29-11-2012, 05:58 PM
Banking Sector Module
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Introduction to Banking
Fundamental Role and Evolution
India
The banking sector is meant to meet the financial needs of the economy. Too much of money
can cause inflation – too little can stifle economic growth and create problems of unemployment
and lost opportunity. Accordingly the apex banking institution, the Reserve Bank of India
(RBI) has a basic function "...to regulate the issue of Bank Notes and keeping of reserves with
a view to securing monetary stability in India and generally to operate the currency and credit
system of the country to its advantage."1
The RBI, which commenced operations on April 1, 1935, is at the centre of India’s financial
system. Hence it is called the Central Bank. It has a fundamental commitment to maintaining
the nation’s monetary and financial stability. It started as a private share-holders’ bank – but
was nationalized in 1949, under the Reserve Bank (Transfer of Public Ownership) Act, 1948.
RBI is banker to the Central Government, State Governments and Banks. Key functions of
RBI Include:
• Monetary policy
• Supervision of Banking companies, Non-banking Finance companies and Financial Sector,
Primary Dealers and Credit Information Bureaus
• Regulation of money market, government securities market, foreign exchange market
and derivatives linked to these markets.
• Management of foreign currency reserves of the country and its current and capital
account.
• Issue and management of currency
• Oversight of payment and settlement systems
• Development of banking sector
United States
After the stock market crash of 1929 and the banking crisis in the 1930s, the US brought in
the Glass-Stegall Act, 1933. The intention was to prohibit commercial banks from investment
banking activities and taking equity positions in borrowing firms.
Many of the restrictions of the Glass-Stegall Act were reversed through the Gramm-Leach-
Bliley Act, 1999 (GLB Act, also called Financial Services Modernisation Act, 1999). The act
permitted commercial banks, investment banks, securities firms and insurance companies to
consolidate. This paved the way for Universal Banking, where all kinds of banking services
would be offered under a single umbrella institution.
Leading economists like Paul Krugman and Joseph Stigilitz believe that the GLB Act was
responsible for the sub-prime mortgage crisis which hit the world in 2007. It also created
huge institutions that were risky to the financial system and too big to fail.
Banking Structure in India
Problems in the banking sector can seriously affect the real economy, as has been experienced
globally in the last few years. Therefore, a well-regulated banking system is a key comfort for
local and foreign stake-holders in any country. Prudent banking regulation is recognized as
one of the reasons why India was less affected by the global financial crisis.
The Banking Regulation Act, 1949 defines a banking company as a company which transacts
the business of banking in India. Banking is defined as accepting, for the purpose of lending
or investment, of deposits of money from the public, repayable on demand or otherwise and
withdrawable by cheque, draft, order or otherwise.
Branch Licensing
Besides the banking license, banks have to obtain prior permission of RBI for opening a new
place of business or changing the location of the existing place of business. ‘Place of business’
includes any place at which deposits are received, cheques are cashed or moneys lent.
The requirement of permission is however not applicable in the following cases:
• Changing the location of an existing place of business within the same city, town or
village.
• Opening a temporary place of business upto one month for the purpose of affordable
banking facilities for any exhibition, mela, conference or like occasion. The temporary
place should however be within the limits of the city, town or village where there is an
existing branch.
Foreign Banks
Foreign banks in India mostly operate as branches of the international entity. Recently, RBI
has come out with a discussion paper on the subject, which incorporates the learning from the
recent global financial crisis. Key points mentioned in the report are as follows:
• There are currently 34 foreign banks operating in India as branches.
o Their balance sheet assets, accounted for about 7.65 percent of the total assets of
the scheduled commercial banks as on March 31, 2010 as against 9.03 per cent as
on March 31, 2009.
o In case, the credit equivalent of off balance sheet assets are included, the share of
foreign banks was 10.52 per cent of the total assets of the scheduled commercial
banks as on March 31, 2010, out of this, the share of top five foreign banks alone
was 7.12 per cent.
• The policy on presence of foreign banks in India has followed two cardinal
• principles of (i) Reciprocity and (ii) Single Mode of Presence. These principles are
independent of the form of presence of foreign banks. Therefore, these principles should
continue to guide the framework of the future policy on presence of foreign banks in
India.
• Prima facie the branch mode of presence of foreign banks in India provides a ring-fenced
structure as there is a requirement of locally assigned capital and capital adequacy
requirement as per Basel Standards.
• It may not be possible to mandate conversion of existing branches into subsidiaries.
However, the regulatory expectation would be that those foreign banks which meet the
conditions and thresholds mandated for subsidiary presence for new entrants or which
become systemically important by virtue of their balance sheet size would voluntarily
opt for converting their branches into Wholly Owned Subsidiaries (WOS) in view of the
incentives proposed to be made available to WOS.