Functions of Commercial Banks

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33.1 Introduction
You have studied in the earlier lesson about different types of banks
and their nature. It may be of interest to you now to know about the
various services/functions performed by commercial banks. In this lesson,
you will study about the various services provided by commercial banks
to the business community in particular and the public in general.




33.2 Objectives
After studying this lesson, you will be able to -
l describe the various functions of commercial banks;
l differentiate between primary and secondary functions of
commercial banks;
l classify and discuss the primary functions of modern commercial
banks;
l enumerate the various modes of acceptance of deposits;
l identify various methods of granting loans;
l describe agency and general utility services of modern commercial
banks.



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33.3 Functions of Commercial Banks
The functions of a commercial banks are divided into two categories:
i) Primary functions, and
ii) Secondary functions including agency functions.
i) Primary functions:
The primary functions of a commercial bank include:
a) accepting deposits; and
b) granting loans and advances;
a) Accepting deposits

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The most important activity of a commercial bank is to mobilise
deposits from the public. People who have surplus income and
savings find it convenient to deposit the amounts with banks.
Depending upon the nature of deposits, funds deposited with
bank also earn interest. Thus, deposits with the bank grow along
with the interest earned. If the rate of interest is higher, public
are motivated to deposit more funds with the bank. There is also
safety of funds deposited with the bank.

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b) Grant of loans and advances
The second important function of a commercial bank is to grant
loans and advances. Such loans and advances are given to
members of the public and to the business community at a higher
rate of interest than allowed by banks on various deposit accounts.
The rate of interest charged on loans and advances varies
depending upon the purpose, period and the mode of repayment.
The difference between the rate of interest allowed on deposits
and the rate charged on the Loans is the main source of a bank’s
income.


i) Loans
A loan is granted for a specific time period. Generally,
commercial banks grant short-term loans. But term loans,
Functions of Commercial Banks :: 23
that is, loan for more than a year, may also be granted.
The borrower may withdraw the entire amount in lumpsum
or in instalments. However, interest is charged on the full
amount of loan. Loans are generally granted against the
security of certain assets. A loan may be repaid either in
lumpsum or in instalments.


ii) Advances
An advance is a credit facility provided by the bank to its
customers. It differs from loan in the sense that loans may
be granted for longer period, but advances are normally
granted for a short period of time. Further the purpose of
granting advances is to meet the day to day requirements
of business. The rate of interest charged on advances varies
from bank to bank. Interest is charged only on the amount
withdrawn and not on the sanctioned amount.
Modes of short-term financial assistance
Banks grant short-term financial assistance by way of cash credit,
overdraft and bill discounting.



a) Cash Credit
Cash credit is an arrangement whereby the bank allows the
borrower to draw amounts upto a specified limit. The amount is
credited to the account of the customer. The customer can
withdraw this amount as and when he requires. Interest is charged
on the amount actually withdrawn. Cash Credit is granted as per
agreed terms and conditions with the customers.
b) Overdraft
Overdraft is also a credit facility granted by bank. A customer
who has a current account with the bank is allowed to withdraw
more than the amount of credit balance in his account. It is a
temporary arrangement. Overdraft facility with a specified limit
is allowed either on the security of assets, or on personal security,
or both.



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c) Discounting of Bills
Banks provide short-term finance by discounting bills, that is,
making payment of the amount before the due date of the bills
after deducting a certain rate of discount. The party gets the
funds without waiting for the date of maturity of the bills. In
case any bill is dishonoured on the due date, the bank can recover
the amount from the customer.



ii) Secondary functions
Besides the primary functions of accepting deposits and lending money,
banks perform a number of other functions which are called secondary
functions. These are as follows -
a) Issuing letters of credit, travellers cheques, circular notes etc.
b) Undertaking safe custody of valuables, important documents, and
securities by providing safe deposit vaults or lockers;
c) Providing customers with facilities of foreign exchange.
d) Transferring money from one place to another; and from one
branch to another branch of the bank.
e) Standing guarantee on behalf of its customers, for making
payments for purchase of goods, machinery, vehicles etc.
f) Collecting and supplying business information;
g) Issuing demand drafts and pay orders; and,
h) Providing reports on the credit worthiness of customers.



33.4 Difference between Primary and Secondary
Functions of Commercial Banks
Primary Functions Secondary Functions
1. These are the main activities 1. These are the secondary
of the bank. activities of the bank.
2. These are the main sources These are not the main souof
income of the bank. rces of income of the banks.
Functions of Commercial Banks :: 25


