Module 1

The Indian Banking

System

Dr. Mrunal Joshi

Content

● The financial institutional structure in India.

● Structure of Commercial Banking System.

● Ownership of commercial banks in India.

● Meaning and functions of:

o Public and private sector banks.

o small finance banks.

 o payment banks, foreign banks.
o Indian banks operating overseas.
o regional rural banks.
o NBFI, NBFC and HFC
o Co-operative credit institutions.
● Banking models in India.
● Bank’s Role as financial intermediaries.
● Types of Lending.
● Features of bank credit and Credit Process.
 Goods/Services

Industry Individual
Financial System

Price for Goods/Services

The financial institutional structure in India
 Public Sector,
Private Sector,
Banking Foreign Banks,
Institutions Commercial
Banks Regional Rural
(60% of total Banks
assets of Financial
Intermediaries) Cooperative
Banks

Financial Non-Banking
Institutions Institutions Finance
(Intermediaries) Companies
Mutual Funds 7

Development IDBI, SIDBI,

Insurance and Finance NABARD, SFCs,
Housing Finance Institutions: ECGC, DIGC
Companies
B.R.C.M. College of Business Administration Dr. Mrunal Joshi
Structure of Commercial Banking System

● Public Sector Bank

● Private Sector Bank
● Foreign Bank
● Regional Rural Bank
Ownership of commercial banks in India

Public Sector Bank:

● 27 Public sector banks comprising SBI and its associate banks (6) and other
21 nationalized banks
● regulated by statutes of the Parliament and some important provisions
under section 51 of the Banking Regulation Act, 1949.
● State Bank of India (SBI) regulated by the State Bank of India Act, 1955.
● Subsidiary banks of State Bank of India regulated by State Bank of India
(Subsidiary Banks) Act, 1959.
● After the merger of SBI with its subsidiaries This merger was enacted under
the State Banks (Repeal and Amendment) Bill of 2017, amendeded the State
Bank of India Act of 1955. (The merger of SBI with its five associate banks
(State Bank of Bikaner and Jaipur, State Bank of Hyderabad, State Bank of
Mysore, State Bank of Patiala, and State Bank of Travancore) and Bharatiya
Mahila Bank was completed on April 1, 2017
● Nationalized banks regulated by Banking companies (Acquisition and
Transfer of Undertakings) Act, 1970 and 1980.
● central government is mandated to hold a minimum shareholding of 51 per
cent in nationalized banks and 55 per cent in State Bank of India (SBI).
● foreign investment cannot exceed 20% of the total paid up capital
● 2006-07 banks allowed to raise capital from public through equity issues.
● The government is considering banks merging the nationalised banks to
ultimately have about four large state run banks.
● The Board of public sector banks comprises of whole time
directors—chairman, managing director(s), executive directors, government
nominee directors, RBI nominee directors, workman and non-workman
directors and other elected directors.
● Banks Board Bureau (BBB) for selection of Managing directors and directors
Private Sector Bank:

● Broad underlying principle is permitting the private sector to own and

operate banks is to ensure that ownership and control is well-diversified and
sound corporate governance principles are observed.
● New private sector bank can enter with a capital of Rs 5 billion - must
retained all time
● Feb 2013 - guidelines for new banks and conversion of NBFCs in to banks
● Aug 2016 - on tap licencing for universal banking - IDFC Ltd and Bandhan
Financial Services
● The Universal bank has to get its shares listed on stock exchanges within six
years from commencement of business
Small Finance Banks (SFB)

● November 2014, RBI gave approvals / licences for Small Finance Banks for
small value customers
● financial inclusion by (a) providing savings vehicles, and (b) supplying credit
to small business units, small and marginal farmers, micro and small
industries and other unorganized sector entities, through high technology,
low cost operations.
● can be established by (a) individuals/ professionals with 10 years’
experience in the banking and finance industry, (b) companies / societies
owned and controlled by residents, (c) existing Non Banking Finance
Companies (NBFC), Micro finance institutions (MFI) and Local Area Banks
(LAB) owned and controlled by residents
● The minimum paid up equity capital required is Rs 1 billion. Promoters’
minimum initial contribution should be 40%.
● Foreign Direct Investment - FDI Policy - maximum of 74% of paid up capital
of the bank - up to 49% automatic route
● all prudential norms and regulations applicable to commercial banks
including CRR and SLR (3% & 18%)
● lending is to be made to sectors specified by RBI
● currently 11 operational Small Finance Banks (SFBs) in India
● MFIs evincing keen interest on converting themselves to SFB due to broad
scope of banking - to lend to Self Help Groups (SHG) or Joint Liability
Groups (JLG) and bigger loans to small borrowers. Example Ujjavan and
Equitas merger (2024), AU Financiers (2017), Fincare - Disha Microfin (2017)
Payment Banks

