BANKING IN INDIA

BANKING IN INDIA – PART 1

 

1.HISTORY AND EVOLUTION OF BANKING IN INDIA

• The term Banking originated in the western world.
• Earliest evidence of Banking in India is found from the period of Vedic Civilization. During those days, loan deeds called rnapatra or rnalekhya were prevalent.
• Various types of instruments were found in Buddhist, Mauryan and Mughal periods.
• The Arthashastra of Kautilya mentions presence of bankers during Mauryan era, known as “Adesha” which are equivalent to Bill of exchange of current times.
• The first bank of India called Bank of Hindostan was established in 1770.

 

A bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be performed either directly or indirectly through capital markets.

 

THREE PRESIDENCY BANKS

• Three Presidency banks were set up under charters from the British East India Company- Bank of Calcutta (1806), Bank of Bombay (1840) and Bank of Madras (1843). These banks worked as quasi central banks in India for many years.

IMPERIAL BANK OF INDIA

• In 1921, the three presidency banks were amalgamated to form Imperial Bank of India.
• In 1955, this Imperial Bank of India was nationalized and renamed as State Bank of India (SBI). Thus, SBI is the oldest Bank of India among the banks that exist today.

Banking in India is truly a reflection of a mixed economy with co-existence of public sector banks, private and foreign banks

OLDEST JOINT STOCK BANK OF INDIA

• India’s Oldest Joint Stock Bank is Allahabad Bank. It is also known as India’s oldest public sector bank. It was established in 1865.

A bank that has multiple shareholders is called joint-stock bank.

FIRST BANKS OWNED / MANAGED BY INDIANS

• The first bank purely managed by Indians was Punjab National Bank, established in Lahore in 1895. The PNB is one of the largest banks in India.
• However, the first Indian commercial bank which was wholly owned and managed by Indians was the Central Bank of India which was established in 1911.

Central Bank of India is called India’s First Swadeshi bank. Its founder was Sir Sorabji Pochkhanawala and its first chairman was Sir Pherozeshah Mehta.

Bank of India was the first Indian bank to open a branch outside India, in London in 1946.

 

Year	Bank
1770	The first bank of India called Bank of Hindostan was established in 1770
1861	Paper Currency Act was enacted by British Government of India
1865	Oldest Joint-Stock bank Allahabad Bank was established
1881	Oudh Commercial Bank, the first Bank of India with Limited Liability to be managed by Indian Board was established at Faizabad.
1895	Punjab National Bank was established. It was first bank purely managed by Indians
1911	Central Bank of India, first Indian commercial bank which was wholly owned and managed by Indians, was established. It was called First Truly Swadeshi bank
1921	Three presidency banks – Bank of Calcutta, Bank of Bombay and Bank of Madras amalgamated to form Imperial Bank of India
1935	Creation of Reserve Bank of India
1949	Nationalization of Reserve Bank of India
1949	Enactment of Banking Regulation Act
1955	Nationalization of Imperial Bank of India, which then became the SBI
1969	Nationalization of 14 major Banks
1980	Nationalization of 7 more banks with deposits over Rs. 200 Crore
Reforms	Committees made for reforms in banking sector ???? Narasimham-I (1991), M Narasimham-I (1997), Dr. Raghuram Rajan Committee (2007) and P J Nayak Committee (2014)

 

2.FINANCIAL INTERMEDIARIES

• The institutions that channel funds between savers (surplus) to user (deficit) agents are called financial intermediaries.
• They serve as middlemen between savers (lenders, investors, households) and borrowers (entrepreneurs, business firms.)
• Such FI can be subdivided into (1) Formal (2) Informal.

 

Parameter	Formal	Informal
Definition	Formal system of finance is licensed by central bank	Informal system of finance is not licensed by central bank
Institution	Commercial & development banks – RRBs, post office banks etc.	Saving collectors, saving and credit associations, and moneylenders
Principle clients	Large businesses, salaried workers, small and medium enterprises	People who avail informal finance are either rural poor or self-employed peoples

 

TYPES OF FINANCIAL INTERMEDIARIES

 

FLs

1.Banks

a. Commercial

• • Public
  • Private
  • Foreign
  • RRB

b. Cooperative

• • Urban
  • State
  • PACS

 

2.NBFI

a. AIFI

• • EXIM
  • NHB
  • SIDBI
  • NABARD

b. PRIMARY DEALERS

c. NBFC

 

According to the alternative view of monetary and banking operations, banks are not intermediaries but ‘fundamental money creation’ institutions, while the other institutions in the category of supposed ‘intermediaries’ are simply investment funds.

 

ADVANTAGES OF FINANCIAL INTERMEDIARIES

1. Risk Spreading
2. Convenience
3. Financial specialist
4. Economy of scale
5. Safe investment
6. Greater liquidity

 

IMPACT OF FI ON THE WHOLE ECONOMY

• FIs help circulate money in the system.
• Ensures high velocity of money.
• They promote the habit of savings.
• A needy businessman will easily get loans.
• Promotes new business, expand existing business, hire more employees, increase production of goods/services.

BANKS IN INDIA

Types of Banks in India

1.Central Bank

2.Scheduled Bank

a. Scheduled Commercial Bank

i. Public sector

• • • SBI Group
    • Nationalized Banks
    • Other Public sector banks

ii. Private sector

• • • New
    • Old

iii. Foreign

iv. RRBs

b. Scheduled Cooperative Banks

i. Rural

• • • Primary Credit Societies

ii. Urban

• • • District Cooperative Banks
    • State Cooperative Banks
    • Urban Cooperative Banks

3. Non-scheduled Banks

a. Local Area Banks

b. Non-scheduled Urban Cooperative Banks

3.RBI : ORIGIN AND EVOLUTION

• Prior to establishment of RBI, the functions of a central bank were virtually done by the Imperial Bank of India . RBI started its operations from April 1, 1935.
• It was established via the RBI act 1934, so it is also known as a statutory body. Similarly, SBI is also a statutory body deriving its legality from SBI Act 1955.
• RBI did not start as a Government owned bank but as a privately held bank.
• Post-independence, the government passed Reserve Bank (Transfer to Public Ownership) Act, 1948 and took over RBI from private shareholders after paying appropriate compensation.
• Thus, nationalization of RBI took place in 1949 and from January 1, 1949, RBI started working as a government-owned bank.

