Banking Notes

Anti-money laundering (AML)

Money laundering is the process of disguising illegal sources of money so that it looks like it
came from legal sources. It is the transfer of illegally obtained money or investments
through an outside party, to conceal the true source. Money laundering can have many
negative consequences for a country’s macroeconomic performance, can impose welfare
losses, and may also have negative cross-border externalities. It can distort allocation of
economic resources and distribution of wealth. It is costly as well as difficult to detect and
eradicate. Some consequences of the economic impact of money laundering could be:

 Impaired banking system soundness

 Potentially large fiscal liabilities
 Reduced ability to attract foreign investment
 Increased volatility of international capital flows and exchange rates
 Difficulty in national tax collection and law enforcement.

International Standards to deal with Money Laundering and

Terrorism Financing
The World Bank and the IMF have been working closely since 2001 with the Financial Action
Task Force on Money Laundering (FATF), the standard setting body in this area, to develop a
methodology for assessing the observance of international standards on the legal,
institutional, and operational framework for anti-money-laundering (AML) and combating
financing of terrorism (CFT). The FATF standards complement resolutions that promote
international cooperation in preventing and containing drug trafficking, organised crime,
corruption, and efforts to finance terrorism.

In addition, all financial supervisory standards have core principles to enhance know-your-
customer (KYC) rules, suspicious transactions reporting, and other due diligence
requirements that help to support AML-CFT (Centre of Financial Technologies) regimes.

The Basel Committee Guidelines

The Basel Committee has issued three documents covering money laundering issues:

1. Statement on Prevention of Criminal use of the Banking System for the purpose of
Money Laundering- This statement contains four principles that should be used by
banking institutions:
 Proper customer identification.
 High ethical standards and compliance with laws and regulations.
 Cooperation with law enforcement authorities.

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  Policies and procedures to be used to adhere to the statement.

2. Core principles for effective Banking Supervision- These principles set out a
comprehensive blueprint for supervisory issues, which cover a wide range of topics.
Core Principle 15 deals with money laundering by stipulating that bank supervisors
must determine that banks have adequate policies and procedures in place,
including KYC norms.
3. Customer due Diligence for Banks- This provides extensive guidance on appropriate
standards for banks to use in identifying their customers. The paper was issued in
response to a number of deficiencies on the basis of the KYC procedures. It helps to
protect banks in terms of safety and soundness.

IAIS Guidelines

This is similar to the Basel Committee’s statement on prevention. It contains four

principles that should be followed by insurance entities.

 Comply with anti-money laundering laws.

 Have KYC procedures in place.
 Cooperate with all law enforcement authorities.
 Have internal AML policies, procedures, and training programs for employees.

IOSCO Guidelines

IOSCO proposes seven specific areas for securities regulators in different countries to
consider while establishing requirements for firms under their jurisdiction.

1. The extent of customer identifying information with a view toward enhancing

the ability of authorities to identify and prosecute money launderers.
2. The adequacy of record-keeping requirements to reconstruct financial
transactions.
3. Whether an appropriate manner is used to address the reporting of suspicious
transactions.
4. What procedures are in place to prevent criminals from obtaining control of
securities businesses and to share information with foreign counterparts.
5. Whether means are appropriate for monitoring compliance procedures
designed to deter and detect money laundering.
6. The use of cash and equivalents in securities transactions, including
documentation to reconstruct transactions.
7. Whether means are appropriate to share information to combat money
laundering.

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Why KYC principle is made necessary?

 To enable proper identification of depositors and other customers.

 To help institute systems and procedures that would enable prevention of
financial frauds, identification of money laundering and other suspicious and
anti-social activities.
 To enable monitoring large value cash transactions and foreign currency
transactions.

Why is introduction necessary?

To gain protection for the banker under Section 131 of the NI Act.

 To enable proper identification of the person opening an account, and ensure

that the customer can be traced later if required.
 To guard against accounts being opened by socially undesirable persons or in
fictitious names to deposit unaccounted money.

Proper Introduction

 An account should be opened only after the meeting between the banker and
the prospective customer.
 The prospective depositor has to be ‘introduced’ by an existing account holder,
or a respectable member of the local community, who is a customer or well
known to the bank. The introducer should be the customer of the bank for at
least 6 months.
 The bank should take steps to ascertain the identity of the depositor by ways
such as obtaining recent photographs, specimen signatures, address and identity
proofs, PAN/GIR number etc.
 If in case the introducer is not able to be physically present to introduce the
account, a confirmation should be obtained in writing.