● Narrow banks - does not undertake lending activities.

● invests the majority of its deposits in ‘safe” instruments such as government
securities.
● In November 2014, this class of niche banks was authorised by RBI.
● objective was to accelerate financial inclusion.
● Intended to provide (a) small savings accounts and (b) payments/
remittance services to migrant labour workforce, low income households,
small businesses, unorganized sector entities and other users.

undertake only the following activities:

● Accept demand deposits - maximum Rs. 100,000 per individual customer.

 ● Undertake payments and remittance services through various channels. - using
newer mobile technology and payment gateways
● issue debit / ATM cards usable on ATM networks of all banks - cannot issue credit
cards.
● Function as a Business Correspondent of another commercial bank, as allowed by
the RBI guidelines
● Distribute non-risk sharing simple financial products like mutual fund units and
insurance products.
Payments banks can use the funds would have to be deployed as follows:
● As Cash Reserve Ratio (CRR) with RBI (3% on Nov 29, 2025)
● Minimum of 75% of demand deposit balances should be invested as Statutory
Liquidity Ratio (SLR), in eligible government securities or treasury bills with
maturity up to one year (Current SLR 18% - limit 40%)
● Maximum of 25% of demand deposit balances should be held in current and time /
fixed deposits with other commercial banks for operations and liquidity
management
The following entities can create Payments banks:

● Existing non bank Pre paid Instrument (PPI) issuers (Mastercard and Visa,
Amazon Pay)
● Individuals / professionals
● Non Banking Finance companies (NBFC) (Paytm, PhonePe, MobiKwik)
● Corporate Business Correspondents (BC)
● Mobile telephone companies (Jio and Airtel)
● Supermarket chains
● Companies
● Real sector cooperatives
● Public sector entities
● The minimum paid up equity capital required is Rs 1 billion. Promoters’
minimum initial contribution should be 40% and hold their stake for the first
five years after the.
● Foreign shareholding will be determined by the Foreign Direct Investment
(FDI) Policy for private sector banks - currently allowed upto a maximum of
74% of paid up capital of the bank - up to 49% automatic route
● 25% of physical access (Branches, ATM) point including BCs in rural areas
● List of the Payment banks (RBI)
○ Airtel Payments Bank Limited
○ India Post Payments Bank Limited
○ Fino Payments Bank Limited
○ Paytm Payments Bank Limited
○ Jio Payments Bank Limited
○ NSDL Payments Bank Limited
Foreign Bank

● to fostering the inherent potential for sustained growth in the domestic

economy and growing integration into the global economy.
● In 2004, RBI permitted foreign banks - regulated by a central bank in their
home countries to establish Wholly Owned Subsidiary (WOS)
● Initially in 2005, foreign banks already operating in India were allowed to
convert their existing branches to WOS.
● Then in April 2009, only the WOS route is permitted for a foreign bank to
operate in India.
● The initial minimum paid up capital for setting up the WOS is Rs 5 billion.
● If foreign bank dilutes its stake in India to 74% or less, the existing FDI policy
applicable
● as WOS is advantageous due to the following reasons:
○ Local incorporation enables creation of separate legal entities that have
their own capital base and local Board of directors;
○ There is a clear distinction between the assets and liabilities of the
foreign banks operating in India and those of their foreign parent bank:
○ Local regulation and law enforcement is possible for better control
● Regional Rural Bank (RRBs)

created for rural credit delivery and to ensure financial inclusion.

capital base is held by the central government, relevant state government

and the commercial bank that “sponsors” them, in the ratio of 50:15:35,
respectively.

