Sources of Funds  

Savings Deposits

Deposits remain the main source of funds for a commercial bank. The money collected
can go toward paying on interest-bearing accounts, completing customer withdrawals
and other transactions. As of February 19, 2018, the total amount of savings deposits
held at commercial banks and other banking institutions in the U.S. totaled more than
$9.1 trillion.

Savings account deposits are especially important to banks as the federal Regulation D
law limits the amount of times a savings account holder can withdraw money. Currently,
the law mandates that account holders can perform six transfers per month in the form
of online, telephone or overdraft transfers. This allows banks to use the accounts' funds
and still meet the withdrawal needs of the customer.

Reserve Funds

A commercial bank builds a reserve fund with deposits so it can pay interest on
accounts and complete withdrawals. Ideally, a bank's reserve fund should be equal to
its capital. A bank builds its reserve fund by accumulating surplus profits during healthy
financial years so that the funds can be used in leaner times. On average, a bank tries
to accumulate approximately 12 percent of its net profit to build and maintain its reserve
fund
Shareholders Capital

Some commercial banks that trade on the stock exchange can use shareholders' capital
to receive the money it needs to stay in business. For example, if a company sells
shares on the market, it increases both its cash flow and its share capital. This process
is also known as equity financing. Banks can only report the amount of capital that was
initially on their balance sheet. Appreciation and depreciation of shares do not count
toward the total sum of a shareholder's capital.

Each time a bank makes a profit it can generally make two choices that include paying

dividends to their shareholders or reinvesting the money back into the bank. Most banks utilize

both options as they will retain a portion of the profit and pay the remainder to their

shareholders. The amount reinvested into the bank typically depends on the company's policy

and the condition of the stock market

Retained Earnings

A lot of commercial banks earn retained earnings or fees to help fund their business. A
retained earning can be collected through overdraft fees, loan interest payments,
securities and bonds. Banks also charge fees for providing customers with services
such as maintaining an account, offering overdraft protection and also monitoring
customers' credit scores.
Banking Sector Reforms in
India: 
After assuming office in June 1991, the then Cong (I) Government,
headed by P.V. Narsimha Rao, introduced major changes in economic
policies consequent upon terrific macroeconomic imbalances
developed in the Indian economy over the last 1 or 2 years.

Such economic policies came to be known as structural reforms.

Devaluation of the Indian rupee, liberalised new EXIM Policy, new

Industrial Policy were the critical elements in structural reforms.
Following these reforms, the Indian economy became more free and
competitive. Successful implementation of trade and industrial
policies demanded that the resource allocation needed to be market-
driven.

In other words, these two reforms needed another prop—the financial

sector reforms—so that scarce investible funds could be channelised in
the productive sectors. It is not enough, however, to change the rules
of monetary management; what is needed is the comprehensive
reform of the banking system, the capital market and their regulations.
This is because the financial sector is at the centre of economic
activity; its health affects the entire economy.

1. Narasimham Committee’s Recommendations:

Against this backdrop, a Committee under the chairmanship of M.
Narasimham was set up by the Government of India to examine the
country’s financial system and its various components and to make
recommendations for reforming and improving the country’s financial
sector. The report was placed before the Parliament in December 1991.

Its major recommendations were:

(a) Establishment of a four-tier hierarchy for the banking
sector:
(i) 4 to 5 large commercial banks which could be of international
character. One such bank is the State Bank of India;

(ii) 8 to 10 national banks having nationwide branches engaged in

universal banking;

(iii) Small banks where business would be confined to specific regions;

and

(iv) Rural banks whose operation would be confined to rural areas

only.

b) Abolition of branch licensing system. Banks themselves would be

allowed to open or close branches.

(c) Entry of private banks, easing of restrictions on foreign banks and

full stop on further nationalisation of banks.

(d) Allowing nationalised banks to issue fresh capital to the public

through the capital market.

(e) Phased reduction of statutory liquidity ratio (SLR) from 38.5 p.c. to
25 p.c. over 5 years, reduction of cash reserve ratio (CRR), from 15 p.c.
to 3 to 5 p.c. over the next five years, and payment of interest on CRR
to commercial banks.

(f) Phasing out of directed credit to priority sectors down to 10 p.c. of

the aggregate bank credit.