 

TIMELINE
1926	The Royal Commission (Hilton Young commission) on Indian Currency and Finance recommended creation of a central bank for India. On the basis of mainly this commission, the RBI Act, 1934 was passed
1934	The RBI Bill was passed and received the Governor General’s assent.
1 April 1935	Reserve Bank commenced operations as India’s central bank as a private shareholders’ bank with a paid up capital of rupees five crore.
1949	The Government of India nationalized the Reserve Bank under the Reserve Bank (Transfer of Public Ownership) Act, 1948.

• The RBI is the supreme monetary and banking authority in the country and controls the banking system in India.
• It is called the ‘Reserve Bank’ as it keeps the reserves of all commercial banks.

Original headquarters of RBI was in Kolkata, but in 1937, it was shifted to Shahid Bhagat Singh Marg, Mumbai.

 

BANKING REGULATION ACT, 1949

• Immediately after the independence, the Government of India came up with the Banking Companies Act, 1949.
• This act was later changed to Banking Regulation (Amendment) Act, 1949.
• Further, the Banking Regulation (Amendment) Act of 1965 gave extensive powers to the Reserve Bank of India as India’s central banking authority.

 

3.2 INSTITUTIONAL STRUCTURE OF RBI

 

RBI

1. Official Directors

• • Governor
  • Governor(Maximum four)

 

2. Non-Official Directors

• • Nominated(10+2)
  • Others(one each from four local boarders)

 

• Central Board of Directors is the top decision making body in the RBI. It is made up of official and non-official directors.
• The Governor and Deputy Governors are the official directors.
• There is a Governor and maximum 4 Deputy Governors (According to Section-8 of RBI Act 1934); so maximum number of Official Directors in RBI’s Central Board of Directors is five.
• Governor and Deputy governors are appointed by Central Government. The tenure of service is maximum of 3 years and can be reappointed
• Further, there are 16 non-official directors in RBI.
• Out of them, four represent the local Boards located in Delhi, Chennai, Kolkata and Mumbai, thus representing 4 regions of India.
• Rest 12 are nominated by the Reserve Bank of India. These 12 personalities have expertise in various segments of Indian Economy.
• The Central Board of Directors holds minimum 6 meetings every year. Out of which, at least 1 meeting every quarter (every 3 months) is held.
• Though, typically the committee of the central board meets every week (Wednesday).

3.3 GOVERNOR OF RBI

• APPOINTMENT– Appointed after the proposal made by the Financial Sector Regulatory Appointments Search Committee (FSRASC), headed by the Cabinet Secretary.
• TERM – According to Section 8 (4) of the RBI Act, the Governor and Deputy Governors shall hold office for such term not exceeding 3 years as the Central Government may fix when appointing them.
• RE-APPOINTMENT – They are eligible for re-appointment
• QUALIFICATION – The RBI Act does not provide for any specific qualification for the governor.
• REMOVAL – The governor can be removed by the central government.

PRESENT GOVERNOR OF RBI– Shri. Shashikant Das (IAS)

 

3.4 SUBSIDIARIES OF RBI

• Deposit Insurance and Credit Guarantee Corporation (DICGC)
• Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL)
• Reserve Bank Information Technology Private Ltd. (ReBIT)
• Indian Financial Technology And Allied Services (IFTAS)

ASSISTIVE BODIES IN RBI – Board of Financial Supervision (BFS) and Board for Payment and Settlement Systems (BPSS); Both of these are chaired by RBI Governor.

 

No. of Press	Four printing presses prints and supply bank notes
Location	1. Dewas – Madhya Pradesh 2. Nashik – Maharashtra 3. Mysore – Karnataka 4. Salboni – West Bengal
Owned by Govt.	The presses in Madhya Pradesh and Maharashtra are owned by the Security Printing and Minting Corporation Of India (SPMCIL), a wholly owned company of GoI. SPMCIL is the only PSU under the Dept. of Economic Affairs (MoF)
Owned by RBI	The presses in Karnataka and West Bengal are owned by Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL), a wholly owned subsidiary of RBI.
Coins	GoI is the issuing authority of coins and supplies coins to the Reserve bank on demand. The RBI puts the coins into circulation on behalf of Central Government

 

3.5 FUNCTIONS OF THE RBI

1. Bank of Issue

• • Issuing money is exclusive right of RBI.
  • All notes except1 note and coins are issued by RBI.
  • It also exchanges or destroys old damaged currencies.
  • 1 notes and coins are issued by Ministry of Finance and circulated by RBI.

2. Custodian and Manager of Foreign exchange

• • RBI keeps the foreign exchange (i.e. foreign currency) which flows into the country.
  • It also keeps the foreign exchange rate stable to certain extent.

3. Banker and Debt Manager to Government

• • It acts as a banker to both central and state governments (except Jammu and Kashmir and Sikkim).
  • It keeps deposits of governments and lends to governments.
  • RBI carries out lending and borrowing operations by issuing government securities on behalf of the government.
  • Though RBI is not a banker to Sikkim and Jammu and Kashmir it manages their public debt to some extent.

4. Banker to bank–

• • It is the banker of all the banks.
  • It keeps the reserve of the banks like cash reserve ratio (CRR) with it.
  • It provides financial assistance to banks against mortgaged securities.
  • It rediscounts bills of exchange.
  • Usually banks borrow and lend money among themselves via call money market, regulated by RBI.
  • RBI provides enough money to banks and so called as lender of last resort.

5. Monetary Management – Controller of Money Supply, Makes Monetary Policy, Credit Control etc
6. Financial Regulator – to Commercial banks, Credit information Companies, RRBs, Local Area Banks, NBFC etc.
7. Representative role – RBI represents govt. as a member of the IMF and World Bank.
8. Central Clearance and Accounts Settlement – As RBI keeps cash reserves from commercial banks therefore it rediscounts their bills of exchange easily.
9. Developmental role – Performing a variety of developmental and promotional functions under which it did set up institutions like IDBI, SIDBI, NABARD, NHB, etc.
10. Promotional Roles – Consumer protection, Ombudsman, Financial Inclusion through PSL norms, 25% rural branch requirements etc.