Recent policy initiatives include recapitalization and amalgamation of RRBs

with the sponsor banks.

two broad phases in the amalgamation of RRBs. - first phase (September

2005-March 2010), RRBs of the same sponsor banks within a state were
amalgamated bringing down their number to 82 from 196.
In the second and ongoing phase, starting from October 2012,
geographically contiguous RRBs within a state under different sponsor
banks would be amalgamated to have just one RRB in medium-size states
and two/three RRBs in large states. (Amalgamation of RRBs - One State One RRB |
Department of Financial Services | Ministry of Finance | Government of India)

MINISTRY OF FINANCE (Department of Financial Services) NOTIFICATION

New Delhi, the 5th April, 2025
List of Regional Rural Banks functioning in the country | Department of Financial Services |
Ministry of Finance | Government of India
Public and private sector banks: Meaning

Public Sector Banks (PSBs) means banks constituted under the State Bank of
India Act, 1955 and Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1970/Banking Companies (Acquisition and Transfer of
Undertakings) Act, 1980.

Private Sector Banks are banking companies licensed to operate in India under
Banking Regulation Act, 1949.
Public and private sector banks: Functions

● Accepting Deposits: Banks provide a safe place for individuals and

businesses to deposit their money, which can be withdrawn when needed.
● Providing Loans: Banks lend money to individuals and businesses for
various purposes, such as home mortgages, business expansion, or
personal loans.
● Payments and Settlements: Banks enable transactions through various
payment methods, like checks, debit/credit cards, and electronic transfers.
● Currency Exchange: Many banks offer foreign exchange services, allowing
customers to buy, sell, or exchange foreign currencies.
● Safekeeping of Valuables: Some banks offer safe deposit boxes for
customers to securely store valuable items and documents.
● Investment Services: Banks also provide investment products like mutual
funds, stocks, and bonds, helping customers grow their wealth.
● Internet Banking Services: Banks offer online and mobile banking services,
making it convenient for customers to access their accounts, pay bills, and
transfer funds.
Small finance banks: Meaning

Small Finance Banks (SFB) licensed under Banking Regulation Act, 1949 and
created with an objective of furthering financial inclusion by primarily
undertaking basic banking activities to un-served and underserved sections
including small business units, small and marginal farmers, micro and small
enterprises and other underserved sections.
Small finance banks: Functions

Focus on Financial Inclusion: Small finance banks are mandated to prioritize

financial inclusion by providing basic banking services to the unbanked
population. They aim to bring people into the formal banking system and bridge
the gap between traditional banks and underserved communities. By setting up
branches in remote areas and offering simplified account opening procedures,
small finance banks actively work towards increasing financial literacy and
encouraging savings habits among the unbanked population.
Targeted Customer Base: Unlike commercial banks that cater to a wide range of
customers, small finance banks primarily focus on serving specific customer segments
These segments include micro and small enterprises, small farmers, low income
households, and migrant workers. By understanding the unique needs and challenges
faced by these customers, small finance banks can tailor their products and services to
provide relevant and accessible solutions This targeted approach ensures that the
banking needs of underserved individuals and businesses are met effectively.
Microfinance Services: Small finance banks often have a strong focus on microfinance,
which involves providing small loans to individuals and small businesses. They
leverage their deep understanding of local markets and customers to offer microcredit
facilities for Income generation activities, agriculture, and other productive purposes.
By extending credit to those who do not have access to traditional banking services,
small finance banks empower individuals and foster entrepreneurship at the grassroots
level.
Simplified Documentation: Recognizing the challenges faced by individuals in rural and
remote areas, small finance banks simplify the account opening process by reducing
the documentation requirements. By embracing innovative solutions such as e KYC
(electronic Know Your Customer), small finance banks facilitate easier access to
banking services for individuals with limited access to formal identification documents.
This streamlines the onboarding process, making banking facilities more accessible to
a wider population.
Technology driven Approach: Small Finance Banks embrace technology to enhance
operational efficiency and provide convenient banking services to their customers. With
the advent of digital banking solutions, these banks leverage mobile banking, internet
banking, and mobile wallets to reach customers in remote areas where physical
branches are not viable By leveraging technology, small finance banks enable
customers to perform various banking transactions, such as fund transfers, bill
payments, and balance inquiries, from the comfort of their homes.
Priority Sector Lending: Small finance banks are mandated to allocate a
significant portion of their lending towards priority sectors, such as agriculture,
microenterprises, and small businesses. This ensures that funds are channelled
to the segments that need them the most, facilitating economic growth and
development. By focusing on priority sector lending, small finance banks
contribute to poverty reduction, job creation, and the overall well being of
underserved communities. 75% → 60% from 2025-26 → 40% of 60% for
sub-sectors under PSL

