MONEY AND BANKING

MONEY AND BANKING

 

Introduction

The word ‘money’ is derived from the Latin word ‘Moneta’ which was the surname of the Roman Goddess of Juno in whose temple at Rome, money was coined. The origin of money is lost in antiquity. Even the primitive man had some sort of money. The type of money in every age depended on the nature of its livelihood. In a hunting society, the skins of wild animals were used as money. The pastoral society used livestock, whereas the agricultural society used grains and foodstuffs as money. The Greeks used coins as money.

 

Stages in the evolution of money

The evolution of money has passed through the following five stages depending upon the progress of human civilization at different times and places.

1. Commodity money

Various types of commodities have been used as money from the beginning of human civilization. Stones, spears, skins, bows and arrows, and axes were used as money in the hunting society. The pastoral society used cattle as money. The agricultural society used grains as money.  The Romans used cattle and salt as money at different times. The Mongolians used squirrel skins as money. Precious stones, tobacco, tea shells, fishhooks and many other commodities served as money depending upon time, place and economic standard of the society.

The use of commodities as money had the following defects.

•All the commodities were not uniform in quality, such as cattle, grains, etc. Thus lack of standardization made pricing difficult.

•It is difficult to store and prevent loss of value in the case of perishable commodities.

•Supplies of such commodities were uncertain.

•They lacked in portability and hence were difficult to transfer from one place to another.

•There was the problem of indivisibility in the case of such commodities as cattle.

2. Metallic money

With the spread of civilization and trade relations by land and sea, metallic money took the place of commodity money. Many nations started using silver, gold, copper, tin, etc. as money.  But metal was an inconvenient thing to accept, weigh, divide and assess in quality. Accordingly, metal was made into coins of predetermined weight. This innovation is attributed to King Midas of Lydia in the eighth century B C. But gold coins were used in India many centuries earlier than in Lydia. Thus coins came to be accepted as convenient method of exchange. As the price of gold began to rise, gold coins were melted in order to earn more by selling them as metal. This led governments to mix copper or silver in gold coins since their intrinsic value might be more than their face value. As gold became dearer and scarce, silver coins were used, first in their pure form and later on mixed with alloy or some other metal.

But metallic money had the following limitations

(i) It was not possible to change its supply according to the requirements of the nation both for internal and external use.

(ii) Being heavy, it was not possible to carry large sums of money in the form of coins from one place to another by merchants.

(iii) It was unsafe and inconvenient to carry precious metals for trade purposes over long distances.

(iv) Metallic money was very expensive because the use of coins led to their debasement and their minting and exchange at the mint cost a lot to the government.

3. Paper money

The development of paper money started with goldsmiths who kept strong safes to store their gold. As goldsmiths were thought to be honest merchants, people started keeping their gold with them for safe custody. In return, the goldsmiths gave the depositors a receipt promising to return the gold on demand. These receipts of the goldsmiths were given to the sellers of commodities by the buyers. Thus receipts of the goldsmith were a substitute for money. Such paper money was backed by gold and was convertible on demand into gold. This ultimately led to the development of bank notes.

The bank notes are issued by the central bank of the country. As the demand for gold and  silver increased with the rise in their prices, the convertibility of bank notes into gold and silver was gradually given up during the beginning and after the First World War in all the countries of  the world. Since then the bank money has ceased to be representative money and is simply ‘fiat money’ which is inconvertible and is accepted as money because it is backed by law.

4.Credit money

Another stage in the evolution of money in the modern world is the use of the cheque as  money. The cheque is like a bank note in that it performs the same function. It is a means of  transferring money or obligations from one person to another. But a cheque is different from a bank note. A cheque is made for a specific sum, and it expires with a single transaction. A cheque is not money. It is simply a written order to transfer money. However, large transactions are made through cheques these days and bank notes are used only for small transactions.

5. Near money

The final stage in the evolution of money has been the use of bills of exchange, treasury bills, bonds, debentures, savings certificates, etc. They are known as ‘near money’. They are close substitutes for money and are liquid assets. Thus, in the final stage of its evolution money became intangible. Its’ ownership in now transferable simply by book entry.

 

Definition of Money

It is very difficult to give a precise definition of money. Various authors have given different definition of money. According to Crowther, “Money can be defined as anything that is generally acceptable as a means of exchange and that at the same time acts as a measure and a store of value”. Professor D H Robertson defines money as “anything which is widely accepted in payment for goods or in discharge of other kinds of business obligations.

From the above two definitions of money two important things about money can be noted.

Firstly, money has been defined in terms of the functions it performs. That is why some economists defined money as “money is what money does”. It implies that money is anything which performs the functions of money. Secondly, an essential requirement of any kind of money is that it must be generally acceptable to every member of the society. Money has a value for ‘A’ only when he thinks that ‘B’ will accept it in exchange for the goods. And money is useful for ‘B’ only when he is confident that ‘C’ will accept it in settlement of debts. But the general acceptability is not the physical quality possessed by the good. General acceptability is a social phenomenon and is conferred upon a good when the society by law or convention adopts it as a medium of exchange.

 

Functions of Money

The major functions of money can be classified into three. They are: The primary functions, secondary functions and contingent functions.

