SHAHZADA HILAL

AHMADHILAL850@GMAIL.COM

+919906837425

BASICS OF BANKING AND INSURANCE

Banking: Meaning and definition

Finance is the life blood of trade, commerce and industry. Now-a-days, banking sector acts

as the backbone of modern business. Development of any country mainly depends upon the

banking system. A bank is a financial institution which deals with deposits and advances

and other related services. It receives money from those who want to save in the form of

deposits and it lends money to those who need it. It deals with deposits and advances and

other related services like lending money to grow the economy. Banks act as bridge

between the people who save and people who want to borrow i.e., It receives money from

those people who want to save as deposits and it lends money to those who want to borrow

it. The money you deposited in bank will not be idle. It will grow by means of interest to

your bank account they will earn interest in return for lending out the same money to

borrowers. This would ensure smooth money flow to develop our economy.

Definition of a Bank

Chamber’s Twentieth century Dictionary defines a bank as, “an institution for the keeping,

lending and exchanging etc. of money”.

According to Banking Regulation Act, “Banking means the accepting for the purpose of

lending or investment of deposits of money from the public, repayable on demand or

otherwise and withdrawable by cheque, draft, and an order or otherwise”.

Oxford Dictionary defines a bank as "an establishment for custody of money, which it pays

out on customer's order."

Prof. Kent defines a bank as, “an organization whose principal operations are concerned

with the accumulation of the temporarily idle money of the general public for the purpose

of advancing to others for expenditure”

Indian Banking Structure

The structure of banking in India consists of following components:

1. Central Bank – Reserve Bank of India (RBI)

2. Commercial Banks

a. Public sector Banks

b. Private Banks

c. Foreign Banks

3. Co-operative Banks

a. Primary Credit Societies

b. Central Co-operative Banks

c. State Co-operative Banks

4. Regional Rural Banks

5. Development Banks

6. Specialized Banks

a. Export Import Bank of India

b. Small Industries Development Bank of India

c. National Bank for Agricultural and Rural Development

7. Microfinance institutions

8. Development financial institutions

Indian Banking system Reserve bank of India, commercial banks, co-operative banks and

regional rural banks broadly make up the banking system in India. There are two more

types of banks, namely development banks and specialized banks for some particular

purposes.

Central Bank – Reserve Bank of India (RBI)

The Reserve Bank of India (RBI), the central bank of India, which was established in 1935,

has been fully owned by the government of India since nationalization in 1949. Like the

central bank in most countries, Reserve Bank of India is entrusted with the functions of

guiding and regulating the banking system of a country.

Commercial Banks

There are three types of commercial banks in India

1. Public sector banks

2. Private Banks

3. Foreign banks

Currently, there are 88 scheduled commercial banks, including 28 public sector banks, 29

private banks and 31 foreign banks.

Public sector banks

these are banks where majority stake is held by the Government of India or Reserve Bank

of India. In 2012, the largest public sector bank is the State Bank of India. This consists of

14 banks which are nationalized in the year 1969 and 6 banks which are nationalized in the

year 1980. Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of

Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank

Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab & Sind Bank

Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United

Bank of India Vijaya Bank State bank and its associates

Private Banks

Private Banks are banks that the majority of share capital is held by private individuals. In

Private sector small scheduled commercial banks and newly established banks with a

network of 8,965 branches are operating. To encourage competitive efficiency, the setting

up of new private bank is now encouraged. Examples of old private sector banks are:

Bank of Rajasthan Catholic Syrian Bank Dhanalakshmi Bank Federal Bank

ING Vysya Bank Karnataka Bank Karur Vysya Bank Lakshmi Vilas Bank Lord

Krishna Bank South Indian Bank Tamilnad Mercantile Bank Examples on new

generation private sector banks are: Bank of Punjab Centurion Bank HDFC Bank

ICICI Bank IDBI Bank Ltd. IndusInd Bank Kotak Mahindra Bank UTI Bank Yes

Bank

Foreign Banks

Foreign banks are registered and have their headquarters in a foreign country but operate

their branches in India. Apart from financing of foreign trade, these banks have performed

all functions of commercial banks and they have an advantage over Indian banks because

of their vast resources and superior management. At the end of September, 2010, 34

foreign banks were operating in India.

Co-operative banks

Co-operative banks are banks incorporated in the legal form of cooperatives. Any

cooperative society has to obtain a license from the Reserve Bank of India before starting

banking business and has to follow the guidelines set and issued by the Reserve Bank of

India. Currently, there are 68 co-operatives banks in India. There are three types of co-

operatives banks with different functions:

Primary Credit Societies:

Primary Credit Societies are formed at the village or town level with borrower and non-

borrower members residing in one locality. The operations of each society are restricted to

a small area so that the members know each other and are able to watch over the activities

of all members to prevent frauds.

Central Co-operative Banks:

Central co-operative banks operate at the district level having some of the primary credit

societies belonging to the same district as their members. These banks provide loans to

their members (i.e., primary credit societies) and function as a link between the primary

credit societies and state co-operative banks.

State Co-operative Banks:

These are the highest level co-operative banks in all the states of the country. They mobilize

funds and help in its proper channelization among various sectors. The money reaches the

individual borrowers from the state co-operative banks through the central cooperative

banks and the primary credit societies.

Regional rural Banks

The regional rural banks are banks set up to increase the flow of credit to smaller

borrowers in the rural areas. These banks were established on realizing that the benefits of

the co-operative banking system were not reaching all the farmers in rural areas.

Currently, there are 196 regional rural banks in India.

Regional rural banks perform the following two functions:

1. Granting of loans and advances to small and marginal farmers, agricultural workers,

cooperative societies including agricultural marketing societies and primary agricultural

credit societies for agricultural purposes or agricultural operations or related purposes.

2. Granting of loans and advances to artisans small entrepreneurs engaged in trade,

commerce or industry or other productive activities.

Development Banks

Development Banks are banks that provide financial assistance to business that requires

medium and long-term capital for purchase of machinery and equipment, for using latest

technology, or for expansion and modernization. A development bank is a multipurpose

institution which shares entrepreneurial risk, changes its approach in tune with industrial

climate and encourages new industrial projects to bring about speedier economic growth.

These banks also undertake other development measures like subscribing to the shares and

debentures issued by companies, in case of under subscription of the issue by the public.

There are three important national level development banks. They are;

Industrial Development Bank of India (IDBI)

The IDBI was established on July 1, 1964 under an Act of Parliament. It was set up as the

central coordinating agency, leader of development banks and principal financing

institution for industrial finance in the country. Originally, IDBI was a wholly owned

subsidiary of RBI. But it was delinked from RBI w.e.f. Feb. 16, 1976. IDBI is an apex

institution to co-ordinate, supplement and integrate the activities of all existing specialised

financial institutions. It is a refinancing and re-discounting institution operating in the

capital market to refinance term loans and export credits. It is in charge of conducting

technoeconomic studies. It was expected to fulfil the needs of rapid industrialization. The

IDBI is empowered to finance all types of concerns engaged or to be engaged in the

manufacture or processing of goods, mining, transport, generation and distribution of

power etc., both in the public and private sectors.

Industrial finance Corporation of India (IFCI)

The IFCI is the first Development Financial Institution in India. It is a pioneer in

development banking in India. It was established in 1948 under an Act of Parliament. The

main objective of IFCI is to render financial assistance to large scale industrial units,

particularly at a time when the ordinary banks are not forth coming to assist these

concerns. Its activities include project financing, financial services, merchant banking and

investment. Till 1993, IFCI continued to be Developmental Financial Institution. After

1993, it was changed from a statutory corporation to a company under the Indian

Companies Act, 1956 and was named as IFCI Ltd with effect from October 1999.

Industrial Credit and Investment Corporation of India (ICICI)

ICICI was set up in 1955 as a public limited company. It was to be a private sector

development bank in so far as there was no participation by the Government in its share

capital. It is a diversified long term financial institution and provides a comprehensive

range of financial products and services including project and equipment financing,

underwriting and direct subscription to capital issues, leasing, deferred credit, trusteeship

and custodial services, advisory services and business consultancy. The main objective of

the ICICI was to meet the needs of the industry for long term funds in the private sector.

Specialized Banks

In India, there are some specialized banks, which cater to the requirements and provide

overall support for setting up business in specific areas of activity. They engage themselves

in some specific area or activity and thus, are called specialized banks. There are three

important types of specialized banks with different functions:

Export Import Bank of India (EXIM Bank):

The Export-Import (EXIM) Bank of India is the principal financial institution in India for

coordinating the working of institutions engaged in financing export and import trade. It is

a statutory corporation wholly owned by the Government of India. It was established on

January 1, 1982 for the purpose of financing, facilitating and promoting foreign trade of

India. This specialized bank grants loans to exporters and importers and also provides

information about the international market. It also gives guidance about the opportunities

for export or import, the risks involved in it and the competition to be faced, etc. Role and

importance of banks in economic development A proper financial sector is of special

importance for the economic growth of developing and underdeveloped countries. The

commercial banking sector which forms one of the backbones of the financial sector should

be well organized and efficient for the growth dynamics of a growing economy. No

underdeveloped country can progress without first setting up a sound system of

commercial banking. The importance of a sound system of banking for a developing

country may be depicted as follows :

1. Capital Formation

The rate of saving is generally low in an underdeveloped economy due to the existence of

deep-rooted poverty among the people. Even the potential savings of the country cannot be

realized due to lack of adequate banking facilities in the country. To mobilize dormant

savings and to make them available to the entrepreneurs for productive purposes, the

development of a sound system of commercial banking is essential for a developing

economy.

2. Monetization

An underdeveloped economy is characterized by the existence of a large non monetized

sector, particularly, in the backward and inaccessible areas of the country. The existence of

this non monetized sector is a hindrance in the economic development of the country. The

banks, by opening branches in rural and backward areas, can promote the process of

monetization in the economy.

3. Innovations Innovations are an essential prerequisite for economic progress. These

innovations are mostly financed by bank credit in the developed countries. But the

entrepreneurs in underdeveloped countries cannot bring about these innovations for lack

of bank credit in an adequate measure. The banks should, therefore, pay special attention

to the financing of business innovations by providing adequate and cheap credit to

entrepreneurs.

4. Finance for Priority Sectors

The commercial banks in underdeveloped countries generally hesitate in extending

financial accommodation to such sectors as agriculture and small scale industries, on

account of the risks involved there in. They mostly extend credit to trade and commerce

where the risk involved is far less. But for the development of these countries it is essential

that the banks take risk in

extending credit facilities to the priority sectors, such as agriculture and small scale

industries.

5. Provision for Medium and Long term Finance

The commercial banks in under developed countries invariably give loans and advances for

a short period of time. They generally hesitate to extend medium and long term loans to

businessmen. As is well known, the new business need medium and long term loans for

their proper establishment. The commercial banks should, therefore, change their policies

in favour of granting medium and long term accommodation to business and industry.

Role of Banks in Indian Economy

In India, as in many developing countries, the commercial banking sector has been the

dominant element in the country’s financial system. The sector has performed the key

functions of providing liquidity and payment services to the real sector and has accounted

for the Bulk of the financial intermediation process. Besides institutionalizing savings, the

banking sector has contributed to the process of economic development by serving as a

major source of credit to households, government, and business and to weaker sectors of

the economy like village and small scale industries and agriculture. Over the years, over 30-

40% of gross household savings have been in the form of bank deposits and around 60% of

the assets of all financial institutions accounted for by commercial banks. An important

landmark in the development of banking sector in recent years has been the initiation if

reforms following the recommendations of the first Narasimham Committee on Financial

System. In reviewing the strengths and weaknesses of these banks, the Committee

suggested several measures to transform the Indian banking sector from a highly regulated

to amore market oriented system and to enable it to compete effectively in an increasingly

globalized environment. Many of the recommendations of the Committee especially those

pertaining to Interest rate, an institution of prudential regulation and transparent

accounting norms were in line with banking policy reforms implemented by a host of

developing countries since 1970s.

Commercial Banks

A bank is a financial institution engaged in banking business. A bank is a financial

intermediary. It deals in money and credit. It deals with other people's money. It collects

the savings of some people and gives the money to those who are in need of it. Thus a

bank is a reservoir of money. It is a manufacturer of money. It manufactures credit and

sells it. That is why a bank is called as a "factory of credit". Commercial banks are profit

making organizations that accept deposits and use these funds to make loans. They are

playing the most important role in modern economic organization. It performs an

important economic organization. They perform an important economic function by

mobilizing the savings of the community and channelize the savings to productive

purposes.

“The tiny streams of capital flowing into the bank vaults become rives and these in turn fall

into ocean of National Finance to drive the wheels of industry and to float the vessels of

commerce.” There are mainly two types of commercial banking institutions in India such

as public sector banks and private sector banks. The commercial banking group consists of

27 Public sector banks, 29 private sector banks, 36 Foreign Banks operating in India, 196

Regional Rural Banks and 4 Local Area Banks.

Functions of Commercial Banks

Commercial banks perform a variety of functions. All functions of commercial banks may

be broadly classified into two - primary functions and secondary functions.

Primary Functions

Primary functions consist of accepting deposits, lending money and investment of funds.

1. Accepting deposits: Bank receives idle savings of people in the form of deposits. It

borrows money in the form of deposits. These deposits may be of any of the following

types:

(a) Current or demand deposit: In the case of current deposits money can be deposited and

withdrawn at any time. Money can be withdrawn only by means of cheques. Usually a

bank does not allow any interest on this kind of deposit because, bank cannot

utilize these short term deposits. This type of deposits is generally opened by business

people for their convenience. Current account holders should keep a minimum balance of

Rs. 2000, to keep the account running.

(b) Fixed or time deposits: These deposits are made for a fixed period. These can be

withdrawn only after the expiry of the fixed period for which the deposits have been made.

The bank gives higher rate of interest on this deposit. The rate of interest depends upon the

duration of deposit. The longer the period the higher will be the rate of interest. For the

evidence of the deposit, the banker issues a ‘Fixed Deposit Receipt’.

(c) Savings Deposits: As the name suggests, this deposit is meant for promotion of savings

and thrift among the people. In the case of savings deposits there are certain restrictions on

the number of withdrawals or on the amount that can be withdrawn per week. A minimum

balance of Rs. 100 should be maintained and if cheque book facility is allowed, the

minimum balance should be Rs. 1000. On the savings deposit, the rate of interest is less

than that on the fixed deposit.

(d) Recurring deposits: This is one form of savings deposit. In this type of deposit, at the

end of every week or month, a fixed amount is deposited regularly. The amount can be

withdrawn only after the expiry of the specified period. This deposit works on the maxim

‘little drops of water make a big ocean’. It may be opened for monthly installments in sums

of Rs. 100 or in multiples of Rs. 100 with a maximum of Rs. 1000.

