UNIT-5 INSURANCE AND OTHER FEE BASED FINANCIAL • Endowment Policy – Provides lump sum on maturity or

SERVICES death. Example: A 20-year policy pays if insured survives or

INSURANCE-is a contract in which an individual or business dies.
transfers financial risk of potential loss to an insurance company in • Money-Back Policy – Periodic payments during policy term
exchange for a premium. It provides financial protection against plus death benefit. Example: 20-year plan gives partial
uncertain future events like accidents, illness, fire, or death. survival benefits every 5 years.
JohnMagee: • Annuity – Provides regular income after retirement.
“Insurance is a plan by which large numbers of people associate Example: Monthly pension after age 60.
themselves and transfer to the shoulders of all, risks that attach to • Unit Linked Insurance Policy (ULIP) – Combines insurance
individuals.” + investment in stocks/bonds. Example: Part of premium goes
to life cover, part to mutual fund-like investment.
2. General Insurance – Provides protection for property, health,
liability, and risks other than life.
• Fire Insurance – Covers loss due to fire. Example: Factory
insured against fire damage.
• Marine Insurance – Covers goods, ships, and cargo during
sea transit. Example: Exporter insures goods shipped abroad.
• Motor Insurance – Covers vehicles against damage/theft +
third-party liability. Example: Car insurance in India is
Life Insurance – Provides financial protection to family in case mandatory.
of death, survival, or retirement. • Accident Insurance – Covers accidental injury, disability, or
• Term Policy – Covers only death risk for a fixed period. death. Example: Coverage after a road accident.
Example: If insured dies within 20 years, family gets the sum • Credit Insurance – Protects lenders against borrower

assured. defaults. Example: Bank insuring loan repayments.

• Whole Life Policy – Covers the insured’s entire lifetime. • Public Liability Insurance – Covers businesses against third-

