A banking company, like any other company or corporate body, is an artificial person

existing
only in the eyes of law. It has separate legal entity with no physical existence of its own. It
acts through the natural human beings that are termed as ‘directors’ and collectively
designated as ‘Board of directors’. It is the supreme authority which manages the affairs of a
bank and is responsible for efficient operations and management of the bank.
Banking refers to any business entity that accepts and safeguards the finances of other
persons and organizations and lends the finances to carry out economic activities such as
making profits. Banking is important in the economy since it provides crucial services for
both businesses and consumers, such as offering car loans, offering checking accounts, home
loans, among other services. Significances of banking in our day to day life include:

 Provision of credit opportunities for cooperation and individuals.

 Facilitates the flow of funds in the economy.
 Ensures financial resource is efficiently allocated towards economic growth and
development.
 Banks are incorporated into our daily life activities like paying salaries, withdrawals,
and savings.

Various types of bank accounts exist to attend to the different needs of the consumers. The
following are the different types of banking accounts and the purpose they serve.
“Banking is the business of accepting for the purpose of lending or investment, of deposits of
money from the public repayable on demand or otherwise and withdraw-able by cheque,
draft, and order or otherwise.” Indian Banking Regulation Act, 1949.

“ Bank is a financial intermediary institution which deals in loans and advances”--- Cairn
Cross.

“ Bank is an institution which collects idle money temporarily from the public and lends to
other people as per need.”---- R.P. Kent.

“ Bank provides service to its clients and in turn receives perquisites in different forms.”---
P.A. Samuelson.

“ Bank is such an institution which creates money by money only.”-----W. Hock.

“ Bank is such a financial institution which collects money in current, savings or fixed
deposit account; collects cheques as deposits and pays money from the depositors‟ account
through cheques.”-----Sir John Pagette.

Indian Company Law 1936 defines Bank as “ a banking company which receives deposits
through current account or any other forms and allows withdrawal through cheques or
promissory notes.”

A banking system refers to a collection of a network of institutions that provides financial

services to the people. The following are some of the institutions that belong to the banking
system; central banks, commercial banks, internet banks, investment banks, savings and loan
associations, insurance companies, and credit unions.
Purpose of banking systems: The purpose of banking systems is to provide security and
confidence in the economy. Suppose banks went bankrupt, it would mean widespread
financial shock in the economy, and many consumers would prefer to withdraw their savings
in cash.
A Bank is a financial institution licensed to receive deposits and make loans. Two of the most
common types of banks are commercial/retail and investment banks. Depending on type, a
bank may also provide various financial services ranging from providing safe deposit boxes
and currency exchange to retirement and wealth management.

The bank usually takes a deposit from the public at a much lower rate called deposit rate
and lends the money to the borrower at a higher interest rate called lending rate. The
difference between the deposit and lending rate is called ‘net interest spread’, and the
interest spread constitutes the banks income.

Banking is defined as “Accepting of deposits of money from public for the purpose of
Lending or Investment, repayable on demand or otherwise and withdrawable by cheque,
draft, or otherwise”

Origin of Banking

Banking in the modern sense of the word can be traced to medieval and early Renaissance
Italy, to the rich cities in the north like Florence, Lucca, Siena, Venice and Genoa. The Bardi
and Peruzzi families dominated banking in 14th century Florence, establishing branches in
many other parts of Europe. One of the most famous Italian banks was the Medici Bank, set
up by Giovanni di Bicci de' Medici in 1397. The earliest known state deposit bank, Banco di
San Giorgio (Bank of St. George), was founded in 1407 at Genoa, Italy.

The name bank is derived from the Italian word banco “desk/bench”, used during the
Renaissance by Florentine’s bankers. These bankers used to make their transactions above a
desk covered by a green tablecloth. There are traces of banking activity even in ancient times.
In fact, the word traces its origins back to the ancient Roman Empire, where moneylenders
would set up their stalls in the middle of enclosed courtyards called macella on a long bench
called a bancu. It is from here that the words banco and bank are derived.

