Deposits

Deposits constitue the main stream of funds for the banker. So he has to make sustained efforts to mobilise deposits from all parts of the country and from all sections of the people. Emphasis is placed on collection of savings from the affluent as well as from small earners in agriculture, industry, trade, profession etc. India is having three sucessive bumper harvests. These have brought a measure of prosperity to the agricultureal classes. But the contribution of agricultureists to the overall savings does not bear any relationship to the income accruing to them.
The government has pumped very large funds to the rural sector. The additional income generated in the rural sector should be mobilised for productive use. To this end the RB’s guidelines have been encouraging to open bank offices in rural and semi urban areas. In order to reach the small potential depositors scattered all over the country, bankers have to put in very hard work.

End-Use of credit

Sustained economic growth is essential for a rise in the level of livings for all citizens. To accomplish this objectives, increased flow of credit into agriculture and industry is essential. While providing credit, bankers have to investigate the purpose of the loan. Banks should ascretain that end use of credit conforms to overall national objectives.

National credit council has identified three sectors deserving priority treatment. They are agriculture, small scale industries and exports. Further, the economic policy of the government has envisaged bank credit to cater the needs of artisans, self-employed workers, retail traders and other weaker sections of the community.

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Bank advances are commonly known as loans. Loans are made by banks to industrialists, businessmen, traders and others. Such loans are credited to customer’s account. The borrower is allowed to issue cheques upto the amount of loan sanctioned. Thus every loan creates bank deposits. Bank can create more deposits by sanctioning more loans and advances.

From the above it is understood that by giving loans and buying assets, a commercial bank is creating money. Two points should be borne in mind. First, every asset acquired by a bank creates an equivalent bank deposit. Usually banks take the initiative to give loans and acquire assets. Thus they control the total volume of deposits in the banking system.

Secondly, commercial banks monetise the debts of others. Further, commercial banks have absolute control over the volume of bank deposits. However, it is subject to:

a) The supply of cash with the banking system.

b) The public demand for cash

c) The cash reserve ratios to be maintained by the banking system.

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A letter of credit is defined as “Letter issued by the importer’s bank in favour of the exporters authorising him to draw bills upto an amount specified in it and assuring him of payment against the delivery of the prescribed documents in his own country”.

A letter of credit is a guarantee to the exporter that his draft will be honoured by a specified bank upto certain amount. The importer of goods approaches his banker to open a letter of credit in favour of the overseas supplier. The importer is called Opener or accountee. His bank is known as Opening bank. The letter of credit is sent to the foreign branch of the bank (or the correspondent bank). Such bank is called negotiating bank.

Thus a letter of credit is a document or order by a banker in one place authorising some other banker acting as his agent or correspondent in another place to honour the drafts or cheques of a person named in the document, upto the amount stated in the letter.

Uses of letters of credit

1) Letters of credit help international, commercial and social relations.

2) A person who travels abroad need not carry with him any large sums of money.

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Extensive speculation was prevailing in stock markets in U.S.A before the stock market crash of 1929. The Federal Reserve Bank of America ordered commercial banks to restrict their loans and advances to stock brokers by raising their margin requirements. Since then many central banks have been following this method. The operation of margin requirements is simple and direct.

This is a method of fixing margin requirements on loans granted by commercial banks to dealers in stocks and shares, essential commodities etc. The central bank prescribes the margin on loans and advances granted by commercial banks. The margin is the difference between the loan value and the market value of securities offered by borrowers on secured loans.

Commercial banks have to follow central bank’s directive in granting loans and advances. If the margin is raised the loan amount is reduced and vice-versa. If the margin prescribed as 30%, the commercial banks can lend only 70% of the market value of securities. Suppose the central bank increases the margin from 30% to 40%, then the commercial banks have to lend only 60% of the market value of the securities. The margin is kept as a cushion against the fall in the market value of the securities. During inflation, the central bank increases the margin while during depression, it lowers the margin.

Advantages of Margin Requirements

i) High margin requirements discourage speculative activities. They divert funds for productive activities.

ii) This method controls inflationary pressures in two ways
It discourages speculative loarding of goods and provides credit for productive activities.

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Branch banking is a system where the banking business is carried on through a network of branches spread throughout the length and the breath of the country. The head office of the bank is located in a big city or a state capital. In the early period of development of banking in England there were only a few banks. Today in England most of the banking business is carried on by five big banks namely, the Midland, the Lloyds, the Barclays, the West Minister and the National Provincial Subssequently National Provincial Bank and the West Minister Bank were merged to form West Minister Bank. They control 75% of the banking business through their 13,500 branches.