2. Lending Money: Lending constitutes the second function f a commercial bank. Out of

the deposits received, a bank lends money to the traders and businessmen. Money is lent

usually for short periods only. A commercial bank lends in any one of the following ways:

(a) Loans: In case of loan, the banker advances a lump sum for a certain period at an

agreed rate of interest. The amount granted as loan is first credited in the borrower’s

account. He can withdraw this amount at any time. The interest is charged for the full

amount sanctioned whether he withdraws the money from this account or not. Loan is

granted with or without security.

(b) Cash credit: Cash credit is an arrangement by which the customer is allowed to borrow

money up to a certain limit. The customer can withdraw the amount as and when required.

Interest is charged only for the amount withdrawn and not for the whole amount as in the

case of loan.

(c) Overdraft: overdraft is an arrangement between a banker and his customer by which

the customer is allowed to withdraw over and above the credit balance in the current

account up to an agreed limit. The interest is charged only for the amount sanctioned. This

is a temporary financial assistance. It is given either on personal security or on the security

of assets.

(d) Discounting of bills: Bank grants advances to their customers by discounting bills of

exchange or pronote. In other words, money is lent on the security of bill of exchange or

pronote. The amount after deducting the interest (discount) from the amount of the bill is

credited in the account of the customer. Thus in this form of lending, the interest is

received by the banker in advance. Bank, sometimes, purchases the bills instead of

discounting them.

3. Investment of funds: Another function is investing the funds in some securities. While

making investment a bank is required

to observe three principles, namely liquidity, profitability and safety. A bank invests its

funds in government securities issued by central government as well as state government. It

also invests in other approved securities like the units of UTI, shares of GIC and LIC,

securities of State Electricity Board etc.

4. Credit Creation: -It is a unique function of Commercial Banks. When a bank advances

loan to its customer if doesn’t lend cash but opens an account in the borrowers name and

credits the amount of loan to that account. Thus, whenever a bank grants loan, it creates an

equal amount of bank deposits. Creation of deposits is called Credit Creation. In simple

words we can define Credit creation as multiple expansions of deposits. Creation of such

deposits will results an increase in the stock deposits. Creation of such deposits will results

an increase in the stock of money in an economy.

Secondary Functions

Secondary functions include agency services and general utility services

Agency Services: Modern commercial banks render a number of services to its customers.

It acts as an agent to its customers.

The following are the important agency services rendered by a commercial bank:

1. It collects the cheques, bills and pronotes for and on behalf of its customers

2. It collects certain incomes like dividend on shares, interest on securities etc., on behalf of

its customers.

3. It undertakes to purchase or sell securities for its customers.

4. It accepts bill of exchange on behalf of its customers.

5. It acts as a referee by supplying information regarding the financial position of its

customers when inquiries made by other business people and vice versa. It supplies this

information confidently.

6. It acts as an executor, administrator and trustee. Modern Functions of a Commercial

Bank

1. Changing cash for bank deposits and bank deposits for cash.

2. Transferring bank deposits between individuals and/or companies.

3. Exchanging deposits for bills of exchange, government bonds, secured and unsecured

promises of trade and industrial units.

4. Underwriting capital issues.

5. Providing 24 hours facility of payments through ATMs.

6. It issues credit cards, smart cards etc.

Central Bank - meaning

A modern central bank performs so many functions of different nature that it is very

difficult to give any brief but accurate definition of a central bank. Any definition of a

central bank is derived from its functions and these functions have varied from

time to time and from country to country. In other words, the functions of central banks

have grown over time making it more difficult to give any brief and unchanging definition

of a central bank. We may say that a central bank is one which acts as the banker to the

governments and the commercial banks, has the monopoly of note issue, operates the

currency and credit system of the country and does not perform the ordinary commercial

banking function. Economists have defined central bank differently, emphasizing its one

function or the other.

According to Vera Smith, “the primary definition of Central banking is a banking system

in which a single bank has either complete or a residuary monopoly of note issue”. In the

statutes of the Bank for International Settlements, a central bank is the bank in any

country to which has been entrusted the duty of regulating the volume of currency and

credit in the country”. The fact that several banks have been named reserve banks appears

to show that in the opinion of some authorities the custody of bank reserves is the

characteristic function of a central bank.

Reserve Bank of India (RBI)

The RBI is the Central Bank of our country. It is the open Institution of India Financial

and monetary system. RBI came into existence on 1st April, 1935 as per the RBI act 1935.

But the bank was nationalized by the government after Independence. It became the public

sector bank from 1st January, 1949. Thus, RBI was established as per the Act 1935 and

empowerment took place in banking regulation Act 1949. RBI has 4 local boards basically

in North, South, East and West – Delhi, Chennai, Calcutta, and Mumbai.

Functions of Reserve Bank of India (RBI)

I. Traditional Functions

Traditional functions are those functions which every central bank of each nation performs

all over the world. Basically these functions are in line with the objectives with which the

bank is set up. It includes fundamental functions of the Central Bank. They comprise the

following tasks.

1. Issue of Currency Notes: The RBI has the sole right or authority or monopoly of issuing

currency notes except one rupee note and coins of smaller denomination. These currency

notes are legal tender issued by the RBI. Currently it is in denominations of Rs. 5, 10, 20,

50, 100, 500, and 1,000. The RBI has powers not only to issue and withdraw but even to

exchange these currency notes for other denominations. It issues these notes against the

security of gold bullion, foreign securities, rupee coins, exchange bills and promissory notes

and government of India bonds.

2. Banker to other Banks: The RBI being an apex monitory institution has obligatory

powers to guide, help and direct other commercial banks in the country. The RBI can

control the volumes of banks reserves and allow other banks to create credit in

that proportion. Every commercial bank has to maintain a part of their reserves with its

parent's viz. the RBI. Similarly in need or in urgency these banks approach the RBI for

fund. Thus it is called as the lender of the last resort.

3. Banker to the Government: The RBI being the apex monitory body has to work as an

agent of the central and state governments. It performs various banking function such as to

accept deposits, taxes and make payments on behalf of the government. It works as a

representative of the government even at the international level. It maintains government

accounts, provides financial advice to the government. It manages government public debts

and maintains foreign exchange reserves on behalf of the government. It provides

overdraft facility to the government when it faces financial crunch.

4. Exchange Rate Management: It is an essential function of the RBI. In order to maintain

stability in the external value of rupee, it has to prepare domestic policies in that direction.

Also it needs to prepare and implement the foreign exchange rate policy which will help in

attaining the exchange rate stability. In order to maintain the exchange rate stability it has

to bring demand and supply of the foreign currency (U.S Dollar) close to each other.

5. Credit Control Function: Commercial bank in the country creates credit according to

the demand in the economy. But if this credit creation is unchecked or unregulated then it

leads the economy into inflationary cycles. On the other credit creation is below the

required limit then it harms the growth of the economy. As a central bank of the nation the

RBI has to look for growth with price stability. Thus it regulates the credit creation

capacity of commercial banks by using various credit control tools.

6. Supervisory Function: The RBI has been endowed with vast powers for supervising the

banking system in the country. It has powers to issue license for setting up new banks, to

open new branches, to decide minimum reserves, to inspect functioning of commercial

banks in India and abroad, and to guide and direct the commercial banks in India. It can

have periodical inspections an audit of the commercial banks in India.

II. Developmental / Promotional Functions of RBI Along with the routine traditional

functions, central banks especially in the developing country like India have to perform

numerous functions. These functions are country specific functions and can change

according to the requirements of that country. Some of the major development functions of

the RBI are given below.

1. Development of the Financial System: The financial system comprises the financial

institutions, financial markets and financial instruments. The sound and efficient financial

system is a precondition of the rapid economic development of the nation. The RBI has

encouraged establishment of main banking and non-banking institutions to cater to the

credit requirements of diverse sectors of the economy.

2. Development of Agriculture: In an agrarian economy like ours, the RBI has to provide

special attention for the credit need of agriculture and allied activities. It has successfully

rendered service in this direction by increasing the flow of credit to this sector. It has

earlier the Agriculture Refinance and Development Corporation (ARDC) to look after the

credit, National Bank for Agriculture and Rural Development (NABARD) and Regional

Rural Banks (RRBs).

3. Provision of Industrial Finance: Rapid industrial growth is the key to faster economic

development. In this regard, the adequate and timely availability of credit to small,

medium and large industry is very significant. In this regard the RBI has always been

instrumental in setting up special financial institutions such as ICICI Ltd. IDBI, SIDBI and

EXIM BANK etc.

4. Provisions of Training: The RBI has always tried to provide essential training to the staff

of the banking industry. The RBI has set up the bankers' training colleges at several places.

National Institute of Bank Management i.e NIBM, Bankers Staff College i.e BSC and

College of Agriculture Banking i.e CAB are few to mention.

5. Collection of Data: Being the apex monetary authority of the country, the RBI collects

process and disseminates statistical data on several topics. It includes interest rate,

inflation, savings and investments etc. This data proves to be quite useful for researchers

and policy makers.

6. Publication of the Reports: The Reserve Bank has its separate publication division. This

division collects and publishes data on several sectors of the economy. The reports and

bulletins are regularly published by the RBI. It includes RBI weekly reports,

RBI Annual Report, Report on Trend and Progress of Commercial Banks India., etc. This

information is made available to the public also at cheaper rates.

7. Promotion of Banking Habits: As an apex organization, the RBI always tries to promote

the banking habits in the country. It institutionalizes savings and takes measures for an

expansion of the banking network. It has set up many institutions such as the

Deposit Insurance Corporation-1962, UTI-1964, IDBI-1964, NABARD- 1982, NHB-1988,

etc. These organizations develop and promote banking habits among the people. During

economic reforms it has taken many initiatives for encouraging and promoting banking in

India.

8. Promotion of Export through Refinance: The RBI always tries to encourage the facilities

for providing finance for foreign trade especially exports from India. The Export-Import

Bank of India (EXIM Bank India) and the Export Credit Guarantee Corporation of India

(ECGC) are supported by refinancing their lending for export purpose.

INNOVATIONS OF BANKING ONLINE BANKING Online banking is an electronic payment system that enables customers of a financial

institution to conduct financial transactions on a website operated by the institution, such

as a retail bank, virtual bank, credit union or building society.

Banking online or by phone allows you to make banking transactions such as transferring

money, paying a bill, checking your balance or setting up a regular payment on your bank

or building society’s secure website. Online banking is accessible via a computer or a

mobile phone. Also known as internet banking.

What would I use this for?

You can make a range of payments: such as paying utility, tax and credit cards; bills; make

one-off payments to other individuals, small businesses or tradesmen; and make transfers

to other bank accounts or savings accounts.

How do I use it?

You will need to speak to your bank to get set up to use their phone or internet banking

service.

You will need the name, sort code and account details of the company/or person you want

to pay. You will also be asked to provide a reference so that the person or company

receiving the number knows what the payment is for.

Internet banking online payments

You will need to log on to your bank or building society’s internet banking service.

Although different banks will structure their websites in different ways when making a

payment you are likely to be asked to select the recipient from a list of previous payees (or

recipients) or to input a new payee’s details (and there may be additional security checks

before you can add a new recipient). You’ll then be asked to enter the amount you want to

pay, and to re-verify that the amount is correct. Your payment will be confirmed.

Telephone banking Phone payments

Work in a similar way to internet banking and you will need to have registered to use the

service. Your bank will have a designated phone banking number, and you will need to

answer some security questions before you can check your balance or set up or make a

payment.

How long does it take to process?

One-off online or phone payments are processed using one of two systems:

Faster Payments or Bacs.

The Faster Payments service is the default service for phone and internet banking

payments and the vast majority will be processed through this system. Faster Payments

enables a payment to be processed 24 hours a day, seven days a week and once you’ve

made the payment it should be with the recipient within a couple of hours, often almost

instantaneously.

Some banks set value limits for the amount you can send via Faster Payments and the

maximum amount that can be sent through the Faster Payments system is £100,000. Also

some accounts, such as savings and deposit accounts won’t enable you to send Faster

Payments or accept them. For these reasons, if speed of a payment is critical you should

check with your bank before sending it. Any payment that cannot be processed as a Faster Payment

will be processed via Bacs. If it goes through this system it will take three days for the payment to

reach the recipient’s account. However Bacs continues to be used for processing all Direct Debits and

salary payments where the speed of the payment is not an issue. Faster Payments was introduced in

May 2008 to speed up internet, phone and standing order payments within the UK.

Security

It is vital that you ensure that you give the correct sort code and account number and name

of the person/business you want to pay. If you give incorrect details your money may end

up in someone else’s account and it may be difficult to get it back. Some banks use hand-held Chip

and PIN card reading devices to add an extra layer of security. You can find more information on how

to stay safe online here.

Useful information

Whether a person can make or receive Faster Payments will always depend on whether the

payment is within a bank’s limits for sending faster payments and whether both accounts

involved are set up to send or receive them. If speed of your payment is important you

should check with your bank.

In addition, some accounts such as credit cards and utility bills may not be able to receive

Faster Payments, and some savings accounts may not be able to send or receive them.

Phone and online payments will be processed via Backs if they can’t be processed as Faster

Payments. This Sort Code Checker shows you whether the account you’re sending money to can

receive the funds through Faster Payments.

PHONE BANKING Telephone banking is a service provided by a bank or other financial institution that

enables customers to perform a range of financial transactions over the telephone, without

the need to visit a bank branch or automated teller machine.

Telephone banking is a service provided by a bank or other financial institution, that enables

customers to perform a range of financial transactions over the telephone, without the need to visit a

bank branch or automated teller machine. Telephone banking times are usually longer than branch

opening times, and some financial institutions offer the service on a 24-hour basis. Most financial

institutions have restrictions on which accounts may be accessed through telephone banking, as well

as a limit on the amount that can be transacted. The types of financial transactions which a customer

may transact through telephone banking include obtaining account balances and list of latest

transactions, electronic bill payments, and funds transfers between a customer's or another's

accounts. From the bank's point of view, telephone banking minimizes the cost of handling

transactions by reducing the need for customers to visit a bank branch for non-cash withdrawal and

deposit transactions. Transactions involving cash or documents (such as cheques) are not able to be

handled using telephone banking, and a customer needs to visit an ATM or bank branch for cash

withdrawals and cash or cheque deposits. Customer verification and authentication is of special

concern with telephone banking. After the customer would call the special phone number set up by

the financial institution, they would enter on the keypad the customer number and password. Some

financial institutions have set up additional security steps for access, but there is no consistency to

the approach adopted. Most telephone banking services use an automated phone answering system

with phone keypad response or voice recognition capability. To ensure security, the customer must

first authenticate through a numeric or verbal password or through security questions asked by a live

representative.

