UNIT 1: INTRODUCTION AND EVOLUTION OF BANKING

Learning Objectives

After studying this unit, you will be able to:

• Describe the history of banking.

• Discuss the characteristics of banks.

Structure

1.1 Introduction
1.2 Birth of Banking
1.2.1 Causes of the Development of Money
1.2.2 Birth of the Banking System
1.2.3 Characteristics of a Commercial Bank
1.3 Self Assessment Test
1.4 Further Readings

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1.1 Introduction

Liberalization and Globalization have shifted the focus of the Indian Banking industry on the retail
segment. All banks, irrespective of their size and origin, have started consolidating their efforts on
maximizing their benefits from this business opportunity. Reforms of the financial sector initiated
in 1995-96, removed the operational constraints that were hindering the growth of the banking
sector in India. Since then, the banking sector has never looked back. In order to acquaint yourself
with banking, it is always beneficial to trace the history of banking. This unit traces the phases of
development of banking and then turns to the present scenario in the banking industry.

1.2 Birth of Banking

1.2.1 Causes of the Development of Money

Money originated very largely from non-economic causes: from tribute as well as from trade, from
blood-money and bride-money as well as from barter, from ceremonial and religious rites as well as
from commerce, from ostentatious ornamentation as well as from acting as the common drudge
between economic [Link] of the most important improvements over the simplest forms of early
barter was the tendency to select one or two items in preference to others so that the preferred items
became partly accepted because of their qualities in acting as media of exchange. Commodities
were chosen as preferred barter items for a number of reasons - some because they were
conveniently and easily stored, some because they had high value densities and were easily portable
and some because they were durable. These commodities, being widely desired, would be easy to
exchange for others and therefore they came to be accepted as money. Though the disadvantages of
barter system provided an impetus for the development of money the impulse of which was purely
economic, the archaeological, literary and linguistic evidence of the ancient world and the tangible
evidence of actual types of primitive money from many countries demonstrate that barter was not
the main factor in the origin and earliest development of money.

A widespread custom of payment for brides in order to compensate the head of the family for the
loss of his daughter's services prevailed in olden times. Rulers have, since very ancient times,
imposed taxes on or exacted tribute from their subjects. Religious obligations might also entail
payment of tribute or sacrifices of some kind. Thus, in many societies, there was a requirement for
a means of payment for blood-money, bride-money, tax or tribute and this gave a great impetus to
the spread of money.

Objects, originally accepted for one purpose, were often found to be useful for other non-economic
purposes and, because of their growing acceptability, began to be used for general trading also,
supplementing or replacing barter. Thus, the use of money evolved out of deeply rooted customs;
the clumsiness of barter provided an economic impulse but that was not the primary factor. It
evolved independently in different parts of the world. The only civilization that functioned without
money was that of the Incas.

1.2.2 Birth of the Banking System

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Banking in its crude form is an age-old phenomenon and its invention preceded that of coinage. As
new and more sophisticated instruments of currency evolved, so did banking. It evolved as business
expanded an barter system gave way to money which needed safe deposit. In its simple form, it
originated from temples and royal palaces around 1000 B.C. in Babylon, as the strongest faith of
people was in the places of worship and royal houses as safe places for keeping money and
valuables. The practice of depositing personal valuables at these places, which were also
functioning as treasuries against a receipt, was perhaps the earliest form of ' banking'.

With the expansion of trade and commerce, the concept of banking gained importance. The
handling of banking gradually transcended from individuals to groups and later to companies. With
the Industrial Revolution of the 18th and 19th centuries, it attained a more significant place in the
area of lending. Bank in their first primitive beginnings and later in more developed forms did not
enjoy a steady and harmonious growth. Banking emerged and evolved through various phases
adapting itself continuously to meet the increasing needs of trade and commerce. In the first half of
the 19th century the East India Company established three banks; the Bank of Bengal in 1809, the
Bank of Bombay in 1840 and the Bank of Madras in 1843, which were known as "Presidency
Banks." These three banks were amalgamated in 1920 and a new bank, the Imperial Bank of India
was established on 27th January, 1921. In 1955, the State Bank of India Act was passed and the
Imperial Bank of India was taken over by the newly constituted State Bank of India. The Reserve
Bank, which acts as the Central Bank, was created in 1935 by passing of The Reserve Bank of India
Act, 1934. The Swadeshi Movement gave a fillip to Indian joint stock banking and several of the
present leading banks were established around this time. By 1913, there were 41 Indian banks in the
field, namely, The Punjab National Bank Ltd., Bank of India Ltd., Canara Bank Ltd., Indian Bank
Ltd. etc.

1.2.3 Characteristics of a Commercial Bank

The word 'bank' is derived from the Greek word 'banque' or the Italian word 'banco' both meaning 'a
bench' at which moneylenders and money changers used to display their coins and transact their
business in the market places. A bank is a profit-seeking firm dealing in money and credit. It
accepts deposits and keeps it under safe custody.

A commercial bank is an institution that primarily accepts deposits and extends credit to serve
consumer and corporate needs for capital. It creates credit by making advances out of the funds
received and thus mobilizes the savings in the economy. Under the Banking Regulation Act 1949,
"Banking includes accepting deposits from the public, for the purpose of lending or investment; and
repayable on demand or otherwise and withdraw able by cheque, draft, order or otherwise." In
contrast to most other financiers, commercial banks extend credit rather than taking an investment
position in a corporate enterprise. Commercial banks receive deposits in two main ways: (a)
consumer or commercial deposits, and (b) central bank and other bank deposits. Commercial banks
generate revenue from the interest charged to consumers and through a variety of customer service
fees.

1.3 Self Assessment Test

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 1. Explain causes of Development of Money.
2. Explain the Birth of Banking System.
3. Explain the Characteristics of a Commercial Bank.

1.4 Further Readings

1. Retail Management Principles And Practices- Author(s)/Editor(s): Dr K N Batik
2 Retail Management - Author(s)/Editor(s): M A Shewan
3 Retail Management - S N Mitra
4 Retail Banking- Raghu Palat

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UNIT 2 : GROWTH OF RETAIL BANKING
Learning Objectives

After studying this unit, you will be able to:

• Define retail banking.

• Discuss present scenario in the banking industry.
• Study The Barriers to the Development of Indian Banking Sector
• Know the birth of banking.

Structure

2.1 Growth of Retail Banking

2.1.1 Retail Banking
2.1.2 What is Retail Banking?
2.1.3 Retail Banking in India
2.1.4 Reasons for Retail Growth — An Analysis
2.1.5 Advantage of Retail Banking
2.1.6 The Path Ahead in India
2.1.7 The Barriers to the Development India Banking Sector
2.2 Self Assessment Test
2.3 Further Readings

2.1 Growth of Retail Banking

2.1.1 Retail Banking

Globalization has carved new benchmarks in the Indian banking industry. Every bank, irrespective
of its size and origin, has started chanting the 'retail banking' mantra. Since retail banking has
evolved new standards; banks have started redrawing their strategies to suit the present needs.
Banking as a whole is undergoing a change. The traditional approach of "the sellers' market" for
banking-related products and services has been redefined to a "buyers' market" in recent years.
Gone are the days where getting a retail loan was somewhat cumbersome. All these emphasize the
momentum that retail banking is experiencing in the Indian economy in recent years. A larger
option for the consumer is getting translated into a larger demand for financial products and
customization of services is fast becoming the norm than a competitive advantage. With the retail
banking sector expected to grow at a rate of 30%, players are focusing more and more on the retail
and are waking up to the potential of this sector of banking. At the same time, the banking sector as
a whole is witnessing structural changes in regulatory frameworks and securitization and stringent
NPA norms are expected to be in place by 2004, which means the faster one adapts to these
changing dynamics the faster is one expected to gain the advantage.

2.1.2 What is Retail Banking?

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Retail banking is, however, quite broad in nature; it is a banking service that is geared primarily
towards individual consumers. Retail banking is usually made available by commercial banks as
well as smaller community banks. Unlike wholesale banking, retail banking focuses strictly on
consumer markets. Retail banking entities provide a wide range of personal banking services,
including offering savings and checking accounts, bill paying services as well as debit and credit
cards. Through retail banking, consumers may also obtain mortgages and personal loans. Although
retail banking is, for the most part, mass-market driven, many retail banking products may also
extend to small and medium-sized businesses. Today much of retail banking is streamlined
electronically via Automated Teller Machines (ATMs) or through virtual retail banking known as
online banking. Related ancillary services include credit cards or depository services. Today's retail
banking sector is characterized by three basic characteristics:

• Multiple products (deposits, credit cards, insurance, investments and securities);

• Multiple channels of distribution (call centre, branch, Internet and kiosk); and
• Multiple customer groups (consumer, small business, and corporate).

2.1.3 Retail Banking in India

Retail banking in India is not a new phenomenon. It has always been prevalent in India in various
forms. For the last few years, it has become synonymous with mainstream banking for many banks.
The typical products offered in the Indian retail banking segment are housing loans, consumption
loans for purchase of durables, auto loans, credit cards and educational loans. The loans are
marketed under attractive brand names to differentiate the products offered by different banks. The
Report on Trend and Progress of India, 2003-04 has shown that the loan values of these retail
lending typically range from Rs.20,000 to Rs.100 lakh. The loans are generally for a duration of
five to seven years, with housing loans granted for a longer duration of 15 years. Credit card is
another rapidly growing sub-segment of this product group. In recent past, retail lending has turned
out to be a key profit driver for banks with retail portfolio constituting 21.5 per cent of total
outstanding advances as on March 2004. The overall impairment of the retail loan portfolio worked
out much less then the Gross NPA ratio for the entire loan portfolio.

Table Composition of Retail Credit

Type March 2000 March 2001 March 2002 March

Housing 14100(3.52). 16143(3.44) 22346(4.16)
Consumer Durables 3855(0.96) 5566(1.91) 7015(1.31.)
Loans given against 2146(0.54) 1697(0.36) 1520(0.28)
bonds
Non priority sector 15409(3.84) 18064(3.85) 22403(4.36)
personal loans
Sub-total 35510(8.86) (41470(8.84) 54283 (10.11)
Goss bank credit 400818(100) 469153 (100) 536727 (100)

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It can be inferred that except loans against shares / bonds, the share of every component of retail
credit has increased three-fold. The declining interest rate and the incentives that are granted to the
housing sector and being translated into higher home loans while the entry of public sector into the
personal loan segment, apart from the aggressive forays of new private sector banks are pushing up
the growth of the growth of these segments. Within the retail segment, the housing loans had the
least gross asset impairment. In fact, retailing makes ample business sense in the banking sector.
While new generation private sector banks have been able to create a niche in this regard, the public
sector banks have not lagged behind. Leveraging their vast branch network and outreach, public
sector banks have aggressively forayed to garner a larger slice of the retail pie. By international
standards, however, there is still much scope for retail banking in India. After all, retail loans
constitute less than seven per cent of GDP in India vis-a-vis about 35 per cent for other Asian
economies. As retail banking in India is still growing from modest base, there is a likelihood that
the growth numbers seem to get somewhat exaggerated. One, thus, has to exercise caution is
interpreting the growth of retail banking in India. The Indian players are bullish on the retail
business and this is not totally unfounded. There are two main reasons behind this. Firstly, it is now
undeniable that the face of the Indian consumer is changing. This is reflected in a change in the
urban household income pattern. The direct fallout of such a change will be the consumption
patterns and hence the banking habits of Indians, which will now be skewed towards retail
products.

