Banks: Kinds And Functions

Banks are financial intermediaries that create money by lending money to a borrower, thereby creating a corresponding deposit on the bank’s balance sheet. A banking system is a group or network of institutions that provide financial services to the society. Banking sector acts as the backbone of modern business. Development of any country mainly depends on its banking system. In this fast lifestyle people cannot do proper transactions without developing the proper banking network. So to provide them with proper banking facilities various kinds of banking systems are developed in the Country.

Kinds Of Banks 

Central Bank 

The Reserve Bank of India is the Central Bank of India. RBI was established on 1st April, 1935 under RBI Act,1934. It was nationalized in the year 1949. The main function is to supervise the financial sector of India. It is a banker’s bank. It controls and coordinates the credit policies of the country. It is subdivided into Scheduled banks and Non-Scheduled banks.

Scheduled Banks

By definition, any bank which is listed in the 2nd schedule of the RBI Act, 1934 is considered a scheduled bank. All the nationalized as well as foreign sector banks are included therein. RBI includes only those ones in the schedule which satisfy all the criteria laid down under Section 42 of the RBI Act,1934.

A scheduled bank is further classified into:

• Commercial Banks

Commercial Banks are the most important component of the banking system in India. These are profit-based financial institutions that accept deposits and grant loans and provide other related services.

According to Culbertson, Commercial banks are the institutions that make short-term bans to business and in the process create money.

These may further be divided into:-

1. Public Sector Bank- These are the nationalized banks where more than 50% stake is held by the government. It contributes to more than 75% of the total banking business in India. SBI is the largest public sector bank in India.
2. Private Sector Bank- In these banks most of the capital or equity is held by the private shareholders. All the banking regulations laid down under the RBI Act, 1934 are applicable to these banks. HDFC, AXIS Bank, YES Bank, are some of the examples under this category.
3. Foreign Bank- At present, there are two types of foreign banks in India. First is the branch form of the present which means Foreign banks have a physical branch in India and second is the Representative office. As of November 2018, India has 45 foreign banks with total of 286 branches currently operating in India. Some examples of foreign banks are BNP    Paribas, AB Bank Ltd., Bank of Nova Scotia, etc.
4. Regional Rural Bank: RRBs are the banks operating in various rural areas in the country. The main aim of introducing Regional rural banks is to provide comfort and necessary banking facilities to the people living in rural areas. Andhra Pradesh Gramin Vikas Bank, Arunachal Pradesh Rural Bank etc., are some examples of Regional Rural Bank in India.

• Cooperative Banks

A cooperative bank is a financial entity that belongs to its members, who at the same time are the owners and the customers of the bank. Both owners and the customers are the members of the bank. They have been established with ‘No Profit, No Loss” motive.

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These maybe classified into:

1. State Cooperative Banks: At present, there are 31 State Cooperatives banks in India. These are governed by the State Government under the State Cooperative Act and are included in the 2nd schedule of the RBI Act,1934.
2. Central Cooperative Banks: These are located at prominent towns or district headquarters. They take loans from the State Cooperative banks and can accept deposits.
3. Primary Agricultural Credit Societies: This is the smallest unit and it works under the village level. It is dependent on State and Central Cooperatives for its funding requirements.

Non-Scheduled Banks

By definition, Non-Scheduled banks are those which are not listed in the 2nd schedule of the RBI, Act 1934. Those with reserve capital less than 5 lakh rupees qualify as Non-Scheduled banks. They are not entitled to borrow from RBI except in some emergency situations or crises.

Essential Functions 

• Financial Intermediation

Banks act as an intermediary in the payment system. An intermediary is one who stands between the two parties. They act as intermediates between the depositors and the borrowers. Depositors save their money in banks and receive interest on it and borrowers receive loans from the banks.

• Accepting Deposits  

This is the primary function of a bank. They accept deposits from the general public by offering them a nominal interest rate over it. 

