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Co-operative banks and their role in India

Study Material > Economics
  • The concept of cooperation is as old as mankind and it forms the basis for domestic and social life. The cooperation is nothing but group instinct in human which enable one to live with others, work with others and help each other in times of stress and strain. Without cooperation, the social and economic progress would not be possible.

Co-operative Banks

  • A co-operative bank is a financial entity which belongs to its members, who are at the same time the owners and the customers of their bank. Co-operative banks are often created by persons belonging to the same local or professional community of sharing a common interest.
  • Cooperative banks generally provide their members with a wide range of banking and financial services (loans, deposits, banking accounts, etc.). Co-operative banks differ from stockholders bank by their organization, their goals, their values and their governance.

Co-operative Banking in India

  • The co-operative banks in India have a history of almost 100 years. The co-operative banks are an important constituent of the Indian Financial System, judging by their role assigned to them.
  • The co-operative movement was originated in the west, but the importance that such bank have assumed in India is rarely paralleled anywhere else in the world. Their role in rural financing continues to be important event today, and their business in urban areas also has increased phenomenally in recent years mainly due to the sharp increase in the number of primary cooperative banks.
  • Co-operative banks in India are registered under the Cooperative Societies Act. The co-operative banks are also regulated by the Reserve Bank of India (RBI) and governed by Banking Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1955. A Regional Rural Bank seeking permission of the Reserve Bank for opening branches has to obtain the recommendation of NABARD.

Establishment of Co-operative Banks in India

  • The co-operative movements in the world and in India have grown well.
  • Though the first documented consumer cooperative was founded in 1769 in a barely furnished cottage in Fenwick, East Ayrshire, the co-operative movement in India is century old.
  • Despite the Co-operative Credit Societies Act was passed in 1904 based on the recommendations of Sir Frederick Nicholson (1899) and Sir Edward Law (1901), paving the way for the establishment of co-operative credit societies in rural and urban areas, during British rule, the co-operatives in India have made remarkable progress in the various segments of Indian economy only after 1950s.
  • In order to facilitate rural financing, the co-operative banks were started in India during 1950s.
  • The first urban cooperative bank in India was formed nearly 100 years back in Baroda.
  • The co-operative banks is an official effort to create a new type of institution based on the principles of co-operative organization and management, suitable for problems peculiar to Indian conditions.
  • These banks were conceived as substitutes for money lenders, to provide timely and adequate short-term and long-term institutional credit at reasonable rates of interest.
  • The concept of Urban Cooperative Bank was first spelt out by Mehta Bhansali Committee in 1939 which defined on Urban Co-operative Bank.
  • The Reserve Bank of India assists the co-operative structure by providing concessional finance through NABARD in the form of General Lines of Credit for lending to agricultural & allied activities. Thus, the whole system is integrated with the Banking structure of the country
  • The co-operative banking structure in India is bifurcated into Short-term structure and Long-term structure. While the short-term structure is three tier structures, long-term co-operative banking structure is the two tier structures as mentioned below:
    1. Short-Term Co-operative Bank Structure
      1. A State Co-operative Bank works at the apex level (works at state level).
      2. The Central Co-operative Bank works at the IntermediateØ Level(works at district level)
      3. Primary co-operative credit societies at base level (works at villageØ level)
    2. Long-Term Co-operative Bank Structure
      1. State Co-operative Agriculture and Rural Development BanksØ (SCARDBs) at the apex level.
      2. Primary Co-operative Agriculture and Rural DevelopmentØ Banks (PCARDBs) at the district level or block level.

Role of Co-operative Banks in India

  • The co-operative banks in India play an important role even today in rural financing. The businesses of co-operative banks in the urban areas also 70 have increased phenomenally in recent years due to the sharp increase in the number of primary co-operative banks. The co-operative banks are expected to perform some duties, namely, extend all types of credit facilities to customers in cash and kind, advance consumption loans, extend banking facilities in rural areas, mobilize deposits, supervise the use of loans etc. The needs of co-operative bank are different.
    1. Co-operative banks in India finance rural areas under:
      1. Farming
      2. Cattle
      3. Milk
      4. Hatchery
      5. Personal finance
    2. Co-operative banks in India finance urban areas under:
      1. Self-employment
      2. Industries
      3. Small scale units
      4. Home finance
      5. Consumer finance
      6. Personal finance