Example: Family receives payout whenever insured dies. party injury/property damage. Example: A mall insures
against accidents inside premises.
 • Property/Casualty Insurance – Covers buildings, homes, 1. Ensure only fit/financially sound entities transact insurance
offices. Example: House insured against earthquake damage. (registration & capital).
• Fidelity Insurance – Protects employer from losses due to 2. Protect policyholders by separating policyholders’ funds from
employee dishonesty. Example: Cashier stealing money. shareholders’ funds; enforce audited accounts and actuarial
• Burglary Insurance – Covers theft or burglary. Example: valuations.
Jewelry shop insures its stock. 3. Maintain solvency — insurers must keep sufficient assets
• Workmen Compensation Insurance – Provides above liabilities.
compensation to employees for workplace injuries. Example: 4. Regulate investments, loans and management to avoid misuse
Worker injured in a factory accident. of policyholders’ money.
• Unemployment Insurance – Provides income during job 5. Give the regulator inspection / direction / enforcement powers
loss. Example: In some countries, unemployed get monthly (including winding-up or removal of management).
allowance. Key provisions & sections (with plain-English explanation +
• National Health Insurance – Covers hospitalization, medical example)
expenses. Example: Ayushman Bharat in India. 1. Definitions & preliminary (Section 2)
• Cash Transit Insurance – Covers money in transit (banks, Defines insurer, life insurer, general insurer, “class of insurance
businesses). Example: ATM cash vans insured. business”, Authority (IRDAI), etc. These definitions determine which
• Employment Liability Insurance – Covers employer’s legal parts of the Act apply.
liability to employees. Example: Compensation for Example: “Life insurance” vs “general insurance” determine whether
occupational diseases. a company must keep a life fund and follow actuarial valuation rules.
INSURANCE ACT 1938 Short intro & purpose 2. Registration of insurers — Section 3 (and 3A/3B)
The Insurance Act, 1938 consolidates and regulates the law relating No person may carry on insurance business in India unless they obtain
to the business of insurance in India. Its core aim is to protect a certificate of registration from the Authority (IRDAI). There are
policyholders’ interests by requiring registration, minimum capital procedural requirements, renewal/annual fee rules (3A), and the
and solvency, strict accounting/separation of funds, controls on regulator checks soundness of terms for life business (3B).
investments/loans, inspection and powers for the regulator, and rules Example: A new company wanting to write life policies must apply
for winding up, amalgamation, agents and claims. to IRDAI, submit required documents and proof of meeting
Main objectives (simple) capital/safety conditions before starting business.
3. Capital & net-owned funds — Section 6 / 6A
The Act sets minimum paid-up equity capital thresholds (as on investing policyholder funds outside India without permission.
amended): e.g. paid-up equity of ₹100 crore for life/general insurers The regulator can issue detailed investment regulations.
and higher for reinsurers, and it also specifies minimum net-owned Example: Insurer A cannot invest large portions of life fund in
funds (current consolidated text shows much larger figures used for illiquid private ventures unless permitted; loans to a director are
regulatory entry conditions). These requirements are to ensure generally restricted.
financial strength before operating. 7. Solvency & sufficiency of assets — Section 64V/64VA (solvency
Example: To obtain registration for life insurance, the proposed margin)
company must show it already has the required ₹100 crore paid-up Insurers must value assets/liabilities correctly and maintain a
equity and meet the net-owned funds requirement. solvency margin. Section 64VA requires an insurer to maintain a
4. Separation of accounts & funds — Section 10–11 specified excess of assets over liabilities (the Act and IRDAI
Insurers must keep separate accounts for different classes (life, fire, regulations set solvency levels and “control levels”); breach can lead
marine, misc.), and separate policyholders’ funds from to regulatory action or winding-up.
shareholders’ funds; annual balance-sheets, revenue accounts and Example: If an insurer’s assets fall below the prescribed solvency
returns must be prepared and audited. margin, IRDAI may require corrective action (capital infusion,
Example: A composite insurer writing both life and motor insurance restricting new business) or take stronger measures.
must maintain separate ledgers/funds so life policy assets are not used 8. Inspection, Investigation & regulator powers — Sections 33–34
to pay motor claims. and related
5. Actuarial investigations & valuation — Section 13 / related The Authority (IRDAI) has power to inspect books, call for
rules information, issue directions, remove/appoint managerial personnel,
Life insurers must have periodic actuarial investigations and provide and order closure of foreign branches if required. These are
abstracts of actuarial reports (valuation of liabilities) as per enforcement tools to protect policyholders.
regulations — to ensure reserves are adequate. Example: On suspicious accounting or prudential breaches, IRDAI
Example: Each year an appointed actuary values the life fund’s can inspect records and direct the insurer to rectify shortcomings or
liabilities and certifies whether reserves are sufficient to meet future replace management.
claims. 9. Amalgamation, transfer of business & winding-up — Sections
6. Investment & loan restrictions — Sections 27–29 (and related) 35–37, 53–58 Any amalgamation/transfer of insurance business
The Act prescribes what assets (approved investments) insurers may requires sanction of the regulator, with safeguards for policyholders;
hold, limits on loans (especially to officers/insiders), and prohibitions
winding-up and valuation of liabilities are governed by the Act (and • To ensure financial stability and solvency of insurers.
company/winding-up laws). • To promote long-term funds for economic growth.
Example: If Insurer X wants to merge with Insurer Y, IRDAI will 4. Role of IRDAI as Regulatory Authority
require disclosure and will protect policyholders’ rights in any IRDAI acts as a watchdog of the Indian insurance sector. Its main
sanction order. roles are:
10. Agents, commissions, rebates — Sections 40–44 1. Regulation of insurers – Grant, renew, modify, suspend, or
The Act prohibits illegal rebates, prescribes agent licensing and cancel licenses of insurance companies.
limits on commissions/expenses to protect the public from mis- 2. Protecting policyholders’ interests – Fair settlement of
selling. claims, transparency in terms, no unfair trade practices.
Example: An insurer cannot pay undisclosed inducements to agents 3. Solvency & financial soundness – Monitoring solvency
to sell unsuitable policies; agents must be registered. margin, capital adequacy, and investment norms.
IRDA ACT 1999 The Insurance Regulatory and Development 4. Regulation of intermediaries – Licensing and monitoring
Authority Act, 1999 (IRDA Act) was enacted by the Government agents, brokers, surveyors, TPAs.
of India to establish an autonomous body — IRDAI (Insurance 5. Control over premium rates and terms – Ensures fairness
Regulatory and Development Authority of India). and prevents exploitation.
• Before 1999, insurance was regulated under the Insurance 6. Consumer grievance redressal – Supervises the Insurance
Act, 1938 and controlled by the Government. After Ombudsman scheme.
liberalization, the Malhotra Committee (1993) 7. Promoting market development – Encourages new
recommended an independent regulator to ensure products, insurance penetration, and rural/social sector
transparency, efficiency, and protection of policyholders. coverage.
IRDA Act, 1999 came into force in April 2000. 8. Reinsurance regulation – Controls placement of
2. Objectives of IRDA Act, 1999 reinsurance business in India and abroad.
• To protect policyholders’ interests. 9. Inspection and investigation – Can inspect insurers’ books,
• To promote fair competition in insurance business. issue directions, and take corrective action.
• To regulate, promote and ensure orderly growth of the 2. FUNCTIONS / POWERS OF IRDAI
insurance and reinsurance industry. A. Regulatory Functions
• To attract private and foreign players into the insurance B. Protective Functions
sector. C. Developmental Functions
D. Judicial / Quasi-Legal Powers  Convertible Loan – Loan that can be converted into equity
MEANING OF VENTURE CAPITAL FINANCING after a certain time or condition.
Venture Capital (VC) financing is a form of private equity  Participating Debentures – Low interest initially; investor
investment where funds are provided by venture capital firms or shares in profits later.
investors to new, innovative, high-risk, high-growth potential  Income Notes – Combination of interest and royalty
businesses (often start-ups) in exchange for equity (ownership payments.
share).  Direct Investment – Venture capitalist invests directly in
It is not just financial support – venture capitalists also provide company shares.
mentoring, expertise, and networks to help the business grow.  Combination Financing – Mix of two or more methods
OBJECTIVES OF VENTURE CAPITAL FINANCING (e.g., equity + loan).
1. Promote Entrepreneurship – Encourage innovative 2. FINANCING PATTERN UNDER VENTURE CAPITAL
business ideas by funding start-ups. Venture capital financing usually follows stages of a company’s
2. Support High-Risk Projects – Finance businesses that may life cycle:
not get loans from banks due to high uncertainty. 1. Seed Capital Stage
3. Earn High Returns – Venture capitalists invest with the o Finance for research, product development, or
objective of gaining substantial profit when the business prototype creation.
grows or goes public. o Very high risk.
4. Technology & Innovation Development – Promote new o Example: Funding given to a student developing a
technologies, R&D, and industrial advancement. new AI tool.
5. Economic Growth – Generate employment, wealth creation, 2. Start-up Stage
and competitiveness in the economy. o Funds for marketing, initial operations, and product
6. Professional Support – Provide mentoring, strategic advice, launch.
and business networks to entrepreneurs o Example: A new food delivery app receives VC
METHODS OF VENTURE CAPITAL FINANCING funding to expand its platform.
 Equity Financing – Investor buys shares and becomes part- 3. Early Stage / Second Stage
owner; returns through profit or capital gain. o For companies that have started sales but are not
 Conditional Loan – No interest; royalty paid on sales once profitable yet.
the business earns profit.
 o Example: A renewable energy company gets finance • Example: If NPV is positive, the project is acceptable.
to expand production.  Internal Rate of Return (IRR)
4. Expansion / Growth Stage • The rate at which NPV becomes zero. Higher IRR means
o Funds for scaling operations, entering new markets, better return.
or diversification. • Example: If IRR = 20% and required return = 15%, accept
o Example: An e-commerce firm raises VC funds to the project.
expand into international markets.  Profitability Index (PI)
5. Bridge / Mezzanine Financing • Ratio of present value of cash inflows to investment.
o Short-term financing before IPO or acquisition. • Example: PI = 1.2 → project is profitable.
o Helps company restructure and prepare for public  Accounting Rate of Return (ARR)
issue. • Based on average annual profit and investment.
o Example: A pharma company receives bridge • Example: ARR = (Average profit / Investment) × 100.
financing before its IPO launch. MEANING OF BILLS DISCOUNTING-Bills Discounting is a
PROCESS OF VENTURE CAPITAL INVESTMENT financial service where a bank/financial institution purchases a bill of
1. Deal Origination (Finding Proposals) exchange (before its maturity) from the holder at a price lower than
2. Screening of Proposals its face value. The difference between the bill’s face value and the
3. Evaluation / Due Diligence discounted price is the discount/charges, which is the bank’s income.
4. Deal Negotiation & Term Sheet It provides short-term finance to the bill holder (usually a
5. Investment Decision & Funding seller/exporter).
6. Post-Investment Monitoring & Support Example:A trader sells goods worth ₹1,00,000 on credit and draws
METHODS OF EVALUATING VENTURE CAPITAL a bill of exchange payable after 90 days. If he needs money
Payback Period Method immediately, he can discount it with the bank. Suppose the bank
• Measures how long it takes to recover the initial investment. charges 10% p.a., the discount = ₹2,500, and the trader gets ₹97,500
• Example: If ₹10 lakh is invested and yearly cash inflow is instantly.
₹2 lakh, payback period = 5 years. Section 5 of NI Act, 1881:
Net Present Value (NPV) A Bill of Exchange is “an instrument in writing containing an
• Compares present value of cash inflows with the initial unconditional order, signed by the maker, directing a certain person
investment.
to pay a certain sum of money only to, or to the order of, a certain • Example: If the seller discounts the bill with a bank, the
person or to the bearer of the instrument.”. bank becomes the endorsee/holder in due course.
PARTIES INVOLVED IN A BILL OF EXCHANGE (AS PER TYPES OF BILLS OF EXCHANGE
NI ACT, 1881) 1. On the Basis of Payment Time
There are mainly three parties (and sometimes a fourth). • (a) Demand Bill / Sight Bill
1. Drawer o Payable immediately on presentation.
• The person who makes/draws the bill. o No grace period.
• Usually the creditor/seller who has supplied goods or o Example: A bill that says, “Pay ₹50,000 to X on
services and is owed money. demand.”
• Example: A textile trader (seller) who sells cloth worth • (b) Time Bill / Usance Bill
₹50,000 on credit and draws the bill on the buyer. o Payable after a specified time period.
2. Drawee o Example: “Pay ₹50,000 to X after 90 days of
• The person on whom the bill is drawn and who has to accept acceptance.”
and pay it. 2. On the Basis of Acceptance
• Usually the debtor/buyer who purchased goods on credit. • (a) Trade Bill
• Example: The cloth buyer who owes ₹50,000 becomes the o Drawn for a genuine trade transaction (sale/purchase
drawee. of goods or services).
3. Payee o Example: Seller draws a bill on buyer for goods
• The person who is to receive the payment mentioned in the worth ₹1,00,000.
bill. • (b) Accommodation Bill
• In most cases, the drawer and payee are the same person, o Drawn without an underlying trade transaction;
unless the drawer endorses (transfers) the bill to another just to provide financial support.
party (like a bank). o Used to raise money temporarily.
• Example: If the seller keeps the bill, he is the payee. If he o Example: X and Y draw bills on each other to
endorses it to the bank, the bank becomes the payee. discount with banks and raise funds.
(Optional) 4. Endorsee / Holder in Due Course 3. On the Basis of Security
• If the bill is transferred, the person to whom it is endorsed • (a) Clean Bill
and who is entitled to receive payment. o Not backed by any collateral security.
 o Carries higher risk, so banks discount at higher rates. BILLS SYSTEM – EXPLANATION
o Example: A bill drawn and accepted only on The Bills System is a method of short-term financing where trade
creditworthiness. debts are settled through Bills of Exchange, instead of direct cash. It
• (b) Documentary Bill is widely used in commercial transactions, banking, and government
o Accompanied by documents of title to goods (e.g., [Link] ensures that sellers (creditors) get early payment and
bill of lading, invoice). buyers (debtors) get credit period, with banks often acting as
o Ensures payment security. intermediaries.
o Example: Exporter sends bill to importer along with Process of the Bills System
shipping documents. 1. Sale of Goods/Services – Seller sells goods to buyer on
4. On the Basis of Parties’ Involvement credit.
• (a) Inland Bill 2. Drawing of Bill – Seller (drawer) draws a bill of exchange
o Both drawer and drawee are in the same country. on the buyer (drawee).
o Example: A bill drawn in Delhi and payable in 3. Acceptance – Buyer accepts the bill, agreeing to pay on due
Mumbai. date.
• (b) Foreign Bill 4. Discounting (Optional) – Seller may discount the bill with a
o Drawer and drawee are in different countries. bank to get cash earlier.
o Example: An Indian exporter draws a bill on a US 5. Payment on Maturity – Buyer pays the amount to the
importer. holder (seller/bank) on due date.
5. On the Basis of Transferability Example
• (a) Negotiable Bill • A trader sells goods worth ₹1,00,000 on 90-day credit.
o Can be transferred by endorsement/delivery. • He draws a bill of exchange on the buyer.
• (b) Non-Negotiable Bill • Buyer accepts it, promising to pay after 90 days.
o Specifically marked as non-transferable. • If the seller needs cash immediately, he discounts the bill
6. Other Special Types with a bank at 10% p.a. → receives ₹97,500.
• Hundis (Traditional Indian Bills) – Indigenous bills used in • On maturity, the buyer pays the bank full ₹1,00,000.
trade, recognized by custom. FACTORING is a financial transaction where a business sells its
• Supply Bills – Drawn by contractors/suppliers on accounts receivable (i.e., outstanding invoices) to a third party, known
government departments for payments. as a factor, at a discount. This arrangement allows the business to
receive immediate cash, improving its short-term liquidity without • Meaning: The seller (client) is liable if the buyer fails to
waiting for customers to pay their invoices. pay the invoice. The factor can claim the money back from
How Does Factoring Work? the seller.
1. Sale of Goods/Services: A business provides goods or • Example: A company sells goods worth ₹1,00,000 to a buyer
services to a customer on credit, generating an invoice on credit. If the buyer defaults, the factoring company can
payable within a specified period. demand ₹1,00,000 from the seller.
2. Selling the Invoice: The business sells this invoice to a 2. Non-Recourse Factoring
factoring company at a discount. • Meaning: The factor assumes the risk of non-payment by
3. Immediate Cash Advance: The factoring company provides the buyer. The seller is not liable if the buyer defaults.
the business with an immediate cash advance, typically a • Example: A small business sells invoices to a factor. The
percentage of the invoice value. factor bears the loss if the customer fails to pay.
4. Collection of Payment: The factoring company collects the 3. Advance Factoring
full payment from the customer when the invoice becomes • Meaning: The factor provides an immediate cash advance
due. to the seller, usually a percentage (70–90%) of the invoice
5. Final Settlement: Once the customer pays, the factoring value.
company remits the remaining balance to the business, minus • Example: Invoice value ₹1,00,000, factor advances ₹80,000
a factoring fee. immediately. Remaining ₹20,000 paid after collection, minus
fees.
4. Maturing Factoring
• Meaning: Payment is made to the seller only after the
customer pays. No advance is given.
• Example: A company submits ₹50,000 invoices to a factor.
The factor waits until the customer pays the full amount,
then remits ₹48,500 (after deducting fee).
5. Full Factoring
[Link] Factoring • Meaning: The factor provides both finance and collection
services and may assume the credit risk.
 • Example: A manufacturer sells invoices of ₹2,00,000. The 9. Invoice Factoring
factor advances 85%, handles collection, and bears risk if • Meaning: Factor finances specific invoices only rather than
buyer defaults. the total receivables.
6. Buyer-based, Seller-based, and Selective Factoring • Example: Seller factors a single invoice worth ₹75,000 for
• Buyer-based Factoring: Factor covers invoices from immediate cash.
specific buyers. 10. Export Factoring
o Example: Invoices from a major retailer are factored. • Meaning: Factoring services for international trade,
• Seller-based Factoring: Factor covers all invoices from the handling foreign receivables and risks.
seller. • Example: An Indian exporter sells goods to a US buyer. The
o Example: A supplier factors all customer invoices, export factor advances funds, handles collections, and covers
regardless of buyer. credit risk.
• Selective Factoring: Factor covers selected invoices only. ROLE OF COMMERCIAL BANKS IN FACTORING
o Example: Only high-value invoices above ₹50,000 1. Providing Immediate Liquidity