(g) Deregulation of interest rates and bringing them on government

borrowing in line with the market-determined rates.

(h) Tightening of prudential norms and strengthening of banking

supervision.

(i) Issue of prudential guidelines governing the financing of financial

institutions.
(j) Proper classification of assets and full disclosure and transparency
of accounts of banks and other financial institutions

(k) Attainment of a minimum 4 p.c. capital adequacy ratio in relation

to risk weighted assets within three years.

(l) Increased competition in lending between ‘development financial

institutions’ and banks.

(m) Setting up of an institution to be called Asset Reconstruction Fund

with a view to taking over a portion of the loan portfolio of banks
which has become bad and doubtful and whose recovery is not easy.

2. Measures Taken So Far:

The Government of India has taken a series of measures following the
recommendations of the Narasimham Committee. At the outset, a
strategy was mapped out to reverse the financial repressions and too
much interference and interventions that characterised the country’s
banking sector almost from the late 1960s was required to be
removed. After 1991, the ‘liberalisation’ approach gave the ‘market’ a
greater role in price-setting and assigned a bigger role to the private
sector in the country’s development.

There has been significant progress in several areas of the banking

sector. In fact, the banking sector has undergone several significant
structural reforms, the capital markets are deeper and more liquid and
equity markets are zooming up. In 2003, it was said by the Standard
Poor that the Indian banking sector had moved from ‘negative’ to
‘stable’. Fitch Ratings assessed that the economic reforms carried out
so far have considerably ‘strengthened’ the fundamentals of the entire
financial sector of India.

As a result of reforms made in the financial sector we now see very

‘limited’ market- based decision-making. For instance—deposit and
lending rates—which had been mostly ‘administered prices’—have now
been liberalised and are being mostly determined by market forces, of
course, subject to a ceiling stipulated by the RBI.
CRR and SLR—which were hiked to 15 p.c. and 38.5 p.c., respectively,
prior to economic reforms—have now been reduced to 5 p.c. (January
2009) and 24 p.c. (November 2008)

Following the recommendations of the Narasimham Committee,

prudential norms for income recognition, classification of assets and
provisioning of bad debts have been introduced. Earlier, no uniform
practices for income recognition, asset classification into performing
and non-performing ones, provisioning for non-performing assets
(NPAs), valuation for securities held in the banks’ portfolio had been
followed by the Indian banking industry. Even capital adequacy
requirements (i.e., the capital base of the banks need to be promoted
to lend more) had not been uniform.

Following the recommendations of the Narasimham Committee,

prudential norms for income recognition, classification of assets and
provisioning of bad debts have been introduced. Earlier, no uniform
practices for income recognition, asset classification into performing
and non-performing ones, provisioning for non-performing assets
(NPAs), valuation for securities held in the banks’ portfolio had been
followed by the Indian banking industry. Even capital adequacy
requirements (i.e., the capital base of the banks need to be promoted
to lend more) had not been uniform.

Reconstruction Company (India) Ltd. has also provided a great boost

to banks’ efforts to recover dues from the defaulting borrowers.

One of the landmark developments in the reform of the financial

sector is the enactment of the securitisation and reconstruction of Fi-
nancial Assets and Enforcement of Securities Interest (SARFAES1) Act
of June 2002. This Act is meant to facilitate foreclosures and enforce-
ment of securities in cases of default and to employer banks and other
financial institutions to recover their dues, even without
court/tribunals’ intervention. This Act actually paved the way for the
creation of ARCI Ltd.
It may be recalled here that one of the major contributing factors for
NPA reduction is the change in the policy of directed and priority
sector lending. The commitment of directed credit to priority sector to
the tune of 40 p.c. had been considered as huge and that too needed to
be cut drastically to 10 p.c. as recommended by the Narasimham
Committee.

Such directed or priority sector lending by the public sector banks

after bank nationalisation created a ‘loan-mela, loan-mafia political
culture’ in the country. By putting a cap on such lending requirements,
reduction of interest rate, subsidy on loans, etc. have now improved
the financial health of the banking industry quite significantly in the
reform era and, hence, reduction of NPAs.