Mobile Banking Mobile banking refers to the use of a smartphone or other cellular device to perform online

banking tasks while away from your home computer, such as monitoring account balances,

transferring funds between accounts, bill payment and locating an ATM.

How it works/Example:

Mobile banking typically operates across all major mobile providers in the U.S. through

one of three ways: SMS messaging; mobile web; or applications developed for iPhone,

Android or Blackberry devices.

Mobile text and alert is the simplest, allowing the user to transfer funds or access account

information via text message. Texting terminology varies from bank to bank, but the

overall function is generally the same. For example, texting "Bal" will obtain the account

balance while "Tra" will allow inter-account transfers. Users need to first register and

verify their phone numbers with their bank, but once that's completed, they can also set up

alerts to let them know about negative balances or deposit confirmations.

Mobile web is the second mobile banking option. Similar to online account access from a

home-based computer, this option allows for checking balances, bill payment and account

transfers simply by logging into the user's account via a mobile web browser.

Mobile banking applications for Android, iPhone and Blackberry, connect the user directly

to the bank server for complete banking functionality without having to navigate a mobile

web browser. These applications can be downloaded either through the bank's website or

through the iTunes store.

Some banks are taking the technology one step further with account rewards

confirmation, person-to-person payments (P2P) and, more importantly, remote deposit

capture (RDC) capability.

Simply put, RDC is a service allowing users to scan checks and transmit the scanned

images to a bank for posting and clearing. In the case of mobile banking, a customer takes

pictures of both sides of a check and forwards the photos to the bank, which

then deposits the funds in the same way as if the deposit was made through a teller. RDC

capability means customers have faster access to their money, while automating yet

another deposit feature.

Why it Matters:

For consumers, mobile banking is a terrific way to efficiently manage the occasional

administrative task on the go. For small and mid-size business owners, mobile banking

gives the precious gift of time. Closing a sale, meeting new customers or smoothing back

office shipping glitches are important revenue producers. Waiting in line at the bank

to deposit a wad of checks is not.

For banks, mobile banking is a brilliant opportunity to simultaneously woo new customers

while paring operational costs. By responding to the innovations in mobile technology,

banks are effectively saying they're paying attention to the needs of their customers, while

at the same time streamlining a number of processes to meet the fast-paced demands of the

21st century.

Consumers should also be aware that mobile banking poses certain identity theft concerns.

While the transmission of data is encrypted across a secure network, hackers are always on

the lookout for ways of accessing this information. Due diligence should be employed when

relying on mobile banking, including close monitoring of your bank accounts, along with

ensuring proper protection in the event that your mobile phone is lost or stolen.

Mobile banking services

Account information

1. Mini-statements and checking of account history

2. Alerts on account activity or passing of set thresholds

3. Monitoring of term deposits

4. Access to loan statements

5. Access to card statements

6. Mutual funds / equity statements

7. Insurance policy management

Transaction

1. Funds transfers between the customer's linked accounts

2. Paying third parties, including bill payments and third party fund transfers(see,

e.g., FAST)

3. Check Remote Deposit

Investments

1. Portfolio management services

2. Real-time stock quotes

3. Personalized alerts and notifications on security prices

Support

1. Status of requests for credit, including mortgage approval, and insurance coverage

2. Check (cheque) book and card requests

3. Exchange of data messages and email, including complaint submission and tracking

4. ATM Location

Content services

1. General information such as weather updates, news

2. Loyalty-related offers

3. Location-based services

A report by the US Federal Reserve (March 2012) found that 21 percent of mobile phone

owners had used mobile banking in the past 12 months.[5] Based on a survey conducted by

Forrester, mobile banking will be attractive mainly to the younger, more "tech-savvy"

customer segment. A third of mobile phone users say that they may consider performing

some kind of financial transaction through their mobile phone. But most of the users are

interested in performing basic transactions such as querying for account balance and

making bill payment.

Future functionalities in mobile banking Based on the 'International Review of Business Research Papers' from World business

Institute, Australia, following are the key functional trends possible in world of Mobile

Banking.

With the advent of technology and increasing use of smartphone and tablet based devices,

the use of Mobile Banking functionality would enable customer connect across entire

customer life cycle much comprehensively than before. With this scenario, current mobile

banking objectives of say building relationships, reducing cost, achieving new revenue

stream will transform to enable new objectives targeting higher level goals such as building

brand of the banking organization. Emerging technology and functionalities would enable

to create new ways of lead generation, prospecting as well as developing deep customer

relationship and mobile banking world would achieve superior customer experience with

bi-directional communications. Among digital channels, mobile banking is a clear IT

investment priority in 2013 as retail banks attempt to capitalise on the features unique to

mobile, such as location-based services.

Challenges for a mobile banking solution Key challenges in developing a sophisticated mobile banking application are :

Handset operability There are a large number of different mobile phone devices and it is a big

challenge for banks to offer mobile banking solution on any type of device. Some of these devices

support Java ME and others support SIM Application Toolkit, a WAP browser, or only SMS.

Initial interoperability issues however have been localized, with countries like India using

portals like "R-World" to enable the limitations of low end java based phones, while focus

on areas such as South Africa have defaulted to the USSD as a basis of communication

achievable with any phone.

The desire for interoperability is largely dependent on the banks themselves, where

installed applications(Java based or native) provide better security, are easier to use and

allow development of more complex capabilities similar to those of internet banking while

SMS can provide the basics but becomes difficult to operate with more complex

transactions.

There is a myth that there is a challenge of interoperability between mobile banking

applications due to perceived lack of common technology standards for mobile banking. In

practice it is too early in the service lifecycle for interoperability to be addressed within an

individual country, as very few countries have more than one mobile banking service

provider. In practice, banking interfaces are well defined and money movements between

banks follow the IS0-8583 standard. As mobile banking matures, money movements

between service providers will naturally adopt the same standards as in the banking world.

On January 2009, Mobile Marketing Association (MMA) Banking Sub-Committee, chaired

by Cell Trust and VeriSign Inc., published the Mobile Banking Overview for financial

institutions in which it discussed the advantages and disadvantages of Mobile Channel

Platforms such as Short Message Services (SMS), Mobile Web, Mobile Client Applications,

SMS with Mobile Web and Secure SMS.

Security

As with most internet-connected devices, as well as mobile-telephony

devices, cybercrime rates are escalating year-on-year. The types of cybercrimes which may

affect mobile-banking might range from unauthorized use while the owner is using the

toilet, to remote-hacking, or even jamming or interference via the internet or telephone

network data streams. In the banking world, currency rates may change by the

millisecond.

Mobile security

Security of financial transactions, being executed from some remote location and

transmission of financial information over the air, are the most complicated challenges that

need to be addressed jointly by mobile application developers, wireless network service

providers and the banks' IT departments.

The following aspects need to be addressed to offer a secure infrastructure for financial

transaction over wireless network:

1. Physical part of the hand-held device. If the bank is offering smart-card based

security, the physical security of the device is more important.

2. Security of any thick-client application running on the device. In case the device is

stolen, the hacker should require at least an ID/Password to access the application.

3. Authentication of the device with service provider before initiating a transaction.

This would ensure that unauthorized devices are not connected to perform financial

transactions.

4. User ID / Password authentication of bank’s customer.

5. Encryption of the data being transmitted over the air.

6. Encryption of the data that will be stored in device for later / off-line analysis by the

customer.

One-time password (OTPs) are the latest tool used by financial and banking service

providers in the fight against cyber fraud.[8] Instead of relying on traditional memorized

passwords, OTPs are requested by consumers each time they want to perform transactions

using the online or mobile banking interface. When the request is received the password is

sent to the consumer’s phone via SMS. The password is expired once it has been used or

once its scheduled life-cycle has expired.

Because of the concerns made explicit above, it is extremely important that SMS

gateway providers can provide a decent quality of service for banks and financial

institutions in regards to SMS services. Therefore, the provision of service level

agreements (SLAs) is a requirement for this industry; it is necessary to give the bank

customer delivery guarantees of all messages, as well as measurements on the speed of

delivery, throughput, etc. SLAs give the service parameters in which a messaging solution

is guaranteed to perform.

Scalability and reliability

Another challenge for the CIOs and CTOs of the banks is to scale-up the mobile banking

infrastructure to handle exponential growth of the customer base. With mobile banking,

the customer may be sitting in any part of the world (true anytime, anywhere banking) and

hence banks need to ensure that the systems are up and running in a true 24 x 7 fashion. As

customers will find mobile banking more and more useful, their expectations from the

solution will increase. Banks unable to meet the performance and reliability expectations

may lose customer confidence. There are systems such as Mobile Transaction

Platform which allow quick and secure mobile enabling of various banking services.

Recently in India there has been a phenomenal growth in the use of Mobile Banking

applications, with leading banks adopting Mobile Transaction Platform and the Central

Bank publishing guidelines for mobile banking operations.

Application distribution

Due to the nature of the connectivity between bank and its customers, it would be

impractical to expect customers to regularly visit banks or connect to a web site for regular

upgrade of their mobile banking application. It will be expected that the mobile application

itself check the upgrades and updates and download necessary patches (so called "Over

The Air" updates). However, there could be many issues to implement this approach such

as upgrade / synchronization of other dependent components.

Personalization

It would be expected from the mobile application to support personalization such as :

1. Preferred Language

2. Date / Time format

3. Amount format

4. Default transactions

5. Standard Beneficiary list

6. Alerts

WHOLWSALE BANKING Wholesale banking is the provision of services by banks to organizations such as Mortgage

Brokers, large corporate clients, mid-sized companies, real estate developers andinvestors,

international trade finance businesses, institutional customers (such as pension funds and

government entities/agencies), and services offered to other banks or other financial

institutions.

Wholesale finance refers to financial services conducted between financial services

companies and institutions such as banks, insurers, fund managers, and stockbrokers.

Universal Banking DEFINITION OF 'UNIVERSAL BANKING'

A banking system in which banks provide a wide variety of financial services, including

both commercial and investment services. Universal banking is common in some European

countries, including Switzerland. In the United States, however, banks are required to

separate their commercial and investment banking services. Proponents of universal

banking argue that it helps banks better diversify risk. Detractors think dividing up banks'

operations is a less risky strategy.

Universal banking is a combination of Commercial banking, Investment banking,

Development banking, Insurance and many other financial activities. It is a place where all

financial products are available under one roof. So, a universal bank is a bank which offers

commercial bank functions plus other functions such as Merchant Banking, Mutual Funds,

Factoring, Credit cards, Housing Finance, Auto loans, Retail loans, Insurance, etc.

Universal banking is done by very large banks. These banks provide a lot of finance to

many companies. So, they take part in the Corporate Governance (management) of these

companies. These banks have a large network of branches all over the country and all over

the world. They provide many different financial services to their clients.

ln India, two reports in 1998 mentioned the concept of universal banking. They are, the

Narasimham Committee Report and the S.H. Khan Committee Report. Both these reports

advised to consolidate (bring together) the banking industry through mergers and

integration of financial activities. That is, they advised a combination of all banking and

financial activities. That is, they suggested a Universal banking.

In 2000, ICICI asked permission from RBI to become a universal bank. RBI wants some

big domestic financial institutions to become universal banks.

Advantages of Universal Banking

The benefits or advantages of universal banking are:-

Investors' Trust: Universal banks hold stakes (equity shares) of many companies. These

companies can easily get other investors to invest in their business. This is because other

investors have full confidence and faith in the Universal banks. They know that the

Universal banks will closely watch all the activities of the companies in which they hold a

stake.

Economics of Scale: Universal banking results in economic efficiency. That is, it results in

lower costs, higher output and better products and services. In India, RBI is in favour of

universal banking because it results in economies of scale.

Resource Utilization: Universal banks use their client's resources as per the client's ability

to take a risk. If the client has a high risk taking capacity then the universal bank will

advise him to make risky investments and not safe investments. Similarly, clients with a low

risk taking capacity are advised to make safe investments. Today, universal banks invest

their client's money in different types of Mutual funds and also directly into the share

market. They also do equity research. So, they can also manage their client's portfolios

(different investments) profitably.

Profitable Diversification: Universal banks diversify their activities. So, they can use the

same financial experts to provide different financial services. This saves cost for the

universal bank. Even the day-to-day expenses will be saved because all financial services

are provided under one roof, i.e. in the same office.

Easy Marketing: The universal banks can easily market (sell) all their financial products

and services through their many branches. They can ask their existing clients to buy their

other products and services. This requires less marketing efforts because of their wellestablished

brand name. For e.g. ICICI may ask their existing bank account holders in all

their branches, to take house loans, insurance, to buy their Mutual funds, etc. This is done

very easily because they use one brand name (ICICI) for all their financial products and

services.

One-stop Shopping: Universal banking offers all financial products and services under one

roof. One-stop shopping saves a lot of time and transaction costs. It also increases the speed

or flow of work. So, one-stop shopping gives benefits to both banks and their clients.

Disadvantages of Universal Banking

The limitations or disadvantages of universal banking are:-

Different Rules and Regulations: Universal banking offers all financial products and

services under one roof. However, all these products and services have to follow different

rules and regulations. This creates many problems. For e.g. Mutual Funds, Insurance,

Home Loans, etc. have to follow different sets of rules and regulations, but they are

provided by the same bank.

Effect of failure on Banking System: Universal banking is done by very large banks. If

these huge banks fail, then it will have a very big and bad effect on the banking system and

the confidence of the public. For e.g. Recently, Lehman Brothers a very large universal

bank failed. It had very bad effects in the USA, Europe and even in India.

Monopoly: Universal banks are very large. So, they can easily get monopoly power in the

market. This will have many harmful effects on the other banks and the public. This is also

harmful to economic development of the country.

Conflict of Interest: Combining commercial and investment banking can result in conflict

of interest. That is, Commercial banking versus Investment banking. Some banks may give

more importance to one type of banking and give less importance to the other type of

banking. However, this does not make commercial sense.

NARROW BANKNG Narrow banking is a proposed type of bank called a narrow bank also called a safe bank.

