“Accepting for the purpose of the landing of investment of deposits of money from public repayable on demand or otherwise and withdrawable by cheques, draft, order or otherwise.”———– Banking Regulation Act 1949
“A bank is an establishment which makes to individuals such advances money as may be required and to which individual entrust money when not required by them for use”.———- Sir Kinley
When we think of banking, the first impression that comes to our mind is of an institution that accepts deposits and makes advances and earns profit in the process. All definitions of banking revolve around it. We need to delve a bit deeper to understand that how this system works? First, we must understand that when people indulge in any kind of occupation, they create wealth. We shall take a farmer’s example. When he indulges in agricultural activities, he produces a crop. That crop is wealth. He uses a certain part of it, and the rest goes into his savings for the future.
“As long as a man spends his income, he puts just as much bread into people’s mouths in spending as he takes out of other people’s mouths in earning. The real villain, from this point of view, is the man who saves”
— Bertrand Russell
When a person saves his money or wealth or product, he actually puts it to rest. When the money is put to rest, it slowly disappears. In the case of a crop, the wealth will disappear with decaying. With surplus even after knowing that their surplus, if not utilized, would vanish in many ways, people are not ready to give it away to the needy or the ones in deficit. One set of people has a surplus and no use, and another has a deficit and simultaneously the need. Banks are the intermediaries between these two. It takes the surplus from those who have it and lends it to those who have the need.
Those who deposit their surplus is called the depositor, and those who take advances from the bank are called loanees.
It promises to pay interest to the depositors and takes a promise of a higher interest from the loanees. The difference between the interest paid and interest collected is called gross Interest Income in banking parlance, the single biggest source of income for any bank.
At times, banks lend more than their capability. Even though all the loans have not turned NPA, the bank cannot meet its repayment liabilities. Here comes the concept of recapitalization of the bank by the promoters, where they pump in more cash into the bank
It has been simple till now, but the working of the financial world is much more nuanced. The depositors are going to get more surpluses as now their source of income includes the interest, which they can invest with other institutions. The deficits of the loanees would increase for they have the interest to pay. (This, to an extent, explains rich getting richer and poor getting poorer.) In normal circumstances, the surpluses go on increasing, as does the deficits. This explains the growing book of bank deposits and advances. As the deficit goes on increasing, some from the set of people with deficit start crumbling and fail to meet their repayment liabilities. Such loans where the ones who have taken the advance fail to repay it become Non-performing assets. Banks need to make provisions for such loans from its income as they are to repay the depositors. If the number of such defaulters becomes large, the bank would not be able to meet its repayment liabilities and fail.
In an ideal world, the number of loan defaulters would have been negligible, and the banks could easily have handled the problem, but sadly the world is not ideal. Even though the chance of depositors needing their surplus is very low, they want their money to be safe and grow. It is an impossible situation when all the depositors require their deposits, besides while the book is growing, the banks can meet the repayment liabilities. It can also hide the NPAs and show that the bank is in good health. Here comes the regulator’s role, which is assigned with the responsibility of checking the bank’s health through various disclosures and audits.
At times, banks lend more than their capability. Even though all the loans have not turned NPA, the bank cannot meet its repayment liabilities. Here comes the concept of recapitalization of the bank by the promoters, where they pump in more cash into the bank.
The discussions till now must have explained the importance not only of the depositor but also of the loanee. The rich get a notion of getting richer, and it helps the poor in survival. The concept of loan is based entirely upon the notion that one can’t eat the bread until it is produced. A loan is about consuming the income of future in present, which doesn’t seem very tangible. So it is that we consume someone else’s income and repay it at a later date.
************************************************************************
Readers