Advantage of Branch Banking

i) Large Scale Operations

Branch banking system possesses large financial resources. It has a number of branches.
A huge financial resources enable branch banking to provide agricultural and industrial loan to large number of people. It can employ officers to carry on increasing financial responsibilities in the sphere of management. The presence of an efficient staff is an asset to a banking company. This advantage is not available to unit banking.

ii) Geographical Spreading of Risks

In the branch banking system, the bank can distribute risks geographically. Banks are operating through several branches. So they can diversify both deposits and assets. Deposits are mobilised from places where savings are in plenty. Loans and advances are made to those areas where there is scarcity of capital and interest rates are high.

iii) Remittance Facilities

The branch banking has the branches which are spread all over the country. So it is easier to transfer funds from one branch to another at a lesser cost. Unit banking system cannot offer this facility. In the unit banking system transfer of funds is effected through correspondent banks. The cost of transfer of funds is high.

iv) Economy in Cash Reserves

One of the important advantages of branch banking is that it results in an economy of cash reserves. When a branch experiences shortage of cash it can be easily met by transferring cash from some other branch. This naturally results in economy of cash reserves. But the unit bank maintains a higher cash reserve in order to meet the requirements of depositors. Keeping of large cash reserve reduces the profitability of the banks concerned.

v) Large Financial Resources

Branch banking system ensures the advantage of large financial resources. The requirements of large customers can be easily met. Loans and Advances can be made on more liberal scale. With large financial resources branch banking has financial strength and ability to meet any crisis.

vi) Greater Public Confidence

Branch banking commands greater public confidence. The reasons for this include huge financial resources and branches spread all over the country.

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Banker acts as a special agent in buying and selling stocks on behalf of his customer. The banker is bound to act in strict confirming with the customer’s instructions. He must follow the usual course of business essential for these operations.

Apart from this, the banker should get precise instructions from the customer. A special form may be used in this regard. The form should contain the following instructions:

1) Particulars of securities to be sold or bought

2) The minimum and maximum price at which the securities are to be sold or bought

3) The period within which they are to be sold or bought.

4) The name and the address of the person in whose name they are to be registered.

Only members of the stock exchange can purchase and sell securities. But in India banks are not the members of the stock exchange. So they entrust this function to the brokers. If the banker does not follow the customer’s instruction strictly and the customer suffers a loss, the banker should make good the same.

All orders issued to the broker should be properly recorded in the register of stock and share transactions. Bankers should obtain from the customer a duly signed authority.
Then only customer’s account can be debited with the purchase moneys. In case of sale of securities, the amount has to be credited to the customer’s account under advice to him.

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Investment Banking (Industrial banks)

Investment Banks are organisations which assist business corporations and governmental bodies to raise funds for long-term capital reqiurements through sale of shares, stocks and bonds. Unlike commercial banks they act primarily as middlemen between business corporations and investors. Generally, they purchase entire issue of new securities of the business corporations and reissue them for public subscription.

Classification of Investment Banks

Investment banks are classified as Originators, underwriters and retailers. As originators they bring out new issue of securities. As underwriters they underwrite the issue. As retailers they retail the securities to individual and institutional investors.
A single institution may act in all these capacities.

Mixed Banking

The Origin of mixed banking lies in the extension of the operations of the investment bank to the commercial banking field.

Mixed banking is defined  as a system where banks make both short-term and long-term investments. For industrial development, the industries, trade and commerce need both short-term and long-term loans.

Investment banking provides longterm loans while commercial banks provide short-term funds. So mixed banking combines the principles of both investment banking and commercial banking.

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The Reserve Bank of India has formulated and enforced liquidity rules. They are of two types,

i) Cash Reserve Ratio (CRR)

Reserve Bank of India Act 1934 requires every commercial bank to keep certain minimum cash reserve with Reserve Bank of India. This statutory cash reserve ratio (CRR) was raised to a maximum of 15% of the total deposit liabilities. An additional 10% of cash reserve ratio was also fixed. This is called incremental cash reserve ratio (ICRR).
In recent years the CRR has been gradually reduced to 8%. On the other hand ICRR has gone up.

ii) Statutory Liquidity Ratio (SLR)

Section 24 of the Banking Regulation Act 1949 requires every commercial bank to maintain a minimum liquidity. The minimum liquidity must be in the form of cash, gold and unencumberred approved securities. Such assets should not be less than 38.5% of their total demand and time liabilities. In the recent past SLR has been gradually reduced to 25% of the total deposit liabilities.

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The traveller’s letter of credit consists of letter of identification. It ensures safety. It has to be produced each time an amount is drawn in respect of it. The customer puts his signature to the letterof identification in the presence of issuing banker. The foot note required the beneficiary to keep letter of identification apart from letter of credit. This precaution makes forgery and false impersonation difficult. Fundamentally, the letter of identification is a proof for identifying the customer.

A letter of credit carries spaces for particulars such as the date, place of payment, the amount in words and figures paid and the name of the cashing banker. These particulars will be recorded for every withdrawal. The paying bank presents the beneficiary’s drafts to the issuing banks and get them reimbursed.