In ancient India there is evidence of loans from the Vedic period (beginning 1750 BC). Later
during the Maurya dynasty (321 to 185 BC), an instrument called adesha was in use, which
was an order on a banker desiring him to pay the money of the note to a third person, which
corresponds to the definition of a bill of exchange as we understand it today. During the
Buddhist period, there was considerable use of these instruments. Merchants in large towns
gave letters of credit to one another.

The definition of a bank varies from country to country. Under English common law, a
banker is defined as a person who carries on the business of banking, which is specified as:
conducting current accounts for his customers, paying cheques drawn on him/her, and
collecting cheques for his/her customers. In most common law jurisdictions there is a Bills of
Exchange Act that codifies the law in relation to negotiable instruments, including cheques,
and this Act contains a statutory definition of the term banker: banker includes a body of
persons, whether incorporated or not, who carry on the business of banking'. Although this
definition seems circular, it is actually functional, because it ensures that the legal basis for
bank transactions such as cheques does not depend on how the bank is organized or
regulated.

In simple terms, a bank is an institution that accepts various types of deposits and then
advances money in form of loans to people requiring it. Money and credit provide the pivot
(axle) around which all the economic activities revolve. Banks are institutions, which accept
deposits and use these funds to grant loans. Banks collect the surplus funds of millions of
individual savers who are widely scattered. The money so collected is channelised to the
investors i.e. people asking for loans for further investment purposes. Banks help in money
growth and capital formation. They are reservoirs of resources for economic growth and
development of the nation. They help in building the infrastructure, boosting the agriculture,
setting up industries and aid to global trade. Thus, a bank, by discharging its functions
effectively enhances the productive and industrious capacity of the nation and boosts the pace
of growth. Banks are the heart of the financial system.

Banking in India originated in the last decades of the 18th century.

• The first bank was The General Bank of India, which started in 1786.

• Bank of Hindustan was the 2nd bank, which started in 1790; both are now defunct.

• The oldest bank in existence in India is the State Bank of India, which originated in the
Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal.

• The period between 1906 and 1911, saw the establishment of banks inspired by the
Swadeshi movement. A number of banks established then have survived to the present such
as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central
Bank of India.

• During the First World War (1914–1918) through the end of the Second World War (1939–
1945), and two years thereafter until the independence of India were challenging for Indian
banking.

From Bank of Hindustan in 1770, the evolution of banking in India can be divided into three
different periods as follows:

Phase I: Early phase of primitive Indian banks to Nationalization of Banks in 1969

Phase II: From Nationalization of India banks in 1969 up to advent of liberalization and
banking reforms in 1991

Phase III: From Indian Financial and Banking Sector Reforms 1991 onward

Post Independence
• India observed the emergence of large number of institutions for providing finance to
different sectors of the economy.

• The entry activities of private sector and foreign banks were restricted through branch
licensing and regulation norms.

• Steps taken by Indian Govt. to regulate banking are:

Reserve bank of India was nationalized on January 1, 1949 under the terms of Reserve bank
of India.

• In 1949, the Banking Regulation Act was in acted.

• The Banking Regulation Act also provided that no new bank or branch of an existing bank
could be opened without a license from the RBI.

• No two banks could have common directors.

Nationalization

The post-nationalization period witnessed certain drastic changes in the economy. All the
leading commercial banks of the country were nationalized in the year 1969 with some
objectives in mind. The objectives of nationalization were as follows:

 To break the ownership and control of banks by a few business families.

 To prevent concentration of wealth and economic power.

 To mobilize savings of the masses from every nook and corner of the country.

To pay more attention to the priority sectors of the economy like agriculture and small scale
industries, the post-nationalization period saw a remarkable expansion in the banking and
financial system. The biggest achievement of nationalization was the reallocation of sectoral
credit in favor of agriculture, small scale industries and exports.

