Commercial Banking in India: A Beginner's

Module

1
NCFM Module Examination Details
Allowable access to Candidate at
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3 Currency Derivatives: A Beginner’s Module 120 60 100 NO 50 NO NO YES NO
4 Equity Derivatives: A Beginner’s Module 120 60 100 NO 50 NO NO YES NO
5 Interest Rate Derivatives: A Beginner’s Module 120 60 100 NO 50 NO NO YES NO
6 Commercial Banking in India: A Beginner’s Module 120 60 100 NO 50 NO NO YES NO
7 FIMMDA-NSE Debt Market (Basic) Module 120 60 100 YES 60 YES NO YES NO
8 Securities Market (Basic) Module 120 60 100 YES 60 NO NO YES NO
9 Clearing Settlement and Risk Management Module 60 75 100 NO 60 YES NO YES NO
INTERMEDIATE
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2 Derivatives Market (Dealers) Module 120 60 100 YES 60 NO NO YES NO
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5 Operation Risk Management Module 120 75 100 YES 60 NO NO YES NO
6 Options Trading Strategies Module 120 60 100 YES 60 NO NO YES NO
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8 Treasury Management Module 120 60 100 YES 60 YES NO YES NO
9 Insurance Module 120 60 100 YES 60 NO NO YES NO
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6 Options Trading (Advanced) Module 120 35 100 YES 60 YES YES YES YES
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10 Investment Planning ** 120 77 150 NO 50 YES NO YES YES
11 Examination 5/Advanced Financial Planning ** 240 30 100 NO 50 YES NO YES YES
17 Financial Modeling Module ### 120 30 100 YES 50 YES NO YES NO
18 Business Analytics Module ### 120 66 100 NO 50 YES NO YES NO

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Preface
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3
CONTENTS
CHAPTER 1: INTRODUCTION ................................................................................... 9

1.1 Definition of banks ............................................................................................ 9

1.2 Evolution of Commercial Banks in India ............................................................... 10

1.3 Functions of Commercial Banks .......................................................................... 11

1.4 Competitive Landscape of Banks in India ............................................................. 12

CHAPTER 2: BANKING STRUCTURE IN INDIA........................................................ 14

2.1 Banking Structure in India ................................................................................ 14

2.2 Role of Reserve Bank of India vis-à-vis Commercial Banks .................................... 18

CHAPTER 3: BANK DEPOSIT ACCOUNTS ................................................................ 20

3.1 Introduction to Bank Deposits ........................................................................... 22

3.2 Types of Deposit Accounts ................................................................................. 24

3.2.1 Current Deposits ................................................................................... 25

3.2.2 Savings Bank Deposits .......................................................................... 25

3.2.3 Term Deposits ...................................................................................... 26

3.3 Strategies of mobilizing deposits ........................................................................ 27

3.4 Common Guidelines of Opening and Operating Deposit Accounts ........................... 28

3.5 Deposit Related Services ................................................................................... 30

3.6 Deposit Services Offered to Non-Resident Indians ................................................ 33

3.6.1 Non Resident Ordinary Accounts (NRO) ................................................... 34

3.6.2 Non-Resident (External) Rupee Accounts ................................................. 34

3.6.3 Foreign Currency Non Resident Account (Banks) ....................................... 35

3.7 Deposit Insurance ............................................................................................ 37

3.7.1 Banks insured by the DICGC .................................................................. 37

3.7.2 Features of the scheme ......................................................................... 37

CHAPTER 4: BASICS OF BANK LENDING ............................................................... 40

4.1 Principles of Lending and Loan policy .................................................................. 40

4.1.1 Principles of lending .............................................................................. 40

4.1.2 Loan Policy ........................................................................................... 41

4.1.3 Compliance with RBI guidelines .............................................................. 43

4.2 Basics of Loan Appraisal, Credit decision-making and Review ................................ 48

4.2.1 Credit approval authorities ..................................................................... 48

4
 4.2.2 Credit appraisal and credit decision-making ............................................. 48

4.2.3 Monitoring and Review of Loan Portfolio ................................................... 49

4.3 Types of Advances............................................................................................ 49

4.3.1 Working Capital Finance......................................................................... 50

4.3.2 Project Finance ..................................................................................... 50

4.3.3 Loans to Small and Medium Enterprises ................................................... 51

4.3.4 Rural and Agricultural Loans ................................................................... 52

4.3.5 Directed Lending ................................................................................... 53

4.3.6 Retail Loan ........................................................................................... 54

4.3.7 International Loans Extended by Banks ................................................... 55

4.4 Management of Non Performing Assets ............................................................... 56

4.4.1 Classification of non-performing Assets.................................................... 56

4.4.2 Debt Restructuring ................................................................................ 57

4.4.3 Other recovery options .......................................................................... 57

4.4.4 SARFAESI Act, 2002 .............................................................................. 58

CHAPTER 5: BANK INVESTMENTS .......................................................................... 60

5.1 Investment Policy ............................................................................................ 61

5.2 Statutory Reserve Requirements ........................................................................ 62

5.2.1 Maintenance of Statutory Liquidity Ratio (SLR) ......................................... 64

5.2.2 Penalties .............................................................................................. 64

5.3 Non-SLR Investments ....................................................................................... 65

5.3.1 Bank Guidelines for investments in other than Government Securities ......... 65

5.3.2 Statutory Prescriptions .......................................................................... 66

5.4 Banks' Investment Classification and Valuation Norms .......................................... 67

5.4.1 Treasury Management ........................................................................... 68

5.4.2 Forex Treasury Management .................................................................. 68

CHAPTER 6: OTHER ACTIVITIES OF COMMERCIAL BANKS ..................................... 69

6.1 Other Basic Banking Activities ........................................................................... 69

6.1.1 Foreign Exchange Services ..................................................................... 69

6.1.2 Banks' services to Government ............................................................... 69

6.1.3 Payment and Settlement Systems ........................................................... 70

6.1.4 NRI Remittances ................................................................................... 75

6.1.5 Cash Management Services and Remittances ........................................... 75

5
6.2 Para-banking Activities ..................................................................................... 75

6.2.1 Primary Dealership Business................................................................... 75

6.2.2 Investment Banking/ Merchant Banking Services ...................................... 76

6.2.3 Mutual Fund Business ............................................................................ 77

6.2.4 Pension Funds Management (PFM) by banks............................................. 77

6.2.5 Depository Services............................................................................... 78

6.2.6 Wealth Management/ Portfolio Management Services ................................ 79

6.2.7 Bancassurance ..................................................................................... 80

CHAPTER 7: RELATIONSHIP BETWEEN BANK AND CUSTOMER .............................. 81

7.1 Strategy for expanding customer base................................................................ 81

7.1.1 Product Life Cycle Strategy .................................................................... 81

7.1.2 Appropriate targeting ............................................................................ 82

7.1.3 Expanding product portfolio.................................................................... 82

7.2 Services to different Customer Groups................................................................ 82

7.2.1 Retail Customers .................................................................................. 83

7.2.2 Corporate Customers ............................................................................ 84

7.2.3 International Presence ........................................................................... 84

7.2.4 Rural Banking Customers ....................................................................... 85

7.3 Competition amongst Banks for Customers ......................................................... 85

7.3.1 Competition for Retail Products and Services ............................................ 85

7.3.2 Competition for Corporate Products and Services ...................................... 85

7.3.3 Competition for International Banking ..................................................... 86

7.3.4 Competition for Rural Customers ............................................................ 86

7.4 Customer Relationship Management ................................................................... 86

7.4.1 Committees on Customer Service ........................................................... 87

7.4.2 Board-approved Policies on Customer Service .......................................... 87

7.4.3 Giving Publicity to the Policies ................................................................ 88

7.4.4 Operations of Accounts by Special Category of Customers ......................... 88

7.4.5 Customer Confidentiality Obligations ....................................................... 88

7.4.6 National Do Not Call Registry.................................................................. 89

7.5 Banking Ombudsman Scheme ........................................................................... 89

7.5.1 Appointment of Banking Ombudsman ...................................................... 89

6
 7.5.2 Filing a Complaint to the Banking Ombudsman ......................................... 89

7.5.3 Limit on the Amount of Compensation as Specified in an Award .................. 89

7.5.4 Further recourse available ...................................................................... 90

7.6 Know Your Customer (KYC) norms ..................................................................... 90

7.6.1 Customer Acceptance Policy ................................................................... 90

7.6.2 Customer Identification Procedures ......................................................... 91

7.6.3 Monitoring of Transactions ..................................................................... 93

7.6.4 Risk Management ................................................................................. 93

7.7 Prevention of Money Laundering Act (PMLA), 2002 ............................................... 93

CHAPTER 8: EVOLVING TRENDS IN MODERN BANKING ......................................... 94

8.1 Technology ................................................................................................. 94

8.1.1 Internet Banking ................................................................................... 95

8.1.2 Mobile Banking Transactions .................................................................. 95

8.1.3 Point of Sale (PoS) Terminals ................................................................. 96

8.2 Outsourcing of Non-core Activities ..................................................................... 98

8.3 Financial Inclusion............................................................................................ 98

8.3.1 Initiatives taken by the RBI .................................................................... 99

8.3.2 Micro Credit ......................................................................................... 100

7
 Distribution of weights
Commercial Banking in India: A Beginner's Module

Chapter Title Weights (%)

No
1 Introduction 10

2 Banking structure in India 16

3 Bank Deposit Accounts 17

4 Basics of Bank Lending 16

5 Bank Investments 15

6 Other Activities of Commercial Banks 10

7 Relationship between Bank and customer 6

8 Evolving Trends in modern Banking 10

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8
CHAPTER 1: Introduction

Banks have played a critical role in the economic development of some developed countries such as
Japan and Germany and most of the emerging economies including India. Banks today are important not
just from the point of view of economic growth, but also financial stability. In emerging economies, banks
are special for three important reasons. First, they take a leading role in developing other financial
intermediaries and markets. Second, due to the absence of well-developed equity and bond markets, the
corporate sector depends heavily on banks to meet its financing needs. Finally, in emerging markets such
as India, banks cater to the needs of a vast number of savers from the household sector, who prefer
assured income and liquidity and safety of funds, because of their inadequate capacity to manage
financial risks.

Forms of banking have changed over the years and evolved with the needs of the economy. The
transformation of the banking system has been brought about by deregulation, technological innovation
and globalization. While banks have been expanding into areas which were traditionally out of bounds for
them, non-bank intermediaries have begun to perform many of the functions of banks. Banks thus
compete not only among themselves, but also with non-bank financial intermediaries, and over the years,
this competition has only grown in intensity. Globally, this has forced the banks to introduce innovative
products, seek newer sources of income and diversify into non-traditional activities.

This module provides some basic insights into the policies and practices currently followed in the Indian
banking system. The first two chapters provide an introduction to commercial banking in India and its
structure. Bank deposits are dealt with in detail in Chapter 3, lending and investments in Chapter 4 &
Chapter 5 respectively. Chapter 6 deals with other basic banking activities of commercial banks, while
Chapters 7 and 8 explain the relationship between a bank and its customers and the trends in modern
banking respectively.

1.1 Definition of banks

In India, the definition of the business of banking has been given in the Banking Regulation Act, (BR Act),
1949. According to Section 5(c) of the BR Act, 'a banking company is a company which transacts the
business of banking in India.' Further, Section 5(b) of the BR Act defines banking as, '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.' This definition points to the three
primary activities of a commercial bank which distinguish it from the other financial institutions. These are:
(i) maintaining deposit accounts including current accounts, (ii) issue and pay cheques, and (iii) collect
cheques for the bank's customers.1

1
Each of these functions is described in detail in later chapters.

9
1.2 Evolution of Commercial Banks in India

The commercial banking industry in India started in 1786 with the establishment of the Bank of Bengal in
Calcutta. The Indian Government at the time established three Presidency banks, viz., the Bank of
Bengal (established in 1809), the Bank of Bombay (established in 1840) and the Bank of Madras
(established in 1843). In 1921, the three Presidency banks were amalgamated to form the Imperial Bank
of India, which took up the role of a commercial bank, a bankers' bank and a banker to the Government.
The Imperial Bank of India was established with mainly European shareholders. It was only with the
establishment of Reserve Bank of India (RBI) as the central bank of the country in 1935, that the quasi-
central banking role of the Imperial Bank of India came to an end.

In 1860, the concept of limited liability was introduced in Indian banking, resulting in the establishment of
joint-stock banks. In 1865, the Allahabad Bank was established with purely Indian shareholders. Punjab
National Bank came into being in 1895. Between 1906 and 1913, other banks like Bank of India, Central
Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up.

After independence, the Government of India started taking steps to encourage the spread of banking in
India. In order to serve the economy in general and the rural sector in particular, the All India Rural Credit
Survey Committee recommended the creation of a state-partnered and state-sponsored bank taking over
the Imperial Bank of India and integrating with it, the former state-owned and state-associate banks.
Accordingly, State Bank of India (SBI) was constituted in 1955. Subsequently in 1959, the State Bank of
India (subsidiary bank) Act was passed, enabling the SBI to take over eight former state-associate banks
as its subsidiaries.

To better align the banking system to the needs of planning and economic policy, it was considered
necessary to have social control over banks. In 1969, 14 of the major private sector banks were
nationalized. This was an important milestone in the history of Indian banking. This was followed by the
nationalisation of another six private banks in 1980. With the nationalization of these banks, the major
segment of the banking sector came under the control of the Government. The nationalisation of banks
imparted major impetus to branch expansion in un-banked rural and semi-urban areas, which in turn
resulted in huge deposit mobilization, thereby giving boost to the overall savings rate of the economy. It
also resulted in scaling up of lending to agriculture and its allied sectors. However, this arrangement also
saw some weaknesses like reduced bank profitability, weak capital bases, and banks getting burdened
with large non-performing assets.

To create a strong and competitive banking system, a number of reform measures were initiated in early
1990s. The thrust of the reforms was on increasing operational efficiency, strengthening supervision over
banks, creating competitive conditions and developing technological and institutional infrastructure. These
measures led to the improvement in the financial health, soundness and efficiency of the banking system.

10
One important feature of the reforms of the 1990s was that the entry of new private sector banks was
permitted. Following this decision, new banks such as ICICI Bank, HDFC Bank, IDBI Bank and UTI Bank
were set up.

Commercial banks in India have traditionally focused on meeting the short-term financial needs of
industry, trade and agriculture. However, given the increasing sophistication and diversification of the
Indian economy, the range of services extended by commercial banks has increased significantly, leading
to an overlap with the functions performed by other financial institutions. Further, the share of long-term
financing (in total bank financing) to meet capital goods and project-financing needs of industry has also
increased over the years.

1.3 Functions of Commercial Banks2

The main functions of a commercial bank can be segregated into three main areas: (i) Payment System
(ii) Financial Intermediation (iii) Financial Services.

Figure 1.1: Main functions of a commercial bank

(i) Payment System

Banks are at the core of the payments system in an economy. A payment refers to the means by
which financial transactions are settled. A fundamental method by which banks help in settling
the financial transaction process is by issuing and paying cheques issued on behalf of
customers. Further, in modern banking, the payments system also involves electronic banking,
wire transfers, settlement of credit card transactions, etc. In all such transactions, banks play a
critical role.

(ii) Financial Intermediation

The second principal function of a bank is to take different types of deposits from customers and
then lend these funds to borrowers, in other words, financial intermediation. In financial terms,
bank deposits represent the banks' liabilities, while loans disbursed, and investments made by
banks are their assets. Bank deposits serve the useful purpose of addressing the needs of
depositors, who want to ensure liquidity,

2
The functions of commercial banks have been described in detail in later chapters.

11
 safety as well as returns in the form of interest. On the other hand, bank loans and investments
made by banks play an important function in channelling funds into profitable as well as socially
productive uses.

(iii) Financial Services

In addition to acting as financial intermediaries, banks today are increasingly involved with
offering customers a wide variety of financial services including investment banking, insurance-
related services, government-related business, foreign exchange businesses, wealth
management services, etc. Income from providing such services improves a bank's profitability.

1.4 Competitive Landscape of Banks in India

Banks face competition from a wide range of financial intermediaries in the public and private sectors in
the areas of financial intermediation and financial services (although the payments system is exclusively
for banks). Such intermediaries form a diverse group in terms of size and nature of their activities, and
play an important role in the financial system by not only competing with banks, but also complementing
them in providing a wide range of financial services. Some of these intermediaries include:

 Term-lending institutions

 Non-banking financial companies

 Insurance companies

 Mutual funds

(i) Term-Lending Institutions

Term lending institutions exist at both state and all-India levels. They provide term loans (i.e., loans with
medium to long-term maturities) to various industry, service and infrastructure sectors for setting up new
projects and for the expansion of existing facilities and thereby compete with banks. At the all-India level,
these institutions are typically specialized, catering to the needs of specific sectors, which make them
competitors to banks in those areas.3 These include the Export Import Bank of India (EXIM Bank), Small
Industries Development Bank of India (SIDBI), Tourism Finance Corporation of India Limited (TFCI), and
Power Finance Corporation Limited (PFCL).

3
A notable exception is the IFCI Ltd, which lends into a variety of sectors.

12
At the state level, various State Financial Corporations (SFCs) have been set up to finance and promote
small and medium-sized enterprises. There are also State Industrial Development Corporations (SIDCs),
which provide finance primarily to medium-sized and large-sized enterprises. In addition to SFCs and
SIDCs, the North Eastern Development Financial Institution Ltd. (NEDFI) has been set up to cater
specifically to the needs of the north-eastern states.

(ii) Non-Banking Finance Companies (NBFCs)

India has many thousands of non-banking financial companies, predominantly from the private sector.
NBFCs are required to register with RBI in terms of the Reserve Bank of India (Amendment) Act, 1997.
The principal activities of NBFCs include equipment-leasing, hire-purchase, loan and investment and
asset finance. NBFCs have been competing with and complementing the services of commercial banks
for a long time. All NBFCs together currently account for around nine percent of assets of the total
financial system.

Housing-finance companies form a distinct sub-group of the NBFCs. As a result of some recent
government incentives for investing in the housing sector, these companies' business has grown
substantially. Housing Development Finance Corporation Limited (HDFC), which is in the private sector
and the Government-controlled Housing and Urban Development Corporation Limited (HUDCO) are the
two premier housing-finance companies. These companies are major players in the mortgage business,
and provide stiff competition to commercial banks in the disbursal of housing loans.

(iii) Insurance Companies

Insurance/reinsurance companies such as Life Insurance Corporation of India (LIC), General Insurance
Corporation of India (GICI), and others provide substantial long-term financial assistance to the industrial
and housing sectors and to that extent, are competitors of banks. LIC is the biggest player in this area.

(iv) Mutual Funds

Mutual funds offer competition to banks in the area of fund mobilization, in that they offer alternate routes
of investment to households. Most mutual funds are standalone asset management companies. In
addition, a number of banks, both in the private and public sectors, have sponsored asset management
companies to undertake mutual fund business. Banks have thus entered the asset management
business, sometimes on their own and other times in joint venture with others.

13
CHAPTER 2: Banking Structure in India

2.1 Banking Structure in India

Banking Regulator

The Reserve Bank of India (RBI) is the central banking and monetary authority of India, and also acts as
the regulator and supervisor of commercial banks.

Scheduled Banks in India4

Scheduled banks comprise scheduled commercial banks and scheduled co-operative banks. Scheduled
commercial banks form the bedrock of the Indian financial system, currently accounting for more than
three-fourths of all financial institutions' assets. SCBs are present throughout India, and their branches
and 1,36,098 ATMs, having grown more than four-fold in the last 40 years now number more than
87,860 across the country (see Table 2.1). Our focus in this module will be only on the scheduled
commercial banks. A pictorial representation of the structure of SCBs in India is given in figure 2.1.

Figure 2.1: Scheduled Banking Structure in India

4
Scheduled banks in India are those that are listed in the Second Schedule of the Reserve Bank of India Act, 1934. RBI includes
only those banks in this schedule which satisfy the criteria as laid down vide section 42 (6) (a) of the Act.

14
Public Sector Banks

Public sector banks are those in which the majority stake is held by the Government of India (GoI). Public
sector banks together make up the largest category in the Indian banking system. There are currently 12
public sector banks in India. In this amalgamation, which came into effect on April 1, 2020, Punjab
National Bank (PNB), Oriental Bank of Commerce, and United Bank of India combined to form the
nation’s second-largest lender. Canara Bank took over Syndicate Bank; Union Bank of India be
amalgamated with Andhra Bank and Corporation Bank; and Indian Bank subsumed Allahabad Bank. The
number of banks has come down from 27 in 2017, to 12 in 2020 after this massive amalgamation
exercise to consolidate these banks.
Public sector banks have taken the lead role in branch expansion, particularly in the rural areas. By end
March 2019, public sector banks had a total of 87,860 branches and 1,36,098 ATMs. This is a staggering
number, having grown from 80,514 branches in 2009. 

Regional Rural Banks

Regional Rural Banks (RRBs) were established during 1976-1987 with a view to develop the rural
economy. Each RRB is owned jointly by the Central Government, concerned State

15
Government and a sponsoring public sector commercial bank. RRBs provide credit to small farmers,
artisans, small entrepreneurs and agricultural labourers. Over the years, the Government has introduced
a number of measures of improve viability and profitability of RRBs, one of them being the amalgamation
of the RRBs of the same sponsored bank within a State. This process of consolidation has resulted in a
steep decline in the total number of RRBs to 86 as on March 31, 2009, as compared to 196 at the end of
March 2005. With the third phase of amalgamation of RRB bringing down the number of such entities to
38 from 56. As of 1st April 2020, there are 43 RRBs in India.

Private Sector Banks

In this type of banks, the majority of share capital is held by private individuals and corporates. Not all
private sector banks were nationalized in in 1969, and 1980. The private banks which were not
nationalized are collectively known as the old private sector banks and include banks such as The
Jammu and Kashmir Bank Ltd., Lord Krishna Bank Ltd etc. 5 Entry of private sector banks was however
prohibited during the post-nationalisation period. In July 1993, as part of the banking reform process and
as a measure to induce competition in the banking sector, RBI permitted the private sector to enter into
the banking system. This resulted in the creation of a new set of private sector banks, which are
collectively known as the new private sector banks. There are 22 private sector banks in India.

Foreign Banks

Foreign banks have their registered and head offices in a foreign country but operate their branches in
India. The RBI permits these banks to operate either through branches; or through wholly-owned
subsidiaries.7 The primary activity of most foreign banks in India has been in the corporate segment.
However, some of the larger foreign banks have also made consumer-financing a significant part of their
portfolios. These banks offer products such as automobile finance, home loans, credit cards, household
consumer finance etc. Foreign banks in India are required to adhere to all banking regulations, including
priority-sector lending norms as applicable to domestic banks.8 In addition to the entry of the new private
banks in the mid-90s, the increased presence of foreign banks in India has also contributed to boosting
competition in the banking sector.

5
Some of the private sector banks, which showed signs of an eventual default, were merged with state owned banks.

6
It may be noted that two important erstwhile developmental financial institutions, viz. Industrial Development Bank of India (IDBI)
and Industrial Credit and Investment Corporation of India (ICICI) converted themselves into commercial banks after the new
bank licensing policy was announced in July 1993.
7
In addition, a foreign institution could also invest up to 74% in domestic private bank, in which up to 49% can be via portfolio
investment.
8
Priority sector lending has been described in a later chapter.

16
 Box 2.1: Number of Foreign Banks

At the end of March 2019, there were 46 foreign banks with 300 branches and 914 ATMs operating in
India.. Under the World Trade Organisation (WTO) Agreement, RBI allows a minimum 12 branches of
all foreign banks to be opened in a year.

