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What is Banking, how it works, types of banks, and functions of banks?

A bank is a type of financial institution regulated by the Government of India

Definition of Bank and Banking

A bank is a type of financial institution regulated by the government. Banks take people’s money as deposits and lend it to others. They also offer various services such as checking and savings accounts, loans, credit cards, and insurance.

Banking include receiving deposits, providing loans, facilitating financial transactions, and supplying financial services such as savings accounts, loans, and credit cards. It helps people and businesses store, invest, and borrow money. Banks have a vital economic function by overseeing money movement and supporting economic endeavors.

In India, most banks are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC), which covers deposit accounts up to a certain limit if a bank fails. The current DICGC coverage limit is INR 5 lakh per depositor, per account ownership type, and financial institution.

Banks, physical or online, handle money flow between people and businesses. They make money from the interest on loans and fees charged for their services. The Reserve Bank of India (RBI) oversees banks and other financial institutions to ensure they follow the proper guidelines.

We will discuss the types and functions of Banks in India in this blog.

Types of Banks in India

Central Bank

The Reserve Bank of India (RBI), also known as the Central Bank, was established on April 1, 1935, under the Reserve Bank of India Act of 1934.

The bank’s central office is in Mumbai, where the Governor develops policies.

The Reserve Bank was initially in private ownership before becoming fully owned by the Government of India in 1949.

The Board for Financial Supervision (BFS) was formed in November 1994 to enhance supervision and surveillance of the financial system and to focus on supervisory policy and skills.

It oversees commercial banks, financial institutions, and non-banking financial intermediaries, with support from the Department of Supervision.

The Reserve Bank administers various Acts, including the Reserve Bank of India Act of 1934, the Banking Regulation Act of 1949, and the Foreign Exchange Management Act of 1999.

It functions as the monetary authority, regulator and supervisor of the financial system, foreign exchange manager, and currency issuer and plays a developmental role.

Additionally, it oversees payment and settlement systems and serves as the banker to the Government and banks.

The Reserve Bank of India operates from 33 locations and has five training establishments, including the RBI Academy and College of Agricultural Banking.

Other autonomous institutions associated with the Reserve Bank include the Institute for Development and Research in Banking Technology (IDRBT).

Cooperative Banks

Cooperative banks are small financial institutions started by a group of people to meet the financial needs of their community. These banks are owned and controlled by their members, who elect a board of directors to oversee operations.

Cooperative banks operate based on the principle of cooperation, where members pool resources to provide banking services such as loans and savings accounts to their community.

Here’s how cooperative banks generally work:

Membership: Individuals or businesses meeting specific criteria can become members by purchasing shares or depositing.

Democratic Governance: Every member has equal voting rights. Members elect a board of directors to oversee the bank’s operations and make key decisions.

Capital Formation: Members contribute to the bank’s capital by purchasing shares or depositing. These funds serve as the primary source of capital for the bank’s lending activities and other financial services.

Most cooperative banks in India cater to the agriculture sector. They can be further divided into short-term and long-term financial institutions.

State Cooperative Banks (SCBs) are organised at a state level and regulated by the Reserve Bank of India (RBI) and the respective state governments.

They provide financial services to rural and low-income populations nationwide, including credit for agricultural activities, small-scale industries, and other small businesses.

Central Cooperative Banks (CCBs) are established and managed according to the Cooperative Societies Act.

They provide financial services to rural and semi-urban populations, offering deposits, loans, and other banking services and promoting and financing agricultural activities.

Farmers and agricultural professionals typically organise Primary Agricultural Credit Societies to provide credit and other services to farmers.

They offer loans at low interest rates and other services to help farmers manage their operations.

Cooperative banks have unique features, such as the “One person, One vote” policy, not-for-profit status, and a focus on social welfare.

They play a vital role in community development by promoting financial literacy, supporting local businesses, and investing in community projects.

Commercial Banks

Commercial banks are important financial institutions. They take deposits from the public and lend money to individuals and businesses to make a profit.

The Reserve Bank of India oversees their operations. The main source of income for commercial banks comes from the difference between the interest rates they charge borrowers and the rates they pay depositors. Some well-known commercial banks in India include the State Bank of India, ICICI Bank, Axis Bank, and HDFC Bank.

Commercial banks offer various financial services to consumers in exchange for payments such as interest, discounts, fees, and commissions.

