Dibrugarh University Solved Question Papers - Indian Banking System (May' 2015)

1. Fill in the blanks:                                                                          1x4=4

2. Write true or false :                                                                    1x4=4

3. Write short notes on (any four) :                                          4x4=16

a) Relationship banking is a marketing approach that is widespread in commercial banks of all sizes. The premise is that the best prospects for bank services are existing customers -- the consumers, families and businesses that already deal with the bank. Relationship bankers and the associates who work with them focus on cross-selling services. They might ask customers about opening investment accounts when they come to withdraw cash or deposit a check. A small business owner will likely hear about investment accounts or services that can boost his company's cash flow.

b) Cash Reserve Ratio (CRR): The present banking system is called a ‘fractional reserve banking system’, because the banks need to keep only a fraction of their deposit liabilities in the form of liquid cash. “Cash reserve ratio refers to the cash which banks have to maintain with the RBI as a certain percentage of their demand and time liabilities.” Originally the objective was to ensure safety and liquidity of bank deposits. But over years it has emerged as an effective tool of directly regulating the lending capacity of the banks i.e., as an instrument of the monetary policy. RBI has the power to impose penal interest rates on the banks in case of a shortfall in the prescribed CRR. The penal rate is generally higher than the bank rate and it increases if the default is prolonged. RBI can also disallow any fresh access to refinance in such cases. The RBI controls credit through change in Cash Reserve Ratio of commercial banks. According to section 42(1) of RBI Act every schedule bank has to maintain a certain percentage reserve of its time and demand deposits. This ratio can be varied from 3% to 15% as directed by the Reserve Bank. Reserve Bank itself changed this ratio according to the credit requirement of the economy. It has been changed several times in the history of Reserve Bank of India. The cash reserve ratio affects on the lend able funds of commercial banks. If this ratio increases the credit creation capacity of commercial banks decreases. On the other hand if this ratio decreases the credit creation capacity of commercial banks increases.

c) Phone Banking: Telephone banking is a service provided by a bank or other financial institution, that enables customers to perform a range of financial transactions over the telephone, without the need to visit a bank branch or automated teller machine. Telephone banking times are usually longer than branch opening times, and some financial institutions offer the service on a 24-hour basis. Most financial institutions have restrictions on which accounts may be accessed through telephone banking, as well as a limit on the amount that can be transacted.

The types of financial transactions which a customer may transact through telephone banking include obtaining account balances and list of latest transactions, electronic bill payments, and funds transfers between a customer's or another's accounts.

From the bank's point of view, telephone banking minimises the cost of handling transactions by reducing the need for customers to visit a bank branch for non-cash withdrawal and deposit transactions. Transactions involving cash or documents (such as cheques) are not able to be handled using telephone banking, and a customer needs to visit an ATM or bank branch for cash withdrawals and cash or cheque deposits.

d) Secured Loan: A banker should grant secured loans only. In case the borrower fails to return the loan, the banker may recover his loan after realizing from the sale of security. In case of unsecured loans, the chances of bad debts will be very high. Security conditions are different in different banks..

In case of secured loans, the bank should carefully examine and value the security. There should be sufficient margin between the amount of loan and the value of the security. If adequate margin is not maintained, the loan might become unsecured in case the borrower fails to pay the interest and return the loan. The amount of loan should not exceed 60 to 70% of the value of the security. If the value of the security is falling, the bank should demand further security without delay. In case he fails to do so, the loan might become unsecured and the bank may have to suffer loss on account of bad debt.

e) Bridge Loan: Bridge loan is a short-term temporary loan extended by financial institutions to help the borrower to meet the immediate expenditure pending disposal of requests for long- term funds or regular loans. Here, the bridge loan is not against any main loan arrangement but against anticipated cash flow. Again, if an indi­vidual is negotiating the sale of his asset, say a house, a bridge loan may be extended by a bank to meet the seller's immediate cash requirements. The loan will be paid off when the borrower realizes his sale proceeds.

Ans: Origin, Growth and development of banks in India

The word Bank has been originated from many words. There is no single word or answer to this origin of the word ‘Bank’. According to some economists, the word ‘Bank’ has been originated from the German word ‘Banck’ which means heap or mound or joint stock fund. From this, the Italian word ‘Ban co’ has been derived. It means heap of money. But according to this group, the word bank is derived from the Greek word ‘Banque’ which mean a ‘bench’. It refers to a place where money-lenders and money changers used to sit and display their coins and transact business. Thus the origin of the word ‘Bank’ can be traced as follows.