At the same time, India compares pretty poorly with the other economies of the world that are now
becoming comparable in terms of spending patterns with the opening up of our economy. For
instance, while the total outstanding retail loans in Taiwan is around 41% of GDP, the figure in
India stands at less than 5%. The comparison with the West is even more staggering. Another
comparison that is natural when comparing retail sectors is the use of credit cards. Here also, the
potential lies in the fact that of all the consumer expenditure in India in 2001, less than 1% was
through plastic, the corresponding US figure standing at 18%.

2.1.4 Reasons for Retail Growth — An Analysis

1. Economic prosperity and the consequent increase in purchasing power has given a fillip to a
consumer boom. Note that during the 10 years after 1992, India's economy grew at an average rate
of 6.8 percent and continues to grow at the almost the same rate — not many countries in the world
match this performance.

2. Changing consumer demographics indicate vast potential for growth in consumption both
qualitatively and quantitatively. India is one of the countries having highest proportion (70%) of the
population below 35 years of age • (young population).

3. Technological factors played a major role. Convenience banking in the form of debit cards,
internet and phone-banking, anywhere and anytime banking has attracted many new customers into
the banking field. Technological innovations relating to increasing use of credit / debit cards,
ATMs, direct debits and phone banking has contributed to the growth of retail banking in India.

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4. Treasury income of the banks, which had strengthened the bottom lines of banks for the past few
years, has been on the decline during the last two years. In such a scenario, retail business provides
a good vehicle for profit maximization. Considering the fact that retail's share in impaired assets is
far lower than the overall bank loans and advances, retail loans have put comparatively less
provisioning burden on banks apart from diversifying their income streams.

5. Decline in interest rates has also contributed to the growth of retail credit by generating the
demand for such credit. In this backdrop, it is necessary to mention two specific domains of retail
lending in India, viz.,

(a) credit cards and (b) housing.

2.1.5 Advantage of Retail Banking

Retail banking has its own advantages and that overpower its disadvantages. The advantages could
be analyzed from two perspectives:

1. Recourse side

a. Retail deposits are stable and contribute to core deposits.

b. They are interest-insensitive and less baring for additional interest.
c. They constitute low cost funds for the banks.
d. Effective CRM with customers builds a strong customer base.
e. Retail banking increases the subsidiary business of the banks.

2. Assets side

a. Retail banking results in better yields and better bottom line.

b. Retail segment is a good avenue for funds deployment.
c. The consumer loans are presumed to be of lower risk and NPA perception.
d. It helps in economic revival.
e. It ensures innovative product development.
f. It involves minimum marketing efforts.

2.1.6 The Path Ahead in India

Retail banking has immense opportunities in a growing economy like India. As the growth story
gets unfolded in India, retail banking is going to emerge as a major driver. The rise of the Indian
middle class is an important contributory factor in this regard. The percentage of middle to high
income Indian households is expected to continue rising. The younger population not only wields
increasing purchasing power, but as far as acquiring personal debt is concerned, they are perhaps
more comfortable than previous generations. Improving consumer purchasing power, coupled with
more liberal attitudes towards personal debt, is contributing to India's retail banking segment. The
combination of the above-mentioned factors promises substantial growth in the retail sector, which
at present, is in the nascent stage. Due to bundling of services and delivery channels, the areas of
potential conflicts of interest tend to increase in universal banks and financial. conglomerates.

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Some of the key policy issues relevant to the retail banking sector are: financial inclusion,
responsible lending, access to finance, long-term savings, financial capability, consumer protection,
regulation and financial crime prevention.

2.1.7 The Barriers to the Development India Banking Sector

1. Customer retention is going to be a major challenge. According to a research by Reichheld

and Sasser in the Harvard Business Review, 5 per cent increase in customer retention can
increase profitability by 35 per cent in banking business, 50 per cent in insurance and
brokerage, and 125 per cent in the consumer credit card market. Thus, banks need to
emphasize on retaining customers and increasing market share.
2. Rising indebtedness could turn out to be a cause for concern in future. India's position, of
course, is not comparable to that of the developed world where household debt as a
proportion of disposable income is much higher. Such a scenario creates high uncertainty.
3. Information technology poses both opportunities and challenges. Even with ATM machines
and Internet Banking, many consumers still prefer the personal touch of their neighborhood
branch bank. Technology has made it possible to deliver services throughout the branch bank
network, providing instant updates to checking accounts and rapid movement of money for
stock transfers. However, this dependence on the network has brought IT department's
additional responsibilities and challenges in managing, maintaining and optimizing the
performance of retail banking networks. Illustratively, ensuring that all bank products and
services are available, at all times, and across the entire organization is essential for today's
retails banks to generate revenues and remain competitive. Besides, there are network
management challenges, whereby keeping these complex, distributed networks and
applications operating properly in support of business objectives becomes essential. Specific
challenges include ensuring that account transaction applications run efficiently between the
branch offices and data centers.
4. KYC issues and money laundering risks in retail banking are yet another important issue.
Retail lending is often regarded as a low risk area for money laundering because of the
perception of the sums involved. However, competition for clients may also lead to KYC
procedures being waived in the bid for new business. Banks must also consider seriously the
type of identification documents they will accept and other processes to be completed.

2.2. Self Assesment Test

1. What is Retail Banking? Explain Retail Banking in India.

2. Explain the Advantages of Retail banking in detail.
3. Explain in detail the Barriers to the Development of Indian Banking Sector.

2.3 Further Reading

1. Keynote address by Ms Shyamala Gopinath, Deputy Governor of the Reserve Bank of

India, at the IBA - Banking Frontiers International Conference on "Retail Banking
Directions: Opportunities & Challenges", Mumbai, 28 May.

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2. Article on 'Mobile Banking Facilities in Indian Banks' - Prof. Aithal.
3. Article on 'Insurance Management' — With specific reference to bank assurance - Mr.
Sudhindra Bhat.
4. Article on 'Money Laundering in Banking' by Prof. [Link] Professor of Finance &
Founder Chairman & Director, Indian Institute of Finance Chief Editor, Finance India

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UNIT 3: BASIS OF BANK ACCOUNT
Learning Objectives

After studying this unit, you will be able to:

• Describe the types of bank accounts.

Structure
3.1 Introduction
3.2 Bank Accounts
3.2.1 Introduction
3.2.2 Definition
3.2.3 Types of Deposit Accounts
3.2.4 Rights of Depositors
3.3 Self Assessment Test
3.4 Further Reading

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3.1 Introduction

One of the important functions of a retail bank is to accept deposit money from the public. The
deposits accepted by the bankers are of two types, namely, demand and time deposits. Demand
deposits are deposits payable on demand and include savings and current account deposits whereas
time deposits are those which are repaid to the customers only after completion of a specific time
period. This type generally takes the form of fixed and recurring deposits. Banks, at a retail level,
d.1 with different categories of customers. Each customer is dealt with, by the bank, in a different
manger in accordance with the rules and regulations. This unit provides an overview of the different
types of bank accounts that could be opened and other issues pertaining to them.

3.2 Bank Accounts

3.2.1 Introduction

A bank is a business that provides banking services for profit. Traditional banking services include
receiving deposits of money, lending money and processing transactions. Some banks (called
Banks of issue) issue banknotes as legal tender. Many banks offer ancillary financial services to
make additional profit; for example: selling insurance products, investment products or stock
broking. Acceptance of deposit being the core activity, it is the most important function that has to
be discussed in detail. Let us study different types of bank accounts that could be opened and
various issues pertaining to them.

3.2.2 Definition

A bank account is a monetary account with a banking institution, recording the balance of money
for a customer. Bank accounts may have a positive or credit balance where the bank holds money
on behalf of the customer; or a negative or debit balance where the customer owes money to the
bank.

Broadly, accounts opened for the purpose of holding credit balances are referred to as deposit
accounts whilst accounts opened fc. ...ie. purpose of holding debit balances are referred to as loan
accounts. Some accounts are by their function rather than the nature of the balance they hold.

3.2.3 Types of Deposit

Accounts The Deposit Products offered by the bank are broadly categorized into the following
types:

1. Savings Bank Account

2. Current Account
3. Term Deposits
4. Deposits held in FCNR (Banks) Accounts
5. Joint Accounts

1. Savings Bank Account

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Obtaining funds held in a Savings Account may not be as convenient as a Demand Account. For
example, one may need to visit an ATM or bank branch, instead of writing a cheque or using a
debit card. This transference is so easy that savings accounts are often termed as near money.

Some Savings Accounts require funds to be kept on deposit for a minimum length of time, but most
permit unlimited access to funds. True Savings Accounts do not offer cheque-writing privileges,
although many institutions call "Savings Accounts" their Higher-interest Demand Accounts or
Money Market Accounts. Savings Bank Account, as the very name suggests, is intended for
savings for the future. There are no restrictions on the number and amount of deposit that can be
made on any day. Minimum amount of withdrawal / deposit is Rs.10/-. Balance in the account
earns interest at rates advised by the Head Office from time to time. The facility of withdrawal by
cheque is also allowed subject to certain restrictions. These accounts can be opened by eligible
persons and also certain organizations and agencies (as approved by the RBI). The bank requires
satisfactory introduction of the person/s opening the account by a person acceptable to the bank.
The rules governing the process of opening a Savings Account are:

• Photograph: The bank is required to obtain 2 recent photographs of the person/s who is/are
authorized to operate the account. The purpose is to check the identity of the person/s
operating the account. In case of minors, the photograph of the guardian has to be produced
while opening the account. It should be noted here that the photograph cannot substitute the
signature of the account holder. It implies that all transactions have to be validated by signing
cheques or any other withdrawal instrument.
• Address: The bank must collect a complete proof of address while opening the bank account.
A recent copy of any of the following documents is acceptable: telephone bill, electricity bill,
ration card, passport, driving license. The bank will provide to the prospective customers
details of the documents required for identification of the person/s opening the account in
addition to a satisfactory introduction.
• PAN/GIR: The bank is required to obtain Permanent Account Number (PAN) or General
Index Register (GIR) number or alternatively obtain declaration in Form no.60 or 61 as per
the income Tax Act (Vide Section 139-A) from the person/s opening the account.
• Minimum Balance: The account holder is required to maintain minimum balance in the
account, as specified by the bank from time to time, separately for computerized and non-
computerized branches and also depending on whether the account holder wants to avail the
cheque book facility or not. Non-compliance of this would attract service charges. Individual
banks have the discretion to change the norms and levy charges for non-compliance of the
same. However, adequate notice will be given informing about the change/s levied. Interest as
prescribed by RBI is paid on half yearly basis on minimum balance between the 10th day and
last day of the month, provided it works out a minimum Re.1 .
• Issue of cheque book is subject to satisfactory operation in the account. Passbook is provided
to customer and updated periodically.
• Specimen signature of the client has to be obtained along with the documents so as to
facilitate verification during withdrawal.