 

NEW INITIATIVE OF RBI IN CREDIT AND MONETARY POLICY REGIME

• Transition to bi-monthly monetary policy cycle
• Recognition of the glide path for disinflation (on recommendation of Urjit Patel Committee report). Under it, the CPI (C) is used by the RBI as the “Headline Inflation” for monetary management.
• A Monetary Policy Framework (2015) has been put in place – an agreement in this regard was signed between the Government of India and the RBI late February 2015. Under the framework, the RBI is to ‘target inflation’ at 4 per cent with a variations of +/- 2 per cent. (of the CPI-C).
• Besides the existing repo route, term repos have been introduced for three set of tenors – 7, 14 and 28 days – Move aimed at improving the transmission of policy and stability to loan market.
• As per the Union Budget 2016-17, individuals will also be allowed by the RBI to participate in the government security market (similar to the developed economies like the USA).
• RBI is progressively reducing banks’ access to overnight liquidity (at the fixed repo rate), and encouraging the banks to increase their dependency on the term repos.

 

3.6 SOURCES OF INCOME AND EXPENDITURE OF RBI

INCOME	EXPENDITURE
Returns from foreign currency assets	Printing of currency
Interest on rupee-denominated government bonds	Staff expenditure
Interest on overnight lending to commercial banks.	Commission given to commercial banks.
Management commission on handling the borrowings of central and state governments.	Commission to primary dealers.

 

3.7 ASSETS AND LIABILITIES OF RBI

RESERVE BANK OF INDIA
LIABILITIES	ASSETS
Currency held by Public	Foreign currency assets
Vault cash held by commercial banks	Bill purchases and discounts
Government securities	Collaterals by commercial banks
Other liabilities	Loan and advances
	Rupee securities Gold coin bullion

 

3.8 INDEPENDENCE OF THE RBI

• Under section 7 of the RBI Act 1934, the central government may from time to time give such directions to the RBI as it may, after consultation with the Governor of the Bank, considered necessary in the public interest. Moreover, there is no legal act mandating autonomy of the RBI.
• RBI is not only vested with the powers to formulate the monetary policy but also to monitor the functioning of all banks.
• To play its role effectively, autonomy in its functioning is sine qua non for RBI.
• However, this has been challenged many times due to a continued tug of war for wresting more power between the bank and the govt.

 

3.9 REASONS FOR DIMINISHING AUTONOMY OF RBI

• check the growth of NPAs.
• Reduced liquidity in the economy due to tight monetary policy followed by RBI.
• Corrective measures taken by RBI to clean up the banking system which are not seen very positively by the government.
• Impossible trinity of RBI- capital mobility, Exchange rate flexibility and monetary autonomy.
• Clashbetween short term populist agenda of the government and long term view for price stability taken by RBI.
• One important limitation is that the Reserve Bank is statutorily limited in undertaking the full scope of actions against public sector banks (PSBs).
• Erosion of statutory powers of the central bank through piece-meal legislative amendments that directly or indirectly eat away separation of the central bank from the government.

 

3.10 PUBLICATIONS OF RBI

1. Report on Trend and Progress of Banking in India-Annually
2. Financial stability report- Half yearly
3. Monetary policy report- Half yearly
4. Report on foreign exchange reserves- Half yearly
5. Bi-monthly Policy Statement
6. Industrial Outlook Survey of the Manufacturing Sector (Quarterly)
7. Consumer Confidence Survey (Quarterly)
8. Report on Financial Review

 

3.11 MINIMUM RESERVE SYSTEM OF RBI

With a minimum value of government-held gold of ₹200 crores (₹115 cr rupee should in the form of Gold or gold bullion and rest ₹85 cr should be in the form of foreign currencies) and the remaining is backed by the government securities issued and held by RBI.

 

OBJECTIVES OF MINIMUM RESERVE SYSTEM (MRS)

• To maintain the money supply in the economy without inflationary pressure and maintain the confidence of the general public in the currency.
• To ensure the confidence of the Indian currency holders that the currency held by them is a legal tender.
• RBI wants to ensure the appropriate supply of currency in the economy through MRS.
• Through the MRS, the RBI accelerate the economic growth of the country without increasing the rate of inflation in the economy.

 

SCHEDULED BANK Vs NON- SCHEDULED BANK

Scheduled Bank	Non-Scheduled Bank
Scheduled banks are those which are mentioned in 2nd schedule of RBI Act 1934	Non-scheduled banks are those which are not in 2nd schedule of RBI Act 1934
Required to deposit CRR money to RBI	Can maintain the CRR money with themselves.
Eligible to borrow / deposit funds in RBI’s window operations.	Depends on RBI’s discretion.
Are required to protect the interests of depositors and abide to RBI norms.	They also need to follow RBI Norms or there can be action under Banking Regulation Act.

 

3.12PRIORITY SECTOR LENDING (PSL)

• All Indian banks have to follow the compulsory target of priority sector lending (PSL).

Categories	Domestic scheduled commercial banks (excluding RRB and SFB) and Foreign banks with 20 and above branches	Foreign banks (less than 20 branches)
Total Priority Sector	40 per cent of Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.	40 per cent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, to be achieved in a phased manner by 2020.
Agriculture #	18 per cent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher. Within this 18 percent target ???? 8 percent is prescribed for Small and Marginal Farmers.	Not applicable
Micro Enterprises	7.5 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.	Not applicable
Advances to Weaker Sections	10 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher	Not applicable
# Domestic banks have been directed to ensure that their overall direct lending to non-corporate farmers does not fall below the system-wide average of the last three years achievement.

In 2007, the RBI included five minorities – Buddhists, Christians, Muslims, Parsis and Sikhs under the PSL.

 

PRIORITY SECTOR LENDING CERTIFICATES (PSLCS) – are a mechanism to enable banks to achieve the PSL target and sub-targets by purchase of these instruments in the event of shortfall.