3. These are obligatory on the These are not obligatory on
part of bank to perform. the part of bank to perform.
But generally all commercial
banks perform these
activities.
Intext Questions 33.1
Write ‘T’ against the statements which are true, and ‘F’ against those
which are false.
a) A country cannot make commercial and industrial progress
without a well organised banking system.
b) Loans may be granted only for long period by bank.
c) Primary activity of commercial banks includes accepting deposits
and lending money.
d) Difference of interest allowed to public on deposits and charged
on loan is the main source of income of banks.
e) In case of dishonour of a bill, which was discounted by a bank,
the amount cannot be recovered from the customer.
f) A loan cannot be repaid in lumpsum by the borrower.
g) Primary functions of banks refer to basic activities of banks.
h) Overdraft is not a credit facility granted by bank.
i) Loans are generally granted against the security of certain assets.
33.5 Different modes of Acceptance of Deposits
Banks receive money from the public by way of deposits. The following
types of deposits are usually received by banks:



i) Current deposit
ii) Saving deposit
iii) Fixed deposit
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iv) Recurring deposit
v) Miscellaneous deposits
i) Current Deposit
Also called ‘demand deposit’, current deposit can be withdrawn by the
depositor at any time by cheques. Businessmen generally open current
accounts with banks. Current accounts do not carry any interest as the
amount deposited in these accounts is repayable on demand without
any restriction.
The Reserve bank of India prohibits payment of interest on current
accounts or on deposits upto 14 Days or less except where prior sanction
has been obtained. Banks usually charge a small amount known as
incidental charges on current deposit accounts depending on the number
of transaction.
Savings deposit/Savings Bank Accounts
Savings deposit account is meant for individuals who wish to deposit
small amounts out of their current income. It helps in safe guarding
their future and also earning interest on the savings. A saving account
can be opened with or without cheque book facility. There are
restrictions on the withdrawls from this account. Savings account holders
are also allowed to deposit cheques, drafts, dividend warrants, etc.
drawn in their favour for collection by the bank. To open a savings
account, it is necessary for the depositor to be introduced by a person
having a current or savings account with the same bank.



Fixed deposit
The term ‘Fixed deposit’ means deposit repayable after the expiry of
a specified period. Since it is repayable only after a fixed period of
time, which is to be determined at the time of opening of the account,
it is also known as time deposit. Fixed deposits are most useful for a
commercial bank. Since they are repayable only after a fixed period,
the bank may invest these funds more profitably by lending at higher
rates of interest and for relatively longer periods. The rate of interest
on fixed deposits depends upon the period of deposits. The longer the
period, the higher is the rate of interest offered. The rate of interest to
Functions of Commercial Banks :: 27
be allowed on fixed deposits is governed by rules laid down by the
Reserve Bank of India.

Recurring Deposits
Recurring Deposits are gaining wide popularity these days. Under this
type of deposit, the depositor is required to deposit a fixed amount of
money every month for a specific period of time. Each instalment may
vary from Rs.5/- to Rs.500/- or more per month and the period of
account may vary from 12 months to 10 years. After the completion of
the specified period, the customer gets back all his deposits alongwith
the cumulative interest accrued on the deposits.
Miscellaneous Deposits
Banks have introduced several deposit schemes to attract deposits from
different types of people, like Home Construction deposit scheme,
Sickness Benefit deposit scheme, Children Gift plan, Old age pension
scheme, Mini deposit scheme, etc.


33.6 Different methods of Granting Loans by Bank
The basic function of a commercial bank is to make loans and advances
out of the money which is received from the public by way of deposits.
The loans are particularly granted to businessmen and members of the
public against personal security, gold and silver and other movable and
immovable assets. Commercial bank generally lend money in the
following form:
i) Cash credit
ii) Loans
iii) Bank overdraft, and
iv) Discounting of Bills
i) Cash Credit :
A cash credit is an arrangement whereby the bank agrees to lend money
to the borrower upto a certain limit. The bank puts this amount of
money to the credit of the borrower. The borrower draws the money
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as and when he needs. Interest is charged only on the amount actually
drawn and not on the amount placed to the credit of borrower’s account.
Cash credit is generally granted on a bond of credit or certain other
securities. This a very popular method of lending in our country.
ii) Loans :
A specified amount sanctioned by a bank to the customer is called a
‘loan’. It is granted for a fixed period, say six months, or a year. The
specified amount is put on the credit of the borrower’s account. He can
withdraw this amount in lump sum or can draw cheques against this
sum for any amount. Interest is charged on the full amount even if the
borrower does not utilise it. The rate of interest is lower on loans in
comparison to cash credit. A loan is generally granted against the
security of property or personal security. The loan may be repaid in
lump sum or in instalments. Every bank has its own procedure of
granting loans. Hence a bank is at liberty to grant loan depending on
its own resources.


The loan can be granted as:
a) Demand loan, or
b) Term loan
a) Demand loan
Demand loan is repayable on demand. In other words it is
repayable at short notice. The entire amount of demand loan is
disbursed at one time and the borrower has to pay interest on it.
The borrower can repay the loan either in lumpsum (one time)
or as agreed with the bank. Loans are normally granted by the
bank against tangible securities including securities like N.S.C.,
Kisan Vikas Patra, Life Insurance policies and U.T.I. certificates.
b) Term loans
Medium and long term loans are called ‘Term loans’. Term loans
are granted for more than one year and repayment of such loans
is spread over a longer period. The repayment is generally made
in suitable instalments of fixed amount. These loans are repayable
over a period of 5 years and maximum upto 15 years.
Functions of Commercial Banks :: 29
Term loan is required for the purpose of setting up of new
business activity, renovation, modernisation, expansion/extension
of existing units, purchase of plant and machinery, vehicles, land
for setting up a factory, construction of factory building or
purchase of other immovable assets. These loans are generally
secured against the mortgage of land, plant and machinery,
building and other securities. The normal rate of interest charged
for such loans is generally quite high.
iii) Bank Overdraft
Overdraft facility is more or less similar to cash credit facility. Overdraft
facility is the result of an agreement with the bank by which a current
account holder is allowed to withdraw a specified amount over and
above the credit balance in his/her account. It is a short term facility.

