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Reserve bank of India (RBI)

• The central bank of the country--Reserve Bank of India (RBI).
• Established in April 1935 with a share capital of Rs. 5 crores on the basis of the recommendations of
the Hilton Young Commission.
• The share capital was divided into shares of Rs. 100 each fully paid up which was entirely owned by
private shareholders in the beginning.
• The Government held shares of nominal value of Rs. 2,20,000.
• Reserve Bank of India was nationalized in the year 1949
• No of members on central board is 20 (incl. governor and 4 deputy governors)
Need for the Reserve Bank
• The Reserve Bank of India Act, 1934 was commenced on April 1, 1935.
• The Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank.
The Bank was constituted for the need of following:
• To regulate the issue of banknotes
• To maintain reserves with a view to securing monetary stability and
• To operate the credit and currency system of the country to its advantage.

Role & Function of RBI

1. Issue Of Currency Notes :-Under section 22 of RBI Act, the bank has the sole right to issue currency
notes of all denominations except one rupee coins and notes. The one-rupee notes and coins and small
coins are issued by Central Government and their distribution is undertaken by RBI as the agent of the
government. The RBI has a separate issue department which is entrusted with the issue of currency
notes.

2. Banker To The Government :-The RBI acts as a banker agent and adviser to the government. It has
obligation to transact the banking business of Central Government as well as State Governments. E.g.:-
RBI receives and makes all payments on behalf of government, remits its funds, buys and sells foreign
currencies for it and gives it advice on all banking matters. RBI helps the Government – both Central
and state – to float new loans and manage public debt. The bank makes ways and meets advances of
the government. On behalf of central government it sells treasury bills and thereby provides short-
term finance.

3. Banker’s bank And Lender Off Last Resort :-RBI acts as a banker to other banks. It provides
financial assistance to scheduled banks and state co-operative banks in form of rediscounting of
eligible bills and loans and advances against approved securities.
RBI acts as a lender of last resort. It provides funds to bank when they fail to get it from other sources.
It also acts as a clearing house. Through RBI, banks make interbanks payments.

4. Controller Of Credit :-RBI has power to control the volume of credit created by banks. The RBI
through its various quantitative and qualitative techniques regulates total supply of money and bank
credit in the interest of economy. RBI pumps in money during busy season and withdraws money
during slack season.

5. Exchange control And Custodian Of Foreign Reserve :-RBI has the responsibility of maintaining
fixed exchange rates with all member countries of IMF. For this, RBI has centralized all foreign
exchange reserves (FOREX). RBI functions as custodian of nations foreign exchange reserves. It has to
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maintain external valu of Rupee. RBI achieves this aim through appropriate monetary fiscal and trade
policies and exchange control.

6. Collection And Publication Of Data :-The RBI collects and complies statistical information on
banking and financial operations of the economy. The Reserve Bank Of India’ Bulletian is a monthly
publication. It not only provides information, but also results of important studies and investigations
conducted by reserve bank are given. ‘The Report on currency and finance’ is an annual publication. It
provides review of various developments of economic and financial importance.

7. Regulatory And Supervisory Functions :-The RBI has wide powers of supervision and control over
commercial and co-operative banks, relating to licensing, establishment, branch expansion, liquidity
of Assets, management and methods of working, amalgamation, re-construction and liquidation. The
supervisory functions of RBI have helped a great in improving the standard of banking in India to
develop on sound lines and to improve the methods of their operation.

8. Clearing House Functions :-The RBI acts as a clearing house for all member banks. This avoids
unnecessary transfer of funds between the various banks.

9. Development And Promotional Functions :-The RBI has helped in setting up Industrial Finance
Corporations of India (IFCI), State Financial Corporations (SFCs), Deposit Insurance Corporation,
Agricultural Refinance and Development Corporation (ARDC), units Trust of India (UTI) etc. these
institutions were set up to mobilize savings, promote saving habits and to provide industrial and
agricultural finance.
RBI has a special Agricultural Credit Department (ACD) which studies the problems of agricultural
credit. For this Regional Rural banks, Co-operative, NABARD etc. were established. The RBI has also
taken measures to promote organized bill market to create elasticity in Indian Money Market in order
to satisfy seasonal credit needs.
Thus RBI has contributed to economic growth by promoting rural credit, industrial financing,
export trade etc.