• The nationalization of banks in India took place in 1969 by Mrs. Indira Gandhi. It
nationalized 14 banks. Before the steps of nationalization of Indian banks, only State Bank of
India (SBI) was nationalized.

• Nationalization of Seven State Banks of India (formed subsidiary) took place on 19 th July,
1960.

• The second phase of nationalization of Indian banks took place in the year 1980. Seven
more banks were nationalized with deposits over 200 crores.

• The stated reason for the nationalization was to give the government more control of credit
delivery.

Adoption of banking technology

The IT revolution had a great impact in the Indian banking system:

• Introduction of online banking in India.

• Formation of committee on Mechanization in the banking Industry in 1984, providing use

of standardized cheque forms and encoders.

• Formation of committee on Computerization in Banks (1988) which emphasized that

settlement operation must be computerized in the clearing houses of RBI.

• Focused on computerization of branches and increasing connectivity among branches

through computers.

• Formation of Committee on Technology Issues relating to Payments System, Cheque

Clearing and Securities Settlement in the Banking Industry (1994) emphasized on Electronic
Funds Transfer (EFT) system, with the BANKNET communications network as its carrier.

• ATMs installed in India by various banks as on end March 2005 is 17,642.

Characteristics of Indian Banking System

From the meaning and nature of banks mentioned in earlier section, the
characteristics/features of a bank may be listed as follows:

1. Dealing in Money: Bank is a business activity which deals with other people’s money i.e.
getting money from depositors and lending the same to borrowers.

2. Banking Business: A bank is a financial institution which does banking activities of selling
financial services like home loans, business loans, lockers, fixed deposit etc. In order to
enable people to confirm that it is a bank and is dealing in money, for easy identification, a
bank should add the word “bank” as its last name.

3. Acceptance of Deposit: A bank accepts money from the people in the form of deposits
where there is an obligation to refund deposits on demand or after the expiry of a fixed tenure
as they feel it is a safest place to deposit money.

4. Lending Money: A bank provides advance money in the form of loans to needy persons for
promotion & development of business, purchase of home, car etc.

5. Easy Payment and Withdrawal Facility: Payment & Withdrawal of money can be made
through issuance of cheques & drafts, ATM, Online Fund Transfer without the need for
carrying money in hand. A bank provides easy payment and withdrawal facility to its
customers in the form of cheques, drafts, ATM’s and ETF.

6. Motive of Profit with Service Orientation: A Bank has a motive of employing funds
received as deposits from the public in a profitable manner with service oriented approach.

7. Linking Bridge: Banks collect money from those who have surplus money and give the
same to those who are in need of money. It acts as a trust/custodian of funds of its customers.
8. Ever increasing Functions: Banking is an evolutionary concept. There is continuous
expansion and diversification as regards the functions, services and activities of a bank.

9. Banking Business: A bank’s main activity should be to do business of banking which

should not be subsidiary to any other business.

10. Name Identity: A bank should always add the word “bank” to its name to enable people
to know that it is a bank and that it is dealing in money.

Objectives of Bank:

1. To establish as an institution for maximizing profits and to conduct overall economic

activities.

2. To collect savings or idle money from the public at a lower rate of interests and lend these
public money at a higher rate of interests.

3. To create propensity of savings amongst the people.

4. To motivate people for investing money with a view to bringing solvency in them .

5. To create money against money as an alternative for enhancing supply of money.

6. To build up capital through savings.

7. To expedite investments.

8. To extend services to the customers.

9. To maintain economic stability by means of controlling money market.

10. To extend co-operation and advices to the Govt. on economic issues.

11. To assist the Govt. for trade& business and socio-economic development.

12. To issue and control notes and currency as a central bank.

13. To maintain and control exchange rates as a central bank.

Structure of Banking:

Reserve Bank of India is the Central Bank of our country. It was established on 1st April
1935 accordance with the provisions of the Reserve Bank of India Act, 1934. It holds the
apex position in the banking structure. RBI performs various developmental and promotional
functions. It has given wide powers to supervise and control the banking structure. It occupies
the pivotal position in the monetary and banking structure of the country.

