Unit I: Introduction to Banking

1. Meaning and Definition of Banking

1.1. Meaning of Banking Banking refers to the industry or system that manages money and
financial transactions. Banks are institutions authorized to accept deposits, provide loans, and
offer various financial services. The primary function of banking is to act as an intermediary
between savers and borrowers, facilitating the flow of funds within the economy.

1.2. Definition of Banking

 Traditional Definition: Banking involves accepting deposits from the public,

safeguarding these funds, and providing loans or advances to individuals and
businesses. It encompasses activities that manage and facilitate the movement of
money.
 Modern Definition: The Banking Regulation Act, 1949 defines a bank as "an
institution which receives deposits from the public, repayable on demand or
otherwise, and withdrawable by cheque, draft, order or otherwise.” This definition
highlights the core functions of deposit-taking and lending.

2. Origin and Development of Banking

2.1. Origin of Banking

 Ancient Banking: Early forms of banking can be traced back to ancient Mesopotamia
around 2000 BC. Temples and palaces acted as depositories of grains and valuables,
providing loans in the form of grain.
 Classical Banking: In ancient Greece and Rome, banking practices evolved with the
establishment of institutions that accepted deposits and provided loans. The Roman
Empire introduced the concept of “argentarii,” who handled banking activities.

2.2. Development of Banking

 Medieval Period: Banking expanded in medieval Europe with the rise of merchant
banks in Italy. Notable examples include the Medici Bank and the Bank of Venice,
which introduced innovations in banking operations and financial instruments.
 17th Century: The Bank of England was established in 1694, marking a significant
development in modern banking by introducing central banking concepts and
government-backed currency.
 19th Century: The industrial revolution spurred the growth of commercial banks,
which played a key role in financing industrial development and infrastructure
projects. Banking practices became more structured with regulatory frameworks.
 20th Century: Technological advancements, including the advent of computers and
the internet, transformed banking operations. The establishment of central banks and
global financial institutions shaped modern banking practices.
  21st Century: The digital revolution led to the rise of online and mobile banking. The
introduction of fintech and digital currencies has further revolutionized the banking
landscape.

3. Customer of a Bank

3.1. Types of Bank Customers

 Individual Customers: Individuals use banks for personal financial needs such as
saving money, obtaining loans, and managing day-to-day transactions. They can open
savings accounts, fixed deposits, and personal loans.
 Business Customers: Businesses use banking services for operational needs,
including managing cash flows, securing loans for expansion, and handling payments
and receipts. They use current accounts, business loans, and trade financing.
 Government Entities: Governments use banks for managing public funds, disbursing
subsidies, and handling public transactions. Banks provide services for managing
government accounts and public debt.
 Institutional Customers: Other financial institutions, such as insurance companies
and investment funds, engage with banks for various financial services, including
asset management and interbank transactions.

3.2. Needs of Bank Customers

 Deposits: Customers need a safe place to store money, earn interest, and manage their
finances. Types of deposits include savings accounts, fixed deposits, and recurring
deposits.
 Loans and Credit: Access to credit for personal needs, business expansion, or
purchasing assets. Common types include personal loans, home loans, auto loans, and
business loans.
 Investment Services: Customers seek advice and products for investing their money,
such as mutual funds, bonds, and equities. Banks often provide investment advisory
services and portfolio management.
 Transaction Services: Facilities for making payments, transfers, and conducting
other financial transactions. This includes services like electronic funds transfers, bill
payments, and check clearing.