are factored. 2. Credit Risk Assessment
7. Bank Participation Factoring 3. Collection Services
• Meaning: The bank participates in factoring by co-financing 4. Providing Financial Advice
or supporting the factoring company. 5. Enhancing Trade Efficiency
• Example: A bank collaborates with a factor to provide 6. Financing Small and Medium Enterprises (SMEs)
liquidity support for ₹10,00,000 invoices. 7. Supporting Export Financing
8. Notified and Undisclosed Factoring WORKING MECHANISM OF FACTORING
• Notified Factoring: The customer is informed that invoices Step 1: Sending Invoice to Customer
are factored. • The Client (the company selling goods/services) sends an
o Example: The buyer receives notice: “Please pay the invoice to the Customer for the goods or services provided.
factor instead of the seller.” • This invoice represents the payment the client expects in the
• Undisclosed Factoring: The buyer is unaware; payment is future.
collected by the factor on behalf of the seller. Step 2: Assign Invoice to Factor
o Example: Buyer continues paying seller, who passes • The Client assigns the invoice to the Factor.
payments to factor.
 • This means the Client sells its receivable (invoice) to the • The Customer pays the Factor the full invoice amount on the
Factor for immediate cash. due date.
• The Factor now has the right to collect payment from the • This is the realization of receivables by the Factor.
Customer. Step 6: Balance 20% on Realization
• After collecting the full payment from the Customer, the
Factor releases the remaining 20% balance to the Client.
• The Factor may deduct service charges or fees before
transferring this balance.
MERCHANT BANKING refers to a specialized area of banking
that provides financial and advisory services to businesses,
especially related to raising capital, managing investments, and
corporate finance activities. Unlike commercial banks, merchant
banks mainly deal with corporate clients rather than the general
public.
Functions of Merchant Banking
1. Issue Management / Capital Raising
Step 3: Payment up to 80% 2. Underwriting Services
• The Factor pays the Client a major portion of the invoice 3. Portfolio Management
value, typically up to 80%, immediately. 4. Loan Syndication
• This is called the advance payment, which improves the 5. Corporate Advisory Services
Client’s cash flow and working capital. 6. Project Counseling
Step 4: Statement to Customer Objectives of Merchant Banking
• The Factor sends a statement to the Customer informing 1. Raising Capital for Clients
them that the invoice has been assigned to the Factor. 2. Providing Financial Advisory Services
• The Customer is now required to pay the Factor directly 3. Underwriting of Securities
instead of the Client. 4. Portfolio Management
Step 5: Payment to Factor 5. Project Appraisal and Counseling
6. Loan Syndication
 7. Facilitating Mergers and Acquisitions (M&A) The Securities and Exchange Board of India (SEBI) regulates
8. Risk Management merchant banking activities in India under the SEBI (Merchant
SERVICES OF MERCHANT BANKING Bankers) Regulations, 1992.
Service Explanation ROLES OF SEBI
Assisting companies in issuing shares, 1. Protecting Investors
Issue Management / 2. Regulating Stock Exchanges and Intermediaries
debentures, bonds, IPOs, and private
Capital Raising 3. Controlling Insider Trading and Fraud
placements.
4. Regulating Takeovers and Mergers
Guaranteeing subscription of securities
Underwriting Services 5. Promoting Investor Education and Awareness
if public subscription is insufficient.
6. Developing the Securities Market
Managing clients’ investments in stocks, 7. Regulating Mutual Funds and Collective Investment Schemes
Portfolio Management
bonds, and other securities. 8. Protecting the Interests of Small Investors
Arranging large loans from multiple UNIT-4 ASSET BASED FINANCIAL SERVICES
Loan Syndication
banks or financial institutions. Meaning of Financial Services
Corporate Advisory Advising on mergers, acquisitions, Financial services are services provided by the finance industry,
Services restructuring, and financial planning. which includes a broad range of businesses that manage money,
Project Appraisal and Evaluating new projects for feasibility, including banks, credit card companies, insurance companies, stock
Counselling profitability, and financing. brokerages, investment funds, and other financial institutions.
Example: Banking services, insurance, mutual funds, leasing,
Advising on hedging and mitigating
venture capital, etc.
Risk Management financial risks, including market and
Needs of Financial Services
credit risks.
1. Efficient Resource Allocation
Facilitating foreign investments, foreign 2. Financial Intermediation
Merchant Banking for
currency operations, and global capital 3. Risk Diversification
International Finance
raising. 4. Support for Trade and Industry
SEBI MERCHANT BANKING REGULATIONS, 1992 5. Financial Inclusion
6. Economic Stability
 2. Financial Activity: Primary business is financial in nature,
such as loans, investments, hire purchase, or leasing.
3. No Demand Deposits: Cannot accept demand deposits like
savings or current accounts.
4. Regulation: Regulated by the RBI under the Reserve Bank
of India Act, 1934.
5. Credit Creation: Can raise money through term loans,
bonds, debentures, etc., but not through demand deposits.
Functions of NBFCs
ASSET-BASED FINANCIAL SERVICES are financial services NBFCs perform several important financial functions that support
where the value of tangible or intangible assets—such as the economy, especially sectors not fully served by traditional banks:
receivables, inventory, equipment, or real estate—is used to secure 1. Providing Loans and Advances
loans. The amount of credit a borrower can access depends on the 2. Asset Financing
liquidation value of these assets. 3. Investment Services
Example: 4. Accepting Deposits (where permitted)
A company can take a loan against its machinery, inventory, or 5. Hire Purchase and Leasing Services
accounts receivable. If the company fails to repay, the lender has the 6. Wealth Management and Financial Advisory
right to sell the pledged assets to recover the loan. 7. Support to Small and Medium Enterprises (SMEs)
NBFC (NON-BANKING FINANCIAL COMPANY) is a financial SERVICES RENDERED BY NBFCS
institution that provides banking-like financial services but does not 1. Loans and Advances
hold a full banking license and cannot accept demand deposits like 2. Asset Financing
a regular bank. NBFCs are regulated by the Reserve Bank of India 3. Investment Services
(RBI) under the Reserve Bank of India Act, 1934, but they focus 4. Deposit Services (For Deposit-taking NBFCs)
mainly on loans, investments, and asset financing rather than full 5. Hire Purchase and Leasing Services
banking operations. 6. Microfinance Services
Key Features of NBFCs: 7. Infrastructure Financing
1. Company Status: Must be a company registered under 8. Factoring and Bill Discounting
the Companies Act. 9. Insurance and Wealth Management
10. Specialized Financing • Example: NBFCs managing mutual funds or stock
TYPES OF NBFCS you mentioned, along with their full forms, portfolios.
meaning, and functions: 5. LC – Loan Company
1. ELC – Equipment Leasing Company • Meaning: Provides loans and advances to individuals,
• Meaning: Provides finance for leasing equipment and businesses, or institutions.
machinery to businesses. • Function: Offers unsecured or secured loans not linked to
• Function: Customers use the equipment while paying specific assets.
periodic lease rentals. Ownership remains with the NBFC. • Example: Business loan providers or personal loan NBFCs.
• Example: Leasing company providing machinery for 6. MNBC – Merchant NBFC
manufacturing units. • Meaning: Provides financial services to promote trade
2. HPFC – Hire Purchase Finance Company and commerce, often assisting businesses in fund-raising.
• Meaning: Provides finance to purchase goods/assets on a • Function: Acts as a merchant banker, providing
hire purchase basis. underwriting, project finance, and advisory services.
• Function: NBFC buys the asset and sells it to the customer • Example: NBFCs providing project finance for industrial
in installments, transferring ownership after final payment. units.
• Example: Vehicle financing companies offering car loans 7. MBFC – Mutual Benefit Finance Company
under hire purchase. • Meaning: Operates on the principle of mutual benefit
3. HFC – Housing Finance Company among its members, pooling funds for lending.
• Meaning: Specializes in providing housing loans and • Function: Members contribute to a fund which is then lent
mortgage finance. to members in need.
• Function: Offers long-term loans for purchasing, • Example: Cooperative finance companies or chit fund
constructing, or renovating houses. NBFCs.
• Example: LIC Housing Finance, HDFC Ltd. 8. RNBC – Residuary Non-Banking Company
4. IC – Investment Company • Meaning: Accepts deposits from the public, but not
• Meaning: Primarily engaged in investing in shares, bonds, classified under other NBFC types.
debentures, and securities. • Function: Can use funds for loans, advances, or investment
• Function: Manages investments and earns income from in various financial instruments.
dividends, interest, or capital gains.
 • Example: Some rural finance companies or niche deposit- Feature Banks NBFCs
taking NBFCs. Cheque & Can provide cheque, Cannot provide cheque
9. NBNFC – Non-Banking Non-Financial Company Payment ATM, and online facility or offer full
• Meaning: A company that does not accept deposits and its Facility payment facilities. payment services.
principal business is not banking or financial services, but LIC Housing Finance,
SBI, HDFC Bank, ICICI
it may undertake finance as a subsidiary activity. Examples Bajaj Finance, Shriram
Bank
• Function: Provides selective financial services but does not Transport Finance
operate as a full NBFC.
RBI Framework for NBFCs
• Example: A manufacturing company providing credit to its
Registration-NBFCs must register with RBI under the Reserve
buyers without being a deposit-taking NBFC.
Bank of India Act, 1934.
DIFFERENCE BETWEEN BANKS AND NBFCS Net Owned Fund (NOF) Requirement-Minimum NOF
Feature Banks NBFCs requirement (₹2 crore for most NBFCs, subject to RBI updates).
Financial institutions that Prudential Norms-Asset classification, provisioning, capital
Financial institutions that adequacy, and income recognition rules.
provide loans, advances,
accept deposits from the Capital Adequacy Norms-NBFCs must maintain a minimum
asset financing, or
Definition public and provide loans
investment services but Capital to Risk-weighted Assets Ratio (CRAR) of 15%.
and other banking
cannot accept demand Asset-Liability Management (ALM)-Guidelines to manage
services.
deposits. liquidity risk.
Can accept demand Cannot accept demand Disclosure Requirements-NBFCs must publish periodic financial
Deposit deposits deposits; only some
statements and disclosures.
Acceptance (savings/current) and NBFCs can accept
time deposits. fixed/recurring deposits. Fair Practices Code-Guidelines to ensure transparency in lending,
interest rates, and recovery processes.
Regulated by RBI under
Regulated strictly by RBI the Reserve Bank of India Priority Sector Lending (PSL)- (for some NBFCs)Requirement to
Regulation under the Banking Act, 1934; lighter lend a certain portion to specified sectors.
Regulation Act, 1949. regulation compared to Meaning of LEASING
banks. Leasing is a financial arrangement in which the owner of an asset
(lessor) allows another party (lessee) to use the asset for a specified
period in exchange for periodic payments, without transferring o Example: Vehicle manufacturer delivering a car to a
ownership. Essentially, it is a hire-purchase or rental agreement for leasing company.
assets like machinery, vehicles, or equipment. Leasing is widely used 4. Financier / Bank (In case of Leveraged Lease)
by businesses that want to use assets without heavy upfront o Sometimes the lessor borrows funds from a bank to
investment. Example: A company leases a vehicle from an NBFC buy the asset, which is then leased to the lessee.
for 3 years, paying monthly rentals. After 3 years, the vehicle may o Example: A leasing company takes a loan from a
return to the lessor, or the lessee may have the option to buy it. bank to finance aircraft leasing.
Characteristics of Leasing 5. Insurance Companies (Optional)
1. Contractual Agreement o Insure the asset against damage or loss.
2. Ownership and Possession o Responsibility may lie with lessor or lessee
3. Specified Period depending on the lease agreement.
4. Periodic Payment TYPES OF LEASING
5. Asset Specific Leasing can be classified based on risk, ownership, and purpose.
6. Financial and Operational Lease Types The main types are:
7. Flexibility 1. Financial Lease (Capital Lease)A long-term lease where the
8. Option to Purchase (sometimes) lessee bears most of the risks and rewards of ownership. Ownership
Parties Involved in Leasing usually does not transfer during the lease, but lessee may have the
1. Lessor (Financier / Leasing Company) option to buy at the end Example: A company leases machinery for
o Provides the asset and finances the lease. 5 years from an NBFC. At the end, the company may purchase it for
o Examples: NBFCs, banks, or specialized leasing a nominal price.
companies. 2. Operating Lease A short-term lease where the lessor bears most
2. Lessee (User / Customer) of the risks and rewards of ownership. Lessee uses the asset
o Uses the asset for business or personal purposes. temporarily without owning [Link];A company rents office equipment
o Examples: Manufacturing company leasing or vehicles for a year. After the term, the asset is returned to the lessor.
machinery, transport company leasing vehicles. 3. Leveraged Lease A lease where the lessor borrows a part of the
3. Manufacturer / Supplier (Sometimes a Third Party) funds from a bank or financial institution to buy the asset, which is
o Supplies the asset to the lessor or directly to the then leased to the lessee eg; An airline leases a plane; the leasing
lessee. company borrows 70% of the plane cost from a bank.
4. Sale and Leaseback Parties Involved in Hire Purchase
The owner of an asset sells it to a leasing company and 1. Seller / Owner
simultaneously leases it back. Helps the owner free capital while o Provides the goods on hire purchase and retains
continuing to use the asset. Example: A company sells its building to ownership until full payment.
a leasing firm and leases it back for 10 years to continue operations. 2. Hirer / Buyer
5. Cross-Border / International Lease Lease between lessor and o Uses the goods and pays installments; ownership is
lessee in different countries. Example: An Indian company leases transferred after final payment.
machinery from a US leasing company. 3. Finance Company / Bank (Optional)
Steps Involved in Leasing o Sometimes a financial institution finances the
1. Identification of Need purchase for the buyer, especially in case of
2. Selection of Asset expensive assets like cars or machinery.
3. Approach to Lessor / Leasing Company Steps in Hire Purchase Transaction
4. Credit Appraisal 1. Identification of Need
5. Negotiation of Lease Terms 2. Negotiation with Seller / HP Provider
6. Execution of Lease Agreement 3. Credit Appraisal / Financial Approval
7. Delivery of Asset 4. Execution of Hire Purchase Agreement
8. Payment of Lease Rentals 5. Delivery of Goods
9. Maintenance and Monitoring 6. Payment of Installments
10. Termination / End of Lease 7. Monitoring and Maintenance
FINANCIAL EVALUATION OF LEASING 8. Ownership Transfer
Meaning of Hire Purchase 9. Default and Repossession (If Any)
Hire Purchase (HP) is a system of buying goods on credit where Hire Purchase Agreement
the buyer (hirer) pays the price of the goods in installments while A Hire Purchase Agreement is a legal contract between the seller
using the goods. Ownership of the goods is transferred to the (owner/financier) and the hirer (buyer) specifying the terms and
buyer only after the last installment is paid. Example: A conditions of hiring goods and eventual ownership transfer.
company buys a machine on hire purchase for ₹5,00,000, paying TYPES OF HP
₹1,00,000 per year for 5 years. Ownership is transferred after the 1. Conditional Sale HP
final installment. 2. Credit Sale HP
 3. Financial HP Feature Leasing Hire Purchase (HP)
4. Dealer HP Hirer has right to use
5. Conditional HP with Option to Return Lessee has right to use and eventual
Use of Asset
Difference Between Leasing and Hire Purchase but not own the asset. ownership after final
Feature Leasing Hire Purchase (HP) payment.
Financial arrangement HP agreements are
System where the Operating lease can often
where the lessor allows usually non-
buyer (hirer) acquires Termination / be terminated early;
the lessee to use an asset cancellable, with
goods on installments; Cancellation financial lease is harder
Meaning for a specified period in repossession in case of
ownership transfers to to cancel.
exchange for periodic default.
the buyer only after all MEANING OF UNDERWRITING -Underwriting is a financial
payments; ownership
installments are paid. service where a company (underwriter) guarantees the purchase of
remains with the lessor.
Remains with the lessor securities (shares, debentures, or bonds) issued by a company, in
Ownership transfers to
during the lease term; case the public does not subscribe to them fully. Example: A
Ownership the hirer only after the
sometimes option to company plans to issue 1,00,000 shares, but only 70,000 are
last installment is paid.
purchase at the end. subscribed by the public. If the company had an underwriter
Can be short-term Usually long-term, agreement, the underwriter would buy the remaining 30,000
(operating lease) or covering the installment shares, ensuring the company raises full capital.
Period
long-term (financial period until full
lease). payment. Forms of Underwriting
A. Firm Underwriting
Lessee pays lease Hirer pays
rentals, which may installments, including • The underwriter agrees to subscribe to the full issue or a
Payment Structure fixed portion of securities if public subscription fails.
include interest or service cost of goods plus
charges. interest/finance charges. • Example:
In operating lease, lessor o A company issues 50,000 shares. An underwriter
Hirer usually bears risk,
bears risk and agrees to subscribe to 20,000 shares if the public
Risk and insurance, and
maintenance; in subscribes to fewer shares.
Maintenance maintenance from the
financial lease, lessee B. Standby Underwriting
beginning.
bears risk.
• The underwriter agrees to buy any unsubscribed shares,
but does not commit to a fixed number in advance.
 • Used to support the issue in case of partial subscription. 2. Commercial Banks
• Example: 3. Co-operative Banks
o IPO issues 1,00,000 shares; underwriter will purchase 4. Development Banks
whatever remains unsold after public subscription. 5. Specialized Banks
C. Partial Underwriting 6. Small Finance Banks (SFBs)
• Only a part of the issue is underwritten by the underwriter. 7. Payments Banks
• Example: [Link] Banks
o Out of 1,00,000 shares, 50,000 shares are 9. Saving Banks
underwritten; the rest is left to public subscription. 10. Exchange Banks
D. Sub-Underwriting 11. Import and Export Bank (EXIM Bank of India)
• The primary underwriter appoints other underwriters FUNCTIONS OF A BANK
(sub-underwriters) to share the risk. 1. Acceptance of Deposits
• Common in large public issues. 2. Lending of Funds –
• Example: 3. Intermediary Role –
o Lead underwriter underwrites 50,000 shares and 4. Creation of Credit
distributes 20,000 shares among sub-underwriters. 5. Withdrawal Facility
UNIT 1 6. Regulated by Law
Meaning-A bank is a financial institution that accepts money from 7. Profit Motive with Service
people (deposits) and provides it to others in need (loans), while also 8. Trust-based Institution
offering services like payments, money transfer, and investment 9. Use of Modern Technology
facilities.
Indian Banking System – Overview The Indian banking system is
the backbone of the country’s financial sector, playing a key role in
economic growth by mobilizing savings and providing credit. It is
well-regulated, mainly by the Reserve Bank of India (RBI), which
ensures stability and trust.
TYPES OF BANKS IN INDIA
1. Central Bank
 • Regulates foreign exchange transactions and cross-border
payments.
• Controls inflow and outflow of foreign currency to ensure
stability in international trade.
5. Companies Act, 2013
• Applies to banks as corporate entities.
• Governs aspects like corporate governance, audit, accounting,
and management practices.

