Overview of Banking

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Utkarsh Saxena

Objectives• From this topic you will be able to

Understand the meaning of bankingUnderstand the role of banks as

○ Financial intermediaries○ Constituents of the payment system○ Financial services providers

Appreciate the role of the banking system in economic development

Understand the various products and services offered by banks

Identify various banking channels

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Definition of Banking Section 5 (b) of the Banking

Regulation Act 1949 defines “Banking” as“Accepting for the purpose of lending and

investment, deposits of money from the public

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

or otherwise” No definition of banking can be

comprehensive enough in the present context

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Roles of Banks• Intermediation

• Between those who save money and those who need money

• Risks in lending• Credit Risk• Liquidity Risk• Interest Rate Risk

• Banks are essentially risk managers• Financial intermediation plays an

important economic function

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Roles of Banks [Contd.] Payment system

Pay deposits on demandPayment through chequesFacilitate movement of moneyCirculatory system of the economy

Financial services providerProducts of mutual funds and insurance

companiesCollection of utility bills, etc.

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Banking – A Business of Trust Banking is based on the trust that

banks will honour their commitments Principles on which banking business

is based LiquiditySafetyProfitabilitySecrecyService Quality

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Summary Up to this point you learned that

“Banking” is defined as “accepting for the purpose of lending and investments, deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise”

Banks are risk managers Banks are constituents of the

payment system Banks provide various financial

services Banking is a business of trust

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Banking Services and Products In this section you will be able to

Understand the various financial services and products offered by banks

Understand various payment and remittance services

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Various financial services & products Payment system constituent

Payments and remittances Collection

Financial Intermediary Deposit Loan

Allied Services Distribution Collection Demat services Safe keeping Advisory

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Payment and Remittance services In this section you will be able to

Understand various modes provided by banks for making local payment as well as making payment at other places

Understand various modes available for remitting money to other places

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Cheque A written instruction issued by a

customer (Drawer) to his bank (Drawee) to pay the specified amount to the person named (Payee) in the cheque

Crossed and uncrossed cheques Requirement of sufficient balance for

making payment

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Payorder/Banker’s Cheque A cheque issued by a bank on itself

For local paymentsTo ensure certainty of payment

An image of a Banker’s cheque

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Demand Drafts Cheque issued by a bank on itself but

payable at another branch In case there is no branch of the

issuing bank, arrangements can be made with the other bank(s) having its/their branch(es)

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Multi City Cheques A cheque which can be paid at any

branch of the bank Networking of the branches and

centralised computer system is a pre-requisite

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Electronic Fund Transfer (EFT) Faster mode of remitting money to far away places Centralised computer system enables the

transaction The payment can be made instantly if the payee /

beneficiary has an account with the payment branch

In case payer and payee maintain accounts with two different banks, the transaction can be completed through the Reserve Bank of India

Cost effective and fast mode of transaction

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Summary Up to this point you learned that

Some of the products offered as part of the payment service are○ Cheques○ Payorder / Bankers Cheque○ Demand Draft (DD)○ Multi City Cheques○ Electronic Funds Transfer (EFT)

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Payment Services [Contd.] In this section you will learn that

Some other products offered as part of the payment service are○ Debit card○ Credit card○ Travel card

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Debit Cards A substitute for cheques Can be used for withdrawing cash

from ATM as well as making payments to third parties through POS

Account of the customer is debited instantly

Add-on facilities 24 X 365 days banking

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Credit Cards Customer gets certain credit limit

from the credit card issuing bank The amount utilized is debited to

credit card account Customer gets some time to make

payment to the bank Customer gets interest free credit for

upto 50 days

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Travel Cards A pre-paid debit card Useful for travel abroad Image of a travel card

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Summary In this section you learned that

Some more products offered as a part of the payment service are

○Debit card

○Credit card

○Travel card

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Collection Services In this section you will be able to

List the different types of collection services

Describe each of these specific collection services

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Different Types of Collection Services Transfer Local Clearing ECS or Electronic Clearing Cheque Collection National Clearing CMS – Cash Management Services Bills Collection Services involving Foreign Exchange

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Transfer Transactions involving transfer of money

from one account to another account within the branch of a bank or within the branches of the same bank

