Understanding Core Banking Concepts

What is Banking?

• Definition: Banking is a financial service acting as an intermediary between savers and borrowers.
• Key Features:

1. 1. Deals in money as a commodity.
   2. Accepts deposits and grants loans.

Banking Defined in Banking Regulation Act 

Sec 5(b) of BR Act 1949 : a “banking”  means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise.  

Sec 5 (c) : “banking company” means any company which transacts the business of banking (in India)

Banking Products

• Broad Categories:

1. 1. Deposit Products: Savings Account, Current Account, Fixed Deposits, Recurring Deposits.
   2. Loan Products: Personal Loans, Home Loans, Car Loans, Education Loans. Business and corporate loans 
   3. Payment Products: Debit/Credit Cards, UPI, Internet Banking, mobile banking, forex cards
   4. Agency Services : Bancasurance, merchant banking etc. 

Various FINANCIAL MARKETS 

• Money Market:  Dealing in short term loan funds up to one year tenure. e.g Treasury bills, Commercial papers. CDs, BoE etc 
• Capital Market: where buyers and sellers trade financial instruments like stocks, bonds currencies and Derivatives 
• Debt Market: Dealing in debt instruments like debentures bonds etc 
• Foreign Exchange Market: Deals in foreign exchange transactions and also determines exchange rates.  

 REGULATORS IN FINANCIAL MARKETS

• Reserve Bank of India (RBI) – Banks and other financial intermediaries 
• Securities Exchange Board of India (SEBI): Primary and secondary market 
• Insurance Regulatory & Development Authority (IRDA)

-  Insurance sector 

• Pension Fund Regulatory & Development Authority (PFRDA) – pension matters (EPFO etc) 
• GST Council : Goods and Services Tax

 Financial Intermediaries 

• • Public  and private Sector Banks
  • State Bank of India
  • Regional Rural Banks
  • Differentiated Banks
  • Foreign Banks
  • Cooperative Banks 
  • Non-Banking Finance Companies (NBFCs)
  • Primary Dealers (PDs)
  • Development Financial Institutions (DFI)
  • Multi Commodity Exchange of  India Ltd (MCX)

Role of RBI

• Functions of RBI:

1. 1. Regulates monetary policy (inflation control).
   2. Issues currency.
   3. Control and Supervision on banking operations.
   4. To ensure financial stability.

 Various rates 

Cash Reserve Ratio (CRR): U/s 42 of RBI Act  (4.50%)

-%age of bank deposits to be kept as cash or equivalent with RBI as reserve 

Statutory Liquidity Ratio (SLR): u/s 24 of BR Act  (18%)

- %age of net Demand and term Liabilities to be kept as Securities with RBI 

Bank Rate : As per Sec. 49 of RBI Act  (6.75%)

- Rate at which banks can take unsecured funds on loan from RBI

Repo Rate  (6.50%)

- Rate at which banks borrow funds from RBI against Securities 

Reverse Repo Rate  (3.35%)

-  Rate at which banks place excess funds with RBI

Who is a Customer?

 Defined in Prevention of Money Laundering Act 2002:

 “Customer means a person who is engaged in a financial transaction or activity with a Reporting Entity and includes on whose behalf the person who engaged in the transaction or activity”.

 Reporting Entities include Banks, Financial Institutions, Intermediaries etc. 

 Who can be a customer?

 Legal Requirements 

• Age of maturity
• Sound Mind
• Not debarred under any law
• Must have an offer, proposal and acceptance
• Contractual relationship with commercial intentions

Types of Customers

 Natural Person

1. Individual and joint account

• • Minors/self /guardian
  • Lunatics.
  • Insolvents.
  • Illiterates
  • Visually impaired persons.
  • Drunkards.

b.  Proprietorship concern

c.  Association of persons

Legal Person

• Private limited/public limited company   ( limited companies)
• Trust 
• Societies 
• Clubs
• Associations
• Partnership firms

Special Types of Customers

Minors

• Sec 3 of Indian Majority Act 1875 (amended 1999) : 18 years
• Opening of account does not inflict any liability on the bank. 
• Overdraft in Minor’s account : Since contract with minor is invalid, any guarantee etc taken alongwith is also invalid. 
• In case minor represents himself major and later claims invalidity of contract due to his minority status. 
• Minor as a Partner :  His share is liable for the acts of the firm but not personally liable.