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 • The table below enlists the important documents required to be submitted by various clientele
while opening a bank account:

Sr. No Type of Client Documents Requirement

1 Individual ID proof
Address proof
PAN number
2 recent passport size photographs
2 Sole proprietorship A certified true copy of it's shops and establishments
license or any approval from the government
A declaration by the sole proprietor that he is the sole
proprietor
3 Hindu Undivided A HUF declaration signed by all the composite members
Family HUF deed
Certified true copy of the IT returns of the last 2 years
4 Partnerships A certified copy of the partners hip agreement
List of all the partners along with their address proofs
A true copy of the resolution of partners to open an
Account
PAN no.
Proof of address
Authorization letter issued to one partner to transact
business
5 Limited Companies Memorandum of Association and Certificate of
Incorporation
Certificate of Commencement of Business
A copy of the Resolution of the Board of Directors
Principal place of business
Copy of PAN number
Address proof
2. Current Account

Reserve Bank of India has defined Current Account as "a form of demand deposit wherefrom
withdrawals are allowed any number of times depending on the balance in the account up to a
particular agreed amount and shall also be deemed to include other deposit accounts that are neither
savings deposit nor term deposit." Current Accounts are designed to meet the needs of such
sections of the public who operate their account regularly and frequently. i.e. traders, businessmen,
corporate bodies or the like who receive money and make payments very often. Current Accounts
are suitable to such category of customers as there is no restriction on the number of withdrawal or
deposit. Current accounts can be opened by individuals, partnership firms, private & public ltd. co.,
HUFs, / specified associates, societies, trusts, etc. Unlike Savings Accounts where the primary
reason for depositing money is to generate interest, the main function of a Demand Account is
transactional

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and therefore most providers either pay no interest or pay a low level of interest on credit balances.
As required by law, while opening the current account, the following regulations need to be
adopted:

• The bank requires satisfactory introduction of the person, opening the account by a person
acceptable to the bank.
• The bank is required to obtain 2 photographs of all the person/s who is/are opening and
operating the account.
• The bank is required to obtain Permanent Account Number (PAN) or General Index Register
(GIR) number or alternatively obtain declaration in Form no.60 or 61 as per the income Tax
Act (Vide Section 139-A) from the person, opening the account (i.e. including partners or
registered / unregistered partnership as also registered / incorporate bodies / companies).
• The bank will provide to the prospective customers details of the documents required for
identification of the person, opening the account in addition to a satisfactory introduction.
Minimum balance as stipulated from time to time is required to be maintained by the
customers
• The bank usually does not pay interest on the balance in the current accouth.
• The bank charges service charge on the following services offered to the customers :
1. Ledger folio used
2. Cheque books issued
3. Non-maintenance of minimum balance
4. Return of cheques, etc.
• The applicant (i.e. account opener) should declare in the Account Opening Form or separately
that he is not enjoying any credit facility with any bank and if he does enjoy any facility, he
should declare full particulars thereof indicating the name of the bank, branch wherefrom he
has availed these facilities and also submit No Objection Certificate from financing
bank/institution.
• Statement of Account is provided to the account holder monthly or more frequently as per the
arrangement.
• Stop Payment facility — The bank will accept stop payment instructions from the depositors
in respect of cheques issued by them (subject to maintenance of required balance). Charges as
specified will be recovered from the customer.
• Closing of the Accounts: While dosing the Current Account, the account holder should return
all the unused cheques to the bank. The bank may also ask the customer to close the account
if the customer is no longer a desirable one or the account is non-operational for along time.
• Term Deposit Account

A Fixed Deposit is defied as " a deposit received by a bank for a fixed period and which is
withdraw able only after expiry of a said fixed period and also includes deposits such as recurring,
cumulative, annuity, reinvestment deposits, cash certificates and so on."
The deposits received by the bank for a fixed period withdraw able after the expiry of the fixed
period and include deposits such as recurring, fixed, etc. Bank has tailored various Term Deposit

21
Schemes to suit the needs and expectation of the investing people in every walk of life. Tenn
Deposits can be opened by individuals, partnership finns, private / public ltd. Companies
HUFs,/ Institutions/Societies/Trusts etc.
As required by law, the following are the rules and regulations that are followed:
• The bank requires satisfactory introduction of the person/s opening the account by a person
acceptable to the bank. The customer is required to submit 2 photographs of all the person/s
who is/are opening and operating the account.
• The bank is required to obtain Permanent Account Number (PAN) or General Index Register
(GIR) number or altematively obtain declaration in Form no.60 or 61 as per the Income Tax At
(Vide Section 139-A) from the person/s opening the account.
• The bank will provide to the prospective customers details of the documents required for
identification of the person/s opening the account M addition to a satisfactory introduction.
Persons as entities already having operative accounts such as SB, Current Account etc. need
not provide the above documents for opening of the Term Deposit Accounts.
• Interest: Interest is paid on fixed deposits at a rate determined by individual banks. Interest is
normally paid on maturity of the deposit which means on completion of the term. On such
deposits I % extra interest can be paid to the retired employees, not to those employees who
have resigned. Higher rate of interest can also be offered to senior citizens.
• Premature withdrawals are allowed unless specified otherwise, at the rate of interest applicable
for the period for which the deposit has run ruling on the date of deposits, subject to penalty if
any prescribed by the bank.
• Maturity: On maturity of the tenn deposit, the account holder can withdraw the amount with
interest or renew the deposit for another specific term. In case the account holder withdraws the
amount, the bank is responsible for withdrawing TDS on the interest accrued on the principal
amount.
• Loans: The fixed deposit can be accepted as a surety for the purpose of issuing loans
• Premature withdrawal of NRE tenn deposits:

a) In the case of premature withdrawal of NRE term deposit, for conversion into Resident Foreign
currency (RFC) accouM, the bank may not levy any penalty for premature withdrawal. If such a
deposit as not run for a minimum period of I year, the bank may, at its discretion, pay interest at a
rate of exceeding the rate payable on Savings Deposit held in RFC Accounts, provided request for
such a conversion is made by NRE account holder, immediately on return to India.

b) Conversion of NRE deposit into Foreign Currency Non-resident deposit and vice versa before
maturity will be subject to the penal provision relating to pre-mature withdrawal.

c) Conversion of NRSR / NRNR deposit into NRO deposit before maturity will be subject to the
penal provision relating to pre-mature withdrawal.

Premature extension / renewal of term deposit — In case the depositor desires to renew the deposit
by seeking premature closure of an existing term deposit, the bank will permit the renewal at the
applicable rate on the date of renewal, provided the deposit has run for a minimum period of 15

22
days and is renewed for a period longer than the balance period of the original deposit. While
prematurely closing a deposit for the purpose of renewal, interest on the deposit for the period it has
remained with the bank will be paid at the rate applicable to the period remained with the bank and
not the contracted rate.

• Generally, loans/overdrafts against deposits are allowed except on Certificate of Deposit

(CD). Such loans are sanctioned by charging interest at rates announced from time to time by
the bank. The bank may also consider loan against deposit standing in the name of minor.

However, a suitable declaration stating that loan is for the benefit of the minor is to be submitted by
the depositor applicant.

• Deposits are renewed by the bank on due dates, on request. Wherever the depositor has
executed the option of automatic renewal in the Account Opening Form, the bank may renew
the deposit until the instructions are revoked in writing. The bank intimates the depositor in
advance regarding the date of maturity.
• Interest on deposit is payable either monthly at discounted value or quarterly or half-yearly.
• Renewal of overdue Term Deposits: When a term deposit is renewed on maturity, on renewed
deposit interest rate for the period specified by the depositor as applicable on the date of
maturity would be extended. If request for renewal is received after the date of maturity, such
overdue deposit will be renewed with effect from the date of maturity at the interest rate
applicable as on the due date, provided such request is received within 14 days from the date
of maturity. In respect of deposits renewed after 14 days from the date of maturity, the
deposits will be renewed from the date of maturity for the period requested applying the rate
of interest ruling on the date of maturity or on the date of renewal whichever is lower, subject
to renewal for a period not less than 15 days from the date of renewal.
• In case of overdue NRE deposits, if renewed (partly or wholly) within 14 days (both days
included) from the date of maturity, then the rate of interest payable on the amount so
renewed will be the rate as on the date of 1; ,aturity or on the date when the depositor seeks
renewal, whichever is lower. In the case of overdue NRE deposits, where the overdue period
exceeds 14 days, and if the depositor places the entire amount of overdue deposit or a portion
thereof as a fresh NRE term deposit, then interest payable is the rate prevailing as on the day
of the fresh deposit provided the period of the fresh deposit is not less than 1 year from the
date of making such fresh deposit.
• Interest on overdue deposit is paid if the deposit is renewed, as decided by the bank from time
to time.
• Interest on bank deposits is exempt from Income Tax up to a limit specified by Income Tax
authorities from time to time.
• Presently, if the total interest on deposits, per depositor per branch per financial year exceeds
Rs.5000/-, the same is subject to Tax Deducted at Source (TDS) at the rate stipulated by the
Income Tax authorities.

23
 • The depositor may furnish declaration in Form No.15-G/ 15-H preferably at the
commencement of the financial year for receiving interest on deposits without deduction of
tax.
• The bank will issue TDS certificate for the tax deducted.

Loan against Term Deposits

A term deposit receipt is an acknowledgement of receipt of the specified amount repayable after the
specified period of time. Customers sometimes require advances against their fixed deposit receipts
with the bank maturing at a future date. Though banks are not bound to allow such advances. They
normally extend this facility. While making advances against a fixed deposit receipt, a banker
should take certain precautions.

Precautions:

• No advance should be made against a fixed deposit receipt issued by another bank, as the
latter has a paramount lien on the deposit receipt issued by it and may refuse to register the
lien of the lending bank.
• Advance should be granted only to the person in whose name the deposit receipt is issued. If
the deposit is in two or more names and loan is to be granted to one of them, all the depositors
should sign a letter of authority.
• In the case of deposits in the names of minors, loans may be granted provided a declaration is
obtained from the guardian that the money belongs to him, but has been kept in the minor's
name as a matter of convenience and the amount of advance is intended to be utilized for the
benefit of the minor.
• The deposit receipt should be discharged by all the depositors on an appropriate revenue
stamp. Even where deposit is payable to "either or survivor" or "anyone or survivor",
discharge by all the depositors must be obtained. The signatures must be tallied with the
specimen signatures in bank's record.
• The bank must take actual possession of the receipt with a letter signed by the
depositor/depositors authorizing the bank to appropriate the proceeds of the receipt on
maturity, in case the customer fails to pay the loan on due date.
• The bank should make a note of its lien across the fixed deposit receipt as well as in the fixed
deposit register and ledger.
• While advancing against the receipt of another branch of the bank. It should confirm that no
loan has already been advanced against that deposit. It should, after granting the loan,
intimate the branch which issued the deposit receipt to note and confirm its lien. A letter
should also be taken from the customer to remit the proceeds to the lending branch on
maturity.
• A margin of 5 per cent to 10 per cent is usually kept on loans against fixed deposi.. In the
[Link] of cash certificates issued by the bank, the margin is calculated on the current value
(surrender value) of the certificates.