Inter-connection through networking enables speedier transfer within branches

Traditional methods (without networking) take time in realisation of proceeds

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Local Clearing Facilitating collection of cheques which

are drawn on local branches of banks Bankers meet at Clearing House for

exchange of cheques RBI and / or SBI and / or commercial

banks maintain Clearing House in different locations

Day’s inward and outward cheques between banks are exchanged and transaction amounts are “netted”

Local clearing is “NET” settlement

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Electronic Clearing Service (ECS) Payment instructions are transmitted electronically Covers high volume, low value transactions Both debit (ECS Debit) and credit (ECS Credit)

transactions are covered Managed by RBI or SBI Credit ECS

Example: Interest on Securities, Dividends, Regular Salaries

Debit ECS

Example: Insurance premiums, Loan repayments, Utility bill payments

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ECS [Contd.] Benefits

SpeedAccuracySecured channelAvoids manual intervention (processing

of transactions)Saves time due to systemic handlingBenefits flow to bank, customer and user

public

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Summary Up to this point you learned that

Some of the products offered as a part of the collection service are○ Transfer ○ Local Clearing○ Electronic Clearing System (ECS)

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Collection Services [Contd.] In this section you will learn that

Some more of the products offered as a part of the collection service are

○ Cheque Collection○ National Clearing○ Cash Management Service (CMS)

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Cheque Collection Local cheques are collected in local

clearing Outstation cheques (upcountry) are

collected by sending the cheques to respective banks’ branches

Unlike local clearing, cheque collection takes time due to travel and realisation of proceeds into customer’s account

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National Clearing Speedier collection of outstation

cheques drawn on larger cities RBI has linked larger cities Works under the same principle as

local clearing Communication has enabled

networking and efficiency in collection Unlike outstation cheque collection,

national clearing facilitates faster collection

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Cash Management Service (CMS) Best suited for customers with wide

network of operations and dealers Enables to manage liquidity efficiently

through speedier collection and efficient management of payments

Availability of MIS on collections and payments – a major benefit of CMS

Distributed collection and payment at point of occurrence of transactions

Enables customers under CMS to reconcile their payments and collections on a daily basis

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Summary Up to this point you learned that

Some more of the products offered as a part of the collection service are○ Cheque Collection○ National Clearing○ Cash Management Service (CMS)

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Collection Services [Contd.] In this section you will learn that

Some further products offered as a part of the collection service are○ Bill Collection ○ Foreign Exchange

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Bill Collection Instead of paying through cheques, business houses

draw bills of exchange at times Bills can be demand bills or usance bills Invoice, bill and document of title to goods (trade

documents) are handed over to the bank by seller The Bank sends the same to the buyer’s bank for

collecting payment Buyer’s bank hands over all trade documents upon

receipt of payment from buyer on a demand bill or receipt of acceptance from the buyer in case of usance bill

Buyer’s bank remits the proceeds to the seller’s bank and seller gets money for goods / services sold

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Foreign Exchange [Forex] Need arises when payments are to be

made to a beneficiary in an overseas country in foreign currency

Payments received in foreign currency needs to be realised in Indian currency

Banks maintain accounts in an overseas country to facilitate transactions involving foreign currency

Such accounts are known as “Nostro” accounts

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Summary Up to this point you learned that

Some further products offered as a part of the collection service are○ Bill Collection ○ Foreign Exchange

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Deposit & Credit Services In this section you will be able to

Describe the products offered by banks in deposit services

Describe credit products offered by banks in retail segment

Identify various products offered as business credit

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Deposit Services Current Accounts

Demand deposits No interest is paid on balances in current accounts

Savings Accounts Demand deposits for non-business entities Interest is paid on balances

Fixed Deposit Accounts Accepted for fixed period Pre-mature payment is permitted as measure of

customer service Recurring Deposit Accounts

Saving of a fixed sum every month for a fixed period

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Retail Credit Products Retail Loans Personal Overdrafts Credit Cards

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Retail Loans Retail Loans

Provided to individuals Nature

Consumer durablesHousingVehicle Personal expenses

Eligibility Margin Interest application Repayment – monthly or quarterly Unsecured and secured