I. Primary functions of money

The primary functions of money are;

•Medium of exchange and

•Measure of value

(i)Medium of exchange

The most important function of money is that it serves as a medium of exchange. In the barter economy commodities were exchanged for commodities. But it had experienced many difficulties with regard to the exchange of goods and services. To undertake exchange, barter economy required ‘double coincidence of wants’. Money has removed this problem. Now a person A can sell his goods to B for money and then he can use that money to buy the goods he wants from others who have these goods. As long as money is generally acceptable, there will be no difficulty in the process of exchange. By serving a very convenient medium of exchange money has made possible the complex division of labour or specialization in the modern economic organization.

(ii) Measure of value

Another important function of money is that the money serves as a common measure of value or a unit of account. Under barter system there was no common measure of value and the value of different goods were measured and compared with each other. Money has solved this difficulty and serves as a yardstick for measuring the value of goods and services. As the value of all goods and services are measured in terms of money, their relative values can be easily compared.

II. Secondary functions

The secondary functions of money are;

(i)Standard of deferred payments

Another important function of money is that it serves as a standard

for deferred payments. Deferred payments are those payments which are to be made in future. If a loan is taken today, it would be paid back after a period of time. The amount of loan is measured in terms of money and it is paid back in money. A large amount of credit transactions involving huge future payments are made daily. Money performs this function of standard of deferred payments because its value remains more or less stable. When the price changes the value of money also changes. For instance, when the prices are falling, value of money will rise. As a result, the creditors will gain in real terms and the debtors will lose. Conversely, when the prices are rising (or, value of money is falling) creditors will be the losers. Thus if the money is to serve as a fair and correct standard of deferred payments, its value must remain stable. Thus when there is severe inflation or deflation, money ceases to serve as a standard of deferred payments.

(ii) Store of value

Money acts as a store of value. Money being the most liquid of all assets is a convenient form in which to store wealth. Thus money is used to store wealth without causing deterioration or wastage. In the past gold was popular as a money material. Gold could be kept safely without deterioration. Of course, there are other assets like houses, factories, bonds, shares, etc., in which wealth can be stored. But money performs as a different thing to store the value. Money being the most liquid of all assets has the advantage that an individual or a firm can buy with it anything at any time. But this is not the case with other assets. Other assets like buildings, shares, etc., have to be sold first and converted into money and only then they can be used to buy other things. Money would perform the store of value function properly if it remains stable in value.

In short, money has removed the difficulties of barter system, namely, lack of double coincidence of wants, lack of division and lack of measure and store of value and lack of a standard of deferred payment. It has facilitated trade and has made possible the complex division of labour and specialization of the modern economic system.

III. Contingent functions

The important contingent functions of money are;

(i) Basis of credit

It is with the development of money market the credit market began to flourish.

(ii) Distribution of national income

Being a common measure of value, money serves as the best medium to distribute the national income among the four factors of production.

(iii) Transfer of value

Money helps to transfer value from one place to another.

(iv) Medium of compensations

Accidents and carelessness cause damage to the property and life. Compensation can be paid to such damages in terms of money.

(v) Liquidity

Liquidity means the ready purchasing power or convertibility of money in to any commodity. Money is the most liquid form of all assets.

(vi) Money guide in production and consumption.

Utility of goods and services can be expressed in terms of money. Similarly, marginal productivity is measured in terms of prices of goods and factors. Thus money become the base of measurement and which directs the production and consumption.

(vii) Guarantor of solvency

Solvency refers to the ability to pay off debt. Persons and firms have to be solvent while doing the business. The deposits of money serves as the best guarantor of solvency.

 

CONCEPT OF BANKING

 Banks are institutions that accept various types of deposits and use those funds for granting loans. The business of banking is that of an intermediary between the saving and investment units of the economy. It collects the surplus funds of millions of individual savers who are widely scattered and channelize them to the investor. According to section 5(b) of the Banking Regulation Act, 1949, “banking” means the 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, and order or otherwise. Banking company means any company which transacts the business of banking in India. No company can carry on the business of banking in India unless it uses as part of its name at least one of the words bank, banker or banking. The essential characteristics of the banking business as defined in section 5(b) of the Banking Regulation Act are: Acceptance of deposits from the public, For the purpose of lending or investment.Withdraw able by means of any instrument whether a cheques or otherwise.   

Development of Banking in India

The history of banking dates back to the thirteenth century when the first bill of exchange was used as money in medieval trade. There was no such word as ‘banking’ before 1640, although the practice of safe-keeping and savings flourished in the temple of Babylon as early as 2000 B.C. Chanakya in his Arthashastra written in about 300 B.C. mentioned about the existence of powerful guilds of merchant bankers who received deposits, advanced loans and issued hundis (letters of transfer). The Jain scriptures mention the names of two bankers who built the famous Dilwara Temples of Mount Abu during 1197 and 1247 A.D.

 The first bank called the ‘Bank of Venice’ was established in Venice, Itlay in 1157 to finance the monarch in his wars. The bankers of Lombardy were famous in England. But modern banking began with the English goldsmith only after 1640. The first bank in India was the ‘Bank of Hindustan’ started in 1770 by Alexander & Co. an English agency house in Calcutta which failed in 1782 with the closure of the agency house. But the first bank in the modern sense was established in the Bengal Presidency as the Bank of Bengal in 1806.

 History apart, it was the ‘merchant banker’ who first evolved the system of banking by trading in commodities than money. Their trading activities required the remittances of money from one place to another. For this, they issued ‘hundis’ to remit funds. In India, such merchant bankers were known as ‘Seths’.

