Commercial Banks

Commercial Banks are the oldest and the largest banking institutions in India. Some of them are more than hundred years old. Their branches are spread all over the country and have penetrated in the countryside as well. Commercial Banking has passed through three distinct phases in India since Independence. The period 1955-1970 witnessed the genesis of public sector in lndian banking concerning with the setting up of the State Bank of India in 1955 and ending with the nationalisation of 14 major banks in 1969.

The two decades after nationalisation of banks i.e. the seventies and eighties witnessed the conversion of class banking  into mass banking. During this period brunch expansion took place on a large-scale, followed by recruitment of large number of bank employees, expansion in priority sector advances, especially for the poor and neglected sectors.
Loan Melns were the main feature of this period. On the other hand, the Reserve Bank of India's regulatory control intensified over various facets of banking operations. The post nationalisation era was not without its resultant problerns. With poor training, employee efficiency and productivity went down, problem of non-recovery of loans cropped up, and pre-ernption of funds in meeting statutory requirements went up, resulting in reduced profitability of banks.

It was such a situation in 1991 when the new economic policies were launched by the Government. A Committee on financial sector under the Chairmanship of Shri M, Narashimham was appointed which suggested measures of far-reaching significance to improve efficiency, productivity and profitability of banks. 

Indian Banking Sector in the Pre- Independence Era

Even if banking business was present in India since the ancient period, modem banking had been started in 1786 with the establishment ofthe General Bank of India Thereafter, three Presidency banks were established in the early 19th century in Bengal, Bombay and Madras. These three banks were merged to form the Imperial Bank of India i 1921, which started business as pnvate shareholders banks, mostly Europeans shareholders Allahabad Bank established m 1865, was the first bank established exclusively by Indians In 1894, Punjab National Bank Ltd was formed. During the period from 1906 and 1913, ‘swadeshi movement’ m India inspired local businessman and political figures to form banks to cater for the Indian community This period witnessed the establishment of a senes of banks like Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank and Bank of Mysore In 1935, the Reserve Bank of India was established as the Central Bank of India.

Indian Banking Sector in the Early Independence Era

After independence, India inherited a weak and unstable banking industry characterized by numerous small and unstable private banks There were approximately 1100 banks in India, mostly small During this period, bank failures became common and frequent, resultmg mto distrust ofthe common mass in the banking system Indian banks faced periodic failures between 1913 and 1948 This series of bank failure drew attention ofthe government and called for some policy measures to recuperate the situation Furthermore, it was comprehended that through the banking sector, scarce financial resources of the economy could be channelized to the strategically important sectors to pave the way of rapid and balanced economic growth of the newly independent country The government of India, appreciating the importance of commercial banks as a tool to facilitate India’s planned development strategy, realized the necessity for an effective and integrated supervisory authority ofthe entire banking system ofthe country In 1949, the Reserve Bank of India (RBI) was nationalized and given soul authority of banking supervision in this country. In 1955, the government nationalized Imperial Bank ofIndia with extensive banking facilities on a large scale especially in rural and semi-urban areas It formed State Bank of India to act as the principal agent of RBI and to handle banking transactions ofthe Union and State Governments all over the country.

Subsequently, in1959, the state owned banks of eight princely states were acquired by the State Bank of India and thus the government dominance in the banking business of India was established. During the five year plan period, the RBI and the government nurtured and encouraged commercial banks through various financial mcentives and other supportive programs to deliver cheap credit to industries to implement the import substitute growth model adopted by the planning commission of India.

The traditional role to provide with only short-term credit was modified by the introduction of formal term loans and underwriting of new issues of corporate securities by Indian commercial banks In order to cater the credit requirements of small and medium size enterprises, the government encouraged banks to continue term lending Refinance Corporation ofIndustry (RIC) Ltd was established in 1958 RIC provided refinance facility to commercial banks agamst approved term loans Later RIC was merged with Industrial Development Bank ofIndia in 1964 Government categorized small-scale industries, agriculture and export as priority sectors in order to direct uninterrupted institutional credit to these sectors to fulfill the national objectives of planning In 1960, government devised Credit Guarantee Scheme (CGS) in consultation with RBI to guarantee the major part of the loans given to the small-scale industries by commercial banks on payment of a small fee It also facilitated the commercial banks to borrow from RBI at concessional rate in case they mcrease the volume of lending to these sectors The guarantee by the government reduced the credit risk ofcommercial banks lending to the small-scale sector.

Concessions provided the banks with mcentive to lend to the priority sector. Likewise Export Risk Insurance Corporation (renamed now as Export Credit and Guarantee Corporation) was established in 1957 It provided credit to exporters, insurance against volatility offoreign exchange rates It also took care of moral hazard problems associated with the asymmetric information of importers and exporters.

To promote growth in agriculture and allied activities. The Agricultural Refinance Corporation Ltd was established as a subsidiary of RBI in 1963 The primary aim of this institute was to act as a refinancing agent for providing medium term and long-term finance to financial institutions for lending to agricultural and allied activities Indian banking sector became matured in this phase due the supervision and rigorous control by RBI By the 1960s the Indian banking sector became an important channel to facilitate development policies At the same time, the banking sector emerged as a large source of employment The State Bank of India was the only nationalized bank then By that time it was felt that despite the progress in 1950s and 1960s, the State Banks were not sufficient to meet the increasing banking demand in the country Moreover, the activities of private banking institutions were uneven among different states, different production sectors as well as within different weaker sections ofthe community .

These factors created a possibility of nationalization of banks Two major objectives of the nationalization of banks in India were rapid branch expansion and channelizing the credit flow to the sectors according to the priorities set by the pohcy makers. In order to achieve social control over banks, several measures had been taken by the government Ultimately, the government nationalized 14 major banks in 1969 The scheduled commercial banks comprised of public sector banks, private sector India banks, foreign banks operating in India, and regional rural banks (RRBs) In 1980, government nationalized another six commercial banks The activities ofprivate sector and foreign banks were restricted through branch licensing and entry regulation norms. 

Indian Banking Sector after Nationalization

Reflecting increasingly socialistic inclmation ofthe policies of the government of India, all large banks ofIndia were nationalized in two phases first in 1969 and second in 1980 Nationalized banks remained corporate entities, retammg most of their staff, with the exception ofthe Board of Directors, which was replaced by the appomtees of the central government. During the phase of nationalization, Indian banks catered to the needs of a planned development m a mixed economic structure In those days, primary thrust ofthe policy makers was not on upgrading efficiency or profitability of production process but to construct the core industries to attain a sustamable development and to mamtam a minimum standard of living for the common people In Iine with this aim, one ofthe major objectives ofthe nationalization ofcommercial banks was to extend the reach oforganized banking services to rural areas as well as neglected and priority sections of the country Subsequently, bank branches were expanded in rural areas with imposition of quantitative credit controls on banks, especially to extend credit flow to the national priority sectors As a result, there was significant increase of banking habits among people and large mobilization of savmgs Commercial banks played a major role in widenmg the scope oftrade and commerce in this country The foreign banks and domestic private banks, coexisting with the nationalized banks during this period, were highly restricted through entry regulations and branch licensing policies of the RBI Therefore, their banking activities were limited in the pre reforms period in India During the nationalized phase, Indian banking system was highly regulated and financially repressed due to the prevalence of reserve requirements, interest rate controls, and regulated allocation of financial resources to the priority sectors In order to finance the huge expenditure required for the five year plans, the fiscal deficit of the government of India was very high in those years.