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Personal Overdrafts Personal Overdraft

For unexpected and periodic requirements

Eligibility Margin Interest application Repayment Unsecured and secured

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Credit Cards Credit Cards

For purchases / withdrawals

Eligibility Credit limit Repayment – monthly or in

installments Unsecured

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Deposit & Credit Services Up to this point you have learned of

The products offered by banks in deposit services

The credit products offered by banks in retail segment

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Deposit & Credit Services [Contd.] In this section you will be able to

Identify various products offered as business credit

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Business Credit Business credit

For acquisition of fixed assets For financing current assets

Eligibility Amount Borrowing/repayment Secured and unsecured

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Term Loans Given for acquiring of fixed assets Secured by a charge on the assets

created out of bank finance Margin requires to be contributed Repayment is out of profits generated

by the assets created and is spread over a time in installments

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Leasing The assets required by the business

are acquired by the bank and leased out to the customer

Lease rentals are paid by the customer

Not very popular now as the tax incentives available earlier are now withdrawn

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Working Capital Facilities In this section you will understand the

various types of working capital facilities

Natureoverdraft cash creditpacking creditdemand loans and lines of creditbusiness cards

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Working Capital Facilities Given for financing the working capital cycle Can be Pre sale or Post sale financing Overdraft

For meeting short term requirements For meeting temporary mismatches in cash flow Can be secured or unsecured

Cash Credit Most Common and popular facility in India Running Account Permanent in nature Limit established and withdrawals within limit Secured by a hypothecation charge on current assets Margin is maintained over the value of assets

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Working Capital Facilities Packing Credit

Similar to cash creditFor meeting export ordersOriginally on order to order basisPresently running account facility is

permittedConcessive interest rateLiquidation can be only by export proceedsDelay in liquidation attracts penaltySecured by a charge on the current assets

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Working Capital Facilities Demand Loans/Lines of Credit

Demand loan is for meeting short term requirements

Attracts cheaper interestPreferred by large corporates as cost

effectiveLiquidated at the end of the stipulated period Line of Credit is an assurance by the banker

to make available short term credit when needed

Terms and conditions are pre-agreedGives a feeling of security for the corporate The assurance is over a period of time

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Working Capital Facilities Business Card

Equivalent of a credit or debit card to individuals

Enables business entities to make their purchase of required supplies without resorting to use of cheques or demand drafts

Interest is charged from day oneBeing popularized in India

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Summary In this section you learned that

Term loans and leasing finance is provided for acquisition of fixed assets

Working capital requirements are ever changing

They can be pre-sale financing or post-sale financing

The nature of facilities of pre-sales financing are○ Overdraft ○ Cash Credit ○ Packing Credit ○ Demand Loans and Lines of Credit ○ Business Card

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Post Sale or Trade Finance In this section you will understand the

various modes of financing post sale or credit salesCheque purchaseBill purchaseBill DiscountLetter of CreditBill NegotiationGuarantees

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Post Sale or Trade Finance Cheque Purchase

Avoids delay involved in collection of cheques Funds are made available to sellers immediately Interest is charged from the date of purchase to date

of realization of the cheque Bill Purchase

Advance against documentary bills is payable at sight Bills are then sent for collection Advance is liquidated from collection proceeds Interest is charged from the date of purchase to the

date of receipt of proceeds is recovered upfront

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Post Sale or Trade Finance Bill Discount

Advance against documentary Usance bills

Interest charged for the Usance period is called discount

Discount is recovered upfront

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Post Sale or Trade Finance Letter of Credit

Guarantee given by the purchaser’s bank to the seller that the bill representing sale of goods will be paid

Parties to an LC are applicant (buyer of goods), issuing bank (buyer’s bank), and beneficiary (Seller of goods)

Treated as a credit facility by the buyer’s bank

It is a non-fund based facilityNormally secured by a charge on current

assetsCommission is charged resulting in fee

income to bank

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Post Sale or Trade Finance Bill Negotiation

Purchase or discounting of a bill accompanied by an LC

Risk to negotiating bank is less Interest/discount is charged upfront

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Post Sale or Trade Finance Guarantees

Issued by banks at the request of customers in respect of transactions other than normal trade transactions

