Chapter 6 — Banks, credit and financial inclusion

Exam fit: common foundation for SI and Constable. Level: basic to intermediate.

Banks connect people who save with households, firms and governments that borrow. They also provide payment, remittance and account services. Banking is not simply “collecting deposits and handing them out”: banks assess repayment risk, manage liquidity, follow capital and conduct rules, and keep records of assets and liabilities. This chapter explains a simple bank balance sheet, how credit works, why loans may become stressed, how deposit protection is limited, and what financial inclusion means.

6.1 A simplified bank balance sheet

A bank balance sheet distinguishes deposits owed from loans due. | Original explanatory diagram; schematic, not a measured data chart.

A balance sheet records assets, liabilities and capital at a point in time. A bank's assets include loans and investments, along with cash and balances held in settlement or reserve accounts. Its liabilities include customer deposits and borrowings. Capital is the owners' residual claim and a buffer against losses. The accounting identity is assets = liabilities + capital.

A customer deposit is an asset to the customer but a liability to the bank, because the bank owes repayment under the account terms. A loan is an asset to the bank because the borrower owes repayment; it is a liability of the borrower. The same transaction therefore appears differently on the two parties' balance sheets.

Worked balance sheet. Suppose a small bank has ₹100 crore in deposits, ₹20 crore in capital, and total assets of ₹120 crore. It holds ₹10 crore in cash and settlement balances, ₹20 crore in eligible liquid investments and ₹90 crore in loans. Assets total ₹120 crore; liabilities and capital also total ₹120 crore. This illustration leaves out provisioning and detailed accounting categories but shows the basic identity.

6.2 Why banks screen and monitor loans

When a bank lends, it expects principal and interest to be repaid according to contract. It evaluates the borrower's income or cash flow, collateral where relevant, business prospects, repayment history and the purpose of the loan. Collateral may reduce loss if a borrower defaults, but it does not guarantee repayment or remove the need to assess the underlying ability to repay.

Credit risk is the chance that the borrower will not meet obligations. Liquidity risk is the risk that funds will not be available when due. Interest-rate risk is the risk that changing market rates affect income or asset values. Banks manage several risks at once. A sound financial system needs both access to credit and responsible lending; forcing credit without assessment can create losses, while excessively restrictive lending can exclude viable borrowers.

6.3 Non-performing assets and stressed credit

A loan becomes overdue when payment is not made on its due date. An asset may be classified as a non-performing asset (NPA) under regulatory rules after specified overdue conditions are met; exact thresholds can depend on the loan type, borrower class and applicable circular. A widely taught 90-day rule applies to many standard term-loan cases, but a book should not reduce every product and circumstance to a universal one-line rule. The current RBI instructions control.

An NPA is not simply “a loan that will never be repaid.” It is a regulatory asset classification indicating impaired performance under defined norms. The bank may restructure, recover, enforce security, recognise provisions or take other permitted steps. An NPA ratio is a credit-quality indicator, but compare the same definition, bank group and reporting period.

Worked example. A bank has gross loans of ₹1,000 crore, of which ₹40 crore are classified as gross NPAs. The gross NPA ratio is 40/1,000 × 100 = 4%. A lower ratio can indicate improved asset quality under comparable definitions, but it does not by itself show the bank's capital strength, profitability or future risks.

6.4 Deposit insurance and depositor protection

The Deposit Insurance and Credit Guarantee Corporation (DICGC) insures eligible deposits in insured banks under the governing Act and scheme. Its published protection limit is up to ₹5 lakh per depositor per insured bank, calculated in the same right and capacity, including principal and interest as covered. The limit is not ₹5 lakh for every account separately at the same bank. Deposits held in different capacities or at separate insured banks are treated under the scheme's rules. Always check the DICGC conditions and current official FAQ before making a consumer-facing claim.

Deposit insurance protects eligible depositors against covered bank failure up to the limit. It does not insure investments in shares, mutual funds or every financial product sold through a bank. A customer should distinguish a bank deposit from market-linked investment and review the product's legal nature, risk and terms.

6.5 Financial inclusion

Financial inclusion means that people and enterprises can access and use appropriate, affordable financial services safely. It includes accounts, payments, savings, credit, insurance and pensions, depending on the programme and definition. Having an account does not prove that it is actively used or that a person can obtain suitable credit. Access, usage, quality and outcomes should be examined separately.