In the name of structural reforms, the Government of India has been

allowing the entry of private sector banks and foreign banks. However,
the licensing requirements of the RBI suggest that these private
bankers would open branches in the rural areas too, after a
moratorium period of three years. This requirement, thus, allows
private banks to fulfil some sort of’ social banking service’ goal.

3. Impact of Reforms:
Thus, reforms in the banking sector have made an indelible mark on
it. It is now experiencing increased efficiency (measured in terms of
profitability or reduction of NPAs, etc), systematic stability, and
financial deepening with greater access.

The basic objectives of financial sector reforms, that is efficiency,

stability and financial deepening, have been largely fulfilled because of
priority sector lending liberalisation, prudential framework and
increased competition between nationalised banks and other banks. It
is said that in some areas the banking sector is inching towards world
standards (in terms of prudential norms and systems).
According to T.T. Ram Mohan; “It is not just that Indian banks have
achieved a turnaround. They have gone on to become among the most
profitable in the world. Internationally, a return of 1 per cent on assets
is considered a benchmark of excellence.” India’s PSBs’ profitability,
measured by net return on assets, rose to a height of 1.12 p.c. in 2003-
04.

However, it declined to 0.8 p.c. in 2006-07 and remained unchanged

from the previous year. Non-performing assets of PSBs have been
showing a decelerating trend. It declined from Rs. 53,174 crore in 2001
to Rs. 38,602 crore in 2007. Gross NPAs as proportion of total assets
has declined from 1.8 p.c. in 2005-06 to 1.5 p.c. in 2006-07.

Meanwhile, in view of the rising NPAs for the first time in 2007-08
since 2001-02, the RBI has cautioned banks not to make any
compromise in the quality of lending. This is because of the policy
stance of the commercial banks relating to the aggressive lending to
the real estate and housing sectors, particularly by private and foreign-
owned banks. Gross NPAs of all scheduled commercial banks shot up
by Rs. 6,126 crore to touch Rs. 56,345 crore during 2007-08.

Unless corrective actions are not taken to prevent ‘undue asset-

liability mismatches’ following mainly defaults and non-payments by
borrowers, the banking industry may experience severe liquidity
crunch against the backdrop of economic recession of 2008-09.
Further, capital adequacy ratio has gone up to 12.7 p.c. in recent years
(2006-08), well above the regulatory minimum of 9 p.c.

Seeing the remarkable performances of banking sector in the reform

era, the London Economist remarked in May 2006: “Earlier, it used to
be argued that the government should get out of PSBs because they
were doing badly. Now it is contended that the government should get
out because they are doing well!”

Despite these progresses and achievements, systemic weaknesses still

remain in the banking sector. Even today, the financial system has not
been able to come out of the ‘government-serving syndrome’. As far as
conduct and allocation of resources are concerned, the financial
system, in effect, tends to serve the government in its objectives.
Secondly, NPAs are declining and profits of banks are rising. This is
definitely a healthy sign.

But it is said that the rise in profitability of banks in India is attributed

to non-interest income (roughly two-thirds of the sub- Standard assets
of scheduled commercial banks). Coming to the composition of loans,
it is observed that bad loans of Indian banks tend to be concentrated
largely on ‘priority sectors’ like heavy industries, infrastructure
projects, etc. instead of stock market or real estate (sensitive sector).
However, profit per employee for the nationalised banks has shown an
accelerating trend. It rose from Rs. 2.23 lakh per employee in 2005-06
to Rs. 2.87 lakh in 2006-07.

The RBI, in its Annual Report 2007-08 presented in August 2008,

says; “As a result of various reforms, the financial markets have
transited to a regime characterised by market- determined interest
and exchange rates, price based instruments of monetary policy—
current account convertibility, phased capital account liberalisation
and an auction-based system in the government securities market…
The vulnerability of financial intermediates can be addressed through
prudential regulations and supervision.”
quantitative and qualitative measures of credit control

Quantitative Measures The quantitative measures of credit control are as follows:

Bank Rate Policy

The bank rate is the Official interest rate at which RBI rediscounts the approved bills held by
commercial banks. For controlling the credit, inflation and money supply, RBI will increase the
Bank Rate
Open Market Operations
Open Market Operations refer to direct sales and purchase of securities and bills in the open
market by Reserve bank of India. The aim is to control volume of credit.
Cash Reserve Ratio
Cash reserve ratio refers to that portion of total deposits in commercial Bank which it has to keep
with RBI as cash reserves.
Statutory Liquidity Ratio
SLR refers to that portion of deposits with the banks which it has to keep with itself as liquid
assets(Gold, approved govt. securities etc.) If RBI wishes to control credit and discourage credit
it would increase CRR & SLR.