Deposit Products and Savings Schemes: Apart from offering credit facilities,
small finance banks also provide a range of deposit products and savings
schemes tailored to the needs of their customers.
These include savings accounts, recurring deposits, fixed deposits, and
customized savings schemes that encourage regular savings By promoting a
culture of saving, Small Finance Banks empower Individuals to build financial
resilience and achieve their long term financial goals.

In conclusion, Small Finance Banks have emerged as significant players in the

Indian banking sector, driving financial inclusion and catering to the unique
needs of underserved communities.
Payment banks: Meaning

Payment Banks are public limited companies licensed under Banking Regulation
Act, 1949, with specific licensing conditions restricting its activities mainly to
acceptance of demand deposits and provision of payments and remittance
services.
Function of Payment banks

● Accepting deposits: Payment banks can accept deposits, but there is a limit
on the amount (currently ₹2,00,000 per customer).
● Facilitating payments and remittances: They enable customers to make and
receive payments, including mobile payments, transfers, and third-party fund
transfers.
● Providing debit cards and ATM access: Payment banks can issue debit
cards and offer ATM services.
● Offering online and mobile banking: They provide digital banking services
like net banking and mobile banking.
● Acting as banking correspondents: Payment banks can partner with other
banks to offer services like loan disbursement, though they cannot offer
these services directly.
● Promoting financial inclusion: By focusing on digital transactions and
reaching underserved populations, they play a key role in expanding access
to financial services.
● Operating on a smaller scale: Unlike traditional banks, they are designed to
operate with lower operating costs and limited credit risk.

In essence, payment banks act as specialized entities focused on

facilitating payments and basic banking services, contributing significantly
to financial inclusion in India.
Foreign banks: Meaning

Foreign Bank is a bank that has its headquarters outside the India but runs its
offices as a private entity at any other location in India. Such banks are under an
obligation to operate under the regulations provided by the Reserve Bank of India
as well as the rule prescribed by the parent organization located outside India.
Functions of Foreign Banks

Core banking services

● Accepting Deposits: Foreign banks accept deposits from individuals,

businesses, and organizations, similar to domestic banks.
● Providing Loans and Advances: They offer various types of loans and
advances to cater to diverse financial needs of individuals, businesses and
even foreign governments.
Specialized international services

● Foreign Exchange Services: A key function is facilitating foreign exchange

transactions, including currency exchange and remittances, which is crucial
for international trade and transactions.
● Trade Finance: Foreign banks facilitate international trade by providing
services like letters of credit and export credit, which help mitigate risks in
cross-border transactions and support businesses engaged in global trade.
● International Clients and Transactions: They cater to the needs of
multinational corporations and high-net-worth individuals, providing services
such as managing accounts, facilitating international transfers, and
supporting their global operations.
● Access to Global Financial Markets: Foreign banks connect Indian
businesses to international financial markets, enabling them to raise capital,
make global investments, and engage in cross-border financial activities.
● Wealth Management and Investment Banking: They offer specialized
services like wealth management and investment banking, which may not
be as readily available from domestic banks,
Indian banks operating overseas: Meaning

Several Indian banks have an overseas presence through branches, subsidiaries,

or representative offices. Major players include State Bank of India, Bank of
Baroda, and ICICI Bank.
These banks offer services like trade finance, remittances, and other banking
facilities tailored for both Indian citizens and non-resident Indians (NRIs) in
various countries.
Indian banks operating overseas essentially refers to the presence and
functioning of Indian financial institutions in countries outside of India. This
presence can take various forms, including:
Branches: These are directly controlled by the parent bank in India and operate
under its brand name, subject to the regulations of both the home (India) and
host country where the branch is established.

Subsidiaries: These are separate legal entities incorporated in the host country,
owned (fully or partially) by the Indian bank, and subject primarily to the
regulations of the host country.

