Evolution of banking institutions

1. Banking Law-Anusha M Virupannavar Assistant Professor KLE Society’s Law,Bengaluru

2. Evolution of banking institutions “bancus” or “banque” which means bench. Early bankers, the Jews transacted their business on benches in the market place.

3. When banker was unable to meet his obligation, his bench was broken up by people; it is called “bankrupt.” • The word “bank” is originally derived from the German word “back” meaning joint stock fund.

4. Early history of banking • 2000 B.C., the Babiloninas had developed a banking system. • Temples of Babylon were used as banks. • Great temples Ephesus & of Delphi were the most powerful of the Greek banking institution .

5. Spread of irreligion destroyed the public sense of security in depositing valuables in temple & priest were no where acting as financial agents. • Aristotle’s dictum-charging of interest was unnatural and consequently immoral. Even now Mohammedans in obedience to the commands contained in their religious books, refuse to accept interest on money loans.

6. Evolution of Banking law • The India banking law is based to a very large extent upon the English Banking Law. • Beside Banking Law, the Law of Contract, the Law of Torts and other branches of commercial and civil laws are applicable to banks as to others.

7. Law merchant or Lexmercatoria • customs of merchants • ratified by courts and become part of general law. • Lord Mansfield’s ruling • Post industrial revolution period, banking law largely judge made law. • Took into consideration customs of merchants of the advanced European Countries.

8. Development of British Banking • Royal exchanger • In England, Edward III-Royal Exchanger for the benefit of the Crown. • Goldsmiths • Land ceased to be the only form of wealth, merchants began to hold part of their “capital” in cash. • Merchants entrusted their cashiers with large sums, later misappropriated.

9. City merchants decided to keep their cash with goldsmiths, who had strong rooms and doors and employed watchmen. • Early beginning of “Issue” and “Deposit” banking • Large sums of money were left with the goldsmiths for safe custody, against signed receipts- “goldsmiths’ notes”. • Notes- embodying an undertaking to return money to depositor or to bearer on demand.

10. Transformed from receipt to a bank note- considerable circulation. • Large money were left with them. • Following Dutch bankers-thought it is profitable to lend which is to be repaid within a fixed time. • In order to attract more depositors they began to offer interest on deposits. • Current banking • In 1672, English banking received a rude setback.

11. Charles II borrowed heavily and repudiated his debts. • Crisis ensued, leading to general suspension of payments. Confidence, however, was restored. • Receive deposits on “current account” i.e., money withdrawal without notice. • Bank of England (1694) • The Tonnage Act • Financial difficulties of William III, was carrying war with France. • The public distrust of goldsmiths.

12. Mr. Patterson-raise $1,200,000, a loan to the Govt, certain concession the right to issue notes were given to proposed institution. • Certain important provisions of the Act are as follows- • Authorized the raising of $1,200,00 by subscription, the subscribers forming a corporation called “The Governor and company of the Bank of England”

13. 2.The Corporation was to lend the whole of its capital to the Govt , interest @ 8% & $4000 for expenses of management. 3. Corp. have a privilege of bank for12 years, Govt preserved the right of annulling the charter after giving 1 yr notice toCorp. 4. Corp. was forbidden to trade in any merchandise, but allowed to deal in bill of exchange, gold or silver bullion & to sell wares or merchandise upon which it has advanced money.

14. The new bank is a big competitor to the comparatively small private banks. • Monopoly of note issue: prohibited any other bank, with more than 6 partners, issuing promissory notes i.e., bank notes • Limited supply of Bank of England notes • The Act gave monopoly of note issue to the Bank of England, so far joint stock companies were concerned, but left private banks having not more than six partners free to issue notes.

15. Notes of pvt banks did not circulate to any appreciable extent • unprofitable and gave it up; began to develop depositbanking. • They received deposits which were at first withdrawable by letter, and later by cheques. • Printed cheque forms were first issued between 1749 & 1759. • Bank of England notes were not popular beyond the metropolis, as it did not have any outside branch. • Pvt banks in provincial cities began to play an important role after the middle of 18th century.

16. Restriction on monopoly • It was realized that joint stock banks with right of issue should be started outside London. • In 1826 an Act was passed which allowed banks to be started with unlimited liability, consisting more than 6 partners , with the right to issue notes, provided they have no office within a radius of 65 miles from London, it was removed –Mr. Joplin-no such monopoly was intended.

17. Peel’s Act, 1844 • No limit to the amount of notes, which pvt bankers and after 1826 the country joint-stock banks were allowed to issue. • resulted in numerous banking crisis and bank failures . • Extinction of the right of issue of bank notes and deposit banking came into place.

