A bank is a financial institution that accepts deposits and creates credit (Prarulebook.co.uk, 2017). This can be done either directly or indirectly through capital markets. Capital market is a financial market where equity backed securities or debt are both bought and sold. Capital markets can be defined the markets where the money is lent for a period longer than a year (O'Sullivan and Sheffrin, 2003). As the banks play an important role in the financial regulation of an economy, they are highly regulated by the Government in most of the countries.
The bank, through its own activity, holds responsibility for the activities and nature of those activities in order to obtain both economic and financial resources through a multitude of instruments created for various purposes that include bonds, deposits or any form of obligations. Alternatively, the banking system is also responsible for facilitating the access to these resources through various banking tools including loans and mortgages. Banks can provide these services in exchange for interest or commissions that have been previously agreed upon in each of the above mentioned operations. The interest collected through provision of various activities is the profit that the banks earn.
The scope of the functions of a banking institution is rather too large. The most important function of a bank is credit creation. Through this, the bank accepts deposits, uses these deposits to lend to the borrowers. The interest rate paid by the banks to the depositors is lower than the interest rate charged on the loans made by the banks. The difference between these two interest rates is the profits that the banks earn. Banks play a vital role in the development of an economy as they facilitate business. They provide loans to the businessmen at reasonable interest rates which is invested in the business. The banks also encourage savings by the households which care later used in the process of credit creation. This makes sure that no money is left idle and it is used in an efficient way.
Overview of banking in india
Before the 20th Century had begun, the villages in India were borrowing money at unreasonably high rates of India. The development of Cooperative movement led to high reduction in the practice of lending and borrowing money at high rates by money lenders. Cooperative banks work alongside the Commercial banks in order to play a supplementary role of providing loans and advice to especially the agricultural sector in India.
One of the first banks established in India was Bank of Hindustan. The three most important banks or presidency banks in India are Bank of Bengal, Bank of Bombay, and Bank of Madras. Later these three banks were combined into State Bank of India after the Imperial Bank of India Act in 1920 (Muthiah, 2011).
In the year 1960, eight state associated banks’ control was given to the State Bank of India under the Subsidiary Banks Act, 1959 (Sbi.co.in, 2017). Nine years after that, 14 major private banks were nationalised in 1969. These were:
Allahabad Bank
Bank of Baroda
Bank of India
Bank of Maharashtra
Canara Bank
Central Bank of India
Dena Bank
Indian Bank
Indian Overseas Bank
Punjab National Bank
Syndicate Bank
United Commercial Bank
United Bank
Union Bank of India
This was followed by nationalisation of 6 more private banks in 1980 (Rbi.org.in, 2017) which include:
Andhra Bank
Corporation Bank
New Bank of India
Oriental Bank of Commerce
Punjab and Sindh Bank
Vijaya Bank (Mishra, 2017).
These nationalised banks are the leading and dominating banks as they are of large size and also, they are the major lenders in the banking system in India (Muraleedharan, n.d.). Also, in 1949, Banking Regulation Act was started which led to empowering of the Reserve Bank of India as the Central bank of India. it is given in The Banking Regulation Act that no new banking institution, subsidiary or a new branch of an existing bank can be opened without obtaining a license from the RBI. It also says that there should be no common directors between two or more banks.
Classification of banking
The Indian Banking sector has been divided into Scheduled Banks and Non-scheduled banks. All the banks mentioned in Schedule 2 in the Reserve Bank of India Act, 1934 are the Scheduled banks. The Scheduled banks are further classified into Scheduled Commercial Banks and Scheduled Co-operative Banks. The classification of Scheduled Cooperative banks are Scheduled State Co-operative banks and Scheduled Urban Co-operative banks.
The classification of Scheduled Commercial Banks are as follows:
State Bank of India and its Associates
Nationalised Banks
Private Sector Banks
Foreign Banks
Regional Rural Banks
Main Functions of banks
The main functions or primary functions of a bank are as follows:
ACCEPTING DEPOSITS
Fixed deposits-
These deposits are for a fixed period of time. They mature after a considerably long period of 1 year or more. The rate of interest offered by the bank is highest on the Fixed Deposits. These interest rates are fixed by the banks. The amount deposited cannot be withdrawn prior to the maturity time. If done so, it leads to a loss of interest to the depositors. This is done so in order to encourage the depositors until the end of the maturity period.
Current Account deposits-
The Current A/C is generally maintained by the businessmen who transact large amounts of money on a daily basis. This facilitates frequent transactions concerning huge amounts of money for commercial purposes. The Banks pay no interest on such types of accounts. Instead, they charge a small amount of money from the individuals with these accounts in order to maintain such an account.
Savings Account deposits
It is mostly used by people who have small savings. Generally, the interest paid on a Savings A/C Deposit is higher than that of a current a/c deposit and lower than the rate of interest paid on the Fixed deposits. In this type of an account, there is no fixed term. The banks might though, limit the number of times money can be withdrawn from the savings account every month.
Recurring Account deposits
In a Recurring Account, a small amount of fixed amount is deposited in the bank every month for a fixed period of time. The interest rate paid on a recurring account deposit is higher than the interest paid on a savings account deposit and lower than that of fixed deposits. The minimum period of such a deposit is 6 months and the maximum time is 10 years.