Joint Ventures and Representative Offices: These are other forms of

international presence, often involving partnerships with local or foreign banks or
limited scope for direct banking activities, according to the Department of
Financial Services.
Indian banks operating overseas: Functions
Support for NRIs (Non-Resident Indians):
● Providing accounts: Offering NRE (Non-Resident External - tax free interest and full
repatriation) and NRO (Non-Resident Ordinary - Indian tax and limited repatriation)
accounts for managing overseas earnings and domestic funds, respectively.
● Deposit schemes: Facilitating FCNR (Foreign Currency Non-Resident) deposits and
other term deposit options.
● Remittance services: Enabling convenient transfer of funds between India and the
overseas location.
● Loan facilities: Offering loans against deposits and catering to specific needs like
NRI home loans.
● Investment guidance: Assisting NRIs with investment options, including mutual
funds and other financial products.
Facilitating International Trade:
● Trade finance: Providing various forms of trade finance, including letters of credit,
bank guarantees, and export credit, to support Indian businesses involved in
international trade.
● Foreign exchange services: Dealing in foreign exchange to assist with international
transactions and manage currency risks.
Supporting Corporate Globalization:
● Financial support for Indian companies expanding abroad: Providing loans and
other financial solutions for Indian companies venturing into overseas markets.
● Project financing and structuring: Offering expertise and solutions for project
financing in foreign jurisdictions.
● Cash management services: Providing efficient cash management solutions for
corporate clients with international operations.
Learning and Expansion:

● Exposure to global best practices: International presence exposes Indian

banks to new technologies, financial products, and management practices,
helping them improve their services.
● Diversification and risk mitigation: Expanding globally can help banks
diversify their revenue streams and mitigate risks associated with solely
relying on the domestic market, according to a LinkedIn post.
● Reaching new markets and client segments: Accessing faster-growing
economies and expanding clientele beyond the Indian diaspora.
Adherence to Regulations:

● Compliance with host and home country regulations: Overseas operations

require strict adherence to the laws and regulations of both India (home
country) and the country where the bank operates.
● Know Your Customer (KYC) compliance: Ensuring adherence to KYC norms
as per local regulations.

In essence, Indian banks operating overseas serve as crucial financial bridges,

facilitating the flow of capital, supporting international trade, and catering to the
diverse financial needs of both individuals and businesses engaged in the global
economy.
Regional rural banks: Meaning

Regional Rural Banks (RRB) are the banks established under the Regional Rural
Banks Act, 1976 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 Central Government. RRBs are owned jointly by the
Government of India, the State Government and Sponsor Banks.
Regional Rural Banks were established under the provision of RRBs Act, 1976
with an objective to create an alternative channel to the cooperative credit
structure so as to facilitate an expanded bandwidth of institutional credit for
agriculture and rural sector.
Regional Rural Banks | Department of Financial Services | Ministry of Finance | Government of India
Regional rural banks: Functions

● Mobilise regional financial resources through

○ Extend loans to artisans, farmers, labourers, and MSMEs
○ Provide credit facility in the agricultural department, renewable energy
sources, and cultural initiatives
○ Loan to priority sectors (87% in 2024 out of which 67.4% to agriculture i.e.
Rs. 6,16,671 cr)
○ Accepting savings and other forms of deposits
○ Distributional and disbursement of pension and wages
● Provide easy and accessible banking: internet banking and UPI services
RRB and its Functions By Unacademy
NBFI: Meaning
Banking and Non- Banking Financial Institutions (NBFIs) - RajRAS | RAS Exam Preparation

● Establish through an act of parliament for development

● Do not accept deposit from public
● Mobilize resources from government and issue of bonds
● Loan to commercial banks e.g. refinance, NABARD to RRBs
● Also known as development banks e.g. SIDBI
● Other NBFI are EXIM, NHB, NaBFID
The ‘financial institutions' (Fls) fall under the category of ‘Non-banking Financial
Institutions (NBFI) that complement banks in providing a wide range of financial
services to a variety of customers and stakeholders.
NBFI: Functions

Based on their major line of activities the four all India financial institutions are
classified into:
1. term-lending institutions EXIM Bank, which invests in projects directly
through investments and loans; and
2. refinancing institution NABARD - National Bank for Agriculture and Rural
Development - refinance and other facilities for agriculture and allied
activities,
3. SIDBI - Small Industries Development Bank of India - for the micro, small and
medium enterprises (MSME) sector and
4. NHB - National Housing Bank - for the housing sector.
Investment institutions, such as LIC and GIC - long-term investment. - Insurance
Regulatory and Development Authority established in 1999, the sector—open for
private and foreign participation.

