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Warning: TT: undefined function: 32UNIT II: BANKS AND SECURITIESBanks are a subset of the financial services industry. It is a financial institution that provides banking and other financial services to their customers. A bank is generally understood as an institution which provides fundamental bank...

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UNIT II: BANKS AND SECURITIES Banks are a subset of the financial services industry. It is a financial institution that provides banking and other financial services to their customers. A bank is generally understood as an institution which provides fundamental banking services such as accepting deposits and providing loans. The banks safeguards the money and valuables and provide loans, credit, and payment services, such as checking accounts, money orders, and cashier’s cheques and some banks also offer investment and insurance products. Due to their critical status within the financial system and the economy, banks are subject to stringent regulations The genesis of Indian banking system could be traced in the Vedic times and the existence of professional banking could be traced back to the 500 BC. Further, Aryans treated money lending as one of the four honest callings, the other three being “tillage, trading and harvesting.” An indigenous banking system was being carried out by the businessmen called Sharoffs, Seths, Sahukars, Mahajans, Chettis, etc. since ancient time. They performed the usual functions of lending moneys to traders and craftsmen and sometimes placed funds at the disposal of kings for financing wars. The indigenous bankers could not, however, develop to any considerable extent the system of obtaining deposits from the public, which today is an important function of a bank. Modern banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India which started in 1786, and the Bank of Hindustan. Thereafter, three presidency banks namely the Bank of Bengal (this bank was originally started in the year 1806 as Bank of Calcutta and then in the year 1809 became the Bank of Bengal), the Bank of Bombay (1840) and the Bank of Madras (1843), were set up. For many years the Presidency banks acted as quasi-central banks with the exclusive right to issue paper currency till 1861, but with the Paper Currency Act, the right was taken over by the Government of India. Later, in 1921, the three banks were amalgamated and the re-organised to form Imperial Bank of India. The Imperial Bank of India remained a joint stock company but without Government participation. The three banks merged in 1925 to form the Imperial Bank of India. Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the economic crisis of 1848-49. Bank of Upper India was established in 1863 but failed in 1913. The Allahabad Bank, established in 1865 , is the oldest survived Joint Stock bank in India . Oudh Commercial Bank, established in 1881 in Faizabad, failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which is now one of the largest banks in India. The Swadeshi movement inspired local businessmen and political figures to found banks of and for the Indian community during 1906 to 1911. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India. A major landmark in Indian banking history took place in 1934 when a decision was taken to establish ‘Reserve Bank of India’ which started functioning in 1935. Since then, RBI, as a central bank of the country, has been regulating banking system.

Changing functions of banks from direct lending to modern system of Investment banking The banking sector plays a crucial role in the economic development of a nation. A sound, efficient, effective, vibrant and innovative banking system stimulates economic growth by mobilizing savings on a massive scale and efficiently allocating resources for productive as well as consumption purposes. Indian banking witnessed a remarkable transformation consequent to the implementation of banking sector reforms since early 90s. Worldwide financial systems have undergone structural changes. The global factors driving these changes have been advancements in technology and computing, external financial liberalization and organizational changes in corporate world. Banking and finance in emerging economies has been no exception. The banking sector reforms can be classified into 6 categories; viz., a) measures meant for promotion of competition, b) measures meant for strengthening the role of the market, c) prudential measures, d) legal measures, e) measures meant for strengthening supervision or supervisory controls and f) measures relating to technology. In addition, know your customer (KYC) guidelines, anti-money laundering (AML) standards, introduction of capital charge for market risk, high graded provisioning for non-performing assets (NPA), were adopted for implementation. Institutional and legal measures introduced for improving banks performance in the area of recovery and for asset quality up gradation included setting-up Lok Adalats, Debt Recovery Tribunals (DRT), Asset Reconstruction Companies (ARC), Settlement Advisory Committees (SAC), Corporate Debt Restructuring Mechanism. Enactment of securitization and reconstruction of financial assets and enforcement of security interest act (Sarfaesi Act) was another important mile stone in reforms. Setting-up Credit Information Bureau (India) Ltd., (CIBL) for sharing credit information and establishment of the Clearing Corporation of India Ltd, (CCIL) to act as central counter party for facilitating payments and settlement systems relating to fixed income securities and money market instruments extended support to banks.