Scheduled and Non-Scheduled Banks: The scheduled banks are those which are enshrined
in the second schedule of the RBI Act, 1934. These banks have a paid-up capital and reserves
 of an aggregate value of not less than Rs. 5 lakhs, they have to satisfy the RBI that their
affairs are carried out in the interest of their depositors.

 All the commercial banks in India- Scheduled and Non-Scheduled is regulated under
Banking Regulation Act 1949.
 By definition, any bank which is listed in the 2nd schedule of the Reserve Bank of India Act,
1934 is considered a scheduled bank. The list includes the State Bank of India and its
subsidiaries (like State Bank of Travancore), all nationalised banks (Bank of Baroda, Bank of
India etc), Private sector banks, Foreign banks, regional rural banks (RRBs), foreign banks
(HSBC Holdings Plc, Citibank NA) and some co-operative banks.

 Till 2017, Scheduled commercial banks in India comprised 26 Public sector banks including
SBI and its associates, and 19 Nationalised Bank and IDBI. The creation of Bhartiya Mahaila
Bank has increased the total no of Public sector SCB’s to 27, but the recent merger of the
Mahaila Bank with SBI had reduced the list back to 26.

 The scheduled private sector bank includes old private sector banks and new private sector
banks. There are 13 old private sector banks and 9 new private sector banks including the
newly formed IDFC and Bandhan Bank.

 There are also 43 Foreign National Banks operating in India.

 The Regional Rural Banks were started in India back in the 1970s due to the inability of the
commercial banks to lend to farmers/rural sectors/agriculture. The governance
structure/shareholding of RRBs is as follows:

 Central Government: 50%,

 State Government: 15% and
 Sponsor Bank: 35%.

 RBI has kept CRR (Cash Reserve Requirements) of RRBs at 3% and SLR (Statutory
Liquidity Requirement) at 25% of their total net liabilities.
All commercial banks (Indian and foreign), regional rural banks, and state cooperative banks
are scheduled banks. Non- scheduled banks are those which are not included in the second
schedule of the RBI Act, 1934. At present these are only three such banks in the country.

Commercial bank: Commercial bank is an institution that accepts deposit, makes business
loans and offer related services to various like accepting deposits and lending loans and
advances to general customers and business man. These institutions run to make profit. They
cater to the financial requirements of industries and various sectors like agriculture, rural
development, etc. it is a profit making institution owned by government or private of both.

Public sector banks: Public sector banks are those where majority of the stake in the bank is
held by government. Where as in private sector bank, majority is held by shareholders of the
bank.

Private Sector Banks: The "private-sector banks" are banks where greater parts of stake or
equity are held by the private shareholders and not by government.

Foreign Banks: A foreign bank with the obligation of following the regulations of both its
home and its host countries. Loan limits for these banks are based on the capital of the parent
bank, thus allowing foreign banks to provide more loans than other subsidiary banks. Foreign
banks are those banks, which have their head offices abroad. CITI bank, HSBC, Standard
Chartered etc. are the examples of foreign bank in India. Currently India has 36 foreign
banks.

Regional Rural Bank (RRB): The government of India set up Regional Rural Banks (RRBs)
on October 2, 1975. The banks provide credit to the weaker sections of the rural areas,
particularly the small and marginal farmers, agricultural labourers, and small entrepreneurs.

Other special features of these banks are:

 (i) their area of operation is limited to a specified region, comprising one or more
districts in any state;
(ii) their lending rates cannot be higher than the prevailing lending rates of
cooperative credit societies in any particular state;
(iii) the paid-up capital of each rural bank is Rs. 25 lakh, 50 percent of which has been
contributed by the Central Government, 15 percent by State Government and 35
percent by sponsoring public sector commercial banks which are also responsible
for actual setting up of the RRBs.

Co-operative Bank: Co-operative bank was set up by passing a co-operative act in 1904.
They are organised and managed on the principal of co-operation and mutual help. The main
objective of co-operative bank is to provide rural credit.