Narrow banking would restrict banks to holding liquid and safe government bonds. Loans

would be made by other financial intermediaries. That is, the deposit taking and payment

activities would be separated from financial intermediation activities. Purported attributes

of narrow banking include -

1. No lending of deposits

2. Extremely high liquidity

3. Extremely high asset security

4. Lower interest rates paid to depositors

5. Regulatory framework with higher level of scrutiny and operational and investing

restrictions

Additional criteria applied to safe banks include -

1. No derivatives

2. No off balance sheet assets

3. High degree of institutional transparency (e.g. continuous real-time disclosure of

financial records)

4. Capped executive salaries

5. Low risk jurisdictions

Offshore bank An offshore bank is a bank located outside the country of residence of the depositor,

typically in a low-tax jurisdiction (or tax haven) that provides financial and legal

advantages.

Definition of Social Banking We acknowledge that a generally accepted definition of “Social Banking” does not exist, and –

given the variety of its historic origins and underlying values – arguably cannot exist. But we

believe that there is a common denominator of many organizations that can be subsumed

under this notion of social banking, which we define as follows:

“Social Banking’’ describes the provision of banking and financial services that consequently pursue,

as their main objective, a positive contribution to the potential of all human beings to develop, today

and in the future. In Social Banking, the focus is on satisfying existing needs in the real economy and

the society whilst simultaneously taking into account their social, cultural, ecological and

economic sustainability. Furthering the common good by generating multiple returns with

respect to these aspects is at its core. Generating a monetary profit is not an end but a

frequent prerequisite to guaranteeing the necessary flexibility for pursuing its objective in

a continuously changing environment. Social Banking is always conscious of its responsibility in

dealing with money as a formative medium. It understands money, banking and finance as means

that are conceived and that can be further developed by humans to achieve its objective.

Social Banking describes a process, not a steady state. It is about jointly identifying and

testing creative new ways to come close to the above-described objective. This involves

multiple aspects and demands, which are sometimes conflicting and often necessitate

compromise. Therefore, Social Banking depends on an on-going and constructive dialogue

of the people involved in and affected by its activities, as well as on a continuous reflection

of their respective motives (why?), actions (what?) and approaches (how?). This requires

the willingness and capacity to develop on both an individual and an institutional level.

Common characteristics

Characteristics of many such understood Social Banking organizations are (in alphabetic

order) for instance

Catalogue of socially, culturally, ecologically and ethically oriented negative criteria to

prevent unsustainable ways of living and doing business that do not foster the common

good,

Catalogue of socially, culturally, ecologically and ethically oriented positive criteria to

support sustainable ways of living and doing business that do foster the common good,

Contestation of the values underlying its activities,

Dialogue with a wider group of stakeholders,

Emphasis on human rights and solidarity,

Equal treatment of genders,

Organizational structures based on participation,

Ownership structures preventing dependency of dominant individual interest,

Pro-active contributions to the public discussion of perceived problem areas.

INSURANCE

Basic terms used in insurance

Different terms are used in the insurance. Important among them are given below -

Insured

The party or the individual who seeks protection against a specified task and entitled to

receive payment from the insurer in the event of happening of stated event is known as

insured. An insured is normally in insurance policy holder.

Insurer

The party who promises to pay indemnity the insured on the happening of contingency is

known as insurer. The insurer is an insurance company.

Beneficiaries

The person or the party to whom the policy proceeds will be paid in the event of the death

or happening of any contingency is called beneficiary.

Contract

An agreement binding at law between two or more parties is called contract. Premium The

amount which is paid to the insurer by the insured in consideration to insurance contract is

known as premium. It may be paid on monthly, quarterly, half yearly, yearly or as agreed

upon it is the price for an insurance policy.

Insured sum

The sum for which the risk is insured is called the insured sum, or the policy money or the

face value of the policy. This is the maximum liability of the insurer towards the insured.

Nature and Characteristics of Insurance

Insurance follows important characteristics – These are follows

1. Sharing of risk

Insurance is a co-operative device to share the burden of risk, which may fall on happening

of some unforeseen events, such as the death of head of family or on happening of marine

perils or loss of by fire.

2. co-operative device

Insurance is a co-operative form of distributing a certain risk over a group of persons who

are exposed to it. A large number of persons share the losses arising from a particular risk.

3. Large number of insured persons - The success of insurance business depends on the

large number of persons Insured against similar risk. This will enable the insurer to spread

the losses of risk among large number of persons, thus keeping the premium rate at the

minimum.

4. Evaluation of risk For the purpose of ascertaining the insurance premium, the volume of

risk is evaluated, which forms the basis of insurance contract.

5. Payment of happening of specified event On happening of specified event, the insurance

company is bound to make payment to the insured. Happening of specified event is certain

in life insurance, but in the case of fire, marine of accidental insurance, it is not necessary.

In such cases, the insurer is not liable for payment of indemnity

6. Transfer of risk Insurance is a plan in which the insured transfers his risk on the

insurer. This may be the reason that may person observes, that insurance is a device to

transfer some economic losses would have been borne by the insured themselves.

7. Spreading of risk Insurance is a plan which spread the risk & losses of few people among

a large number of people. John Magee writes, “Insurance is a plan by which large number

of people associates themselves and transfers to the shoulders of all, risk attached to

Individuals”.

8. Protection against risks

Insurance provides protection against risk involved in life, materials and property. It is a

device to avoid or reduce risks.

9. Insurance is not charity Charity pays without consideration but in the case of insurance,

premium is paid by the insured to the insurer in consideration of future payment.

10. Insurance is not a gambling Insurance is not a gambling. Gambling is illegal, which

gives gain to one party and loss to other. Insurance is a valid contact to indemnity against

losses. Moreover, Insurable interest is present in insurance contracts it has the element of

investment also.

11. A contract

Insurance is a legal contract between the insurer and insured under which the Insurer

promises to compensate the insured financially within the scope of insurance Policy, the

insured promises to pay a fixed rate of premium to the insurer.

12. Social device Insurance is a plan of social welfare and protection of interest of the

people. Rieged and miller observe “insurance is of social nature”

Function of insurance

Insurance becomes very useful in today’s life. It plays significant role in this competitive

era. According to Sir William Beveridge the functions of insurance can be divided into

three categories.

1) Primary functions

2) Secondary functions

3) Indirect functions

Primary function

1. To provide protection

The most important function of insurance is to provide protection against risk of loss. It is

one check the reality of the misfortune happening, and pays the cost of damages of losses.

2. To provide certainty

The future is totally uncertain. Any misfortune happening may occur at any stage of life.

The amount of loss and time of losses both are uncertain. Insurance provides certainly

towards the losses. The policy holders pay the premium to get certainty

3. Distribution of risk It is a co-operative effort where the risk is distributed among the

group of People. Thus, no one have to bear the losses occurred due to uncertainty.

Secondary function

1. Helps in economic progress

Insurance plays an important role in economic progress. It gives fully certainty to the

industrialists towards the risks. The entrepreneurs can more concentrate on Innovative

and profitable techniques of the production. They should not require Thinking over the

risks. The industrialists can establish new industries in environment. Thus, industries have

got development in economic and commerce of the nation.

2. Insurance prevents losses Insurance plays vital role in preventing the losses. The amount

of premium is minimized by using such appliances like the fire extinguisher. If one uses

interior Machinery which may be caused for misfortune, the amount of premium will be

high. Thus, indirectly, insurance provides help to minimize the chances of risks.

Indirect function

1. A forced savings Life insurance is also a method of savings in India. Income tax act gives

relief in payment of income tax because government wants to habituate general public to

save money. It encourages the habit of thrift and savings among the people. Thus, it

becomes compulsory savings to people of nation.

2. Promote foreign trade

It is compulsory to take marine insurance policy in foreign trade in India. Foreigners can’t

issue the foreign trade bill unless the cargo is fully insured. Thus Foreign trade is totally

depends upon the insurance sector of the nation. It gives relief to entrepreneurs from the

uncertainty of foreign trade.

3. Others Insurance provides certainties towards risks in entrepreneurship. It gives

Confidence in general public. It is one of the important source of investment which

develops the trade and commerce of the nation.

Advantages/benefits/uses of insurance

a. Risk transfer- individual or businessman can easily and conveniently transfer the risk of

loss

b. Protection- insurance give protection to the property of insured and life insurance

provides financial protection

c. Assured profit- a policy holders can enjoy a normal expected profit say up to 15 to 20%

on their investment

d. Effect on prices (benefit to consumers)-Manufacturers passes on the consumer, the cost

of insurance along with other Production cost. Still it is beneficial to the consumers because

without insurance the Cost would have been much more.

e. Basis of credit- policies act as valuable assets and the policy holders can avail credit or

emergency loan against it

f. Investment- a life insurance contract provides not only protection but also investment, or

a pension in old age

g. Capital formation- insurance companies as institutional investors can mobilise small

national savings in the form of premium and ensure capital for productive sectors.

h. Insurance encourage saving- life insurance is like a compulsory saving. For people have

limited means of income there is no other better alternative than LIC.

i. Invisible export- Providing insurance service overseas is our invisible export, like export

of material goods and the profit brought in is contribution to the favourable balance of

Trade.

j. Reducing cost of social services- No victim or heirs of a deceased victim of motor

accidents now a day’s goes Without compensation from insurance funds built out of

compulsory insurance of Motor vehicles. Limitations of Insurance.In spite of number of

advantages of insurance, it has certain limitations. On account of such limitations, the

benefits of insurance could not be availed in full.

a. All the risks cannot be insured. Only pure risks can be insured and speculative risks are

not insurable.

b. Insurable interest (financial interest) en the subject matter of insurance either at the

time of insurance or at the time of loss, or at both the times must be present, in the absence

of which the contract of insurance becomes void.

c. In case the loss arises from the happening of the event cannot be valued in terms of

money, such risks are not insurable.

d. Insurance against the risk of a single individual or a small group of persons are not

advisable, since it is not practicable due to higher cost involved.

e. Another important limitation is that the premium rates are higher in our country & as

such, certain category of people cannot avail the advantage of insurance. The main reason

for the higher rate of premiums is the higher operating cost.

f. It becomes difficult to control moral hazards in insurance. There are certain people who

may utilize the insurance plans for their self-interest by claiming false claims from

insurance companies.

Classification of Insurance

We can classify the insurance as following:

I. On the basis of Risk

a. Personal insurance

b. Property insurance

c. Liability insurance

d. Fidelity guarantee

II. Insurance On the basis of nature of business

a. Life insurance

b. General insurance - 1. Fire insurance

2. Marine insurance

3. Social insurance

4. Miscellaneous insurance

III. Miscellaneous insurance may include

a) Vehicle insurance

b) Accident insurance

c) Burglary insurance

d) Crop insurance

e) Cattle insurance

f) engineering insurance etc.

For our sake, we can classify insurance into 2 groups’ i.e. life insurance and nonlife

(general) insurance.

I. Life Insurance

It is governed by the LIC act 1956. It is contract in which the insurer, inconsideration of

payment of premium compensate to a person on death or on the expiry of certain period

whichever is earlier. (Life insurance details given in the following module)

II. General Insurance

General Insurance covers a wide range of services. Section 6(b) of the insurance act 1938

defines General Insurance. It includes all the risks except life. Its classification is:

A. Marine Insurance :- Marine insurance is the oldest insurance which was introduced long

back to compensate on sea and to compensate the loss due to various sea perils or loss of

the ship etc. In today’s context, marine insurance is an important part of trade and

commerce and is a significant part of global insurance business. Marine play a key role in

international trade. Law relating to Marine Insurance Act 1963. According to section 3 of

marine insurance act, 1963 defines marine insurance as, a contract where by an insurer

undertakes to indemnify the assured against marine losses that is to say the losses

incidental to marine adventure.

Features of marine insurance contract:

1. Features of a valid contract: marine insurance is a contract; therefore it should possess

the features of a valid contract, according to Indian contract act. They are; The proposal

forms called slips are the offer from the merchant. The original slip is submitted along with

the other material information. This is proposal from the merchant or the ship owner is the

offer. The master and crew of the ship have an insurable interest in respect of their

wages. Premium is consideration to contract. The policy is prepared, stamped and

signed and it will be the legal evidence of the contract When slip is presented to the

insurer, he checks it and satisfied he puts initial. Now the proposal is accepted. Once the

slip is accepted the offer of the proposer is accepted by the insurer

2. Insurable interest in marine policy: Owner of the goods has insurable interest to the

extent of total value of the goods. Owner of the ship can insure the ship to its full price

Buyer of the goods who insured them has insurable interest even he rejects the goods.

Insurer has an insurable interest in his risk and may reinsure in respect of it. The

receiver freight can insure up to the amount of freight to be received by him. The policy

holder has an insurable interest in the charges of any insurance which he may affect. If

the subject matter insured is mortgaged, the mortgager has an insurable interest

3. Disclosure by agent (utmost good faith):

When insurance policy is taken through an agent, he must disclose to the insurer every

fact. The agent is deemed to know all the details of material information. If the information

is false, the insurer can avoid the policy. If negligence can be held against the broker, he

may be liable for breach of contract4. Principle of Indemnity: Marine insurance is a

contract of indemnity. It implies that the policy holder cannot make profit out of a claim.

In the absence of principle of indemnity, the policy holder may make profit out of claim.

The insurance contract implies that the indemnifies only to the extent agreed upon. The

basis of indemnity is always a cash basis.

5. Principle of subrogation:

This principle specifies that the policy holder should not get more than the actual loss. The

insurer has a right to pay the amount of loss after reducing the money received by the

policy holder from the third party. After indemnification the insurer gets all the rights of

insured on the third parties. But he cannot file suit in his name. There fore he has to take

the support of the support of the policy holder.

6. Average clause:

A marine policy is invariably subject to average clause.

7. Express and implied Warranties:

All marine insurance contracts are subject to certain express and implied warranties.

8. Principle of contribution:

Principle of contribution also applicable in the case of marine insurance contracts.

Maritime perils-Maritime perils are also called as “Perils of the sea”. It means the perils

consequent on, or incidental to the navigation of the sea, that is to say, war perils, rovers,

thieves, captures, seizures, restraints and detainment etc. Following losses have been held

to be perils of the sea:

a. Loss caused because of collisions against a sunken rock.

b. Loss caused because of collision with another ship

c. Loss caused because of heating due to the closure of ventilators to prevent the immersion

of sea water.

d. Loss caused because rats made a hole in the bottom of a ship and sea water entered into

ship through that hole and damaged the cargo. Marine Policy The instrument in which the

contract of insurance is affected is known as marine policy or sea policy. It is a document

which incorporates the details of terms and conditions of marine insurance.