Types & Function of Co-operative Banks, India

  • The co-operative banks are small-sized units which operate both in urban and non-urban centers. They finance small borrowers in industrial and trade sectors besides professional and salary classes. The co-operative banking structure in India is divided into following 5 categories:
    1. Primary Co-operative Credit Society
      1. The primary co-operative credit society is an association of borrowers and non-borrowers residing in a particular locality.
      2. The funds of the society are derived from the share capital and deposits of members and loans from central co-operative banks.
      3. The borrowing powers of the members as well as of the society are fixed.
      4. The loans are given to members for the purchase of cattle, fodder, fertilizers and pesticides.
    2. Central Co-operative Banks
      1. These are the federations of primary credit societies in a district and are of two types-those having a membership of primary societies only and those having a membership of societies as well as individuals.
      2. The funds of the bank consist of share capital, deposits, loans and overdrafts from state co-operative banks and joint stocks.
      3. These banks provide finance to member societies within the limits of the borrowing capacity of societies. They also conduct all the business of a joint stock bank.
    3. State Co-operative Banks
      1. The state co-operative bank is a federation of central co-operative bank and acts as a watchdog of the co-operative banking structure in the state.
      2. Its funds are obtained from share capital, deposits, loans and overdrafts from the Reserve Bank of India. The state co-operative banks lend money to central co-operative banks and primary societies and not directly to the farmers.
    4. Land Development Banks
      1. The Land development banks are organized in 3 tiers namely; state, central, and primary level and they meet the long term credit requirements of the farmers for developmental purposes.
      2. The state land development banks oversee, the primary land development banks situated in the districts and tehsil areas in the state. They are governed both by the state government and Reserve Bank of India.
      3. Recently, the supervision of land development banks has been assumed by National Bank for Agriculture and Rural development (NABARD). The sources of funds for these banks are the debentures subscribed by both central and state government.
      4. These banks do not accept deposits from the general public.
    5. Urban Co-operative Banks
      1. The term Urban Co-operative Banks (UCBs), though not formally defined, refers to primary co-operative banks located in urban and semi urban areas.
      2. These banks, till 1996, were allowed to lend money only for non-agricultural purposes. This distinction does not hold today. These banks were traditionally centered on communities, localities, work place groups.
      3. They essentially lend to small borrowers and businesses. Today, their scope of operations has widened considerably.
  • The origins of the urban co-operative banking movement in India can be traced to the close of nineteenth century. Inspired by the success of the experiments related to the co-operative movement in Britain and the cooperative credit movement in Germany, such societies were set up in India.
  • Co-operative societies are based on the principles of cooperation, mutual help, democratic decision making, and open membership.
  • Co-operatives represented a new and alternative approach to organization as against proprietary firms, partnership firms, and joint stock companies which represent the dominant form of commercial organization.
  • They mainly rely upon deposits from members and non-members and in case of need, they get finance from either the District central co-operative bank to which they are affiliated or from the Apex co-operative bank if they work in big cities where the apex bank has its Head Office.
  • They provide credit to small scale industrialists, salaried employees, and other urban and semi-urban residents.

 Functions of Co-operative Banks

  • Co-operative banks also perform the basic banking functions but they differ from commercial banks in the following respects:
    1. Commercial banks are joint-stock companies under the companies’ act of 1956, or public sector bank under a separate act of a parliament whereas co-operative banks were established under the co-operative societies acts of different states.
    2. Commercial bank structure is branch banking structure whereas Cooperative banks have a three tier setup, with State Co-operative Bank at Apex level, Central / District Co-operative Bank at district level, and Primary Co-operative Societies at rural level.
    3. Only some of the sections of Banking Regulation Act of 1949 (fully applicable to commercial banks), are applicable to co-operative banks, resulting only in partial control by RBI of co-operative banks.
    4. Co-operative banks function on the principle of cooperation and not entirely on commercial parameters.

 Credit Structure of Co-operative Banking in India

  • India's co-operative banking structure consists of two main segments:
    1. Agricultural and
    2. Non-agricultural credit
  • There are two separate structures in the case of agricultural credit - one for short and medium term credit and the other for long term credit. The co-operative credit structure for short and medium terms is a three tier, one with primary agricultural credit societies at the base level, the central co-operative bank at the district level and state co-operative bank at the apex level. Though the organisation of central and state co-operative banks was mainly for the benefit of the agricultural credit sector, they serve non-agricultural societies too.