Nomination Facility for Deposit Accounts

Legal status of the Nominee

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The nominee cannot become the absolute owner of the amount received by him. The
law of succession has to ultimately prevail. Other points to be remembered are:

 A single depositor or many depositors (in the case joint accounts) together, can
nominate a person to whom, in the event of death of the deposit customers, the
balance in the deposit account may be paid. The nominee’s right to receive
these balances arises only after the death of all the depositors.
 Only individuals can be nominees. This implies that organizational bodies such as
associations, trusts, or their office bearers cannot be designated nominees.
 The nominee has the right to receive the deposit amount to the exclusion of all
other interested persons. The nominee can also request the bank to close a term
deposit before maturity.
 If the nominee is a minor, the depositors can name any person to receive the
deposit amount in the event of the depositor’s death while the nominee
continues to be a minor.
 The nomination can be varied or cancelled by the depositor/s at any time. In the
case of a joint account, all depositors should agree in writing to the change in
nomination.
 Once it makes payment to the designated nominee after due diligence, the bank
is fully discharged from its liability in respect of the deposit. Such payment shall
not be bound by any claim made by a person other than the nominee.
 Mere renewal of the deposit does not cancel nomination or any variation in the
nomination.
 Nomination facility is available to all types of deposit accounts irrespective of
the nomenclatures used by different banks.
 If the customer prefers not to nominate, the fact should be recorded.

PRUDENTIAL NORMS

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Prudential Norms for Asset Classification, Income Recognition and
Provisioning

Asset Classification
An asset including leased asset becomes non-performing when it ceases to generate income
for the bank. An NPA is a loan or an advance where

 Interest/Installment remain overdue for a period more than 90 days in case of term
loans
 Account remains “out of order” in respect of an overdraft/cash credit (OD/CC)
 Loan granted for short duration crops will be treated as NPA if amount not repaid for
2 crop seasons
 Amount of liquidity facility remains outstanding for a period exceeding 90 days in a
securitization transaction

Banks should classify an asset as NPA only if interest charged during any quarter is not fully
serviced within 90 days of quarter.

Income Recognition

 Policy
Policy to be objective and based on record of recovery. Income from NPAs to be
booked only when it is actually received (not accrual)

 Reversal of Income
The finance charge component of finance income [as defined in ‘AS 19 - Leases’
issued by the Council of the Institute of Chartered Accountants of India (ICAI)] on the
leased asset which has accrued and was credited to income account before the asset
became non-performing, and remaining unrealised, should be reversed or provided
for in the current accounting period. If any advance becomes NPA as at the close of
any year, interest accrued and credited to income account in the corresponding
previous year, should be reversed or provided for if the same is not realised. Fees,
commission and similar income that have accrued should cease to accrue in the
current period and should be reversed or provided for with respect to past periods, if
uncollected.

 Leased Assets
Unrealized finance charge component of finance income on the leased asset,
accrued and credited to income account before the asset became non-performing
should be reversed or provided for in the current accounting period.

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  Appropriation of Recovery in NPAs
Interest realized on NPAs may be taken to income account provided the credits in
the accounts towards interest are not out of fresh/additional credit facilities
sanctioned to the borrower.

Asset Classification
 Classification is only for the purpose of computing the amount of provision that
should be made with respect to bank advances and certainly not for the purpose of
presentation of advances in the banks balance sheet.

Sub-standard Assets - which has remained NPA for a period less than or equal to
12 months
Doubtful Assets - has remained in the sub-standard category for a period of 12
months
Loss Assets - loss has been identified by the bank or internal or external auditors
or the RBI inspection but the amount has not been written off wholly.

Provisioning Norms

 Adequate provisioning has to be made for NPAs and are to be classified in the
following terms
- Loss Assets
Loss assets should be written off. If loss assets are permitted to remain in the
books for any reason, 100 percent of the outstanding should be provided for.
 Provision on Doubtful assets
- 100 percent of the extent to which the advance is not covered by the realisable
value of the security
- In regard to the secured portion, provision may be made on, at the rates ranging
from 20 percent to 100 percent of the secured portion depending upon the
period for which the asset has remained doubtful
For 1 year – 20%
For 1-3 years – 30%
For >3 years – 100%
 Provision on sub standard assets
- A general provision of 10 percent on total outstanding should be made
- The ‘unsecured exposures’ which are identified as ‘substandard’ would attract
additional provision of 10 per cent.
- The provisioning requirement for unsecured ‘doubtful’ assets is 100 per cent.