Credit – Debit Cards Credit cards are an easy method To Buy Now and Pay Later. The credit card is a double aged tool which enables one to pay for purchases with the card instead of paying cash on the spot. Thus they are extremely convenient as they can do away with the necessity of carrying large sums of cash around. Further, the card becomes handy when a person on tour finds that he has run out of cash but has to pay a bill incurred which can be defrayed by using the credit card. Another feature of the usage of the card is that the risk of loss of money is totally absent and the card, even if lost, can be obtained again, provided it is intimated to the issuer immediately. If one is trapped for cash, he can withdraw money at specified branches of the bank upto a specified monthly limit. Thus, we find that credit card takes care of liquidity problem of individuals. It is a tool at hands of its holders to tide over a budget deficit for a short period of time. Debit Cards, on the other hand do not allow credit. The account usually debited

immediately or on the same day when the card has been used to draw money are make purchases. No credit period is allowed. ATM : Automated Teller Machines are increasingly providing functionalities that take away the routine teller functions and are an effective personalized secure customer information and crosssell channel. With the RBI working towards the implementation of the cheque truncation initiative, this deposit module will facilitate faster cheque processing as the scanned image of the cheque and directly be sent for clearing with the ATM being the point of deposit and truncation. This will facilitate faster access to funds for consumers as well as cost and operational efficiencies for the banks. Mobility in Banking: Mobile phone banking takes one step ahead of internet and tele-banking. The customer can do a banking activity, without even making a phone call. The most obvious advantage of mobile phone banking over tele-banking and internet banking is that it is truly “Any Time Any Where Banking”. There are broadly two types of services that a customer could avail through mobile phone. a) Alert Services – Alert services helps a customer keep a track of the activity on his accounts and b) Requests – Allows a customer call for information pertaining to his bank accounts and transactions. The mobile banking works through a set of text messages. The use of mobile phones in the country has become a revolutionary, therefore it is no surprise, that banks are offering services over mobile phones, as part of their tech banking initiatives. Bank on the Net: Internet banking has become a necessity in today’s busy life styles. Using this mode to transact, saves precious time and effort. From across the seven seas, as long as the customer has an access to the internet, he can have an access to his bank. Internet banking allows a customer to conduct a plethora of banking activities using the net. The best part about internet banking is the convenience offered along with total confidentiality and safety. The virtual ease with which a customer can bank today is reassuring. Fund Transfers Internet banking or online banking allows a customer to transfer funds from one account to another, across branches and cities. Some banking institutions have gone one step ahead by offering the customers the facility to transfer money from his account to that off any person with an account at the same bank or any bank, any time and from anywhere. All that the customer has to do is submit a signed declaration stating that he wants to access this facility. Fixed Deposits and Demand Drafts As part of internet banking activities, a majority of banks allow the customers to create a new fixed deposit. The customer is simply required to fill in the details of the bank account from which he wishes to transfer funds, the amount and duration of the deposit. The bank will do the rest and transfer the interest and maturity amount back to the account from which the customer has deposited. A number of banks are willing to issue demand

drafts from the customer’s account, once he provides them with the details of the amount, location and beneficiary over the net. Pay Utility Bills The customers can now even pay telephone, mobile and electricity bills over the net. However, some banks limit the facilities like these and creation of new fixed deposits and demand drafts requests to regular banking hours. In case, the customer puts in the request after banking hours, the bank promptly executes it on the next working day. So it is definitely better than standing in queues at utility offices or banking premises on a working day. So it is clear that banks in India are operating in an increasingly competitive environment. Not only the banking market has seen a large number of players competing with one another, but also the new entrants have the advantage of starting with a strong capitalization, modern technology, lean network and, more importantly without any accumulated problem of the past. It is also fair to expect that the initial target of the new competitors will be the most profitable segment of the banking business, i.e., high value corporate customers, business relating to high networth individuals, foreign trade related business and so on. Customers now have a real choice. Banks have become more customer responsive. The future of Indian banking, therefore holds greater promise for those who are willing to accept the challenge. Role of banks to issue securities The sale of stocks and bonds is one of the primary ways for a company to raise capital. But executing these transactions requires special expertise, from pricing financial instruments in a way that will maximize revenue to navigating regulatory requirements. That’s where an investment bank usually comes into the picture. In essence, investment banks are a bridge between large enterprises and the investor. Their main roles are to advise businesses and governments on how to meet their financial challenges and to help them procure financing, whether it be from stock offerings, bond issues or derivative products. Role as an advisor Deciding how to raise capital is a major decision for any company or government. In most cases, they lean on an investment bank – either a large Wall Street firm or a “boutique” banker – for guidance. Taking into account the current investing climate, the bank will recommend the best way to raise funds. This could entail selling an ownership stake in the company through a stock offer or borrowing from the public through a bond issue. The investment firm can also help determine how to price these instruments by utilizing sophisticated financial models. In the case of a stock offering, its financial analysts will look at a variety of different factors – such as earnings potential and the strength of the management team – to estimate how much a

share of the company is worth. If the client is offering bonds, the bank will look at prevailing interest rates for similarly rated businesses to figure out how much it will have to compensate borrowers. Investment banks also offer advice in a merger or acquisition scenario. For example, if a business is looking to purchase a competitor, the bank can advise its management team on how much the company is worth and how to structure the deal in a way that’s favorable to the buyer. Underwriting stocks and bonds If an entity decides to raise funds through an equity or debt offering, one or more investment banks will also underwrite the securities. This means the institution buys a certain number of shares – or bonds – at a predetermined price and re-sells them through an exchange. Investment bank underwriters help securities issuers lessen their risk in exchange for a premium. Key Points 

Security issuers want to mitigate the risk of having an unsuccessful issue.