Primary Agricultural Credit Societies

  • Primary Agricultural Credit Societies (PACS) are the foundation of the co-operative credit structure and form the largest number of co-operative institutions in India.
  • Most of these societies have been organised mainly to provide credit facilities and to inculcate the habit of thrift and economy among their members.
  • The share capital of a society is divided into units, called shares, contributed by the members.
  • The most important source of finance of Primary Agricultural Credit Societies is members' deposits. Borrowings constitute the most important element of their working capital.
  • The criteria for borrowings differ from state to state according to their liability. Punctuality in the repayment of loans has hardly been observed by the members with the result that there has been a steep rise in the amount of over dues all over the country.

District Central Co-operative Banks

  • District Central Co-operative Banks (DCCBs) occupy the middle level position in the three tier co-operative credit structure of the country.
  • In the beginning of the formation of Primary Agricultural Credit Societies, they could not function effectively without gaining financial support from an outside agency. The formation of District Central Co-operative Banks was thus a felt need for mutual help.
  • The Co-operative Societies Act of 1912 permitted the registration of District Central Co-operative Banks. Even before the enactment of this Act, some District Central Co-operative Banks were established to cater to the needs of primary
  • In 1906, forerunner of the first District Central Co-operative Banks was established as a primary society in Uttar Pradesh. At Ajmer in Rajasthan the first District Central Co-operative Banks was established in 1910. But the first full-fledged DCCB as per the provisions of the Act of 1912 was started in Jabalpur District of the Central Province.
  • The major objectives of the District Central Co-operative Banks are:
    1. To provide loans to affiliated societies.
    2. To act as a balancing centre of finance for primary societies
    3. To arrange for the supervision and control of the affiliated societies
    4. To raise deposits from members and non-members
    5. To convene conferences of the member societies and also prescribe uniform procedure for the working of primary societies
    6. To open branches of the bank at important places with the permission of the Registrar of Co-operative Societies and
    7. To maintain and utilise state partnership.
  • Generally, the area of operation of a District Central Co-operative Banks is limited to one district.

State Co-operative Banks in India

  • The State Co-operative Banks (SCBs) or the Apex Banks occupy a crucial position in the three tier co-operative credit structure in India.
  • These Apex Banks or State Co-operative Banks are formed by federating District Central Co-operative Banks in each state. The Apex Banks assume a key-position in the co-operative credit structure because the financial assistance from RBI and the National Bank for Agriculture and Rural Development are invariably routed through them.
  • The major deficiencies in the working of the cooperative societies are as follows:
    1. The essence or basic features of cooperative banking system must be a larger reliance on resources mobilised locally and a lesser and lesser dependence on higher credit institutions. However, many PACSs are at present dependent on CCBs and have failed miserably in mobilising rural savings. Heavy dependence on outside funds has, on the one hand, made the members less vigilant not treating these funds as their own and on the other led to greater outside interference and control. Overall, this has made the cooperatives a "mediocre, inefficient and static system".
    2. The cooperative credit institutions are plagued by the problem of high level of over-dues. These over-dues have clogged the process of credit recycling since they have substantially reduced the capacity of cooperatives to grant loans.
    3. Rural Cooperative institutions have a high level of NPAs.
    4. A large number of rural cooperative credit institutions have incurred substantial losses.
    5. The Primary Agricultural Credit Societies is the most important link in the short-term cooperative credit structure. However, most of them are too small in size to be economical and viable. Besides, several of them are also dormant while some are defunct.
    6. Because of their strong socio-economic position and grip over the rural economy, big landowners have cornered greater benefits from cooperatives. This is the opposite of what the planners intended.
    7. There are considerable regional disparities in the distribution of credit by cooperative societies with six States (Gujarat, Maharashtra, Karnataka, Kerala, Punjab and Tamil Nadu) accounting for 70 per cent of the short- term loans provided by the PACSs as of end-March 2010.
    8. The powers which vest in the government under the cooperative laws and rules are all-pervasive. Over the years, State has come to gain almost total financial and administrative control over the cooperatives, in the process stifling their growth. Instead of strengthening the base, a weak base was vastly expanded as per plan targets and an immense governmental and semi governmental superstructure was created.

