Principles of Indian Banking

This document contains the contents of the book.

This document contains the preface of the book.

Money is something which is generally accepted as a medium of exchange without any force. It is one of the most drastic inventions of mankind. Before money came into existence, exchange of goods and services took place through barter system, i.e. goods and services were exchanged for goods and services. Barter means direct exchange of goods and services. In other words, barter refers to exchanging of goods and services without the use of money. For example, corn may be exchanged for cloth, house for horses, bananas for oranges and so on.

The demand for money is the desired holding of financial assets in the form of money: that may be in the form of cash or bank deposits. It can refer to the demand for money, that narrowly defined as M-1 (non-interest-bearing holdings), or in the broader sense demand of money defined as M-2, M-3 and M-4. Money in the sense of M1 is dominated as a store of value by interest-bearing assets. However, money is necessary to carry out transactions. In other words, it provides liquidity to the customer.

The demand for money occurs from two significant roles of money. The prime factor is that money performs as a medium of exchange and the next it is a store of value. Therefore, individuals and businesses wish to keep money in a portion of cash and in the form of assets. There are two outlooks on this matter. The first is the scale outlook which is associated to the contact of the earnings or affluence level upon the demand for money. The demand for money is straight associated to the earnings level. The higher the earnings level, there will be higher demand for money. The second is the substitution outlook which
is associated to relative attractiveness of assets that can be substituted for money.

In monetary economics, the quantity theory of money states that money supply has a direct, proportional relationship with the price level. While mainstream economists agree that the quantity theory holds true in the long run, there is still disagreement about its applicability in the short run. Criticism of the theory argue that velocity of money is not stable and, in the short-run, prices are sticky, so the direct relationship between money supply and price level does not hold.

Continues increase in the general price level is called the inflation. The directory meaning of the word ‘inflation’ is expansion or an act of inflating. Inflation was first defined by the neo-classical economists. According to them, inflation means rise in prices as a result of the excessive increase in the quantity of money. They believe inflation is fundamentally a monetary phenomenon. But economists do not agree that money supply alone is the cause of inflation. They define inflation in terms of a continuous rise in prices. F.S. Brooman defines it as “a continuing increase in the general price level.”

Banking is a business of accepting deposits and lending money. It is carried out by financial intermediaries, which perform the functions of safeguarding deposits and providing loans to the public. In other words, Banking means accepting the deposits for the purpose of lending or investment for profit motives and giving the facility to customers to withdraw money by cheque, draft order and so on.

In the earlier societies functions, of a bank was done by the corresponding institutions dealing with loans and advances. Britishers brought into India the modern concept of banking by the start of Bank of England in 1694. In 1708, the bank of England was given the monopoly for the issue of currency notes by an Act. In nineteenth century, various banks started their operations, which primarily were receiving money on deposits, lending money, transferring money from one place to another and bill discounting.

The Reserve Bank of India (RBI) is India’s central bank and make, which controls the monetary policy of the Indian economy. It was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act 1934. The share capital was divided into shares of 100 each and fully paid which was entirely owned by private shareholders in the beginning. Following India’s independence in 1947, the RBI was nationalized in the year 1949.

Commercial banking activities are different from investment banking, which include underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients. Some commercial banks, such as Citibank and JPMorgan Chase, also have investment banking divisions, while others, such as Ally, operate strictly on the commercial side of the business.

It refers to the unique power of the banks to expand secondary deposits as a multiple of their cash reserve either by giving loans and advances or by investing in securities. Central bank is the first source of money supply in the form of currency in circulation. The Reserve Bank of India has the note issuing authority in the country. The RBI ensures availability of currency to meet the transaction needs of the economy. The total volume of money in the economy should be adequate to facilitate the various types of economic
activities such as production, distribution and consumption. The commercial banks are the second most important sources of money supply. The money that supply by commercial banks supply is called credit money.

Financial System refers to the financial needs of different sectors of the economy and the ways and means to meet such needs efficiently and economically. Funds are required for meeting various monetary needs. The financial system of any country comprises of financial institution, financial markets, financial instruments, and financial services. They constituent parts of financial system which are interdependent and work complementarily to each other. The financial system contributes to growth and development of the economy by mobilizing savings and allocating them to investors. The initiation of financial reforms in the early 1990s was essentially to bring about transformation in structure, effectiveness and stability of the financial system.

Capital market deals in medium-term and long-term loans securities. Business firms need only two types of finances: Short-term finance for purchasing raw-materials, for payment of salaries etc. Long-term finance for purchasing capital equipment and fixed assets such as machinery and tools etc. It meets long-term requirements of a firm. It is a market in which long-period securities are exchanged.

The Indian money market consists of diverse sub-markets, each dealing in a particular short-term credit. The money market fulfills the borrowing and investment requirements of providers and users of short-term funds, and balances the demand supply of short-term funds by providing an equilibrium mechanism. It also serves as a focal point for the Central Bank’s intervention in the market.