They aim to make money while considering social welfare, fairness, and regional development. India’s banking system includes the Reserve Bank of India, commercial banks, and cooperative banks.

Profitability, liquidity, safety, and social welfare are the primary principles that banks try to incorporate into their operations. Commercial banks also provide maturity intermediation services to the economy.

Unlike other financial institutions, commercial banks uniquely communicate credit and monetary policies to businesses. They deal in a wide range of assets and cater to various borrowers, extending monetary policies to non-bank lenders and other sectors of the economy.

Commercial banks in India are classified as scheduled and non-scheduled banks. Scheduled banks are further categorized as public sector banks, private sector banks, and foreign banks.

Public sector banks are government-owned and focused on serving society, while private sector banks aim to maximize profit. Foreign banks operate as private businesses in India but are headquartered outside the country.

Commercial banks’ primary functions include accepting deposits, advancing loans, and acting as agents for their customers.

They also play a significant role in credit creation, discounting bills of exchange, financing foreign trade, providing overdraft facilities, and offering general utility services.

In conclusion, commercial banks are crucial for providing institutional credit and supporting trade and commerce with short-term loans. They attract people’s savings and contribute to the economy by pooling them.

Small Finance Banks

Small finance banks in India are special types of banks created by the RBI and the government of India. They were made to help more people access basic banking services, especially those unable to get these services before. This includes small farmers, small businesses, and other small groups.

Small finance banks offer basic banking services like loans and taking deposits. The RBI made the rules for these banks in November 2014, and 10 out of 72 companies that applied got the license to become small finance banks.

Most people in India live in rural areas, and it’s difficult to bring banking services to these areas. Small finance banks were created to help people in these areas access banking services.

Small finance banks provide savings and banking services to small businesses, farmers, and other small groups. They focus on using advanced technology and low-cost methods.

Small finance banks can offer savings accounts, current accounts, fixed deposits, and loans. They can also do other activities with the RBI’s approval, but they can’t do everything that regular banks do.

Small Finance Banks are regulated by the RBI in India and have to follow the rules set by the central bank. They are registered as public limited companies and are governed by different laws and regulations.

Payments Banks

Payment Banks are smaller-scale banks recommended by the Nachiket Mor Committee to offer banking and financial services to areas with limited access to traditional banking.

They aim to help the unbanked and underbanked populations, such as migrant laborers, low-income households, and small entrepreneurs. Payment Banks are different from regular banks as they focus on providing basic banking services.

There are currently 6 Payment Banks in India: Airtel Payment Bank, India Post Payment Bank, Fino, Paytm Payment Bank, NSDL Payment Bank, and Jio Payment Bank.

Payment Banks operate on a smaller scale and require a minimum paid-up capital of Rs. 100,00,00,000.

The promoters must contribute at least 40% of the initial capital for the first five years.

Payment Banks can accept deposits up to Rs. 2,00,000 and offer savings and current accounts, invest deposits in government securities and other scheduled commercial banks, make personal payments, receive cross-border remittances, and issue debit cards.

However, Payment Banks cannot undertake lending, issuing credit cards, accepting time and NRI deposits, or setting up subsidiaries for non-banking financial activities.

The advantages of having Payment Banks include the expansion of rural banking and financial inclusion, growth of the formal financial system, efficient handling of low-value, high-volume transactions, and access to diverse services.

However, Payment Banks face challenges such as a lack of awareness among people to access these services, the need for more incentives for involved agents, a lack of infrastructure and operational resources, and technological hurdles.

Banks provide many services to individuals and businesses in India. These include accounts for saving and checking, loans, credit cards, investment services, and online and mobile banking.

Some of the main functions of banks are:

1. Keeping your money safe: You can deposit money in a bank and withdraw it when needed.

2. Lending money: Banks give money to people and businesses for things like buying a home, growing a business, or personal needs.

3. Making and receiving payments: Banks help you make payments using checks, debit/credit cards, and electronic transfers.

4. Exchanging money: Many banks allow you to buy, sell, or exchange foreign currencies.

5. Keeping valuables safe: Some banks provide secure deposit boxes for storing valuable items and documents.

6. Helping you invest: Banks offer investment products like mutual funds, stocks, and bonds to help you grow your money.

7. Online banking: Banks offer online and mobile banking services, so you can easily access your accounts, pay bills, and transfer money.

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