Inter Bank Transfer

  • Inter Bank Transfer enables electronic transfer of funds from the account of the remitter in one Bank to the account of the beneficiary maintained with any other Bank branch. There are two systems of Inter Bank Transfer - RTGS and NEFT. Both these systems are maintained by Reserve Bank of India.
  • RTGS - Real Time Gross Settlement:- This is a system where the processing of funds transfer instructions takes place at the time they are received (real time). Also the settlement of funds transfer instructions occurs individually on an instruction by instruction basis (gross settlement). RTGS is the fastest possible interbank money transfer facility available through secure banking channels in India.
  • NEFT - National Electronic Fund Transfer:- This system of fund transfer operates on a Deferred Net Settlement basis. Fund transfer transactions are settled in batches as opposed to the continuous, individual settlement in RTGS.

Various committees Related to the Development in the field of Banking

  • Narasimham I – The purpose was to study all aspects relating to the structure. Organization, functions and procedures of the financial systems and to recommend improvements in their efficiency and productivity. It submitted its report in November 1991.
  • Narasimham II – The purpose was to review the progress of the implementation of the banking reforms, since 1992 with an aim to further strengthening the financial institutions of India. It focused on issues like size of banks and capital adequacy ratio (CAR). It submitted its report in April 1998.
  • Damodaran Committee- The purpose was to look into the issues of customer services and evaluate the existing system of grievance redressal mechanism in banks and recommend methods to improve it.
  • Khandelwal committee:- The purpose was to look into the Human Resources issues of Public Sector Banks (PSBs). It made 105 recommendations.
  • Nachiket Mor Committee:- The purpose was to look into the financial services for small businesses and low income households. The motive of the committee was to frame a clear and detailed vision for financial inclusion and financial depending in India.
  • Bimal Jalan Committee / New bank Licenses, 2014:- The purpose was to scrutinize the application for new banks in India. It submitted its report in February, 2014 and recommended ‘in-principle approval’ of banking licenses to Bandhan microfinance and IDFC (Infrastructure Development and Finance Corporation).
  • Deepak Mohanty Committee:- It was established on 15 July, 2015 to prepare five year action plan to spread the reach of financial services across country to unbanked population. It comprised 14 members.

Base Rate System

  • Base Rate System introduced in banking sector by the RBI with effect from July 1, 2010.
  • Base Rate System will replace Benchmark Prime Lending Rate BPLR introduced in 2003.
  • Base Rate System introduced on the recommendation of Deepak Mohanty Committee- aims at enhancing transparency in lending rate of banks and enabling better transmission of Monetary Policy.
  • Base Rate is the minimum lending rate that banks can charge their customers. Prior to this, all lending rates were pegged to a Benchmark Prime Lending Rate BPLR.
  • The banks were charging the customers an interest rate which was either above BPLR (the banks charged much above the BPLR from the risky and no bargaining customers like 12-13%) or below BPLR (Ex like 6-7% to the customers who have bargaining power), thus BPLR serving as an anchor rate. From July 1, 2010, the Base Rate has become the new floor rate below which no bank can lend.

Basel Norms 

  • Basel is a city in Switzerland. It is the headquarters of Bureau of International Settlement (BIS), which fosters co-operation among central banks with a common goal of financial stability and common standards of banking regulations. 
  • BIS fosters co-operation among central banks with a common goal of financial stability and common standards of banking regulations.
  • The Bank for International Settlements (BIS) established on 17 May 1930, is the world's oldest international financial organisation. There are two representative offices in the Hong Kong and in Mexico City. In total BIS has 60 member countries from all over the world and covers approx 95% of the world GDP.
  • The set of the agreement by the Basel Committee on Banking Supervision (BCBS), which mainly focuses on risks to banks and the financial system are called Basel accord. 
  • The purpose of the accord is to ensure that financial institutions have enough capital on account to meet the obligations and absorb unexpected losses. 
  • India has accepted Basel accords for the banking system.
  • Basel accord has given us three basel norms which are BASEL 1,2 and 3.

Basel I

  • In 1988, The Basel Committee on Banking Supervision (BCBS) introduced capital measurement system called Basel capital accord, also called as Basel 1.
  • It focused almost entirely on credit risk, It defined capital and structure of risk weights for banks.
  • The minimum capital requirement was fixed at 8% of risk-weighted assets (RWA).

 Basel II

  • Basel II takes a three pillar approach.
    1. Pillar 1 (Minimum capital requirements).
    2. Pillar 2 (Supervisory oversight).
    3. Pillar 3 (Market discipline and disclosures).
  • Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.
  • Banks were needed to develop and use better risk management techniques in monitoring and managing all the three types of risks that is credit and increased disclosure requirements.
  • The three types of risk are- operational risk, market risk, capital risk.
  • Banks need to mandatory disclose their risk exposure, etc to the central bank.