Bank → Banco → Banque → Bank

Banking industry in India has a long history. It has travelled a long path to assume its present form. The banking industry in Indian started with small money lenders and has now large joint stock world class banks in its fold. The growth of banks in India is discussed below over two eras:

A) Pre-Independence Period: Banking in its crude from is as old as authentic history. All throughout the period of India history, indigenous bankers and money lenders are recorded to have existed and carried on the business of banking and money lending on a large scale. Between 2000 and 1400 BC during the Vedic Period records of deposits and lending are found. Renowned Hindu Law giver Manu has dealt with the matter of deposits and pledges in section of his work. According to Manu – “a sensible man should deposit has money with a person of good family, or good conduct, will acquainted with the Law, veracious, having many relatives, wealthy and honourable”. Reference is also made to the same in Kautilya’s Arthashastra. The Indian banks enjoyed considerable public confidence and this can be gauged from fact that hundis were used from the days of Mahabharata. During the Moghul Period, the indigenous bankers were most prominent in connection with the financing of trade and use of instruments of trade. From the early Vedic period right through the Moghul period as well as that of the East India Company’s rule until the middle of the 19^th Century, indigenous bankers were the hub of the Indian Financial System providing credit not only to the trade but also to the Government.

Agency House: The indigenous bankers lost their importance to a certain with the advent of the English traders in India. The starting of modern banking in India can be traced to the beginning of the East India Company’s trade relation with our country. The growing trade Interest of the English merchants and non-existence of any organised banks in India, many English Agency Houses which were essentially trading company started to add banking business to their activities. The bank of Hindustan, was the earliest bank started under European direction in India. The banking business of Agency House could not continue for long. Most of these Houses failed because of their complete disregard towards the principle of banking business. The Bank of Hindustan could not withstand the failure of its parent from and was closed down in 1832.

Presidency Banks: The banking business of Agency House which survived and continued to carry on trade and banking together was progressively taken over by the Presidency Banks. The three Presidency Banks   viz.:

a) The Bank of Bengal (1809);

b) The Bank of Mumbai (1840); and

c) The Bank of Chennai (1843)

were established under the Charter of the East India Company. These Banks acted as banker to the East India Company at Kolkata, Mumbai and Chennai and performed Central Banking functions for their respective areas.

Principle of Limited Liability: A land-mark development took place in the year 1860. It was in this year the principle of “limited liability” was first applied to the joint stock banks. Till then little or so banking legislation existed in India. Many banks has arised like mushrooms and failed, mostly due to speculation, mismanagement and fraud on the part of the management. The introduction of the principle of limited liability promoted the growth of banks in India. By 1895, there were 15 joint stock banks with limited liability in India.

The Swadeshi Movement: Swadeshi movement prompted Indians to start many new institutions. The number of joint stock banks increased remarkably during 1906-1913. The peoples Bank of India Limited, the Bank of India Limited, the Central Bank of India Limited, Indian Bank Limited and the Bank of Baroda Limited were setup during that period.

Imperial Bank of India: The three Presidency Banks were amalgamated into the Imperial Bank of India which was brought into existence on 27^th January, 1921, by the Imperial Bank of India Act, 1920. The liability of shareholders of the Imperial Bank was limited like that of shareholders of other banks registered under the Company Act. However the word “limited” did not from a part of the name of the Bank.

B) Post-Independence Period: After independence, Government has taken most important steps in regard of Indian Banking Sector reforms. In 1955, the Imperial Bank of India was nationalized and was given the name “State Bank of India”, to act as the principal agent of RBI and to handle banking transactions all over the country. It was established under State Bank of India Act, 1955.

In 1959, the 'State Bank of India' (Subsidiary Banks) Act was passed by which the public sector banking was further extended. The following banks were made the subsidiaries of State Bank of India:

(i) The State Bank of Bikaner

(ii) The State Bank of Jaipur

(iii) The State Bank of Indore

(iv) The State Bank of Mysore

(v) The State Bank of Patiala

(vi) The State Bank of Hyderabad

(vii) The State Bank of Saurashtra

(viii) The State Bank of Travancore

These banks forming subsidiary of State Bank of India was nationalized in1960. In 1963, the first two banks were amalgamated under the name of "The State Bank of Bikaner and Jaipur".