Qualitative Measures
Qualitative measures are used by the RBI for selective purposes. Some of them are
Margin requirements
This refers to difference between the securities offered and amount borrowed by the banks.
Consumer Credit Regulation
This refers to issuing rules regarding down payments and maximum maturities of instalment
credit for purchase of goods.
RBI Guidelines
RBI issues oral, written statements, appeals, guidelines, warnings etc. to the banks.
Rationing of credit
The RBI controls the Credit granted / allocated by commercial banks.
Moral Suasion
Psychological means and informal means of selective credit control.
Direct Action
This step is taken by the RBI against banks that don’t fulfil conditions and requirements. RBI
may refuse to rediscount their papers or may give excess credits or charge a penal rate of interest
over and above the Bank rate, for credit demanded beyond a limit.

Future of Indian Banking Sector

The Bank of Hindustan and the General Bank of India were established in the late 18 thcentury
but did not survive for very long. The British presidency government then established the Bank
of Calcutta, Bank of Bombay, and Bank of Madras which were merged in 1921 to form the
Imperial Bank of India. In 1955 it became the State Bank of India and is the oldest surviving
bank in India. A number of banks have been established pre and post independence. In 1935
the Reserve Bank of India was established and it was nationalized in 1949. That same year the
Banking Regulation Act was passed, which authorized the Reserve Bank of India to regulate,
control and inspect all banks in India. It also stipulated that RBI will have to authorize the
establishment of any new banks.
Technological innovation began in the Banking sector back in the 1980s. Since the
establishment of the ICICI Bank, digitization in banking industry has been commendably fast.
Banks offering a number of services over the internet has resulted in the growth of banking
sector in India. Banks have been able to expand their customer base, provide additional
services, and ensure that customers are able to handle a number of banking tasks over the
internet in the comfort of their homes or offices.

The rapid changes that the banking sector in India has experienced are indicative of the future
of banking in India. We can expect further rapid technological changes that would revolutionize
customer experience regarding Banking. The future of banking technology will indeed be
beyond expectations.

Digitization in Banking Industry

Digitization in banking industry basically refers to the different services rendered by the bank
being available online. It is also called internet banking, or online banking. Mobile banking,
telephone banking, use of ATMs, et al are all aspects of digitization in banking industry.
Banking Industry Analysis
A banking industry analysis provides some keen insights into the working and growth of
banking sector in India. Let us consider some factors that are involved.
1. Robust Economy:
With liberalization in the 1990s, the Indian economy grew rapidly. Many multinationals have
their operations in India. Outsourcing jobs from developed countries has created an additional
job market in India. Our GDP percentage has continued to increase. A growing economy would
require good banking services and would automatically contribute to the positive future of
banking industry.

2. Education:
With education being stressed so much, Gen Y is not satisfied with just basic education. Most of
them take on higher education, as well as go for specialized courses. Education helps them take
on specialized jobs which also pay more. Increasing financial capabilities of individuals creates a
demand for good banking services and thus contributes to the growth of banking sector.

3. Population:
The increase in working population has meant that more individuals have additional disposable
income, resulting in the need for banking services. This is true not only with regard to cities but
also with regard to rural population.

4. Operational Efficiency:
Technology has drastically improved the operational efficiency of the banking industry. This has
made it possible for more individuals to open and operate bank accounts much more easily
and has led to the growth of the banking sector in India.

5. Digitization:
Digitization has lowered operating costs and increased the profitability of the banks. This in
turn has made it possible for banks to offer a higher rate of interest, which attracts customers.

The socio-economic trends we see in India today only indicate a steady growth of the banking
sector in India. This growth will also be the fuel for further development of banking technology,
thus brightening the future of Indian banking sector.