Basel III

  • In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008.
  • In 2008, Lehman Brothers collapsed in September 2008, the need for a fundamental strengthening of the Basel II framework had become apparent.
  • Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive.
  • The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.
  • Presently Indian banking system follows Basel II norms.
  • The Reserve Bank of India has extended the timeline for full implementation of the Basel III capital regulations by a year to March 31, 2019.

Non-Banking Financial Companies (NBFC)

  • A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of:
    1. Loans and advances
    2. Acquisition of shares/stocks/bonds/ debentures/securities issued by Government or local authority or other marketable securities of a like nature
    3. Leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. 
  • The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI) within the framework of the [Reserve Bank of India Act, 1934] (Chapter III-B) and the directions issued by it.
  • NBFCs are essentially banks, since they perform the basic twin functions of attracting deposit from the public and making loans. But they do not allow depositors to issue cheque and withdraw their money from deposits. Also, unlike commercial banks, they are not incorporated as a bank and are not governed by the provisions of the Banking Regulation Act, 1949. However, with the enactment of RBI( Amendment) Act, 1997, the RBI now control the functioning of NBFCs.

Committees related to NBFCs in India

  • James S. Raj Committee
  • Chakravarty Committee

 Difference between banks & NBFCs

  • NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below:
    1. NBFC cannot accept demand deposits;
    2. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
    3. Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

NBFCs are categorized Into

  • In terms of the type of liabilities into
    1. Deposit accepting NBFCs and
    2. Non-Deposit accepting NBFCs,
      1. Non deposit taking NBFCs by their size into:-
        1. Systemically important (NBFC-NDSI) and
        2. Other non-deposit holding companies (NBFC-ND)
  • By the kind of activity they conduct. Within this broad categorization the different types of NBFCs are as follows: 
    1. Asset Finance Company (AFC)
    2. Loan Company (LC)
    3. Infrastructure Finance Company (IFC)
    4. Systemically Important Core Investment Company (CIC-ND-SI)
    5. Infrastructure Debt Fund
    6. Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI)
    7. Non-Banking Financial Company – Factors (NBFC-Factors)
    8. Mortgage Guarantee Companies (MGC)
    9. NBFC- Non-Operative Financial Holding Company (NOFHC)
  • Capital to risk weighted assets ratio (CRAR) norms were made applicable to NBFCs - D in 1998. The CRAR norm for NBFC - D is 12% (15% in case of unrated NBFCs – D)
  • Under RBI Act, 1934, the NBFCs have to get registered with RBI. However, to obviate dual regulation, certain category of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI such as:-
    1. Venture capital fund
    2. Merchant banking companies, Stock Broking Companies registered with SEBI.
    3. Insurance Company holding a valid certificate of registration issued by IRDA.
    4. Nidhi companies under the Companies Act, 1956.
    5. Chit companies under the chit fund Act, 1982.
    6. Housing finance companies regulated by National Housing Bank (RBI).
    7. Insurance market in India includes both the public and private sector organizations.

Development Financial Institution

  • Financial agencies that provide medium to long-term financial assistance and engaged in promotion and development of key sectors of economy.
  • This institutions have been set up to meet the growing demands of particular segments, such as, export, rural housing and small industries.
  • These institutions have been playing a crucial role in channelising credit to the needy sectors and addressing the challenges/issues faced by them.
  • Development financing is a risky business. It involves financing of industrial and infrastructure projects that usually have long gestation period. The long tenor of such loans has associated with it uncertainty as to performance of the loan asset. The repayment of the long-term project loans is dependent on the performance of the project and cash flows arising from it rather than the reliability of the collaterals. The project could go wrong for a variety of reasons, such as, technological obsolescence, market competition, change of Government policies, natural calamities, poor management skills, poor infrastructure.
  • The markets and banking institutions were highly averse to such uncertain outcome, besides not possessing enough information and skills to predict with any certainty the outcome. There was also the cost considerations associated with such risky ventures. The long-term loan comes with a higher price tag due to the term premium loaded into the pricing. In such a situation the long term financing would be scarce as well as costly so as to render the project financially unviable.
  • The financial institutions in India were set up under the strong control of both Central and State Governments. The Government utilized these institutions for the achievements in planning and development of the nation as a whole. The all India financial institutions can be classified under the following heads according to their economic importance:
    1. All-India Development Banks (Ex: ICICI, IDBI, IIBI, SIDBI)
    2. Specialized Financial Institutions (Ex: EXIM Bank )
    3. Investment Institutions (Ex: LIC, UTI, GIC)
    4. Refinance Institutions ( Ex: NABARD,NHB)
  • Reserve Bank of India regulates and supervises All India Financial Institutions. These institutions are IDBI, ICICI Ltd, IFCI Ltd., IIBI Ltd., NABARD, NHB, Exim Bank, SlDBI and IDFC. Reserve Bank of India undertakes on-site inspection of these institutions and has also evolved off-site Surveillance system through obtaining periodic information.

