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What is Banking System in India? Research Team | Posted On Saturday, February 21,2009, 07:04 PM

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What is Banking System in India?




Banking Regulation Act, 1949 defines banking as, "the accepting for the purpose of lending or investment, of deposits from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise."

Most of the Banking activities are derived from the above definition. Apart from the activity of accepting and lending money, banks are allowed to perform certain activities which are supplementary to this business of accepting deposits and lending, Banks are allowed to perform certain activities which are ancillary to this business of accepting deposits and lending. A bank's relationship with the public revolves around accepting deposits and lending money. Another activity which is assuming increasing importance is transfer of money - both domestic and foreign - from one place to another. This process is generally known as "remittance business" in banking phrase. Forex (foreign exchange) business is largely a part of remittance although it involves buying and selling of foreign currencies.

In short, a banker or bank is a financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money, it is an institution where one can deposit and borrow money and take care of financial affairs.

The first modern bank, named Bank of St. George was founded in Italy in Genoa in 1406.

Banking law is based on the analysis of the relationship between the bank and the customer. The definition of a customer is any person for whom the bank agrees to conduct an account.

A bank is defined as "a commercial institution licensed as a receiver of deposits and giver of loans, both short and long term"

A banking company is defined as, "any company which transacts the business of banking in India."

Functions of Bank

Functioning of a Bank is among the more problematical of corporate operations. Since Banking involves dealing directly with money, governments in most countries regulate this sector rather strictly. In India, the regulation traditionally has been very strict and at the same time NPAs are also of a very high order. The process of financial reforms, which started in 1991, has cleared the staleness but a lot remains to be done. The large number of policy and regulations that a Bank has to work with makes its operations even more complicated, sometimes bordering on illogical. Banking Regulation Act of India, 1949 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 cheques, draft, order or otherwise."The law governing Banking Activities in India is called as "Negotiable Instruments Act 1881". Following are the major activities of banks :

  • Borrowing or raising of money
  • Lending or advancing of money with or without security
  • Drawing, accepting, discounting, buying, selling and collecting bills of exchange, hundis, promissory notes, drafts, and other instruments
  • Granting and issuing of letters of credit, circulars notes and travelers’ cheques
  • Buying and selling of foreign exchange
  • Buying and selling of bullion
  • Acquiring, holding, underwriting and dealing in stocks, funds, shares, debentures, bonds and investments of all kinds
  • Purchasing and selling of bonds and other forms of securities on behalf of customers
  • Receiving all kinds of bonds or valuables on deposit or for safe custody
  • Collecting and transmitting of money and securities
  • Carrying on and transacting all kind of guarantee and indemnity business
  • Managing, selling and realizing any property which form the security or part of the security for any loans or advances.
  • Acting as an agent for any government or local authority or for any other persons
  • Contracting and issuing public or private loans
  • Insuring, guaranteeing, underwriting, and participating in managing and carrying out of any issue (shares and Debentures) and lending of money for the purpose of any such issue
  • Undertaking and execution of trusts
  • Undertaking the administration of estates as executor, trustee etc.
  • Establishing and supporting institutions funds, trusts etc.
  • Acquiring, constructing and maintaining building for its own purpose
  • Selling, exchanging, managing, developing, leasing, mortgaging or disposing its own property
  • Performing all such activities that are incidental or favorable for the promotion or advancement of its business
  • Performing all other business specified by the Central Government as the lawful business of a banking company

Prohibited Activities of a Bank :

Banking Regulation Act prohibits banks from performing some activities. Banks are not allowed to do such activities, they are :

