5.Indian Economy : Commercial Banking

Commercial Banks are banking organizations that deal with the deposits and loans of businesses

Commercial banks exhibit the money multiplier effect by accepting deposits, holding a certain amount as a reserve, and then dispersing the funds as loans to add liquidity to the economy.

Commercial Bank

They operate under the Banking Companies Act, 1956.
These banks are run solely for profit motive and not for the purposes of charity.
They issue bank checks and drafts and accept term deposits.
The first commercial bank in India was Oudh/ Awadh Commercial Bank that started in 1881.
Punjab National Bank, started in 1894, was the first bank, commercial in nature, which continues to function till date.
There are 48 commercial banks in which 27 are classified as public sector banks, 19 are categorized under nationalized banks, and 2 banks are termed under ‘Other Public Sector Banks.’

Note:

First Bank in India was Bank of Hindustan established in 1770.
Later the General Bank of India started in 1786. Both the Banks served only the Britishers and did not provide banking services to the people at large.
The first foreign Bank in India was established in 1858. Its name was Chartered Bank.
The largest bank in the world is ICBC [Industrial and Commercial Bank of China].

Scheduled Commercial Banks

Banks which are dealing with day to day working and listed under the second schedule of the Reserve Bank of India Act, 1934.
Requirements to be listed under the Second Schedule of RBI are:
- The Paid up capital of the bank should be more than Rs 5 crore.
- The banks should work in the interests of the depositors.
A scheduled commercial bank will get the protection of the RBI.

Public Sector Bank

Ownership of government is 51%
Largest government bank is State Bank of India. It was nationalized in 1955. It is the 53rd largest bank across the globe.
In 1969, 14 Private Banks, whose deposits were more than 50 crore rupees, were nationalized.
In 1980, six more private banks whose deposits were more than 200 crore rupees were nationalized.

State Bank of India

State Bank of India (SBI) is the oldest commercial bank in India. It was constituted under the State Bank of India Act, 1955.
The State Bank of India dates back to the foundation of the Bank of Calcutta on June 2, 1806 in Calcutta.
Three years later, the bank was renamed as the Bank of Bengal in 1809.
In 1921, the bank was amalgamated with the Bank of Bombay and Bank of Madras to form the Imperial Bank of India.
The control of the Bank was taken over by the government in 1955 based on the recommendations of All India Rural Credit Survey Committee. This resulted in the formation of the State Bank of India on 1 July 1955.
Later, the State Bank of India (Subsidiary Banks) Act was passed in 1959 which enabled the State Bank of India to take over seven former State-associated banks as its subsidiaries (later named Associates).
Today, SBI in totality is SBI + 7 subsidiaries + Bharatiya Mahila Bank.

Nationalization of Banks

Nationalization of banks was implemented under the Banking Companies (Acquisition and Transfer of Undertakings) Act of 1970.
Reasons for Nationalization of banks:
- Lack of bank branches in the Country. In 1965, one branch was serving approximately 65,000- 66,000 citizens.
- Nationalization of banks would provide the government an opportunity to open banks in the rural areas. Post nationalization, the government opened many branches in rural areas.
- By 1991, 1 branch served around 14,000 people. This further provided employment opportunities to the people
- One major benefit of nationalization was people’s trust on banks increased and the deposits in banks which stood at around Rs 820 crore in 1949, increased to 1,92,000 crore in 1991. This provided a boost to investment activities in the country.
Oriental Bank of Commerce (OBC) and the United Bank of India (BOI) are merged into Punjab National Bank.
Canara Bank and Syndicate Bank are merged.
Union Bank of India merges Andhra Bank and Corporation Bank.
The Indian bank will be combined with Allahabad Bank.
Vijaya Bank and Dena Bank were merged with Bank of Baroda.

Advantages of Merger of Banks

The merger would result in an increase in the assets of the banks which can then provide more funds for investment activities in the country.
Merger of banks enables diversification of activities of the banks which can expand the market access of the banks.
It would increase the efficiency of the banks and lower down the risks of bankruptcy.

Positive Impact of Bank Nationalization

Financial savings rose as lenders opened new branches in areas that were unbanked.
Gross domestic savings almost doubled as a percentage of national income in the 1970s.
Public deposits in the banks increased significantly.

