self learning material banking & insurance operations

Self Learning MaterialBanking & Insurance Operations

(MBA-927)

Course: Master Business Administration

Semester-IV

Distance Education Programme

I.K. Gujral Punjab Technical University

Jalandhar

Table of Contents

LessonNo.

Title Written by PageNo.

1 BANKING SYSTEM AND STRUCTURE Dr. Savita, Assistant Professor,Department of Commerce,Maharaja Agarsen University,Baddi.

1

2 TYPES OF BANKS Dr. Savita, Assistant Professor,Department of Commerce,Maharaja Agarsen University,Baddi.

20

3 BANKING REGULATION ACT 1949 Dr. Savita, Assistant Professor,Department of Commerce,Maharaja Agarsen University,Baddi.

37

4 CRM IN BANKS AND NEGOTIABLEINSTURMENT ACT, 1881

Dr. Savita, Assistant Professor,Department of Commerce,Maharaja Agarsen University,Baddi.

52

5 BANKING OPERATIONS ANDCONTEMPORARY DEVELOPMENTS INBANKING


73

6 ROLE OF COMMERCIAL BANKS IN

FOREIGN TRADE


90

7 EXPORT-IMPORT BANK OF INDIA Dr. Savita, Assistant Professor,Department of Commerce,Maharaja Agarsen University,Baddi.

107

8 MANAGEMENT OF LOANS ANDADVANCES


120

9 RISK MANAGEMENT IN BANKS Dr. Savita, Assistant Professor,Department of Commerce,Maharaja Agarsen University,Baddi.

135

10 BANKING SECTOR REFORMS Dr. Savita, Assistant Professor,Department of Commerce,Maharaja Agarsen University,Baddi.

154

11 INSURANCE Dr. Savita, Assistant Professor, 193

Department of Commerce,Maharaja Agarsen University,Baddi.

12 ACCOUNTING FOR INSURANCE Dr. Savita, Assistant Professor,Department of Commerce,Maharaja Agarsen University,Baddi.

238

© IK Gujral Punjab Technical University JalandharAll rights reserved with IK Gujral Punjab Technical University Jalandhar

Lesson-1BANKING SYSTEM AND STRUCTURE

Structure

1.1.Objectives

1.2.Introduction

1.3.Definition of Bank

1.4.Features/Characteristics of Bank

1.5.Structure of Banking System

1.6.Summary

1.7.Glossary

1.8.Check Your Progress

1.9.References & Suggested Readings

1.10 Terminal and Model Questions

1.1 Objectives

After completing this lesson, you will be able to:i. Understand the concept of bank, banker and banking.

ii. Know the salient features/characteristics of bank.iii. Various types of banks.iv. Understand the also of Scheduled/Non Scheduled banks as well as Public, Private and

Foreign banks.

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1.2 Introduction

Banking system is as old as civilization. There is no clear idea regarding the starting of banking

system as the banking activities had started in different countries in different period of time.

Some says about the origin of banking is traced in Greek as Greek temples carried on a thriving

business of safe keeping and lending, centuries before the evolution of modern banking. With the

growth of industry, trade and commerce, the banking system also grew over a long period of

time and gained maturity. The earlier bankers were goldsmith who dealt in precious metals.

People with surplus gold and money gradually began to deposit their precious metals with them.

Since everyone believed in the integrity and ability of these goldsmiths to honour the receipts

issued. The receipts gradually began to pass from one hand to another hand in discharge of

obligations. These receipts thus began to circulate as bank notes. The goldsmiths gradually came

to know from the experience that only a small proportion of the precious metal deposited with

them was withdrawn by the depositors. They could thus safely lend out a part of these deposits to

others. The art of banking fell with the Roman Empire. However, Europe saw the re-emergence

of commerce and trade in the 15th and 16th centuries. In the history of modern banking, there

have been three ancestors:

The Merchants,

The Goldsmiths, and

The Money Lenders.

The Merchants: The merchants helped in the remittance of money from one place to

another. Due to the possibility of theft of money during transit period, merchants started

issuing documents called ‘Hundies’. It is a letter of transfer by which one merchant

direct another merchant to pay the bearer of this the specific amount of money.

The Goldsmiths: The Goldsmiths came into picture, when money in the form of gold

and silver, because paper money not in circulation. They started taking safe custody of

gold and other valuables by charging some commission. Goldsmiths issued receipt to

the owners of valuables and such receipts were used just like cheques as a medium of

exchange and a means of payment by one merchant to another merchant in ancient

times.

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The Money Lenders: With the passing of time, the goldsmiths replaced by money

lenders. On the basis of their experiences, they found the withdrawal of coins was much

less than the deposits and they need not hold whole of the coins with them. So after

keeping some reserves they started advancing the coins as loans by charging some

interest. In this way, the goldsmith money lender started performing two main functions

of modern banking. They started accepting deposits from the people and advancing

loans to the people who are in need of money. Now the goldsmiths deal with the paper

currency instead of gold and silver.

1.3 Definitions of Bank

Banking system plays a significant role in the economic growth of the country. Banks are the

important participants of Indian financial system. In the era of modern banking, bank performs a

number of activities. So it is very difficult task to give one definition of banking. Different

economist gave various definition of banking time to time.

According to the Oxford Dictionary, “Bank is an establishment for the custody of money,

which it pays out on customer’s order”.

According to Findlay Shiras, “A banker or bank is a person, firm or company having a place

of business where credits are opened by deposits or collections of money or currency or where

money is advances or loaned”.

According to John Paget, “Nobody can be a banker who does not (a) take deposit account, (b)

take current accounts, (c) issue and pay cheques, and (d) collect cheques- crossed and uncrossed

for its customer’s”.

According to Banking Companies (Regulation) Act of India, 1949, “Banking means the

accepting, for the purpose of lending or investment, of deposits of money from the public,

repayable on demand or otherwise, and withdrawable by cheque, draft or otherwise”.

So in simple words, we can say that, Banks are the buyers and sellers of the use of money and

the bank always uses the word ‘bank’ for itself. People can bank upon it. Banks are

intermediaries between the surplus units of the society who save and the deficit units of the

society who borrow. Thus modern bank can be concluded:

A commercial bank is a financial establishment which deals with money and credit.

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Banks main aim is to earn profit.

It accepts deposits from the public.

These deposits are repayable on demand.

Deposits are withdrawable by cheques, drafts or otherwise during banking hours.

Banks create credit by lending money out of the profits mobilized.

A part of deposits may also invest in the marketable securities.

1.4 Features/Characteristics of Bank

In India, commercial banks have played a major role in mobilizing the savings of the individuals.

Important features of commercial banks are given as under:

It is an establishment for earning profit: Commercial Banks is a commercial

establishment which deals with money and debts. As it is commercial establishment so

its main objective is to earn profit by giving various types of financial services to its

customers in return for interest. Profit of a bank is difference between the rate of interest

paid by bank on deposited money and rate of interest received by bank on lending

money.

Accept deposits from people: Commercial Banks encourage people to make deposits.

They accept deposits from people. People can deposit their cash balances in their

account as per their convenience, which may be Fixed Account, Current Account,

Saving Account and Recurring Account etc.

Repayment of deposits: Banks repay the accepted deposits to the customer whenever

they required, on demand or otherwise.

Withdrawal may be made by cheque, draft or otherwise: Customer can withdraw their

deposit money from bank through cheques, drafts or otherwise during the banking

hours.

Advancing loan to the public: Banks advances loans to those who are in need of money

to earn interest. The public can borrow money from banks to meet their requirements

and needs.

1.5 Structure of Banking System

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The Indian Financial System today consists of an impressive network of banks and financial

institutions and wide range of financial instruments. Indian banking is an active participant in

reshaping deregulated environment of Indian economy. The banks initiated a number of

measures to respond to the changed environment of economy in addition to their traditional

banking to fulfill the newly emerging demands and aspirations of the customers. The banks have

introduced various innovative financial products and services like venture capital finance,

factoring, mutual fund, housing finance, credit card, lease financing, loan syndication and other

merchant banking services etc. The structure of Indian Banking System can be classified into

two broad categories such as:

A. Organized sector

B. Unorganized sector

It is clear from the above mentioned figure that India has two type of structure, Organised and

Unorganised. Now we will discuss it in detail.

A. Organized Sector: Organized sector is that sector which is governed by some rules

and regulations. Organized banking sector are shown in the following figure.

Organised Sector

ReserveBank of India

CommercialBank










A. Organized sector






Structure of BankingSystem

Organised Sector

CommercialBank

Co-operativeBank

SpecialisedBank

Unorganised Sector

IndigeneousBankers










A. Organized sector






Unorganised Sector

MoneyLenders

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Reserve Bank of India: Reserve Bank of India is the leader of Indian Banking System. It is

the apex financial institution of India. The Reserve Bank of India as apex institution

organizes, supervises, regulates, runs and develops the monetary system and financial system

of the country. In simple words, it controls the whole banking system in India.

(a) Commercial Bank: Commercial banks hold a significant position in the Indian Banking

System. In organized sector it is a oldest banking institution. Commercial banks consists of

scheduled and unscheduled commercial banks, private sector, public sector and foreign banks.

State bank and its associates and other nationalized banks are also falls in this category. These

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commercial banks cater to the needs of the trade, commerce, industry, small business, agriculture

and entrepreneurial activities. Commercial banks are further divided into:

Scheduled and Non-Scheduled Banks: Commercial banks may be Scheduled or Non-

Scheduled banks. Those banks which are listed in the 2nd Schedule of the RBI Act 1934,

called Scheduled Banks. A bank which fulfills the conditions is eligible to register under

the 2nd Schedule of RBI. These conditions are:

I. It must have a paid-up capital and reserves of an aggregate value of at least rupees

five lakhs.

II. The bank must carry on the business of banking in India.

III. These banks must satisfy that their affairs are not conducted in a manner

detrimental to the interest of depositors.

IV. It must be corporation and not a partnership or a single owner firm.

V. These banks are required to maintain certain amount of reserves with the RBI so

that they can enjoy the facilities of financial accommodation and remittance

facilities at concessional rates from RBI.

VI. It may be classified according to their ownership as Public sector banks, Private

sector banks and foreign banks.

Source: Section 42 of the RBI Act 1934.

On the other hand, Non-Scheduled banks are those banks which are not listed in

the 2nd schedule of RBI Act 1934 and these banks are not entitled to borrowing or

rediscounting facilities at concessional rates from RBI.

Public Sector Banks: Public Sector banks are those banks which are owned and

controlled by the Government of India. The Government of India entered the banking

business in 1955 with the establishment of State Bank of India by taking over the

Imperial Bank of India. At present there are 27 public sector banks consisting of:

I. 19 Nationalized Banks

II. 07 State Bank of India and its Associates

III. 01 Bhartiya Mahila Bank

All the nationalized banks are fully owned and controlled y Government of India whereas

the State Bank of India is largely owned by the Reserve Bank of India. However, there is

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some private ownership in the share capital of state bank. State Bank of India established

under the State bank of India Act 1955 and its subsidiaries under the State Bank of India

Act, 1959(subsidiary Banks). Another important step toward public sector banking was

taken in1969, when 14 banks were nationalized. Again in 1980 six more banks were

nationalized, but in 1993-1994, one bank was merged. List of nationalized banks are:

1. Bank of Baroda

2. Punjab National Bank

3. Bank of India

4. Canara Bank

5. Vijaya Bank

6. Central Bank of India

7. Union Bank of India

8. Indian Bank

9. Indian Overseas Bank

10. UCO Bank

11.Allahabad Bank

12.United Bank of India

13.Corporation Bank

14.Oriental Bank of Commerce

15.Punjab and Sind Bank

16.Dena bank

17.Syndicate Bank

18.Bank of Maharashtra

19.Andra Bank

20.New Bank of India

In 1993-1994, new Bank of India was merged with National Bank. List of State Bank and Its

Associates commonly known as State Bank of India Group or SBI Group:

1. State Bank of India

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2. State Bank of Mysore

3. State Bank of Patiala

4. State Bank of Hyderabad

5. State Bank of Bikaner and Jaipur

6. State Bank of Travancore

7. Bhartiya Mahila Bank (Founded in 2013)

8. State Bank of Saurashtra (merged in 2008)

9. State Bank of Indore (merged in 2010)

Private Sector Banks: Private Sector Banks are those banks which are controlled by big

industrial houses. In 1991 the process of reforming banking industry initiated with the

setting up of the Narasimham Committee which stressed on the ways to improve the

banking sector at large. On the recommendation of Narsimham Committee, the Reserve

Bank of India, announced guidelines for the entry of private players in the banking sector.

Reserve Bank of India has grouped the private banks as Old Private Sector Banks and

New Private Sector Bank. Old private sector banks are those banks which carried out

their banking business before 1990s. they are as follows:

1. Bharat Overseas Bank Ltd

2. The Vyasya Bank Ltd

3. The Jammu & Kashmir Bank Ltd

4. The South Indian Bank Ltd

5. Karnataka Bank Ltd

6. Bank of Madura Ltd.

7. The Catholic Syrian Bank Ltd.

8. The Fedral Bank Ltd

9. Tamilnad Mercantile Bank Ltd

10. The Laxmi Vilas Bank Ltd

11. The Sangli Bank Ltd

12. The Dhan Luxmi Bank Ltd

13. Lord Krishna Bank Ltd

14. The Nedungadi Bank Ltd

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15. The United Western Bank Ltd

16. The Karur Vysya Bank Ltd

After liberalization in 1991, some new banks started their operations. These are:

1. Indus Ind Bank Ltd

2. The UTI Bank Ltd

3. HDFC Bank Ltd

4. The ICICI Bank Ltd

5. Global Trust Bank Ltd

6. The Times of India Bank Ltd

7. IDBI Bank Ltd

8. The Development Co-operative Bank Ltd

9. Kotak Mahindra Bank

10. Bala Ji Corporation Bank

These banks are introduced superior level of technology and customer satisfaction. These new

banks have new concepts and products and have a specific business plans. These banks are

targeting specific products and customer groups than the entire financial sectors.

Foreign Banks: Foreign banks are those banks which are registered outside India but got

permitted to operate their business in India through their branches in India. Basically

these banks confined to metropolitan cities and other big commercial centers with limited

number of branches. At present 34 foreign banks are operated businesses in India. Some

of these are listed below:

1. Bank of Ceylon

2. Bank Indonesia International

3. Barclays Bank

4. State Commercial Bank of Mauritius

5. Overseas Chinese Bank Corporation

6. Dresdner Bank

7. Chase Manhattan Bank

8. Development Bank of Singapore

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9. Commerz Bank

10. Fiji Bank

11. Cninatrust Commercial Bank

12. Cho Hung Bank

13. Toronto Dominion Bank

14. Krug Thai Banking Public Company Ltd

15. ANZ Grindlays Bank

16. The Standard and Chartered Bank

17. Honkong Bank

However ANZ Grindlays Bank has 56 branches in India, The Standard and Chartered Bank has

24 and Honkong Bank has 21 branches in India. All other foreign banks have less than 10

branches.

(b) Regional Rural Banks: Regional Rural Banks are framed to cater the need of the rural area

and to fill the gap in rural credit. On the recommendations of Narasimham committee in 1975,

Regional Rural Banks were set up for developing rural economy. Basically it was established for

the purpose of development of agriculture, industry and other productive activities in the rural

areas. These banks provide credit and other facilities, mainly to the small and marginal farmers,

agricultural labour, artisans and entrepreneurs. To achieve the purpose, five Regional Rural

Banks were set up on 2nd October, 1975 at

1. Bhiwani in Haryana

2. Jaipur in Rajasthan

3. Moradabad in Utter Pradesh

4. Gorakhpur in Utter Pradesh

5. Malda in West Bengal

These RRB’s were sponsored by various nationalized banks such as Punjab National

Bank, United Commercial Bank, Syndicate Bank and State Bank of India.

(c) Co-Operative Banks: Co-Operative Banks are those banks which are collectively run

by a group of individuals/ societies with the goal of mutual help of the members. These

co-operative banks function on the principles of co-operation and their activities are rural

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oriented. The size of assets and liabilities of these banks are much smaller than

commercial banks.

The main goal of these banks is to mutual help of the member of co-operative banks. Actually,

co-operative banks were intended to protect the small producers especially the poor

agriculturists, against the malpractices of money lenders. But now the co-operative banks are

performing the most urgent task of financing agriculture and small industry by mobilizing

surplus resources from the urban and the rural masses by promoting thirft among them. Co-

operative banks were established under the co-operative societies Act 1904, but today they three-

tier system are operating in co-operative banking in India:

1. State Co-Operative Banks

2. District/Central Co-Operative Banks

3. Primary Credit Societies

Now, we will explain it one by one.

1. State Co-Operative Banks: State Co-Operative Bank is the apex institution of Indian Co-

Operative banking. These banks are like a Reserve Bank for the co-operative banking system in a

particular state to a large extent. RBI provides funds to State Co-operative Banks which further

finance the needs of Central Co-operative and Primary Credit Societies. The district or central

co-operative banks have no permission to deal directly with RBI. If there is any need to transfer

funds from a district co-operative bank having surplus to another district co-operative bank

having deficit, it can be done only through the state co-operative bank. State Co-Operative Banks

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mobilize their deposits through the public, commercial banks and from Reserve bank of India.

These banks finance the Central Co-operative Banks, co-ordinate their activities and control their

working. State Co-Operative Banks are the important link between Central Co-operative

Societies, Primary Societies and Reserve Bank of India. The main functions of the State Co-

Operative banks is to connects co-operative credit societies with money market in the country,

supervises, controls and renders guidelines to the Central Co-Operative Banks and act as a

banker bank for District/ Central Co-operative Banks. They also assist the State Government in

drawing up cooperative development related plans for the state.

2. Central/District Co-Operative Banks: Central/District Co-Operative Banks are in the middle

of three-tier co-operative structure. The main function of Central/District Co-Operative Banks is

to provide credit to the member primary credit societies. These banks have their own capital and

they also get deposits from public. Central/District Co-Operative Banks grant loans to the

Primary Credit Societies and secured loans to individuals. The share capital of these banks is

mainly provided by the member societies and the State Governments, with a small proportion

coming from the individuals. In addition to the main capital, their main sources of funds are

deposits and borrowings.

3. Primary Credit Societies: Primary Credit Societies form the base of three tier structure of

co-operative banking in India. It is an association of persons residing in a particular area. The

fund of society consists of share capital, deposits from its members and non-members, loans

from Central Co-operative Banks. The liability of each member is unlimited. Primary Credit

Societies normally loan for short period for purchase of cattle, fodder, fertilizer, pesticides etc.

(d) Specialized Banks: Specialized Banks are those Banks that established with a

view to cater the specific needs of industry, agriculture, foreign trade. To achieve

the purpose various specialized institutions have been set up. These are given

below:

1. Industrial Development Bank of India: It is established for rapid

industrial growth of the economy. The main objective to set up of IDBI is

to meet the growing financial needs of industrialization and to coordinate

the activities of all agencies which are concerned with the provision of

finance for industrial development.

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2. Export-Import Bank of India: EXIM Bank was set up to provide

financial assistance to exports and imports to encourage India’s foreign

trade and financing of joint ventures in foreign countries.

3. Industrial Finance Corporation of India: IFCI was established in1948

with the objective of providing direct financial assistance to the corporate

and co-operative sector of the country.

4. Industrial Reconstruction Bank of India: IRBI was set up in 1985, as a

primary agency for rehabilitation of sick industrial units.

5. National Bank for Agriculture and Rural Development: NABARD was

established in 1982 with the objective to provide credit to agriculture, SSI,

village and cottage industries, handicraft and other allied economic

activities. It also provides assistance to the Government of India and the

RBI and other organisations in the matters relating to rural development.

6. Land Development Bank: Land Development Bank was set up in 1920 in

order to provide long term credit to the farmers for purchase of farm

equipments like tractors and pumps, reclamation of land and fencing,

digging up new wells and repairs of old wells, redemption of old debts etc.

B. Unorganized Sector: Unorganized Sector consists of:

1. Indigenous Bankers

2. Money Lenders

1. Indigenous Bankers: Indigenous Bankers are the roots of modern banking.

These are the individuals or partnership firm performing the banking functions,

especially in those areas which are not covered or are poorly served by the banks.

RBI cannot exercise any control over them. It was realized by the Banking

Commission that the operation of the indigenous bankers need to be regulated.

Thus the RBI lay down the rules and guidelines for the commercial banks to deal

with the indigenous bankers.

2. Money Lenders: Money Lenders are those peoples who have their own funds

for lending. They include farmers, merchants, traders, goldsmith, village

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shopkeepers, etc. Generally money lenders charge very high rates of interest and

their operations are totally unregulated.

So, after studying the structure, we can say that, the Indian Banking System has taken a

long journey beginning from money lenders to present banking system. Government of

India has taken various steps time to time to strengthen the banking system such as

formed various committees for smooth functioning of banking system. Modern banking

aims at providing multiple services to the customers under one roof at competitive

prices. Now banks have diversified portfolios such as underwriting of securities,

investments, mutual funds, insurance business, leasing and financial advisory work. In

simple words, we can say that sense of competition and high technology completely

changes the era of modern banking system. In order to avail economies of the scale,

achieving customer satisfaction and achieving larger share of the market, banks are now

increasing their balance sheet size with mergers and acquisitions. Now developments in

the field of communication and information technology and the competition from within

and outside have changed the complete profile of banking system. The past few years

have seen a remarkable use of technology in banking services which has today led the

banking industry growing at a rapid pace. Innovation in technology has opened up new

vistas for banking institutions interested in offering value added services. Deployment

of technology, improved customer services and innovative product has brought required

competition into the banking industry. Customers are more conscious for their rights

and demanding more than ever before. The pressure on banking institutions is to find

new ways to create and deliver value to the customer.

Today banks are not moving in its traditional way. With the advancement in technology

and innovations in management, now a days, banks are offering a variety of products

and value added services to cater the needs of the customer such as E-Banking, Online

Banking, Mobile Banking, SMS Banking, Phone Banking, Investment Banking etc.

Thus, the importance of banking sector is immensely increasing as the progress and

prosperity of any country can be seen from the strength of its banking sector. Modern

banking, which is considered as e-age banking plays a pivotal role in satisfying the

customer needs, improving the traditional mechanism with the help of technology and

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developing the CRM (customer relationship management). Some of latest trends

which are prevailing in the modern banking system are explained below:

Online banking: Internet facilities have given birth to the revolution in the field of

information technology throughout the world. With this facility now banking services are

available to customer 24x7. One of the major obstacles of geographical distances of

banking sector is almost solved by this facility. Online banking facilitates more services,

improve customer access, increase customer loyalty, attract new customers, reduce

customer attrition and provide services offered by competitors.

Core Banking: Core banking solutions are computer based banking software which

works on a platform. It is a computerization of a bank’s operation in such a way that

customer account information can be accessed centrally which helped banks to offer

better service.

E-Banking: With the advancement in the information technology, now commercial

banks have computerized their banking operations. E-Banking includes internet banking,

telephone banking, ATM, electronic fund transfers, cheque clearing, etc. In this type of

banking computerization is done both for the front office as well as back office

operations.

Universal Banking: Under universal banking, wide ranges of financial services are

provided by the banks under one roof. It is just like super-stores of financial services

which offering banking and financial services through a common platform. Universal

banking is generally performed by big banks which can manage the cost of widespread

activities. So, it is a system of banking where banks are allowed to provide a variety of

services to their customers.

Globalization of Banking: The process of reforming the banking industry was initiated

in 1991and as a result the process of globalization, liberalization and privatization has

introduced in the Indian economy. It enables Indian banks becoming more global by

conducting more international banking business and also by opening their overseas

offices.

In nutshell, we can say that banking system is the life blood of any economy as they direct

the affairs of the economy in various ways. By financing the requirements of basic industries,

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banks lubricant the entire monetary and financial system and on the other hand, to remain in

the competition, the modern banking system must follow some principles such as, Principle

of profitability, solvency, liquidity, trust, and principle of intermediation.

1.6 Summary

Banking system plays a significant role in the economic growth of the country. This system is as

old as civilization. With the growth of industry, trade and commerce, the banking system also

grew over a long period of time and gained maturity. Banks are the important participants of

Indian financial system. In the era of modern banking, bank performs a number of activities.

Banks are the buyers and sellers of the use of money and the bank always uses the word ‘bank’

for itself. People can bank upon it. Banks are intermediaries between the surplus units of the

society who save and the deficit units of the society who borrow.








merchant banking services etc.

1.7 Glossary

Bank: A bank or banker is a person, firm or company having a place of business where credits

are opened by deposits or collections of money or currency or where money is advances or

loaned”.

Banking: Banking means the accepting, for the purpose of lending or investment, of deposits of

money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft or

otherwise.

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Reserve Bank of India: Reserve Bank of India is the leader of Indian Banking System. It is the

apex financial institution of India. The Reserve Bank of India as apex institution organizes,

supervises, regulates, runs and develops the monetary system and financial system of the

country. In simple words, it controls the whole banking system in India.

Public Sector Banks: Public Sector banks are those banks which are owned and controlled by

the Government of India.

Regional Rural Banks: Regional Rural Banks are framed to cater the need of the rural area and

to fill the gap in rural credit

1.8 Check Your Progress

State whether the following statements are true or false?

i. RBI is the regulator of Indian Banking System.

ii. Organized sector is that sector which is governed by some rules and regulations.

iii. On the recommendation of Narsimham Committee, the Reserve Bank of India,

announced guidelines for the entry of private players in the banking sector.

iv. Non-Scheduled banks are those banks which are listed in the 2nd schedule of RBI Act

1934

Answers: i) True, ii) True, iii) True, iv) False

1.9 References & Suggested Readings

1. Banking, Theory Law and Practice, Sundaram & Varshney, Sultan chand & sons;2004

2. Principles of Banking Varshney & Malhotra, Sultan Chand & Sons, 2005.

3. Money, Banking and International Trade, Vaish M.C, New Age International Pvt.Ltd,

1997

4. Banking, Theory, Law & Practice, Gordon.E, Natarajan.K., Himalaya Publishing House,

New Delhi.

5. Banking, Law and Practice in India Banking, Tannan's

6. Banking: Law and Practice P.N. Varshney

7. Management of Banking and Financial Services Justin Paul and Padmalatha Suresh

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1. Define Bank. What are the types of Banks?

2. Discuss in detail the structure of Indian Banking System.

3. What are the latest trends in Banking System? Explain

4. Write a note on Scheduled and Non-Scheduled banks.

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Lesson-2TYPES OF BANKS

Structure

2.1 Objectives

2.2 Introduction

2.3 Classification of banks

2.4 Functions of Commercial Banks

2.5 Guidelines issued by RBI for improving customer services

2.6 Summary

2.7 Glossary




2.1 Objectives

After completing this lesson, you will be able to:i. Understand the concept and classification of banks.

ii. Know the salient features of various bank.iii. Various functions of banks.iv. Understand the guidelines issued by RBI with respect to providing facilities to customers.

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2.2 Introduction

Banks play a significant role in the development of a country. Indian banking has contributed the

economic development in the last seven decades in an effective way. A sound banking system is

indispensable in the modern economy. Now banks have not only plays a role of financial

intermediaries engaged in the mobilization of resources and lending them to industry, rather they

acted as a agent of change in the Indian economy. The extent of services offered differs from

bank to bank, depending upon the size and type of bank. All banks operating in India fall under

different classes on the basis of ownership, function, structure, and as per schedule of the

Reserve Bank of India.

2.3 Classification of Banks: The criteria of classification of bank could be:

On the basis of Domicile On the basis of Second Schedule of Reserve Bank of India On the basis of Title

On the basis of Organizational Structure On the basis of Function

Now we will discuss it one by one.

On the basis of Domicile: On the basis of domicile, banks can be classify into two

categories:

I. Domestic Banks: Domestic banks are the banks incorporated in India and having

their head offices in India. They are the integral part of commercial banking.

Domestic banks also have branches in foreign countries. In order to expand their

Classification of Banks

On the basis ofDomicile

On the basis ofSecond

Schedule

On the basis ofTitle

On the basis ofOrganisational

Structure

On the basis ofFunction

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business in foreign countries, the prudential limit also extended by these banks in

credit and non-credit facilities.

II. Foreign Banks: Those banks which are incorporated or registered outside India

are called foreign banks. They have an office or branch in India and have their

head office in foreign country. After introducing the new economic policy in

1991, these types of banks increased in India as the process of globalization of

Indian economy, foreign banks been called up for investing here. Basically, these

banks have concentrate on corporate clients and providing specialized

international services to them. Basically, these banks confined to metropolitan

cities and other big commercial centers with limited number of branches. They

have to operate according to the banking regulation in India. Foreign banks are

allowed to operate in India only if they are financially sound. A foreign bank must

have a minimum of 25 million US dollars in at least 3 branches. It must have 10

million US dollars in the first branch and 10 million in the second branch. The

third branch should have at least 5 million US dollar. It can open more branches if

its performance in India fulfills the criteria adopted in the Indian banks. At present

34 foreign banks are operated businesses in India.

On the basis of the Second Schedule of Reserve Bank of India: On the basis of second

schedule of Reserve Bank of India, banks can be classified into two categories:

I. Scheduled Bank: Scheduled Banks are those banks which occupy a place in the

Second Schedule of Reserve Bank of India. In order to fall under this category, a

bank must satisfy these conditions:

a) Previously, Reserve bank of India has prescribed minimum limit on capital

and reserves of rupees five lakhs only but at present, the Reserve bank of

India has prescribed a minimum capital of Rupees hundred crore for starting a

new commercial bank.

b) The bank must carry on the business of banking in India.

c) These banks must satisfy that their affairs are conducted in a manner as

directed by Reserve Bank of India.

d) It must be a corporation or company.

Source: Section 42 of the RBI Act 1934.

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II. Non-Scheduled Banks: Those banks which are not occupy position in the 2nd

schedule of Reserve Bank of India, are called Non-scheduled banks and these banks

are not entitled to borrowing or rediscounting facilities at concessional rates from

RBI. Their number has continuously declined over the time. At present only one bank

is a non-scheduled bank.

On the basis of Title: Banks can be classified into three categories on the basis of Title:

I. Public Sector Banks: Public banks are those banks, the major ownership of

which is held by the Government. Business of banking conducted by the

government in this type of ownership. It is further classified into two categories

such as State bank and its associates and other nationalized banks. The SBI has

13000 branches and 51 foreign branches. SBI was initiated in 1921 with the name

of Imperial bank and it was created by amalgamating three Presidential banks-

Banks of Bengal, Bank of Bombay and Bank of Madras. In 1955 Imperial bank

was merged into State Bank of India and a separate State Bank of India Act 1955

passed. The bank became the first nationalized bank of India with an objective of

expanding business in rural and urban areas as well as facilitates the agriculture

and industry sector. It has now begun to extend its business in many new areas.

In 1969, Government of India nationalizes 14 banks and in again1980, six more

banks were nationalized. One of them-new bank was later on merged with Punjab

national bank. The Government of India does not want to contribute more to the

capital of Public sector banks. Therefore, public sector banks are raising capital

from public by making public issues. Starting with Oriental bank of Commerce,

more and more banks are going to make public issue of capital.

II. Private Sector Banks: Private Sector Banks are those banks which are controlled

by big industrial houses. In 1991 the process of reforming banking industry

initiated with the setting up of the Narasimham Committee which stressed on the

ways to improve the banking sector at large. On the recommendation of

Narsimham Committee, the Reserve Bank of India, announced guidelines for the

entry of private players in the banking sector. Reserve Bank of India has grouped

the private banks as Old Private Sector Banks and New Private Sector Bank. Old

private sector banks are those banks which carried out their banking business

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before 1990s and the new private sector banks are those banks which started their

banking business after issuing the new guidelines of Reserve Bank of India in

1993. These new private sector banks are showing much better performance as

compared to old private sector banks. These banks are strategic in their thinking

and operation and that’s the reason, they have shown excellent results in short

span. These banks are customer oriented and have new products and have access

to the latest banking technology.

III. Regional Rural Banks: Regional Rural Banks are framed to cater the need of the

rural area and to fill the gap in rural credit. On the recommendations of

Narasimham committee in 1975, Regional Rural Banks were set up for

developing rural economy. Basically it was established for the purpose of

development of agriculture, industry and other productive activities in the rural

areas. These banks provide credit and other facilities, mainly to the small and

marginal farmers, agricultural labour, artisans and entrepreneurs. To achieve the

purpose, five Regional Rural Banks were set up on 2nd October, 1975 at Bhiwani

in Haryana, Jaipur in Rajasthan, Moradabad in Utter Pradesh, Gorakhpur in Utter

Pradesh and Malda in West Bengal.These RRB’s were sponsored by various

nationalized banks such as Punjab National Bank, United Commercial Bank,

Syndicate Bank and State Bank of India.

IV. Co-Operative Banks: Co-Operative Banks are those banks which are collectively

run by a group of individuals/ societies with the goal of mutual help of the

members. These co-operative banks function on the principles of co-operation and

their activities are rural oriented. The size of assets and liabilities of these banks

are much smaller than commercial banks.

The main goal of these banks is to mutual help of the member of co-operative banks.

Actually, co-operative banks were intended to protect the small producers especially the

poor agriculturists, against the malpractices of money lenders. But now the co-operative

banks are performing the most urgent task of financing agriculture and small industry by

mobilizing surplus resources from the urban and the rural masses by promoting thirft

among them. Co-operative banks were established under the co-operative societies Act

1904, but today they three-tier system are operating in co-operative banking in India:

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1. State Co-Operative Banks

2. District/Central Co-Operative Banks

3. Primary Credit Societies

Now, we will explain it one by one.

1. State Co-Operative Banks: State Co-Operative Bank is the apex institution of Indian Co-

Operative banking. These banks are like a Reserve Bank for the co-operative banking system in a

particular state to a large extent. RBI provides funds to State Co-operative Banks which further

finance the needs of Central Co-operative and Primary Credit Societies. The district or central

co-operative banks have no permission to deal directly with RBI. If there is any need to transfer

funds from a district co-operative bank having surplus to another district co-operative bank

having deficit, it can be done only through the state co-operative bank. State Co-Operative Banks

mobilize their deposits through the public, commercial banks and from Reserve bank of India.

These banks finance the Central Co-operative Banks, co-ordinate their activities and control their

working. State Co-Operative Banks are the important link between Central Co-operative

Societies, Primary Societies and Reserve Bank of India. The main functions of the State Co-

Operative banks is to connects co-operative credit societies with money market in the country,

supervises, controls and renders guidelines to the Central Co-Operative Banks and act as a

banker bank for District/ Central Co-operative Banks. They also assist the State Government in

drawing up cooperative development related plans for the state.

2. Central/District Co-Operative Banks: Central/District Co-Operative Banks are in the middle

of three-tier co-operative structure. The main function of Central/District Co-Operative Banks is

to provide credit to the member primary credit societies. These banks have their own capital and

they also get deposits from public. Central/District Co-Operative Banks grant loans to the

Primary Credit Societies and secured loans to individuals. The share capital of these banks is

mainly provided by the member societies and the State Governments, with a small proportion

coming from the individuals. In addition to the main capital, their main sources of funds are

deposits and borrowings.

3. Primary Credit Societies: Primary Credit Societies form the base of three tier structure of

co-operative banking in India. It is an association of persons residing in a particular area. The

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fund of society consists of share capital, deposits from its members and non-members, loans

from Central Co-operative Banks. The liability of each member is unlimited. Primary Credit

Societies normally loan for short period for purchase of cattle, fodder, fertilizer, pesticides etc.

On the basis of Organizational structure: On the basis of Organization Structure banks

can be divided into:

I. Unit Banking: As the name suggests, it is a system where bank operates in a

small or limited area. A unit bank concentrates on the local customers and caters

their needs. These types of banks perform their business through single office and

having no branch office. These types of banking are popular in western countries

but not popular in India.

II. Branch Banking: Branch banking is that system of banking in which bank

establishes its head office in some big city and operates the various branches all

over the country. Bank has large network of branches scattered all over the

country and even in foreign countries also. This type of banking is very popular in

India.

III. Chain Banking: in this type of banking system, an individual or a group of

individuals control two or more banks. They purchased bulk of shares of two or

more banks in order to control or manage the baking affairs of those banks. Every

bank has its own board of directors as well as management and own identity.

IV. Group Banking: It is a common trust, association or corporation for different

banks. Under this type of banking, two or more banks are brought under the

control of the same management through a holding company. Holding company

has a control over the functioning of these banks. The holding company is known

as parent banking company and the groups of banks operating under holding

company are called subsidiary banks.

V. Correspondent Banking: This type of banking is not popular in India. Under this

system of banking, small banks called respondent banks procure deposits from the

local communities and then they deposit the funds with the correspondent banks

that basically cater to the needs of urban people. So respondent banks and

correspondent banks are related to each other and act in coordination.

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On the basis of functions: On the basis of functions we can classify banks as follows:

I. Commercial Bank: Commercial banks are the integral part of the

financial sector of developing economies. In mobilizing the savings of the

individuals, they played very important role. It is a financial institution

that creates demand deposits. Commercial bank acts as a vehicle through

which demand deposits act as a medium of exchange and circulate among

the public.

II. Industrial Bank: Those banks which extended their help to the industrial

sector of the economy are called Industrial bank. They provide long term

and medium term loans to the industry and work for their development

and growth. To attain the purpose, Government of India established

various banks for the growth of industry. Some of them are given below:

-Industrial Development Bank of India: It is established for rapid

industrial growth of the economy. The main objective to set up of IDBI is

to meet the growing financial needs of industrialization and to coordinate

the activities of all institutions that are concerned with the finance for

industrial development.

-Industrial Finance Corporation of India: IFCI was established in1948

with the objective of providing direct financial assistance to the corporate

and co-operative sector of the country.