Reserve Bank of India Act, 1934

MONETARY AND NON MONETARY FUNCTIONS OF
RESERVE BANK OF INDIA
MONETARY FUNCTIONS OF RBI
1. Issue of Currency
2. Control of Credit
Contribution to Economy 3. Formulation of Monetary Policy
KEY REGULATIONS IN INDIAN BANKING SECTOR 4. Regulation of Money Supply
1. Reserve Bank of India Act, 1934 5. Lender of Last Resort
• Establishes the RBI as the central bank of India. 6. Maintaining Price Stability
• Empowers RBI to issue currency, regulate banks, and control 7. Maintaining Cash Reserves of Banks
monetary policy. 8. Open Market Operations
2. Banking Regulation Act, 1949 Non-Monetary Functions of RBI
• Governs the functioning of all banks in India. 5. Regulation and Supervision of Banks
• Covers licensing of banks, capital requirements, management 6. Foreign Exchange Management
control, merger/amalgamation, and winding up of banks. 7. Developmental Functions
• Gives RBI the power to regulate and inspect banks. 8. Government’s Banker
3. Negotiable Instruments Act, 1881 9. Consumer Protection and Financial Education
• Provides the legal framework for cheques, promissory notes, PROVISIONS OF RBI ACT IN BANKING SECTOR
and bills of exchange. 1. Regulation of Cash Reserve Ratio (CRR) — Section 42
• Ensures smooth functioning of payment and settlement • Every scheduled commercial bank must maintain a percentage
systems. of its net demand and time liabilities (NDTL) with the RBI as
4. Foreign Exchange Management Act (FEMA), 1999 CRR.
 • The RBI has the power to vary CRR from time to time, which • Provides legal recognition to these instruments, ensuring that
directly affects liquidity in the banking sector. banks can operate in money markets under RBI’s oversight.
• Helps control inflation, manage credit supply, and ensure
financial stability. 6. Inspection and Supervision of Banks — Section 35
• RBI has powers to inspect banks, call for information, and
2. Statutory Liquidity Ratio (SLR) enforce compliance with regulations.
• Though mainly under the Banking Regulation Act, the RBI • Ensures banks follow prudent practices, manage risks, and
Act empowers RBI to influence liquidity by requiring banks maintain solvency.
to hold a certain portion of their funds in liquid assets (gold,
cash, approved securities). 7. Regulation of NBFCs and Co-operative Banks — Chapter III-
• Ensures stability of banks and supports government B
borrowing through investments in government securities. • RBI regulates Non-Banking Financial Companies (NBFCs),
which operate alongside banks.
3. Issue of Bank Notes — Section 22 • RBI also has supervisory powers over certain co-operative
• RBI has the sole authority to issue currency notes in India banks, ensuring financial discipline in the broader banking
(except Re.1 note issued by Ministry of Finance). ecosystem.
• This provision ensures uniformity of currency and confidence BANKING REGULATION ACT, 1949
in the monetary system, which is vital for the banking sector’s • Enacted in March 1949 as the Banking Companies Act, 1949.
functioning. • Later renamed as the Banking Regulation Act, 1949.
• Extends to the whole of India.
4. Control over Monetary Policy — Sections 45Z & Related • Administered by the Reserve Bank of India (RBI).
• The RBI formulates and implements monetary policy to Objectives
regulate credit, interest rates, and liquidity in banks. • To ensure proper management and regulation of banks.
• Monetary Policy Committee (MPC), introduced later, • To safeguard depositors’ interests.
operates under the framework of the RBI Act to decide repo • To give RBI powers to supervise, inspect, and control banks.
rate, reverse repo rate, etc. • To maintain financial stability and healthy growth of the
banking sector.
5. Regulation of Money Market & Derivatives — Chapter III-D NEGOTIABLE INSTRUMENTS ACT, 1881
(Inserted in 2006 Amendment) 1. Introduction
• RBI regulates repo, reverse repo, call/notice money, • Enacted: 1881, one of the oldest commercial laws in India.
commercial papers, and derivatives. • Governs promissory notes, bills of exchange, and cheques.
 • Purpose: To ensure the free and secure transfer of
money/credit instruments in trade. NEGOTIABLE INSTRUMENTS ACT, 1881 – PROVISIONS
2. Meaning of Negotiable Instrument WITH EXAMPLES
• A negotiable instrument is a document guaranteeing 1. Definition of Negotiable Instruments (Sec 13)
payment of a certain sum of money, either on demand or at a Provision: Promissory notes, bills of exchange, and cheques
set time, with the payee being named or bearer. are negotiable instruments.
3. Types of Negotiable Instruments (as per Act) Example: A cheque issued by Mr. A to Mr. B for ₹50,000 is
1. Promissory Note (Section 4) – A written promise to pay a a negotiable instrument because it can be transferred further.
certain sum. 2. Promissory Note (Sec 4)
2. Bill of Exchange (Section 5) – An order by maker to pay a Provision: Written promise by one person to pay another.
sum to a third party. Example: “I promise to pay Mr. X ₹10,000 on 1st October
3. Cheque (Section 6) – A bill of exchange drawn on a banker, 2025” signed by Mr. Y.
payable on demand. 3. Bill of Exchange (Sec 5)
to dishonour of cheques. Provision: Written order to pay [Link]: Mr. A
Key Provisions of 2002 Amendment directs Mr. B to pay ₹20,000 to Mr. C after 90 days → This
1. Strengthened Section 138 (Dishonour of Cheque) is a bill of exchange.
o Imprisonment up to 2 years (earlier 1 year). 4. Cheque (Sec 6)
o Fine up to twice the cheque amount. Provision: A bill of exchange drawn on a banker. Example:
2. Section 139 – Presumption in favour of holder: Ms. P issues a cheque of ₹15,000 drawn on her SBI account
o The court will presume that the cheque was issued for in favour of Mr. Q.
discharge of debt or liability unless proved otherwise. 5. Negotiation (Sec 14)
3. Section 141 – Offences by Companies: Provision: Transfer of instrument so transferee becomes
o Makes company directors, managers, or officers [Link]: Mr. R endorses a cheque to Mr. S by signing at the
personally liable for cheque dishonour. back → Now Mr. S is the holder.
4. Section 143 – 147 – Speedy trial provisions: 6. Holder & Holder in Due Course (Sec 8 & 9) Provision:
o Cases to be tried by Magistrate of First Class. Holder has the right to possess and recover money; holder in
o Summary trials introduced for faster disposal. due course gets the instrument in good faith for value.
o Compounding of offences allowed. Example: Mr. A receives a cheque from Mr. B for ₹5,000.
Impact of the 2002 Amendment Mr. A gives it to Mr. C in good faith for a loan repayment →
• Increased trust and confidence in cheque transactions. Mr. C becomes holder in due course.
• Strengthened legal remedies for dishonour of cheques.
• Helped in reducing frauds in banking and trade. 7. Presumptions (Sec 118)
 Provision: Court presumes instrument is made for 1. Legal Authority – Section 42(1) of the RBI Act empowers
[Link]: If Mr. X issues a cheque to Mr. Y, the court RBI to require scheduled commercial banks to maintain a
will assume it was against a loan or debt unless Mr. X proves certain portion of their NDTL as CRR.
otherwise. 2. Minimum Percentage – RBI determines and revises the CRR
8. Crossing of Cheques (Sec 123–131A) percentage as per economic conditions.
Provision: Crossing means payment only through bank account. 3. Maintenance – CRR must be maintained daily with RBI in
Example: A cheque marked with “Account Payee Only” cannot be the form of cash.
encashed in cash; it must be deposited in the account. 4. Applicable Banks – All scheduled commercial banks must
9. Dishonour of Instrument (Sec 91–98) maintain CRR; some provisions extend to certain cooperative
Provision: Dishonour occurs when payment is [Link]: A banks.
cheque of ₹25,000 issued by Mr. D is returned by bank due to 5. Purpose – Controls inflation, manages liquidity, and regulates
insufficient funds → Dishonour of cheque. credit flow.
10. Penalty for Dishonour of Cheque (Sec 138 – before 2002) 6. Review Frequency – RBI reviews CRR regularly as part of
Provision: Jail up to 1 year or fine equal to cheque amount. monetary policy announcements.
Example: Mr. A issues cheque of ₹50,000 which bounces; Mr. B can 7. Penalty for Non-compliance – Banks failing to maintain
file a case → Mr. A may face 1 year jail or fine up to ₹50,000. CRR must pay penal interest or face other regulatory action.
CASH RESERVE RATIO (CRR) 8. Calculation Basis – CRR is calculated on the basis of Net
CRR is the minimum percentage of a commercial bank’s Net Demand and Time Liabilities (NDTL) of the bank.
Demand and Time Liabilities (NDTL) that it must keep as a cash 9. Transparency – RBI publishes CRR rates and changes in its
reserve with the Reserve Bank of India (RBI).It is a statutory Monetary Policy Statement.
requirement under the RBI Act, 1934 (Section 42).This money is 10. Exemptions – Certain liabilities, such as borrowings from the
kept with the RBI in cash form only (not gold or securities). RBI, may be excluded from NDTL for CRR calculation.
Purpose of CRR NON-PERFORMING ASSETS (NPA)
1. Liquidity Control → Helps RBI regulate the flow of money • A Non-Performing Asset (NPA) is a loan or advance given
in the economy. by a bank that has stopped generating income for the
2. Inflation Control → Higher CRR reduces money available [Link] simple words, when a borrower fails to pay interest
with banks → less lending → controls inflation. or principal on time, the loan becomes an NPA.
3. Financial Stability → Ensures banks always maintain a Types of NPAs
portion of deposits safely with RBI. 1. Sub-standard Assets → NPA for less than or equal to 12
4. Credit Regulation → By changing CRR, RBI controls banks’ months.
lending capacity. 2. Doubtful Assets → NPA for more than 12 months.
PROVISIONS RELATED TO CRR (UNDER RBI ACT, 1934)
 3. Loss Assets → Assets identified as non-recoverable by the o RBI allows restructuring of loans under certain
bank or auditors. conditions to avoid default classification.
Example 9. Priority Sector Lending (PSL) NPAs:
• Bank lends ₹10 lakh to Mr. A. o Special norms for NPAs in priority sector loans with
• Mr. A is supposed to pay EMI every month. potential restructuring benefits.
• If Mr. A does not pay EMI for 3 consecutive months (90 10. Disclosure Norms:
days), the loan is classified as an NPA. o Banks must disclose NPAs and provisioning in their
PROVISIONS RELATED TO NPAS annual financial statements.
1. Definition of NPA – As per RBI, any loan or advance overdue
for 90 days or more is treated as NPA. FINANCIAL STATEMENT OF BANKS
2. Classification of NPAs: Meaning
o Sub-standard Assets – Overdue up to 12 months. • A financial statement of a bank is an official record of its
o Doubtful Assets – Overdue more than 12 months. financial performance and position during a particular
o Loss Assets – Loans that are not recoverable. period (usually quarterly or annually).
3. Provisioning Norms: • It shows how much money the bank owns, owes, earns, and
o Banks must maintain provisions against NPAs spends.
according to RBI guidelines. Percentage depends on • Prepared as per Banking Regulation Act, 1949 and RBI
the category of NPA (e.g., 15%–100%). guidelines.
4. Income Recognition: BALANCE SHEET
o No interest income can be recognized unless it is • A Balance Sheet is a financial statement that shows the
actually received in cash. financial position of an organization (like a bank,
5. Reporting to RBI: company, or firm) on a specific date (usually 31st March
o Banks must submit periodic reports on NPAs, asset every year). It gives a snapshot of what the business owns
quality, and provisioning. (assets) and owes (liabilities), along with the owner’s
6. Monitoring: equity/capital.
o Banks must have an Asset Quality Review (AQR) Income Statement
system to monitor loan performance. • An Income Statement (also called Profit and Loss
7. Recovery Measures: Account) is a financial statement that shows a bank’s
o Use of SARFAESI Act (2002), Debt Recovery income, expenses, and profit or loss during a particular
Tribunals (DRT), Lok Adalats, and legal period (quarterly or annually).Unlike a balance sheet (which
proceedings. shows position at a point in time), the income statement
8. Restructuring of NPAs: shows performance over time.
Components of Bank’s Income Statement • Ensures the bank has sufficient capital to absorb unexpected
1. Income losses and remain [Link] using ratios like:
o Interest Income → interest earned on loans, o Capital Adequacy Ratio (CAR / CRAR)
advances, investments. o Tier 1 & Tier 2 Capital under Basel norms
o Other Income → commission, fees, forex earnings, Example: RBI requires a minimum CRAR of 9%. If
ATM charges, etc Example: Loan interest = ₹200 Bank X has 12%, it is financially strong.
crore, Commission = ₹20 crore. 2. Asset Quality (A)
2. Expenses • Refers to the quality of a bank’s loans, investments, and
o Interest Expenses → interest paid on deposits, advances.
borrowings. • High NPAs = Poor asset quality.
o Operating Expenses → salaries, rent, technology • Ratios used:
cost. o Gross NPA ratio
o Provisions & Contingencies → money kept aside o Net NPA ratio
for bad loans (NPAs)Example: Deposit interest = o Provision Coverage Ratio Example: If 90% of loans
₹120 crore, Salaries = ₹30 crore. are being repaid on time, asset quality is good
3. Net Profit (or Loss) 3. Management Efficiency (M)
Net Profit = Total Income – Total Expenses\text{Net Profit = Total • Evaluates the ability and skill of management in handling
Income – Total operations, risk, compliance, and growth.
Expenses}Net Profit = Total Income – Total Expenses Example: • Indicators:
Income = ₹220 crore, Expenses = ₹170 crore → Profit = ₹50 crore. o Cost-to-Income Ratio
CAMEL Framework - CAMEL is a rating system used by o Compliance with RBI guidelines
regulators (like the RBI in India, or the Federal Reserve in the US) o Quality of internal audit & governance Example: A
to assess the overall health and performance of banks. The word bank with strong internal controls and low fraud
CAMEL is an acronym of five key parameters: cases shows good management
C → Capital Adequacy 4. Earnings (E)
A → Asset Quality • Measures the bank’s profitability and sustainability.
M → Management Efficiency • Ratios used:
E → Earnings o Net Interest Margin (NIM)
L → Liquidity o Return on Assets (ROA)
Components of CAMEL o Return on Equity (ROE) Example: If Bank Y earns
1. Capital Adequacy (C) ₹100 crore profit consistently, it has strong earnings
capability.
 5. Other Payment Systems
5. Liquidity (L) • NACH (National Automated Clearing House): For bulk
• Checks whether the bank can meet short-term obligations, payments like salaries, subsidies, EMIs, bills.
like deposit withdrawals, without stress. • BBPS (Bharat Bill Payment System): For paying utility bills,
• Ratios used: DTH, gas, etc.
o Liquidity Coverage Ratio (LCR) • NETC (National Electronic Toll Collection): FASTag for
o Credit-Deposit Ratio automatic toll payments.
o Cash Reserve Ratio (CRR) & Statutory Liquidity Meaning of Paper-Based Payment System-A paper-based
Ratio (SLR) Example: If a bank has enough liquid payment system is a traditional payment method where transactions
assets to repay all depositors in emergencies, liquidity are carried out using physical paper instruments instead of
is good.
electronic or digital modes.
Importance of CAMEL Framework
1. Ensures Financial Stability Types of Paper-Based Payment Systems in India (with
2. Early Warning System Examples)
3. Protects Depositors’ Interests
4. Improves Regulatory Oversight 1. Cheques
5. Guides Investors & Shareholders
6. Enhances Management Accountability • A cheque is a written order from an account holder to a
7. Promotes Healthy Competition bank, instructing it to pay a specified sum to the person
UNIT 3 DEVELOPMENT IN BANKING TECHNOLOGY named or to the bearer.
Payment System-A payment system is a system that enables the
transfer of money between individuals, businesses, banks, and • Types of Cheques:
institutions. It consists of instruments (like cash, cheques, cards),
people, rules, procedures, and technology used to settle financial o Bearer Cheque: Payable to the person holding it.
transactions. o Order Cheque: Payable only to the named person.
In other words, it is the mechanism through which monetary
transactions are settled – either in cash or electronically. o Crossed Cheque: Can only be deposited into a bank
Types of Payment Systems in India account, not encashed directly.
1. Paper-based Payment Systems
2. Retail Electronic Payment Systems • Example: Mr. Ramesh issues a cheque of ₹20,000 to pay his
3. Card Payment Systems supplier.
4. Mobile & Digital Wallets
2. Demand Draft (DD) E–Payment System- (Electronic Payment System) is a digital
method of transferring money from one account to another through
• A demand draft is a prepaid instrument issued by a bank,
electronic modes instead of physical cash or paper [Link]
directing another branch of the same bank to pay a specified
uses computer networks, internet, mobile devices, and digital
amount to the mentioned person.
platforms to complete transactions securely and instantly. In India,
• It is safer than cheques because it cannot bounce (payment is e–payments are regulated by the Reserve Bank of India (RBI) and
already collected in advance). the National Payments Corporation of India (NPCI) under the
Payment and Settlement Systems Act, 2007.
• Example: A student buying a DD of ₹50,000 for paying
university admission fees. Types of E–Payment Systems (with Examples)