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 - Unsecured exposure is defined as an exposure where the realizable value of the
security, as assessed by the bank is not more than 10 percent
 Provision on Standard Assets
- The banks should make a general provision of a minimum of 0.40 percent to 1
percent on standard assets on global loan portfolio basis
- However, provisions for certain sectors like agriculture and SMEs are to be
0.25%.
 Floating Provisions
- Internal policies approved by the Banks’ Board would determine the level of
floating provisions. Such provisions will have to be separately held for ‘advances’
and ‘investments’ and would be used only under ‘extra-ordinary’ circumstances,
as dictated in the policy and after approval from RBI.
 Writing-off NPAs
- Provisions made for NPAs are not eligible for tax deduction. However, tax
benefits can be claimed for writing off advances.

ELECTRONIC BANKING
With the introduction of computers in Indian banks and with the advent of ATMs the
banking services are provided across the banks. Customers need not necessarily visit the
branches to do the banking transactions, when the banks provide them with tele- banking
or remote banking facility. This type of banking is called electronic banking and the concept
is becoming popular with individuals as well as corporate entities in India.

Anytime Banking
ATMS have eliminated the time limitations of customer service and offer a host of banking
services, including deposits, withdrawals, requisitions and transfers. The customer need not
be concerned much about the security as most ATMs locations have guards or alternatively
are located in lobbies, access to which is electronically controlled by means of customer’s
ATM card. Besides, access to the account is through a PIN which is strictly supposed to be
known only to the cardholder.

Anywhere Banking
With the introduction of ATMS and tele-banking, financial details can be accessed from
remote locations and basic transactions can be effected even outside the bank. Interstation
connectivity of ATMS has also facilitated withdrawals from other stations, a service that is
particularly useful for frequent travellers. The facility of using credit cards on ATMs is also
available and more recently mutual agreements between banks are made for allowing the

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use of any bank’s ATM cards on other bank’s ATMs. With the implementation of Rangarajan
committee’s report, Government approval to set up ATMs at non branch locations such as
airports, shopping malls and office complexes has revolutionised banking in the Indian
context.

Home banking (Corporate)

Today, banking customers are more affluent and technically sophisticated than before. With
less and less time available to conduct routine banking business, more and more of them
have become comfortable with the idea of using machines for a wide range of banking
services.

Corporate banking
Remote banking has become very popular among corporate customers especially big
business and industrial houses which are already automated. More and more banks are
providing customer terminals right in the customer’s office which facilitates the customers
to operate the account without physically coming to the bank. For availing this service from
the bank the customer requires a computer, a telephone connection and a modem.
Moreover any of these items need not be dedicated for this purpose and could be utilised
only at the time of performing banking transactions thereby do not involve any additional
investments.

At present by using the remote banking facility corporate customers will be able to get the
following services.

Getting their current balance or getting their statement of accounts for any pre-
defined period.
Ordering cheque books.
Ordering intra-bank and inter-bank fund transfer.
Instructing stop payments of cheques.
International remittances.
Opening letter of credits.

INTERNET BANKING
Banks have traditionally been in the forefront of harnessing technology to improve their
products, services and efficiency. They have, over a long time, been using electronic and
telecommunication networks for delivering a wide range of value added products and
services. With the popularity of PCs and easy access to the internet and World Wide Web
(WWW), banks use internet as a channel for receiving instructions and delivering their
products and services to their customers. this form of banking is generally referred to as
Internet Banking , although the range of products and services offered by different banks
vary both in their content and sophistication.

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The levels of banking services offered through the internet can be categorised into three
types:

The basic level service is the banks’ websites which disseminate information on
different products and services offered to customers and members of the public in
general. It may receive and reply to customer queries through e-mails.
In the next level is the simple transactional websites which allow customers to
submit their instructions, applications for different services, queries on their account
balances, etc., but do not permit any fund-based transactions on their accounts.
The third level of internet banking services are offered by fully transactional
websites, which allows the customers to operate their accounts for transfer of funds,
payment of utility bills, subscribing to other products of the bank and to transact
purchase and sale of securities....etc. the above forms of banking were provided by
traditional banks as an additional method of serving the customer by new banks ,
who deliver banking services primarily through internet or other electronic delivery
channels as the value added services. Some of the banks are known as ‘virtual’ banks
or ‘internet only’ banks and may not have any physical presence in a country despite
offering different banking services.

