MODULE3-BANKING

Commercial banking in India –Structure-Functions of commercial banks –conflict between profitability and
liquidity, credit creation and credit multiplier – Non-Performing Assets- Digital Payment System in India –
RTGS, NEFT, Prepaid Payments instruments. (25 Hrs)

COMMERCIAL BANKING IN INDIA

Commercial banks form a significant part of the country’s Financial Institution System. Commercial Banks
are those profit seeking institutions which accept deposits from general public and advance money to
individuals like household, entrepreneurs, businessmen etc. with the prime objective of earning profit in the
form of interest, commission etc. Banks accept deposits from public and lend them mainly for commercial
purposes for comparatively shorter periods are called Commercial Banks. The operations of all these banks
are regulated by the Reserve Bank of India, which is the central bank and supreme financial authority in
India. The main source of income of a commercial bank is the difference between these two rates which they
charge to borrowers and pay to depositers. Examples of commercial banks –State Bank of India, Axis Bank,
and HDFC Bank.

They provide services to the general public, organisations and to the corporate community. They are oldest
banking institution in the organised sector. Commercial banks make their profits by taking small, short-term,
relatively liquid deposits and transforming these into larger, longer maturity loans. This process of asset
transformation generates net income for the commercial bank. Many commercial banks do investment
banking business although the latter is not considered the main business area. The commercial banking
system consists of scheduled banks (registered in the second schedule of RBI) and non scheduled banks.
Features of Commercial banks are;
They accepts deposits on various accounts.
Lend funds to organisations, trade, commerce, industry, small business, agriculture etc by way of loans,
overdrafts and cash credits.
They are the manufacturers of money.
The perform many subsidiary services to the customer.
They perform many innovative services to the customers

STRUCTURE OF COMMERCIAL BANKS IN INDIA

The commercial banks can be broadly classified under two heads:

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 1. Scheduled Banks:
Scheduled Banks refer to those banks which have been included in the Second Schedule of Reserve Bank of
India Act, 1934.

In India, scheduled commercial banks are of three types:

(i) Public Sector Banks:
These banks are owned and controlled by the government. The main objective of these banks is to provide
service to the society, not to make profits. State Bank of India, Bank of India, Punjab National Bank, Canada
Bank and Corporation Bank are some examples of public sector banks.

(i) Public sector banks are of two types:

(a) SBI and its subsidiaries;
(b) Other nationalized banks.
(ii) Private Sector Banks:
These banks are owned and controlled by private businessmen. Their main objective is to earn profits. ICICI
Bank, HDFC Bank, IDBI Bank is some examples of private sector banks.
(iii) Foreign Banks:
These banks are owned and controlled by foreign promoters. Their number has grown rapidly since 1991,
when the process of economic liberalization had started in India. Bank of America, American Express Bank,
Standard Chartered Bank are examples of foreign banks.
2. Non-Scheduled Banks:
Non-Scheduled banks refer to those banks which are not included in the Second Schedule of Reserve Bank
of India Act, 1934. Banks with a reserve capital of less than 5 lakh rupees qualify as non-scheduled banks.
Unlike scheduled banks, they are not entitled to borrow from the RBI for normal banking purposes, except,
in emergency or “abnormal circumstances." Jammu & Kashmir Bank is an example of a non-
scheduled commercial bank
FUNCTIONS OF COMMERCIAL BANKS :-

Modern commercial banks perform a variety of functions. They keep the wheels of commerce, trade and
industry always revolving. Functions of a Commercial Bank can be classified into three.
1. Principal/ Primary/ Fundamental functions/ Banking Functions
2. Subsidiary/ Secondary/ Supplementary / Non-banking Functions
3. Innovative functions.

I. Primary / Banking Functions :- (Principal/ Fundamental functions )

Commercial banks have two important banking functions. One is accepting deposits and other is
advancing loans.

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1) Deposits :-
One of the main function of a bank is to accept deposits from the public. Deposits are accepted by the
banks in various forms.
a) Current Account Deposits :-
Current Accounts are usually opened by businessmen who have a number of regular transactions with the
bank, both deposits and withdrawls. There is no restriction on number and amount of deposits. There is also
no restriction on withdrawls. No interest is paid on current deposits. Banks may even charge interest for
providing this facility. These accounts are also known as demand deposits as amount can be withdrawn on
demand.
b) Saving Account Deposits :-
Saving Accounts are opened by salaried and other less income people. There is no restriction on number
and amount of deposits. withdrawls are subject to certain restrictions. It earns Interest but less than fixed
deposits. It encourages saving habit among salary earners and others. Saving deposits are an important source
of funds for banks.
c) Fixed Account Deposits :-
Deposits in fixed account are time deposits. Money under this account is deposited for a certain fixed
period of time varying from 15 days to several years. A high rate of interest is paid. If money is withdrawn
before expiry date, the depositor receives lower rate of interest. Deposits can be renewed for further period.
Many banks sanction loans against security of fixed deposits.
d) Recurring Account Deposits/ Cumulative Deposit account:-
In Recurring deposit, a specified amount is regularly deposited by account holder, at an internal of
usually a month. This is to form the habit of small savings among the people. At the end of maturity period,
the account holder gets a substantial amount. Interest on this type of deposit is almost equal to fixed deposits.
Thus by creating variety of deposits, banks motivate people in a variety of ways and encourage
savings in the economy.