This facility is made available to current account holders who operate
their account through cheques. The customer is permitted to withdraw
the amount as and when he/she needs it and to repay it through deposits
in his account as and when it is convenient to him/her.
Overdraft facility is generally granted by bank on the basis of a written
request by the customer. Some times, banks also insist on either a
promissory note from the borrower or personal security to ensure safety
of funds. Interest is charged on actual amount withdrawn by the
customer. The interest rate on overdraft is higher than that of the rate
on loan.
iv) Discounting of Bills
Apart from granting cash credit, loans and overdraft, banks also grant
financial assistance to customers by discounting bills of exchange. Banks
purchase the bills at face value minus interest at current rate of interest
for the period of the bill. This is known as ‘discounting of bills’. Bills
of exchange are negotiable instruments and enable the debtors to
discharge their obligations towards their creditors. Such bills of exchange
arise out of commercial transactions both in internal trade and external
trade. By discounting these bills before they are due for a nominal
amount, the banks help the business community. Of course, the banks
recover the full amount of these bills from the persons liable to make
payment.



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Intext Questions 33.2
Fill in the blanks with suitable words
(a) There are four important ways of lending money by banks. They
are :
1
2
3
4
(b) Bank loans can be divided into two categories viz _______ and
__________.
(c) When the loan is repayable on demand or at a very short notice,
the loan is known as __________.
(d) If the loan granted by a bank is on long-term or medium-term,
the loan is called _________.
(e) ____________ is a flexible system of lending under which the
borrower has the option to withdraw the funds as and when
required.
(f) _____________ is an agreement with the bank by which a current
account holder is allowed to withdraw over and above the amount
in his account.
(g) In discounting the bills the banks ________ bills of exchange
before they become due for payment.
(h) Due date of bill is also known as date of _________________.
33.7 Agency and General Utility Services provided by
Modern Commercial Banks
You have already learnt that the primary activities of commercial banks
include acceptance of deposits from the public and lending money to
Functions of Commercial Banks :: 31
businessmen and other members of society. Besides these two main
activities, commercial banks also render a number of ancillary services.
These services supplement the main activities of the banks. They are
essentially non-banking in nature and broadly fall under two categories:
i) Agency services, and
ii) General utility services.
i) Agency Services
Agency services are those services which are rendered by commercial
banks as agents of their customers. They include :
a) Collection and payment of cheques and bills on behalf of the
customers;
b) Collection of dividends, interest and rent, etc. on behalf of
customers, if so instructed by them;
c) Purchase and sale of shares and securities on behalf of customers;
d) Payment of rent, interest, insurance premium, subscriptions etc.
on behalf of customers, if so instructed;
e) Acting as a trustee or executor;
f) Acting as agents or correspondents on behalf of customers for
other banks and financial institutions at home and abroad.
ii) General utility services
General utility services are those services which are rendered by
commercial banks not only to the customers but also to the general
public. These are available to the public on payment of a fee or charge.
They include :
a) Issuing letters of credit and travellers’ cheques;
b) Underwriting of shares, debentures, etc.;
c) Safe-keeping of valuables in safe deposit locker;
d) Underwriting loans floated by government and public bodies.
32 :: Business Studies
e) Supplying trade information and statistical data useful to
customers;
f) Acting as a referee regarding the financial status of customers;
g) Undertaking foreign exchange business.
Intext Questions 33.3
Write “T” against the statements which are true and “F” against those
which are false.
(i) Accepting deposits is an essential function of a modern
commercial bank.
(ii) Granting loan to the borrowers is not the main function of a
bank.
(iii) Ancillary services are also known as supplementary functions of
a commercial bank.
(iv) General utility services are called non-banking services.
(v) Services rendered by banks to the general public constitute the
main function of banks.
(vi) Bank charges some amount for the services rendered.
(vii) Bank cannot buy and sell shares and debentures on behalf of
customers.
(viii) Bank stands guarantee against loan raised by its customers from
other financial institutions.
ix) Safe deposit vaults are made available by bank only to fixed
deposit account holders.
(x) Banks generally grant long-term loans to industries.
33.8 What You Have Learnt
In this lesson you have studied various services/functions performed by
commercial banks. Commercial banks render services to the business
community, as well as to the general public.
Functions of Commercial Banks :: 33
The functions of banks are divided into two categories : (i) Primary
functions, (ii) Secondary functions. Primary functions include accepting
deposits and lending money. Loans given by banks are : Short-term
loan and long-term loans. Banks grant short-term loan to its customers
by way of cash credit, overdraft, discounting of bills.
Banks accepts deposits from the public and their customers in the form
of Current deposit, Saving, deposit, fixed deposit, and under other
deposit schemes. Banks grant loans to customers as demand loan and
term loan.
The ancilliary services of banks are agency services and general utility
services. Agency services are rendered as agent of customers, whereas
general utility services are rendered to the general public.
33.9 Terminal Exercise
1. Explain the Primary functions of banks.
2. Explain the Secondary functions of banks.
3. Describe the functions of modern commercial banks.
4. Explain the methods of granting loan by bank.
5. What do you mean by bank overdraft? Explain the procedure for
granting overdraft by bank.
6. Differenciate between loans and advances.
7. Explain cash credit facility allowed by banks to customers.
8. What do you mean by discounting of bills by bank?
9. Explain in brief the agency functions of a commercial bank.
10. Differenciate between Primary and Secondary functions rendered
by bank.
11. Describe briefly the various modes of acceptance of deposits by
banks.
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33.10 Answers to Intext Questions
33.1 True a) c) d) g) i)
False b) e) f) h)
33.2 a) i) loans
ii) Cash credit
iii) Overdraft
iv) Discounting of bills
b) Short-term, Long-term
c) Short-term
d) Term loan
e) Cash credit
f) Overdraft
g) Discount
h) Maturity
33.3 True i) iii) iv) vi) viii)
False ii) v) vii) ix) x)