18. Growth of deposit banking and cheque currency • Currency and Bank Notes Act, 1928- Bank of England was given exclusive right to issue notes. • In 1947 it was nationalized. • History of Banking in India • India was not a stranger to the concept of Banking.

19. Provisions of banking were found in Kautilya’sArthashastra- SahukarsandMahajans • Manusmriti etc • Hundi • “hund”, means to collect. • The bills of exchange are generally used for the collection of debts.

20. For instance, when a merchant in Bombay sells goods to a merchant in Delhi, the former draws a bills of exchange on the latter, so to collect the price of those goods. llly when a merchant in Calcutta desires to collect a debt, due to merchants in Madras, the former may draw a Hundi for the amount upon the latter.

21. Types of “Hundis”-3 types • “Darshanihundi” payable at sight • “Muddatihundi” payable after specified period of time. • “Shah Jog Hundi” payable by drawee only to a respectable person. • Nature of document a promissory note or a hundi • unconditional undertaking that the defendants has promised to pay an amount to petitioner.

22. Mere inscription of word “Hundi” above the stamp is not sufficient to hold the document as “Shah Jog Hundi” • Usury- The Usurious Loans Act, 1918 • Usury, or high rate of interest, was widely prevalent in India. • In Bengal, money was frequently lent to farmers at 40% or 60% per annum, while the standing crop was mortgaged for repayment of the loan.

23. Most writers attribute usury to the state of insecurity in India risk-low financial status of the borrowers. • Money lender rather than a banker. • State Money-Lenders Acts • The money lenders in India are regulated under the respective State Money-Lenders Acts e.g., the Kerala Money Lenders Act, 1958, the Karnataka Money Lenders Act, 1961etc

24. Money- Lending legislations of various states have similar salient provisions - • Requirement of Registration/license • Duty of money lenders with respect to maintaining and providing statement of accounts to the debtors. • Penalty for carrying on business without license • Intimidating the debtors or interfering with their day to day activities • Maximum rate of interests

25. The Constitution of India has conferred power to legislate on matters relating to money lending to the states. • RBI working group/Radhakrishna Expert Group on Agricultural indebtedness (2008) recommended there should be stricter and more transparent regulation of Money- Lenders.

26. Indigenous banking • Pvt. firms or individuals • Business was hereditary and confined to few castes & communities like vaishyas, Jains, Marwaries and Chettis. • Financial intermediaries • Indigenous bankers v. money lenders • Deal in short term credit instrument like hundis and commercial bill. • They provided credit to traders, agriculturist, small producers and Govt also. • Lending on basis of promissory note.

27. Simple method of accounting. • Easily accessible. • Do not have fix banking hours. • No much formalities and procedures. • Defects in Indigenous banking • Hindrance in the development of an organized money market. • High rate of interest • Involved other business. • Manipulating accounts • Secrecy of accounts, neither audited nor published. • Commission agents

28. Deducting interest in advance-undeseriable practice. • Give loans for any purpose. • Suggestions: • Indian Central Banking Enquiry Committee,1931 • The Banking Commission, 1971 • Only banking business and not any other activity. • Maintain account books in a prescribed and recognized form and get them audited. • Linked with commercial banks.

29. Benefit of Bankers’ Book Evidence Act shpuld be extended to them. • Their banking practices need to be upgraded. • These banks are encouraged to become corporate bodies rather than continuing as family based enterprises.

30. Functions of Commercial bank • profit-based financial institution. • Primary functions Fixed or time deposit Accepting deposits Saving Deposit Current Deposit Recurring Deposit

31. Loans Loans and advances Cash Credit Overdraft Purchasing and discounting of bills

32. Secondary Functions • Agency Functions Utility Functions • Transfer of funds/ Locker facility remittance • Payment of bills Foreign exchange • Underwriter Provide market info • Collection of cheque Advice to exporters • Collecting money on Behalf of customers • Income tax returns • Trustee, administrator

33. Functions of Industrial Development Bank of India (IDBI) • Set up in July 1964, as a wholly-owned subsidiary of RBI. Autonomy in 1976. • Apex institution in the arena of development banking. • Major role is to coordinate the activities of other development banks. • Provides medium & long term finance to business units.

34. Functions: • Planning, promoting & developing industries-fill gaps in the industrial structure by conceiving, preparing & floating new projects. • Technical & administrative assistance for promotion, management & expansion of industry. • Providing refinance to the IFCI and other financial institutions. • Purchasing or underwriting shares and debentures of industrial concerns.

35. Guaranteeing deferred payments due from industrial concerns. • Undertaking market and investment research, surveys and techno-economic studies. • Entrepreneurship development programme.