24
 • In case the loan is advanced against a fixed deposit receipt in the name of a third party, along
with the usual documents from the party, the banker tak. the fixed deposit receipt duly
discharged by the person in whose name the deposit stands. Also, a letter of approval to apply
the proceeds of the receipt in case the loan 15 101 paid is taken from the party in whose name
deposit receipt is issued.
• Interest on loans against fixed deposit is now governed by the Reserve Bank of India
directive. Banks are required to charge a minimum of 2 per cent above the interest payable on
such deposit. Thus, for example, if a loan is advanced on the security of a fixed deposit
receipt carrying interest @ 9% per annum the bard( must charge interest at the minimum rate
of 11 per cent per annum. He may, of course, charge a rate higher than this.

4. Deposits held in FCNR (Banks) Accounts

The deposits under the category means, "term deposits" received for a fixed period and withdraw
able only after the expiry of the said fixed period and shall also include Reinvestment Deposits and
Cash Certificates or other deposits of similar nature.
Other important features:
(i) Covers deposits in Pound Sterling, US Dollar, Japanese Yen and EURO from non-
resident individuals of Indian nationality or origin (NRIs).
(ii) Repatriation of funds in foreign cun-encies is permitted.
(iii) Presently the deposits are accepted under this category for the following maturity
periods:
a. One year and above but less than two years.
b. Two years and above but less than three years.
c. Three years only.
(iv) No Recurring Deposits shall be accepted under FCNR (B) Scheme.
(v) Transfer of funds from the existing NRE accounts to FCNR(B) accounts and vice versa,
of the same account holder, is permissible.

Manner of payment of interest:

a. The interest on the deposits accepted under the scheme will be paid on the basis of 360 days
to year.
b. The interest on FCNR deposits will be calculated and paid in the manner indicated below:
i. For deposits up to one year, at the applicable rate without any compounding effect,
ii. In respect of deposits for more than 1 year, at intervals of 180 days each and thereafter for
remaining actual number of days. However, the depositor will have the option to receive
the interest on maturity with compounding effect.

• Payment of interest on ovemlue FCNR(B)Deposits :

i. Overdue FCNR (B) deposit or a portion thereof may be renewed provided the overdue
period from the date of maturity fill the date of renewal (both days inclusive) does not
exceed 14 days. men the rate of interest payable Notes on the amount of the deposit so
renewed shall he the appropriate rate of interest for the period of renewal as prevailing

25
 on the date of maturity of the earlier deposit or on the date of renewal. whichever is
lower.
ii. If the overdue period exceeds 14 days. renewal of the FCNR (B) deposit from the date
of maturity is prohibited. In such cases. if the depositor placoo the entire maturity
proceeds of the overdue deposit or a portion thereof. a fresh FCNR (B) deposit, simple
interest will bc paid for the overdue period on the amount so placed . fresh FCNR (B)
deposit as per the Scheme

• Interest payable on the deposit of a deceased depositor

1. Where the amount of deposit is claimed before maturity by premature closure:
i. Where claimant is non-resident:
a. Where the deposit has not completed the minimum period of deposit, i.e., I year, no
interest is payable.
b. Where the deposit has completed the mininunn period of deposit, interest is payable at
the rate of interest applicable for the period run as prevailing on the effective date of
deposit, without penal cut.
ii. Where claimant is resident: As in 1 (i) above.
2. Where the amount of deposit is claimod during the tenure of the deposit, but settlement is made
after the maturity date.
i. Where the claimant is non-resident: Interest is payable at the contracted rate till the date of
maturity. For the period from the date of maturity till the date of payment, simple interest
is payable at the applicable interest rate for FCNR (B) deposits as prevailing on the date of
maturity for the period for which the deposit remained with the bank beyond the date of
maturity.
ii. Where the claimant is resident: Branch will convert the maturity proceeds into Indian
Rupeoo on the maturity date. Interest on such Rupee amount is payable for the subsequent
period form the date of maturity till the date of payment at a rate as applicable to domestic
deposit of similar maturity.
3. Where the amount of deposit is claimed after maturity date:
i. Where the claimant is non-resident: As in 2 (i) above
ii. Where the 010114000 10 resident: The foreign currency deposit proceeds will be first
notionally converted into Rupees and on such Rupee amount, interest is payable for the
subsequent period from the date of maturity till the date of payment at a rate as applicable
to domestic deposit of similar maturity.

5. Joint Accounts:
Deposit accounts can be opened by an individual in his own name or by more than one individual
subject to maximum of four persons, known as Joint Account. SB Account can be opened by a
minor jointly with natural guardian or with mother as guardian.
• Operations of Joint Account : The Joint Account opened by more than one individual subject to
a maximum of 4 persons can be operated by single individual or by more than one individual
jointly. The mandate for operating the account can be modified with the consent of all the joint

26
account holders. In case of SB Account opened by minor jointly with the natural guardian the
operation is by the natural guardian only.
• Transfer of Accounts: Current Account, SB, Term Deposits may be transferred from one
branch to another branch within the bank at the request of the account holders subject to
certain conditions.
• Addition of Names : The bank may, at the request of the depositor/s, allow addition of
name/s subject to the condition that the total number of depositors does not exceed four in
case of both the SB, CA & Term Deposits. Deletion in name/s of depositor/s is also
permitted, subject to the condition that one of the original depositors should continue to be a
depositor.
• Change in Rate of Interest: The rate of interest on deposits will be prominently displayed in
the branch premises apart from placing the same on our bank's website. The changes, if any,
with regard to the deposit schemes and other related services shall also be communicated
upfront and shall be prominently displayed. The same may also be published in a newspaper.
• Customer Information: The customer information collected from the customers shall not be
used for cross-selling of services/ products by the bank, subsidiaries & affiliates. If the bank
proposes to use such information, it shall be with the consent of the account holder/s.
• Secrecy of the Customer Accounts: The Bank shall not disclose details / particulars of the
customers' accounts to a third person or party without the express or implied consent from the
customer. However, there are some exceptions viz. Disclosure of information under
compulsion of law, where there is a duty towards the public to disclose and where interest of
the bank requires disclosure.
• Inoperative Accounts: SB & CA accounts in which there are no operations for a period of 2
years and above from the date of last operation, except by way of any charges debited, or
interest debited/credited will be treated as inoperative account. Service charges are levied to
inoperative account. Depositor/s can revive the account. In case the balance is less than
Rs.20/- account will be closed if there is no response from the depositor to the notice sent by
the bank.
• Repayment under Joint Deposits The Joint Account holder can give any of the following
mandates for disposal of balance in the account.
1. Either or survivor
2. No.1 or survivor

Jointly

Either or survivor : The bank will be making payment of the maturity proceeds to the surviving
depositor who presents the deposit receipt and furnishes the proper discharge without reference to
the other depositor as well as to the legal heirs of the deceased depositor.

No.1 or survivor: If No.1 is not alive on the date of maturity the bank will be making payment to
the survivor without reference to the legal heirs of no. 1 . If No.1 dies after maturity, the claim will
be settled in favor of the survivor subject to production of a notarized indemnity for indemnifying
the bank in case of the claim from legal heirs of the No.1.

27
Payable jointly: If one or more of the depositors dies on or after maturity, the amount will be paid
jointly to the surviving depositors along with the legal heirs of the deceased depositor. If the
depositor has registered nomination with the bank, the balance outstanding in the account of the
deceased depositor will be settled in favor of the nominee after the bank is satisfied about the
identity of the nominee.

• The bank may not insist on succession certificate from the Legal heirs irrespective of the amount
involved. However, the bank may adopt such safeguards in considering settlement of claims as
appropriate including abstention of indemnity.

• In the absence of nomination and where there are no disputes among the claimants, the bank will
settle the claim in respect of the deceased person to his/ her legal heirs after observing all the
formalities.

• In the case of NRE deposit where the claimant/s are residents, the deposit on maturity will be
treated as domestic deposit and interest will be paid for the subsequent period at a rate applicable to
the domestic deposit of a similar maturity.

Payment of Interest

a. In respect of the deposit of the deceased closed before maturity and repaid to the legal heirs /
representatives of the deceased depositor, interest is payable at the rate applicable for the
period for which the deposit actually remained with the bank without any penal cut.
ii. In the event of the death of the depositor before the date of the maturity of the deposit and the
amount of the deposit is claimed after the date of maturity, the bank shall pay interest at the
contracted rate till the date of maturity. From the date of maturity till the date of payment, the
bank shall pay simple interest at the applicable rate prevailing on the date of maturity, for the
period for which the deposit remained with the bank beyond the date of maturity. In the event
of death of the depositor after the date of maturity, the bank shall pay interest at SB rate
prevailing on the date of maturity from the date of maturity till the date of payment.

3.2.4 Rights of Depositors

Deposits being the basic financial raw materials, depositors form the core for banking business.
There is now an awakening on depositors' rights, rightly so, in the banks, as it is fulfillment of such
rights which can enable an effective resource management mechanism in banks. Further, the
depositor, being a consumer of various products and services offered by the bank, is entitled to the
following rights:

• Right to Information: A depositor will have right to information about price, quality,
quantity and standard of the produCts/services offered by the bank to enable him / her to
take an independent decision.
• Right to Choose: A depositor will have the absolute freedom to choose among the various
products and services offered by the bank to suit his her requirements.

28
 • Right to Avail / Utilize the Products and Services: A depositor will have the right to
avail/utilize the products/services chosen by him / her without any intervention / obstacle.
• Right to be Heard and Redressal of Grievances: A depositor will have the right to be heard
and seek redressal against deficient service / poor quality of products and services, unfair
trade practices and unscrupulous exploitation. This includes his/ her right to fair redressal of
any genuine grievance relating to products / services which he /she has chosen to utilize.

3.3 Self Assessment Test

1. Explain Bank Accounts and also explain Savings Account and Current Accounts.
2. Explain Term Deposits and Deposits held in FCNR Banks.
3. Explain Joint Accounts and Rights of Deposits

3.4 Further Reading

1. Retail Management Principles And Practices- Author(s)/Editor(s): Dr K N Bank

2. Retail Managemen - Author(s)/Editor(s): M A Shewan
3. Retail Management - S N Mitra
4. Retail Banking- Raghu Palat

29
UNIT 4: CLIENT PROFILE OF RETAIL BANK
Learning Objectives

Learning Objectives

After studying this unit, you will be able to:

• Describe the types of bank accounts.