EVOLUTION OF SBI

The origin of the State Bank of India goes back to the first decade of the nineteenth
century with the establishment of the Bank of Calcutta in Calcutta on 2 June 1806. Three
years later the bank received its charter and was re-designed as the Bank of Bengal (2
January 1809). A unique institution, it was the first joint-stock bank of British India
sponsored by the Government of Bengal. The Bank of Bombay (15 April 1840) and the
Bank of Madras (1 July 1843) followed the Bank of Bengal. These three banks remained
at the apex of modern banking in India till their amalgamation as the Imperial Bank of
India on 27 January 1921.

Primarily Anglo-Indian creations, the three presidency banks came into existence either
as a result of the compulsions of imperial finance or by the felt needs of local European
commerce and were not imposed from outside in an arbitrary manner to modernise
India's economy. Their evolution was, however, shaped by ideas culled from similar
developments in Europe and England, and was influenced by changes occurring in the
structure of both the local trading environment and those in the relations of the Indian
economy to the economy of Europe and the global economic framework.
Bank of Bengal H.O.
Establishment
The establishment of the Bank of Bengal marked the advent of limited liability, jointstock
banking in India. So was the associated innovation in banking, viz. the decision to
allow the Bank of Bengal to issue notes, which would be accepted for payment of public
revenues within a restricted geographical area. This right of note issue was very valuable
not only for the Bank of Bengal but also its two siblings, the Banks of Bombay and
Madras. It meant an accretion to the capital of the banks, a capital on which the
proprietors did not have to pay any interest. The concept of deposit banking was also an
innovation because the practice of accepting money for safekeeping (and in some cases,
even investment on behalf of the clients) by the indigenous bankers had not spread as a
general habit in most parts of India. But, for a long time, and especially upto the time
that the three presidency banks had a right of note issue, bank notes and government
balances made up the bulk of the investible resources of the banks.

The three banks were governed by royal charters, which were revised from time to time.
Each charter provided for a share capital, four-fifth of which were privately subscribed
and the rest owned by the provincial government. The members of the board of
directors, which managed the affairs of each bank, were mostly proprietary directors
representing the large European managing agency houses in India. The rest were
government nominees, invariably civil servants, one of whom was elected as the
president of the board.
Group Photogaph of Central Board (1921)
Business
The business of the banks was initially confined to discounting of bills of exchange or
other negotiable private securities, keeping cash accounts and receiving deposits and
issuing and circulating cash notes. Loans were restricted to Rs.one lakh and the period of
accommodation confined to three months only. The security for such loans was public
securities, commonly called Company's Paper, bullion, treasure, plate, jewels, or goods
'not of a perishable nature' and no interest could be charged beyond a rate of twelve per
cent. Loans against goods like opium, indigo, salt woollens, cotton, cotton piece goods,
mule twist and silk goods were also granted but such finance by way of cash credits
gained momentum only from the third decade of the nineteenth century. All
commodities, including tea, sugar and jute, which began to be financed later, were
either pledged or hypothecated to the bank. Demand promissory notes were signed by
the borrower in favour of the guarantor, which was in turn endorsed to the bank.
Lending against shares of the banks or on the mortgage of houses, land or other real
property was, however, forbidden.
Indians were the principal borrowers against deposit of Company's paper, while the
business of discounts on private as well as salary bills was almost the exclusive
monopoly of individuals Europeans and their partnership firms. But the main function of
the three banks, as far as the government was concerned, was to help the latter raise
loans from time to time and also provide a degree of stability to the prices of
government securities.
Old Bank of Bengal
Major change in the conditions
A major change in the conditions of operation of the Banks of Bengal, Bombay and
Madras occurred after 1860. With the passing of the Paper Currency Act of 1861, the
right of note issue of the presidency banks was abolished and the Government of India
assumed from 1 March 1862 the sole power of issuing paper currency within British
India. The task of management and circulation of the new currency notes was conferred
on the presidency banks and the Government undertook to transfer the Treasury
balances to the banks at places where the banks would open branches. None of the
three banks had till then any branches (except the sole attempt and that too a shortlived
one by the Bank of Bengal at Mirzapore in 1839) although the charters had given
them such authority. But as soon as the three presidency bands were assured of the free
use of government Treasury balances at places where they would open branches, they
embarked on branch expansion at a rapid pace. By 1876, the branches, agencies and
sub agencies of the three presidency banks covered most of the major parts and many
of the inland trade centres in India. While the Bank of Bengal had eighteen branches
including its head office, seasonal branches and sub agencies, the Banks of Bombay and
Madras had fifteen each.
Bank of Madras Note Dated 1861 for Rs.10
Presidency Banks Act
The presidency Banks Act, which came into operation on 1 May 1876, brought the three
presidency banks under a common statute with similar restrictions on business. The
proprietary connection of the Government was, however, terminated, though the banks
continued to hold charge of the public debt offices in the three presidency towns, and the
custody of a part of the government balances. The Act also stipulated the creation of
Reserve Treasuries at Calcutta, Bombay and Madras into which sums above the specified
minimum balances promised to the presidency banks at only their head offices were to
be lodged. The Government could lend to the presidency banks from such Reserve
Treasuries but the latter could look upon them more as a favour than as a right.
Bank of Madras
The decision of the Government to keep the surplus balances in Reserve Treasuries
outside the normal control of the presidency banks and the connected decision not to
guarantee minimum government balances at new places where branches were to be
opened effectively checked the growth of new branches after 1876. The pace of
expansion witnessed in the previous decade fell sharply although, in the case of the Bank
of Madras, it continued on a modest scale as the profits of that bank were mainly derived
from trade dispersed among a number of port towns and inland centres of the
presidency.

