Definition, Functions and Types of Banks

Banking in India: Definition, Functions and Types of Banks

Definition of a Bank

A bank is a financial institution which performs the deposit and lending function. A bank allows a person with excess money (Saver) to deposit his money in the bank and earns an interest rate. Similarly, the bank lends to a person who needs money (investor/borrower) at an interest rate. Thus, the banks act as an intermediary between the saver and the borrower.

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.

Essential Features/functions of the Bank

Financial Intermediation

The process of taking funds from the depositor and then lending them out to a borrower is known as Financial Intermediation. Through the process of Financial Intermediation, banks transform assets into liabilities. Thus, promoting economic growth by channelling funds from those who have surplus money to those who do not have desired money to carry out productive investment.

The bank also acts as a risk mitigator by allowing savers to deposit their money safely (reducing the risk of theft, robbery) and also earns interest on the same deposit. Bank provides services like saving account deposits and demand deposits which allow savers to withdraw money on an immediate basis thus, providing liquidity (which is as good as holding cash) with security.

How Banks promote economic growth?

Types/Structure of Banks in India

Scheduled Commercial Banks

  • 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.

Important Facts Relating to Scheduled Commercial Banks

  • In terms of Business, Public sector banks dominate the Indian Banking.
  • PSB accounts for close to 50% of total assets, 70% of deposits and close to 70% of the advances.
  • Amongst the Public-Sector Banks, SBI and its Associates has the highest number of Branches.
  • The committee on Regional Rural Bank headed by M Narasimhan recommended the setting up of RRBs for the purpose of providing rural credit.
  • An RRB is sponsored by a Public-Sector Bank which also provides a part of its share capital. Example: Maharashtra Gramin Bank (sponsored by the Bank of Maharashtra) and the Himachal Gramin Bank (Sponsored by Punjab National Bank). RRBs were set up to eliminate other unorganized financial institutions like money lenders and supplement the efforts of co-operative banks.
  • The Private Commercial banks account for close to 1/4th of the assets of the total banking assets.

Why RRBs Failed to Achieve ITs Objective

The RRB Amendment Bill, 2014

  • The Regional Rural Banks (Amendment) Bill, 2014 was introduced by the Minister of Finance, Mr Arun Jaitley, in Lok Sabha on December 18, 2014.  The Bill seeks to amend the Regional Rural Banks Act, 1976. It was passed by parliament in April 2015.
  • The Regional Rural Banks Act, 1976 mainly provides for the incorporation, regulation and winding up of Regional Rural Banks (RRBs).
  • Sponsor banks:  The Act provides for RRBs to be sponsored by banks.  These sponsor banks are required to (i) subscribe to the share capital of RRBs, (ii) train their personnel, and (iii) provide managerial and financial assistance for the first five years.  The Bill removes the five-year limit, thus allowing such assistance to continue beyond this duration.
  • Authorized capital:  The Act provides for the authorized capital of each RRB to be Rs five crore.  It does not permit the authorized capital to be reduced below Rs 25 lakh.  The Bill seeks to raise the amount of authorized capital to Rs 2,000 crore and states that it cannot be reduced below Rs one crore.
  • Issued capital:  The Act allows the central government to specify the capital issued by an RRB, between Rs 25 lakh and Rs one crore.  The Bill requires that the capital issued should be at least Rs one crore.
  • Shareholding:  The Act mandates that of the capital issued by an RRB, 50% shall be held by the central government, 15% by the concerned state government and 35% by the sponsor bank.  The Bill allows RRBs to raise their capital from sources other than the central and state governments, and sponsor banks.  In such a case, the combined shareholding of the central government and the sponsor bank cannot be less than 51%.  Additionally, if the shareholding of the state government in the RRB is reduced below 15%, the central government would have to consult the concerned state government.
  • The Bill states that the central government may by notification raise or reduce the limit of the shareholding of the central government, state government or the sponsor bank in the RRB. In doing so, the central government may consult the state government and the sponsor bank.  The central government is required to consult the concerned state government when reducing the limit of the shareholding of the state government in the RRB.
  • Board of directors:  The Act specifies the composition of the Board of Directors of the RRB to include a Chairman and directors to be appointed by the central government, NABARD, sponsor bank, Reserve Bank of India, etc.  The Bill states that any person who is a director of an RRB is not eligible to be on the Board of Directors of another RRB.
  • The Bill also adds a provision for directors to be elected by shareholders based on the total amount of equity share capital issued to such shareholders.  If the equity share capital issued to shareholders is 10% or less, one director shall be elected by such shareholders.  Two directors shall be elected by shareholders where the equity share capital issued to them is from 10% to 25%.  Three directors shall be elected in case of equity share capital issued being 25% or above.  If required, the central government can also appoint an officer to the board of directors to ensure the effective functioning of the RRB.
  • The Act specifies the term of office of a director (excluding the Chairman) to be not more than two years.  The Bill raises this tenure to three years.  The Bill also states that no director can hold office for a total period exceeding six years.
  • Closure and balancing of books:  As per the Act, the books of an RRB should be closed and balanced as on December 31 every year.  The Bill changes this date to March 31 to bring the Act in uniformity with the financial year.

Non-scheduled Banks

  • Non-scheduled banks by definition are those which are not listed in the 2nd schedule of the RBI Act, 1934.
  • Banks with a reserve capital of less than 5 lakh rupees qualify as non-scheduled banks.
  • Unlike scheduled banks, they are not entitled to borrow from the RBI for normal banking purposes, except, in emergency or “abnormal circumstances.”
  • Jammu & Kashmir Bank is an example of a non-scheduled commercial bank.

Cooperative Banks

  • 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.

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