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Banking and the Future of Indian Banking by Samaira Dayani

The banking sector is poised to grow at a rapid pace by digitizing financial services dissemination, further formalizing credit to micro, small and medium enterprises (MSMEs), adopting innovative digital operating models, adapting to the continuously evolving landscape, benefiting from the adoption of emerging technologies, and driving consumption-fueled growth for our economy.

BASICS OF INDIAN BANKING SYSTEM

Introduction - Central Banks and Commercial Banks

Commercial Banks

Commercial and central banks are essential parts of the country’s economy. While commercial banks deal directly with the end users, central banks offer their products and services to the government and other commercial banks.

A commercial bank is a type of financial institution that provides various banking services to individuals, businesses, and other organizations. These services include accepting deposits, making loans, and facilitating the transfer of funds. Commercial banks also offer a wide range of other financial services such as issuing credit and debit cards, providing online and mobile banking, and offering investment products. They accept deposits from customers and use these funds to make loans to businesses and individuals. They also earn a profit by charging interest on loans and paying lower interest on deposits. Some commercial banks offer safe deposit boxes or vaults for customers to store valuable items, such as documents, jewelry, and other valuables. Commercial banks ensure liquidity by taking the funds that their customers deposit in their accounts and lending them out to others. Commercial banks play a role in the creation of credit, which leads to an increase in production, employment, and consumer spending, thereby boosting the economy.

Central Banks

A central bank is a financial institution that is responsible for overseeing the monetary policy of a country. The meaning of central bank is a financial institution that has the privilege of producing and distributing money (and credit) for a country or a group of countries. It acts as a regulator and supervisor of the country's financial system, and is typically responsible for issuing and controlling the supply of currency, managing the country's foreign exchange reserves, and acting as a lender of last resort to commercial banks. The main functions of a central bank include maintaining price stability, ensuring the smooth functioning of financial markets, and promoting economic growth.

The Reserve Bank of India (RBI) is the central bank of India.It is an apex body that controls, operates, regulates, and directs a country’s banking and monetary structure.

Roles and Functions of the RBI

The Reserve Bank of India was established on April 1, 1935. The RBI is completely owned by the government of India.

The following are some of the vital functions of the RBI:

● Monetary Authority: It formulates, implements and monitors the monetary policy. The objective is to maintain price stability while keeping in mind the objective of growth.

● Issuer of currency: RBI is the authority who issues notes, destroys the old notes and decides which currency is fit for circulation among the people. It also puts coins minted by the Government of India into circulation. The objective is to give the public an adequate quantity of supplies of currency notes and coins in good quality.

● Custodian and Manager of Foreign Exchange Reserves: In order to stabilize the external value of Indian currency, the RBI maintains the reserves of foreign currencies to stabilize the exchange rate. The objective is to facilitate external trade and payment and promote orderly development and maintenance of the foreign exchange market in India.

● Lender of Last Resort: It also acts as a lender of last resort for the Scheduled Commercial Banks (SCBs). Usually, banks and other financial institutions borrow and lend among themselves to meet their financial needs. But, in times of crisis, the SCBs approach the RBI to get financial assistance.

● 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 functions such as accepting deposits, and taxes and making payments on behalf of the government. It works as a representative of the government even at the international level.

Monetary Policy:

Monetary policy is a set of tools used by a nation's central bank to control the overall money supply and promote economic growth, as well as to control inflation.

The following are some of the tools used by the Reserve Bank of India to control the flow of money:

● CASH RESERVE RATIO/ CRR:

The cash reserve Ratio is a particular minimum amount of the total deposits of customers that need to be maintained by the commercial bank as a reserve either in cash or as deposits with RBI. The CRR rate will be fixed as per the guidelines of the Central Bank.

It ensures the liquidity system is consistent and maintained well in all commercial banks. RBI gets to control and coordinate the credit maintained by banks through the CRR rate which helps to have a smooth supply of cash and credit in the economy.

When the CRR rate is reduced by RBI, commercial banks can offer more advances to borrowers which in turn increases the flow of cash to the public.

Another objective of CRR is to keep inflation under control. During high inflation in the economy, RBI raises the CRR to reduce the amount of money left with banks to sanction loans. It squeezes the money flow in the economy, reducing investments and bringing down inflation.

As of 2024, the CRR is at 4.5%. This rate has been stable since early 2023. The CRR was reduced to 3.0% in 2020 during the COVID-19 pandemic to increase liquidity in the banking system.

Post-pandemic, the CRR was increased to 4.0% in 2021 and then to 4.5% in 2022 and 2023 as the economy began to recover and the RBI shifted its focus to managing inflation and ensuring economic stability.