The value chain approach was developed by Michael Porter in the 1980s in his book “Competitive Advantage: Creating and Sustaining Superior Performance” (Porter, 1985). The concept of value added, in the form of the value chain, can be utilized to develop an organization’s sustainable competitive advantage in the business domain of the 21st C. All organizations consist of activities that link together to develop the value of the business, and together these activities form the organization’s value chain. Such activities may include purchasing activities, manufacturing the products, distribution and marketing of the company’s
products and activities (Lynch, 2003). The value chain framework has been used as a powerful analysis tool for the strategic planning of an organization for nearly two decades. The aim of the value chain framework is to maximize value creation while minimizing costs.

Project financing is the long-term financing of infrastructure and industrial projects that is based upon the projected cash flows of the project rather than the balance sheets of the project sponsors. Usually, a project financing structure involves a number of equity investors, known as sponsors, as well as a syndicate of banks or other lending institutions that provide loans to the operation. The loans are most commonly non-recourse of banks, which are secured by the project assets and paid entirely from project cash flow, rather
than from the general assets or creditworthiness of the project sponsors, a decision in part supported by financial modeling. The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of these assets, and are able to assume control of a project if the project company has difficulties complying with the loan terms.

Venture capital (VC) is financial capital provided to early-stage, high-potential growth and start-up companies. The venture capital fund earns money by owning equity in the companies it invest in which usually have a novel technology or business model in high technology industries, such as biotechnology, IT and software. The typical venture capital investment occurs after the seed funding round as the first round of institutional capital to fund growth (also referred to as Series A round) in the interest of generating a return through an eventual realization event, such as an IPO or trade sale of the company. Venture capital is also type of private equity.

A bank is a business firm. Its main aim is to earn profit. In order to achieve this objective, it provide services to the customers. It offers a variety of interest bearing obligations to the public. These obligations are the sources of funds for the bank and are shown on the liability side of the balance sheet of a commercial bank.

Merchant banking is a term originated from the London (UK) which initiated financing to foreign trade by accepting bills and soon this service was spread out to help underdeveloped countries’ government raise long-term funds. This service later got to know by its name “Merchant Banking and Securities House Association” as an association. Merchant banking can be defined as a financial institution which includes a vast array of activities such as shares underwriting, managing portfolio, project counselling, insurance etc. and all of these services are complimentary, i.e. free.

E-banking in simple terms means, it does not involve any physical exchange of money, but it's all done electronically from one account to another using the Internet. Internet banking is just like normal banking with one big exception. You don't have to go to the bank for transactions. Instead, you can access your account anytime anywhere in any part of the world. For busy executives, students and homemakers, e-banking is virtual blessing. No more talking precious time off from work to get a demand draft made or a cheque book issued.

A credit card is a payment card issued to users as a mode of payment. It allows the cardholder to pay for goods and services based on the holder’s promise to pay for them. The issuer of the card creates a revolving account and grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance to the user. Credit card is a small plastic card containing a means of identification, such as a signature or picture that authorizes the person named on it to charge goods or services to an account, for which the cardholder is billed periodically.

In today’s life, Banking is a sector or place which is most visited and most working department in the country whether it may be private, nationalized, RRB’s, co-operative etc. Almost all the economy transactions are dealt with banks only. The load of work is increasing day-by-day on banks taking into account whether it is scholarship or farmers loan or subsidy to farmers or for students or corporate sectors. As a result of increasing workload on banks, there is also an increase of inadequacies and deficiency of services by the banks to the customers or the general public.

Universal banking is a combination of Commercial banking, Investment banking, Development banking, Insurance and many other financial institutions. It is a place where all financial products are available under one roof. So, a universal bank is a bank which offers commercial banking functions plus other functions such as Merchant Banking, Mutual Funds, Factoring, Credit cards, Housing Finance, Auto loans, Retail loans, Insurance, etc.

Indian economic environment is witnessing path-breaking reform measures. The financial sector, in which the banking industry is the largest player, has also been undergoing a drastic change. Today the banking industry is stronger and capable to bear the pressure of competition. While internationally accepted prudential norms have been adopted, with higher disclosures and transparency, Indian banking industry is gradually moving towards adopting the best practices in accounting, corporate governance and risk management. Interest rates have been deregulated, while the rigour of directed lending is being progressively reduced.

The Securities and Exchange Board of India (frequently abbreviated SEBI) is the regulator for the securities market in India. It was officially established by the Government of India in the year 1988 and given statutory powers in 1992 with SEBI Act 1992 being passed by the Indian Parliament. Controller of Capital Issues was the regulatory authority before SEBI that came into existence; it derived authority from the Capital Issues (Control) Act, 1947.