Exchange Banks: Functions, Working and Defects

In this article we will discuss about:- 1. Functions of Exchange Banks 2. Working of Exchange Banks in India 3. Defects 4. Suggestions to Improve.

Functions of Exchange Banks:

Exchange banks perform the following functions in India:

1. Financing Exports:

The exchange banks facilitate the payment of goods exported. This is done through Document against Acceptance (D.A.) Bill which the Indian exporter draws against the importer. This bill is sent to the importer through the exchange bank. The importer returns it to the exporter after acceptance and the latter discounts it from his exchange bank.

2. Financing Imports:

The exchange banks also facilitate the financing of imports. When an Indian importer imports goods, he receives through the exchange bank on the basis of the Document Against Payment (D.P.) Bill drawn by the foreign exporter.

3. Financing Internal Trade:

The exchange banks finance the internal trade of the country. They finance the movement of goods from one commercial centre to another. They advance loans to traders and discount their bills of exchange.

4. General Banking Functions:

The exchange banks perform general banking functions like Indian banks such as accepting deposits, advancing loans, agency services, credit remittance facility, locker facility, stock invest facility, card facility, etc.

5. Encourage Foreign Investments:

The exchange banks encourage the flow of foreign investments into India. Foreign investors usually rely on their banker’s judgement for overseas investment. Exchange banks are an important medium for projecting the country’s image abroad. They provide Indian corporations access to foreign collaborators as well as introduce foreign companies to Indian corporations.

6. Access to International Capital Markets:

The exchange banks help in providing Indian corporations and government agencies access to international capital markets.

7. Develop Expertise and Innovations:

The exchange banks help in developing expertise and innovations in several areas such as trade, finance, payment systems, currency and interest rate risk management and financial engineering. To the extent these help in improving the efficiency of Indian banks, competitiveness improves.

8. Mobilising Funds from Non-Resident Indians:

The exchange banks help in mobilising deposits from non­resident Indians (NRI) abroad through their network of branches located in foreign countries.

9. Canalising Agent:

The exchange banks play the role of canalising agents for foreign currency credits for major projects. For example, Grindlays helped in arranging credits for the HBJ gas pipeline.

10. Revival of Sick Industries:

The exchange banks help in the revival of Indian sick industries by putting their Indian clients in touch with NRIs who might be willing to invest in the equity of firms in question, and also facilitate the transfer of technology.

11. Cover the Risks of Exchange Rate:

The exchange banks cover the risks of exchange rate movements by booking forward contracts.

12. Some Innovative Schemes:

Some exchange banks in India have started a number of new schemes for their clients which are as follows:

(a) General Purpose Loan:

Some exchange banks offer the Freedom Finance Scheme whereby the client can avail of loan facility from Rs.10,000 to 50,000 for expenditure like a marriage, a holiday or even an admission to an institute for higher studies.

(b) Fixed Deposits:

The exchange banks have introduced an innovation in fixed deposits which they call under different names to attract customers. The Citibank has Unfixed Deposit, the Grindlays has an Easy Access Deposit and a High Performance Saving Account, and the Hong Kong Bank the Smart Money Account. These banks provide the facility of withdrawing up to 75 per cent of the deposit to a depositor while paying 2 per cent interest during the withdrawal period over the overall interest earned for the deposit period.

(c) Global Banking Systems (GBS):

GBS is the Bank of America’s standard computer system which operates worldwide in Europe, Asia and America. GBS enables the BOA to provide its customers speedy and efficient service throughout the world. Banking services like funds transfers or letters of credit involving any of its branches worldwide are automatically transmitted through BOA global network of telecommunication.

(d) Finance Against Securities in Time:

The Standard Chartered Bank has started Finance Against Securities in Time (FAST) facility which provides loans to all individuals who have invested in shares and other securities.

(e) Non-Fund Business:

The exchange banks undertake non-fund business on a fairly substantial scale. It includes letters of credit for imports, advising of letters of credit to exporters, execution of overseas contracts, syndication of international loans, and public flotation of equities and debentures.

(f) Mutual Funds and Technology Funds:

Several exchange banks have opened divisions like mutual funds and technology funds which provide venture capital for new and existing companies to expand, modernise and diversify.

(g) Merchant Banking:

They are engaged in merchant banking, equipment leasing, housing finance, car finance, venture capital, factoring, etc.