Some of the distinctive features of i-banking are:

It removes the traditional geographical barriers as it could reach out to

customers of different countries/legal jurisdiction.
It has added a new dimension to different kinds of risks traditionally associated
with banking, heightening some of them and throwing new risk control
challenges and risk perceptions.
Security of banking transactions, validity of electronic contract , customer’s
privacy ,etc, which have always been matters of concern ,given that the internet
is a public domain, not subject to control by any single authority or group of
users.
It poses a strategic risk of loss of business to those banks who does not respond
in time to this new technology, being the efficient and cost effective mechanism
of banking services.

Automated Teller Machines (ATM)

ATMs are electronic banking outlet, which allow customers to complete basic transactions
by using ATM cards without the aid of a branch representative. Inventor John Shepherd-
Barron installed the world's first automatic cash dispenser at a Barclays Bank branch near
London in 1967. HSBC -- the Hong Kong and Shanghai Banking Corporation -- was the first

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bank to introduce the ATM concept in India in 1987. For facilitating the operations through
these ATMs the customers are provided with an ATM card with a unique personal
identification number (PIN). Whenever a customer performs the transaction, the person has
to key in the pin which is validated by the ATM, before the machine permits any transaction.
The pin has to be kept secret by the customer to prevent any misuse.

Convenience of ATMs

To the Customers:
a) 24*7 access availability.
b) Less time for transactions
c) Privacy in transactions
d) Any branch/anywhere banking enabled
e) Acceptability of cards across multiple bank ATMs
f) Other services enabled in ATMs in addition to cash dispensing includes clearing
cheque, cheque deposits, balance enquiry, cheque book requisition etc.

To the bank
a) Cost of setting up ATMs is lower than setting up a branch
b) ATM frees the bank staffs for more productive works
c) ATMs help for cross selling of the bank’s products
d) Serves as a media for publicity of the bank
e) Less hassle in handling the cash

Credit Card
It is a small plastic card around 8.5cm by 5.5 cm. It has the name and the account number of
the holder embossed on it. In addition the date up to which the card is valid will also be
embossed and a specimen signature panel on the reverse. Here the transactions are
charged to the total value of transactions debited to card holder’s account once in a month.
The card holder has the option to pay the entire amount as soon as the amount debited or
he may choose to pay certain percentage of the amount debited and pay the rest in monthly
instalments. Service fee is charged on the amount which is deferred.

Debit Cards
A bank issued card that allows its user to access their funds for the purpose of paying for
merchandise. This card acts like a credit card, the difference being that funds are
immediately taken from the cardholders accounts.

Smart Cards:

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This card exactly looks like any other plastic cards with an integrated circuit installed. The IC
chip contains memory, may contain a processor and communicates with the rest of the
world through contacts on the surface of the card. A secure pin pad is provided which allows
the user to enter pin and to store secret keys for application. There are two main types of
smart cards: Intelligent memory chip and microprocessor cards.

Memory smart cards have been around for several years. They are being used in pay
phones, identification access control, voting and other applications.

Processor smart cards are suited for banking and financial applications where reuse of the
card is allowed. They have a built-in memory and processor along with operating system. As
intelligence is built-in, these cards can protect themselves against fraudulent operations. For
smart cards ISO 7816 defines the physical features and communication protocols. ISO 10202
defines the security features.

Member Card
These cards are exclusively used by member of a group or club or any chain of hotels. For
example Taj card is a card issued by the management of Taj group of hotels to be used by
the patrons of their hotels. These cards are for use in their hotels only.

Advantages of Credit Card system

To the card holder:

a) Convenient for customer to carry a credit card in wallet and allows him to draw cash
too
b) It provides a proof of purchase through banking channels to strengthen his position
in case of any disputes.
c) It gives him exposure to banking
d) It inculcates a sense of financial discipline in him

To the merchant establishment:

a) Increase the sales because of increased purchasing power of cardholder due to
unbilled credit available to him
b) Avoid all the cost and security problems involved in handling the cash
c) Assured and immediate payment.
d) Systematic accounting and promotional support on a national scale.

To the banks:
a) Scope for better profitability
b) Helps in establishing banking relationship with new customers

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 c) Provides additional customer services to existing customers.
d) Saving the expenses on cash holding and manpower to handle clearing transactions.

Cheque Truncation
A cheque truncation is defined by the section 6(b) of Negotiable Instrument Act as ‘ a
cheque which is truncated during the course of a clearing cycle, either by the Clearing House
or by the Bank, whether paying or receiving payments, immediately on generation of an
electronic image for transmission, substituting the further physical movement of the cheque
in writing.

Characteristics:
a) Electronic image of paper cheque
b) The electronic image substitutes the paper cheque from the point and time of
truncation onwards.
c) The paper cheque is to be kept in the custody of the bank/clearing house that
truncated the cheque
d) Addition of digital signature is optional

It can be done in two ways: using MICR data and using image processing.