2) Loans And Advances :-

Banks not only mobilize money but also lend to its credit worthy customers for maximizing profits. Loans
and Advances are granted to :-
a) Business And Trade :-
Commercial banks grant short-term loans to business and trade activities in following forms:-
i) Overdraft :-
Commercial banks grant overdraft facility to current account holders. Under this system a borrower is
allowed to draw more than what is deposited in his account. The borrower is granted to a fixed additional
amount against collateral security. Interest is charged for actual amount drawn.
ii) Cash Credit :-
Cash credit is given by the bank to any businessman to meet regular working capital needs, against the
security of goods or personal security. Interest is charged on actual amount drawn by the customer. In this
type of credit scheme, banks advance loans to its customers on the basis of bonds, inventories and other
approved securities. Under this scheme, banks enter into an agreement with its customers to which money
can be withdrawn many times during a year.
iii) Discounting of Bills :-
When the holder of the bill is not in a position to wait till the maturity of the bill and requires cash
urgently, he sells the bill of exchange to bank. Bank advance credit by discounting bills of exchange,
government securities or any other approved financial instruments. The bank purchases the instruments at a
discount.

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 iv) Money at Call :-
Banks also grant loans for a very short period, generally not exceeding 7 days. Such advances are
repayable immediately at a short notice hence they are called as Money at Call or Call money. These loans
are given to dealers or brokers in stock market against Collateral Securities.
v) Direct Loans :-
Loans are given to customers against the security of moveable properties. Their maturity varies from 1 to
10 years. Interest has to be paid on entire loan amount sanctioned. Loans are of many types like :- personal
loans, term loans, call loans, participative loans, collateral loans etc.

b) Loans to Agriculture :-
Banks grant short-term credit to agriculture at a lower rate of interest. Loans are granted for irrigation,
purchase of equipments, inputs, cattle etc.
c) Loans To Industries :-
Banks grant secured loans to small and medium scale industries to meet their working capital needs. The
time period may be from one to five years. It may be in the form of Overdraft, cash credit or direct loan.
d) Loans To Foreign Trade :-
Loans are granted to export and import in the form of direct loans, discounting of bills, guarantee for
deferred payments etc. Here the rate of interest is low.

e) Consumer Credit / Personal loans :-

Banks also grant credit to household in a limited amount to buy some durable consumer goods like television
sets, refrigerators, washing machine etc. Such consumer credit is repayable in installments. Under 20-point
programme, the scope of consumer credit has been extended to cover expenses on marriage, funeral etc., as
well.
f) Miscellaneous Advances :-
Banks also gives advances like packing credits to exporters, export bill purchased or discounted, import
finance, finance to self-employed, credit to weaker sections of society at concessional rates etc.

II. Secondary / Non-banking Functions :-

Banks gives various forms of services to public. Such services are termed as non- banking or secondary
functions :-

1. Agency Services:-
Banks perform certain functions on behalf of their customers. While performing these services, banks act
as agents to their customers, hence these are called as agency services. Important agency functions are :-
a) Collection :-
Commercial banks collect cheques, drafts, bills, promissory notes, dividends, subscriptions, rents and
any other receipts which are to be received by the customer. For these services banks charge a nominal
amount.
b) Payment :-
Banks also makes payments on behalf of their customers like paying insurance premium, rent, taxes,
electricity and telephone bills etc for such services commission is charged.
c) Income – Tax Consultant :-
Commercial banks acts as income-tax consultants. They prepare and finalise the income tax
returns of their clients.

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d) Sale And Purchase Of Financial Assets :-
As per the customers instruction banks undertake sale and purchase of securities, shares and any
other financial assets. Nominal charges are charged by a bank.
e) Trustee, Executor And Attorney :-
As a trustee, banks becomes the custodian and manager of customer funds. Bank also acts as
executor of deceased customer’s will. As an Attorney the banks sign the documents on behalf of customer.
f) E- Banking :-
Through Electronic Banking, a customer can operate his bank account through internet. He can
make payments of various bills. He can even transfer money from one place to another.

2. Utility Services :-
Modern Commercial banks also performs certain general utility services for the community, such as :-
a) Letter Of Credit :-
Banks also deal in foreign trade. They issue letter of credit and provide guarantee to foreign traders for
the soundness of their customers.
b) Transfer Of Funds :-
Banks arrange transfer of funds cheaply and safely from one place to another. Transfer can be in the
form of Demand draft, Mail transfer Travellers cheques etc.
c) Guarantor :-
Banks offer a guarantee of payment on behalf of importer to facilitate imports with deferred
payments.
d) Underwriting :-
This facility is provided to Joint Stock Companies and to government to enable them to raise funds.
Banks guarantee the purchase of certain proportion of shares, if not sold in the market.
e) Locker Facility :-
Safe Lockers are provided to the customers. So that they can deposit their valuables like Jewellary,
Securities, Shares and other documents.
f) Referee :-
Banks may act as referee with respect to financial standing, business reputation and respectability
of customers.
g) Credit Cards :-
Credit card facility have been introduced by commercial banks. It enables the holder to minimize
the use of hard cash. Credit card is a convenient medium of exchange which enables its holder to buy goods
and services from member – establishment without using money.