To facilitate large borrowing requirements ofthe government, arising due to high fiscal deficit, interest rates on government securities were artificially pegged at low levels The market conditions played no role in determination ofthis interest rate RBI set the target of 40 percent ofthe net bank credit to priority sector for Indian commercial banks (both public sector and domestic private sector banks) and 32 percent for the foreign private banks operating in India. The over regulated and over administered banking polices eroded the capital base of most of the public sector banks and the banks accumulated huge amount of non performing asset which became an alarming problem for the entire banking industry. To cope with the adverse situation, a policy ofrecapitalization of 19 nationalized banks was adopted by the government through a budgetary provision. The government also provided the banks with money towards writing down the capital base for adjustment of their losses. However, acute problem occurred m the productivity, efficiency and profitability aspects of the commercial banks.

This regime witnessed the policy of directed investment in the form of high SLR (Statutory Liquidity Ratio) and CRR (Cash Reserve Ratio) The policies of non-market oriented directed credit programs, extra administrative interference in credit decision-making, high operatmg costs, and regulated interest rates, non-transparent accounting system coupled with nonexistence of operational flexibility, internal autonomy and absence of competition had contaminated the health ofthe commercial banks and threatened their future survival During 1980s, there was very high level of monetization of government’s fiscal deficit in India This large scale monetization, in effect led to frequent hike in the cash reserve ratio ofthe banks to cope with the adverse effects ofthe highly expansionary monetary policies The mterest structure ofthe economy was much regulated and complex As an outcome ofthe social and economic policy to provide concessional credits to certain priority sectors , higher mterest were charged to the borrowers of the non-concessional sectors.

This gave birth to a segmented and underdeveloped banking sector in this country Administered interest rate for lending led to regulation of deposit rates in order to keep cost of funds to banks at a reasonable level The operational expenditure ofthe public sector banks tremendously increased manifolds due to rise in number of branches, poor supervision, rising staff level and high unit cost administering loan to the priority sector However, during 1980s, it was clear that operational efficiency of Indian commercial banks was not satisfactory. Administered and distorted interest rate structure, differential lending rates to priority and non priority sectors etc adversely affected the viability and profitability ofbanks Banks were characterized by low profitability and huge amount of non performing asset. The major reasons behind the massive deterioration in banking performance was highly regulated interest and cash reserve ratio policies, low interest charged on government bonds, directed lending, lack of competition, and lack of transparency, accountability, and prudential norms in the banking activities.

Activities of the commercial banks in India are expanding at a rapid space during the period after Independence. There is territorial as well as functional. Expansion of the activities of the bank. Banks which are conservative and conventional in their approach have come out from their shell and face the challenges of planned economic growth. In recent years non-conventional sectors are receiving the attention of commercial banks in India. A better understanding of the implications of financing nonconventional sector by commercial banks is possible only if one looks back the position of commercial banks during the pre-nationalization era. Banking in India before nationalization. Commercial Banks are is the institutions that ordinarily accept deposits from the people and advances loans. Commercial Banks also create in India; such banks alone are called Commercial Banks which have been established in accordance with the provisions of the Banking Regulation Act, 1949. Commercial Banks may be Scheduled Banks of NonScheduled Banks. 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. According to Reserve Banks of India Act 1934, ‘A Scheduled Bank is that bank which has been included in the second schedule of the Reserve Bank’.

STRUCTURE OF INDIAN COMMERCIAL BANKS

Having established the pivotal role performed by the banking system in the Indian financial sector and by implication, in the overall financial intermediation process, thus supporting the real sector of the economy. The strong points of the financial system are its ability to mobilize savings, its vast geographical and functional reach and institutional diversity. Between 1965 and 1990, the household sector’s gross savings in the form of financial assets rose from 5.5 per cent to 12.2 per cent of net domestic product. Since 1969 when major banks were nationalized, the number of commercial bank branches increased from about 8,300 to well over 65,000 by 2005.

The commercial banking structure in India consists of: Scheduled Commercial Banks and Unscheduled Banks. Scheduled commercial banks constitute those banks, which have been included in the Second Schedule of Reserve Bank of India (RBI) Act, 1934. RBI includes only those banks in this schedule, which satisfy the criteria laid down vide section 42 (6) (a) of the Act. Indian banks can be broadly classified into nationalized banks/ public sector banks, private banks and foreign banks. The Indian banks include 27 public sector banks excluding 196 Regional Rural Banks (RRBs).

CLASSIFICATION OF COMMERCIAL BANKS

1. Scheduled banks: - Banks which have been included in the Second Schedule of RBI Act 1934. A scheduled bank is one, which is registered, in the second schedule ofthe Reserve Bank of India. The following conditions must be fulfilled by a commercial bank for inclusion in the schedule.

1. The banker concerned must be in business of banking in India;

2. It is either a company defined in Section 3 ofthe Indian Companies Act 1956, or corporation or a company incorporated by or under any law inforce in any place outside India or an institution notified by the Central Government in this behalf;

3. It must have paid-up capital and reserves of an aggregate real exchangeable value ofnot lessthan rupeesfive lakhs;

4. It must satisfy the Reserve Bank ofIndia that its affairs are not conducted in amanner detrimental to the interests ofits depositors.

Schedule banks are under the purview ofthe various credit control measures of the RBI. They are required to maintain a certain minimum balance in their accounts with RBI and do certain things prescribed by the RBI. They also enjoy certain privileges from the RBI such as refinancing facilities, clearance facilities etc.

According to Section 42.of the Reserve Bank of lndia Act, 1934, banks-both public sector and private sector banks, are given the status of a Scheduled Banks, if their names are included in the Second Schedule to the Reserve Bank of India Act. For this purpose, the bank must satisfy the 1 following conditions:

i) It must have a paid-up capital and reserves of an aggregate value of not less than Rs. 5 lakhs,

ii) It must satisfy the Reserve Bank of India that its affairs are not being conducted in a manner detrimental to the interest of its depositors, and

iii) It must be a State Co-operative Bank or a company or an institution notified by'the Central Government in this behalf, - or a corporation, or a company incorporated under any law.

Thus, besides Commercial Banks, Regional Rural Banks, State Co-operative Banks and Urban Co-operative Banks are also entitled to get the status of a Scheduled Banks.

2. Public Sector Banks: - are those banks in which majority of stake are held by the government. The public sector banks include State Bank of India, its subsidiaries, nationalized banks and IDBI Bank. Thus, there are 28 public sector banks at present State Bank ofIndia is the biggest commercial bank in the country. It was originally established in 1806 when the Bank of Calcutta (latter called Bank ofBengal) was established, and then amalgamated as the imperial bank ofIndia after merger with the Bank ofMadias and the Bank ofBombay. The share of Imperial Bank was sold to the Reserve Bank of India and thus it came into existence on My 1, 1955 under the State Bank ofIndia Act 1955. The State Bank of India has played an important role in extending credit facilities to cooperative undertakings, self-employed professionals, and small-scale and cottage industries. The central government nationalized other state banks functioning in different states and made them subsidiaries ofthe State Bank ofIndia. At present State Bank of India have seven subsidiaries. These are

(1) State Bank of Bikanir,

(2) State Bank ofHyderabad,

(3) State Bank ofIndore,

(4) State Bank of Mysore,

(5) State Bank of Saurasthra,

(6) State Bank of Patiala and

(7) State Bank of Travancore.