Development Banks

  • Development Banks in lndia came into existence in the Post-Independence era. Prior to Independence, only commercial banks existed which provided the business community with short-term working capital finance The need, therefore, was felt for the establishment of institutions, which could provide medium to long-term finance to industry.
  • The first development bank, set up in India in 1948, was the Industrial Finance Corporation of India. Its objective was "to make medium and. long-term credit more readily available to industrial concerns in India, particularly in circumstances where normal banking accommodation was inappropriate or recourse to capital issue method was impracticable." Development Banking differs from commercial banking in several ways.
  • Commercial Banking is primarily concerned with short-term lending for financing working capital requirements of a concern. Development banking, on the other hand, is concerned with lending funds for medium to long-term for financing the investments in fixed assets of the company. commercial banking is security-oriented, while development banking is project-oriented.
  • Development banks also finance large-scale projects jointly with commercial banks. Developments Banks have recently been permitted to grant short-term working capital finance to the corporates. They have entered into various other types of financial activities and have undertaken various financial services as well.
  • INDUSTRIAL FINANCE CORPORATION OF INDIA (IFCI) was the first development bank establislied in India in the year 1948. It was established as a statutory corporation undcr the IFCI Act, 1948 with the objective of making mcdium and long term funds more readily available to industrial concerns in India. IFCI was converted into public limited company on July 1, 1993 and is now known as the Industrial Finance Corporation of India Ltd. It aims to provide financial assistance to industry by way of rupee and foreign currency loans, underwrites/subscribes the issue of stocks, shares, bonds and debentures of industrial concerns, etc.
  • INDUSTRIAL DEVELOPMENT BANK OF INDIA: Industrial Development Bank of India is one of the four All India Development Banks in India. In addition, it is the apex banking institution in the field of long-term industrial finance and thus, it functions as the principal financial institution for coordinating the functions and the activities of other All India Financial Institutions. IDBI was established in 1964 as a wholly owned subsidiary of the Reserve Bank of India (RBI). In February 1976, it was de-linked from the RBI and its entire share capital was transferred to the Central Government. As an apex, developmental financial institution, IDBI provides both direct as well as indirect assistance to large and medium scale enterprises. Direct assistance by IDBI constitutes a major part of Bank's total assistance. Direct assistance is provided by way of Project Finance, underwriting and direct subscription to shares and debentures, guarantees for deferred Payments and Equipment Finance Schemes. IDBI provides indirect assistance through refinance of Term Loans and Re-discounting of Bills.
  • INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA LIMITED: Industrial Credit and Investment Corporation of India Ltd. (ICICI) was the first development bank set-up as a joint stock company in India in 1955. Though Industrial Finance Corporation of India had already come into existence at that time, necessity to establish another institution in the private sector was felt primarily to channelise the World Bank funds to the Indian industry and also to build up a capital market in India. The core business activity of the ICICI has traditionally been the business of providing project finance. But over the years, it has undertaken many non-projects based activities and has diversified into new but allied activities through the establishment of its subsidiaries. Though ICICI had entered into varied and diversified financial services through its subsidiaries, a significant step was taken by merging itself with its subsidiary ICICI Bank Ltd. Along with ICICI Ltd., two of its subsidiaries-ICICI Personal Finance Services and ICICI Capital were also merged with the Bank. Thus, ICICI Bank Ltd. has become the largest bank in the private sector. the apparent reason for the merger was to emerge as a Universal Bank, i.e. a bank which undertakes all types of banking and financial businesses.
  • INDUSTRIAL INVESTMENT BANK OF INDIA LIMITED: Industrial Investment Bank of India (IIBI) was originally setup as Industrial Reconstruction Bank of India under the Industrial Reconstruction Bank of India Act, 1984, as a principal--credit and reconstruction agency for industrial revival by undertaking modernisation, expansion, reorganization, diversification or rationalisation of industry. However, with the establishment .of the Board for Industrial and Financial Reconstruction (BIFR), the role of IRBI as a principal agency for industrial reconstruction was marginalised. Hence, it was considered prudent to convert IRBI into a full-fledged all-purpose developmental financial institution. IRBI was converted into a Government company under the Companies Act, 1956 and was re-named as Industrial Investment Bank of India (IIBI). This restructuring aims at providing adequate operational flexibility and functional autonomy to meet the challenges of the changing environment. IIBI undertakes all the functions of a development bank. These functions include providing long/inedium-term loan/assistance to medium and large industrial units, and providing under-writing support to, issuing of shares and bonds.
  • SMALL INDUSTRIES DEVELOPMENT BANK OF INDIA (SIDBI): SIDBI is the principal institution in the country for promotion, financing and development of industries in the tiny and small-scale sectors. It co-ordinates the functions of other institutions engaged in similar activities. It is the principal financial institution for promotion, financing and development of small scale industries in the economy. It aims to empower the Micro, Small and Medium Enterprises (MSME) sector with a view to contributing to the process of economic growth, employment generation and balanced regional development.