A) TRADITIONAL FUNCTIONS B) PROMOTIONAL FUNCTIONS C) SUPERVISORY FUNCTIONS

1) Monopoly of currency notes
issue 1) Promotion of banking habit 1) Granting license to Banks.
2) Banker to the and expansion of banking
2) Inspecting and making enquiry or
Government(both the central systems.
determining position in respect of
and state) 2) Provides refinance for export
matters under various sections of RBI
3) Agent and advisor to the promotion. (E P C G)
and Banking regulations.
Government 3) Expansion of the facilities for
4) Banker’s Bank the provision of the 3) Periodical review of the work of the
5) Acts as the clearing house of agricultural credit through commercial banks.
the country NABARD.
4) Giving directives to commercial banks.
6) Lender of the last resort (B R 4) Extension of the facilities for
P) the small scale industries. 5) Control the non-banking finance
7) Custodian of the foreign 5) Helping the Co-operative corporations.
exchange reserves sectors.
6) Ensuring the health of financial
8) Maintaining the external value 6) Prescribe the minimum
system through on-site and off-site
of domestic currency statutory requirement. (SLR)
verification.
9) Controller of forex and credit 7) Innovating the new banking
(Credit Policy) business transactions.
10) Ensures the internal value of
the currency
11) Publishes the Economic
statistical data
12) Fight against economic crisis
and ensures stability of
Economy.
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What is monetary policy?

A macroeconomic policy tool used to influence interest rates, inflation, and credit availability through
changes in the supply of money available in the economy. In India it is also called the Reserve Bank of India’s
‘Credit Policy’ as the stress is primarily on directing credit.

There are two kinds of tools:

 Quantitative tools –control the volume of credit and inflation, indirectly.
 Qualitative tools –they control the supply of money in selective sectors of the economy.

QUESTIONS

Explain the quantitative and selective methods of credit control used by RBI ?
Explain the Monetary Policy measures taken by RBI to control credit ?
Write note on Quantitative I Selective methods of credit control ?
Explain Monetary Management of RBI ?
General / Quantitative Credit Control Methods