An account can help receive wages, pensions or transfers and can reduce the need to carry cash. Digital payments can lower transaction frictions and create records, but access depends on devices, connectivity, literacy, authentication, language, dispute redress and cybersecurity. A failed transaction or fraud can impose costs, especially on people with low digital confidence. Financial inclusion therefore includes consumer protection and grievance access, not only account-opening counts.

Small firms may lack audited accounts, collateral or a long credit history. Alternative data and guarantee programmes can help lenders assess some borrowers, but must be designed with privacy, consent, fairness and repayment capacity in mind. Credit access is not always the correct solution to a household shock; insurance, grants, savings and public services may be more appropriate in some cases.

6.6 Digital payments and settlement

A digital payment is an instruction or transfer recorded electronically. A transaction may pass through a payment instrument, service provider, acquiring institution, bank and settlement system. The user sees a simple tap or scan, while the system verifies, routes and settles the transaction under rules. The receipt shown to a user is useful evidence, but a transaction can fail, remain pending or be reversed. Customers should follow official dispute channels and never share one-time passwords or authentication credentials with an unsolicited caller.

Digital payments are not identical to digital lending. A fast payment transfer moves funds; a loan creates a repayment obligation and may involve a regulated lender. An app interface does not by itself tell a borrower who the legal lender is, what the annualised cost is, or how complaints are handled. Read the terms and check the regulated entity.

6.7 Credit in Andhra Pradesh's productive economy

Consider a small cold-storage enterprise serving farmers and fishers. It may need term credit for buildings and equipment, working-capital credit for electricity and labour, and an account for receiving payments. The lender will examine expected cash flows, seasonal demand, power reliability, insurance, buyer contracts, borrower contribution and repayment schedule. If electricity costs or output prices change, the repayment capacity can change too. A loan improves productive capacity only when the project is viable and the borrower can service the debt.

An agricultural household may need credit before harvest, but seasonal income is irregular. Loan design, repayment timing, crop risk, warehouse access and insurance matter. A generic monthly instalment may fit some borrowers poorly. This is why product suitability and local information matter alongside access.

Worked application and examiner distinction

A simplified bank balance sheet has assets such as loans and investments, and liabilities such as customer deposits and borrowings. Equity absorbs losses before depositors, subject to the applicable legal resolution framework. A deposit is a bank liability because the bank owes the depositor under the account terms. A loan is an asset because the borrower owes the bank. If a borrower defaults, asset quality deteriorates; expected loss provisions reduce earnings and capital. A loan does not become a “bad asset” merely because one instalment is late: classification depends on regulatory definitions and loan category.

Financial inclusion is more than opening an account. A useful assessment asks whether the account is accessible, used, affordable, safe and suited to the user's needs. A digital payment can lower transaction friction, but connectivity, authentication, grievance redress and fraud prevention matter. Credit access also needs suitability: a loan can support a productive activity, smooth a shock or create a repayment burden if cash flows are unstable.

Deposit insurance is subject to the DICGC rules, including the insured-bank and same-right/same-capacity conditions described in the official FAQ. Never turn the headline limit into “every account gets a separate limit” without checking the rule. Likewise, RBI prudential rules vary by facility and are updated; teach the concept and verify exact thresholds at the date of an exam.

Second worked calculation and interpretation

An account is opened for a seasonal worker, but the nearest service point is far away and digital access is unreliable. The account is formally available but may be difficult to use. Assess inclusion by checking access, affordability, usage, safety, product suitability and grievance redress. A low-balance account can still be useful if deposits, transfers or payments work reliably; an account count alone cannot show this.

Credit suitability is also contextual. A dairy farmer may have seasonal cash flows and need a repayment schedule aligned with income. A short weekly repayment may be manageable for one borrower and risky for another. Lenders need to assess repayment capacity; consumers need clear terms and complaint channels. Financial inclusion is not simply maximising the volume of loans. The objective includes useful and responsible access.

Applied examiner workshop

Three banking concepts should not be conflated. Credit risk is the possibility a borrower does not repay. Liquidity risk is inability to meet cash obligations when due, even if assets may be valuable over time. Solvency risk is a deeper condition in which asset value and capital are inadequate relative to liabilities. A bank can be liquid today but suffer future credit losses; it can hold valuable long-term assets yet face a short-term liquidity mismatch.