The SBI and its associate banks have a network of 15,814 branches throughout the country as on March 2008. SBI and its associates account for 20.1 percent oftotal bank branches. Nationalized banks refer to the private sector banks that were nationalized in two phases. In the first phase of nationalization, 14 private sector banks were nationalized in the year 1969 and in the second phase 8 more private sector banks were nationalized by the Central Government. Later, Punjab National Bank was merged with the New Bank of India in the year 1993. Thus, there are 19 nationalized banks. The IDBI Bank got the status of a commercial bank in1 the year 2004 and categorized as Other Public Sector Bank by the RBI. The nationalized banks including IDBI Bank had a network of 39,204 branches (which is about 50 percent of the total) as on 31st March 2008 throughout the country as shown in Table 2.2. All the public sector banks (28) are notified as scheduled commercial banks by the Central government of India. Regional Rural Banks account for 19 percent ofthe total bank branches with only 4 percent oftotal assets of scheduled commercial banks.

3. Private Sector Banks: - are those banks in which majority of stake are held by private individuals. The private sector banks include both scheduled commercial banks and non-scheduled commercial banks. These banks perform the same functions as performed by other commercial banks and follow the regulations framed by the RBI. Private sector banks are further classified into old private sector banks and new private sector banks that emerged after 1991. There were 17 old private sector banks and 8 new private sector banks as on 31st March 2008. These banks have a network of 8,294 branches that accounts for 10.5 percent of the total. Eg. ICICI Bank, IDBI Bank, HDFC Bank, AXIS Bank etc.

Private Sector banks fall in two categories. Those private sector banks which were in existence at the time of nationalisation are 23 and are called Old Private Sector Banks. Till 1993 no new bank coulrd be established in India. In 1993, Reserve Bank of India formulated guidelines for the establisshment of new private sector bunks in India. According to these guidelines, a new bank was required to have a minimvrrn capital of Rs. 100 crore and to observe the capital adequacy norm of 8% from the very beginning. Nine new banks were set up according to these guidelines. One of them was subsequently, merged with another. After the merger of ICICI Ltd., one of the All India Development Banks in India, with its subsidiary IICI Bank Ltd. on March 30, 2002; IClCI Bank Ltd. has become the second largest commercial bank in lndia after the State Bank of India. It is obviously the largest bank in the private seetor. In 2001, these guidelines were revised with the effect that the amount of capital has been raised to Rs. 200 crore (to .be further raised to Rs. 300 crore) and capital adequacy norm was raised to 9%.

4. Foreign Banks: - are the banks with Head office outside the country in which they are located. Foreign banks also undertake usual banking business in addition to foreign exchange transactions. Foreign scheduled commercial banks are regarded under the second schedule of RBI but have their registered offices outside India. These banks have played a prominent role in India’s foreign trade until the Second World War. Since then, a number of leading Indian banks also entered into the field of foreign exchange. Similarly, foreign banks have also entered in the field ofinternal trade and started competing with Indian commercial banks in attracting deposits, discounting bills and making advances to trade and industry. There were 29 foreign banks with 279 branches in India as on March 2008.

Eg. Citi Bank, Standard Chartered Bank, Bank of Tokyo Ltd. etc.

5. None scheduled commercial banks: - Banks which are not included in the Second Schedule of RBI Act 1934. Banks that are not included in the second schedule ofthe RBI are known as non-scheduled banks. They may be classified into four groups:

1. Banks with paid-up capital and reservesin excess ofRs. 5 lakhs.

2. Banks with paid-up capital and reserves ranging between Rs. 50,000 and one lakh rupees.

3. Banks with paid-up capital and reserves ranging between one lakh of rupees and five lakhs.

4. Banks with paid-up capital and reserves below Rs. 50,000. Non-scheduled banks are not entitled to all the facilities that the scheduled banks avail from the RBI.

Public Sector banks account for the major share of the banking business in India and are sub-classified into two categories i.e.

a. State Bank of India Group, and

b. Nationalised Bank

State Bank of India Group:

This group comprises State Bank ,of india and its seven subsidiaries which is the largest commercial bank in India. State Bank of India came into existence in 1955 when the Government converted the then existing Imperial bank of India into State Bank of India under the State Bank of India Act, 1955. At that time, about 93% of its shares were held by the Reserve Bank of India. State Bank of India acts as the agent of Reserve Bank of India at places where the latter  has no office of its own. In 1959, eight state associated banks were converted into the subsidiaries of State Bank of India under the State Bank of India (Subsidiary Banks) Act 1959. Later, one of them was merged with another. Thus, State Bank Group comprises of eight banks. The objective of formation of State Bank Group was to accelerate the extension of banking facilities in the countryside.

Nationalised Banks

After about a decade, in July 1969, 14 major commercial banks in India were nationalised by the enactment of Banking Companies (Acquisition and Transfer of Undertakings) Act 1970. A decade later in 1980, 6 more commercia% banks were nationalised with deposits of Rs. 200 crore each. One of them was subsequently merged with another, thus, the total number of nationalised banks is 19 at present. The decision to nationalise the major commercial banks was taken with the objective of opening a large number of branches throughout the country, especially in the rural areas and to mobilise deposits on a massive scale for the purpose of lending to productive purposes. These were the projects, which had remained neglected so far, i.e. agriculture, small industries and small businesses, weaker sections, etc. Initially, cent percent ownership of nationalised banks was vested, in the Government of India. Subsequently, after the amendment in the Act, private ahare holding has also been permitted with the provision that the share of the Government shall not fall below 51%. A few banks have ' since issued shares to the public, with the result the Government shareholding percentage has been reduced.

 

Off-Balance Sheet Exposure of Scheduled Commercial Banks in India

RESOURCES OF COMMERCIAL BANKS

Banking business essentially lies in the acceptarlce of deposits for the purpose of lending and investment. Acceptance of deposits thus, constitutes the main source of .funds for them. Their own funds constitute a small percentage of their total resources. As we shall see later, efforts are being made during recent years to increase the owned funds of the banks also.

Paid Up Capital and Reserves

The authorised capital of nationalised banks is Rs. 1500 crore each. The Central Government has subscribed to the . 100% paid-up capital in case of some banks, while in other cases, its percentage holding has declined with the issuance of shares to the public. Banks transfer 20% (now 25%) of their net profits to a Statutory Reserve Fund every year. Besides, they also maintain other Reserve Funds, e.g. Capital Reserves, Share premium, revenue" and other reserves and Investment Fluctuation Reserve. 

