Module 4

Recent Trends of Banking System in India

Credit Card Policy and Regulation

Basic features of credit cards

1.2.1 The term “credit card” usually/generally refers to a plastic card assigned to a cardholder,
usually with a credit limit, that can be used to purchase goods and services on credit or obtain
cash advances.

1.2.2 Credit cards allow cardholders to pay for purchases made over a period of time, and to
carry a balance from one billing cycle to the next. Credit card purchases normally become
payable after a free credit period, during which no interest or finance charge is imposed. Interest
is charged on the unpaid balance after the payment is due. Cardholders may pay the entire
amount due and save on the interest that would otherwise be charged. Alternatively, they have
the option of paying any amount, as long as it is higher than the minimum amount due, and
carrying forward the balance.

1.2.3 A credit card scheme typically involves the following parties:

• Cardholders - persons who are authorized to use credit cards for the payment of goods and
services;

• Card issuers - institutions which issue credit cards;

• Merchants - entities which agree to accept credit cards for payment of goods and services;

• Merchant acquirers – Banks/NBFCs which enter into agreements with merchants to process
their credit card transactions; and

• Credit card associations - organisations that license card issuers to issue credit cards under
their trademark, e.g. Visa and MasterCard, and provide settlement services for their members
(i.e. card issuers and merchant acquirers).

Credit card schemes normally operate at an international level too, meaning that cardholders
belonging to card issuers in one country can make purchases at the place of business of
merchants in another country.

1.2.5 The focus of this circular is on the operations, risks and controls associated with credit
card schemes of which banks (or their subsidiaries or affiliated companies under their control)
are either the card issuer or the merchant acquirer.

1.3 Types of credit cards

Credit cards can be broadly categorised into two types:

General purpose cards and private label cards: The former are issued under the trademark of
credit card associations (VISA and Mastercard) and accepted by many merchants while the
latter are only accepted by specific retailers (e.g. a departmental store).

Banks in India can undertake credit card business either departmentally or through a subsidiary
company set up for the purpose. They can also undertake domestic credit card business by
entering into tie-up arrangement with one of the banks already having arrangements for issue
of credit cards.

Most of the card issuing banks in India offer general purpose credit cards. These cards are
normally categorised by banks as platinum, gold or classic to differentiate the services offered
on each card and the income eligibility criteria. Banks may, at the request of a cardholder, issue
a supplementary card (also referred to as ‘add-on cards’) to another individual who is usually
an immediate family member of the cardholder. The types of credit cards mentioned above are
illustrative and not exhaustive. Banks may, from time to time, introduce new credit card
products to satisfy customer needs and cater to the changes in market conditions.

Interest rates and other charges

Credit card dues are in the nature of non-priority sector personal loans and as such banks are
free to determine the rate of interest on credit card dues without reference to their BPLR and
regardless of the size in terms of the Master Circular on Interest rates on advances

Further, the banks/NBFCs have to adhere to the following guidelines relating to interest rates
and other charges on credit cards:

a. Card issuers should ensure that there is no delay in dispatching bills and the customer
has sufficient number of days (at least one fortnight) for making payment before the
interest starts getting charged.
b. Card issuers should quote Annualized Percentage Rates (APR) on card products
(separately for retail purchase and for cash advance, if different).
c. Banks/NBFCs should step up their efforts on educating the cardholders of the
implications of paying only ‘the minimum amount due’.
d. he banks /NBFCs should not levy any charge that was not explicitly indicated to the
credit card holder at the time of issue of the card and without getting his / her consent.
e. There should be transparency (without any hidden charges) in issuing credit cards free
of charge during the first year.

Protection of Customer Rights

Customer’s rights in relation to credit card operations primarily relate to personal privacy,
clarity relating to rights and obligations, preservation of customer records, maintaining
confidentiality of customer information and fair practices in debt collection. The card issuing
bank/NBFC would be responsible as the principal for all acts of omission or commission of
their agents (DSAs / DMAs and recovery agents).