Contents of marine policies are:

1. Name of the insured

2. Policy number

3. Sum insured

4. Premium

5. Stamp duty

6. Steamer or other conveyance

7. Voyage or journey.

8. Number and date of bill of lading and other similar document related.

9. Interest to be insured.

10. Subject matter insured and the risk insured.

11. Place where claims are payable

12. Place and date of issue of policy.

13. Authorised signatures.

The coverage under marine insurance policy includes the following:

a) The ship (hull and machinery).

b) The insurable goods and property exposed to maritime perils.

c) Other incidental earnings like freight, commission etc. which will be lost along with the

property due to the maritime perils.

d) The third party liabilities incurred by the insurer or other person responsible for or

interested in the property.

e) Expenses incurred to prevent and minimise loss

B. Fire Insurance:

Fire insurance is a recent developed concept in insurance sector. It is covered under the

insurance act 1938.

Definition: “Fire insurance is a cover against the risk of loss of property due to fire

accident.” Fire Insurance is a contract where by the insurer undertakes in consideration of

the premium paid to make good any loss cause by the fire during a specific period. The

specific amount to be assured or claimed in case of loss should be mentioned or specified

in the contract. Subject matter of Fire insurance

As per fire insurance, the following are the examples of insurable property:

1. Building

2. Electrical installation in building

3. Contents of building such as machinery, plant and equipment, accessories etc.

4. Goods (finished/WIP) and raw materials in factories and godowns

5. Contents of dwelling, shops, hotels etc.

6. Furniture, fixtures, fitting etc.

Features of Fire Insurance: (fundamental principles of fire insurance)

1. It is a General Contract: It is one of the important features of fire insurance; It contains

all the features of a valid contract. This is accepted by the insurer for the consideration of

the premium. The insurer issues the policy with all terms and conditions of the contract.

2. Contact of Indemnity: Fire insurance is a contract of indemnity, in the event of loss the

insured can recover actual amount of loss. Insured is allowed to gain excess amount out of

the loss caused due to fire.

3. Contract of Uberimae fidei: a fire insurance contract is based on absolute good faith and

therefore insured must make full and adequate disclosure of all material facts of subject

matter of insurance.

4. Principles of Insurable interest : insurable interest must exist at the time of effecting the

policy as well as the time of loss.

5. Principles of mitigation of loss and subrogation etc. are applicable in fire insurance.

4. Period of the policy: Fire insurance policy is issued for one year. Therefore they are

popular as Annual insurance

C. Miscellaneous insurance:

Health, Motor, property and others come under this category.

Health insurance provides for the payment of benefits to cover the loss due to sickness.

Motor Insurance provides the benefits in case of, damage or loss due to accident.

Deposit insurance provides Insurance against bank deposit. This scheme was introduced by

our government in 1962.

Postal insurance was introduced in 2006 by postal department of India. This scheme

provides insurance to postal saving account holders for accidental death.

Accident insurance policies offered by insurer are personal accident insurance; crackle

core insurance, passenger flight capon insurance, suhana safer policy, kidnap & ransom

insurance, Bhagya shri policy etc.

Life insurance- concept

Life insurance is a contract under which the insurer (Insurance Company) inconsideration

of a premium paid undertakes to pay a fixed sum of money on the death of the insured or

on the expiry of a specified period of time whichever is earlier. In case of life insurance, the

payment for life insurance policy is certain. The event insured against is sure to happen

only the time of its happening is not known. So life insurance is known as ‘Life Assurance’.

The subject matter of insurance is life of human being. Life insurance provides risk

coverage to the life of a person. On death of the person insurance offers protection against

loss of income and compensate the titleholders of the policy.

Basic Principles of Life Insurance Contract.

1. Insurable interest

The insured must have insurable interest in the life assured. In absence of insurable

interest, Contract of insurance is void. Insurable interest must be present at the time of

entering into contract with insurance company for life insurance. It is not

necessary that the assured should have insurable interest at the time of maturity also.

2. Utmost good faith

The contract of life insurance is a contract of utmost good faith. The insured should be

open and truthful and should not conceal any material fact in giving information to the

insurance company, while entering into a contract with insurance company.

Misrepresentation or concealment of any fact will entitle the insurer to repudiate the

contract if he wishes to do so.

3. Not a contract of indemnity

The life insurance contract is not a contract of indemnity. A Contract of life insurance is

not a contract of indemnity. The loss of life cannot be compensated and only a fixed sum of

money is paid in the event of death of the insured. So, the life insurance contract is not a

contract of indemnity. The loss resulting from the death of life assured cannot be calculated

in terms of money.

Features of life insurance

Following are the important features of valid contract of life insurance

1. Elements of a valid contract

2. Insurable interest

3. Utmost good faith

4. Warranties

5. Assignment and Nomination

6. Cause is certain

7. Premium (consideration)

8. Term of policy

9. Return of premium (surrender)

Importance of Life Insurance.

Life Insurance is of great importance to individuals, groups, business community and

general public. Some of the main benefits of life insurance are given below.

i) Protection against untimely death Life insurance provides protection to the dependents

of the life insured and the family of the assured in case of his untimely death. The

dependents or family members get a fixed sum of money in case of death of the assured.

ii) Saving for old age. After retirement the earning capacity of a person reduces. Life

insurance enables a person to enjoy peace of mind and a sense of security in his/her old age.

iii) Promotion of savings. Life insurance encourages people to save money compulsorily.

When a life policy is taken, the assured is to pay premiums regularly to keep the policy in

force and he cannot get back the premiums, only surrender value can be returned to him.

In case of surrender of policy, the policyholder gets the surrendered value only after the

expiry of duration of the policy.

iv) Initiates investments Life Insurance Corporation encourages and mobilizes the public

savings and channelizes the same in various investments for the economic development of

the country. Life insurance is an important tool for the mobilization and investment of

small savings.

v) Credit worthiness Life insurance policy can be used as a security to raise loans. It

improves the credit worthiness of business.

vi) Social Security Life insurance is important for the society as a whole also. Life

insurance enables a person to

provide for education and marriage of children and for construction of house. It helps a

person to make financial base for future.

vii) vii) Tax Benefit Under the Income Tax Act, premium paid is allowed as a deduction

from the total income under section 80C

Life insurance Policies

Life insurance policies can be grouped into the following categories:

1. Term Policy

In case of Term assurance plans, insurance company promises the insured for a nominal

premium to pay the face value mentioned in the policy in case he is no longer alive during

the term of the policy.

Term assurance policy has the following features:

• It provides a risk cover only for a prescribed period. Usually these policies are short-term

plans and the term ranges from one year onwards. If the policyholder survives till the end

of this period, the risk cover lapses and no insurance benefit payment is made to him.

• The amount of premium to be paid for these policies is lower than all other life insurance

policies. As savings and reserves are not accumulated under this policy, it has no surrender

value and loan or paid-up values are not allowed on these policies.

• This plan is most suitable for those who are initially unable to pay high premium

• when income is low as required for Whole Life or Endowment policies, but requires life

cover for a high amount.

2. Whole Life Policy

This policy runs for the whole life of the assured. The sum assured becomes payable to the

legal heir only after the death of the assured. The whole life policy can be of three types.

(1) Ordinary whole life policy – In this case premium is payable periodically throughout

the life of the assured

(2) Limited payment whole life policy – In this case premium is payable for a specified

period (Say 20 Years or 25 Years) Only.

(3) Single Premium whole life policy – In this type of policy the entire premium is payable

in one single payment.

3. Endowment Life Policy

In this policy the insurer agrees to pay the assured or his nominees a specified sum of

money on his death or on the maturity of the policy whichever is earlier. The premium for

endowment policy is comparatively higher than that of the whole life policy. The premium

is payable till the maturity of the policy or until the death of the assured whichever is

earlier. It provides protection to the family against the untimely death of the assured.

4. Health insurance schemes An individual is subject to uncertainty regarding his health.

He may suffer from ailments, diseases, disability caused by stroke or accident, etc. For

serious cases the person may have to be hospitalized and intensive medical care has to be

provided which can be very expensive. It is here that medical insurance is helpful in

reducing the financial burden. These days the vulnerability to lifestyle diseases such as

heart, cancer, neurotic, and pollution based, etc are on the increase. So it makes sense for

an individual to go for medical insurance cover.

5. Joint Life Policy This policy is taken on the lives of two or more persons simultaneously.

Under this policy the sum assured becomes payable on the death of any one of those who

have taken the joint life policy. The sum assured will be paid to the survivor(s). For

example, a joint life policy may be taken on the lives of husband and wife, sum assured will

be payable to the survivor on the death of the spouse.

6. With Profit And Without Profit Policy

Under with profit policy the assured is paid, in addition to the sum assured, a share in the

profits of the insurer in the form of bonus. Without profit policy is a policy under which

the assured does not get any share in the profits earned by the insurer and gets only the

sum assured on the maturity of the policy. With profit and without profit policies are also

known as participating and non–participating policies respectively.

7. Double Accident Benefit Policy

This policy provides that if the insured person dies of any accident, his beneficiaries will get

double the amount of the sum assured.

8. Annuity Policy Under this policy, the sum assured is payable not in one lump sum

payment but in monthly, quarterly and half-yearly or yearly instalments after the assured

attains a certain age. This policy is useful to those who want to have a regular income after

the expiry of a certain period e.g. after retirement. Annuity is paid so long as the assured

survives. In annuity policy medical check-up is not required. Annuity is paid so long as the

assured survives.

9. Policies For Women Women, now a days are free to take life assurance policies.

However, some specially designed policies suit their needs in a unique manner; important

policies for women are

A. Jeevan Sathi is also known a Life Partner plan where the husband and wife are covered

under this endowment policy

B. Jeevan Sukanya

10. Group Insurance

Group life insurance is a plan of insurance under which the lives of many persons are

covered under one life insurance policy. However, the insurance on each life is independent

of that on the other lives. Usually, in group insurance, the employer secures a group policy

for the benefit of his employees. Insurer provides coverage for many people under single

contract.

11.Policies For Children

Policies for children are meant for the various needs of the children such as education,

marriage, security of life etc. Some of the major children policies are:

(1) Children’s deferred assurances

(2) Marriage endowment and educational annuity plans

(3) Children endowment policy

12. Money Back Policy

In this case policy money is paid to the insured in a number of separate cash payments.

Insurer gives periodic payments of survival benefit at fixed intervals during the term of

policy as long as the policyholder is alive The contract for the life insurance starts with the

proposal made by the proposer in standard application form available with insurance

company and then various other documents are prepared.

SAVING & INVESTMENT POLICIES OF INSURANCE

TYPES OF LIFE INSURANCE POLICIES

1. LIFE INSURANCE POLICIES ISSUED BY LIC.

2. LIFE INSURANCE POLICIES ISSUED BY BIRLA SUN LIFE INSURANCE

COMPANY LIMIITES.

3. LIFE INSURANCE POLICIES ISSUED BY SBI LIFE INSURANCE CO LTD

1. LIFE INSURANCE POLICIES ISSUED BY LIC :-

I. WHOLE LIFE POLICIES- Whole life policies are issued for life period of insured. It

means that the policy amount will be paid only at the death of the life insured. Under these

types of policies, the insured cannot get the policy amount during his life period. Only the

dependents of life insured will get the advantages of this policy.

Whole life policies are:-

a) Whole life policy with profit- This is a policy at lower rates of premium. The premiums

are payable throughout the life time of insured and the sum assured becomes payable on

the death of the insured or attaining the age of 80 years whichever is earlier.

b) Whole life limited premium- Under this type of whole life policy the payment of

premium is limited to certain fixed period. The sum assured is payable on the death of the

policy holders.

c) Whole life single premium policy- It is not very common policy. Single premium is paid

at the beginning of the policy in one instalment. The policy is available with and without

profits.

II. Term life insurance policy- life insurance policy which provides only risk cover during a

specified period without any survival benefit, is called term life insurance policy. Term

insurance policies are for a short period of years ranging from 3 months to 7 years. In case

of a term life insurance, the sum assured is payable only in the event of death during the

term. In case of survival the life insurance contract comes to an end at the end of the term.

There is no refund of premium. These policies are usually non-participating. Since only

death risk is covered, the premium is low.

III. Endowment type policies:-

a) Pure endowment policy- the sum assured is payable only on the surviving of life assured

in endowment term. In case of death within the term, premium may be returned or not.

The pure endowment policy is opposite of the term policy because the insured is paid only

if he survives in pure endowment policy and if he dies within the term policy he gets

nothing. Actually these two policies that is pure endowment and term policy are the base of

all other policies. Pure endowment is for the benefit of policy holder whereas term policy is

for the benefit of others.

b) Ordinary endowment policy- it is the most popular and common policy of LIC. The

premiums under the policy are paid for a fixed term. In case the death takes place during

the term, the sum assured along with accumulated bonus is paid to the family of policy

holder.

c) Double endowment policy. Under this policy if the life insured dies during the

endowment period, the basic sum assured is payable and if he survives to the end of the

term, double of sum assured is paid.

d) Joint life endowment plan. Under this policy, two lives can be insured under one life

insurance contract.

e) Marriage endowment policy- this policy has the special condition that the sum assured is

only payable after the expiry of the endowment term even if death of the life insured takes

place earlier. This policy is designed to meet the needs of a policyholder who wants to make

arrangement of certain sum for the marriage of a female dependent.

f) Education annuity policy- this policy is also taken out on the life of father or guardian for

the benefits of their child’s education.

g) Triple benefit policy- this policy is a combination of a whole life limited payment and a

pure endowment with a guaranteed annual bonus payable during the endowment term.

This policy is guaranteed for a fixed terms of 15, 20, or 25 years. Premium are payable

throughout the term or till pre mature death of policy holder.

2. Policies according to premium payment- the life insurance policies are of following types

according to the payment of premium:

a) Single premium policy- the whole premium is paid at the beginning of the policy in this

type of policies. This type of policy is only useful to those persons who got a windfall

income and are expected not to continue to receive such returns in subsequent years.

b) Level premium policies- the regular and equal premiums are paid at a definite interval

under level premium policy. The premium is lesser than the single premium policy.

3. Policies according to participation of profits- life insurance policies according to

participation may be without profit policies & with profit policies.

a) Without profit policies- the policyholders of this type of policies are not entitled to share

the profits of the insurer. These policy holders get only the sum assured and no bonus is

given to them.

b) With profit policies- the policyholders of this type of policies are entitled to share the

profit of the insurance company. The policy holder only share the profits, not the loss. If

there is loss, the policy holder cannot get the bonus. The amount of bonus depends on the

profit after providing provision for taxes, contingency etc. in this type of policy there is no

guarantee that the insured will get something by way of profit every year.