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Underwriters will buy the securities from the issuer and then sell it on the market. The underwriter aims to buy the securities below market price, and then sell them for a profit.

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Underwriters deal with both companies and government. The issuer could issue stocks, bonds, or any other type of security.

Key Terms 

security: proof of ownership of stocks, bonds, or other investment instruments.

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issuer: The firm or government selling the security.

Underwriting refers to the process that a large financial service provider ( bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products ( equity capital, insurance, mortgage, or credit). Underwriters exist in a number of different industries, and are primarily responsible for evaluating the risk of potential clients. In investment banking, underwriters are best known for the role that they play in initial public offerings ( IPOs ). IPOs are when a company decides to sell equity on the stock market for the first time. They sell their own stock on the market and in the process, raise money through selling equity. However, investment banks are involved in the underwriting of all types of securities, not just stock. The company needs to set a price for its stock; they want to set it high enough to raise much money as possible but low enough that they will be able to sell their stock. Thus, there is a risk to the company in the offering of securities. For all types of securities, whether offered by

companies or the government, there is a risk that the issuer may not be able to have a successful securities offering. That is where the job of the security underwriter comes in. The underwriter offers to take on some of the risk of the offering in exchange for a premium. In essence, the underwriter buys the securities from the issuer and then turns around to sell the securities on the market. This means that the issuer gets cash up front. The issuer knows that it is probably not getting the full market value of the securities, but that’s okay because it no longer has the risk of having to find enough buyers to purchase the securities at a desirable price. The underwriting investment bank likes the deal because if it can sell the securities on the market at a higher price than it purchased them, it can make a profit. There are sometimes multiple investment banks involved in the underwriting of a security. The details of the process may vary from deal to deal, but the fundamental job of the underwriter(s) is to take some of the issuer’s risk in exchange for a premium. The Role of an Advisor The advisory group of an investment bank is primarily concerned with facilitating the mergers and acquisitions of businesses. Key Points 

Mergers and acquisitions ( M&A ) require an investment bank to bring the buyer and seller together and to help negotiate the deal.

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The advisor is hired by the client company to find a buyer/seller. The advisor pitches the deal to potential buyers/sellers using a pitch book, which contains all relevant financial information.

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The advisor also helps facilitate the deal which is incredible context because it must account for everything from financial projections to assets to brand names.

Key Terms 

M&A: Mergers and acquisitions (M&A) are aspects of corporate strategy, corporate finance, and management dealing with the buying, selling, dividing, and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or new location, without creating a subsidiary, other child entity or using a joint venture.

Advisory Role Investment banks also play the role of advisor to companies. They are not consultants, but are more like facilitators. The advisory group in an investment bank is often termed M&A.

M&A stands for “mergers and acquisitions”, which refers to the the buying, selling, dividing and combining of different firms. For example, if a company wants to sell of an unprofitable division, they will hire an investment bank to find a company that would want to buy it. Investment banks play a large role in facilitating M&A deals. The advisory group is charged with the task of helping buyers find sellers and vice versa, and then facilitating the deal.

THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT, 2002 The financial sector has been one of the key drivers in India’s efforts to achieve success in rapidly developing its economy. While the banking industry in India is progressively complying with the banking and financial prudential norms and accounting practices, there are certain areas in which the banking and financial sector don’t have a level playing field as compared to other participants in the financial markets in the world. There is no legal provision for facilitating securitization of financial assets of banks and financial institutions. Further, unlike international banks, the banks and financial institutions in India don’t have power to take possession of securities and sell them. They have to approach the civil courts for recovery of dues which was time consuming. There were huge arrears of cases before courts. Civil courts also failed to deliver both in ascertainment of dues and execution of decree after judgement. Failure of civil courts led to promulgation of Recovery of debts due to banks and financial institutions Act (hereinafter mentioned as RDDBFI Act) w.e.f. 27th august, 1993. RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL INSTITUTIONS ACT, 1993 (DRT ACT) Recovery of the dues of loans from the borrowers through courts was a major issue for the banks and financial institutions due to huge back log of cases and the time involved. The Act came into operation from 24th June 1993. Important highlights of DRT Act, 1993 are: 1. This Act constituted the special ‘Debt Recovery Tribunals’ for speedy recovery; 2. This Act is applicable for the debt due to any Bank or Financial Institution or a consortium of them, for the recovery of debt above ` Ten lakhs; 3. This Act is applicable to the whole of India except the State of Jammu & Kashmir; 4. The term ’debt’ covers the following types of debts of the Banks and Financial Institutions: (a) any liability inclusive of interest, whether secured or unsecured; (b) any liability payable under a decree or order of any Civil Court or any arbitration award or otherwise; or (c) any liability payable under a mortgage and subsisting on and legally recoverable on the date of application.

Some examples of interpretation of the term ‘debt’ by diff...