Advantages:
a) It stops the flow of cheque through banking system
b) It reduces the clearing time.

The Advent of Information Technology in Banking

IT has greatly transformed the banking operations. The use of computers and telecom
technology are the main foundation around which most banks today base their services and
operations.

Two successive committees on computerization (Rangarajan committees) set the tone for
computerization in India. The second committee set up in 1989 made way for integrated use

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of telecom and computers for applying the technological breakthroughs in banking
operations. The comprehensive agreements with unions in 1993 helped banks introduce an
almost unrestricted use of IT tools.

MICR (Magnetic Ink Character Reader) technology was a major step towards automated
clearing houses for speedy clearance of cheques in the 4 metro cities. Banknet and SWIFT
(Society for Worldwide Inter-Bank Financial Telecommunications) was commissioned in
the year 1991 for transmission of messages. Electronic Funds Transfer (EFT) now known as
National Electronic Funds Transfer (NEFT) system, Electronic Clearing System (ECS) and
Real Time Gross Settlement (RTGS) systems were also introduced in major cities in India.

Foreign banks have been aggressive with their operations with the latest technology in
India. A major turning point was the birth of the fourth generation computer systems. There
was also great improvement in telecom technology and concepts of Local Area Network
(LAN) and Wide Area Network (WAN) of systems. At present IT helps banks cross
geographical barriers and take banking to the doorstep of customers.

Structured Message Transfer System Using Swift

Society for Worldwide Inter-Bank Financial Telecommunications (SWIFTs) was founded in
1973 by 239 banks spread over fifteen countries with a view of creating a unified
international transaction processing and transmission system to meet the ever growing
telecommunication requirement of the banking industry. It is a non-profit making
organization established under Belgian Law with its headquarters in Brussels. SWIFT is
wholly owned by its member banks. It is basically a message transmission system. All
transactions are process without the exchange of paper, bank note, cheque, draft etc. and is
a true epitome of paperless banking. In India, all nationalized banks are members of Swift.
Bank locations are connected to the SWIFT regional processor in Mumbai.

Major Features of SWIFT

- Operational throughout the year twenty four hours a day.
- Transfer of messages to any part of the world is almost immediate.
- All message formats for interbank transactions are standardized. At present 400
different standardized formats are used by SWIFT for transmission.
- All messages are acknowledged. (either accepted or rejected)
- Information is confidential and protected against unauthorized disclosure and
tampering.
- SWIFT assumes financial liability for the accuracy and timely delivery of all validated
messages from the point they enter network to the point of leaving the network.
- Method of transmission is cost effective.

Major Message Types

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Standard message formats have been developed by SWIFT to handle the following business
areas:

- Customer transfers and cheques

- Financial Trading
- Documentary Credits and guarantees
- Precious metals and syndications
- Cash Management and customer status
- Financial institution transfers
- Collections and cash letters
- Securities
- Traveler Cheques
- Supporting system messages

Security in SWIFT
The responsibility in security of data messages is between regional processors. The security
provides for protecting networks against unauthorized access and protection of
transmission against loss or mutilation of messages, errors in transmission, loss of privacy
and fraudulent charge.

Key Authentication Mechanism: The SWIFT authentication is an improved and

automated version of the telegraphic test keys. It is automatically calculated on the entire
message text. This ensures that any changes in the message text to be detected.

Encryption: is a security control to ensure data confidentiality. It is done on the SWIFT

network and is available to users.

Checksum: is a security control to prevent automatic changes during transmission. It uses

both text and receivers address as part of its mechanism.

Developments in SWIFT
SWIFT has helped in standardizing and automating international payments messaging.
SWIFT has also allowed its facilities to non- banking financial institutions.

Developments in banks

1. Electronic Clearing Service

This scheme was introduced by RBI in 1990-91.It provides alternative method of effecting
bulk payment of transactions of repetitive nature. The payment of dividend, interest,
salaries, pensions and other transactions of similar nature may be done against a single

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debit to the government/corporate account. The various government departments, large
size public limited companies, financial institutions and banks are major users of the above
scheme.

Merits of the scheme

 Paperwork is minimized and there by the cost of printing, dispatch etc also is
reduced.
 The work load on destination branches (where the account of the beneficiaries are
maintained) is reduced.
 The customers get immediate credit in respect of interest and dividend on securities
held by them.

Demerits of the scheme

 The scheme does not cover amounts exceeding rs.1 lac.