-Industrial Reconstruction Bank of India: These type of banks are

established by an act of Parliament to provide assistance of sick industrial

units in 1985.

III. Agricultural Bank: These are the banks which give credit to agricultural

sector of the economy. These banks provide short term as well as long

term finance to farmers. Some of the examples of these banks are:

National Bank for Agriculture and Rural Development: NABARD was

established in 1982 with the objective to provide credit to agriculture, SSI,

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village and cottage industries, handicraft and other allied economic

activities. It also provides assistance to the Government of India and the

RBI and other organizations in the matters relating to rural development.

Land Development Bank: Land Development Bank was set up in 1920 in

order to provide long term credit to the farmers for purchase of farm

equipments like tractors and pumps, reclamation of land and fencing,

digging up new wells and repairs of old wells, redemption of old debts etc.

IV. Export-Import Bank of India: Those banks which was established to

provide financial assistance and encouragement to India’s foreign trade as

well as to the exporters and importers and financing of joint ventures in

foreign countries.

V. Indigenous Bankers: Indigenous Bankers are the roots of modern

banking. These are the individuals or partnership firm performing the

banking functions, especially in those areas which are not covered or are

poorly served by the banks. RBI cannot exercise any control over them. It

was realized by the Banking Commission that the operation of the

indigenous bankers need to be regulated. Thus the RBI lay down the rules

and guidelines for the commercial banks to deal with the indigenous

bankers.

2.4 Functions of Commercial Bank

Commercial banks are very important constituents in the development of the country. They are

providing banking facilities to the all section of the society. The main business of banking is

consisting of mobilizing of deposits from the public and deploying them by way of credit to the

various sectors of the economy. In the era of globalization, they have equipping themselves with

all the modern facilities in order to cater the needs of the economy. To achieve the objective

banks have performed various functions. So functions of commercial banks can be categorized as

under:

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1. Primary Functions: The basic function of the bank is Acid-test function. It means

accepting deposits from the people and lending or advancing to the people. These are the

functions, without performing of which an institute cannot be called a banking institution

at all. Hence primary functions of the banks are:

Accepting Deposits: The first and most important function of the bank is to accept

deposits from those who can save and spare for the safe custody with the banker. Banks

accepts deposits by mobilizing the savings of the people. To mobilize the savings and to

hold deposits, banks pay interest on the deposits. Banks have different kinds of accounts

to attract the savings of the people like(a) Saving Deposit Account (b) Fixed Deposit

Account(c) Current Deposit Account (d) Recurring Deposit Account(e) Flexible Deposit

Account.

Lending or Advancing Loans: Lending or Advancing loans is another important acid

test function of the banks. Without landing, the process of earning revenue does not

begin. After keeping certain cash reserves as per the conditions of the Reserve Bank of

India, banks lend their deposits to the needy borrowers. There are various types of loans

which are provided by the banks to the borrowers like (a) Money at Call (b) Overdraft

facilities (c) Cash Credit (d) discounting of exchange bills (e) Term(long term, medium

term, short) loans (f) Assistance(Credit) to government.

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Credit Creation: It is one of the basic functions of Banks. Banks are created credit

because the demand deposits. So when a bank grants a loan, it does not grant cash but

opens an account in favour of the customer and credits the amount of the loan sanctioned

in the account of the customer. Thus banks create a claim against themselves and in the

process they create credit. On the other hand, banks need not keep the entire deposits in

cash. Only a part of the deposits is required to be kept in cash because the bank in

practice is never required to repay all the deposits in cash. So they keep a part of the

deposit in cash and use the remaining for creating and multiplying credit. So in this way,

banks can create credit many times more than the deposits with them. They are rightly

called factories of money.

2. Secondary Functions: Apart from performing the primary functions, commercial banks

also render very useful services to their customers. Sometimes banks acts as an agent on

behalf of the customers, which is called agency functions and banks, render some utility

functions also to their customers, popularly known as Utility functions. So secondary

functions can be classified as:

Facilitative(Agency) Functions

Utility Service Functions

Facilitative (Agency) Functions: When banks act on behalf of the customers, they became the

agent of the customers and their relationship is called Agency. It is also called facilitative

functions because banks gave various facilities to their customers. Some of important agency or

facilitative functions are given below:

(a) Remittance of Funds: Banks remit funds on behalf of their customers from one

place to another. It is done through cheques, bank drafts, mail transfers, computer

transfers etc.

(b) Purchase and Sale of Securities: Banks are also engaging themselves in the sale and

purchase of stock exchange securities like shares, stocks, bonds, and debentures, etc.

They act as a broker in behalf of customer and perform the function of a broker.

(c) Collection and Payment of Credit Instrument: Commercial banks collect and pay

cheques, promissory notes and hundies and other credit negotiable instruments on

behalf of their customers.

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(d) Represents and Correspondence: Commercial banks also acts as a representatives

and correspondents of their customers and help them in getting passport, traveler’s

tickets, booking of vehicle and plots, etc.

(e) Collection of Dividend on Shares and Interest on Debentures: Commercial banks

also collect dividend on shares and interest on debentures held by their customers.

They also collect dividend and interest income of their customers and credit to their

account.

(f) Bullion Trading: In October 1997, Indian banks have allowed import of gold which

has been put under Open General License category.

(g) Trustee and executor of wills: Commercial banks also preserve the wills of their

clients as trustees.

Utility Service Functions: Bank renders various general utility services for their clients. They

act as a helping hand in solving the general problems of the customers. Some of them are given

below:

(a) Letter of Credit: In foreign trade letter of credit is very important document. It is a

document which certifies the customer’s credit worthiness.

(b) Foreign Exchange Facilities: Banks also transact business of foreign exchange. In

India, commercial banks are the main authorized dealers of foreign exchange.

(c) Issuing of Gift cheque Facility: For the special occasion of the customer banks

provided the facility of gift cheques in the denomination of different amounts like 11,

21, 51, 101, 501 and so on. For issuing these gift cheques banks do not charge

anything.

(d) Merchant Banking Services: Commercial banks also render merchant banking

services to their customers. They provide consultancy services and advisory services

to their clients.

(e) Receiving the valuables of the customers: Banks accept valuable documents and

precious jewellery of customers for safe custody by way of providing them Locker

facility. It is provided to the customers at very nominal annual rent.

(f) Acting as an Underwriter: Banks also underwrite the securities issued by the joint

stock companies and government for commission basis. In some underwriter

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contracts, bank agrees to take the securities up to the amount of which the bank has

underwritten, in case those securities are not taken up by the public.

(g) Issuing of Credit Cards and Smart Cards: Now a day smart card and credit card

technology is also commonly used by the banks to market their products. Under this

system, credit card holder is allowed to avail credit from the listed outlet without any

additional cost. So credit card holder need not carry cash all the time. Credit cards are

very popular in western countries. International credit cards are joining hands with

Indian banks.

In addition to these functions, a number of development functions are also performed

by commercial banks. Banks are helpful in accelerating the rate of capital formation

by mobilizing the saving of the people, they provide banking facilities to the rural

areas at concessional rates of interest. Commercial banks are very helpful in creating

employment opportunities for young entrepreneurs and small scale industries by

providing them financial assistance. So we can say that it is impossible to visualize

economic development without commercial banks.

2.5 Guidelines Issued by Reserve Bank of India for Improving Customer Services

The Reserve Bank of India, has tried to improve the customer service in the banking sector. It

has taken several measures for protection of customer’s rights, enhancing the quality of customer

services and strengthening the grievance redressal mechanism in banks. It has also made changes

to improve the customer service department. In order to improve customer services, it has

brought together all activities relating to customer service in banks and the Reserve Bank of

India in a single department. The new department started in 2006 was to focus exclusively on

delivery of customer services. the functions of the Customer Service Department were to include

dissemination of information relating to customer service and grievance redressal by banks. It

was to act as a nodal department for the banking codes and Standard Board of India (BCSBI). On

1 July 2006 ‘code of bank commitment’ towards customers was released. The code is the first

formal collaboration by the Reserve Bank of India, the banks and the Banking Codes and

Standard Board of India to provide a minimum standard for banking services to customers. This

code would endeavour to bring about reliability transparency and accountability in transactions

with customers. These are as follows:

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Banks are prohibited, subject to regular safeguards, on succession certificate, for releasing to

the, heirs or survivors the balance in deposit account and other assets held by the deceased

account holders.

Banks are allowed to accept Public Provident Fund and extended all possible help to their

clients in regarding PPF Account.

Banks are directed to observe in non- business working days even in rural branches.

Mail transfer should be credited to customers account in maximum 7 days from the date of

deposit the funds. If they fail to do so, they should pay interest on the proceeds of the transfer

for delayed period at a uniform rate of 5% per annum.

If due date of payment of proceeds of fixed deposit falls on a Sunday or on a holiday or on a

non-business working day, banks should pay interest at the originally contracted rate for the

holiday intervening between the date of expiry of deposit and the date of actual payment of

proceeds of the deposit.

Banks are directed to make payments against drafts without awaiting receipts of confirmatory

advice, and accept passports and postal identifications as adequate for the purpose of

identification.

In case of delayed collection outstation cheques, banks have to pay interest at saving bank

rate.

In order to provide direct credit to the beneficiaries accounts Reserve Bank of India also

initiated Electronic Credit Clearing Scheme.

Banks are directed to augment the installed capacity of locker facility, not for business

reasons but as to serve the community and they are further directed by the RBI that 80% of

this capacity should be made available on the first come first served basis.

Banks are instructed to utilize application money in respect of bond or debentures only for

the purposes specified under the Companies Act.

Banks are directed to avoid any stipulation requiring borrowers to keep a part of the loan

amount as deposits.

Reserve Bank of India also issued guidelines for banks to entry into insurance business.

Commercial banks were instructed to pay a interest of 2% above the prevailing bank rate as a

penalty for any delayed credit to customers accounts.

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Banks were adjusted to identify the complaints prone branches, endeavor for a customer

friendly attitude, and introduction of ATMs endeavor for speedier ways to settle transactions.

Reserve Bank of India also guidelines on Fair Practices code for Lenders. This code was to

protect the interest and rights of borrower against harassment by lenders. Banks are required

to provide information about fees, charges and important matters affecting the interest of

borrowers regarding loan application of priority sector advances up to rupees two lakh. If

banks rejected the loan application of small borrowers up to rupees two lakh, they had to

convey in writing the reason for rejection of loan applications. In 2013, there are several

complaints relating to non-adherence of bank codes.

Banks were asked to start single window service for the issuance of drafts/bankers

cheques/pay orders.

In 2006 the Customer Service Department was set up in the Reserve Bank of India. In 2013,

customer service was given lot of attention. A KYC form was to be filled up by the customer

and on the basis of this, identity proof opening of accounts was made simpler for customers.

Transfer of accounts from one city to another was made easier in case of movement or

migration of a customer.

A ‘do not call registry’ was maintained for privacy of people from telemarketing operations.

(Source: RBI site www.rbi.org.in)

2.6 Summary

A sound banking system is indispensable in the modern economy. Now banks have not only

plays a role of financial intermediaries engaged in the mobilization of resources and lending

them to industry, rather they acted as an agent of change in the Indian economy. The extent of

services offered differs from bank to bank, depending upon the size and type of bank.

Commercial banks are very important constituents in the development of the country. They are

providing banking facilities to the all section of the society. The main business of banking is

consisting of mobilizing of deposits from the public and deploying them by way of credit to the

various sectors of the economy. In the era of globalization, they have equipping themselves with

all the modern facilities in order to cater the needs of the economy.

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2.7 Glossary

I. Unit Banking: Unit banking is a system where bank operates in a small or limited area.

A unit bank concentrates on the local customers and caters their needs.

II. Branch Banking: Branch banking is that system of banking in which bank establishes

its head office in some big city and operates the various branches all over the country.

III. Chain Banking: In this type of banking system, an individual or a group of

individuals control two or more banks. They purchased bulk of shares of two or more

banks in order to control or manage the baking affairs of those banks.

IV. Group Banking: It is a common trust, association or corporation for different banks.

Under this type of banking, two or more banks are brought under the control of the

same management through a holding company.

2.8 Check your progress


i. Public Sector banks are those banks in which the major ownership is held with govt.

ii. Regional Rural banks set up after the recommendations of the Narsimham Committee.

iii. A Unit banking is a system where bank operates in a small or limited area.

iv. Online banking caters the needs of urban area customers.






1997


New Delhi.




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1. Discuss in detail the classification of banks.

2. What are the various functions of Commercial Banks? Explain

3. Write a note on the emerging concepts of banking system.

4. Write a note on Public and Private Sector banks.

5. Discuss the guidelines issued by RBI for improving customer services.

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Lesson-3

BANKING REGULATION ACT 1949

Structure

3.1 Objectives

3.2 Introduction

3.3 Banking Regulation Act, 1949

3.4 Summary

3.5 Glossary




3.1 Objectives

After completing this lesson, you will be able to:i. Understand the brief history of banking companies act.

ii. Know about the Banking Companies Regulation Act, 1949iii. Understand the meaning and definitions of various terms under the Act.

Page 37 of 244

3.2 Introduction

Before 1949, Indian banks were controlled by the Indian Companies Act. But when banks started

to grow they faced some issues such as poor liquidity of the banks, appointment of incompetent

directors with long tenure and high salaries and speculative investments. To tackle with these

issues, a separate act for banking needed. As a result, a bill was introduced in Parliament in

March 1948, passed in 1949 and came into force from 16 March 1949 as Banking Companies

Act 1949.

3.3 The Banking Regulation Act

The Banking Regulation Act 1949 is divided into five parts:

1. Preliminary (It contained definitions under section 1 to 5A)

2. Business of Banking Companies (It contained the Scope of Banking Companies under

section 6 to 36A). it is further divided into three parts:

A. Control over the management (Section 36AA to 36AC)

B. Prohibition to certain activities to the Banking Companies (Section 36AD)

C. Acquisitions of the undertakings of Banking Companies in certain cases (section

36AE to 36AJ)

3. Suspension of business and winding up of Banking Companies (under section 36B to 45).

It is further divided into two parts:

A. Special provisions for speedy disposal of winding up proceeding (under section 45A

to 45X)

B. Nomination of Deposit Accounts and Lockers.

4. Miscellaneous (under section 46 to 55A)

5. Application of the Act to Cooperative Banks (under section 56)

The Banking Regulation Act1949 amended time to time as per the need of changing

circumstances. It is amended to include new provisions in1950, 1956, 1963, 1964, 1969,

1988 and 1994.

Some of the important provisions of Banking Regulation Act are given below:

1. Preliminary (It contained definitions under section 1 to 5A)

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According to Banking Regulation Act 1949, Section 5(b), “Banking means the

accepting, for the purpose of lending or investment, of deposits of money from the

public, repayable on demand or otherwise, and withdrawable by cheque, draft or

otherwise”.

According to Section 5(c), “Banking Companies means any company which

transacts the business of banking in India”.

According to (Section (a)),“Branch or Branch office means any branch at which

deposits are accepted, cheques encashed or money lent.”

(Source: www.fiuindia.gov.in/files/released_acts/banking_regulation_act.html)

2. Business of Banking Companies (It contained the Scope of Banking Companies

under section 6 to 36A)

According to section 6 of the Act, Banking Company may engage in any of the

following business.

a) Accept, discount, buy, sell, collect and deal in bills of exchange, promissory

notes, drafts, bills of lading, warrants, etc.

b) Advancing loans

c) Borrowing or Raising of money

d) Buying and selling of foreign exchange, foreign currencies, bullion, etc.

e) Underwriting of shares, debentures and other type of securities on behalf of

others.

f) Granting and issuing of Letter of Credit of various kinds, Travelers cheques

and gift cheques.

g) Collection and transmission of money and securities.

h) Providing a locker facility to their customers.

i) Acting as the agent for Government or local authority or any other person.

j) Acquiring, holding and dealing with any property of right or title in such

property which may form the security for any loans.

k) The acquisition, construction and alteration of any building if necessary and

convenient for the purposes of the company.

l) May act as trustees for their clients.

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m) Government may by notification in the official gazette specify any kind of

business as a form of business in which it is lawful for a banking company to

engage.

n) Dealing with all or any part of the property and rights of the banking

company.

Section 8 prohibits a banking company from dealing in the buying or selling or bartering

of goods directly or indirectly except in relation with the realization of security given to

or held by it.

According to Section 9, no banking company can hold any immovable property except

such as is acquired for its own use, for a period exceeding seven years, from the date of

acquisition.

According to Section 11, the minimum limits of paid up capital and reserves to be

complied with by a banking company which want to carry on business in India.

A banking company has also prohibition on certain type of employment as banking company

cannot employ any person who is or has been adjudicated insolvent or has been convicted by a

criminal court of an offence involving moral turpitude.

(Source: https://indiankanoon.org/search/?formInput=convicted%20employee&pagenum=9)

Section 10A of the Banking Regulation Act deals with the Constitution of Board of

Directors. According to this, not less than 51% of the total number of members of a

banking company shall consist of persons who satisfy the following conditions:

(a) In order to become a director of the banking company they must have a knowledge or

experience in areas such as accountancy, agriculture and rural economy, banking, co-

operation, law, small scale industry, economics, finance or any other knowledge

which Reserve Bank of India thinks fit.

(b) According to Section 10B of the Banking Regulation Acts, every banking company

shall have one of its directors as a whole time or a part time chairman. In case a

director is appointed as a whole time chairman, he shall be entrusted with the

management of the whole of the affairs of the banking company.

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(c) Only professional banker shall become the chairman of banking company.

Appointment of chairman shall be made by the banking company subject to the

approval of Reserve Bank of India.

Mainly banks failed in India due to liquidity of funds. So Reserve Bank of India provided

provisions to maintain adequate liquidity. These are given below:

(a) Every banking company not being a scheduled bank, shall maintain in India by way

of cash reserve with itself or in current account opened with the Reserve Bank of

India or the State Bank of India partly in cash with itself and partly in such accounts a

sum equivalent to at least 3% of the total of its time and demand liabilities in India.

(b) Banking company not to hold shares in other companies more than 30% of the paid

up capital of the company or 30% of its own paid up capital whichever is less.

(c) Banking company shall maintain in India in cash, gold or unencumbered approved

securities, value at a price not exceeding the current market price, an amount which

shall not at the close of business on any day be less than 20% of the total of its

demand and time liabilities in India.

Section 20 of the Banking Regulation Act deals with the loans and advances for banking

company. According to the provisions no banking company shall provide any loan or

advances on the security of its own shares.

Section 21 deals with the determination of policy regarding loans and advances. Reserve

Bank of India may in the general interest of the depositors or public determine the policy

in relation to loan and advances followed by the banking companies. Reserve Bank of

India may issue directions to the banking companies regarding:

(a) The purpose for which advances may or may not be made

(b) The margin to be maintained in respect of secured advances

(c) The maximum amount of advances or other financial accommodation which,

having regard to the paid-up capital, reserves and deposits of a banking company

and other relevant considerations, may be made by that banking company to any

one company, firm, association of persons or individuals.

(d) The maximum amount up to which, having regard to the consideration referred to

in clause (c), guarantees may be given by a banking company on behalf of any

one company, firm, association of persons or individual, and

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(e) The rate of interest and other terms and conditions on which advances may be

made or guarantees may be given.

According to section 22 of the Act, in order to commence or operate banking business in

India, it is necessary for every banking company to obtain license from the Reserve Bank

of India. Before issuing the license, the Reserve Bank of India must satisfy the following

issues:

(a) Bank is or will be in a position to pay its present or future depositors in full as their

claims accrue.

(b) The affairs of the banking company are managed as per the guidelines issued by

Reserve Bank of India.

(c) In case of foreign bank, it complies with all the provisions of the Act of the country of

their origin. The law of the country of foreign banks origin does not discriminate

between such banks and Indian banks and it is also ensured that their business in

India will be in the public interest in general.

(d) If all the conditions which are given above are satisfied, then Reserve Bank of India

may issue license to the banking company to commerce business in India.

It is mandatory for every banking company or foreign company to obtain prior

permission from the Reserve Bank of India to open a new place of business in India or to

change the location of its existing place of business. If change occurs within the same

city, town or village then no such permission is needed. The permission of the Reserve

Bank is not required where banking company opens a temporary place of business for a

period not exceeding six months, with in a city, town or village or the environs thereof

with in which banking company has already a place of business, for the purpose of

affording the banking facilities to the public on the occasion of an exhibition, a

conference or any other like occasion. Banking company may apply for the extension and

Reserve Bank will grant permission for expansion only after satisfied regarding the

financial soundness of the company, adequacy of its capital structure, general character of

its management, public interest served due to such extension.

Section 35 of the Act empowers the Reserve Bank of India or under the direction of

Central Government an inspection of any banking company and books of accounts of the

company to ensure that the affairs of the banking company are conducted in the interest

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of the depositors and every employee or director is under obligation to provide such

documents to the Reserve Bank of India where an inspection is conducted under the

directions of the Central Government and the report for the inspection will be submitted

to the Central Government. If Central Government is not satisfied with the inspection

report then it may prohibit the banking company from receiving fresh deposits and direct

the RBI to apply under section 38 for the winding up of the banking company.

Under section 36AB Reserve Bank has a power to appoint additional director for the

interests of depositors. But it may be noted that in any case number of directors shall not

exceed five or 1/3 of the maximum strength fixed for the board by the articles, whichever

is less.

RBI has all powers to issue directions to the banks if it deems necessary to do so in the

public interest. The Reserve Bank of India has exclusive powers over the banks in for

smooth functioning of the banking system in the country. Some of the important power of

the Reserve Bank of India is given below:

a) The Reserve Bank of India has a power to prohibit the banking companies to enter

into any particular transaction or class of transactions.

b) The RBI has a power to decide credit policy for banks.

c) The RBI has a power to assist banks in their proposals for amalgamation as court

sanction a scheme of arrangement of amalgamation only if the scheme is certified

by Reserve Bank of India.

d) The RBI has a power to issue license for new banks and for new branches.

e) The Reserve Bank of India also vested all powers to control management.

f) The RBI has a power to receive returns from all the banking companies and

conducting a careful scrutiny to ensure that the provisions of the Act are fully

complied with.

g) The Reserve Bank of India may require any banking company to call for a

meeting of its directors to discuss any matter relating to the affairs of the company

or an officer of the bank to discuss any such issue with the officers of the RBI or

an officer of RBI to be deputed to supervise the proceedings of any board meeting

and report to the RBI.

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Every banking company must prepare their final accounts as per the requirements of the

Act. Provisions regarding the Act given as under:

(a) The final account must be prepared for each calendar year as on 31st December.

(b) All banking companies to finalize their final accounts in the prescribed format as

given in schedule 111 of the Act.

(c) The final account along with the auditor’s report must be published in the prescribed

manner. Three copies of such account along with auditor’s report must be submitted

to the Reserve Bank of India within three months and such final accounts to be

audited by a duly qualified Chartered Accountant.

(d) The appointment, reappointment and removal of any auditor of a banking company

can be done with the prior approval of the Reserve Bank of India.

All banking companies are required to submit the returns with the Reserve Bank of India

such as Return of Liquid assets and liabilities(monthly), Return of Assets and

liabilities(quarterly), monthly return of Assets and liabilities in India, in addition to above

stated documents. These returns should be in the form and manner prescribed by the Act.

The return must be submitted at the close of business on the last Friday of every month or

if that Friday is a public holiday under Negotiable Instrument Act 1881, at the close of

business on the preceding working day. Such returns must be submitted within one month

from the end of the calendar year. Every bank must submit a return showing particulars

of unclaimed deposits of the last ten years as follows:

(a) In case of Fixed deposits ten years will be counted from the date of expiry of the

fixed deposit receipt.

(b) In case of Savings and Current deposits ten years will be counted from the date of last

transaction.

According to section 33, every banking company incorporated outside India is required,

not later than the first Monday in August of every year in which it carries on business, to

display in a conspicuous place in its principal office and in every branch office in India a

copy of its last audited balance sheet and profit and loss account prepared under section

29. It shall keep them so displayed till they are replaced by subsequent balance sheet and

profit and loss account.

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3. Section 36AE and 36AJ empowers Central Government to acquire any banking company

on the recommendations of Reserve Bank of India. The Reserve Bank of India will

recommend such acquisitions under following circumstances:

(a) When the banking company has failed on more than one occasion to comply with the

directions given to it in writing under section21 or section 35A.

(b) When the banking company is managed in a manner detrimental to the interest of the

depositors.

(c) When the Reserve Bank of India intends to provide credit in a better manner

generally or to any particular community or to any particular area.

However, the Central Government will give a reasonable opportunity to the bank

proposed to be acquired for explanation. If the Central Government is not satisfied

with the reply filed by the bank, the Central Government in consultation with the

Reserve Bank of India will finalize its scheme of acquisition.

A banking company which is temporarily unable to meet its obligations may make an

application to the High Court for suspension of its business.

A banking company is deemed to be unable to pay its debts if:

(a) It has refused to meet any lawful demands made at any of its officers within two

working days or in other cases five days.

(b) Where the Reserve Bank of India, certifies in writing that the banking company is

unable to meet its debts.

In both the above cases, the banking company can make an application to the High Court. The

High Court on such an application may make an order staying the commencement or

continuance of all the actions and proceedings against the company for a fixed period, which is

maximum of six months or such terms and conditions as it thinks fit and proper.

(www.theindianlawyer.in/statutesnbareacts/acts/b8.html)

Banking company shall be winding up by the order of the High Court under following

circumstances:

(a) If the Reserve Bank of India makes an application to the High Court U/S 37 of the

Act.

The Reserve Bank may make an application if

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i. The banking company has failed to comply with the requirements specified

under section 11.

ii. The banking company has become disentitled to carry on banking business in

India U/S 22

iii. The banking company has been prohibited from receiving fresh deposits by an

order U/S 35 or U/S 42 of the Reserve Bank of India Act 1934.

(b) If the banking company is unable to pay its due debts.

When there is voluntarily wound up by a banking company then the High Court may

make an order that the voluntary winding up shall continue but subject to the supervision

of the court or order for the winding up of the banking company by the High Court if at

any stage during the voluntary winding up proceedings, the banking company is not able

to meet its debts as they accrue or voluntary winding up cannot continued without

detriment to the interest of the depositors.

When wound up take place subject to supervision of the High Court, the High Court may

order for the winding up of the company if it is satisfied that winding up subject to the

supervision of the court cannot be continued without detriment to the interests of the

depositors.

No banking company can amalgamate with another banking company unless a scheme

containing the terms of such amalgamation has been placed in draft form before the

shareholders of each of the banking companies concerned separately, and approved by

the resolution passed by a majority in number representing two-thirds in value of the

shareholders of each of the said companies. Notice of every meeting shall be given to

every shareholder of each of the banking companies concerned in accordance with the

relevant articles of association, indicating the time, place and object of the meeting, and

shall also be published at least once a week for three consecutive weeks is not less than

two newspapers which circulate in the locality or localities where the registered offices of

the banking companies concerned are situated, one of such newspapers being in a

language commonly understood in the locality or localities.

If the scheme of amalgamation is approved b the requisite majority of shareholders in

accordance with the provisions then it shall be submitted to the Reserve Bank for

sanction. If the scheme is sanctioned by the RBI by an order in writing it shall be binding

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on the banking companies concerned and all on all the shareholders thereof. On

sanctioning the scheme of amalgamation by the RBI, the assets and liabilities of the

amalgamated company shall become those of the banking company which under the

scheme of amalgamation is to acquire the business of the amalgamated company.

4. Section 46 of the Act deals with the provisions regarding Penalties and fines. It is given

as under:

(a) The banking company will be fined for submitting false or inaccurate returns and the

person responsible for such false returns will be liable for imprisonment up to three

years.

(b) If the banking company fails to furnish documents, accounts or other relevant

information during inspection, the penalty is rupees 2000/- and an additional fine of

rupees 100/- per day during the continuance of the default.

(c) If a banking company receives deposits from the customers in contravention of the

order of the RBI, the penalty is twice the amount of such deposits.

(d) If the banking company fails to comply with the provisions of the Banking

Regulation Act 1949, the penalty is rupees 2000 plus rupees 100 per day till the

default continues.

(e) Where a default has been committed by the banking company, every person who was

an officer at the time of default and is responsible for such default shall be deemed

guilty of such default.

5. The cooperative banks were brought within the ambit of the Banking Regulation Act by

passing an amendment to it, in 1965, called the Banking Laws Act 1965. The provisions

of the Act are applicable to the cooperative banks with certain modifications covered

under section 56 of the Act. These are as follows:

(a) The banking company shall be constructed as cooperative bank.

(b) Cooperative bank means a state cooperative bank, a central cooperative bank and a

primary cooperative bank but it excludes Land Development Banks and other credit

societies.

(c) No cooperative bank shall commence business of banking in India unless the

aggregate value of its paid up capital and reserve is more than one lakh rupees.

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(d) Every cooperative bank shall maintain a cash reserve of a sum equivalent to at least

3% of its time and demand deposits as on the last Friday of the second preceding

fortnight.

(e) The cooperative banks shall not make any loans or advances on the security of its

own shares or grants unsecured loans or unsecured loans or advances to any of its

directors or to the firms or private companies or managing agents or guarantor or to

the individual in cases where any of its directors is a guarantor.

(f) Every cooperative bank shall prepare its final accounts as on the last work day of the

year ending with 30th June every year.

(g) The above said provisions shall not apply to a cooperative bank whose license has

been cancelled or refused or which has been prohibited from accepting deposits.

The Banking Laws (Amendment) Act 1983, had added Part 111B to the Banking

Regulation Act. The part makes provision for nomination in deposit accounts and also for

lockers. The provisions regarding this part is given below:

(a) Where a deposit is held by a banking company to the credit of one or more persons,

the depositors or, as the case may be, all depositors together, may nominate, in the

prescribed manner, one person to whom in the event of the death of the sole

depositors, or the death of all the depositors, the amount of deposit may be returned

by the banking company.

(b) Notwithstanding anything contained in any other law for the time being in force or in

any disposition, whether testamentary or otherwise, in respect of such deposit, where

a nomination made in the prescribed manner purports to confer on any person the

right to receive the amount of deposit from the banking company, the nominee shall,

on the death of the sole depositor or, as the case may be, on the death of all the

depositors, become entitled to all the rights of the sole depositor or, as the case may

be, of the depositors, in relation to such deposit to the execution of all the persons,

unless the nomination is varied or cancelled in the prescribed manner.

(c) Where the nominee is a minor, it shall be lawful for the depositor making the

nomination to appoint in the prescribed manner any person to receive the amount of

deposit in the event of his death during the minority of the nominee.

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(d) Payment by a banking company in accordance with the provision of this section shall

constitute a full discharge to the banking company of its liability in respect of the

deposit: Provided that nothing contained in this sub-section shall affect the right or

claim which any person may have against the person to whom any payment is made

under this section.

Banking Laws (Amendment) Act, 2012 came into force with effect from 18th Jan 2013 to

widen the scope of powers of the Reserve Bank of India and to enable the nationalized

banks raise capital in the capital market. The distinguished features of this Act are given

below:

(a) The RBI has been given power to appoint an administrator to manage the affairs of a

company for a maximum period of twelve months.

(b) Subject to the guidelines issued by RBI, Banking companies can now issue

preference shares.

(c) The nationalized banks can increase or reduce its authorized capital subject to the

prior approval by the Central Government and from the Reserve Bank of India.

(d) The nationalized banks can now increase capital through Bonus shares and Rights

issue with the prior approval by the Central Government and from the Reserve Bank

of India.

(e) Banks can now create a fund known as Depositor Education and Awareness Fund by

utilizing the amount in the inoperative deposit account for the welfare/ awareness

among the depositors/ public.

3.4 Summary

The lesson contains the provisions regarding Banking Regulation Act, 1949. It has described

various provisions of the Act like definitions under section 1 to 5A, Business of Banking

Companies, Control over the management (Section 36AA to 36AC), Prohibition to certain

activities to the Banking Companies (Section 36AD), Acquisitions of the undertakings of

Banking Companies in certain cases (section 36AE to 36AJ), Suspension of business and

winding up of Banking Companies (under section 36B to 45) and application of the Act to

Cooperative Banks (under section 56).

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3.5 Glossary

o Banking u/s 5(b): “Banking means the accepting, for the purpose of lending or

investment, of deposits of money from the public, repayable on demand or otherwise, and

withdrawable by cheque, draft or otherwise”.

o Banking u/s 5(c): “Banking Companies means any company which transacts the

business of banking in India”.

o Banking u/s 5(a): “Branch or Branch office means any branch at which deposits are

accepted, cheques encashed or money lent.”



i. Banking Companies Regulation Act, 1949 is the replacement of Companies Act on

banks.

ii. The nationalized banks can increase or reduce its authorized capital subject to the prior

approval by the Central Government and from the Reserve Bank of India.

iii. Where the nominee is a minor, it shall be lawful for the depositor making the nomination

to appoint in the prescribed manner any person to receive the amount of deposit in the

event of his death during the minority of the nominee.

iv. E-banking caters the needs of urban area customers.



1. Bare Act; Banking Companies Regulation Act, 1949


3. Money, Banking and International Trade, Vaish M.C, New Age

International Pvt.Ltd, 1997

4. Banking, Theory, Law & Practice, Gordon.E, Natarajan.K., Himalaya

Publishing House, New Delhi.



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7. Management of Banking and Financial Services Justin Paul and

Padmalatha Suresh


1. Define the term banking under Section 5.

2. Explain the guidelines of Banking Law Amendment Act, 2012.

3. Discuss the provisions regarding penalties and fines under section 46 of

the Banking Companies Regulation Act, 1949.4. Discuss the powers of RBI given by Banking Companies Regulation Act.

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Lesson-4CRM IN BANKS AND NEGOTIABLE INSTURMENT ACT, 1881

Structure

4.1 Objectives

4.2 Introduction to CRM in banks

4.3 Obligation of bankers towards customers

4.4 Negotiable Instruments Act, 1881

4.5 Types of Negotiable Instruments

4.5.1 Promissory Note

4.5.2 Bills of Exchange

4.5.3 Cheques

4.6 Crossing and its types

4.7 Endorsement

4.8 Collecting Banker

4.9 Summary

4.10 Glossary




4.1 ObjectivesAfter completing this lesson, you will be able to:

i. Understand the concept of CRM in banks.ii. Know about the Negotiable Instruments Act, 1881.

iii. Know various types of negotiable instruments.iv. Understand about crossing, endorsement .

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4.2 Introduction to CRM in banks

Customer Relationship Management (CRM) is a customer driven business strategy designed

to optimize profitability, revenue and customer satisfaction. CRM is also a paradigm shift

from “product centric and mass marketing” to “customer centric” way of business. CRM

involves relationship marketing, which is to establish, maintain, enhance (long term)

relationships with customers and other partners so that the objectives of the parties involved

are met. This is achieved my mutual exchange and fulfillment of promises.

CRM is based on the short term orientation of the management with focus on achieving the

following objectives:

a) Attract new customers.

b) Increase sales per customer

c) Reduce costs through optimization of business process.

d) Improve customer relationship/increase loyalty.

CRM has a number of positive effects on the running of bank. It provides management with a

clear picture of the business, facilitating decision-making. Using a common architecture and

data mode, customer information can be shared faultlessly between front-end staff facing the

customers to driven services and the back-office staff who structure the deals. Front-end staff

of a bank can profile a customer, create and maintain a customer account with contacts,

manage activities, and explore business development possibilities. Similarly, a call centre

agent can maintain client data/information, produce call notes, replies to customer inquiries,

and address and track customer service requests. In a nutshell, implementation of the CRM

concepts in banks can result in the following advantage :

a) Speed and accuracy in information analysis.

b) Foundation for organization-wide data and information

c) Understanding customer behaviour.

d) Facilitating business process re-engineering.

e) Multiple products- credit deposits, investment, insurance etc.

f) Multiple distribution channels-branch, internet, call centre, field sales etc.

g) Multiple customer group-customer, small business, corporation etc.

Many documents are used in the modem commercial world. But, certain documents are freely

used in commercial transactions which are called negotiable instruments. A negotiable

instrument is one the legal title o which can be transferred is free from all defects and the

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transferee can sue in his own name. But this negotiable instrument is not assignable, but

transferable. Thus, negotiability "easy transferability from one person to another in return for

consideration."

4.3 Obligations of Bankers towards Customers

The relationship that arises between banker and customer, in conducting, various businesses

involve certain obligations and rights on the banker as well as the customer.

1. Obligation to Pay Cheques

It is a statutory obligation of the bank, having sufficient funds of the customer to pay cheques

duly drawn and presented. A bank will be forced to compensate the customer for any loss or

damage caused by its default. The bank’s liability for wrongful dishonor of cheque is of

serious nature. The bank will be forced to pay exemplary damage to the customer. However,

bank may refuse payment of a cheque for reasons such as

o Insufficient funds in the account

o Cheque is not properly drawn

o Cheque is stale (presented after stipulated date)

o Cheque is crossed but presented for cash

o Cheque is received after receipt of notice of death, insolvency or lunacy of the drawer

of the cheque.

So also, when instructions are received from the drawer to stop the payment of cheque or

when attachment / garnishee order is received from a competent authority, payment can be

refused. If the drawer’s signature differs, bank can refuse payment and also when the amount

of the cheque differs in words and figures.

2. Secrecy

It is one of the principal duties of the banker to maintain complete secrecy of the status of

customer’s account and failure to do so will make the bank to compensate the customer for

any damage or loss suffered. However, a bank is justified in making disclosure, under the due

process of law or under express or implied consent of the customer.