India witnessed rapid commercialisation in the last quarter of the nineteenth century as
its railway network expanded to cover all the major regions of the country. New
irrigation networks in Madras, Punjab and Sind accelerated the process of conversion of
subsistence crops into cash crops, a portion of which found its way into the foreign
markets. Tea and coffee plantations transformed large areas of the eastern Terais, the
hills of Assam and the Nilgiris into regions of estate agriculture par excellence. All these
resulted in the expansion of India's international trade more than six-fold. The three
presidency banks were both beneficiaries and promoters of this commercialisation
process as they became involved in the financing of practically every trading,
manufacturing and mining activity in the sub-continent. While the Banks of Bengal and
Bombay were engaged in the financing of large modern manufacturing industries, the
Bank of Madras went into the financing of large modern manufacturing industries, the
Bank of Madras went into the financing of small-scale industries in a way which had no
parallel elsewhere. But the three banks were rigorously excluded from any business
involving foreign exchange. Not only was such business considered risky for these banks,
which held government deposits, it was also feared that these banks enjoying
government patronage would offer unfair competition to the exchange banks which had
by then arrived in India. This exclusion continued till the creation of the Reserve Bank of
India in 1935.
Bank of Bombay
Presidency Banks of Bengal
The presidency Banks of Bengal, Bombay and Madras with their 70 branches were
merged in 1921 to form the Imperial Bank of India. The triad had been transformed into
a monolith and a giant among Indian commercial banks had emerged. The new bank
took on the triple role of a commercial bank, a banker's bank and a banker to the
government.

But this creation was preceded by years of deliberations on the need for a 'State Bank of
India'. What eventually emerged was a 'half-way house' combining the functions of a
commercial bank and a quasi-central bank.
The establishment of the Reserve Bank of India as the central bank of the country in
1935 ended the quasi-central banking role of the Imperial Bank. The latter ceased to be
bankers to the Government of India and instead became agent of the Reserve Bank for
the transaction of government business at centres at which the central bank was not
established. But it continued to maintain currency chests and small coin depots and
operate the remittance facilities scheme for other banks and the public on terms
stipulated by the Reserve Bank. It also acted as a bankers' bank by holding their surplus
cash and granting them advances against authorised securities. The management of the
bank clearing houses also continued with it at many places where the Reserve Bank did
not have offices. The bank was also the biggest tenderer at the Treasury bill auctions
conducted by the Reserve Bank on behalf of the Government.
The establishment of the Reserve Bank simultaneously saw important amendments
being made to the constitution of the Imperial Bank converting it into a purely
commercial bank. The earlier restrictions on its business were removed and the bank
was permitted to undertake foreign exchange business and executor and trustee
business for the first time.
Imperial Bank
The Imperial Bank during the three and a half decades of its existence recorded an
impressive growth in terms of offices, reserves, deposits, investments and advances, the
increases in some cases amounting to more than six-fold. The financial status and
security inherited from its forerunners no doubt provided a firm and durable platform.
But the lofty traditions of banking which the Imperial Bank consistently maintained and
the high standard of integrity it observed in its operations inspired confidence in its
depositors that no other bank in India could perhaps then equal. All these enabled the
Imperial Bank to acquire a pre-eminent position in the Indian banking industry and also
secure a vital place in the country's economic life.
Stamp of Imperial Bank of India
When India attained freedom, the Imperial Bank had a capital base (including reserves)
of Rs.11.85 crores, deposits and advances of Rs.275.14 crores and Rs.72.94 crores
respectively and a network of 172 branches and more than 200 sub offices extending all
over the country.
First Five Year Plan
In 1951, when the First Five Year Plan was launched, the development of rural India was
given the highest priority. The commercial banks of the country including the Imperial
Bank of India had till then confined their operations to the urban sector and were not
equipped to respond to the emergent needs of economic regeneration of the rural areas.
In order, therefore, to serve the economy in general and the rural sector in particular,
the All India Rural Credit Survey Committee recommended the creation of a statepartnered
and state-sponsored bank by taking over the Imperial Bank of India, and
integrating with it, the former state-owned or state-associate banks. An act was
accordingly passed in Parliament in May 1955 and the State Bank of India was
constituted on 1 July 1955. More than a quarter of the resources of the Indian banking
system thus passed under the direct control of the State. Later, the State Bank of India
(Subsidiary Banks) Act was passed in 1959, enabling the State Bank of India to take
over eight former State-associated banks as its subsidiaries (later named Associates).
The State Bank of India was thus born with a new sense of social purpose aided by the
480 offices comprising branches, sub offices and three Local Head Offices inherited from
the Imperial Bank. The concept of banking as mere repositories of the community's
savings and lenders to creditworthy parties was soon to give way to the concept of
purposeful banking subserving the growing and diversified financial needs of planned
economic development. The State Bank of India was destined to act as the pacesetter in
this respect and lead the Indian banking system into the exciting field of national
development.