Traveller’s letter of credit is issued on the payment of the full amount by the beneficiary.
Sometimes, it may be issued against the gurantee of the customer to pay the amount with interest later. Such letter of credit is called gurantee letter of credit.

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Most of the banks have now opened up ‘Merchant Banking’ departments. It is a British concept introduced by Grindlays Bank in 1969. Following the footlines of Grindlays Bank, in India, a number of banks have set up mmechant banking. State Bank of India, Bank of Baroda, Bank of India, Canara Bank, Indian Bank, Indian Overseas Bank and Syndicate Bank have organised merchant banking division.

Services of Merchant banking division:

1. Project counselling

Merchant banking offers project counselling such as preinvestment and feasibility studies to identify a project.

2. Liaison work

It undertakes work for entrepreneurs. Merchant banking divisions help them in getting government consent, letter of intent, industrial licences etc.

3. Project reports

After exploring means and sources of finance, merchant banking divisions prepare project reports.

4. Financial plan

Merchant banking divisions prepare a viable financial plan. They also file applications for loan.

5. Corporate financing

Merchant banking departments specialises in domestic corporate financing. It deals with public issue activities such as preparation and issue of prospectus, underwriting of capital issues and acting as managers to new issues.

6. Corporate restructure

The services of merchandising divisions are of a fairly wide range. They examine the propasals for mergers and amalgamations of companies and arrangement of loans or short-term finance.

7. Expansion/diversification

Small Scale Industries may undertake expansion and diversification programmes. Such planning involves structural changes in the form of organisation.
Their capital base also needs to be expanded. Merchant banking division provides assistance to small scale industries in the area of expansion or diversification.

8. Foreign collaboration

Merchant banking divisions have international connections. They assist in arranging foreign exchange elements required by industries for their projects.
They also helps in obtaining loan from banks and other institutions outside India.

9. Dealing in foreign exchange business

Commercial banks acts as an intermediary in the settlement of debt within a country. Such settlement is possible through the medium of a cheque or draft or a credit instument. Likewise it acts as an intermefisry in foreign debts. For this purpose the commercial banks maintain a foreign exchange department. It is manned by specialists in this line. For this purpose banks have branches in other countries. Whenever they have no branches of their own they maintain accounts with correspondent banks.

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Primary functions peformed by commercial banks include two. They are

i) Receiving deposits from the public:

The commercial banks are to attract deposits from the public. People who have cash balances and who want to keep them in a safe place, deposit the same with a bank.
Commercial banks accept deposits from any person in the public. The term person, in this context, includes individuals, business organisations like partnership firms, companies etc and other institutions. Such deposits are repayable either on demand or on the expiry of a stipulated period. The important kinds of deposits include current deposits, savings deposits and fixed deposits.

Current deposits are withdrawable by the depositor at any time by means of cheques. Normally banks do not pay interest on current deposits. In fact they make a small charge on the customers with current account.

Savings deposits are intended to inculcate the habit of savings deposits. The withdrawal of money from savings account is restricted to some extent. For instance, they may not be withdrawn more than once or twice a week or more than a fixed sum of money at a time.
Fixed deposits are made for specific periods. They can be withdrawn only on the expiry of the specific periods. Depositors like fixed deposits for their safety as well for the interest they bring to them.

ii) Making loans and advances

The second important function of a commercial banks is to make loans and advances. Loans and advances are made out of deposits of the public. Direct loans and advances are given to all types of persons. Particularly businessmen and investors are lent against personal security, gold and silver and other movable and immovable assets. The various froms of loans and advances are: cash credit, overdraft, loan system and purchase and discounting of bills.

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The growth of commercial banking during the first three plan periods has been lopsided. Without demanding proper security some banks were diverting funds to large and medium industries.

Bank branches were opened only in big cities. Rural areas were neglected. Banks made discrimination between private sector and public sector between rural and urban and between agriculture, trade and industry. The banks were financing those industries which were producing luxury goods. The government felt that this type of growth was not in consonance with planning.The growth appeared to be defiant in many respects. There was a growing demand for the bank credit for the development of agriculture, industry and selfemployment. So it was essential for teh banking system to attract savings.

Therefore, the government felt that need for social banking as against capitalist banking. A scheme of social control was introduced in 1967. The government enacted Banking Laws Amendment Act in 1968. This act has given more power to the government to control banking. The objectives of this Act was to ensure more equitable distribution of the resources of the banking system. The priority sectors like agriculture, small-scale industry, public sector and self-employment were to receive their due share in obtaining bank finance. Apart from this the banks are required to reconstitute their board of directors.

The government set up National credit council in 1968. The Finance Minister was the chairman and the Governor of the Reserve Bank was the vice chairman of the council.
The main functions of the National credit council were:

1. assessing the volume of credit required for the economy as a whole.

2. providing guidelines for the distribution of credit to the priority sector.

3. ensuring equitable distribution of credit in the economy.

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