A deposit run can create liquidity pressure because depositors seek cash at once. A bank's loan portfolio may not be converted to cash immediately without loss. Central-bank facilities and regulation can support stability under conditions, but depositors and shareholders do not have identical claims. DICGC protection has a defined limit and conditions; it is not unlimited insurance for every sum in every financial product.

For an exam, identify whose balance sheet holds the claim. A borrower's liability is the lender's asset. A customer deposit is the bank's liability. A default can reduce expected recovery; provisioning recognises expected loss. The exact NPA classification timing is rule-specific and can differ across categories. The stable principle is to understand risk, recognition and capital rather than memorise an old threshold without a current circular.

Chapter recall

• A customer deposit is a bank liability and a customer's asset; a bank loan is a bank asset and a borrower's liability.
• Bank capital absorbs losses; liquidity helps meet payments when due.
• NPA classification follows current regulatory definitions; thresholds can vary by product and rule.
• DICGC protection is limited and applies to eligible deposits under scheme rules; it is not a blanket guarantee for every financial product.
• Financial inclusion includes suitable use and protection, not only account ownership.
• Digital payments and digital loans are different; verify the legal lender and loan terms.

Quick retrieval

1. Why is a deposit a liability for a bank?

2. What does bank capital do?

3. Why can a gross NPA ratio not alone establish that a bank is safe?

4. Is the DICGC limit per account or per depositor per insured bank under the specified capacity rules?

5. What extra evidence is needed to show that financial inclusion is effective?

Chapter 6 practice MCQs

1. A customer's bank deposit is normally recorded as:

• A. an asset owned by the bank for free
• B. a tax owed to a municipality
• C. a liability of the bank
• D. a share in the Reserve Bank

Answer: C. The bank owes the depositor money under account terms, so the deposit is a liability of the bank and an asset of the customer.

2. A loan made by a bank is usually:

• A. an asset of the bank and a liability of the borrower
• B. a liability of the bank and an asset of the borrower only
• C. a tax revenue receipt
• D. an insurance claim

Answer: A. The bank has a contractual claim to repayment; the borrower owes that repayment.

3. A bank's accounting identity is:

• A. Assets = population + inflation
• B. Capital = taxes + imports
• C. Deposits = GDP − exports
• D. Assets = liabilities + capital

Answer: D. A balance sheet balances assets with liabilities and owners' capital.

4. Bank capital is important because it:

• A. is the same as customer deposits
• B. can absorb losses and support the bank's resilience
• C. guarantees every loan will be repaid
• D. removes the need for liquidity

Answer: B. Capital provides a loss-absorbing buffer, subject to regulatory definitions. It does not eliminate all risk.

5. Liquidity risk refers most directly to the risk that a bank:

• A. has too much literacy
• B. may not have funds available to meet payments when due
• C. will record too many customers in a census
• D. must pay GST on every deposit

Answer: B. Liquidity concerns the availability of funds for obligations when due. It differs from solvency and credit risk.

6. A collateralised loan is not automatically safe because:

• A. collateral removes all legal rules
• B. the borrower no longer owes money
• C. collateral may not fully cover the debt and repayment capacity still matters
• D. interest is prohibited

Answer: C. Collateral may reduce loss but values can fall, enforcement can take time, and cash flow remains important.

7. A loan classified as an NPA is best understood as:

• A. any loan with a high interest rate
• B. a loan that can never be repaid under any circumstance
• C. an asset classified as non-performing under applicable regulatory norms
• D. an account held by a government employee

Answer: C. NPA is a regulatory asset classification. It signals impaired performance under specified rules but does not prove the loan is irrecoverable.

8. A bank has gross loans of ₹800 crore and gross NPAs of ₹24 crore. Its gross NPA ratio is:

• A. 30%
• B. 24%
• C. 3%
• D. 0.3%

Answer: C. Divide 24 by 800 and multiply by 100: 3%.

9. Why should an NPA threshold question name the loan type and applicable rule?

• A. NPA is another word for CPI
• B. All loans use the same threshold forever
• C. The ratio depends only on the bank's logo
• D. Regulatory treatment can vary by product and current instructions

Answer: D. Asset-classification instructions can vary by product and change over time. A universal unqualified rule can be misleading.

10. DICGC deposit insurance is most accurately described as:

• A. a guarantee that bank shares cannot fall
• B. unlimited protection for every investment sold by any app
• C. limited protection for eligible deposits in insured banks under scheme conditions
• D. insurance for every borrower against repayment

Answer: C. DICGC cover applies to eligible deposits and is subject to a monetary limit and scheme conditions.