On 19th July, 1969, 14 major Indian commercial banks of the country were nationalized. In 1980, another six banks were nationalized, and thus raising the number of nationalized banks to20. Seven more banks were nationalized with deposits over 200 Crores. Later on, in the year 1993, the government merged New Bank of India with Punjab National Bank. It was the only merger between nationalized banks and resulted in the reduction of the number of nationalized banks from 20 to 19. Till the year1980 approximately 80% of the banking segment in India was under government’s ownership. On the suggestions of Narsimhan Committee, the Banking Regulation Act was amended in 1993 and hence, the gateways for the new private sector banks were opened.

Or

Ans: In addition to the business of banking, a banking company may engage in any one or more of the following forms of business, namely,-

(a) the borrowing, raising, or taking up of money; the lending or advancing of money either upon or without security; and drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of exchange, hundies, promissory notes, coupons, drafts, bill of lading, railway receipts, warrants, debentures, certificates, scrips and other instruments, and securities whether transferable or negotiable or not; the granting and issuing of letters of credit, travelers' cheques and circular notes; the buying, selling and dealing in bullion and specie; the buying and selling of foreign exchange including foreign bank notes; the acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments of all kinds; the purchasing and selling of bonds, scrips or other forms of securities on behalf of constituents or others; the negotiating of loan and advances; the receiving of all kinds of bonds, scrips or valuables on deposit or for safe custody or otherwise; the providing of safe deposit vaults; the collecting and transmitting of money and securities;

(b) acting as agents for any government or local authority or any other person or persons; the carrying on of agency business of any description including the clearing and forwarding of goods, giving of receipts and discharges and otherwise acting as an attorney on behalf of customers, but excluding the business of a 30[Managing Agent or Secretary and Treasurer] of a company;

(c) contracting for public and private loans and negotiating and issuing the same;

(d) the effecting, insuring, guaranteeing, underwriting, participating in managing and carrying out of any issue, public or private, of State, municipal or other loans or of shares, stock, debentures or debenture stock of any company, corporation or association and the lending of money for the purpose of any such issue;

(e) carrying on and transacting every kind of guarantee and indemnity business;

(f) managing, selling and realizing any property which may come into the possession of the company in satisfaction or part satisfaction of any of its claims;

(g) acquiring and holding and generally dealing with any property or any right, title or interest in any such property which may form the security or part of the security for any loans or advances or which may be connected with any such security;

(h) undertaking and executing trusts;

(i) undertaking the administration of estates as executor, trustee or otherwise;

(j) establishing and supporting or aiding in the establishment and support of associations, institutions, funds, trusts, and conveniences calculated to benefit employees or ex-employees of the company or the dependents or connections of such persons; granting pension and allowances and making payments towards insurance; subscribing to or guaranteeing moneys for charitable or benevolent object or for any exhibition or for any public, general or useful object;

(k) the acquisition, construction, maintenance and alteration of any building or works necessary or convenient for the purpose of the company;

(l) selling, improving, managing, developing, exchanging, leasing, mortgaging, disposing of or turning into account or otherwise dealing with all or any part of the property and rights of the company;

(m) doing all such other things as are incidental or conducive to the promotion or advancement of the business of the company;

(o) any other form of business which the Central Government may, by notification in the Official Gazette, specify as a form of business in which it is lawful for a banking company to engage.

Ans: Branch Banking – Introduction, Advantages and Disadvantages

Branch Bank is a type of banking system under which the banking operations are carried with the help of branch network and the branches are controlled by the Head Office of the bank through their zonal or regional offices. Each branch of a bank will be managed by a responsible person called branch manager who will be assisted by the officers, clerks and sub-staff. In England and India, this type of branch banking system is in practice. In India, State Bank of India (SBI) is the biggest public sector bank with a very wide network of 16000 branches.

According to Gold field and chandler,” A branch bank is a baking corporation that directly own two or more banking agencies.”

Thus branch banking is a system in which a bank renders its banking activities at two or more places. Head office has the overall control over the working of various branches.

Advantages of Branch Banking: Branch banking system has the following advantages:

1. Economies of Large Scale operations: Branch banking enjoys the advantages and economies of large scale operations. Under branch banking system economies can maintained through large scale of operations and wider geographical coverage increase public confidence in the banking system.

2. Economy of Cash Reserves: Under branch banking system a particular branch can operate without keeping large amounts of reserves. In time of need, resources can be transferred from one branch to another. It is not easy for a .unit bank to draw on another unit bank.

3. Proper use of capital: There is a proper use of capital under the branch banking system. Since the resources are transferred from one branch to another. So the capital can be properly used by investing in the profitable branches.

3. Economy of Costs: Branch banking has the advantage of effecting remittances of funds from one place to another with greater ease and at a lesser cost than unit banking, for inter-office indebtedness can be far more easily adjusted.

