Banking forms the backbone of any modern economy. In simple terms, a bank is a financial institution that accepts deposits from the public and provides loans and credit facilities. It acts as a bridge between people who have surplus money (depositors) and those who need money (borrowers). By doing so, banks facilitate the smooth flow of money and credit in the economy.
The word “bank” originates from the Italian word banco, meaning a bench, as medieval bankers used benches to conduct money-lending activities. Over time, banking has evolved from simple money-lending to a wide range of financial services like investment advisory, wealth management, digital transactions, and insurance.
Download UNIT 1 – Introduction to Banking, Economic Role, and RBI Notes
Get simplified revision notes for this unit:
Download Unit 1 Notes PDF
1. Functions of Banks
Banks perform several essential functions that contribute to economic stability and growth.
a) Accepting Deposits
Banks provide a safe place for individuals and businesses to deposit money. They offer different types of accounts such as savings accounts, current accounts, and fixed deposits, catering to various customer needs.
b) Providing Loans and Advances
Banks lend money to individuals, businesses, and governments for consumption and investment purposes. Loans may be short-term (like working capital loans) or long-term (like home loans).
c) Credit Creation
One of the most significant roles of banks is credit creation. When banks provide loans, they create additional money in the economy, which fuels business activity and economic growth.
d) Payment and Settlement Services
Banks facilitate smooth payments through cheques, debit/credit cards, UPI, and online banking, reducing the need for physical cash.
e) Other Services
These include foreign exchange transactions, safe deposit lockers, investment advice, and insurance services.
2. Types of Banks
The Indian banking system consists of various types of banks to serve different needs:
Commercial Banks – Public sector banks (like SBI), private sector banks (like HDFC), and foreign banks (like HSBC).
Cooperative Banks – Operate on a cooperative basis, mainly serving rural and semi-urban areas.
Regional Rural Banks (RRBs) – Provide banking services to rural areas and support agriculture and allied activities.
Development Banks – Provide long-term capital for industries and infrastructure projects.
Small Finance Banks & Payment Banks – Cater to underserved sections, offering limited financial services.
3. Structure of the Indian Banking System
The Indian banking structure is broadly classified into:
Scheduled Banks – Listed in the Second Schedule of the RBI Act and follow certain regulations.
Non-Scheduled Banks – Smaller banks not listed in the schedule.
At the top of this structure is the Reserve Bank of India (RBI), the country’s central bank, which regulates all banks and ensures monetary stability.
4. Economic Role of Banks
Banks play a vital role in economic growth by:
Mobilizing Savings – Encouraging people to save and investing these savings in productive uses.
Facilitating Trade and Industry – Providing credit to businesses for working capital and expansion.
Promoting Financial Inclusion – Ensuring banking services reach rural and underprivileged areas.
Supporting Government Policies – Helping implement schemes like Jan Dhan Yojana and Mudra Loans.
For example, by lending to farmers during the sowing season, banks enable agricultural production, which boosts rural incomes and overall demand in the economy.
5. Reserve Bank of India (RBI)
The RBI is the central bank of India, established in 1935. It is the apex monetary authority responsible for regulating and supervising the financial system. Its main functions include:
a) Issuing Currency
The RBI is the sole authority for issuing currency notes in India (except ₹1 notes issued by the Ministry of Finance).
b) Controlling Monetary Policy
Through tools like repo rate, reverse repo rate, and CRR, the RBI regulates the supply of money to control inflation and promote growth.
c) Regulating Banks
It lays down guidelines for banks, monitors their functioning, and ensures they maintain financial stability.
d) Managing Foreign Exchange
The RBI manages the country’s foreign currency reserves and ensures stability in the exchange rate.
6. Monetary Policy and Its Role
Monetary policy refers to the process by which the RBI controls the money supply in the economy. It uses quantitative tools (like changing interest rates) and qualitative tools (like credit rationing) to achieve objectives such as price stability, economic growth, and employment generation.
For example, during high inflation, the RBI may increase the repo rate to make borrowing costlier, thereby reducing money circulation and controlling price rise.