3. Subsidiary Activities :-
Many commercial banks also undertakes subsidiary activities such as :-
1) Housing Finance :-
Housing finance is provided against the security of immoveable property of land and buildings. Many
banks such as SBI, Bank of India etc. have set up housing finance subsidiaries.
2) Mutual Funds :-
A Mutual fund is a financial intermediary that pools the savings of investors for collective investment in
diversified portfolio securities Many banks like SBI, Indian Bank etc. have set up mutual fund subsidiaries.
3) Merchant Banking :-
A variety of services are offered by merchant banking like :-

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 Management, Marketing and Underwriting of new issues, project promotion, corporate advisory services,
investment advisory services etc.
4) Venture Capital Fund :-
Venture capital fund provides start-up share capital to new ventures of little known, unregistered,
risky, young and small private business, especially in technology oriented and knowledge intensive business.
Many commercial banks like SBI, Canara Bank etc. have set up venture Capital Fund Subsidiaries.
5) Factoring :-
Factoring is a continuing arrangement between a financial intermediary (factor) and a business concern
(client) where by the factor purchases the clients accounts receivable. Banks like SBI and Canara Bank have
established subsidiaries to provide factoring services.
Thus various services are provided by commercial Banks.

III. Innovative Functions

The adoption of Information and Communication technology enable banks to provide many innovative
services to the customers such as;
 ATM services
Automated Teller Machine (ATM) is an electronic telecommunications device that enables the clients of
banks to perform financial transactions by using a plastic card. Automated Teller Machines are established
by banks to enable its customers to have anytime money. It is used to withdraw money, check balance,
transfer funds, get mini statement, make payments etc. It is available at 24 hours a day and 7 days a week.
 Debit card and credit card facility
Debit card is an electronic card issued by a bank which allows bank clients access to their account to
withdraw cash or pay for goods and services. It can be used in ATMs, Point of Sale terminals, e-commerce
sites etc. Debit card removes the need for cheques as it immediately transfers money from the client's
account to the business account. Credit card is a card issued by a financial institution giving the holder an
option to borrow funds, usually at point of sale. Credit cards charge interest and are primarily used for short
term financing.
 Tele-banking :
Telephone banking is a service provided by a bank or other financial institution, that enables customers to
perform financial transactions over the telephone, without the need to visit a bank branch or automated teller
machine
 Internet Banking:
Online banking (or Internet banking or E-banking) is a facility that allows customers of a financial institution
to conduct financial transactions on a secured website operated by the institution. To access a financial
institution's online banking facility, a customer must register with the institution for the service, and set up
some password for customer verification. Online banking can be used to check balances, transfer money,
shop onlline, pay bills etc.
 Bancassurance:
It means the delivery of insurance products through banking channels. It can be done by making an
arrangement in which a bank and an insurance company form a partnership so that the insurance company
can sell its products to the bank's client base. Banks can earn additional revenue by selling the insurance

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 products, while insurance companies are able to expand their customer base without having to expand their
sales forces
 Mobile Banking:
Mobile banking is a system that allows customers of a financial institution to conduct a number of financial
transactions through a mobile device such as a mobile phone or personal digital assistant. It allows the
customers to bank anytime anywhere through their mobile phone. Customers can access their banking
information and make transactions on Savings Accounts, Demat Accounts, Loan Accounts and Credit Cards
at absolutely no cost.
 Electronic Clearing Services :
It is a mode of electronic funds transfer from one bank account to another bank account using the services of
a Clearing House. This is normally for bulk transfers from one account to many accounts or vice versa. This
can be used both for making payments like distribution of dividend, interest, salary, pension, etc. by
institutions or for collection of amounts for purposes such as payments to utility companies like telephone,
electricity, or charges such as house tax, water tax etc

CONFLICT BETWEEN PROFITABILITY AND LIQUIDITY

Liquidity, Profitability and Solvency play an important role in the smooth survival of the banks. These are
the fundamental factors in the maintenance of bank’s financial viability. Liquidity defined as the ability of a
bank to increase the assets and meet obligations as they come due, without incurring unacceptable losses.
Profitability is defined as the ability of the bank to generate revenue in excess of cost, in relation to banks’
capital base.

Liquidity and Profitability of the banks are inter-related. Immediate survival of bank anchors on its liquidity,
while its long term survival and growth depends on the profitability. Both are essential for the successful
existence of the banks. Profitability and Liquidity are two basic concepts that attract the attention of all
banks. Given the position of banks as catalyst to economic development, they cannot afford to fail their
customers nor the public in any of these two issues. Banks want to make profits but at the same time they are
concerned about liquidity and safety. Banks have to earn profits because if they don’t, they would not work
at all, as the shareholders would withdraw their invested capital in the business if proper and adequate
dividends are not earned. Hence they have to earn profits for their shareholders and at the same time satisfy
the withdrawal needs of its customer.