The next stage in the growth of banking was the goldsmith. The business of goldsmith was such that he had to take special precautions against theft of gold and jewellery. If he seemed to be an honest person, merchants in the neighborhood started leaving their bullion, money and ornaments in his care. As this practice spread, the goldsmith started charging something for taking care of the money and bullion. As evidence for receiving valuables, he issued a receipt. Since gold and silver coins had no marks of the owner, the goldsmith started lending them. As the goldsmith was prepared to give the holder of the receipt an equal amount of money on demand, the goldsmith receipts became like cheques as a medium of exchange and a means of payment.

The next stage in the growth of banking is the moneylender. The goldsmith found that on an average the withdrawals of coins were much less than the deposits with him. So he started advancing the coins on loan by charging interest. As a safeguard, he kept some money in the reserve. Thus the goldsmith-money-lender became a banker who started performing the two functions of modern banking that of accepting deposits and advancing loans.  

In India our historical, cultural, social and economic factors have resulted in the Indian money market being characterized by the existence of both the unorganized and the organized sectors.   

 

       Unorganized Sector: The unorganized sector comprises moneylenders and indigenous bankers which cater to the needs of a large number of people especially in the rural areas. They have been meeting the financial requirements of the rural populace since times immemorial. Their importance can be gauged from the fact that Jagat Seths, hereditary bankers of the Nawab of Bengal, were recognized even by Aurangzeb and the East India Company who were compelled to borrow from them also publicly honored them.

The indigenous bankers are different from the proper banks in a number of ways. For instance, they combine banking activities with trade whereas trading is strictly prohibited for banks in the organized sector. They do not believe in formalities or paper work for making deposits or withdrawing money. In fact, since a substantial percentage of their clientele is illiterate, they frequently take a thumb impression of their customers on a blank paper. Even if they use a ‘Hundi’ as a negotiable instrument yet it will not be indicated on its face whether the transaction is supported by valuable consideration or it is merely as a result of mutual accommodation. The rate of interest charged by them fluctuates directly with the need of the borrower and may sometimes be as high as 300 percent! They are insulated from all type of monetary and credit controls as they fall outside thy purview of RBI. Though they are still the major source of funds for small borrowers, but now their market has started shrinking because of the fast expansion of branches of banks in the unorganized sectors.

Functions of Bank

 According to section 6 of the Banking Regulation Act, 1949, the primary functions of a bank are: acceptance of deposits and lending of funds. For centuries, banks have borrowed and lent money to business, trade, and people, charging interest on loans and paying interest on deposits. These two functions are the core activities of banking. Besides these two functions, a commercial bank performs a variety of other functions which can be categorized in two broad categories namely (a) Agency or Representative functions (b) General Utility functions.

(a)   Agency or Representative functions:

Ø  Collection and Payment of Various Items: Banks carry out the standing instructions of customers for making payments; including subscriptions, insurance premium, rent, electricity and telephone bills, etc.

Ø  Undertake government business like payment of pension, collection of direct tax (e.g. income tax) and indirect tax like excise duty.

Ø  Letter of Reference: Banks buy and sell foreign exchange and thus promote international trade. This function is normally discharged by Foreign Exchange Banks.

Ø  Purchase and Sale of Securities: Underwrite and deal in stock, funds, shares, debentures, etc.

Ø  Government’s Agent: Act as agents for any government or local authority or any other person or persons; also carry on agency business of any description including the clearing and forwarding of goods, giving of receipts and discharges, and otherwise acting as an attorney on behalf of customers, but excluding the business of a managing Agent or Secretary and treasurer of a company.

Ø  Purchase and Sale of Foreign Exchange: Banks buy and sell foreign exchange and thus promote international trade. This function is normally discharged by Foreign Exchange Banks.

Ø  Trustee and Executor: Banks also act as trustees and executors of the property of their customers on their advice.

Ø  Remittance of Money: Banks also remit money from one place to the other through bank drafts or mail or telegraphic transfers. 

(a) General Utility functions:

Ø  Locker facility: Banks provide locker facilities to their customers. People can keep their gold or silver jewellery or other important documents in these lockers. Their annual rent is very nominal.

Ø  Business Information and Statistics: Being familiar with the economic situation of the country, the banks give advice to their customers on financial matters on the basis of business information and statistical data collected by them.

Ø  Help in Transportation of Goods: Big businessmen or industrialists after consigning goods to their retailers send the Railway Receipt to the bank. The retailers get this receipt from the bank on payment of the value of the consignment to it. Having obtained the Railway Receipt from the bank they get delivery of the consignment from the Railway Goods Office. In this way banks help in the transportation of goods from the production centers to the consumption centers.

Ø  Acting as a Referee: If desired by the customer, the bank can be a referee i.e. who could be referred by the third parties for seeking information regarding the financial position of the customer.

Ø  Issuing Letters of Credit: Bankers in a way by issuing letters of credit certify the credit worthiness of the customers. Letters of credit are very popular in foreign trade.

Ø  Acting as Underwriter: Banks also underwrite the securities issued by the government and corporate bodies for commission. The name of a bank as an underwriter encourages investors to have faith in the security.