1. Bank Rate Policy :-

Bank rate is the rate at which the Central bank lends money to the commercial banks for their liquidity
requirements. Bank rate is also called discount rate. In other words bank rate is the rate at which the
central bank rediscounts eligible papers (like approved securities, bills of exchange, commercial papers
etc) held by commercial banks.
Bank rate is important because it is the pace setter to other marketrates of interest. Bank rates have
been changed several times by RBI to control inflation and recession. By 2003, the bank rate has been
reduced to 6% p.a.
2. Open market operations :-
It refers to buying and selling of government securities in open market in order to expand or contract the
amount of money in the banking system. This technique is superior to bank rate policy. Purchases inject
money into the banking system while sale of securities do the opposite. During last two decades the RBI
has been undertaking switch operations. These involve the purchase of one loan against the sale of
another or, vice-versa. This policy aims at preventing unrestricted increase in liquidity.
3. Cash Reserve Ratio (CRR)
The Gash Reserve Ratio (CRR) is an effective instrument of credit control. Under the RBl Act of, l934
every commercial bank has to keep certain minimum cash reserves with RBI. The RBI is empowered to
vary the CRR between 3% and 15%. A high CRR reduces the cash for lending and a low CRR increases
the cash for lending. The CRR has been brought down from 15% in 1991 to 7.5% in May 2001. It further
reduced to 5.5% in December 2001. It stood at 5% on January 2009. In January 2010, RBI increased the
CRR from 5% to 5.75%. It further increased in April 2010 to 6% as inflationary pressures had started
building up in the economy. As of March 2011, CRR is 6%.
4. Statutory Liquidity Ratio (SLR)
Under SLR, the government has imposed an obligation on the banks to ,maintain a certain ratio to its
total deposits with RBI in the form of liquid assets like cash, gold and other securities. The RBI has power
to fix SLR in the range of 25% and 40% between 1990 and 1992 SLR was as high as 38.5%. Narasimham
Committee did not favour maintenance of high SLR. The SLR was lowered down to 25% from 10thOctober
1997.It was further reduced to 24% on November 2008. At present it is 25%.
5. Repo And Reverse Repo Rates
In determining interest rate trends, the repo and reverse repo rates are becoming important. Repo
means Sale and Repurchase Agreement. Repo is a swap deal involving the immediate Sale of Securities
and simultaneous purchase of those securities at a future date, at a predetermined price. Repo rate helps
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commercial banks to acquire funds from RBI by selling securities and also agreeing to repurchase at a later
date.
Reverse repo rate is the rate that banks get from RBI for parking their short term excess funds with RBI.
Repo and reverse repo operations are used by RBI in its Liquidity Adjustment Facility. RBI contracts credit
by increasing the repo and reverse repo rates and by decreasing them it expands credit. Repo rate was
6.75% in March 2011 and Reverse repo rate was 5.75% for the same period. On May 2011 RBI announced
Monetary Policy for 2011-12. To reduce inflation it hiked repo rate to,7.25% and Reverse repo to 6.25%
QUALITATIVE / SELECTIVE CREDIT CONTROL METHODS
Under Selective Credit Control, credit is provided to selected borrowers for selected purpose,
depending upon the use to which the control try to regulate the quality of credit - the direction towards the
credit flows. The Selective Controls are :-
1. Ceiling On Credit
The Ceiling on level of credit restricts the lending capacity of a bank to grant advances against certain
controlled securities.
2. Margin Requirements
A loan is sanctioned against Collateral Security. Margin means that proportion of the value of security
against which loan is not given. Margin against a particular security is reduced or increased in order to
encourage or to discourage the flow of credit to a particular sector. It varies from 20% to 80%. For
agricultural commodities it is as high as 75%. Higher the margin lesser will be the loan sanctioned.
3. Discriminatory Interest Rate (DIR)
Through DIR, RBI makes credit flow to certain priority or weaker sectors by charging concessional rates of
interest. RBI issues supplementary instructions regarding granting of additional credit against sensitive
commodities, issue of guarantees, making advances etc. .
4. Directives
The RBI issues directives to banks regarding advances. Directives are regarding the purpose for which
loans may or may not be given.
5. Direct Action
It is too severe and is therefore rarely followed. It may involve refusal by RBI to rediscount bills or
cancellation of license, if the bank has failed to comply with the directives of RBI.
6. Moral Suasion
Under Moral Suasion, RBI issues periodical letters to bank to exercise control over credit in general or
advances against particular commodities. Periodic discussions are held with authorities of commercial
banks in this respect.

Monetary Policy 2005-06 Current Monetary Policy

Key Figures Key Figures

• Reverse Repo Rate Hiked by 25 bps, stands at 5% • Reverse Repo 4%
• Repo Rate Unchanged at 6% • Repo Rate 4.25%
• Bank Rate Unchanged at 6% • Bank Rate 6%
• CRR Unchanged at 5% • CRR Unchanged 5.5%
• Inflation FY06 5-5.5% • Inflation 5.07%
• GDP FY06 Target 7%
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Recent changes in banking sector in India

A commercial bank is a type of bank that provides services such as accepting deposits, making business loans, and
offering basic investment products.

The functions of a commercial banks are divided into two categories:

1) Primary functions
2) Secondary functions Functions of Commercial Banks
Primary Functions Secondary Functions
1. These are the main activities These are the secondary
of the bank. activities of the bank.
2. These are the main sources These are not the main sources of
income of the bank. of income of the banks.
3. These are obligatory on the These are not obligatory on
part of bank to perform. the part of bank to perform.
But generally all commercial
Primary functions:
banks perform these
a) accepting deposits activities.
b) granting loans and advances
Loans - granted for a specific time period
Advances - credit facility provided by the bank to its customers

The difference between the rate of interest allowed on deposits and the rate charged on the Loans is the main source of
a bank’s income.

Secondary functions
 Issuing letters of credit, traveler’s cheques, etc.
 Undertaking safe custody of valuables, important documents, and
securities by providing safe deposit vaults or lockers;
 Providing customers with facilities of foreign exchange.
 Transferring money from one place to another; and from one
branch to another branch of the bank.
 Standing guarantee on behalf of its customers, for making
payments for purchase of goods, machinery, vehicles etc.
 Collecting and supplying business information;
 Issuing demand drafts and pay orders,
 Providing reports on the credit worthiness of customers.