A commercial bank should be liquid enough to meet the daily cash need for customers. A prudent bank tries
to make some profit from every deposit made into account by a customer. And mindful of the cost of these
deposits (interest paid to the customers or lenders), a bank must turn these liabilities to assets that can earn

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enough to take care of running cost. In the bid to make more profits a bank may trade on very risky ventures.
However the regulatory authorities through rules and policies may prohibit a bank from over trading or
creating excess credits. To avoid ugly "cash run’’, banks must be adequately liquid. They may resort to
withdrawing cash from cash from their accounts.

The proper use of liquidity brings about profitability. A bank must be socially responsible in the pursuit of
profit to create goodwill for itself, hence repeat purchases of its products by confident customers and
prospects alike. There must therefore be a balancing of profitability with customer satisfaction through
excellent services delivery strategies.

In order to make the best out of these conflicting corporate objectives, there is need to strike a balance
between profitability and liquidity is through ALM. ALM (Asset - Liability Management) is the process of
planning, organizing, and controlling asset and liability volumes, maturities, rates, and yields in order to
balance interest rate risk and maintain acceptable profit and liquidity levels.
One of the main ways in which this is done is by adjusting the interest rates on loans and deposits in line with
their respective maturities in an aim to reduce interest rate risk and maximise profitability. Banks also
achieve this by placing guidelines on the types of loans and deposits the sales and marketing departments
have to sell at a moment in time.

Apart from ALM, liquidity buffer which describes minimal levels of cash that are deposited within central
banks This buffer is required to ensure that a bank’s liquidity remains at a sufficient level to protect the bank
if a run on the bank were to occur.

Also, Loan-Deposit Ratio (LTD) which is utilised to assess the liquidity and profit earning potential of a
bank at any instant and is given by the formula:

If the ratio is greater than 1, the bank does not have enough deposits to fund its outgoing loans. This is a
risky position to be in. If a run on the bank were to occur in these circumstances, the bank would not have
enough money in stock to cover the deposits made by its customers. The bank would therefore have to rely
on wholesale markets that may or may not be prepared to help the bank at its time of need.

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 If, on the other hand, the ratio is less than 1, the bank is utilising its own customer’s deposits to finance its
loans. This is a better position to be in as there is a surplus of customer deposits which in turn would be held
in liquidity

All in all, striking a balance between the two corporate objectives, gives a win situation for all parties as
shareholders interest will be protected by earning returns on invested funds which add up to profit to be
declared at the end of the year and customers (most especially demand deposit customers, ) will have access
to their deposit at any time.

CREDIT CREATION
(‘Loans create deposits’ and ‘deposits create loans’)

Creation of credit is one of the important functions of commercial banks. Banks can expand their demand
deposits as a multiple of their cash reserves because demand deposits serve as the principal medium of
exchange. Demand deposits are an important constituent of money supply and the expansion of demand deposits
means the expansion of money supply. The entire structure of banking is based on credit. Credit basically means
getting the purchasing power now and promising to pay at some time in the future. Bank credit means bank
loans and advances.
A bank keeps a certain part of its deposits as a minimum reserve to meet the demands of its depositors and lends
out the remaining to earn income. The loan is credited to the account of the borrower. Every bank loan creates
an equivalent deposit in the bank. Therefore, credit creation means expansion of bank deposits.
The two most important aspects of credit creation are:

1. Liquidity – The bank must pay cash to its depositors when they exercise their right to demand cash against
their deposits.

2. Profitability – Banks are profit-driven enterprises. Therefore, a bank must grant loans in a manner which
earns higher interest than what it pays on its deposits.
The bank’s credit creation process is based on the assumption that during any time interval, only a fraction of its
customers genuinely need cash. Also, the bank assumes that all its customers would not turn up demanding cash
against their deposits at one point in time.

Basic Concepts of Credit Creation

 Bank as a business institution – Bank is a business institution which tries to maximize profits through loans
and advances from the deposits.
 Bank Deposits – Bank deposits form the basis for credit creation and are of two types:

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o Primary Deposits – A bank accepts cash from the customer and opens a deposit in his name. This is a primary
deposit. This does not mean credit creation. These deposits simply convert currency money into deposit
money. However, these deposits form the basis for the creation of credit.

o Secondary or Derivative Deposits – A bank grants loans and advances and instead of giving cash to the
borrower, opens a deposit account in his name. This is the secondary or derivative deposit. Every loan crates a
deposit. The creation of a derivative deposit means the creation of credit.
 Cash Reserve Ratio (CRR) – Banks know that all depositors will not withdraw all deposits at the same time.
Therefore, they keep a fraction of the total deposits for meeting the cash demand of the depositors and lend the
remaining excess deposits. CRR is the percentage of total deposits which the banks must hold in cash reserves
for meeting the depositors’ demand for cash.

 Excess Reserves – The reserves over and above the cash reserves are the excess reserves. These reserves are
used for loans and credit creation.
 Credit Multiplier – Given a certain amount of cash, a bank can create multiple times credit. In the process of
multiple credit creation, the total amount of derivative deposits that a bank creates is a multiple of the initial
cash reserves.