Disclosure in the bank’s interest is permitted. So also it is an accepted custom among the

bankers to disclose certain information to a fellow banker on written request. While

disclosing information to others, only bare facts should be revealed and not any comments

and conclusions on the matter. The disclosing bank should indicate to the other bank that in

turn it should maintain secrecy.

3. Banker ‘s Lien

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Lien generally is the right of the creditor to retain possession of the goods and securities

owned by the debtor until the debt is repaid. It however, does not vest the right to sell the

goods. But the banker’s lien has a wider connotation. It is an implied pledge.

The bank has the right to sell the subject matter in possession in the ordinary course of

business as a banker, and adjust the unpaid debt. Lien may be a general or particular lien.

General lien empowers the bank to retain all movables in its possession but particular lien

gives the right to retain the goods or property connected with particular debt.

Banker’s general lien is not applicable to safe custody articles, documents / money deposited

for specific purpose and securities / valuables left through oversight.

4. Mandate

The account holder alone has the right to operate his account with the bank. No person other

than the account holder can order the bank to debit the account. But the account holder can

give mandate or a power of attorney to another person to operate his account.

A mandate is an authority given by the account holder in favour of a third person. This is

issued by an account holder with a direction to his banker authorizing third person to operate

the account. It is unstamped letter signed by the customer.

A letter of mandate is generally issued for a short period as a temporary measure. Mandate

letter should not be accepted from the limited companies. A mandate will automatically

lapse, on death, insanity, insolvency and bankruptcy of the account holder,

5. Power of Attorney

It is a document executed by the donor or principal in favour of donee or agent to act on

behalf of the former as per authority given in the document. The following points must be

taken into consideration by the banker while accepting power of attorney issued by the

customer.

There are two types of power of attorney.

o Special Power, and General Power: While the special power of attorney is given for a

specific purpose, the other one covers many activities. Power to sign the cheque, stop

payment, signing loan documents when given to Power of Attorney holder, the donor

is ultimately liable to pay the loan amount. It is a stamped document. The original

power of attorney should be perused and a copy should be obtained and filed with the

Bank. The donor can withdraw or cancel the Power of Attorney at any time.

6. Circumstances Leading to Closure of Accounts

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The relationship between the banker and the customer is established by mutual agreement

open and operate the account. This relationship may be terminated at any time by either party

by closing the accounts. In fact, the banker-customer relationship imposes an implied

obligation on the banker not to close the account of the customer except in extraordinary case

supported by indisputable reasons.

In other words, the banker should carefully examine the issue before closing the customer’s

account and unless there are justifiable reasons, it should not close the accounts of the

customer.

A bank may take initiative to close the account of an undesirable customer after giving proper

notice for the following reasons.

7. Loans and Advances

As already said, the Bank deposits are used for lending or investment or both. In addition,

bank handles purchase and sale of foreign currencies and also lends for import and export

trade. The commercial banks lend money by way of overdrafts, demand loans, cash credit, or

by way of purchase or discounting of bills of exchange or hundies, for the purpose of

financing trade, commerce, industrial or any other business activity.

Lending by the banks is mostly against security such as goods, book debts, land and

buildings, livestock, share, securities etc. When the advance is given against such security, it

is termed as a secured advance and in cases where the advance is not backed by any security,

it is classified as unsecured or clean advance.

4.4 NEGOTIABLE INSTRUMENTS ACT,1881

In India, the negotiable instruments are governed by the by the Negotiable Instruments Act of

1881. Sec.13 of the Negotiable Instruments Act simply states that "negotiable means

promissory note of exchange or cheque payable either to order or to bearer ". Thus, Law

recognizes three kinds of negotiable instruments, namely a cheque, a bill of exchange and a

promissory note. But, in recent times because of mercantile usage or custom, certain other

documents have been included in the category of Negotiable Instruments there are: dividend

warrants, bearer bonds, bearer scrips debentures payable to bearer, share warrants to bearer

and treasury bills.

Definition: A Negotiable Instruments thus plays a key role in the modern business as a

document which can be transferable with ease. Wills defines it as "one property is acquired

by anyone who takes it bonafide and fro value, notwithstanding any defects of title in

the person from whom took it."

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Characteristic Features of Negotiable Instruments:

(i) Free Transfer: there is no formality to be complied with for the transfer of a

negotiable instrument. It can be very easily transferred from one person to

another, either by mere delivery or, by endorsement and delivery.

(ii) Transfer free from Defects: it confers an absolute and goods title on the

transferor has a bad title to the instrument, he can still pass on a good title to any

holder, who takes it in good faith and without negligence and for valuable

consideration. Thus, it cuts off prior defences in the instruments. This is a peculiar

feature of a negotiable instrument.

(iii) Right to Sue: it confers a right on the holders to Sue in his own name, in case of

need.

(iv) No Notice to transfer: the transferor of Negotiable Instruments can simply

transfer the documents, with out serving any notice of transfer, to the party who is

liable on the instruments to pay.

(v) Presumptions as Negotiable Instruments: Secs.118 and 119 of the Negotiable

Instruments Act deal with certain presumptions which are applicable only to all

Negotiable Instruments. For instance, it is presumed that the instrument has been

always obtained for consideration. Likewise there are other presumptions

regarding date time of acceptance, time o transfer, order of endorsements, stamp

holder to be a holder in due course etc.

(vi) Credit of the party: the credit of the party who signs the Instruments to the

instruments. Therefore, such instruments will never be dishonored normally.

4.5 Types of Negotiable Instruments

As stated earlier, the Negotiable Instruments can be broadly classified into two viz.:

(i) Instruments Negotiable by law, and

(ii) Instruments Negotiable by custom or usage of trade.

In India law recognizes only three instruments as negotiable and they are:

(i) Promissory note;

(ii) Bill of Exchange

(iii) Cheque.

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4.5.1 Promissory Note

Sec.4 of Negotiable Instruments Act defines a Promissory Note as “an instruments in writing

(not being a bank note or a currency note) containing an unconditional undertaking, signed by

the maker, to pay a certain sum of money only to or to the order of a certain person or to the

bearer of the instruments'.

Thus a promissory note contains a promise by the debtor- to the creditor to pay a certain sum

of money after a certain date. Hence, it is always drawn by the debtor. He is called the maker'

of the instrument.

Promissory note must be in writing and it must be duly stamped in BolIam Venkataiah vs.

Venmuddala Venkata Ramana Reddy (1985), it was held that, a pro-note cannot be

admissible in evidence cannot be admissible to prove the terms of a pro-note.

4.5.2 Bill of Exchange

Unlike the promissory note, the bill of exchange contains an order from the creditor to the

debtor, to pay a certain period. Sec, 5 of the Negotiable Instruments Act defines a bill of

exchange as follows:

"An instrument in writing containing and-unconditional order, signed by the maker, directing

a certain person to pay a certain sum of money only to, or to the order of a certain person or

to the bearer of the instrument."

Thus, a bill is always drawn by the creditor on the debtor. The person who draws it, is called

the 'drawer' and the person on whom it is drawn is called 'drawee' or 'acceptor' and the person

to whom the amount is payable is called the 'payee'.

Features of bill of exchange and a Promissory Note

Instrument in Writing: A bill or a promissory note must be in writing only. Oral

orders or promissory do not make a valid instrument.

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Unconditional Order / promise: The 'order' that is stated in the bill and the promise'

that is given in a promissory note must be unconditional if there is any conditional, it

will affect the validity of the instrument.

Drawn on a creation Person: A bill is always was on a certain person, preferable, by

the seller on his customer (creditor). Hence the drawee must be a certain person.

A certain Sum of money: The 'order' or the promise must be to pay a certain sum of

money. The amount to be paid must be definite. According to Sec. 5 of the Negotiable

Instruments Act, the sum payable may be certain, inspite of the fact that,

(a) It includes future interest, or.

(b) It is payable at an indicated rate of exchange.

(c) It is payable according to the course of exchange.

Payee to the certain: A bill or a promissory note is drawn payable to a certain person

or to his bearer of the instrument. However, promissory notes/bills cannot be made

payable to bearer on demand. This high privilege has been given only to the R.B.I for

issuing bank notes, making them payable to bearer on demand.

Payable on Demand or after a Certain Date: A bill of exchange or a promissory

note may re payable at sight (demand bill) or after the expiry of a certain period

specified therein (time bill). In case of time bill acceptance is essential and usually 3

days of grace are allowed in the case payment of such a bill.

Signed by the drawer/maker: A bill or the promissory note must be signed by the

drawer or the maker respectively.

Delivery Essential: a bill or promissory note is deemed to be drawn only when the

person who has prepared it delivers it to the other party to whom it is meant. Hence,

delivery is essential to constitute a Negotiable Instruments.

4.5.3 Cheques

A cheque, being a Negotiable Instruments can be passed from hand to hand easily and so it

has become a popular mode of payments. A cheque is the most economical and safe method

of money transaction because the transfer cost is very low and also the possibility of loss is

minimum.

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Definition of Cheque: section of 6 of the Negotiable Instruments Act defines a cheque as

follows:

"A bill of exchange drawn on a specified banker and not expressed to be payable otherwise

than on demand."

Even though a cheque is considered to be very similar to a bill of exchange it is different

from a bill in many respects. Chalmer rightly points out that, "A cheques are bills of

exchange but all bills of Exchange are not cheques."

The Salient Features of a Cheque:

1. Instruments in writing: A cheque must necessarily be an instrument in writing.

Oral orders therefore do not constitute a cheque. There is no specific rule regarding

the writing materials to be used. It may be done by means of a nib, a pencil, a type

writer or any other printed character. So also, according to the Negotiable

Instruments Act, writing out cheques with lead pencils also. But, bankers in their

own interest, and in the interest of their customers, allow the cheques to be drawn

only in ink. In all other cases, fraudulent alterations unauthorized by the drawer are

easy to make but difficult to detect.

2. An Unconditional Order: A cheque is an order to pay and it is not request. In the

indigenous bill of exchange, words of courtesy with, little monetary implication

were generously employed. They are conspicuous by their absence in the modern

cheque. It is not essential that the word 'order' must form a part of the writing

because the word ‘order' must form a part of the writing because the word 'pay' itself

denotes a command and words like 'please' or 'kindly' are dispensed with in cheque.

3. On a Specified Banker: A Cheque is always drawn on a particular banker only.

Usually the name and address of the banker is clearly printed of the cheque leaf

itself. It is advisable that the full name of the banker is mentioned in the cheque. For

e.g. instead of "l O B" it must be written "Indian Overseas Bank." A cheque drawn

on a particular branch of a particular bank cannot be encashed at another branch of

the same bank, unless there is an agreement between the parties.

4. Payee to be certain: in order that a cheque may be a valid one, it must be made

payable to the order of a certain specified person or to his agent or the bearer

thereof. That is why Sir John Paget rightly points out that "A normal cheque is one

in which there is a drawer, a drawee whom the amount the cheque is payable. The

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payee must, therefore, be a certain person. He may be a human being or an artificial

person i.e., a body corporate, e.g., a company, an authority, a trade union etc.

5. A Certain Sum of Money: A cheque is usually drawn for a definite sum of money.

Indefiniteness has no place in monetary transaction any phrase like 'less than Rupee

One Hundred Only' or Above rupees two hundred only does not give a clear and

concrete idea to the parties concerned and it will render the cheque invalid. That is

why the modem bankers request their customers to draw the amount both in words

and figures even through, the Negotiable Instruments Act is silent on this point. If

there is any difference between the amount in figures and words, the bankers can

return the cheque, since, the amount is not certain.

6. Payable on Demand: A cheque is always payable only on demand. It is not

necessary to use the word 'on demand' as in the case of a demand bill. As per Sec.19

of the Negotiable Instruments Act, unless a time factor is specified by the drawer,

the cheque is always payable on demand.

7. To signed by the drawer: The cheque must be signed by the drawer i.e., the drawer

normally puts his- signature at the bottom right hand comer of the cheque. The

signature must be that of the person in whose name the account is kept or his

authorised agent. When the signature differs from the specimen or it is slightly

different, the banker need not honour the cheque.

4.6 Crossing

Meaning: A cheque without crossing is called an open cheque. It is open to many risks. In

order to protect it from risks, crossing has been introduced.

Kinds of crossing: Crossing is of two type's namely general crossing and special crossing.

General Crossing: section 123 of the Negotiable Instruments Act, 1881 defines general

crossing as follows:

"Where a cheque bears across its face an addition of the words. 'And company , or any

abbreviation thereof, between two parallel transverse lines or two parallel transverse lines

simply, either with or without the words "not negotiable ", that addition shall be deemed to be

a 'crossing " and the cheque shall be deemed to be crossing generally. "

Essential of General Crossing:

1. Two lines are to paramount importance in crossing.

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2. The lines must be drawn parallel and transverse, Transverse means, that, they

should be arranged in a crosswise direction. They should not be straight lines.

3. The lines are generally drawn on the left hand sign so as not to obliterate or

alter the printed number of the cheque. Preferably, the line should cut cross

some of the writings.

4. The words ‘And company' or its abbreviation may be Written in between the

lines. They themselves are not essential, and so, they do not constitute

crossing without two parallel transverse lines.

5. So also, the words 'Not negotiable' may be added to a crossing but they

themselves do not constitute a crossing.

Significance of general crossing:

(i) The effect of general crossing is that it gives a direction to the paying banker.

(ii) The direction is that, the paying banker should not pay the cheque at the counter.

It should be paid only to a fellow banker. In other words, payment is made

through an account and not at the counter.

(iii) If a crossed cheque is paid at the counter contravention of the crossing:

a. The payment does-not amount to payment in due course. So, the paying

banker will lose his statutory protection.

b. He has no right to debit his-customer's account since, it will constitute a

breach of his customer's mandate.

c. He will be liable to the drawer for any loss, which he may suffer,

d. He will be liable to the true owner of the cheque who may be a third party,

irrespective of the fact, that, there is no contract between the banker and the

third party. As a general rule, a banker is answerable only to his customer and

this liability to a third party here is an exception.

(iv) The main intention of crossing a cheque is to give protection to it. When a cheque

is crossed generally, a person who is not entitled to receive its payment is

prevented from getting that cheque cashed at the counter of the paying banker.

Special Crossing.

Sec.124 of the Negotiable Instruments Act, 1881 defines special crossing as follows:

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"Where a cheque bears across its face, an addition of the words. The name of a banker with

or without the words "not negotiable," that addition shall be deemed a 'crossing " and the

cheque shall be deemed to be crossing special; and to be crossed to that banker.

Essential of Special Crossing:

(a) Two parallel transverse lines are not at all essential for a special crossing.

(b) The name banker must be necessarily specified across the face of the cheque. The

name of the banker itself constitute special crossing.

(c) It must appear on the left hand side, preferably on the corner, so as not to obliterate

the printed number of the cheque.

(d) The two parallel transverse line and the words 'Not negotiable' may be added to a

special crossing.

Significance of special crossing:

It is also a direction to the paying banker. The direction is that, the paying

banker should pay the cheque only to the banker whose name appears in the

crossing or to his agent.

If a cheque specially crossed to a banker is present by another bank, not in the

capacity of its agent, the paying banker is justified in returning the cheque.

A special crossing gives more protection to the cheque than a general crossing.

It makes a cheque still safer because, a person, who does not have a real claim

for it, without find it difficult to obtain payment. In special crossing, the

cheque is specially crossed to the payee's banker.

Not Negotiable Crossing:

Sec’s 123 and 124 of the Act permit the use of the words 'Not Negotiable' in the crossing.

This type of crossing is termed as 'Not Negotiable' in the crossing this type of crossing is

termed as 'Not Negotiable' crossing.

Significance of not negotiable crossing:

'Not Negotiable' does not mean transferable. Not Negotiable crossing does not affect the

transferability; it kills only the 'negotiability'. Negotiability is something different from

transferability. As per law, negotiability means transferability by mere delivery or

endorsement and delivery plus transferability free from defect.

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Account Payee Crossing:

There is no provision in law regarding this type of crossing. But it has peen developed in

practice. If the words ‘A/c payee', are added to a crossing, it becomes and A/c payee crossing.

Significance of A/c payee crossing:

A/c payee crossing does not restrict the transferability of cheques. This type of crossing gives

a further protection to a cheque. This crossing gives a direction to the collecting banker. The

direction is that, the collection banker should not collect it for any person other than the

payee. In other words, a colleting banker should ensure that, the cheque is credited only to the

account of the payee. Hence such cheque cannot be negotiated further in actual practice, A/c

payee crossed cheques cannot be collected to the account of any person other than the payee

himself. The safest form of crossing will be a combination of 'Not Negotiable' and A/c payee

crossing, which give the fullest protection to a cheque.

Not Transferable Crossing:

To ensure cent percent protection, banks have recently stated using the words Not

transferable in the crossing along with the words Not Negotiable. This type of crossing has

been evolved in the banking custom.

Significance: this of crossing cheque can crossing 'Not Negotiable' and A/c payee can be

transferred to others in the strict .sense of the term. But once it is crossed 'Not Transferable'

can not be to anybody and thus the cheque in question gets the fullest protection from all

kinds of frauds.

Double Crossing:

Sec.125 of the Act provides that "where a cheque is crossed specially, the banker to whom it

is crossed may be again cross it especially to another banker, his agent for collection".

Sec. 127 of the Act lays down that, "where cheque is crossed specially to more than one

banker except when crossed to an agent for the purpose of collection the banker on whom it

is drawn shall refuse payment therefore”. Thus, if a cheque is crossed to two or more banks,

the paying banker in put in confused position as to whom he should pay. Such ambiguity

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renders the cheque is crossed, can cross it again in favour of another banker for the purpose

of collection It does not render the cheque invalid.

4.7 Endorsement

Endorsement is nothing but the process of signing one name affixing an accepted rubber

stamp impression on a cheque, for the purpose; of transfer. Thus it is both a contract and a

transfer. Delivery of the instrument is necessary to complete its endorsement.

Definition of Endorsement:

Endorsement has been defined in Sec. 15 of the Negotiable instrument Act 1881 as follows:

"where the maker or holder of a negotiable instrument signs the same, otherwise than as such

maker, for the purpose of negotiable, on the back or face thereof, or a slip of a paper annexed

thereto... he is said to enclose the same, and is called the endorser."

It is quit evident from the above mentioned definition that, the endorsement can be made that

either on the back of the instrument or on the face/thereof. But according to Sec. 6 of the

Indian securities Act of 1886, an endorsement made on a document, elsewhere than on the

back it self, is not valid. In practice, an endorsement must be made on the back of the

instrument.

Kinds of Money Market:

I.Blank Endorsement: According to Sec.16 (1) of the Negotiable instrument Act "if the

endorsement is said to "Bank. ..."An endorsement in blank, as it is generally called

General endorsement, specifies no endorsee, and as such, the instrument becomes

payable to the bearer." Hence, cheque endorsed in blank can be negotiated by mere

delivery. Thus, a cheque, originally payable to order, becomes payable to bearer by an

endorsement in blank.

Example: A cheque is payable to D. David or order.

If it simply signed by David on the back, it constitutes a blank endorsement.

II.Special Endorsement: it is otherwise called a full endorsement Sec.16 (1) the Negotiable

instrument Act lays down that "…if he (endorser) adds a direction to pay the amount

mentioned, to or to the order of a special person, the endorsement is said to be in "full"

and the person so specified person, the endorsee of the instrument." Thus if the endorser

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adds a direction to pay the amount to the order of a certain person, then, the

endorsement is said to be full. An instrument with a blank endorsement can be

converted into a special endorsement by any holder by specifying the name of an

endorsee and putting his signature. A cheque, originally a bearer cheque, can be

converted into an order cheque, by means of a full endorsement.

Ex: a cheque is payable to D. David or order. He adds a direction to pay the amount Mr.

Stephen or order and puts his signature below the endorsement in the following forms must

be regarded as special, where the cheque is endorsed by X in favour of Y:

(i) pay to the order of Y – X

(ii) X m favour Y.

(iii)Y or order x.

(iv)Please exchange, Y. X.

III.Restrictive Endorsement: a restrictive endorsement is one which limits the further

negotiation of an instrument. The endorsee in such cases cannot further endorse it.

Generally, the word 'only', is added after the endorsee's name. Ex: A cheque is payable

to D. David. He endorsee it as follows:

a. 'Pay to Samuel only'-D. David

b. 'For deposit only'-D. David.

c. 'Pay to the order or Samuel -D. David.

An endorsement may be restrictive for the purpose of constituting the endorsee as an agent

for collection

Ex: (a) 'Pay to Kumar for my use'-- D. David.

(b) 'Pay to Rajan on my account'- D. David

(c) 'Pay to Mohan for the account of Rajaram'-- D. David

In all these cases, transferability of the instrument is restricted.

IV.Conditional Endorsement: this is not a common form of endorsement. It may take many

forms: It may either limit the liability of the endorser or create some liability to the

endorsee to receive the payment of the instrument. That is, an endorsement may-be

preceded by a certain condition, which should have been fulfilled by the endorsee, for

obtaining payment; the endorsee's right to receive money is subject to the fulfillment of

a particular event.

Ex: A cheque payable to D. David is endorsed as follows:

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(a) 'Pay to Jebaraj or order on arrival of S.S Victoria'-- D. David.

(b) 'Pay to Kamalchand on completion of the house building'-- D. David.

(c) , Pay to Y, if he marries X within a month ' --D. David.

V.Sans Recourse Endorsement: it is an endorsement which limits the liability of the

endorser free from all liability to any subsequent holder.

Ex: A cheque payable to D. David is endorsed as follows: '.Pay to Rabindran or order"

without recourse to me"-- D. David

It signifies that, if the cheque is dishonoured, Rabindran and the subsequent endorsees cannot

hold D. David liable, since he has already excluded his liability by means of his endorsement.

In India, the words, 'without' recourse' are mostly used instead of 'Sans recourse'.

VI.Sans Frais Endorsement: 'Sans Frais' means 'without expense'. Here, the endorser does

not want any expense to be incurred on his account on the instrument. But, he dose not

want any additional expenditures like noting and protesting charges to be borne by him.

Ex: D: David endorses the cheque as follows:

"Pay to raja or order: Notice of dishonour waived" --D. David.

VII.Facultative Endorsement: it is an endorsement, where by, the endorser waives some of

his rights on the instrument.

Ex: the Facultative Endorsement might read as follows:

"Pay to Raja or order. Notice of dishonour waived"-- D. David.

Normally, when a bill is dishonoured, notice of dishonour should be served by the holders to

all the pervious parties. But, in the above example the holders can, without serving .any

notice to D. David. Make him liable, in case the bill is dishonoured. .

VIII.Partial Endorsement: if only a part of the amount of the instrument is endorsed it as a

case of partial endorsement. According to Sec 56 of the Negotiable Instrument Act -

"No "Writings on a negotiable instrument is valid for the purposed of negotiable

instrument is valid of the purpose of negotiability, if such a writing purports to transfer

only to be due on the instrument.” Law recognizes only an endorsement of the entire

amount of the instrument. Hence, partial endorsement is not valid.

Ex: a cheque fro Rs. 500 is endorses by D. David. As follows:

"Pay to Chandra Rs. 100 --D. David.

Suppose the same cheque is endorsed as follows:

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"Pay to Chandra Rs. 100 only and pay to Rajapandian Rs. 400 only.

4.8 COLLECTING BANKER:

Meaning: A collecting banker is one who undertakes to collect the amount of a cheque for

his customer from the paying banker. A banker is under no legal obligation to collect cheques

drawn upon other banks for a customer will be satisfied merely with the function of payment

of cheque alone. Moreover, in-the case of crossed cheque, there is no other alternative to

collect the cheques except through some banker. In rendering such service, a banker should

be careful, because, he is answerable to a number of people with whom he has no contractual

relationship and any negligence or carelessness on his part may land him in difficulties.

STATUTORY PROTECTION:

According to Sec. 131 of the Negotiable Instrument Act, "A banker who has in good faith

and without negligence, received payment for a customer of a cheque, crossed generally or

specially to himself shall not, in case the title to the cheque proves defective, incur any

liability to the true owner of the cheque, by reason only of having received such payment ".

Thus, Sec., 131 protects the collecting banker against an action of conversion. Of course, this

a very high privilege given to the collecting banker. Here, the banker is protected to a certain

extent even against the equity principles of law i.e., the object of law is always to protect the

rights of the true owner.

The above statutory protection is available it the collecting banker only if he fulfills the

following conditions:

The cheque he collects must be a crossed cheque.

He must collect such crossed cheques only for his customer as an agent and not as a

holder for value.

He must collect such crossed cheque is good faith and without negligence.

(1) Crossed cheque only: Statutory protection can be claimed by a collecting

banker only for crossed cheques. It is so because, in the case of an open

cheque, it is not absolutely necessary for a person to seek the service of a

banker. So a banker, while colleting an open cheque in which his customer has

no title; becomes liable for conversion.

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(2) Collections on Behalf of customers as an agent: the above protection can be

claimed by a banker only for those cheque collected by him as an agent of his

customer. If he acts as a holder for value, he will acquire a personal interest in

them, and so, he cannot claim protection under sec.13l. so also, if he collects a

cheque for a person other than a customer, he will not be protected. That is, if

the stranger (other than the customer) for whom he collects a cheque has no

title, and then the banker will be liable for conversion.

(3) In the Good Faith and, without Negligence: in order to get the protection

under the Section, a collecting banker must act in the good faith and without

negligence. This applies to the whole transaction from the receipt of the

cheque from the customer to the receipt of the proceeds from the cheque from

the customer to the receipt of the proceeds from the paying banker. The

question of good faith is not very material because, joint stock banks do not

act otherwise than in good faith.

DUTIES OF A COLLECTING BANKER

(i) Exercise Reasonable Care and Diligence in his Collection Work: when banker

collects a cheque for his customer, he acts only as an agent of the customer. As an

agent, he should exercise reasonable care, diligence and skill in collection work.

He should observe almost care, care when presenting a cheque or a bill for

payment. Reasonable care and diligence depends upon the circumstances of each

case.

(ii) Present the cheque for collection without any delay: the banker must present the

cheque fro payment without any delay. If there in delay in presentment, the

"customer may suffer” losses due to the insolvency of the drawer or insufficiency

of funds in the account of the drawer or insolvency of the banker himself. In all

such cases. The banker should bear loss.

(iii)Notice to customer in the case of dishonour of a cheque: if the cheque, he collects,

has been dishonoured, he should inform his customer without any delay. The

Negotiable instruments Act has prescribe a reasonable time for giving the notice

of dishonour. If he fails to do so, and consequently, any loss arises to the

customer, the banker has to bear the loss.

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(iv)Present the bill of acceptance at an Early Date: As per Sec: 61 of the Negotiable

Instruments Act, a bill of exchange must be accepted. Acceptance gives an

additional currency to the bill, because, the drawee becomes liable thereon from

the date of acceptance. Moreover, in the case of a bill of exchange payable after

sight, acceptance, is absolutely essential to fix the date of maturity. If banker

undertakes to collect bills, it is his duty to present them for acceptance at early

date. Sooner a bill is presented and got accepted, earlier is its maturity.

(v) Present the bill for Payment: the banker should present bills for payment in proper

time and at proper place. If he fails to do so, and if any loss occurs to the

customer, then, the banker will be liable, According to Sec 66, of the Negotiable

Instruments Act a bill must be presented on maturity. As per Sec.21, sight bills are

payable on demand. Sec.22 lays down that the maturity of the bills is the date on

which it is due for payments, to which, 3 days of grace are added.

Protest and Note a Foreign bill for Non- Acceptance: in case of dishonour of a bill by non-

payment, it is the duty of the collecting banker to inform the customer immediately.

Generally, he returns the bill to the customer. In the absence of specific instructions,

collecting bankers do not get the- inland bills noted and protested for dishonour, If the bill in

question happens to be a foreign bill; the banker should have it protested and noted by a

Notary Public, and then, forwarded it to the customer.

4.9 Summary

The past few years have seen a remarkable use of technology in banking services which has

today led the banking industry growing at a rapid pace. Innovation in technology has opened

up new vistas for banking institutions interested in offering value added services.

Deployment of technology, improved customer services and innovative product has brought

required competition into the banking industry. Customers are more conscious for their rights

and demanding more than ever before. The pressure on banking institutions is to find new

ways to create and deliver value to the customer.

Today banks are not moving in its traditional way. With the advancement in technology and

innovations in management, now a days, banks are offering a variety of products and value

added services to cater the needs of the customer such as E-Banking, Online Banking, Mobile

Banking, SMS Banking, Phone Banking, Investment Banking etc.

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4.10 Glossary

1. Customer Relationship Management: Customer Relationship Management (CRM) is a

customer driven business strategy designed to optimize profitability, revenue and customer

satisfaction

2. Negotiable Instruments: Sec.13 of the Negotiable Instruments Act simply states that

"negotiable means promissory note of exchange or cheque payable either to order or to bearer

". Thus, Law recognizes three kinds of negotiable instruments, namely a cheque, a bill of

exchange and a promissory note.

3. Bills of Exchange: An instrument in writing containing and-unconditional order, signed by

the maker, directing a certain person to pay a certain sum of money only to, or to the order of

a certain person or to the bearer of the instrument.

4. Cheque: A cheque, being a Negotiable Instruments can be passed from hand to hand

easily and so it has become a popular mode of payments.

4.11 Check your progress:


i. Promissory Note is a negotiable instrument.

ii. Negotiable instruments are payable either to order or to bearer.

iii. A cheque may have unique features of crossing.

iv. Payment of cheque can be drawn any time after its issue date.



1. Bare Act; Negotiable Instrument Act, 1881



1997

4. Banking, Theory, Law & Practice, Gordon.E, Natarajan.K., Himalaya Publishing

House, New Delhi.




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1. Define CRM in banks. Explain the obligations of banker towards customers.

2. Explain the Negotiable Instrument Act, 1881. Also give its salient features.

3. What are the various types of negotiable instruments?

4. What are the various types of crossing? Explain with the help of suitable examples.

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Lesson-5BANKING OPERATIONS AND CONTEMPORARY DEVELOPMENTS IN

BANKING

Structure

5.1 Objectives

5.2 Introduction

5.3 KYC Norms and Operations

5.4 Banking products at a glance

5.5 Retail banking services

5.6 Contemporary developments in Banking Sector

5.6.1 E-banking

5.6.2 Mobile banking

5.6.3 Universal banking

5.7 Summary

5.8 Glossary





i. Understand the concept of KYC norms and operations.ii. Know various types of banking products.

iii. Various retail banking services.iv. Understand contemporary developments in banking sector.

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5.2 Introduction

Indian Banking System, which is considered to be the back bone of Indian Financial System,

is changing rapidly with the change in the economic environment of the country. The Indian

economy is no longer a stagnant economy. It has already transformed into a fast growing

economy with a GDP rate of more than 7.3%. The Indian Financial System today consists of

an impressive network of banks and financial institutions and wide range of financial

instruments. Indian banking is an active participant in reshaping deregulated environment of

Indian economy. The banks initiated a number of measures to respond to the changed

environment of economy in addition to their traditional banking to fulfill the newly emerging

demands and aspirations of the customers. The banks have introduced various innovative

financial products and services like venture capital finance, factoring, mutual fund, housing

finance, credit card, lease financing, loan syndication and other merchant banking services

etc.












Thus, the importance of banking sector is immensely increasing as the progress and

prosperity of any country can be seen from the strength of its banking sector. Modern

banking, which is considered as e-age banking plays a pivotal role in satisfying the customer

needs, improving the traditional mechanism with the help of technology and developing the

CRM (customer relationship management).

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5.3 KYC Norms and Operations

The RBI has taken strong, stage-wise steps time by time to strengthening the banking system.

Guidelines issued by it in 2002 have been refined continuously. Guidelines are issued by the

RBI to identify the customers and systems and procedures that all banks should have follow

for early detection and prevention of financial frauds, money laundering, scrutiny and

monitoring of large value transaction etc.

“KYC is an acronym for “Know your Customer”, a term used for customer identification

process. It involves making reasonable efforts to determine true identity and beneficial

ownership of accounts, source of funds, the nature of customer’s business, reasonableness of

operations in the account in relation to the customer’s business, etc which in turn helps the

banks to manage their risks prudently. The objective of the KYC guidelines is to prevent

banks being used, intentionally or unintentionally by criminal elements for money

laundering. Reserve Bank of India has issued guidelines to banks under Section 35A of the

Banking Regulation Act, 1949 and Rule 7 of Prevention of Money-Laundering (Maintenance

of Records of the Nature and Value of Transactions, the Procedure and Manner of

Maintaining and Time for Furnishing Information and Verification and Maintenance of

Records of the Identity of the Clients of the Banking Companies, Financial Institutions and

Intermediaries) Rules, 2005.

Customer identification means identifying the customer and verifying his/her identity by

using reliable, independent source documents, data or information. Bank has laid down

Customer Identification Procedure to be carried out at different stages i.e. while establishing

a banking relationship; carrying out a financial transaction or when the bank has a doubt

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about the authenticity/veracity or the adequacy of the previously obtained customer

identification data.

To ensure that the latest details about the customer are available, banks have been advised to

periodically update the customer identification data based upon the risk category of the customers.

Banks create a customer profile based on details about the customer like social/financial

status, nature of business activity, information about his clients’ business and their location,

the purpose and reason for opening the account, the expected origin of the funds to be used

within the relationship and details of occupation/employment, sources of wealth or income,

expected monthly remittance, expected monthly withdrawals etc. When the transactions in

the account are observed not consistent with the profile, bank may ask for any additional

details / documents as required. This is just to confirm that the account is not being used for

any Money Laundering/Terrorist/Criminal activities.

The information collected from the customer for the purpose of opening of account is

treated as confidential and details thereof are not divulged for cross selling or any other

similar purposes.

Objectives of KYC Guidelines

1) To prevent bank from being used, by unscrupulous or criminal elements for their

criminal activities including money laundering.

2) To minimize frauds and risks and protects bank’s reputation.

3) To avoid opening of accounts with fictitious name and address.

4) To weed out bad customers and protect good ones.

What is expected from the Customer?

1) Provide valid proof of identification along with proof of address.

2) Provide reference of introducer.

3) Provide other relevant information as warranted under the KYC/AML.

4) Provide account specific information as & when required.

5) Provide periodical mandatory information about himself/account.

Valid Documents for ID proof and Address proof

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Prospective customer can give self-attested copy of one of the documents from the following

indicative list. The original of these documents are, however, required to be shown to the

bank officials for verification.

Proof of Identity Proof of Address

Passport

Voter ID Card

Driving License

PAN Card

Photo Credit Card

Defense ID Card

Any other valid proof as may be

accepted by the bank

Passport

Voter ID Card

Driving License

Latest Utility Bill

Rent/Lease Deed

Credit Card Statement

Employer’s/Public authority’s letter

with address

Note:-

1. Address Proof of Close Relatives (Parents, Spouse, Son, Daughter etc.) may be

provided with sufficient evidence in case prospective customer resides with the

relative and no valid address proof in his name is available.

2. In case of joint holder, independent proof of identity & address for all individuals are

required.”

(Source:https://www.atozinbanking.com/index.php/study-material-on-banking/65-know-

your-customers-guidelines-by-rbi)

5.4 BANKING PRODUCTS AT A GLANCE

Given below are the services provided by public and private sector banks in India:

1. DEPOSITS

Many products are listed in retail banking which are explained as below:

FIXED DEPOSIT

The deposits which are given to bank for a specified period of time are called as fixed

deposits. It is also known as FD or term deposit. Amount deposited by the way of FDs

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is repayable on the expiry of a specified time. In short, fixed deposit account is one

wherein money is deposited for a fixed period and is not supposed to be withdrawn

before the expiry of the fixed period. This period usually varies from 7 days to five

years. The rate of interest allowed on such accounts generally increases with the

period of deposit. This account is also known as Term Deposit Account. Since fixed

deposit accounts are repayable after a fixed or specified period, this is the most

suitable form of accepting deposit for a commercial bank. Banks allow a higher rate

of interest to attract such deposits. A customer deposits their money in such account

with a view to earn interest as well as to withdraw the same on the expiry of the

period of the deposit. But if a customer does need money before the expiry of the

fixed period, he can either take a loan against the fixed deposit or the bank may allow

him to withdraw a deposit before the expiry of the due date. In case the customer

takes a loan against the deposit, he has to pay interest at a higher rate than the allowed

deposit. If he withdraws the money before the due date, he foregoes a part of interest

accrued on such deposit. Up to March 1988, the banks charged a penalty of one

percent in case of premature withdrawals. Effectively, the rate of interest used to be

one percent less than the normal rate of interest. But now, RBI has permitted banks to

decide their own penal interest rated for premature withdrawals. With liberalization

and globalization of Indian economy, the interest rates being offered on long term

deposits are linked with expectations regarding the behavior of interest rates during

the period under consideration. In post 1991 period, Indian banks have seen the period

when the interest rates increased up to the tenure of a year or two and declined for

higher maturity period.

SAVING ACCOUNT

Saving bank account is generally opened to save the money from their current income

in order to meet the future needs. This is an account into which small savings are

deposited into bank by customers. This account is meant for the benefit of middle

class and low income group people. A saving bank deposit account can be opened by

any person with a minimum specified deposit. The special feature of this account is

that deposits can be made in this account for any number of times in a week but

withdrawals can be made only once or twice a week. Restrictions on withdrawals are

imposed by banks to discourage the habit of frequent withdrawals. The rate of interest

payable by the banks on such deposits is very low as compared to fixed deposit

account. The saving bank account holder is issued a pass book. The depositor is

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normally required to present his pass book together with a withdrawal for m whenever

he wants to withdraw money. But now banks have begun to allow cheque facility also

to saving bank depositors who maintain a minimum balance. However, the cheque

book facility is not extended to minors.