2. LIFE INSURANCE POLICIES ISSUED BY BIRLA SUN LIFE INSURANCE

COMPANY LIMIITES.

a) Birla flexi sano plus endowment- Birla flexi sano plus endowment policy offers you the

dual benefit of insurance cover as well as an investment opportunity by investing a part of

the premium that one pay regularly in an investment fund, which will provide market

linked returns. This policy is best suited for people who want to maximize their savings to

realize their long term goals and protect their families with an insurance policy.

b) Birla flexi life line whole policy- Birla flexi life line whole policy is a policy in which the

policy holder keeps enjoys life insurance for the whole life until death or up to 100 years of

age whichever is earlier and pays premium for the same period or shorter period and

enjoys the benefits of savings along with the insurance.

3. LIFE INSURANCE POLICIES ISSUED BY SBI LIFE INSURANCE CO LTD

SBI LIFE –SUKHJEEVAN- sukhjeevan is a life insurance policy issued by SBI life. It is a

single premium endowment assurance policy with a built in accidental death benefit and

permanent benefit cover. This policy is best suited for the individuals seeking a short term

investment plan at the same time have an insurance cover.

Proposal Forms

The proposal form is a standardized form. The proposal form is a type of an application

form, which a proposer has to fill all the relevant details about the life to be assured. The

agent has the proposal form with him provided by the insurer. There are different types of

policies and so the different types of proposal forms are there. It has the entire details

regarding the duration of the policy, type of plan, mode of payment, etc. A proposal form is

to be to be completed by the proposer in his own handwriting and signed in the presence of

the agent. The proposal form contains a declaration at the end, to ensure the authenticity of

the information given. Usually the proposal form contains the following information to be

filled by the prospective insured:

1. Name of life assured

2. Address

3. Date of Birth

4. Occupation

5. Age

6. Name of the employer (if any)

7. Sum assured of the proposed policy

8. Number and age of the family members

9. Family medical history

10. Proposer’s Medical history

Besides these there are other related forms regarding health, occupation, the agent’s

confidential report and many others. In addition there is a consent letter which shows the

consent of the life assured to the imposition of some clause or extra premium, duly signed

by the life assured

First Premium Receipt

The agent provides the proposal form and other related documents and the underwriter

examines the form and other documents and then determines the terms on which to accept

the risk or reject the same. The consent of the person assured is obtained in the form of

payment of premium. After receiving the payment, the insurance company issues the First

Premium Receipt, which acknowledges the proposal of the life-assured. It contains all

particulars of the policy. It has the details of the next premium to be paid. The policy bond

is sent within 45-50 days from the date of first premium receipt to the life assured. The

First Premium Receipt is an important and powerful document on the basis of which the

lifeassured can ask the insurer to issue the policy bond, which is treated as Evidence of the

Contract of Life assurance. Policy Bond After issuing the First Premium Receipt, the next

step is that of the insurer of sending the policy bond to the life-assured and this document is

also known as Policy Contract, which is the ultimate evidence of the life-assured. The

Policy Contract contains all the terms and conditions of the contract between insurance

company and the life assured, duly stamped as per the Indian Stamp Act. The policy is sent

to the life assured by the insurer. The policy contract contains the details of the

insurance such as duration of the policy, the type of policy, sum assured, premium amount

and the date of maturity, extra premium, nominee, assignee etc.

Assignment and Nomination

The Policyholder should be advised for nomination, if no nomination was effected. When

nomination or assignment is effected by a policyholder, it should be scrutinized thoroughly

to see whether it was in order or not. If there is any material omission or mistake, it may be

returned to the policyholder or the assignee with a covering letter giving instructions as to

the corrections to be made in the assignment or nomination. When a document is sent for

correction, reminders should be sent every fortnight until the requirements are complied

with. The policyholder should follow the instructions printed on the back of assignment or

nomination.

Nomination

Nomination is the process of identifying a person to receive the policy money in the event of

the death of the Policyholder. Nomination can be done at the beginning of the Policy by

giving details of nominee in the proposal form. However, if the nomination is not given at

the beginning, the policyholder can give it at a later date. For that purpose a prescribed

form is to be filled up and nomination can be endorsed on Policy Bond.

Change in Nomination. Change of nomination can be done by the policy holder any time

during the term of the policy and any number of times he wants to. Procedure of

nomination is same every time.

Withdrawal of nomination Nomination can be withdrawn by the policy holder without

giving prior notice to the nominee. Nomination can be done only by a policyholder who has

attained majority and on a policy on his life. Under Nomination, the Nominee gets only the

right to receive the policy money in the event of the death of the Policyholder.

Death of the Nominee

If the nominee dies and the policyholder is still surviving then the nomination would be

ineffective. If Nominee dies after the death of the Policyholder but before receiving policy

money, then also Nomination becomes ineffective and only the legal heirs of the

policyholder can claim money.

Nomination at a later date

After the policy is prepared and issued and if no Nomination has been given the assured

can give the nomination only by an endorsement on the policy itself. A nomination is not

required to be stamped. Nomination in favour of a stranger cannot be given as there is no

insurable interest involved in that case. For nomination in favour of wife and children,

specific names of wife and children should be given.

Successive nominee

Where it is mentioned in nomination that the policy money should be paid to “Nominee A

failing him to Nominee B whom failing to Nominee C, etc.”, such nomination is called

successive nomination. Such nomination would be in favour of one individual in the order

mentioned. All such Nomination would mean that if Nominee A were dead at the time in

question the Nominee B would take the whole amount and that if both Nominees A and B

were then dead then Nominee C would take the whole amount and so on.

A Minor Nominee

In view of the Insurance (Amendment Act) 1950, the Life Assured has the right, where a

nominee is a minor, to appoint any person as the Appointee to receive the moneys secured

by the policy in the event of the assureds’ death during minority of the nominee. The

person so appointed will not be a guardian of the minor Nominee’s power will be limited to

the right to receive the policy money in the event of the assureds’ death during the minority

of the Nominee. The appointment must be a major. The appointment of Appointee must be

communicated to the insurance company. So his name can be registered with the company.

The appointment can be cancelled or changed by the life assured any time before the

maturity of the policy.

Differences between Assurance (life insurance) and

Insurance (general insurance / non-life insurances)

1. Scope – the term “Assurance” is used only in life insurance and therefore the scope is

comparatively limited. The term insurance is used for all other types of risk coverage and

therefore, the scope is wider.

2. Renewal of Policy -The life insurance contract is a continuing contract and it will not

lapse unless the premium is regularly paid. It is not certain that the event insured against

may happen or not. Most of the general insurance policies are annual policies, so renewal

of policy is required.

3. Element of investment- the element of investment is present in assurance since there is

certainly of receiving payment either on death or on maturity of the policy. General

insurance lacks the element of investment since there is no certainty of receiving payment.

4. Assurance –in life insurance, the insurer gives assurance to the insured to pay the claim

in any case, either on maturity or death. In general insurance, the insurer only promises to

secure the property in case of actual loss.

5. Amount of Claim- In LI, the policy amount is paid to the assured in full on the maturity

or on death along with bonus, etc. announced by the insurance company from time to time.

In GI, The payment of claim is subjected to the element of actual loss but not more than the

insured sum.

6. Insurable Interest- In a life policy, the insurable interest is one that required by law and

such interest is not measurable in terms of money. In GIs, the insured is required to have

an insurable interest in terms of money

7. Principle of indemnity- Principle of indemnity does not apply in life assurance. The sum

assured is payable unrespectable of any profit or loss and the full extent of the amount

insured. Principle of indemnity is the basis of general insurance

contracts.

8. Certainty of event –in LIs, the event (death or reaching maturity) is bounded to happen

sooner or later. It is not certain that the event insured against may happen or not in the

case of GIs.

9. Insured Sum -Insurance policy for any amount or any number of policies can be taken in

LIs. In general insurance, the policy amount is restricted to market value of assets; not

more than that. This is because that indemnity cannot be more than the value of asset.

10. Certainly of payment of claim- in LIs, Payment of claim either on maturity of the policy

or on death of the assured is certain. There is no certainly to receive payment since it is

paid only in case of loss of the property insured in GIs.

11. Insurable interest on the date of the policy or the policy falls due-In life insurance

insurable interest is to be proved at the date of the contract and it is not necessarily be

present at the time, when the policy falls due for claim. In marine insurance, the insured

must be having insurable interest on the subject matter at the time of loss, but not

necessarily be present at the time of affecting the policy.

12. Subject matter- Human life is subject matter of life insurance. Goods and properties

are subject matter of general insurance.

13. Principle of subrogation – This is not applicable in life insurance. This principle is

applicable in general insurance.

14. Surrender of policy-in life insurance, the policy can surrender before maturity period.

In the case of fire and marine insurance, policy cannot be surrendered before maturity.

Legal Frameworks of Insurance (Law relating to insurance)

There are mainly four laws are concerned with the insurance business of India are as

follows.

A. Insurance Act, 1938

B. Life Insurance Corporation Act, 1956

C. General Insurance Business (Nationalization) Act, 1972

D. Insurance Regularity and Development Authority Act, 1999 (IRDA)

A. INSURANCE ACT, 1938

The insurance act originally passed in the year 1938. however It amended for several times,

It latest amendment of the insurance act was the, the IRDA itself when it became the

authority to perform many tasks required to be done under the insurance act such as

issuing licenses, issuing registration certificates, monitoring compliance with the provisions

of the Act, issuing directives, laying down norms. The all above said functions were

performed by the controller of Insurance earlier as per the Insurance Act, 1938. The

provisions of the Act may be briefly described as follows. a. Registration To obtain the

certificate of registration is compulsory to the every insurance company. The Registration

should be renewed annually. The paid up capital must be of Rs. 100 crores for life

insurance or general and Rs. 200 crores for re-insurance business. Every insurer has to

deposit in cash or approved securities, a sum equivalent to 1 % in life insurance or 3% in

general insurance of the total gross premium in-any financial year commencing after 31st

March, 2000 with the Reserve Bank of India. The amount is not being exceeding Rs. 10

crores. The deposit amount is Rs. 20 crores for reinsurance businesses. Every insurance

company must keep the accounts separately of all receipts and payment in respect of each

class of insurance business such as the marine or miscellaneous insurance. Insurers must

invest his assets only in those investments which approved under the provisions of the Act.

Every insurance company has to do a minimum insurance business in the rural or social

sector, as may be specified in the order. The authority can be investigated the affair of the

insurer at any time. b. Licensing of agents License is the pre requirement for becoming the

agent. Person can’t work as an insurance agent unless he has obtained a license from the

authority. There is some disqualification as per the act for a person to be an agent, as

follows:

1. Being unsound mind.

2. Being convicted of criminal misappropriation or criminal breach of trust or cheating or

forgery or Abetment or Attempt to commit any such offence.

3. Being found to have been guilty of or connived at any fraud, Dishonesty or

misappropriation against any insured on insurer. c. Licensing of surveyors and loss

assessors No insurer can settle any claim equal to or exceeding Rs. 20000/- without the

report on the loss from a licensed surveyor. The person can act as a surveyor or loss

assessor only after obtaining license from the authority. The authority can’t issue the

license without get satisfaction about the applicant.

d. Solvency margin The authority for the insurer also decides the solvency margin. The act

clarifies how the assets and liabilities have to be determined and the extent to which the

assets are to exceed the liabilities. These provisions exist to ensure the adequacy of

insurer’s solvency

e. Payment of premium before assumption of risk A risk can be assumed by the, insurance

company after receiving the premium or a guarantee that the premium will be paid within

the prescribe time. Sometimes agents collect the premium amount and dispatch or

deposited to the insurance company. They have to deposit the money within the 24 hours

except the bank and postal holiday. The agent has to deposit the premium in full without

deducting his commission. If any refund of, the premium will be due, the insurer directly

shall paid the amount to the insured by crossed or order cheque or by postal money order.

B. Life Insurance Corporation Act,1956

Life Insurance Business in India was nationalized with effect from January 19, 1956. On

the date, the Indian business of 16 non-Indian insurers operating in India and 75 Provident

Societies were taken over by Government of India. Life Insurance Corporation of India,

Act was passed by the Parliament on June 18, 1956 and came into effect from July 1,

1956. Life Insurance Corporation of India commenced its functioning as a corporate

bodyfrom September 1, 1956. Its working is governed by the LIC Act. The LIC is a

corporate having perpetual succession and a common seal with a power to acquire hold

and dispose of property and can by its name sue and be sued.

Important Provisions of Life Insurance Corporation Act, 1956

1. Constitution

2. Capital

3. Functions of the Corporation

4. Transfer of Services

5. Set-up of the Corporation

6. Committee of the Corporation

7. Authorities

8. Finance, Accounts and Audit

9. Miscellaneous Life Insurance Corporation of India (LIC)

The LIC of India was set up under the LIC Act, 1956 under which the life insurance was

nationalized. As a result, business of 243 insurance companies was taken over by LIC on 1-

9- 1956.

It is basically an investment institution, in as much as the funds of policy holders are

invested and dispersed over different classes of securities, industries and regions, to

safeguard their maximum interest on long term basis. LIC is required to invest not less

than 75% of its funds in Central and State Government securities, the government

guaranteed marketable securities and in the socially-oriented sectors. At present, it is the

largest institutional investor. It provides long term finance to industries. Besides, it extends

resource support to other term lending institutions by way of subscription to their shares

and bonds and also by way of term loans. LIC which has entered into its 57th year has

emerged as the world’s largest insurance co. in terms of number of policies covered. The

LIC’s total coverage of policies including individual, group and social schemes has crossed

the 11 crore.

C. GIBNA (The General Insurance Business Nationalization Act- 1972)

The General Insurance Business Nationalization Act was passed in 1972 to set up the

general insurance business. It was the nationalization of 107 insurance companies into one

main company called General Insurance Corporation of India and its four subsidiary

companies with exclusive privilege for transacting general insurance business. This act has

been amended and the exclusive privilege ceased on and from the commencement of the

insurance regulatory and development authority act 1999. General Insurance Corporation

has been working as a reinsurer in India. Their subsidiaries are working as a separate

entity and plays significant role in the public sector of general insurance.

General Insurance Corporation of India (GIC) General insurance industry in India was

nationalized and a government company known as General Insurance Corporation of

India was formed by the central government in November, 1972. General insurance

companies have willingly catered to these increasing demands and have offered a

plethora of insurance covers that almost cover anything under the sun. Objective of the

GIC are:

1. To carry on the general insurance business other than life, such as accident, fire etc.

2. To aid and achieve the subsidiaries to conduct the insurance business and,

3. To help the conduct of investment strategies of the subsidiaries in an efficient and

productive manner.