4. Risks-spreading Economy: The spreading of risks geographically is another major advantage of the branch banking system. In branch banking, losses incurred one branch can be offset by profits earned by the profit making branches which is not possible in case of unit banking.

5. Easy and cheaper transfer of funds: Since the branches of bank under branch banking are spread all over the country, it is easier and cheaper, for it to transfer funds from one place to another.

6. Greater Safety and Liquidity: Branch banking also offers a wider scope for the selection of diverse securities and varied investments, so that a higher degree of safety and liquidity can be maintained.

7. Balanced economical growth: Under branch banking, the banking facilities can be made available to all cities, towns, and even backward areas in the country. Thus, branch banking is very helpful in achieving a balanced growth of the country's economy.

8. Convenient for the Central Bank's Supervision: Under a system of branch banking it is more convenient for the central bank or the government to regulate and supervise the activities of banks, as control becomes more effective and easier since only the head office is to be dealt with for the purpose.

9. Provision for Training the Personnel: Finally, branch banking provides the best training ground for personnel. A person may be trained in a small branch Where the pressure of work is less and he may be transferred later to an active branch.

Disadvantages or Demerits of Branch Banking: Branch banking generally suffers from the following limitations:

1. Danger of Mismanagement: Under the branch banking system a number of difficulties as regards management, supervision and control, a number of branches undue expansions lead the danger of mismanagement.

2. Delays in Decision-making: The system of branch banking also suffers from red tape and delay on account of the inadequate authority of branch managers. Usually, application for big credits has to be referred to the head office by the branch manager. This causes delay and gives little initiative to branch managers.

3. Lack of Personal Contact: A large bank tends to become more and more impersonal in its dealings. The general managers have hardly any personal contact with the local people or the staff of different branches.

4. High operating and maintenance expenses: Branch banking is very expensive, because with the opening of too many branches, establishment and maintenance charges of the branches are bound to be high and, as a result, profits may shrink.

5. Concentration of Monopoly Power in the hands of few banker: Branch banking sometimes creates monopoly power in the hands of few large bankers. Such a monopoly power in the hands of a few big bankers is a source of danger to the community whose goal is a socialistic pattern of society.

6. Lack of initiative: Branch banking lacks initiative. No branch office can take independent decisions and also branch manager has limited powers.

7. Regional imbalances: Branch banking encourages regional imbalances. The financial resources of economically backward areas tend to get transferred to industrial and business centres. Due to which backward areas continue to be neglected and remain over backward.

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(b) Distinguish between:                                                                                              6+6=12

Ans: Public sector banks and Private sector banks

Public Sector Banks: Public Sector Banks are those banks in which majority stake (i.e., more than 50% of the shares) is held by the government of the country. The words such as “The” or “Ltd” will not be found in their names because the ownership of these banks are with the government and the liability is unlimited in nature. Some examples of public sector banks in India include Andhra Bank, Canara Bank, Union Bank of India, Allahabad Bank, Punjab National Bank, Corporation Bank, Indian Bank and so on.

Private Sector Banks: Private Sector Banks are those banks which are owned by group of private shareholders. They elect board of directors which manages the affairs of the banks. Some examples of private banks in India include The Lakshmi Vilas Bank Ltd., The Karur Vysya Bank Ltd., The City Union Bank Ltd., HDFC Bank, Axis Bank and son.

Investment: The term investment means employment of funds to buy an asset. Here investment means employment of funds by the banks to buy securities from the market. The securities which are purchased by the banker from the market includes:

Besides these securities, banks also invest in fixed deposits, units and capital of various financial institutions. However, amongst all these, a marked preference of the banker is noted in favour of government and semi-government securities. Investment by banks in these securities constitutes the “third line of defence” of the banks.

Principles of Sound Investment: Banks are one of the genuine investors in the securities market. Banks invest in the market in the hope of earning some return. However the investment of funds by banks involves borrowed funds and hence their prime concern is the safety of the funds invested. A banker therefore select the securities very carefully and follow the following principles of sound investments:

                In conclusion, it may be said that for a banker the government and semi-government securities are most ideal for investment of funds. Government securities with virtually no risks, have a ready market, are eligible for refinance and bring reasonably good return.

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Ans: Nationalisation of Banks in India: Nationalization is a process whereby a national government or State takes over the private industry, organisation or assets into public ownership by an Act or ordinance or some other kind of orders.  This strategy has been frequently adopted by socialist governments for transition from capitalism to socialism. 