3. Pay Order / Banker’s Cheque 1. Card-Based Payments

• Issued by a bank, payable only within the same city (local • Debit Cards – Linked to bank accounts, money deducted
payments). instantly.

• It is used for making payments like fees, tenders, or local o Example: Using an SBI debit card for shopping at
obligations. Big Bazaar.
• Example: A company issues a pay order of ₹1,00,000 in • Credit Cards – Buy now, pay later facility provided by
favor of the municipal corporation for license fees. banks.

4. Money Order (Post Office Instrument) o Example: Using an HDFC credit card to book airline
tickets.
• Issued through the post office, enabling remittance of money
from one place to another. • Prepaid Cards / Gift Cards – Preloaded with money.

• Mostly used in rural areas where banks are less accessible. o Example: Amazon Gift Card, Paytm Prepaid Card.

• Example: A person working in Mumbai sends ₹5,000 as a 2. Electronic Fund Transfer Systems
money order to his family in a village.
• NEFT (National Electronic Funds Transfer): Batch-based
transfer, suitable for any amount.
 • RTGS (Real Time Gross Settlement): Immediate • Example: A villager withdrawing ₹2000 using Aadhaar
settlement for high-value transfers (₹2 lakh & above). number & fingerprint at a nearby banking correspondent.

• IMPS (Immediate Payment Service): Instant transfer, 6. Internet Banking (Net Banking)
24×7, even on holidays.
• Bank-provided platform for online fund transfer, bill
• Example: Transferring ₹50,000 instantly to a friend using payment, ticket booking, etc.
IMPS.
• Example: Using ICICI Net Banking to pay electricity bills.
3. UPI (Unified Payments Interface)
7. NACH (National Automated Clearing House)
• Mobile-based, real-time payment system for 24×7
• For bulk and repetitive payments like salaries, subsidies,
transactions.
EMI deductions, insurance premiums.
• Works with apps like PhonePe, Google Pay, Paytm, BHIM.
• Example: Employer credits monthly salary to employees
• Example: Paying ₹300 at a grocery store by scanning a QR through NACH.
code with PhonePe.
8. BBPS (Bharat Bill Payment System)
4. Digital Wallets / Mobile Wallets
• Integrated system for paying utility bills, gas, DTH, water,
• Virtual wallets store money digitally for quick payments. insurance.

• Examples: Paytm Wallet, Amazon Pay, Freecharge, • Example: Paying electricity bill of BESCOM via BBPS.
Mobikwik.
9. NETC (National Electronic Toll Collection)
• Used for mobile recharge, shopping, or bill payments.
• Uses FASTag for automatic toll payment on highways.
5. Aadhaar Enabled Payment System (AePS)
• Example: Vehicle passes toll plaza, payment deducted from
• Allows transactions using Aadhaar authentication at micro linked bank account.
ATMs.
Working Mechanism of E–Payment Systems
The e-payment system works through a series of steps involving 4. Instant Fund Transfer – Through NEFT, RTGS, IMPS,
the payer (customer), payee (merchant/service provider), bank, UPI.
and payment gateway/processor.
5. Secure Transactions – Uses encryption, OTP, PIN,
Steps in the E–Payment Process biometric verification.

1. Initiation of Transaction 6. Wide Range of Services – Bill payments, ticket booking,

online shopping, account management.
2. Authentication
7. User-Friendly Platforms – Websites and mobile apps
3. Authorization
designed for easy use.
4. Fund Transfer / Settlement
Uses of E–Banking
5. Confirmation
• Fund Transfer: NEFT, RTGS, IMPS, UPI.
E–Banking (Electronic Banking) refers to the use of electronic
• Bill Payments: Electricity, water, gas, phone, DTH.
channels like the internet, mobile apps, ATMs, and telephone
banking to provide banking services to customers. It eliminates the • Shopping & Ticketing: Online purchases, flight/train
need for physical branch visits by allowing customers to perform booking.
financial transactions online such as money transfer, bill
• Account Services: Balance inquiry, statement download,
payments, balance inquiry, and loan applications. In India, e–
cheque book request.
banking is regulated by the Reserve Bank of India (RBI).
• Loan & Investment: Apply for loans, open FD/RD, invest
Features of E–Banking
in mutual funds.
1. 24×7 Availability – Services accessible anytime, anywhere.
• Tax & Fee Payments: Income tax, GST, insurance
2. Multiple Channels – Internet banking, mobile banking, premiums, university fees.
ATMs, SMS banking, phone banking.
Plastic Money-refers to the use of plastic cards such as debit cards,
3. Paperless Transactions – Digital records instead of manual credit cards, prepaid cards, and smart cards to make financial
entries. transactions without using physical cash. It is called plastic money
because the cards are made of plastic (PVC material) and serve as 10. Limits & Controls – Spending limits, daily withdrawal
a substitute for carrying cash or paper-based instruments like limits set by banks.
cheques. Examples: Visa, MasterCard, RuPay Debit Card, HDFC
Credit Card, Paytm Prepaid Card.
Features of Plastic Money

1. Cashless Transactions – Enables payment without carrying

physical currency.
2. Portability – Easy to carry in wallets and usable anywhere.

3. Variety of Cards – Debit cards, credit cards, prepaid/gift

cards, smart cards.
Difference between Credit Card and Debit Card
4. Wide Acceptance – Can be used at ATMs, POS terminals,
online platforms. Basis Debit Card Credit Card
A card linked to the
5. Security Features – PIN, CVV, OTP, chip-enabled cards for A card that allows the
customer’s bank
safety. customer to borrow
Meaning account; money is
money up to a credit
deducted directly at the
6. Credit Facility – Credit cards allow "buy now, pay later." limit and repay later.
time of transaction.
7. Global Usability – International cards (like Source of Customer’s own bank Bank/NBFC provides
Visa/MasterCard) work worldwide. Funds account balance. credit facility.
Deferred – bill
8. Linked to Accounts – Debit cards directly linked to bank Payment Immediate – money is generated monthly;
accounts; prepaid cards can be loaded with money. Timing deducted instantly. repayment required
later.
9. Reward Benefits – Loyalty points, cashback, discounts on
Provides credit; can pay
usage. Credit Facility No credit facility.
later or convert to EMIs.
 Basis Debit Card Credit Card 6. Low Denomination Use – Commonly used for small day-to-
High – may lead to day transactions.
Risk of Low – limited to
overspending and debt
Overspending available bank balance. 7. Secure & Encrypted – Uses PINs, OTPs, and encryption for
trap.
security.
Interest charged on
Interest No interest, since
unpaid dues (usually 8. Regulated – In India, regulated by RBI & NPCI.
Charges payment is immediate.
30–40% annually).
E–Money (Electronic Money) is a digital alternative to cash that Types of E–Money
represents monetary value stored electronically. 1. Card-Based E–Money
It allows users to make payments through computers, mobile
phones, cards, or online platforms without using physical cash. • Stored on plastic cards (smart cards, prepaid cards).

It is issued by banks or authorized institutions and backed by real • Example: Metro smart card, prepaid debit cards, travel
money in bank accounts. cards.

Examples: UPI, Paytm Wallet, Google Pay, prepaid cards, e-cash. 2. Software-Based E–Money

Features of E–Money • Stored in electronic wallets or online platforms.

1. Digital Form – Exists only electronically, not physically. • Example: Paytm Wallet, Amazon Pay, PhonePe Wallet,
Google Pay Wallet.
2. Stored Value – Represents prepaid value stored in cards,
wallets, or servers. 3. Network Money (UPI / Mobile Banking)

3. Instant Payments – Enables real-time or near-instant • Transactions through mobile-based platforms directly linked
transactions. to bank accounts.

4. Network-Based – Requires internet or mobile network for • Example: UPI, IMPS, mobile banking apps.
transactions. 4. Central Bank Digital Currency (CBDC) – (new form in India)
5. Portability – Can be carried in smartphones, cards, or other • Issued by RBI as Digital Rupee (e₹), representing fiat
devices. money in electronic form.
 • Works as a legal tender similar to cash but in digital form. o Any bank’s cardholder can use them.
ATM (Automated Teller Machine o Example: Tata Indicash ATMs.

An ATM (Automated Teller Machine) is an electronic banking 4. Brown Label ATMs

machine that allows customers to perform basic financial
o Owned by service providers but bank handles cash
transactions without visiting a bank branch or interacting with
management & network connectivity.
bank staff. Customers can withdraw cash, deposit money, transfer
funds, check account balances, etc., using their ATM or debit/credit o Cost-sharing model between banks and ATM
card along with a PIN. operators.