Ø  Issuing of Traveller’s Cheques and Credit Cards: Banks have been rendering great service by issuing traveller’s cheques, which enable a person to travel without fear of theft or loss of money. Now, some banks have started credit card system, under which a credit card holder is allowed to avail credit from the listed outlets without any additional cost or effort. Thus a credit card holder need not carry or handle cash all the time.

Ø  Issuing Gift Cheques: Certain banks issue gift cheques of various denominations e.g some Indian banks issue gift cheques of the denomination of Rs. 101, 501, 1001 etc. These are generally issued free of charge or a very nominal fee is charged.

Ø  Dealing in Foreign Exchange: Major branches of commercial banks also transact business of foreign exchange. Commercial banks are the main authorized dealers of foreign exchange in India.

Ø  Merchant Banking Services: Commercial banks also render merchant banking services to the customers. They help in availing loans from non-banking financial institutions.

  

BANKING STRUCTURE OF INDIA

The structure of banking varies widely from country to country. Often a country’s banking structure is a consequence of the regulatory regime to which it is subjected. The banking system in India works under the constraints that go with social control and public ownership. Nationalization, for instance, was a structural change in the functioning of commercial banks which was considered essential to better serve the needs of development of the economy in conformation with national policy and objectives. Similarly, to meet the major objectives of banking sector reforms, government stake was reduced up to 51 per cent in public sector banks. New private sector banks were allowed and foreign banks were permitted additional branches.

 

Structure of Indian Banking System   The Indian financial system comprises a large number of commercial and cooperative banks, specialized developmental banks for industry, agriculture, external trade and housing, social security institutions, collective investment institutions, etc. The banking system is at the heart of the financial system.

    The Indian banking system has the RBI at the apex. It is the central bank of the country under which there are the commercial banks including public sector and private sector banks, foreign banks and local area banks. It also includes regional rural banks as well as cooperative banks.

 

Reserve Bank of India

The central bank plays an important role in the monetary and banking structure of nation. It supervises controls and regulates the activities of the banking sector. It has been assigned to handle and control the currency and credit of a country. In older days, the central banks were empowered to issue the currency notes and bankers to the Union governments. The first central bank in the world was Riks Banks of Sweden which was established in 1656. The Reserve Bank of India, the central bank of our country, was established in 1935 under the aegis of Reserve Bank of India Act, 1934. It was a private shareholders institution till January 1949, after which it became a state-owned institution under the Reserve Bank of India Act, 1948. It is the oldest central bank among the developing countries. As the apex bank, it has been guiding, monitoring, regulating and promoting the destiny of the Indian financial system.

 

Objectives of RBI

It plays a more positive and dynamic role in the development of a country. The financial muscle of a nation depends upon the soundness of the policies of the central banking. The objectives of the central banking system are presented below:

1.      The central bank should work for the national interest of the country.

2.      The central bank must aim for the stabilization of the mixed economy.

3.      It aims at the stabilization of the price level at average prices.

4.      Stabilization of the exchange rate is also essential.

5.      It should aim for the promotion of economic activities.

Constitution and Management

Reserve Bank of India has been constituted as a corporate body having perpetual succession and a common seal. Its capital is Rs. 5 crore wholly owned by the Government of India. The general superintendence and direction of the affairs and business of the Bank has been vested in the Central Board of Directors. The Central Government, however, is empowered to give such directions to the Bank as it may, after consultation with its Governor, consider necessary in the public interest.

 

The Central Board of Directors consists of the following:

a)      A Governor and not more than four Deputy Governor to be appointed by the Central Government.

b)      Four directors to be nominated by the Central Government, one from each of the four local boards.

c)      Ten directors to be nominated by the Central Government.

d)     One Government official to be nominated by the Central Government.

Besides the Central Board of Directors, four Local Boards have also been constituted for each of the four areas specified in the first schedule to the Act. A Local Board has five members appointed by the Central Government to represent as far as possible, territorial and economic interests and the interests of cooperative and indigenous banks. A Local Board advises the Central Board on matters referred to it by the Central Board and performs such duties as are delegated to it by the Central Board.

 

Functions of RBI

The RBI functions are based on the mixed economy. The RBI should maintain a close and continuous relationship with the Union Government while implementing the policies. If any differences arise, the government’s decision will be final. The main functions of the RBI are presented below:

Ø  Welfare of the public

Ø  To maintain the financial stability of the country.

Ø  To execute the financial transactions safely and effectively.

Ø  To develop the financial infrastructure of the country.

Ø  To allocate the funds effectively without any partiality.

Ø  To regulate the overall credit volume for price stability.

Authorities

The RBI has the full authority in the following aspects:

Ø  Currency issuing authority

Ø  Monitoring authority

Ø  Banker to the Union Government

Ø  Foreign exchange control authority

Ø  Promoting authority.

 

1. Currency Issuing Authority- The RBI has the sole authority to issue the currency notes and coins. It is the fundamental       right of the RBI. The coins and one rupee notes are issued by the Government of India and they are circulated through the RBI. The notes issued by the RBI issues by the RBI will have legal identity everywhere in India. The RBI issues the notes of the denomination of RS. 1000, 500, 100, 50, 20 and 10. The RBI has the authority to circulate and withdraw the currency from circulation. It has also the authority to exchange notes and coins from one denomination to other denominations as per the requirement of the public. The currency notes may be distributed throughout the country through its 15 full pledged offices, 2 branch offices, and more than 4000 currency chests. The currency chests are maintained by different banks in various locations. The RBI issues currency notes, based on the availability of balances of gold, bullion, foreign securities, rupees, coins and permitted bills.

