Banking Basics


Banking Regulation Act of India, 1949 defines Banking as "accepting, for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheques, draft, order or otherwise."

Most of the activities a Bank performs are derived from the above definition. In addition, Banks are allowed to perform certain activities which are ancillary to this business of accepting deposits and lending. A bank's relationship with the public, therefore, revolves around accepting deposits and lending money. Another activity which is assuming increasing importance is transfer of money - both domestic and foreign - from one place to another. This activity is generally known as "remittance business" in banking parlance. The so called forex (foreign exchange) business is largely a part of remittance albeit it involves buying and selling of foreign currencies.

The law governing Banking Activities in India is called "Negotiable Instruments Act 1881". The banking activities can be classified as :

Accepting Deposits from public/others (Deposits)
Lending money to public (Loans)
Transferring money from one place to another (Remittances)
Acting as trustees
Acting as intermediaries
Keeping valuables in safe custody
Collection Business
Government business

1) Accepting deposits is one of the two major activities of the Banks.

Banks are also called custodians of public money. Basically, the money is accepted as deposit for safe keeping. But since the Banks use this money to earn interest from people who need money, Banks share a part of this interest with the depositors. The quantum of interest depends upon the tenor - length of time for which the depositor wishes to keep the money with the Bank - and the ease of withdrawal. The thumb rule is, longer the tenor, higher the rate of interest and lesser the restrictions on withdrawal, lesser the interest. Exceptions, however, exist. Deposits are accepted from both resident (domestic) or non-resident Indian customers.

It is the business of the banker to accept deposits so that he can lend it to others and earn interest. Depending upon the liquidity position of the market and the size of deposit, the earnings can vary and if the size of the deposit is big enough, it is advisable to shop around and get the best rate.

Type of deposit accounts (Domestic Customers)

1.Fixed Deposit Accounts

2.Demand Deposits
* Savings Account
*Current account

Most of the other products offered by the Banks viz. Recurring Deposit Account, Multi Option Deposit Account, Special Term Deposit Accounts, Current Fixed Account etc. are essentially combinations of the above basic type of accounts and are packaged by different Banks to attract different groups of customers.


2) Lending money to the public

Lending money is one of the two major activities of any Bank. Banks accept deposit from public for safe-keeping and pay interest to them. They then lend this money to earn interest on this money. In a way, the Banks act as intermediaries between the people who have the money to lend and those who have the need for money to carry out business transactions. The difference between the rate at which the interest is paid on deposits and is charged on loans, is called the "spread".

Banks lend money in various forms and they lend for practically every activity. Let us first look at the lending activity from the point of view of security. Loans are given against or in exchange of the ownership (physical or constructive) of various type of tangible items. Some of the securities against which the Banks lend are :

1. Commodities
2. Debts
3. Financial Instruments
4. Real Estate
5. Automobiles
6. Consumer durable goods
7. Documents of title


Apart from the above categories, the Banks also lend to people on the basis of their perceived personal worth. Such loans are called clean and the Banks are understandably cagey about extending such loans. The credit card arms of the various Banks, however, fill up this void.

Cash credit Account

This account is the primary method in which Banks lend money against the security of commodities and debt. It runs like a current account except that the money that can be withdrawn from this account is not restricted to the amount deposited in the account. Instead, the account holder is permitted to withdraw a certain sum called "limit" or "credit facility" in excess of the amount deposited in the account.
Cash Credits are, in theory, payable on demand. These are, therefore, counter part of demand deposits of the Bank.

Overdraft

The word overdraft means the act of overdrawing from a Bank account. In other words, the account holder withdraws more money from a Bank Account than has been deposited in it.


How does this account then differ from a Cash Credit Account?

The difference is very subtle and relates to the operation of the account. In the case of Cash Credit, a proper limit is sanctioned which normally is a certain percentage of the value of the commodities/debts pledged by the account holder with the Bank. Overdraft, on the other hand, is allowed against a host of other securities including financial instruments like shares, units of mutual funds, surrender value of LIC policy and debentures etc. Some overdrafts are even granted against the perceived "worth" of an individual. Such overdrafts are called clean overdrafts.

Bill Discounting

Bill discounting is a major activity with some of the smaller Banks. Under this type of lending, Bank takes the bill drawn by borrower on his(borrower's) customer and pay him immediately deducting some amount as discount/commission. The Bank then presents the Bill to the borrower's customer on the due date of the Bill and collect the total amount. If the bill is delayed, the borrower or his customer pay the Bank a pre-determined interest depending upon the terms of transaction.

Term Loan

Term Loans are the counter parts of Fixed Deposits in the Bank. Banks lend money in this mode when the repayment is sought to be made in fixed, pre-determined installments. This type of loan is normally given to the borrowers for acquiring long term assets i.e. assets which will benefit the borrower over a long period (exceeding at least one year). Purchases of plant and machinery, constructing building for factory, setting up new projects fall in this category. Financing for purchase of automobiles, consumer durables, real estate and creation of infra structure also falls in this category.