CURRENT ACCOUNT

A current account is generally being opened by business firms and it can be operated

many times during a working day having no restriction on the number and the amount

of withdrawals. This account may be defined as running account between a banker

and a customer. Since customer can deposit money into or withdraw money. The

object of current account is to provide facilities to businessman for depositing and

withdrawing money whereby they are relived of the task of handling cash themselves

and the risk inherent therein. This account can be freely operated by the depositor. He

can withdraw money from his account by cheque at any time during the working

hours of the bank on any working day.

RECURRING DEPOSIT

In this account, a depositor is required to deposit an amount chosen by him. The rate

of interest on the recurring deposit account is higher than as compared to the interest

on the saving account. So in a recurring deposit account, a predetermined amount is

deposited into account every month. The rate of interest is normally equal to the rate

of interest payable on a term deposit account of the same period. With liberalization,

foreign banks and private sector banks have come up again. These banks are using

latest technology and are presenting certain innovative accounts under different

names.

NRI ACCOUNT

NRI accounts are generally opened by a person who is of Indian origin but settled in

abroad. The banks offer very attractive schemes on this account because the amount

deposited in such accounts is in the form of foreign exchange. At present there are

many schemes available for NRI account, depending upon their need for housing,

industry and currency.

CORPORATE SALARY ACCOUNT

These accounts are generally opened with zero balance. Under this account, salary is

deposited in the account of the employees by the employer.

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KID’S ACCOUNT (MINOR ACCOUNT)

Now a day’s banks encourage the general public to open the account of their children

with the bank.

SENIOR CITIZENSHIP SCHEME

Banks have also started various schemes to provide the social security to senior

citizens of the country.

2. LOANS AND ADVANCES

The main focus of the banking industry is advancing of funds to the businessman, household

industries including MSMEs and SMEs. The major part of the income of bank is generated

by way of loans and advances. Three basic principles of bank lending that are safety,

liquidity, and profitability followed by banks. The various types of loans provided by bank is

discussed as under:

i) PERSONAL LOANS: Personal loans are offered by bank to meet the household

needs of the public. It is generally given at a reasonable rate of interest. The credit

limit is decided on the basis of the income of the borrower.

ii) HOUSING LOANS: Housing loan is also another important segment of loans after

personal loan. Banks provide loans for purchase or construction of new house,

expansion of existing property, purchase of land etc. The rate of interest is monitored

by RBI.

iii) EDUCATION LOANS: Banks provide loans for completing the education of the

children. The loan is provided at a very reasonable rate of interest and repaid,

generally, after completing the education.

iv) VEHICAL LOANS: Banks also provide vehicle loans to meet the financial needs of

the society. Two wheeler and Four wheeler loans are very popular in this segment.

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v) PREFESSIONAL LOANS: Banks provide loans to professionals like doctors,

engineers, Chartered Accountants, lawyers etc. These loans are to be repaid in EMIs.

vi) CONSUMER DURABLE LOANS: Sometimes in order to purchase the durable

goods, banks offer the loans to public. The borrower only have to give a small down

payment and the rest payment is financed by bank.

vii) LOANS AGAINST SHARES AND SECURITIES

The banks also finance against shares for different uses. Now-a-days finance against

shares are given mostly in demat shares. A little margin is normally accepted by the

bank on market value. For these loans the documents required are normally DP notes,

letter of continuing security, pledge form, power of attorney. This loan can be used

for business or personal purpose of the borrower.

5.5 RETAIL BANKING SERVICES

1. CREDIT CARDS: A credit card is a monetary instrument. It enables the card holder to

obtain goods and services without actual payment at the time of purchasing. The

introduction of credit card by banks is one of the new phenomenons in the banking sector.

A credit card is a charge card. It is a direct charge against the limit sanctioned. Credit

cards are popularly known as plastic money. This plastic card has carried the photo,

identity, signature of holder. It has name of issuing bank on it with validity period. Credit

cards are electronic cards. These cards enable the holders to pay for their purchases

without physically carrying cash. Most of the people use credit card while shopping and

paying other expanses as it provides convenience. There is no need to carry cash all the

time because, the plastic cards will do meet the expenses. The issuer bank of the card

provides a short term loan to card holders. It enables the holder to make purchases and

pay for them later. Issuer offers interest free credit to holders for period of 30-50 days.

2. DEBIT CARDS: A Debit Card is also a plastic card. It offers an alternative payment

mode to cash while making purchases. Physically debit card is like a credit card,

however, it works more similar to write a cheque as the amounts are withdrawn directly

from the bank account of the customer. Now a day, banks provide a Debit Card cum

ATM on opening an account with a bank. It is used by holder to withdraw from his

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account or make payment for purchases at merchant stores. Debit cards allow the holder

to spend only what is in his account. Debit Card allows the card holders electronic access

of their bank account at a bank. A debit card holder needs to be an account holder of the

bank. There must be balance amount in the account of holder to operate the debit card.

3. INTERNET BANKING: Internet banking refers to a banking transaction routed through

internet. This mode of banking permits customer to perform banking transaction through

the website of bank hosted in internet. Internet banking is also known as virtual banking,

online banking or anywhere banking. It enables a client to perform his banking activities

on his personal computer at the place and time of his choice.

4. MOBILE BANKING: Mobile banking also known as M-Banking. It is a term used for

performing balance checks, account transactions, payments, credit applications and other

banking transactions through a mobile device such as mobile phone. The earliest mobile

banking services were offered through SMS service which is called SMS banking. Hence,

mobile banking is an innovative solution designed for modern and energetic people who

value their time.

5. TELEPHONE BANKING: Telephone Banking is a service which provided by a

financial institution to its customers to perform transactions over the telephone. Most

telephone banking use an automatic phone answering system with phone keypad response

or voice recognition capability. To ensure guarantee, the customer first authenticate

through a numeric or verbal password or through security question asked by a live

representative with the obvious exception of cash withdrawals and deposit, it offer

virtually all the funds transfers between a customer’s account etc.

6. AUTOMATED TELLER MACHINES (ATM): An Automatic Teller Machine is an

electronic device. It is operated by customer himself with a plastic card to make

withdrawals, deposits and other banking transactions. ATM is located in the bank

building or in busy places to provide around the clock banking facilities to customers.

ATM is the dynamic technique of providing e-banking services to customers. Today,

ATMs not only providing the facility of dispensing cash to customers but used as a device

for interacting with customers in their local language for increased convenience.

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Following are the features available on ATMs which can be accessed from anywhere at

any time:

a. Withdrawal of cash

b. Deposit of cheque and cash

c. Balance Enquiry

d. Request for cheque book

e. Payment of utility of bills etc.

7. SMART CARD: Smart Card is a chip based card. Smart card having a microchip will

store a monetary value. It performs all the functions of magnetic stripe like ATM cards,

Credit Card, debit etc.

8. RTGS and NEFT: RTGS as the name suggests is a real time funds transfer system

which assists the customer to transfer funds from one bank to another in real time or gross

basis. The transaction is not put on a wqaiting list and cleared out instantly. Reserve Bank

of India maintains RTGS payment gateway which makes transactions between banks

electronically. The transferred amount is instantly deducted from the account of one bank

and credited to the account of another bank. NEFT means National Electronic Fund

Transfer. it is a nationwide money transfer system which allows facility to the customers

to transfer funds electronically from their respective bank accounts to any other account

of the same bank or any other bank network. NEFT needs a transferring bank and a

destination bank for fund transfer. Almost all the banks enabled to perform a NEFT

transaction with the RBI organizing the records of all the bank branches at a certralized

database. The customer registers the beneficiary, receiving the funds before transferring

the funds. For this purpose, the customer must possess the information such as the

recipient, bank of recipient, a valid account number belonging to the recipient and IFSC

code of respective bank of recipient.

5.6.1 E-BANKING: THE NEW AGE BANKING

E-Banking is the latest in the series in the series of technological wonders of the recent past.

It refers to use of technology and communication system to perform banking transactions

electronically without visiting a bank. Banks are increasingly making use of electronic

payments system for offering banking services at the door steps of the clients. The

widespread use of technology in banking operation has totally replaced the traditional system

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of confining banking activities to bank branches. E-banking assists the bank customer to

enjoy the facilities like anywhere banking and anytime banking. It also helps the banks to

reduce their operating costs. The use of electronic devices in banking activities also improves

the customer’s services and overall efficiency of the banks.

E-banking involves the use of computer networks, internet and digital stored value system.

The application of electronic technology towards transfer of funds through an electronic

terminal or computer to conduct various transactions like cash receipts, payments, and

transfer of funds is known as E-banking.

E-banking activities refer to the delivery of banks services to a customer at home or at office

through electronic delivery channels. It is the use of electronic technology for transfer of

funds, cash receipts, payments etc. it is anywhere, anytime banking around the clock.

Following are some of these modern trends in banking in India.

Automated Teller Machine

Debit Card

Credit Card

Net Banking

Telephone Banking

(Note: All these products have already discussed in detail)

5.6.2 MOBILE BANKING: MEANING AND CONCEPT

Mobile banking can also be defined as "the account that travels with you”. Mobile

banking is also known as M-Banking. It is a term used for performing balance checks,

account transactions, payments, credit applications and other banking transactions

through a mobile device such as mobile phone. The earliest mobile banking services were

offered through SMS service which is called SMS banking. Hence, mobile banking is an

innovative solution designed for modern and energetic people who value their time.

Mobile banking can take the form of following types:

Short massages are sent to the customers mobile phones. SMS massages can

be used for both passive and active banking operations. A client automatically

receives massages about his account balance after certain operation is

performed.

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Global System Mobile (GSM) is not just about voice communications but also

supports wireless personal digital assistance and other devices, just as it

supports telephonically. The main advantage of this service is simplicity. A

client can know about instructions on the mobile phone display as they do in

case of computers. For this mobile handset must be GSM compatible.

5.6.3 UNIVERSAL BANKING: THE CONCEPT

'Universal Banking' refers to the banks that offer a variety of financial products

beyond the commercial banking functions like Retail loans, Housing Finance, Auto loans,

Merchant Banking, Investment banking, Mutual Funds, Factoring, Credit Cards, Insurance

etc. It is a multi-functional financial supermarket which provides both banking and financial

services through a single window i.e. multiple financial services are offered under one roof.

The banks and financial institutions focus on leveraging their large branch network and offer

wide range of services under single brand name. Corporates can get loans and avail of other

handy services, while individuals can bank and borrow. It includes not only services related

to savings and loans but also investment. Thus, Universal banks are financial institutions that

may offer the entire range of financial services. They may own equity interests in firms,

including nonfinancial firms. They may vote the shares of companies they own and, if they

are delegated as proxies for the owners, they may vote the shares of others. In fact, they may

elect their employees as members of the boards of directors of those companies.

As per the World Bank,

“In Universal Banking, large banks operate extensive network of branches, provide

many different services, hold several claims on firms (including equity and debt) and

participate directly in the Corporate Governance of firms that rely on the banks for

funding or as insurance underwriters”.

UNIVERSAL BANKING MODEL: AN INTERNATIONAL SCENARIO

The Universal banking can be segregated broadly into three models:

Swedish or Hong Kong type model in which the banking corporate engages in In-

house activities associated with banking.

Germany and the UK model, under which certain types of activities are required to

be carried out by separate subsidiaries.

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US type model, in which there is a holding company structure and separately

capitalized subsidiaries. The United States continues to block commercial banks from

engaging in securities transaction and underwriting.

Universal Banks in Different Forms

Figure: Different Forms of Universal Banks

Universal banks have been playing a vital role in developing the business of the

financial institution. It has played a leading role in Germany, Switzerland, and other

Continental European countries. The major financial institutions in these countries typically

are universal banks which offer the entire range of banking services. Germany today and

before the second World War offers the best example of universal banking (In practice,

German universal banks conduct only securities and merchant banking operations within the

bank; insurance, mortgage banking, portfolio management and investment funds are provided

in affiliates, organized under an "Allfinanz" financial holding company). Since European

economic unification permits banks to operate in all European Community (EC) countries as

they are permitted to operate in their home country, it is likely that all countries in the EC

will be served by universal banks, subject to some restrictions on share ownership by banks,

as well as by specialized banks. In addition, banks in Switzerland and many non-European

countries (with the exception of Japan) permit universal banking. Most other countries

(notably, Canada) allow banks to offer any financial service through bank-owned

subsidiaries. By contrast, the United States is served only by specialized banking.

Commercial banks are not permitted to offer full service securities transactions and

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underwriting. Banks may not underwrite insurance and, in most states and cities, they may

not sell it either. Banks generally may not hold equities in nonfinancial companies and are

restrained from taking an active role in disciplining poor managers of these companies. The

primary laws that prohibit universal banking in the United States are the 1933 Glass-Steagall

Act, which separates commercial and investment banking, and the Bank Holding Company

Act and the National Banking Act, which generally prevent banks from offering insurance

policies, real estate brokerage, and other financial products.

Source:https://www.scribd.com/document/140920770/Universal-Banking-in-India

Conception-to-Revolution

Services Offered by Universal Banks in India

Services on offer ICICI IDBI SBI HDFC LIC

Insurance Yes No Yes Yes Yes

MF Yes Yes Yes Yes Yes

Banking Yes Yes Yes Yes Yes

Merchant banking Yes Yes Yes No No

Broking Yes Yes Yes Yes No

Housing Yes No Yes Yes Yes

Credit/debit cards Yes No Yes Yes No

Figure: Services Offered by Universal Banks in India

5.7 Summary










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5.8 Glossary

i) Know Your Client: KYC is an acronym for “Know your Customer”, a term used for

customer identification process. It involves making reasonable efforts to determine

true identity and beneficial ownership of accounts, source of funds, the nature of

customer’s business, reasonableness of operations in the account in relation to the

customer’s business etc which in turn helps the banks to manage their risks prudently.

ii) Fixed Deposit: The deposit with the bank for a period, which is specified at the time

of making the deposit, is known as fixed deposit. Such deposits are also known as FD

or term deposit

iii) Debit Card: A Debit Card is also a plastic card. It offers an alternative payment mode

to cash while making purchases. Physically debit card is like a credit card; however, it

works more similar to write a cheque as the amounts are withdrawn directly from the

bank account of the customer.

iv) Credit Card: A credit card is a monetary instrument. It enables the card holder to

obtain goods and services without actual payment at the time of purchasing. The

introduction of credit card by banks is one of the new phenomenons in the banking

sector. A credit card is a charge card. It is a direct charge against the limit sanctioned.

Credit cards are popularly known as plastic money.



i. KYC is a process to know the identity of the client with the help of some

documentary proof.

ii. Fixed remained with the bank for a specified time and at a pre-determined rate of

interest.

iii. Credit card is a plastic money.

iv. A debit card is used to defer the purchase payments.



Books

1. Bare Act; Banking Companies Regulation Act, 19492. Principles of Banking Varshney & Malhotra, Sultan Chand & Sons, 2005.

Page 88 of 244

3. Money, Banking and International Trade, Vaish M.C, New Age International Pvt.Ltd,1997

4. Banking, Theory, Law & Practice, Gordon.E, Natarajan.K., Himalaya PublishingHouse, New Delhi.

5. Banking, Law and Practice in India Banking, Tannan's6. Banking: Law and Practice P.N. Varshney7. Management of Banking and Financial Services Justin Paul and Padmalatha Suresh

Publications1) George J Benston. "Universal Banking", The Journal of Economic Perspectives,

08/19942) Mahesh K. Harma. "Prospects of Technological Advancements in Banking Sector

Using Mobile Banking and Position of India", 2009 International Association ofComputer Science and Information Technology - Spring Conference, 04/2009


1. Define KYC. What are its objectives? Also explain the valid documents for ID proof

and address proof.

2. Explain the various types of bank accounts offered by public and private sector banks.

3. What is the difference between RTGS and NEFT? Also explain the rules pertaining to

it.

4. What are the contemporary developments in banking sector? Explain

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Lesson-6ROLE OF COMMERCIAL BANKS IN FOREIGN TRADE

Structure

6.1 Objectives

6.2 Introduction

6.3 Role of Commercial Banks in Foreign Trade Financing

6.4 Other techniques of Financing of International trade

6.5 Export Financing

6.5.1 Pre-Shipment Finance

5.5.2 Post-Shipment Finance

6.6 Sources of Funds

6.7 Summary

6.8 Glossary





i. Understand the concept Foreign Trade Financing.ii. Know about the role of Commercial banks in foreign trade financing.

iii. Understand about various techniques of Export and Import financing.iv. Understand the concept of Pre-shipment finance and Post-shipment finance.

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6.2 Introduction

International trade transactions involve at least two parties; i.e., seller (exporter) and buyer

(importer). The nature of international transaction is altogether different from domestic trade in

respect of payment, delivery and maturity. For example, both importer and exporter being

resident of different countries, they are living- top far to each other, speaking different

languages, living in different political environment, using different currencies, having different

culture and religion etc. Further, they both know that they have different standard of honouring

obligations to each other. In case of default, the other party will have a hard time catching up to

seek redress. Hence, foreign trade transactions involve more risk in comparison to home trade.

Since due to long distance, it is not possible to simultaneously handover goods with one hand

and accept payment with the other, the importer would prefer the following:

Exporter Ships the goods

IMPORTER EXPORTER

Importer pays after the goods received

If this is done, then all risk is shifted to the exporter, which he may not agree. The exporter

would like the opposite of this. Being stranger to each other, (importer and exporter) and

unwilling to trust a stranger, the problem would be solved by using a highly respected bank as

intermediary.

In that situation the importer obtains the bank's promise to pay on his behalf, knowing the

exporter will trust the bank then the exporter ships the goods to the importer's country. Title of

the goods is given to the bank on a document. The exporter asks the bank to pay for the goods to

the importer's country. Title of the goods is given to the bank on a document.

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1st Importer obtains banks 2nd Bank promises exporterPromise to pay on behalf of to pay on behalf of importerimporter

6th Importer pays the bank 4th Bank pays exporters

5th Bank gives merchandise 3rd Exporter ships to the bankto the importer trusting bank’s promise

Source: Eikeman, Sonehill & Moffet book p.440

The exporter asks the bank to pay for the goods and the bank does so. After that the bank, having

paid for the goods, now passes title to the importer whom the bank trusts. The importer

reimburses the bank.

6.3 Role of Commercial Banks in Foreign Trade Financing

Commercial banks play a pivotal role in the development of foreign trade. Without commercial

banks, the international finance and import-export industry would not exist. Due to Commercial

banks it is makes possible to transfer of funds and trade of business practices between different

countries and different customs all over the world. Commercial banking also makes possible the

distribution of economic and business information among customers and the capital markets of

all countries across the globe. In nutshell we can say that, commercial banks serve as a

worldwide barometer of economic health and business trends. The following are the various

instruments which are offered by commercial banks for meeting the requirements of

importers and exporters:

1. Letter of Credit

Letter of Credit is an instrument issued by a bank at the request of the importer, in which the

bank promises to pay a particular sum of amount to beneficiary presenting specified document in

ExporterBankImporter

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the letter of credit. Letter of credit is also known as “Commercial Letter of Credit”, a

Documentary Letter of Credit; or simply a Credit. It means letter of credit reduces the risk of

non-completion of the transaction.

Issuing BankThe relationship between issuing The relationship between buyer &Bank and the beneficiary is governed by the issuing bank is governed byterms of LIC issued by the bank terms of the applicant and the

agreement for the LIC

Beneficiary Applicant

(Seller) (Buyer)The relationship between the buyer and the beneficiary isgoverned by the sales contact.

Essence of the agreement

“The L/C is a letter which is addressed to the seller, written and signed by bank acting on behalf

of the buyer. The essence of L/C is the promise by a bank to pay against specific documents

which must a company any draft drawn against the credit. The letter of credit is not a guarantee

of the underlying transaction between a bank and a beneficiary and it is separate from the

commercial transaction. For a true LI C, following elements must be present with respect to the

issuing bank.

1. The bank must receive a fee for issuing the letter of credit.

2. L/C must contain a specified expiration date or a definite maturity.

3. The L/C must specify stated maximum amount of money to pay.

4. Bank's obligation must arise only on presentation of specified documents.

5. The customer's (Importer) unqualified obligation to reimburse the bank on the

same condition as the bank has paid.

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The Draft

'A draft' is also called a bill of exchange (B/E) or 'First of exchange'. It is unconditional order

written by an exporter (seller) instructing an importer (buyer) or his agent to pay a specified

amount of money at a specified time. A draft can become a negotiable instrument if the

following requirements are fulfilled.

1) It must be in writing and signed by the maker or drawer or originator.

2) It must contain an unconditional promise to pay.

3) Amount must be specified and certain to pay

4) It must be payable on demand or at a definite future date.

5) It must be payable on demand to order or to bearer.

Drafts are of two types: sight draft and time drafts. A sight draft is payable on

presentation to the drawee. It means the drawee must pay at once or dishonour the draft. On the

other hand, when drafts are payable at specified future date, and as such become a useful

financing device. It is also known as 'Usance' or ‘Tenor' draft. When a time draft is drawn on and

accepted by a bank, it becomes a banker's acceptance. If the draft is drawn on and as accepted by

business fulfill, then it becomes a trade acceptance. Further a draft can be clean or documentary.

A clean draft is that draft which is not accompanied by any paper and normally is used in non-

trade remittances.

Bill of Lading

Another important document in international trade is the 'bill of lading' (B/L). The bill of lading

is issued to the exporter by a common carrier transporting the goods (merchandise). It serves

three purposes such as a receipt, a contract and a document of title.

(1) As a receipt.

The bill of lading indicates that carrier (transporter) has received the goods from the exporter

described on the face of document. Usually the carrier is not responsible for ascertaining that the

containers hold what is alleged to be their contents. So description of goods on the bill of lading

is usually short and simple.

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(2) As a Contract

The bill of lading describes the contract between the carrier and exporter in which the former

agrees to carry the goods from port of shipment to port of destination in return for certain

charges.

(3) As a document of title.

The bill of lading is used to obtain payment or a written promise of payment before the goods are

released to the importer. It is also used as collateral against which funds may be advanced to the

exporter by its local banker.

6.4 Other techniques of Financing of International trade

The following are the other important techniques which are available to MNCs for financing

their trade:

1. Bankers' Acceptances (B/A)

Bankers' acceptance is an important method of assisting international trade in which a banker

accepts 'the time draft' drawn on it by the exporter. By accepting the draft, the bank makes an

unconditional promise to pay the holder of the draft a stated amount on a specified date. In this

way, by accepting the draft, it creates a negotiable instrument which is freely traded in the money

market.

2. Discounting

As we have seen that the trade draft has been accepted by the importer's bank, then draft takes

the shape of Banker's acceptance. Hence, discounting is another technique of getting funds other

than from the importer's bank like financial institutions, or other banks. The exporter gets the

amounts of the draft less interest and commission on the same. Normally the shipping documents

and other papers are duly insured from a insurance agency against both commercial and political

risks.

3. Factoring

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Factoring is another important technique of financing foreign trade. In this technique, the firm or

exporters sell their accounts receivables to the 'Factor' at a discount to enhance the liquidity.

Factoring can be with recourse and non-recourse. In with recourse factoring, the exporter

assumes the risks if the debtors do not make payment to the factor whereas in non-recourse

factoring, the factor assumes all the credit and political risks except for those involving dispute

between the transaction parties. Most factoring in practice is done on the basis of non recourse.

Factor charges a fee for his service rendered to the exporter. This fee is decided on an individual

company basis and is normally related to the annual turnover. In general this fee varies from

1.75% to 2% of sales.

4. Forfaiting

Forfaiting is another specialised factoring technique used in the case of extreme credit risk. In the

field of export financing when the accounts receivable of an exporter are factored whereby the

exporter gives up the right to receive payment in favour of forfeiter the transaction is known as

forfaiting. In other words, forfaiting is normally without recourse which is discounting of

medium term export receivable denominated in fully convertible currencies like US dollar,

Swiss, Franc, Pound, deutsche mark etc. This technique is used normally in capital goods exports

with a five year maturity and

repayments in semi annual instalments. The forfaiting fee is set at a fixed rate, normally 1.25

percent above London inter-bank rate (LIBOR) or local cost of funds. This technique is very

much popular in western countries.

5. Institutional Financing

In export financing, most of the governments of developed and non developed countries have

attempted to provide their domestic exporters with a competitive edge in the form of low-cost

assistance and concessionary rates on political and economic risk insurance. Normally

government itself or through any agency like export-import bank and other financial institutions

provide financial assistance to the exporters. This assistance is normally classified into two

categories, i.e., Pre-shipment credit and Post shipment credit.

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6.5 EXPORT FINANCING

The requirement of finance for an exporter may arise either at the pre-shipment stage or the post-

shipment stage. Timely availability of credit at competitive rates enables an exporter to produce

quality goods and ship it within the delivery schedules prescribed by the overseas buyer. It

simply enhances the credibility of exporters and in the process increase the share in the market.

6.5.1 PRE-SHIPMENT FINANCE

It is working capital finance provided by commercial banks to the exporter prior to shipment of

goods.

Pre-shipment finance can be classified as:

a. Packing credit.

b. Advance against Government incentives receivable

c. Advance against cheques/drafts received as advance payment.

a. Packing Credit :

Pre Shipment Finance is provided by way of export packing credit (EPC) for purchasing,

manufacturing, processing, transporting, warehousing, packing, shipping etc. of the

goods meant for export. The advances are granted to the exporter against the lodgement

of irrevocable L/C established or transferred on his favour or confirmed order or contract.

The CP advance must be liquidated within 6 months from the proceeds of the relative

export bill. Hence, packing credit is short term finance in India, it is provided to the

Indian and foreign commercial banks to those who are members of the Foreign Exchange

Dealers Association. In India, packing credits-scheme is governed by Reserve Bank of

India.

Importance of Finance at Pre Shipment Stage:

For purchase raw material, and other inputs for manufacturing goods.

For assembling the goods.

For storing the goods till the goods are shipped.

For packing, marking and labeling of goods.

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For payment of pre-shipment inspection charges.

For purchasing heavy machinery or other capital goods.

For consultancy services.

For export documentation expenses.

FORMS OR METHODS OF PRE-SHIPMENT FINANCE:

Following are the methods of pre-shipment finance:

i). Cash Packing Credit Loan:

In this cash packing credit loan, bank generally grants packing credit advantage initially on non

security basis. Later on, the bank may ask for security also.

ii). Advance against Hypothecation:

Packing credit is given for processing the goods for export. In this type advances are given

against the security and the security remains in the possession of the exporter. But, exporter is

required to execute the hypothecation deed in favour of the bank.

iii). Advance against Pledge:

As the name depict, bank provides packing credit against security only. The security remains in

the possession of the bank and on collection of export proceeds; the bank makes necessary

entries in the packing credit account of the exporter.

iv). Advance against Red L/C:

In this case the importer authorizes the local bank to grant advances for processing of export

goods to the exporter to meet working capital requirements through issuing of Red Letter of

Credit. The issuing bank stands as a guarantor for this type of packing credit.

v). Advance against Back-To-Back L/C:

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A request may be made by the merchant exporter who is in possession of the original L/C to his

bankers to issue Back-To-Back L/C in favors of the sub-supplier against the security of original

L/C. The sub-supplier then obtains packing credit on the basis of Back-To-Bank L/C.

vi). Advance against Exports through Export Houses:

The manufacturer, who exports through export houses or other agencies can obtain packing

credit also, provided such manufacturer submits an undertaking from the export houses that they

have not or will not avail of packing credit against the same transaction.

vii). Advance against Duty Draw Back (DBK):

DBK means refund of customs duties paid on the import of material. It also includes a refund of

central excise duties. Banks offer pre-shipment as well as post-shipment advance against claims

for DBK.

viii). Special Pre-Shipment Finance Schemes:

Exim-Bank’s also launched foreign currency pre-shipment credit scheme to grant credit

to the exporters.

Packing credit for Deemed exports is also there to facilitate export.

b. Advance against Government incentives receivable

These advances are generally granted at post-shipment stage. But, in some cases, where the value

of material to be procured for export is more than the FOB value of the contract and considering

the availability of receivables from Government, advances are granted for the FOB value that is

maximum period of 90 days. These advances are liquidated by negotiation of export bills and out

of proceeds of receivables from Government of India.

C. Advance against Duty Drawback

Pre-shipment finance can also be extended against duty drawback entitlements. When the final

assessment is made by customs and duties are refunded by them, then the loan so extended will

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be adjusted. Duty drawback loans are normally granted by banks at the post-shipment stage for a

period not exceeding 90 days at lower interest rate as specified.

ROLE OF CUSTOMS AND C&F AGENTS

Freight forwarders act on behalf of exporters and importers in arranging services such as loading

and unloading of goods, obtaining payment on their behalf , booking of space for them, and

customs clearance for air, sea payloads, land transportation, rail freight, custom agency services,

door-to-door pick-up services and delivery services, etc. They provide services on commission

basis.

Before proceeding to discuss about post-shipment finance, we shall, in brief, discuss the customs

formalities to be followed by exporters for clearance of goods to be exported.

Customs Formalities for Clearance of Goods to be exported from India

The main document required by the customs authorities for permitting clearance is the shipping

bill. While the exporter should submit the shipping bill in case of export by sea or air, he is

required to submit a bill of export in case the export is by road. Shipping bills are of four kinds:

White shipping bill prepared in triplicate is to be submitted for export of duty free goods.

Green shipping bill prepared in quadruplicate should be submitted, for export of goods

under which duty drawback is to be claimed.

Yellow shipping bill in triplicate is to be submitted for export of dutiable goods.

Blue shipping bill prepared in seven copies will be required, for exports

under the DEPB scheme.

Other documents required for processing of shipping bill includes:

GR forms in duplicate for shipment to all countries.

4 copies of the packing list giving details like contents, quantity, gross and net

weights of each package.

4 copies of invoice giving all relevant details like number of packages, quantity,

unit rate, total f.o.b or c.i.f value, correct and full description of the goods, etc.

Purchase order of the buyer.

AR4 (original and duplicate) and invoice.

Inspection/Examination certificate.

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The customs appraiser first checks if the quantity and value declared on the shipping bill tallies

with that indicated in the LC or purchase order. In addition he will check if other formalities like

exchange control regulations, pre-shipment inspection has been complied with or not. After

verification, all documents, with the exception of the original GR form, the original shipping bill

and a copy of the commercial invoice are handed over to the forwarding agent to be submitted to

the dock appraiser. The original GR form is then forwarded by the customs department to the

Reserve Bank of India. It is the dock appraiser who endorses the "Let Export" endorsement on

the duplicate copy of the shipping bill. After endorsement, the documents are returned to the

forwarding agent who submits the same to the preventive officer of the customs department who

endorses the "Let Ship" endorsement on the duplicate copy of the shipping bill. The duplicate

copy of the shipping bill is then handed over by the forwarding agent to the agent of the shipping

company following which the captain of the ship in which the goods are loaded hands over a

"Mate Receipt" to the Shed superintendent of the port. After payment of port charges, the

forwarding agent is given the mate receipt. The mate receipt is then handed over to the

preventive officer who records the certificate of shipment on all the copies of the shipping bill,

original and duplicate copies of the AR4. Following this, the mate receipt is handed over by the

forwarding agent to the shipping company to procure the bill of lading. After the goods have

been shipped, the exporter should send a shipping advice to the importer enclosing relevant

documents which include non-negotiable copy of bill of lading, invoice, packing specification,

etc.”

(Source: https://www.scribd.com/document/32252234/Export-finance)

6.5.2 POST SHIPMENT FINANCE

“Post-shipment finance is defined as "any loan or advance granted or any other credit provided

by an institution to an exporter from India from the date of extending the credit after shipment of

the goods to the date of realization of the export proceeds".

Post-shipment finance can be classified as under:

Negotiation/Payment/Acceptance of export documents under letter of credit.

Purchase/discount of export documents under confirmed orders/export

Contract etc.

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Advances against export bills sent on collection basis.

Advances against exports on consignment basis.

Advances against undrawn balance on exports.

Advances against receivables from the Government of India.

Advances against retention money relating to exports.

Advances against approved deemed exports”

(Source: https://www.scribd.com/document/32658947/post-shipment-credit)

Rediscounting of Export Bills Abroad

The scheme was introduced by the Reserve Bank of India on 6th October, 1993. It serves as an

additional window for early realization of export proceeds. Under this scheme, the overseas

market for rediscounting of export bills can be accessed by the authorized dealers and exporters.

Authorized dealers can have the eligible export bills in their portfolio for rediscounting abroad.

Exporters also have been permitted for discounting their export bills directly subject to the

following conditions:

a) Export bills may be direct discounted by the exporters with overseas bank or any agency

will be done only through the branch of an authorized dealer which is designated for this

reason.

b) It (Discounting of export bills) will be routed through designated bank/authorized dealer

from whom the packing credit facility has been availed of. In case, these are routed

through any other bank/authorized dealer, the latter will first arrange to adjust the amount

outstanding under the packing credit with the concerned bank out of the proceeds of the

rediscounted bills.

6.6 SOURCE OF FUNDS

Authorized dealers can utilize the foreign exchange resources available with them in Exchange

Earners Foreign Currency Accounts (EEFC), Resident Foreign Currency Accounts (RFC),

Foreign Currency ( on-Resident) Accounts (Banks) Scheme and Escrow Accounts to discount

usance bills and retain them in their portfolio without resorting to rediscounting. In the case of

demand bills these may have to be routed through the existing post-shipment credit facility.

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For rediscounting of bills, authorized dealers may, wherever necessary, access the local market,

which will enable the country to save foreign exchange to the extent of the cost of rediscounting.

It is comparatively easier to have a facility against bills portfolio (covering all eligible bills) than

to have a rediscounting facility abroad on bill by bill basis, as various rediscounting agencies

may require detailed information relating to the underlying transactions, such as names of

exporters and importers, commodities exported, letter of credit details, etc.

Authorized dealers can therefore arrange a "Bankers Acceptance Facility" (BAF). Each

Authorized dealer can have his own BAF limits fixed with an overseas bank or a rediscounting

agency or an arrangement with any other agency such as a factoring agency. Under the scheme,

rediscounting is available in any convertible currency.

6.7 Summary

Commercial banks play a pivotal role in financing International Trade. A country's international

trade consists of both importing and exporting goods and services. Exporting is the act of

producing goods or services in one country and selling or trading them to another country. The

counterpart to exporting is importing which is the acquisition and sale of goods from acquired

from another country and selling them within the country. Although it is common to speak of a

nation's exports or imports in the aggregate, the company that produces the good or service, as

opposed to a national government, usually conducts exporting in terms of logistics and sales

transactions. However, export and import levels may be highly influenced by government

policies, such as offering subsidies that either restrict or encourage the sale of particular goods

and services abroad. Exporting is just one method that companies use to establish their presence

in economies outside their home country. Importing is the method used to acquire products not

readily available from within the country or to acquire products at a less expensive cost than if it

were produced in that country.

6.8 Glossary

1. Letter of Credit: Letter of Credit is an instrument issued by a bank at the request of the

importer, in which the bank promises to pay a particular sum of amount to beneficiary presenting

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specified document in the letter of credit. Letter of credit is also known as “Commercial Letter of

Credit”, a Documentary Letter of Credit; or simply a Credit.

2. Draft: It is also called a bill of exchange (B/E) or 'First of exchange'. It is unconditional order

written by an exporter (seller) instructing an importer (buyer) or his agent to pay a specified

amount of money at a specified time.

3. Discounting: As we have seen that the trade draft has been accepted by the importer's bank,

then draft takes the shape of Banker's acceptance.

4. Factoring: Factoring is another important technique of financing foreign trade. In this

technique, the firm or exporters sell their accounts receivables to the 'Factor' at a discount to

enhance the liquidity.



i. Commercial Banks play a vital role in financing Imports and exports of the country.

ii. Letter of Credit is an instrument issued by a bank at the request of the importer, in which

the bank promises to pay a particular sum of amount to beneficiary presenting specified

document in the letter of credit.

iii. A draft is an unconditional order written by an exporter (seller) instructing an importer

(buyer) or his agent to pay a specified amount of money at a specified time.

iv. In factoring, the firm or exporters sell their accounts payables to the 'Factor' .



Books




1997


New Delhi.


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6. International Finance, Vishal Kumar, Kalyani Publishers.



Websites

1) www.scribd.com

2) www.slideshare.net

3) jru.edu.in

4) www.powerfulwords.co.uk

5) www.indiastudychannel.com

6) www.coursehero.com

7) www.enotes.com

8) www.kashanccim.org

9) www.infodriveindia.com

10) www.pearson.com.au

11) smallbusiness.chron.com

12) www.pondiuni.org

13) thestar.com.my

14) www.eiilmuniversity.ac.in

15) www.ucoonline.co.in

16) www.securities.com

17) www.abhinavjournal.com

18) www.authorstream.com

Publications

1) Constas, "F", Encyclopedic Dictionary of International Finance and Banking, 2001.


1. Explain the role of commercial banks in foreign trade transactions?

2. What is a Letter of Credit? Explain its types

3. What are the various instruments used in foreign trade transactions? Explain

4. Write a detailed note on Export Financing?

5. Write a detailed note on Import Financing?

6. What is the procedure of Exporting goods to foreign country?

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7. Write a note on Import Procedure?

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Lesson-7EXPORT-IMPORT BANK OF INDIA

Structure

7.1 Objectives

7.2 Introduction

7.3 Meaning and Objectives of EXIM Bank

7.4 Functions of EXIM Bank

7.5 Services of EXIM Bank

7.6 Summary

7.7 Glossary





i. Understand the concept Export-Import Bank of India.ii. Know about the salient features of EXIM bank.

iii. Understand the role of EXIM bank.iv. Understand the financing of EXIM bank.