Liberalization of Insurance Industry While no aspect of the reform process in India has gone smoothly since its inception in 1991, no

individual initiative has stirred the proverbial hornets' nest as much as the proposal to liberalize the

country's insurance industry. However, the political debate that followed the submission of the report

by the Malhotra Committee has presumably come to an end with the ratification of the Insurance

Regulatory Authority (IRA) Bill both by the central Cabinet and the standing committee on finance.

This section traces the evolution of the life insurance companies in the US from firms underwriting

plain vanilla insurance contracts to those selling sophisticated investment contracts bundled with

insurance products. In this context, it brings into focus the importance of portfolio management in the

insurance business and the nature and impact of portfolio related regulations on the asset quality of

the insurance companies. It also provides a rationale for the increased autornatisation of insurance

companies, and the increased emphasis on agent independent marketing strategies for their products.

If politicized, regulations have potential to adversely affect the pricing of risks, especially in the non-

life industry, and hence the viability of the insurance companies. Finally, the backdrop of US

experience provides some pointers for Indian policymakers.

Introduction The insurance sector continues to defy and stall the course of financial reforms in India. It continues to

be dominated by the two giants, Life Insurance Corporation of India (LIC) and the General Insurance

Corporation of India (GIC), and is marked by the absence of a credible regulatory authority. The first

sign of government concern about the state of the insur¬ance industry was revealed in the early

nineties, when an expert committee was set up under the chairmanship of late R.N.Malhotra.

The Malhotra Committee, which submitted its report in January 1994, made some farreaching

recommendations, which, if implemented, could change the structures of the insurance industry. The

Committee urged the insurance companies to abstain from indiscriminate recruitment of agents, and

stressed on the desirability of better training facilities, and a closer link between the emolument of

the agents and the management and the quantity and quality of business growth. It also emphasized

the need for a more dynamic management of the portfolios of these companies, and proposed that a

greater fraction of the funds available with the insurance companies be invested in non-government

securities. But, most importantly, the Committee recommended that the insurance industry be

opened up to private firms, subject to the conditions that a private insurer should have a minimum

paid up capital of Rs. 100 crore, and that the promoter's stake in the otherwise widely held company

should not be less than 26 per cent and not more than 40 per cent. Finally, the Committee proposed

that the liberalized insurance industry be regulated by an autonomous and financially independent

regulatory authority like the Securities and Exchange Board of India (SEBI). Subsequent to the

submission of its report by the Malhotra Committee, there were several abortive attempts to

introduce the Insurance Regulatory Authority (IRA) Bill in the Parliament. It is evident that there was

broad support in favour of liberalization of the industry, and that the bone of contention was

essentially the stake that foreign entities were to be allowed in the Indian insurance companies. In

November 1998, the central Cabinet approved the Bill which envisaged a ceiling of 40 per cent for

non-Indian stakeholders: 26 per cent for foreign collaborators of Indian promoters, and 14 per cent for

nonresident Indians (NRI’s), overseas corporate bodies (OCB’s) and foreign institutional investors

(FII’s). However, in view of the widespread resentment about the 40 per cent ceiling among political

parties, the Bill was referred to he standing committee on finance. The committee has since

recommended at each private company be allowed to enter only one of the three areas of business

life insurance, general or non-life insurance, and reinsurance that the overall ceiling for foreign

stakeholders in these companies be reduced to 26 per cent from the proposed 40 per cent. The

committee has also recommended that the minimum paid up share capital of the new insurance

companies be raised to Rs. 200 crore, double the amount proposed by the Malhotra Committee.

Economic Rationale-- The insurance industry is a key component of the financial infrastructure of an

economy, and its viability and strengths have far reaching consequences for not only its money and

capital markets,' but also for its real sector. For example, if households are unable to hedge their

potential losses of wealth, assets and labor and non-labor endowments with insurance

contracts, many or all of them will have to save much more to provide for events that might occur in

the future, events that would be inimical to their interests. If a significant proportion of the

households behave in such a fashion, the growth of demand for industrial products would be

adversely affected. Similarly, if firms are unable to hedge against "bad" events like fire and the job

injury of a large number of laborers, the expected payoffs from a number of their projects, after

factoring in the expected losses on account such "bad" events, might be negative. In such

an event, the private investment would be adversely affected, and certain potentially hazardous

activities like mining and freight transfers might not attract any private investment. It is not

surprising, therefore, that economists have long argued that insurance facility is necessary to ensure

the completeness of a market.

Malhotra Committee Report In the backdrop of new industrial policy, the Government of India set up in 1993 a highpowered

committee headed by Mr. R. N. Malhotra to examine the structure of the insurance industry, to assess

its strength and weaknesses in terms of the objective of providing high quality services to the public

and serving as an effective instrument for mobilization of financial resources for development, to

review the then existing structure of regulation and supervision of insurance sector and to suggest

reforms for strengthening and modernizing regulatory system in tune with the changing economic

environment. The Malhotra Committee submitted its report in 1994. Some of the major

recommendations made by it were as under:-

(a) The establishment of an independent regulatory authority (akin to Securities and Exchange Board

of India);

(b) Allowing private sector to enter the insurance field;

(c) Improvement of the commission structure for agents to make it effective instrument for procuring

business specially rural, personal and non-obligatory lines of business;

(d) Insurance plans for economically backward sections, appointment of institutional agents;

(e) Setting up of an institution of professional surveyors/loss assessors;

(f) Functioning of Tariff Advisory Committee (TAC) as a separate statutory body;

(g) Investment on the pattern laid down in s.27;

(h) Marketing of life insurance to relatively weaker sections of the society and specified proportion of

business in rural areas;

(i) Provisions for co-operative societies for transacting life insurance business in states;

(j) The requirement of specified proportion of the general business as rural nontraditional business to

be undertaken by the new entrants;

(k) Welfare oriented schemes of general insurance;

(l) Technology driven operation of General Insurance Corporation of India (GICI); GIC to exclusively

function as a reinsurer and to cease to be the holding company;

(m) Introduction of unlinked pension plans by the insurance companies; and

(n) Restructuring of insurance industry

THE COMMITTEE ON REFORMS IN THE INSURANCE SECTOR

THE GOVERNMENT appointed the committee on reforms in the insurance sector (1994) in April 1993

headed R.N.MALHOTRA, the former Governor of the Reserve Bank of India. The terms of reference of

the said Committee were:

(1) to examine the structure of the insurance industry as it has evolved within the existing framework

and to assess its strength and weaknesses in terms of the objective of creative an efficient and viable

insurance industry providing a wide reach of insurance services and a variety of insurance products

with a high quality of service to the public and serving as an effective instrument for mobilization of

financial resources for development.

(2) To make recommendations for changes in the structure of the insurance industry, as

well as the general framework of policy, as may be appropriate for the pursuit of the above

objectives keeping in mind the structural changes currently underway in other parts of the

financial system and in the economy.

(3) to make specific suggestions regarding the LIC and the GIC, which would help to

improve the functioning of these organizations in the changing economic environment

(4) to review the present structure of regulation and supervision of the insurance sector and

to make recommendations for strengthening and modernizing the regulatory system in the

tune with changing requirements.

(5) To review and make recommendations on the role and functioning of the surveyors,

intermediaries and other ancillaries of the insurance sector.

(6) To make recommendations o such other matters as the Committee considers relevant

for the health and long-term development of the insurance sector. In under a year. The Committee

submitted its Report, which was approved in principle by the government. The major thrust of the

recommendations was towards the opening up of the insurance sector, for which initiative had to

come from the government.

SOME IMPORTANT QUESTIONS

Q.1: Define Bank / Commercial Bank and Discuss the functions of Commercial Banks.

Ans. A) MEANING AND DEFINATION OF COMMERCIAL BANK:

In modern economy commercial Banks Play an important role in the financial sector. A

Bank is an institution dealing in money and credit. Credit money is the major component

of money supply in a modern economy. Commercial banks are the creators of credit. The

strength of economy of any country basically depends on a sound and solvent banking

system. A Commercial bank is a profit seeking business firms dealing in money or rather

claims to money. It safeguards the savings of the public and give loans and advances.

The Banking Companies Act of 1949, defines banking company as “accepting for the

purpose of lending or investment of deposit money from the public, repayable on demand

or otherwise and withdrawals by cheque, drafts, order or otherwise”.

B) FUNCTIONS OF COMMERCIAL BANKS :

Modern commercial banks perform a variety of functions. They keep the wheels of

commerce, trade

and industry always revolving. Major functions of a commercial bank are: Primary or

Banking functions

and Secondary or Nonbanking functions.

FUNCTIONS OF COMMERCIAL BANKS.

Commercial banks have two important banking functions. One is accepting deposits and

other is advancing loans.

1) Deposits :

One of the main function of a bank is to accept deposits from the public. Deposits are

accepted by the banks in various forms.

a) Current Account Deposits :

Current Accounts are usually opened by businessmen who have a number of regular

transactions with the bank, both deposits and withdrawls. There is no restriction on

number and amount of deposits. There is also no restriction on withdrawls. No interest is

paid on current deposits. Banks may even charge interest for providing this facility. These

accounts are also known as demand deposits as amount can be withdrawn on demand.

b) Saving Account Deposits :

Saving Accounts are opened by salaried and other less income people. There is no

restriction on number and amount of deposits. withdrawls are subject to certain

restrictions. It earns Interest but less than fixed deposits. It encourages saving habit among

salary earners and others. Saving deposits are an important source of funds for banks.

c) Fixed Account Deposits :

Deposits in fixed account are time deposits. Money under this account is deposited for a

certain fixed period of time varying from 15 days to several years. A high rate of interest is

paid. If money is withdrawn before expiry date, the depositor receives lower rate of

interest. Deposits can be renewed for further period. Many banks sanction loans against

security of fixed deposits.

d) Recurring Account Deposits :

In Recurring deposit, a specified amount is regularly deposited by account holder, at an

internal of usually a month. This is to form the habit of small savings among the people. At

the end of maturity period, the account holder gets a substantial amount. Interest on this

type of deposit is almost equal to fixed deposits. Thus by creating variety of deposits, banks

motivate people in a variety of ways and encourage savings in the economy.

2) Loans And Advances :

Banks not only mobilize money but also lend to its credit worthy customers for maximizing

profits. Loans and Advances are granted To :

a) Business And Trade :

Commercial banks grant shortterm loans to business and trade activities in following

forms:

i) Overdraft :

Commercial banks grant overdraft facility to current account holders Under this system a

borrower is allowed to draw more than what is deposited in his account. The borrower is

granted to a fixed additional amount against collateral security. Interest is charged for

actual amount drawn.

ii) Cash Credit :

Cash credit is given by the bank to any businessman to meet regular working capital needs,

against the security of goods or personal security. Interest is charged on actual amount

drawn by the customer.

iii) Discounting Of Bills :

When the holder of the bill is not in a position to wait till the maturity of the bill and

requires cash urgently, he sells the bill of exchange to bank. Bank advance credit by

discounting bills of exchange, government securities or any other approved financial

instruments. The bank purchases the instruments at a discount.

iv) Money At Call :

Banks also grant loans for a very short period, generally not exceeding 7 days. Such

advances are repayable immediately at a short notice hence they are called as Money at

Call or Call money. These loans are given to dealers or brokers in stock market against

Collateral Securities.

v) Direct Loans :

Loans are given to customers against the security of moveable properties. Their maturity

varies from 1 to 10 years. Interest has to be paid on entire loan amount sanctioned. Loans

are of many types like : personal loans, term loans, call loans, participative loans, collateral

loans etc.

b) Loans to Agriculture :

Banks grant shortterm credit to agriculture at a lower rate of interest. Loans are granted

for irrigation, purchase of equipments, inputs, cattle etc.

c) Loans To Industries :

Banks grant secured loans to small and medium scale industries to meet their working

capital needs. The time period may be from one to five years. It may be in the form of

Overdraft, cash credit or direct loan.

d) Loans To Foreign Trade :

Loans are granted to export and import in the form of direct loans, discounting of bills,

guarantee for deferred payments etc. Here the rate of interest is low.

e) Consumer Credit / Personal loans :

Banks also grant credit to household in a limited amount to buy some durable consumer

goods like television sets, refrigerators, washing machine etc. Such consumer credit is

repayable in installments. Under 20point programme, the scope of consumer credit has

been extended to cover expenses on marriage, funeral etc., as well.

f) Miscellaneous Advances :

Banks also gives advances like packing credits to exporters, export bill purchased or

discounted, import finance, finance to self-employed, credit to weaker sections of society at

concessional rates etc.

II. Secondary / Nonbanking Functions:

Banks gives various forms of services to public. Such services are termed as non banking or

secondary functions :

1. Agency Services:

Banks perform certain functions on behalf of their customers. While performing these

services, banks act as agents to their customers, hence these are called as agency services.

Important agency functions are :

a) Collection :

Commercial banks collect cheques, drafts, bills, promissory notes, dividends, subscriptions,

rents and any other receipts which are to be received by the customer. For these services

banks charge a nominal amount.

b) payment :

Banks also makes payments on behalf of their customers like paying insurance premium,

rent, taxes, electricity and telephone bills etc for such services commission is charged.

c) Income – Tax Consultant :

Commercial banks acts as incometax consultants. They prepare and finalise the income tax

returns of their clients.

d) Sale And Purchase Of Financial Assets :

As per the customers instruction banks undertake sale and purchase of securities, shares

and any other financial assets. Nominal charges are charged by a bank.

e) Trustee, Executor And Attorney :

As a trustee, banks becomes the custodian and manager of customer funds. Bank also acts

as executor of deceased customer’s will. As an Attorney the banks sign the documents on

behalf of customer.

f) E Banking :

Through Electronic Banking, a customer can operate his bank account through internet.

He can make payments of various bills. He can even transfer money from one place to

another.

2. Utility Services :

Modern Commercial banks also performs certain general utility services for the

community, such as :

a) Letter Of Credit :

Banks also deal in foreign trade. They issue letter of credit and provide guarantee to

foreign traders for the soundness of their customers.

b) Transfer Of Funds :

Banks arrange transfer of funds cheaply and safely from one place to another. Transfer

can be in the form of Demand draft, Mail transfer Travellers cheques etc.

c) Guarantor :

Banks offer a guarantee of payment on behalf of importer to facilitate imports with

deferred payments.

d) Underwriting :

This facility is provided to Joint Stock Companies and to government to enable them to

raise funds. Banks guarantee the purchase of certain proportion of shares, if not sold in the

market.

e) Locker Facility :

Safe Lockers are provided to the customers. So that they can deposit their valuables like

Jewellary, Securities, Shares and otherdocuments.

f) Referee :

Banks may act as referee with respect to financial standing, business reputation and

respectability of customers.

g) Credit Cards :

Credit card facility have been introduced by commercial banks. It enables the holder to

minimize the use of hard cash. Credit card is a convenient medium of exchange which

enables its holder to buy goods and services from member – establishment without using

money.