 The scheme is operated only in few cities like Chennai, Mumbai, Kolkata, and New
Delhi.

2. SWIFT (Society for worldwide interbank financial

telecommunication)
Swift, as a cooperative society, was formed in May 1973 with 239 participating banks from
15 countries with its headquarters at Brussels. It started functioning in May 1977.Reserve
bank of India and 27 other public sector banks aswellas 8 foreign banks in India have
obtained the membership of the SWIFT. It provides rapid, secure, reliable and cost effective
mode of transmitting the financial message worldwide. At present more than 3000 banks
are the members of this Network. SWIFT is a method of sophisticated message transmission
of international repute.

Salient features of SWIFT:

 This is highly effective, reliable, and safe means of fund transfer.

 The network facilitates transfer of message relating to fixed deposits, Interest
Payments, Debit credit statements, Foreign exchange etc.
 This service is available throughout the year, 24 hours a day.
 It serves almost all financial institutions and selected range of other users.

3. Real Time Gross Settlement (RTGS)

The RTGS is a new system of payments evolved in the Indian banking environment. Its main
objective is to enable online clearing and settlement of payment on a real-time basis across

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banks in different cities. The RTGS is an upgraded technology aimed at is given reducing
dependence on payments through cheques. It is radically different from the present day
paper-based clearing system. It not only permits net settlements between banks but also
eliminates systematic risk due to advanced technological innovations.

Under RTGS system payments are cleared singly and bilaterally as they occur. When a
payment message is moved through the clearing house, the paying banks account with the
RBI is simultaneously debited and credited in the receiving banks account. There is no end of
day procedures as in the case of paper based clearing system. There is a certainty of
payment and the receiving bank can credit the beneficiary account immediately and allow
full use of funds.

Advantages of RTGS

 Certainty of payment: All payments under RTGS are irrecoverable and final. So
beneficiary account can be credited immediately. Under paper based system, credit
may not be given due to technical reasons such as incorrect account details, foreign
accounts etc.
 Faster collection of funds: The RTGS would provide an opportunity to collect funds
at a faster rate due to improved technology. It has the effect of reducing the
receivers working cycle.
 No settlement risk: It reduces settlement risk since credit to an account is final with
no possibility of subsequent returns.
 Improved liquidity management: From banks point of view , the liquidity
management can be improved since funds can be seamlessly transferred across
banks
 Less fraud and less processing cost: The processing costs and the risk of less fraud
are greater in the case of paper based clearing system. They are considerably
reduced under RTGS.
 Better inventory management: Faster funds transfer facilitate better inventory and
supply chain management. With these benefits, it is expected that volumes of
transactions under RTGS will rise and the transactions volumes by cheque payment
will see a decline in the coming years.

4. NEFT:
 National Electronic Funds Transfer (NEFT) is a nation-wide payment system facilitating one-
to-one funds transfer. Under this Scheme, individuals, firms and corporates can
electronically transfer funds from any bank branch to any individual, firm or corporate
having an account with any other bank branch in the country participating in the Scheme.

Who transfer funds using NEFT?

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Individuals, firms or corporates maintaining accounts with a bank branch can transfer funds
using NEFT. Even such individuals who do not have a bank account (walk-in customers) can
also deposit cash at the NEFT-enabled branches with instructions to transfer funds using
NEFT. However, such cash remittances will be restricted to a maximum of Rs.50,000/- per
transaction. Such customers have to furnish full details including complete address,
telephone number, etc. NEFT, thus, facilitates originators or remitters to initiate funds
transfer transactions even without having a bank account.

Who receives funds through NEFT SYSTEM?

Individuals, firms or corporate maintaining accounts with a bank branch can receive funds
through the NEFT system. It is, therefore, necessary for the beneficiary to have an account
with the NEFT enabled destination bank branch in country.

Operating hours of NEFT?

Presently, NEFT operates in hourly batches - there are eleven settlements from 9 am to 7
pm on week days (Monday through Friday) and five settlements from 9 am to 1 pm on
Saturdays.

How does the NEFT system operate?

Step-1 : An individual / firm / corporate intending to originate  transfer of funds through

NEFT has to fill an application form providing details of the beneficiary (like name of the
beneficiary, name of the bank branch where the beneficiary has an account, IFSC of the
beneficiary bank branch, account type and account number) and the amount to be remitted.
The application form will be available at the originating bank branch. The remitter
authorizes his/her bank branch to debit his account and remit the specified amount to the
beneficiary. Customers enjoying net banking facility offered by their bankers can also initiate
the funds transfer request online. Some banks offer the NEFT facility even through the
ATMs. Walk-in customers will, however, have to give their contact details (complete address
and telephone number, etc.) to the branch. This will help the branch to refund the money to
the customer in case credit could not be afforded to the beneficiary’s bank account or the
transaction is rejected / returned for any reason.