• Know the Client Profile of Retail Banks

Structure
4.1 Client Profile of Retail Banks
4.1.1 Introduction
4.1.2 Definition
4.1.3 Types of Bank Customers
4.2 Self Assessment Test
4.3 Further Reading

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4.1 Client Profile of Retail Banks

4.1.1 Introduction

A bank is a business that provides banking services for profit. Traditional banking services include
receiving deposits of money, lending money and processing transactions. Many banks offer
ancillary financial services to make additional profit; for example: selling insurance products,
investment products or stock broking. The primary activity of banking being accepting deposits and
lending, this

unit has made an attempt to provide an overview of different types of customers that accesses the
services of banks. Before we look into the types of customers accessing the services of banks, let us
define the term 'customer'.

4.1.2 Definition

A customer is someone who makes use of or receives the products or services of an individual or
organization. The word is historically derived from "custom," meaning "habit"; a customer was
someone who frequented a particular shop, who made it a habit to purchase goods there, and with

whom the shopkeeper had to maintain a relationship to keep his or her "custom," meaning
"expected purchases" in the future. Customers can be classified into two main groups: internal and
external.

Internal customers work for the same organization as the supplier of the goods or services, possibly
in another department or another branch. External customers do not work for the same
organization; they may be another organization or a member of the public. A customer, from the
banking perspective, is one who has an account with a bank.

4.1.3 Types of Bank Customers

Customers of a bank can be classified into the following categories:

1. Minors & women

2. Literates & illiterates
3. Lunatics
4. Trustees
5. Executors and administrators
6. Limited Companies
7. Clubs, Societies and Charitable Institutions
8. Non-Resident

1. a) Minors

As per the Indian Contract Act of 1872, a minor is non-competent to contract and cannot open an
account. A minor is defined as any individual below the age to 18. A minor can open a bank

31
account. Even though a minor cannot enter Notes into a contract, he/ she can open an account
subject to certain provisions:

• Minor is someone who is under 18 years of age. If a minor has a guardian appointed by a
court, then she will remain a minor till the age of 21. In case of minor, it is preferable that a
Savings Bank Account is opened rather than a Current Account.
• It is advisable to open the bank account of the minor in the name of the guardian. If the
account is opened in the name of the minor, it still implies that the account is in the name of
the guardian and the beneficiary of the balance being the minor. In the case of a Hindu minor,
the natural guardian is the father and then the mother. This does not include stepfathers/
stepmothers. In regard to a minor married girl, her husband shall be the natural guardian. If
the father becomes a Sanyasi, (Hindu holy man) or does not remain a Hindu he will remain a
guardian. A Hindu father may appoint a guardian. Such a guardian will act after the death of
the parents. The court may appoint a guardian if, in the court's opinion, the father is unfit to
be one.
• The Supreme Court has held that a mother can act as the natural guardian if the father is not
in actual charge of the affairs of the minor because of his indifference or because of an
agreement with the mother.
• The Indian Contract Act 1872 states that a minor is not capable of entering into a valid
contract. A contract for the supply of necessaries of life to a minor is, however, a valid
contract. A minor can repudiate all other contracts. A banker must therefore be careful in his
dealings with minors.
• If a minor enters into a contract representing himself as a major and then refuses to honor the
contract on the grounds that he is a minor, the minor has to restore the benefits he got through
the contract.

Modus operandi for opening a Savings Bank Account:

• A Savings Bank Account can be opened in the name of the minor to be operated upon by the
guardian. In the name of the minor to be operated by himself if he is 12 years old or more.
Two minors above the age of 12 can create a Joint Account.
• At the time of opening the account, the date of birth of the minor is recorded.
• When the minor reaches maturity, the minor's account in the guardian's name should be
closed and the balance should be paid to the account holder or the balance should be
transferred new account.
• If the father of a Hindu minor dies, his mother becomes the natural guardian. If the mother
also dies during his minority, there would be either a guardian appointed by the will of the
mother (natural guardian) or a guardian will be appointed by the court. Banks would return
the balance in the account to that guardian.

In the case of Muslim minors, mothers cannot sign as guardians.

• Risk: There is no risk in opening an account in the name of a minor so long as it is not overdrawn.
Bankers cannot recover the money due if there is a loan or an overdraft as it is void ab initio

32
invalid. If a minor has pledged assets for a loan, the banker cannot possess these assets, as the
pledge is invalid.

• If an advance is granted to a minor on the guarantee of third party, this advance cannot be
recovered from the guarantor also as the contract between the creditor (banker) and the principal
debtor (minor) is invalid.

• Minor and Partnership: A partnership is based on two or more persons who are competent to
enter a contract. A minor can be admitted to a partnership with the consent of the other partners but
he will not be liable for losses. In view of the restricted liability of the minor, the bank should be
careful while lending to partnership firm which has a minor partner. He must within 6 months of
becoming a major repudiate his liability as a partner. Otherwise he can be held liable for the debts
of the partnership.

• Minor and Guarantor: A minor is not competent to contract but he can act as an agent of the
principal.

(b) Married Women

Contractual Capacity: The Indian Contact Act of 1872 doesn't make any distinction between a
man and a woman on the basis of marriage. A married woman may enter into a valid contract.
Therefore she is given the authority to open a bank account. She has the right to draw and endorse
cheques as any other customer.

 While opening the account of a married woman, the details of her husband should also be
taken by the banker. In case credit has to be granted to a married woman, it should be
granted only after adequate appraisal.
 With regard to debts taken, the husband will not be liable unless the loan is taken with his
consent and authority or it is for the necessaries of life.

Pardanashin Woman: Some consideration that are taken:

6. Any contract that she enters may have been subject to undue influence and
7. The contract may not have been made freely and with full understanding of the contract.

2. Illiterate Persons

• An illiterate person does not suffer from any legal disability and hence accounts may be
opened for illiterate persons. However, there are some considerations that have to be taken:
• The thumb impression of the illiterate person has to be taken by the banker in the presence of
two witnesses.
• For the purpose of ease in time of withdrawals the photograph of the illiterate person has to
be attested by a responsible person.
• Withdrawal by the illiterate customer should be permitted only if the customer comes
personally to the bank.

33
3. Lunatics

A lunatic is a person of an unsound mind. According to the Indian Contract Act of 1872, a person
of an unsound mind is declared incompetent to contract. Therefore, any contract entered by a
person of unsound mind with the bank is not enforceable. Banks are advised not to open an account
in the name of a person of unsound mind. If unknowingly the bank has opened an account of
lunatic, then the Notes operations of the account should be immediately terminated.

4. Trustee

• Section 3 of the Indian Trust Act of 1882 defines trust as "an obligation annexed to the
ownership of property and arising out of confidence reposed in and accepted by the owner
and accepted by him for the benefit of the other and the owner." In short, a trustee is the one
who manages the trust. Trusts are formed by a document called the Trust Deed.
• While dealing with a Trust, the banker should consider the following :
• Bankers should examine the trust deed thoroughly and determine the powers vested in the
trustees. Trustees are usually expected to act jointly. They are not permitted to delegate their
powers unless the Trust Deed permits them to do so.
• The bank should retain a Xerox certified copy of the Trust Deed. • If there are two or more
trustees then the bank should be clear as to who is going to operate the account. The bank
must be clear on the issues of appointment of new trustees in case of one or more trustee dies
or retires.
• Trusts and mortgage: The trustees have no implied powers to bowwow any sum against the
property of the trust. If the Trust Deed confers these powers on the trustees then the bank can
grant a loan.
• Unless explicitly mentioned by the Trust Deed, the operational powers of the trustee are not
influenced by the insolvency state of the trustees.

5. Executors and Administrators

• Executors are persons appointed by the will of a person to manage his estate after his death.
The power and authority of an executor is derived from the will and he has to act in
accordance with the directions given in the will. In other words, on the death of the testator,
the executor named in the will is granted by the court an official probate. Hence the executor
shall operate with respect to the right conferred to him on the basis of the will of the testator.
• Executor vs. Administrators: An administrator is appointed by the court in case there is no
will left behind by the deceased person. In view of
• this, the court issues an administration order that authorizes the administrator to act in
accordance to the rights conferred to them by the court. The only difference between an
executor and an administrator is based on the origin of appointment.

Following are some of the aspects that have to be given special attention by the banker :

• On the death of the testator the bank should freeze the operations of the account.

34
 • Once the official probate issued by the court is produced by the administrator or the executor,
they should be allowed permitted to operate the account.
• Death of an account holder, all payments from his account must be stopped.
• Though it is an existing account, the bank should get the signatures of the new account
operators on an account opening form. On careful scrutiny of the official probate, the bank is
expected to transfer the outstanding balance from the deceased account to the executors or
administrators account.
• The banker should honor only those cheques that are signed by the executor or the
administrator. If the authority is granted to one or more executors to operate the account then
any one of the executors can revoke the authority. In such a circumstance, the banker should
obtain a fresh letter of authority specifying the names of the people operating the account.
• The executor or the administrator is not granted the right to set off his/ her personal debts
from the proceeds of the trust account.
• In case of power of attorney holder, unlike an administrator, a general notice of authority is
given. The power of attorney holder is an agent of the account and acts in his name.
• This may be special or specific (to operate the bank a, or other specific powers like the sale of
property) or general (which may give the holder authority to act on the custodial behalf for
many activities including banking).
• The banks must ensure that the power of attorney should be stamped and registered at the
Registrar of Documents or attested by a notary.
• The power of attorney should act in accordance with the powers granted on him. The power
of attorney must produce all the details of identification to the bank.

6. Limited Companies

• Limited companies are legal entities created under the Companies Act. It is an artificial
person operating under a common seal and having perpetual succession. A public limited
company has to have a minimum of seven members. There is no maximum limit. On the
other hand, a private limited company has to have at least two members. It cannot have more
than fifty members.

While dealing with such companies, banks must consider the following points:

• Banks must examine the company's memorandum and articles of association to determine
what it mayor may not do. The Certificate of Incorporation and Certificate Commencement of
Business, issued by Registrar of Companies, must be examined as these provide conclusive
proof that the company is incorporated and is permitted to do business. A private limited
company is not required to obtain a Certificate of Commencement of Business. A certified
copy of both the documents has to be retained by the bankers.
• Along with an application to open a bank account, the company must furnish a board
resolution that approves the opening of the bank account and how the account should be
operated and by whom. The bank should obtain a list of the Board of Directors and indicate
as to who is authorised to operate the account. A specimen signature should be obtained.

35
 • A latest copy of the balance sheet should be submitted to ascertain the financial position of
the company.
• Banks must ensure that borrowings are only for purposes mentioned in the Memorandum of
Association.
• The bank must obtain a certified copy of the resolution to borrow.
• The Board must also pass a resolution that the borrowing is within its limits.