Source: RBI

Co-operative Banks

Co-operative banks cater to the financing needs of agriculture, retail trade, small industry and self-
employed businessmen in urban, semi-urban and rural areas of India. A distinctive feature of the co-
operative credit structure in India is its heterogeneity. The structure differs across urban and rural areas,
across states and loan maturities. Urban areas are served by urban co-operative banks (UCBs), whose
operations are either limited to one state or stretch across states. The rural co-operative banks comprise
State co-operative banks, district central co-operative banks, SCARDBs and PCARDBs.9

The co-operative banking sector is the oldest segment of the Indian banking system. As of March 2019,
there were 1,544 urban co-operative banks, and 96,248 rural co-operative banks in the country. The
latter accounted for 64.7 per cent of the total assets of the co-operative sector. Owing to their
widespread geographical penetration, cooperative banks have the potential to become an important
instrument for large-scale financial inclusion, provided they are financially strengthened. 11 The RBI and
the National Agriculture and Rural Development Bank (NABARD) have taken a number of measures in
recent years to improve financial soundness of co-operative banks.

In addition to this vast network, there are also 3 Local Area Banks, 10 Small Finance Banks and 6
Payments Banks in India.

The Local Area Bank Scheme was introduced in August 1996 to aid the setting up of new private local
banks with jurisdiction over two or three contiguous districts. This would enable the mobilization of rural
savings by local institutions and make them available for investments in the local areas. The Local Area
Banks (LABs) were expected to bridge the gaps in credit availability and strengthen the institutional credit
framework in the rural and semi-urban areas. Following this, guidelines for setting up of LABs in the
private sector were announced by the Reserve Bank of India (RBI) on 24th August 1996.

Small finance banks are a type of niche banks in India. The aim behind these to provide financial
inclusion to sections of the economy not being served by other banks, such as small business units, small
and marginal farmers, micro and small industries and unorganised sector entities.

A payments bank is like any other bank, but operating on a smaller scale without involving any credit risk.
In simple words, it can carry out most banking operations but can’t advance loans or issue credit cards. It
can accept demand deposits (up to Rs 1 lakh), offer remittance services, mobile
payments/transfers/purchases and other banking services like ATM/debit cards, net banking and third
party fund transfers.

17
2.2 Role of Reserve Bank of India vis-à-vis Commercial Banks

The Reserve Bank of India (RBI) is the central bank of the country. 12 It was established on April 1, 1935

under the Reserve Bank of India Act, 1934, which provides the statutory basis for its functioning. When

the RBI was established, it took over the functions of currency issue from the Government of India and

the power of credit control from the then Imperial Bank of India.

As the central bank of the country, the RBI performs a wide range of functions; particularly, it:

 Acts as the currency authority


 Controls money supply and credit

 Manages foreign exchange

 Serves as a banker to the government

 Builds up and strengthens the country's financial infrastructure

 Acts as the banker of banks

 Supervises banks

As regards the commercial banks, the RBI's role mainly relates to the last two points stated above.

RBI as Bankers' Bank

As the bankers' bank, RBI holds a part of the cash reserves of banks; lends the banks funds for short
periods and provides them with centralised clearing and cheap and quick remittance facilities.
Banks are supposed to meet their shortfalls of cash from sources other than RBI and approach RBI only
as a matter of last resort, because RBI as the central bank is supposed to function as only the 'lender of
last resort'.

9
SCARDB stands for state co-operative agricultural and rural development banks and PCARDB stands for primary
co-operative agricultural and rural development banks.

10
Financial Inclusion implies provision of financial services at affordable cost to those who are excluded from the formal financial
system.
11
Every country has its own central bank. The central bank of USA is called the Federal Reserve Bank, the central bank of UK is
Bank of England and the central bank in China is known as the People's Bank of China and so on. Most central banks were
established around the early twentieth century.

18
To ensure liquidity and solvency of individual commercial banks and of the banking system as a whole,
the RBI has stipulated that banks maintain a Cash Reserve Ratio (CRR). The CRR refers to the share of
liquid cash that banks have to maintain with RBI of their net demand and time liabilities (NDTL).13 CRR is
one of the key instruments of controlling money supply. By increasing CRR, the RBI can reduce the funds
available with the banks for lending and thereby tighten liquidity in the system; conversely reducing the
CRR increases the funds available with the banks and thereby raises liquidity in the financial system.

RBI as supervisor

To ensure a sound banking system in the country, the RBI exercises powers of supervision, regulation
and control over commercial banks. The bank's regulatory functions relating to banks cover their
establishment (i.e. licensing), branch expansion, liquidity of their assets, management and methods of
working, amalgamation, reconstruction and liquidation. RBI controls the commercial banks through
periodic inspection of banks and follow-up action and by calling for returns and other information from
them, besides holding periodic meetings with the top management of the banks.

While RBI is directly involved with commercial banks in carrying out these two roles, the commercial
banks help RBI indirectly to carry out some of its other roles as well. For example, commercial banks are
required by law to invest a prescribed minimum percentage of their respective net demand and time
liabilities (NDTL) in prescribed securities, which are mostly government securities. 14 This helps the RBI to
perform its role as the banker to the Government, under which the RBI conducts the Government's
market borrowing program.

13
These are mainly deposits. NDTL is discussed in Chapter 3 under section 3.3.
14
The concept of demand and time liabilities has been explained in Chapter 3.

19
CHAPTER 3: Bank Deposit Accounts

As stated earlier, financial intermediation by commercial banks has played a key role in India in
supporting the economic growth process. An efficient financial intermediation process, as is well known,
has two components: effective mobilization of savings and their allocation to the most productive uses. In
this chapter, we will discuss one part of the financial intermediation by banks: mobilization of savings.
When banks mobilize savings, they do it in the form of deposits, which are the money accepted by banks
from customers to be held under stipulated terms and conditions. Deposits are thus an instrument of
savings.

Since the first episode of bank nationalization in 1969, banks have been at the core of the financial
intermediation process in India. They have mobilized a sizeable share of savings of the household sector,
the major surplus sector of the economy. This in turn has raised the financial savings of the household
sector and hence the overall savings rate. Notwithstanding the liberalization of the financial sector and
increased competition from various other saving instruments, bank deposits continue to be the dominant
instrument of savings in India.

House Holds’ Net Financial Savings is derived as a difference of the Household Gross Financial Savings
(GFS) during the year and Household Gross Financial Labilities. Hence the NFS is the result of two
dynamics i.e. Gross savings and Gross liabilities. While, the NFS as a share of GNDI has seen a
significant improvement in 2019-20 compared that of last year, it is not due to a proportionate increase in
the Gross Financials Savings. As per RBI’s data, Household GFS for 2019-20 is 10.5% of GNDI. This is a
marginal improvement over last year when it was 10.4 % of GNDI.

A deeper look into the various components of Gross Financial Savings indicates varying trends.

Bank Deposits which have shown an improvement in the previous year with 4.1% of GNDI from the
lowest point of 3.1% in 2017-18, fell to 3.6% of the gross disposable income. This preliminary estimate for
2019-20 is a reflection of people not preferring to make deposits in banks which could be due to the fall in
deposit interest rates. Except for 2016-17, the bank deposits have generally seen a declining trend.
Meanwhile, investments into insurance funds as a saving option is estimated to improve with 1.7% of
GNDI compared to that of 1.3% in the previous year, which happened to be the record low. However, the
share of disposable income being deposited into Insurance funds is yet to reach the earlier highs of over
2% of GNDI. Nevertheless, the reversal of the decreasing trend in 2019-20 indicates that people are more
inclined to invest in Insurance and mutual funds compared to Bank deposits, which are offering lower
returns.
The preliminary estimates for other components do not indicate major changes in 2019-20. However, the
savings in the form of currency marginally fell to 1.4% of GNDI compared to 1.5% in 2018-19. This was
not as steep a fall as in 2018-19 when it fell from 2.8% in 2017-18 to 1.5%. The investment of disposable
income into Provident & Pension funds has remained the constant over the last five years.

20
Table 3.1:
Household Gross Financial Savings & its components - as share of GNDI
2011-12 to 2019-201

According to RBI, bank credit and deposits stood at Rs 102.19 lakh crore (US$ 1.45 trillion) and Rs
140.20 lakh crore (US4 1.98 trillion), respectively, in the fortnight ending July 31, 2020.
Table 3.2: Financial Savings of the Household Sector (Gross)

1
Source: Factly.in and RBI website
21
3.1 Introduction to Bank Deposits

One of the most important functions of any commercial bank is to accept deposits from the public,

basically for the purpose of lending. Deposits from the public are the principal sources of funds for banks.

22
Safety of deposits

At the time of depositing money with the bank, a depositor would want to be certain that his/ her money is
safe with the bank and at the same time, wants to earn a reasonable return.

The safety of depositors' funds, therefore, forms a key area of the regulatory framework for banking. In
India, this aspect is taken care of in the Banking Regulation Act, 1949 (BR Act). The RBI is empowered to
issue directives/advices on several aspects regarding the conduct of deposit accounts from time to time.
Further, the establishment of the Deposit Insurance Corporation in 1962 (against the backdrop of failure
of banks) offered protection to bank depositors, particularly small-account holders. This aspect has been
discussed later in the Chapter.

Deregulation of interest rates

The process of deregulation of interest rates started in April 1992. Until then, all interest rates were
regulated; that is, they were fixed by the RBI. In other words, banks had no freedom to fix interest rates
on their deposits. With liberalization in the financial system, nearly all the interest rates have now been
deregulated. Now, banks have the freedom to fix their own deposit rates with only a very few exceptions.
The RBI prescribes interest rates only in respect of savings deposits and NRI deposits, leaving others for
individual banks to determine.15

15
Savings deposits and NRI deposits have been described later in this chapter.

23
Deposit policy

The Board of Directors of a bank, along with its top management, formulates policies relating to the types
of deposit the bank should have, rates of interest payable on each type, special deposit schemes to be
introduced, types of customers to be targeted by the bank, etc. Of course, depending on the changing
economic environment, the policy of a bank towards deposit mobilization, undergoes changes.

3.2 Types of Deposit Accounts

The bank deposits can also be classified into (i) demand deposits and (b) time deposits.

(i) Demand deposits are defined as deposits payable on demand through cheque or otherwise.
Demand deposits serve as a medium of exchange, for their ownership can be transferred from
one person to another through cheques and clearing arrangements provided by banks. They
have no fixed term to maturity.

(ii) Time deposits are defined as those deposits which are not payable on demand and on which
cheques cannot be drawn. They have a fixed term to maturity. A certificate of deposit (CD), for
example, is a time deposit (See box 3.2)

Box 3.1: Certificate of Deposit

A Certificate of Deposit (CD) is a negotiable money market instrument and is issued in dematerialised
form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution
for a specified time period. Guidelines for issue of CDs are currently governed by various directives
issued by the RBI, as amended from time to time.

CDs can be issued by (i) scheduled commercial banks (SCBs) excluding Regional Rural Banks (RRBs)
and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by
the RBI to raise short-term resources within the umbrella limit fixed by RBI. Deposit amounts for CDs
are a minimum of Rs.1 lakh, and multiples thereof.

Demand and time deposits are two broad categories of deposits. Note that these are only categories of
deposits; there are no deposit accounts available in the banks by the names 'demand deposits' or 'time
deposits'. Different deposit accounts offered by a bank, depending on their characteristics, fall into one of
these two categories. There are several deposit accounts offered by banks in India; but they can be
classified into three main categories:

 Current account

 Savings bank account

 Term deposit account

24
Current account deposits fall entirely under the demand-deposit category and term deposit account falls
entirely under time deposit. Savings bank accounts have both demand-deposit and time-deposit
components. In other words, some parts of savings deposits are considered demand deposits and the
rest as time deposits. We provide below the broad terms and conditions governing the conduct of current,
savings and term-deposit accounts.

3.2.1 Current Deposits

A current account is a form of demand-deposit, as the banker is obliged to repay these liabilities on
demand from the customer. Withdrawals from current accounts are allowed any number of times
depending upon the balance in the account or up to a particular agreed amount. Current deposits are
non-interest bearing. Among the three broad categories of deposits--current account deposit, savings
accounts deposit and term deposits--current account deposits account for the smallest fraction.

A current account is basically a running and actively operated account with very little restriction on the
number and amount of drawings. The primary objective of a current account is to provide convenient
operation facility to the customer, via continuous liquidity.

On account of the high cost of maintaining such accounts, banks do not pay any interest on such
deposits. In addition, many banks insist on customers maintaining minimum balances to offset the
transaction costs involved. If minimum balances are not maintained, these banks charge the customers a
certain amount.

Current accounts can be opened by rich individuals/ partnership firms/ private and limited companies/
Hindu Undivided Families (HUFs)/ societies/ trusts, etc.

3.2.2 Savings Bank Deposits

Savings deposits are a form of demand deposits, which is subject to restrictions on the number of
withdrawals as well as on the amounts of withdrawals during any specified period. Further, minimum
balances may be prescribed in order to offset the cost of maintaining and servicing such deposits.
Savings deposits are deposits that accrue interest at a fixed rate set by RBI (3.5 percent as of January
2010).

Savings bank accounts are used by a large segment of small depositors as they can put their regular
incomes into these accounts, withdraw the money on demand and also earn interest on the balance left in
the account.

The flexibility provided by such a product means that savings bank accounts cannot be opened by big
trading or business firms. Similarly, institutions such as government departments and bodies, local
authorities, etc. cannot open savings bank accounts.

25
Savings account deposits together with current account deposits are called CASA deposits (See Box
3.2).
Box 3.2: CASA Deposits

From a bank's viewpoint, CASA deposits (Current Account and Savings Account deposits) are low-cost
deposits, as compared to other types of deposits. Current account is non-interest bearing, while interest
payable on savings accounts is very low (currently 3.5 percent). To be competitive, it is important for
banks to garner as much low-cost deposits as possible, because by doing so banks can control the cost
of raising deposits and hence can lend at more competitive rates. The methods used by banks to mobilize
CASA deposits include offering salary accounts to companies, and encouraging merchants to open
current accounts, and use their cash-management facilities.

Banks with low CASA ratios (CASA deposits as % of total deposits) are more dependent on term deposits
for their funding, and are vulnerable to interest rate shocks in the economy, besides the lower spread they
earn. (As discussed above, banks earn profit on the spread between their deposit and loans rates.)

The table given below shows that the share of current account and savings account (CASA) deposits in
total deposits is the highest for foreign banks followed by the State Bank Group. It can also be observed
that the share of CASA deposits in total deposits of the scheduled commercial banks as a whole has
been declining. This means that the cost of deposit mobilization of the commercial banks is rising, which
may pose a challenge for the banking sector in the coming years.
The share of current account and savings account (CASA) deposits of SCBs was at 41.2 per cent. As on
31st December 2019 as per RBI reports.

Bank-wise Share of CASA Deposits in Total Deposits (in percent)

Source: Report on Trend and Progress of Banking 2008-09, RBI.

3.2.3 Term Deposits

A "Term deposit" is a deposit received by the Bank for a fixed period, after which it can be withdrawn.
Term deposits include deposits such as Fixed Deposits / Reinvestment deposits/

26
Recurring Deposits etc. The term deposits account for the largest share and have remained within the
range of over 55% of total deposits in the recent years.

Interest is paid on term-deposits, either on maturity or at stipulated intervals depending upon the deposit
scheme under which the money is placed. Also, a customer can earn interest on a term-deposit for a
minimum period of 7 days. Interest rates on term-deposits are usually higher than on savings deposits.
Term deposits include:

 Fixed deposits on which a fixed rate of interest is paid at fixed, regular intervals;

 Re-investment deposits, under which the interest is compounded quarterly and paid on maturity,
along with the principal amount of the deposit. Some banks have introduced "flexi" deposits
under which, the amount in savings deposit accounts beyond a fixed limit is automatically
converted into term-deposits; and

 Recurring deposits, under which a fixed amount is deposited at regular intervals for a fixed term
and the repayment of principal and accumulated interest is made at the end of the term. These
deposits are usually targeted at persons who are salaried or receive other regular income. A
Recurring Deposit can usually be opened for any period from 6 months to 120 months.

3.3 Strategies of mobilizing deposits

To maximize their profits, commercial banks always attempt to mobilize savings at the lowest cost
possible. While mobilizing deposits, banks have to comply with various directives issued by the RBI, the
Indian Bank Association (IBA), Government of India and other statutory authorities/agencies. At the same
time, since banks operate in a very competitive environment, they have to reach out to a wide spectrum
of customers and also offer deposit products that lead to higher customer satisfaction.

Banks devise various strategies to expand the customer base and reducing the cost of raising deposits.
This is done by identifying target markets, designing the products as per the requirements for customers,
taking measures for marketing and promoting the deposit products. It is essential not only to expand the
customer base but also to retain it. This is done by providing counselling, after-sales information and also
through prompt handling of customer complaints.

While the strategies for mobilizing bank deposits vary from bank to bank, one common feature is to
maximize the share of CASA deposits The other common features generally observed are as follows:

 Staff members posted at branches are adequately trained to offer efficient and courteous service
to the customers and to educate them about their rights and obligations.

27
 A bank often offers personalized banking relationship for its high-value customers by appointing
Customer Relationship Managers (CRMs).

 Senior citizens/pensioners have become an important category of customers to be targeted by a
bank. Products are developed by banks to meet the specific requirements of this group.


 While banks endeavour to provide services to the satisfaction of customers, they put in place an
expeditious mechanism to redress the complaints of the customers.

3.4 Common Guidelines of Opening and Operating Deposit Accounts

To open and operate a bank account, the following guidelines need to be followed.

Due Diligence Process: A bank before opening any deposit account has to carry out due diligence as
required under "Know Your Customer" (KYC) guidelines issued by RBI and or such other norms or

procedures adopted by the bank.16 The 'due diligence' process, while opening a deposit account, involves

the bank having adequate knowledge of the person's identity, occupation, sources of income, and
location. Obtaining an introduction of the prospective depositor from a person acceptable to the bank,
obtaining recent photographs of people opening/ operating the account are part of the due diligence
process. For customers providing proof of identification and address, there is no need for personal
introduction to the bank for opening of a new savings bank account. To promote financial inclusion in rural
areas / tribal areas, KYC norms have been relaxed for below the poverty line (BPL) families.

Minimum Balance: For deposit products like a savings bank account or a current account, banks normally
stipulate certain minimum balances to be maintained as part of terms and conditions governing operation
of such accounts. But for people below the poverty line, banks encourage the opening of 'No-frills
Accounts', typically a special savings bank account where no minimum balance requirement is required.
For a savings bank account, the bank may also place restrictions on number of transactions, cash
withdrawals, etc., during a given period.

Transparency: Failure to maintain minimum balance in the accounts, where applicable, will attract levy of
charges as specified by the bank from time to time. Similarly, the bank may specify charges for issue of
cheques books, additional statement of accounts, duplicate passbook, folio charges, etc. All such details
regarding terms and conditions for operation of the accounts and schedule of charges for various services
provided should be communicated to the prospective depositor while opening the account for the sake of
transparency.

16
The KYC guidelines have been described in detail in Chapter 7.

28
Eligibility: A savings bank account can be opened by eligible person(s) and certain
organizations/agencies, as advised by the RBI from time to time. But current accounts can be opened by
individuals, partnership firms, private and public limited companies, Hindu Undivided Families (HUFs),
specified associates, society trusts, etc. Eligibility criteria for a savings account and a current account are
largely similar, but there are important differences too. While both the accounts can be opened by
individuals, the savings account cannot be opened by a firm. Term Deposit Accounts can be opened by
all categories of account holders.

Requirement of PAN: In addition to the due diligence requirements, under KYC norms, banks are
required by law to obtain a Permanent Account Number (PAN) from the prospective account holder or
alternate declarations as specified under the Income Tax Act.

Operation of Joint Account: Deposit accounts can be opened by an individual in his own name or by more
than one individual in their own names (known as a 'joint account').

A joint account can be operated by a single individual or by more than one individual jointly. The mandate
for who can operate the account can be modified with the consent of all account holders. Joint accounts
opened by minors with their parents or guardians can be only operated by the latter.

Accountholders of a joint account can give mandates on the operation of the account, and the disposal of
balances in the event of the demise of one or more of the holders. Banks classify these mandates as
'Either or Survivor', and 'Anyone or Survivor(s)', etc.

Power of Attorney: At the request of the depositor, the bank can register mandate/power of attorney given
by him authorizing another person to operate the account on his behalf.

Closure/renewal of deposits: Term-deposit account holders at the time of placing their deposits can give
instructions with regard to closure of deposit account or renewal of deposit for further period on the date
of maturity. In absence of such mandate, the bank will usually seek instructions from the depositor(s) as
to the renewal of the deposit or otherwise by sending intimation before say, 15 days of the maturity date
of the term deposit. If no mandate is given or received by the bank before the date of maturity of term
deposit, the bank will be at liberty to roll over the deposit on due date.

Nomination: A depositor is permitted to officially authorize someone, who would receive the money of his
account when the depositor passes away. This is called the nomination process. Nomination facility is
available on all deposit accounts opened by individuals. Nomination is also available to a sole proprietary
concern account. Nomination can be made in favour of one individual only. Nomination so made can be
cancelled or changed by the account holder/s any time. Nomination can be made in favour of a minor too.

29
 Box 3.3: Operation of Special Classes of Deposit Account Holders

Minors' Accounts

Savings bank accounts can be opened by minors along with their guardians, and operated solely by
the guardians, until the minor attains majority. Verification of signatures and other identification is
repeated before the major starts operating the account.

Account of illiterate/visually challenged persons

Accounts of illiterate/visually challenged individuals are usually opened by banks at their own
discretion, in the presence of a mutually known witness. Terms and conditions of operating the account
in this case are then specifically explained by the bank to the account-holder.

Deposit schemes for Senior Citizens

Banks have developed fixed-deposit schemes specifically meant for senior citizens (i.e., individuals
over the age of 60 years). Such schemes usually provide an incentive by way of additional interest,
over and above the normal rate of interest, on term-deposits across various maturities. Such schemes
are applicable for both fresh deposits as well as renewals of maturing deposits.

3.5 Deposit Related Services

As per the RBI guidelines, banks are required to provide some services to the depositors and to
recognise the rights of depositors. The ultimate objective of the banking industry should be to provide a
customer different services they are rightfully entitled to receive without demand. We take a quick look at
some such services provided by banks in India.

Customer Information

Customer information collected from the customers should not be used for cross-selling of services or
products by the bank, its subsidiaries and affiliates. If the bank proposes to use such information, it
should be strictly with the 'express consent' of the account-holder.

Banks are not expected to disclose details/particulars of the customer's account to a third person or party
without the expressed or implied consent from the customer. However, there are some exceptions, such
as disclosure of information under compulsion of law or where there is a duty to public for the bank to
disclose.

Interest Payments

 Savings bank accounts: Interest is paid on savings bank deposit account at the rate specified by
RBI from time to time. In case of savings bank accounts, till recently, banks paid interest on the
minimum balance between the 11th and the last day of the

30
 month. With effect from April 1, 2010, banks have been advised to calculate interest on savings
bank deposit by considering daily product, which would benefit the holders of savings bank
accounts.

 Term deposits: Term-deposit interest rates are decided by individual banks within these general
guidelines. In terms of RBI directives, interest is calculated at quarterly intervals on term deposits
and paid at the rate decided by the bank depending upon the period of deposits. The interest on
term deposits is calculated by the bank in accordance with the formulae and conventions
advised by Indian Bank Association.17 Also, a customer can earn interest on a term deposit for a
minimum period of 7 days, as stated earlier.


 Tax deducted at source (TDS): The bank has statutory obligation to deduct tax at source if the
total interest paid/payable on all term deposits held by a person exceeds the amount specified
under the Income Tax Act and rules there under. The Bank will issue a tax deduction certificate
(TDS Certificate) for the amount of tax deducted. The depositor, if entitled to exemption from
TDS, can submit a declaration to the bank in the prescribed format at the beginning of every
financial year.

Premature Withdrawal of Term Deposit

The bank on request from the depositor, at its discretion, may allow withdrawal of term-deposit before
completion of the period of the deposit agreed upon at the time of placing the deposit. Banks usually
charge a penalty for premature withdrawal of deposits. The bank shall declare their penal interest rates
policy for premature withdrawal of term deposit, if any, at the time of opening of the account.