It can be as a replacement of EMD, for receipt of mobilisation advance, for release of retention money, towards payment of penalty for non performance

Commission is charged for issue of guarantee resulting in fee income to bank

It is a non-fund based facility

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Summary In this section you learned that

The various products available for post-sale finance are:○ Cheque Purchase ○ Bill Purchase ○ Bill Discount ○ Letter of Credit (LC) ○ Bill Negotiation ○ Guarantees

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Allied Services In this section you will be able to

Appreciate the various allied services offered by banks in their role as provider of financial services

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Provider of Allied Services The services provided by banks

under the role of provider of allied services are DistributionCollection of taxes and billsDeMAT accountsSafe keepingAdvisory services

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Distribution In banking today, distribution of products

and third parties have assumed great importance due toGeneration of fee incomeAbility to provide single umbrella serviceAbility to create exit barrier

Activities involved are:Mutual Fund UnitsInsurance ProductsSale of BondsTrade in Gold / Gold coinsMobile Phone RechargeShares of companies offering Public Issues

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Collection of Taxes and Bills The products offered by banks within

the collection service areTaxesUtility Bills

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DeMat Account A depository is like a bank. Only

difference is that it holds your securities and not cash

The account opened with a depository participant is called a DeMat account

Dematerialisation is the process of converting physical shares into electronic form

Rematerialisation is the process of converting securities from electronic form into physical form

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DeMat Account Physical securities are transferred on

basis of transfer deeds, DeMat securities get transferred electronically

Each security (i.e., share of a particular company) has a unique identification No. called ISIN (International Securities Identification Number) through which the securities are recognised

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DeMat Account Transfers are affected

Through the TIFD or Delivery Slip Which is given by the seller to his DP The shares will be transferred out of the

sellers DeMat account And into the buyers DeMat account with his

DP The entire clearing process is put

through a central depository At present we have two depositories,

namely CDSL & NSDL who are registered with SEBI

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Safe Keeping Safe Deposit Vault:

Safe keeping facility is a traditional function of banks

Lockers provided at very reasonable ratesRents are charged as per size of the locker

and are payable in advanceLockers can be hired by individuals, firms,

Ltd. Companies, associations, societies etcLockers are rented out for a minimum period

of one year

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Safe Keeping Safe Custody Service:

Under safe custody, banks accept sealed packets for safe keeping in their strong rooms for which a receipt is issued

Articles are returned upon the customer handing over the receipt

Not offered any more as a matter of course

Banks today deposit the duplicate keys of branches for safe custody with other banks in the area for use in emergencies

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Advisory Service The product offered by banks within

the Advisory service is:Investment Advice

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Summary In this section, you learned that

The services provided by banks under the role of provider of allied services are ○ Distribution○ Collection of taxes and bills○ DeMAT accounts○ Safe keeping○ Advisory services

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Banking Channels In this section, you will be able to

Appreciate the various channels offered by banks in their role as providers of financial services

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Banking Channels

Banking Channels:ATMsPOS Terminals Internet bankingPhone bankingMobile bankingBranch

Migrating from branch banking to other channels- Advantages:Convenience to customersCost effective to banksNearly 70% of transactions through non-

branch channels

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Summary In this section you learned that

The various non-branch banking channels available in India are:○ ATMs○ POS terminals, mainly for credit cards○ Phone Banking (call centre)○ Internet Banking○ Mobile Banking (SMS through mobile

phones)There is increased use of non-branch

channels

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Summary From the topic of Overview of

Banking you will have Understood the meaning of bankingUnderstood the role of banks as

○ Financial intermediaries○ Constituents of the payment system○ Financial services providers

Appreciated the role of the banking system in economic development

Understood the various products and services offered by banks

Been able to identify the various banking channels

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Check your understanding Sections A, B and C

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Group Assignment Prepare a pictorial representation on

one of the following topicsDraw up a scrapbook to support the

presentation Topics

Banks contribute to economic growth of a region in their role as intermediaries

Economy will come to a halt without the payment mechanism of banks

Allied services offered by banks add value to the Banks and to customers

Banking is a business of trust

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E-Learning module “Introduction to Retail Banking”

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