2. Monitoring Authority- The RBI has the full authority to control all the aspects of the banking system in India. The RBI is known as the Banker’s Bank. The banking system in India works according to the guidelines issued by the RBI. The RBI is the premier banking institute among the commercial banks. All the commercial banks, foreign banks and cooperative urban banks in India should obey the rules and regulations which are issued by the RBI from time to time. The RBI controls the deposits of the commercial banks through the CRR and the SLRs. Every bank should deposit a certain amount in the RBI. The commercial banks have the power to borrow the money from the RBI when they are in need of finance. Hence it is known as the lender of the last resort. The RBI has the authority to control the credit supply in the economy or monetary systems of the nation.

3. Banker to the Union Government- Generally in any country all over the world the Central bank dominates the banking sector. It advises the government on monetary policies. The RBI is the bankers to the Union Government and also to the state governments in the country. It provides a wide range of banking services to the government. It also transfers the funds, collects the receipts and makes the payment on behalf of the Government. It also manages the public debts. The Government will not pay any remuneration or brokerage to the RBI for rendering the financial services. Any deficit or surplus in the Central Government account with the RBI will be adjusted by creation or cancellation of the treasury bills. The treasury bills are known as the Adhoc Treasury bills.

4. Foreign Exchange Regulation Authority- The RBI’s another major function is to control the foreign exchange reserves position from time to time. It maintains the stability of the external value of the rupee through its domestic policies and forex market. The RBI has the full authority to regulate the market as discussed below:

·         To monitor the foreign exchange control.

·         To prescribe the exchange rate system.

·         To maintain a better relation between rupee and other currencies.

·         To interact with the foreign counterparts.

·         To manage the foreign exchange reserves.

It administers the FERA, 1973. It is replaced by the FEMA which would be consistent with full capital account convertibility with policies of the Central Government.

The RBI administers the control through the authorized forex dealers. The RBI is the custodian of the country’s foreign exchange reserves. The foreign exchange is precious and it takes the responsibility of the better utilization.

5. Promoting Authority:

The RBI’s function is to look after the welfare of the financial system. It renders the promotion services to strengthen the country’s banking and financial structure. It helps in mobilizing the savings and diverting them towards the productive channel. Thus the economic development can be achieved. After the nationalization of the commercial banks, the RBI has taken a number of series of actions in various sectors such as agriculture sector, industrial sector, lead bank scheme and cooperative sector.  

 

Commercial Banks

Amongst the banking institutions in the organized sector, commercial banks are the oldest institutions, some of them having their genesis in the nineteenth century. Initially, they were set up in large numbers, mostly as corporate bodies with shareholdings by private individuals. In the sixties of the twentieth century, a large number of weaker and smaller banks were merged with other banks. As a consequence, a stronger banking system emerged in the country. Subsequently, there has been a drift towards state ownership and control. Today 27 banks constitute strong public sector in Indian commercial banking. Commercial banks operating in India fall under different sub-categories on the basis of their ownership and control over management.

Public Sector Banks

Public sector in Indian banking emerged to its present position in three stages. First, the conversion of the then existing Imperial Bank of India into the State Bank of India in 1955, followed by the taking over of the seven state associated banks as its subsidiary banks, second the nationalization of 14 major commercial banks on July 19, 1969 and last, the nationalization of 6 more commercial banks on April 15, 1980. Thus 27 banks constitute the Public sector in Indian Commercial Banking.

Private Sector Banks

After the nationalization of major banks in the private sector in 1969 and 1980, no new bank could be set up in India for about two decades, though there was no legal bar to that effect. The Narasimham Committee on Financial Sector Reforms recommended the establishment of new banks in India. Reserve Bank of India, thereafter, issued guidelines for the setting up of new private sector banks in India in January 1993.

   These guidelines aim at ensuring that the new banks are financially viable and technologically up-to-date from the start. They have to function in a professional manner, so as to improve the image of commercial banking system and to win the confidence of the public.

   In January 2001 Reserve Bank of India issued new rules for the licensing of new banks in the private sector. The salient features are as follows:

Ø  A new bank may be started with a capital of Rs. 200 crore. The net worth is to be raised to Rs. 300 crore in three years.

Ø  The promoter’s minimum holding in the capital shall be 40 per cent with a lock-in-period of 5 years. Excess holding over 40 per cent will have to be diluted within a year.

Ø  Non-resident Indians can pick up 40 per cent equity share in the new bank. Any foreign bank or finance company may join as technical collaborators or as co-promoter, but their equity participation will be restricted to 20 per cent, which will be within the ceiling of  40 per cent allowed to Non –resident Indians.

Ø  Corporates have been allowed to invest up to meet existing priority sector norms and prudential norms and also to open 25 % of their branches in rural and semi-urban areas. Preference will be given to promoters with expertise in financing priority areas and rural and agro based industries.

Ø  Non-banking finance companies may convert themselves into banks if their net worth is Rs. 200  crore, capital adequacy ratio is 12%, non performing assets below 5% and possess triple A credit rating.

In addition to the above guidelines, the new banks are governed by the provisions of the Reserve Bank of India Act, the Banking Regulation Act and other relevant statutes.