Premature Renewal of Term Deposit

In case the depositor desires to renew the deposit by seeking premature closure of an existing term
deposit account, the bank will permit the renewal at the applicable rate on the date of renewal, provided
the deposit is renewed for a period longer than the balance period of the original deposit. While
prematurely closing a deposit for the purpose of renewal, interest on the deposit for the period it has
remained with the bank will be paid at the rate applicable to the period for which the deposit remained
with the bank and not at the contracted rate.

Advances against Deposits

The Bank may consider requests of the depositor(s) for loan/overdraft facility against term deposits duly
discharged by the depositor(s) on execution of necessary security documents.

17
The Indian Banks' Association (IBA) is an association of banks from both the public and the private sector and represents the
management of banks.

31
The bank may also consider giving an advance against a deposit standing in the name of minor.
However, a suitable declaration stating that the loan is for the benefit of the minor, is to be furnished by
the depositor-applicant.

Settlement of Dues in Deceased Deposit Account

a) If the depositor has registered nomination with the bank; the balance outstanding in the account
of the deceased depositor will be transferred/ paid to the nominee after the bank is satisfied
about the identity of the nominee, etc.

b) The above procedure will be followed even in respect of a joint account where nomination is
registered with the bank.

c) In case of joint deposit accounts where joint account holders do not give any mandate for
disposal, when one of the joint account holders dies, the bank is required to make payment
jointly to the legal heirs of the deceased person and the surviving depositor(s). In these cases,
delays may ensue in the production of legal papers by the heirs of the deceased. However, if the
joint account holders had given mandate for disposal of the balance in the account in the forms
such as 'either or survivor', 'former/latter or survivor', 'anyone of survivors or survivor'; etc., the
payment will be made as per the mandate. In such cases, there is no delay in production of legal
papers by the heirs of the deceased.

d) In the absence of nomination, the bank will pay the amount outstanding to all legal heirs against
joint application and on receipt of the necessary documents, including court order.

Stop Payment Facility

The Bank will accept 'stop payment' instructions from the depositors in respect of cheques issued by
them. Charges, as specified, will be recovered.

Dormant Accounts

Accounts which are not operated for a considerable period of time (usually 12/24 months for savings bank
accounts and 6/12 months for current accounts), will be transferred to a separate dormant/inoperative
account status in the interest of the depositor as well as the bank. 18 The depositor will be informed if there
are charges that the bank would levy on dormant/inoperative accounts. Such accounts can be used again
on an activation request to the bank.

18
Such a practice is in the interest of the depositor since it avoids the possibility of frauds on the account. It is also in the interest
of the bank as it reduces the servicing costs that the bank would have had to incur if the account were to remain active.

32
Safe Deposit Lockers

This facility is not offered through all bank branches and wherever the facility is offered, allotment of safe
deposit vault will be subject to availability and compliance with other terms and conditions attached to the
service. Safe deposit lockers may be hired by an individual (not a minor) singly or jointly with another
individual(s), HUFs, firms, limited companies, associates, societies, trusts etc. Nomination facility is
available to individual(s) holding the lockers singly or jointly. In the absence of nomination or mandate for
disposal of contents of lockers, with a view to avoid hardship to common persons, the bank will release
the contents of locker to the legal heirs against indemnity on the lines as applicable to deposit accounts.

Redress of Complaints and Grievances

Depositors having any complaint/grievance with regard to services rendered by the bank have a right to
approach the authorities designated by the bank for handling customer complaints/ grievances. In case
the depositor does not get a response from the bank within one month after the bank receives his
representation /complaint or he is not satisfied with the response received from the bank, he has a right to
approach the Banking Ombudsman appointed by RBI.19

3.6 Deposit Services Offered to Non-Resident Indians

Banks actively seek banking business from Non-Resident Indians (NRIs) by offering different types of
deposit accounts (and related services) in accordance with RBI guidelines, including:

 Non-resident ordinary account;


 Non-resident (external) Rupee account; and

 Foreign currency non resident account (Banks)

Definition of Non-Resident Indian (NRI)20

As per the Foreign Exchange Management Act (FEMA), 1999, an NRI means:

 Non-Resident Indian National (i.e. Non-resident Indian holding Indian passport), and

 Persons of Indian Origin (i.e., Non-residents holding foreign passports)

Non-resident Indian Nationals include

(i) Indian citizens who proceed abroad for employment or for any business or vocation in
circumstances indicating an indefinite period of stay outside India.

20
NRI is defined differently under different acts. For the purpose of bank accounts, FEMA definition holds.

33
(ii) Indian citizens working abroad on assignments with foreign governments, international/
multinational agencies such as the United Nations, the International Monetary Fund, the World
Bank etc.

(iii) Officials of Central and State Governments and Public Sector Undertakings (PSUs) deputed
abroad on assignments with foreign governments, multilateral agencies or Indian diplomatic
missions abroad.

PIO (Persons of Indian Origin) is defined as a citizen of any country other than Bangladesh or Pakistan, if

a. he has at any time held an Indian passport; or

b. he or either of his parents or any of his grand parents was a citizen of India; or

c. the person is a spouse of an Indian citizen or a person referred to in sub-clause

(a) or (b).

In general, NRI is thus a person of Indian nationality or origin, who is resident abroad for business or
employment or vocation, or with the intension of seeking employment or vocation and the period of stay
abroad is uncertain.21

3.6.1 Non Resident Ordinary Accounts (NRO)

These are Rupee accounts and can be opened by any person resident outside India. Typically, when a
resident becomes non-resident, his domestic Rupee account gets converted into an NRO account. In
other words, it is basically a domestic account of an NRI which help him get credits which accrue in India,
such as rent from property or income from other investments. New accounts can be opened by sending
fresh remittances from abroad. NRO accounts can be opened only as savings account, current account,
recurring deposits and term-deposit accounts. Regulations on interest rates, tenors etc. are similar to
those of domestic accounts. While the principal of NRO deposits is non-repatriable, current income such
as interest earnings on NRO deposits are repatriable. Further, NRI/PIO may remit an amount, not
exceeding US$1million per financial year, for permissible transactions from these accounts.

3.6.2 Non-Resident (External) Rupee Accounts

The Non-Resident (External) Rupee Account NR(E)RA scheme, also known as the NRE scheme, was
introduced in 1970. This is a rupee account. Any NRI can open an NRE account with funds remitted to
India through a bank abroad.

An NRE rupee account may be opened as current, savings, recurring or term deposit account.
Since this account is maintained in Rupees, the depositor is exposed to exchange risk.

21
Thus, a student going abroad for studies or a tourist going abroad for brief visit is not an NRI.

34
This is a repatriable account (for both interest and principal) and transfer from/to another NRE account or
FCNR (B) account (see below) is also permitted. Local payments can also be freely made from NRE
accounts. NRIs / PIOs have the option to credit the current income to their NRE accounts, provided
income tax has been deducted / provided for. Interest rates on NRE accounts are determined by the RBI,
for both savings and term deposits.

3.6.3 Foreign Currency Non Resident Account (Banks)

The Foreign Currency Non-Resident Account (Banks) or FCNR(B) accounts scheme was introduced with
effect from May 15, 1993 to replace the then prevailing FCNR(A) scheme introduced in 1975.

 These are foreign currency accounts, which can be opened by NRIs in only designated
currencies: Pound Sterling, US Dollar, Canadian Dollar, Australian Dollar, EURO and Japanese
Yen.

 Repatriation of principal amount and interest is permitted.

 These deposits can be opened only in the form of term deposits.

 Deposits are in foreign currency and are repaid in the currency of issue. Hence, there is no
exchange risk for the account holder.

 Transfer of funds from existing NRE accounts to FCNR(B) accounts and vice- versa, of the same
account holder, is permissible without the prior approval of RBI.

A bank should obtain the prior approval of its Board of Directors for the interest rates that it will offer on
deposits of various maturities, within the ceiling prescribed by RBI.

Table 3.4 compares the different features of the deposit accounts available to the NRIs.

35
Table 3.4 Comparison of Deposit Schemes available to NRIs

Particulars Foreign Currency Non-Resident Non-Resident

(Non-Resident) (External) Rupee Ordinary Rupee
Account (Banks) Account Scheme Account Scheme
Scheme (FCNR(B) (NRE Account) (NRO Account)
Account)

Who can open an NRIs NRIs Any person resident

account? (individuals/entities of (individuals/entities of outside India (other
Bangladesh/Pakistan Bangladesh/Pakistan than a person
nationality/ownership nationality/ownership resident in Nepal and
require prior approval require prior approval Bhutan).
of RBI) of RBI) (Individuals/entities
of Bangladesh
Pakistan nationality
ownership as well as
erstwhile OCBs
require prior
approval of RBI)

Currency in which Pound Sterling, US Indian Rupees Indian Rupees

account is Dollar, Japanese Yen,
denominated Euro, Canadian Dollar
and Australian Dollar

Repatriability Repatriability Repatriability Not repatriable *

Type of Account Term Deposit only Savings, Current, Savings, Current,

Recurring, Fixed Recurring, Fixed
Deposit Deposit

Period for fixed For terms not less At the discretion of As applicable to
deposits than 1 year and not the bank resident accounts
more than 5 years.

Rate of Interest Subject to cap # Subject to cap # Banks are free to

determine interest
rates for term
deposits.

Source: FAQ section, Reserve Bank of India Website

Note:

* Except for the following: (i) current income, (ii) up to USD 1 million per financial year (April-March), for
any bonafide purpose out of the balances in the account / sale proceeds of assets in India acquired by
way of inheritance / legacy inclusive of assets acquired out of settlement subject to certain conditions.

# As determined by the RBI from time to time.

36
3.7 Deposit Insurance

Deposit insurance helps sustain public confidence in the banking system through the protection of
depositors, especially small depositors, against loss of deposit to a significant extent. In India, bank
deposits are covered under the insurance scheme offered by Deposit Insurance and Credit Guarantee
Corporation of India (DICGC), which was established with funding from the Reserve Bank of India. The
scheme is subject to certain limits and conditions. DICGC is a wholly-owned subsidiary of the RBI.

3.7.1 Banks insured by the DICGC

All commercial banks including branches of foreign banks functioning in India, local area banks and
regional rural banks are insured by the DICGC.22

Further, all State, Central and Primary cooperative banks functioning in States/Union Territories which
have amended the local Cooperative Societies Act empowering RBI suitably are insured by the DICGC.
Primary cooperative societies are not insured by the DICGC.

3.7.2 Features of the scheme

When is DICGC liable to pay?

In the event of a bank failure, DICGC protects bank deposits that are payable in India. DICGC is liable to
pay if (a) a bank goes into liquidation or (b) if a bank is amalgamated/ merged with another bank.

Methods of protecting depositors' interest

There are two methods of protecting depositors' interest when an insured bank fails:

(i) by transferring business of the failed bank to another sound bank 23 (in case of merger or
amalgamation) and (ii) where the DICGC pays insurance proceeds to depositors (insurance pay-out
method).

Types of deposit covered by DICGC

The DICGC insures all deposits such as savings, fixed, current, recurring, etc. except the following types
of deposits:

 Deposits of foreign Governments;


 Deposits of Central/State Governments;

22
Primary agricultural credit societies (PACS) are village-level cooperatives that disburse short-term credit. There are over 95000
such societies in the country.
23
In 2004, Global Trust Bank was merged into Oriental Bank of Commerce, after significant losses from NPAs, and a three-month
Govt. imposed moratorium.

37
 Inter-bank deposits;

 Deposits of the State Land Development Banks with the State co-operative bank;

 Any amount due on account of any deposit received outside India;

 Any amount, which has been specifically exempted by the corporation with the previous
approval of RBI.

Maximum deposit amount insured by the DICGC

Each depositor in a bank is insured up to a maximum of Rs100,000 for both principal and interest amount
held by him in the same capacity and same right. For example, if an individual had a deposit with principal
amount of Rs.90,000 plus accrued interest of Rs.7,000, the total amount insured by the DICGC would be
Rs.97,000. If, however, the principal amount were Rs. 99,000 and accrued interest of Rs 6,000, the total
amount insured by the DICGC would be Rs 1 lakh.

The deposits kept in different branches of a bank are aggregated for the purpose of insurance cover and
a maximum amount up to Rs 1 lakh is paid. Also, all funds held in the same type of ownership at the
same bank are added together before deposit insurance is determined. If the funds are in different types
of ownership (say as individual, partner of firm, director of company, etc.) or are deposited into separate
banks they would then be separately insured.

Also, note that where a depositor is the sole proprietor and holds deposits in the name of the proprietary
concern as well as in his individual capacity, the two deposits are to be aggregated and the insurance
cover is available up to rupees one lakh maximum.

Cost of deposit insurance

Deposit insurance premium is borne entirely by the insured bank. Banks are required to pay the
insurance premium for the eligible amount to the DICGC on a semi-annual basis. The cost of the
insurance premium cannot be passed on to the customer.

Box 3.4: Premium charged and claims paid by DICGC

The premium rates charged by DICGC were raised to Re 0.12 per deposit of Rs.100 with effect from
February 2020. The Deposit Insurance and Credit Guarantee Corporation (DICGC) has collected Rs
88,523 crore as premium from banks, and the total payout to depositors of failed commercial banks on
account of claims stood at Rs 296 crore, in 2019

Source: DICGC

38
Withdrawal of insurance cover

The deposit insurance scheme is compulsory and no bank can withdraw from it. The DICGC, on the other
hand, can withdraw the deposit insurance cover for a bank if it fails to pay the premium for three
consecutive half year periods. In the event of the DICGC withdrawing its cover from any bank for default
in the payment of premium, the public will be notified through the newspapers.

39
CHAPTER 4: Basics of Bank Lending

Banks extend credit to different categories of borrowers for a wide variety of purposes. For many
borrowers, bank credit is the easiest to access at reasonable interest rates. Bank credit is provided to
households, retail traders, small and medium enterprises (SMEs), corporates, the Government
undertakings etc. in the economy.

Retail banking loans are accessed by consumers of goods and services for financing the purchase of
consumer durables, housing or even for day-to-day consumption. In contrast, the need for capital
investment, and day-to-day operations of private corporates and the Government undertakings are met
through wholesale lending.

Loans for capital expenditure are usually extended with medium and long-term maturities, while day-to-
day finance requirements are provided through short-term credit (working capital loans). Meeting the
financing needs of the agriculture sector is also an important role that Indian banks play.

4.1 Principles of Lending and Loan policy

4.1.1 Principles of lending

To lend, banks depend largely on deposits from the public. Banks act as custodian of public deposits.
Since the depositors require safety and security of their deposits, want to withdraw deposits whenever
they need and also adequate return, bank lending must necessarily be based on principles that reflect
these concerns of the depositors. These principles include: safety, liquidity, profitability, and risk
diversion.

Safety

Banks need to ensure that advances are safe and money lent out by them will come back. Since the
repayment of loans depends on the borrowers' capacity to pay, the banker must be satisfied before
lending that the business for which money is sought is a sound one. In addition, bankers many times
insist on security against the loan, which they fall back on if things go wrong for the business. The
security must be adequate, readily marketable and free of encumbrances.

Liquidity

To maintain liquidity, banks have to ensure that money lent out by them is not locked up for long time by
designing the loan maturity period appropriately. Further, money must come back as per the repayment
schedule. If loans become excessively illiquid, it may not be possible for bankers to meet their obligations
vis-à-vis depositors.

40
Profitability

To remain viable, a bank must earn adequate profit on its investment. This calls for adequate margin
between deposit rates and lending rates. In this respect, appropriate fixing of interest rates on both
advances and deposits is critical. Unless interest rates are competitively fixed and margins are adequate,
banks may lose customers to their competitors and become unprofitable.

Risk diversification

To mitigate risk, banks should lend to a diversified customer base. Diversification should be in terms of
geographic location, nature of business etc. If, for example, all the borrowers of a bank are concentrated
in one region and that region gets affected by a natural disaster, the bank's profitability can be seriously
affected.

4.1.2 Loan Policy

Based on the general principles of lending stated above, the Credit Policy Committee (CPC) of individual
banks prepares the basic credit policy of the Bank, which has to be approved by the Bank's Board of
Directors. The loan policy outlines lending guidelines and establishes operating procedures in all aspects
of credit management including standards for presentation of credit proposals, financial covenants, rating
standards and benchmarks, delegation of credit approving powers, prudential limits on large credit
exposures, asset concentrations, portfolio management, loan review mechanism, risk monitoring and
evaluation, pricing of loans, provisioning for bad debts, regulatory/ legal compliance etc. The lending
guidelines reflect the specific bank's lending strategy (both at the macro level and individual borrower
level) and have to be in conformity with RBI guidelines. The loan policy typically lays down lending
guidelines in the following areas:

 Level of credit-deposit ratio


 Targeted portfolio mix

 Hurdle ratings

 Loan pricing

 Collateral security

Credit Deposit (CD) Ratio

A bank can lend out only a certain proportion of its deposits, since some part of deposits have to be
statutorily maintained as Cash Reserve Ratio (CRR) deposits, and an additional part has to be used for
making investment in prescribed securities (Statutory Liquidity Ratio or SLR requirement).24 It may be
noted that these are minimum requirements. Banks have the option of having more cash reserves than
CRR requirement and invest more in SLR securities than they are required to. Further, banks also have

41
the option to invest in non-SLR securities. Therefore, the CPC has to lay down the quantum of credit that
can be granted by the bank as a percentage of deposits available. Currently, the average CD ratio of the
entire banking industry is around 70 percent, though it differs across banks. It is rarely observed that
banks lend out of their borrowings.

Targeted Portfolio Mix

The CPC aims at a targeted portfolio mix keeping in view both risk and return. Toward this end, it lays
down guidelines on choosing the preferred areas of lending (such as sunrise sectors and profitable
sectors) as well as the sectors to avoid.25 Banks typically monitor all major sectors of the economy. They
target a portfolio mix in the light of forecasts for growth and profitability for each sector. If a bank
perceives economic weakness in a sector, it would restrict new exposures to that segment and similarly,
growing and profitable sectors of the economy prompt banks to increase new exposures to those sectors.
This entails active portfolio management.

Further, the bank also has to decide which sectors to avoid. For example, the CPC of a bank may be of
the view that the bank is already overextended in a particular industry and no more loans should be
provided in that sector. It may also like to avoid certain kinds of loans keeping in mind general credit
discipline, say loans for speculative purposes, unsecured loans, etc.

Hurdle ratings

There are a number of diverse risk factors associated with borrowers. Banks should have a
comprehensive risk rating system that serves as a single point indicator of diverse risk factors of a
borrower. This helps taking credit decisions in a consistent manner. To facilitate this, a substantial degree
of standardisation is required in ratings across borrowers. The risk rating system should be so designed
as to reveal the overall risk of lending. For new borrowers, a bank usually lays down guidelines regarding
minimum rating to be achieved by the borrower to become eligible for the loan. This is also known as the
'hurdle rating' criterion to be achieved by a new borrower.

24
Each bank has to statutorily set aside a certain minimum fraction of it net demand and time liabilities in prescribed assets to fulfil
these requirements. CRR and SLR have been discussed in chapter 1 and Chapter 5 respectively.
25
For example, in the last decade, a number of banks identified retail finance as an area with potential for strong growth and have
therefore sought to increase their financing in retail space. One advantage of financing a large number of small loans is that risk
concentration is reduced. However, during an economic downturn, the retail portfolio may also experience significantly high
credit defaults.

42
Pricing of loans

Risk-return trade-off is a fundamental aspect of risk management. Borrowers with weak financial position
and, hence, placed in higher risk category are provided credit facilities at a higher price (that is, at higher
interest). The higher the credit risk of a borrower the higher would be his cost of borrowing. To price credit
risks, banks devise appropriate systems, which usually allow flexibility for revising the price (risk premium)
due to changes in rating. In other words, if the risk rating of a borrower deteriorates, his cost of borrowing
should rise and vice versa.

At the macro level, loan pricing for a bank is dependent upon a number of its cost factors such as cost of
raising resources, cost of administration and overheads, cost of reserve assets like CRR and SLR, cost of
maintaining capital, percentage of bad debt, etc. Loan pricing is also dependent upon competition.

Collateral security

As part of a prudent lending policy, banks usually advance loans against some security. The loan policy
provides guidelines for this. In the case of term loans and working capital assets, banks take as 'primary
security' the property or goods against which loans are granted.26 In addition to this, banks often ask for
additional security or 'collateral security' in the form of both physical and financial assets to further bind
the borrower. This reduces the risk for the bank. Sometimes, loans are extended as 'clean loans' for
which only personal guarantee of the borrower is taken.

4.1.3 Compliance with RBI guidelines

The credit policy of a bank should be conformant with RBI guidelines; some of the important guidelines of
the RBI relating to bank credit are discussed below.

Directed credit stipulations

The RBI lays down guidelines regarding minimum advances to be made for priority sector advances,
export credit finance, etc.27 These guidelines need to be kept in mind while formulating credit policies for
the Bank.

Capital adequacy

If a bank creates assets-loans or investment-they are required to be backed up by bank capital; the
amount of capital they have to be backed up by depends on the risk of individual assets that the bank
acquires. The riskier the asset, the larger would be the capital it has to be

26
For example, in case of a home loan, the house for which the loan is taken serves as the 'primary security'.
27
Priority sector advances and export credit have been discussed later in this chapter.

43
backed up by. This is so, because bank capital provides a cushion against unexpected losses of banks
and riskier assets would require larger amounts of capital to act as cushion.

The Basel Committee for Bank Supervision (BCBS) has prescribed a set of norms for the capital
requirement for the banks for all countries to follow. These norms ensure that capital should be adequate
to absorb unexpected losses.28 In addition, all countries, including India, establish their own guidelines for
risk based capital framework known as Capital Adequacy Norms. These norms have to be at least as
stringent as the norms set by the Basel committee.

A key norm of the Basel committee is the Capital Adequacy Ratio (CAR), also known as Capital Risk
Weighted Assets Ratio, is a simple measure of the soundness of a bank. The ratio is the capital with the
bank as a percentage of its risk-weighted assets. Given the level of capital available with an individual
bank, this ratio determines the maximum extent to which the bank can lend.

The Basel committee specifies a CAR of at least 8% for banks. This means that the capital funds of a
bank must be at least 8 percent of the bank's risk weighted assets. In India, the RBI has specified a
minimum of 9%, which is more stringent than the international norm. In fact, the actual ratio of all
scheduled commercial banks (SCBs) in India stood at 14.6% in March 2020.

The RBI also provides guidelines about how much risk weights banks should assign to different classes
of assets (such as loans). The riskier the asset class, the higher would be the risk weight. Thus, the real
estate assets, for example, are given very high risk weights.

This regulatory requirement that each individual bank has to maintain a minimum level of capital, which is
commensurate with the risk profile of the bank's assets, plays a critical role in the safety and soundness
of individual banks and the banking system.

Credit Exposure Limits

As a prudential measure aimed at better risk management and avoidance of concentration of credit risks,
the Reserve Bank has fixed limits on bank exposure to the capital market as well as to individual and
group borrowers with reference to a bank's capital. Limits on inter-bank exposures have also been
placed. Banks are further encouraged to place internal caps on their sectoral exposures, their exposure to
commercial real estate and to unsecured exposures. These exposures are closely monitored by the
Reserve Bank. Prudential norms on banks'

28
A Bank typically faces two types of losses in respect of any borrower or borrower class - expected and unexpected losses.
Expected losses should be budgeted for, and provisions should be made to offset their adverse effects on the Bank's balance
sheet. However, to cushion against unexpected losses, which are unpredictable, banks have to hold adequate amount of
capital.

44
exposures to NBFCs and to related entities are also in place. Table 4.1 gives a summary of the RBI's
guidelines on exposure norms for commercial banks in India.