Example: SBI ATM, HDFC ATM, ICICI ATM. 5. Green ATMs

Types of ATMs o Used for promoting paperless and eco-friendly
banking.
1. On-site ATMs
o Provide e-statements, online services without paper
o Located inside or within the premises of a bank
slips.
branch.
6. Mobile ATMs
o Example: SBI ATM inside an SBI branch.
o ATM machines mounted on vehicles to serve
2. Off-site ATMs
remote/rural areas or during emergencies.
o Installed away from bank premises (malls, railway
7. Cash Deposit Machines (CDM) / Recycler ATMs
stations, airports).
o Allow customers to deposit money as well as
o Example: ICICI ATM in a shopping mall.
withdraw cash.
3. White Label ATMs (WLA)
Working Mechanism of ATM
o ATMs set up by non-banking entities but regulated
by RBI.
An ATM (Automated Teller Machine) works as an electronic 2. Location of ATM – Malls, airports, and market areas have
banking terminal that connects a customer’s card to their bank higher demand.
account through a secure network to process transactions.
3. Day of the Week / Month – Demand rises during salary
Step-by-Step Working days, weekends, and festivals.

1. Customer Authentication 4. Seasonal Variations – Holidays, wedding seasons, festive

shopping.
2. Transaction Selection
5. Special Events – Elections, strikes, or emergencies may
3. Transaction Processing
increase demand.
4. Authorization
6. Customer Profile – Rural vs. urban ATMs show different
5. Cash Dispensing (for withdrawals) withdrawal behaviors.

6. Data Recording & Session End 7. Nearby Banking Facilities – ATMs in areas with fewer
bank branches may see more usage.
Forecasting of Cash Demand at ATM-refers to the process by
which banks predict how much cash is needed in each ATM Methods of Forecasting Cash Demand
machine for a given period (daily, weekly, monthly).
1. Historical Trend Analysis
• ATMs do not run out of cash (cash-out situation), and
o Analyzing past data (daily/weekly/monthly
• Banks do not overfill ATMs, which causes idle funds and withdrawals).
higher cash handling costs.
o Example: If an ATM dispensed ₹5,00,000 last Friday,
It is a part of cash management strategy in electronic banking. a similar demand is expected next Friday.

Factors Affecting Cash Demand at ATMs 2. Statistical / Quantitative Models

1. Historical Usage Data – Past withdrawal patterns at each o Moving Average Method – Average of past few days
ATM. used for prediction.
 o Exponential Smoothing – Assigns more weight to 5. Facilitate Electronic Governance (E-Governance)
recent data.
6. Data Protection & Privacy
o Regression Analysis – Forecasting based on
7. Regulation of Certifying Authorities
variables (day, location, season).
8. Promote IT Industry & Foreign Investment
3. Machine Learning / AI Models (Modern Approach)
Scope / Application of IT Act, 2000
o Banks use AI algorithms that analyze multiple factors
(events, trends, spending habits). The IT Act applies to all electronic records, transactions, and
cyber activities taking place in India. It gives legal recognition to
o Example: Predicting cash demand will be 30% higher
e-documents and protects against cybercrimes.
before Diwali.
1. Legal Recognition of Electronic Transactions
IT Act, 2000 (Information Technology Act, 2000)-is a law enacted
by the Government of India to provide legal recognition to • Electronic contracts, digital records, and e-signatures are
electronic transactions, e-commerce, and digital signatures, and legally valid.
to prevent cybercrimes. It came into force on 17th October 2000,
• Example: Online agreements between Amazon and
making India one of the first Asian countries to have a cyber law.
customers are enforceable.
This Act gives legal validity to electronic records and
communications (emails, contracts, digital signatures) which earlier 2. E-Governance
had no legal recognition.
• Enables filing of forms, applications, and documents with
Objectives of IT Act, 2000 government offices electronically.
1. Legal Recognition of E-Transactions • Example: Online filing of Income Tax Returns (ITR), GST
returns, MCA (company) filings.
2. Promote E-Commerce & Digital Business
3. E-Commerce and Digital Business
3. Digital Signatures & Authentication
• Provides a legal framework for online trade, digital
4. Prevent Cybercrimes & Fraud
payments, and e-contracts.
 • Example: Flipkart, Paytm, Zomato transactions are legally • Example: Fraudulent withdrawal using cloned ATM card =
protected. offence.