4. Structure of Banking in India

4.1. Classification of Banks in India

 Commercial Banks: These include:

o Public Sector Banks (PSBs): Banks where the majority of shares are held by
the government. They serve a broad segment of the population. Examples:
State Bank of India (SBI), Bank of Baroda, Punjab National Bank.
 o Private Sector Banks: Banks owned by private shareholders. They often
focus on technology-driven services and personalized customer service.
Examples: HDFC Bank, ICICI Bank, Axis Bank.
o Foreign Banks: Banks headquartered outside India but operating within the
country. They cater to both domestic and international customers. Examples:
Citibank, HSBC, Standard Chartered.
 Cooperative Banks: These banks operate on a cooperative basis, focusing on
providing financial services to their members, especially in rural and semi-urban
areas.
o Urban Cooperative Banks: Serve urban areas, offering services like savings
accounts and loans. Example: Saraswat Bank.
o Rural Cooperative Banks: Provide financial services in rural areas, including
agricultural loans and microfinance. Example: Karnataka Vikas Grameen
Bank.
 Development Banks: Specialize in providing long-term capital for industrial
development and infrastructure projects.
o Industrial Development Bank of India (IDBI): Focuses on industrial
financing and development.
o National Bank for Agriculture and Rural Development (NABARD):
Supports rural development and agricultural projects.
 Regional Rural Banks (RRBs): Established to provide credit and financial services
in rural areas to promote agriculture and rural development. Examples: Uttar Bihar
Gramin Bank, Andhra Pradesh Grameena Vikas Bank.

4.2. Regulatory Bodies

 Reserve Bank of India (RBI): The central regulatory authority for the banking sector
in India. It formulates and implements monetary policy, supervises financial
institutions, and maintains financial stability.
 Banking Regulation and Development Act, 1949: Governs the operations and
regulations of banks, including their formation, management, and supervision.

5. Banks and Economic Development

5.1. Role of Banks in Economic Development

 Financial Intermediation: Banks channel funds from savers to borrowers,

facilitating investment in businesses and infrastructure. This process helps to
stimulate economic growth and development.
 Credit Creation: By providing loans, banks create credit, which increases the money
supply and supports economic activity. This credit creation is crucial for funding
business expansion and consumer spending.
 Investment Facilitation: Banks offer various investment products and services,
enabling individuals and businesses to invest in different sectors, contributing to
overall economic development.
 Infrastructure Development: Banks finance large-scale infrastructure projects, such
as roads, bridges, and energy projects, which are essential for economic growth and
development.
  Employment Generation: Through their operations and the businesses they finance,
banks contribute to job creation and economic stability. They also provide
employment opportunities within the banking sector itself.

5.2. Impact on Different Sectors

 Agriculture: Banks provide agricultural loans and financial support for rural
development, helping farmers improve productivity and access modern farming
techniques.
 Industry: Financing from banks supports industrial growth, including funding for
manufacturing, technology, and small and medium enterprises (SMEs). Banks also
facilitate trade finance and working capital.
 Services: Banks support the service sector, including sectors like IT, education, and
healthcare, by providing financing, investment, and transactional services.

6. Functions of Commercial Banks

6.1. Conventional Functions

 Accepting Deposits: Banks accept deposits from individuals and businesses in

various forms, such as savings accounts, current accounts, fixed deposits, and
recurring deposits. They provide a safe place for funds and offer interest on deposits.
 Providing Loans and Advances: Banks offer various types of loans, including
personal loans, home loans, auto loans, and business loans. They assess
creditworthiness and provide financial assistance based on the borrower’s needs and
repayment capacity.
 Credit Creation: Through the lending process, banks create credit, which expands
the money supply in the economy. This process involves lending out a portion of
deposited funds while keeping a reserve.
 Money Transfer and Payment Services: Banks facilitate payments and money
transfers through various methods, including checks, electronic funds transfer (EFT),
wire transfers, and online banking. They also provide services like bill payments and
foreign exchange.