Changing Role of Banks in India

The role of banks in India has changed a lot since economic reforms of 1991. These changes came due to LPG, i.e.
liberalization, privatization and globalization policy being followed by GOI. Since then most traditional and outdated
concepts, practices, procedures and methods of banking have changed significantly. Today, banks in India have
become more customer-focused and service-oriented than they were before 1991. They now also give a lot of
importance to their rural customers. They are even willing ready to help them and serve regularly the banking needs
of country-side India.
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The following points briefly the changing role of banks in India.

1. Better Customer Service Before 1991, the overall service of banks in India was very poor. There
were very long queues (lines) to receive payment for cheques and to deposit money. In those days,
some bank staffs were very rude to their customers. However, all this changed remarkably after Indian
economic reforms of 1991.
Banks in India have now become very customer and service focus. Their service has become quick,
efficient and customer-friendly. This positive change is mostly due to rising competition from new
private banks and initiation of Ombudsman Scheme by RBI.
2. Mobile Banking Under mobile banking service, customers can easily carry out major banking
transactions by simply using their cell phones or mobiles.
Here, first a customer needs to activate this service by contacting his bank. Generally, bank officer asks
the customer to fill a simple form to register (authorize) his mobile number. After registration, this
service is activated, and the customer is provided with a username and password. Using secret
credentials and registered phone, customer can now comfortably and securely, find his bank balance,
transfer money from his account to another, ask for a cheque book, stop payment of a cheque, etc.
Today, almost all banks in India provide a mobile-banking service.
3. Bank on Wheels The 'Bank on Wheels' scheme was introduced in the North-East Region of India.
Under this scheme, banking services are made accessible to people staying in the far-flung (remote)
areas of India. This scheme is a generous attempt to serve banking needs of rural India.
4. Portfolio Management In portfolio management, banks do all the investments work of their clients.
Banks invest their clients' money in shares, debentures, fixed deposits, etc. They first enter a contract
with their clients and charge them a fee for this service. Then they have the full power to invest or
disinvest their clients' money. However, they have to give safety and profit to their clients.
5. Issue of Electro-Magnetic Cards Banks in India have already started issuing Electro-Magnetic Cards
to their customers. These cards help to carry out cash-less transactions, make an online purchase, avail
ATM facility, book a railway ticket, etc.
Banks issue many types of electro-magnetic cards, which are as follows:
1. Credit cards help customers to spend money (loaned up to a certain limit as previously settled by
the bank) which they don't have in hand. They get a monthly statement of their purchases and
withdrawals. Along with the transacted amount, this statement also includes the interest and service
fee. The entire amount (as reflected in the statement of credit card) must be paid back to the bank
either fully or in installments, but before due date.
2. Debit cards help customers to spend that money which they have saved (credited) in their
individual bank accounts. They need not carry cash but instead can use a debit card to make a purchase
(for shopping) and/or withdraw money (get cash) from an ATM. No interest is charged on the usage of
debit cards.
3. Charge cards are used to spend money up to a certain limit for a month. At the end of the month,
customer gets a statement. If he has a sufficient balance, then he only had to pay a small fee. However, if
he doesn't have a necessary balance, he is given a grace period (which is generally of 25 to 50 days) to
repay the money.
4. Smart cards are currently being used as an alternative to avail public transport services. In India,
this covers Railways, State Transport and City (Local) Buses. Smart card has an integrated circuit (IC)
embedded in its plastic body. It is made as per norms specified by ISO.
5. Kisan credit cards are used for the benefit of the rural population of India. The Indian farmers
(kisans) can use this card to buy agricultural inputs and goods for self-consumption. These cards are
issued by both Commercial and Co-operative banks.
6. Universal Banking In India, the concept of universal banking has gained recognition after year 2000.
The customers can get all banking and non-banking services under one roof. Universal bank is like a
super store. It offers a wide range of services, including banking and other financial services like
insurance, merchant banking, etc.
7. Automated Teller Machine (ATM) There are many advantages of ATM. As a result, many banks
have opened up ATM centres to offer convenience to their customers. Now banks are operating ATM
centres not only in their branches but also at public places like airports, railway stations, hotels, etc.
Some banks have joined together and agreed upon to set up common ATM centres all over India.
8. Internet Banking Internet banking is also called as an E-banking or net banking. Here, the customer
can do banking transactions through the medium of the internet or world wide web (WWW). The
customer need not visit the bank's branch. Through this facility, the customer can easily inquiry about
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bank balance, transfer funds, request for a cheque book, etc. Most large banks offer this service to their
tech-savvy customers.
9. Encouragement to Bank Amalgamation Failure of banks is well-protected with the facility of
amalgamation. So depositors need not worry about their deposits. When weaker banks are absorbed
by stronger banks, it is called amalgamation of banks.
10. Encouragement to Personal Loans Today, the purchasing power of Indian consumers has increased
dramatically because banks give them easy personal loans. Generally, interest charged by the banks on
such loans is very high. Interest is calculated on reducing balance. Large banks offer loans up to a huge
amount like one crore. Some banks even organise Loan Mela (Fair) where a loan is sanctioned on the
spot to deserving candidates after they submit proper documents.
11. Marketing of Mutual Funds A mutual fund collects money from many investors and invests the
money in shares, bonds, short-term money market instruments, gold assets; etc. Mutual funds earn
income by interest and dividend or both from its investments. It pays a dividend to subscribers. The
rate of dividend fluctuates with the income on mutual fund investments. Now banks have started
selling these funds in their own names. These funds are not insured like other bank deposits. There are
different types of funds such as open-ended funds, closed-ended funds, growth funds, balanced funds,
income funds, etc.
12. Social Banking The government uses the banking system to alleviate poverty and unemployment.
Many social development programmes are initiated by the banks from time to time. The success of
these programmes depends on financial support provided by the banks. Banks supply a lot of finance to
farmers, artisans, scheduled castes (SC) and scheduled tribe (ST) families, unemployed youth and
people living below the poverty line (BPL).