Deposits 

Deposits from the public, institutions, and organizations constitute the bulk of the resources of commercial banks. They accept deposits under three types of deposit accounts

: i) Fixed Deposits: the minimum period of such deposits is 15 days

ii) Savings Deposits

iii) Current Deposits 

No interest is payable on current deposits, while interest on Money Market savings bank accounts is prescribed by Reserve Bank of India. Currently it is payable @ 4% p.a. Interest is calculated on the minimum balance held in the savings accounts from ll'h day of the month till the last day of the month. Interest rates on fixed deposits were prescribed by Reserve Bank of India till a few years ago. Now, such'interest rates are ~ompletely deregulated. Banks are permitted to prescribe their 'own interest rates for fixed deposits of different maturities. At the stance of the Reserve Bank of India, banks pay slightly higher rates on bulk deposits of Rs. 15 lakh and above and on deposits held in the names of senior citizens (i.e. persons of age 60 years and abdie). Deposits with Commercial banks, as well as with Regional Rural Banks and Co-operative banks ate insured by Deposit Insurance and Credit Guarantee Corporation of India upto an amount of Rs. 1 lakh in each account. These banks pay the insurance premium @ 5 paise per cent to the corporation for this insurance. Scheduled Commercial Banks also solicit large deposits through certificates of deposits. The outstanding amount of CDs issued by them stood at Rs. 1695 crore as on October 20, 2000, but declined to Rs. 823 crore as on October 5, ' 2001.

Borrowings

Banks augment their resources by borrowings also. Sources of such borrowings are:

i) Reserve Bank of India

ii) Other Banks

iii) Other Institutions and Agencies.

Reserve Bank of India provides refinance for export credit and also provides short-term funds under its Liquidity Adjustment Facility (explained fully in Unit on Money Market). Moreover, banks get refinance from other Apex Banks like Exim Bank, IDBI etc. 

 

EMPLOYMENT OF RESOURCES 

As you have keen, bulk of banks' funds are raised in the form of deposits, which are repayable on demand or after a specified period. Banks, therefore, employ these funds partly in liquid assets like cash balances with themselves and other banks and money at call and short notice and the rest of the amount is either invested in securities or given in the form of loans and advances. 

Cash and Balances with other Banks 

These are the most liquid assets of a bank and are called the first line of defence, because banks can immediately ' repay the claims of the dePositors with these balances. Banks keep a reasonable amount of cash, say 10% or so of ,deposits, in such balances.

 ii) Money at Call and Short Notice : The surplus money with the bkks is lent to other banks which are in need of funds for a day or a few days. Banks earn interest on-such amount lent to other banks. The / interest rate varies from day to 'day on the basis of demand 1 for and supply of funds.

 iii) . Cash Reserves with Reserve Bank of India Under Section 42 of the Reserve Bank of India Act, 1934, scheduled commercial banks are required to maintain at least 3 % of their net demand and time liabilitiescwith the Reserve Bank of India. This is the statutory minimum limit, Reserve Pank of India is empowered to raise it'to a higher percentaie of upto 20%.  With effect from June 1, 2002, the Cash Reserve Ratio ICRR) is required to be maintained @ 5% (reduced from . 5.5%). In recent years, Reserve Bank of India has gradually reduced this rate. With every reduction in CRR, Commercial' Banks',balances with Reserve Bank of India are released to them, thereby increasing their liquidity. Reserve Bank of India pays interest at bank rate on eligible balances i.e. balances held in excess of statutory 3% limit.

iv) Investments P 7' Banks invest substantial portion of their deposit liabilities  in investments. Primarily, rbanks are under compulsion to invest in Government and other approved securities to meet the Statutory Liquidity requirement under section 24 'of the  Banking  Act, 1949. , Besides, Resew Bank of India has also permitted the' banks to invest in corporate securities, i.e. equity shares, convertible . bonds and debentures within the ceiling of 5% of their total outstanding advances as on March 31 of the previous year. Thus, commercial banks do invest in corporate securities, predominantly, bonds and debentures. Investments of banks are shown under the following head A in their Balance Sheets :

1) Government .Securities

2) Other approved securities

3) Shares

4) Debentures and Bonds

5) Subsidiaries and Joint Ventures

6) Others (Commercial Paper, IndiraVikas Patras, Units of UTI and Mutual Funds) Though the Statutory Liquidity Requirement at present is 25% of net demand and time liabilities, banks do invest more than this percentage, which is mainly due to their investments in corporate bonds and debentures. The investment-deposit ratio of Scheduled Commercial banks (on an outstanding basis) was 38.5% as on March 23, 2001.

v) want and Advances Granting loans and advances is the principal business of commercial banks. There are three forms in which such loans are granted :

a) Bills purchased and discounted,

b) Cash credits, overdrafts and loans repayable on demand, and

c) Term loans.

• Bill of exchange arises out of genuine trade transactions. When the bills are payable at sight or presentment, banks purchase them from customers (i.e. drawersJ of the bills). In case of time bills or usance bills banks discount them.
•  Cash Credit is a running account wherein a cash credit limit is prescribed for a customer. He is permitted to withdraw the amount any time he likes and may return the money wheneyer he is able to do so. Interest is charged on the actual amount lent and for the period of loan. Overdraft is a temporary facility which is granted to account holders. They are permitted to draw more than their deposits for some exigency or urgent work. Short-term loans are granted- to the customers, which are repayable on demand.
• Term loans are loans for medium to long periods. Such loans are granted by banks either singly, or jointly with term lending institutions. These loans are meant for investment in futed assets or for expansion, modernisation, etc.  On the basis of security taken by banks, loans are divided into:

i) Secured by Tangible Assets (including advances against book debts)

ii) Covered by Bank/ Government guarantees

iii) Unsecured Bulk of loans

 vi) Interest Rate Policy Reserve Bank of India has introduced financial sector reforms to provide operational flexibility to the banks. Till 1994 interest rates charged by banks on their advances were regulated by Reserve Bank of India. In October i334, Reserve Bank introduced the Prime Lending Rate (PRL) EIS the minimum lending rate ~hargeable by banks to their borrowers with Credit Limit dbove Rs. 2 lakhs. Thereafter, banks were given autonomy to fix their own PLR and maximum spread thereon. At present, banks are permitted to determine their own PLR. They are also permitted to offer tenor linked PLRs, i.e. different PLRs for loans with different maturities, with effect from April 19, 2001. Commercial banks have been permitted to lend at rates below PLR to exporters and other credit worthy borrowers including public enterprises.

vii) Sectoral Deployment of Bank Credit t Commercial banks serve the needs of different sectors of the economy. They not only provide finance to industry and trade, but are also engaged in the business of granting i consumer credit, retail credit and housing loans, etc. Their  priority sector advances constitute over 40% a6 the bank credit. The following table shows the sectoral employment of cc+stand;qe bank credit as on July 27, 2001

 

ROLE OF COMMERCIAL BANKS IN ECONOMIC DEVELOPMENT

Commercial banks are one source of financing for small businesses. The role of commercial banks in economic development rests chiefly on their role as financial intermediaries. In this capacity, commercial banks help drive the flow of investment capital throughout the marketplace. The chief mechanism of this capital allocation in the economy is through the lending process which helps commercial banks.

1.Capital Formation

Banks play an important role in capital formation, which is essential for the economic development of a country. They mobilize the small savings of the people scattered over a wide area through their network of branches all over the country and make it available for productive purposes.

Now -a-days, banks offer very attractive schemes to induce the people to save their money with them and bring the savings mobilized to the organized money market. If the banks do not perform this function, savings either remains idle or used in creating other assets,(eg.gold) which are low in scale of plan priorities.

2. Creation of Credit

Banks create credit for the purpose of providing more funds for development projects. Credit creation leads to increased production, employment, sales and prices and thereby they bring about faster economic development.

3. Channelizing the Funds towards Productive Investment

Banks invest the savings mobilized by them for productive purposes. Capital formation is not the only function of commercial banks. Pooled savings should be allocated to various sectors of the economy with a view to increase the productivity. Then only it can be said to have performed an important role in the economic development.