Redressal of Grievances

a. Generally, a time limit of 60 (sixty) days may be given to the customers for preferring their
complaints / grievances.
b. The card issuing bank /NBFC should constitute Grievance Redressal machinery within the
bank/NBFC and give wide publicity about it through electronic and print media.

Banks/NBFCs should ensure that their call centre staff are trained adequately to competently
handle all customer complaints.

d. Banks/NBFCs should also have a mechanism to escalate automatically unresolved

complaints from a call center to higher authorities and the details of such mechanism should
be put in public domain through their website.

e The grievance redressal procedure of the bank/NBFC and the time frame fixed for
responesponding to the complaints should be placed on the bank's website.

Credit Policy

Monetary policy refers to the policy of the central bank with regard to the use of monetary
instruments under its control to achieve the goals specified in the Act. The Reserve Bank of
India (RBI) is vested with the responsibility of adopting and implementing monetary policy.
This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934. The
primary objective of monetary policy is to maintain price stability while keeping in mind the
objective of growth. Price stability is a necessary precondition to sustainable growth.

Monetary Policy Framework

The RBI Act explicitly provides empowers the Reserve Bank to operate the monetary policy
framework of the country

• The framework aims at setting the policy (repo) rate based on an assessment of the current
and evolving macroeconomic situation; and modulation of liquidity conditions to anchor
money market rates at or around the repo rate. Repo rate changes transmit through the money
market to the entire the financial system, which, in turn, influences aggregate demand – a key
determinant of inflation and growth.

• Once the repo rate is announced, the operating framework designed by the Reserve Bank
envisages liquidity management on a day-to-day basis through appropriate actions, which aim
at anchoring the operating target– the Weighted Average Call Rate (WACR) – around the repo
rate.

• The operating framework is fine-tuned and revised depending on the evolving financial
market and monetary conditions, while ensuring consistency with the monetary policy

Instruments of Monetary Policy

There are several direct and indirect instruments that are used for implementing monetary
policy.
• Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity
to banks against the collateral of government and other approved securities under the Liquidity
Adjustment Facility (LAF).

• Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on
an overnight basis, from banks against the collateral of eligible government securities under
the LAF.

• Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo
auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected
under fine-tuning variable rate repo auctions of range of tenors. The aim of term repo is to help
develop the inter-bank term money market, which in turn can set market-based benchmarks for
pricing of loans and deposits, and hence improve transmission of monetary policy. The Reserve
Bank also conducts variable interest rate reverse repo auctions, as necessitated under the market
conditions.

• Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can
borrow additional amount of overnight money from the Reserve Bank by dipping into their
Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides
a safety valve against unanticipated liquidity shocks to the banking system.

• Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement
in the weighted average call money rate.

• Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of
exchange or other commercial papers. The Bank Rate is published under Section 49 of the
Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore,
changes automatically as and when the MSF rate changes alongside policy repo rate changes.

• Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain
with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL)
that the Reserve Bank may notify from time to time in the Gazette of India.

• Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in
safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes
in SLR often influence the availability of resources in the banking system for lending to the
private sector.

• Open Market Operations (OMOs): These include both, outright purchase and sale of
government securities, for injection and absorption of durable liquidity, respectively.

MONETARY AND CREDIT POLICY

As part of the Monetary Management, the Reserve Bank of India announces their policies on
a regular basis, which is called as Monetary and Credit Policy Monetary Policy statement
consists of two parts.

Part A cover Monetary Policy and is divided into four sections viz., –

1. Overview of global and domestic macroeconomic developments

2. Outlook and projections for growth, inflation and monetary aggregates

3. Stance of monetary policy and

4. monetary measures.

Part B deals with the developmental and regulatory policies consisting five sections viz.,

(a) Financial Stability (b) Financial Markets (c) Credit Delivery and Financial Inclusion

(d) Regulatory and Supervisory Measures and (e) Institutional Developments

The various aspects of global economy and domestic economy and the significant events which
took place in the past year, are covered. Further the outlook for the future in respect of global
and domestic economies are discussed. The policy also highlights the important risks like
inflation risk, current account deficit and the monetary measures to manage such and other
risks are covered. Added to these, the issues and policy measures relating to financial stability,
financial markets, control measures through regulations and supervision are also covered. The
Policy also indicates the quarterly review period. Various initiatives taken by the Reserve Bank
of India as Regulator and Supervisor in the Indian Banking Scenario are also highlighted. It
also includes the credit delivery and other issues relating to priority sector lending.