7. Clubs, Societies and Charitable Institutions

 Non-trading concerns, like clubs or associations, open an account with the bank for the
purpose of functioning. They have their independent identity as they are incorporated under
the Act. These organizations are governed by their bye laws or its constitution which will
detail how they are to operate.
 A resolution of the Managing Committee is required to open a bank account. This should
detail who are the signatories and the manner in which the account should be operated.
 If the person appointed to operate the account dies or resigns, operation should stop till the
society/club nominates another person.

8. Non-Resident

• The Foreign Exchange Management Act defines a 'resident' and states that all others are non-
residents.

A person resident in India is:

(i) A person residing in India for more than one hundred and eighty two days during the course of
the preceding financial year but does not include:

(A) A person who has gone out of India or stays outside India, in either case

(a) for or on taking up employment outside India, or

(b) for carrying on a business or vocation outside India, or
(c) for any other purpose in such circumstances as would indicate his intention to stay outside
India for an uncertain period.

(B) A person who has come to India or stays in India, in either case other than:

(a) for or on taking up employment in India, or

(b) for carrying on a business or vocation in India, or
(c) for any other purpose in such circumstances as would indicate his intention to stay in India
for an uncertain period;

(ii) any person or corporate body registered or incorporated in India.

(iii) an office, branch or agency in India owned or controlled by a person resident outside India.

36
(iv) an office, branch or agency in India outside India owned or controlled by a person resident in
India. A person resident outside India is a person who is not resident in India i.e. a person who stays
outside India or has otherwise gone out of India:

(a) for or on taking up employment outside India, or

(b) for carrying on a business or vocation outside India, or
(c) for any other purpose, in such circumstances as vPliuld indicate his intention to stay outside
India for an uncertain period.

To open any NRI account, a duly filled in account opening form has to be submitted with the
following:

• Passport copy
• 2 photographs
• Initial money remittance.
• Self-attested copy of photographs.

In the Account Opening Form, the signature may be verified by anyone of the following:

• Indian embassy/Consulate
• Bank abroad
• A person known to the bank
• Notary public

A NRI can usually open any of the following types of accounts:

• NRE Saving Bank A/c / Current Accounts

• Fixed Deposits in Indian Rupees
• Fixed Deposits in Foreign Currency

9. Persons of Indian Origin

(a) For the purposes of availing of the facilities of opening and maintenance of bank accounts and
investments in shares/securities in India:

• A foreign citizen (other than a citizen of Pakistan or Bangladesh) is deemed to be of Indian origin,
if, he, at any time, held an Indian passport,

OR

• he or either of his parents or any of his grand parents was a citizen of India by virtue of the
Constitution of India or Citizenship Act, 1955 (57 of 1955).

Note: A spouse (not being a citizen of Pakistan or Bangladesh) of an Indian citizen or of a person of
Indian origin is also treated as a person of Indian origin for the above purpose provided the bank
accounts are opened or investments in shares / securities in India are made by such persons only
jointly with their NRI spouses.

37
(b) For investments in immovable properties:

A foreign citizen (other than citizen of Pakistan, Bangladesh, Afghanistan, Bhutan, Sri Lanka or
Nepal), is deemed to be of Indian origin if, he held an Indian Passport at any time,

OR

He or his father or paternal grand-father was a citizen of India by virtue of the Constitution of India
or the Citizenship Act, 1955 (57 of

1955).

Definition

Citizen of a foreign country (other than a citizen of Bangladesh or Pakistan) is a PIO if:

(a) he/ she at any time held an Indian Passport; OR

(b) he/ she or either of his/ her parents or any of his/ her grandparents was a citizen of India; OR

(c) spouse (not being a citizen of Bangladesh or Pakistan) of an Indian citizen or (a) or (b) above.

Documentation Process

• Photocopy of the relevant pages of current Passport OR

• Copy of PIO card
• Copy of past Indian Passport of self / parent / grand-parent along with a self-declaration about
Indian origin OR
• Self-declaration for PIO as given on the Relationship Form
• At least one of the following address proofs (for First Applicant only)
• Utility Bill
• Driving License
• Residence Permit (Govt. issued Identity Card)
• Credit Card Bills
• Rent Receipt
• Overseas / Indian Bank Statement
Note: (All Originals should be present with you for verification)

38
4.2 Self Assessment Test

1. Explain the following Types of Bank Customers

a. Minors and Women
b. Literates and Illiterates
2. Explain the following Types of Bank Customers
a. Lunatic
b. Trustees
c. Executors and administrators
3. Explain the following Types of Bank Customers
a. Clubs, Societies and Charitable Institutions
b. Non-Resident
4. Explain the Documentation Process in detail

4.3 Further Reading

1. Retail Management Principles And Practices- Author(s)/Editor(s): Dr K N Bank

2. Retail Managemen - Author(s)/Editor(s): M A Shewan
3. Retail Management - S N Mitra
4. Retail Banking- Raghu Palat
5. Keynote address by Ms Shyamala Gopinath, Deputy Governor of the Reserve Bank of
India, at the IBA - Banking Frontiers International Conference on "Retail Banking
Directions: Opportunities & Challenges", Mumbai, 28 May.
6. Article on 'Mobile Banking Facilities in Indian Banks' - Prof. Aithal.

39
UNIT 5 : PORTFOLIO, DEPOSITS & INTEREST RISK
MANAGEMENT
Learning Objectives

Learning Objectives

After studying this unit, you will be able to:

• Distinguish between 'wholesale markets' and `retail markets'

• Study the product and service portfolio.
• Understand the Primary Deposits & Interest Rate Risk Management
• Know the Client Profile of Retail Banks

Structure
5.1 Product and Service Portfolio
5.1.1 Interest Rate Strategies
5.1.2 Deposit Pricing Strategies
5.2 Primary Deposits & Interest Rate Risk Management
5.2.1 Wholesale Markets
5.2.2 Retail Markets
5.3 Self Assessment Test
5.4 Further Reading

40
5.1 Product and Service Portfolio

We also find that just as in the case of CRM, the product-needs and product preferences of
customers also undergo changes. Therefore, even to effectively implement customer segmentation
based business model, it is necessary to refine the products and services. In this regard, it is not just

sufficient to introduce cosmetic changes in the existing products and services to retrofit in various
business segments. Thus, banks should clearly perceive the requirements of customers and come
out with segment specific-products and services.

For introducing new products and services or pulling out obsolete ones from the market, it is
necessary to have a proper system of business intelligence.

This requires monitoring the competitors' moves on products and services front including quality
and prices and introduction of new products and services for which it would be worth emulating
foreign banks. By setting up a formalized system of receiving continuous feedback from customers,
it will be possible for the banks to develop a highly innovative product or service capable of
creating a better brand for itself. Growing expectations of the customers drive business strategies
for the banks, thereby causing changes in the banks' operations. In line with the maturation trend in
banking industry, the thrust of business strategy has been shifting from what is termed as 'Product-
based' to 'Customer-focused' approach. Switching over from plain products and services to offering
tailor-made products to individual customer, advisory services, availability of 'referred delivery
channels, walking ATMs and OSAs on constant move to deliver banking services adopted steps.
Bundled products and services offer, market risk mitigating products demonstrates how banks have
been tuning their services to the needs of the consumers.

Most of the above-mentioned products and operations are technology-based and do not involve a
human touch in operations. Nevertheless, the importance of human touch in operations is evidenced
by the fact that steps to improve branch operations are also being simultaneously carried out.

Branches are the basic delivery channels of products and services. Hence, the counter services at
the branches should be fine-tuned in relation to customer-centric business model. Under any
technology-enabled transformation, branches are required to focus on sales and services. This is
possible only if all the back office functions from branches could be taken away and put at a central
place. In this context, the system of regional processing center, and centralized system of loan
processing become extremely important. Functioning of Universal Tellers and Relationship
Managers at the grass root level can help in setting up a customer-centric model. The basic rule is
that all the banking requirements of the customers should be taken care of by the tellers. In a highly
technological environment, a customer of any line of business branch should be able to get the
banking service at any branch. At present, not many banks are equipped to provide such levels of
service, but for driving a customer-centric business strategy such changes in the branch functioning
would definitely be required. Banks are opening branches despite having highly developed internet
and mobile banking systems. But the shape and ambience of branches are bound to change in the

41
light of technology-enabled business transformation of banks. Easy identification of a branch with
its sleek ambience and large area of the

branches for customers rather than for the bank staff will be a common feature. A hypothetical view
on the workflow of a customer entering in such branch can be as follows:

i. A customer entering in the branch is welcomed by a Customer Relationship Manager

and is directed to a counter where his banking related requirements are to be met.
ii. The branch is fully equipped with online ATMs which help him withdraw cash and
fulfill other related requirements.
iii. On the Internet kiosk, he can find out information about new products, apply for loans,
make online payments, get other internet-based information etc.
iv. From a set of neatly stacked section-wise brochures, he can get all minute details about
various products and services.
v. If customer is a global investor, he can find details about the growth of the funds
invested (corpus) and the future outlook.
vi. A host of financial research material providing latest developments and current and
future outlook are available in the branch for the customers' use.
vii. If it is a corporate finance branch and the customer is a high net worth person, financial
analyst can assist him in business needs and provide all advisory services.

5.1.1 Interest Rate Strategies

The different types of deposits held by the banks, at any point of time depend on the type of
products and services demanded by the customers. The next important factor that bears a lot of
importance is the policies of banks with respect to the interest it charges its customers and the
interest rate it offers on all its deposits. Every bank has its own policy that contains the following:

• Service fees vs. minimum balance requirement

• Deposit cost and volumes and their repercussion on profits
• Credit availability
• Customer relationship pricing
• Other elements of product differentiation

Developing a good policy has gained great importance as this directly influences the profitability of
the bank. The factors on which the deposit policy of each bank depends on are:

• Cost of funds for the bank

• Competitor pricing strategy
• Interest elasticity
• Past deposit flows
• Maturity structure of deposits

5.1.2 Deposit Pricing Strategies

42
Banks incur both financial and operating costs while acquiring funds. Financial costs pertain to
explicit payments to lenders minus revenues obtained from service charges and fees whereas
operating costs relate to labor costs, unadjusted premises expenses and other non-interest expenses.

Segmenting Deposit Customers

The introduction of interest bearing checking accounts during 1970s in the New England states has
led to a fierce competition for customer deposits among banks and non-bank thrift institutions
across United States. This led to the emergence of widespread use of deposit fee schedules. This
sort of pricing deposits is also called conditional pricing approach as the bank sets up a schedule of
fees in which the customer pays a low fee or even no fee if the deposit balance remains above some
minimum level but a higher fee is levied if the average balance falls below the minimum level.
Thus the customer pays a price conditioned on the use of the deposit. Deposit fee schedules vary
deposit prices according to one or more of these factors:

a. Number of transactions done through the account (e.g., number of cheques written, deposits
made, wire transfers, stop payment orders or notices of insufficient funds issued).
b. The average balance held in the account over a selected period (usually per month).
c. The maturity of the deposit in days, weeks or months.