4. Encouraging Right Type of Industries

Many banks help in the development of the right type of industries by extending loan to right type of persons. In this way, they help not only for industrialization of the country but also for the economic development of the country. They grant loans and advances to manufacturers whose products are in great demand. The manufacturers in turn increase their products by introducing new methods of production and assist in raising the national income of the country. Sometimes, sub-prime lending is also clone. That is how there was an economic crisis in the year 2007-08 in the US.

5. Banks Monetize Debt

Commercial banks transform the loan to be repaid after a certain period into cash, which can be immediately used for business activities. Manufacturers and wholesale traders cannot increase their sales without selling goods on credit basis. But credit sales may lead to locking up of capital. As a result, production may also be reduced. As banks are lending money by discounting bills of exchange, business concerns are able to carryout the economic activities without any interruption.

6. Finance to Government

Commercial banks also support the role of the federal government as an agent of economic Development. Generally, commercial banks help fund government spending by purchasing bonds issued by The Department of the Treasury. Both long and short term Treasury bonds help finance government Operations, programs and support deficit spending. Government is acting as the promoter of industries in underdeveloped countries for which finance is needed for it. Banks provide long -term credit to Government by investing their funds in Government securities and short-term finance by purchasing Treasury Bills. RBI has given ? 68,000 crores to the government of India in the year 2018-19, this is 99% the RBI's surplus.

7. Employment Generation

After the nationalization of big banks, banking industry has grown to a great extent. Bank’s branches are opened frequently, which leads to the creation of new employment opportunities.

8. Banks Promote Entrepreneurship

In recent days, banks have assumed the role of developing entrepreneurship particularly in developing countries like India by inducing new entrepreneurs to take up the well-formulated projects and provision of counseling services like technical and managerial guidance.

Banks provide 100% credit for worthwhile projects, which is also technically feasible and economically viable. Thus commercial banks help for the development of entrepreneurship in the country.

9. Risk:

One of the most significant roles of commercial banks in economic development is as arbiters of risk. This occurs primarily when banks make loans to businesses or individuals. For instance, when individuals apply to borrow money from a bank, the bank examines the borrower's finances, including income, credit score and debt level, among other factors. The outcome of this analysis helps the bank gauge the likelihood of borrower default. By weeding out risky borrowers, commercial banks lessen the risk of financial losses. 

10.Small Business:

Commercial banks also finance business lending in a variety of ways. A business owner may solicit a loan to finance the start-up costs of a small business. Once funded, the small business may begin operations and embark on a growth plan. The aggregate effect of small business activity generates a significant portion of employment around the country.

11. Wealth:

Commercial banks also offer types of accounts to hold or generate individual wealth. In turn, the deposits commercial banks attract with account services are used for lending and investment. For example, commercial banks commonly attract deposits by offering a traditional menu of savings and checking accounts for businesses and individuals. Similarly, banks offer other types of timed deposit accounts, such as money market accounts and certificates of deposit. 

IMPORTANCE OF BANKS IN THE DEVELOPMENT OF THE COUNTRY

Banks are one of the most important parts of any country. In this modern time money and its necessity is very important. A developed financial system of the country ensures to attain development. A modern bank provides valuable services to a country. To attain development there should be a good developed financial system to support not only the economic but also the society. So, a modern bank plays a vital role in the socio economic matters of the country. Some of the important role of banks in the development of a country is briefly showing below. 

PROMOTE SAVING HABITS OF THE PEOPLE: Bank attracts depositors by introducing attractive deposit schemes and providing rewards or return in the form of interest. Banks providing different kinds of deposit schemes to its customers. It enable to create banking habits or saving habits among people.

 CAPITAL FORMATION AND PROMOTE INDUSTRY: Capital is one of the most important parts of any business or industry. It is the life blood of business. Banks are increase capital formation by collecting deposits from depositors and convert these deposits in to loans advances to industries.

SMOOTHING OF TRADE AND COMMERCE FUNCTIONS: In this modern era trade and commerce plays vital role between any countries. So, the money transaction should be user friendly. A modern bank helps its customers to sent funds to anywhere and receive funds from anywhere of the world. A well developed banking system provides various attractive services like mobile banking, internet banking, debit cards, credit cards etc. these kinds of services fast and smooth the transactions. So, bank helps to develop trade and commerce

GENERATE EMPLOYMENT OPPORTUNITY: Since a bank promote industry and investment, there automatically generate employment opportunity. So, a bank enables an economy to generate employment opportunity.

 SUPPORT AGRICULTURAL DEVELOPMENT: Agricultural sector is one of the integral part of any economy. Food self sufficiency is the major challenge and goal of any country. Modern bank promote agricultural sector by providing loans and advances with low rate of interest compared to other loans and advances schemes.

 APPLYING OF MONITORY POLICY: Monitory policy is a important policy of any government. The major aim of monitory policy is to stabilize financial system of the country from the dangerous of inflation, deflation, crisis etc.

BALANCED DEVELOPMENT: Modern banks spreading its operations throughout the world. we can see number of big banks like citi bank, Baroda bank etc. It helps a country to spread banking activities in rural and semi urban areas. With the spreading of banking operations around the country, helps to attain balanced development by promoting rural areas. Modern bank plays vital role in the socio- economic development of the country. A developed banking system enables the country to attain balanced development without any special consideration of rich and poor, cities and rural areas etc.

 FUNCTIONS OF COMMERCIAL BANKS

The commercial banks serve as the king pin of the financial system of the country. They render many valuable services. Commercial banks provide banking services to businesses and consumers through a network of branches. These banks are in business to make a profit for their owners and they are usually public limited companies managed by shareholders. In India, however, most of the top commercial banks are owned by the government. But many private commercial banks have been established in the recent years. Commercial banks are all-purpose banks that perform a wider range of functions such as accepting demand deposits, issuing cheques against saving and fixed deposits, making short-term business and consumer loans, providing brokerage services, buying and selling foreign exchange and so on. 

Commercial banks perform many functions. They satisfy the financial needs of the sectors such as agriculture, industry, trade, communication, so they play very significant role in a process of economic social needs. The functions performed by banks, since recently, are becoming customer-centered and are widening their functions. Generally, the functions of commercial banks are divided into two categories: primary functions and the secondary functions. The following chart simplifies the functions of commercial banks. Commercial banks perform various primary functions, some of them are given below. Commercial banks accept various types of deposits from public especially from its clients, including saving account deposits, recurring account deposits, and fixed deposits. These deposits are payable after a certain time period. Commercial banks provide loans and advances of various forms, including an overdraft facility, cash credit, bill discounting, money at call etc. They also give demand and demand and term loans to all types of clients against proper security. Credit creation is most significant function of commercial banks. While sanctioning a loan to a customer, they do not provide cash to the borrower. Instead, they open a deposit account from which the borrower can withdraw. In other words, while sanctioning a loan, they automatically create deposits, known as a credit creation from commercial banks. Along with primary functions, commercial banks perform several secondary functions, including many agency functions or general utility functions. 