Table 4.1: Exposure norms for Commercial banks in India

Exposure to Limit

1. Single Borrower 15 per cent of capital fund (Additional

5 percent on infrastructure exposure)

2. Group Borrower 40 percent of capital fund (Additional

10 percent on infrastructure exposure)

3. NBFC 10 percent of capital fund

4. NBFC - AFC 15 percent of capital fund

5. Indian Joint Venture/Wholly owned 20 percent of capital fund

subsidiaries abroad/ Overseas step
down subsidiaries of Indian
corporates

6. Capital Market Exposure

(a) Banks' holding of shares in any The lesser of 30 percent of paid-up share
company capital of the company or 30 percent of
the paid-up capital of banks

(b) Banks' aggregate exposure to 40 percent of its net worth

capital market (solo basis)

(c) Banks' aggregate exposure to 40 percent of its consolidated net worth

capital market (group basis)

(d) Banks' direct exposure to capital 20 percent of net worth

market (solo basis)

(e) Banks' direct exposure to capital 20 percent of consolidated net worth

market (group basis)

7. Gross Holding of capital among 10 per cent of capital fund

banks / financial institutions

Source: RBI Master Circular, July 1, 2019

Some of the categories of the above table are discussed below:

 Individual Borrowers: A bank's credit exposure to individual borrowers must not exceed 15 % of
the Bank's capital funds. Credit exposure to individual borrowers may exceed the exposure norm
of 15 % of capital funds by an additional 5 % (i.e. up to 20 %) provided the additional credit
exposure is on account of infrastructure financing.

45
 Group Borrowers: A bank's exposure to a group of companies under the same management
control must not exceed 40% of the Bank's capital funds unless the exposure is in respect of an
infrastructure project. In that case, the exposure to a group of companies under the same
management control may be up to 50% of the Bank's capital funds. 29


 Aggregate exposure to capital market: A bank's aggregate exposure to the capital market,
including both fund based and non-fund based exposure to capital market, in all forms should
not exceed 40 percent of its net worth as on March 31 of the previous year.

In addition to ensuring compliance with the above guidelines laid down by RBI, a Bank may fix its own
credit exposure limits for mitigating credit risk. The bank may, for example, set upper caps on exposures
to sensitive sectors like commodity sector, real estate sector and capital markets. Banks also may lay
down guidelines regarding exposure limits to unsecured loans.

Lending Rates

Banks are free to determine their own lending rates on all kinds of advances except a few such as export
finance; interest rates on these exceptional categories of advances are regulated by the RBI.

It may be noted that the Section 21A of the BR Act provides that the rate of interest charged by a bank
shall not be reopened by any court on the ground that the rate of interest charged is excessive.

The concept of benchmark prime lending rate (BPLR) was however introduced in November 2003 for
pricing of loans by commercial banks with the objective of enhancing transparency in the pricing of their
loan products. Each bank must declare its benchmark prime lending rate (BPLR) as approved by its
Board of Directors. A bank's BPLR is the interest rate to be charged to its best clients; that is, clients with
the lowest credit risk. Each bank is also required to indicate the maximum spread over the BPLR for
various credit exposures.

However, BPLR lost its relevance over time as a meaningful reference rate, as the bulk of loans were
advanced below BPLR. Further, this also impedes the smooth transmission of monetary signals by the
RBI. The RBI therefore set up a Working Group on Benchmark Prime Lending Rate (BPLR) in June 2009
to go into the issues relating to the concept of BPLR and suggest measures to make credit pricing more
transparent.

29
Banks may, in exceptional circumstances, with the approval of their boards, enhance the exposure by additional 5% for both
individual, and group borrowers

46
Following the recommendations of the Group, the Reserve Bank has issued guidelines in February 2010.
According to these guidelines, the 'Base Rate system' will replace the BPLR system with effect from July
01, 2010.All categories of loans should henceforth be priced only with reference to the Base Rate. Each
bank will decide its own Base Rate. The actual lending rates charged to borrowers would be the Base
Rate plus borrower-specific charges, which will include product-specific operating costs, credit risk
premium and tenor premium.

Since transparency in the pricing of loans is a key objective, banks are required to exhibit the information
on their Base Rate at all branches and also on their websites. Changes in the Base Rate should also be
conveyed to the general public from time to time through appropriate channels. Apart from transparency,
banks should ensure that interest rates charged to customers in the above arrangement are non-
discriminatory in nature.

Guidelines on Fair Practices Code for Lenders

RBI has been encouraging banks to introduce a fair practices code for bank loans. Loan application forms
in respect of all categories of loans irrespective of the amount of loan sought by the borrower should be
comprehensive. It should include information about the fees/ charges, if any, payable for processing the
loan, the amount of such fees refundable in the case of non-acceptance of application, prepayment
options and any other matter which affects the interest of the borrower, so that a meaningful comparison
with the fees charged by other banks can be made and informed decision can be taken by the borrower.
Further, the banks must inform 'all-in-cost' to the customer to enable him to compare the rates charged
with other sources of finance.

Regulations relating to providing loans

The provisions of the Banking Regulation Act, 1949 (BR Act) govern the making of loans by banks in
India. RBI issues directions covering the loan activities of banks. Some of the major guidelines of RBI,
which are now in effect, are as follows:

 Advances against bank's own shares: a bank cannot grant any loans and advances against the
security of its own shares.

 Advances to bank's Directors: The BR Act lays down the restrictions on loans and advances to
the directors and the firms in which they hold substantial interest.

 Restrictions on Holding Shares in Companies: In terms of Section 19(2) of the BR
Act, banks should not hold shares in any company except as provided in sub-section

(1) whether as pledgee, mortgagee or absolute owner, of an amount exceeding 30% of the
paid-up share capital of that company or 30% of its own paid-up share capital
and reserves, whichever is less.

47
4.2 Basics of Loan Appraisal, Credit decision-making and Review

4.2.1 Credit approval authorities

The Bank's Board of Directors also has to approve the delegation structure of the various credit approval
authorities. Banks establish multi-tier credit approval authorities for corporate banking activities, small
enterprises, retail credit, agricultural credit, etc.

Concurrently, each bank should set up a Credit Risk Management Department (CMRD), being
independent of the CPC. The CRMD should enforce and monitor compliance of the risk parameters and
prudential limits set up by the CPC.

The usual structure for approving credit proposals is as follows:

 Credit approving authority: multi-tier credit approving system with a proper scheme of delegation
of powers.

 In some banks, high valued credit proposals are cleared through a Credit Committee approach
consisting of, say 3/ 4 officers. The Credit Committee should invariably have a representative
from the CRMD, who has no volume or profit targets.

4.2.2 Credit appraisal and credit decision-making

When a loan proposal comes to the bank, the banker has to decide how much funds does the proposal
really require for it to be a viable project and what are the credentials of those who are seeking the
project. In checking the credentials of the potential borrowers, Credit Information Bureaus play an
important role (see Box)

Box 4.1: Credit Information Bureaus

The Parliament of India has enacted the Credit Information Companies (Regulation) Act, 2005,
pursuant to which every credit institution, including a bank, has to become a member of a credit
information bureau and furnish to it such credit information as may be required of the credit institution
about persons who enjoy a credit relationship with it. Credit information bureaus are thus repositories of
information, which contains the credit history of commercial and individual borrowers. They provide this
information to their Members in the form of credit information reports.

To get a complete picture of the payment history of a credit applicant, credit grantors must be able to
gain access to the applicant's complete credit record that may be spread over different institutions.
Credit information bureaus collect commercial and consumer credit-related data and collate such data
to create credit reports, which they distribute to their Members. A Credit Information Report (CIR) is a
factual record of a borrower's credit payment history compiled from information received from different
credit grantors. Its purpose is to help credit grantors make informed lending decisions - quickly and
objectively. As of today, bureaus provide history of credit card holders and SMEs.

48
4.2.3 Monitoring and Review of Loan Portfolio

It is not only important for banks to follow due processes at the time of sanctioning and disbursing loans,
it is equally important to monitor the loan portfolio on a continuous basis. Banks need to constantly keep a
check on the overall quality of the portfolio. They have to ensure that the borrower utilizes the funds for
the purpose for which it is sanctioned and complies with the terms and conditions of sanction. Further,
they monitor individual borrowal accounts and check to see whether borrowers in different industrial
sectors are facing difficulty in making loan repayment. Information technology has become an important
tool for efficient handling of the above functions including decision support systems and data bases. Such
a surveillance and monitoring approach helps to mitigate credit risk of the portfolio.

Banks have set up Loan Review Departments or Credit Audit Departments in order to ensure compliance
with extant sanction and post-sanction processes and procedures laid down by the Bank from time to
time. This is especially applicable for the larger advances. The Loan Review Department helps a bank to
improve the quality of the credit portfolio by detecting early warning signals, suggesting remedial
measures and providing the top management with information on credit administration, including the
credit sanction process, risk evaluation and post-sanction follow up.

4.3 Types of Advances

Advances can be broadly classified into: fund-based lending and non-fund based lending.

Fund based lending: This is a direct form of lending in which a loan with an actual cash outflow is given to
the borrower by the Bank. In most cases, such a loan is backed by primary and/or collateral security. The
loan can be to provide for financing capital goods and/or working capital requirements.

Non-fund based lending: In this type of facility, the Bank makes no funds outlay. However, such
arrangements may be converted to fund-based advances if the client fails to fulfil the terms of his contract
with the counterparty. Such facilities are known as contingent liabilities of the bank. Facilities such as
'letters of credit' and 'guarantees' fall under the category of non-fund based credit.

Let us explain with an example how guarantees work. A company takes a term loan from Bank A and
obtains a guarantee from Bank B for its loan from Bank A, for which he pays a fee. By issuing a bank
guarantee, the guarantor bank (Bank B) undertakes to repay Bank A, if the company fails to meet its
primary responsibility of repaying Bank A.

In this chapter, we will discuss only some important types of fund-based lending.

49
4.3.1 Working Capital Finance

Working capital finance is utilized for operating purposes, resulting in creation of current assets (such as
inventories and receivables). This is in contrast to term loans which are utilized for establishing or
expanding a manufacturing unit by the acquisition of fixed assets.

Banks carry out a detailed analysis of borrowers' working capital requirements. Credit limits are
established in accordance with the process approved by the board of directors. The limits on Working
capital facilities are primarily secured by inventories and receivables (chargeable current assets).

Working capital finance consists mainly of cash credit facilities, short term loan and bill discounting. Under
the cash credit facility, a line of credit is provided up to a pre-established amount based on the borrower's
projected level of sales inventories, receivables and cash deficits. Up to this pre-established amount,
disbursements are made based on the actual level of inventories and receivables. Here the borrower is
expected to buy inventory on payments and, thereafter, seek reimbursement from the Bank. In reality, this
may not happen. The facility is generally given for a period of up to 12 months and is extended after a
review of the credit limit. For clients facing difficulties, the review may be made after a shorter period.

One problem faced by banks while extending cash credit facilities, is that customers can draw up to a
maximum level or the approved credit limit, but may decide not to. Because of this, liquidity management
becomes difficult for a bank in the case of cash credit facility. RBI has been trying to mitigate this problem
by encouraging the Indian corporate sector to avail of working capital finance in two ways: a short-term
loan component and a cash credit component. The loan component would be fully drawn, while the cash
credit component would vary depending upon the borrower's requirements.

According to RBI guidelines, in the case of borrowers enjoying working capital credit limits of Rs. 10
crores and above from the banking system, the loan component should normally be 80% and cash credit
component 20 %. Banks, however, have the freedom to change the composition of working capital
finance by increasing the cash credit component beyond 20% or reducing it below 20 %, as the case may
be, if they so desire.

Bill discounting facility involves the financing of short-term trade receivables through negotiable
instruments. These negotiable instruments can then be discounted with other banks, if required, providing
financing banks with liquidity.

4.3.2 Project Finance

Project finance business consists mainly of extending medium-term and long-term rupee and foreign
currency loans to the manufacturing and infrastructure sectors. Banks also provide financing by way of
investment in marketable instruments such as fixed rate and floating rate

debentures. Lending banks usually insist on having a first charge on the fixed assets of the borrower.

50
During the recent years, the larger banks are increasingly becoming involved in financing large projects,
including infrastructure projects. Given the large amounts of financing involved, banks need to have a
strong framework for project appraisal. The adopted framework will need to emphasize proper
identification of projects, optimal allocation and mitigation of risks.

The project finance approval process entails a detailed evaluation of technical, commercial, financial and
management factors and the project sponsor's financial strength and experience. As part of the appraisal
process, a risk matrix is generated, which identifies each of the project risks, mitigating factors and risk
allocation.

Project finance extended by banks is generally fully secured and has full recourse to the borrower
company. In most project finance cases, banks have a first lien on all the fixed assets and a second lien
on all the current assets of the borrower company. In addition, guarantees may be taken from sponsors/
promoters of the company. Should the borrower company fail to repay on time, the lending bank can have
full recourse to the sponsors/ promoters of the company. (Full recourse means that the lender can claim
the entire unpaid amount from the sponsors / promoters of the company.) However, while financing very
large projects, only partial recourse to the sponsors/ promoters may be available to the lending banks.

4.3.3 Loans to Small and Medium Enterprises

A substantial quantum of loans is granted by banks to small and medium enterprises (SMEs). While
granting credit facilities to smaller units, banks often use a cluster-based approach, which encourages
financing of small enterprises that have a homogeneous profile such as leather manufacturing units,
chemical units, or even export oriented units. For assessing the credit risk of individual units, banks use
the credit scoring models.

As per RBI guidelines, banks should use simplified credit appraisal methods for assessment of bank
finance for the smaller units. Further, banks have also been advised that they should not insist on
collateral security for loans up to Rs.10 lakh for the micro enterprises.

Box 4.2: Specialised Branches for SME Credit

Given the importance of SME sector, the RBI has initiated several measures to increase the flow of
credit to this segment. As part of this effort, the public sector banks (PSBs) have been
operationalizing specialized SME bank branches for ensuring uninterrupted credit flow to this sector.
As at end-March 2017, Scheduled commercial banks have operationalised as many as 2998
specialized SME bank branches.

Source:RBI

51
Small Industries Development Bank of India (SIDBI) also facilitates the flow of credit at reasonable
interest rates to the SME sector. This is done by incentivising banks and State Finance Corporations to
lend to SMEs by refinancing a specified percentage of incremental lending to SMEs, besides providing
direct finance along with banks.

4.3.4 Rural and Agricultural Loans

The rural and agricultural loan portfolio of banks comprises loans to farmers, small and medium
enterprises in rural areas, dealers and vendors linked to these entities and even corporates. For farmers,
banks extend term loans for equipments used in farming, including tractors, pump sets, etc. Banks also
extend crop loan facility to farmers. In agricultural financing, banks prefer an 'area based' approach; for
example, by financing farmers in an adopted village. The regional rural banks (RRBs) have a special
place in ensuring adequate credit flow to agriculture and the rural sector.

The concept of 'Lead Bank Scheme (LBS)' was first mooted by the Gadgil Study Group, which submitted
its report in October 1969. Pursuant to the recommendations of the Gadgil Study Group and those of the
Nariman Committee, which suggested the adoption of 'area approach' in evolving credit plans and
programmes for development of banking and the credit structure, the LBS was introduced by the RBI in
December, 1969. The scheme envisages allotment of districts to individual banks to enable them to
assume leadership in bringing about banking developments in their respective districts. More recently, a
High Level Committee was constituted by the RBI in November 2007, to review the LBS and improve its
effectiveness, with a focus on financial inclusion and recent developments in the banking sector. The
Committee has recommended several steps to further improve the working of LBS. The importance of the
role of State Governments for supporting banks in increasing banking business in rural areas has been
emphasized by the Committee.

4.3.5 Directed Lending

The RBI requires banks to deploy a certain minimum amount of their credit in certain identified sectors of
the economy. This is called directed lending. Such directed lending comprises priority sector lending and
export credit.

A. Priority sector lending

The objective of priority sector lending program is to ensure that adequate credit flows into some of the
vulnerable sectors of the economy, which may not be attractive for the banks from the point of view of
profitability. These sectors include agriculture, small scale enterprises, retail trade, etc. Small housing
loans, loans to individuals for pursuing education, loans to weaker sections of the society etc also qualify
as priority sector loans.

To ensure banks channelize a part of their credit to these sectors, the RBI has set guidelines

52
defining targets for lending to priority sector as whole and in certain cases, sub-targets for lending to
individual priority sectors (See Table 4.2).

Table 4.2: Targets under Priority Sector Lending

Domestic commercial banks Foreign banks

Total Priority 40 per cent of ANBC or CEOBSE, 40 percent of ANBC or CEOBSE,

Sector advances whichever is higher whichever is higher

Total agricultural 18 percent of ANBC or CEOBSE, Not applicable

advances whichever is higher
7.5 percent of ANBC or Credit
Micro Enterprise Equivalent Amount of Off-Balance
Advances Sheet Exposure, whichever is higher. Not applicable
advances

Advances to 10 percent of ANBC or CEOBSE, Not applicable

weaker sections whichever is higher

Source: RBI FAQ https://m.rbi.org.in/Scripts/FAQView.aspx?Id=87

Note: ANBC: Adjusted Net Bank Credit

CEOBSE: Credit Equivalent of Off-Balance Sheet Exposure

The RBI guidelines require banks to lend at least 40% of Adjusted Net Bank Credit (ANBC) or credit
equivalent amount of Off-Balance Sheet Exposure (CEOBSE), whichever is higher. In case of foreign
banks, the target for priority sector advances is 40% of ANBC or CEOBSE, whichever is higher to be
achieved in a phased manner by 2020.

In addition to these limits for overall priority sector lending, the RBI sets sub-limits for certain sub-sectors
within the priority sector such as agriculture. Banks are required to comply with the priority sector lending
requirements at the end of each financial year. A bank having shortfall in lending to priority sector lending
target or sub-target shall be required to make contribution to the Rural Infrastructure Development Fund
(RIDF) established with NABARD or funds with other financial institutions as specified by the RBI.

53
 Box 4.3: Differential Rate of Interest (DRI) Scheme

Government of India had formulated in March, 1972 a scheme for extending financial assistance at
concessional rate of interest @ 4% to selected low income groups for productive endeavors. The
scheme known as Differential Rate of Interest Scheme (DRI) is now being implemented by all
Scheduled Commercial Banks. The maximum family incomes that qualify a borrower for the DRI
scheme is revised periodically. Currently, the RBI has advised the banks that borrowers with annual
family income of Rs.18,000 in rural areas and Rs.24,000 in urban and semi-urban areas would be
eligible to avail of the facility as against the earlier annual income criteria of Rs.6,400 in rural areas and
Rs.7,200 in urban areas. The target for lending under the DRI scheme in a year is maintained at one
per cent of the total advances outstanding as at the end of the previous year.

Source: RBI Circulars

B. Export Credit

As part of directed lending, RBI requires banks to make loans to exporters at concessional rates of
interest. Export credit is provided for pre-shipment and post-shipment requirements of exporter borrowers
in rupees and foreign currencies. At the end of any fiscal year, 12.0% of a bank's credit is required to be
in the form of export credit. This requirement is in addition to the priority sector lending requirement but
credits extended to exporters that are small scale industries or small businesses may also meet part of
the priority sector lending requirement.

4.3.6 Retail Loan

Banks, today, offer a range of retail asset products, including home loans, automobile loans, personal
loans (for marriage, medical expenses etc), credit cards, consumer loans (such as TV sets, personal
computers etc) and, loans against time deposits and loans against shares. Banks also may fund dealers
who sell automobiles, two wheelers, consumer durables and commercial vehicles. The share of retail
credit in total loans and advances was 27.9% at end- July 2020.

Customers for retail loans are typically middle and high-income, salaried or self-employed individuals,
and, in some cases, proprietorship and partnership firms. Except for personal loans and credit through
credit cards, banks stipulate that (a) a certain percentage of the cost of the asset (such as a home or a
TV set) sought to be financed by the loan, to be borne by the borrower and (b) that the loans are secured
by the asset financed.

Many banks have implemented a credit-scoring program, which is an automated credit approval system
that assigns a credit score to each applicant based on certain attributes like income, educational
background and age. The credit score then forms the basis of loan evaluation. External agencies such as
field investigation agencies and credit processing agencies may be

54
used to facilitate a comprehensive due diligence process including visits to offices and homes in the case
of loans to individual borrowers. Before disbursements are made, the credit officer checks a centralized
delinquent database and reviews the borrower's profile. In making credit decisions, banks draw upon
reports from agencies such as the Credit Information Bureau (India) Limited (CIBIL).

Some private sector banks use direct marketing associates as well as their own branch network and
employees for marketing retail credit products. However, credit approval authority lies only with the bank's
credit officers.

Two important categories of retail loans--home finance and personal loans--are discussed below.

Home Finance: Banks extend home finance loans, either directly or through home finance subsidiaries.
Such long term housing loans are provided to individuals and corporations and also given as construction
finance to builders. The loans are secured by a mortgage of the property financed. These loans are
extended for maturities generally ranging from five to fifteen years and a large proportion of these loans
are at floating rates of interest. This reduces the interest rate risk that banks assume, since a bank's
sources of finance are generally of shorter maturity. However, fixed rate loans may also be provided;
usually with banks keeping a higher margin over benchmark rates in order to compensate for higher
interest rate risk. Equated monthly installments are fixed for repayment of loans depending upon the
income and age of the borrower(s).

Personal Loans: These are often unsecured loans provided to customers who use these funds for various
purposes such as higher education, medical expenses, social events and holidays. Sometimes collateral
security in the form of physical and financial assets may be available for securing the personal loan.
Portfolio of personal loans also includes micro-banking loans, which are relatively small value loans
extended to lower income customers in urban and rural areas.

4.3.7 International Loans Extended by Banks

Indian corporates raise foreign currency loans from banks based in India as well as abroad as per
guidelines issued by RBI/ Government of India. Banks raise funds abroad for on-lending to Indian
corporates. Further, banks based in India have an access to deposits placed by Non Resident Indians
(NRIs) in the form of FCNR (B) deposits, which can be used by banks in India for on-lending to Indian
customers.

55
4.4 Management of Non Performing Assets

An asset of a bank (such as a loan given by the bank) turns into a non-performing asset (NPA) when it
ceases to generate regular income such as interest etc for the bank. In other words, when a bank which
lends a loan does not get back its principal and interest on time, the loan is said to have turned into an
NPA. Definition of NPAs is given in 4.4.1. While NPAs are a natural fall-out of undertaking banking
business and hence cannot be completely avoided, high levels of NPAs can severely erode the bank's
profits, its capital and ultimately its ability to lend further funds to potential borrowers. Similarly, at the
macro level, a high level of non-performing assets means choking off credit to potential borrowers, thus
lowering capital formation and economic activity. So the challenge is to keep the growth of NPAs under
control. Clearly, it is important to have a robust appraisal of loans, which can reduce the chances of loan
turning into an NPA. Also, once a loan starts facing difficulties, it is important for the bank to take remedial
action.

Box 4.4: Level of Non Performing Assets

The gross non-performing assets of the banking segment were Rs. 68, 973 crores at the end of March
2009, and the level of net NPAs (after provisioning) was Rs.31, 424 crores. Although they appear to be
very large amounts in absolute terms, they are actually quite small in comparison to total loans by banks.
The ratio of gross non-performing loans to gross total loans has fallen sharply over the last decade and is
at 2.3 per cent as at end-March 2009was at 8.5% as on march 2020. However, this is likely to increase to
double digits to as much as 14.7% as per RBI Financial Stability Report. This ratio, which is an indicator
of soundness of banks, is comparable withhigher than most of the developed countries such as France,
Germany and Japan. The low level of gross NPAs as a percent of gross loans in India is a positive
indicator of the Indian banking system.

Source: Report on Trend and Progress of Banking in India 2008-09, RBI and Report on Currency and
Finance 2006-08.