State/regional level financial institutions comprise of State financial corporations

(SFCs) and State Industrial and development corporations (SIDCs).

Some institutions, including a few from those listed above, have been notified as
‘public financial institutions’ by the Government of India under the Companies
Act, 1956. Of these, a few have ceased operations (such as the Industrial
Investment Bank of India), while some others have been converted into NBFCs .
Examples of FIs converted into NBFCs are Industrial Finance Corporation of
India (IFCI, 1993) and Tourism Finance Corporation of India (TFCI).
NBFC: Meaning and Functions

A Non-Banking Financial Company (NBFC) is a company registered under the

Companies Act, 1956 engaged in the business of loans and advances,
acquisition of shares/stocks/bonds/debentures/securities issued by
Government or local authority, etc. and regulated by the Reserve Bank of India.
The RBI Act 1934 was amended in January 1997 to bring in a comprehensive
legislative framework for regulating NBFCs. The amendment called for
compulsory registration and maintenance of minimum ‘net owned funds’
(NOF—the concept of ‘capital’ for NBFCs), for all NBFCs and conferred powers on
RBI to determine policies and issue directions to NBFCs.
The two major categories of NBFCs in India are the deposit taking (NBFC-D)
(from the public) and nondeposit taking (NBFC-ND) NBFCs.
Housing Finance Companies (HFC) are considered a special type of NBFC.
The Residuary Non-banking Finance companies (RNBC), also accepts deposits
from the public. Earlier, RNBCs held almost 90 per cent of all NBFC deposits, but
their business model was found unviable. Hence, RNBCs were required to
migrate to other business models. The two RNBCs exited the present business
model by repaying their liabilities by 2015.
Non-deposit taking NBFCs have been further bifurcated into NBFC-ND and
NBFC-ND-SI, as shown in Figure 1.8D. ‘SI’ stands for ‘systemically important’.
Understandably, NBFCs with asset size of over Rs 5 billion are classified in this
category.
While deposit taking NBFCs (NBFC-D) were subject to some prudential
regulation since 1963, the non-deposit taking institutions (NBFC-ND) were
almost unregulated. As ‘systemic risk’ became a frequently used term and began
threatening the stability of financial systems, RBI designated those NBFCs with
asset size of over Rs 5 billion as ‘systemically important’ (NBFC-ND-SJ), due to
their linkages with money markets, equity markets, banks and financial
institutions and brought them under a specific regulatory framework (capital
adequacy and exposure norms“) from April 1, 2007. NBFC-ND-SI is the fastest
growing segment of NBFCs, growing at a compound rate of 28 per cent between
2006 and 2008.
They raise resources“ primarily from issue of debentures, borrowings from banks
and other financial institutions and issue of commercial paper (a money market
instrument, discussed n a later chapter). This category of NBFCs is closely
monitored by RBI due to their systemic importance.