Challenges face by banks in India

 High transaction costs : A major concern before the banking industry is the high transaction cost of
carrying non- performing assets in their books. The growth led to strains in the operational
efficiency of banks and the accumulation of non-performing assets (NPA’s) in their loan portfolios.
 IT revolution : The Indian banks are subject to tremendous pressures to perform as otherwise their
very survival would be at stake. The application of IT and e-banking is becoming the order of the
day with the banking system heading towards virtual banking.
 Timely technological up gradation : Already electronic transfers, clearings, settlements have
reduced translation times. To face competition it is necessary for banks to absorb the technology
and upgrade their services.
 Intense Competition : The RBI and Government of India kept banking industry open for the
participants of private sector banks and foreign banks. The foreign banks were also permitted to set
up shop on India either as branches or as subsidiaries. Due to this lowered entry barriers many new
players have entered the market such as private banks, foreign banks, non-banking finance
companies, etc. The foreign banks and new private sector banks have spearhead the hi-tech
revolution. For survival and growth in highly competitive environment banks have to follow the
prompt and efficient customer service, which calls for appropriate customer centric policies and
customer friendly procedures.
 Privacy and Safety : Among the most important aspects of savings, i.e., safety, liquidity and
profitability, safety is at the top most priority. The areas which might endanger security in e-
banking can be : Credit risk Liquidity, interest rate risk, market risks, Legal risk.
 Global banking: The impact of globalization becomes challenges for the domestic enterprises as
they are bound to compete with global players. If we look at the Indian Banking Industry, then we
find that there are 36 foreign banks operating in India, which becomes a major challenge for
Nationalized and private sector banks.
 Financial inclusion: Financial inclusion has become a necessity in today’s business environment.
Whatever is produced by business houses, that has to be under the check from various perspectives
like environmental concerns, corporate governance, social and ethical issues. In India, RBI has
initiated several measures to achieve greater financial inclusion, such as facilitating no-frills
accounts and GCCs for small deposits and credit.
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 A Development Bank is a polygonal development finance institution devoted to improving the

social and monetary development of its associate nations.
 Its main emphasis is the welfare of the people. For example the Asian Development Bank's
overarching goal is to decrease poverty in Asia and the Pacific.
 It helps improve the value of people's lives by providing loans and scientific support for a broad
variety of development activities.