4.4.1 Classification of non-performing Assets

Banks have to classify their assets as performing and non-performing in accordance with RBI's
guidelines. Under these guidelines, an asset is classified as non-performing if any amount of interest or
principal instalments remains overdue for more than 90 days, in respect of term loans. In respect of
overdraft or cash credit, an asset is classified as non-performing if the account remains out of order for a
period of 90 days and in respect of bills purchased and discounted account, if the bill remains overdue for
a period of more than 90 days.

All assets do not perform uniformly. In some cases, assets perform very well and the recovery of principal
and interest happen on time, while in other cases, there may be delays in recovery or no recovery at all
because of one reason or the other. Similarly, an asset may exhibit good quality performance at one point

56
of time and poor performance at some other point of time. According to the RBI guidelines, banks must
classify their assets on an on-going basis into the following four categories:

Standard assets: Standard assets service their interest and principal instalments on time; although they
occasionally default up to a period of 90 days. Standard assets are also called performing assets. They
yield regular interest to the banks and return the due principal on time and thereby help the banks earn
profit and recycle the repaid part of the loans for further lending. The other three categories (sub-standard
assets, doubtful assets and loss assets) are NPAs and are discussed below.

Sub-standard assets: Sub-standard assets are those assets which have remained NPAs (that is, if any
amount of interest or principal instalments remains overdue for more than 90 days) for a period up to 12
months.

Doubtful assets: An asset becomes doubtful if it remains a sub-standard asset for a period of 12 months
and recovery of bank dues is of doubtful.

Loss assets: Loss assets comprise assets where a loss has been identified by the bank or the RBI. These
are generally considered uncollectible. Their realizable value is so low that their continuance as bankable
assets is not warranted.

4.4.2 Debt Restructuring

Once a borrower faces difficulty in repaying loans or paying interest, the bank should initially address the
problem by trying to verify whether the financed company is viable in the long run. If the company/ project
is viable, then rehabilitation is possible by restructuring the credit facilities. In a restructuring exercise, the
bank can change the repayment or interest payment schedule to improve the chances of recovery or
even make some sacrifices in terms of waiving interest etc.

RBI has separate guidelines for restructured loans. A fully secured standard/ sub-standard/ doubtful loan
can be restructured by rescheduling of principal repayments and/or the interest element. The amount of
sacrifice, if any, in the element of interest, is either written off or provision is made to the extent of the
sacrifice involved. The sub-standard accounts/doubtful accounts which have been subjected to
restructuring, whether in respect of principal instalment or interest amount are eligible to be upgraded to
the standard category only after a specified period.

To create an institutional mechanism for the restructuring of corporate debt, RBI has devised a Corporate
Debt Restructuring (CDR) system. The objective of this framework is to ensure a timely and transparent
mechanism for the restructuring of corporate debts of viable entities facing problems.

4.4.3 Other recovery options

57
If rehabilitation of debt through restructuring is not possible, banks themselves make efforts to recover.
For example, banks set up special asset recovery branches which concentrate on
recovery of bad debts. Private and foreign banks often have a collections unit structured along various
product lines and geographical locations, to manage bad loans. Very often, banks engage external
recovery agents to collect past due debt, who make phone calls to the customers or make visits to them.
For making debt recovery, banks lay down their policy and procedure in conformity with RBI directives on
recovery of debt.

The past due debt collection policy of banks generally emphasizes on the following at the time of
recovery:

 Respect to customers

 Appropriate letter authorizing agents to collect

 Due notice to customers

 Confidentiality of customers' dues

 Use of simple language in communication and maintenance of records of communication

In difficult cases, banks have the option of taking recourse to filing cases in courts, Lok Adalats, Debt
Recovery Tribunals (DRTs), One Time Settlement (OTS) schemes, etc. DRTs have been established
under the Recovery of Debts due to Banks and Financial Institutions Act, 1993 for expeditious
adjudication and recovery of debts that are owed to banks and financial institutions. Accounts with loan
amount of Rs. 10 lakhs and above are eligible for being referred to DRTs. OTS schemes and Lok Adalats
are especially useful to NPAs in smaller loans in different segments, such as small and marginal farmers,
small loan borrowers and SME entrepreneurs.

If a bank is unable to recover the amounts due within a reasonable period, the bank may write off the
loan. However, even in these cases, efforts should continue to make recoveries.

4.4.4 SARFAESI Act, 2002

Banks utilize the Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 (SARFAESI) as an effective tool for NPA recovery. It is possible where non-performing
assets are backed by securities charged to the Bank by way of hypothecation or mortgage or assignment.
Upon loan default, banks can seize the securities (except agricultural land) without intervention of the
court.30
SARFAESI Act, 2002 gives powers of "seize and desist" to banks. Banks can give a notice in writing to
the defaulting borrower requiring it to discharge its liabilities within 60 days. If the borrower fails to comply
with the notice, the Bank may take recourse to one or more of the following measures:
 Take possession of the security for the loan
 Sale or lease or assign the right over the security
 Manage the same or appoint any person to manage the same

58
The SARFAESI Act also provides for the establishment of asset reconstruction companies regulated by
RBI to acquire assets from banks and financial institutions.

The Act provides for sale of financial assets by banks and financial institutions to asset reconstruction
companies (ARCs). RBI has issued guidelines to banks on the process to be followed for sales of
financial assets to ARCs.

30
SARFAESI is effective only for secured loans where bank can enforce the underlying security eg hypothecation , pledge and
mortgages. In such cases, court intervention is not necessary, unless the security is invalid or fraudulent. However, if the asset
in question is an unsecured asset, the bank would have to move the court to file civil case against the defaulters.

59
CHAPTER 5: Bank Investments

In addition to loans and advances, which were discussed in Chapter 4, banks deploy a part of their
resources in the form of investment in securities/ financial instruments. The bulk of a bank's assets are
held either in the form of (a) loans and advances and (b) investments. Investments form a significant
portion of a bank's assets, next only to loans and advances, and are an important source of overall
income. Commercial banks' investments are of three broad types: (a) Government securities, (b) other
approved securities and (c) other securities. These three are also categorised into SLR (Statutory
Liquidity Ratio) investment and non-SLR investments. SLR investments comprise Government and other
approved securities, while non-SLR investments consist of 'other securities' which comprise commercial
papers, shares, bonds and debentures issued by the corporate sector.

Figure 5.1 : Classification of Bank Investments

Under the SLR requirement, banks are required to invest a prescribed minimum of their net demand and
time liabilities (NDTL) in Government- and other approved securities under the BR act, 1949. (Note that
SLR is prescribed in terms of banks' liabilities and not assets). This provision amounts to 'directed
investment', as the law directs banks to invest a certain minimum part of their NDTL in specific securities.
While the SLR provision reduces a bank's flexibility to determine its asset mix, it helps the Government
finance its fiscal deficit.31

31
The Government finances its fiscal deficit (broadly, government expenditure minus government revenue) by bor-rowing, in other
words, through the issue of Government securities. Because of the legal provision mandating

60
It is the RBI that lays down guidelines regarding investments in SLR and non-SLR securities. Bank
investments are handled by banks through their respective Treasury Department. This chapter discusses
banks' investment policy and operational details and guidelines relating to investments.

5.1 Investment Policy

Each bank is responsible for framing its own Internal Investment Policy Guidelines (or, simply, Investment
policy). The Asset Liability Committee (ALCO) of a bank, comprising senior bank officials and headed in
most cases by the CEO, plays a key role in drafting the investment policy of the bank. The investment
policy and the changes made therein from time to time have to obtain the bank Board's approval for it.
The aim of an Investment Policy of a bank is to create a broad framework within which investment
decisions of the Bank could be taken. The actual decisions regarding investment are to be taken by the
Investment Committee set up by the Board.

The Investment Policy outlines general instructions and safeguards necessary to ensure that operations
in securities are conducted in accordance with sound and acceptable business practices. The parameters
on which the policy is based are return (target return as determined in individual cases), duration (target
duration of the portfolio), liquidity consideration and risk. Thus, while the Policy remains within the
framework of the RBI guidelines with respect to bank investment, it also takes into consideration certain
bank-specific factors, viz., the bank's liquidity condition and its ability to take credit risk, interest rate risk
and market risk. The policy is determined for SLR and non-SLR securities, separately.

The Investment Policy provides guidelines with respect to investment instruments, maturity mix of
investment portfolio, exposure ceilings, minimum rating of bonds/ debentures, trading policy, accounting
standards, valuation of securities and income recognition norms, audit review and reporting and
provisions for Non-Performing Investments (NPI). It also outlines functions of front office/ back office/ mid
office, delegation of financial powers as a part of expeditious decision-making process in treasury
operations, handling of asset liability management (ALM) issues, etc.

Several banks follow the practice of a strategy paper. Based on the market environment envisaged by
Asset Liability Committee (ALCO) in the Asset Liability Management (ALM) Policy, a Strategy Paper on
investments and expected yield is usually prepared which is placed before the CEO of the Bank. A review
of the Strategy Paper may be done at, say half yearly basis and put up to the CEO.

banks to invest a minimum fraction of their NDTL in government securities, banks are captive financiers of the Government's fiscal
deficit. Of course, banks are not the only subscribers of government securities.

61
5.2 Statutory Reserve Requirements
5.2.1 Maintenance of Statutory Liquidity Ratio (SLR)

Banks' investments in Central and State Government dated securities including treasury bills are
governed by the RBI guidelines regarding maintenance of minimum level of SLR securities as well as
their own approved policy.

As stated earlier, under the Banking Regulation Act, 1949, the RBI prescribes the minimum SLR level for
Scheduled Commercial Banks (SCBs) in India in specified assets as a percentage of the bank's NDTL.
The actual percentage (that is, the value of such assets of an SCB as a percentage of its NDTL) must not
be less than such stipulated percentage. The RBI may change the stipulated percentage from time to
time.

Over the years, this ratio (SLR ratio) has changed a lot, but has broadly moved on a downward trajectory,
from the of 38.5% of NDTL in the early 90's (September 1990) to 25% by October 1997, with the financial
sector reforms giving banks greater flexibility to determine their respective asset mix. The SLR was
further reduced to 24 percent of NDTL in November 2008, but has been raised back to 25 percent level
since October 2009. Currently, it is at 25 percent level.

Banks can and do invest more than the legally prescribed minimum in SLR, as can be seen from Table
5.1.

Table 5.1: SLR Investment of SCBs: Actual vs. Statutory Requirement

End-March Actual SLR Investment Statutory SLR requirement

as % of NDTL as % of NDTL

2006 31.3 25

2007 27.9 25

2008 27.8 25

2009 28.1 24

Source: Report on Trend and Progress of Banking in India, RBI, 2008-09

The RBI has prescribed that all SCBs should maintain their SLR in the following instruments which will be
referred to as "statutory liquidity ratio (SLR) securities":

i. Dated securities as notified by RBI;

ii. Treasury Bills of the Government of India;

iii. Dated securities of the Government of India issued from time to time under the market borrowing
programme and the Market Stabilisation Scheme;

iv. State Development Loans (SDLs) of the State Governments issued from time to time under their
market borrowing programme; and

62
v. Any other instrument as may be notified by RBI.

These investments must be unencumbered.

The composition of investment by commercial banks is given in the following Table. It can be seen that
SLR investments, particularly government securities, form the bulk of total securities. Non-SLR
investments form a relatively small part of banks' total investment.

Table 5.2: Investments by Commercial Banks

(Rupees crore)

End- SLR Investments Non-SLR Total

March Investments Investments

2017 3402800 645400 4048200

(77) (23) (100)

2018 3331700 763400 4095100

(81) (19) (100)

2019 3381056 870887 4251943

(79) (21) (100)

2020 3693570 836614 4530184

(81) (19) (100)

Source: RBI Bulletins

Note: The figures in bracket show the investments as a percent to the total investment.

5.2.2 Penalties

If a banking company fails to maintain the required amount of SLR securities on any given day, it shall be
liable to pay to the RBI penal interest for that day at the rate of 3 per cent per annum above the Bank
Rate on the shortfall and, if the default continues on the next succeeding working day, the penal interest
may be increased to a rate of 5 per cent per annum above the Bank Rate for the concerned days of
default on the shortfall.32

32 The Bank Rate is determined by the RBI from time to time. It is the rate at which the RBI lends to the banks, and should not be
confused with the repo rate, which is the lending rate the RBI uses in the daily repo (repurchase) markets.

63
5.3 Non-SLR Investments

If there is any proposal to invest or disinvest in non-SLR securities, the concerned officials must refer
these proposals to the Investment Committee of the bank. Upon vetting and clearance by the Investment
Committee, financial sanction should be obtained from the appropriate authority in terms of the Scheme
of Delegation of Financial Powers.

Non-SLR Investments can include:

 Investments in Associates/ Subsidiaries and Regional Rural Banks


 Strategic Investments

 Venture Capital Investments

 PSU Bonds

 Corporate Investments

 Mutual Funds

 Bonds/debentures issued by Securitisation Companies (SCs) and Reconstruction Companies
(RCs)

However, as per RBI guidelines, the investments (SLR as well as Non-SLR) will be disclosed in the
balance sheet of the Bank as per the six-category classification listed below:

a. Government securities,

b. Other approved securities,

c. Shares,

d. Debentures & Bonds,

e. Investment in subsidiaries/ joint ventures in the form of shares, debentures, bonds etc, and

f. Others (Commercial Paper, Mutual Fund Units, etc.).

5.3.1 Bank Guidelines for investments in other than Government Securities

According to the RBI, banks desirous of investing in equity shares/ debentures should observe the
following guidelines:

i. Build up adequate expertise in equity research by establishing a dedicated equity research

department, as warranted by their scale of operations;

ii. Formulate a transparent policy and procedure for investment in shares, etc., with the approval of
the Board; and

64
iii. The decision in regard to direct investment in shares, convertible bonds and debentures should
be taken by the Investment Committee set up by the bank's Board. The Investment Committee
should also be held accountable for the investments made by the bank.

Further, with the approval of respective Boards, banks should clearly lay down the broad investment
objectives to be followed while undertaking transactions in securities on their own investment account and
on behalf of clients, clearly define the authority to put through deals, procedure to be followed for
obtaining the sanction of the appropriate authority, procedure to be followed while putting through deals,
various prudential exposure limits and the reporting system. Accordingly, the Boards of banks lay down
policy and prudential limits on investments in various categories, as stated earlier.

Investment proposals should be subjected to the same degree of credit risk analysis as any loan
proposal. Banks should have their own internal credit analysis and ratings even in respect of issues rated
by external agencies and should not entirely rely on the ratings of external agencies. The appraisal
should be more stringent in respect of investments in instruments issued by non-borrower customers.

As a matter of prudence, banks should stipulate entry-level minimum ratings/ quality standards and
industry-wise, maturity-wise, duration-wise and issuer-wise limits to mitigate the adverse impacts of
concentration of investment and the risk of illiquidity.

5.3.2 Statutory Prescriptions

Statutory prescriptions relating to the investment portfolio are to be complied with. The investments have
to be within the specific and general prudential limits fixed by RBI and in conformity with the provisions of
the BR Act and other applicable laws and guidelines that are issued by the regulators like RBI, Securities
Exchange Board of India (SEBI), etc.

For example, banks should not invest in non-SLR securities of original maturity of less than one-year,
other than Commercial Paper and Certificates of Deposits, which are covered under RBI guidelines.

Further, according to RBI guidelines, a bank's investment in unlisted non-SLR securities should not
exceed 10 per cent of its total investment in non-SLR securities as on March 31, of the previous year, and
such investment should comply with the disclosure requirements as prescribed by Securities Exchange
Board of India (SEBI) for listed companies. Bank's investment in unlisted non-SLR securities may exceed
the limit of 10 per cent, by an additional 10 per cent, provided the investment is on account of investment
in securitised papers issued for infrastructure projects, and bonds/ debentures issued by Securitisation
Companies (SCs) and Reconstruction Companies (RCs) set up under the SARFAESI Act and registered
with RBI.

65
A bank may also decide to put in place additional quantitative ceilings on aggregate non-SLR investments
as a percentage of the bank's net worth (equity plus reserves). There are also restrictions regarding
exposure to a particular industry.

Rating requirements

Banks must not invest in unrated non-SLR securities. However, the banks may invest in unrated bonds of
companies engaged in infrastructure activities, within the ceiling of 10 per cent for unlisted non-SLR
securities as mentioned earlier. Furthermore, the debt securities shall carry a credit rating of not less than
investment grade from a credit rating agency registered with the SEBI.

Limits on Banks' Exposure to Capital Markets

The aggregate exposure of a bank to the capital markets in all forms (both fund based and non-fund
based) should not exceed 40% of its net worth as on March 31 of the previous year. Within this overall
ceiling, the bank's direct investment in shares, convertible bonds/ debentures, units of equity-oriented
mutual funds and all exposures to venture capital funds (both registered and unregistered) should not
exceed 20 per cent of its net worth.

The above-mentioned ceilings are the maximum permissible and a bank's Board of Directors is free to
adopt a lower ceiling for the Bank, keeping in view its overall risk profile and corporate strategy. Banks
are required to adhere to the ceilings on an ongoing basis.

Restrictions on Investments in a Single Company

No bank can hold shares, as a pledgee, mortgagee or absolute owner in any company other than a
subsidiary, exceeding 30 per cent of the paid up share capital of that company or 30 per cent of its own
paid-up share capital and reserves, whichever is less.

5.4 Banks' Investment Classification and Valuation Norms

The key features of RBI guidelines on categorization and valuation of banks' investment portfolio are
given below.

The investment portfolio of a bank normally consists of both "approved securities" (predominantly
Government securities) and "others" (shares, debentures and bonds). The Bank should classify their
entire investment portfolio under three categories viz. 'Held to Maturity' (HTM)33, 'Held for Trading' (HFT),
and 'Available for Sale' (AFS).

HTM includes securities acquired with the intention of being held up to maturity; HFT includes securities
acquired with the intention of being traded to take advantage of the short-term

33
HTM must not be more than 25% of the portfolio.

66
price/ interest rate movements; and AFS refers to those securities not included in HTM and HFT. Banks
should decide the category of investment at the time of acquisition.

Profit or loss on the sale of investments in both HFT and AFS categories is taken in the income
statement. Shifting of investments from / to HTM may be done with the approval of the Board of Directors
once a year, normally at the beginning of the accounting year. Similarly, shifting of investments from AFS
to HFT may be done with the approval of the Board of Directors, the ALCO or the Investment Committee.
Shifting from HFT to AFS is generally not permitted. However, it will be permitted only under exceptional
circumstances like not being able to sell the security within 90 days due to tight liquidity conditions, or
extreme volatility, or market becoming unidirectional. Such transfer is permitted only with the approval of
the Board of Directors/ ALCO/ Investment Committee.

HTM securities are not marked to market and are carried at acquisition cost or at an amortised cost if
acquired at a premium over the face value. (In the case of HTM securities, if the acquisition cost is more
than the face value, premium should be amortised or written off over the period remaining to maturity.)
AFS and HFT securities are valued at market or fair value as at the balance sheet date.

Valuation of investments is to be done as per guidelines issued by RBI from time to time.
However, banks may adopt a more conservative approach as a measure of prudence.

The 'market value' for the purpose of periodic valuation of investments included in the AFS and HFT
would be the market price of the scrip as available from the trades/ quotes on the stock exchanges, price
list of RBI and prices declared by Primary Dealers Association of India (PDAI) jointly with the Fixed
Income Money Market and Derivatives Association of India (FIMMDA) periodically. In respect of unquoted
securities, RBI has laid down the detailed procedure to be adopted. For example, banks should value the
unquoted Central Government securities on the basis of the prices/ yield to maturity (YTM) rates put out
by the PDAI/ FIMMDA at periodic intervals.

5.4.1 Treasury Management

Investment transactions are undertaken as per the approved investment policy of the bank and in
accordance with the trading policy and Manual of Instructions. With a view to synergising strengths, a
bank usually operates an integrated treasury department under which both domestic and forex treasuries
are brought under a unified command structure. The following distinction is important to note. The task of
domestic treasury operations is predominantly to make investments on their own account, while the task
of forex treasury is to predominantly conduct operations on behalf of clients. The discussions so far on
SLR and non-SLR operations fall under domestic treasury management.

67
5.4.2 Forex Treasury Management

The Forex department of a bank does the following:

 administers and monitors merchant or client transactions emanating from branches,


 undertakes cover operation for merchant transactions, trades in inter-bank forex market,

 manages foreign currency funds like Foreign Currency Non Resident (FCNR) Accounts,
Exchange Earners Foreign Currency (EEFC) Accounts, etc. and maintains Nostro Accounts 34.

While bulk of the forex treasury operations are on behalf of the clients, the banks also handle proprietary
trading, i.e., forex trading on the banks' own account.

One important safeguard that banks are required to take is to make a clear separation between their
transactions on their own account and those on behalf of their clients.

34
FCNR accounts are maintained by NRIs, while EEFC accounts are maintained by exporters; a Nostro account is an account a
bank holds with another bank in a foreign country, usually in the currency of that foreign country

68
CHAPTER 6: Other Activities of Commercial Banks

As a continuation of their main deposit taking and lending activities, banks pursue certain activities to
offer a number of services to customers. They can be put into two broad categories:
(a) Other basic banking activities and (b) Para-banking activities. The former includes provision of
remittance facilities including issuance of drafts, mail transfers and telegraphic transfers, issuance of
travellers' cheques & gift cheques, locker facility etc. Banks also undertake various para-banking activities
including investment banking services, selling mutual funds, selling insurance products, offering
depository services, wealth management services, brokerage, etc. While the services offered assist the
banks to attract more depositors and borrowers, they also manage to increase their income in the
process. Banks earn fees by offering these services to the customers, as opposed to interest income
earned from the lending activities.

6.1 Other Basic Banking Activities

6.1.1 Foreign Exchange Services

Banks undertake foreign exchange transactions for their customers. The foreign exchange contracts arise
out of spot (current) and forward foreign exchange transactions entered into with corporate and non-
corporate customers and counter-party banks for the purpose of hedging and trading. Banks derive
income from the spread or difference between buying and selling rates of foreign exchange.

Leading banks provide customer specific products and services which cater to risk hedging needs of
corporates at domestic and international locations, arising out of currency and interest rate fluctuations.
These include products such as options and swaps, which are derived from the foreign exchange market
or the interest rate market. These are tailor made products designed to meet specific risk hedging
requirements of the customer.

In addition to the direct foreign exchange related income on buying and selling of foreign exchange,
income is generated in related services while undertaking the main foreign exchange business. These
services include the establishment of letters of credit, issuance of guarantees, document collection
services, etc.

Some banks, including leading public sector banks, private sector banks and local branches of foreign
banks earn significant income from foreign exchange related transactions.

6.1.2 Banks' services to Government

Banks offer various types of services to government departments including direct and indirect tax
collections, remittance facilities, payments of salaries and pensions, etc. Banks also

69
undertake other related businesses like distribution of Government and RBI bonds and handling public
provident fund accounts. Government departments pay fees to banks for undertaking this business.
Banks such as State of Bank of India, with a wide network of branches, are able to earn significant
income by offering these services to government departments.

6.1.3 Payment and Settlement Systems

As stated in Chapter 1, in any economy, banks are at the core of the payment and settlement systems,
which constitute a very important part of the commercial banks' functions. The payment and settlement
systems, as a mechanism, facilitate transfer of value between a payer and a beneficiary by which the
payer discharges the payment obligations to the beneficiary. The payment and settlement systems
enable two-way flow of payments in exchange of goods and services in the economy. This mechanism is
used by individuals, banks, companies, governments, etc. to make payments to one another.

The RBI has the power to regulate the payment system under the provisions of the Payment and
Settlement Systems (PSS) Act 2007, and the Payment and Settlement Systems Regulations 2008.35 The
Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) is a sub-committee of
the Central Board of RBI and is the highest policy making body on the payment system. The Board is
assisted by a technical committee called National Payments Council (NPC) with eminent experts in the
field as members.