 Co-operative banks operate in both urban and non-urban areas. All banks registered under the
Cooperative Societies Act, 1912 are considered co-operative banks.
 In the urban centres, they mainly finance entrepreneurs, small businesses, industries, self-
employment and cater to home buying and educational loans.
 Likewise, co-operative banks in the rural areas primarily cater to agricultural-based activities,
which include farming, livestock’s, diaries and hatcheries etc.
 They also extend loans to small scale units, cottage industries, and self-employment activities
like artisanship.
 Unlike commercial banks, who are driven by profit, cooperative banks work on a “no profit,
no loss” basis.
 Co-operative Banks are regulated by the Reserve Bank of India under the Banking
Regulation Act, 1949 and Banking Laws (Application to Co-operative Societies) Act, 1965.
Functions of commercial banks

1. Primary or Principle functions

2. Secondary or Subsidiary function

1. Primary or Principle functions

 Receiving deposits -Accepting various types of deposits is an important function of the

commercial banks. Deposits constitute the main sources of the funds for commercial banks.
Deposits are of various types like demand deposits, savings deposits and fixed deposits.

a) Demand deposits- Demand deposits also known as current deposits are those which can be
withdrawn by the depositor at any time by means of cheques. The bank does not pay any
interest on demand deposits. In fact, a bank makes a small charge on the customers with a
current account. It is convenient for businessmen to pay creditors by drawing cheques and
also get the cheques received by them collected.

b) Savings deposits -Savings deposits are those deposits on which a bank pays a certain
percentage of interest to the depositors but the bank places certain restrictions on their
withdrawals. For instance, today in India only 150 withdrawals in a year are allowed by the
banks. Further the total amount withdrawals that can be made is restricted to Rs.20, 000. Or
10% of the credit balance in the customer’s accounts whichever is greater. A proper and
satisfactory introduction is necessary to open savings bank account. These accounts are
meant for encouraging thrift and a habit of savings among the people.

c) Fixed deposits- There are deposits which can be withdrawn after the expiry of a specified
fixed period these are also called time deposits. The rate of interest is higher than that
allowed on savings deposit. The fixed deposits are withdrawn by surrendering the fixed
deposit receipts, obtained from the bank at the time of depositing the money.

 Lending of funds- The bank lends fund by means of loans, overdrafts, cash credits and
discounting of bills.

a) Loan- Loan is financial accommodation under which bank grants an advance on a separate
account called loan account. Interest is charged on the entire amount of loan sanctioned.
Loans are given to all types of persons against the personal security of the borrower or
against the personal movable or immovable properties.

b) Overdraft- An overdraft is a financial accommodation under which a current account

holder is permitted to overdraw his account upto an agreed limit. Interest is charged on the
exact amount overdrawn by the customer. It is granted against the security of the borrower. It
is advantageous to the borrower because interest is charged only on the amount actually
overdrawn by him.

c) Cash credit- A cash credit is a financial accommodation under which an advance is granted
on a separate account called cash credit account upto a specified limit. Interest is charged on
the amount made use of by the borrower. It is granted against the security of goods or
personal security of one or more persons other than the borrower. Traders prefer cash credit
to direct loans as they need not pay interest on the entire amount.

d) Discounting of bills -Discounting of bills is a financial arrangement under which a

customer holding a bill of exchange can get a loan equivalent to the value of the bill, less
discount. The discount represents interest on the money lent for the unexpired period of the
bill. On maturity, the banker collects the proceeds of the bill from its acceptor.

 Investment of funds in securities- Investment of funds in securities is one of the

important functions of commercial banks; they invest a considerable amount of their funds in
Government and industrial securities.

2. Secondary or subsidiary Functions

The secondary or subsidiary functions of a bank can be divided into two classes, viz

a) Agency service - Agency services are those services which are rendered by the bank
as an agent of their customer. They are:

 Collection of cheques, drafts, etc. on behalf of the customer.