The banking sector in India has been facing extreme changes with the economic growth of the country. In 1948, RBI (Transfer of public ownership) Act was passed to nationalised the Reserve Bank. On Jan 1, 1949, RBI was nationalised. In 1955, the Imperial Bank of India was nationalized and was given the name “State Bank of India”, to act as the principal agent of RBI and to handle banking transactions all over the country. It was established under State Bank of India Act, 1955.

On 19th July, 1969, 14 major Indian commercial banks of the country were nationalized. In 1980, another six banks were nationalized, and thus raising the number of nationalized banks to20. Seven more banks were nationalized with deposits over 200 Crores. Later on, in the year 1993, the government merged New Bank of India with Punjab National Bank. It was the only merger between nationalized banks and resulted in the reduction of the number of nationalized banks from 20 to 19. Till the year1980 approximately 80% of the banking segment in India was under government’s ownership. On the suggestions of Narsimhan Committee, the Banking Regulation Act was amended in 1993 and hence, the gateways for the new private sector banks were opened.

In spite of these criticisms, we cannot ignore the fact that at present, nationalisation of banks is an accomplished fact. By and large this measure received support from almost all sections of the public. It was welcomed by the middle class people and small industrialists and small traders.

Ans: The money market is not a well-defined place where the business is transacted as in the case of capital markets where all business is transacted at a formal place, i.e. stock exchange. The money market is basically a telephone market and all the transactions are done through oral communication and are subsequently confirmed by written communication and exchange of relative instruments.

From the above definition, it is clear that the money market consist of many sub-market such as the inter-bank call money, bill discounting, treasury bills, Certificate of deposits (CDs), Commercial paper (CPs), Repurchase Options/Ready Forward (REPO or RF), Inter-Bank participation certificates (IBPCs), Securitized Debts, Options, Financial Futures, Forward Rate Agreement (FRAs), etc. which collectively constitute the money market.

A well-developed money market is essential for a modern economy. Though, historically, money market has developed as a result of industrial and commercial progress, it also has important role to play in the process of industrialization and economic development of a country. Importance of a developed money market and its various functions are discussed below:

1. Financing Trade: Money Market plays crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.

2. Financing Industry: Money market contributes to the growth of industries in two ways:

(a) Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc.

(b) Industries generally need long-term loans, which are provided in the capital market. However, capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market.

3. Profitable Investment: Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity.

4. Self-Sufficiency of Commercial Bank: Developed money market helps the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market.

5. Help to Central Bank: Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank.

Money market helps the central bank in two ways:

(a) The short-run interest rates of the money market serves as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy,

(b) The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policy.

Or

Ans: E-Banking or Internet banking

Online banking also known as internet banking, e-banking, or virtual banking, is an electronic payment system that enables customers of a bank or other financial institution to conduct a range of financial transactions through the financial institution's website. Internet banking is a term used to describe the process whereby a client executes banking transactions via electronic means. This type of banking uses the internet as the chief medium of delivery by which banking activities are executed. The activities clients are able to carry out are can be classified to as transactional and non transactional.

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Ans: Revolving Credit Facility: Under a Revolving Credit Facility a bank fixes up a credit limit to a borrower for certain period, say Rs.10 crore for 3 years period. The borrower will get a maximum credit facility of Rs.10 crore at any point of time once the loan is repaid. The borrower's facility automatically gets renewed up to Rs.10 crore during the 3 year period any number of times. In other words, the credit facility revolves around with a maximum of Rs.10 crore outstand­ing at any point of time over a 3 year period. In principle, under a Revolving Facility there is no formal repayment period. The borrower is allowed to draw, repay and again draw throughout the loan period.

Ans: Retail banking is a major form of commercial banking but mainly targeted to consumers rather than corporate clients. It is the method of banks' approach to the customers for sale of their products. The products are consumer-oriented like offering a car loan, home loan facility, financial assistance for purchase of consumer durables, etc. Retail banking therefore has large customer-base and hence, large number of transactions with small values. It may therefore be cost ineffective in a highly competitive environment. Most of the Rural and semi-urban branches of banks, in fact, do retail banking. In the present day situation when lending to corporate clients lead to credit risk and market risk, retail banking may eliminate market risk. It is one of the reasons why many a wholesale bankers like foreign banks also prefer to go for consumer financing albeit for marginally higher net worth individual.

Advantages of Retail banking: Advantages of Retail Banking are given below

Disadvantages of Retail Banking: Disadvantages of Retail Banking are given below: