Structure of Commercial banks

Introduction
The banking system plays an important role in promoting economic growth not
only by channelling savings into investments but also by improving allocative
efficiency of resources. The recent empirical evidence, in fact, suggests that
banking system contributes to economic growth more by improving the
allocative efficiency of resources than by channelling of resources from savers
to investors. An efficient banking system is now regarded as a necessary pre-
condition for growth.The banking system of India consists of the RBI, commercial
banks, cooperative banks and development banks (development finance
institutions). These institutions, which provide a meeting ground for the savers
and the investors, form the core of India’s financial sector. Through
mobilization of resources and their better allocation, banks play an important
role in the development process of underdeveloped countries.
Structure
Scheduled Banks: that are included in the second schedule of the Reserve Bank of India Act,
1934 are considered to be scheduled banks. All scheduled banks enjoy the following facilities:
Such a bank becomes eligible for debts/loans on bank rate from the RBI
Such a bank automatically acquires the membership of a clearing house.
The scheduled banks are:
1. Commercial bank The institutions that accept deposits from the general public and
advance loans with the purpose of earning profits are known as Commercial Banks.
2. Cooperative Banks A Cooperative Bank is a financial entity that belongs to its
members, who are also the owners as well as the customers of their bank. They provide
their members with numerous banking and financial services. Cooperative banks are the
primary supporters of agricultural activities, some small-scale industries.

• Public Sector Banks

Refer to a type of commercial banks that are nationalized by the government of a
country. In public sector banks, the major stake is held by the government. In India,
public sector banks operate under the guidelines of Reserve Bank of India (RBI), which is the
central bank. Some of the Indian public sector banks are State Bank of India (SBI), Corporation
Bank, Bank of Baroda, Dena Bank, and Punjab National Bank.

• Private Sector Banks

Refer to a kind of commercial banks in which major part of share capital is held by
private businesses and individuals. These banks are registered as companies with
limited liability. Some of the Indian private sector banks are Vysya Bank, Industrial
Credit and Investment Corporation of India (ICICI) Bank, and Housing Development
Finance Corporation (HDFC) Bank.

• Foreign Banks
Refer to commercial banks that are headquartered in a foreign country, but operate
branches in different countries. Some of the foreign banks operating in India are Hong Kong and
Shanghai Banking Corporation (HSBC), Citibank, American Express Bank, Standard &
Chartered Bank, and Grindlay’s Bank. In India, since financial reforms of 1991, there is a rapid
increase in the number of foreign banks. Commercial banks mark significant importance in the
economic development of a country as well as serving the financial requirements of the general
public.

● Rural Regional Banks:

were established under the Regional Rural Banks Ordinance, 1975 with the aim of ensuring
sufficient institutional credit for agriculture and other rural sectors. The area of operation of
RRBs is limited to the area notified by the Government. RRBs are owned jointly by the
Government of India, the State Government and Sponsor Banks. An example of RRB in India is
Arunachal Pradesh Rural Bank.

The principles of commercial banking

1. Principles of safety: Bank is the custodian of depositor’s money. Bank lends money
as per prescribed guidelines after ensuring safety only.

2. Principles of profitability: It works on spread and creates reasonable profit for

shareholders after fulfilling all mandatory requirements.

3. Principles of liquidity: Bank manages liquidity to the depositors and creditors by

best allocation of incoming and outgoing money of various maturity dates.

4. Principles of solvency: Commercial bank should be financially sound and capable

of raising capital for continuing the business.

5. Principles of collection of saving : Now a day's banks repair the focus to produce
more investment deposits from the individuals.

6. Principles of economy: Commercial banks never strive for any pointless

expenditure. They continuously attempt to keep up their capacities with economy that
raise their yearly benefits.

7. Principles of secrecy: Commercial banks keep up and keep the customers’

accounts confidential. None except a lawful individual is permitted to see the records of
the customer’s account.

8. Principles of providing services: Commercial banks believed that client services

ought to be done effectively, efficiently and instantly.
9. Principles of relation: Commercial banks always try to create & continue a fabulous
relation with their clients and potential customers. It is nowadays mandates requirement
too. (KYC Norms)

10. Principles of modernization: It is the time of science and innovation or technology.

So, to adapt with the propelled world the commercial bank needs to embrace cutting
edge specialized or updated services like on-line banking, mobile banking, MasterCard
and so on.

11. Principles of specialization: It is a time of specialization. Here commercial banks

section their entire capacities into different parts & spot their HR as per their proficiency.