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7.2 Introduction

In order to achieve the objective of globalization, India is relying up to a great extent on exports.In fact every developing nation wants to enhance its exports to earn foreign exchange. The globalpresence of any country is also dependent on exports to a great extent.That is why vigorous engagement as well focus in global trade has become one of theindispensible factors for the growth of not only the organizations but for the prosperity andgrowth of nations also. This has proved to be true and a wise strategy for not only the majortrading and developed nations, but also for developing countries like India where the factors ofproductions are limited and the sources of earning foreign exchange are also scarce.

After we have followed the policy of Liberalization, privatization and globalization the foreigntrade sector has been an important area of the reforms in the Indian economy. The result is thatdue to reforms in this area India’s share in global trade is continuously increasing in the pastyears.

EXIM bank was established as an apex financial institution for financing, facilitating andpromoting India’s International trade. Since its inception it has continuously strived and workedto contribute towards achieving the objectives of globalization. The bank works on strongfundamentals and works according to the growing need of international business environmentalfactors. It provides wide range of financing programmes to promote exports and also providescompetitive edge to the companies by giving them advisory and support services at all stages ofexport business cycle.

Export-Import Bank of India (EXIM Bank), set up in 1982 as an apex financial institution tofinance, facilitate and promote India’s international trade, has constantly strived to contributetowards India’s globalization efforts. With strong business fundamentals, and in line with theincreasingly competitive global trading environment, the Bank proactively seeks to enhance thecompetitive edge of Indian companies through a comprehensive range of financing programmesand advisory and support services which encompass all stages of the export business cycle.

7.3 Meaning and Objectives of EXIM Bank

Export import bank of India is famously known as EXIM bank. It was setup in 1982 by an act ofparliament that is export import bank of India act 1981. It is headquartered at Mumbai, India.Presently, its chairman and managing director is Yaduvendra Mathur. EXIM bank is regarded asthe India's top most export financing institution. It has always acted as purveyor of export credit.Over the period of time, it has emerged as a key player in enhancing cross border trade andinvestment in India. This institution was launched by government of India with a mandate notonly to increase exports but also to supplement India foreign trade and investment with overallobjective of economic growth. EXIM bank has played a major role in partnering Indianindustries at various levels. This institution in particular has supported small and mediumenterprises by extending them credit for wide range of products and services. It has assisted them

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in import of technology, export products development, export production, export marketing, preshipment, post shipment and overseas investment.

Objectives

As per the preamble of the EXIM BANK the objective of the bank is stated as below:“… for providing financial assistance to exporters and importers, and for functioning as theprincipal financial institution for coordinating the working of institutions engaged in financingexport and import of goods and services with a view to promoting the country’s internationaltrade…”

1. The Board of EXIM Bank

EXIM Bank is guided by various people of expertise at the Board level. Senior policy makers,expert bankers, major players in industry, professionals in exports are at the senior board of thebank. According to the EXIM Bank Act maximum of 16 directors can be there on the board.Chairman and Managing Director as well as 13 directors of the board are appointed byGovernment of India. Three directors from scheduled commercial banks and four directors whoare industry/trade experts are also the part of the board, the head office of EXIM bank is situatedat Mumbai. Nine domestic offices of EXIM bank are operating at Ahmadabad, Bangalore,Chandigarh, Chennai, Guwahati, Hyderabad, Kolkata, New Delhi, Pune. The bank is working atoverseas level also and presently has overseas offices at seven places i.e Addis Abada, Dubai,Johannesburg, London, Singapore, Washington D.C and Yangon.

Role and Vision of EXIM Bank of India

After its establishment since 1982 EXIM bank has played a pivotal role in promotion of India’sInternational trade and investment. It has acted as India’s principal institution which hascoordinated working of all those institutions which are engaged in financing exports and imports.Time and again by starting various types of financing programmes EXIM bank has contributedin the development of the economy. Majorly two types of programmes are started by EXIM banki.e Export Credits and Export Capability creation. In the early years of inception from 1982-85 itwas providing export credits only. Then; from 1986-94, it worked on the area of exportcapability creation. Today the role of EXIM has widened to a great extent and it offers acomprehensive range of products and services covering all stages of the Export Business Cycle.

The vision of EXIM bank

“To develop commercially viable relationships with a target set of externally oriented companiesby offering them a comprehensive range of products and services, aimed at enhancing theirinternationalization efforts”

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7.4 Functions of EXIM Bank:

EXIM bank is the apex banking institution in the field of financing foreign trade in India. The

EXIM bank provides financial assistance to exporters and importers functions as the principal

financial institution for coordinating the working of other institutions engaged in the financing of

exports and imports of goods and services. it provides refinance facilities also to the commercial

banks against their export import financing activities. Broadly, the functions of EXIM banks: (1)

financing of exports from and imports into not only India, but also third countries, of goods and

services. (2) Financing of joint ventures in foreign countries. (3) Financing of export and import

of machinery and equipment on lease basis. (4) Providing loans to an Indian party so as to enable

it to contribute in the share capital of a joint venture in a foreign country.

The functions of EXIM Bank include:

(a) To Plan, promote and develop exports and imports;

(b) To provide technical, administrative and managerial assistance for promotion, managementand expansion of export sector.

c) To undertake surveys like market and investment which are related to the development ofexports of goods and services.

The other functions of EXIM include the following:

EXIM bank operates three broad programmes of financing that is, loans, re-discounting, andguarantees. At present, important programmes undertaken by the bank are:

(a) Loans to Indian companies are provided under its:

Direct financial assistance to exporters.

Technology and consultancy services. Overseas investment financing for equity participation by an Indian company in joint

venture abroad.

(b) Loans to foreign Governments, Companies and Financial Institutions are provided under its:

Overseas buyers credit scheme. Lines of credit to foreign governments.

Re-lending facility to banks overseas.

(c ) loans to commercial banks in India are available under:

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Export ills re-discounting scheme i.e. short term bills. Re-finance of export credit.

Guarantee programme is available in case of construction and turnkey contracts.In addition to above functions, bank also includes:

1. To guarantee and find out the harmonized approach in solving any type of problems faced bythe exporters in India.2. To assist in enhancing exports of the country3. To do export projections and find out mechanisms to achieve them4. To facilitate and encourage joint ventures and increase exports of technical services5. To expand buyers’ credit and lines of credit;6. To boost developmental and financial activities in order to facilitate and increase exportsector.7. The bank also undertakes limited merchant banking functions such as underwriting of stocks,shares, bonds, or debentures of companies engaged in export or import and providing technical,administrative and financial assistance to parties in connection with exports or imports. The paidup capital of the bank is rs 500 crores wholly subscribed to by the central Government. TheGovernment also grants loans to the bank. The bank can raise resources from: The open market through the issue of bonds and debentures, From Reserve Bank of India and its National Industrial credit, and Can borrow in foreign currencies in or outside India.

Thus the main objective of Export-Import Bank (EXIM Bank) is to provide financial assistanceto promote, foster and boost the export production in India. The basic function of the bank is toassist the exporting activities by providing finance at various stages. The financial assistanceprovided by theEXIM Bank widely includes the following:

Direct financial assistance

Foreign investment finance Term loaning options for export production and export development

Pre-shipping credit Buyer's credit Lines of credit

Re-loaning facility Export bills rediscounting

Refinance to commercial banks The Export-Import Bank also provides non-funded facility in the form of guarantees to

the Indian exporters.

Development of export makers

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Expansion of export production capacity Production for exports

Financing post-shipment activities Export of manufactured goods

Export of projects Export of technology and software’s

7.5 Services provided by EXIM Bank:

The Bank is playing an important role in promoting and boosting foreign trade by offering awide variety of services which are discussed as below:1. Project exportsProject exports are one of the important things in the portfolio of India’s exports. The contractswhich are financed by EXIM Bank remained quite diverse in the past few years. The bank has along track history of providing finance to various projects in the area of construction,engineering, technology transfer, procurement, consultancy, technology based projects etc. In itsbroader categories the finance is provided to the following areas-

a. Turnkey projects – covering engineering, construction, designing, erection of widerange of projects.

b. Construction projects- covering wide range of infrastructure projectsc. Technical and Consultancy Service Contracts- Covering skill based activities,

Training, project implementation services, management contracts, super vision oferection of plants, CAD/ CAM solutions in software exports, finance and accountingsystems etc.

2. Research AnalysisEXIM bank has constituted one Research and Analysis group RAG. It is basically a team ofexperienced people from the field of economics, strategists who work on providing insights onvarious aspects of economics, trade and investment through qualitative and quantitative researchtechniques. This team continuously works on monitoring and studying the global trends of worldand domestic economies and its impact on Indian economy as well as other developing nations.The various works of the group are categorized under regional, sectoral and policy relatedstudies. The research studies are basically carried to find out various avenues for enhancingInternational engagement. The various studies carried out through the research team helps toprovide economic outlook of a country as well as it also provides information regardingeconomic risk involved in doing business with country.

3. Marketing Advisory Services

EXIM bank plays a great role in promoting exports at international level. It helps to enhanceexport capabilities and support the Indian firms to enhance their competitiveness at the global

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level through its advisory services. EXIM Bank through its Marketing Advisory Servicessupports and helps the Indian exporting firms in going global by proactively assisting/ supportingin finding and locating overseas distributors or buyers or investors for their products andservices. The bank is also assisting the Indian firms in identifying the opportunities in theforeign if the firms want to set up plants or new projects or want to go for any kind of mergersand acquisition abroad. The bank is equipped with well versed knowledgeable people withmarket experience, in depth knowledge, understanding of international markets and internationalbusiness environment to support and assist the Indian companies to beat various marketinginitiatives and this advisory service is fee based. The bank has helped in setting up of wide rangeof projects and products in overseas as well as domestic market which includes Handicrafts, agroequipments, Marine products, spices etc. The bank has successfully catered the markets of US,Singapore, Middle East etc and has contributed to a great extent in promoting India’s productsand services worldwide.

4. Export Advisory ServicesIn the export advisory services, EXIM bank has created an EAS group which provides variousadvisory and support services. It helps the exporters to evaluate their various kinds ofinternational risks to which they are exposed to in the international markets. The group iscontinuously working to help the exporters in exploiting export opportunities and improve theircompetitiveness at the global market. Various type of value added services are provided to theIndian projects exporters on various projects which are funded by multilateral agencies.

The group is providing customized support to the interested companies. It is catering to theirneeds in the areas of exploring market potential, defining marketing arrangements and services,finding out various distribution channels.

“The Bank provides a wide range of information, advisory and support services, whichcomplement its financing programmes.” All such services are fee based to Indian organizationsand overseas entities.

The advisory services cover the following areas-

-Feasibility studies

-Investment facilitation

-Assisting in going for joint ventures

5. Overseas Investment Finance

EXIM bank through its overseas finance program encourages Indian firms to go for acquisitionsof the foreign companies. Acquisitions have become an important growth strategy fo companiesall over the world. It is the fastest means to grow and diversify. It can be regarded as one of theimportant ways of getting access to foreign companies, foreign markets, modern and advanced

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technology. Moreover the bank also encourages through its finance programmes setting up ofmanufacturing units abroad. EXIM Bank finances joint ventures with foreign companies byproviding term loan upto 80% of the equity investments of the companies. It also provides termloans for the joint ventures and acquisitions by the Indian companies towards up to 80% of loanextended by them to the overseas joint ventures. This financing service of EXIM bank hasencouraged FDI in India as well as by Indian firms outside the country and contributedimmensely towards the economic development of country.

The Bank is also providing term loans to overseas Joint ventures or new projects towards partfinancing for the following:

(i) Assisting in doing capital expenditure for acquisition of assets,

(ii) Finance for day today financing i.e. working capital,

(iii) Financial assistance for equity investment in any other company,

(iv)Financial Assistance for acquisition of brands or patents or rights or any other type ofIntellectual Property Rights

(v) Financial assistance for acquisition of another company,

6. Line of credit

A Line of Credit (LOC) is a unique financing mechanism of EXIM Bank. By this scheme EXIMBank extends support to their clients for wide variety of export of projects, buying equipments,availing goods and services from India. EXIM Bank extends LOCs on its own and also at thebehest and with the support of Government of India. EXIM Bank provides Lines of Credit to:

Foreign Governments Nominated agencies of foreign governments like central banks, state owned commercial

banks National or regional development banks; Overseas financial institutions;

Commercial banks abroad; Other suitable overseas entities.

7. Buyer’s creditBuyer's Credit is a financial assistance facility that is given to the foreign project company whichintends to award any kind of project execution to any Indian project exporter. The financing isgiven to all kinds of projects and service exports from India.

EXIM bank extends this Facility for development, upgrading or expansion of infrastructurefacilities. It is also given for financing of public or private projects such as plants and buildings;professional services such as surveyors, architecture, consultations, etc. This facility has helpedexporters and contractors of India to expand and diversify their areas abroad and tap various non

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traditional markets. It has promoted competitive environment for exporters and contractors whowant to bid or negotiate for any kind of overseas job. Buyer’s credit is given through deferredcredit. The biggest benefit is to foreign customers who can obtain medium and long termfinance from EXIM Bank.

7.6 Summary

In order to achieve the objective of globalization, India is relying up to a great extent onexports. In fact every developing nation wants to enhance its exports to earn foreignexchange. The global presence of any country is also dependent on exports to a great extent.That is why vigorous engagement as well focus in global trade has become one of theindispensible factors for the growth of not only the organizations but for the prosperity andgrowth of nations also. This has proved to be true and a wise strategy for not only the majortrading and developed nations, but also for developing countries like India where the factorsof productions are limited and the sources of earning foreign exchange are also scarce.After we have followed the policy of Liberalization, privatization and globalization the

foreign trade sector has been an important area of the reforms in the Indian economy. Theresult is that due to reforms in this area India’s share in global trade is continuouslyincreasing in the past years. EXIM bank was established as an apex financial institution forfinancing, facilitating and promoting India’s International trade. Since its inception it hascontinuously strived and worked to contribute towards achieving the objectives ofglobalization. The bank works on strong fundamentals and works according to the growingneed of international business environmental factors. It provides wide range of financingprogrammes to promote exports and also provides competitive edge to the companies bygiving them advisory and support services at all stages of export business cycle. EXIM bankis offering a wide variety of financing programmes for exporters, constructors, engineers etc.of India and abroad. The export oriented units are benefitted as they various types of creditfacilities. Whether they want to establish a new project or want to go for joint venture /acquisition overseas, expand, modernize, they are supported by EXIM bank. In turn it helpsto boost exports and create a healthy and competitive environment in the country tocontribute towards economic development. This bank is truly facilitating inclusiveglobalization. Not only big industrial houses or government gets credit facility from EXIMBank but it facilitates small and medium scale enterprises also. In its recent developments itis also catering to the needs of rural India. Various artisans, artists get boost to start theirenterprises and get market abroad by the support of EXIM Bank. The bank has supportedalmost 150 companies to establish and promote their ventures in around 54 countries aroundthe world. With the growing share of service sector in exports the bank has played a pivotalrole in catalyzing India’s software exports since the era of eighties. Since then Bank hascovered almost every area where it has provided finance to Indian as well as overseasexporters. It is undoubtedly playing crucial, important and supporting role in the economicdevelopment of the country

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7.7 Glossary

1. EXIM Bank: Export-Import Bank of India (EXIM Bank), set up in 1982 as an apex financialinstitution to finance, facilitate and promote India’s international trade, has constantly strived tocontribute towards India’s globalization efforts. . EXIM bank was established as an apexfinancial institution for financing, facilitating and promoting India’s International trade. Since itsinception it has continuously strived and worked to contribute towards achieving the objectivesof globalization. The bank works on strong fundamentals and works according to the growingneed of international business environmental factors. It provides wide range of financingprogrammes to promote exports and also provides competitive edge to the companies by givingthem advisory and support services at all stages of export business cycle. EXIM bank is offeringa wide variety of financing programmes for exporters, constructors, engineers etc. of India andabroad. The export oriented units are benefitted as they various types of credit facilities. Whetherthey want to establish a new project or want to go for joint venture / acquisition overseas,expand, modernize, they are supported by EXIM bank. In turn it helps to boost exports andcreate a healthy and competitive environment in the country to contribute towards economicdevelopment. This bank is truly facilitating inclusive globalization. Not only big industrialhouses or government gets credit facility from EXIM Bank but it facilitates small and mediumscale enterprises also. In its recent developments it is also catering to the needs of rural India.Various artisans, artists get boost to start their enterprises and get market abroad by the supportof EXIM Bank.

2. Export Advisory ServicesIn the export advisory services, EXIM bank has created an EAS group which provides variousadvisory and support services. It helps the exporters to evaluate their various kinds ofinternational risks to which they are exposed to in the international markets. The group iscontinuously working to help the exporters in exploiting export opportunities and improve theircompetitiveness at the global market. Various type of value added services are provided to theIndian projects exporters on various projects which are funded by multilateral agencies.

3. Lines of Credit: A Line of Credit (LOC) is a unique financing mechanism of EXIM Bank. Bythis scheme EXIM Bank extends support to their clients for wide variety of export of projects,buying equipments, availing goods and services from India. EXIM Bank extends LOCs on itsown and also at the behest and with the support of Government of India. EXIM Bank providesLines of Credit to:

Foreign Governments Nominated agencies of foreign governments like central banks, state owned commercial

banks

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National or regional development banks and commercial banks abroad. Overseas financial organizations or Institutions

Other suitable overseas institutions.

4. Board of EXIM Bank: EXIM Bank is guided by various people of expertise at the Board level.Senior policy makers, expert bankers, major players in industry, professionals in exports are atthe senior board of the bank. According to the EXIM Bank Act maximum of 16 directors can bethere on the board. Chairman and Managing Director as well as 13 directors of the board areappointed by Government of India. Three directors from scheduled commercial banks and fourdirectors who are industry/trade experts are also the part of the board, the head office of EXIMbank is situated at Mumbai. Nine domestic offices of EXIM bank are operating at Ahmadabad,Bangalore, Chandigarh, Chennai, Guwahati, Hyderabad, Kolkata, New Delhi, Pune. The bank isworking at overseas level also and presently has overseas offices at seven places i.e AddisAbada, Dubai, Johannesburg, London, Singapore, Washington D.C and Yangon.

5. Project exportsProject exports are one of the important things in the portfolio of India’s exports. The contractswhich are financed by EXIM Bank remained quite diverse in the past few years. The bank has along track history of providing finance to various projects in the area of construction,engineering, technology transfer, procurement, consultancy, technology based projects etc. In itsbroader categories the finance is provided to the following areas-

Turnkey projects – covering engineering, construction, designing, erection ofwide range of projects.

Construction projects- covering wide range of infrastructure projects Technical and Consultancy Service Contracts- Covering skill based

activities, Training, project implementation services, management contracts,super vision of erection of plants, CAD/ CAM solutions in software exports,finance and accounting systems etc.



i. Export-Import Bank of India is the premier export finance institution.

ii. Pre-shipment Rupee Credit is extended to finance temporary funding requirement of

export contracts.

iii. Forfeiting is a mechanism of financing exports by discounting export receivables.

iv. In factoring, the firm or exporters sell their accounts payables to the 'Factor' .


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Books


2. Principles of BankingVarshney& Malhotra,Sultan Chand & Sons, 2005.


1997


New Delhi.





Websites

1) www.eximbankindia.com

2) indiandata.com

3) mbaisherebyravali.blogspot.hk

4) www.powerfulwords.co.uk

5) www.scribd.com

6) jru.edu.in

7) www.tedo.biz

8) www.cdc.org.in

9) www.slideshare.net

10) www.eximsupport.com

11) www.ukessays.com

12) www.kkhsou.in

13) skpatelmba.org

14) www.pondiuni.org

15) shuchita.co.in

16) eximbankindia.com

Page 118 of 244

17) www.mu.ac.in

18) www.uohyd.ernet.in


1. What do you know about the Export Import Bank of India? Write a detailed note.

2. Discuss the objectives and functions of EXIM bank?

3. Discuss the role of EXIM bank in connection with Indian economy?

4. What are the various provisions of funding by EXIM bank?

5. Discuss the Pre-shipment and Post-shipment financing of EXIM bank?

6. What are various provisions for financing loans to the exporters by EXIM bank?

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Lesson-8MANAGEMENT OF LOANS AND ADVANCES

Structure

8.1 Objectives

8.2 Introduction

8.3 Types of Advances

8.4 Basic Principles of Lending

8.5 Security of the Loan

8.6 Summary

8.7 Glossary




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i. Understand the types of advances.

ii. Understand the fund based and non-fund based facilities of the banks

iii. Know about the principles of lending.

iv. Understand the security of the loan.

8.2 Introduction

Lending is one of the principal services provided by the bank. If deposit is the backbone of a

bank, lending is the raw material for bank. Lending or advancing loans is one of the two basic

functions of the commercial banks. Lending is the revenue generating process of the

commercial bank. Without lending the process of earning profit does not start for the banks.

Lending policy of bank is governed by monetary policy of the RBI. The banks lend money

out of Deposits received from the customers. Deposits are repayable on date of maturity or on

short notice or on demand by customer. Hence, the bank cannot lend money for a longer

period out of deposits for short period. A commercial bank is essentially a medium or short

term lender. It is clear that a commercial bank cannot lend for long period any substantial part

of funds which have been borrowed for short period from depositors

The most peculiar feature of lending is that the sources which are deployed by banks by way

of lending to different sectors are not their own resources, but they are the resources

belonging to the public and the banks owe a duty to the depositors to repay their deposits

either on demand or on maturity depending upon the type and nature of deposits. In view of

this, it is necessary that the money which is lent by the commercial banks should come back

to them in the normal course of business by way of repayment of the advances as well as the

interest due thereon. The commercial banks, therefore, have to be careful while lending

money to different sectors of the economy and to different type of borrowers. The business of

lending, nevertheless, is not without certain inherent risks. Largely, depending on the

borrowed funds, a bank cannot afford to take undue risks in lending.

8.3 Types of Advances

(A) Fund Based Facilities

Many types of advances are allowed by the commercial banks in India. Demand loans are

given normally for the purchase of fixed assets, whereas working capital facilities are allowed

for acquiring current assets etc. Various types of fund based facilities are discussed below:

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1. Loans: In a loan account the entire amount is paid to the borrower at one time or

sometimes in instalments either in cash or by transfer to his account or by making

payment directly to the supplier of goods, machinery or vehicle etc. No subsequent debit

is ordinarily allowed except by way of interest and other bank charges. Loan accounts

with no definite payment schedule are considered repayable on demand hence called

‘demand loans’. Where a loan is given for a specific period or term without allowing the

demand character of the loan to be affected in any way, it is called ‘Term Loan’. Loans

are generally granted by the banks for acquiring fixed assets. No cheque book facility is

allowed in such accounts. Demand loans are also given by the banks against their own

deposits, life policies, shares etc.

2. Overdraft: Overdraft means allowing the borrower to over draw his current balance.

An overdraft account is a fluctuating or running account, the balance sometimes being

in credit and at other times in debit. Overdraft facilities are generally allowed in current

accounts only. For opening of an overdraft account, first of all current account will have

to be opened formally. Current account enables a customer to draw cheques upto the

extent of balance lying in his account but an overdraft arrangement enables a customer

to draw over and above his own balance up to the extent of the limit stipulated.

Overdrafts may be allowed to salaried customers against their salary to be received or

against cheques or against salary bills in course of collection. As per the

recommendations’ of the Working Group on customer service, an overdraft of

maximum Rs. 2,500/ can be allowed in savings accounts of such customers where the

bank is crediting the salary of such employees every month. It should, however, be

noted that such advances are not be treated as a supplemental income of the customer

but only a stand-by arrangement for ai casual pressing demand.

3. Cash Credit: A cash credit is essentially a drawing account and the amounts may be

debited or credited any number of times. Cheque book is issued to the customer to make

drawing on this type of account after properly assessing the requirements of the

customer and viability of the project. As the very name implies in a cash credit account,

credit is given in cash. Security for such advances may consist in pledge or

hypothecation of goods (raw material, stock-in-progress, finished goods etc.) or

documentary bills in collection etc. Cash Credit facility as a matter of rule and practice

is allowed for one year although in fact this money never comes back to bank’s basket.

The demand for more and more credit limit continues for years together. Limits are to

be renewed every year. Every month the borrower is required to furnish the bank, the

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figures of sales, purchases, stocks lying at his premises along with the life of such

stocks.

4. Bills Purchased and Discounted:

Bills Purchased: Clean or documentary bills payable on demand and discounted by a

banker are classified as bills purchased (DBP).

Bills Discounted: Clean or documentary bills after a certain period and discounted by

banks are classified as bills discounted (U.B.D.)

Operations in BP and BD Accounts

Bills facilities allowed to the customers against their bills drawn on different persons at

different centres. After the limit has been sanctioned by the competent authority, the

operation starts by debiting the amount to Demand Bills Purchased (DBP). Account or

Usance Bills Discounted (U.B.D,). Account as the case may be? Customer’s Account is

credited after deducting commission etc. stipulated in the sanction letter. When the bills

are realised on due date, interest for the appropriate period at the sanctioned rate is

charged and debited to customer ’s current account maintained with the bank -and the

entries of BP or BD are reversed.

5. Composite Loans: Another category of advances is also becoming popular for small

advances. Under this facility, only one loan account is sanctioned for the requirements

of current assets as well as fixed assets. This is called composite loans . As per RBI

guidelines, such advance is usually granted to farmers, artisans and cottage and village

Industries. Like other advances, advance against bills should be allowed by a banker

after satisfying himself about the creditworthiness of the drawer (i.e. seller) and the

genuineness of the bills. The banks should also verify the financial standing of the

drawees of the bills by obtaining their confidential reports.

6. Consumption Loans: Normally banks provide loans for productive purposes only, but

these days’ loans are also granted, on a limited scale, to meet the need for the purchase

of consumer durable items, educational expenses, medical needs or, expenses relating to

marriage and social ceremonies etc. Such loans are called consumption loans.

7. Bridge Loans: Bridge loans are essentially short term loans which are granted by the

banks to industrial undertakings to meet the urgent needs during the period when

sanctioning of term loans from financial institutions is in the-process or raising funds

from the capital market is in the pipeline. Bridge loans are given by the commercial

banks and are automatically repaid out of amount of the term loan or the fund raised in

the capital market

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(A) Non-Fund Based Facilities

1. Letter of Credit: It is an instrument issued by a bank at the request of the importer, in

which the bank promises to pay a particular sum of amount to beneficiary presenting

specified document in the letter of credit. Letter of credit is also known as

“Commercial Letter of Credit”, a Documentary Letter of Credit; or simply a Credit. It

means letter of credit reduces the risk of non-completion of the transaction.

It is innovative funding mechanism for the import of goods and services on deferred

payment systems LOC is an arrangement of a financing institution/bank of one

country with another institution/bank to support the export of goods and services so as

enables the importers to import deferred payments terms. This may be backed by a

guarantee furnished by the institutions/ bank in the importing country. The LOC helps

the experts to get payment immediately as soon as the goods shipped since the funds

could be paid out of the pool accounts with the financing agency and it would be

debited to the account of the borrower’s agency/ importers whose contract for availing

the facility is already approved by the financing agency on the recommendation of the

overseas institutions. It acts as conduct of financing, which is for a certain period and

on certain terms for the required goods to be imported. The greatest advantages of

LOC is saving a lot of time and money on mutual verifications of bonafide sources of

finance etc. It serves as a source of forex.

2. Guarantees: A guarantee is a contract to perform the promise or discharge a liability

of a third person in case of his default. The person (in this case the bank) who gives

the guarantee is known as ‘the surety’, the person in respect of whose default the

guarantee is given is known as, ‘the principal debtor and the person/department to

whom the guarantee is given is called ‘the beneficiary’. The guarantee ‘once issued

cannot be revoked without the consent of the beneficiary, before the expiry of its

validity. So the guarantee though a ‘contingent liability’ in terms of balance sheet

item, so a definite undertaking enforceable on the happening of a certain event

(default).

Types of Guarantees: We can broadly classify the guarantees into the following three

categories:

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(a) Financial Guarantees: The guarantees given in lieu of purely monetary

obligations are classified as financial guarantees. Specifically, they will cover the

following types

(i) Bid bond/tender money guarantee: These guarantees are submitted along with

bids/tenders filed by the bidders/tenders and are issued for a percentage (usually 1

percent or 2 percent) value of the amount of the bid. These guarantees are valid till

finalisation of the bid/tender. The utility of these guarantees ceases after signing of the

contract.

(ii) Security deposit guarantees: When a contract is awarded, to a particular party, it

is required to furnish a security-deposit in cash or in lieu thereof a bank guarantee. It is

also for a certain percentage value (normally 10 percent) of the contract.

(iii) Advance, payment guarantees: The contract always provides for some advance

payments. To secure such payment, advance: payment guarantee is required to be

furnished.

(b) Performance Guarantees: These guarantees are issued in respect of performance of

a contract or obligation. In such guarantees, in the event of non-performance or short

performance of an obligation, the guaranteeing bank will be called upon to make good

the monetary loss arising out of the non-fulfilment of the guarantee obligation.

Although, these guarantees are for performance, the quantum of pecuniary obligation

is reduced to monetary terms and for the amount the guarantee is issued. Performance

guarantees can illustratively be of the following types:

(i) performance for installation of plant and machinery within a given time frame and

with agreed specification;

(ii) performance of plant/machinery up to the agreed level;

(iii) performance relating to supply of agreed material within stipulated period;

(iv) performance towards payment of agreed sum at agreed periodical intervals.

(c) Deferred Payment Guarantees (DPG): Purchase of machinery requires either a

cash payment or a deferred payment plan duly supported by an assurance from a

commercial bank that stipulated instalments will be paid on respective due dates. The

concept of DPG had its origin to the limited availability of funds from commercial

banks for a medium to long term investment. The mechanism of DPG channelizes the

cheaper funds from development banks to industrial establishments. The assets created

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out of DPG are duly charged to the guaranteeing bank to secure their long term

contingent liability.

8.4 Basic Principles of Lending

The business of lending, which is the main business of banks, carry certain inherent risks. A

banker must strive to earn profit (from lending) without exposure to greater risks. Banks

cannot take more than calculated risks whenever it wants to lend. Therefore, banks have to

follow a cautious approach towards lending, based on certain principles. There are three

cardinal principles of bank lending that have been followed by the commercial banks since

long. These are the principles of safety, liquidity and profitability. These principles are inter

woven and cannot be isolated. However, these principles are not exclusive and one can add

more criteria for deciding advances i.e. like the purpose of the loan, the diversification of

risks, the security of the loan etc. These principles should be regarded as statements of

general tendencies only and not irrefutable laws, which are inelastic and incapable of wider

interpretations to meet the given situation. These principles are being discussed below: -

1. Principle of Safety: As the bank lends the funds entrusted to it by the depositors, the

first and foremost principle of lending is to ensure the safety of funds lent. Safety of

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funds means that whatever is lent should come back through repayment of the loan. The

safety of the loan depends upon the proper selection of the borrowers, his willingness

and capacity to repay back the loan taken.

Willingness to repay depends upon:

The honesty of the borrower

His integrity

His character

Fairness in dealing

Business morality

Creditworthiness of the borrower

The capacity to repay back the loan depends upon:

Viability of the project

Strengths of tangible assets of the borrower

Success of the business of the borrower

If any advance is deficient in savings, it has impact ultimately on the profits of the bank.

An unsafe advance effects adversely the long-term profitability of the bank. Banks

needs to ensure that the advance granted not only appears to be safe at the time it is

released but continues to be safe until it is repaid. The bank, therefore, must closely

watch the activities of the borrower during the currency of the advance.

After the nationalization of banks, a new direction has been given to Indian banking

and to the pattern of lending in particular. Banks had to reorient their lending policies in

their efforts to achieve the social objectives expected from them. Economic viability of

the project has replaced consideration of security in most of the lending to the priority

sectors. Production oriented lending is preferred and credit for consumption or

unproductive purposes has been curbed. The need-based approach has replaced the

erstwhile security based approach. In the final analysis, ta bank’s loan is safe only if it

meets the production needs of the enterprise and helps in generating adequate internal

cash surplus to meet the repayment. Over financing can result in overtrading,

stockpiling or diversion of funds. While, underfinancing can compel the borrowers to

resort to market borrowings at exorbitant rates of interest. proper appraisal of the needs

of the borrowers is, therefore, necessary.

2. Principle of Liquidity: Coming back of bank’s money is not the only point to be given

attention, but it is also necessary that the money should come back or repaid fairly and

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quickly more or less on demand. Since the bulk of funds-in which a bank deals is

depositors’ money and the banker has necessarily to meet the demands of depositors. It

is essential that the borrower would be in a position to repay the loan either on demand

or within a reasonable period thereafter. If the money does not come back as stipulated,

the bank may face a crisis of liquidity, and a mismatch of the assets and liabilities,

which in turn could affect the capacity of the bank to meet its own obligations to return

the money to the depositors. Hence it is not enough that money comes back but it

should come back in time. Otherwise, such delay in the face of prudential guidelines on

income recognition and asset classification, render the accounts non-performing.

The role of commercial banks in providing short-term, medium-term and long-term is

becoming increasingly important over the years. Most of the credit extended by banks

in the field of industrial finance is by way of loans payable on demand, particularly, for

the purpose of working capital finance. The commercial banks do provide long-term

finance for the purpose of acquisition of fixed assets. If a large part of banks’ funds is

lent for a long term period i.e. for acquiring fixed assets, the ability of the bank to meet

the demands of its depositors may be seriously affected. Thus it must be ensured that

the money be lent for short term periods with definite repayment schedule.

3. Principle of Profitability: The commercial banks being commercial in character, have

to -make profits. No commercial organisation can survive without making profits.

Therefore, while making advances, the commercial banks should be guided by the

consideration of an adequate return or profit. The difference between the rate at which a

banker borrows from the public by way of deposits and lends money to borrowers by

way of advances constitutes his gross profit. The banker, therefore, should be governed

by a satisfactory margin of profit. Banks pay interest on deposits received, salary to

their staff and incur other expenses for its day to day functioning.

The rates of interest charged by banks were, in the past, primarily dependent on the

directives issued by the RBI. But now banks are free to determine their own rates of

interest on advances of above Rs.2 lakh. The variation in the rates of interest charged

from different customers depend upon the standing of the customer, the nature and

value of the security, size of the advance and the degree of risk involved in lending.

The general principle followed is ‘greater the risk higher the rate. Some banks rate the

customers into categories A, B and C depending upon the value of their connections to

the bank and their willingness to observe financial discipline and charge interest rate

accordingly. In case of small industries, a progressively high rate is often charged as the

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amount of the-loan increases on the principle that the large borrowers are in a better

position to bear heavy burden of interest.

4. Principle of Security: Besides safety, liquidity and profitability of the advances, the

importance of adequate and acceptable security: should not be undermined. Security is

considered as an insurance or cushion to fall back upon in the event of some unforeseen

development.

Loan given by the bank should be secured ones so that in case of need, the bank should

fall back upon for repayment by enforcing the securities available to it. The unsecured

loans can result into loss to the bank, since the bank will not be able to recover the

loans granted. There is no doubt that the best security is the borrower himself, his

character, capacity and capital. If the borrower lacks business integrity to meet his

commitments, he is not a good risk. On the other hand, a poor borrower may be a good

risk due to his determination to be honest and his willingness to repay. The capacity of

the borrower refers to his qualification, experience and his ability to run the business-on

professional lines. Capital refers to the stake of the borrowers in the venture. A

reasonable stake on the part of the borrower creates a sense of involvement and

commitment to the business. Bankers, however, finance the entire capital in the case of

entrepreneurs and borrowers from the weaker sections of the community but expect that

they will build up their stake from profits over a period of time.

Apart from the personal security of the borrowers, banks rely on the impersonal

security i.e. tangible assets financed by the banks e.g. stocks, machinery, vehicles,

livestock etc. The security created out of bank loan must be properly investigated and

examined so that there may not be any misutilization of funds. Security offered by the

borrowers or accepted by the banks must possess following attributes :

* Marketable being passed on the banker easily and at little cost.

* Ascertainable (in regard to its value).

* Stable (in regard to price fluctuation).

*Transferable (transfer title should be clear and marketable)

* Durable (non-perishable)

5. Principle of Purpose: Investigation into the purpose for the money sought to be lent

cannot be ignored by the banks. Purpose of the loan can be analysed from two angles.

One with regard to the policies of the government and the directives of the country’s

Central Bank. And secondly whether the advances are granted for productive or; un-

productive purposes.

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The criteria from the point of view of the government policies had gained special

significance in the context of the new direction in bank lending especially after the

nationalization of banks. Advances to priority sectors –viz agriculture, small scale

industry, small borrowers, transport operators, professionals, exports, weaker sections

of the society, setting up of industrial estates, consumption and housing loans etc.

should be encouraged in the interest of the nation. While observing these priorities,

banks, being custodians of public funds, take care to ensure that the purpose for which a

loan is granted includes the elements of safety and repayment capacity if not the

security, to back the loan. There are occasions, however, when the need of the borrower

given the high priority in the national interest and an advance is granted despite the

heavy risks involved and the requirement of the safety being not fully satisfied. An

example is the provision of credit to units with little stake of their own, manufacturing

essential supplies to defence departments when a war breaks out.

To ensure the safety and liquidity of fluids, banks should grant loans for productive

purposes only. Banks cannot lend for unlawful activities, Usually, the banks would like

to give advances for a productive purpose. The loans given for productive purposes

help to generate additional income which would act as an incentive to purpose the

financed activity.