11. The published DICGC protection limit for an eligible depositor at an insured bank is up to:

• A. ₹50 lakh per credit card
• B. ₹5 lakh under the applicable same-right-and-capacity rules
• C. ₹5 lakh for every separate account without aggregation
• D. an unlimited amount

Answer: B. The DICGC limit is up to ₹5 lakh per depositor per insured bank under the same-right-and-capacity rules, subject to coverage details.

12. Which is not automatically covered by deposit insurance simply because a bank sold it?

• A. a market-linked mutual-fund investment
• B. an eligible bank deposit
• C. an eligible savings deposit
• D. an eligible term deposit

Answer: A. A mutual-fund investment is not a bank deposit and is not covered as a deposit by DICGC. Product nature matters.

13. Financial inclusion is strongest when it includes:

• A. access, suitable use, affordability and consumer protection
• B. only account-opening numbers
• C. only credit-card issuance
• D. only app downloads

Answer: A. Inclusion concerns whether services are available and useful, safe and appropriate, not just whether an account exists.

14. A person owns a bank account but cannot use it because the nearest service point is inaccessible and connectivity is unreliable. This illustrates:

• A. that inflation is zero
• B. that deposits are not liabilities
• C. that GDP equals savings
• D. the difference between account ownership and effective access/use

Answer: D. Account ownership is not the same as convenient and effective use. Physical, digital and accessibility barriers matter.

15. A digital payment is different from a digital loan because:

• A. all digital payments create debt
• B. payment systems do not need records
• C. a loan never involves an app
• D. a payment transfers funds, while a loan creates a repayment obligation

Answer: D. A payment is a funds transfer; a loan creates a debt contract. A digital interface does not determine the legal nature of the transaction.

16. A borrower receiving a loan offer through an app should first identify:

• A. how many emojis appear in the offer
• B. only the colour of the app
• C. the legal lender, total cost, repayment terms and complaint process
• D. the app's advertising slogan

Answer: C. The borrower needs the identity of the regulated lender and the contractual cost/terms, including recourse for complaints.

17. A cold-storage project borrows for equipment but faces uncertain power costs and seasonal demand. The lender should assess:

• A. the previous year's CPI base alone
• B. only the owner's social-media followers
• C. the district's name
• D. cash flow, operating risks, repayment schedule and project viability

Answer: D. Repayment ability depends on expected cash flows and risks. Equipment alone does not guarantee a viable loan.

18. A bank loan with a seasonal repayment schedule may suit an agricultural borrower better than a fixed monthly schedule because:

• A. farmers never use money in other months
• B. income and cash flows may be concentrated around harvest and sale periods
• C. loan rules do not apply to agriculture
• D. seasonal schedules cancel the principal

Answer: B. Repayment design should reflect cash-flow timing and risk while respecting the contract and regulation.

19. A bank's gross NPA ratio falls from 5% to 4% in comparable periods. This most directly suggests:

• A. a lower share of gross loans classified as gross NPAs under the same definitions
• B. that the bank has no risk of loss
• C. that all borrowers received a pay rise
• D. that the bank has unlimited liquidity

Answer: A. The ratio is a credit-quality indicator under comparable definitions. It does not establish overall safety, capital adequacy or liquidity by itself.

20. Why can forcing credit to borrowers without suitable assessment be harmful?

• A. It can create unsustainable debt and losses, even while access goals are important
• B. It always eliminates poverty
• C. It guarantees repayment
• D. It makes deposits disappear from the balance sheet

Answer: A. Responsible lending must balance access with repayment capacity and risk. Poor design can harm borrowers and lenders.

21. A digital transaction is pending, and the receipt does not show final settlement. The user should:

• A. delete the bank account immediately
• B. share an OTP with an unsolicited caller
• C. assume every pending transaction is final
• D. check official status and use the provider/bank's dispute route without sharing credentials

Answer: D. Transactions can fail, remain pending or reverse. Use official dispute channels and never disclose authentication credentials to unsolicited callers.

22. The bank's asset side includes loans because:

• A. loans are grants with no repayment
• B. the bank owns the borrower's entire business
• C. deposits do not appear anywhere
• D. borrowers owe principal/interest to the bank under their contracts

Answer: D. A performing loan is a contractual claim and hence an asset to the bank, subject to impairment and accounting rules.