Negative Impact of Bank Nationalization

Credit planning also meant that the interest rate structure became incredibly complex. There were different rates of interest for different types of loans.
Due to less competition between the public and private sectors as a result of nationalization, PSU operations have once more adopted a bureaucratic approach. Lack of initiative and accountability, populist pressures, irresponsible trade unionism, red tape, etc.

Consequences of Bank Nationalization

The impact of bank nationalization can be thought about in terms of three core areas: deposits, lending and interest rates.

Financial Inclusion

Financial Inclusion means that everyone in the country should be able to get the benefit of banking facilities.
Normally it is said that there should be atleast one account with each and every household of the country.
Having an account would lead to savings and can be used for the purpose of investment.
To provide a boost to financial inclusion, the central government, in 2011, came up with a No frills account [account where minimum balance is not to be maintained].
The name was changed to Jan Dhan Account in 2014 under the Pradhan Mantri Jan Dhan Yojana. This universalized banking activities in the country.
The Nachiket Mor Committee was set up by the Government to ensure financial inclusion. This committee recommended establishment of New Banks in the country, after which Small Finance Banks and Payment Banks were established in the country.

Small Finance Bank

The small finance bank shall be registered as a public limited company under the Companies Act, 2013.
The minimum paid-up equity capital for small finance banks shall be Rs. 100 crore.
The small finance bank will primarily engage in fundamental banking operations such as deposit acceptance and lending to unserved and underserved populations.
25% of their branches should be opened in rural areas.
SFBs must maintain Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR).
They are expected to offer 75% of their Adjusted Net Bank Credit (ANBC) to sectors qualifying for priority sector lending. Out of which 50% loans to be given to MSME sector.
SFBs can also transfer to a universal bank if they meet the minimum paid-up capital/net worth standards of universal banks.
They are not permitted to work as a Business Correspondent (BC) for another bank. They can, however, have their own BC network.

Payment Bank

The payments bank will be registered as a public limited company under the Companies Act, 2013, and licensed under Section 22 of the Banking Regulation Act, 1949.
The minimum paid-up equity capital of the payments bank shall be Rs. 100 crore.
A payments bank is like any other bank, but operating on a smaller scale without involving any credit risk.
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.
Acceptance of demand deposits, i.e., current deposits, and savings bank deposits from individuals, small businesses and other entities are permitted.
Apart from amounts maintained as Cash Reserve Ratio (CRR) with RBI on its outside demand and time liabilities, it will be required to invest minimum 75 percent of its “demand deposit balances” in Government securities/Treasury Bills.

Note: On 2nd October 1975, the inaugural Regional Rural Bank named “Prathama Grameen Bank” was established.

Cooperative Banks

These banks are registered under the Cooperative Societies Act 1912.
They are regulated by RBI under the Banking Regulation Act 1949 and Banking laws application to Cooperative Societies Act 1965.
These banks are working at four different levels:
1. Primary Agricultural Cooperative Societies at the village level.
2. District Central Cooperative Banks at the district level.
3. State Cooperative Banks at the state level.
4. Primary Agricultural and Rural Development Banks for long term loans.

Primary Agricultural Banks

Primary Agricultural Banks which are otherwise known as Urban Cooperative Banks are registered as Cooperative Societies under the Cooperative Societies Act of the concerned state or the Multistate cooperative societies and function in urban areas and the business is similar to that of Commercial banks.
They are licensed by RBI for the banking business.
RBI is both the controlling and inspecting authority for the primary cooperative banks.

Lead Bank Scheme: (Launched in December 1969)

The genesis of the Lead Bank Scheme (LBS) can be traced to the Study Group headed by Prof. D. R. Gadgil (Gadgil Study Group) on the Organizational Framework for the Implementation of the Social Objectives, which submitted its report in October 1969.
The Study Group drew attention to the fact that commercial banks did not have adequate presence in rural areas and also lacked the required rural orientation. The Study Group, therefore, recommended the adoption of an ‘Area Approach’ to evolve plans and programmes for the development of an adequate banking and credit structure in the rural areas.
Pursuant to the above recommendations, the Lead Bank Scheme was introduced by the Reserve Bank of India in December 1969.
Introduced for both Private as well as Public sector banks. The Scheme aims at coordinating the activities of banks and other developmental agencies through various fora in order to achieve the objective of enhancing the flow of bank finance to the priority sector and other sectors and to promote banks’ role in the overall development of the rural sector.
For coordinating the activities in the district, a particular bank is assigned ‘Lead Bank’ responsibility of the district. The Lead Bank is expected to assume a leadership role for coordinating the efforts of the credit institutions and the Government for better financial inclusion in rural areas.
In literal terms, Lead Bank means the Bank which leads from the front. Lead role will be assigned to a bank for executing development in the assigned district. Commercial Banking
Later came the problem when banks complained about constraints in handling the district area (as said in the Lead bank scheme).
RBI came up with a solution and asked banks to handle particular areas of the district. This led to formation of a new approach, called Service Area Approach.