The IT initiatives and the related issues are also discussed. The Monetary policy outlines the
various measures taken and expected to be taken by the Reserve Bank of India in their role as
the Monetary Management.

Electronic Payment Services

INTRODUCTION

Over the years, especially n the later part of the 20th century, the Indian Banking Sector has
undergone fast growth and with the advent of technological changes, Indian banks are adopting
to the new environment. The two successive Committees on Computerization (Rangarajan
Committees) were responsible for bank computerization in India.

Over the years led by the initiatives of the Reserve Bank of India, banks in India have witnessed
lot of changes into their banking operations duly supported by IT and communication
revolution. Some important areas where the IT plays important roles are: Funds Transfer
mechanism: ECS, EFT, RTGS, NEFT Clearing House operations: MICR, CTS Innovative on
line e- banking services: Tele banking, Mobile banking, SMS banking, Credit/ Debit Cards,
ATMs, Internet banking, Core Banking Solutions, etc.
Communication Networks in Banking System

As per the recommendations of the Saraf Committee, the Reserve Bank of India has set up a
country wide data communication network for banks linking major centers of the country,
known as INFINET (Indian Financial Network) and this network uses satellite communication
with very small aperture terminals (VSATs) as earth stations. VSAT network is a single closed
user group network for the exclusive use of banks and other financial institutions. The VSATs
are owned by individual banks and the RBI. The hub is owned by the RBI and the Institute for
Development and Research in Banking Technology (IDRBT). Satellite services based on
VSAT technology can establish reliable links to all sites. The central hub monitors and controls
the flow of network traffic.

AUTOMATED CLEARING SYSTEMS

Clearing House Inter-bank Payment System (CHIPS)

This is a clearing system run by New York clearing house. The financial transactions such as
– foreign and domestic trade services, international loans, syndicated loans, foreign exchange
trade settlements, are carried out through CHIPS. The CHIPS have a direct interface with the
SWIFT system.

Clearing House Automated Payment System (CHAPS)- CHAPS is an automated system set up
in UK which ensures immediate settlement of payments.

Clearing House Automated Transfer System (CHATS) - CHATS provide the inter-bank
transfer facilities in Hong Kong. CHATS provide same day inter-bank settlement, instant order
confirmation and enquiry facilities. The integrity of message transmission is carried out
through authentication and encryption techniques.

ELECTRONIC FUND MANAGEMENT

Banking operations over the years and decades have witnessed many changes and have been
adopting from time-to-time new innovations. The technological revolution especially in the
Information and Technology front has changed the functioning of banks. In today’s globalized
competitive business environment banks are trying to have the competitive edge by using the
latest technology to cut down turnaround time, cut costs and increase efficiency. “e Banking”
through many innovative products and services has revolutionized banking Operation.

IT revolution has paved way for banks to implement different systems to handle funds
management in banks. This methodology is collectively recognized as Electronic Fund
Management.

Electronic Clearing System (ECS)

One of the earliest electronic forms of funds transfer is the Electronic Clearing System. ECS
is a retail funds transfer system to effect payments (utility bills, dividends, interest, etc) ECS
helps corporates, government departments, public sector undertakings, utility service providers
to receive and/or pay bulk payments. ECS is divided into ECS (credit) and ECS (debit) ECS –
important aspects/ features On receipt of the required mandate, the funds (payments/ receipts)
can be handled by a bank through ECS.
 ECS (debit) is generally used by utility companies like electricity companies, telephone
companies and other to receive the bill payments directly from bank accounts of their clients.
Instead of payment of utility bills by means of cash or cheque payments, an individual or a
company can make payment through ECS. In case the company has the facility of payment
through ECS, the client can give a mandate to the company to receive the utility bill amount
from his bank account directly. The utility company (service provider) based on the ECS
mandate given by the client, would advise the client’s bank to debit the bill amount to the
client’s account on the due date (or on a any date before the due date as per the client’s request)
and transfer the amount to the company’s own bank account. Similarly, ECS (Credit) can
facilitate payment to various clients like dividend warrants, maturity values of Annuities.