Step-2 : The originating bank branch prepares a message and sends the message to its
pooling centre (also called the NEFT Service Centre).

Step-3 : The pooling centre forwards the message to the NEFT Clearing Centre (operated by
National Clearing Cell, Reserve Bank of India, Mumbai) to be included for the next available
batch.

Step-4: The Clearing Centre sorts the funds transfer transactions destination bank-wise and
prepares accounting entries to receive funds from the originating banks (debit) and give the
funds to the destination banks (credit). Thereafter, bank-wise remittance messages are
forwarded to the destination banks through their pooling centre (NEFT Service Centre).

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Step-5: The destination banks receive the inward remittance messages from the Clearing
Centre and pass on the credit to the beneficiary customers’ accounts.

Advantages:

 The remitter need not send the physical cheque or Demand Draft to the beneficiary.

 The beneficiary need not visit his / her bank for depositing the paper instruments.

 The beneficiary need not be apprehensive of loss / theft of physical instruments or

the likelihood of fraudulent encashment thereof.

 Cost effective.

 Credit confirmation of the remittances sent by SMS or email.

 Remitter can initiate the remittances from his home / place of work using the
internet banking also.

 Near real time transfer of the funds to the beneficiary account in a secure manner.

RTGS v/s NEFT

 The fundamental difference between RTGS and NEFT is that while RTGS is based on
gross settlement, NEFT is based on net-settlement. Gross settlement is where a
transaction is completed on a one-to-one basis without bunching with other
transactions. As for a Deferred Net Basis (DNS), or net-settlement, this is where
transactions are completed in batches at specific times. Here, all transfers will be
held up until a specific time. RTGS transactions are processed throughout the
working hours of the system.

 RTGS transactions involve large amounts of cash; basically only funds above Rs
100,000 may be transferred using this system. For NEFT, any amount below Rs
100,000 may be transferred, and this system is generally for smaller value
transactions involving smaller amounts of money.

 RTGS processes in real time (push transfer), while NEFT processes in cycles during
the given working day. This causes NEFT transactions that are initiated later than the
last cycle to be completed the next day.

5. MICR (Magnetic ink character recognition cheques)

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MICR cheques are special types of cheques designed exclusively for speeding of the clearing
process in banks. Banks usually receive a large number of cheques for collection and
clearing and it takes lot of time to complete the clearing process under the manual system.
Therefore, in order to speed up the clearing system, MICR concept was introduced in
banks.MICR cheques are made of special quality paper with prescribed weight and MICR
code numbers are printed therein with a special magnetic ink. The cheque contains code
numbers for name of the bank, name of the branch, name of the city where the bank is
located, transaction code etc. Such cheques are processed by electronic machines, namely,
encoder and sorter.
The MICR code numbers are printed on the bottom portion of the cheques. That portion
should be kept intact and should not be tampered. Therefore, MICR cheques should not be
folded. Nothing should be written on the space, where code numbers are printed. The banks
should be very careful to see that no rubber stamp is affixed on this portion. The customer
should be very careful to avoid putting their signatures in the restricted part of the cheques.

Advantages of MICR cheques

 The chances of errors are minimized as the instruments are processed by the
machine
 The transfer of funds between the banks takes place quickly
 It reduces the work load in banks
 The customers are benefitted because of the speedy disposal of clearing cheques.

Mergers and Acquisitions in Banks

Value creation through mergers

Value is created in two ways. The first is that the combined bank might be able to immediately
generate increased earnings (or cash flow) on a per share or otherwise comparable basis,

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 compared to historical norms. The second is through the increase in market share and product
depth, which eventually led to increased earnings. The sources of these potential gains are
wide- ranging and include:

1. Economies of scale, Cost Cutting

 Consolidation of data processing and back room operations.

 Consolidation, diversification, and streamlining of investment departments and the securities
portfolio.
 Consolidation of the credit department, including loan documentation and preparation
 Consolidation of loan review and audit operations
 Consolidation of branch delivery systems, including use of the internet
 Other scale economics

2. Increased Market share

 Brand identification
 Political and market power enhancements
 Removal of a computer

3. Enhanced product lines

 Stronger and more diversified product lines

 Improved marketing/ distribution of products

4. Entry into attractive new Markets

 Entrance into new growth markets

 Easier access to faster growth markets

5. Improved managerial capabilities and increased financial leverage

 Improve profitability through loan purchase and maintenance of loan quality

 Alternative to paying dividends
 Increased financial coverage, buyers rarely pay a premium for excess capital

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6. Financial and operating leverage

 Expansion into other lines of business and achievement of additional operating leverage
 Fixed cost of technology distributed over a larger customer base.