The customer selects that bank and deposit plans that result in the lowest fees possible and or the
maximum yields given the number of cheques written, the number of deposits and withdrawals
expected and the planned average balance. The bank must also be acceptable to the customer from
the standpoint of safety, convenience and service availability.

The checking account price schedules that were introduced in New England can be classified into
three categories: (a) flat rate pricing (b) free pricing and (c) conditional free pricing. In flat rate
pricing, the depositor's cost is a fixed charge per cheque per time period or both. Thus there may be
a monthly account maintenance apart from the fee on each account regardless of the level of the
activity. In free pricing there would not be any monthly account maintenance fee or per-transaction
charge. The word free pricing misleads most of the customers because though the bank does not
charge an explicit fee on deposit services, the customer may incur an implicit fee in the form of lost
income (opportunity cost) because the effective interest rate paid on the deposit may be less than
the going rate on investments of comparable risk. Many banks have found free pricing unprofitable,
as it tends to attract small and highly active deposits that earn positive returns for the bank only if
the market interest rates are high. Conditionally, free deposits have come to replace both flat rate
and free deposit pricing systems in many banking markets.

Bank A Bank B
Regular Checking Account Regular Checking Account
Minimum opening Rs.100 Minimum opening Rs.100
balance If minimum balance If minimum
daily balances daily balance is
Rs.600 or more No fee Rs.500 or more No fee
Rs.300- Rs.599 Rs.5.00 pm Less than Rs.500 Rs.3.50 pm

43
Less than Rs.300 Rs.10.00 pm
If the depositor's colected monthly balance If the cheques written Rs.0.15 per debit
averages Rs.1500 there is no fee or ATM transactions
(debits) exceed 10 per
month and the balance
is below Rs.500
No limit on the number of cheques written
Regular savings Regular savings
account account
Minimum opening Rs.100 Minimum opening Rs.100
balance balance
Service fees: Service fees:
If the balance falls Rs.3,00 pm If the balance falls Rs.2.00 pm
below Rs.200 below Rs.100.
Balance of Rs.200 or No fee Balance of Rs.200 or No fee
more more
Fee for more than two Fee for more than
three Withdrawals per
month
withdrawals per Rs .2 .00 Rs.2.00
month
Table

This pricing favors large denomination deposits because services are free if the account balance
stays above the minimum figure. One of the advantages of this pricing method is that the customer
chooses the plan suitable to him and not the bank. This self-selection process is a form of market
signaling that can give the bank valuable data on the behavior and cost of its deposits.
Conditionally free pricing also allows a bank to divide its deposit market into high-balance, low-
activity deposits and low-balance, high-activity accounts.

The following is an example of the use of conditional pricing techniques for deposits: In the
example above, Bank A appears to favor high balance, low activity checking deposits while Bank B
is more lenient towards checking small accounts. For example, Bank A begins assessing a checking
account service fee when the customer's balance falls below Rs. 600 while Bank B charges no fees
for checking account services until the customer's account balance drops below Rs.500. Moreover,
Bank A assesses significantly higher service fees on low balance checking accounts than does Bank
B- Rs. 5 to Rs.10 p.m. versus Rs. 3.50 p.m. On the other hand, Bank A allows unlimited cheque
writing facilities from its regular accounts while B levies a fee if more than 10 cheques or
withdrawals occur every month.

Similarly Bank A charges a Rs. 3 p.m. service fee if a customer savings account dips below Rs. 200
while Bank B charges only Rs. 2 fee if the customer's savings balance drops below Rs.I00. These
price differences reflect differences in the philosophy of the management of the owners of these
two banks and the types of customers each bank is seeking to attract. Bank A is located in an
affluent neighborhood of homes and offices and gives preference to high income individuals and

44
businesses that keep high deposit balances and also write high number of cheques. Whereas Bank B
is located in university area actively soliciting student deposits, which tend to have relatively small
balances. Bank B's pricing schedules are set up to accept low balance deposits but the bank also
recognizes the need to discourage excessive cheque writing by numerous small depositors which
would result in high costs. Therefore it charges higher per cheque fees than Bank A. In the above
case, the banks' deposit pricing policy is generally sensitive to

i) The types of customers each bank plans to serve, with each institution establishing pricing
schedules that appeal to the needs of individuals and businesses representing a significant
portion of its market
ii) The cost incurred by the bank in serving different types of customers, with more banks
pricing their deposit plans in such a way as to cover all or at least a portion of anticipated
service costs.

1. Cost plus Margin Deposit

In banking, the idea of charging the customer for the total cost of deposit-related services has not
been universally accepted. In fact a few years ago, the notion that the customers should receive
most deposit related services free of charge has attracted great attention and was considered a wise
innovation, one that responded to the growing challenges posed by other financial intermediaries
that were invading traditional banking markets. But soon many banks found a reason to question the
wisdom of this new marketing strategy because they were flooded with numerous low balance high
activity accounts that blew their operating costs.

The development of interest bearing checkable deposits, particularly Now offered bankers the
opportunity to reconsider the pricing of their deposit services. Unfortunately many of the early
entrants into this new market moved aggressively to capture a major share of the customers through
below cost pricing. Customer charges were set below the true level of operating and overhead costs
associated with providing checkable deposit and other deposit plans. This resulted in a substantial
increased rate of return to the customer known as the implicit rate of return - the difference between
the true cost of supplying fund raising services and the service charges actually assessed to the
customer.

In the United States, the banks principally competed through variations in the implicit interest rate
for deposits paid to the customer over a period of 50 years stretching from the Great Depression to
the beginning of the 1980s. This was due to the presence of regulatory ceilings on deposit interest
rates beginning in 1933 with the passage of the Glass-Steagall Act. These legal interest rate ceilings
were designed to protect the banks from excessive interest rate competition for deposits, which
could allegedly cause them to fail. Prevented from offering higher explicit interest rates, US banks
instead competed by offering higher implicit returns through mail services where the bank promised
to pay the postage both ways by tempting depositors with gifts ranging from teddy bears to toasters
and by building convenient neighborhood branch office systems.

45
However such non-price competition distorted the allocation of scarce resources in the banking
sector. To counter such problems, the Depository Institutions Deregulation Act, 1980 a Federal Act
was passed that called for gradual phasing out of deposit rate ceilings. Today the responsibility of
setting deposit prices in the US (and in other leading developed nations as well) has been
transferred from public regulators to private decision makers i.e., the banks and customers.

The competition in the banking sector has intensified after deregulation. This added pressure on
their profitability in terms of higher cost of funds, narrower net interest margin as well as higher
cost of customer retention and solicitation. Meanwhile, it is also widely acknowledged that
deregulation would provide banks with the opportunity to enlarge their market share of the deposits
to be deregulated. Small and medium sized banks, in particular, view this as a chance to compete
with large banks for deposits.

They consider that a liberalized environment would allow more flexibility in pricing, more room for
the provision of innovative banking products and more opportunities to acquire new customers. On
a sector-wide level, the banks believe that deregulation would promote greater efficiency in the
banking sector and add impetus to the trend towards consolidation in the market. Deregulation has
brought more frequent use of unbundled service pricing as greater competition along with the rising
insurance fees has raised the average cost of a deposit for bankers. This means that deposits are
usually priced separately from loans and other bank services and each deposit service is often
priced high enough to recover all or most of the cost of providing that service. Thus the price of
deposit services would conform to the following Cost plus profit deposit pricing formula.

Relating deposit pricing to the bank's costs as shown above has encouraged the banks to match
prices and costs more closely and to eliminate many of the former free services. In the US, for
example, more and more banks are now levying fees for excessive withdrawals from savings
deposits, charging for customer balance, enquiries, increasing fees on bounced cheques and stop
payment orders, assessing charges on cash withdrawals and balance enquiries made through ATMs,
charging monthly maintenance fees even on small savings deposits and raising required minimum
deposit balances. In most cases, the fees have outpaced the inflation. The results of these trends
have generally been favorable to banks, with increases in service fee income outstripping losses
from irate customers closing their accounts.

Estimating Average Deposit Service Costs

Cost plus pricing demands an accurate calculation of the cost of each deposit service. One of the
popular approaches discussed by Simonson and Marks and by Edmister is to base deposit prices on
the bank's estimated cost of funds. This requires the banker,

46
(a) to calculate the cost rate of each source of bank funds [adjusted for reserves required by the
central bank, deposit insurance fees and float];
(b) to multiply each cost rate by the relative proportion of bank funds coming from that particular
source; and
(c) to sum all resulting products to derive the weighted average cost of bank Notes funds. This so
called 'pooled funds approach' is based on the assumption that it is not the cost of each type of
deposit that matters but the weighted average cost of all bank funding sources.

2. Marginal Costing Deposit Pricing

Marginal Costing: The added cost of bringing new funds is a better technique than the weighted
average cost to help price deposits and other bank fund sources. The reason is that frequent changes
in the interest rates will make average cost a misleading and unrealistic standard for pricing. For
example, if the interest rates are declining, the marginal cost of raising new money may fall well
below the average cost of all the funds raised by the bank. Some loans and investments that are
unprofitable when compared to average cost will now look profitable when measured against the
lower marginal interest cost we must pay today to make these new loans and investments.
Conversely, if interest rates are raising the marginal cost of today's new money may substantially
exceed the bank's average cost of funds. And if the management grants new loans based on average
cost, they may turn out to be highly unprofitable when measured against the higher marginal cost of
raising new funds in present market. One of the most publicized failures in banking history, the
collapse of Franklin National Bank of New York in 1974 was caused in part by a management
strategy that compared the expected yield on new loan requests to the bank's average cost of funds.
Franklin's loan officers were permitted to grant loans if the new loan's yield exceeded the bank's
average cost by one-percentage points or more. Unfortunately when the interest rates on new
borrowings (marginal cost) rose sharply, Franklin's 0.5% profit margin over average cost was just
too small. Huge quantities of its loans and investments were generating yields well below their
current funding costs, which eroded Franklin's capital base.

Economist James E. McNulty suggested the use of marginal or new money cost to set the interest
rates of banks that can be offered on the new deposit accounts. For example, a bank wants to raise
Rs.25 million in new deposits by offering its depositors an interest rate of 7%. However, the bank
management estimates that if the bank offers a 7.5% interest rate, it can raise Rs.50 million in new
deposits. At 8%, Rs.75 million while at 8.5%, the new deposits would be Rs.I00 million and at 9%,
the bank: can get 125 million from new as well as existing deposit holders. If the management is
expected to generate a yield of 10% upon investing the new deposit money, what deposit interest
rate should it offer to its customers?

According to McNulty's method, we need to first find out the marginal cost of moving the deposit
rate from one level to another and the marginal cost rate expressed as the percentage of the volume
of additional funds coming into the bank. The marginal cost rate is then compared to the expected
additional revenue (marginal revenue) the bank expects to earn from investing its deposits.