FUNCTION OBJECTIVES

 Financial Gap Fillers Lay Foundations for Industrialization

 Undertake Entrepreneurial Role Meet Capital Needs
 Joint Finance Need for Promotional Activities
 Refinance Facility Help Small and Medium Sectors
 Credit Guarantee
 Underwriting of Securities

Role or Function of development Banks

1. Small Scale Industries (SSI)- Development banks play an important role in the promotion and
development of the small-scale sector. Government of India (GOI) started Small industries
Development Bank of India (SIDBI) to provide medium and long-term loans to Small Scale Industries
(SSI) units. SIDBI provides direct project finance, and equipment finance to SSI units. It also
refinances banks and financial institutions that provide seed capital, equipment finance, etc., to SSI
units.
2. Development of Housing Sector- Development banks provide finance for the development of the
housing sector. GOI started the National Housing Bank (NHB) in 1988.NHB promotes the housing
sector in the following ways: It promotes and develops housing and financial institutions. It
refinances banks and financial institutions that provide credit to the housing sector.
3. Large Scale Industries (LSI)- Development banks promote and develop large-scale industries (LSI).
Development financial institutions like IDBI, IFCI, etc., provide medium and long-term finance to the
corporate sector. They provide merchant banking services, such as preparing project reports, doing
feasibility studies, advising on location of a project, and so on.
4. Agriculture and Rural Development -Development banks like National Bank for Agriculture & Rural
Development (NABARD) helps in the development of agriculture. NABARD started in 1982 to
provide refinance to banks, which provide credit to the agriculture sector and also for rural
development activities. It coordinates the working of all financial institutions that provide credit to
agriculture and rural development. It also provides training to agricultural banks and helps to
conduct agricultural research.
5. Enhance Foreign Trade- Development banks help to promote foreign trade. Government of India
started Export-Import Bank of India (EXIM Bank) in 1982 to provide medium and long-term loans to
exporters and importers from India. It provides Overseas Buyers Credit to buy Indian capital goods.
It also encourages abroad banks to provide finance to the buyers in their country to buy capital
goods from India.
6. Review of Sick- Units Development banks help to revive (cure) sick-units. Government of India
(GOI) started Industrial investment Bank of India (IIBI) to help sick units. IIBI is the main credit and
reconstruction institution for revival of sick units. It facilitates modernization, restructuring and
diversification of sick-units by providing credit and other services.
7. Entrepreneurship Development- Many development banks facilitate entrepreneurship
development. NABARD, State Industrial Development Banks and State Finance Corporations
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provide training to entrepreneurs in developing leadership and business management skills. They
conduct seminars and workshops for the benefit of entrepreneurs.
8. Regional Development -Development banks facilitate rural and regional development. They
provide finance for starting companies in backward areas. They also help the companies in project
management in such less-developed areas.
9. Contribution to Capital Markets -Development banks contribute the growth of capital markets.
They invest in equity shares and debentures of various companies listed in India. They also invest in
mutual funds and facilitate the growth of capital markets in India.

Conversion of financial institute into bank

The IDBI is a financial institute and is converted in a commercial bank due major problems :

 High cost funds

 Burden of bad loans
 Lack of demand for funds investment purposes
The govt of India decided to convert IDBI into a banking company. To give effect to this , an Amendment Act entitled
the Industrial Development Bank Act, 2003. The main provisions of Act are as follows:

1) The undertaking of IDBI shall be transferred to and vest in a company.

2) The company shall be deemed to be banking company within the meaning of Banking Regulation
Act, 1949 and shall not require a licence under section 22 of that Act.
3) The company shall carry on banking business in accordance with the provisions of that Act, in
addition to the business which may be carried on and transferred by the Development Bank.
4) The company shall not be required to maintain liquid assets for 5 years as required under section 24
of the Banking Regulation Act, 1949.
On July 29, 2004 the Boards of Directors of IDBI and IDBI Bank Ltd, decided to merge IDBI Bank Ltd with its
parent company IDBI. IDBI Ltd has taken over all the branches of IDBI Bank Ltd , and has emerged as the
seventh largest commercial bank in terms of resources.

Benefits of this merger are :

1) The size of the bank has been enlarged by taking over the branches of IDBI Bank Ltd. The number
of branch offices was increase by 119 in addition to 8 extension counters and 330 ATMs.
2) The benefits of economies of scale
3) The bank will be able to price its production attractively, thereby improving the quality of its assets.
4) The bank will have access to cheaper cheaper short-term retail funds in the form of deposits as a
commercial bank.
5) The bank will be able to enlarge the clientele base through market penetration.