CREDIT CREATION BY A SINGLE BANK

There are two ways of analyzing the credit creation process:

a. Credit creation by a single bank

b. Credit creation by the banking system as a whole
In a single bank system, one bank operates all the cash deposits and cheques. The process of creating credit is
explained with the hypothetical example below:

Let’s assume that the bank requires to maintain a CRR of 20 percent.

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 If a person (person A) deposits 1,000 rupees with the bank, then the bank keeps only 200 rupees in the cash
reserve and lends the remaining 800 to another person (person B). They open a credit account in the
borrower’s name for the same.

 Similarly, the bank keeps 20 percent of Rs. 800 (i.e. Rs. 160) and advances the remaining Rs. 640 to person C.

 Further, the bank keeps 20 percent of Rs. 640 (i.e. Rs. 128) and advances the remaining Rs. 512 to person D.
This process continues until the initial primary deposit of Rs. 1,000 and the initial additional reserves of Rs. 800
lead to additional or derivative deposits of Rs. 4,000 (800+640+512+….).

Adding the initial deposits, we get total deposits of Rs. 5,000. In this case, the credit multiplier is 5 (reciprocal of
the CRR) and the credit creation is five times the initial excess reserves of Rs. 800.

MULTIPLE CREDIT CREATION BY THE BANKING SYSTEM

The banking system has many banks in it and it cannot grant loans in excess of the cash it creates. When a bank
creates a derivative deposit, it loses cash to other banks.
The loss of deposit of one bank is the gain of deposit for some other bank. This transfer of cash within the
banking system creates primary deposits and increases the possibility for further creation of derivative deposits.
Here is an illustration to explain this process better:

As explained above, the initial deposit of Rs. 1,000 with bank A leads to a creation of total deposits of Rs. 5,000.
LIMITATIONS OF CREDIT CREATION
Bank cannot expand deposits to an unlimited extent by granting loans and advances even though this process
of granting loans and advances is profitable to them. Their power to create credit is subject to the following
limitations:

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 Amount of Cash available with the Bank: Credit creation depends on the amount of cash available with
bank. Larger the amount of cash with the banking system, greater will be the credit creation and vice versa.
Cash Reserve Ratio: CRR is the minimum cash required to be maintained by a bank with [Link] sets the
limit for the creation of credit. Higher the CRR smaller will be the credit creation and vice versa.
Leakages: The credit creation by the banks is subject to certain conditions. If there is any leakage in this
process the credit creation by the banks will be limited. In credit creation, it is expected that the banks lend
the entire amount of excess deposits over the minimum statutory reserve. If there is any down fall in such
lending, it will affect the creation of credit to that extent. Leakage may occur either because of unwillingness
of banks to utilise their surplus funds for granting loans or unwillingness of borrower to keep whole amount
of loan in the bank. Both will lead to lesser credit creation.
Security for loans: The securities acceptable to bank places a limit on credit creation by the banks. While
lending, the banks insist upon the securities from the customers. All type of assets are not acceptable to banks
as securities. If borrower is not able to provide sufficient security, credit creation is not possible.
Credit policy of banks: If banks want to create excess reserves, the credit creation will be limited to that
extent.
Monetary Policy of the Central Bank: The capacity of credit creation by banks is largely depends upon
the policies followed by the Central Bank from time to time. The total supply of cash depends upon the
policy of the Central Bank.
Banking habit of the people: The banking habit of the people also sets the limit for the capacity of banks
to create credit. The volume of employed population, monetary habits, etc., determines the amount of cash
that the public wishes to hold. If people prefer to make transactions by using cash instead of using cheques,
the banks will be left with smaller amount of cash and there will be lesser credit creation.
Effect of Trade Cycle: The effects of trade cycles also place the limitation on the credit creation, i.e., the
conditions of inflation and deflation set a limit on the creation. During the period of economic prosperity
there will be greater demand for bank loans and therefore, they can create greater volume of credit. But in
times of recession, there is no prosperity and the business people will hesitate to borrow.

CREDIT MULTIPLIER
It is s a model that illustrates how banks can create money. The rate at which credit is created depends on the
reserve ratio and the capital ratio for banks.

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 Below is the formula to calculate the credit multiplier i.e. the change in deposits divided by the change in
reserves.

• The credit expansion in the banking system is influenced by the credit multiplier.

• “The credit multiplier is the reciprocal of the required reserve ratio”.

• Credit multiplier = 1/required reserve ratio

• If reserve ratio is 20%

• Then credit multiplier = 1/0.20 = 5

• The formula for change in deposits in the banking system is

• D = (1/r)(E)

• D represent the change in the banking system as a whole

• “r” is the required reserve ratio

• E is the primary deposit

• If initial deposit is $1000 and required reserve ratio is 20% then change in deposits in the banking system as
whole will be

• D = (1/0.2)(1000)

• = $5000

NON PERFORMING ASSETS

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 Definition: A non performing asset (NPA) is a loan or advance for which the principal or interest payment
remained overdue for a period of 90 days.
Non-Performing Assets refers to that classification of loans and advances in the books of a lender in which
the there is no payment of interest and principal have been received and are “past due”. In most of the cases
debt has been classified as Non-Performing Assets where the loan payments have been outstanding for more
than 90 days. In the term sheet/sanction letter of every loan, the period of default under which the loan will
be classified as non-performing assets are generally mentioned.