Marginal cost = Change in the total cost

47
(New interest rate x Total funds raised at a new rate) - (Old interest rate x Total funds raised at old
rate)

Marginal cost analysis is the key to incorporating advances in deposit pricing. Funding cost is
minimized when the marginal cost (not the rate paid) of all funding alternatives is equal. Implicit in
this concept is that funding diversification can result in cost savings over a single funding source. If
for example, Global Bank notices that its primary competing institution has just increased its three-
year CD rate 50 basis points above its current rate of 5% for a month-long special promotion, it is
estimated that 30% of Global Bank's Rs.I0 million maturing CDs (Rs.3 million) will leave if it does
not match the rate increase. What should Global Bank do? If the rate increase is matched, funding
costs will escalate. If nothing is done, customers, and the critical funding they represent, will be
lost. An institution can face such pricing dilemmas very frequently. Access to advance funding
eliminates the threat of lost depositors on both the liquidity and liability structure. If price sensitive
depositors depart for higher rates elsewhere, their funding can always be replaced with advances.
Advances represent a- source of funding diversification, which can be used for leverage in deposit
pricing. In addition, they can help an institution avoid overpaying for deposits.

Marginal cost rate = Change in total cost / Additional funds raised

Marginal Cost of Deposits

Incremental Cost = Cost of Retained CDs + Rollover Premium

(Rs.30, 00,000 x 5.5%) + (Rs.70, 00,000 x 5%)

Rs.2, 00,000

Incremental Funds = Rs.30, 00,000

Marginal Cost = Rs.2,00,000 / Rs.30,00,000 = 6.67 %

Marginal Cost of Advances

Incremental Cost = New Advance Cost

(Rs.30, 00,000 x 5.6%) = Rs.1,68,000

Incremental Funds = Rs.30,00,000

Marginal Cost = Rs.1,68,000/Rs.30,00,000 = 5.6%

The rollover premium of 50 basis points or Rs.35,000 is paid to loyal deposit even though they
would have been content with the lower rate of 5%. When cost of overpaying these price
insensitive depositors is factored in, the actual of retaining the Rs.3 million of rate sensitive
deposits is 117 basis points hi than the new rate of5.5%.

48
How would the strategy affect the institution relative to the competitor conduct the CD promotion?
Assume the competitor initially had the same three year rate (5.0%) and a similar amount of CDs
maturing during the promotion (million). The cost implications are illustrated below.

Marginal Cost of Deposits

Incremental Cost =New CD Cost + Rollover Premium

=Rs.30,00,000 x 5.5%) + (Rs.1,00,00,000 x .5%)

=Rs.2,15,000

Incremental Funds = Rs.30,00,000

Marginal Cost = Rs.2,15,000/Rs.30,00,000

=7.17%

The marginal cost approach provides valuable information to the management not only about
setting deposit interest rates but also about decision as to how far the bank should go in expanding
its deposit base before the added cost deposit growth is met with the additional revenues and total
profits begin to decline. The management needs to find either new sources of funding with 10
marginal costs or find new loans and investments promising greater marginal revenues or both
when profits start to fall.

The following two general rules apply to marginal cost calculations in deposit accounts:

a. When raising rates, the greater the proportion of non-rate sensitive new money, the higher the
marginal cost of the new funds.
b. When dropping rates, the greater the percentage of funds that leave, the higher the marginal
cost of the funds that left.

3. Market Penetration Deposit Pricing

Market penetration deposit pricing does not emphasize on profits and recovery in the short run. The
strategy in this type of pricing is to offer either high interest rates on deposits, usually well above
the market levels or charge customer fees well below market standards in order to attract new
customers. management hopes that the large deposit volumes and the associated loan business
would offset the thinner profit margin. Market penetration pricing strategies primarily aimed at
rapidly growing markets in which a bank is determined to capture the largest possible market share.
Identifying a bank to hold one's deposits is an expensive process for customers. Customers usually
buy more than one banking service. A deposit account represents an ongoing relationship between
customer and bank; it usually grows to encompass loans, trust services and so on. Foregoing the
relationship can be costly for the customer, a fact that tends to make many consumers loyal to the
bank they have already chosen. Thus deposits tend to be quasi fixed factors of production for banks.
They are usually less sensitive than other funds sources to changes in fees or interest rates or to

49
deposit plans offered by competing banks. If the bank can offer an above market rate of return to
the depositor long enough to capture his or her deposit, the high cost of moving that deposit will
tend to keep the customer loyal to the bank even after less generous deposit pricing occurs. Bankers
often get a disappointing response from the public when they start reducing fees or raising interest
rates to attract new deposits due to the fixed-factor aspect of deposits. The customers usually do not
change banks on a spur of the moment as both households and businesses consider multiple factors
and not just price in deciding where to deposit. The costs and risks associated with the change are
not insignificant. A study by the Federal Reserve Board and Greenwich Associates suggests that
households generally rank convenience, service availability, and safety above price in choosing
which bank will hold their checking account.

Moreover familiarity, which includes not only name but also safety, is considered an important
factor in how individuals and families choose a bank to hold their savings account rather than the
interest rate paid. Business firms usually prefer to keep their deposits with the banks, which are
reliable sources of credit and are relatively in good financial shape. They also regard the quality of
the bank officers and the quality of advice they receive from the banker.

4. Upscale Target Pricing

Upscale target pricing refers to the aggressive pricing of certain urban banks for high balance and
low activity deposits. These banks indulge in carefully designed advertising programs to target
established professionals, businesses, managers and high-income households with services and
service fees that result in high profit margins. Other deposit accounts especially low balance high
activity ones may be priced break even or may be discouraged altogether through higher prices. The
upscale customers usually respond quickly to the price differentials. These customers know that
deregulation is in progress and the prices would be falling with time.

Increasingly local deposit markets are characterized by widespread use of conditional and upscale
target pricing, intense competition and a growing cadre of informed, price sensitive customers
shopping around for the best terms available.

5. Promotional Pricing

This is used to introduce new products. In brief, the product is priced below its cost to attract
customers. More frequently promotional pricing is used to improve the demand for existing
products also. The potential reasons of promotional pricing are protecting market share, modifying
existing products, developing brand recognition or overall bank image, targeting particular market
segments of the population in certain market segments and increasing sales to a cost efficient level
at which economies of scale can be obtained.

6. Relationship Pricing

According to this the bank's best customers get the best pricing. The pricing is done according to
the number of services used by the customer. Relationship banking is an expression that includes
fulfilling long-term needs as opposed to immediate needs such as cashing a cheque. Customers who

50
purchase two or more bank services may be granted lower deposit fees or have some fees waived
compared to the fees charged to customers having only a limited relationship with the bank. The
idea is that selling multiple services increases the dependence of the customer and makes it harder
for him to switch over to other banks thereby making the relationship strong between the customer
and the bank. The banks can cross sell a variety of services at low user costs and increase
convenience compared to selling each service individually. In theory customer relationship pricing
promotes customer loyalty and makes the customer insensitive to the interest rates offered on
deposits or the prices posted on other banking services by competing financial service firms.

5.2 Primary Deposits & Interest Rate Risk Management

Checking accounts and regular savings accounts are one of the most important sources of funding
for financial institutions. Depending on the institution, such accounts often represent between 10%
and 50% of funding of most of the banks and therefore are called core deposits. While they are the
most basic of deposit services, a great deal of controversy surrounds analyzing the sensitivity of
these core deposits to changes in market rates. Strategies aimed at managing interest rate risk are
generally implemented in two markets - wholesale markets and retail markets. The methods used
by institutions to modify their interest rate risk are different in each market.

5.2.1 Wholesale Markets

Securities markets are the primary wholesale markets used by financial institutions. Financial
instruments offered in the securities markets are underwritten to meet a set of standards that are
commonly recognized throughout the market. For example, when a broker attempts to sell an
institution a five-year bond, the buyer knows by definition the amount of cash flows. Once a bond's
issue date and rate is known, comparative prices can be readily obtained from other brokers as even
they sell bonds that have identical cash flow characteristics. Generally, an institution will buy bonds
from the bond house offering the best price.

Only large financial institutions are influential to play a significant role in setting the price of
instruments sold in the wholesale markets. Consequently, an institution will either accept the
market rate/price offered or not participate in the market. Institutions manage their interest rate risk
in the wholesale markets by selling products with undesirable interest rate risk characteristics and
purchasing products that have desirable characteristics.

5.2.2 Retail Markets

In retail markets an institution can negotiate the rate on its products and services with its customers
who are either retail consumers or businesses. The negotiation occurs either from the customer, or
through the actions taken by the institution's pricing committee. An important difference between
the retail markets and wholesale markets is that retail products are not standardized. Retail products
have features, that are rate-related and non-rate related and are different from their competitors.

The rate-related features are components of a product's price that are related to its rate and are
important to the customer. An example would be the frequency of interest payments, compounding

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.tiethods and early withdrawal penalties on CDs. Because institutions often underwrite products that
do not meet standards, these features vary from institution to institution, whereas non-rate related
features are components of a product's price that are not related to its rate. Examples of such factors
are location convenience, time convenience, other account relationships, safety and soundness, and
customer loyalty, which are as important as rate to the customer of a CD. Generally, the greater the
value a customer places on a product's rate-related and non-rate related features, the less sensitive
the customer will be to the rate paid on the instrument. Because the values placed on rate-related
and non-rate related features would vary from customer to customer, their responses to an
institution's pricing actions will also vary. Financial institutions control the demand for their
products by changing their rates relative to rates offered by competitors. Pricing is the primary
technique used by institutions in managing interest rate risk in the retail markets. If a deposit
account has desirable interest rate risk characteristics, an institution will raise its rates relative to its
competitors, bringing in more rate sensitive customers. If a deposit account has undesirable interest
rate characteristics, the institution will lower its rates relative to competitors, losing some of its rate
sensitive customers in the process. Because pricing is a key tool in managing interest rate risk, it
makes sense for institutions to develop a mechanism for evaluating pricing alternatives and making
pricing decisions.

5.3 Self Assessment Test

1. Explain the Product and Service Portfolio.
2. Distinguish between Wholesale Markets and Retail Markets.
3. Explain in detail Primary Deposits and Interest Rate Risk management in your words.
5.4 Further Reading
1. Retail Management Principles And Practices- Author(s)/Editor(s): Dr K N Bank
2. Retail Managemen - Author(s)/Editor(s): M A Shewan
3. Retail Management - S N Mitra
4. Retail Banking- Raghu Palat
5. Keynote address by Ms Shyamala Gopinath, Deputy Governor of the Reserve Bank of India, at
the IBA - Banking Frontiers International Conference on "Retail Banking Directions:
Opportunities & Challenges", Mumbai, 28 May.
6. Article on 'Mobile Banking Facilities in Indian Banks' - Prof. Aithal.

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