1. Cost cutting often receives considerable attention because the acquirer has some direct control
of noninterest expense. Banks with excess data processing capacity, for example, often view
acquisitions as a way of generating activity that lowers unit costs by spreading fixed technology
costs across more items.
2. Value is created a second way by increasing market share. The high costs related to brand
identification can be spread over a larger revenue stream. Larger market share also has the
potential of reducing competition.
3. Increasing market share can also lead to an enhanced product line and open markets. Large
product lines can bring economies of scale and scope.
4. Cross-selling opportunities and enhanced delivery channels for existing and new products make
size attractive as well.
5. Most banks also attempt to achieve additional operating and financial leverage. Greater
operating leverage can be achieved by eliminating the duplication of services and spreading the
fixed cost of delivery over a larger base of customer and products.
6. To enhance value, the acquirer would like to retain the best employees of the target bank,
retain the targets best customers, and preserve the best parts of the target’s culture.

Motives behind Mergers

Any acquisition takes place with a number of motives culminating in a positive synergy. The
following objectives sum up the motives behind mergers:

1. To counter competition from global majors and to increase the size and competitiveness of
banks to enable them to compete in global markets.
2. To overcome slow pace of growth and enhance profitability of banks due to globalization of the
banking industry.
3. Loss making banks due to high NPAs can improve their performance and recover by merging
with good performers.

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4. Some banks may have an excess of various resources like underutilized capital, human,
technological and managerial resources while some may be falling short. Mergers of such
organizations can result in optimum utilization of resources.
5. To achieve diversification of presence and services, banks may decide to merge.
6. To fight off local and foreign competitions by increasing the size and portfolio base.
7. To gain economies of scale, operation and scope of activities.
8. To bring about product innovations to reach a larger number of customers.
9. Disintermediation and competition has increased pressure on banks and increased pressure on
banks and increased profitability can be achieved only through consolidation.
10. Competency in technology and knowledge of banks has also contributed to increased
consolidation in the banking industry.
In India, the merger and takeover phenomenon in the past was understood largely as one of
the sick units being taken over by healthy ones. This is because of the reason that Sec 72A of
the Income Tax Act, 1961 provides for the carry forward of losses.

The advantage that the merging corporations get is that the book losses of the sick corporation
get written off against the future profits, thus saving the profitable corporations some tax
outflow.
As far as the banking sector is concerned, the following reasons are more
relevant:

1. Growth with external efforts: with economic liberalization, the competition in the
banking sector has increased and hence there is a need for megabanks, which will be
intensely competing for market share. In order to increase their market share and
market presence, some of the powerful banks have started looking for banks which
could be merged with them. They realized that they need to grow fast to capture the
opportunities in the market. Since the internal growth is a time-taking process, they
started looking for target banks.
2. Deregulation: With the liberalization of entry barriers, many private banks came into
existence. As a result of this, there has been an intense competition and banks have
started looking for target banks which banks market presence and branch network.

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3. Technology: the new banks which entered as a result of lifting of entry barriers have
started many value-added services with the help of their technological superiority. The
older banks which cannot compete in this area may decide to go in for mergers with
these high-tech banks.
4. New products and services : The new generation private sector banks which have
developed innovative products and services with the help of their technology may
attract some old generation banks for merger due to their incapacity to face these
challenges.
5. Overcapacity: the new generation private sector banks have started their operation
with huge capacities. With the presence of many players in the market these banks may
not be able to capture the expected market share on its own. Therefore in order to fully
utilize their capacities, these banks may look for target banks which may not have
modern day facilities.
6. Customer base: In order to utilize the capacity of the new generation private sector
banks, they need huge customer base. Creating huge customer base takes time.
Therefore these banks have started looking for target bank with good customer bases.
Once there is a good customer base, the banks can sell other banking products like car
loans etc. to these customers as well.
7. Merger of weak banks: There has been a practice of a merging weak bank with a
healthy bank in order to save the interest of the customers of the weak bank. The
Narasimham Committee II discouraged this practice. However, the Khan Group
suggested that weak Developmental Financial Institutions (DFIs) may be allowed to
merge with healthy banks.

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