Refinance Institutions

  • NATIONAL BANK FOR AGRICULTURE AND RURAL DEVELOPMENT (NABARD): National Bank for Agriculture and Rural Development (NABARD) is the apex financial institution, in the area of agricultural finance and rural development. It was set up in July 1982 by merging the Agricultural Credit Department and Rural Planning and Credit cell of the Reserve Bank of India and the entire undertaking of Agriculture Refinance and Development Corporation. NABARD undertakes the following functions:
    1. Credit to Farm Sector: NABARD provides financial assistance to the farm sector by way of refinance for various agriculture and allied activities, like minor irrigation, plantation and horticulture, land development, farm mechanisation, and animal husbandry. The refinance is provided to commercial banks, State Co-operative Banks, Regional Rural Banks and, State Land Development Banks. Besides providing refinance, NABARD also provides short term loans to State Co-operative Banks and Regional Rural Banks for financing seasonal agricultural operation, marketing of crops, purchase of agricultural inputs.
    2. Developmental Activities: NABARD undertakes various developmental activities such as formulation of credit plans, building of institutions, promotion of Research and Technology. It also co-ordinates rural credit agencies and develops expertise to deal with agriculture and rural problems.
    3. Regulatory Function: The Banking Regulation Act, 1949 has empowered NABARD to inspect the working of the Regional Rural Banks and Co-operative Banks. Its recommendation is required for opening of a new branch before the RBI gives its permission to do so.
  • National Housing Bank (NHB): National Housing Bank (NHB) was set up in July 1988 under the National Housing Bank Act, 1987 as the apex bank in the field of housing finance. It is a wholly owned subsidiary of the Reserve Bank of India. It is, the principal agency to promote housing finance institutions at the regional and local levels and to provide financial and other support to such institutions. National Housing Bank provides re-finance to the Housing Finance Companies, which are spread all over the country and account for the major share, followed by commercial banks and co-operative banks and Land Development Banks.

Specialised Financial Institutions

  • EXPORT-IMPORT BANK OF INDIA (EXIM BANK): Export-Import Bank of India (EXIM Bank) was set up in 1982 for the purpose of financing, facilitating and promoting the foreign trade of EXIM Bank is wholly owned by the Government of India. It is the apex financial institution in the country for co-coordinating the working of institutions engaged in financing exports and imports. Besides export finance, it also renders various advisory services to exporters and other entities connected with foreign trade. Exim Bank undertakes a variety of lending and service programmes, which are meant for Indian entities, Commercial Banks and Overseas entities. Exim Bank operates a wide variety of schemes for the benefit of Indian exporters. Exim Bank provides finance/refinance to commercial banks in India /abroad to enable them to provide finance to Indian exporters/importers from India. Exim Bank also operates schemes for the benefit of Overseas Entities. As a complement to its financing programmes, Exim Bank offers a wide range of information, advisory and support services to Indian companies and foreign entities. 

