard to maintenance of health because of existence of a health insurance policy.
Such careless acts increase the chance of loss.
Classification of Risk
1. On the basis of Occurrence: Pure Risk and Speculative Risk
1.1 Pure Risk:
(i) Pure (static) risk is a situation in which there are only the possibilities of loss or no
loss. The only outcome of pure risks are adverse (in a loss) or neutral (with no loss),
never beneficial.

74
(ii) Examples of pure risks include premature death, occupational disability, catastrophic
medical expenses, and damage to property due to fire, lightning, or flood.
(a) Personal risk: Risk of premature death; risk of old age; risk of poor health;
risk of unemployment.
(b) Property Risk: Direct loss; indirect loss or consequential loss; extra
expenses.
(c) Liability Risk.
1.2 Speculative Risk
(i) Speculative (dynamic) risk is a situation in which either profit or loss is possible. The
outcome of such speculative risk is either beneficial (profitable) or loss.
(ii) Examples: betting on a horse race, investing in stocks/bonds and real estate.
(iii) In the business level, in the daily conduct of its affairs, every business entity faces
decisions that involve an
element of risk. The decision to venture into a new market, purchase new equipments,
diversify on the existing product line, expand or contract areas of operations, commit
more to advertising, borrow additional capital, etc., carry risks inherent to the business.
(iv) Speculative risk is uninsurable with some exceptions.
Difference between pure and speculative risk
(i) Through the use of commercial, personal, and liability insurance policies, insurance
companies in the private sector generally insure only pure risks. Speculative risks are
not considered insurable, with some exceptions.
(ii) The law of large numbers can be applied more easily to pure risks than to
speculative risks. The law of large numbers is important in insurance because it enables
insurers to predict loss figures in advance. It is generally more difficult to apply the law
of large numbers to speculative risks in order to predict future losses. One of the
exceptions is the speculative risk of gambling, where casinos can apply the law of large
numbers in a veiy efficient manner.
(iii) Society as a whole may benefit from a speculative risk even though a loss occurs, but
it is harmed if a pure risk is present and a loss occurs. For instance, a computer
manufacturer's competitor develops a new technology to produce faster computer
processors more cheaply. As a result, it forces the computer manufacturer into
bankruptcy. Despite the bankruptcy, society as a whole benefits since the competitor's
computers work faster and are sold at a lower price. On the other hand, society would
not benefit when most pure risks, such as an earthquake, occur.
2. On the basis of Flexibility: Static and Dynamic risk.
2.1 Static Risk
Static risks are risks connected with losses caused by the irregular action of nature or by
the mistakes and misdeeds of human beings. Static risks are the same as pure risks and
would, by definition, be present in an unchanging economy.
2.2 Dynamic Risk
Dynamic risks are risks associated with a changing economy. Important examples of
dynamic risks include the changing tastes of consumers, technological change, new
methods of production, and investments in capital goods that are used to produce new
and untried products.
Static and dynamic risks have several important differences -
1. Most static risks are pure risks, but dynamic risks are always speculative risks where
both profit and loss are possible.

75
2. Static risks would still be present in an unchanging economy, but dynamic risks are
always associated with a changing economy.
3. Dynamic risks usually affect more individuals and have a wider impact on society
than do static risks.
4. Dynamic risks may be beneficial to society but static risks are always harmful.
3. On the basis of Measurement:
3.1 Financial Risk
A financial risk is one where the outcome can be measured in monetary terms.
■
I. Classification on basis of firm specification: (a) Business risk.
II. Classification on basis of shareholder specification: (a) Interest rate risk; (b)
Liquidity risk; (c) Market risk.
III. Classification of on basis of firm and shareholder: (a) Event risk; (b)
Exchange rate risk; (c) Purchasing power risk; (d) Tax risk.
3.2 Non-financial risk.
The great social decisions of life are examples of non-financial risks: the selection of a
career, the choice of a marriage partner, having children. There may or may not be
financial implications, but in the main the outcome is not measurable financially.
4. On the basis of Coverage: Fundamental and Particular risk.
4.1 Fundamental Risk
Fundamental risks affect the entire economy or large numbers of people or groups within
the economy. Examples of fundamental risks are high inflation, unemployment, war, and
natural disasters such as earthquakes, hurricanes, tornadoes, and floods.
4.2 Particular Risk
Particular risks are risks that affect only individuals and not the entire community.
Examples of particular risks are burglary, theft, auto accident, dwelling fires. With
particular risks, only individuals experience losses, and the rest of the community are
left unaffected.
Distinction between fundamental and particular risk
The distinction between a fundamental and a particular risk is important, since
government assistance may be necessary in order to insure fundamental risk. Social
insurance, government insurance programs, and government guarantees and subsidies
are used to meet certain fundamental risks in our country. For example, the risk of
unemployment is generally not insurable by private insurance companies but can be
insured publicly by federal or state agencies. In addition, flood insurance is only available
through and/or subsidized by the federal government.
5. On the basis of Behavior: Subjective and Objective risk.
5.1 Subjective risk
Subjective risk is defined as uncertainty based on a person's mental condition or state of
mind. For example, assume that an individual is drinking heavily in a bar and attempts
to drive home after the bar closes. The driver may be uncertain whether he or she will
arrive home safely without being arrested by the police for drunken driving. This mental
uncertainty is called subjective risk.
5.2 Objective Risk
Objective risk is defined as the relative variation of actual loss from expected loss. For
example, assume that a fire insurer has 5000 houses insured over a long period and, on