Real Time Gross Settlement (RTGS)

One of the important IT revolutions in Indian Banking Scenario was the implementation of the
Real Time Gross Settlement (RTGS) system by the Reserve Bank of India. With the changing
scenario from manual environment to electronic mode, banks started to use faster, safer and
efficient methods to transfer funds. In this regard, two important and popular electronic funds
transfer systems are Real Time Gross System (RTGS) and National Electronic Funds Transfer
System (NEFT) RTGS is an electronic payment system, where payment instructions are
processed on a ‘continuous’ or ‘REAL TIME’ basis and settled on a ‘GROSS’ or ‘individual’
basis without netting the debits against credits.

In India, RBI introduced this system and the system is functioning well. The payments so
effected are ‘final’ and ‘irrevocable’. The settlement is done in the books of the central bank
(RBI). The RTGS system allows transfer of funds across banks on a real time (immediate)
basis. Each participant bank needs to open a dedicated settlement account for putting through
its RTGS transactions. Not only does it allow transfer of funds, it also reduces the credit risk.
Both customers and banks can transfer funds monies the same day at regular intervals within
the banking hours.

(a) Real Time Gross Settlement helps banks to settle interbank and forex settlements

(b) It also helps banks in handling big ticket funds transfers

(c) Since RTGS it is routed through RBI platform, the credit risk is minimized (this is one of
the main advantages in settlement of funds)

(d) Unlike in case of cheque clearance, the drawer of the cheque cannot enjoy the float time
(the date of issuance of cheque and the date on which it is received in inward clearing and
debited by his banker) However, in the case of RTGS, the remitter’s account is debited first
and then only the funds are transferred

(e) If all relevant details such as the beneficiary’s name, account number, IFSC code of the
receiving branch, name of the beneficiary bank, etc., are correctly furnished it would assist the
remitting bank to effect the transfer quickly

(f) As the name RTGS suggests, the transfer mechanism works on real time and, therefore, the
beneficiary branch/bank should receive the funds immediately. The beneficiary’s branch/bank
should give credit to the beneficiary’s account immediately or latest within 2 hours of receiving
the fund.
National Electronic Funds Transfer (NEFT)

NEFT is a system similar to RTGS with certain differences. RTGS handles big ticket
transactions, whereas NEFT handles smaller size transactions. Most branches are using this
facility to transfer funds in an efficient manner. Once the applicant for the transfer of funds
furnishes full and correct details (correct account details means correct name of the beneficiary,
the correct account number, the branch and bank of the beneficiary, and the correct IFS code,
etc.) funds can be transferred to the beneficiary’s account by the remitting bank. Transfer of
funds through NEFT is safe, quick. It reduces the paper work and is cost effective.

NEFT is an innovative electronic media for effecting transfer of funds. Special features of
NEFT are:

1. NEFT is a funds transfer system which enables a customer of a bank to transfer funds to
another customer of another bank having account with any participating bank

2. NEFT allows both intra and inter-bank funds transfer within a city and across cities

3. Since it is in the form of e transfer, without any physical movement of instruments, funds
can be transferred quickly

4. The beneficiary customer gets funds in his account on the same day or at the earliest on the
next day depending upon the time of settlement

5. Both the originating and destination bank branches should be on NEFT platform

6. The correct details of IFSC, beneficiary’s name, account numbers, etc., should be furnished
to the originating bank.

7. The originating bank branch can keep track of the status of the NEFT transaction.

8. In case for any reason the destination branch is not able to afford credit to the beneficiary’s
account, destination branch/bank have to return the funds to the originating bank within two
hours of completion of the batch through which the transaction was processed.