Service area approach

The Service Area Approach (SAA) introduced as a sub scheme for Lead Bank scheme in April 1989, in order to bring about an orderly and planned development of rural and semi- urban areas of the country, was extended to all Indian scheduled commercial banks including Regional Rural Banks (RRBs).

Under the SAA, all rural and semi-urban branches of banks were allocated specific villages, generally in geographical contiguous areas, the overall development and the credit needs of which were to be taken care of by the respective branches.

Differential Rate of Interest Advances (DRI Advances)

Government of India had formulated in March, 1972 a scheme for extending financial assistance at concessional rate of interest at 4% to selected low-income groups for productive endeavors initially by public sector banks and then by private sector banks also. The scheme is known as the Differential Rate of Interest Scheme (DRI).

Eligibility:

Income criteria: Income to be less than or equal to 24000 rs per annum for urban families. Income less than or equal to 18000 rs per annum for rural families.
Land criteria: Maximum 1 acre to be owned at irrigated areas and 2.5 acre land in un-irrigated areas.
Note : Any eligibility criteria of land won’t apply to SC & ST families.

Interest Rate Determination

Base Rate

Base rate is the minimum rate of interest of Banks below which banks are not allowed to lend to its customers except in the cases allowed by the RBI such as differential rate of interest, loans to bank employees, loans against fixed deposit.
Base rate is decided in order to enhance transparency in the credit market and ensure that banks pass on the lower cost of funds to their customers.
Loan pricing will be done by adding base rate and a suitable spread depending on the credit risk premium.
Every bank needs to calculate its Base rate on its own.
Base rate is always greater than Repo Rate.
Problems in Base Rate:
- There was the same rate of interest for every person irrespective of other differences like,
  - If one is taking a loan for short term or long term.
  - The risk factor.

Marginal Cost of funds-based Lending Rate (MCLR)

From the financial year 2016–17 (i.e., from 1st April, 2016), banks in the country have shifted to a new methodology to compute their lending rate. The new methodology, MCLR (Marginal Cost of funds-based Lending Rate) which was articulated by the RBI in December 2015.
According to the rule every bank has to calculate its MCLR across different tenures. To this, the bank will add other components including operating cost and tenor premium.
A tenor premium is the compensation for the risk associated with lending for the long term.
Taking all these component banks will publish MCLR for 1 day, 1 month, 3 months, 6 months, 1 year and so on.

Repo Rate Linked Lending Rate (RRLLR)

As the name suggests, repo rate linked lending rate or RRLLR is the lending rate which is linked to the RBI’s repo rate. However, the effective RRLLR interest rate depends on multiple factors.
RRLLR = Repo Rate + Operation Cost + Risk assigned.
NOTE: Operation Cost + Risk assigned together called as Spread. Now RRLLR is not in use.
For example, the RLLR-linked home loan interest rate will depend on several factors such as what the loan amount is, the loan-to-value of the loan and even the risk group of the borrower, amongst other things. There can be a Spread or Margin charged by the bank.
To explain, a bank may have an RLLR of 6.5 per cent, but the actual home loan interest could be 7.5 per cent, of which 1 per cent will be the Spread or Margin of the bank.
Banks are free to fix Margin while lending to the borrowers.

External Benchmark Lending Rates

The lending rates set by banks based on external benchmarks like the repo rate.
91-day and 182-day Treasury bills are known as external benchmark lending rates, or EBLR.
Each bank has the option to link its lending rates to any such external benchmark. This would guarantee a clear and efficient method of determining loan rates in line with the macroeconomic scenario.
Rarely operational now-a-days.

Call Money

It implies banks are borrowing/lending among each other on a day-to-day basis, i.e., that a bank short of funds on a particular day is borrowing from another bank which has the surplus amount.
Rate of interest here is decided by Banks themselves.
In a same way,
- When banks borrow money from other banks for more than 1 day to 14 days, it is called ‘Notice money.’
- When banks borrow money from other banks for exceeding 14 days it is called ‘Term money’.

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