Banking in India

Banking in the sense that we use it today originated in the Western world. It was first introduced to India in the 17th century by British rulers. Since then, the sector has undergone significant changes, and Indian banks are now among the best in emerging market economies, with a strong focus on globalization.

What are NBFCs?

A bank is a financial institution that primarily deals with deposit mobilization and loan forwarding. The nature of the deposits and loans is highly differentiated. Banks are regulated by the country’s central bank—in India, the Reserve Bank of India (RBI) (Reserve Bank of India). The non-bank financial institution falls into a similar category in terms of functions, with the main difference (though oversimplified) being that it does not allow depositors to withdraw money from their accounts.

Non-banking financial companies (NBFCs) are quickly becoming an important part of the Indian financial system. It is a diverse group of institutions (other than commercial and cooperative banks) that engage in financial intermediation in a variety of ways, such as accepting deposits, making loans and advances, leasing, and hiring purchases, among other things. Certain activities, such as agriculture, industry, and the sale-purchase or construction of an immovable property, are prohibited.

How NBFCs raise funds?

They raise funds from the general public, either directly or indirectly, and lend them to end-users. They provide loans to wholesale and retail traders, small businesses, and self-employed individuals. As a result, they have expanded and diversified the financial sector’s product and service offerings. They are gradually being recognized as being complementary to the banking sector because of their-

  • customer-oriented services;
  • simplified procedures;
  • attractive rates of return on deposits; and
  • flexibility and timeliness in meeting the credit needs of specified sectors.

The Reserve Bank of India, which regulates NBFCs, has given them a broad definition (a kind of ‘umbrella’ definition): “a financial institution formed as a company involved in receiving deposits or lending in any manner.” They have been divided into two categories based on their liability structure:

  1. deposit-taking NBFCs (NBFC-D), and
  2. non-deposit taking NBFCs (NBFC-ND).

A deposit-taking company must be registered with the RBI before an NBFC can operate. They must be a company (incorporated under the Companies Act, 1956) with a minimum NOF (net owned fund) of $2 million to be eligible for registration.

NBFCs are exempted from RBI’s regulatory

Certain types of NBFCs that are regulated by other financial regulators are exempted from the RBI’s regulatory control to avoid dual regulation:

  • venture capital fund, merchant bank, stockbroking firms (SEBI registers and regulates them);
  • insurance company (registered and regulated by the IRDA);
  • housing finance company (regulated by the National Housing Bank);
  • Nidhi company (regulated by the Ministry of Corporate Affairs under the Companies Act, 1956);
  • chit fund company (by respective state governments under Chit Funds Act, 1982). Some of the important regulations relating to the acceptance of deposits by the NBFCs are:
  • Accepting and/or renewing public deposits for a minimum of 12 months and a maximum of 60 months is permitted.
  • Demand deposits are not accepted (i.e., the savings and current accounts).
  • cannot offer interest rates higher than the RBI’s interest rate ceiling. Depositors are not eligible for gifts, incentives, or any other additional benefits. • Their deposits are not insured and should have a minimum investment-grade credit rating.
  • The RBI does not guarantee NBFCs’ deposit repayment.
  • The requirement to adhere to the RBI’s Capital Adequacy Ratio (CAR) norm.

In order to provide greater ‘operational flexibility to the NBFCs and their enhanced regulation, the RBI announced certain policy changes regarding them—

  • Existing 3 categories of the NBFCs (asset finance companies, investment companies, and
  • loan companies) were merged into a new category—NBFC-Investment and Credit Companies (NBFC-ICCs).
  • Now onwards they will be regulated by their activity rather than an entity.
  • Deposit-taking NBFC-ICC will invest up to 20 percent of its net assets in unquoted shares of another company (which is not a subsidiary or a company in the same group of the NBFC).
  • Excluding core investment companies (CICs) the exposures to all of them will be risk-weighted as per credit ratings (similar to corporates).

Two New NBFCs

During 2017-18, RBI introduced two new NBFC categories—Peer to Peer (P2P) and Account Aggregators—to promote financial inclusion through direct interaction between small lenders and small borrowers while also addressing consumer protection (AA). According to the Economic Survey 2019-20, after growing at a rapid pace in 2017-18, the sector has slowed since late 2018-19 due to a lack of funds, primarily due to panic following the failure of IL&FS (a major NBFC) to honor its Commercial Papers payments (CPs). Since then, the RBI has attempted to alleviate the sector’s liquidity crisis in a variety of ways. 

With a balance sheet size of over 30 lakh crores and a very safe capital to risk-weighted assets ratio (CRAR) of 19.5 percent, the sector accounted for around 18% of bank assets by September 2019. (against the requirement of 15 percent).

Previous Year Questions for UPSC Prelims

Ques 1: When the cash reserve ratio (CRR) is increased by the RBI, it will:

(a) Increase the supply of money in the economy

(b) Decrease the supply of money in the economy

(c) No impact on the supply of money in the economy

(d) Initially increase the supply but later on decrease automatically.

Answer: Option B

Explanation: When RBI increases the CRR, fewer funds are available with banks as they have to keep larger portions of their cash in hand with RBI. Thus hike in CRR leads to an increase in interest rates on loans provided by the Banks. A reduction in CRR sucks money out of the system causing a decrease in the money supply.

Ques 2: Open Market Operations means:

(a) Sale of agricultural products in the government-regulated Mandis.

(b) Sale and purchase of bonds and securities to the commercial banks by the RBI.

(c) Sale and purchase of bonds and securities by the RBI to the government.

(d) Sale and purchase of bonds and securities by the commercial banks to the customers.

Answer: Option B

Explanation: Open market operations (OMO) refers to when the Federal Reserve buys and sells primarily U.S. Treasury securities on the open market in order to regulate the supply of money that is on reserve in U.S. banks, and therefore available to loan out to businesses and consumers. 

Ques 3: Which of the following is not the monetary tool?

(a) CRR

(b) SLR

(c) Deficit financing

(d) Open market operations

Answer: Option C

Explanation: Deficit financing means generating funds to finance the deficit which results from an excess of expenditure over revenue. The gap is covered by borrowing from the public by the sale of bonds or by printing new money.

Quick Questions on Banking In India for UPSC Preparation

Banking is an industry that is known for handling financial activities such as cash, credit, deposits, investment, loans, and other kinds of financial transactions. It is important for the Indian economy as it provides safeguard to normal citizens by providing cash security, and credit security. 

A banking system is essential for economic development and growth. It is critical for releasing wealth, creating opportunities, creating jobs, and facilitating trade. It enables individuals and businesses to participate in the global economy.

Banking in India can be traced backed to year 1770. The first bank of India named as “Bank of Hindustan” was started its operation in 1770 located in Calcutta.

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