There are two types of payments: paper based and electronic. Payments can be made in India in paper
based forms (in the forms of cash, cheque, demand drafts), and electronic forms (giving electronic
instructions to the banker who will make such a payment on behalf of his customers; credit card; debit
card).

Paper based clearing systems

The primary paper based payment instrument is the cheque. The process of cheque payment starts when
a payer gives his personal cheque to the beneficiary. To get the actual payment of funds, the receiver of
the cheque has to deposit the cheque in his bank account. If the beneficiary has an account in the same
bank in the same city then the funds are credited into his account through internal arrangement of the
bank. If the beneficiary has an account with any other bank in the same or in any other city, then his
banker would ensure that funds are collected from the payer's banker through the means of a 'clearing
house'.

35
Aside from the regulatory role, the RBI, as the central bank of the country, has been playing a developmental role in this
important area and has taken several initiatives for a secure and efficient payment system.

70
A clearing house is an association of banks that facilitates payments through cheques between different
bank branches within a city/ place. It acts as a central meeting place for bankers to exchange the
cheques drawn on one another and to claim funds for the same. Such operations are called 'clearing
operations'. Generally one bank is appointed as in-charge of the clearing operations. In the four metros
and a few other major cities, however, RBI is looking after the operations of the clearing house.

The paper based clearing systems comprise: (a) MICR Clearing, (b) Non- MICR clearing and
(c) High Value clearing. MICR stands for Magnetic Ink Character Recognition (MICR). MICR is a
technology for processing cheques. This is done through information contained in the bottom strip of the
cheque where the cheque number, city code, bank code and branch code are given.

Generally, if a cheque is to be paid within the same city (local cheque), it takes 2-3 days for the money to
come to the beneficiary's account. In case of High Value Clearing, however, which is available only in
some large cities, cheque clearing cycle is completed on the same day and the customer depositing the
cheque is permitted to utilise the proceeds the next day morning.36

The introduction of 'Speed Clearing' in June 2008 for collection of outstation cheques has significantly
brought down the time taken for realisation of outstation cheques from 10-14 days; now the funds are
available to customers on T+1 (transaction day + 1 day) or T+2 (transaction day + 2 days) basis.

Cheque Truncation

Cheque Truncation is a system of cheque clearing and settlement between banks based on electronic
data/ images or both without physical exchange of instrument. Cheque truncation has several
advantages. First, the bank customers would get their cheques realised faster, as T+0 (local clearing) and
T+1 (inter-city clearing) is possible in Cheque Truncation System (CTS). Second, faster realisation is
accompanied by a reduction in costs for the customers and the banks. Third, it is also possible for banks
to offer innovative products and services based on CTS. Finally, the banks have the additional advantage
of reduced reconciliation and clearing frauds.

36
To encourage customers to move from paper-based systems to electronic systems, which are more secure, faster and less
costly, the banks were advised in April 2009 to increase the threshold amount of cheque eligible to be presented in High Value
Clearing from Rs.1 lakh to Rs.10 lakhs and gradually discontinue the scheme in an undisruptive manner over a period of the
next one year. However, the facility of MICR/ Non-MICR clearing will continue to be available for paper-based instruments.

71
Electronic Payment Systems

Payments can be made between two or more parties by means of electronic instructions without the use
of cheques. Generally, the electronic payment systems are faster and safer than paper based systems.
Different forms of electronic payment systems are listed below.37

Real Time Gross Settlement (RTGS) system, introduced in India in March 2004, is a system through
which electronic instructions can be given by banks to transfer funds from their account to the account of
another bank. The RTGS system is maintained and operated by RBI and provides a means of efficient
and faster funds transfer among banks facilitating their financial operations. As the name suggests, funds
transfer between banks takes place on a 'real time' basis. Therefore, money can reach the beneficiary
instantaneously. The system which was operationalised with respect to settlement of transactions relating
to inter-bank payments was extended to customer transactions later. Though the system is primarily
designed for large value payments, bank customers have the choice of availing of the RTGS facility for
their time-critical low value payments as well. More than 60,000 branches as at end-September 2009 are
participants in the RTGS.

Electronic Funds Transfer (EFT) is a system whereby anyone who wants to make payment to another
person/ company etc. can approach his bank and make cash payment or give instructions/ authorisation
to transfer funds directly from his own account to the bank account of the receiver/ beneficiary. RBI is the
service provider for EFT. The electronic payment systems comprise large value payment systems as well
as retail payment mechanisms.

In addition, there are some electronic payment systems which are exclusively for retail payments. The
retail payment system comprises Electronic Clearing Services (ECS), National Electronic Funds Transfer
(NEFT) and card based payment systems including ATM network.

Electronic Clearing Service (ECS) is a retail payment system that can be used to make bulk payments/
receipts of a similar nature especially where each individual payment is of a repetitive nature and of
relatively smaller amount. This facility is meant for companies and government departments to make/
receive large volumes of payments rather than for funds transfers by individuals. The ECS facility is
available at a large number of centres. The ECS is further divided into two types - ECS (Credit) to make
bulk payments to individuals/ vendors and ECS (Debit) to receive bulk utility payments from individuals.

37
In addition to these systems, some banks in India have begun to offer certain banking services through the Internet that facilitate
transfer of funds electronically.

72
Under ECS (Credit), one entity/ company would make payments from its bank account to a number of
recipients by direct credit to their bank accounts. For instance, companies make use of ECS (Credit) to
make periodic dividend/ interest payments to their investors. Similarly, employers like banks, government
departments, etc make monthly salary payments to their employees through ECS (Credit). Payments of
repetitive nature to be made to vendors can also be made through this mode.

The payments are affected through a sponsor bank of the Company making the payment and such bank
has to ensure that there are enough funds in its accounts on the settlement day to offset the total amount
for which the payment is being made for that particular settlement. The sponsor bank is generally the
bank with whom the company maintains its account.

ECS (Debit) is mostly used by utility companies like telephone companies, electricity companies etc. to
receive the bill payments directly from the bank accounts of their customers. Instead of making electricity
bill payment through cash or by means of cheque, a consumer (individuals as well as companies) can opt
to make bill payments directly into the account of the electricity provider/ company/ board from his own
bank account. For this purpose, the consumer has to give an application to the utility company (provided
the company has opted for the ECS (Debit) scheme), providing details of the bank account from which
the monthly/ bi-monthly bill amount can be directly deducted. Thereafter, the utility company would advise
the consumer's bank to debit the bill amount to his account on the due date of the bill and transfer the
amount to the company's own account. This is done by crediting the account of the sponsor bank, which
again is generally the bank with whom the company receiving the payments, maintains the account. The
actual bill would be sent to the consumer as usual at his address.

The settlement cycle under the ECS has been reduced to T+1 day from earlier T+3 days across the
country. To widen the geographical coverage of ECS beyond the existing ECS centres and to have a
centralised processing capability, the National Electronic Clearing Service (NECS) was operationalised
with effect from September 29, 2008. The NECS is a nationwide system in which as many as 114 banks
with 30,780 branches participated as at the end of September, 2009.

National Electronic Funds Transfer (NEFT) system, introduced in November 2005, is a nationwide funds
transfer system to facilitate transfer of funds from any bank branch to any other bank branch. The
beneficiary gets the credit on the same day or the next day depending on the time of settlement. Ninety
one banks with over 61,000 branches participated in NEFT as at end of September 2009.

The banks generally charge some processing fees for electronic fund transfers, just as in the case of
other services such as demand drafts, pay orders etc. The actual charges depend upon the amount and
the banker-customer relationship. In a bid to encourage customers to move

73
from paper-based systems to electronic systems, RBI has rationalised and made transparent the charges
the banks could levy on customers for electronic transactions. RBI on its part has extended the waiver of
its processing charges for electronic modes of payment up to the end of March 2011.

In order not to be involved with day-to-day operations of the retail payment system, RBI has encouraged
the setting up of National Payment Corporation of India (NPCI) to act as an umbrella organisation for
operating the various retail payment systems in India. NPCI has since become functional and is in the
process of setting up its roadmap. NPCI will be an authorised entity under the Payment & Settlement
Systems Act and would, therefore, be subjected to regulation and supervision of RBI.

Credit/ Debit cards are widely used in the country as they provide a convenient form of making payments
for goods and services without the use of cheques or cash. Issuance of credit card is a service where the
customer is provided with credit facility for purchase of goods and services in shops, restaurants, hotels,
railway bookings, petrol pumps, utility bill payments, etc. The merchant establishment who accepts credit
card payments claims the amount subsequently from the customer's bank through his own bank. The
card user is required to pay only on receipt of the bill and this payment can be either in full or partially in
instalments.

Banks issuing credit cards earn revenue from their customers in a variety of ways such as joining fee,
additional card fee, annual fee, replacement card fee, cash advance fee, charge slip/ statement retrieval
fee, charges on over limit accounts and late payment fee, interest on delayed payment, interest on
revolving credit, etc. The fees may vary based on the type of card and from bank to bank. Banks earn
income not only as issuers of credit cards, but also as acquirers where the transaction occurs on a point
of sale terminal installed by the bank.38 As the Indian economy develops, it is expected that the retail
market will increasingly seek short-term credit for personal uses, and to a large extent, this rising demand
would be met by the issuance of credit cards.

Debit Card is a direct account access card. Unlike a credit card, in the case of a debit card, the entire
amount transacted gets debited from the customer's account as soon as the debit card is used for
purchase of goods and services. The amount permitted to be transacted in debit card is to the extent of
the amount standing to the credit of the card user's account.

38
A Point of Sale (POS) terminal is the instrument in which the credit card is swiped. The bank that installs POS terminal is called
the acquirer bank. A more detailed discussion on the POS terminal is given in Section 8.1.3.

74
Automated Teller Machines (ATMs) are mainly used for cash withdrawals by customers. In addition to
cash withdrawal, ATMs can be used for payment of utility bills, funds transfer between accounts, deposit
of cheques and cash into accounts, balance enquiry and several other banking transactions which the
banks owning the ATMs might want to offer.

6.1.4 NRI Remittances

NRI, as an individual, can remit funds into India through normal banking channels using the facilities
provided by the overseas bank. Alternately, an NRI can also remit funds through authorised Money
Transfer Agents (MTA). Further, a number of banks have launched their inward remittance products
which facilitate funds transfer on the same day/ next day.

6.1.5 Cash Management Services and Remittances

Many banks have branches rendering cash management services (CMS) to corporate clients, for
managing their receivables and payments across the country. Under cash management services, banks
offer their corporate clients custom-made collection, payment and remittance services allowing them to
reduce the time period between collections and remittances, thereby streamlining their cash flows. Cash
management products include physical cheque-based clearing, electronic clearing services, central
pooling of country-wide collections, dividend and interest remittance services and Internet-based payment
products. Such services provide customers with enhanced liquidity and better cash management.

6.2 Para-banking Activities

The Reserve Bank of India (RBI) has allowed the Scheduled Commercial Banks (SCBs) to undertake
certain financial services or para-banking activities and has issued guidelines to SCBs for undertaking
these businesses. The RBI has advised banks that they should adopt adequate safeguards so that para-
banking activities undertaken by them are run on sound and prudent lines. Banks can undertake certain
eligible financial services either departmentally or by setting up subsidiaries, with prior approval of RBI.

6.2.1 Primary Dealership Business

Primary Dealers can be referred to as Merchant Bankers to Government of India. In 1995, the Reserve
Bank of India (RBI) introduced the system of Primary Dealers (PDs) in the Government Securities Market,
which comprised independent entities undertaking Primary Dealer activity. In order to broad base the
Primary Dealership system, banks were permitted to undertake Primary Dealership business in 2006-07.
To do primary dealership business, it is necessary to have a license from the RBI.

75
The two primary objectives of the PD system are to:

 strengthen the infrastructure in the government securities market to make it vibrant, liquid and
broad based.

 improve secondary market trading system, which would (a) contribute to price discovery,

(b) enhance liquidity and turnover and (c) encourage voluntary holding of government securities.

A bank can do PD business either through a subsidiary or departmentally. A subsidiary of a scheduled

commercial bank dedicated predominantly to the securities business (particularly, the government
securities market) can apply for primary dealership. To do PD business departmentally, only banks which
do not have a partly or wholly owned subsidiary undertaking PD business and fulfill the following criteria
can apply:

 Minimum net owned funds (NOF) of Rs.1,000 crores


 Minimum CRAR of 9 per cent

 Net NPAs of less than 3 per cent and a profit making record for the last three years

6.2.2 Investment Banking/ Merchant Banking Services

Investment Banking is not one specific function or service but rather an umbrella term for a range of
activities. These activities include issuing securities (underwriting) for companies, managing portfolios of
financial assets, trading securities (stocks and bonds), helping investors purchase securities and
providing financial advice and support services. It can be seen that all these services are capital market
related services. These services are offered to governments, companies, non-profit institutions and
individuals.

A number of commercial banks have formed subsidiaries to undertake investment banking services.
Here, it is important to draw the distinction between Merchant Banking and Investment Banking.

As per the Securities and Exchange Board of India (SEBI) (Merchant Bankers) Rules, 1992 and SEBI
(Merchant Bankers) Regulations, 1992, merchant banking service is any service provided in relation to
issue management either by making arrangements regarding selling, buying or subscribing securities as
manager, consultant, advisor or rendering corporate advisory service in relation to such issue
management. This, inter alia, consists of preparation of prospectus and other information relating to the
issue, determining financial structure, tie up of financiers and final allotment and refund of the subscription
for debt/ equity issue management and acting as advisor, consultant, co-manager, underwriter and
portfolio manager. In addition, merchant banking services also include advisory services on corporate
restructuring, debt or equity restructuring, loan restructuring, etc. Fees are charged by the merchant
banker for

76
rendering these services. Banks and Financial Institutions including Non Banking Finance Companies
(NBFCs) providing merchant banking services are governed by the SEBI Rules and Regulations stated
above.

On the other hand, the term 'Investment Banking' has a much wider connotation and has gradually come
to refer to all types of capital market activity. Investment banking thus encompasses not merely merchant
banking but other related capital market activities such as stock trading, market making, broking and
asset management as well as a host of specialized corporate advisory services in the areas of mergers
and acquisitions, project advisory and business and financial advisory.

Investment banking has a large number of players: Indian and foreign. The large foreign investment
banks such as Goldman Sachs and Merrill Lynch (which are standalone investment banks) have entered
India attracted by India's booming economy. However, the Indian investment banking firms (including
investment banking arms of Indian commercial banks) have generally succeeded in holding their own as
they are able to service both small and large customers. However, one area foreign banks still dominate
is global mergers and acquisitions.

6.2.3 Mutual Fund Business

A number of banks, both in the private and public sectors have sponsored asset management companies
to undertake mutual fund business. Banks have entered the mutual fund business, sometimes on their
own (by setting up a subsidiary) and sometimes in joint venture with others. Other banks have entered
into distribution agreements with mutual funds for the sale of the latter's mutual fund products, for which
they receive fees. The advantage that banks enjoy in entering the mutual fund businesses is mainly on
account of their wide distribution network.

Money Market Mutual Funds (MMMFs) come under the purview of SEBI regulations. Banks and Financial
Institutions desirous of setting up MMMFs would, however, have to seek necessary clearance from RBI
for undertaking this additional activity before approaching SEBI for registration.

6.2.4 Pension Funds Management (PFM) by banks

Consequent upon the issue of Government of India Notification dated May 24, 2007, banks

77
have been advised that they may now undertake Pension Funds Management (PFM) through their
subsidiaries set up for the purpose. This would be subject to their satisfying the eligibility criteria
prescribed by Pensions Fund Regulatory and Development Authority (PFRDA) for Pension Fund
Managers. Banks intending to undertake PFM should obtain prior approval of RBI before engaging in
such business.

The RBI has issued guidelines for banks acting as Pension Fund Managers. According to the guidelines,
banks will be allowed to undertake PFM through their subsidiaries only, and not departmentally. Banks
may lend their names/ abbreviations to their subsidiaries formed for PFM, for leveraging their brand
names and associated benefits thereto, only subject to the banks maintaining 'arm's length' relationship
with the subsidiary. In order to provide adequate safeguards against associated risks and ensure that
only strong and credible banks enter into the business of PFM, the banks complying with the following
eligibility criteria (as also the solvency margin prescribed by PFRDA) may approach the RBI for necessary
permission:

 Net worth of the bank should be not less than Rs.500 crores.

 CRAR should be not less than 11% during the last three years.

 Bank should have made net profit for the last three consecutive years.

 Return on Assets (ROA) should be at least 0.6% or more.

 Level of net NPAs should be less than 3%.

 Performance of the bank's subsidiaries, if any, should be satisfactory.


6.2.5 Depository Services

In the depository system, securities are held in depository accounts in dematerialized form. Transfer of
securities is done through simple account transfers. The method does away with the risks and hassles
normally associated with paperwork. The enactment of the Depositories Act, in August 1996, paved the
way for the establishment of National Securities Depository Limited (NSDL) and later the Central
Depository Services (India) Limited (CDSL). These two institutions have set up a national infrastructure of
international standards that handles most of the securities held and settled in dematerialised form in the
Indian capital markets.

78
As a depository participant of the National Securities Depository Limited (NSDL) or Central Depository
Services (India) Limited (CDSL), a bank may offer depository services to clients and earn fees. Custodial
depository services means safe keeping of securities of a client and providing services incidental thereto,
and includes:

 maintaining accounts of securities of a client;


 collecting the benefit of rights accruing to the client in respect of the securities;

 keeping the client informed of the action taken or to be taken by the issuer of securities, having a
bearing on the benefits or rights accruing to the client; and

 maintaining and reconciling records of the services referred to in sub-clause

(a) to (c).

6.2.6 Wealth Management/ Portfolio Management Services39

A number of banks and financial institutions are seeking a share in the fast-growing wealth management
services market. Currently, a high net worth individual can choose from among a number of private sector
and public sector banks for wealth management services.40 In addition to high net worth resident Indians,
non-resident Indians (NRIs) form a major chunk of the customer base for personal wealth management
industry in India.

Banks that do portfolio management on behalf of their clients are subject to several regulations. No bank
should introduce any new portfolio management scheme (PMS) without obtaining specific prior approval
of RBI. They are also to comply with the guidelines contained in the SEBI (Portfolio Managers) Rules and
Regulations, 1993 and those issued from time to time.

The following conditions are to be strictly observed by the banks operating PMS or similar scheme:

 PMS should be entirely at the customer's risk, without guaranteeing, either directly or indirectly,
a pre-determined return.

 Funds should not be accepted for portfolio management for a period less than one year.

39
Portfolio management deals with only financial assets whereas wealth management covers both financial assets and non
financial assets such as real estates.
40
HSBC Private Bank in Asia, for example, provides the full spectrum of private banking solutions for affluent individuals and their
families. Their services include investment services, family wealth advisory services, private wealth solutions such as wealth
planning and protection, and traditional banking services. (Source: HSBC website)

79
 Portfolio funds should not be deployed for lending in call/ notice money; inter-bank term deposits
and bills rediscounting markets and lending to/ placement with corporate bodies.


 Banks should maintain client wise account/ record of funds accepted for management and
investments made and the portfolio clients should be entitled to get a statement of account.


 Banks' own investments and investments belonging to PMS clients should be kept distinct from
each other, and any transactions between the bank's investment account and client's portfolio
account should be strictly at market rates.

 PMS clients' accounts should be subjected by banks to a separate audit by external auditors.

6.2.7 Bancassurance

With the issuance of Government of India Notification dated August 3, 2000, specifying 'Insurance' as a
permissible form of business that could be undertaken by banks under Section 6(1) (o) of the BR Act,
banks were advised to undertake insurance business with a prior approval of the RBI. However,
insurance business will not be permitted to be undertaken departmentally by the banks.

A number of banks (both in public and private sectors) have entered into joint venture partnerships with
foreign insurance companies for both life and non-life insurance business. At present, Indian partners
(either alone or jointly) hold at least 74% of Indian insurance joint ventures. This is because the maximum
holding by foreign companies put together cannot exceed 26% of the equity of Indian insurance ventures.
Laws and regulations governing insurance companies currently provide that each promoter should
eventually reduce its stake to 26% following the completion of 10 years from the commencement of
business by the concerned insurance company.

The advantage that banks have in entering the insurance business is mainly on account of their wide
distribution network. Banks are able to leverage their corporate and retail customer base for cross selling
insurance products. Banks collect fees from these subsidiaries for generating leads and providing
referrals that are converted into policies.
In addition, some banks distribute Third Party Insurance Products. With a view to provide "one stop
banking" to their customers, banks distribute life insurance products and general insurance products
through their branches. Banks have entered into agency agreements with life and non-life companies to
distribute their various insurance products, for which they are paid a commission. The personnel involved
in selling these insurance products have to be authorised by the IRDA regulations to act as specified
persons for selling insurance products.

80
CHAPTER 7: Relationship between Bank and Customer
In India, banks face a challenge of providing services to a broad range of customers, varying from highly
rated corporates and high net worth individuals to low-end depositors and borrowers. Banks usually place
their customers into certain categories so that they are able to (a) develop suitable products according to
customer requirements and (b) service customers efficiently. The bank-customer relationship is
influenced by several dimensions, notably:

 While banks are competing with each other to attract the most profitable businesses, financial
inclusion is increasingly becoming part of their agenda. An important issue in India is that a large
number of people, nearly half of the adult population, still do not have bank accounts. 'Financial
Inclusion' would imply bringing this large segment of the population into the banking fold.


 Second, banks have started using innovative methods in approaching the customers; technology
is an important component of such efforts.

 Finally, on account of security threats as well as black money circulating in the system, care has
to be taken to identify the customers properly, know the sources of their funds and prevent
money laundering.

7.1 Strategy for expanding customer base

Driven by competition, banks are increasingly making their services customer-friendly. There are three
key components of strategies to expand and retain the customer base:

 Product life cycle strategy


 Appropriate targeting

 Expanding product portfolio

7.1.1 Product Life Cycle Strategy

Product life cycle strategy means addressing the concerns of the customers throughout the life cycle of
the banking products. The product life-cycle strategy of a banking product (such as bank loans)
comprises:

 Identifying target markets;


 Developing and designing suitable products;

 Marketing the products;

 Sales and advice processes;

 After-sales service; and

 Complaint handling.

81
7.1.2 Appropriate targeting41

Banks focus on customer profiles and offer differentiated deposit and credit products to various
categories of customers depending on their income category, age group and background. For example,
banks may segment various categories of customers to offer targeted products, such as Private Banking
for high net worth individuals, Defence Banking Services for defence personnel, and Special Savings
Accounts for trusts.

Banks use multiple channels to target specific segments of population. Banks deliver their products and
services through a variety of channels, ranging from traditional bank branches, extension counters and
satellite offices, to ATMs, call centres and the Internet. Some private banks also appoint direct marketing
agents or associates, who deliver retail credit products. These agents help banks achieve deeper
penetration by offering doorstep service to the customer.

7.1.3 Expanding product portfolio

To ensure that their customers get 'one-stop solution', a key component of banks' customer strategy is to
offer an expanded set of products and services. Through their distribution network, banks may offer
Government of India savings bonds, insurance policies, a variety of mutual fund products, and distribute
public offerings of equity shares by Indian companies. As a depository participant of the National
Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL), a bank
may offer depository share accounts to settle securities transactions in a dematerialized mode and so on.

7.2 Services to different Customer Groups

Developing and properly categorising a customer data base forms part of the core strategy of a bank. A
typical bank with a widespread network of branches aims at serving the following broad customer groups.

 retail customers;

 corporate customers;

 international customers;

 rural customers.

A bank formulates its overall customer strategy to increase profitable business keeping in mind its
strengths and weaknesses. The key strategy components and trends in each of these customer groups
are briefly discussed below.

41
This aspect is described in detail under 7.2

82
7.2.1 Retail Customers

With growing household incomes, the Indian retail financial services market has high growth potential.

The key dimensions of the retail strategy of a bank include customer focus, a wide range of products,

customer convenience, widespread distribution, strong processes and prudent risk management.