4. Cybercrimes & Offences 8. International & Cross-Border Application

• Covers offences like hacking, identity theft, cyber terrorism, • Applies to cybercrimes committed outside India if they
phishing, online fraud, spreading viruses, publishing obscene involve a computer/network located in India.
content.
• Example: A hacker sitting in the US targeting an Indian
• Example: Hacking a bank’s server or creating fake job bank server.
portals is punishable.
9. Regulation of Intermediaries
5. Regulation of Digital Signatures & Certificates
• Social media platforms, ISPs, and online service providers
• Digital signatures and e-signatures used in online must follow due diligence.
transactions are recognized and regulated.
• Example: WhatsApp must take steps to prevent fake news
• Example: DSC (Digital Signature Certificate) used by CAs under IT Act obligations.
for e-filing company returns.
10. Promotion of IT Industry & E-Governance
6. Cybersecurity & Data Protection
• Facilitates growth of IT companies, outsourcing, digital start-
• Protects against unauthorized access, alteration, or ups, and paperless government services.
destruction of data.
The Payments Vision 2025 is a strategic roadmap released by the
• Example: Unauthorized access to a company’s confidential RBI to guide the development of India's payment systems until
files = penalty under Sec. 43. 2025. It builds upon the achievements of the previous vision and
sets clear goals to further strengthen the digital payment
7. Electronic Banking & E-Payments
infrastructure, ensuring it meets the evolving needs of the economy
• ATM transactions, net banking, UPI, credit card payments and society.
fall under IT Act protection.
Objectives
 1. Enhance Payment System Integrity: Ensure that payment 1. Malware – Malicious software like viruses, worms, Trojans,
systems are secure, reliable, and resilient to cyber threats. spyware, and ransomware that can damage systems or steal
data.
2. Promote Financial Inclusion: Expand access to digital
payment services, especially in underserved and rural areas. 2. Phishing Attacks – Fraudulent emails or messages that trick
users into revealing sensitive information.
3. Foster Innovation: Encourage the development and
adoption of new technologies to improve payment services. 3. Ransomware – Malware that encrypts files and demands
payment for unlocking them.
4. Strengthen Customer Confidence: Build trust among users
through transparent, efficient, and user-friendly services. 4. Hacking / Unauthorized Access – Intruders breaking into
systems to steal, modify, or delete data.
5. Establish Global Leadership: Position India as a global
leader in digital payments by enhancing international 5. Denial of Service (DoS) / Distributed Denial of Service
interoperability. (DDoS) Attacks – Overloading servers or networks to make
services unavailable.
Security Threats
6. Insider Threats – Employees or trusted users misusing their
Meaning
access to compromise data or systems.
A security threat refers to any potential danger that can exploit a
7. Social Engineering – Manipulating individuals to reveal
vulnerability in a system to gain unauthorized access, cause
confidential information (e.g., pretexting, baiting).
damage, or steal information.
8. SQL Injection – Exploiting vulnerabilities in web
In simple words, it is anything that can harm the confidentiality,
applications to access or manipulate databases.
integrity, or availability of data, networks, or computer systems.
9. Man-in-the-Middle (MitM) Attack – Intercepting
Example: Hacking into a bank’s server to steal customer data is a
communication between two parties to steal or alter data.
security threat.
10. Zero-Day Exploits – Attacks exploiting software
Cyber Security Threats
vulnerabilities before they are patched by developers.
 11. Password Attacks / Credential Theft – Brute force, CAPITAL ADEQUACY refers to the measure of a bank’s
dictionary attacks, or keylogging to steal passwords. financial strength, specifically its ability to cover risks with its
own capital. It ensures the bank has enough capital to absorb losses
12. Drive-by Downloads – Automatic downloading of malware
and protect depositors. Example: If a bank has high capital
when visiting a compromised website.
adequacy, it can handle bad loans or financial shocks without failing.
13. Cyber Espionage / Advanced Persistent Threats (APTs) – Banks are required to maintain a minimum Capital Adequacy
Long-term targeted attacks to steal sensitive information for Ratio (CAR) as per RBI or Basel norms.
political, financial, or strategic purposes Strategies for Capital Funding:
1. Equity Financing
Initiatives by RBI to Tackle Security Threats
2. Debt Financing:
1. Issuing Cybersecurity Guidelines 3. Internal Funding (Retained Earnings)
4. Hybrid Instruments:
2. Encouraging Two-Factor / Multi-Factor Authentication
5. Venture Capital / Private Equity
3. Regulation of Payment Systems Meaning of Deposits
A deposit is a sum of money placed by an individual or organization
4. RBI Security Audits and Inspections
with a bank or financial institution for safekeeping, earning interest,
5. Monitoring and Reporting Mechanisms or for future withdrawal. Deposits are a primary source of funds for
banks, which they use to provide loans and other financial services.
6. Public Awareness & Financial Literacy
Features of Deposits
7. Strengthening Digital Payment Ecosystem 1. Safe Custody of Money: Banks provide a secure place to
keep money.
8. Collaboration with Cyber Security Agencies
2. Return or Interest: Banks usually pay interest on deposits
9. Guidelines for Outsourcing and Third-Party Services (except some accounts like current accounts).
3. Repayable on Demand or Maturity: Deposits can be
10. Development of Security Infrastructure
withdrawn either on demand (like savings accounts) or after
UNIT-2 MANAGING BANK FUNDS OR PRODUCTS AND a fixed period (like fixed deposits).
RISKMANAGEMENT 4. Receipt Issued: Banks issue a deposit receipt or passbook as
proof of the deposit.
 5. Legal Contract: Deposit is a contractual relationship Feature Savings Account Current Account
between depositor and bank. Moderate, some High, unlimited
Liquidity
6. Source of Bank Funds: Banks use deposits to provide loans restrictions transactions
or investments. Cheque Book / Cheque facility and Cheque facility and
Types of Deposits Online online banking online banking
1. Savings Deposits Transactions available available
2. Current Deposits / Current Account ₹50,000 deposited by ₹2,00,000 deposited by
3. Fixed Deposits (Term Deposits) Example a student or salaried a shopkeeper for daily
person business
4. Recurring Deposits
5. Other Deposits
Designing Deposit Schemes-Designing a deposit scheme means
creating a bank product or account type that attracts deposits from
Current Account and a Savings Account: customers, tailored to their needs and the bank’s objectives.
Feature Savings Account Current Account
For business or Objectives:
For personal savings
Purpose professional
and small transactions
transactions • Attract more funds from customers
Earns interest on the • Provide convenience and flexibility
Usually no interest on • Ensure profitability for the bank
Interest balance (usually 3-
the balance • Promote long-term relationships
6%)
Low minimum
Higher minimum Steps/Considerations in Designing a Deposit Scheme:
Minimum Balance balance required
balance required
(varies by bank)
1. Identify Target Customers:
Limited withdrawals No limit on o Individuals (salaried, students, senior citizens)
Withdrawal
per month (as per withdrawals or o Businesses and professionals
Limits
bank policy) transactions o NRIs
Overdraft facility 2. Type of Deposit:
Overdraft Facility Usually not available
available for businesses o Savings Account, Current Account, Fixed Deposit,
Individuals, salaried Businesses, companies, Recurring Deposit, Special Deposits
Who Can Open
persons traders, professionals 3. Interest Rate Offered:
 o Competitive but sustainable o RBI directives on interest rates for savings, term
o Can be fixed, tiered, or promotional deposits, etc.
4. Minimum Balance & Tenure: Meaning of Non-Deposits
o Decide minimum deposit amount Non-deposit sources are funds that a bank or financial institution
o Tenure for term deposits or recurring deposits raises without taking deposits from customers. These are usually
5. Liquidity/Withdrawal Rules:
borrowed funds or funds generated internally. Unlike deposits, these
o How easily can the customer withdraw?
o Premature withdrawal penalties for fixed deposits
sources are not repayable on demand like savings or current
6. Additional Benefits: accounts.
o Free ATM/debit card, online banking, insurance, Example:
bonus interest for senior citizens • Borrowing ₹5,00,000 from another bank for short-term
funding.
Pricing of Deposit Source- refers to the cost to the bank for • Issuing debentures to raise ₹10 crore for expansion.
mobilizing funds from various sources. Banks pay interest or
Features of Non-Deposits
provide benefits to attract deposits, which is essentially the cost of
funds. 1. Not from General Public: Raised through borrowing or
internal sources, not public deposits.
Factors Affecting Pricing: 2. Interest or Cost: Usually has a cost (like interest or
dividend) for the bank.
1. Type of Deposit: 3. Short-term or Long-term: Can be for working capital
o Current account: no interest, so cheaper source of
(short-term) or capital expansion (long-term).
funds
o Savings account: low interest 4. Repayment Obligation: Bank must repay or honor the
o Fixed deposits: higher interest, more expensive borrowings on maturity.
2. Tenure of Deposit: Types of Non-Deposit Sources
o Longer-term deposits may have higher interest rates A. Borrowings from Other Banks or Financial Institutions
3. Liquidity Needs of Bank: • Meaning: Banks can borrow money from RBI, other banks,
o High liquidity needs → higher interest offered to
or financial institutions to meet liquidity needs.
attract deposits quickly
• Example: Interbank lending, borrowing from RBI under
4. Market Rates / Competition:
o Interest rates offered by other banks influence pricing repo facility.
5. Regulatory Guidelines: B. Issue of Bonds/Debentures
 • Meaning: Raising long-term funds by issuing bonds or • Assessing the borrower’s creditworthiness
debentures to investors. • Determining loan amount, interest rate, and tenure
• Example: HDFC Bank issues debentures worth ₹100 crore • Monitoring loan utilization
to fund expansion. • Ensuring timely repayment
C. Refinance or Loans from Central/Development Banks Example:
• Meaning: Borrowed from RBI, NABARD, SIDBI, or other • A bank giving a home loan to Mr. A after checking his
development institutions. income, credit score, and repayment capacity is practicing
• Example: SIDBI provides refinance to a commercial bank loan management.
for lending to MSMEs. 2. Types of Loans
D. Capital from Shareholders A. Secured Loans
• Meaning: Equity capital invested by promoters or B. Unsecured Loan
shareholders. Other Classification of Loans
• Example: A bank raises ₹200 crore through an IPO or Type of Loan Meaning Example
private placement. Home Loan / Loan to purchase/build a ₹30 lakh home
E. Internal/Retained Earnings Mortgage Loan house loan from SBI
• Meaning: Profits earned by the bank that are retained
Car / Vehicle Loan Loan to buy vehicles ₹10 lakh car loan
instead of paying as dividends.
• Example: SBI retains ₹500 crore from its annual profit to Loan for personal needs ₹2 lakh personal
Personal Loan
strengthen capital. like medical, travel loan
F. Other Short-Term Borrowings ₹5 lakh for MBA
Education Loan Loan for higher education
• Meaning: Borrowings in the form of call money, certificate studies
of deposits (CDs), or commercial paper (CPs). ₹1 lakh against
Gold Loan Loan against gold jewelry
• Example: A bank issues ₹50 crore in commercial paper to gold ornaments
meet short-term fund requirements. ₹50 lakh for
Meaning of Loan Management Business / Loan to finance business
expanding a
Loan Management refers to the process by which banks or Commercial Loan needs
factory
financial institutions grant, monitor, and recover loans efficiently
while minimizing the risk of default. It involves:
Type of Loan Meaning Example 1. Adoption of Artificial Intelligence (AI) and Automation
2. Growth of Digital Lending
Overdraft / Cash Short-term loan against ₹10 lakh overdraft
3. Focus on Financial Inclusion
Credit current account facility 4. Regulatory Enhancements
Meaning of Loan Management TYPES OF LOAN PRICING METHODS in banking, along with
Loan Management is the systematic process by which banks grant, examples:
monitor, and recover loans while managing credit risk efficiently. 1. Fixed Rate Loans
It ensures proper use of bank funds, minimizes defaults, and 2. Floating Rate Loans
maintains regulatory compliance. 3. Cost-Benefit Loan Pricing
Objective: 4. Customer Profitability Analysis (CPA) Pricing
• Ensure timely and responsible lending 5. Cost Plus Analysis
• Minimize risk of non-performing assets (NPAs) 6. Relationship-Based Pricing
• Maximize profitability while safeguarding deposits 7. Risk-Based Pricing
Process of Loan Management in Indian Banks MEANING OF INVESTMENT MANAGEMENT IN BANKS
Step 1: Loan Application / Proposal Investment Management (IM) in banks refers to the professional
Step 2: Credit Appraisal management of a bank’s investment portfolio to achieve financial
Step 3: Risk Assessment & Classification goals while minimizing risk. Banks invest in various instruments
Step 4: Loan Sanction / Approval like government securities, bonds, mutual funds, corporate debt, and
Step 5: Documentation other financial assets to earn income, maintain liquidity, and manage
Step 6: Disbursement of Funds risk.
Step 7: Monitoring & Supervision Example:
Step 8: Recovery / Repayment • A commercial bank invests ₹50 crore in government bonds
Step 9: Reporting & Compliance to earn stable interest income.
Key Issues in Loan Management • Another bank invests in corporate debentures to diversify
1. Rising Defaults in Unsecured Retail Loans income sources.
2. Margin Pressures Amid High Interest Rates Features of Investment Management in Banks
3. Cybersecurity and IT Risks. 1. Objective-Oriented
4. Legal and Recovery Challenges
2. Risk and Return Trade-Off
Recent Trends in Loan Management
 3. Professional Management 5. Mitigation of Maturity Mismatch
4. Diversification 6. Risk Management
5. Liquidity Consideration 7. Strategic Planning
6. Regulatory Compliance 8. Customer Confidence
Functions of Investment Management in Banks
1. Portfolio Planning and Construction
2. Investment Appraisal and Selection
3. Execution of Investments
4. Monitoring and Control
5. Risk Management
6. Compliance and Reporting
7. Maximizing Returns
8. Strategic Advisory
MEANING OF ASSET AND LIABILITY MANAGEMENT
PROCEDURE OF ALM
(ALM)
1. Setting Objectives
Asset and Liability Management (ALM) is the process by which
2. Establishing ALM Policy
banks manage their assets and liabilities to ensure financial
3. Data Collection
stability, profitability, and liquidity. It involves matching the
4. Risk Identification
maturities and interest rates of assets (loans, investments) with
5. Measurement and Analysis
liabilities (deposits, borrowings) to minimize risk.
6. Setting Limits
Example: A bank has short-term deposits and long-term loans.
7. Strategy Formulation
ALM helps ensure the bank has enough liquidity to meet deposit
8. Implementation
withdrawals while earning income from loans.
9. Monitoring and Reporting
2. Needs / Importance of Asset and Liability Management
10. Review and Feedback
1. Liquidity Management
EMERGING ISSUES OF ASSET-LIABILITY MANAGEMENT
2. Interest Rate Risk Management
(ALM) IN BANKS. These reflect both global and Indian banking
3. Profitability Optimization
trends:
4. Capital Adequacy & Regulatory Compliance
1. Interest Rate Volatility 4. Competition
2. Liquidity Risk Management 5. Public Confidence Crisis
3. Credit Risk in ALM FINANCIAL DISTRESS PREDICTION MODELS are tools
4. Market Risk and Volatility used by banks, regulators, and investors to assess the likelihood
5. Regulatory Compliance Pressure that a bank or firm will face financial difficulties or bankruptcy
6. Technological Challenges in the future.
7. Complexity of Financial Products These models use financial ratios, accounting data, and market
8. Globalization and Cross-Border Risks variables to provide early warnings of distress.
9. Economic and Geopolitical Uncertainty Types of Prediction Models
10. Integration of ESG (Environmental, Social, Governance) Factors A. Accounting-Based Models
FINANCIAL DISTRESS IN BANKS These rely on financial statement ratios to predict distress.
Financial distress refers to a situation where a bank faces difficulty 1. Altman’s Z-Score Model
in meeting its financial obligations, such as paying depositors, • Developed by Edward Altman (1968) for manufacturing
creditors, or managing operational expenses. firms; later adapted for banks.
It occurs before insolvency or bankruptcy, indicating a warning Example:
stage where the bank is under pressure due to poor liquidity, high A bank with low working capital and high leverage may have a Z-
losses, or mismanagement. score of 1.5, indicating high probability of distress.
Causes of Financial Distress in Banks 2. Ohlson O-Score Model
A. Internal Causes • Uses logistic regression with 9 accounting ratios and
1. Poor Asset Quality variables.
2. Liquidity Mismatch • Predicts probability of bankruptcy.
3. Inadequate Capital • Variables include size of firm, liquidity, profitability,
4. Poor Management and Governance leverage, and current liabilities.
5. High Operating Costs Example:
B. External Causes A bank with negative retained earnings, high total liabilities, and
1. Economic Downturn low current ratio will have a high O-score, signaling distress.
2. Regulatory Changes B. Market-Based Models
3. Market Volatility
These use market information such as stock prices, volatility, and It involves corrective measures in operations, finances,
credit spreads. management, and strategy to ensure long-term sustainability.
1. Merton’s Distance-to-Default Model Strategies/Methods for Rehabilitation
• Based on option pricing theory. A. Financial Restructuring
• Measures how far a firm’s asset value is from the default B. Operational Restructuring
point. C. Managerial or Governance Restructuring
Interpretation: D. Liquidity Management
• Higher Distance-to-Default (DD) → lower probability of E. Strategic or Business Restructuring
distress. F. Government or Regulatory Support
• Lower DD → higher risk. FINANCIAL SICKNESS IN BORROWERS
Example: Financial sickness refers to a situation where a borrower
If a bank’s asset value drops below its debt obligations due within a (individual, firm, or company) is unable to meet its financial
year, DD falls → indicates potential financial distress. obligations due to poor liquidity, high debt, or declining
C. Hybrid Models profitability.
• Combine accounting ratios and market indicators. For banks and financial institutions, early detection of financial
• Often use logistic regression, discriminant analysis, or sickness is critical to prevent loan defaults and minimize credit risk.
machine learning. Signals of Financial Sickness in Borrowers
• Examples include Artificial Neural Networks (ANN), The signals can be classified into financial, operational, and
Decision Trees, and Support Vector Machines (SVM). behavioral indicators:
Example: A. Financial Indicators
An ANN model can take in multiple ratios like CAR, NPA ratio, 1. Declining Profitability
ROA, liquidity ratio, and predict the probability of bank distress 2. High Leverage / Debt Burden
with higher accuracy than traditional models. 3. Liquidity Problems
MEANING OF REHABILITATION OF FINANCIAL 4. Negative Cash Flow
DISTRESS 5. Accumulating Losses
Rehabilitation refers to the process of restoring a financially B. Operational / Business Indicators
distressed bank or firm to a stable, solvent, and profitable 1. Decline in Sales or Market Share
condition. 2. High Inventory / Receivables
 3. Inefficient Cost Management Main Strategies Used in Risk Management
4. Disruption in Production or Services A. Risk Avoidance
C. Behavioral / Management Indicators B. Risk Reduction / Mitigation
1. Frequent Borrowing C. Risk Sharing / Transfer
2. Avoiding Financial Disclosures D. Risk Retention / Acceptance
3. Delayed Payments E. Risk Monitoring and Review
4. Change in Management Behavior F. Risk Hedging
5. Over-Dependence on Banks
MEANING OF RISK MANAGEMENT G. Risk Diversification
Risk Management is the process of identifying, assessing, H. Contingency Planning
monitoring, and controlling potential events or situations (risks) RISK MEASUREMENT AND MANAGEMENT Is the
that could negatively affect an organization’s assets, income, or systematic process of identifying, assessing, quantifying,
operations. In banks and financial institutions, risk management is mitigating, and monitoring risks faced by banks to ensure
essential to protect capital, maintain liquidity, ensure financial stability, profitability, and regulatory compliance. It helps
profitability, and comply with regulatory requirements. banks make informed decisions and take corrective actions before
Types of Risk Management risks turn into losses.
A. Credit Risk Management Steps in Risk Measurement:
B. Market Risk Management 1. Identification of Risks
C. Liquidity Risk Management 2. Risk Quantification
D. Operational Risk Management 3. Risk Assessment / Evaluation
E. Legal and Compliance Risk Management 3. Risk Management Process
F. Strategic Risk Management Step 1: Risk Identification
G. Reputational Risk Management Step 2: Risk Measurement / Analysis
RISK MANAGEMENT STRATEGIES are the planned Step 3: Risk Evaluation / Prioritization
approaches or techniques used by banks to identify, assess, Step 4: Risk Mitigation / Control
mitigate, and monitor risks to minimize potential losses and ensure Step 5: Risk Monitoring and Reporting
stability. Effective strategies aim to reduce the probability and Step 6: Feedback and Review
impact of adverse events while optimizing opportunities. ROLE OF RBI IN RISK MANAGEMENT
A. Regulatory Framework and Guidelines o Short-term rates may rise faster than long-term rates.
B. Supervision and Monitoring o A bank holding long-term fixed deposits and short-
C. Risk Assessment and Early Warning Systems term loans may earn less than expected.
D. Guidance on Risk Management Practices C. Optionality Risk
E. Financial Stability and Contingency Measures • Definition: Risk arising from embedded options in bank
F. Training and Capacity Building products (loans, deposits) that customers may exercise.
Interest Rate Risk (IRR) • Example:
Interest Rate Risk refers to the potential loss a bank or financial o Prepayment of fixed-rate loans by borrowers when
institution may face due to changes in interest rates, which affect interest rates fall.
the value of assets, liabilities, and off-balance-sheet items. It o Early withdrawal of deposits during rising rates.
primarily affects net interest income and economic value of D. Basis Risk
equity. Common in banks because liabilities (deposits) and assets • Definition: Risk from different interest rate indices
(loans, investments) have different maturities and repricing affecting assets and liabilities unequally.
periods. • Example:
Types of Interest Rate Risk o Loan linked to 6-month LIBOR while deposit is
A. Repricing Risk linked to 3-month LIBOR.
• Definition: Risk arising from timing mismatches in the o Changes in indices affect net interest income.
repricing of assets and liabilities. E. Spread Risk
• Example: • Definition: Risk due to change in the spread between rates
o A bank gives a 5-year fixed-rate loan but funds it of different financial instruments.
with a 1-year deposit. • Example:
o If interest rates rise after 1 year, the bank has to pay o Corporate bond yield increases relative to
more on deposits while earning the same on loans, government securities.
reducing profit. o Bank holding bonds with fixed spread faces losses in
B. Yield Curve Risk / Basis Risk portfolio value.
• Definition: Risk due to changes in the shape of the yield Management of Interest Rate Risk
curve affecting assets and liabilities differently. A. Gap Analysis
• Example: B. Duration Analysis
C. Hedging Using Derivatives o Example: An importer agrees to pay USD 100,000 in
D. Product Design Adjustments 3 months at INR 83/USD. Even if INR depreciates,
E. ALM Committee Monitoring payment is locked at 83.
F. Stress Testing and Scenario Analysis 2. Futures Contracts
FOREIGN EXCHANGE RISK (FOREX RISK) refers to the o Standardized contracts traded on exchanges to
potential loss a bank, firm, or investor may incur due to buy/sell currency at a future date at a fixed rate.
fluctuations in exchange rates between currencies. o Useful for hedging predictable exposures.
• Common in banks, multinational companies, importers, 3. Options Contracts
exporters, and investors holding foreign currency o Gives the right, but not obligation, to buy/sell
assets/liabilities. currency at a predetermined rate.
• Forex risk can reduce profits, increase costs, or erode asset o Protects against adverse movements while allowing
value. Example: An Indian importer buys goods worth USD benefit from favorable changes.
100,000. If INR depreciates from 82/USD to 85/USD, the o Example: Call option for USD to cover import
payment in INR increases, resulting in foreign exchange payments.
loss. 4. Currency Swaps
2. Types of Forex Risk o Agreement to exchange currency cash flows
A. Transaction Risk between two parties at specified rates and times.
B. Translation Risk (Accounting Risk) o Used for long-term hedging of foreign currency
C. Economic Risk (Operating Exposure) liabilities.
D. Competitive Risk B. Natural Hedging / Operational Techniques
E. Contingent Risk 1. Matching Currency Flows
Methods to Manage Forex Risk o Match revenues and expenses in the same currency
A. Hedging Using Financial Instruments to minimize exposure.
1. Forward Contracts o Example: An exporter earning USD uses USD to pay
o Agreement to buy/sell foreign currency at a for imported raw materials.
predetermined rate on a future date. 2. Netting
 o Consolidate multiple currency inflows and 2. Reporting requirements for currency exposure.
outflows within a company or group to reduce the 3. Guidelines for hedging and derivatives use.
need for external forex transactions. Example: Banks must maintain overall net open position (NOP)
3. Leading and Lagging within RBI limits to control forex risk.
o Adjust the timing of payments or receipts G. Insurance (Political / Economic Risk)
depending on expected exchange rate movements. • For exporters/importers facing country risk or payment
o Example: Advance payment if INR is expected to default, export credit insurance or political risk insurance
depreciate. can mitigate losses.
C. Diversification
MARKET RISK
• Spread transactions across multiple currencies or markets
to reduce dependence on a single currency. Market Risk is the potential loss a bank, financial institution, or
• Reduces impact of adverse movement in one currency. investor may incur due to changes in market variables such as:
D. Monitoring and Forecasting
• Interest rates
• Continuously track exchange rates, economic indicators,
and currency trends. • Equity prices
• Use technical and fundamental analysis to anticipate
• Commodity prices
currency movements.
• Helps in timely hedging or adjusting exposures. • Foreign exchange rates
E. Setting Limits and Policies
It affects the value of assets, liabilities, or off-balance sheet items.
• Banks and firms should establish:
o Exposure limits per currency. Example:
o Stop-loss limits for trading desks.
• A bank holding government bonds may face losses if
o Risk management policies approved by senior
interest rates rise, reducing bond prices.
management.
F. Using RBI Guidelines (for Indian Banks) OPERATIONAL RISK
• RBI provides frameworks for managing forex risk:
Operational Risk is the risk of loss resulting from inadequate or
1. Prescribed limits on open foreign exchange
failed internal processes, people, systems, or external events.
positions.
 • It is different from credit or market risk, as it does not o Wrong data entry affecting account balances.
arise from external market conditions or borrower default.
C. Systems / Technology Risk
• Present in daily banking operations, IT systems, human
• Definition: Risk arising from failure or breakdown of IT
resources, and compliance processes.
systems and infrastructure.
Example:
• Example:
• A bank suffers a financial loss due to fraudulent
o Online banking system crash causing transaction
transactions by an employee or system failure during
failures.
online banking.
o Cyber attacks leading to loss of data or funds.
Types of Operational Risk
D. Legal and Compliance Risk
A. Process Risk
• Definition: Risk of loss due to violation of laws,
• Definition: Risk arising from faulty or inefficient internal
regulations, or contractual obligations.
processes.
• Example:
• Example:
o Penalty for non-compliance with KYC/AML norms.
o Delay in loan disbursement due to improper approval
workflow. o Lawsuits due to misleading financial disclosures.