Regulation over financial institution

  • The Development Financial Institutions constitute an important segment of the Indian Financial System. They provide long-term funds for the development of industries, Infrastructure projects and other major activities and thus, help in the growth of the economy.
  • They are basically governed by their own statues and charters---Industrial Development Bank of India by the provisions of IDBI Act, 1964 and the Industrial Finance Corporation of India Ltd. the Industrial Credit and Investment Corporation Ltd. (ICICI) and the Industrial Investment Bank of India (IIBI) by their respective Memorandum of Association Articles of Association, besides the Companies Act, 1956. Moreover, these financial institutions are also controlled by the regulations made by both the regulators of the Indian Financial System, namely the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI). Section 45 L of the Reserve Bank of India Act, 1934, extends the supervisory authority of the Reserve Bank over the financial institutions.

Some Definition

  • Bridge Loans: These are short-term loans which are granted to the borrowers of term , loans by a bank or financial institutions to enable them to meet their immediate needs for funds. These loans are adjusted/repaid when the term loan is disbursed by the financial institutions.
  • Equity Assistance Scheme: Assistance, which is provided in the form of subscribing to the equity shares of the company.
  • Refinance of Term Loans: Term loans are provided by Commercial Banks and State Financial Corporation to industrial concerns. On the basis of these loans, these institutions can get loans from Industrial, Development Bank of India or Small Industries Development Bank of India. Such loans are called Refinance of Term Loans.
  • Venture Capital: Venture Capital is that capital which is provided by Venture Capital Fund/Company to an entrepreneur to undertake a new non-traditional venture with high risk and with the prospects of earning high return. This is provided in the form of equity besides loans.

Financial Inclusion

  • Financial inclusion may be defined as the process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost
  • The Government of India and the Reserve Bank of India have been making concerted efforts to promote financial inclusion as one of the important national objectives of the country. Some of the major efforts made in the last five decades include –
    1. Nationalization of banks
    2. Building up of robust branch network of scheduled commercial banks
    3. Co-operatives and regional rural banks
    4. Introduction of mandated priority sector lending targets
    5. Lead bank scheme
    6. Formation of self-help groups
    7. Permitting Business Correspondents / Business Facilitators (BCBF) to be appointed by banks to provide door step delivery of banking services
    8. Zero balance Basic Savings Bank Deposit (BSBD).
  • The fundamental objective of all these initiatives is to reach the large sections of the hitherto financially excluded Indian population.
  • The essence of financial inclusion is to ensure delivery of financial services which include - bank accounts for savings and transactional purposes, low cost credit for productive, personal and other purposes, financial advisory services, insurance facilities (life and non-life) etc.
  • Financial inclusion broadens the resource base of the financial system by developing a culture of savings among large segment of rural population and plays its own role in the process of economic development. Further, by bringing low income groups within the perimeter of formal banking sector; financial inclusion protects their financial wealth and other resources in exigent circumstances. Financial inclusion also mitigates the exploitation of vulnerable sections by the usurious money lenders by facilitating easy access to formal credit.

CRISIL Financial Inclusion Index (Inclusix)

  • CRISIL’s Inclusix is a comprehensive index for measuring the progress of financial inclusion in the country, down to the district-level. A pro bono initiative by CRISIL.
  • CRISIL’s Inclusix methodology is similar to other global indices, such as UNDP's Human Development Index, measures financial inclusion on the three critical parameters of basic banking services –
    1. Branch penetration
    2. Deposit penetration
    3. Credit penetration
  • Bank branch penetration is measured as number of bank branches per one lakh population.
  • Deposit penetration Measured as number of saving deposit accounts per one lakh population.
  • Average of three measures used for measuring credit penetration namely
    1. Number of loan accounts per one lakh population.
    2. Number of small borrower loan accounts per one lakh population.
    3. Number of agriculture advances per one lakh population.
  • In the Indian context, the term ‘financial inclusion’ was used for the first time in April 2005 in the Annual Policy Statement presented by Y.Venugopal Reddy, the then Governor,  Reserve Bank of India. Later on, this concept gained ground and came to be widely used in India and abroad. While recognizing the concerns in regard to the banking practices that tend to exclude rather than attract vast sections of population, banks were urged to review their existing practices to align them with the objective of financial inclusion.
  • In India, RBI has initiated several measures to achieve greater financial inclusion some of these steps are:
    1. Opening of no-frills accounts
    2. Relaxation on know-your-customer (KYC) norms
    3. Engaging business correspondents (BCs)
    4. Use of technology
    5. Opening of branches in unbanked rural centres

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