76
an average, l percent, or 50 houses are destroyed by fire each year. However, it would
be rare for exactly 50 houses to bum each year and in some years; as few as 45 houses
may burn. Thus, there is a variation of 5 houses from the expected number of 50, or a
variation of 10 percent. This relative variation of actual loss from expected loss is known
as objective risk.
Objective risk can be statistically measured by some measure of dispersion, such as the
standard deviation or coefficient of variation. Since objective risk can be measured, it is
an extremely useful concept for an insurance company or a corporate risk manager. -
^
As the number of exposures increases, the insurance company can predict its future loss
experience more accurately because it can rely on the ―Law of large numbers.‖ The law
of large numbers states that as the number of exposure units increase, the more closely
will the actual loss experience approach the probable loss experience. For example, as
the number of homes under observation increases, the greater is the degree of accuracy
in predicting the proportion of homes that will burn.
6. On the basis of Diversification: Diversified and Non-diversified risk.
7. Other risks: (a) Crime exposures; (b) Human Resources exposures; (c)
Foreign loss exposure; (d) Intangible property exposures; (e) Government
exposures.
8. Internal and External risks.
9. Insurable and Non-insurable risks.
Managing Risks
The following methods are followed for managing risks:
1. Avoiding Risks.
2. Reducing Risks. ;
3. Transferring Risks: (a) Hedging; (b) Underwriting; (c) Subcontracting; (d) Sharing
or spreading risks; (e) Insurance; (f) Assuming Risks.
Risk Management
‗Risk, in insurance terms, is the possibility of a loss or other adverse event that has the
potential to interfere with an organization‘s ability to fulfill its mandate, and for which an
insurance claim may be submitted‘.
What is RisklManagement?
Risk management ensures that an organization identifies and understands the risks to
which it is exposed. Risk management also guarantees that the organization creates and
implements an effective plan to prevent losses or reduce the impact if a loss occurs.
A risk management plan includes strategies and techniques for recognizing and
confronting these threats.
Benefits to Managing Risk
1. Risk management provides a clear and structured approach to identifying risks.
Having a clear understanding of all risks allows an organization to measure and prioritize
them and take the appropriate actions to reduce losses.
2. Saving resources: Time, assets, income, property and people are all valuable
resources that can be saved if fewer claims occur.
3. Protecting the reputation and public-image of the organization.
4. Preventing or reducing legal liability and increasing the stability of operations.
5. Protecting people from harm.

77
6. Protecting the environment.
7. Enhancing the ability to prepare for various circumstances.
8. Reducing liabilities.
9. Assisting in clearly defining insurance needs.
Role of Insurance in Risk Management
Insurance is a valuable risk-financing tool. Few organizations have the reserves or funds
necessaiy to take on the risk themselves and pay the total costs following a loss.
Purchasing insurance, however, is not risk management. A thorough and thoughtful risk
management plan is the commitment to prevent harm. Risk management also addresses
many risks that are not insurable, including brand integrity, potential loss of tax-exempt
status for volunteer groups, public goodwill and continuing donor support.

Risk Management Process

Risk Management Comprises of following steps: .