12. Principles of location: Commercial banks choose a perfect or suitable place

where the availability of customers is large.

13. Principles of publicity: It is a period of exposure and advertisement. On the off

chance that you might want to gain more money, you need to give more commercial
publicity through different media. All things considered, commercial banks follow this
sort of principle to build their clients and customers.

14. Principles of loan and investment policy:

The fundamental acquiring wellsprings of commercial banks are loaning and
contributing money to the suitable projects. So, commercial banks dependably attempt
to gain profit through perfect venture.

Employment of funds

Employment of funds, Lending policies, Loans and Advances, Guarantees, Advances secured
by Collateral securities, Agency Services, Financing of Exports Special Banking Services,
Advances to Priority Sectors and Credit Guarantee schemes, Legal issues in short term and
long term finance, Money laundering, SARFAESI Act 2002.

Employment of funds

The employment or investment of funds by a commercial bank means the safe utilization and
profitable use of its funds. The bank obtains money from different sources and pays interest on
them. It is the utmost desire of every commercial bank that it should invest its funds in a manner
which serves its own as well as customer's interest. Its own interest is to earn profit for the
shareholders. The other interest is of the customers along with interest as and when demanded
by them. These two objectives of liquidity and profitability are obtained by utilizing the surplus
funds into ready convertible securities. The main types of earning assets of a bank are different
which is money including at short notice, investment in government and semi
government securities. Public deposits are a powerful source of funds of banks. There are three
types of the banks a deposit :
one is current deposits,
second is saving deposits and
the third one is time deposits.
Due to the spread of literacy, banking habits and growth in the volume of business operations
there is marked increase in deposit money with banks. So the main mainly makes its
investments in the other countries of the world.

EMPLOYMENT OR ADVANCING FUNDS :-

The main business of the commercial bank is to obtain money from the customer and invest this
money. Bank earns the profit and pays interest to the customers from this profit. So it keeps in
view its own interest and also the customer, so there are two objectives :
i. It earns the profit for the customers.
ii. To meet the demand of the customers it should keep sufficient cash.

Earning Assets of Commercial bank

The cash reserves of a bank may be strengthened by a judicious selection of
certain earning liquid assets. Among these ‘Money at Call and Short Notice’ stands first.
This item represents largely the amounts lent to the discount market and/or to stock
exchange which are recoverable either on demand or on serving a short notice. This
constitutes the second line of defence. This asset has an advantage over ‘Cash Reserves’,
the first line of defence of a commercial bank in so far as it satisfies, to a certain extent, both
the attributes of a sound banking asset, viz., profitability as well as liquidity. It is liquid in the
sense that it is recoverable at call or short notice; it is profitable in the sense that it earns
interest.
‘Bills discounted’ is also considered as a highly earning liquid asset and is
included among the ‘money market assets.’ It is considered to liquidate itself
automatically out of the sale of the goods covered by such a bill (i.e., a first class
bill of exchange is considered to be a self liquidating paper). Again, it is readily
shiftable to the central bank (by rediscounting it with the central bank) without
much loss because of the very short length of life of such a bill. As a matter of fact, a bill of
exchange is generally of three months duration and as such the loss involved in
rediscounting it will not be very great, even when it is not shifted. All this indicates that ‘bills
discounted’ is one of the most earning liquid assets, satisfying both the qualities of an ideal
banking asset.
It is not unusual for a commercial bank to invest its funds in stock exchange
securities like government securities, semi-government securities, industrial
securities, etc. These are represented by the term ‘Investments’. They enable the
bank to obtain more earning than that afforded by ‘Loans at Call and Short Notice
or ‘Bills Discounted’, although they are less liquid. Here the bank gives importance not only
to the safety of the investment but also to the possibility of easy conversion into cash
without loss.
The principles that influence a bank in rating these securities while selecting them are the
safety of capital, easy marketability, stability of price and stability of income. The bank
should always bear in mind that in buying these
securities it is not its primary object to gain by a possible rise in the prices of these
securities. Consideration should be given to this factor only if it is satisfied with thesafety
and stability of capital. Generally commercial banks prefer governmentsecurities to the
shares and stocks of joint stock companies. The reasons are manifold.
Firstly, the repayment of capital is ensured because this depends on the
creditworthiness of the whole nation, whereas in the case of an ordinary stock
exchange security, safety of capital is entirely dependent on the creditworthiness
of a single institution.
Secondly, the yield from a government security is steady and reasonable.
Thirdly, they are easily saleable without causing a glut in their market prices, whereas in
the case ordinary industrial securities, sale of a large block of shares is likely to depress
their prices. The item ‘Loans and Advances’ comes next in the order of liquidity.