Money Laundering

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Facets of Money Laundering

Introduction
Significant advancements in trade & commerce, information technology, economic and
social sectors around the world have expanded the frontiers of financial transactions in
several ways. However, the integrity of such financial institutions is threatening
worldwide with the money being laundered relating to terror financing transactions under
the guise of trade.
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According to an estimate of International Monetary Fund (IMF) the aggregate size of
money laundered every year in the world could be somewhere between two and five
percent of the world’s Gross Domestic Product (GDP). Money laundering is becoming
an imminent threat to financial security around the world because of its serious effects
on the economic, social and political factors of the countries. It affects demand for
money, exchange, interest rate volatility, and heightened risks to asset quality havocs on
the world economy and this need to be tackled.


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Money laundering and its Process
Money laundering is the process of concealing the illegal source of dirty money and
converting into legitimate funds. The money changes its appearance and difficult to
trace out the source. The source of generating may be from drug trafficking, terrorism,
smuggling, extortion etc. It is also called as the ‘fruits of crime’.

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PLACEMENT
Financial institions
(Money Integrates into
the Financial System)
INTEGRATION
Financial institions (Money
Exchange Houses,
Commodities/Precious Metals,
like Gold, Platinum
Securities Brokers, etc.,)
LAYERING
Financial institions (large
volume of transactions,
transfer between accounts
in different locations
across the globe), offshore
bank etc.,
ILLICIT ACTIVITIES
Drug Trafficking, Fraud,
Extortion, Pornography,
Smuggling of gold, diamonds
etc.,

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Who will come across the suspicious Transactions?
Financial entities, Includes banks, credit societies, trusts and lending
Institutions/companies and agents of the such institutions who accept deposit
liabilities;
Life insurance companies, brokers or agents;
Securities dealers, portfolio managers and investment bankers, and other
middleman in Securities markets.
Forex Dealers: Persons who are engaged in the business of foreign exchange;
Money services businesses, Which includes alternative remittance systems,
popularly known as Hawala, Hundi, Chitti, etc.
Agents, Who are selling National Saving Certificates, money orders and other
Financial Instruments etc.,
Chartered Accountants while carrying out certain activities on behalf of their
clients

Real estate, brokers or sales representatives of real estate when they carrying
out certain activities on behalf of their clients;
The process of money laundering involves disguising the sources of money or assets
derived from criminal activity. The techniques of laundering funds vary considerably and
quite often ticklish. However, there are generally three stages in the process, which are
briefly as under –
Placement: The proceeds of crime are diverted into the financial system. The form of
money is changed or converted. This mechanism usually involves the conversion of
currency into some other form, or the physical movement of the currency. In total, the
form of the money i.e., cash is deposited in multiple transactions into bank accounts.
Layering: At this stage, launderer moves the funds in anticipation to find an adequate
financial or business infrastructure, offshore transferring, transfers involving large
volume of funds between different locations across the globe. It also involves creating
complex layers of financial transactions to disguise the audit trail and the source and
ownership of funds (e.g., the purchasing and selling of stocks, commodities or real
estate etc.,)

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Integration: In this layer the launderer finds a beneficial mode of investment and makes
his dirty money to appear legitimate. He may invest in financial markets, real estate and
other commercial/industrial assets. Hence, the laundered funds are integrated into the
mainstream economy and it is difficult to trace out source of money.