 Payment of bills of exchange, life insurance premium etc., on behalf of the customer.
  Purchase and sale of securities on behalf of the customer.

 Arranging for transfer of money (remittance) from one place to another on behalf of the
customer.

 Acting as a trustee, executors, administrators and attorney.

 Acting as correspondents of other banks and financial institutions.

 Banks also issue credit cards to their customers.

a) General utility services -These are the services rendered not only to the customers
but also to the general public as well.

 Accepting valuables and securities for safe custody

 Providing foreign exchange to the importers and exporters.

 Issuing of travellers cheques, circular notes, etc

 Underwriting shares, debentures and Govt securities.

 Acting as referees and providing information relating to the credit worthiness of their
customer.

 Collection of information useful to the customers or to the general public and their
publication.

 Banker may institute scholarship endowment establish book banks for the benefit of the
students, arrange exhibitions and undertake any such other activities beneficial to the
community in general.

Role of commercial banks in socio economic development

Banks help in accelerating the economic growth of a country in the following ways:

1. Accelerating the Rate of Capital Formation: Commercial banks encourage the habit of
thrift and mobilise the savings of people. These savings are effectively allocated among the
ultimate users of funds, i.e., investors for productive investment. So, savings of people result
in capital formation which forms the basis of economic development.

2. Provision of Finance and Credit: Commercial banks are a very important source of
finance and credit for trade and industry. The activities of commercial banks are not only
confined to domestic trade and commerce, but extend to foreign trade also.

3. Developing Entrepreneurship: Banks promote entrepreneurship by underwriting the

shares of new and existing companies and granting assistance in promoting new ventures or
financing promotional activities. Banks finance sick (loss-making) industries for making
them viable units.
4. Promoting Balanced Regional Development: Commercial banks provide credit facilities
to rural people by opening branches in the backward areas. The funds collected in developed
regions may be channelized for investments in the under developed regions of the country. In
this way, they bring about more balanced regional development.

5. Help to Consumers: Commercial banks advance credit for purchase of durable consumer
items like Vehicles, T.V., refrigerator etc., which are out of reach for some consumers due to
their limited paying capacity. In this way, banks help in creating demand for such consumer
goods.

6. Channelizing the Funds to Productive Investment: Capital formation is not the

only function of commercial banks. Banks invest the savings mobilized by them for
productive purposes. Pooled savings should be distributed to various sectors of the economy
to increase the nation’s productivity.

7. Fuller Utilization of Resources: Savings pooled by banks are utilized to a greater extent
for the development purposes of various regions in the country. It ensures fuller utilization of
resources.

8. Encouraging the Right Type of Industries: The banks help develop the right industries
by extending loans to the right type of persons. In this way, they help the country’s
industrialization and economic development.

9. Bank Rate Policy: Economists believe that changing the bank rates can make changes in a
country’s money supply. Federal or state banks in developing countries; the interest rate is to
be paid by banks for the deposits accepted by them and the rate of interest to be charged by
them on the loans they granted.

10. Bank Monetize Debt: Commercial banks transform the loan to be repaid after a certain
period into cash, which can be immediately used for business activities. Manufacturers and
wholesale traders cannot increase their sales without selling goods on credit. But credit sales
may lead to the locking up of capital.

11. Finance to Government: The government is acting as the promoter of industries in

underdeveloped countries for which finance is needed it. Banks provide long-term credit to
the government by investing their funds in Government securities and short-term finance by
purchasing Treasury Bills.

12. Bankers as Employers: After the nationalization of big banks, the banking industry has
grown to a great extent. Bank branches are opened in almost all the villages, which creates
new employment opportunities. Banks are also improving people for occupying various posts
in their office.

References:

https://kanchiuniv.ac.in/coursematerials/BANKING%20THEORY%20LAW%20AND
%20PRACTICES%20(2).pdf
https://www.iedunote.com/role-of-banks-in-economic-development

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_1_Syllabus_Module_1

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