37. The scope of business of the IDBI extended- direct industrial assistance by way of project loans, equipment finance scheme. • Assistance to service sector industries like health care, informatics. • Small Industries Development Bank of India (SIDBI)-1990-subsidary to IDBI delinked in 1997- apex bank in financing small scale industries.

38. Cooperative Banks • Germany • First cooperative credit society was Act (1904) • Registered under respective state Cooperative Societies Act. (1959). • Small financial entities. • Voluntary association of members of locality or professional community. • Operate in rural (finance farming, cattle) and urban areas (self employment, small scale units, personal finance). • They are governed by RBI (licensing, rate of interest, area of operation), State Govt (management, merging, liquidation) • Higher rate of interest on deposits. Credit oriented movement.

39. Cooperative Banking Structure

40. The Maclagan committee (1915) on co-operative, recommended some important policies regarding the three-tier system of co-operative societies. • The first urban co-operative society was established in India, “AnnyonaShakariMandli Co-operative Bank‟ located in Baroda (Gujarat state) on 5 Feb 1889. • Economic sustainable development. • Banking to doorsteps of common people.

41. The Objectives and Functions of the Urban Co-Operative Banks: • 1. Primarily, to rise funds for lending money to its members • 2. To attract deposits from members as well as non-members • 3. To encourage thrift, self-help ad mutual aid among members. • 4. To draw, make, accept, discount, by sell, collect and deal in bills of exchange, draft, certificates and other securities • 5. To provide safe deposits vaults. • 6. To issue letters of credit and traveler‟scheques • 7. To arrange for the safe custody of valuables • 8. It acts as an agent of its customers • 9. To borrow funds and utilize them for giving loans to needy persons

42. Problems • Many regulatory bodies. • No expertise & skills. • Recruitments are Politicized. • Unduly dependent on refinance. • No active participation of members. • Reforms • RBI suggested: Single regulatory body.

43. Reserve Bank of India (RBI) • Established on 1st April, 1935 under the RBI Act, 1934. • Was established on recommendations of Hilton Young Commission. • RBI nationalized in 1949 • Originally a shareholders’ bank. • Paid up capital was Rs. 5 crores. • Took over the function of currency issue from GOI & power of credit control from SBI.

44. In 1949 Banking Companies Act was enacted and now renamed as Banking Regulation Act, 1949. • Functions of RBI • RBI was constituted to: 1. Regulate the issue of banknotes 2. Maintain reserves with a view to securing monetary stability. 3. Operate the credit & currency system of the country to its advantage.

45. 1.Issuer of currency in India • Sole authority to issue, control & regulate currency in India. • It issues & exchanges or destroys currency & coins not fit for circulation. • Objective is to give adequate quantity of supplies of currency notes & coins in good quantity. 2. Banker to the Govt • Performs merchant banking functions of State & Central Govts. • Also acts as banker to GOI and State Govts.

46. Accept money on account of the Govt, to make payment on behalf of the Govt. • Carries out exchange remittance& other banking operations including Govt securities and management of public debt of the govt. 3. Baker of Commercial Banks • RBI act as Banker of Banks. • Maintains banking accounts of all scheduled Banks. • All banks keep and maintain their accounts with RBI

47. 4. Organizer of Commercial Banking System • Concerned with the organization of a sound & healthy commercial banking system. • Ensuring effective co-ordination & control over credit through appropriate monetary & credit policies followed from time to time. 5. Regulator & supervisor of Financial Sysem • Prescribes broad parameters of banking operations. • Objective is to • maintain public confidence in the system • protect depositors interest. • provide cost effective banking service to the public.

48. 6. Financial Supervision • Guidance of the Board for Financial Supervision (BFS), constituted in Nov 1994 as a committee of the Central Board of Directors of the RBI. • Objective of BFS: undertake consolidated supervision of financial sector comprsing commercial banks, financial institutions & non banking financial institutions. • BFS through the Audit Sub-Committee aims at upgrading the quality of the statutory audit & internal audit functions in banks & FI.

49. BFS oversees the functioning of Department of Banking Supervision(DBS), Department of Non-Banking Supervision(DNBS) & Financial Institution Division (FID). • Gives direction on the regulatory & supervisory issues. 7. Monetary Authority • RBI formulates, implements & monitors the monetary policy. • Objective is maintaining price stability & ensuring adequate flow of credit to productive sectors.

50. 8. Control the volume of credit • Exercise it control over volume of credit created by the commercial banks in order to ensure price stability. • Quantitative Credit Control • Bank Rate • Repo Rate • Reverse Repo Rate • Open Market Operations • Variable Reserve Requirements • Selective Credit Control