There are four types of deposits:

1. Saving deposit: It is a deposit usually of an individual or non-profit organization drawing regular interest payable on 30 days notice. The depositors just need to maintain a minimum balance, the amount of which varies from bank to bank. The account can be opened on a single name or joint name.
2. Fixed deposit: They are also known as term deposits. It is a financial instrument that provides a higher rate of interest until the maturity date. No withdrawal of money is allowed until the maturity date. In case the depositors withdraw money before the maturity date, banks levy a penalty because of premature withdrawal.
3. Current deposit: It is a deposit to a bank without a specified maturity date. It is generally opened by businessmen. They act as short-term loans to meet urgent needs. A high rate of interest is charged by banks including the charges for overdraft facility in order to maintain a reserve for unknown demands.
4. Recurring deposit: It is a special kind of deposit offered to the general public by banks where they can deposit the fixed amount every month and can earn interest on the rate applicable to fixed deposits. This type of account is operated by salaried persons.

• Lending Money

Banks accept deposits and lend money. This is one of the most important functions because the economic development of the country mainly depends on the credit schemes of the banks. 

The most popular form of lending are:

1. Overdraft: It is a facility by which the customer is permitted to draw money over the credit balance of his/her account. 
2. Cash Credits: It is a short-term credit given to businessmen for meeting their working capital requirements. Through cash credit, a larger amount of loan is sanctioned than that of the overdraft and even for a longer period.
3. Loans and Advances: It is a financial facility provided by the banks. Loans are long-term financing and advances are for a short period of time. The interest charged on loans is lower than overdraft and cash credits.
4. Discounting of Bills of Exchange: It is a document acknowledging an amount of money owed in consideration of goods received.

• Agency

Banks perform the following functions as an agency:

1. Transfer of funds: Transferring funds from one branch and place to another.
2. Payments on behalf of Customers: Payments such as electricity bills, rents, etc. can be made on behalf of their client.
3. Intermediary: Bank acts as a representative of its client for other institutions. The bank acts as a trustee, executor, advisor, administrator.

• Utility Functions

These include:

1. Issuing letter of credit, traveler’s cheque, etc.
2. Underwriting of shares and debentures.
3. The facility of foreign exchange to their customers
4.  Safe custody of valuables, important documents and provide a facility of safe deposit vaults and lockers.

• Risk Management 

It is a logical development and execution plan to deal with the potential losses. It is usually practiced by the institution to manage its exposure to losses and risk and to protect the value of its assets. 

It involves three steps:

1. Identifying the potential risks 
2. Developing an action plan to manage the activities that incur these potential risks.
3. Continuously reviewing and reporting all the risk management practices.

The main purpose is to evaluate the potential losses and to take precautions to deal with them.

•  Economic Development  

Banks play an important role in the economic development of the country. The banks collect money from the individual and then lend them to businessmen and other manufacturers, by which manufacturers fulfill their requirements for raw materials i.e., working capital. In this way, it leads to economic development of the country. A sound banking system mobilizes the scattered and small savings of the society. This ensures proper utilization of all the resources available. Banks facilitate internal and international trade because a large part of the trade is done on credit. They provide long-term credit to the government by investing their funds in government securities and by purchasing treasury bills. They provide guarantee, on behalf of their customers on the basis of which goods are supplied on credit and this is particularly important because the parties reside in different countries and are not familiar to one another. Nowadays banks even provide 100% credit for worthwhile projects, which is technically feasible and economically viable. This helps in the development of entrepreneurship in the Country.

Conclusion 

Banks play an important role in the financial system of the country. And a well-functioning financial system is fundamental to a modern economy. Thus to work smoothly, banks must comply with strict regulatory requirements.

References:

[1] Banking Sectors and NBFC’s, available at: https://www.drishtiias.com/daily-updates/daily-news-editorials/co-operative-banking-in-india (last visited on September 25, 2020).

[2] Functional- Reserve Bank of India, available   at: https://m.rbi.org.in//scripts/fun_urban.aspx (last visited on September 23, 2020).

[3] Banking in India: Definition, functions and Types, available at:

https://www.civilsdaily.com/banking-in-india-definition-functions-and-types-of-banks/ (last visited on September 28, 2020).

[4] Reports: Reserve Bank of India, available at: https://m.rbi.org.in//Scripts/PublicationReportDetails.aspx?UrlPage=&ID=60 (last visited on September 28, 2020).

[5] Different types of banks in India, available at: https://www.technofunc.com/index.php/domain-knowledge-2/banking-domain/item/type-of-banks (last visited on September 28, 2020).

[6] Banking System in India, available at: 

https://www.livemint.com/Industry/xTuU1VicSbsCVvspNf1wtK/Different-types-of-banks-in-India-explained.html (last visited on October 1, 2020).

BY – Roopal Dhoot | ILS Law College, Pune