Working of Exchange Banks in India:

The number of exchange banks, better known as foreign banks, operating in India at present is 36. They have a network of 204 branches. Among the biggest foreign banks in India are: Citi Bank, ANZ Grindlays Bank, Standard Chartered Bank, Hong Kong Bank, American Express Bank, Bank of America, British Bank of Mideast, Bank of Tokyo, and Deutsche Bank.

For operating in India, every foreign bank is required to obtain a licence from the RBI. The licence is given with the condition that there should not be any discrimination against any Indian bank operating in that country to which the foreign bank belongs.

A foreign bank is required to bring in $ 10 million for the first branch it sets up, $ 10 million for the second and $ 5 million for the third. It is also required to deposit with the RBI either in cash or in the form of unencumbered approved securities or both an amount equal to the amount specified above.

Every foreign bank operating in India is also required to deposit with the RBI at the end of each calendar year 20 per cent of its profits earned in India. Every foreign bank is further required to keep 12 per cent of the total of its time and demand liabilities with the RBI as CRR (Cash Reserve Ratio) which is interest free.

In addition to the CRR, it is required to maintain in cash, gold or unencumbered securities, known as Statutory Liquidity Ratio (SLR) up to the level of its outstanding net demand and time liabilities equal to 25 per cent with effect from 13 April, 1996. Every foreign bank is required to maintain its assets equivalent to not less than 85 per cent of its demand and time liabilities in India at the close of business on the last Friday of every quarter. Foreign banks operating in India are required to comply with the capital adequacy norm of 8 per cent from 1 April, 1993 which they have achieved.

The foreign banks operating in India are required to provide a minimum of 32 per cent of their net outstanding advances to the priority sector in India every year. It is inclusive of the sub-targets of 10 per cent each in respect of credit for exports and small scale industries, the shortfall, if any, in the overall target as well as sub-targets has to be made good by placing deposits with the Small Industries Development Bank of India (SIDBI) at a rate of 8 per cent with effect from March 1995.

For opening a new branch or to change the location of an existing branch, a foreign bank is required to take prior permission of the RBI. With effect from 22 April, 1992, they have been permitted to expand branches on considerations of national advantage from the viewpoint of facilitating exports and investment, with no change in other conditions.

They are also required to submit the various statements of their assets, liabilities, investments and advances, etc. to the RBI as per the RBI guidelines. Besides, the RBI is empowered to inspect their books and accounts whenever it deems essential from time to time.

The performance of 36 foreign banks in India during 2002-03 showed decrease in their income by 7.10 per cent over 2001-02, operating profits by 6.10 per cent, net profits by 22.25 per cent and total assets by 2.72 per cent. The foreign banks have an edge over Indian banks in the spheres of customer service and technology back-up.

Defects in the Working of Exchange Banks:

Despite better and efficient working of exchange banks, these banks have certain defects in their working from the Indian viewpoint. These arise from the liberal attitude of the Reserve Bank of India towards them.

Some of the defects are:

1. Vast Funds in Non-Costing Deposits:

The exchange banks hold vast funds in their non-costing current accounts. They are able to invest out of them at prescribed rates of interest so that their margin of profits on these no-cost funds increases. In the case of nationalised banks the share of non-costing current Accounts in total deposits is IS per cent whereas in the case of exchange banks it is 21 per cent. Thus their deposits cost them less as compared to Indian banks. As a result, they earn more profits than Indian banks.

2. Large Non-Fund Business:

The exchange banks undertake non-fund business on a fairly large scale. The combined average ratio of non-fund income of exchange banks is 13 per cent against 9.0 per cent in the case of nationalised banks, except the State Bank of India. Consequently, they are able to earn more profits than Indian banks. This is because of their monopolistic position in foreign business.

3. Ignore Term Advances:

The exchange banks ignore such advances as term loans, hypothecation advances and other short term advances, But they engage themselves in bill business for very short periods of 30 to 90 days with the result that their current account funds increase. They are able to invest these funds for short periods in the inter-bank call, money market and earn interest

4 Ignore Priority Sectors:

They are required to lend 32 per cent of net bank credit to priority sectors including 10 per cent for exports. But in 1999-2000, they lent 22.5 per cent for exports and 10.2 per cent to SSIs and ignored all other priority sectors.