The functions of commercial banks are explained below:

Primary functions

• Collection of deposits
•  Making loans and advances

 Collection of deposits: The primary function of commercial banks is to collect deposits from the public. Such deposits are of three main types: current, saving and fixed.  The primary function of commercial banks is receiving of deposits in the form of savings bank account, current account and term deposits from the savers usually from the public. People usually prefer to deposit their savings with the commercial banks because of safety, security and liquidity. The aggregate deposits of scheduled commercial banks in India rose rapidly from Rs. 822 crores in 1951 to Rs. 3,763 crores in 1967. The total deposits of commercial banks was Rs. 4,661 crores in 1969 that increased to Rs. 34,237 crores by 735 per cent by 1979. The total deposits of commercial banks increased in the decade of 1981 to 1991 from Rs. 40,413 crores to Rs. 2,00,569 crores by 5 times. Out of which the proportion of current, saving and fixed deposits were Rs. 6,286, Rs.11,805 and Rs. 22,322 crores which is almost 1: 2: 3 ratio increased to Rs. 30,335, Rs. 56,152 and Rs. 114082 crores i.e., almost 5 times during one decade with almost same proportion. The total deposits with commercial banks by the end of 2005 increased to Rs. 21,00,000 crores

•  current account is used to make payments. A customer can deposit and withdraw money from the current account subject to a minimum required balance. If the customer overdraws the account, he may be required to pay interest to the bank. Cash credit facility is allowed in the current account.
•  Savings account is an interest yielding account. Deposits in savings account are used for saving money. Savings bank account-holder is required to maintain a minimum balance in his account to avail of cheque facilities.
•  Fixed or term deposits are used by the customers to save money for a specific period of time, ranging from 7 days to 3 years or more. The rate of interest is related to the period of deposit. For example, a fixed deposit with a maturity period of 3 years will give a higher rate of return than a deposit with a maturity period of 1 year. But money cannot be usually withdrawn before the due date. Some banks also impose penalty if the fixed deposits are withdrawn before the due date. However, the customer can obtain a loan from the bank against the fixed deposit receipt.

Loans and advances: Commercial banks have to keep a certain portion of their deposits as legal reserves. The balance is used to make loans and advances to the borrowers.  The commercial banks is giving loans and advances to the all types of persons, particularly to businessmen and investors, against personal security, gold and sliver and other movable and immovable assets. The bank advances loans in the form of cash credit, call loans, overdraft and discounting bills of exchange to businessmen. After reforms in banking sector and establishment of new private sector banks and foreign banks, the other commercial banks also started giving loans and advances not only to their traditional businesses but also for vehicles, housing, consumer durables, etc. by increasing the base of lending activities.Individuals and firms can borrow this money and banks make profits by charging interest on these loans. Commercial banks make various types of loans such as:

1. Loan to a person or to a firm against some collateral security;

2. Cash credit (loan in installments against certain security);

3. Overdraft facilities (i.e. allowing the customers to withdraw more money than what their deposits permit); and

4. Loan by discounting bills of exchange.

Credit creation:

Credit creation is one of the most important functions of the commercial banks. Like other financial institutions, they aim at earning profits. For this purpose they accept deposits and advance loans by keeping small cash in reserve for day-to-day transactions. When a bank advances a loan, it opens an account in the name of the customer and does not pay him in cash but allows him to draw the money by cheque according to his needs. By granting a loan, the bank creates credit or deposit

 Secondary functions

 Use of cheque system and credit cards.

The commercial banks will allow the depositors of the bank to withdraw and make payment of their amount in their bank account through cheques. Now the banks are allowed to use debit and credit cards for making their payments.

Agency Services: The customers may give standing instruction to the banks to accept or make payments on their behalf. The relationship between the banker and customer is that of Principal and Agent. The agency functions are to collect and clear cheque, dividends and interest warrant and to make payments of rent, insurance premium, etc. and deal in foreign exchange transaction and to purchase and sell securities and to act as trustee, attorney, correspondent and executor and to accept tax proceeds and tax returns.

The following agency services are provided by the bankers:

1. Payment of rent, insurance premium, telephone bills, installments on hire purchase, etc. The payments are obviously made from the customer’s account. The banks may also collect such receipts on behalf of the customer.

2. The bank collects cheques, drafts, and bills on behalf of the customer.

3. The banks can exchange domestic currency for foreign currencies as per the regulations.

4. The banks can act as trustees / executors to their customers. For example, banks can execute the will after the death of their clients, if so instructed by the latter.

General Utility Services:

The commercial banks also provide various general utility services to their customers. The utility functions are to provide safety locker facility to customers and to provide money transfer facility and to issue traveller's cheque and to act as referees and to accept various bills for payment: phone bills, gas bills, water bills, etc. and to provide merchant banking facility and to provide various cards: credit cards, debit cards, smart cards, etc.Some of these services are discussed below:

1. Safeguarding money and valuables: People feel safe and secured by depositing their money and valuables in the safe custody of commercial banks. Many banks look after valuable documents like house deeds and property, and jeweler items.

2. Transferring money: Money can be transferred from one place to another. In the same way, banks collect funds of their customers from other banks and credit the same in the customer’s account.

3. Merchant banking: Many commercial banks provide merchant banking services to the investors and the firms. The merchant banking activity covers project advisory services and loan syndication, corporate advisory services such as advice on mergers and acquisitions, equity valuation, disinvestment, identification of joint venture partners and so on.

4. Automatic Teller Machines (ATM): The ATMs are machines for quick withdrawal of cash. In the last 10 years, most banks have introduced ATM facilities in metropolitan and semi-urban areas. The account holders as well as credit card holders can withdraw cash from ATMs.

5. Traveler’s cheque: A traveler’s cheque is a printed cheque of a specific denomination. The cheque may be purchased by a person from the bank after making the necessary payments. The customer may carry the traveler’s cheque while travelling. The traveler’s cheques are accepted in banks, hotels and other establishments.

6. Credit Cards: Credit cards are another important means of making payments. The Visa and Master Cards are operated by the commercial banks. A person can use a credit card to withdraw cash from ATMs as well as make payments to trade establishments.

 Financing foreign trade.

The commercial banks finance foreign trade of its customers by accepting foreign bills of exchange and collecting them from foreign banks. It also transacts other foreign exchange business and buys and sells foreign currency.

Transfer of funds

Commercial banks will help the customers to transfer their money from one account to another account, from one place to another place through cheques. Now the transfer of funds from one place to another place, or from one party account to another party account or one bank to another bank is done through Electronic Fund Transfer (EFT). This facility helps in transfering funds from one bank to another bank or to another party account easy. The technology like MICR helps the banks to have innovative banking like anywhere banking, anytime banking, and virtual banking and so on.

Miscellaneous functions

The miscellaneous functions performed by the commercial banks are: it provides safety locker facility, making and receiving payments on behalf of its depositors, issuing letters of credit and traveller’s cheques etc.advances. A bank makes investments for the purpose of earning profits. First it keeps primary and secondary reserves to meet its liquidity requirements. Banks invest in securities either for fulfilment of SLR/CRR requirements or for earning profit on the idle funds. Banks invest in “approved securities” (predominantly Government securities) and “others” (shares, debentures and bonds). The values/rates of these securities are subject to change depending on the market conditions. Some securities are transacted frequently and some are held till maturity. The Ghosh Committee recommended that “a bank’s investment portfolio should be bifurcated into two parts, namely, ‘permanent investment’ and ‘current investment’. The committee recommended that banks should make necessary provision for the depreciation in the value of current investment and there is no need to provide for permanent investment.