6. Principle of Diversification of Risk: This is also cardinal principle of sound lending.

A prudent banker always tries to select the borrower carefully and takes intangible

assets as securities to safeguard his interest. Yet some risk is always involved in

lending. Natural calamities like floods, earthquakes and political disturbances may ruin

even a prosperous business. An industry may face depressionary conditions and the

price of the goods may sharply fall. So banks take calculated risks in granting loans but

sometimes their calculations do go wrong. To minimise the incidence of risks due to

unforeseen contingencies, the bank follows the principle of diversificat ion of risks

based on the famous maxim ‘do not keep all the eggs in one basket’. This means that

banks should spread the risks by the dispersal of their funds to a large number of

borrowers. The bank should not concentrate its funds in a few industries or in a few

cities or regions of the country. But the advances should be spread over a reasonably

wider area, distributed among a good number of customers belonging to different trades

and industries. If a big customer meets misfortune or certain trades or industries are

affected adversely, the overall position of the bank will not be in jeopardy.

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lt is now a well-recognized practices among bankers, to spread the bank’s loanable

funds over different types of advances to commercial, industrial and other sectors of the

economy. The quality of lending can be judged by the composition of the lending

portfolio.

8.5 Security of the Loan

Security constitutes an important segment of the lending policy of the banks. Security offers

following advantages to the bank:

1. In the event of the borrower defaulting payment, the banker as a secured creditor; can

legally take possession of the security, can sell it and recover the loan from the

proceeds.

2. The bank can always exercise better degree of control over the advance, once the

sufficient security in the form of borrower ’s assets are charged to the bank.

3. Once the security is offered to the bank, the borrower cannot normally raise a loan

from another source against the same security.

4. The end use of the fund can be insured in a better way with the possession of security

in the hands of bank.

5. The borrower remains conscious of his obligations towards bank.

Charging of Security: Charging is creation of a right over the property or making the

security available as cover for an advance. Effective charging of security by the bank is very

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essential. In other words, the charge created over security offered to the bank should be

legally water-tight. Modes of charging a security are followings

I. Pledge: According to Section 172 of Indian Contract Act, 1872 ‘Pledge is the bailment of

goods as security for payment of a debt or performance of a promise’. Bailment according to

Section 148 of the Contract Act is the delivery of goods by one person to another for some

purpose, under a contract that the goods shall, when the purpose is accomplished, be returned

or otherwise disposed of according to the directions of the person delivering them.

A pledge is said to be created when the goods or documents of title of goods handed over by

the borrower or "the prospective borrower to the lender with the intention of their being

treated as security for the repayment of the advance. Although under law, the contract of

pledge need not necessarily be in writing, yet the banks always make this agreement in

writing.

II. Hypothecation: Hypothecation is an equitable charge without possession. Neither the

ownership nor the possession is transferred by the borrower to the lender. Only a sort of

charge is created by way of an agreement and the bank’s name plate is displayed at the

godown/business premises of the borrower. The borrower is required to submit statements of

the stock kept with him every month. Hypothecation facility was initially started for reputed

customers but now a days the banks are granting these facilities to their customers very

frequently.

III. Mortgage: Mortgage according to the Transfer of Property Act, 1882, Section 58(a) is a

transfer to an interest in the immovable property for the purpose of securing payment of

money advanced by way of loans or an existing or future debt or the performance of an

engagement which gives rise to a pecuniary liability. Banks in India prefer to create two types

of mortgages on the securities offered by their borrowers, namely

Simple/Registered Mortgage

Equitable Mortgage

IV. Assignment: Assignment means a transfer by one person of a right, property or debt

(existing or future) to another person. As a matter of practice, banks create charge of

assignment on the life policies while making advances against there. Assignment of charge

can be created on actionable claims which means claim to any debt, right or property other

than a debt secured by mortgage of immovable property. Banks always prefer to create legal

assignment i.e. in writing and register the same with the concerned department.

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V. Set-Off: It is a right, which in the absence of an agreement to the contrary, enables a

creditor (banker) to adjust wholly or partially a debit balance of the debtor lying to a debtor’s

credit with the creditor (banker).

8.6 Summary

Lending is one of the principal services provided by the bank. If deposit is the backbone of a

bank, lending is the raw material for bank. Lending or advancing loans is one of the two basic

functions of the commercial banks. Lending is the revenue generating process of the

commercial bank. Without lending the process of earning profit does not start for the banks.

Lending policy of bank is governed by monetary policy of the RBI. The banks lend money

out of Deposits received from the customers. Deposits are repayable on date of maturity or on

short notice or on demand by customer. Hence, the bank cannot lend money for a longer

period out of deposits for short period. A commercial bank is essentially a medium or short

term lender.

8.7 Glossary

1. Loans: In a loan account the entire amount is paid to the borrower at one time or

sometimes in instalments either in cash or by transfer to his account or by making payment

directly to the supplier of goods, machinery or vehicle etc. No subsequent debit is ordinarily

allowed except by way of interest and other bank charges

2. Overdraft: Overdraft means allowing the borrower to over draw his current balance. An

overdraft account is a fluctuating or running account, the balance sometimes being in credit

and at other times in debit. Overdraft facilities are generally allowed in current accounts only.

3. Cash Credit: A cash credit is essentially a drawing account and the amounts may be

debited or credited any number of times. Cheque book is issued to the customer to make

drawing on this type of account after properly assessing the requirements of the customer and

viability of the project.

4. Letter of Credit: It is an instrument issued by a bank at the request of the importer, in

which the bank promises to pay a particular sum of amount to beneficiary presenting

specified document in the letter of credit.



i. In a loan account the entire amount is paid to the borrower at one time or sometimes

in instalments either in cash or by transfer to his account.

ii. Overdraft allows the borrower to over draw his current balance.

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iii. A cash credit is essentially a drawing account and the amounts may be debited or

credited any number of times.

iv. A letter of credit is issued by factor.



1. Banking and Insurance by Amandeep Kaur & Poonam Agarwal, S.Vikas & Co.



1997


House, New Delhi.






1. Define Loans and Advances. What are its types?

2. What are the fund based and non-fund based facilities of the banks?

3. What are the various principles of Lending? Explain

4. Write a detailed note on the security of the loan.

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Chapter-9

RISK MANAGEMENT IN BANKS

Structure

9.1 Objectives

9.2 Introduction

9.3 Risk and Types of Risk

9.4 Risk Management

9.5 Asset liability Management

9.6 Basel Norms


9.8 Summary

9.9 Glossary

9.10 Answer to Check Your Progress



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9.1 OBJECTIVES

After reading this lesson, you should be able to:

Understand Risk and types of Risk.

Risk Management.

Concept of Asset Liability Management in Banks.

Basel Norms.

9.2 INTRODUCTION

Banking sector is considered as the lifeline of the nation. It plays an important role in the growth

and management of the economy of a country. Due to the growing integration of domestic

markets with the external markets, changes in the political, economic, financial, social, legal and

technological environments the Indian Banking Industry has undergone a radical change. With

the deregulation and globalization of financial markets, entry of new players, introduction of new

financial instruments Indian banking sector is exposed to severe competition in selling their

products and procuring capital. Banks are therefore compelled to face the challenge of various

types of financial and non financial risks. Risk Management is a proactive action in the present

for the future. The main function of risk management is to identify measure and monitor the

profile of the bank.

9.3 RISK

The word ‘Risk’ has been derived from the Latin word “Rescum.” Risk is the potentiality that

both the expected and unexpected events may have an adverse impact on the bank’s capital or

earnings. Risk arises due to uncertainty or unpredictability of the future which arises due to

changes in internal and external business environment. Risk and uncertainties form an integral

part of banking. In banking sector risk results from the variations and fluctuations in assets or

liabilities or both. Since risk is directly proportionate to return so the more risk a bank takes it

can expect to generate more money.

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Types of Risks

The various types of financial and non financial risks which the banks are exposed to are:

Financial Risks

Credit Risk: Credit risk refers to the risk that the borrower of the bank fails to repay the loan on

agreed terms and the bank may lose the principal of the loan or the interest associated with it or

both. It also includes the pre-payment risk resulting in loss of opportunity to the bank to earn

higher interest income. Credit risk is an essential characteristic of the business of lending funds.

Loans given by banks are considered to be the largest source of credit risk. But other than loans

banks are also increasingly facing credit risk in various financial instruments including

acceptances, interbank transactions, trade financing, foreign exchange transactions, financial

futures, swaps, bonds, equities, options. Credit risk consists primarily of two components

(i) Quantity of risk, and

(ii) Quality of risk.

Quantity of risk is the outstanding loan balance as on the date of default and the Quality of risk

is the severity of loss defined by Probability of Default as reduced by the recoveries that could be

made in the event of default. The credit risk is a combined outcome of Default Risk and

Exposure Risk.

Liquidity Risk: Liquidity is the capacity of the bank to make the cash available to meet

depositor’s payment commitments on demand or as and when they are due and to undertake new

transactions when they are profitable. Liquidity risk is the risk that a bank will not have

sufficient liquid resources to carry out its day-to-day operations and to meet its commitments.

The demand for liquid funds in banks arises on account of the following obligations:

To make payments on deposits, borrowings, and other liabilities.

To fund loans and advances.

To settle claims against the bank.

To honor contingent liabilities that devolves on the bank out of contractual obligations.

Causes of Liquidity Risk

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Gap in assets and liabilities maturity date.

non recovery of cash receipts from recovery of loans

conversion of contingent liabilities into fund based commitment

Heavy reliance on corporate deposits.

Less allocation of funds in liquid instruments.

Provision for adequate liquidity in a bank is crucial because shortfall of liquidity in meeting

commitments to other banks and financial institutions can have serious impact on the bank’s

reputation.

Market Risk: Market risk is defined as the risk of losses in on- or off-balance sheet positions

that arise from movement in market prices. Market risk arises from movements in market prices

which are caused due to changes in interest rates, foreign exchange rates, and equity and

commodity prices. Market risk is the most prominent risk for banks. The bank should develop a

sound and well informed strategy to manage market risk. Market risk is measured by various

techniques such as value at risk and sensitivity analysis. Components of Market Risk are:

Interest Rate Risk

Foreign Exchange Risk

Equity Risk

Commodity Risk

Interest Rate Risk: Interest Rate Risk is inherent in banking business. This risk to the income or

capital arises due to fluctuations in the interest rates. Due to deregulation of interest rates,

interest rates are determined by the market force. Interest rate risk significantly impacts and

alters bank’s profitability and market value. The fluctuations in interest rates affect banks

earnings by changing its Net Interest Income (NII). The cost of liabilities and the earning of

assets of the banks are also closely related to market interest rate volatility. This type of risk

arises when there is a mis match between assets & liabilities of the bank, which are subject to

interest rate adjustment within a specified period.

Foreign Exchange Risk: When a bank holds assets or liabilities in foreign currencies it is

exposed to foreign exchange risk as exchange rates are volatile and no one can predict what the

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exchange rate will be in the next period. The uncertain movement in exchange rate poses a threat

to the earnings and capital of bank, if such a movement is in undesired and unanticipated

direction. This undesired movement in the exchange rates can lead to sizeable losses. Foreign

exchange risk is also known as exchange rate risk or currency risk. It involves currency rate risk,

transaction risks (profits/loss on transfer of earned profits due to time lag) and transportation risk

(risks arising out of exchange restrictions).

Equity Price Risk: This risk arises due to potential of banks to suffer losses on their exposures

in the capital markets, due to adverse movements in the prices of equity.

Commodity Price Risk: This risk arises due to exposure of banks in commodity markets.

Commodity price risk is more volatile and complex to measure. Banks in developed markets use

derivatives to hedge commodity price risk.

Non Financial Risks

Operational Risk: Basel II has recognized operational risk as a distinct class of risk outside

credit and market risk. The Basel Committee on Banking Supervision defines operational risk

“as the risk of loss resulting from inadequate or failed internal processes, people and systems or

from external events.” Operational risk occurs in all day-to-day banking activities. This risk is

highly dynamic in nature and arises due to many causes such as incompetency of personnel and

misuse of powers, the failure of the information technology system and the possibilities of errors

in information processing, data transmission, data retrieval, and inaccuracy of result or output.

Two of the most common operational risks are–

(a) Transaction Risk: Transaction risk is the risk arising from fraud, both internal and external,

failed business processes and the inability to maintain business continuity and manage

information.

(b) Compliance Risk: Compliance risk is the risk of legal or regulatory sanction, financial loss

or reputation loss that a bank may suffer as a result of its failure to comply with any or all of the

applicable laws, regulations, code of conduct and standards of good practice.

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Strategic Risk: This is the risk arising out of certain strategic decisions taken by the banks for

sustaining themselves in the present day scenario for example decision to open a subsidiary may

run the risk of losses if the subsidiary does not do good business.

Regulatory Risk: It is defined as the risk associated with the impact on profitability and

financial position of a bank due to changes in the regulatory conditions, for example the

introduction of asset classification norms have adversely affected the banks of NPAs and balance

sheet bottom lines.

Reputational Risk: Reputational risk is the risk of damage to a bank’s image and public

standing. It leads to loss of confidence of public in a bank. It occurs due to following reasons:

the bank’s failure to honor commitments to the government, regulators, and the public.

mismanagement of the bank’s affairs.

non-observance of the codes of conduct under corporate governance.

suppression of facts and manipulation of records and accounts are also instances

of reputational risk.

Bad customer service, inappropriate staff behavior, and delay in decisions.

9.4 RISK MANAGEMENT IN BANKS

Risk Management is defined as a planned way of dealing with the potential loss or damage. It is

an ongoing process of forecasting, analyzing and evaluating potential risks and taking some

corrective actions to reduce or minimize those risks. Risk Management is an important tool

towards optimum use of capital for generating profits. Now a day’s all banks set up separate risk

management departments in order to monitor, manage, and measure these risks. The department

continuously measures the risk of banks current portfolio of assets, or loans, liabilities, or

deposits, and other exposures. The department also communicates the bank’s risk profile to other

bank functions and takes steps, either directly or in collaboration with other bank functions, to

reduce the possibility of loss or to mitigate the size of the potential loss.

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CREDIT RISK MANAGEMENT

The management of credit risk includes

a) measurement through credit rating/ scoring,

b) quantification through estimate of expected loan losses,

c) Pricing on a scientific basis and

d) Controlling through effective Loan Review Mechanism and Portfolio Management.

Following are the tools through which credit risk is managed:

Exposure Ceiling: Prudential Limit is linked to Capital Funds – say 15% for individual

borrower entity, 40% for a group with additional 10% for infrastructure projects

undertaken by the group, Threshold limit is fixed at a level lower than Prudential

Exposure; Substantial Exposure, which is the sum total of the exposures beyond

threshold limit should not exceed 600% to 800% of the Capital Funds of the bank (i.e. six

to eight times).

Review/Renewal: Multi-tier Credit Approving Authority, constitution wise delegation of

powers, Higher delegated powers for better-rated customers; discriminatory time

schedule for review/renewal, Hurdle rates and Bench marks for fresh exposures and

periodicity for renewal based on risk rating, etc are formulated.

Risk Rating Model: Set up comprehensive risk scoring system on a six to nine point

scale. Clearly define rating thresholds and review the ratings periodically preferably at

half yearly intervals. Rating migration is to be mapped to estimate the expected loss.

Risk based scientific pricing: Link loan pricing to expected loss. High-risk category

borrowers are to be priced high. Build historical data on default losses. Allocate capital to

absorb the unexpected loss. Adopt the RAROC framework.

Portfolio Management: The need for credit portfolio management emanates from the

necessity to optimize the benefits associated with diversification and to reduce the

potential adverse impact of concentration of exposures to a particular borrower, sector or

industry. Stipulate quantitative ceiling on aggregate exposure on specific rating

categories, distribution of borrowers in various industry, business group and conduct

rapid portfolio reviews. The existing framework of tracking the non-performing loans

around the balance sheet date does not signal the quality of the entire loan book. There

should be a proper & regular on-going system for identification of credit weaknesses well

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in advance. Initiate steps to preserve the desired portfolio quality and integrate portfolio

reviews with credit decision-making process.

Loan Review Mechanism: This should be done independent of credit operations. It is also

referred as Credit Audit covering review of sanction process, compliance status, review

of risk rating, pick up of warning signals and recommendation of corrective action with

the objective of improving credit quality. It should target all loans above certain cut-off

limit ensuring that at least 30% to 40% of the portfolio is subjected to LRM in a year so

as to ensure that all major credit risks embedded in the balance sheet have been tracked.

This is done to bring about qualitative improvement in credit administration. Identify

loans with credit weakness. Determine adequacy of loan loss provisions. Ensure

adherence to lending policies and procedures. The focus of the credit audit needs to be

broadened from account level to overall portfolio level. Regular, proper & prompt

reporting to Top Management should be ensured. Credit Audit is conducted on site, i.e. at

the branch that has appraised the advance and where the main operative limits are made

available. However, it is not required to visit borrowers factory/office premises.

The ideal credit risk management system should throw a single number as to how much a bank

stands to lose on credit portfolio and therefore how much capital they ought to hold.

MARKET RISK MANAGEMENT:

Market Risk Management provides a comprehensive and dynamic frame work for measuring,

monitoring and managing liquidity, interest rate, foreign exchange and equity as well as

commodity price risk of a bank that needs to be closely integrated with the bank’s business

strategy. Following measures should be adopted by banks to manage market risk.

Top management of banks should clearly articulate the market risk policies, agreements,

review mechanisms, auditing and reporting systems etc.

Bank should form Asset Liability Management Committee whose main should be to

maintain and manage the balance sheet within the risk or performance parameters.

The banks should set up an independent middle office to track the market risk on a real

time basis. Middle office should consist of members who are market experts in analyzing

the market risk.

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OPERATIONAL RISK MANAGEMENT

Operational Risk management is one of the most complex and fastest growing areas in

banking. Operational risk is more difficult to measure than market or credit risk due to the non-

availability of objective data, redundant data, lack of knowledge of what to measure etc. This

risk can be reduced to great extent by effectively controlling organization as a whole by taking

certain steps, like assuring that designed processes is carried out carefully & with the help of

experts, and are followed in desired way.

An effective operational risk management process consists of clearly defined steps which involve

identification of the risk events, analysis,

assessment of the impact,

treatment and reporting.

Role of RBI in Risk Management in Banks

RBI plays an important role in Risk Management in Indian Banks. CAMELS was used by RBI to

evaluate the financial soundness of the Banks. CAMELS is the collective tool of six components

namely

Capital Adequacy

Asset Quality

Management

Earnings Quality

Liquidity

Sensitivity to Market risk

The CAMEL was recommended for the financial soundness of bank in 1988 while the sixth

component called sensitivity to market risk (S) was added to CAMEL in 1997.

In India, the focus of the statutory regulation of commercial banks by RBI until the early 1990s

was mainly on licensing, administration of minimum capital requirements, pricing of services

including administration of interest rates on deposits as well as credit, reserves and liquid asset

requirements.RBI in 1999 recognised the need of an appropriate risk management and issued

guidelines to banks regarding assets liability management, management of credit, market and

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operational risks. The entire supervisory mechanism has been realigned since 1994 under the

directions of a newly constituted Board for Financial Supervision (BFS), which functions

under the aegis of the RBI, to suit the demanding needs of a strong and stable financial system.

A process of rating of banks on the basis of CAMELS in respect of Indian banks and CACS

(Capital, Asset Quality, Compliance and Systems & Control) in respect of foreign banks has

been put in place from 1999.

9.5 ASSET LIABILITY MANAGEMENT

Asset Liability Management is the ongoing process of formulating, implementing, monitoring,

and revising strategies related to assets and liabilities to achieve financial objectives, for a given

set of risk tolerances and constraints.

The Asset Liability Management (ALM) is a part of the overall risk management system in the

banks. It is one of the most important risk management functions in a bank. Asset Liability

Management is the process by which bank manages its balance sheet in order to control risks

caused by changes in interest rates, exchange rates, credit risk and the liquidity position of bank.

It implies examination of all the assets and liabilities simultaneously on a continuous basis with a

view to ensuring a proper balance between funds mobilization and their deployment with respect

to their a) maturity profiles, b) cost, c) yield, d) risk exposure, etc. It includes product pricing for

deposits as well as advances, and the desired maturity profile of assets and liabilities.

It involves conscious decisions with regard to asset liability structure in order to maximize

interest earnings within the frame work of perceived risk with quantification of risk.

Assets of a Bank

Fixed Assets Fixed Assets

Liquid Assets

notice

Cash in hand, balances with RBI, balances with other banks, money at call

and short

Term Loans Term loans

Short-Term

Loans

Advances not in term loans, bills purchased and discounted, cash credits,

overdrafts

Investments Other than SLR like shares, debentures, bonds, etc.

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SLR Securities Government securities and other approved securities

Liabilities of a Bank

Net Worth Capital, reserves and surplus

Short-Term

Deposits

Saving bank deposits and demand deposits

Long-Term

Deposits

Deposits not included in short-term

Borrowings From RBI, other banks, other financial institutions both from India and

abroad

The focus of ALM is on managing the structure of bank’s balance sheet (liabilities and assets) in

such a way that the Net Interest Income (NII) is maximized within the overall risk-preference

(present and future) of banks. ALM requires an integrated approach to decision making with

regard to demand/time maturities and portfolios of financial assets and liabilities. It manages

three central risks (i) Interest Rate Risk (ii) Liquidity Risk (iii) Foreign currency risk. The banks

with foreign exchange operations, it also includes manages Currency risk. The assets and

liabilities of a bank continuously changes which directly affect and causes mismatch between

interest cost and interest income. Through ALM, the bank groups the assets and liabilities

according to the maturity, rate, risk, and size so as to control mismatches. It is not possible to

eliminate the gaps arising due to mismatches, the ALM aims at minimizing the gaps as they are

risk-prone and directly affect the Net Interest Income. Thus ALM will enable the bank to protect

and if possible improve the Net Interest Income through conscious strategies and decisions.

PRINCIPLES OF ALM PROCESS

Economic Value ALM focuses on Economic Value. Economic value is based on future

cash flows of asset and liability. ALM uses these future cash flows to determine the risk

exposure and achieve the financial objectives of bank.

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Mutual Dependence The mutual dependence principle of ALM implies that assets and

liabilities must be managed together in order to optimize achievement of economic and

financial objectives as liabilities and the assets associated with these liabilities are

mutually dependent.

Diversification This principle of ALM implies that the level of risk associated with given

financial objective can be reduced through diversification by combining exposures that

are less than 100% positively correlated. It applies to all combinations of asset and

liability portfolios.

Risk/Reward Trade off ALM process determines the riskiness of a portfolio by the net

position of the combined assets and liabilities. It is a general view that greater rewards are

generally expected from portfolios with higher levels of risk. But the higher risk and

greater reward relationship may not hold true if the portfolio is sub-optimal for a given

level of risk.

Dynamic Environment ALM is an ongoing process. The risks to which bank is exposed

and the rewards associated with these risks are determined by internal and external

factors that change over time. Internal factors arise from the financial objectives, risk

tolerances, and constraints of the bank. External factors include interest rates, equity

returns, competition, the legal environment, regulatory requirements, and tax constraints.

Such factors often impact both assets and liabilities simultaneously.

Hedging The process of ALM relies on the principle of hedging as to reduce the overall

risk of a portfolio Hedging plays an integral role in the ALM process. Once the risks

associated with a portfolio or transaction has been identified, the existing risks can be

modified to suit the bank’s risk tolerances and financial objectives.

STEPS OF AN ALM PROCESS

ALM process consists of five fundamental steps:

To assess the risk and reward objectives: The first and foremost step is to assess the

risk and reward objectives of the bank. The basic purpose of ALM is to minimize

risk. The level of risk will vary with the return requirements and bank’s objectives.

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To identify risks: In the second step all sources of risk for all assets and liabilities are

identified. Risks are then broken down into their component pieces and the underlying

causes of each component are assessed. Relationships of various risks to each other

and/or to external factors are also identified.

To quantify the level of risk exposure: Exposure to risk is quantified in the third step.

Risk exposure can be quantified 1) relative to changes in the component pieces, 2) as a

maximum expected loss for a given confidence interval in a given set of scenarios, or 3)

by the distribution of outcomes for a given set of simulated scenarios for the component

piece over time. Regular measurement and monitoring of the risk exposure is necessary.

To formulate and implement strategies: The fourth step is to formulate and implement

strategies. ALM strategies comprise both pure risk mitigation and optimization of the

risk/reward tradeoff. Risk mitigation can be accomplished by modifying existing risks

through techniques such as diversification, hedging, and portfolio rebalancing so that the

portfolio has the most desirable risk/reward trade off for a given risk tolerance level.

Optimization presupposes that the management team has been previously educated on the

risk/reward profile of the business and understands the necessity to take action based on

ALM analysis.

Monitoring the risk exposures and revising the strategies: In the last step of ALM

process all identified risk exposures are monitored and reported to top management on a

regular basis. If a risk exposure exceeds its approved limit, corrective actions are taken to

reduce the risk exposure.

TOOLS OF ALM

The main tools of ALM are.

GAP Analysis: GAP is the “excess” of interest sensitive assets over interest sensitive

liabilities or vice – versa. Because both assets and liabilities are sensitive in different

degree so it is necessary to identify GAP so as to match identical groups of assets with

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liabilities In the ALM process, GAP is generally used for quantifying the rate sensitive

groups only.

Duration Analysis: Duration analysis is carried out with respect to banks’ cash flows and

average maturity. Under this method, impact of changes in interest rate on the market

value of assets and liabilities is considered.

Value-at-risk (VAR): This method is variant of the practice of ‘Market-to Market’

approved securities based on Yield- to Maturity.

Risk Management: The risk profiles of assets and liabilities are evaluated to ensure that

they are within the acceptable levels of risk. The availability of hedging mechanisms (e.g.

derivative instruments) facilitates risk management.

9.6 BASEL NORMS

The Basel Committee on Banking Supervision (BCBS) established in the year 1974 is

an international banking regulatory committee formed to develop banking supervisory

regulations. The objective of the BCBS is to gain a better understanding of the challenges faced

by modern banking system in terms of risk and it risk management and to frame supervisory and

regulatory standards and guidelines to help the banking system diminish these risks and function

properly. India is a member of the BCBS.

BASEL I NORMS

BCBS in the year 1998 introduced capital measurement system Basel Capital Accord also known

as Basel I. It focused entirely on credit risk. It defined capital and structure of risk weights for

banks. The minimum capital requirement was fixed at 8% of Risk Weighted Assets

(RWA).Basel I norms comprised of four pillars:

Pillar I Constituents of Capital: It prescribes the nature of capital that is eligible to be treated as

reserves. Capital is classified into Tier I and Tier II capital.

Pillar II Risk Weighting: It creates a comprehensive system to provide weights to different

categories of bank’s assets and liabilities.

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Pillar III Target Standard Ratio: It acts as unifying factor between the first two pillars. A

universal standard wherein Tier I and Tier II capital should cover atleast 8 percent of risk

weighted assets of a bank with atleast 4 percent being covered by Tier I capital.

Pillar IV Transitional and implementing arrangement: It sets different stages of implementation

of the norms in a phased manner.

Tier-I Capital which is first readily available to protect the unexpected losses is called as Tier-I

Capital. It is also termed as Core Capital. Tier-I Capital consists of:-

1. Paid-Up Capital.

2. Statutory Reserves.

3. Other Disclosed Free Reserves: Reserves which are not kept side for meeting any specific

liability.

4. Capital Reserves: Surplus generated from sale of Capital Assets.

Tier-II Capital which is second readily available to protect the unexpected losses is called as

Tier-II Capital. Tier-II Capital consists of:-

1. Undisclosed Reserves and Paid-Up Capital Perpetual Preference Shares.

2. Revaluation Reserves (at discount of 55%).

3. Hybrid (Debt / Equity) Capital.

4. Subordinated Debt.

5. General Provisions and Loss Reserves.

Tier II Capital cannot exceed 50% of Tier-I Capital for arriving at the prescribed Capital

Adequacy Ratio.

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Risk Weighted Assets (RWA) means assets with different risk profiles. For example personal

loan without collateral carries more risk as compared to housing loans which are backed by

collateral. So with different types of loans the risk percentage on these loans also varies.

Capital Adequacy Ratio is calculated based on the assets of the bank. The values of bank's assets

are not taken according to the book value but according to the risk factor involved.

Capital Adequacy Ratio (CAR)=Total Capital/RWA*100

Total Capital= Tier1+ Tier2 capital

RWA- Risk Weighted Assets

BASEL II NORMS

In 2004, BCBS issued second phase of guidelines known as Basel II norms. These were

considered to be the refined and reformed versions of Basel I accord. The guidelines were based

on three PILLARS which are as follows-

Pillar I established minimum regulatory capital requirements for credit, market and operational

risks .Banks had to develop their own internal models specific to their portfolios. Banks should

maintain a minimum capital adequacy requirement of 8% of risk assets.

Pillar II established principles for banks Internal Capital Adequacy Assessment Process

(ICAAP) which is intended to identify those additional risks that are material but are not easily

recognized. Such risks include strategic, operational and liquidity risks.

Pillar III established enhanced reporting requirements for market disclosures. It aims to induce

discipline in the banking sector of a country. Banks need to mandatory disclose their risk

exposure, etc to the central bank.

BASEL III NORMS

Page 150 of 244

Basel III norms were introduced by BCBS in 2010. These guidelines were introduced in

response to the financial crisis of 2008.

The Basel III Guidelines are based upon 3 very important aspects which are called 3 pillars of

the Basel II.

First Pillar Minimum Capital Requirement The first pillar Minimum Capital Requirement is

mainly for total risk including the credit risk, market risk as well as Operational Risk.

Second Pillar Supervisory Review Process is basically intended to ensure that the banks have

adequate capital to support all the risks associated in their businesses. In India , the RBI has

issued the guidelines to the banks that they should have an internal supervisory process which is

called ICAAP or Internal Capital Adequacy Assessment Process. With this tool the banks can

assess the capital adequacy in relation to their risk profiles as well as adopt strategies for

maintaining the capital levels. Apart from that, there is another process stipulated by RBI which

is actually the Independent assessment of the ICAAP of the Banks. This is called SREP or

Supervisory Review and Evaluation Process.

Third Pillar Market Discipline The idea of the third pillar is to complement the first and second

pillar. This is basically a discipline followed by the bank such as disclosing its capital structure,

tier-I and Tier –II Capital and approaches to assess the capital adequacy.

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9.7 CHECK YOUR PROGRESS

1. Liquidity is the capacity of the bank to make the cash available to meet depositor’s payment

commitments on demand or as and when they are due.(true or false)

2. Reputational risk is the risk of damage to a ___________________.

3. Money Laundering is the process of making dirty money ______________.

4. Basel I norms focused on ___________risk.

9.8 SUMMARY

Banks are operating in a deregulated and highly competitive environment which has resulted in

increase in both financial and non financial risks. The type of risks can be categorized as Credit

Risk, Market Risk, Liquidity Risk, Operational Risk, Strategic Risk, Regulatory Risk,

Reputational Risk. Banks have to follow a pro active approach in managing these risks. Asset

Liability Management is one of the best approaches for measuring the overall risk. Banks should

also comply with Basel III accord given by BCBS.

9.9 GLOSSARY

NET INTEREST INCOME: is the difference between revenues generated by interest-bearing

assets and the cost of servicing (interest-burdened) liabilities.

CAR: Capital Adequacy Ratio (CAR) also known as Capital to Risk (Weighted) Assets

Ratio (CRAR) is the ratio of a bank's capital to its risk.

VAR: Value at risk (VAR) is a statistical technique used to measure and quantify the level

of financial risk within a firm or investment portfolio over a specific time frame.

9.10 ANSWERS TO CHECK YOUR PROGRESS

1. True 2. Bank’s Reputation 3. Clean Money 4. Credit

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9.11 REFERENCES & SUGGESTED READINGS




1997


New Delhi.




9.12 TERMINAL AND MODEL QUESTIONS

Q.1 Explain various types of financial and non financial risks faced by banks.

Q.2 Explain in detail the concept of Asset Liability Management.

Q.3 Discuss the Basel I, II and III norms.

Q.4 Explain in detail the concept of Capital Adequacy in Banks.

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Lesson-10BANKING SECTOR REFORMS

Structure

10.1 Objectives

10.2 Introduction

10.3 Narasimham Committee Report- I

10.4 Implementation of Narasimham Committee-I's Recommendations

10.5 Narasimham Committee- II

10.6 Verma Committee Report on weak banks

10.7 Challenges In Banking Sector

10.8 Basel Norms

10.9 Money Laundering

10.10 Summary

10.11 Glossary




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i. Understand the need of reforms in banking sector.

ii. Know about the Narasimham Committee-I's Reports & Recommendations.

iii. Understand the Basel Norms.

iv. Understand the concept of Money Laundering.

10.2 Introduction

“The need for financial reforms had arisen in India because the financial institutions and

market were in a bad shape. The banking sector suffered from lack of competitions, low

capital base, low productivity and high intermediation costs. The Role of technology was

minimal, and the quality of services did not receive adequate attention. Proper risk

management system was not followed and prudential norms were weak. All these resulted in

poor asset quality. The banks were running either at a loss or on very low profits and

consequently were unable to provide adequately for loan defaults and build their capital, there

had been organizational inadequacies, the weakening of management and control functions.

The growth of restrictive practices, the erosion of work culture and flaws in credit

management. The strain on the performance of the banks had emanated partly from the

imposition of high cash reserve ratio (CRR), and SLR, and directed credit programs for the

priority sectors—all at below market or concessional or subsidized interest rates. Further the

functioning of the financial system and the credit delivery as well as recovery process had

become politicized, which damage the quality of lending and culture of repaying loans. The

widespread or across-the-board write-offs of the loans had seriously jeopardized the viability

of banks. As a closure of sick industrial units was discouraged by government, banks had to

continue to finance non-viable sick units, which further compromised their own viability.

There were lacks of transparency in preparing statements of accounts by banks.”

Source: (http://www.academia.edu/26824178/Banking_Sector_Reforms)

So an alarming increase of sickness in the Indian financial system had required urgent

remedial measures or reforms which were ultimately introduced in 1991. It was the response

to the growing inefficiencies of the banking system that the Government of India set up the

following committees:

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10.3 NARASIMHAM COMMITTEE REPORT- I

“In August 1991, the Government of India appointed a committee to review the financial

system under the Chairmanship of Sri M Narasimham, former Governor of the Reserve Bank

of India to examine all aspects relating to the structure, organization and functioning of the

financial system. The Committee’s report was put in Parliament on December 17, 1991.”

Source: (http://documents.tips/documents/recent-trends-in-public-sector-banks.html)

Narasimham committee’s main recommendations are as follows:

1. Reduction in Statutory Liquidity Ratio and CRR: The Committee recommended a

reduction in Statutory Liquidity Ratio to 25% over a period of five years. It also

recommended the progressive reduction in Cash Reserve Ratio (CRR) from the

present high level.

2. Interest Rates on SLR and CRR: The interest rate on SLR should get linked with

the market rates whereas rate of interest on CRR should be related to average cost of

funds of banks.

3. Abolition of Directed Credit: The directed credit programmes should be abolished.

The priority sector should be redefined to include marginal farmers, tiny sector of

industry, small business and transport operators, village and cottage industries, rural

artisans and other weaker sections.

4. Free Determination of Interest Rates: The committee recommended the freely

determination of rate of interest by the bank without the intervention of the RBI.

Attempts should be made to achieve a minimum 4% capital adequacy ratio in relation

to risk weighted assets by March 1993

5. Adoption of Uniform Accounting Practices: “The Committee recommended for the

adoption of uniform accounting practices particularly in regard to income recognition

and provisioning against doubtful debts.”

Source:(http://www.shareyouressays.com/116508/11-recommendations-made-by-

the-narasimham-committee-on-the-financial-system-of-india)

6. Income Recognition: “In banks and financial institutions which are following accrual

system of accounting, no income should be recognized in respect of non-performing

assets. (as asset would be considered NPA, if interest on such assets is past due for a

period exceeding 180 days on balance sheet date.)”

Page 156 of 244

Source:(http://www.shareyouressays.com/116508/11 -recommendations-made-

by-the-narasimham-committee-on-the-financial-system-of-india)

7. Provisioning: The Committee recommended that the assets should be classified into

four categories- Standard, Sub-standard, Doubtful, and Loss assets. Provision of 10%

in case of sub-standard assets and 100% of security shortfall in case of doubtful debts.

Loss assets should be either fully written off or 100% provision should be created.

8. Transparency: It also recommended to make the bank balance sheet more

transparent and making full disclosures in them as per the International Accounting

Standard Committee norms.

9. Establishment of Special Tribunals: The special Tribunals should be set up to speed

up the process of the recovery of loans. As Assets Reconstruction Fund should be

established to take over the bad and doubtful debts of banks and financial institutions

at a discount.

10. Reconstitution of Banking System: Regarding structure of the banking system it

should follow a new pattern of :

i) 3 or 4 large banks which could become international character.

ii) 8 to 10 national banks with branches throughout the country engaged in

universal banking.

iii) Local Banks with operations in a specified region.

iv) Rural Banks confined to rural areas concentrating on agriculture finance.

11. Abolition of Branch Licensing: The Committee recommended abolition of branch

licensing and leaving the matter of ope3ning and closing of branches to the

commercial judgment of individual banks.

12. Computerization: Committee favored Rangrajan Committee on Computerization.

Computers are indispensable tools of customer service.

13. Ending of Dual Control: “The dual control over the banking system of the Finance

Ministry and Reserve Banks should be ended. The Reserve Bank should establish a

separate quasi-autonomous body to take over to supervisory function over the banks.”

Source:(http://www.shareyouressays.com/116508/11-recommendations-made-by-the-

narasimham-committee-on-the-financial-system-of-india)

Page 157 of 244

14. Control: The Committee favoured less regulated and administered system. Banks

should be given freedom to recruit officers. The banks be inspected on the basis of

internal inspection report.