Recent Developments in Banking Sector

Like any other industry, computerization and new technology is very rapidly changing the face
of banking. Or perhaps it can be said that in recent times the entire concept of banking has
undergone a change, and it is not over yet. Consider some recent developments in banking
sector:

1. Electronic Cheques:
The Negotiable Instruments Act has undergone a number of amendments and now includes
the provision of truncated cheques and e-cheque instruments. Soon we can expect e-cheques
to replace paper cheques in the banking process.
2. Fund Transfers:
India has introduced a number of options to make fund transfers easy. Using Real Time Gross
Settlement (RTGS), electronic instructions can be given to banks to transfer funds to another
bank account. This is done on a ‘real time’ basis, which means that the receiving bank has the
money instantly and the beneficiary has the money in their account within two hours. RBI
provides the Electronic Funds Transfer (EFT) facility wherein funds could be transferred to the
account of another person or company. Large companies or government organizations can use
Electronic Clearing Service (ECS) whereby they can make bulk payments or receipts of a similar
nature from/to multiple parties. Individuals and organizations can also use the National
Electronic Fund Transfer (NEFT) to make one to one payments.

3. Tele Banking:
Banks have started providing a number of services over the telephone. Chatbots are used for a
number of queries and phone banking executives handle the rest of the queries.

4. Mobile Banking:

A number of banks have developed applications providing different banking services. We can
expect to have more services provided through these applications and we will see the user
interface becoming more user friendly.

5. Purchases:
Point of Sale (POS) terminals scan a magnetically encoded card (debit/credit card) to enable a
fund transfer from the customer to the business. A number of digital wallets are also now
available. These enable a customer to electronically debit a certain amount from his account
and credit it to the business’ account. PayPal, PayTM, MobiKwik, PhonePe, and other such e-
wallets are becoming increasingly common, especially as the government is encouraging
cashless transactions.

6. Automatic Teller Machines:

ATMs are perhaps the most widely used aspect of digital banking. Today however, ATMs not
only allow a person to withdraw cash at any time of the day, but also allow an individual to pay
their utility bills, and even transfer funds between accounts, besides offering other services.

Future of Banking Technology

What is the future of Indian banking sector? The future of Indian banking sector is tied in with
the future of banking technology.
1. Machine Learning:
Data science can be used to predict the needs of customers and provide them with customized
products that suit their needs.

2. Artificial Intelligence
With AI making inroads in digital banking in India, there will be changes to banking processes.
We can expect to see smarter operations as backend processes are streamlined.
3. Personalized Service:
Digital banking will help customize the screens for customers based on their usage history. It
will also allow for automatically filling in certain information required on online forms. This will
ensure a much better user experience.

4. Security:
While passwords and OTPs are already in use, we can look forward to advanced biometric
authentication, voice recognition and face recognition in the near future. ATMs will become
contactless, and the mobile phone would be used to operate it.

5. Blockchain Technology:
More and more banks will adopt blockchain technology which means that the account details of
a customer will be maintained in real-time across banks while eliminating the risk of hacking by
criminals. Financial transactions become encrypted packets called blocks and get added to an
encrypted chain, much like an email chain.

Future of Banking in India

Banking in India is at the crossroads now. They are under intense pressure to accept and evolve
with digitization. Their very existence is at stake. They need to adopt a holistic approach to
digitization. It is not just a customer relation tool, neither is it just something that speeds up a
banking process. It is changing the entire concept of banking. Product innovation and
development according to the needs of individual customers is the current buzzword. The
agility that banks in India have displayed during the past couple of decades demonstrates that
they will continue to evolve. The Indian banking sector will continue to grow, and digitization
will continue. Banking will be an important aspect of economic growth. The future of banking
technology is e-banking or digital banking.

What can we expect?

When the digitization in banking industry becomes mature, we can imagine a scenario
somewhat like what we experience with the World Wide Web today. Banks will lose their
individual identity because to the customer they will all be interconnected and will provide all
their services online. No more physical trips to the bank, no more bank counters, and so on.
Instead customers will access all banking services and do all their banking activities over the
internet, in the comfort of their homes or offices.
The future of Indian banking sector is bright because we have seen them take on technology,
innovate its use, and improve their customer services with digitization. Recent developments in
the banking sector give us confidence in the growth of banking sector in India