RBI has also advised the banks to classify the existing investment in approved securities into two categories. Initially from the accounting year 1992-93, banks should not keep more than 70% of their investment in permanent category, and 30% of the portfolio as current investments to facilitate valuing all the investments on fully ‘marked to market’ basis. Guidelines were laid down for transfer of approved securities from ‘current’ to ‘permanent’ and ‘vice versa’ in 1992. These guidelines ensure that latent losses are provided for at the time of such transfer. In 1993 the entire investment portfolio of banks other than investments classified as ‘permanent’ has to be classified into six categories for the purpose of valuation.

The valuation will be done for each category of investments. While net depreciation has to be provided by debit to the profit and loss account, net gains have to be ignored. Permanent investments can be carried at book value. Premium will have to be amortized over the life of the investment but discount cannot be recognized as income. In between 1993 to 1998 the said minimum ratio of 30 per cent has been increased in a phased manner to 60 per cent as on March 31, 1998. It has further been decided to increase the ratio to 70 per cent for the year ending March 31, 1999. 

MOTIVES OF INVESTMENT POLICY

The commercial banks have to follow the guidelines issued by RBI for investments. The following are the motives of investment policy of RBI.

1. Safety and security.

Safety and security of the funds which are deposited by the customers of the bank is very important in banks. The money which is deposited by the customers in banks should be safe and they should get back whenever they require. The banks should see that the money which is deposited in commercial banks should not be misused by the banks through its unscrupulous management or mismanagement and lead to loss and consequently lead to bankruptcy. Hence the RBI will guide the commercial banks through its monetary policies and issues guidelines to follow in their investment policies. To safeguard the interests of the depositors in commercial banks the deposits are insured up to Rs. 1,00,000.

2. Liquidity of funds in banks.

Commercial banks have to maintain liquidity of funds deposited by the depositors of the banks. The banks should see that the money deposited is allowed by the banks to withdraw whenever the customers require during working hours of the bank. This will ensure more confidence among the customers of the bank. There are several cases where Indian commercial banks ensured liquidity to the depositors of the bank. Recently during 2001 the rumours spread among the customers of the ICICI Bank in Maharashtra that there is no cash in the bank. Hence many customers went for withdrawing of the funds deposited and the ATM counters were flooded with customers. The bank also made arrangements for cash and also assured the customers not to panic. Immediately the RBI assured that there is no liquidity problem in the bank. Hence liquidity in banks is a very important motive of the investment policy. Therefore banks are directed to keep some percentage of the funds in the form of Cash Reserve Ratio in RBI and also insist to invest in Statutory Liquid Ratio to convert into easy liquidity. 3. Profitability of the bank. The soundness of any bank is measured by its profitability. The customers will come forward to deposit their funds with banks on the basis of the profitability of the banks. Hence the banks have to earn profits.

Factors Determining Liquidity of Banks

The liquidity of a bank is determined by the top management of the bank on the basis of the nature of business conditions in a country. This is also guided by the central bank of that country to ensure liquidity in an economy. The extent of liquidity is ensured on the basis of the following factors. 1. The size of liquid reserves. The size of the liquid reserves will depend upon the extent of liquid reserves considered essential by the banking community. If the liquid reserves in a bank will increase the liquidity position of the banks but the amount available for lending will decrease. During the year 1991 to 1995 the CRR of the commercial banks with the RBI was 15 to 14.5 percent on Net Demand and Time Liabilities (NDTL), hence the amount available with the banks for lending was less hence it hampered the growth of our economy. By realizing this problem RBI after accepting reform process in the economy reduced this ratio. Since then the amount available for lending with the banks has increased, consecutively the Credit Deposit (CD) ratio also increased. It was around 56 percent during 2004 it went up to 71 per cent during the month of February 2006 by showing good symptom of growth in the credit activities in an economy. 2. Banking habits of the people. Liquidity of a bank depends upon the banking habits of people. 

Well organized money market. Well organized and developed money market is another factor which will have its influence on the liquidity position of the banks. If the money market is well organized, the commercial banks will borrow and lend their cash in the money market which reduces the idle money with the banking sector and also supports the liquidity position in the banking sector and also in an economy.

PROFITABILITY OF COMMERCIAL BANKS

Profitability is a key parameter in assessing the performance of any business firm. Even in the banking sector after the banking sector reforms the priorities in banking operations underwent far reaching changes. There had been a shift in the emphasis from development or social banking to commercially viable banking. Profitability became the prime mover of the financial strength and performance of banks; hence the performance of the bank is measured on the basis of its profitability. Now the main agenda is to enhance the profitability and reduce the hurdles which are faced by the banks in their profit maximization and to develop strategies to achieve this objective. In this changed scenario, profitability and productivity are the twin indicators of the competitive edge of the banking industry. The main reason for the fundamental paradigm shift in the banking from social banking to “profit banking” was the introduction of capital adequacy requirements. There are four ways to achieve and sustain the required capital adequacy: fresh equity issue, ploughing back of profit, debt offering and revaluation of assets. Raising capital through equity route is very difficult because servicing the equity base, offering reasonable returns, raising fresh capital when the capital market is not favourable and when the performance of banks is not good. Similarly debt raising also will have the limitations too, as tier II capital cannot exceed tier I capital and subordinated debt cannot exceed 50% of the tier II capital.

Provisioning for loan losses, loan quality improvements or non-Performing Assets: Provisioning for loan losses and non-performing assets reduce the profitability of the banking system. NPAs, reduces the net profits of banks on account of loss in income and the provisioning for NPAs will reduce the profit of the banks.

Interest rate movements: Interest rate movements affect the net interest margins of the banks. A net interest margin refers to difference between interest on deposits and interest on advances. When interest rates increase, the impact is immediate on the advances, which reduces the demand for advances and reduces the profits of the banks. The change in interest rates are exposed to interest rate risks and assetliability mismatches, which calls for Asset Liability Management (ALM). 

Rigidity of the operating cost structure: About 60 to 70 per cent of the operating costs of Indian commercial banks is on account of employee costs. The other significant cost components are real estate and technology costs. These costs are non-controllable to a significant extent and are rising constantly hence, reducing the profitability of banks. 

Unit Specific factors

1. Banking structure. Structure of the banking system will have its impact on the profitability of banks. The diversified banking structure with operations spread across regions having different economic/business profiles, like Indian public sector banks will have higher operating costs in view of a larger network, lower margins due to greater competition.

2. Size of Bank. Indian situation suggests that when banks are considered groups in terms of big, medium and small, the bigger banks have greater scope for economies of scale.The per centages of total expenses to working funds are lower for bigger size banks than for small size banks. Whereas in other countries like European Investment Banks, a study of American and Japanese banks have observed that there is no convincing correlation between the size of banks and earning power.

3. Branch network or Franchise strength. A large network of branches located at potential centres provides access to low cost deposits as well as increased scope for earning more fee-based income in the form of commission on remittance services and bills for collection.