15. Financial Institutions: The Committee made the following recommendations

regarding financial institutions:

i) Transferring of direct lending function of IDBI to a separate institution while

retaining IDBI as apex and re-financing role.

ii) The Reserve Bank should set up a new agency to supervise financial

institutions such as merchant Banks, mutual funds, leasing companies, venture

capital companies and factor companies.

iii) Liberalisation of capital market.

iv) “Prudential guidelines relating to capital adequacy, debt-equity ratio, income

recognition, provisioning, sound financial and accounting policies, disclosures

and valuation of assets should be laid down.”

Source:(https://www.ukessays.com/essays/economics/history-of-indian-

financial-sector-economics-essay.php)

10.4 IMPLEMENTATION OF NARASIMHAM COMMITTEE-I's RECOMMENDATIONS:

All most all the recommendations made by the Committee have been implemented or are

being implemented. These are:

1) Interest Rate Deregulation: In April 1998, the interest rates on deposits and loans

are almost completely deregulated. All advances from RBI are now linked to bank

rate. All lending rates of banks have been linked with Prime Lending Rate (PLR)

from 1997.

2) Reduced CRR and SLR: Cash Reserve Ratio and Statutory Liquidity Ratio have

been brought down to 10% and 25% respectively.

3) Capital Adequacy Ratio: All banks are required to achieve 8% of capital to risk

weighted assets ratio as per BIS norms by March 1997.

4) Prudential Accounting Standards: The various Prudential Accounting Standards

regarding income recognition, asset classification and provisioning have been

implemented.

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5) Private and Foreign Banks: Setting up of new private sector banks and entry of

foreign banks has been allowed.

6) Branch Licensing: Branch licensing has been liberalized. The domestic banks

satisfying capital adequacy requirements are free to start new branches.

7) Public Issues: Nationalized banks have been allowed to raise capital from public upto

49% of capital. Various banks have made public issues of equity capital.

8) Supervision: Board for Financial Supervision has been established to supervise the

financial institutions.

9) Customer Services: Banking Ombudsman scheme 1995 was introduced for speedy

settlement of customer disputes.

10) Merger of Banks: New Bank of India was merged with Punjab National Bank in

1993.

11) Recovery Tribunals: Special Debt Recovery Tribunals have been set up.

12) Computerization: An agreement for computerization was signed

with trade unions. Bank computerization is taking place at a fast

speed.

10.5 NARASIMHAM COMMITTEE- II

The Government of India has issued a Notification on 26th December 1997 for constitution

of Committee on “Banking Sector Reforms” and it was also headed by Shri M. Narasimham.

“The Committee submitted its report to the Finance Minister on April 23, 1998.

KHAN WORKING GROUP

Khan Committee was constituted under the chairmanship of R.H.Khan, CMD chairman

cum managing director) of IDBI. It is also known as “Harmonization of Role of

Development Finance Institutions and Commercial Banks. This committee was formed

to review the role, structure and operation of Development Financial Institutions and

banks in the emerging operating environment. The committee submitted its report in

May 1998. Following recommendations were made by this committee.

1. Merger of Banks and Financial institutions: The committee recommends merger

between

(1) Banks and financial institutions

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(2) Banks and Banks

(3) Strong institutions to weal institutions

(4) Strong banks to weak banks

The basic criteria for the merger should be viability and profitable considerations

and it should be done in a market oriented custom or fashion.

2. Establishment of Super Regulator: To ensure uniformity in regulatory treatment and

speedy legal reforms, a super regulator should be established to co-ordinate multiple

regulators.

3. Universal Banking: The committee suggests the Indian financial sector should move

toward universal banking. Under the concept of universal banking, almost all the

financial services are provided by the same institutions or group of institutions.

Universal banking almost abolished the distinction between commercial banks and

DFIs.

4. Redefine Priority Sector: Priority sector need to be redefined. The committee has

suggested a change in the method of determining priority sector targets for banks and

DFIs. Concessional funding of certain sectors should be provided through specially

targeting subsidies, if the need so arises. Generally, lending should be included in

priority sector lending. Infrastructure credit should be kept out of net bank credit.

The process of fixing targets should also be reviewed.

5. Elimination of certain restrictions on DFIs: The restrictions on DFIs concerning

resource mobilization are against the liberalization of financial sector. The

committee suggested elimination of such restrictions.

6. Co-ordination Committee: To harmonize the lending policies and the quality of credit,

a coordination committee of banks and DFIs should be setup.

7. Recommendation regarding State Level Financial Institutions: The committee has

made important recommendations regarding state level financial institutions. These

are:

Page 160 of 244

(a) An eventual merger of SFC, SIDC and SSDIC in each state into a single entity to

improve their efficiency.

(b) IDBI’s holdings to the State Level Financial Institutions should be transferred to

its subsidiary SIDBI, which in turn should serve all ties with Industrial

Development Bank of India and come directly under Reserve Bank of India.

(c) SIDBI should be given the same role and status for small and medium industries

finance as NABARD has in respect of agriculture development.

(d) SIDBI should play the role of stakeholder and fund provider. It should get

concessional finance from Reserve Bank of India.

(e) SIDBI should be vested with overall responsibility with regard to operations of

State Financial Corporations.

(f) After reconstructing, strong SFC may be encouraged to go to public. The States

share may be reduced to fifty percent.

(g) The CEO’s of State Level Financial Institutions should be professional with a

fixed tenure.

8. Committee has given some other recommendations too:

(a) Quick legal reforms in the area of debt recovery.

(b) Reduce Cash Reserve Ratio.

(c) No Cash Reserve Ratio for financial institutions.

(d) Scrap Statutory Liquidity Ratio.

(e) Institutional neutral regulatory framework for both foreign and local entities.

Page 161 of 244

10.6 Verma Committee Report on Weak Banks

The Reserve bank of India in consultation with Government of India constituted a

Working Group to suggest measures for the revival of weak Public Sector Banks. M. S.

Verma former chairman of State Bank of India was appointed chairman of the Working

Group. Verma Panel Group submitted its report in 1999. The terms of reference of the

Group were:

(a) To suggest criteria for the identification of weak public sector.

(b) To study and examine the problems of weak banks.

(c) To undertake a case by case examination of weak banks and to identify banks that is

potentially revivable.

(d) To suggest a strategic plan of financial, organizational and operational restructuring

for weak public sector banks.

The Working Group identified 7 parameters for the identification of banks strengths

or weaknesses covering the aspects of solvency, earning capacity and profitability.

These parameters are:

Capital Adequacy Ratio

Coverage Ratio

Return on Assets

Net Interest Margin

Ratio on Profit to Average working funds

Ratio of Operating Cost to Income

Ratio of Staff Cost to Income

27 public sector banks were evaluated by the committee on the basis of these

7 parameters for the year 1997-1998 and 1998-1999. Public sector banks

have been categorized into following five categories based on their

compliance level.

1. Banks compliance with All Efficiency Parameters:

(a) Oriental Bank of Commerce

(b) State Bank of Patiala

2. Banks Non-Compliance with 1 or 2 Efficiency Parameters:

(a) Bank of Baroda

(b) Punjab National Bank

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(c) Canara Bank

(d) Corporation Bank

(e) State Bank of Indore

(f) State Bank of Hyderabad

(g) State Bank of Saurashtra


(a) Andhra Bank

(b) Bank of India

(c) Dena bank

(d) Syndicate Bank

(e) Bank of Maharashtra

(f)State Bank of India

(g) State Bank of Mysore

(h) State Bank of Bikaner and Jaipur

(i)State Bank of Travancore


(a) Allahabaad Bank

(b) Union Bank of India

(c) Punjab and Sind Bank

(d) Central Bank of India

(e) Indian Overseas Bank

(f)Vijaya Bank

5. Banks Non-Compliance with more than 5 Efficiency Parameters:

(a) United Bank of India

(b) UCO Bank

(c) Indian Bank

The Verma Panel Group developed a four dimensional restructuring

programme for public sector banks that is Operational Restructuring,

Organizational Restructuring, Financial Restructuring, and Systematic

Restructuring.

Page 163 of 244

10.7 CHALLENGES IN BANKING SECTOR

Three processes of liberalization and globalization has presented certain challenges to

the Indian Banking. These are as follows:

1. Mergers and Acquisition: Mergers and Acquisitions are the need of the hour for

the Indian commercial banks. To competitive and effective in rendering

financial services, that too of international standards, Indian banks need to be

stronger. So Mergers and Acquisition are a major challenge for banks of today.

They have to improve their productivity and profitability, otherwise they will

always have the danger of being merged or taken over.

2. Structure of Indian economy: Certain challenges have also emerged from the

structure and size of the Indian economy. Banks cannot afford to ignore any

segment of the economy. Wide disparities in the Indian economy also pose

various problems to the functioning of the banks.

3. Global challenges: The reforms have brought a very tough competition from

International banks. Many foreign banks are entering in Indian banking scene

with innovative financial product. This has put a serious threat for the Indian

banking. Indian banks have to get financial strength to compete with

international banks. They have to bring more efficiency, more productivity and

more profitability along with innovativeness. The size of banks may have to be

increased both quantitatively as well as qualitatively to have coed high

competitive strength.

4. New private sector challenges: The public sector banks have to face new

challenges with the entry of new private sector banks. These banks are

equipped with latest technology and innovative products, these new private

sector banks have aroused high customer’s expectations. So public sector banks

will have to prepare themselves to come up to the expectations of their

customers. Otherwise they will not only loose new clientele but their existing

clientele will also not avail their banking services.

5. Spread management: Spread is the difference between interest earned on loan

and advances and interest paid on deposits and borrowings. Spread

management, plays an important role in determining the profitability of banks.

Spread is the net amount available to the banks for meeting their operating,

Page 164 of 244

administrative and management expenses. Banks must manage their spread

management more efficiently to get maximum return.

6. Managing technology: The revolution in information technology has affected

Indian banking industry as well. After liberalization, all the new private sector

banks have introduced international standards of information technology like

installation of ATMs, internet banking, mobile banking, credit cards, debit

cards, electronic fund transfer etc. technology carries high price tag and Indian

public sector banks need to mix business and technology strategies closely to

be effective.

7. Pricing of Financial Services: Banks need to charge for various financial

services with proper cost benefit analysis periodically. There must be proper

risk assessment of the financial services before pricing them. While it is

essential to provide banking services at minimum cost, there is prima face no

justification to enter into loss making areas.

10.8 BASEL NORMS

“The Basel Committee on Banking Supervision (BCBS) established in the year 1974 is

an international banking regulatory committee formed to develop banking supervisory

regulations. The objective of the BCBS is to gain a better understanding of the challenges

faced by modern banking system in terms of risk and it risk management and to frame

supervisory and regulatory standards and guidelines to help the banking system diminish

these risks and function properly. India is a member of the BCBS.

BASEL I NORMS

BCBS in the year 1998 introduced capital measurement system Basel Capital Accord also

known as Basel I. It focused entirely on credit risk. It defined capital and structure of risk

weights for banks. The minimum capital requirement was fixed at 8% of Risk Weighted

Assets (RWA).Basel I norms comprised of four pillars:

Pillar I Constituents of Capital: It prescribes the nature of capital that is eligible to be treated

as reserves. Capital is classified into Tier I and Tier II capital.

Pillar II Risk Weighting: It creates a comprehensive system to provide weights to different

categories of bank’s assets and liabilities.

Page 165 of 244

Pillar III Target Standard Ratio: It acts as unifying factor between the first two pillars. A

universal standard wherein Tier I and Tier II capital should cover atleast 8 percent of risk

weighted assets of a bank with atleast 4 percent being covered by Tier I capital.

Pillar IV Transitional and implementing arrangement: It sets different stages of

implementation of the norms in a phased manner.

Tier-I Capital which is first readily available to protect the unexpected losses is called as

Tier-I Capital. It is also termed as Core Capital. Tier-I Capital consists of:-

1. Paid-Up Capital.

2. Statutory Reserves.

3. Other Disclosed Free Reserves: Reserves which are not kept side for meeting any

specific liability.

4. Capital Reserves: Surplus generated from sale of Capital Assets.

Tier-II Capital which is second readily available to protect the unexpected losses is called as

Tier-II Capital. Tier-II Capital consists of:-

1. Undisclosed Reserves and Paid-Up Capital Perpetual Preference Shares.

2. Revaluation Reserves (at discount of 55%).

3. Hybrid (Debt / Equity) Capital.

4. Subordinated Debt.

5. General Provisions and Loss Reserves.

Tier II Capital cannot exceed 50% of Tier-I Capital for arriving at the prescribed Capital

Adequacy Ratio.

Risk Weighted Assets (RWA) means assets with different risk profiles. For example personal

loan without collateral carries more risk as compared to housing loans which are backed by

collateral. So with different types of loans the risk percentage on these loans also varies.

Page 166 of 244

Capital Adequacy Ratio is calculated based on the assets of the bank. The values of bank's

assets are not taken according to the book value but according to the risk factor involved.

Capital Adequacy Ratio (CAR)=Total Capital/RWA*100

Total Capital= Tier1+ Tier2 capital

RWA- Risk Weighted Assets

BASEL II NORMS

In 2004, BCBS issued second phase of guidelines known as Basel II norms. These were

considered to be the refined and reformed versions of Basel I accord. The guidelines were

based on three PILLARS which are as follows-

Pillar I established minimum regulatory capital requirements for credit, market and

operational risks .Banks had to develop their own internal models specific to their portfolios.

Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.

Pillar II established principles for banks Internal Capital Adequacy Assessment Process

(ICAAP) which is intended to identify those additional risks that are material but are not

easily recognized. Such risks include strategic, operational and liquidity risks.

Pillar III established enhanced reporting requirements for market disclosures. It aims to

induce discipline in the banking sector of a country. Banks need to mandatory disclose their

risk exposure, etc to the central bank.

BASEL III NORMS

Basel III norms were introduced by BCBS in 2010. These guidelines were introduced in

response to the financial crisis of 2008.

Page 167 of 244

The Basel III Guidelines are based upon 3 very important aspects which are called 3 pillars of

the Basel II.

First Pillar Minimum Capital Requirement The first pillar Minimum Capital Requirement is

mainly for total risk including the credit risk, market risk as well as Operational Risk.

Second Pillar Supervisory Review Process is basically intended to ensure that the banks

have adequate capital to support all the risks associated in their businesses. In India , the RBI

has issued the guidelines to the banks that they should have an internal supervisory process

which is called ICAAP or Internal Capital Adequacy Assessment Process. With this tool the

banks can assess the capital adequacy in relation to their risk profiles as well as adopt

strategies for maintaining the capital levels. Apart from that, there is another process

stipulated by RBI which is actually the Independent assessment of the ICAAP of the Banks.

This is called SREP or Supervisory Review and Evaluation Process.

Third Pillar Market Discipline The idea of the third pillar is to complement the first and

second pillar. This is basically a discipline followed by the bank such as disclosing its capital

structure, tier-I and Tier –II Capital and approaches to assess the capital adequacy”.

Source:( http://www.bankexamstoday.com/2014/11/basel-ii-and-basel-iii-norms-all-that.html)

10.9 MONEY LAUNDERING

“Money laundering is the process of making dirty money (derived from criminal activity)

looks clean by concealing the identity, source, and/or destination of money, and is a main

Page 168 of 244

operation of the underground economy. Money laundering includes any financial transaction

which generates an asset or a value as the result of an illegal act.

According to Swiss Bank, ‘Money laundering is a process whereby the origin of funds

generated by illegal means is concealed.’’ Money laundering includes drug trafficking, gun

smuggling, corruption, etc.

Process of Money Laundering

Placement: In this the dirty money is physically deposited with a financial institution or used

to purchase an asset. This is the highest risk area for the crime.

Layering: In this the dirty money I distanced from its source by a series of transactions

designed to help anonymity and disguise the audit trail. In this way the source, ownership,

and location of the funds is disguised. Examples: wiring funds from one account to another.

Integration: In this dirty money is placed with clean money into the economy using an

apparently normal business or personal transaction, so that criminals can add it to their

wealth. Here it is very difficult to separate illegal and legal wealth.

Effects of Money Laundering

Increased crime and corruption.

Weakening financial institutions, possibly to the point of collapse (BCCI, Barings

Bank for example). Reputational risk of dealing with criminals, costs of investigations

and fines

Loss of control over monetary policy in smaller countries, as the size of money

laundering transactions causes measurement errors. This can cause currency exchange

rate and interest rate fluctuations.

Economic distortion, because money launderers are not interested in the economics of

a transaction, they will put their money into schemes that offers privacy rather than

economic benefit.

Loss of tax revenue This increases the burden of taxation on normal tax payers.

Social costs e.g. treating drug addicts”

Source:( http://aml-expert.com/study-notes/effects-of-money-laundering)

Page 169 of 244

10.10 Summary“Financial Sector Reforms set in motion in 1991 have greatly changed the face of Indian

Banking. The banking industry has moved gradually from a regulated environment to a

deregulated market economy. The market developments kindled by liberalization and

globalization have resulted in changes in the intermediation role of banks. The pace of

transformation has been more significant in recent times with technology acting as a catalyst.

While the banking system has done fairly well in adjusting to the new market dynamics,

greater challenges lie ahead. Financial sector would be opened up for greater international

competition under WTO prescriptions. Banks will have to gear up to meet stringent

prudential capital adequacy norms under Basel I & II. In addition, the Free Trade Agreements

(FTAs) such as with Singapore and Thailand may have an impact on the shape of the banking

industry. Banks will also have to cope with challenges posed by technological innovations in

banking”.

Source: (http://www.academia.edu/26824178/Banking_Sector_Reforms)

10.11 Glossary

1.“ CRR: Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of

customers, which commercial banks have to hold as reserves either in cash or as deposits

with the central bank. CRR is set according to the guidelines of the central bank of a country.

2. SLR: Statutory Liquidity Ratio refers to the amount that the commercial banks require to

maintain in the form of cash, or gold or govt. approved securities before providing credit to

the customers. Here by approved securities we mean, bond and shares of different companies.

3. Capital Adequacy Ratio: The capital adequacy ratio (CAR) is a measure of a bank's

capital. It is expressed as a percentage of a bank's risk weighted credit exposures. ... Also

known as "Capital to Risk Weighted Assets Ratio (CRAR).

4. Basel Committee: The Basel Committee on Banking Supervision provides a forum for

regular cooperation on banking supervisory matters. Its objective is to enhance understanding

of key supervisory issues and improve the quality of banking supervision worldwide”.

Source:( https://atoppomba.wordpress.com/2014/02/26/banking-terms/)


State whether the following statements are true/false:

1. The need for financial reforms had arisen in India because the financial institutions

and market were in a bad shape.

Page 170 of 244

2. All lending rates of banks have been linked with Prime Lending Rate (PLR) as per the

recommendations of Narasimham’s Committee’s Report.

3. The Basel III Guidelines are based upon 3 very important aspects which are called 3

pillars.

4. The capital adequacy ratio (CAR) is a measure of a bank's borrowed capital.



Books1. Principles of Banking by Varshney & Malhotra, Sultan Chand & Sons, 2005.2. Money, Banking and International Trade, Vaish M.C, New Age International Pvt.Ltd,


House, New Delhi.4. Banking, Law and Practice in India Banking, Tannan's5. International Finance, Vishal Kumar, Kalyani Publishers.6. Banking: Law and Practice P.N. Varshney7. Management of Banking and Financial Services Justin Paul and Padmalatha Suresh

Websites

1) www.bitak.securities.bg2) www.etheses.saurashtrauniversity.edu3) www.imsports.rediff.com4) www.ukessays.com5) www.iibf.org.in6) www.mbaknol.com7) www.niilmuniversity.in8) www.ijaers.com9) de.slideshare.net10) www.gujaratmba.com11) shodhganga.inflibnet.ac.in:808012) www.rbi.org.in13) www.bankexamstoday.com14) www.managementparadise.com15) www.food.indiaabroad.com16) www.ibspo.in17) ijemr.in18) www.capgemini.com19) www.gtuexam.co.in20) kalyan-city.blogspot.com21) www.investopedia.com22) www.slideshare.net23) finance.mapsofworld.com24) www.mahendras.org25) www.scribd.com

Page 171 of 244

26) www.ibtindia.com27) www.frca.org.fj


1. What do you understand by banking sector reforms? Discuss the need of financial

sector reforms.

2. Discuss the recommendations of Narasimham’s Committee-I’s recommendations.

3. What do you understand by Basel Norms? Discuss in detail

4. Write a note on Money Laundering.

Page 172 of 244

Chapter -11

INSURANCE

Structure

11.1 Objectives

11.2 Introduction

11.3 Life Insurance Policies

11.4Claims Procedure in respect of a Life Insurance Policy

11.5 General Insurance

11.6Claim procedure in respect of a general insurance policy

11.7 Reinsurance

11.8Bancassurance

11.9 Legal Framework of Insurance

11.10 Insurance Ombudsman


11.12 Summary

11.13 Glossary

11.14References & Suggested Readings


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11.1 OBJECTIVES


Understand types of Insurance

Life Insurance and its products

General Insurance and its products

Reinsurance

Concept of Bancassurance

Legal framework of Insurance

Insurance Ombudsman

11.2 INTRODUCTION

There are two types of Insurances offered broadly. These are given below:

(a) Life Insurance

(b) General Insurance

Life Insurance plans deal with the life of a person and general insurance policies are other than

related to life of a person.

Life insurance is a different from other insurances. It is an intangible product which provides

both financial and mental support and peace to the beneficiaries in case something unfortunate

happens to insured. The person who purchases insurance pays a fixed premium in exchange of a

promise from the insurer of compensation in the event of some specified loss.

Purpose of Life Insurance: - The main purpose of life insurance is to provide risk coverage to

the family of insured with respect to value of his future earnings. Life insurance is also a vehicle

for saving and wealth accumulation. So life insurance products also offer safety and security of

investment with certain rate of return.

11.3 LIFE INSURANCE POLICIES

Some of the common life insurance policies have been discussed below:

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Term Insurance- Term Insurance is a life insurance plan which provides valid insurance cover

for a certain time period which has been specified in the contract, say for one year. After the end

of policy term the policy does not provide a death benefit. No pay out is made if the insured

survives the tenure. This insurance is the cheapest way to get a guaranteed life insurance cover

since there is no cash accumulation. This plan needs to be renewed for another term. These plans

are renewed at the same premiums for the whole duration of their term.

Whole Life policy - Whole life Insurance Policy is a permanent life insurance policy. It is a term

plan with unlimited term. There is no fixed term of cover. In this policy the nominee gets the

death benefit when the insured dies, no matter whenever the death might occur and there is no

maturity benefit. Premiums are several times higher than the premium for the same amount of

term insurance, but they typically become smaller in the insured’s later years.

Endowment Policy –This is a policy which is taken up for a specific period called ‘endowment

policy period’. This policy matures at the expiry of specified period or at the attainment of

particular age or on the death of the life insured, whichever is earlier. The rate of premium is

certain more than the whole life policy. This policy is a good combination of both family

protection and investment. This policy is most popular policy with the policy holders. The policy

holder gets sum assured plus bonuses declared every year by insurance company till the maturity

of policy.

Money Back Policy – Money back policy is also taken up for a specific period with some

survival benefits. Under this policy, a certain amount is paid to the policy holder as survival

benefits at specific period and the balance amount is paid on the maturity of the policy term. In

case the death of the life insured, the full amount is paid to the nominee without any deduction of

amount paid earlier.

ULIP –Unit Linked Insurance Plan is a hybrid type of life insurance product, which not only

provides risk cover for the policy holder but also give him the benefit of investment. In a ULIP

both the investment part and the protection part can be managed according to specific needs and

choices. The investments in ULIP are subject to risks associated with the capital markets and are

borne by the policy holder. A part of the premium that the policy holder pays is allocated

towards insurance and the remaining is utilized for investment in funds available within the

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plan. The value of each unit of a fund is determined by dividing the total value of the fund's

investments by the total number of units. The lock in period for ULIP plans is 5 years and the

policy holder also gets deduction under section 80C of Income tax act, 1961.

Joint Life Policy - Joint life insurance policies are designed to cover couples or partnerships in

the event of either partner’s death. Life insurance is designed to ensure that dependents do not

suffer financially in the event of death.

Group Policy - Group insurance policy is an insurance policy that covers a defined group of

people. It is a type of life insurance policy in which a single contract covers the entire group of

people. In Group insurance policy the policy owner is an employer of an organization and the

policy covers the employees or members of the group. This life insurance policy basically gives

advantages of standardized coverage at a very competitive premium rates. The employer as a

policy owner keeps the master insurance policy. All those who are covered receive a certificate

of insurance that serves as proof of insurance but is not actually the insurance policy.

Life insurance providers: Some of the Life Insurance Providers in India are Aegon Life

Insurance Co. Ltd., Aviva Life Insurance Co. India Ltd., Bajaj Allianz Life Insurance Co. Ltd.,

Bharti AXA Life Insurance Co. Ltd., Birla Sun Life Insurance Co. Ltd., Canara HSBC Oriental

Bank of Commerce Life Insurance Co. Ltd.

MATTERS TO BE STATED IN LIFE INSURANCE POLICY

1) “A life insurance policy shall clearly state

the name of the plan, terms and conditions of the insurance contract;

the benefits payable;

the contingencies on the happening of which the benefits are payable;

the details of the riders attached to the main policy;

the age at the entry;

the premiums payable, periodicity of payment, grace period allowed for payment

of the premium, the date the last installment of premium

the implication of discontinuing the payment of an installment(s) of premium and

also the provisions of a guaranteed surrender value

the provisions for nomination, assignment, and loans on security of the policy;

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the address of the insurer to which all communications in respect of the policy

shall be sent.

(2) On issuance of the policy, the insurer shall inform the insured by the letter that he has a

period of 15 days from the date of receipt of the policy document to review the terms and

conditions of the policy. If the insured finds the policy not as per the agreed , he has the option to

return the policy stating the reasons for his objection. In such case refund of the premium paid

will be made to the insured subject only to a deduction of a proportionate risk premium for the

period on cover and the expenses incurred by the insurer on medical examination of the proposer

and stamp duty charges.

(3) The insurer is entitled to repurchase the unit at the price of the units on the date of

cancellation apart from the above mentioned deductions in case ULIP plan is cancelled by the

insured.

(4) If the age has not been admitted by the time the policy is issued, the insurer shall make

efforts to obtain proof of age and admit the same as soon as possible.

(5) Any insurer carrying on life insurance business shall at all times, respond within 10 days of

the receipt of any communication from its policyholders in all matters, such as (a) recording

change of address (b) noting a new nomination or change of nomination under a policy (c) noting

an assignment on the policy (d) issuance of duplicate policy (e) guidance on the procedure for

registering a claim and early settlement thereof.”

Source: www.irdaindia.org

11.4 CLAIMS PROCEDURE IN RESPECT OF A LIFE INSURANCE POLICY

Life insurance policies are a hedge against unavoidable circumstances. These policies are taken

by the customers in order to compensate their dependants in case some unforeseen event happens

or occurs. Payment of claim is the final obligation of the insurer in terms of the insurance

contract. It is the ultimate objective of life insurance. The three main types of claim in life life

insurance policies are

Survival Benefit Claim

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Maturity Benefit Claim

Death Benefit Claim

Following are the documents required for the payment of maturity claim

(i) Age proof, if age is not admitted.

(ii) Original policy document for cancellation.

(iii) In case assignment is executed on a separate paper, that document has to be surrendered.

(iv) Discharge form duly executed.

(v) Indemnity bond in case the policy document is lost or destroyed, duly executed by the

policyholder and a surety of sound financial standing.

Following are the documents required for payment of a death claim.

(i) An intimation of death by the nominee or a near relative.

(ii) Proof of age if not already admitted.

(iii) Proof of death.

(iv) Doctor’s certificate who attended the deceased during his last illness.

(vi) Certificate of cremation or burial from a reputable person who attended the funeral.

(vii) An employer certificate if any, of the deceased.

Procedure for the claim settlement

A life insurance company has to process the claim without any delay upon receiving a

request for settlement of claim

Any requirement of additional documents or an queries shall be raised all at once within

a period of 15 days of the receipt of the claim.

A claim under a life policy shall be paid or be disputed giving all the relevant reasons,

within 30 days from the date of receipt of all relevant papers and clarifications required.

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Where there is a delay on the part of the insurer in processing a claim the life insurance

company shall pay interest on the claim amount at a rate which is 2% above the bank

rate prevalent at the beginning of the financial year in which the claim is reviewed by it.

Where a claim is ready for payment but the payment cannot be made due to any reasons

of a proper identification of the payee, the life insurer shall hold the amount for the

benefit of the payee and such an amount shall earn interest at the rate applicable to a

savings bank account with a scheduled bank effective from 30 days following the

submission of all papers and information.

1.5 GENERAL INSURANCE

Insurance contracts that do not come under life insurance are known as General Insurance It is a

type of insurance which covers all form of insurance except life. General insurance covers

insurance of property against fire, burglary, theft; personal insurance covering health, travel and

accidents; and liability insurance covering legal liabilities. Common forms of general insurance

are motor, fire, home, marine, health, travel, accident and other miscellaneous forms of non-life

insurance. General Insurance policies are mostly annual contracts which mean that these policies

need to be renewed after the expiry of one year. If some contingency covered under the policy

occurs the policy holder will get the claim otherwise no claim is given to the policyholder. So the

tenure of general insurance policies is not that of a lifetime. There are however, a few products

which have a long term.

General Insurance Products

The broad categories of general Insurance are:

Fire Insurance

Marine Insurance

Motor Insurance

Health Insurance

Miscellaneous Insurance

“Types of General Insurance

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Motor Insurance

Motor insurance covers all damages and liability to a vehicle against various on-road and off-

road emergencies. A comprehensive policy even secures against damage caused by natural and

man-made calamities, including acts of terrorism.

Motor insurance offers protection to the vehicle owner against:

Damage to the vehicle

It also pays for any third party liability determined by law against the owner of the

vehicle

Motor insurance is mandatory in India as per the Motor Vehicles Act, 1988 and needs to

be renewed every year. Driving a motor vehicle without insurance in a public place is a

punishable offence.

In fact, third party insurance is a statutory requirement in our country i.e. the owner of the

vehicle is legally liable for any injury or damage caused to a third party life or property,

by or arising out of the use of the vehicle in a public place.

A comprehensive motor insurance policy would include personal accident and liability

only policy (third party insurance) in addition to own damage cover (damage to owner’s

vehicle) in one policy.

Common motor insurance categories include:

Car Insurance

Two Wheeler Insurance

Commercial Vehicle Insurance

Some attractive benefits of motor insurance include roadside assistance, cashless servicing at

nation-wide network of workshops and garages, personal accident cover, towing assistance.

Health Insurance

Health care costs are increasing every year. Sedentary lifestyle and stress at work negatively

affect the health and can result in a critical illness or medical emergency. Such a scenario is sure

to adversely affect one financially, due to the massive outlay of money on medical expenditure.

A health insurance policy is the only way to mitigate the financial risks, apart from leading a

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healthy lifestyle. Health insurance guarantees peace of mind in times of crisis, and helps secure

own health and that of one’s family.

Health insurance covers the medical and surgical expenses of the insured individual due to

hospitalisation from an illness. Additional riders enhance the benefits and scope of the cover.

Health insurance often includes cashless facility at empanelled hospitals, pre and post

hospitalisation expenses, ambulance charges, daily cash allowance etc.

Common types of health insurance policies include:

Individual Policy

Family Floater Policy

Surgery Cover

Comprehensive Health Insurance

Travel Insurance

International travel, whether on vacation or business, can turn into a nightmare if one

experiences contingencies like loss of baggage, loss of passport, delay in flight, medical

emergency etc. Such eventualities will surely take the fun away from travelling.

Travel insurance, also referred to as visitor insurance, covers one against unseen medical and

non-medical emergencies during overseas travel, ensuring a worry-free travel experience. It

protects the insured against misfortunes while travelling. Backed up by travel insurance, the

whole experience is like no other.

Different types of travel insurance policies include:

Individual Travel Policy

Family Travel Policy

Student Travel Insurance

Senior Citizens Travel Policy

In addition to the above, some insurance companies offer special plans like a corporate travel

policy or comprehensive policy for travel to special destinations like Asia and/or Europe.

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Home Insurance

Home is often the most treasured possession of an individual and also the largest financial

investments one makes in life. Safeguarding the physical structure and contents of home seems

like a logical thing to do.

Home insurance protects the house and/or the contents in it, depending on the scope of insurance

policy opted for. It secures the home against natural calamities and man-made disasters and

threats. Home insurance provides protection against risks and damages from fire, burglary, theft,

flood, earthquakes etc. covering the physical asset (building structure) and valuables (contents)

in it.

Home insurance ensures that one’s hard-earned savings are utilised to meet important needs

instead of using them for rebuilding the house if some harm was to come to it.

Marine (Cargo) Insurance

Business involves the import and export of goods, within national borders and across

international borders. Movement of goods is fraught with risk of mishaps which can result in

damage and/or destruction of shipments. This leads to substantial financial losses for both the

importers as well as the exporters.

Marine cargo insurance covers goods, freight, cargo and other interests against loss or damage

during transit by rail, road, sea and/or air. Shipments are protected from the time the goods leave

the seller’s warehouse till they reach the buyer’s warehouse. Marine cargo insurance offers

complete financial protection during transit of goods and compensates in the event of any loss

suffered.

The party responsible for insuring the goods is determined by the sales contract. Marine cargo

insurance policy can be taken by buyers, sellers, import/export merchants, buying agents,

contractors, banks etc. The policy usually covers the cargo, but can also be extended to cover the

interest of a third party post transfer of ownership as determined by terms of sale.

Common types of policies:

Open Cover

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Open Policy

Specific Voyage Policy

Annual Policy

The hull of a ship or boat can be insured under marine hull insurance.

Rural Insurance

Insurance solutions to meet the needs of agriculture and rural businesses form part of rural

insurance. IRDA has stipulated annual targets for insurers to provide insurance to the rural and

social sector.

As per these regulations, insurers are required to meet year-wise targets:

In percentage terms of policies underwritten and percentage of total gross premium

income by general insurers under rural obligation

In terms of the number of lives under social obligation

Commercial Insurance

Commercial insurance encompasses solutions for all sectors of the industry arising out of

business operations. Insurance solutions for automotive, aviation, construction, chemicals, foods

and beverages, manufacturing, oil and gas, pharmaceuticals, power, technology, telecom,

textiles, transport and logistics sectors. It covers small and medium scale enterprises, large

corporations as well as multinational companies.

Common types of commercial insurance:

Property Insurance

Marine Insurance

Liability Insurance

Financial Lines Insurance

Engineering Insurance

Energy Insurance

Employee Benefits Insurance

International Insurance Solutions”

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Source: https://www.policybazaar.com

Some other Types of General Insurance:

Property Insurance

Personal Accident

Householder

Shopkeeper

Corporate Insurance

Commercial Insurance

Fire Insurance

Crop Insurance

A general insurance policy should specifically and clearly state the name and address of the

insured; full description of the property or interest insured; period of Insurance; sums insured;

perils covered and not covered; premium payable; policy terms, conditions and warranties; the

obligations of the insured in relation to the subject matter of insurance upon occurrence of an

event giving rise to a claim and the rights of the insurer in the circumstances; the details of the

riders attaching to the main policy; any special conditions attaching to the policy..

11.6 CLAIM PROCEDURE IN RESPECT OF A GENERAL INSURANCE POLICY

On the happening of the unforeseen event covered under the policy an insured or the

claimant shall give notice to the insurer of any loss arising under contract of insurance

within such time as allowed by the insurer

General insurer shall respond immediately on the receipt of the communication from the

insured or the claimant

Insurer will give clear indication to the insured on the procedures that needs to be

followed.

In cases where a surveyor has to be appointed for assessing a loss/ claim, the same needs

to be appointed within 72 hours of the receipt of intimation from the insured.

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If the insured is unable to furnish all the particulars required by the surveyor the insurer

or the surveyor shall inform in writing the insured about the delay that may result in the

assessment of the claim.

The surveyor shall communicate his findings to the insurer within 30 days of his

appointment with a copy of the report being furnished to the insured.

On the receipt of a survey report, if the insurer finds that it is incomplete in any respect,

he shall require the surveyor after intimating the insured to furnish an additional report on

certain specific issues as may be required by the insurer.

Such a request may be made by the insurer within 15 days of the receipt of the original

survey report.

The surveyor shall furnish an additional report within three weeks of the date of receipt

of communication from the insurer.

An insurer shall within a period of 30 days offer a settlement of the claim to the insured

on receipt of the survey report or the additional survey report, as the case may be.

In case the insurer decides to reject a claim under the policy, he, for any reasons to be

recorded in writing communicates so within a period of 30 days from the receipt of the

survey report or the additional survey report, as the case may be.

Where the claim is accepted by the insurer the payment of the amount due shall be made

within 7 days from the date of acceptance of the offer by the insured.

In the cases of delay in the payment, the insurer shall be liable to pay interest at a rate

which is 2% above the bank rate prevalent at the beginning of the financial year in which

the claim is reviewed by it.

11.7 REINSURANCE

“Reinsurance is an insurance for insurers. It is a type of an insurance cover for insurance

companies. It is a process where the reinsurer takes on all or part of the risk covered under a

policy issued by an insurance company in consideration of a premium payment. The company

which requests for the cover is known as CEDANT and the reinsurer is called the CEDED.

Reinsurance is classified under two heads –

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Treaty reinsurance

Facultative reinsurance.

Treaty reinsurance:

Treaties are agreements that cover broad groups of policies such as all of a primary insurer’s auto

business. In most treaty agreements, once the terms of the contract, including the categories of

risks covered, have been established, all policies that fall within those terms – in many cases both

new and existing business—are covered, usually automatically, until the agreement is cancelled.