III. Subsidiary Activities :

Many commercial banks also undertakes subsidiary activities such as :

1) Housing Finance :

Housing finance is provided against the security of immoveable property of land and

buildings. Many banks such as SBI, Bank of India etc. have set up housing finance

subsidiaries.

2) Mutual Funds :

A Mutual fund is a financial intermediary that pools the savings of investors for collective

investment in diversified portfolio securities Many banks like SBI, Indian Bank etc. have

set up mutual fund subsidiaries.

3) Merchant Banking :

A variety of services are offered by merchant banking like :

Management, Marketing and Underwriting of new issues, project promotion, corporate

advisory services, investment advisory services etc.

4) Venture Capital Fund :

Venture capital fund provides startup share capital to new ventures of little known,

unregistered, risky, young and small private business, especially in technology oriented and

knowledge intensive business. Many commercial banks like SBI, Canara Bank etc. have set

up venture Capital Fund Subsidiaries.

5) Factoring :

Factoring is a continuing arrangement between a financial intermediary (factor) and a

business concern (client) where by the factor purchases the clients accounts recieveable.

Banks like SBI and Canara Bank have established subsidiaries to provide factoring

services. Thus various services are provided by commercial Banks.

Q.2: Explain the process of multiple credit creation of commercial banks.

OR

Write note on multiple credit creation by commercial banks. “Every loan

creates a

Deposit”. Discuss. Ans. A) MULTIPLE CREDIT CREATION BY COMMERCIAL BANKS:

Creation of credit is an important function of a commercial bank. Prof. Sayers said “Banks

are not merely purveyors of money but, also in an important sense manufacturers of

money”. In a modern economy Bank’s deposits form a major proportion of total money

supply. A bank’s demand deposits arise mainly from : Cash deposits by customers and

Bank Loans and Investments.

1. Cash Deposits By Customers :

These are termed as primary deposits as they arise from the actual deposits of cash in a

bank made by its customers. In receiving such deposits, the bank plays a passive role. The

creation of primary deposits, however is nothing but transforming the currency money in

to deposit money.

2. Bank Loans And Investments :

These are termed as derivative or active deposits. The derivative deposits are lent in the

form of loans or advances, discounting of bills or used for purchasing securities or other

assets. Deposit account in the name of the customer or seller, credits him with the amount

of loan granted or value of security purchased, subject to withdrawl by cheque, as

required. Hence loans advanced or purchases of securities creates deposits.

Thus every loan creates a deposit. They increase the quantity of bank money. The size of

derivative demand deposits is determined by the banks lending and investment activities.

There will be a constant inflow and outflow of cash with the banks. For the sake of liquidity

and safety some proportion of total deposit must be maintained in cash, for e.g. : 10% to

20% to meet the demand for cash at the counter. This is known as Cash Reserve Ratio.

Primary deposits serve as a basis for creating derivative deposits, that is credit creation,

and for increasing money supply. Commercial banks are profit seeking institutions and

when they find that large volume of cash received lies Idle, they use these resources for

advancing loans or for making investment in securities, shares etc. there by earning high

rate of interest. The creation of credit also depends on excess cash reserves or cash reserve

ratio. The derivative deposits are used as working capital.

When the borrower withdraws money from his loan account by cheque it is deposited by

the payee in some other bank. Those banks again create deposit on the basis of fresh

deposits received after keeping required reserves. Ultimately, the total volume of credit or

derivative deposits or bank money created by all banks would be a multiple of the original

amount of new cash reserves in the system. Thus multiple expansion of credit takes place.

Q.4: Explain in details the Items included in Asset Side of Commercial

Bank Balance Sheet. OR

Explain the Assets and Liabilities of Commercial Banks. OR

Write notes on: Assets and Liabilities of Commercial Banks. OR

Explain the Balance Sheet of Commercial Banks. Ans. A) BALANCE SHEET OF COMMERCIAL BANKS :

Banks are the most important financial intermediary in an economy. Banks performance

can be analysed by its balance sheet and profit and loss account. Bank publish balance

sheet in their annual accounts. The balance sheet of a commercial Bank is a statement of its

liabilities and Assets at a particular time. Liabilities show the sources of funds through

which bank raises funds for its business. Assets represents uses of funds to generate income

for bank. Thus, the balance sheet indicates the manner in which bank has raised funds and

invested them in various types of assets. It is customary to state liabilities on left and assets

on right side.

B. LIABILITIES OF A COMMERCIAL BANK (LIABILITIES PORTFOLIO) :

The liabilities of a commercial bank shos how the bank raises funds for its business.

1) Share Capital (Paidup) :

It is the contribution made by the shareholders of the bank. This indicates the bank’s

liabilities to its shareholders.

2) Reserves And Surplus :

It is the amount accumulated over the years out of undistributed profits to meet

contingencies. Reserves and surplus are liabilities of the bank, as they belong to its

shareholders.

3) Deposits :

Deposits from the public constitute the biggest proportion of banks working funds. The

deposits accepted by bank in current, fixed and savings account are liabilities of bank to

their customers. They are categorized as demand, time and saving deposits. These funds

are liabilities of bank to their customers, which have to be returned to them. But at the

same time, these funds are also assets to bank since the banker can make use of them to get

certain interest yielding assets.

4) Borrowings :

When a bank borrows from other banks liability is created. It consist of borrowing /

refinance obtained from RBI, commercial banks and other financial institutions. It also

includes overseas borrowings.

5) Other Liabilities :

In course of its business, miscellaneous liabilities are incurred by bank. They include bills

payable like drafts, travelers cheques, pay slips etc. It also includes income tax provision.

C. ASSETS OF A COMMERCIAL BANK (ASSETS PORTFOLIO):

The assets portfolio shows how the bank uses the funds entrusted to it:

1) Cash Balances :

A bank holds cash to meet the daytoday withdrawls of deposits by its customer. This is

known as cash reserve. Bank hold cash balances with itself, with other banks and with RBI.

In India, Commercial Banks are obliged to keep a certain proportion of total deposits in

the form of cash reserve requirement with RBI. Cash has perfect liquidity, but yields no

profit.

2) MONEY AT CALL AND SHORT NOTICE :

It refers to short term loans made in money market. Such loans are borrowed by

speculators in stock exchange market. Their maturity vary between one day to 15 days.

These loans are repayable on demand and at the option of either lender or borrower. Thus,

these forms of assets are highly liquid and are interest earning too, though at a

comparatively low rate.

3) Bills Discounted :

Banks funds are invested in commercial bills which are shortdated, usually three months.

Banks also invest in treasury bills. These assets are selfliquidating in nature.

4) Investments :

Investment in various kinds of securities is a major part of assets of a bank. Mainly

commercial banks invest in government securities, shares etc. Securities and bonds are

known as banks secondary reserves because they are shiftable and Interest yielding.

Usually banks prefer medium and short term securities. This secondary reserve fails to

convert securities in to cash at the same time.

5) Loans And Advances :

The most important asset item in the Balance sheet of a bank is loans advances. The

profitability of a bank depends upon the extent to which it grants loans advances to

customers. The various types of loans advances provided by banks are : Cash Credit,

Overdraft, Loans, Installments, purchase and discounting of Bills. Banks mostly grant

short term working capital loans only so that they can have fair liquidity with

high profitability.

6) Other Assets : It includes fixed assets, furniture and fixtures etc. It will also include the

net position of interoffice account. From above assets and liabilities, banks will have to

balance their revenues against expenses in such a way to generate income to sustain

profitability from business.

Q.5:Explain the trade – off between bank’s objectives of liquidity

and profitability. OR

Write note on trade – off between liquidity and profitability

objectives of bank. OR

Explain commercial bank’s objectives of liquidity and profitability.

How do the

banks reconcile these two conflicting objectives? Ans. A) OBJECTIVES OF PORTFOLIO MANAGEMENT (TRADEOFF BETWEEN

LIQUIDITY AND PROFITABILITY) :

A commercial bank has to manage its assets and liabilities with three objectives in mind,

namely : Liquidity, profitability and solvency. Liquidity means the capacity of the bank to

give cash on demand in exchange for deposits. But a commercial bank is a profit – seeking

institution. It has to arrange its assets in such a way that it makes maximum profits. The

bank should also maintain the confidence of public by making cash available on demand.

Liquidity and profitability are, therefore, conflicting considerations for bankers. Cash has

perfect liquidity but yields no return at all, while other incomeyielding assets such as

loans are profitable but have no liquidity. The bank should strike a balance between

liquidity andprofitability. Another consideration of the bank is its own solvency and

security. This refers to liquidity and shiftability. Liquidity is the capacity to produce cash

on demand. Shiftability means the assets acquired by bank should be easily shiftable to

other banks or central bank. Those securities would be preferred by a bank which can be

shifted easily without any loss to the bank than the risky and more profitable ones.

A bank which is solvent may not be liquid. Its assets may exceed its liabilities, but the assets

may not be in such a form that they are readily convertible in to cash. Thus, the two

motives of a bank’s liquidity and profitability are contradictory, but have to be reconciled.

A good banker is one who follows a wise investment policy and distributes the assets in

such a way that both the requirements of liquidity and profitability are satisfied. The assets

should bring in maximum profits and should provide maximum security to the depositors.

The secret of success of a bank lies in striking a sound balance between liquidity and

profitability.

B. RECONCILING TWIN OBJECTIVES :

A good banker is one who follows a wise investment policy and distributes the assets in

such a way that both the requirements of liquidity and profitability are satisfied. The secret

of success of a bank lies in striking a balance between liquidity and profitability. The

commercial bank arranges its assets in an ascending order of profitability and descending

order of liquidity. As we move down the balance sheet the assets become less and less liquid

and more and more profitable. The more liquid the assets, the less profitable it is. Let us

Explain :

1) Cash :

Cash balance have perfect liquidity, but no profitability. Cash is held to meet the

withdrawl needs of depositors.

2) Money At Call :

Surplus cash of commercial banks is lend to each other. This earns some interest and is also

very liquid

3) Investment In Securities :

Statutorily banks have to invest a part of their assets in government securities. These

securities have low rate of interest but banks can borrow from RBI against these securities.

Thus investment in securities provide returns as well as liquidity to bank.

4) Loans And Advances :

Here liquidity is low but profitability is high. Thus banks hold various assets in such a way

that the requirements of liquidity and profitability are balanced

Q.6: Explain / what are the factors affecting Liquidity and

profitability of Banks?

OR

Write note on factors determining Liquidity and profitability of a

bank. Ans. A. FACTORS AFFECTING LIQUIDITY OF BANKS :

The amount of liquid assets held by bank, depends upon the following factors :

1) Statutory Requirements :

Every commercial bank has to keep a minimum cash balance by law. The extent of reserves

held by bank depends upon the statutory requirements like CRR and SLR. These limits are

fixed by central bank. Commercial banks also have to maintain liquid assets in the form of

gold and approved securities.

2) Nature Of Money Market :

It will be easy for banks to buy and sell securities if the money marketis fully developed. In

such case need for cash will be less.

3) Banking Habits :

Banking habits of customers have a direct bearing on banks cash balance and liquidity

position. In developed countries for making payments cheques are used hence, the use of

cash is less. On other hand, in developing countries banking habits are not fully developed,

so banks have to maintain large cash reserves.

4) Structure Of Banks :

Under unit banking, every bank is an independent unit and they have to keep a high degree

of liquidity. Under branch banking, the cash reserves can be centralized in head office and

branches can have smaller liquid reserves.

5) Business Conditions :

In Industrialised countries, business in brisk and speculative activities are undertaken so,

the demand for money is large. In agricultural countries, during off season, demand is less

so, the banks can manage with small cash balances.

6) Monetary Transactions :

During busy season such as festival times, harvest season, beginning of month etc. banks

will have to keep large percentage of cash. Thus, the size of liquid reserves also depend on

the number and magnitude of monetary transactions.

7) Number And Size Of Deposits :

When the number and size of deposits rise, banks have to keep more liquidity and vice

versa.

8) Nature Of Deposits :

The nature of deposits also determines the liquidity requirements of a bank. Deposits are

various types such as time deposits, demand deposits etc. Larger the demand and short

term deposits, larger will be liquidity.

9) Clearing House Facility :

When clearing house facilities are available, then large transactions can be made through

book adjustments. This will reduce cash requirements of commercial banks.

10) Liquidity Policy Of Other Banks :

A Bank which decides to hold large cash balances will have more customers due to

goodwill. Hence other bank will also try to improve their liquidity position to attract

customers. Thus, the liquidity position of one bank depends on the liquidity policy of other

banks. On the whole, we can say by looking in to past experience, each bank has to take its

own decision on liquidity requirement.

B) FACTORS AFFECTING PROFITABILITY OF BANKS :

1) Cost Of Funds :

Share capital, reserves, deposits, borrowing and other liabilities are the sources of funds for

bank. The cost of funds refers to interest expenses.

2) Yield On Funds :

Banks fund are used for different sources like CRR, SLR requirement, loans and Advances

etc. Many of these give rise to yields mainly in terms of interest income. This depends on

the portfolio management of banks.

3) Spread : The difference between interest income and interest expenses in defined as

spread. High interest spreads shows the level of efficiency and a relatively less competitive

market.

4) NonInterest Income :

NonInterest income is income derived from nonfinancial asset and services and includes

commission and brokerage on remittance facilities, guarantees underwriting, contracts etc,

locker rentals and other service charges.

5) Amount Of Working Capital :

Profitability is directly related to the amount of working funds deployed by banks.

Working funds are funds deployed by a bank in its business.

6) Non performing Assets :

Profitability also depends on NPAs. Larger the NPAs lower will be the profitability and

vice versa.

7) Competition :

When the level of Competition increases, there is fall in margins and hence it results in

lower profitability.

8) Operating cost :

If operating cost are higher, profitability of banks will be lower and vice versa. Operating

cost includes : Salaries, bonus, gratuity, expenses on stationery, printing, rent, depreciation

etc.

9) Risk Cost :

Risk cost is the cost which is likely to be incurred on annual loss on assets. For e.g.:

provisions for bad and doubtful debts is included under this head. Thus risk cost also

affects the profitability of banks.

10) Burden :

The total noninterest expenses representing the transaction cost will generally be more

than miscellaneous income. The difference between the two is known as Burden. Higher the

burden, lesser will be the profitability of banks. Thus from above we can say that the

objectives of liquidity and profitability have to be reconciled. A successful banker will

adopt a prudent investment policy keeping the requirements of liquidity and profitability.