Profitability Performance of Commercial Banks

Profitability is one major criterion for evaluating the performance of banks. If profitability has to be planned and improved, detailed, systematic and objective analysis is necessary. It calls for studying the factors determining profitability, how they behave, how they are related to each other and how valid inter-bank comparisons are. To evaluate the profitability performance of the banks largely ratios are used as a tool for comparison. There is no unanimity in the selection of ratios. The ratios usually used are:

1. Net Profit / Net Worth

2. Spread / Working Funds

3. Burden / Working Funds

4. Interest Income / Total Earning Assets

5. Non-Interest Income / Total Earning Assets

6. Interest Expenses / Total Earning Assets

7. Non-Interest Expenditure (Operating Expenditure) / Total Earning Assets

8. Net Profit / Working funds

9. Net Non-Performing Assets / Net advances

10. Capital Adequacy Ratio

11. Savings Deposit / Total Deposits

12. Current Deposits / Total Deposits

13. Term Deposits / Total Deposits 

Interest expense constitutes interest paid on deposits, RBI/inter-bank borrowings and others

 Non-interest expenses are also called operating expenses or overhead, which constitutes expenses incurred for establishment, rent, taxes and lighting, printing and stationery, advertisement, depreciation etc. In order to evaluate the performance of the commercial banks the Reserve Bank of India uses CAMEL method. The prime task of regulatory agencies is to frame regulations and examine their adherence by banks through the examination process. This will help the RBI to evaluate how far a particular commercial bank has compliance with the guidelines. This is a major strategy in enhancing the control mechanism, supervision by the regulatory authorities. Central banks address to the issue by on-sight and off-sight inspections/examinations. CAMEL refers to:

C = Capital Adequacy Ratio

A = Assets Ratios

M = Management Ratios

E = Earning Ratios.

L = Liquidity Ratio

 

               Commercial banks play a very important role in the economy of a country as they create money by pooling savings in form of deposits and lending for better uses; facilitates payment mechanism; and provide a variety of services. Commercial banks in India, in its modem form, exist since 1770 but got momentum after the nationalization of banks that took place in the year 1969. Thereafter, banking sector had gone through many reform measures. However, it was found that the financial performance of most of the banks deteriorated. To strengthen the banking sector as a whole, reform measures were recommended by MJ Nlarasimham in 1991 and 1998 in phased manner.

As per the Reserve Bank of India (RBI), India’s banking sector is sufficiently capitalised and well-regulated. The financial and economic conditions in the country are far superior to any other country in the world. Credit, market and liquidity risk studies suggest that Indian banks are generally resilient and have withstood the global downturn well.

Indian banking industry has recently witnessed the roll out of innovative banking models like payments and small finance banks. RBI’s new measures may go a long way in helping the restructuring of the domestic banking industry.

The digital payments system in India has evolved the most among 25 countries with India’s Immediate Payment Service (IMPS) being the only system at level five in the Faster Payments Innovation Index (FPII). *

Market Size

The Indian banking system consists of 12 public sector banks, 22 private sector banks, 46 foreign banks, 56 regional rural banks, 1485 urban cooperative banks and 96,000 rural cooperative banks in addition to cooperative credit institutions. As on January 31, 2020, the total number of ATMs in India increased to 210,263 and is further expected to increase to 407,000 by 2021.

Public sector banks’ assets stood at Rs 72.59 lakh crore (US$ 1,038.76 billion) in FY19.

During FY16–FY20, credit off-take grew at a CAGR of 13.93%. As of FY20, total credit extended surged to US$ 1,936.29 billion.

During FY16–FY20, deposits grew at a CAGR of 6.81% and reached US$ 1.90 trillion by FY20. Credit to non-food industries increased 3.3% y-o-y, reaching US$ 1.26 trillion on February 28, 2020 and US$ 1.42 trillion on March 13, 2020.

Investments/Developments

Key investments and developments in India’s banking industry include:

• In 2019, banking and financial services witnessed 32 M&A (merger and acquisition) activities worth US4 1.72 billion.
• In March 2020, State Bank of India (SBI), India’s largest lender, raised US$ 100 million in green bonds through private placement.
• In February 2020, the Cabinet Committee on Economic Affairs gave its approval for continuation of the process of recapitalization of Regional Rural Banks (RRBs) by providing minimum regulatory capital to RRBs for another year beyond 2019–20 – till 2020–21 to those RRBs which are unable to maintain minimum Capital to Risk weighted Assets Ratio (CRAR) of 9% as per the regulatory norms prescribed by RBI.
• In October 2019, Department of Post launched the mobile banking facility for all post office savings account holders of CBS (core banking solutions) post office.
• Deposits under Pradhan Mantri Jan Dhan Yojana (PMJDY) stood at Rs 1.06 lakh crore (US$ 15.17 billion.
• In October 2019, Government e-Marketplace (GeM) signed a memorandum of understanding (MoU) with Union Bank of India to facilitate a cashless, paperless and transparent payment system for an array of services.
• In August 2019, the Government announced major mergers of public sector banks, which included United Bank of India and Oriental Bank of Commerce to be merged with Punjab National Bank, Allahabad Bank to be amalgamated with Indian Bank and Andhra Bank and Corporation Bank to be consolidated with Union Bank of India.
• The NPAs (Non-Performing Assets) of commercial banks recorded a recovery of Rs 400,000 crore (US$ 57.23 billion) in the last four years including record recovery of Rs 156,746 crore (US$ 22.42 billion) in FY19.
• Allahabad Bank’s board approved the merger with Indian bank for the consolidation of 10 state-run banks into the large-scale lenders.

• The total equity funding of microfinance sector grew at 42 y-o-y to Rs 14,206 crore (US$ 2.03 billion) in 2018-19.

Government Initiatives

• As per Union Budget 2019–20, the Government proposed fully automated GST refund module and an electronic invoice system that will eliminate the need for a separate e-way bill.
• Under the Budget 2019–20, Government proposed Rs 70,000 crore (US$ 10.2 billion) to the public sector banks.
• Government smoothly carried out consolidation, reducing the number of Public Sector Banks by eight.

• As of September 2018, the Government of India made Pradhan Mantri Jan Dhan Yojana (PMJDY) scheme an open-ended scheme and added more incentives.
• The Government of India planned to inject Rs 42,000 crore (US$ 5.99 billion) in public sector banks by March.

Achievements

Following are the achievements of the Government:

• As on March 31, 2019, the number of debit and credit cards issued were 925 million and 47 million, respectively.
• According to RBI, India’s foreign exchange reserve stood at approximately US$ 414.14 billion as of April 19, 2020.

• To improve infrastructure in villages, 204,000 point of sale (PoS) terminals have been sanctioned from the Financial Inclusion Fund by National Bank for Agriculture & Rural Development (NABARD).
• Deposits under Pradhan Mantri Jan Dhan Yojana (PMJDY) increased to Rs 1.28 lakh crore (US$ 18.16 billion) during the week ended April 8, 2020.
• Unified Payments Interface (UPI) recorded 1.25 billion transactions in March 2020, valued at Rs 2.06 lakh crore (US$ 29.22 billion).

Road Ahead

Enhanced spending on infrastructure, speedy implementation of projects and continuation of reforms are expected to provide further impetus to growth in the banking sector. All these factors suggest that India’s banking sector is poised for a robust growth as rapidly growing businesses will turn to banks for their credit needs.

Also, the advancement in technology has brought mobile and internet banking services to the fore. The banking sector is laying greater emphasis on providing improved services to their clients and upgrading their technology infrastructure to enhance customer’s overall experience as well as give banks a competitive edge.

India’s digital lending stood at US$ 75 billion in FY18 and is estimated to reach US$ 1 trillion by FY23 driven by the five-fold increase in the digital disbursements.