Concept of Universal Bank

Universal Banking is a multi-purpose and multi-functional financial supermarket (a company offering a
wide range of financial services e.g. stock, insurance and real-estate brokerage) providing both
banking and financial services through a single window.

Definition of Universal Banking: As per the World Bank, "In Universal Banking, large banks operate
extensive network of branches, provide many different services, hold several claims on firms(including
equity and debt) and participate directly in the Corporate Governance of firms that rely on the banks
for funding or as insurance underwriters".
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Advantages of Universal Banking

 Economies of Scale. The main advantage of Universal Banking is that it results in greater
economic efficiency in the form of lower cost, higher output and better products. Many
Committees and reports by Reserve Bank of India are in favour of Universal banking as it
enables banks to explit economies of scale and scope.
 Profitable Diversions. By diversifying the activities, the bank can use its existing expertise in
one type of financial service in providing other types. So, it entails less cost in performing all
the functions by one entity instead of separate bodies.
 Resource Utilization. A bank possesses the information on the risk characteristics of the
clients, which can be used to pursue other activities with the same clients. A data collection
about the market trends, risk and returns associated with portfolios of Mutual Funds,
diversifiable and non diversifiable risk analysis, etc, is useful for other clients and information
seekers. Automatically, a bank will get the benefit of being involved in the researching
 Easy Marketing on the Foundation of a Brand Name. A bank's existing branches can act as
shops of selling for selling financial products like Insurance, Mutual Funds without spending
much efforts on marketing, as the branch will act here as a parent company or source. In this
way, a bank can reach the client even in the remotest area without having to take resource to
an agent.
 One-stop shopping. The idea of 'one-stop shopping' saves a lot of transaction costs and
increases the speed of economic activities. It is beneficial for the bank as well as its customers.
 Investor Friendly Activities. Another manifestation of Universal Banking is bank holding
stakes in a form : a bank's equity holding in a borrower firm, acts as a signal for other investor
on to the health of the firm since the lending bank is in a better position to monitor the firm's
activities.

Disadvantages of Universal Banking

 Grey Area of Universal Bank. The path of universal banking for DFIs is strewn with obstacles.
The biggest one is overcoming the differences in regulatory requirement for a bank and DFI.
Unlike banks, DFIs are not required to keep a portion of their deposits as cash reserves.
 No Expertise in Long term lending. In the case of traditional project finance, an area where
DFIs tread carefully, becoming a bank may not make a big difference to a DFI. Project finance
and Infrastructure finance are generally long- gestation projects and would require DFIs to
borrow long- term. Therefore, the transformation into a bank may not be of great assistance in
lending long-term.
 NPA Problem Remained Intact. The most serious problem that the DFIs have had to
encounter is bad loans or Non-Performing Assets (NPAs). For the DFIs and Universal Banking or
installation of cutting-edge-technology in operations are unlikely to improve the situation
concerning NPAs.

NON PERFORMING ASSETS (NPA)

 NPA is defined as a credit facility in respect of which the interest and/or installment of
principal has remained ‘past due’ for a specified period of time.
 An asset, including a leased asset, becomes non-performing when it ceases to generate
income for the bank.
 In accounting, originally Bad & Doubtful Debts
Non Performing Asset means a loan or an account of borrower, which has been classified by a bank or financial
institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to
asset classification issued by RBI.
 Earlier assets were declared as NPA after completion of the period for the payment of total amount of
loan and 30 days grace.
 In present scenario assets are declared as NPA if none of the installment is paid till 180 days i.e. six months
in respect of a term loan.
OUT OF ORDER
 An account should be treated as out of order if the outstanding balance remains continuously in excess
of sanctioned limit /drawing power.
OVERDUE
 Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on due date fixed by
the bank.
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TYPES OF NPA
A] Gross NPA:
Gross NPAs are the sum total of all loan assets that are classified as NPAs as per RBI guidelines as on Balance
Sheet date. Gross NPA reflects the quality of the loans made by banks. It consists of all the non standard assets
like as sub-standard, doubtful, and loss assets.
It can be calculated with the help of following ratio:
Gross NPAs Ratio  Gross NPAs
Gross Advances
B] Net NPA:
Net NPAs are those type of NPAs in which the bank has deducted the provision regarding NPAs. Net NPA shows the
actual burden of banks. Since in India, bank balance sheets contain a huge amount of NPAs and the process of
recovery and write off of loans is very time consuming, the provisions the banks have to make against the NPAs
according to the central bank guidelines, are quite significant. That is why the difference between gross and net NPA
is quite high.
It can be calculated by following_
Net NPAs  Gross NPAs – Provisions
Gross Advances - Provisions