5. Operate Funds Management Schemes:

Due to the liberal policy of RBI, the exchange banks accept funds under the funds management schemes. These funds are not considered deposits. They are treated as non­-statutory because the banks are not required to maintain the prescribed Cash Reserve Ratio (CRR) and Statutory Liquidity- Ratio (SLR) on these Funds. These banks are making a profit of about Rs.200 crores annually from these funds.

6. Discriminate against Indian Firms:

The exchange banks discriminate against Indian trading firms. They offer D.P. Bills to Indian importers whereby they are required to make full payment in order to get possession of goods. On the other hand, the Indian exporters are required to export goods against D. A. Bills whereby they receive deferred payments.

7. Encourage Foreign Shipping and Insurance Companies:

These banks generally force Indian exporters and importers to get the services of foreign shipping and insurance companies. This goes against the interests of Indians.

8. Unhealthy Competition with Indian Banks:

Due to their superior management techniques, larger funds and RBI’s liberal policy towards them, the exchange banks have been able to provide better services and higher interest rates to their customers. This has led to unhealthy competition with Indian banks. As a result, their profits have been rising at a much higher rate than those of Indian banks.

9. Foreign Links:

The exchange banks being foreign banks have links in foreign countries where they have their head offices. Their directors, shareholders and management are entirely foreign. So their main interest is to earn higher profits, part of which are taken away.

10. Hindrance to Bill Market:

They are a hindrance to the development of Indian Bill Market because they discount the export bills in London Bill Market while the import bills are fully paid before the delivery of goods.

11. Help Transfer Illegal Money:

The exchange banks help transfer the illegal money kept abroad into Foreign Currency Non-Resident (FCNR) deposits of their branches. Thus they encourage black money within the country.

Suggestions for Improvement of Exchange Banks:

A number of suggestions have been made to improve the working of exchange banks in India so that they may be more helpful to the economy.

Some of the suggestions are:

1. No Preferential Treatment:

The exchange banks operating in India should be treated at par with Indian commercial banks.

2. Restriction on Branch Expansion:

RBI should not allow exchange banks to open more branches in the country so that their activities are confined to port cities and big commercial centres. RBI has done well in asking the exchange banks to bring in an initial capital of Rs.15 crore in foreign exchange to open a branch.

3. Restriction on Non-Costing Deposits:

The exchange banks encourage the opening of current accounts by multinational corporations and big industrial houses because they bring them more profits without paying interest. They do not welcome small depositors. RBI should direct them to accept small saving deposits and place a limit on non-costing deposits.

4. Restriction on Funds Management’ Schemes:

The exchange banks are earning huge profits by accepting money under the funds management schemes which are not considered deposits. RBI should place restrictions on such schemes by asking these banks to maintain the prescribed Cash Reserve Ratio and the Statutory Liquidity Ratio on these funds as applicable to Indian banks.

5. Regulation of Lending Activities:

The exchange banks are allowed to undertake lending advancing and investment activities without much restriction. RBI should regulate such activities. They should be directed to give more advances for long term and invest in Indian companies rather in multinationals operating in India.

6. Participate in Social Banking:

The exchange banks participate less in social banking. RBI should direct them to lend more to small scale industry sector, retail trade, self-employed persons, etc.

7. Limit on Repatriation of Profits:

As exchange banks in Indian earn huge profits, they also repatriate huge sums to their head offices abroad, even after keeping 20 per cent of their annual profits with RBI. Recently, RBI has asked these banks to keep another 20 per cent of their profits in the Indian books. This is not enough. They should be asked to keep at least 50 per cent of their profits in India.

8. Removal of Discrimination against Indian Importers:

The exchange banks should remove discrimination against Indian importers by offering them D.A. Bills, as is the practice in advanced countries.

9. Indians in Management:

All exchange banks operating in India should be directed to have at least one Indian on the Management working in India.

10. No Mergers:

The exchange banks operating in India should not be allowed to merge their branches without the permission of the Reserve Bank.

11. No Control over Indian Banks:

The exchange banks should not be allowed to have any type of direct or indirect control over Indian banks. They should not be permitted to acquire the shares of Indian banks.

12. No Association:

The exchange banks operating in India should not be allowed to form any association without the permission of RBI.