Figure 1.8E also shows another classification of NBFCs according to their asset
profile. Across NBFC categories, asset finance companies (AFC) hold the largest
share in total assets/liabilities (above 70 per cent). They are followed by loan
companies (LC) with about 30 per cent.
It can be gauged from the above discussion that NBFCs, especially NBFC-NDs,
do not have access to lowcost sources of funds like the banks do.* Therefore, to
compensate for high cost of funds, a significant segment of NBFC-ND
companies have adopted a capital market based business model, such as
providing loans against shares or financing public issues. While this is a model
where high yields are possible, the risks are also higher.
Account Aggregators (AA) is the latest category of NBFCs authorised by RBI in
September 2016 (https://
[Link]/rdocs/notification/PDFs/MD46859213614C3046C 1
[Link]). At present, financial asset holders such as holders of
savings bank deposits, fixed deposits, mutual funds and insurance policies, get a
scattered view of their financial asset holdings if the entities with whom these
accounts are held fall under the purview of different financial sector regulators.
This gap will be filled by account aggregators who will provide information on
various accounts held by a customer in a consolidated, organised and retrievable
manner.
The option to avail the services of an account aggregator (AA) by a customer will
be purely voluntary. The NBFC-AA will be regulated by RBI. The business model
will be driven entirely by Information Technology (IT), and will be governed by a
Citizens’ Charter for customer protection. The minimum Net Owned Funds
(capital) requirement for an AA is Rs 2 crore. Once authorized, the AA will be
bound by the terms and conditions of the licence that include customer
protection, grievance redressal, data security, audit control, corporate
governance and risk management. The AA will not involve itself in the financial
transactions of customers. The pricing of its services will be in accordance with
a policy approved by its Board of Directors.
HFC: Meaning and Functions

Housing finance companies (HFC) are special types of NBFCs. When the
National Housing Bank (NHB), one of the all India financial institutions
(described earlier) was set up in 1988, there were about 400 housing finance
companies regulated by the RBI that financed only 20 percent of the population’s
home financing needs. The remaining 80 per cent was being financed through
informal sources.
Housing Development Finance Corporation (HDFC) was the largest housing
finance company. The housing finance market has grown stupendously since
then, with many banks and other institutions entering the sector. The NHB is the
regulator and supervisor of HFCs.
Other types of NBFCs are Chit Funds that are regulated by the State
Governments, and Mutual Benefit companies that are regulated by Ministry of
Corporate Affairs, Government of India. The multiplicity of regulators poses
challenges in the functioning of the non banking sector There are further
regulatory challenges in this fast growing segment.
For example, RBI’s Panel for financial regulation and supervision classifies
NBFCs into a third set of broad categories:
1. Stand-alone NBFCs.
2. NBFCs that are subsidiaries/associates/joint ventures of banking
companies.
3. NBFCs and banks under the same parent company, i.e., ‘sister companies’.
4. NBFCs that are subsidiaries/associates of non-financial companies.
Banking models in India
Figure 1.9 shows the ways in which financial conglomerates can be organized. In

● the ‘universal bank’ model, all financial operations are conducted within a
single corporate entity.
● In the ‘operating subsidiary’ model, operations are conducted as
subsidiaries of a financial institution.
● In the ‘holding company’ model, financial operations are carried out by
distinct entities (such as banks, mutual funds, insurance, NBFCs and HFCs),
each with separate capital and management, but together owned by a single
institution (financial or non-financial).

In India, the universal banking model is followed.

In structuring universal banks, the conglomerate structure is bank-led, i.e., banks
themselves are holding companies which operate certain businesses through
Subsidiaries, Joint Ventures and Affiliates. The policy has evolved over a period
of time.

The current policy has been expounded in the FAQs on the New Banks Guidelines
dated 3rd June 2013 ([Link]). The general principle in this regard is that
para-banking activities, such as credit cards, primary dealer, leasing, hire
purchase, factoring etc., can be conducted either inside the bank departmentally
or outside the bank through subsidiary/ joint venture /associates.
Activities such as insurance, stock broking, asset management, asset
reconstruction, venture capital funding and infrastructure financing through
Infrastructure Development Fund (IDF) sponsored by the bank can be undertaken
only outside the bank. Lending activities must be conducted from inside the
bank.
Bank’s Role as financial intermediaries.

The prime objective of the financial system is to channel surpluses arising in the
economy through the activities of households, corporate houses and the
government, into deficit units in the economy, again in the form of households,
corporate houses and the government.

The financial system comprises ‘financial markets’ and ‘financial intermediaries’.

Financial intermediaries serve three useful purposes:

● They mitigate the default risk of deficit units when surplus units lend to
them.
● They ensure liquidity of savings by surplus units.
● They lower information costs.