(a) Risk Analysis
(b) Risk Identification
(c) Risk Assessment
(d) Risk Planning
(e) Risk Controlling

Risk Analysis.
Risk Analysis is the process of identifying* analyzing and communicating the major risks.
Risk analysis involves risk assessment, risk management and risk communication. Once
risks have been identified, they must then be assessed as to their potential severity of
impact (generally a negative impact, such as damage or loss) and to the probability of
occurrence. These quantities can be either simple to measure, in the case of the value of

78
a lost building, or impossible to know for sure in the case of the probability of an unlikely
event occurring. This process is known as risk analysis. In the assessment process it is
critical to make the best educated decisions in order to properly prioritize the
implementation of the risk management plan.
Risk Planning and Control
Once risk and identified and analyzed, it is important to plan and adopt a suitable
strategy for controlling the risk. Risk planning and controlling is the stage which comes
after the risk analysis process is over. There are five major methods of handling and
controlling risk.
a. Risk avoidance;
b. Risk retention;
c. Risk transfer;
d. Loss control; and
e. Insurance.
(a) Risk Avoidance
Risk avoidance is one method of handling risk. A business firm can avoid the risk of
being sued for a defective product by not producing the product.
(b) Risk Retention
Risk retention is a second method of handling risk. An individual or a business firm may
retain all or part of a given risk. Risk retention can be either active or passive. Active risk
retention means that an individual is consciously aware of the risk and deliberately plans
to retain all or part of it.
Factors limiting the insurability of risk;
1. Premium Loading: Administrative costs and capital costs
2. Moral Hazard.
3. Adverse selection.
Re-insurance
Reinsurance holds a greater role in the realm of insurance as primary insurers can bear
on to the business of insurance in an liberated way as the risks they are exposed to,
constantly make them to look back with caution. Reinsurance provides them cushion
through risk transfer and a source to share their liability and increases their ability to
undertake huge risk exposures and undertake claims. Without reinsurance cover, it is
obvious that large claims might jeopardize the viability of individual insurers or even the
entire insurance system.
Reinsurance is an insurance of insured risk where the insurer retains a part and cedes
the balance of a risk to the reinsurer. This is done to facilitate a greater spread and
reduce liability on the part of the insurer. In other words, reinsurance is insurance of
insured risk taken by insurance companies to protect their liability commitments beyond
their net capacity. It is the foundation on which the whole edifice of insurance rests. This
is a widely used risk transfer mechanism and provides the backbone to insurance
industry. Reinsurance is one of the major risk and capital management tools available to
primary insurance companies.
Reinsurance may be defined as a contractual arrangement under which one insurer,
known as the primary insurer, transfers to another insurer, known as the reinsurer,
some or all of the losses to be incurred by the primary insurer under insurance contracts
it has issued or will issue in the future. Reinsurance is a contract of indemnity, even in
life insurance and personal accident insurance.

79
The primary insurer is sometimes referred to as the ceding insurer, ceding company,
cedent, or reinsured. Reinsurers also may reinsure some of the loss exposures they
assume under reinsurance contracts. Such a
transaction is known as retrocession. The insurer or reinsurer to which the exposure is
transferred is known as a retrocessionaire and the reinsurer transferring the exposure
is called the retrocedent.
Types of Reinsurance
1. Pro-rata reinsurance or proportional reinsurance and
2. Excess of loss or non-proportional reinsurance.
Under Pro-rata or proportional reinsurance (also called participating reinsurance) the
premiums as well as the losses are shared between the primary insurer and reinsurer in
the agreed proportions.
Under this, no amount of insurance is ceded. This reinsurance arrangement will not
come into effect until the primary insurer has sustained a loss exceeding his retention
under the contract and is covered by^thexxcess of loss agreement.
It is to be noted that both facultative reinsurance and treaty reinsurance can be written
as* a pro rata or excess of loss or a combination of the two.
Regulatory Framework of Insurance- IRDAI And Its Role
Insurance Regulatoiy Development Authority of India (IRDAI) is a statutory body set
up for protecting the interests of the policyholders and regulating, promoting and
ensuring orderly growth of the insurance industry in India. The head office of IRDAI is at
Hyderabad.
Structure and Composition
The IRDA is a ten member body appointed by the GOI consisting of
■ Chairman
■ Five whole-time members
■ Four part-time members
Duties, Powers & Functions of IRDAI
Section 14 of IRDAI Act, 1999 states that subject to the Provisions of this Act and any
other law for the time being in force, the Authority shall have the duty to regulate,
promote and ensure orderly growth of the insurance business and re-insurance
business.
Regulation of Entities: Insurers
□ Types of Insurers
■ Life Insurers
■ Non-life Insurers including specialized insurers viz.
❖ Standard Health Insurance companies
❖ Agricultural Insurance Company
❖ Export Credit and Guarantee Corporation
■ Reinsurers