● STATUTORY LIQUID RATIO (SLR):

SLR requires commercial banks to keep a certain amount of their money invested in specific central and state government securities. It is the minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities.

One of the main objectives is to prevent commercial banks from liquidating their liquid assets when the RBI raises the CRR. SLR also helps RBI control inflation. Raising SLR makes banks park more money in government securities and reduce the level of cash in the economy. This helps raise price levels and inflation in the economy. Doing the opposite helps maintain cash flow in the economy. Reducing SLR leaves more liquidity with banks, which in turn can fuel growth and demand in the economy.

As of January 29, 2024, the current SLR in India is 18%. In recent years, the SLR has been gradually reduced to promote more lending and stimulate economic growth. For example, the RBI reduced the SLR from 19.5% to 18.0% over the past few years. From 2015 to 2019, the RBI steadily decreased the SLR from around 21.5% to 18.75%.

● REPO RATE:

The Repo Rate is the interest rate at which the Reserve Bank of India (RBI) loans money to commercial banks. The repo rate is utilized by the Indian central bank to restrict the flow of money in the market. When the market is impacted by inflation, the RBI raises the repo rate.

An increased repo rate means that banks borrowing money from the central bank during this period will have to pay more interest. This inhibits banks from borrowing money, reducing the amount of money in the market and helping to negate inflation. The repo rate is a critical tool used by central banks to manage the economy and maintain financial stability. When the economy slows down, central banks can lower the repo rate to make borrowing cheaper and encourage investment and spending. This can help to stimulate economic growth.

● REVERSE REPO RATE:

The reverse repo rate is the rate at which the RBI borrows funds from the country's commercial banks.

This aims to absorb the liquidity in the market, which helps restrict the borrowing power of the investors. When faced with high levels of inflation, the RBI increases the reverse repo rate, thus encouraging banks to park more funds with the RBI. Controlling inflation is a crucial goal of central banks. Central banks can use the reverse repo rate to influence the money supply and overall economic liquidity. Reducing liquidity through the reverse repo rate can help control inflation by limiting the money available for spending and borrowing.

The current reverse repo rate is 3.35%. In December 2019, the reverse repo rate was 4.90%. It continued to decrease in 2020 and reached 3.35% in December of the same year. Ever since, the rate has remained the same.

Digital Banking

Online banking means accessing banking features and services via your bank’s website from your computer. You may log into your account to check your balance or pay your electricity bill. You can access additional banking features, such as applying for a loan or credit card, at many banks via your online banking portal.

Digital banking means to digitize all the banking operations and substitute the bank's physical presence with an everlasting online presence, eliminating a consumer's need to visit a branch

Online banking in the U.S. has its roots back in the 1990s. In October 1994, Stanford Federal Credit Union was the first institution to let its customers access banking functions via the new World Wide Web. By the time the 21st century rolled around, it’s estimated that 80% of U.S. banks offered their customers the ability to bank online.

The following are the different types of digital banking:

● UPI Transactions (Unified Payments Interface)-

This allows money transfer from your bank account using a single window directly to the vendor from your mobile. Several bank accounts can be linked with one app. It enables individuals to transfer money instantly between bank accounts using their smartphones. UPI eliminates the need for traditional methods like cheques or net banking processes. UPI allows for the user to transfer the funds instantly between the bank accounts linked to the UPI platform.

Some of the apps allowing UPI services in India are GooglePay, BHIM app, PhonePe, FreeCharge, Cred, etc.

● Mobile Banking-

Mobile banking means using an app to access many of those same banking features via mobile devices such as smartphones or tablets. These apps are proprietary, issued by the bank where you hold your account, and usually use the same login information as your online banking portal. Mobile banking enables clients and users to carry out various transactions, which may vary depending on the institution.

Mobile banking is very convenient in today’s digital age with many banks offering impressive apps. The ability to deposit a check, to pay for merchandise, to transfer money to a friend or to find an ATM instantly are reasons why people choose to use mobile banking. However, establishing a secure connection before logging into a mobile banking app is important or else a client might risk personal information being compromised.

Using a mobile banking application, you can easily access your banking account, check balance, transfer funds, pay bills, deposit checks, etc. Overall, you can access almost all products and services provided by your banking institution. Plus it’s convenient to use, allowing you to check your banking account 24/7, conduct financial transactions or tasks whenever you are connected to the internet.

● ATM (Automated Teller Machine)-

An automated teller machine or ATM cash dispenser can be defined as an electronic banking outlet that enables customers to complete routine transactions without the assistance of a branch representative. These days any person who owns a credit or a debit card can access cash at several ATMs in a hassle-free manner.