 

 

Local Area Bank

In 1996, Government decided to allow new local area banks with the twin objectives of Providing an institutional mechanism for promoting rural and semi-urban savings, and For providing credit for viable, economic activities in the local areas.

Such banks can be established as public limited companies in the private sector and can be promoted by individuals, companies, trusts and societies. The minimum paid up capital of such banks would be Rs. 5 crore with promoter’s contribution at least Rs. 2 crore. They are to be set up in district towns and the area of their operations would be limited to a maximum of 3 geographically contiguous districts. At present, five Local Area Banks are functional, one each in Punjab, Gujrat, Maharashtra and two in Andhra Pradesh.

 

Foreign Bank

Foreign Commercial Banks are the branches in India of the joint stock banks incorporated abroad. Their number has increased to forty as on 31^st March, 2002. These banks, besides financing the foreign trade of the country, undertake normal banking business in the country as well.

Licensing of Foreign Bank: In order to operate in India, the foreign banks have to obtain a license from the Reserve Bank of India. For granting this license, the following factors are considered:

 

Ø  Financial soundness of the bank.

Ø  International and home country rating.

Ø  Economic and political relations between home country and India.

Ø  The bank should be under consolidated supervision of the home country regulator.

Ø  The minimum capital requirement is US $ 25 million spread over three branches - $ 10 million each for the first and second branch and $5 million for the third branch.

Ø  Both branches and ATMs require licenses and these are given by the RBI in conformity with WTO’s commitments.

Function of Foreign Banks: The main business of foreign banks is the financing of India’s foreign trade which they can handle most efficiently with their vast resources. Recently, they have made substantial inroads in internal trade including deposits, advances, discounting of bills, mutual funds, ATMs and credit cards. A large part of their credit is extended to large enterprises and MNCs located mostly in the tier one cities- mainly the metros, though some banks are now foraying in the rural sector as well. Technology used by these banks has been a major driver of change in the Indian banking industry. A highly trained and efficient workforce and the huge pool of capital resources at the disposal of these banks have created tremendous goodwill and prestige of foreign banks in India.

   Apart from their main businesses, foreign banks are also instrumental in shaping the attitudes, perceptions and policies of foreign governments, corporates and other clients towards India, especially in the following areas:

Ø  Bringing together foreign institutional investors and Indian companies.

Ø  Organizing joint ventures.

Ø  Structuring and syndicating project finance for telecommunication, power and mining sectors.

Ø  Providing a thrust to trade finance through securitization of export loan.

Ø  Introducing new technology in data management and information systems.

 

Performance: Foreign banks are not subject to the stringent norms regarding opening of rural branches, priority sector lending or bound by the social philosophy of Indian banks. These factors combined with the financial, technical and human resources of the foreign banks have ensured a healthy growth of these banks in India.

 

Co-operative Banks

Besides the commercial banks, there exist in India another set of banking institutions called co-operative credit institutions. These have been in existence in India since long. They undertake the business of banking both in urban and rural areas on the principle of co-operation. They have served a useful role in spreading the banking habit throughout the country. Yet, their financial position is not sound and a majority of co-operative banks has yet to achieve financial viability on a sustainable basis.

   The cooperative banks have been set up under the various Co-operative Societies Acts enacted by the State Governments. Hence the State Governments regulate these banks. In 1966, need was felt to regulate their activities to ensure their soundness and to protect the interests of depositors. Consequently, certain provisions of the Banking Regulation Act 1949 were made applicable to co-operative banks as well. These banks have thus fallen under dual control viz., that of the State Govt. and that of the Reserve Bank of India which exercises control over them so far as their banking operations are concerned.

 

Features of Cooperative banks

Ø  These banks are government sponsored government supported and government subsidized financial agencies in India.

Ø  Unlike commercial banks which focus on profits, cooperative banks are organized and managed on principles of cooperation, self help and mutual help. They function on a “no profit, no loss” basis.

Ø  They perform all the main banking functions but their range of services is narrower than that of commercial banks.

Ø  Some of them are scheduled banks but most are unscheduled banks.

Ø  They have a federal structure of three-tier linkages and vertical integration.

Ø  Cooperative banks are financial intermediaries only, particularly because a significant amount of their borrowings is from the RBI, NABARD, the central and state governments and cooperative apex institutions.

Ø  There has been a shift of cooperative banks from the rural to the urban areas as the urban and non-agricultural business of these banks has grown over the years.

 

Weaknesses: Cooperative banks suffer from too much dependence on RBI, NABARD and the government.

Ø  They are subject to too much officialization and politicization. Both the quality of loans assets and their recovery are poor. The primary agricultural cooperative societies- a vital link in the cooperative credit system- are small in size, very week and many of them are dormant.

Ø  The cooperative banks suffer from existence of multiple regulation and control authorities.

Ø  Many urban cooperative banks have failed or are in the process of liquidation.

Ø  Cooperative banks have increasingly been facing competition from commercial banks, LIC, UTI and small savings organizations.

 

Regional Rural Banks

Regional Rural Banks are relatively new banking institutions which supplement the efforts of the cooperative and commercial banks in catering to the credit requirements of the rural sector. These banks have been set up in India since October 1975, under the Regional Rural Banks Act, 1976. At present there are 196 RRBs functioning in 484 districts. The distinctive feature of a Regional Rural Bank is that though it is a separate body corporate with perpetual succession and a common seal. It is very closely linked with the commercial bank which sponsors the proposal to establish it and is called the sponsor bank. The central government establishes a RRB, at the request of the sponsor bank and specifies the local limits within which it shall establish its branches and agencies.