o Mistakes in cheque processing or reconciliation. E. External / Event Risk

B. People / Human Risk • Definition: Risk due to events beyond the bank’s control.

• Definition: Risk due to errors, negligence, or fraud by • Example:

employees.
o Natural disasters destroying branch infrastructure.
• Example:
o Terrorist attacks or geopolitical events affecting
o Misappropriation of funds by a teller. operations.
3. Ways to Overcome / Manage Operational Risk E. Insurance / Risk Transfer
A. Strong Internal Controls • Transfer some operational risks through insurance policies.

• Implement checks and balances, approval hierarchies, • Example: Fraud insurance, cyber risk insurance, and
and standard operating procedures (SOPs). business interruption insurance.

• Example: Dual verification for fund transfers above a certain F. Business Continuity and Disaster Recovery Planning
limit.
• Prepare contingency plans to maintain operations during
B. Staff Training and Awareness disruptions.

• Train employees on fraud prevention, compliance, and • Example: Backup data centers for IT systems; alternate sites
operational procedures. for branch operations.

• Example: Regular workshops on cybersecurity and KYC G. Monitoring and Reporting

norms.
• Regular internal audits, risk reporting, and Key Risk
C. Technological Upgradation Indicators (KRIs).

• Use secure IT systems, backup servers, and real-time • Example: Weekly reports on system downtime, fraud cases,
monitoring. and process errors.

• Example: Installing firewalls, anti-virus software, and secure H. Regulatory Compliance

authentication for online banking.
• Adhere to RBI / Basel II & III guidelines for operational
D. Risk Assessment and Mapping risk management.

• Identify processes prone to operational risk and assign risk • Example: Maintain operational risk capital as per Basel
ratings. norms.

• Example: Map all steps in loan processing to find high-risk SOLVENCY RISK
areas.
Solvency Risk is the risk that a bank, financial institution, or H. Monitoring Financial Health
borrower may not be able to meet its long-term financial
NON-PERFORMING ASSET (NPA) refers to a loan or advance
obligations due to insufficient capital or net worth. It occurs
in which the borrower has stopped paying interest or principal
when liabilities exceed assets, or when capital adequacy is
for a specified period. In India, according to RBI, a loan is
inadequate to absorb losses. Solvency risk is more serious than
classified as an NPA if: Interest and/or principal remain overdue for
liquidity risk because it indicates potential insolvency or
more than 90 days for term loans. Example: A corporate borrower
bankruptcy. Example: A company has huge debts and declining
takes a term loan of ₹1 crore. If interest or principal is overdue for
profits. Even if it can pay short-term obligations, it may default on
more than 90 days, the loan is classified as NPA.
long-term loans due to low net worth.
METHODS TO RECOVER NPAS (NON-PERFORMING
Causes of Solvency Risk
ASSETS) IN BANKS:
1. Excessive Debt / High Leverage
A. One-Time Settlement (OTS)
2. Declining Profits or Continuous Losses
B. Restructuring / Rehabilitation
3. Poor Asset Quality
C. Legal Recovery
4. Market Volatility
D. Asset Reconstruction Companies (ARCs)
5. Inadequate Capital Management
E. Recovery Through Compromise / Negotiation
Ways to Overcome / Manage Solvency Risk
G. Recovery Through Sale of Secured Assets
A. Maintaining Adequate Capital H. Recovery Through Collection Agencies
CURRENT ISSUES IN NPAS
B. Asset Quality Improvement
A. Rising NPA Levels
C. Profitability Enhancement
B. Slow Recovery Process
D. Risk Management Practices C. Stress in Specific Sectors
D. Willful Defaults
E. Debt Restructuring and Refinancing
E. Impact of Economic Slowdown
F. Regulatory Compliance F. Regulatory and Reporting Issues
G. Lack of Effective Early Warning Systems
G. Contingency Planning
H. High Recovery Costs
I. Corporate Governance Issues Type Description Example
J. Challenges in Resolving Stressed Assets
MERGING OF BANKS One bank absorbs
SBI and its associate
Absorption another; acquiring bank
Merging of Banks refers to the process in which two or more banks merger
continues
banks combine their operations to form a single [Link]
merger can involve: Merger of Dena Bank,
Two or more banks form
Amalgamation Vijaya Bank, and Bank
1. Absorption: One bank is absorbed by another, and a new bank
of Baroda
only the acquiring bank continues to exist.

2. Amalgamation: Two or more banks combine to form

a completely new bank. TYPES OF BANK MERGERS WITH EXAMPLES:
1. Horizontal Merger
Example: In India, State Bank of India (SBI) merged with its Definition:
associate banks in 2017 to become a single large entity. • Merger between two banks operating at the same level in

2. Reasons for Merging of Banks the same industry and offering similar products/services.
Purpose:
1. Financial Strength • Expand market share, branch network, and customer
2. Operational Efficiency base.
3. Competitive Advantage Example:
4. Reducing Non-Performing Assets • SBI merging with its associate banks (State Bank of
5. Regulatory Push Bikaner, State Bank of Mysore, etc.) in 2017.
6. Expansion of Services • Both were in retail and commercial banking, so it was
3. Types of Bank Mergers horizontal.
2. Vertical Merger
Definition:
• Merger between banks at different stages of the banking
process or supply chain.
• Typically done to control more of the operational chain.
Example: Definition:
• A commercial bank merging with a credit card company • Merger between parent bank and its wholly-owned
or a mortgage subsidiary to control lending and payments. subsidiary.
3. Conglomerate / Congeneric Merger • Requires less legal and regulatory formalities.
Definition: Example:
• Merger between banks or financial institutions that are in • SBI merging with SBI Subsidiaries (like State Bank of
related but not directly competing businesses. Travancore) was treated as a short-form merger because SBI
• Focuses on diversifying products and reducing risk. was the parent.
Example: MERGING AND ACQUISITION OF BANKS INTO
• A commercial bank merging with an insurance company SECURITIES MARKETS – PURPOSE AND BENEFITS (IN
or asset management firm. SHORT):
4. Reverse Merger Benefits:
Definition: 1. Economies of scale – lower costs through larger operations.
• A smaller or weaker bank merges with a larger bank, but 2. Improved financial strength – higher capital and better risk
the smaller bank’s shareholders get significant control. management.
• Often used to list the smaller bank in stock markets 3. Wider range of services – banks can offer investment and
indirectly. securities products.
Example: 4. Better customer reach – expanded network and market
• If a smaller cooperative bank merges with a public bank but share.
the cooperative bank’s management gains influence. 5. Increased profitability – from diversified income sources.
5. Cash Merger How Merging and Acquisition of Banks into Securities Markets
Definition: is Done (in short):
• Merger in which the acquiring bank pays cash to the 1. Identification & Evaluation: Banks identify potential
shareholders of the acquired bank. partners or targets (other banks or financial firms) for merger
Example: or acquisition.
• Bank A acquires Bank B by buying shares at an agreed 2. Due Diligence: Financial, legal, and operational details are
cash price. carefully examined.
6. Short-Form Merger
 3. Valuation & Negotiation: The value of each entity is
assessed and merger/acquisition terms are negotiated.
4. Approval Process:
o Approval from RBI, SEBI, and sometimes
Competition Commission of India (CCI).
o Approval from shareholders and boards of both
institutions.
5. Integration: After legal approval, both institutions combine
their assets, liabilities, systems, and staff.
6. Listing & Trading: The merged entity may issue new shares
or get listed on the securities market for trading.
Example:
When HDFC Bank merged with HDFC Ltd (2023) – it combined
banking and financial services, becoming part of a larger financial
market presence.