 

CATEGORIES IN PSL

Priority sector loans to the following borrowers are eligible to be considered under Weaker Sections category:-

1.	Small and Marginal Farmers
2.	Beneficiaries under Government Sponsored Schemes – Such as NRLM, NULM etc.
3	Weaker sections of society – Scheduled Castes and Scheduled Tribes, women
4	Beneficiaries of Differential Rate of Interest (DRI) scheme
5	Self Help Groups
6	Distressed farmers indebted to non-institutional lenders
7	Persons with disabilities
8	Minority communities
9	Agriculture
10	Micro, Small and Medium Enterprises
11	Housing
12	Renewable Energy
13	Social Infrastructure
14	Education
15	Start ups

 

Recent changes in PSL (7 Aug 2020)

NEWS – Priority sector lending: Start-ups included, renewables limits expanded

The changes include broadening the scope of PSL to include start-ups, increasing the limits for renewable energy, including solar power and compressed biogas plants and increasing the targets for lending to small and marginal farmers and weaker sections.

“The revised guidelines also aim to encourage and support environment-friendly lending policies to help achieve Sustainable Development Goals (SDGs),” the RBI said

 

Q. Priority Sector Lending by banks in India constitutes (CSE- 2013) Agriculture Micro and Small Enterprises Weaker Sections All of the above

 

3.13 MONETARY POLICY OF RBI

• Monetary Policy is an instruments under RBI aimed at regulating interest rates, money supply and availability of credit in an economy.
• RBI decides monetary policy cycle on bi-monthly basis.

 

OBJECTIVES OF MONETARY POLICY

• Economic and financial stability – To regulate monetary expansion so as to maintain a reasonable degree of price stability. Maintaining price stability.
• Development – To ensure adequate financial resources for the purpose of development.
• flow of credit – Adequate flow of credit to productive sectors.
• Employment and growth – Promotion of productive investments & trade. Equitable distribution of income. Employment generation
• International trade and exports – Promotion of exports and economic growth. Maintaining exchange rate stability.

 

TOOLS OF MONETARY POLICY

Quantitative Instruments

1. Liquidity Adjustment Facility (Repo and Rev. Repo
2. Open Market Operations
3. SLR, and CRR
4. Bank Rate
5. Credit Ceiling
6. Marginal Standing Facility

Qualitative Instruments

1. Credit Rationing
2. Moral Suasion
3. Promt Corrective Action(PCA)
4. Direct action by RBI on banks
5. Differential Interests Rates

QUANTITATIVE INSTRUMENTS

1.RESERVE RATIO (CRR)

• • CRR is the certain % (fixed by the RBI) of Net Time and Demand Deposits of a Scheduled bank in India need to kept with the RBI in the form of cash only.
  • CRR aimed to have control over banks credit.
  • The ratio between 3% (floor) -15% (ceiling) removed via RBI (Amendment) Bill 2006.

An increase in CRR ???? higher proportion of deposits to be kept with RBI by banks ???? less funds are available to be provided as credit to the economy ???? money supply will decrease.

 

2.STATUTORY LIQUIDITY RATIO (SLR)

• • The schedule banks needs to also keep certain % (fixed by the RBI) of their Net Time and Demand Deposits kept with itself (i.e. not with RBI) in the form of liquid assets such as cash, gold and select government securities.
  • Need of SLR is to prevents bank from lending all its deposits which is too risky and it is mandatory under Banking Regulation Act 1949.
  • Similar to CRR, SLR aimed to have control over banks credit.
  • SLR includes G-Secs, thus it ensures certain amount of money is secured for govt.
  • There were excessively high rates (about 25-30 percent) prevalent before 1991 reforms with provision of ceiling and floor.

An increase in SLR ???? higher proportion of funds to be kept aside by banks in liquid form ???? less funds available to be provided as credit to the economy ???? money supply will decrease.

Higher the CRR and SLR, lower will be the liquidity in the system as Banks will have lesser money for providing loans. For instance, CRR and SLR rate is 4% and 19.5% respectively. Bank deposits is Rs.100 crores then bank can sanction loans upto 76.5 crores.

 

Q. When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points, which of the following is likely to happen? (CSE-2015) India’s GDP growth rate increases drastically Foreign Institutional Investors may bring more capital into our country Scheduled Commercial Banks may cut their lending rates It may drastically reduce the liquidity to the banking system

 

Q. In the context of Indian economy, which of the following is/are the purpose / purposes of ‘Statutory Reserve Requirements? (2014) To enable the Central Bank to control the amount of advances the banks can create. To make the people’s deposits with banks safe and liquid. To prevent the commercial banks from making excessive profits. To force the banks to have sufficient vault cash to meet their day-to-day requirements. Select the correct answer using the code given below. 1 only 1 and 2 only 2 and 3 only 1, 2, 3 and 4

 

 

3.BANK RATE

• • Rate at which RBI provides long-term borrowings to its clients. Its clients include GoI, state governments, banks, financial institutions, cooperative banks etc.
  • Increase in the bank rate is the symbolizes tightening of RBI monetary policy. (i.e. Dearer Monetary Policy)
  • An increase in bank rate will make borrowing from RBI expensive ???? discourage banks to borrow from RBI ???? money supply will tend to decrease.
  • It presently uses it as a penalty rate imposed by RBI on banks for violations of RBI directives.

 

Q.An increase in the Bank Rate generally indicates that the (CSE-2013) market rate of interest is likely to fall Central Bank is no longer making loans to commercial banks Central Bank is following an easy money policy Central Bank is following a tight money policy

Q. The lowering of Bank Rate by the Reserve Bank of India leads to (CSE-2012) More liquidity in the market Less liquidity in the market No change in the liquidity in the market Mobilization of more deposits by commercial banks

 

4. REPO RATE (POLICY RATE)

• • It is the rate (Rate of Repurchase) at which commercial banks borrow from RBI (which provides short-term liquidity to banks) by mortgaging their dated Government securities and Treasury bills (T-Bills).
  • Increase in repo rate borrowing from RBI expensive banks will borrow less from RBI ???? less credit will be provided by banks to households ???? money supply will decrease.
  • Decrease in Repo Rate ???? Borrowing from RBI is cheaper ???? Banks will borrow more ???? More credit is available ???? Money supply will increase.
  • Reduction in Repo rate helps the banks to get money at a cheaper rate and increase in Repo rate discourages the banks to borrow from RBI.
  • The Call Money Market of India (inter-bank market) operates at this rate and banks use this route for overnight borrowings.
  • Repo rate has direct relation with the interest rates banks charge on the loans they offer (as it affects the operational cost of the banks).