80
Regulation of Entities: Insurance Intermediaries
Types of Intermediaries Intermediaries as Channels of distribution
■ Insurance agents
■ Corporate agents including banks
■ Brokers
■ Microfinance agents
■ Web-aggregators
■ Others like common service centres
Other intermediaries
■ Third party administrators
■ Surveyors and loss-assessors
■ Insurance repositories
■ Registration
0 Issue to the applicant a certificate of registration, renew, modify, withdraw, suspend,
or cancel such registration.
Protection
0 Protection of the interests of the policyholders in matters concerning assigning of
policy, nomination by policyholders, insurable interest;, settlement of insurance claim,
surrender value of policy and other terms and conditions of contracts of insurance.
Code of Conduct
0 Specifying the code of conduct for surveyors and loss assessors.
0 Promoting efficiency in the conduct of insurance business.
0 Promoting and regulating professional organisations connected with the insurance and
re-insurance business.
Qualifications and Training
0 Specifying requisite qualifications, code of conduct and practical training for
intermediary or insurance intermediaries and agents.
Fees and Charges
0 Levying fees and other charges for carrying out the purposes of this Act.
Information and Audit
0 Calling for information from, undertaking inspection of conducting enquiries and
investigations including audit of insurers, intermediaries, insurance intermediaries and
other organizations connected with the insurance business.
0 Specifying the form and manner in which books of account shall be maintained and
statement of accounts shall be rendered by insurers and other insurance intermediaries.
Control and Regulation
0 Control and regulation of the rates, advantages, terms and conditions that may be
offered by insurers in respect of general insurance business not so controlled and
regulated by the Tariff Advisory Committee under section 64 U of the Insurance Act,
1938 n.:
0 Regulating investment of funds by insurance companies.
0 Regulating maintenance of margin of solvency.

81
0 Supervising the functioning of the Tariff Advisory Committee.
Disputes Settlement & Premium
0 Adjudication of disputes between insurers and intermediaries or insurance
intermediaries.
0 Specifying the percentage of premium income of the insurer to finance schemes for
promoting and regulating professional organisations.
0 Specifying the percentage of life insurance business and general insurance business to
be undertaken by the insurer in the rural or social sector. : «
Brief History of IRDAI
1991: GOI begins the economic reforms programme in financial sector reforms.
1993: Committee on Reforms in the insurance sector, headed by Shri R. N. Malhotra
(retired governor, RBI) set up to recommend reforms in insurance sector.
1994: Malhotra Committee recommends reforms after studying the insurance sector
and taking inputs from all the stakeholders.
Key recommendations of Malhotra Committee are:
^ Private sector companies should be allowed to promote insurance companies.
^ Foreign promoters should be allowed.
Government to vest its regulatory powers on an independent regulatory body
answerable to parliament.
. 1996: Setting up of an interim body called the Insurance Regulatory Authority
. 1999: Enactment of the Insurance Regulatory and Development Authority (IRDA) Act,
1999.
.2000: Formation of the IRDA as an autonomous regulatory body on 19.04.2000.
. Since 2000, IRDA has been serving as an independent regulatory authority of the
insurance industry and to instill confidence among the policyholders in the financial
viability of the insurance companies. IRDAI has been playing a pivotal role in the
insurance sector with a fundamental commitment to discharge its mandate for orderly
growth of Insurance sector.
. IRDAI has played a very important role in the growth and development of the sector by
protecting policyholders‘ interests; registering and regulating insurance companies;
licensing and setting norms for insurance intermediaries, regulating and overseeing
premium rates and terms of non-life insurance covers; specifying financial reporting
norms, regulating investment of policyholders‘ funds and ensuring by maintenance of
solvency margin by insurance companies; ensuring insurance coverage in rural areas
and of vulnerable sections of society; promoting professional organisations connected
with insurance and all other allied and development functions.

82