  • Engaging directly or indirectly in trading activities and undertaking risks.
  • Buying or selling of goods directly or indirectly.
  • Any action that may be in direct clash with their other work such as acting as stock brokers or broker in the money market or in trading goods.
  • Engaging on its own account along with others or alone in wholesale or retail trade including import or export.
  • Purchasing of any immovable property except as essential for the purpose of conducting its business or for providing amenities for its staff or for its own use.
  • Holding any part of the share capital of other institutions or having a direct interest in any financial, commercial, agricultural or other undertaking.
  • Engaging in any buying or selling of goods for others except in connection with undertaking the administration of estates as executor, trustee or otherwise.
  • Holding shares in any company as mortgagee or pledgee or an absolute owner of an amount exceeding 30 percent of the paid up capital of that company or 30 percent of its own capital whichever is less.
  • Investing in a subsidiary company, financial institution, financial services company or stock exchange where the investment exceeds 10 percent of the bank’s paid up capital and reserves.
  • Participating in equity of financial services ventures without obtaining the prior approval of RBI.

Subsidiary company of a bank:

Banking companies have the right to set up a subsidiary company of their own for the purpose of doing any business that is permitted to the banking company. But they have to obtaining the prior approval of the RBI.

A bank can set up a subsidiary company only for carrying out limited activities, such as :

  • Undertaking of any business that is permitted by the Banking Act or Reserve bank of India
  • Carrying on the business of banking outside India
  • Undertaking of such businesses which, in the opinion of the RBI, would be beneficial to the spread of banking in India
  • Carrying out leasing business and investing in shares of equipment leasing companies

Services Offered by banks:

  • Accepting deposits
  • Lending of credit
  • Collection of cheques, demand drafts, promissory notes, bills of exchange, etc.
  • Purchase of domestic and foreign currency documentary, negotiation of bills under domestic and foreign letters of credit, advising of domestic and foreign letters of credit established by branches and correspondents
  • Giving standing instructions for payments
  • Issue of performance guarantees and financial guarantees
  • Safe custody of securities and deeds
  • Purchasing and selling of securities
  • Fund remittance
  • Collection of bills, interest on securities, dividend on shares
  • Credit transferring
  • Issuance of travelers’ cheques and gift cheques
  • Acting as trustees and executors
  • Issue of credit cards
  • Underwriting of shares

Bank Account:

A Bank Account is the record of financial relationship between the customer and the Bank. It contains details of all the moneys deposited with the Bank and withdrawn from it.

Law of banking:

The law implies rights and obligations into the relationship between the customer and the Bank as follows :

  • The bank engages to pay the customer's cheques up to the amount remaining to the credit of the customer's account, plus any agreed overdraft limit.
  • The bank account balance is the financial position between the customer and the bank, when the account is in credit, the bank owes the balance to the customer, when the account is overdrawn, and the customer owes the balance to the bank.
  • The bank has a lien on cheques deposited to the customer's account, to the extent that the customer is obliged to the bank.
  • The bank engages to punctually collect the cheques deposited to the customer's account as the customer's agent, and to credit the proceeds to the customer's account.
  • The bank has a right to combine the customer's accounts, since each account is just a part of the same credit relationship.The bank may not pay from the customer's account without the permission from the customer.
  • The bank must not reveal the particulars of the transactions going through the customer's account unless the customer agrees, there is a public duty to disclose, the bank's interests require it, or under compulsion of law.
  • The bank should not close a customer's account without reasonable notice to the customer.

These implied contractual terms may be changed by express agreement between the customer and the bank. The statutes and regulations in force in the authority may also modify the above terms and/or create new rights, obligations or limitations relevant to the bank-customer relationship.

In India almost 80% of the banking business is under the control of Public Sector Banks (PSB). PSBs are still dominating the Indian commercial banking system. Shares of the leading PSBs are already listed on the stock exchanges.

The Reserve bank of India (RBI) has given licenses to new private sector banks as part of the liberalization process. The RBI has also been granting licenses to industrial houses. Many banks are successfully running in the retail and consumer segments but are yet to deliver services to industrial finance, small business retail trade and agricultural finance.

The PSBs are playing an important role in the industry due to its number of branches and foreign banks facing the limitation of limited number of branches. Hence, in order to achieve an efficient banking system, the responsibility is on the Government to encourage the PSBs to be run on professional lines.

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