 

5. REVERSE REPO RATE

• • It is the rate at which RBI borrows from commercial Banks by mortgaging its dated Government securities and Treasury bills.
  • An increase in reverse repo rate means that commercial banks will get more incentives to park their funds with the RBI, thereby decreasing the supply of money in the market.
  • A decrease in reverse repo rate means that commercial banks will get less incentive to park their funds with RBI and thus more money is available in the market increasing the money supply.
  • It has a direct bearing on the interest rates charged by the banks and the financial institutions on their different forms of loans.

 

6. MARGINAL STANDING FACILITY (MSF)

• • Liquidity management window given by RBI under which banks can borrow additional overnight (one day) liquidity over and above LAF window.
  • Introduced to deal with unforeseen liquidity crunch because under LAF banks can borrow overnight liquidity only by pledging securities over and above the securities held under SLR requirement.
  • Under MSF, on the other hand, banks can pledge securities held for SLR purposes.
  • The interest rate for MSF is Repo rate plus 1%. Usually, the Reverse Repo rate is Repo rate minus 1%. Therefore, the Repo rate act as an anchor rate. The Repo rate stands in the middle of two. The MSF rate stands above and Reverse Repo rate stands below the Repo Rate.

MSF (RR+1%) ???? RR (Anchor rate) ???? RRR (RR-1%)

• • Under this facility, banks can borrow funds up to 1% of their Net Demand and Time Liabilities (NDTL)

NDTL shows the difference between the sum of demand and time liabilities (deposits) of a bank (with the public or the other bank) and the deposits in the form of assets held by the other bank.

Bank’s NDTL = Demand and time liabilities – deposits with other banks

 

Q.The terms ‘Marginal Standing Facility Rate’ and ‘Net Demand and Time Liabilities’, sometimes appearing in news, are used in relation to (2014) a) Banking operations b) Communication networking c) Military strategies d) Supply and demand of agricultural products

 

7. OPEN MARKET OPERATIONS (OMO)

• • OMO refers to sale and purchase of government securities by RBI in the open market with the aim of influencing liquidity in the economy in the medium term.

 

If RBI sells	If the RBI buys
If the RBI sells these instruments, banks and public will buy it and pay money to the RBI.	If the RBI buys these instruments from instrument holders, it will pay money to the latter.
During inflation the RBI sells government securities. As a result money supply in the economy falls causing prices to fall.	During deflation, the RBI will buy back the securities thus causing money supply to rise which cures deficiency in demand.

Open Market Purchase by RBI ???? It will release liquidity in the economy ???? money supply will increase.

 

Q. With reference to Indian economy, consider the following: (2015) Bank rate Open market operations Public debt Public revenue Which of the above is/are component/components of monetary policy? a) 1 only b) 2, 3 and 4 only c) 1 and 2 only d) 1, 3 and 4

 

Q. In the context of Indian economy, ‘Open Market Operations’ refers to (2013) borrowing by scheduled banks from the RBI lending by commercial banks to industry and trade purchase and sale of government securities by the RBI None of the above

 

8. LIQUIDITY ADJUSTMENT FACILITIES (LAF)

• • Monetary policy instrument that the RBI uses in order to influence the liquidity conditions in the market in the short term.
  • Under the LAF window, the RBI uses various instruments to inject or absorb liquidity to or from the market respectively.
  • Repo and Reverse repo rates are a part of RBI’s “Liquidity Adjustment Facility (LAF)”.
  • The RBI introduced a LAF as a result of the Narasimham Committee on Banking Sector Reforms (1998).

9. LONG TERM REPO OPERATIONS (LTRO)

• • New policy tool used by the RBI to inject more liquidity into the Economy.
  • Similar to the term repos, but with a longer maturity period of 1 year and 3 years.
  • Through the LTRO, the RBI seeks to inject long term liquidity into the economy at a lower interest rate.
  • The LTROs would be carried out through e-Kuber.

e-Kuber is the Core Banking Solution (CBS) of the RBI which enables each bank to connect their single current account across the country.

 

LATEST RBI BANK RATES IN INDIAN BANKING ( July 2020)

Repo Rate	4.00%
Reverse Repo Rate	3.35%
MSF	4.25%
Bank Rate	4.25%
Cash Reserve Ratio	3.00%
Statutory liquidity ratio	18.00%

Source – https://www.rbi.org.in/

 

 

QUALITATIVE INSTRUMENTS

1. CREDIT RATIONING

• • Rationing of credit is a method by which the RBI seeks to limit the maximum amount of loans and advances and, also in certain cases, fix ceiling for specific categories of loans and advances.

2. MARGIN REQUIREMENTS

• • Qualitative tool used by the RBI in order to regulate the credit flow to a particular sector.
  • When a bank advances credit to its customers it does so against collateral. However there is a difference between the value of the security and the loan offered. This difference is called ‘Margin’.

3. MORAL SUATION

• • It refers to a method adopted by the Central Bank to persuade or convince the commercial banks to advance credit in the economic interest of the country.
  • “Persuasion” without applying punitive measures.
  • Since it involves no administrative compulsion or threats of punitive action it is a psychological and informal means of selective credit control.

 

4. DIFFERENCIAL RATE OF INTEREST

• • The differential rate of interest (DRI) is a lending programme launched by the government in April 1972 which makes it obligatory upon all the public sector banks in India to lend 1 per cent of the total lending of the preceding year to ‘the poorest among the poor’ at an interest rate of 4 per cent per annum.