Business of a Regional Rural Bank

A Regional rural bank carries on the normal banking business i.e., the business of banking as defined in section 5(b) of the Banking Regulation Act, 1949 and engages in one or more forms of businesses specified in Section 6 (1) of that Act. A Regional rural bank may in particular, undertake the following types of businesses, namely:

Ø  The granting of loans and advances, particularly to small and marginal farmers and agricultural laborers, and to cooperative societies for agricultural operations or for other connected purposes, and

Ø  The granting of loans and advances, particularly to artisans, small entrepreneurs and persons of small means engaged in trade, commerce or industry or other productive activities within the notified areas of a rural bank.

Regional Rural Banks are thus primarily meant to cater to the needs of the poor and small borrower in the countryside.

Capital

The authorized capital of a RRB shall be Rs. 5 crore which may increased or reduced(not below Rs. 25 lakh) by the Central Government in consultation with NABARD and the sponsor bank. The issued capital shall not be less than Rs. 25 lakh. Of the issued capital, the Central Government shall subscribe fifty percent, the sponsor bank thirty five percent and the concerned State Government fifteen percent.

 The shares of the Rural Banks shall be deemed to be included in the securities enumerated in Section 20 of the Indian Trusts Act, 1882 and shall also be deemed to be approved securities for the purpose of the Banking Regulation Act 1949.

Management

Each Rural Bank is managed by a Board of Directors. The general superintendence, direction and management of the affairs and business vest in the Board. In discharging its functions the Board of Directors acts on business principles and shall have due regard to public interests. A regional rural bank is guided by the directions, issued by the Central Government in regard to matters of policy involving public interest.

 

Meaning of Inflation

Inflation simply means a continuous increase in general price level. It can be described as a decline in the real value of money or a loss of purchasing power in the medium of exchange. When the general price level rises, each unit of currency buys fewer goods and services.

Inflation has been defined in several ways by different economists.

According to Coulbourn "Inflation is too much of money chasing too few goods."

According to Keynes, ‘Inflation is the form of taxation which the public finds hardest to evade.’

According to Samuelson,‘Inflation denotes a rise in general level of prices’.

According to Milton Friedman, ‘Inflation is always and everywhere a monetary phenomenon.’

According to Brooman, “Inflation is a continuing increase in the general price level.”

According to Johnson, “Inflation is a sustained rise in prices”.

According to Shapiro, “Inflation is a persistent and appreciable rise in the general level of prices.”

According to Crowther, "Inflation is a state in which the value of money is falling i.e. the prices is rising."

 

Features of Inflation

The characteristics or features of inflation are as follows:

1. It is a long-term process.

2. It is a state of disequilibrium.

3. It is scarcity oriented.

4. It is dynamic in nature.

5. It is a post full employment phenomenon.

6. It is a purely monetary phenomenon.

7. Inflationary price rise is persistent and irreversible.

8. Inflation is caused by excess demand in relation to supply of all types of goods and services.

9. Inflation involves a process of the persistent rise in prices. It involves rising trend in price level.

 

 

 

 

 

 Terms related to Inflation

The important terms related to inflation are as follows:

1.      Deflation is a condition of falling prices. It is just the opposite of inflation. In deflation, the value of money goes up and prices fall down. Deflation brings a depression phase of business in the economy.

2.      Disinflation refers to lowering of prices through anti-inflationary measures without causing unemployment and reduction in output.

3.      Reflation is a situation of rising prices intentionally adopted to ease the depression phase of the economy. In reflation, along with rising prices, the employment, output and income also increase until the economy reaches the stage of full employment.

4.      Stagflation: Paul Samuelson describes Stagflation as the paradox of rising prices with increasing rate of unemployment. It simply means stagnation (unemployment) plus inflation.

5.      Stagnation: Stagnation in the rate of economic growth which may be a slow or no economic growth at all.

6.      Statflation: The term 'Statflation' was coined by Dr. P.R. Brahmananda to describe the inflationary situation of India. According to Brahmananda, Rising prices in the middle of a recession is known as Statflation.

 

Types of inflation

Inflation can be of different types based on certain important aspects, which is given below.

 

Types of Inflation on Coverage

1. Comprehensive Inflation: When the prices of all commodities rise throughout the economy it is known as Comprehensive Inflation. Another name for comprehensive inflation is Economy Wide Inflation.

2. Sporadic Inflation: When prices of only few commodities in few regions (areas) rise, it is known as Sporadic Inflation. It is sectional in nature. For example, rise in food prices due to bad monsoon (winds bringing seasonal rains in India).

 

Types of Inflation on Time of Occurrence

1.  War-Time Inflation: Inflation that takes place during the period of a war-like situation is known as War-Time inflation. During a war, scare productive resources are all diverted and prioritized to produce military goods and equipments. This overall result in very limited supply or extreme shortage (low availability) of resources (raw materials) to produce essential commodities. Production and supply of basic goods slow down and can no longer meet the soaring demand from people. Consequently, prices of essential goods keep on rising in the market resulting in War-Time Inflation.