 A Non-Performing Assets (NPA) is generally classified on the bank’s balance sheet and the % of NPA out of
the total advances has become a vital ratio for the banks to keep a check on before making the results public.
 More than 90 days where payment is due on the banks’ loans and advances move to non-performing assets
(NPA).

For example, Company XYZ has taken a loan of $100 million from Bank ADCB on which it needs to pay
$10,000 of interest every month for 5 years. Now on the borrower defaults on the payment for three
consecutive months i.e. 90 days then the bank needs to classify the loan as a non-performing asset in
their balance sheet for that financial year.

#1 – Term Loans

A term loan i.e. plain vanilla debt facility will be treated as an NPA when the principal or the interest
installment of the loan has been due for more than 90 days.

#2 – Cash Credit and Overdraft

A cash credit or an overdraft when remaining past due for more than 90 days it can be treated as an NPA

#3 – Agricultural Advances

Agricultural advances that have been past due for more than two crop seasons for short crop duration or one
crop duration for long duration crops.

There could be various other types of NPAs including residential mortgage, home equity loans, credit card
loans and non-credit card outstandings, direct and indirect consumer loans.

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Classification of NPA for Banks

Banks are required to make sub standardization of the non-performing assets (NPA) into the following type
of four broad groups: –

#1 – Standard Assets

Standard assets are those assets which have remained non-performing assets for a period of 12 months or less
than 12 months and the risk of the asset is normal

#2 – Sub- Standard Assets

For a period of more than 12 months, non-performing assets are classified under sub-standard assets. Such
kind of advances possess more than normal risk and the creditworthiness of the borrower is quite weak.
Banks are generally ready to take some haircut on the loan amounts which are categorized under this asset
class

#3 – Doubtful Debts

For a period which is exceeding 18 months, non-performing assets come under the category of Doubtful
Debts. Doubtful debts itself means that the bank is highly doubtful of the recovery of its advances. The
collection of such kind of advances is highly questionable and there is the least probability that the loan
amount can be recovered from the party. Such kind of advances put the bank liquidity and reputation at
jeopardy

#4 – Loss Assets

The final classification of non-performing assets is loss assets were the loan has been identified either by the
bank itself or an external auditor or internal auditor that the loan amount collection is not possible, and a
bank has to take a dent in its balance sheet. The Bank, in this case, has to write off the entire loan amount
outstanding or need to make a provision for full amount which needs to write off in future

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The banking sector has been facing the severe problems of the rising NPAs. But
the problem of NPAs is more in public sector banks when compared to private
sector banks and foreign banks, the NPAs in PSB are increasing due to external
as well as internal factors.

1. External Factors
a. Ineffective recovery tribunal
The Govt. has set of numbers of recovery tribunals, which works for recovery of
loans and advances, due to their carelessness and ineffectiveness in their work
the bank suffers the consequence of non-recover, their by reducing their
profitability and liquidity.
b. Willful Defaults
There are borrowers who are competent to pay back loans but are intentionally
withdrawing it. These groups of people should be recognized and proper
measures should be taken in order to get back the money extended to them as
advances and loans.
c. Natural calamities
This is the measure factor, which is creating alarming increase in NPAs of the
PSBs. every now and then India is hit by major natural calamities thus making
the borrowers unable to pay back there loans. Thus the bank has to make large
amount of provisions in order to pay damages those loans, hence end up the
fiscal with a reduced profit. Basically ours farmers depends on rain fall for
cropping. Due to irregularities of rain fall the farmers are not to attain the
production level thus they are not repaying the loans.
d. Industrial sickness
Inappropriate project handling , ineffective management , lack of adequate
resources , lack of advance technology , day to day changing govt. Policies
produce industrial sickness. Therefore the banks that finance those industries
ultimately end up with a low recovery of their loans reducing their profit and
liquidity.
e. Lack of demand
Entrepreneurs in India could not predict their product demand and starts
production which ultimately piles up their product thus making them unable to
pay back the money they borrow to operate these activities. The banks recover
the amount by selling of their assets, which covers a smallest label. Therefore
the banks record the non recovered part as NPAs and has to make provision for
it.
f. Change on Govt. policies

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With every new govt. banking sector gets new policies for its operation, so it has
to cope with the changing principles and policies for the regulation of the rising
of NPAs. For example, the fallout of handloom sector is continuing as most of the
weavers Co-operative societies have become defunct largely due to withdrawal
of state patronage. The rehabilitation plan worked out by the Central
government to renew the handloom sector has not yet been implemented, so
the over dues due to the handloom sectors are becoming NPAs.

2. Internal Factors
a. Defective Lending process
There are three cardinal principles of bank lending that have been followed by
the commercial banks, that is, Principles of safety, Principle of liquidity,
Principles of profitability. Principles of safety mean that the borrower is in a
position to pay back the loan, including both principal and interest. The refund of
loan depends upon the borrowers, Capacity to pay and Willingness to pay.