LENDING ACTIVITIES
Call loans
Call loans are the loans given to a brokerage firm and later used in order to finance the margin accounts. There is a daily calculation of the interest rate on a call loan. The resulting interest rate is referred to as the call loan rate.Call loans use securities as collateral for the loan. It is important to note that a call loan can be canceled at any time. These call loans can be cancelled anytime.
Short term loans
The short term loans are given for a period of less than one year. These loans are mostly used for working capital needs that are temporary. Even though the company doesn't qualify for the line of credit, it impossible to obtain a short term loan.
Medium term loans
The medium term loans vary for a period from 1 year to 5 years. This time period is considered to be intermediate in nature.
Long term loans
Overdraft facility
The overdraft facility is given to customers with credit worthiness. It is widely used by businessmen. It enables the holders of the current account to withdraw more than the amount held by them in the account. Though they can withdraw more than what is held in their account, they need to pay a very high rate of interest on the amount of overdraft.
Cash credit
According to the facility of cash credit, the borrower can borrow a certain amount of money against a mortgage or a security.
Bills of Exchange
The banks lend money to the borrowers by purchasing or exchanging the bills of exchange. The banks charges commission for exchanging it before the date of maturity.
The Secondary functions of the banks include:
Merchant Banking
The banks underwrites securities and advices the customers in various aspects. No one is allowed to carry out the functions of the merchant banking unless they have got a certificate from Securities and Exchange Board of India (SEBI) which states that they can do so. Thus, merchant banking is an institution which provides various services to people including exchanging bills, managing the portfolio, corporate finances and so on.
Leasing
It is a written agreement in which the banks fund the immovable properties by renting them out to businessmen for a specified period of time. The terms regarding the rent, duration and so on are agreed upon and the written agreement is made according to that.
Mutual funds
It mobilises the savings of public and invests them in the stock market.
Credit cards
It enables the credit card user to pay for goods and services up to certain amount of money every month which has to be paid back to the banks.
Venture Capital
ATMs
This facility enables the customers to withdraw cash at any time in the cash points.
Tele-banking
It is a telephone based customer service where customers get the details they want through the telephone.
Underwriting facilities
Underwriting facilities are given to the joint stock companies in which the banks guarantee to purchase certain share in case they are not sold in the market.
Locker Services
The commercial banks provide locker facilities to the depositors in which they can keep their valuables, documents and other important things. This locker is maintained by the bank for a certain fees (Sharma, 2013).
The size of a business means it’s ability to possess a variety of production capabilities or the quantity and different types of services that the business can offer to its customers. In simple words, the best indication of size of a firm is how big a management group or the amount of assets it possesses compared to other firms in the same industry (Sritharan, 2015). Firm size is ideal speed and extent of growth that is required to survive the competition in the economy. Bank size is an important indicator that measures the economies or diseconomies of scale that are existing in the banking sector. A large bank reduces cost as a result of economies of scale and scope of the banking activities. Size is generally measured by annual turnover, gross value of assets, logarithm of number of employees, logarithm of number of offices or branches, logarithm of total assets. Growth in size of a firm can be in terms of revenue, profits, assets, number of employees or number of offices which are all the pre-requisites for higher profitability and good financial health. In a study conducted by Omondi and Muturi (2013), they had suggested that firms should expand in such a way that it can achieve the optimum size. Achievement of that would lead to economies of scale that would further result in higher profitability. Though larger firms earner higher profit, if the firms’ size keeps increasing, it might result in diseconomies of scale due to many factors. (Yuqi, 2007). Firm size is one of the important determinant of profitability. There is empirical evidence that larger banks operate efficiently as compared to the smaller banks due to many factors. This is because the former have greater cumulative experience and they have a huge amount of activities on which the fixed costs can be spread (Kigen, 2014). It has been found that growth in size causes a diseconomies of scale by Shepherd (1972), whereas in an another study, there were results that showed the firm size does not have a significant effect on the profits earned by the banks.
Non-Performing Assets
A Non-performing asset (NPA), according to the Glossary of Reserve Bank of India is defined as “A credit facility in respect of which the interest and/or instalment of principal has remained ‘past due’ for a specified period of time”. In other words, an asset is called as non performing when there is a termination of the process of generating income for the lender.
CAUSES FOR NON-PERFORMING ASSETS IN PUBLIC SECTOR BANKS
The banking sector holds a lot of importance for an economy to perform well. The failure of the banking sector may have an adverse impact on other sectors. Previously Indian banking system was operating in a closed economy but after Globalisation in 1990s, it now faces the challenges of an open economy. On one hand banks did not have a need to develop sophisticated treasury operations and skills of Asset and Liability Management as there was a protected environment ensured. On the other hand there are a combination of factors of profitability and competitiveness were assigned an inferior rank in the background due to the feature of directed lending and the socialistic characteristic of banking (social banking) .
This resulted in unsustainable NPAs and consequently led to a higher cost of the banking services. One of the most important causes of Non-Performing Assets into the banking sector is that commercial banks are required to provide a certain percentage of their credit capacity (40%) to priority sectors under the directed lending system.