2. Post-War Inflation: Inflation that takes place soon after a war is known as Post-War Inflation. After the war, government controls are relaxed, resulting in a faster hike in prices than what experienced during the war.

3. Peace-Time Inflation: When prices rise during a normal period of peace, it is known as Peace-Time Inflation. It is due to huge government expenditure or spending on capital projects of a long gestation (development) period.

 

Types of Inflation on Government Reaction or its degree of control

1. Open Inflation: When government does not attempt to restrict inflation, it is known as Open Inflation. In a free market economy, where prices are allowed to take its own course, open inflation occurs.

2. Suppressed Inflation: When government prevents price rise through price controls, rationing, etc., it is known as Suppressed Inflation. It is also referred as Repressed Inflation. However, when government controls are removed, Suppressed inflation becomes Open Inflation. Suppressed Inflation leads to corruption, black marketing, artificial scarcity, etc.

 

 

Types of Inflation on Rising Prices rate of inflation

1. Creeping Inflation: When prices are gently rising, it is referred as Creeping Inflation. It is the mildest form of inflation and also known as a Mild Inflation or Low Inflation. According to R.P. Kent, when prices rise by not more than (upto) 3% per annum (year), it is called Creeping Inflation.

2. Chronic Inflation: If creeping inflation persist (continues to increase) for a longer period of time then it is often called as Chronic or Secular Inflation. Chronic Creeping Inflation can be either Continuous (which remains consistent without any downward movement) or Intermittent (which occurs at regular intervals). It is called chronic because if an inflation rate continues to grow for a longer period without any downturn, then it possibly leads to Hyperinflation.

3. Walking Inflation: When the rate of rising prices is more than the Creeping Inflation, it is known as Walking Inflation. When prices rise by more than 3% but less than 10% per annum (i.e. between 3% and 10% per annum), it is called as Walking Inflation. According to some economists, walking inflation must be taken seriously as it gives a cautionary signal for the occurrence of Running inflation. Furthermore, if walking inflation is not checked in due time it can eventually result in Galloping inflation.

4. Moderate Inflation: Prof. Samuelson clubbed together concept of Creeping and Walking inflation into Moderate Inflation. When prices rise by less than 10% per annum (single digit inflation rate), it is known as Moderate Inflation. According to Prof. Samuelson, it is a stable inflation and not a serious economic problem.

5. Running Inflation: A rapid acceleration in the rate of rising prices is referred as Running Inflation. When prices rise by more than 10% per annum, running inflation occurs. Though economists have not suggested a fixed range for measuring running inflation, we may consider price rise between 10% to 20

% per annum (double digit inflation rate) as a running inflation.

6. Galloping Inflation: According to Prof. Samuelson, if prices rise by double or triple digit inflation rates like 30% or 400% or 999% per annum, then the situation can be termed as Galloping Inflation. When prices rise by more than 20% but less than 1000% per annum (i.e. between 20% to 1000% per annum), galloping inflation occurs. It is also referred as Jumping inflation. India has been witnessing galloping inflation since the second five year plan period.

7. Hyperinflation: Hyperinflation refers to a situation where the prices rise at an alarming high rate. The prices rise so fast that it becomes very difficult to measure its magnitude. However, in quantitative terms, when prices rise above 1000% per annum (quadruple or four digit inflation rate), it is termed as Hyperinflation. During a worst case scenario of hyperinflation, value of national currency (money) of an affected country reduces almost to zero. Paper money becomes worthless and people start trading either in gold and silver or sometimes even use the old barter system of commerce. Two worst examples of hyperinflation recorded in world history are of those experienced by Hungary in year 1946 and Zimbabwe During 2004-2009 under Robert Mugabe's regime.

 

Types of Inflation on Causes

1. Deficit Inflation: Deficit inflation takes place due to deficit financing.

2. Credit Inflation: Credit inflation takes place due to excessive bank credit or money supply in the economy.

3. Scarcity Inflation: Scarcity inflation occurs due to hoarding. Hoarding is an excess accumulation of basic commodities by unscrupulous traders and black marketers. It is practiced to create an artificial shortage of essential goods like food grains, kerosene, etc. with an intension to sell them only at higher prices to make huge profits during scarcity inflation. Though hoarding is an unfair trade practice and a punishable criminal offence still some crooked merchants often get themselves engaged in it.

4. Profit Inflation: When entrepreneurs are interested in boosting their profit margins, prices rise.

5. Pricing Power Inflation: It is often referred as Administered Price inflation. It occurs when industries and business houses increase the price of their goods and services with an objective to boost their profit margins. It does not occur during a financial crisis and economic depression, and is not seen when there is a downturn in the economy. As Oligopolies have the ability to set prices of their goods and services it is also called as Oligopolistic Inflation.

6. Tax Inflation: Due to rise in indirect taxes, sellers charge high price to the consumers.

7. Wage Inflation: If the rise in wages in not accompanied by a rise in output, prices rise.

8. Build-In Inflation: Vicious cycle of Build-in inflation is induced by adaptive expectations of workers or employees who try to keep their wages or salaries high in anticipation of inflation. Employers and Organisations raise the prices of their respective goods and services in anticipation of the workers or employees' demands. This overall builds a vicious cycle of rising wages followed by an increase in general prices of commodities. This cycle, if continues, keeps on accumulating inflation at each round turn and thereby results into what is called as Build-in inflation.