Capacity to pay depends upon, Tangible assets, Success in business. Willingness

to pay depends on, Character, Honest, Reputation of borrower. The banker
should, therefore take utmost care in ensuring that the enterprise or business for
which a loan is sought is a sound one and the borrower is competent of carrying
it out successfully, he should be a person of integrity and good character.
b. Inappropriate technology
Due to improper technology and management information system, market
driven decisions on real time basis can not be taken. Proper MIS and financial
accounting system is not implemented in the banks, which leads to poor credit
collection, so NPA, therefore all the branches of the bank should be
computerized.
c. Improper SWOT analysis
The inappropriate strength, weakness, opportunity and threat analysis is another
reason for increase in NPAs. While providing unsecured advances the banks
depend more on the honesty, integrity, and financial soundness and credit
worthiness of the borrower, so, banks should consider the borrowers own capital
investment and bank should collect credit information of the borrowers from, a.
Bankers b. Enquiry from market/segment of trade, industry, business. c. From
external credit rating agencies.

Banker should examine the balance sheet which shows the true picture of
business will be revealed on analysis of profit/loss a/c and balance sheet. When
bankers give loan, he should examine the purpose of the loan. To make sure
safety and liquidity, banks should grant loan for productive purpose only. Bank
should examine the profitability, viability, long term acceptability of the project
while financing.

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 d. Poor credit appraisal system
Deprived credit appraisal is an additional factor for the increase in NPAs, due to
poor credit appraisal the bank gives advances to those who are not able to repay
it back. They should use better credit appraisal to reduce the NPAs.
e. Managerial deficiencies
The banker should always select the borrower very cautiously and should take
tangible assets as security to safe guard its interests. When accepting securities,
banks should consider, the Marketability, Acceptability, Safety, Transferability
etc. The banker should follow the principle of diversification of risk based on the
famous maxim “do not keep all the eggs in one basket”, which means that the
banker should not grant advances to a few big farms only or to concentrate
them in few industries or in a few cities. If a latest big customer meets
misfortune or certain traders or industries affected adversely, the overall
position of the bank will not be affected.
f. Absence of regular industrial visit
The irregularities in spot visit also increases the NPAs, absence of regularly visit
of bank officials to the customer point decreases the collection of interest and
principals on the loan. So the NPAs can be collected by regular visits.

DIGITAL PAYMENT

Digital payment is a type of cashless payment where the payment is made through digital nodes. These
digital nodes are used by both, the payer and the payee. Also called electronic payment, no hard cash or
physical form of cash is used in digital payments. Digital payments are entirely made online and they are
convenient, instant, and time-saving.

In order to encourage and promote digital payments in India, the government of India
has been taking several steps. One such step is digital payments. The digital India
payments is a part of Digital India campaign. The aim of digital payment is to make
India a paperless, cashless, and digitally empowered economy.

When we talk about cash payments, we first have to withdraw cash from the bank
account. Then, we can use the cash to pay at stores, shops, etc. Lastly, the
shopkeeper goes to the bank and deposits the cash paid by you. This entire process is
time-consuming. On the contrary, in digital payment, the money is transferred
directly from the payer’s bank account to the payee’s account instantly.

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 The digital payment system in India is convenient and offers the flexibility of making
a payment anytime and anywhere. This method has speeden up the transaction cycle.
In addition, post demonetization, people have slowly started taking the digital
payment method. Today, even small shop owners and small-time merchants are
accepting digital payment.

There are various modes and types of digital transactions. Some of them include
the use of bank cards, such as debit/credit card, mobile wallets, internet banking,
digital payment Apps, UPI (Unified Payments Interface), bank prepaid cards, mobile
banking, etc.

Bank cards is among the most used type of cashless payment method. It comes with
a number of features, such as convenience, security, etc. The main benefit of a debit
or credit card is that it can be used for making other types of digital payments.

For instance, you can save your card information in the mobile Apps to make a
cashless payment. A few of well-known card payment systems include Visa,
MasterCard, and Rupay. You can also these banking cards for online purchase and
online transaction, PoS machines, and in digital payments.

USSD, Unstructured Supplementary Service Data, is another method of

paying digital currency. This method of the digital payment system in India can be
used without downloading any mobile App and without mobile data. Also, there is no
need for the user to have a smartphone to carry out the digital transactions through
USSD. This method is backed by the NPCI – National Payments Corporation of India.

This service is also known as *99#. The main aim for which this mode was introduced
is to create an environment for the underserved sections of the society and integrate
them into banking. One important feature of USSD is that it can be availed in Hindi
as well. The USSD can be used for:

 Initiate funds transfers

 Get bank statements
 Make balance queries

Aadhaar Enabled Payment System (AEPS)

AEPS is a service usually used for banking transactions, such as cash withdrawal,
balance inquiry, cash deposit, funds transfers, etc. All the cashless transactions are
carried out through Aadhaar verification. No physical visit to a bank is required or
even there is no need to provide any banking cards. You can avail this service
through your Aadhaar Card which is registered with the bank. So, this service can be
availed if your Aadhaar Number is registered with the bank.