The fee income that banks earn while extending commercial banking services to retail customers includes

retail loan processing fees, credit card and debit card fees, transaction banking fees and fees from

distribution of third party products. Cross selling of the entire range of credit and investment products and

banking services to customers is often a key aspect of the retail strategy.

Retail Lending Activities

There is widespread acceptance by the average consumer of using credit to finance purchases. Given

this background, retail credit has emerged as a rapidly growing opportunity for banks. Banks also focus

on growth in retail deposit base which would include low cost current account and savings bank deposits.

Retail deposits are usually more stable than corporate bulk deposits or wholesale deposits.

Banks offer a range of retail products, including home loans, automobile loans, commercial vehicle loans,
two wheeler loans, personal loans, credit cards, loans against time deposits and loans against shares.
Banks also fund dealers who sell automobiles, two wheelers, consumer durables and commercial
vehicles. A few banks have set up home finance subsidiaries in order to concentrate on this business in a
more focused manner.

Personal loans are unsecured loans provided to customers who use these funds for various purposes

such as higher education, medical expenses, social events and holidays. Personal loans include micro-

banking loans, which are relatively small value loans to lower income customers in urban and rural areas.

Credit cards have become an important component of lending to the retail segment in the case of a
number of banks. As the Indian economy develops, it is expected that the retail market will seek short-
term credit for personal uses, and the use of credit cards will facilitate further extension of banks' retail
credit business.

83
 Box 7.1: Share of retail loans in total loans

The share of retail loans in total loans and advances of Scheduled Commercial Banks (SCBs) was
24% at end-March 2019. The maximum share was accounted for by housing loans followed by 'other
personal loans', auto loans, credit card receivables, loans for commercial durables, in that order.

Source: Report on Trends and Progress of Banking in India, 2018-19, RBI.

Lending to small and medium enterprises

Most of the private and foreign banks have integrated the strategy with regard to small and medium
enterprises with their strategy for retail products and services. Hence, the retail focus includes meeting
the working capital requirements, servicing deposit accounts and providing other banking products and
services required by small and medium enterprises. Of late, public sector banks are also very active in
lending to this business segment. Banks often adopt a cluster or community based approach to financing
of small enterprises, that is, identifying small enterprises that have a homogeneous profile such as
apparel manufacturers or jewellery exporters.

7.2.2 Corporate Customers

Corporate business covers project finance including infrastructure finance, cross border finance, working
capital loans, non-fund based working capital products and other fee-based services. Banks often have to
make special efforts to get the business of highly rated corporations.

The recent emphasis on infrastructure in India, including projects being built on private-public partnership
basis, is leading to profitable business opportunities in this area. Further, Indian companies are also going
global, and making large acquisitions abroad. This trend is likely to pick up momentum in future and
banks which gear themselves up to meet such requirements from their customers will gain.

There is also a growing demand for foreign exchange services from the corporate customers. Banks offer
fee-based products and services including foreign exchange products, documentary credits (such as
letter of credit or LC) and guarantees to business enterprises. Corporate customers are also increasingly
demanding products and services such as forward contracts and interest rate and currency swaps.

7.2.3 International Presence

Indian banks while expanding business abroad have usually been leveraging home country links. The
emphasis has been on supporting Indian companies in raising corporate and project finance overseas for
their investments in India and abroad (including financing of overseas acquisitions by Indian companies),
and extending trade finance and personal financial services (including remittance and deposit products)
for non-resident Indians.

84
7.2.4 Rural Banking Customers

Over 70% of India's citizens live in rural areas. Hence, there is a need for banks to formulate strategies
for rural banking, which have to include products targeted at various customer segments operating in
rural areas. These customer segments include corporates, small and medium enterprises and finally the
individual farmers and traders. Primary credit products for the rural retail segment include farmer
financing, micro-finance loans, working capital financing for agro-enterprises, farm equipment financing,
and commodity based financing. Other financial services such as savings, investment and insurance
products customised for the rural segment are also offered by banks.

7.3 Competition amongst Banks for Customers

Banks seek to gain advantage over their competitors by offering innovative products and services, use of
technology, building customer relationships and developing a team of highly motivated and skilled
employees. The relative strengths and weaknesses of different classes of banks-such as public sector
banks, new private sector banks, old private sector banks and foreign banks-are described below.

7.3.1 Competition for Retail Products and Services

In the retail markets, competition is intense among all categories of banks. However, even though foreign
banks have product and delivery capabilities, they are constrained by limited branch network. Over the
last decade, because of their stronger technology and marketing capabilities, the new private sector
banks have been gaining market share at the expense of public sector banks. They are slowly moving
towards the Tier II cities to tap potential business.

7.3.2 Competition for Corporate Products and Services

In the case of corporate business, public sector banks and the new private sector banks have developed
strong capabilities in delivering working capital products and services. Public sector banks have built
extensive branch networks that have enabled them to raise low cost deposits and, as a result, price their
loans and fee-based services very competitively. Their wide geographical reach facilitates the delivery of
banking products to their corporate customers located all over the country.

Traditionally, foreign banks in India have been active in providing trade finance, fee-based services and
other short-term financing products to highly rated Indian corporations. A few Indian public sector and
private sector banks effectively compete with foreign banks in these areas. The larger Indian commercial
banks also compete with foreign banks in foreign currency lending and syndication business. However,
foreign banks are at an advantage due to their larger balance sheets and global presence.

85
In project finance, a few large Indian commercial banks have entered the infrastructure finance space.
ICICI Bank and IDBI Bank have an advantage in this area as they were already in this business in their
previous avatar. However, given their strong deposit base, the larger commercial banks have decided to
expand their presence in this market. In project finance, foreign banks have an advantage where foreign
currency loans are involved.

7.3.3 Competition for International Banking

Indian commercial banks have limited access to foreign currency resources, and hence, face difficulty in
participating in global takeovers and acquisitions being undertaken by Indian companies, although some
leading Indian banks are participating in financing such cases in a limited manner.

In delivering sophisticated foreign exchange products like derivatives, a few Indian banks in the private
sector are competing with their foreign counterparts.

For products and services targeted at non-resident Indians and Indian businesses, there is intense
competition among a large number of banks, both Indian and foreign.

7.3.4 Competition for Rural Customers

In the agriculture and priority segments, the principal competitors are the large public sector banks,
regional rural banks (RRBs) and cooperative banks. This is due to the extensive physical presence of
public sector banks and RRBs throughout India via their large branch networks and their focus on
agriculture and priority sectors.

7.4 Customer Relationship Management

Over the years, the RBI has taken a number of initiatives to improve the quality of customer service.
These steps include grievance redress through the Banking Ombudsman Scheme 42 and setting up a
Customer Service Department within RBI.

RBI has set up a full-fledged Customer Service Department with a view to making banks more customer-
friendly and has taken a number of steps to disseminate instructions/ guidelines relating to customer
service and grievance redressal by banks by placing all customer related notifications and press releases
on its multi-lingual Internet site. Customers of commercial banks can also approach the RBI with their
grievances.

In February 2006, RBI set up the Banking Codes and Standards Board of India (BCSBI) as an
independent autonomous watchdog to ensure that customers get fair treatment in their dealings

42
Discussed under section 7.5.

86
with banks. The BCSBI has published the "Code of Banks' Commitments to Customers "(the Code)"
which sets minimum standards of banking practice and benchmarks in customer service for banks to
follow. Commercial banks have become members of the BCSBI and have adopted the Code as their Fair
Practice Code in dealings with customers.

The main RBI directives on customer services include the following.43

7.4.1 Committees on Customer Service

Banks are required to constitute a Customer Service Committee of their respective Boards and include
experts and representatives of customers as invitees to enable improvements in the quality of customer
service.

Further, banks have to establish Customer Service Committee at branch level. Each bank is also
expected to have a nodal department / official for customer service in the Head Office and each
controlling office whom customers with grievances can approach in the first instance and with whom the
Banking Ombudsman and RBI can liaise.

7.4.2 Board-approved Policies on Customer Service

Customer service is projected as a priority objective of banks along with profit, growth and fulfilment of
social obligations. Banks need to have a board approved policy for the following:

 Comprehensive Deposit Policy


 Cheque Collection Policy

 Customer Compensation Policy in areas such as erroneous debits, payment of interest in case
of delays in collection, etc.44 and

 Customer Grievance Redressal Policy

Banks should provide a complaints/ suggestions box at each of their offices. Further, at every office of the
bank, a notice requesting the customers to meet the branch manager may be displayed regarding
grievances, if the grievances remain unattended. A complaint book with perforated copies in each set
may be introduced, so designed as to instantly provide an acknowledgement to the customers and
intimation to the controlling office.

43
However, the banking system cannot depend only on regulatory steps to improve customer service. Market based solutions are
also necessary.
44
According to RBI guidelines, in the case of delays in collection of bills, the concerned bank should pay interest to the aggrieved
party for the delayed period in respect of collection of bills at the rate of 2% per annum above the rate of interest payable on
balances of Savings Bank accounts.

87
7.4.3 Giving Publicity to the Policies

Banks should ensure that wide publicity is given to the customer policies formulated by them by placing
them prominently on their web-site and also disseminating the policies through notice board in their
branches, issuing booklets/ brochures, etc.

7.4.4 Operations of Accounts by Special Category of Customers

Banks should develop policies for special categories of customers including sick/ old/ incapacitated
persons, persons with disabilities, visually impaired persons, etc. Such a customer may require
identification through the customer's thumb or toe impression by two independent witnesses known to the
bank, one of whom should be a responsible bank official.

7.4.5 Customer Confidentiality Obligations

The scope of the secrecy law in India has generally followed the common law principles based on implied
contract. Bankers' obligation to maintain secrecy about customers' accounts arises out of the contractual
relationship between the banker and customer, and as such no information should be divulged to third
parties except under circumstances which are well defined. The following exceptions are normally
accepted, where:

 disclosure is under compulsion of law


 there is duty to the public to disclose

 interest of bank requires disclosure, and

 disclosure is made with the express or implied consent of the customer.

Box 7.2: Collecting Information from Customers for Cross-selling Purposes

At the time of opening of accounts of the customers, banks are required to collect certain information;
but they also collect a lot of additional personal information, which can be potentially used for cross
selling various financial services by the banks, their subsidiaries and affiliates. Sometimes, such
information is also provided to other agencies. RBI has advised banks that the information provided by
the customer for Know Your Customer (KYC) compliance (see Section 7.5) while opening an account
is confidential and divulging any details thereof for cross selling or any other purpose would be in
breach of customer confidentiality obligations.

Wherever banks desire to collect any information about the customer for a purpose other than KYC
requirements, it should not form part of the account opening form. Such information may be collected
separately, purely on a voluntary basis, after explaining the objectives to the customer and taking his
express approval for the specific uses to which such information could be put.

Source: RBI Guidelines

88
7.4.6 National Do Not Call Registry

With a view to reducing the number of unsolicited marketing calls received by customers, the RBI has
advised banks that all telemarketers, viz., direct selling agents/ direct marketing agents engaged by them
should be registered with the Department of Telecommunications (DoT).

7.5 Banking Ombudsman Scheme

The Banking Ombudsman Scheme makes available an expeditious and inexpensive forum to bank
customers for resolution of complaints relating to certain services rendered by banks. The Banking
Ombudsman Scheme was introduced under Section 35 A of the Banking Regulation Act (BR Act), 1949
with effect from 1995.

All Scheduled Commercial Banks, Regional Rural Banks and Scheduled Primary Co-operative Banks are
covered under the Scheme.

7.5.1 Appointment of Banking Ombudsman

The Banking Ombudsman is a senior official appointed by the RBI to receive and redress customer
complaints against deficiency in certain banking services (including Internet banking and loans and
advances). At present, fifteen Banking Ombudsmen have been appointed, with their offices located
mostly in state capitals.

7.5.2 Filing a Complaint to the Banking Ombudsman

One can file a complaint before the Banking Ombudsman if (a) the reply to the representation made by
the customer to his bank is not received from the concerned bank within a period of one month after the
bank has received the representation, or (b) the bank rejects the complaint, or (c) if the complainant is not
satisfied with the reply given by the bank. The Banking Ombudsman does not charge any fee for filing
and resolving customers' complaints.

7.5.3 Limit on the Amount of Compensation as Specified in an Award

The amount, if any, to be paid by the bank to the complainant by way of compensation for any loss
suffered by the complainant is limited to the amount arising directly out of the act or omission of the bank
or Rs 10 lakhs, whichever is lower.

Further, the Banking Ombudsman may award compensation not exceeding Rs 1 lakh to the complainant
only in the case of complaints relating to credit card operations for mental agony and harassment. The
Banking Ombudsman will take into account the loss of the complainant's time, expenses incurred by the
complainant and harassment and mental anguish suffered by the complainant while passing such award.

89
7.5.4 Further recourse available

If a customer is not satisfied with the decision passed by the Banking Ombudsman, he can approach the
Appellate Authority against the Banking Ombudsman's decision. Appellate Authority is vested with a
Deputy Governor of RBI. He can also explore any other recourse available to him as per the law. The
bank also has the option to file an appeal before the appellate authority under the scheme.

7.6 Know Your Customer (KYC) norms

Banks are required to follow Know Your Customer (KYC) guidelines. These guidelines are meant to weed
out and to protect the good ones and the banks. With the growth in organized crime, KYC has assumed
great significance for banks. The RBI guidelines on KYC aim at preventing banks from being used,
intentionally or unintentionally, by criminal elements for money laundering or terrorist financing activities.
They also enable banks to have better knowledge and understanding of their customers and their
financial dealings. This in turn helps banks to manage their risks better. The RBI expects all banks to
have comprehensive KYC policies, which need to be approved by their respective boards.

Banks should frame their KYC policies incorporating the following four key elements:

a) Customer Acceptance Policy;

b) Customer Identification Procedures;

c) Monitoring of Transactions; and

d) Risk Management.

7.6.1 Customer Acceptance Policy

Every bank should develop a clear Customer Acceptance Policy laying down explicit criteria for
acceptance of customers. The usual elements of this policy should include the following. Banks, for
example, should not open an account in anonymous or fictitious/ benami name(s). Nor should any
account be opened where the bank's due diligence exercises relating to identity has not been carried out.
Banks have to ensure that the identity of the new or existing customers does not match with any person
with known criminal background. If a customer wants to act on behalf of another, the reasons for the
same must be looked into.

However, the adoption of customer acceptance policy and its implementation should not become too
restrictive and should not result in denial of banking services to general public, especially to those who
are financially or socially disadvantaged.

90
7.6.2 Customer Identification Procedures

Customer identification means identifying the customer and verifying his/her identity by using reliable,
independent source documents, data or information. For individual customers, banks should obtain
sufficient identification data to verify the identity of the customer, his address and a recent photograph.
The usual documents required for opening deposit accounts are given in Box 7.3. For customers who are
legal persons, banks should scrutinize their legal status through relevant documents, examine the
ownership structures and determine the natural persons who control the entity. Now PAN card and
Adhaar Card are mandatory for opening a bank account.

Box 7.3: Documents for opening deposit accounts under KYC guidelines

The Customer identification will be done on the basis of documents provided by the prospective
customer as under:

a) Passport or Voter ID card or Pension Payment Orders (Govt./PSUs) alone, whereon the address
is the same as mentioned in account opening form.

b) Any one document for proof of identity and proof of address, from each of the under noted items:

Proof of Identity

i) Passport, if the address differs from the one mentioned in the account opening form

ii) Voter ID card, if the address differs from the one mentioned in the account opening form

iii) PAN Card

iv) Govt./ Defence ID card

v) ID cards of reputed employers

vi) Driving License

vii) Pension Payment Orders (Govt./PSUs), if the address differs from the one mentioned in the
account opening form

viii) Photo ID card issued by Post Offices

viii) Photo ID card issued to bonafide students of Universities/ Institutes approved by UGC/
AICTE

Proof of address

i) Credit card statement

ii) Salary slip

iii) Income tax/ wealth tax assessment

91
 iv) Electricity bill

v) Telephone bill

vi) Bank account statement

vii) Letter from a reputed employer

viii) Letter from any recognized public authority

ix) Ration card

x) Copies of registered leave & license agreement/ Sale Deed/ Lease Agreement may be accepted
as proof of address

xi) Certificate issued by hostel and also, proof of residence incorporating local address, as well as
permanent address issued by respective hostel warden of aforesaid University/ institute where
the student resides, duly countersigned by the Registrar/ Principal/ Dean of Student Welfare.
Such accounts should be closed on completion of education/ leaving the University/ Institute.

xii) For students residing with relatives, address proof of relatives along with their identity proof, can
also be accepted provided declaration is given by the relative that the student is related to him
and is staying with him.

Source: State Bank of India website

7.6.3 Monitoring of Transactions

Ongoing monitoring is an essential element of effective KYC procedures. Banks can effectively control
and reduce their risk only if they have an understanding of the normal and reasonable activity of the
customer so that they have the means of identifying the transactions that fall outside the regular pattern of
activity. Banks should pay special attention to all complex, unusually large transactions and all unusual
patterns which have no apparent economic or visible lawful purpose. Banks may prescribe threshold
limits for a particular category of accounts and pay particular attention to the transactions which exceed
these limits.

Banks should ensure that any remittance of funds by way of demand draft/ mail/ telegraphic transfer or
any other mode and issue of travellers' cheques for value of Rs 50,000 and above is effected by debit to
the customer's account or against cheques and not against cash payment.

Banks should further ensure that the provisions of Foreign Contribution (Regulation) Act, 1976 as
amended from time to time, wherever applicable, are strictly adhered to.

7.6.4 Risk Management

Banks should, in consultation with their boards, devise procedures for creating risk profiles of their
existing and new customers and apply various anti-money laundering measures keeping in view the risks
involved in a transaction, account or banking/ business relationship.

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Banks should prepare a profile for each new customer based on risk categorisation. The customer profile
may contain information relating to customer's identity, social/ financial status, nature of business activity,
information about his clients' business and their location etc. Customers may be categorised into low,
medium and high risk. For example, individuals (other than high net worth individuals) and entities whose
identities and sources of wealth can be easily identified and transactions in whose accounts by and large
conform to the known transaction profile of that kind of customers may be categorised as low risk.
Salaried employees, government owned companies, regulators etc fall in this category. For this category
of customers, it is sufficient to meet just the basic requirements of verifying identity.

There are other customers who belong to medium to high risk category. Banks need to apply intensive
due diligence for higher risk customers, especially those for whom the sources of funds are not clear.
Examples of customers requiring higher due diligence include (a) non-resident customers; (b) high net
worth individuals; (c) trusts, charities, NGOs and organizations receiving donations; (d) companies having
close family shareholding or beneficial ownership;
(e) firms with 'sleeping partners'; (f) politically exposed persons (PEPs) of foreign origin; (g) non-face-to-
face customers and (h) those with dubious reputation as per public information available etc.

Banks' internal audit and compliance functions have an important role in evaluating and ensuring
adherence to the KYC policies and procedures. Concurrent/ Internal Auditors should specifically check
and verify the application of KYC procedures at the branches and comment on the lapses observed in
this regard.

7.7 Prevention of Money Laundering Act (PMLA), 2002

The PMLA, 2002 casts certain obligations on the banking companies in regard to maintenance and
reporting of the following types of transactions:

a) all cash transactions of the value of more than Rs 10 lakh or its equivalent in foreign currency;

b) all series of cash transactions integrally connected to each other which have been valued below
Rs 10 Lakh or its equivalent in foreign currency where such series of transactions have taken
place within a month and the aggregate value of such transactions exceeds Rs 10 Lakh;

c) all cash transactions where forged or counterfeit currency notes or bank notes have been used
as genuine and where any forgery of a valuable security or a document has taken place
facilitating the transaction; and

d) all suspicious transactions whether or not made in cash

93
CHAPTER 8: Evolving Trends in Modern Banking

There are a number of trends evolving in modern banking, the most important of which relate to (a)
technology, (b) outsourcing of services and (c) financial inclusion

8.1 Technology

Banks in India have started using technology in a proactive manner. The huge number of bank customers
and their myriad needs are being met in increasingly sophisticated ways. In a number of areas, the
foreign banks and the new private sector banks have been the first movers in the application of
technology, but public sector banks are also catching up. One major advantage that Indian banks have is
the availability of major IT companies in India who are the world leaders in IT applications.

8.1.1 Internet Banking

Through its website, a bank may offer its customers online access to account information and payment
and fund transfer facilities. The range of services offered differs from bank to bank depending mainly on
the type and size of the bank. Internet banking is changing the banking industry and affecting banking
relationships in a major way (see box 8.1).

Box 8.1: Examples of Online Payment Services offered by some banks

Shopping Online: One can shop securely online with the existing debit/credit card. This can also be
done without revealing the customer's card number.

Prepaid Mobile Refill: A bank's account holder can recharge his prepaid mobile phone with this service.

Bill Pay: A customer can pay his telephone, electricity and mobile phone bills through the Internet,
ATMs, mobile phone and telephone.

Register & Pay: One can view and pay various mobile, telephone, electricity bills and insurance
premiums on-line. After registering, customers can get sms and e-mail alerts every time a bill is
received.

RTGS Fund Transfer: RTGS is an inter-bank funds transfer system, where funds are transferred as
and when the transactions are triggered (i.e. real time).

Online Payment of Taxes: A customer can pay various taxes online including Excise and Service Tax,
Direct Tax etc.

94
8.1.2 Mobile Banking Transactions

Some banks have started offering mobile banking and telebanking to customers. The expansion in the
use and geographical reach of mobile phones has created new opportunities for banks to use this mode
for banking transactions and also provide an opportunity to extend banking facilities to the hitherto
excluded sections of the society.

The RBI has adopted Bank Led Model in which mobile phone banking is promoted through business
correspondents of banks.45 The operative guidelines for banks on Mobile Banking Transactions in India
were issued on October 8, 2008. Only banks who have received one-time approval from the RBI are
permitted to provide this facility to customers.

8.1.3 Point of Sale (PoS) Terminals

To use smart cards/debit cards/credit cards for the purchase of an item or for payment of a service at a
merchant's store, the card has to be swiped in a terminal (known as Point of Sale or POS terminal) kept
at the merchant's store. As soon as the card is put on the terminal, the details of the card are transmitted
through dial-up or leased lines to a host computer. On verification of the genuineness of the card, the
transaction is authorised and concluded. It is thus a means to 'check out' whether the cardholder is
authorized to make a transaction using the card. POS terminal is a relatively new concept.

A Point of Sale (PoS) terminal is an integrated PC-based device, with a monitor (CRT), PoS keyboard,
PoS printer, Customer Display, Magnetic Swipe Reader and an electronic cash drawer all rolled into one.
More generally, the POS terminal refers to the hardware and software used for checkouts.

In recent years, banks are making efforts to acquire Point of Sale (PoS) terminals at the premises of
merchants across the country as a relatively new source of income. 'Acquiring' a POS terminal means
installing a POS terminal at the merchant premises. The installer of the

45
For more details on Business Correspondents of banks, please see 8.3.1

95
PoS terminals is the acquirer of the terminal and the merchants are required to hold an account
(merchant account) with the acquirer bank. The acquirer bank levies each transaction with a charge, say
1% of the transaction value. This amount is payable by the merchant. Most merchants do not mind
absorbing this cost, because such facilities expand their sales. Some merchants, however, pass on the
cost to the customer. This business is known as merchant acquisition business.

Banks are vying with one another for PoS machine acquisition, since it offers a huge opportunity to
generate additional income by increasing the card base and encouraging card holders to use them for
their merchant transactions. Leading banks--both in the public and private sectors-- are planning to install
hundreds of thousands of these terminals across the country. Some banks are planning joint ventures
with global companies who have experience and expertise in this area.

PoS terminals are predominantly used for sale and purchase transactions. The PoS terminals have
proved to be very effective in combating fraudulent transaction by on-line verification of cards. Also, the
RBI is expected to permit cash withdrawal transactions to cardholders from PoS terminals installed with
shopkeepers, mall stores, etc.