Banks can perform all these functions in better way as:

● they have the expertise;

● they have the experience to back their decision of lending to a similar or the
same industry;
● they have ready access to current information on the borrowers’ cash flows
through observing transactions in the accounts;
● various deposit resources are pooled to form large loans, making which are
relatively cheaper for banks;
● borrowers value their ongoing relationship with the banks and hence part
with information more readily and on a regular basis; and
● diversification of deposits over many independent assets is possible for
banks.
Types of Lending and Features of bank credit

Broadly, three types of lending can be identified:

1. Fund-Based - most direct form - supported by prime and/or collateral

securities
2. Non-fund-based - no funds outlays at the time of entering into an agreement
- crystallize into fund-based advances for the bank if the customer fails to
fulfil the terms of his contract with the counterparty - LCs, BGs
3. Asset-based - emerging - bank looks primarily or solely to the earning
capacity of the asset being financed - securitization or project finance
Fund-based advances - further classified based on the tenure: short-term loans,
long-term loans and revolving credits

● Short-Term Loans
○ Typically, these are loans with maturities of 1 year or less
○ ‘secured loans’ - prime securities, collateral securities
○ ‘special purposes’, may or may not be secured - depending on the borrower’s
creditworthiness - terms and conditions - may require full payment of interest and principal
at maturity
● Long-Term Loans Bank lending - longer than a year - known as term loans
○ More than 1 year
○ Structured repayment
○ Purpose of acquisition of assets
○ Substitute of equity
 ○ for Working Capital
○ fully disbursed at inception - repayment depends on cash inflow
○ maximum tenure 10 years, the average ranging between 3 and 5 years
● Thus, long-term loans are generally structured to be more adaptable to
borrowers’ specific requirements.
● Revolving credits offer the most flexibility to borrowers. Assessed to meet
the borrowers’ requirements over a period of 1 year or more, revolving
credits permit drawings from the line of credit at any time, and similarly,
repay the whole or part of the outstanding loans as and when cash inflows
happen in the borrowers’ firms.
Credit Process

● credit decisions impact the profitability of banks, and ultimately their

competitiveness and Survival in the industry
● deal with conflicting objectives of increasing the loan portfolio (targets) and
maintaining loan quality (mitigation of risk)
● decisions fit in with the overall strategy of the bank
● availability of tools and techniques + judgement
Constituents of the Credit Process
● The Loan Policy - written documents, authorized by individual bank’s Board
of Directors - set guidelines - procedures for appraising, sanctioning,
granting, documenting and reviewing loans - conform to organisational
objectives
● Business Development and Initial Recommendations - building its loan asset
portfolio, relationship with existing customers, build new clientele and cross
sell non-credit services - market research and detailed credit investigation -
addressed as the ‘five Cs’, (capacity, capital, collateral, conditions, character)
or remember through mnemonics such as ‘CCC’ (capital, character,
capability) or ‘PARTS’ (purpose, amount, repayment, terms, security), or
‘CAMPARI"’ (character, ability, means, purpose, amount, repayment,
insurance).
● Broad Steps to Credit Analysis
○ Building the Credit file - credit history and track record of borrower - opinion about
willingness and desire to repay
○ Project and Financial appraisal - past financial statements, Cash flow statements, liquidity,
net worth, repayment capacity, sensitivity analysis, value of collaterals
○ Qualitative Analysis - integrity of borrower
○ Due diligence - include checking on the borrower’s address (if a new borrower), pre-approval
inspections of the borrower’s workplace, and interviews with the borrower’s competitors,
suppliers, customers and employees, credit report from other sources, industrial relation
○ Risk assessment - All potential internal and external risks - Credit rating agencies play an
important role -
○ Making the recommendation - examining the ‘fit’ of the credit with the ‘loan policy’ - may
suggest procedures to improve the borrower’s financial condition
● Credit Delivery and Administration - Decision depends on the size of the
bank, the loan size and type of exposures planned - ‘discretionary limits’ - the
loan officer’s appraisal forms - ‘sanction letter’ - ‘loan agreement’ - signed by
the borrower(s) and guarantors
● Terms and Conditions of Lending - derives control over the borrower’s
operations and also mitigates the risks of lending - three distinct portions:
Conditions precedent, Representations and warranties, Covenants positive
and negative
● Events of Default - end of the banker-borrower relationship
● Updating the Credit File and Periodic Follow-UP: reminders, update of
financial performance
● Credit Review and Monitoring
References:

Suresh P. & Paul J. (2022), Management of Banking and Financial Services, Fourth
Edition, Pearson

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