ATM machines are a convenient and secure node, allowing many consumers to undertake quick self-service transactions. Modern ATMs provide a strong and substantial payment infrastructure in smaller towns, especially in emerging markets, contributing significantly to financial inclusion. Using an ATM simply involves inserting your bank-issued ATM card, entering your personal identification number (PIN) and following the prompts on the screen to complete your desired transaction.

Firstly, they provide convenient 24/7 access to our bank accounts, allowing us to withdraw cash or perform transactions at any time. This eliminates the need to visit a physical bank branch during its working hours. Additionally, ATMs are often located in various locations, making them easy to access in emergencies or when we are travelling. Furthermore, ATMs have simplified banking procedures, reducing the dependence on human tellers. They allow us to perform routine transactions quickly and efficiently, saving us time and effort.

● Summary of Digital Banking

According to Statista, the digital banking sector will grow continuously over the next five years. This trend reflects the ongoing development and expansion of digital banking services in the foreseeable future.

The following are some of the merits of digital banking:

● Convenience

Digital banking enables consumers to perform banking functions from the comfort of their homes, be it an older individual who is worn out on waiting in lines or a working-class professional who is caught up with work, or a regular individual who would not like to visit the bank's branch to run a single task. It also offers convenience.

● Easily Accessible

Digital banking allows a user to carry out banking work around the clock, with 24*7 availability of access to banking functions.

● Paperless Transactions

Probably the biggest drawback of traditional banking was the excessively placed importance on paper. Banking has become paperless with the advancement of digital banking as a service. A user can sign into their account at any point on schedule to monitor records.

● Automatic Payments

Digital banking allows a user to set up automatic payments for regular service bills like power, gas, telephone, and credit cards. The customer no longer has to make a conscious effort to remember the due dates. The customer can choose alerts on upcoming payments and outstanding dues.

The graph below shows the comparison between the channels used for investment transactions.

The following are some of the demerits of digital banking:

● Downtime

If you rely solely on an online bank, you could be challenged to access your accounts should your bank experience an online or mobile app outage and there’s no branch for you to visit instead.

● Security

There’s always the chance that your username and password could be hacked; however, online banks pursue the same degree of risk-reducing security protections, such as multi-factor authentication, as brick-and-mortar banks do. However, neither system is completely safe, and hacked accounts can result in identity theft due to stolen login credentials.

● Tech Related Service Disruption

If your internet service is delayed or unavailable for a while, it will limit your ability to access accounts online. Similarly, you won't be able to access your banking information over the Internet or a mobile device if the bank's servers crash or become momentarily inaccessible as a result of planned site maintenance.

● Limited Services

You might be able to submit an initial application for a new account, a loan, or a mortgage online, but you will often need to go to a branch to sign documents and provide identification. Similarly to this, even if you may transfer funds to a checking account or debit card to make purchases, you'll need to go to a branch office or an ATM close by if you need cash.

Conclusion – Indian Banking System and Economy at a Large : Future

The imminent growth of 5G internet usage, deeper smartphone penetration, expansion of digital payments, frictionless data-led digital lending, risk-mitigated secure data protection, and accelerating Enhanced Access and Service Excellence (EASE) reforms, climate-conscious sustainable goals and collaboration between banks and FinTechs will enable the next wave of technology-fueled innovation in banking services in India.

The future state of the Indian Banking lies in the modernisation of the core banking system. Introduction of new, better and agile technologies is carving out new paths of growth and optimization. The increased competition, unprecedented situation and the new normal arising out of the pandemic, will prompt the banking system to stay relevant and banking as we know might undergo a revolutionary change with a paradigm shift.

Banking will be more lifestyle oriented and banks will look to extend their core systems to kick-start growth by launching new products, build digital experiences, and augment operational efficiency by leveraging the likes of AI, machine learning and cloud technologies. These would include themes like digital on boarding and quick loan disbursals.

References

Central and commercial banks:

https://www.shiksha.com/online-courses/articles/difference-between-central-bank-and-commercial-bank/

https://testbook.com/key-differences/difference-between-central-bank-and-commercial-banks-in-india#:~:text=The%20main%20difference%20between%20the,customers%20and%20making%20a%20profit.

https://www.investopedia.com/terms/c/commercialbank.asp

https://www.vedantu.com/commerce/functions-of-central-bank

Roles of rbi:

https://www.rbi.org.in/commonperson/English/Scripts/Organisation.aspx

https://www.nextias.com/blog/reserve-bank-of-india-rbi/

http://www.jnpg.org.in/WebDoc/EContent/Company_Account/Functions%20of%20RBI.pdf

Monetary policy tools:

https://cleartax.in/s/cash-reserve-ratio-crr