Illiterate Person

• Bank’s discretion to open deposit accounts other than current account (IBA Guidelines)
• No cheque book facility in Savings Account
• Joint accounts of two illiterate persons or one literate and one illiterate person can be opened. 

Types of Customers

Lunatic:

• Not capable of entering into contract as per Contract Act 1872. 

Blind Person:

• RBI rules mandate that all banking services shall be provided to blind and low vision customers without any discriminations. 

Power of Attorney (Power of Attorney Act 1882)

• Bank to ensure : POA is duly stamped, registered with Registrar of Documents and is in full operations and is within the validity period. 
• POA holder should be properly identified through KYC.
• POA becomes invalid when :-
  • the Principal revokes
  • the Principal dies, becomes insolvent or of unsound mind.
  • the Agent renounces the business of agency.

Bankers obligation

• Duty to honour cheque/ payment instructions of customer-  Sec 31 of NI Act 1881
• Duty to maintain secrecy of accounts—Sec 13 of Banking companies(acquisition & transfer of undertaking) Act 1970
• Exceptions:

1. 1. Under compulsion of law under Banker’s Book Evidence Act , Criminal Procedure Code, FEMA, IT Act,  BR Act 1949, RBI Act 1934.
   2. To protect national Interest—money laundering etc
   3. In the interest of the Bank.
   4. With the implied consent of the customer
   5. As per banking practices

Relationship stands terminated when.. 

1. Bank comes to know the death/lunacy/ insolvency of the customer
2. the customer close the account with an appropriate notice.
3. the bank closes the account with a due notice to the customer. If notice not given, bank can be held liable.
4. On garnishee order or attachment order from the competent authority

Money Laundering

• Money Laundering is the process by which illegal funds and assets are converted into legitimate funds and assets.
• It means converting Dirty Money into Clean Money.

Prevention of Money Laundering Act (PMLA) - 2002

 Channels of illegal funds generation:

• Drug trafficking
• Human Trafficking 
• Arms, antique, gold smuggling
• Prostitution rings
• Financial frauds  
• Corruption

Rationale of Know Your Customer- KYC

• To prevent banks from being used, by unscrupulous or criminal elements for their criminal activities including money laundering.
• To minimize frauds and risks and protect banks reputation.
• To avoid opening of accounts with fictitious name and address.
• To weed out bad customers and protect good ones.

KYC – Know Your Customer

• Definition: The process of verifying a customer’s identity.
• Purpose: Preventing money laundering, ensuring legal compliance.
• Documents Required:

1. 1. ID proof (Aadhaar, PAN).
   2. Address proof (Electricity Bill, Passport).

Concept of Interest

• Definition: Interest is the cost of borrowing money or the return on saving money.
• Types:
  • Simple Interest: Calculated on the principal amount.
  • Compound Interest: Interest on principal + previously earned interest.
• Formula Examples:
  • Simple Interest: SI=(P×R×T)/100
  • Compound Interest: CI=P×(1+R/100)^n

Fixed versus variable rates 

• Fixed rates are fixed for the full term. It saves the borrower from interest rate risk in case of increasing rates regime. Beneficial for short term loans
•  Variable rate are floating rates i.e. base rate plus spread. Spread remains fixed but base rate keeps changing with market fluctuation. It is helpful to the banks as interest rate risk is taken care of. Beneficial for long term loans as in the decreasing rate regime effective loan rate also decreases.