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Unified Payment Interface

The UPI full form is Unified Payment Interface. It is a payment transaction which
any customer with a bank account can use with the help of a UPI-based App. You can
link more than one bank account with the UPI mobile App on their smartphone and
initiate fund transfer seamlessly. The best benefit of UPI is that there is no use of
bank account number of IFSC code to initiate fund transfer through UPI. The only
required thing is Virtual Payment Address (VPA).

There are a number of UPI Apps both for Android and iOS platforms that you can use.
To use the UPI service, you must have a valid bank account and registered mobile
number with the bank. Another benefit of UPI is that there are no charges for UPI
transactions. You can send and receive money through UPI. Also, UPI id and
password can be easily recovered if you misplace them.

A mobile wallet is like a virtual wallet where all your banking details are saved in a
mobile App. This wallet saves you from the hassle of remembering CVV or 4-digit pins
of the banking cards. All your details are securely saved in the mobile wallet. Many
banks provide their mobile wallet Apps which can be easily downloaded. Also, there
are some private mobile wallet Apps, such as Paytm, Freecharge, Mobikwik, etc. You
can add or send money or purchase goods through a mobile wallet App.

ELECTRONIC FUND TRANSFER/NATIONAL ELECTRONIC FUND TRANSFER (NEFT):

National Electronic Funds Transfer (NEFT) is a nation-wide payment system facilitating one-to-one funds
transfer. Under this Scheme, individuals, firms and corporate can electronically transfer funds from any bank
branch to any individual, firm or corporate having an account with any other bank branch in the country
participating in the Scheme. In NEFT, the funds are transferred based on a deferred net settlement in which
there are 11 settlements in week days and 5 settlements in Saturdays.
REAL TIME GROSS SETTLEMENT SYSTEM (RTGS):
It can be defined as the continuous (real-time) settlement of funds transfers individually on an order
by order basis . 'Real Time' means the processing of instructions at the time they are received rather than at
some later time. It is the fastest possible money transfer system in the country.

NEFT RTGS
Based on Deferred Net Settlement(DNS) Based on Gross Settlement
Fastest method of money transfer Slower than RTGS transfer
Complete transactions in batches Complete transactions individually

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 There is no minimum limit of transactions. Minimum amount to be remitted is 2 lakhs
Settlement on hour basis. (11 settlements Settlement in real time (at the time the
from 9am to 7pm) transfer order is processed)

PRE-PAID PAYMENT INSTRUMENTS (PPIS)

Pre-paid Payment Instruments (PPIs) are payment instruments that facilitate transactions like purchase of goods
and services, including funds transfer, against the value stored on such instruments. The value stored on PPIs
represents the value paid by the holders by cash through a bank account etc. There are large variety of PPIs
including smart cards, magnetic stripe cards, internet accounts, internet wallets or digital wallets, mobile
accounts, mobile wallets, paper vouchers and any such instrument which can be used to access the pre-paid
amount. Prepaid payment instruments are those which facilitate purchase of goods and services against the value
stored on such instruments. PPI sector is regulated by the RBI and as per the RBI regulations, there are four
types of PPIs:

(i) Closed system payment instruments

(ii) Semi-closed system payment instruments and

(iii) Open system payment instruments (multipurpose cards).

(iv) Semi-Open system payment instruments

Closed System Payment Instruments: These are payment instruments issued by a person/entity for facilitating
the purchase of goods and services from him/it. These instruments do not permit cash withdrawal or redemption.
Being very simple type, these instruments cannot be used for payments and settlement for third party services

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and hence these PPI are not classified as payment systems. The implication is that RBI approval is not required
for issuing the closed system payment instruments. In the real world, closed system payment instruments
include bonus point like wallets issued by web portals for online purchases /shopping for their customers.
Mobile prepaid cards also come under this category.

Semi-Closed System Payment Instruments: These are payment instruments can be used for purchase of goods
and services, including financial services at a group of clearly identified merchant locations/ establishments.
These PPIs can be used for third party purchase settlements and the specific contract between the issuer and the
merchant is needed for the use of these PPIs. Still, the semi-closed system payment instruments cannot be used
for cash withdrawal or redemption by the holder. For higher payments, KYC norms are required. Example of
semi closed system payments is Paytm wallets.

Open System Payment Instruments (multipurpose cards): These are payment instruments can be used for
purchase of goods and services, including financial services like funds transfer at any card accepting merchant
locations (point of sale terminals) and also permit cash withdrawal at ATMs / BCs. An important feature of these
PPIs that they can be used for limited cash transfer and cash withdrawals. During the time of demonetization, the
RBI raised cash withdrawal limit of these PPIs to Rs 20000. These PPIs can be issued only by banks. Example
for open system payment instrument is Vodafone mPesa.

Only banks can issue open system payment instruments. On the other hand, Closed and Semi Closed System
Instruments can be issued by NBFC and other entities who avails a license from the RBI.

Semi-open System Payment Instruments: These are payment instruments which can be used for purchase of
goods and services at any card accepting merchant locations (Point of sale terminals). These instruments do not
permit cash withdrawal or redemption by the holder.

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