 

5. DIRECT ACTION

• • This step is taken by the RBI against banks that don’t fulfill conditions and requirements. RBI may refuse to rediscount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate, for credit demanded beyond a limit.

 

6. PROMPT CORRECTIVE ACTION (PCA)

• • The PCA is triggered when banks breach certain regulatory requirements like minimum capital, and quantum of non-performing assets.
  • To ensure that banks don’t go bust, RBI has put in place some trigger points to assess, monitor, control and take corrective actions on banks which are weak and troubled.

7. CONSUMER CREDIT REGULATION

• • RBI can issue rules to set the minimum/maximum level of down-payments and periods of payments for purchase of certain goods.

3.15 UNCONVENTIONAL MONETARY POLICY INSTRUMENTS BY RBI

 

1. ZERO INTEREST RATE POLICY (ZIRP)

• • Policy also called as ‘Quantitative Easing’.
  • This policy was adopted by USA from 2008 in the wake of financial crisis to inject money into the economy.
  • Under this policy, the Fed Bank provides loans to the banks at low interest rates (0.25%) to spur investment level in the economy.

2. NEGATIVE INTEREST RATE POLICY (NIRP)

• • In NIRP, the banks would be required to pay interest to the central bank if they park their surplus reserves.
  • This encourages the banks to provide loans to the borrowers at cheaper rates instead of parking their surplus reserves with the Central Bank.
  • This policy is usually followed in developed economies such as Japan, Denmark, Sweden, Switzerland etc

3. HELICOPTER MONEY

• • This involves the central bank of the country printing currency notes and distributing it to the people free of cost. The idea is to promote demand in the economy during recession.

 

3.16 OTHER MONETARY TOOLS USE BY RBI

1. CALL MONEY MARKET

• It is a Inter Bank money market for short-term financial assets that are close substitutes of money.
• The call money market is an important segment of the money market where borrowing and lending of funds take place on overnight basis (for one day)
• Money market also known as ‘overnight borrowing money at call’.
• Funds raising/borrowing maximum period ???? 14 days (“Short notice”)
• Borrowing can take place against securities or without securities.
• Rate of Interest – ‘glides’ with ‘repo rate’.
• Longer the interest rate ???? higher the interest rate.
• Real call rate ???? revolves nearby current repo rate, according to the availability and demand of fund in market.
• Borrowers as well as lenders ???? Schedule commercial banks, cooperative banks.
• Lender only ???? LIC, GIC, mutual funds, IDBI and NABARAD.

 

2. MARKET STABILISATION SCHEME (MSS)

• MSS is a policy tool used by the Reserve Bank of India to suck out excess liquidity from the market through issue of securities like T-Bills, Dated Securities etc. on behalf of the government.
• The RBI initiated the MSS scheme in 2004, to control the surge of US dollars in the Indian market, RBI started buying US dollars while pumping in rupee
• MSS was introduced to deal with the excess liquidity in the market which could lead to inflation.
• The issued securities under the MSS are government bonds and they are called as Market Stabilisation Bonds and these securities are owned by the government though they are issued by the RBI.

 

Post demonetization (2016) RBI has raised the ceiling for MSS 20 times to suck excess cash out of the banking system and help banks earn some return from the voluminous deposits they have garnered after the government’s demonetization move.

3. STANDING DEPOSIT FACILITY SCHEME

• Standing deposit facility is a collateral free liquidity absorption mechanism which aims to absorb liquidity from commercial banking system into RBI.
• Concept was first recommended by the Urjit Patel committee report in 2014.
• The new scheme has been proposed by the Union Budget 2018-19.
• The scheme is aimed at helping RBI to manage liquidity in a better way, especially when the economy is flush with excess fund (as was seen after the demonetisation 2016).

 

 

3.17 TYPES OF MONETARY POLICY

TYPES OF MONETARY POLICY

1. CONTRACTIONARY MONETARY POLICY
2. EXPENSIONARY MONETARY POLICY

 

CONTRACTIONARY MONETARY POLICY

• Contractionary Monetary Policy also called a Dear Money Policy.
• It is pursued to control Inflation.

 

Case 1	Case 2
· If CRR is increased. · SLR is also increased · Lending capacity of the Banks decreases · Bank rate is increased. · This leads to RBI charging higher rate of interest on bank lending due to which banks borrow less from RBI.	· Repo Rate is increased · Reverse Repo Rate is also increased · This leads to, RBI paying more interest on Banks deposits · Thus Banks prefer to deposit extra money with RBI instead of giving loans to public · It is called Dear Money Policy as loans get expensive for the public

 

EXPANSIONARY (CHEAP) MONETARY POLICY

• This policy is adopted to increase money supply in the economy in order to stimulate economic growth.
• It is also pursued to overcome recession.
• CRR, SLR, Repo Rate, Reverse Repo Rate, Bank Rate should be reduced.
• It is called Cheap Money policy as interest rates are low thus borrowing money becomes cheap.

 

 

3.18 STRATEGIES OF A MONETARY POLICY MAKING

STRATEGIES OF A MONETARY POLICY MAKING

1. Exchange rate stability
2. Multiple Indicators
3. Inflation targeting

 

STRATEGIES OF A MONETARY POLICY MAKING

1. Exchange rate stability – Singapore & other export-oriented economies use this.
2. Multiple Indicators – Central Bank tries to focus on Growth, Employment, Inflation Control and Exchange rate stabilization. India’s RBI had this before 2016.
3. Inflation targeting – here the Central Bank only aims to keep inflation under control, then other indicators (growth, employment, exchange rate) will automatically fall in line. It was successful in Western nations, adopted in India 2016, based on Urjit Patel Committee Report (2013-14), by amending RBI Act Section 45.

3.19 MONETARY POLICY COMMITTEE (MPC)

• MPC is a statutory body created under Monetary Policy Framework Agreement 2015 between the RBI and Government in 2016
• MPC is entrusted with the responsibility of fixing the benchmark repo rate (policy rate) required to contain inflation as defined in the Monetary Policy Framework Agreement.
• The meetings of the MPC are held at least 4 times a year and it publishes its decisions after each such meeting.
• MPC is 6-member body including 3 members from RBI and 3 members to be nominated by the Central Government.