Indian Financial System Code (IFSC)

IFSC is an alpha-numeric code that identifies a bank-branch participating in the RTGS/NEFT

system. IFSC has 11 digit code and the first four alpha characters represents the bank, the 5th
code is 0 (zero), which is reserved for future use and the last six digits are numeric characters
represents the branch. Correct IFSC code is essential for identifying the beneficiary’s branch
and bank as destination for funds transfers. E.g. Syndicate Bank Cuffe Parade Branch,
Mumbai- SYNB0005087

Automated Teller Machines (ATMs)

ATMs are used as a channel for cash management of individual customers. ATMs can be
accessed by ATM card, debit or credit cards. To have access the customer (the card holder)
needs to use his Personal Identification Number (PIN) issued by his/her banker and access
password. ATMs generally used for cash deposit and withdrawals, they can also be used for
payment of utility bills, funds transfer thereby ATMs serve as a channel for electronic funds
management. Requests for new cheque book and statement of accounts can also be given
through ATMs. White Label ATMs- RBI has vide notifications dated 20th June, 2012,
permitted non-banking entities to set up or start ATMs which are called White Label ATMs
(WLA). From such ATMs customers of any bank will be able to withdraw money, takeout
statement, change PIN etc. These WLAs will not display logo of any bank. However, WLA
operator has been permitted to display advertisements, and offer value added services as per
regulations in force. While WLA operator is entitled to receive a fee from the banks for use of
ATM resources by their customers, WLAs are not permitted to charge Bank customers directly
for use of WLA.

Internet Banking

Internet banking one of the popular e-banking modes has changed the banking operations and
offer virtual banking services to the clients on 24 x 7 basis. It is also called as convenient
banking, since the customer (account holder) can have access to his bank account from
anywhere at any time, through the bank’s web site. The customer is allowed online access to
account details and payment and funds transfer facilities. Net banking services of a bank can
be accessed through a Personal Identification Number (PIN) and access password as in the case
of ATMs. In net banking the advantage for the bank customer is that funds can be transferred
from the client’s bank account to another account with the same bank or another bank through
NEFT/RTGS. Another method of funds transfer facility is online payment of taxes. Bank
customer can pay various taxes like income tax, service tax, etc.; Net banking can be used as a
channel by the customer to pay the utility bills (electricity bills, telephone bills, etc) on line.
Customers can make use of net banking to pay the insurance premiums and similar other
payments.

E-Cheque

Computerization of Clearing of Cheques

Over the years Reserve Bank of India as a facilitator has been playing a vital role in the
implementation of innovative systems, to enable banks not only to function effectively but also
to offer better customer service. RBI is in charge of the clearing house and clearing operations.
It has always taken lead to introduce new systems to speed up clearing process as well to reduce
the turnaround time in clearance of funds. Computerization of clearing operations was the first
major step initiated by RBI, over the years RBI has been upgrading the system with new
changes. To overcome the increasing volume of cheques through the clearing mechanism, RBI
has fully automated the clearing house operations. This is based on the Magnetic Ink Character
Recognition technology; RBI upgraded the clearing functions with new set of MICR cheques.
Under this new system, cheques should have MICR code consisting of 9 digits. Each cheque
would have the unique 9 digit MICR code along with the cheque number.

MICR code consists of 9 digits as:

– First three digits indicates CITY {identical to the first three digit of the postal pin code of the
CITY (For example: in case of Mumbai, it would be 400)}
 – Next three digits represents the Bank and each bank has been given a three digit code called
bank code

– Last three digits denote the branch code Under this MICR system the computer program
would read and sort out the cheques based on the codes, thereby, in quick turnaround time, the
system is able to handle volume

Cheque Truncation System (CTS)

Cheques are being used as a medium for exchange of funds, which play a key role in the funds
management of customers and banks. The efficient cheque clearing system helps in settlement
of receipts and payments. Cheque Truncation is a new system introduced in Indian Banking
Scenario. It is a system of cheque clearance and settlement between banks based on electronic
data and/or images without the need for exchange of physical cheques and negotiable
instruments like demand drafts, pay orders, dividend warrants, etc.