Classification of loans
Another way to classify the loans is through the activity being financed. Viewed from this angle, bank loans are bifurcated into :

* Priority sector lending
* Commercial lending


3)Remittance Business- Apart from accepting deposits and lending money, Banks also carry out, on behalf of their customers the act of transfer of money - both domestic and foreign.- from one place to another. This activity is known as "remittance business" . Banks issue Demand Drafts, Banker's Cheques, Money Orders etc. for transferring the money. Banks also have the facility of quick transfer of money also know as Telegraphic Transfer or Tele Cash Orders.

In Remittance business, Bank 'A' at a place 'a' accepts money from customer 'C' and makes arrangement for payment of the same amount of money to either the customer 'C' or his "order" i.e. a person or entity, designated by 'C' as the recipient, through either a Branch of Bank 'A' or any other entity at place 'b'. In return for having rendered this service, the Banks charge a pre-decided sum known as exchange or commission or service charge. This sum can differ from bank to bank. This also differs depending upon the mode of transfer and the time available for effecting the transfer of money. Faster the mode of transfer, higher the charges.

Demand Draft

A demand draft or "DD" is an instrument most banks in India use for effecting transfer of money. It is a Negotiable Instrument. To buy a "DD" from a Bank, you are required to fill an application form which asks the following information :

* Type of instrument needed
* Name of the recipient
* Name of the sender
* Amount to be transferred
* Place where the transferred money is to be paid
* Mode in which money is to be paid i.e. in cash or through a Bank Account
* Mode in which you will pay money to the Bank i.e. in cash or by debit to your account


The application form along with the cheque on your account or cash is deposited with the counter clerk who gives you a Demand Draft (which looks like a cheque) for the amount.

Tips:

1. Check the particulars like name of the beneficiary, amount, place where payable etc. filled in the DD, match these with what you had filled in the application form.
2. Spellings of the beneficiary's name should be exactly the same.
3. Get the DD "crossed" for security.
4. Your PAN number will be necessary if the amount of DD exceeds Rs.10,000/=
5. Charges for issuing drafts differ from Bank to Bank. So if your requirements are large, do shop around for best bargain.

4)Trustee Business

Under section 3 of Indian Trusts Act, 1882 a trust is an obligation annexed to the ownership of property, and arising out of a confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner.

Banks also act as trustees for various requirements of the corporates, Government and General Public. For example, whenever a company wishes to issue secured debentures, it has to appoint a financial intermediary as trustee who takes charge of the security for the debenture and looks after the interests of the debenture holders. Such entity necessarily have to have expertise in financial matters and also be of sufficient standing in the market/society to generate confidence in the minds of potential subscribers to the debenture. Banks are the natural choice. For general public also the Banks normally have a facility called "safe custody" where Banks act as trustees.

Banks also act as bankers to trustees appointed under the act mentioned above. A banker has a few special obligations in such accounts and accordingly special care is taken in such accounts.

5) Acting as Intermediaries


6) Lockers

Bankers are in the business of providing security to the money and valuables of the general public. While security of money is taken care of through offering various type of deposit schemes, security of valuables is provided through making secured space available to general public for keeping these valuables. These spaces are available in the shape of LOCKERS. The latter are small compartments with dual locking facility built into strong, fire and burglar resistant cupboards. These are stored in the Bank's Strong Room and are fully secure. Lockers can neither be opened by the hirer or the Bank individually. Both must come together and use their respective keys to open the locker.

Hiring of Lockers is a losing proposition for the Banks, if seen in isolation as it involves major expenditure on buying those cabinets, providing a secure place to keep them and manning the facility so that the customers are serviced immediately. Banks offer this facility as a sop to attract deposits. So do not be surprised if your Banker requests you to make a "small" fixed deposit before a locker can be allotted to you.

7) Collection Business

Apart from transferring money from one place to another, Banks are also in the business of "collecting" your money from other places. For instance, if you have received a payment by way of a cheque or DD drawn or payable at any station other than your own, you can deposit it in your account with your local banker and request for collection of the amount. The Bank will send the cheque to its branch at that centre and get the amount collected for a small fee. The amount of cheque/ draft will be deposited in your account and the fee deducted separately from your account. Banks also undertake collection of bills of exchange - both usance and demand - for their business clientele.

Tips:

1. There are RBI norms for the time expected to be taken for collection business and these norms are prominently displayed in banking hall of all banks. If your collection is delayed beyond this period, the Bank is expected to pay interest on the amount. If it does not, demand it.
2. Retain the counter foil of all deposits made in the bank as this is the only proof of deposit made till your account is credited
3. If your business involves a number of such payments, it is advisable to open an account with a Bank which has a large network of Branches.
4. Charges for each of these activities differ from bank to bank. While selecting a bank for opening an account, these charges are an improtant parameter which one should keep in mind.


8) Government business


Bank Account
A Bank Account is the record of financial relationship a customer has with the Bank. It contains details of all the moneys deposited with the Bank and withdrawn from it. There are many Bank accounts, but basically there are two types:

DEPOSITS
LOANS