Tools of money laundering
Smurfing: It is used as a tool by money launderer. It involves multiple deposits of lowvalue
monetary instruments purchased from banks or financial institutions with proceeds
of crime. It may be in several forms like, multiple deposits of cash or monetary
instruments in amounts specifically below the ceiling amount (it is Rs.50, 000 in India).
It can be done by one or more persons by making deposits into one or more accounts
during several visits to bank. Some times, it involves, deposit of multiple monetary
instruments into accounts with different financial institutions.
Structuring
It is through multiple cash deposits or withdrawals at amounts below than ceiling
amount. Both structuring and smurfing are similar types of suspicious activity, which may
result in money laundering.

E-Banking/Cyber Banking Many banks have started providing their banking services
on net by taking advantage of the global reach of the Internet and World Wide Web.
Cyber banking is vulnerable to money laundering because it facilitates fast movement of
funds across the globe within a short span of time and anonymity of user.


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Money laundering in Insurance
Insurance is another mode used in different ways by money launderers. In this regard,
International Association of Insurance Supervisors has issued guidance paper on Anti-
Money laundering and Combating the financing of terrorism. Accordingly, insurer should
assess the customer prior to establishment of a business relationship. It has clearly
specified factors to be considered while issuing the policy and how to investigate. Some
of the important factors are –
¨ Type and background of customer and/or beneficial owner
¨ The customer’s and/or beneficial owner’s geographical base
¨ The geographical sphere of the activities of the customer and/or beneficial owner

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¨ The nature of the activities
¨ Means of payment as well as the type of payment (cash, wire transfer, etc.,)
¨ The source of funds
¨ The source of wealth
¨ The frequency and scale of activity
¨ The type and complexity of the business relationship
¨ Whether or not payments will be made to third parties
¨ Whether a business relationship is dormant
¨ Any bearer arrangements

International Initiatives in Anti-money laundering
Deception is the heart of money laundering. Laundered funds find their way into
legitimate trade and commerce. It becomes difficult to carry the business in legal way
for an honest businessman due to competition by a money launderer who has unlimited
cash resources from undisclosed source. With these and other factors money
laundering is considered as a crime and the United States became first country to enact
law as the Money Laundering Control Act, 1986. Subsequently, the international
community also felt the need for curbing transactions resulting money laundering.

The International Criminal Police Organisation (INTERPOL): An International
organisation having 168 member countries headquartered at France, functioning as a
means for exchanging information about crime and criminals. This agency is
coordinating through National Central Bureau of all member countries (for example CBI
in India) around the world. INTERPOL is continuously monitoring and taking aggressive
steps towards international crimes money laundering and drug trafficking, etc.,
developing and implementing model legislation, providing training and other technical
inputs to member countries.

United Nations: The United Nations Narcotics Convention of 1988, popularly known as
Vienna Convention, made the member signatories to make money laundering as
criminal offence, and an extraditable. It also ensures co-operation and greatest
assistance amongst member countries in investigations, prosecutions, and judicial
proceedings.
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British Commonwealth: The member countries have set up a “Common Wealth
Scheme for Mutual Assistance in Criminal Matters”, for tackling international money
laundering activities. Each members are assisting each other in criminal investigations,
to include “identifying, locating, and assessing the value of, property believed to have
been derived or obtained, directly or indirectly, from, or to have been used in, or in
connection with, the commission of an offence and believed to be within the requested
country”.

Financial Action Task Force
It is an international organization formed with the initiatives of G-7 countries in July 1989
at Paris. The Task force continuously monitors its members' progress in implementing
necessary measures, reviews money laundering and terrorist financing techniques and
counter-measures, and promotes the adoption and implementation of appropriate
measures globally. It has also released a series of task reports recommending changes
in legislation on criminal law, banking and international cooperation.
Accordingly, FATAF is active in its aim of curbing the money laundering activities and
accepted to the working definition of money laundering as -
¨ The conversion or transfer of property, knowing it is derived from a criminal
offence, for the purpose of concealing or disguising its illicit origin or of assisting
any person who is involved in the commission of the crime to evade the legal
consequences of his actions,
¨ The concealment or disguising of the true nature, source, location, disposition,
movement, rights with respect to, or ownership of property knowing that it is
derived from a criminal offence,
¨ The acquisition, possession or use of property, knowing at the time of its receipt
that it was derived from a criminal offence or from participation in a crime.
Asia / Pacific Group on Money Laundering (APG)
It ensures the adoption, implementation and enforcement of internationally accepted
anti-money laundering and counter-terrorist financing standards as set out in the FATF
Forty Recommendations and FATF Eight Special Recommendations. It is assisting
countries and territories of the region in enacting laws to deal with the proceeds of crime,
mutual legal assistance, confiscation, forfeiture and extradition; providing guidance in
setting up systems for reporting and investigating suspicious transactions and helping in
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the establishment of financial intelligence units. The APG also enables regional factors
to be taken into account in the implementation of anti-money laundering measures. The
APG also expanded its scope of functions to counter terrorist financing after the events
of 11 September 2001.
The Financial Crimes Enforcement Network (FinCEN)
It is a network formed in 1990 and acts as a means of bringing people and information
together to fight the complex problem of money laundering. It has worked to maximize
information sharing among law enforcement agencies and its other partners in the
regulatory and financial communities. Through cooperation and partnerships, FinCEN's
network approach encourages cost-effective and efficient measures to combat money
laundering domestically and internationally.
The mission is to support law enforcement investigative efforts and foster interagency
and global cooperation against domestic and international financial crimes; and to
provide U.S. policy makers with strategic analyses of domestic and worldwide money
laundering developments, trends and patterns. FinCEN works toward those ends
through information collection, analysis and sharing, as well as technological assistance
and innovative, cost-effective implementation of the Bank Secrecy Act and other
Treasury authorities.
Software solutions
Recently many software development enterprises have come out with innovative
banking and financial solutions towards Anti-money laundering and it can be useful to
Retail Banks, Commercial Banks, Investment Banks, Brokers & Trading Organisations
and Insurance Firms etc., This solution pro-actively monitor all transaction activities
across the organisation and effectively detects money laundering activities and terrorist
financing. The system generates all statutory reports and provides for generation of
suspicious activity reports. It also captures customer details, stores compliance rules,
monitors transactions and flags any violation of transactions against customer profile
and compliance rules.