• These Government of India nominees are appointed by the Central Government based on the recommendations of a search cum selection committee. Moreover, nominees of the MPC will hold office for a period of four years and will not be eligible for re-appointment.
• Decisions are taken by majority with the Governor having the casting vote in case of a tie.
• Chairperson of MPC – RBI Governor
• Quorum for meeting – 4 members
• To ensure transparency – Govt can send message only in writing.
• Committee must publish its proceedings of the meeting on the 14th day, and “Monetary policy report” at every 6 months.
• Inflation target decided by Union Government after consulting with RBI Governor.
• The present mandate of the committee is to maintain 4% annual inflation (until March 31, 2021) with bandwidth of ceiling 6% and a floor of 2%.
• If Target fail: If inflation not kept in 4% +/-2% zone for 3 consecutive quarters then Committee must send report to Govt. with reasons and remedies.

 

3.20 LIMITATIONS OF MONETARY POLICY

• Existence of black money in the economy limits the working of the monetary policy
• Conflicting objectives – To achieve the objective of economic development, the monetary policy is to be expansionary but to achieve the objective of price stability and curb on inflation policy is to be contractionary.
• Underdeveloped Indian money market – The weak money market limits the coverage, as also the efficient working of the monetary policy.
• Indian Banks don’t immediately pass on the RBI rate cuts to customers (monetary transmission), citing NPA/Bad loans/profitability problem.
• Government Side Issues – Fiscal repression, Fiscal slippage, Fiscal deficit, Subsidy leakage, Populist Loan-waivers etc.
• Structural Issues in Economy – Lack of electricity-road infrastructure / Ease of Doing Biz production, long pending land and labour reforms.
• Presence of Informal moneylenders in rural areas – circulate illegitimacy money at exorbitant interest rates.
• Poor penetration of banking sector and financial inclusion etc.

 

Q. Which of the following statements is/are correct regarding the Monetary Policy Committee (MPC)? (2017) It decides the RBI’s benchmark interest rates. It is a 12-member body including the Governor of RBI and is reconstituted every year. It functions under the chairmanship of the Union Finance Minister. Select the correct answer using the code given below 1 only 1 and 2 only 3 only 2 and 3 only

 

 

FINANCIAL STABILITY AND DEVELOPMENT COUNCIL

FSDC is a non-statutory apex council setup in 2010 under the Ministry of Finance and chaired by the Finance Minister. Its constitution was proposed by the Raghuram Rajan committee (2008) on financial sector reforms.

Members ????

1. Governor of RBI,
2. Chairperson of SEBI
3. Chairperson of IRDA
4. Chairperson of PFRDA
5. Finance Secretary and/or Secretary, Department of Economic Affairs (Union Finance Ministry)
6. Secretary, Department of Financial Services
7. Chief Economic Adviser.

Functions of FSDC ????

• Monitor macro-prudential supervision of the economy.
• Assess the functioning of the large financial conglomerates.
• Enhancing inter-regulatory coordination
• Promoting holistic financial sector development.
• To strengthen and institutionalize the mechanism for maintaining financial stability

In recent meeting, it was noted that the COVID-19 pandemic poses a serious threat to the stability of the global financial system since its impact and timing of recovery was still uncertain.

 

 

Q. With reference to ‘Financial Stability and Development Council’, consider the following statements (CSE-2016) It is an organ of NITI Aayog. It is headed by the Union Finance Minister. It monitors macro prudential supervision of the economy Which of the statements given above is/are correct? 1 and 2 only 3 only 2 and 3 only 1, 2 and 3

3.21 MONETARY POLICY TRANSMISSION

• Monetary policy transmission is said to have occurred when the changes in the policy rates (repo, reverse repo) will lead to corresponding change in the interest rates in retail sector. (Housing, auto loans etc.)

INTEREST RATES AND MONETARY POLICY TRANSMISSION

• Subject to norms of the RBI, Banks in India are free to determine interest rates on the loans/deposits they extend to their customers.
• However banks publish the minimum interest rates they charge their best clientele.
• This minimum interest rate is commonly called as prime lending rate. However the problem with prime lending rate was that it was not transparent.
• In 2016, RBI introduced the concept of MCLR in order to ensure monetary policy transmission.
• Under MCLR the banks use the marginal cost for obtaining funds to set their lending rates.
• MCLR has replaced base rate system of fixing interest rates.

 

3.22 BENCHMARK PRIME LENDING RATE (BPLR)

• BPLR was used as benchmark rate by banks for lending till June 2010.
• Under BPLR, bank loans were priced on the actual cost of funds.
• However, the BPLR was subverted, resulting in an opaque system. The bulk of wholesale credit (loans to corporate customers) was contracted at sub-BPL rates and it comprised nearly 70% of all bank credit.
• Under BPLR system, banks were subsidising corporate loans by charging high interest rates from retail and small and medium enterprise customers.

3.23 BASE RATE

• Base Rate is the interest rate below which Scheduled Commercial Banks will lend no loans to its customers –
• It replaced the idea of BPLR on 1 July, 2010. The BPLR system, introduced in 2003, fell short of its original objective of bringing transparency to lending rates.
• This was mainly because under this system, banks could lend below BPLR. This made a bargaining by the borrower with bank- ultimately one borrower getting cheaper loan than the other, and blurred the attempts of bringing in transparency in the lending business.
• Loans taken between June 2010 and April 2016 from banks were on base rate.
• Base rate is calculated on following three parameters –

 

 

BASE RATE

1. Blended cost of funds (liabilities)
2. Average cost of funds
3. Marginal cost of funds

 

• Hence, the rate depended on individual banks and they changed it whenever their cost of funds and other parameters changed.
• For the same reason, it was also difficult to assess the transmission of policy rates of the Reserve Bank to lending rates of banks.
• The Base Rate system is aimed at enhancing transparency in lending rates of banks and enabling better assessment of transmission of monetary policy.
• Banks are not allowed to offer any loan below their base rates.