EFFECTS OF NPA ON BANKS & FI

 Restriction on flow of cash done by bank due to the provisions of fund made against NPA.
 Drain of profit.
 Bad effect on goodwill.
 Bad effect on equity value.
Factor for rise in NPAs
The banking sector facing serious problems of rising NPAs. This is due to :

1) Internal factors : a) defective lending process, b) Inappropriate technology, c) Analyze the balance
sheet, d) Purpose of the loan, e) poor credit appraisal system, f) Managerial deficencies, g) Absence
of regular industrial visit.
2) External factors : a) Ineffective recovery tribunal, b) willfull defaults, c) natural calamities, d)
Industrial sickness, e) Lack of demand, f) change of govt policies.
Categories of NPAs
 Standard Assets: Arrears of interest and the principal amount of loan does not exceed 90 days
at the end of financial year
 Substandard Assets – Which has remained NPA for a period less than or equal to 12 months.
 Doubtful Assets – Which has remained in the sub-standard category for a period of 12 months
 D1 i.e. up to 1 year : 20% provision is made by the banks
 D2 i.e. up to 2 year: 30% provision is made by the bank
 D3 i.e. up to 3 year : 100% provision is made by the bank.
 Loss Assets – where loss has been identified by the bank or internal or external auditors or the
RBI inspection but the amount has not been written off wholly.
Provisioning Norms
 STANDARD ASSETS – general provision of a minimum of 0.40 percent on standard assets
 SUBSTANDARD ASSETS – 10% on total outstanding balance, 10 % on unsecured exposures identified as sub-
standard & 100% for unsecured “doubtful” assets.
 DOUBTFUL ASSETS – 100% to the extent advance not covered by realizable value of security. In case of
secured portion, provision may be made in the range of 20% to 100% depending on the period of asset
remaining sub-standard
 LOSS ASSETS – 100% of the outstanding
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Tools for recovering NPA

SARFAESI
Act Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act,
2002 (SARFAESI)
 The Act provides three alternative methods for recovery of non-performing
assets, namely: -
1) Securitisation (SCs)
2) Asset Reconstruction (ARCs)
3) Enforcement of Security without the intervention of the Court.
 NPA loans with outstanding above Rs. 1.00 lac.
 NPA loan accounts where the amount is less than 20% of the principal and
interest are not eligible to be dealt with under this Act
Securitisation: It means issue of security by raising of receipts or funds by SCs/ARCs. A securitisation
company or reconstruction company may raise funds from the QIBs by forming schemes for acquiring
financial assets. The SC/ARC shall keep and maintain separate and distinct accounts in respect of each
such scheme for every financial asset acquired, out of investments made by a QIB and ensure that
realisations of such financial asset is held and applied towards redemption of investments and payment
of returns assured on such investments under the relevant scheme.
This Act empowers the Bank:
 To issue demand notice to the defaulting borrower and guarantor, calling upon them to
discharge their dues in full within 60 days from the date of the notice.
 To give notice to any person who has acquired any of the secured assets from the borrower
to surrender the same to the Bank.
 To ask any debtor of the borrower to pay any sum due or becoming due to the borrower.
 Any Security Interest created over Agricultural Land cannot be proceeded with.
PRIME AND SUB-PRIME RATE
Definition of 'Prime Rate'
The interest rate that commercial banks charge to their most credit-worthy customers. Generally a
bank's best customers consist of large corporations. The prime interest rate, or prime lending rate, is
largely determined by the federal funds rate, which is the overnight rate which banks lend to one
another. The prime rate is also important for retail customers, as the prime rate directly affects the
lending rates which are available for mortgage, small business and personal loans.
Definition of 'Subprime Rates'
Interest rates charged to subprime borrowers, such as on loans to people with poor credit scores from
one or more credit bureau. Subprime rates will be higher than prime rates for the same type of loan,
although there is no exact amount or spread that constitutes subprime.