Self liquidating theory

Traditional banking theory favoured by the conservative bankers holds that the
earning assets of a bank should be limited to short-term self liquidating productive
loans. These include self liquidating commercial papers or short-term loans intended to
provide the current working capital, which in itself is of a self liquidating nature. The merit of
the ‘self liquidating theory’ of commercial bank loans is derived from the fact that such loans
are considered to liquidate themselves automatically out of the sale of goods covered by
such a transaction. For instance, look at the case of a bill of exchange, a typical example of
a self liquidating paper, drawn for the purpose of purchasing raw materials. The bill is
covered by a genuine commercial transaction. And a bank is justified in giving a loan
against such a paper because such self liquidating papers automatically provide the bank
with liquidity through loan repayments. Not only that but they are also shiftable to the central
bank in times of emergencies since the central bank, being the lender of the last resort, is
willing to rediscount such self liquidating papers. The loss avoiding aspect of liquidity is also
present here because of the very short periods for which these loans are given. Moreover,
they protect the business world against inflation because of their elastic nature to
correspond with trade demands. Their volume increases as production increases and
decrease as production decreases. No wonder, the traditional bankers heavily favoured the
claims of self liquidating theorists.

Anticipated income theory

The Anticipated Income theory holds that liquidity can be guaranteed whenever secured advance instalments are made on future

salary of the borrower. This hypothesis relates advance reimbursement to pay than depend on guarantee. This theory additionally

holds that a banks liability can be impacted by the development example of advances and speculation portfolios. The hypothesis

perceived that specific sorts of credits have more liquidity than others. Based on this theory, bank executives received stepping
stool impact in the venture portfolio. Banks guaranteed a specific measure of protections developing every year and on occasion

when assets may be requested for loaning or withdrawal. Anyway there was no sign about the future pay of the borrower. The

huge currency markets began the training which later spread all through U.S. The underlying foundations of the theory can be

followed to the restoration of federal fund markets in the 1980's and improvement of negotiable time deposits as a significant

currency advertise instrument. Banks in U.S depend for liquidity on government finances advertise, Euro dollar market or offer

of advance participation certificates. Such obtaining came to be called to be known as liquidity management. This theory was

proposed by H.V. Prochanow in 1944 based on the act of expanding term credits by the US commercial banks. This theory

expresses that independent of the nature and highlight of a borrower's the same old thing, the bank designs the liquidation of the

term-credit from the expected normal income of the borrower. A term-credit is for a period exceeding one year and reaching out

to a period of less than five years. It is admitted against the hypothecation (vow as security) of hardware, stock and even

immovable property. The bank puts confinements on the money related exercises of the borrower while loaning this credit. While

loaning an advance, the bank considers security alongside the foreseen profit of the borrower. So a credit by the bank gets

reimbursed by the future profit of the borrower in portions, rather giving a singular amount at the maturity of the loan. Using the

anticipated income theory, these loans are typically paid off by the borrower in a series of instalments. Viewed in this way, the

bank’s loan portfolio provides the bank with continuous flow of funds that adds to the bank's liquidity. Moreover, even though

the loans are long term, in a liquidity crisis the bank can sell the loans to obtain needed cash in secondary markets. The

anticipated income theory was developed by H.V. Prochanow in 1944 on the basis of the practice of extending term loans by the

US commercial banks. According to this theory, regardless of the nature and character of a borrower’s business, the bank plans

the liquidation of the term-loan from the anticipated income of the borrower. A term-loan is for a period exceeding one year and

extending to less than five years. It is granted against the hypothecation of machinery, stock and even immovable property. The

bank puts restrictions on the financial activities of the borrower while granting this loan. At the time of granting a loan, the bank

takes into consideration not only the security but the anticipated earnings of the borrower. The Anticipated Income theory holds

that liquidity can be ensured if scheduled loanpayments are made on future income of the borrower This theory relates loan

repayment toincome than rely on collateral. This theory also holds that a banks liability can be influencedby the maturity pattern

of loans and investment portfolios. The theory recognised that certain types of loans have more liquidity than others. On the basis

of this theory, bank management adopted ladder effect in the investment portfolio. Banks ensured a certain amount of securities

maturing annually and at times when funds might be demanded for lending or withdrawal. However there was no clue about the

future income of the borrower.