Facultative reinsurance:

Facultative covers specific individual, generally high-value or hazardous risks, such as a

hospital, that would not be accepted under a treaty. With facultative reinsurance, the reinsurer

must underwrite the individual “risk,” say a hospital, just as a primary company would, looking

at all aspects of the operation and the hospital’s attitude to and record on safety. In addition, the

reinsurer would also consider the attitude and management of the primary insurer seeking

reinsurance coverage. This type of reinsurance is called facultative because the reinsurer has the

power or “faculty” to accept or reject all or a part of any policy offered to it in contrast to treaty

reinsurance, under which it must accept all applicable policies once the agreement is signed.

Advantages of Reinsurance:

The advantages of reinsurance are:

1 It safeguards capital and reinforces stability.

2 It enables the insurer to take up large claims and expand capacity.

3 It helps the insurance company to upgrade itself. The reinsure can provide important

underwriting training and skill development and share expertise gained from other countries.

4 The reinsurer can contribute towards designing the product, pricing and marketing new

products. It can also offer back office support such as faster processing of claims and automation

of operations.

5 Reinsurance can also help a company to withdraw froma line of business.”

Source: www.iii.org/issue-update/reinsurance

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11.8 BANCASSURANCE

Banc assurance refers to selling of insurance and related financial products by the Banks. Inorder to improve the services and widen the area of working the banc assurance in India wasintroduced. Banc assurance helps in broadening the channels through which insurance policiesare sold. Both RBI and IRDA have a set of guidelines for companies doing banc assurance.

Benefits of Bancassurance:-

It encourages customers of banks to purchase insurance policies.

It is a source of income for the banks.

. It helps insurer to expand penetration of insurance through banks.

It helps in improving the services to the policy holders.

It increases a healthy positive competition among the life insurance providers, the benefitof which is enjoyed by the customers.

Bancassurance companies:-

SBI life insurance Company

LIC is tied up with Vijaya bank, Oriental bank of commerce, Corporation bank

ICICI Lombard

Barclays – MetLife India

Axis bank – MetLife India

Aviva Life - ABN Amro

Guidelines for Banks

“Scheduled commercial banks are permitted to undertake insurance business as agent of

insurance companies on fee basis, without any risk participation. The subsidiaries of banks will

also be allowed to undertake distribution of insurance product on agency basis. All banks

entering into insurance business will be required to obtain prior approval of the Reserve Bank of

India. RBI will give approval keeping in view all relevant factors including the position in regard

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to the level of non-performing assets of the applicant bank so as to ensure that non-performing

assets do not pose any future threat to the bank in its present or the proposed line of activity, viz.,

insurance business.

The eligibility criteria for joint venture participant are as under:

i. The net worth of the bank should not be less than Rs.500 crore;

ii. The CRAR of the bank should not be less than 10 per cent;

iii. The level of non-performing assets should be reasonable;

iv. The bank should have net profit for the last three consecutive years;

v. The track record of the performance of the subsidiaries, if any, of the concerned bank

should be satisfactory.”

Source: https://rbi.org.in

11.9 REGULATORY FRAMEWORK FOR INSURANCE

The life insurance business was introduced in India in the year 1818 with the establishment of

Oriental Life Insurance Company. But this company failed in 1834. In the year 1912, India Life

Companies Assurance Act was introduced. It was the first statutory measure to regulate life

insurance .In the year 1928 the India Insurance Companies act was enacted .Finally, in the year

1938, Insurance companies Act introduced by amending and consolidating the earlier legislation

in order to protect the interest of Insurance public. This act was amended by the Government of

India in the year 1950. In the year 1956 insurance sector was nationalized .The LIC absorbed 154

Indian, 16 non-Indian insurers and also 75 provident societies. Till late 90s when the private

sector was reopened LIC enjoyed the monopoly. In 1999 Insurance Regulatory Development

Authority was constituted on the recommendation of Malhotra Committee. IRDA is an

autonomous body to regulate and develop the insurance industry. The IRDA Act of 1999 had

paved the way for the entry of private players into the insurance market.

The following Acts regulate the Insurance Business in India.

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• Insurance Act, 1938

• IRDA Act, 1999

• Insurance Amendment Act, 2002

• Exchange Control Regulations (FEMA)

• Insurance Co-op Society

• Indian Stamp Act, 1899 Consumer Protection Act, 1986

• Insurance Ombudsman

a) Protection of consumers’ interest

b) To ensure the financial soundness of the insurance industry

c) To help the healthy growth of the insurance market.

11.10 INSURANCE OMBUDSMAN

The institution of Insurance ombudsman was created by a government of India with effect from

11th November, 1988. It was formed with the purpose of quick disposal of the grievances of the

insured customers and to mitigate their problems out of the court system in a cost effective and

efficient way.

Tenure The Ombudsman is appointed for a term of three years or till the holder of office attains

the age of sixty five years whichever is earlier. There is no provision for re-appointment.

At present there are twelve insurance ombudsman in India with their offices located at (1)

Bhopal, (2) Bhubaneswar, (3) Cochin, (4) Guwahati, (5) Chandigarh, (6) New Delhi, (7)

Chennai, (8) Kolkata, (9) Ahmedabad, (10) Lucknow, (11) Mumbai, (12) Hyderabad. Each

ombudsman has the power to redress the complaint of individual where sum insured is less than

Rs.20 lacs. In order to expedite the disposal of the complaints the Ombudsman can hold sitting at

various places within their area of jurisdiction.

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https://www.irdai.gov.in/ADMINCMS/cms/NormalData_Layout.aspx?page=PageNo233&

mid=7.1


Q1. Life Insurance is a product that is _________________

Q2. A claim under life insurance policy shall be given within _________ days after receiving all

necessary documents.

Q3. Treaty reinsurance covers individual risk. True/false

Q4. Ombudsman empowered to redress the complaint where sum assured is less than Rs. 20

lakh. True/ False

Ans1. Intangible, Ans2. 30 days, Ans3. False, Ans4. True

11.12 SUMMARY

To conclude Life insurance covers risk of individual life and General Insurance covers risk of

other than individual life like motor, buildings, theft, fire etc. Reinsurance covers risk of

individual insurance companies. Bancassurance is a distribution channel of banks and insurance

companies. Banks do tie up with insurance companies to earn fee income by selling insurance

products in the banks. The regulatory frame work in relation to the insurance companies seeks to

care of three major concerns i.e protection of consumers’ interest,to ensure the financial

soundness of the insurance industry and to help the healthy growth of the insurance market.

Ombudsman redresses the complaint of policy holders against insurance companies.

11.13 GLOSSARY

ULIP is Unit Linked Insurance Plan.

Lapsed Policymeans the break in policy due to non- payment of due premium.

11.14 REFERENCES&SUGGESTED READINGS

Websites

1. www.policyholder.gov.in

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2. www.icsi.in

3. www.reckonindia.com

4. www.irdaindia.org

5. www.insuranceinstituteofindia.com

6. law.geekupd8.com

7. m.economictimes.com

8. www.onestopallsolutions.co.in

9. www.hdfclife.com

10. www.iii.org

11. depthofwealth.com

12. www.squidoo.com

13. irdindia.in

14. www.tpcc.in

15. www.consumercourt.in

16. www.businesstoday.in

17. www.mahendras.org

18. en.wikipedia.org

19. eastindiavyapaar.com

20. www.bimabazaar.com

21. www.ficci.com

22. utibank.myiris.com

23. online.vmou.ac.in

24. loyalinsurance.in

Page 191 of 244

25. www.scribd.com

26. www.investmentsinindia.org

27. assets.vmou.ac.in

28. www.gibl.in

Books1. Banking and Insurance by Jagroop Singh, Kalyani Publishers

2. Banking, Theory Law and Practice,Sundaram&Varshney, Sultan chand& sons;2004

3. Principles of BankingVarshney& Malhotra,Sultan Chand & Sons, 2005.


1997


New Delhi.




1. Define Insurance. What are the types of Insurance/

2. What are various types of Life Insurance Policies?

3. What is the procedure of claim under General Insurance?

4. Define Bancassurance. Explain the advantages of bancassurance.

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Lesson- 12

ACCOUNTING FOR INSURANCE

Structure

12.1 Objectives

12.2 Introduction

12.3 Important terms used in Insurance Business

12.4 Final Accounts of Life Insurance Companies

12.5 Final Accounts of General Insurance Business

12.6 Solvency Margin Requirements-Life Insurance

12.7 Solvency Margin Requirements-General Insurance


12.9 Summary

12.10 Glossary

12.11 Answer to Check Your Progress



12.1 OBJECTIVES


Know about books of accounts maintained for insurance business.

Understand to prepare final accounts of Life Insurance business.

Understand to prepare final accounts of General Insurance business.

Solvency requirements of Life and General Insurance business.

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12.2 INTRODUCTION

The insurance industry now a days is better positioned to grow. A financially sound insurance

sector contributes to the economic growth and development. It also helps in the management of

risk, allocation of resources, and mobilization of long term savings. Since insurance is related to

future and future is uncertain the insurance accounting also exhibits various interesting and

complicated issues. Various accounting treatments have been adopted to enhance the

transparency and to improve the confidence of public in the insurance sector both life and

general “The insurance companies are required to prepare their financial statements i.e. Revenue

Account, Profit and Loss Account and Balance Sheet according to the Insurance Regulatory and

Development Authority (Preparation of Financial Statements and Auditors’ Report of Insurance

Companies) Regulations, 2002.Insurance business in India is regulated by the provision of the

The Insurance Regulatory and Development Authority Act,1999. “

Source:www.icicibank.com/managed-assets/docs/investor/annual-reports/2002/ar_2k2(148-

158).pdf

“The main features of the act are as follows:-

1. For every company engaged in business of life insurance or general insurance, the

minimum paid up equity capital has been fixed at Rs 100 crores. For carrying on

exclusively the business a reinsurer, the minimum paid up equity capital is Rs. 200

crores.

2. It is obligatory for every insurer to undertake the minimum percentage of life insurance

business and general insurance business in the rural or social sector that may be specified

by the Insurance Regulatory and Development Authority.

3. Every year the accounting year of every insurance company is to end at 31st March.

4. The insurance companies are required to prepare their financial statements i.e. revenue

account, profit and loss account and balance sheet as per IRDA regulations.

5. The insurer carrying on life insurance business shall comply with the requirements of

Schedule A.

6. An insurer carrying on general insurance business shall comply with the requirements of

Schedule B. “

Page 194 of 244

Source:https://www.scribd.com/document/64252771/Accounting-of-Insurance-Companies

Insurers carrying on Life Insurance Business should comply with the requirements of

Schedule A of the Regulations which among other things, gives the following Forms:

Revenue Account – Form A – RA

Profit and Loss Account – Form A – PL

Balance Sheet – Form A-BS

Insurers doing General Insurance Business should comply with requirements of Schedule B of

the Regulations which among other things, gives the following Forms:

Revenue Account – Form B – RA

Profit and Loss Account – From B – PL

Balance Sheet – From B – BS

12.3 IMPORTANT TERMS USED IN INSURANCE BUSINESS

Insurance Policy: It is the document issued by the insurance company containing terms of

insurance contract. It specifies the losses that are covered by the policies and also the maximum

amount that can be paid out in the event of loss/death.

Premium: “The payment made by the insured to the Insurance Company in consideration of the

contract of Insurance. Any premium which is being received by the insurance company during

the year is shown in Revenue Account.”

Source: https://quizlet.com/5036892/contract-law-flash-cards/

Claims: “A claim occurs when a policy fall due for payment. In Life insurance it arises on the

death or on maturity of policy.In case of General Insurance, the claim arises only when the loss

occurs.

Surrender Value: Surrender Value applies only to Life Insurance Policies. When the policy

holder wishes to realize the amount of policy before the expiry of the full period of the policy he

surrenders his right under the policy and is paid an amount calculated by a fixed formula.

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Commission: Insurance companies get business through agents. These agents receive

commission on the basis of the amount of premium they generate for the Insurance Company.

Commission paid is an expense of the insurance company.

Reinsurance: If Insurance Company does not wish to bear the whole risk of a policy, and then it

will reinsure a part of risk with some other insurer. In such a case insurer is said to have ceded a

part of its business to other insurer.

Ceding Company: An insurance company that shifts part or all of a risk it has assumed to

another insurance company. The ceding company shares the premium amount it has received to

cover the risk.

Commission on reinsurance ceded: When a company gets reinsurance business it has to pay

commission to the Ceding Company. This commission paid by the reinsurance company is called

‘Commission on reinsurance accepted’ and is shown as an expense in the revenue account of the

reinsurance company. This commission received by the ceding company is called as

‘Commission on reinsurance ceded.’ It is the income of the ceding company and is shown on the

credit side of revenue account. “

Source:http://www.icaiknowledgegateway.org/littledms/folder1/chapter-5-financial-

statements-of-insurance-companies.pdf

12.4 FINAL ACCOUNTS OF LIFE INSURANCE COMPANIES

The chief feature of life insurance business is that the life insurance contracts are for a long term

and that on a particular date the future implications of a contract must be considered before profit

can be ascertained.

The prescribed performa’s for preparing financial statements of life insurance companies

are :

Revenue Account: “Revenue account is also known as policyholders’ account. Life insurance

companies should comply with the requirements of Schedule A for preparing its revenue

account.”

Source: https://www.taxmann.com/TEMP/104010000000041034/41593.pdf

Page 196 of 244

“Registration number of the company and the date of registration with IRDA are given on the

top of the revenue account.

Premium earned income from investments and other incomes are added up and written as Total

(A) in the revenue account.

Commission paid, operating expenses, provision for doubtful debts, bad debts written off,

provision for tax and other provisions are added up and shown as Total (B). “

Source:http://www.aicofindia.com/AICEng/General_Documents/Statutory_Info/Stat_Curr

ent/q2%2010-11.pdf

The net of benefits paid, interim bonuses paid and any change in valuation of liability of life

insurance policy are added. This becomes (C). When we subtract total (B) and (C) from total (A)

we can find Surplus orr Deficit

Profit and Loss Account:“This is a shareholders’ account. “Surplus from revenue account,

income from investments and other incomes are given and total is written as Total (A).”

Source: https://www.accountingcoach.com/blog/revenue-income-gain

“Expenses include expenses other than those directly related to insurance business, bad debts

written off, and provisions (other than taxation). These expenses are added up and shown under

the head of Total (B).”

Difference between Total (A) and Total (B) is profit or loss.

Source: http://www.cra-arc.gc.ca/tx/bsnss/tpcs/slprtnr/bsnssxpnss/menu-eng.html

Out of these profits provision for taxation is made. Profit after tax is then appropriated towards

interim dividends, proposed final dividend, and other reserves. Balance of profit is carried to the

balance sheet.

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Balance Sheet: “Balance sheet is also prepared in summary form. Details of various heads are

given in the accompanying schedules. Schedule number five to schedule number fifteen gives the

details of various heads given in the balance sheet. Sources of funds include shareholders’ funds,

borrowings, policyholders’ funds and funds for future appropriations. Application of funds have

investments, assets held to cover linked liabilities, loans, fixed assets, net current assets,

miscellaneous expenditure ( to the extent not written off or adjusted ) and debit balance in profit

and loss account as main heads.”

Source:http://www.exidelife.in/docs/default-source/public-disclosures/l3-a-bs-balance-

sheet22278FF3C5AB

.

Page 198 of 244

of 244

Notes: (applicable to Schedules 8 and 8A & 8B):

Page 208 of 244

of 244

Notes:

(a) No item shall be included under the head “Miscellaneous Expenditure” and carried forward

unless:

1. some benefit from the expenditure can reasonably be expected to be received in future, and

2. the amount of such benefit is reasonably determinable.

(b) The amount to be carried forward in respect of any item included under the head

“Miscellaneous Expenditure” shall not exceed the expected future revenue/other benefits related

to the expenditure.

Source:http://www.icaiknowledgegateway.org/littledms/folder1/chapter-5-financial-

statements-of-insurance-companies.pdf

Page 213 of 244

12.5 FINAL ACCOUNTS OF GENERAL INSURANCE BUSINESS

Insurance other than life insurance is called general insurance. Fire insurance against loss of

property due to fire and marine insurance against loss of cargo, freight and ship are examples of

general insurance.

According to PART V of Schedule B of the IRDA Regulations 2002 regarding preparation of

financial statements of insurance companies, a general insurance company is required to prepare

the revenue account, profit and loss account and the balance sheet in Form B-RA, B-PL, and B-

BS respectively.

A general insurance company must prepare separate revenue accounts for fire, marine, and

miscellaneous insurance business and separate schedules shall be prepared for marine cargo,

marine other than marine cargo and also for miscellaneous insurance including motor,

workmen’s compensation, public/ product liability, engineering, aviation, personal accident,

health insurance and others.

Following are the prescribed formats of financial statements of general insurance companies.

Revenue Account: Revenue account of a general insurance company is prepared in ‘Form B-

RA’. It is prepared in a summary form. Details are given in the accompanying schedules.

A separate revenue account is prepared for fire, marine and miscellaneous insurance business

and separate schedules shall be prepared for marine cargo, other than marine cargo and various

classes of miscellaneous insurance business i.e. motor, health, public and product liability,

engineering, aviation and others. Particulars about income earned from premiums, profit on sale

of investments, income from interest, dividends and rent and other incomes are given.

Total of all incomes is stated under the heading Total (A).

Net claims incurred, commission paid and operating expenses related to insurance business are

added up and sum is shown under the heading Total (B).

Difference between Total (A) and Total (B) is the operating profit or loss. Appropriations

towards shareholders account and reserves are also shown in the revenue account.

Profit and Loss Account: Profit and Loss Account of general insurance company is prepared in

“Form B-PL”. Incomes include operating profit, income from investments and other income (to

Page 214 of 244

be specified). Expenses include provisions (other than tax), expenditure other than related to

insurance business, bad debts written off and other expenses. Difference between total income

and total expenditure is the profit or loss. After various appropriations, balance profits are carried

forward to the balance sheet.

Balance Sheet: Balance Sheet of a general insurance company is prepared in ‘Form BBS’. It is

also prepared in a summary form. Details are given in the schedules. Total fifteen schedules are

prepared, out of which first four relate to revenue account and remaining eleven schedules relate

to the balance sheet. Balance sheet shows share capital, reserves and surplus, fair value change

account and borrowings as sources of funds. Application of funds include investments, loans,

fixed assets, net current assets, miscellaneous expenditure to the extent not written off or

adjusted and debt balance in profit and loss account. Contingent liabilities are shown in a

separate statement.

“Reserve for Unexpired Risks:

An insurance company issues general insurance policies throughout the accounting year.

Premium is received at the time of issue of the policy. But the period for which the policy is

issued may cover part of the current accounting year and a part of the next accounting year.

It means the company may be required to pay for losses which may take place next year in

respect of at least some of the policies issued in the current accounting year. It is therefore,

wrong to consider the premium received in an accounting year to be income of the insurance

company without taking into account a reserve for unexpired risks.”

Source:http://www.accountingnotes.net/final-accounts/final-accounts-of-general-insurance-

business/9501

Schedule II B of the Insurance Regulatory and Development Authority (Assets, Liabilities

and Solvency Margin of Insurance) Regulation 2000 lays down that the reserve for unexpired

risks, shall be, in respect of:

(i) Fire business, 50 per cent,

(ii) Miscellaneous business, 50 per cent

Page 215 of 244

(iii) Marine business other than marine hull business, 50 per cent, and

(iv) Marine hull business, 100 per cent of the premium, net of reinsurances, received or

receivable during the preceding twelve months.

To ascertain the amount of surplus for which a general insurance company can take credit in

respect of a particular type of general insurance business, in the relevant Revenue Account, net

premium earned is adjusted for Reserve for Unexpired Risks as in the beginning and as at the

end of the accounting year concerned.

Illustration 1:

Indian Insurance Co. Ltd. furnishes you with the following information:

(i) “On 31.3.2011 it had reserve for unexpired risks to the tune of Rs 40 crore. It comprised of Rs

15 crore in respect of marine insurance business; Rs 20 crore in respect of fire insurance business

and Rs 5 crore in respect of miscellaneous insurance business.

(ii) It is the practice of Indian Insurance Co. Ltd. to create reserve at 100% of net premium

income in respect of marine insurance policies and at 50% of net premium income in respect of

fire and miscellaneous insurance policies.

(iii) During the year ended 31st March, 2012, the following business was conducted:”

Source:http://www.yourarticlelibrary.com/accounting/problems-accounting/accounting-

problems-on-insurance-companies/79803/

Page 216 of 244

of 244

Notes: to forms B-RA and B-PL

(a) Premium income received from business concluded in and outside India shall be separately

disclosed.

(b) Reinsurance premiums whether on business ceded or accepted are to be brought into account

gross (i.e. before deducting commissions) under the head reinsurance premiums,

(c) Claims incurred shall comprise claims paid, specific claims settlement costs wherever

applicable and change in the outstanding provision for claims at the year-end.

(d) Items of expenses and income in excess of one percent of the total premiums (less

reinsurance) or Rs 5,00,000 whichever is higher, shall be shown as a separate line item.

(e) Fees and expenses connected with claims shall be included in claims.

(f) Under the sub-head “others” shall be included items like foreign exchange gains or losses and

other items.

(g) Interest dividends and rentals receivable in connection with an investment should be stated as

gross amount, the amount of income tax deducted at source being included under ‘advance taxes

paid and taxes deducted at source”.

(h) Income from rent shall include only the realised rent. It shall not include any notional rent.”

Page 220 of 244

of 244

Notes:

(a) Investments in subsidiary/holding companies, joint ventures and associates shall be separately

disclosed, at cost.

(i) Holding company and subsidiary shall be construed as defined in the Companies Act, 1956.

(ii) Joint Venture is a contractual arrangement whereby two or more parties undertake an

economic activity, which is subject to joint control.

(iii) Joint control is the contractually agreed sharing of power to govern the financial and

operating policies of an economic activity to obtain benefits from it.

(iv) Associate is an enterprise in which the company has significant influence and which is

neither a subsidiary nor a joint venture of the company.

(v) Significant influence (for the purpose of this schedule) means participation in the financial

and operating policy decisions of a company, but not control of those policies. Significant

influence may be exercised in several ways, for example, by representation on the board of

directors, participation in the policy making process, material inter-company transactions,

interchange of managerial personnel or dependence on technical information. Significant

influence may be gained by share ownership, statute or agreement. As regards share ownership,

if an investor holds, directly or indirectly through subsidiaries, 20 percent or more of the voting

power of the voting power of the investee, it is presumed that the investor does have significant

influence unless it can be clearly demonstrated that this is not the case. Conversely, if the

investor holds, directly or indirectly through subsidiaries, less than 20 percent of the voting

Page 227 of 244

power of the investee, it is presumed that the investor does not have significant influence, unless

such influence is clearly demonstrated. A substantial or majority ownership by another investor

does not necessarily preclude an investor for having significant influence.

(b) Aggregate amount of company’s investment other than listed equity securities and derivative

instruments and also the market value thereof shall be disclosed.

(c) Investments made out of Catastrophe Reserve should be shown separately.

(d) Debt securities will be considered as “held to maturity” securities and will be measured at

historical cost subject to amortisation.

(e) Investment Property means a property [land or building or part of a building or both] held to

earn rental income or for capital appreciation or for both, rather than for use in services or for

administrative purposes.

(f) Investments maturing within twelve months from balance sheet date and investments made

with the specific intention to dispose of within twelve months from balance sheet date shall be

classified as short- term investments.

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12.6 IRDAI (ASSETS, LIABILITIES, AND SOLVENCY MARGIN OF LIFE

INSURANCE BUSINESS) REGULATIONS, 2016

“Valuation of Assets

Every insurer shall prepare a statement of the value of assets in accordance with Schedule I in

respect of life insurance business.

Page 233 of 244

Determination of Amount of Liabilities

Every insurer shall prepare a statement of the amount of liabilities in accordance with Schedule

II in respect of life insurance business.

Determination of Solvency Margin

Every insurer shall prepare a statement of solvency margin in accordance with Schedule III, in

respect of life insurance business.

SCHEDULE I

“VALUATION OF ASSETS

1. The following assets shall be placed with value zero,

(1) Agents' and Intermediaries' balances and outstanding premiums in India, to the extent

they are not realised within a period of thirty days;

(2) Agents' and Intermediaries' balances and outstanding premiums outside India, to the

extent they are not realisable ;

(3) Sundry debts, to the extent they are not realisable;

(4) Advances and receivables of an unrealisable character;

(5) Furniture, fixtures, dead stock and stationery;

(6) Deferred expenses;

(7) Debit balance of Profit and loss appropriation account balance and any fictitious

assets other than pre-paid expenses;

(8) Reinsurer's balances outstanding for more than ninety days;

(9) Leasehold improvements

(10) Service Tax Unutilized Credit outstanding for more than ninety days;

(11) Any other assets, which are considered inadmissible under Section 64V of the

Insurance Act, 1938.

2. All other assets of an insurer have to be valued in accordance with the Regulations and other

instructions issued by the Authority regarding Preparation of Financial Statements and

Page 234 of 244

Auditor's Report of insurance companies, Other Forms of Capital and Investments, as

applicable from time to time.

3. Statement of Assets: Every insurer shall prepare a statement of assets in Form Assets AA of

Insurance Regulatory and Development Authority of India (Actuarial Report and Abstracts for

Life Insurance Business) Regulations, 2016.”

Source:https://www.taxmann.com/topstories/104010000000048111/irda-notifies-

regulations-for-assets-liabilities-and-solvency-margin-for-life-insurance-business.aspx

SCHEDULE II

“VALUATION OF LIABILITIES - LIFE INSURANCE

1. In this Schedule, "Valuation date", in relation to an actuarial investigation, means thedate to which the investigation relates and the Policy Accounts" means funds earmarkedfor Variable Linked Business and Variable Non-Linked Business.

2. Mathematical Reserves shall be determined separately for each contract by a

prospective method of valuation.

3. The gross premium method of valuation shall discount the future policy cash flows at

an appropriate rate of interest.

4. Where a policy provides built-in options, that may be exercised by the policyholder,

such as conversion or addition of coverage at future date(s) without any evidence of

good health, annuity rate guarantees at maturity of contract, etc., the costs of such

options shall be estimated and treated as special cash flows in calculating the

mathematical reserves.

5. The valuation parameters shall constitute the bases on which the future policy cash

flows shall be computed and discounted. Each parameter shall have to be appropriate

to the block of business to be valued.

6. This Schedule shall also apply to the valuation of business in the books of reinsurer

7. Reserves in respect of linked business shall consist of two components, namely, unit

reserves and general fund reserves. Unit reserves shall be calculated in respect of the

units allocated to the policies in force at the valuation date using unit values at the

Page 235 of 244

valuation date. General fund reserves (non-unit reserves) shall be determined using a

prospective valuation method set out in the Schedule

8. The appointed actuary shall make aggregate provisions in respect of the following,

where it is not possible to calculate mathematical reserves for each policy, in the

determination of mathematical reserves:-

(a) Policies in respect of which extra premiums have been charged on account of

underwriting of under-average lives that are subject to extra risks such as occupation

hazard, over-weight, under-weight, smoking history, health, climatic or geographical

conditions;

(b) Lapses policies not included in the valuation but under which a liability exists or

may arise;

(c) Options available under individual and group insurance policies;

(d) Guarantees available to individual and group insurance policies;

(e) The rates of exchange at which benefits in respect of policies issued in foreign

currencies have been converted into Indian Rupees and what provision has been made

for possible increase of mathematical reserves arising from future variations in rates of

exchange.”

Source:https://www.irdai.gov.in/ADMINCMS/cms/frmGeneral_Layout.aspx?page=Page

No58&flag=1

SCHEDULE III

“DETERMINATION OF SOLVENCY MARGINS—LIFE INSURANCE BUSINESS

1. (1) "Available Solvency Margin" means the excess of value of assets (as furnished in

form-AA specified under Insurance Regulatory Development Authority of India

(Actuarial Report and Abstracts for Life Insurance Business) Regulations, 2016) over

the value of life insurance liabilities (as furnished in form-H of Insurance Regulatory

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Development Authority of India (Actuarial Reports and Abstracts for Life Insurance

Business) Regulations, 2016) and other liabilities of policyholders' fund and

shareholders' funds;

(2) "Solvency Ratio" means the ratio of the amount of Available Solvency Margin to the

amount of Required Solvency Margin as specified in form-KT-3 of Insurance

Regulatory Development Authority of India (Actuarial Report and Abstracts for Life

Insurance Business) Regulations, 2016.

2. Every insurer at all time shall maintain its Available Solvency Margin at a level which is not

less than higher of fifty per cent of the amount of minimum capital as stated under Section 6 of

the Act and one hundred per cent of Required Solvency Margin failing which the Authority

shall act in accordance with sub-section (2) of Section 64VA of the Act.

3. "Control level of Solvency" shall mean the level of solvency margin specified by the

Authority in accordance with sub-section (3) of Section 64VA of the Act on the breach of

which the Authority shall act in accordance with sub-section (4) of section 64VA of the Act

without prejudice to taking any other remedial measures as deemed fit. The control level of

solvency is hereby specified as a solvency ratio of 150 %.

4. Determination of Required Solvency Margin : Every insurer shall determine the Required

Solvency Margin, the Available Solvency Margin and the Solvency Ratio as per Insurance

Regulatory Development Authority of India (Actuarial Report and Abstracts for Life Insurance

Business) Regulations, 2016.”

Source:https://www.taxmann.com/topstories/104010000000048111/irda-notifies-

regulations-for-assets-liabilities-and-solvency-margin-for-life-insurance-business.aspx

12.7 IRDAI (ASSETS, LIABILITIES, AND SOLVENCY MARGIN OF GENERAL

INSURANCE BUSINESS) REGULATIONS, 2016

“Admissibility of Assets For The Purpose of Calculation of Solvency Margin

Every general insurer shall prepare a statement of admissible assets in FORM IRDAI-GI-TA in

accordance with Schedule I.

Determination of Amount of Liabilities

Page 237 of 244

Every general insurer shall prepare a statement of the amount of liabilities in FORM IRDAI-GI-

TR in accordance with Schedule II.

Determination of Solvency Margin

Every General insurer shall prepare a statement of solvency margin in FORM IRDAI-GI-SM in

accordance with Schedule III.

SCHEDULE I

1. Valuation of Assets

(1) The following assets should be placed with value zero:

(a) Agents' and Intermediaries' balances and outstanding premiums in India, to the extent

they are not realized within a period of thirty days;

(b) Premiums receivables relating to State/Central government sponsored schemes, to the

extent they are not realized within a period of 180 days;

(c) Agents' and Intermediaries' balances and outstanding premiums outside India, to the

extent they are not realizable ;

(d) Sundry debts, to the extent they are not realizable;

(e) Advances and receivables of an unrealizable character;

(f) Furniture, fixtures, dead stock and stationery;

(g) Deferred expenses;

(h) Debit balance of Profit and loss appropriation account balance and any fictitious

assets other than pre-paid expenses;

(i) Co-insurer's balances outstanding for more than ninety days;

(j) Balances of Indian Reinsurers and Foreign Reinsurers having Branches in India

outstanding for more than 365 days;

(k) Other Reinsurer's balances outstanding for more than 180 days;

(l) Leasehold improvements

(m) Service Tax Unutilized Credit outstanding for more than ninety days;

(n) Any other assets, which are considered inadmissible under section 64V of the

Insurance Act, 1938.

Page 238 of 244

(2) All other assets of a general insurer have to be valued in accordance with the Regulations

and other instructions issued by the Authority regarding preparation of financial statements,

auditor's report, other forms of capital and investments, and any other Regulations as applicable

from time to time.

2. Statement of Admissible Assets

Every general insurer shall prepare a statement of admissible assets in form IRDAI-GI-TA

Schedule II

DETERMINATION OF AMOUNT OF LIABILITIES

1. DETERMINATION OF AMOUNT OF LIABILITIES

(1) The amount of liabilities shall be determined on the Valuation Date separately for

each line of business as listed in the FORM IRDAI-GI-SM and in accordance with

this regulation

(2) The amount of liabilities for each line of business shall be determined as the aggregate

of Unexpired Risk Reserves as mentioned in clause 2 below and Claims Reserves as

mentioned in clause 3 below.

2. PREMIUM RESERVES

(1) Unearned Premium Reserve (UPR):

UPR will be estimated as per the extant provisions and shall be certified by the Chief

Financial Officer and the Statutory Auditor .

(2) Premium Deficiency Reserve (PDR):

The PDR shall be calculated using sound actuarial principles. Though the PDR shall

be maintained at the insurer level, PDR on segmental basis would be monitored by the

Authority for verifying the sustainability of products and accordingly an appropriate

action may be taken by the Authority.

(3) Unexpired Risk Reserve (URR):

Unexpired Risk Reserve is defined as sum total of UPR and PDR”

SCHEDULE III

Page 239 of 244

DETERMINATION OF SOLVENCY MARGIN – GENERAL INSURANCE BUSINESS

1.(1) "Available Solvency Margin (ASM)" shall be calculated as the excess of value of

assets (as furnished in Form IRDAI-GI-TA) over the value of liabilities (as furnished

in Form IRDAI-GI-TR) with further adjustments as shown in Table IB of FORM

IRDAI-GI-SM.

(2) "Solvency Ratio" means the ratio of the amount of Available Solvency Margin to the

amount of Required Solvency Margin as specified in Table IB

2. Every insurer at all time shall maintain its Available Solvency Margin at a level which is not

less than higher of fifty per cent of the amount of minimum capital as stated under Section 6 of

the Act and one hundred per cent of Required Solvency Margin failing which the Authority

shall act in accordance with sub-section (2) of Section 64VA of the Act.

3. "Control level of Solvency" shall mean the level of solvency margin specified by the

Authority in accordance with sub-section (3) of Section 64VA of the Act on the breach of

which the Authority shall act in accordance with subsection (4) of section 64VA of the Act

without prejudice to taking any other remedial measures as deemed fit. The control level of

solvency is hereby specified as a minimum solvency ratio of 150 %.

4. Determination of Required Solvency Margin (RSM): Every general insurer shall determine

the Required Solvency Margin, the Available Solvency Margin, and the Solvency Ratio in

FORM IRDAI-GI-SM.”

Source:https://www.taxmann.com/topstories/104010000000048093/irda-notifies-norms-

for-determination-of-assets-liabilities-and-solvency-margin-for-general-insurance-

business.aspx


1. The payment made by the insured to the Insurance Company in consideration of the contract

of Insurance is called_____________.

2.____________ in life insurance arises on the death or on maturity of policy.

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3. If Insurance Company does not wish to bear the whole risk of a policy, and then it will

reinsure a part of risk with some other insurer. It is called Reinsurance. True/ False

4. Commission paid is an expense of the insurance company. True/ False.

12.9 SUMMARY

To summarize life insurance is a contract under which the insurance company guarantees that the

insured will get a certain sum of money on reaching a certain age, or on his death. General

Insurance includes all types of insurance except Life insurance.Insurancr business is being

regulated by the provisions of the Insurance Regualtory and Development Authority Act, 1999 in

India.

12.10 GLOSSARY

Commission on reinsurance accepted: When a company gets reinsurance business, it has to

pay commission to some other company, it is known as Commission on Reinsurance accepted.

Commission on Reinsurance Ceeded: When a company passes on a part of business to some

other company, then this company gets commission from the company to whom it gives

business, it is known as Commission on reinsurance ceded.

Annuity: Annuity is an annual payment which an insurance company guarantees to pay to the

insured throughout his life in consideration of a lump sum money paid by him in the beginning.

12.11 ANSWERS TO CHECK YOUR PROGRESS

1. Premium 2. Claim 3. True 4. True


Q.1 Explain in detail the final accounts maintained by Life Insurance Companies.

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Q.2 Explain in detail the final accounts maintained by General Insurance Companies.

Q.3 Explain in detail the Regulations with regard to Solvency Margins of Life Insurance

Companies.

12. 13 WEBSITE SOURCES , REFERENCES & SUGGESTED READINGS

WEBSITE SOURCES

www.icicibank.com/managed-assets/docs/investor/annual-reports/2002/ar_2k2(148-158).pdf

https://www.scribd.com/document/64252771/Accounting-of-Insurance-Companies

http://shodhganga.inflibnet.ac.in/bitstream/10603/10016/12/12_chapter%204.pdf

https://en.wikipedia.org/wiki/Insurance

http://www.icaiknowledgegateway.org/littledms/folder1/chapter-5-financial-statements-of-

insurance-companies.pdf

https://www.taxmann.com/TEMP/104010000000041034/41593.pdf

https://www.taxmann.com/topstories/104010000000048093/irda-notifies-norms-for-determination-

of-assets-liabilities-and-solvency-margin-for-general-insurance-business.aspx

http://www.aicofindia.com/AICEng/General_Documents/Statutory_Info/Stat_Current/q2%2010-

11.pdf

http://www.yourarticlelibrary.com/accounting/problems-accounting/accounting-problems-on-

insurance-companies/79803/

http://www.accountingnotes.net/final-accounts/final-accounts-of-general-insurance-business/9501

REFERENCES & SUGGESTED READINGS

1. www.irdai.gov.in

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2. shodhganga.inflibnet.ac.in

3. www.irdaindia.org

4. www.sma.net.in

5. icmai.in

6. www.cholainsurance.com

7. www.icsi.edu

8. www.scribd.com

9. www.prsindia.org

10. www.hdfclife.com

11. financialservices.gov.in

12. bcvaz.in

13. www.imtechuae.com

Books



3. Money, Banking and International Trade, Vaish M.C, New Age International Pvt.Ltd,1997

4. Banking, Theory, Law & Practice, Gordon.E, Natarajan.K., Himalaya Publishing House,New Delhi.




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8. Corporate Accounting by S.P. Jain and K.L.Narang, Kalyani Publishers

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