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Indian Initiatives
With the intention of protecting our society from the globally recognized and, growing
problem of money laundering, the Central Government moved the Prevention of Moneylaundering
Bill in the Parliament on 29th October 1999. After incorporating several
suggestions both Rajaya Sabha and Lok Sabha passed the Bill in the winter session of
the Parliament in 2002. Further, the Government recently amended certain provisions of
this Act.

Recent changes in the Amended legislation 2005
· Definition of Investigation has been extended. Now investigation
includes, investigations conducted by the Director or any authority
authorised by the Central Government.
· Chairman and members of existing Appellate Tribunal under any
other Act shall be appointed as such under this Act.
· Police officer has to get authorisation by the Central Government for
investigating offences under this Act.

Vistas for CAs
Legislation on Anti-money laundering has opened wide professional opportunities to the
profession of Chartered Accountancy.
¨ Development of Accounting & Auditing Standards: Guidance notes and
Standards can be set and can be made compulsory to follow while undertaking
auditing of clients books of accounts. A chartered accountant who audits the books
of accounts of a client may come across the several transactions which may
directly/indirectly reflects money-laundering practices. He is also under professional
obligation to report such activities in his audit report and to concerned authorities.
¨ Monitoring Mechanism: As a profession of great importance on financial
sovereignty and integrity, research studies can be enunciated to know and assess
the new methods of deployment of illegal funds by launderer. It can also assist
enforcement directorate in framing regulations to curb financial crimes of the nation.
¨ Enforcement Directorate: It should contain efficient staff with sufficient knowledge
on insurance, banking, securities market, foreign exchange etc., Here, a qualified
chartered accountant who is adept in the above filed of knowledge shall be a right
person for this right job. He can also undertake an Independent investigation under
this authority.

¨ Adjudicating Authority: There is no doubt that a CA excels in the filed of finance,
accountancy, etc., Hence, he shall be having an advantage over others in becoming
a member to the adjudicating authorities. [Under section 6(3) of the Prevention of
Money-laundering Act, 2002.]
¨ Member to Appellate Tribunal Act specifically provides an opportunity to a
practicing Chartered Accountant in becoming a member to ‘Appellate Tribunal’,
which hears appeals against the orders of the Adjudicating Authority and authorities.
[Under section 28(2) of the Prevention of Money-laundering Act, 2002.]

¨ Legal representation A person preferring an appeal to the Appellate Tribunal [under
section 39(1) of the Prevention of Money-laundering Act, 2002] may appoint a
representative of his choice to present his case before the Appellate Tribunal. Here,
a qualified Chartered Accountant, who is an authoritative in finance, accounting,
taxation and other matters shall be in better position to appreciate the client’s case
before the Tribunal.
Conclusion
Money laundering is serious threat to global financial system and good governance. It is
also boosting international crimes and terrorist activities. In this regard, most of the
governments have already enacted statute to combat money-laundering activities. In
this regard, the effort of the Indian Government in enacting the Prevention of Money
Laundering Act 2002 is most timely, appropriate and appreciable.
International developments
Sl.
No.
Countries Statue
1. USA ¨ The Money Laundering Act, 1986
¨ The Bank Secrecy Act
¨ USA PATRIOT Act
¨ Canadian Proceeds of Crime
(Money Laundering) and Terrorist
Financing Act

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¨ Office of Foreign Assets Control
(OGAC) regulations
¨ Financial Action Task Force of
South America (GAFISUD)
2. Caribbean ¨ Caribbean Financial Action Task
Force (CFATF)
3. Europe ¨ First EU Money Laundering
Directive (1991)
¨ Second EU Money Laundering
Directive (2001)
4. UK ¨ Proceeds of Crime Act 2002 (PoCa)
¨ Terrorism Act 2000
¨ Financial Services Authority (FSA)’s
Handbook of rules and guidance
(20001)
¨ Joint Money Laundering Steering
Group (JMLSG) Guidance
5. Asia ¨ Asia Pacific Group on Money
Laundering (APG)
Dr. P.T. Giridharan
Joint Director &
Secretary, Committee on Financial Markets &
Investors’ Protection
A.N.Vijaya Kumar


Education Officer