Cheque truncation - Special features:

– Bank customers would get their cheques realized faster

– Quick realization helps in better cash management (receivables/payables)

– In the long run, it would reduce the administrative costs for bank

– Importantly this would assist banks in reconciliation and also reduction in clearing frauds.

Foreign Direct Investment (FDI) in Banking Sector

It refers to Cross-border investment made by a resident in one economy with the objective of
establishing a lasting interest in an enterprise. According to IMF and OECD definitions, the
acquisition of at least ten per cent of the ordinary shares or voting power in a public or private
enterprise by non-resident investors makes it eligible to be categorized as FDI. However, in
India there is no such official guideline for FDI, though FII is defined in SEBI regulations: To
support the economic growth of a nation, on account of inadequate domestic capital, flow of
foreign capital is encouraged through the channel- Foreign Direct Investment. Apart from the
capital funds, the FDI also brings with it, other benefits like technical knowhow, business
expertise and knowledge and other advantages.

FIPB: Functions: The main functions of Foreign Investment Promotion Board are:

(a) Expedite clearance process, (b) periodically review implementation of cleared

proposals, (c) Review general and sectoral policy guidelines, (d) undertake investment
promotion activities.
MUTUAL FUNDS

Mutual Funds play a key role as a financial intermediary in the financial services sector. A
mutual fund pools money from investors and invests in Stocks, Debt and other financial
securities. SEBI Regulations 1993 defines a mutual fund as: “ a fund established in the form of
a trust by a sponsor to raise monies by the trustees through the sale of units to the public, under
one of more schemes, for investing in securities in accordance with these regulations” Role of
Mutual Funds in the Capital Market: Mutual funds assist investors to have access to the capital
markets through various schemes (as explained below). Mutual funds through their network
across the country and also as financial advisors to their clients help the investors to invest in
different schemes. To bring in uniformity as per SEBI’s directives it is mandatory for any
entity/person who markets/sells mutual fund products, to clear the required examinations
conducted by the Association of Mutual Funds in India (AMFI)

Mutual Funds are classified into two broad categories based on the basis of execution.

(i) Open ended and (ii) Close ended.

Apart from the above classification, mutual funds can also be classified into :

Open ended funds: This is one of the popular mutual fund scheme. In this case, the size of the
fund and the period of the fund is not pre fixed. The investors are free to buy and sell any
number of units at any point of time.The main objective of the fund is income generation. The
investors have the freedom of free entry and exit to/from an open ended fund. The units are not
listed on the stock market, however the mutual fund would buy the units based on the Net Asset
Value (NAV) of the units. Advantage to the investor is that the investor gets quick cash when
he sells the units to the mutual fund on any working day.

Close ended funds: Unlike the open ended funds, the corpus (total amount to be collected) and
the duration are predetermined in this scheme. These are available for a parrticular period, and
the investors can buy the units at the face value. Other important features are: (i) The objective
of the fund is capital appreication (ii) The units under this scheme are traded in stock exchanges
(iii) At the time of redemption, the total funds collected under a close ended scheme would be
liquidated and the proceeds are distributed among the unit holders.

Income Funds: The objective of this fund scheme is to distribute income to the investors,
regularly. The fund managers through their investment strategy, aim to provide a return better
than the bank’s fixed deposit interest .

Growth Funds: For long term investors, one of the suitable option is growth funds. The fund
managers aim to achieve capital appreciation through this fund. Regular income, is not
distributed under this fund, like income funds.

Balanced Funds: The features of the balanced funds are the combination of both income and
growth funds. The special feature is that this fund aims at distribution of regular income and
capital appreciation. The fund managers try to achieve.this by balancing the investments
between high growth equity shares as well as fixed income securities like debt instruments (T
Bills, GOI Sec, etc.)
Money Market Funds: An open ended scheme which exclusively invest in Money Market
instruments like Certificate of Deposits, Commercial Papers,T.Bills and similar instruments,
which are higly liquid and safe instruments. .

Tax Savings Schemes: As part of tax planning, investors and income tax payers can invest in
this fund. Depending upon the tax concession based on the provisions of the Income Tax Act,
the investments under this fund attracts lot of investments especially during the period of
January,February and March every year.