PoS terminals, having gained significant acceptance in metros, need to become more popular in tier-2
and tier-3 cities. Public sector banks appear to be more interested in targeting the smaller towns and
cities where they have strong branch presence. The challenges of setting up a widespread PoS network
will be primarily (a) operational costs and (b) viability in smaller towns and cities. Experts feel that once
the technology stabilises and costs per unit comes down, PoS terminals will become popular all over
India.

8.2 Outsourcing of Non-core Activities

Outsourcing can enable banks to stay ahead of competition. Growing competition in the banking sector
has forced banks to outsource some of their activities to maintain their competitive edge. Decision to
outsource could be on cost considerations as well as lack of expertise in banks in delivering certain
services. Banks typically outsource their non-core functions so that they can concentrate on their core
functions.

However, there are risks involved in the process of outsourcing to a third party. These risks include non-
compliance with regulations, loss of control over business, leakage of customer data, lack of expertise of
the third party, poor service from third party, etc.

The key driving force behind outsourcing activities by any firm, irrespective of the nature of its business, is
cost saving. Initially, foreign banks were involved in outsourcing their activities in order to leverage India's
significant cost advantages. Organisations such as American Express, Citibank, Standard Chartered
Bank, ANZ Grindlays, HSBC, and ABN Amro have been outsourcing

96
their Information Technology Outsourcing (ITO)/Business Process Outsourcing (BPO) requirements to
leading Indian IT companies.

Outsourcing Activities of Indian Banks

During the recent years, Indian banks also have started outsourcing their non-core activities. The
outsourced services may include software application support, maintenance of hardware and software,
hosting services, managing data centres, managing ATM networks across the country, and disaster
management. Further, banks are also giving contracts to third parties in order to manage other support
services such as call-support services, help-desk support, credit card processing, cheque processing and
clearing, ATM cash replenishment, cheque clearing and collection, loan servicing, data processing, etc.
The two main reasons for Indian banks outsourcing non-core activities are similar to the overseas banks,
i.e. cost consideration and lack of expertise in certain areas. Through outsourcing, banks can also benefit
from the domain expertise of the service providers.

Outsourcing helps banks not only to focus on their core activities, but also in certain cases to reduce the
capital investment in developing the required infrastructure. Further, in-house provision of services may
be more expensive because they do not enjoy any economy of scale. Service providers on the other hand
may enjoy economies of scale because they cater to the outsourcing requirements of a number of banks
and companies and pass on some of the benefits of scale to the outsourcing banks. It is not only the
small banks who have started outsourcing non-core activities; large public sector banks are also
outsourcing their non-core services.

Certain precautions need to be taken while outsourcing non-core functions. The legal contract entered
into with the vendors should be approved only after the quantification of benefits through a thorough
analysis. The vendor's domain knowledge is important for delivering the services as per contract; for
example customizing the bank's IT requirements. It is therefore important for banks to verify whether the
vendors have the required domain knowledge.

While outsourcing, the major concern for banks relates to security. There have been case instances
where the employees of vendors have leaked confidential information of clients. For banks, such leakage
of customer's account details can be disastrous, with huge fallout in terms of monetary losses as well as
severe damage to the bank's reputation.

To cope with the challenges, the RBI has proposed that the board of directors of a bank should be
responsible for the outsourcing policy as well as approving such activities undertaken by a bank. In
addition, the Information Technology Act, 2000 aims at tackling some aspects of cyber crimes such as
leakage of confidential information by vendors. As part of internal inspection/audit, internal inspectors/
auditors in banks look into security related aspects of outsourcing.

97
Going forward, it is expected that outsourcing in the banking sector in India will increase as competition in
the industry grows and support services increasingly becomes more sophisticated and expensive.

8.3 Financial Inclusion

Despite the expansion of the banking network in India since independence, a sizeable proportion of the
households, especially in rural areas, still do not have a bank account. Considerable efforts have to be
made to reach these unbanked regions and population. Financial Inclusion implies providing financial
services viz., access to payments and remittance facilities, savings, loans and insurance services at
affordable cost to those who are excluded from the formal financial system. Box 8.3 gives indications of
the low access to banking services in India.

8.3.1 Initiatives taken by the RBI

The Lead Bank Scheme introduced by the RBI in 1969 is the earliest attempt by the RBI to foster financial
inclusion. Under the scheme, designated banks are made key instruments for local development and
entrusted with the responsibility of identifying growth centres, assessing deposit potential and credit gaps
and evolving a coordinated approach for credit deployment in each district, in concert with other banks
and other agencies. As at March 2009, there were 26 banks, mostly in the public sector, which have been
assigned lead responsibility in 622 districts of the country.
The RBI's recent measures to promote financial inclusion includes: advising banks to open 'no frills'
accounts, introduction of Business Correspondent (BC)/ Business Facilitator (BF) model and adoption of
Information and Communication Technology (ICT) solutions for achieving greater outreach.

Basic Savings Bank Deposit Accounts

To achieve the objective of greater financial inclusion, all banks have been advised by the RBI to make
available a basic savings bank deposit account – earlier called 'no-frills' account either with 'nil' or very
low minimum balances. They have also been advised to keep the transaction charges low, which would
make such accounts accessible to vast sections of population.. The growth of such deposits should be
encouraged with affordable infrastructure and low operational costs through the use of appropriate
technology. All facilities like cheque book, etc would be offered to these account holders with no
requirement of minimum balance. Banks are free to provide additional value-added services, including
issue of cheque book, beyond the above minimum facilities, which may/may not be priced (in non-
discriminatory manner) subject to disclosure. Offering such additional services will not make it a non-
BSBD Account, so long as the prescribed minimum services are provided free of charge.

Use of Business Facilitators and Correspondents

With the objective of ensuring a greater financial inclusion and increasing the outreach of the banking
sector, the RBI has introduced business facilitators and business correspondent models to enable
banks to use the services of NGOs, Self Help Groups (SHGs) and micro finance institutions as
intermediaries in providing financial and banking services. These intermediaries serve as the
facilitators /correspondents of the banks.
98
In the business facilitator model, these intermediaries help the banks facilitate services such as
identification of borrowers, collection and preliminary processing of loan applications, creating awareness
about savings and other products, processing and submission of applications to banks and post-sanction
monitoring.

In addition to activities which the intermediaries can engage in the business facilitator model, the scope of
activities under the business correspondent's models include disbursal of small value credit, recovery of
principal/collection of interest, collection of small value deposits, receipt and delivery of small value
remittances etc.

As the engagement of intermediaries as business facilitators/correspondents involves a significant

reputational, legal and operational risks, banks need to give due consideration to those risks. The bank's
arrangement with the business correspondents should:

 Specify the suitable limits on cash holding by intermediaries, as also limits on individual
customer payments and receipts.
 Require that the transactions are accounted for and reflected in the bank's books by the end of
the day or next working day.

 Require all agreements/contracts with the customer to clearly specify that the bank is
responsible to the customer for acts of omission and commission of the business facilitator /
correspondent.

Banks pay reasonable commission/ fees to the Business Facilitators/ Correspondents. The banks'
agreement with them however should specifically prohibit them from charging any fees to the customers
for the services rendered by them on behalf of the banks.

Adoption of technology

To give an impetus to financial inclusion, the RBI has formulated a scheme to accelerate the pace of
adoption of the biometric access/ smart card based Electronic Benefit Transfer (EBT) mechanism by the
banks and roll out the EBT system in the States that are ready to adopt the scheme. As per the scheme,
RBI would partially reimburse the banks, for a limited period, the cost of opening accounts with biometric
access/ smart cards. Through these accounts, payment of social security benefits, National Rural
Employment Guarantee Act (NREGA) payments and payments under other government benefit
programmes would be routed.

The potential of information technology (IT) in extending banking services to under-served markets in
rural and semi-urban areas is enormous. The use of Smart Card technology, mobile ATMs, coverage of
rural post offices under electronic payments networks - all could contribute to providing financial services
to more people and thereby serve financial inclusion.

India is experiencing an explosion in the use of mobile communication technology, and this could be
exploited by the financial sector for spreading the banking habit. Mobile phone users belong to all strata
of society, spread across urban, semi-urban and rural areas. However, while encouraging the spread of

99
cost-effective banking through mobile communications, it has to be ensured that essential security
features are maintained.

8.3.2 Micro Credit

Micro Credit is defined as provision of credit and other financial services and products of very small
amount to the poor in rural, semi-urban and urban areas for enabling them to raise their income levels.
Micro Credit Institutions (MCIs) are those which provide these facilities.

Banks are allowed to devise appropriate loan and savings products and the related terms and conditions
including size of the loan, unit cost, unit size, maturity period, grace period, margins, etc. Such credit
covers not only consumption and production loans for various farm and non-farm activities of the poor but
also includes their other credit needs such as housing and shelter improvements.

Self-Help Groups (SHGs)

As stated earlier, despite the expansion of the banking sector, the rural poor--particularly the marginal
farmers and landless labourers--depend to a very large degree on the moneylenders for credit. Several
studies have shown that Self Help Savings and Credit Groups have the potential to bring together the
banks and the rural poor.

A Self-Help Group (SHG) is a registered or unregistered group of 15-20 people who voluntarily join
together to save small amounts regularly. These pooled savings are used to make interest bearing loans
to group members. In addition to inculcating the habit of thrift, SHG activity develops among its members
the capacity to handle resources. When the group matures and stabilizes, it gets linked to the banks
under a SHG-banks linkage program and banks start providing credit to SHGs. Note that banks provides
credit to SHGs and not to individuals belonging to the SHG. It is the SHGs who pass on the loans to the
individuals. Thus, the SHGs become responsible for repayment to the banks.

The group members use collective wisdom and peer pressure to ensure proper end-use of credit and
timely repayment thereof. Peer pressure acts as an effective substitute for collaterals. Box 8.6 gives an
indication of the financial inclusion through the self-help groups.
What are the advantages of financing through SHGs? An economically poor individual gains strength
as part of a group. Besides, financing through SHGs reduces transaction costs for both lenders and
borrowers. While lenders have to handle only a single SHG account instead of a large number of
small-sized individual accounts, borrowers as part of a SHG cut down expenses on travel for
completing paper work and on the loss of workdays in availing loans.

Since 1991-92, the National Bank for Agriculture and Rural Development (NABARD) has been
encouraging banks to extend micro credit loans to SHGs. The scheme was then extended to RRBs
and co-operative banks. More than 90 per cent of the groups linked with banks are exclusive women's
groups
.
100
While the SHG-bank linkage programme has emerged as the dominant micro finance dispensation model
in India, other models too have evolved. For example, micro finance delivery through microfinance
institutions (MFIs) has also emerged as an important delivery channel.

References

1. Indian Financial System, by Bharati V Pathak, (Pearson Education)

2. Management of Banking & Financial Services, by Justin Paul & Padmalatha Suresh, (Pearson
Education)

3. Commercial Banking, The Management of Risk, Benton E Gup & James W Kolari, (Wiley
Student Edition)

4. Modern Banking, Theory & Practice, D.Muraleedharan, PHI, (Eastern Economy Edition)

5. Laws & Practices of Banking, The Indian Institute of Bankers, (Macmillan)

6. Banking Regulation Act, 1949

7. The Reserve Bank of India Act, 1934

8. Annual Report of the Reserve Bank of India for the Year 2008-09

9. Report on Trend and Progress of Banking in India 2008-09

10. Reserve Bank of India Master Circulars

11. Report on Currency and Finance 2006-08, "The Banking Sector in India: Emerging Issues and
Challenges", RBI.

101
 MODEL TEST PAPER

COMMERCIAL BANKING IN INDIA: A BEGINNER'S MODULE

Q.1 RBI controls the commercial banks through [2 Marks]

(a) periodic inspection of banks
(b) follow up action
(c) calling for returns and other information
(d) All of the above

Q.2 The Lead Bank scheme was introduced by the RBI in: [2 Marks]
(a) 1969
(b) 1973
(c) 1971
(d) 1967

Q.3 Under the new system, the RBI acts as the banker to Central Government only, not
banker to State Governments. [2 Marks]
(a) FALSE
(b) TRUE

In a 'no frills' savings bank account, banks usually waive minimum balances condition. [2 Marks]

(a) FALSE
(b) TRUE

Q.5 Hindu Undivided Families (HUFs) are not allowed to open current accounts. [1 Mark]
(a) FALSE
(b) TRUE

Q.6 While private sector banks and foreign banks earn fees for undertaking government
related business, public sector banks have to offer these services for free to government
departments. [2 Marks]
(a) TRUE
(b) FALSE

Q.7 The three main types of deposit accounts collected by banks are savings bank,
certificates of deposit and term deposits. [1 Mark]
(a) TRUE
(b) FALSE

102
Q.8 _____ and ____ are two major companies in the mortgage business and provide stiff
competion to the commercial banks in the disbursal of housing loans. [2 Marks]
(a) NEDFI, HDFC
(b) NEDFI, HUDCO
(c) HDFC, HUDCO
(d) LIC, HUDCO

Q.9 In case a depositor wishes to withdraw his deposits prematurely, banks [2 Marks]
(a) do not allow the same till maturity of the deposits
(b) charge a penalty for the same
(c) do not charge any penalty and allow the same
(d) do not allow premature withdrawal

Q.10 What percentage of India's population lives in rural areas? [1 Mark]

(a) 50% to less than 55%
(b) 65% to less than 70%
(c) 70% to less than 75%.
(d) 60% to less than 65%
(e) 55% to less than 60%

Q.11 For filing and resolving customer complaints, the Banking Ombudsman [1 Mark]
(a) charges a fee of Rs. 500/-
(b) does not charge any fee
(c) charges a fee of Rs. 1500/-
(d) charges a fee of Rs. 1000/-

Q.12 Term deposits are meant for individuals and small businesses, and not for large
companies. [1 Mark]
(a) TRUE
(b) FALSE

Q.13 Foreign banks can be involved in all segments of personal loans, except in household
consumer finance. [2 Marks]
(a) FALSE
(b) TRUE

103
Q.14 In case a depositor is a sole proprietor and holds deposits in the name of the proprietory
concern as well as in the individual capacity, the maximum insurance cover is available
upto. [1 Mark]
(a) Rs. 1,00,000/-
(b) Rs. 2,00,000/-
(c) Rs. 5,00,000/-
(d) None of the above

Q.15 Banks give contracts to third parties in order to manage support services like
[2 Marks]
(a) help desk support
(b) credit card processing
(c) call support service
(d) All of the above

Q.16 In case of FCNR(B) Scheme, the period for fixed deposits is [2 Marks]
(a) as applicable to resident accounts
(b) for terms not less than 1 year and not more than 5 years
(c) for terms not less than 2 years and not more than 6 years
(d) at the discretion of the Bank

Q.17 To create a strong and competitive banking system, reform measures were initiated
in early 1990s. The thrust of these reforms was on [2 Marks]
(a) increasing operation efficiency
(b) strengthening supervision over banks
(c) developing technological and institutional infrastructure
(d) All of the above

Q.18 The past due debt collection policy of banks generally emphasizes on _________ at
the time of recovery [2 Marks]
(a) respect to customers
(b) appropriate letter authorising agents to collect recovery
(c) due notice to customers
(d) All of the above

Q.19 Bank sponsored mutual funds dominate the mutual fund industry [2 Marks]
(a) TRUE
(b) FALSE

104
Q.20 According to the risk diversification principle of bank lending, diversification should be
in terms of [2 Marks]
(a) customer base
(b) geographic location
(c) nature of business
(d) All of the above

Q.21 A Bank's aggregate exposure to the capital market, including both fund based and
non-fund based exposure to capital market, in all forms should not exceed 50% of its
net worth as on March 31 of the previous year. [2 Marks]
(a) TRUE
(b) FALSE

Q.22 Which of the following aspects are outlined by the loan policy of a bank? [2 Marks]
(a) rating standards
(b) lending procedures
(c) financial covenants
(d) All of the above

Q.23 Public sector banks are not allowed to enter the mutual fund business. [2 Marks]
(a) TRUE
(b) FALSE

Q.24 The RBI has adopted _____ Model in which mobile banking and is promoted through
business correspondents of banks [1 Mark]
(a) Bank Led
(b) Band Mobile
(c) Mobile
(d) All of the above

Q.25 Services offered to government departments include all the above except: [1 Mark]
(a) payments of salaries and pensions
(b) distributing RBI bonds to government departments
(c) direct and indirect tax collections
(d) remittance facilities

Q.26 In case of FCNR(B) Scheme, the period for fixed deposits is [2 Marks]
(a) for terms not less than 1 year and not more than 5 years
(b) for terms not less than 1 year and not more than 6 years
(c) for terms not less than 2 years and not more than 6 years
(d) for terms not less than 2 years and not more than 5 years

105
Q.27 The main advantage that banks have in entering the insurance ventures is the strong
capital base of banks. [1 Mark]
(a) FALSE
(b) TRUE

Q.28 While spreading the message of promotion of financial inclusion banks can make use of
Business Correspondents to facilitate the opening of 'no frills' accounts. [2 Marks]
(a) FALSE
(b) TRUE

Q.29 Savers from the household sector prefer

(i) assured income
(ii) liquidity
(iii) safety of funds [1 Mark]
(a) only (i)
(b) only (ii)
(c) only (iii)
(d) (i), (ii), (iii)

Q.30 At present both IDBI and IDBI Bank operate as separate companies in the fields of
term lending and commercial banking businesses respectively. [2 Marks]
(a) FALSE
(b) TRUE

Q.31 The concept of base rate to be introduced with effect from July 1, 2010 would include
[2 Marks]
(a) product-specific operating cost
(b) credit risk premium
(c) tenor premium
(d) All of the above

Q.32 Credit appraisal can be done on a simplified basis by banks while carrying out credit
appraisal of smaller units. [2 Marks]
(a) TRUE
(b) FALSE

Q.33 BCSBI stands for [1 Mark]

(a) Banking Codes and Standards Board of India
(b) Banking Credit and Standards Board of India
(c) Banking Codes and Service Board of India
(d) Banking Credit and Service Board of India

106
Q.34 While bulk of the forex treasury operations is on behalf of the clients, the major
portion of domestic treasury operations consists of proprietary trading [2 Marks]
(a) FALSE
(b) TRUE

Q.35 Banks have to ensure that underwriting commitments taken up by them in respect of
primary issue of shares or convertible debentures or units of equity-oriented mutual
funds comply with the ceiling prescribed for the banks' exposure to the capital markets.
[1 Mark]
(a) FALSE
(b) TRUE

Q.36 The concept of limited liablity introduced in Indian banking resulted in establishment
of [2 Marks]
(a) joint stock banks
(b) urban banks
(c) rural banks
(d) none of the above

Q.37 Derivative products like swaps cover only foreign exchange risks and not interest rate
risks. [1 Mark]
(a) FALSE
(b) TRUE

Q.38 Which of the following types of account fall under the time deposit category?
(i) Current account
(ii) Term deposit account [1 Mark]
(a) only (ii)
(b) only (i)
(c) (i) and (ii)
(d) None of the above

Q.39 An efficient financial intermediation process has which of the following components:
(i) effective mobilisation of savings
(ii) their allocation to the most productive uses [1 Mark]
(a) only (i)
(b) only (ii)
(c) (i) and (ii)
(d) None of the above

107
 Q.40 A Nostro account is an account which an exporter maintains with a bank abroad [2 Marks]

(a) FALSE
(b) TRUE

Q.41 The main function of a commercial bank can be segregated into:

(i) payment system
(ii) Financial intermediation
(iii) Financial Services [1 Mark]
(a) (i), (ii), (iii)
(b) (i), (iii)
(c) (i), (ii)
(d) (ii), (iii)

Q.42 Self-Help Groups are set up to basically borrow from banks without making any savings
contribution. [2 Marks]
(a) FALSE
(b) TRUE

Q.43 A commercial paper issue made by a corporate is a non-SLR instrument [2 Marks]

(a) FALSE
(b) TRUE

Q.44 As at end-June 2008, the number of bank branches in the country was: [2 Marks]
(a) Between 75,000 to 80,000
(b) Between 70,000 to 75,000
(c) Between 80,000 to 85,000
(d) Between 65,000 to 70,000

Q.45 Loss assets comprise assets where a loss has been identified by [2 Marks]
(a) RBI
(b) Bank
(c) a and b
(d) None of the above

Q.46 RBI acts as the issuer of currency in India, but only the Central Government has the
right to destroy currency notes. [2 Marks]
(a) FALSE
(b) TRUE

108
Q. 47 No bank may hold shares in any company other than a subsidiary, exceeding 20.0%
of the paid up share capital of that company. [2 Marks]
(a) TRUE
(b) FALSE

Q.48 The deposits of regional rural banks are not covered by the DICGC [1 Mark]
(a) FALSE
(b) TRUE

Q.49 Normally, the following types of customers require higher due diligence under KYC
norms, except: [1 Mark]
(a) politically exposed persons (PEPs) of foreign origin.
(b) non-resident customers;
(c) farmers with land holding over 10 acres;
(d) high net worth individuals;

Q.50 The Banking Ombudsman is a senior official appointed by the RBI. [1 Mark]
(a) TRUE
(b) FALSE

Q.51 The RBI has prescribed that all SCBs should maintain their SLRs in [2 Marks]
(a) dated securities notified by RBI
(b) T-Bills of Government of India
(c) State Development Loans
(d) All the above

Q.52 What does EBT stand for? [1 Mark]

(a) Electronic Belated Transfer
(b) Electric Beginners transaction
(c) Electronic Benefit Transfer
(d) Electronic Beginning Transaction

Q.53 With growing savings among households in India, the need for retail credit is declining. [1 Mark]

(a) TRUE
(b) FALSE

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Q.54 In India, the RBI prescribes the minimum SLR level for Scheduled Commercial Banks
in India in specified assets as a percentage of Bank's ______ [3 Marks]
(a) Net Demand and Time Liabilities
(b) Demand Liabilities
(c) Time Liability
(d) None of the above

Q.55 If the beneficiary of a cheque has lost the cheque, he can instruct the paying bank to stop
payment of the cheque without waiting for the account holder's instructions.
[2 Marks]
(a) TRUE
(b) FALSE

Q.56 The CRR refer to the share of _____ that banks have to maintain with RBI of their net
demand and time liabilities. [2 Marks]
(a) illiquid cash
(b) forex reserves
(c) gold
(d) liquid cash

Q.57 While outsourcing, the only consideration should be cost savings [2 Marks]
(a) TRUE
(b) FALSE

Q.58 Lord Krishna Bank Ltd. is a [2 Marks]

(a) new private sector bank
(b) old private sector bank
(c) public sector bank
(d) regional rural bank

Q.59 Government securities issued by the Central Government are considered to be part of
SLR securities, but not securities issued by State Governments. [2 Marks]
(a) FALSE
(b) TRUE

Q.60 Under the Banking Regulation Act insurance is not included in the list of permissible businesses.
However, Ministry of Finance provides special permission to banks to
enter the insurance business. [2 Marks]
(a) FALSE
(b) TRUE
________________________________________

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Correct Answers :

Question No. Answers Question No. Answers

1 (d) 31 (d)
2 (a) 32 (a)
3 (a) 33 (a)
4 (b) 34 (b)
5 (a) 35 (b)
6 (b) 36 (a)
7 (b) 37 (a)
8 (c) 38 (a)
9 (b) 39 (c)
10 (c) 40 (a)
11 (b) 41 (a)
12 (b) 42 (a)
13 (a) 43 (b)
14 (a) 44 (a)
15 (d) 45 (c)
16 (b) 46 (a)
17 (d) 47 (a)
18 (d) 48 (a)
19 (b) 49 (c)
20 (d) 50 (a)
21 (b) 51 (d)
22 (d) 52 (c)
23 (b) 53 (b)
24 (a) 54 (a)
25 (b) 55 (b)
26 (a) 56 (d)
27 (a) 57 (b)
28 (b) 58 (b)
29 (d) 59 (a)
30 (a) 60 (a)

111