6.2. Innovative Functions

 Investment Banking: Banks offer services related to raising capital, underwriting

securities, and advising on mergers and acquisitions. Investment banking services are
essential for corporate financing and strategic transactions.
 Wealth Management: Banks provide wealth management services to high-net-worth
individuals, including financial planning, investment advisory, and portfolio
management. These services aim to grow and protect clients’ assets.
 Digital Banking: The rise of digital banking has led to the development of online and
mobile banking platforms. Banks offer services such as digital wallets, online account
management, and electronic transactions, enhancing customer convenience.
 Financial Inclusion: Banks focus on providing financial services to underserved and
unbanked populations. This includes offering microfinance, opening no-frills
accounts, and implementing initiatives to promote financial literacy and access.
7. Central Bank - Reserve Bank of India (RBI)

7.1. Overview of RBI

 Formation: The Reserve Bank of India (RBI) was established on April 1, 1935, under
the Reserve Bank of India Act, 1934. It was set up to regulate the monetary and
financial system of India and to ensure financial stability.
 Objectives: The primary objectives of RBI are to maintain price stability, ensure
financial stability, and support economic growth by formulating and implementing
monetary policy.

7.2. Functions of RBI

 Monetary Authority: The RBI formulates and implements monetary policy to

control inflation, stabilize the currency, and promote economic growth. It uses tools
such as repo rates, reverse repo rates, and cash reserve ratios to manage liquidity and
interest rates.
 Regulator of Financial System: The RBI regulates and supervises banks and
financial institutions to ensure their soundness and compliance with regulations. It
sets prudential norms and conducts inspections to monitor the health of the financial
system.
 Issuer of Currency: The RBI has the exclusive authority to issue and manage
currency notes in India. It ensures an adequate supply of currency and manages the
currency circulation system.
 Manager of Foreign Exchange: The RBI manages foreign exchange reserves and
implements foreign exchange policies. It oversees the foreign exchange market and
regulates transactions involving foreign currencies.
 Developmental Role: The RBI supports the development of financial markets and
institutions. It promotes financial inclusion, supports infrastructure development, and
fosters innovation in the financial sector.
 Banker to the Government: The RBI provides banking services to the central and
state governments, including managing government accounts, public debt, and
conducting monetary transactions on behalf of the government.

8. Emerging Trends in Banking

8.1. Technological Advancements

 Digital Banking: The shift towards digital banking has transformed how customers
interact with banks. Online and mobile banking platforms offer a range of services,
including account management, fund transfers, and bill payments, all accessible from
digital devices.
 Fintech Integration: Collaboration between banks and fintech companies has led to
innovations in payment systems, lending platforms, and investment management.
Fintech solutions provide faster and more efficient financial services.
  Blockchain Technology: Blockchain technology is being explored for its potential to
enhance security, transparency, and efficiency in banking transactions. It is used in
applications such as cryptocurrency, smart contracts, and secure transaction records.

8.2. Regulatory Changes

 Enhanced Compliance: Banks are adapting to evolving regulatory requirements

related to data protection, anti-money laundering (AML), and combating the financing
of terrorism (CFT). Compliance measures are crucial for maintaining regulatory
standards and protecting financial systems.
 Open Banking: Open banking initiatives are being implemented to allow third-party
access to banking data through application programming interfaces (APIs). This
fosters competition, encourages innovation, and provides consumers with more
financial service options.

8.3. Customer-Centric Innovations

 Personalized Banking: Banks are leveraging data analytics to offer personalized

financial products and services. Customization based on customer behavior and
preferences enhances the customer experience and drives engagement.
 Artificial Intelligence (AI): AI is used in various banking applications, including
chatbots for customer service, fraud detection systems, and predictive analytics for
credit risk assessment. AI improves operational efficiency and enhances decision-
making.

8.4. Financial Inclusion Initiatives

 Expansion of Banking Services: Efforts are being made to extend banking services
to rural and underserved areas through technology and financial literacy programs.
Initiatives such as mobile banking units and agent banking are aimed at reaching
remote populations.
 Government Schemes: Government-led schemes, such as Pradhan Mantri Jan Dhan
Yojana (PMJDY) and financial literacy programs, aim to increase access to banking
services and promote financial inclusion for all segments of society.