 

3.24 MARGINAL COST OF FUNDS BASED LENDING RATE

• The MCLR refers to the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is an internal benchmark or reference rate for the bank.
• In 2016, RBI introduced the concept of MCLR in order to ensure monetary policy transmission.
• Under MCLR, the banks use the marginal cost for obtaining funds to set their lending rates.
• Marginal cost includes cost that the banks incur to obtain fund like in case of deposit from customers or at repo rate from RBI.
• MCLR has replaced base rate system of fixing interest rates in 2016.
• Since October 2019, The RBI has made it mandatory for all banks to link all new floating rate loans to an external benchmarking. The move is aimed at faster transmission of monetary policy rates.

Base Rate	MCLR
Applies to home loans taken from 1 april 2010 to 31st march 2016.	Applies to home loans taken 1 april 2016 onwards.
Following repo rate cuts by the RBI, lenders may take a long time to reduce their interest rates	Following repo rate cuts by the RBI, MCLR will change right away.
The benefits of a rate cut do not trickle down to the customer quickly when interests rates fall.	Lenders reduce the MCLR soon after a rate cut. So, customers quickly.

 

REASONS FOR IMPLEMENTING THE MCLR SYSTEM

• To improve the transmission of monetary policy
• To bring transparency in the methodology of banks to fix interest rates.
• To ensure that bank credit is available at interest rates which are fair to both borrowers and lenders.
• Currently it is an internal benchmark or reference rate for the bank.
• Banks will have more competition and their long-run value will increase.

THE MAIN FEATURES OF MCLR

• It will be a tenor linked internal benchmark, to be reset on annual basis.
• Actual lending rates will be fixed by adding a spread to the MCLR.
• To be reviewed every month on a pre- announced date.
• Existing borrowers will have the option to move to it.

 

PROBLEM WITH MCLR-BASED SYSTEM

• Due to internal benchmarking of loan, policy rate cuts often don’t reach the borrowers.
• It is opaque since it’s an internal benchmark that depends on the way a bank does its business.

 

FINANCIAL INCLUSION INDEX

It was launched by the Minister of Finance. The composite index gives a snap shot of level of financial inclusion that would guide Macro Policy perspective. The index will have three measurement dimensions, viz. (i) access to financial services; (ii) usage of financial services; and (iii) the quality of the products and the service delivery.

 

Q. What is/are the purpose/purposes of the `Marginal Cost of Funds based Lending Rate (MCLR)’ announced by RBI? (CSE-2016) These guidelines help improve the transparency in the methodology followed by banks for determining the interest rates on advances. These guidelines help ensure availability of bank credit at interest rates which are fair to the borrowers as well as the banks. Select the correct answer using the code given below. 1 only 2 only Both 1 and 2 Neither 1 nor 2

 

3.25 EXTERNAL BENCHMARKING OF INTEREST RATES

• Under the new system which will come into effect from April 1, 2019, banks will have to link their lending rates with an external benchmark instead of MCLR.

 

BENEFITS

• Better transmission of policy rate cuts.
• It will make interest rate fixing more transparent.
• Better benchmark for borrowers to compare loans offered by different banks.

 

Marginal Cost of Lending Rate	Repo-Linked Loan
Linked to banks’ cost of funds	Linked to RBI’s lending rate
Takes 4-6 months to move after RBI rate cut	Responds immediately to RBI rate cut
RBI rate cuts not fully passed on to borrowers	Rate cuts are automatically passed on
Resets annually for most banks	Reset every three months
Changes by 5-10 bps	Usually changes 25bps or more
Revised every month	Reviewed bi-monthly
Low volatility	Higher volatility

100bps=1% | Repo RBI’s lending rate to banks

 

• NET DEMAND AND TIME LIABILITY (NDTL)

• Banks are in the business of accepting deposits and deploying these funds by way of lending and thereby earning profit in the process.
• The resources mobilized by the bank for lending are its liabilities. Liabilities of a bank can be classified broadly into:

 

LIABILITIES OF BANK

1. Demand Liabilities
2. Time Liabilities

• Demand and time deposits from public form the largest share of bank’s liabilities.

Demand Liabilities	Time Liabilities
The demand liabilities for a bank include all those liabilities which are payable on demand, Which includes – Current deposits, Savings bank deposits and Demand Drafts (DDs).	Time liabilities of a bank are those liabilities of a bank which are payable otherwise on demand means after a certain time period. Ex: Fixed Deposit.
In total it is called NDTL.

 

3.27 CHRONOLOGY OF LENDING RATES

YEAR	INITIATIVES
1969	Began nationalization of private banks, and ‘Administered Interest Rates’ on them.
1991	M. Narasimham suggested deregulation: Govt should not dictate / administer individual banks’ interest rates. RBI should only give methodology to banks.
2003	RBI introduced Bench march Prime lending rate(BPLR).
2010	RBI introduced BASE Rate + Spread system; update frequency on individual banks’ discretion.
2016	RBI introduced Marginal cost of lending rates(MCLR) + Spread system.
2019	The RBI has made it mandatory for all banks to link all new floating rate loans (i.e. personal/retail loans, loans to MSMEs) to an external benchmarking. The move is aimed at faster transmission of monetary policy rates.

 

3.28 WAYS AND MEANS OF ADVANCES (WMA)

• The RBI gives temporary loan facilities to the centre and state governments as a banker to the government. This temporary loan facility is called WMA.
• It is a mechanism to provide to States to help them tide over temporary mismatches in the cash flow of their receipts and payments.
• It was introduced on April 1, 1997, after putting an end to the four-decade-old system of ad-hoc (temporary) Treasury Bills to finance the Central Government deficit.
• Under Section 17(5) of RBI Act, 1934, the RBI provides Ways and Means Advances (WMA) to the central and State/UT governments.

 

WAYS TO AVAIL WMA

• This facility can be availed by the government if it needs immediate cash from the RBI.
• The WMA is to be vacated after 90 days.
• The interest rate for WMA is currently charged at the repo rate.
• The limits for WMA are mutually decided by the RBI and the Government of India.

 

TYPES OF WMA

1. Normal
2. Special

 

• Special WMA or Special Drawing Facility is provided against the collateral of the government securities held by the state.
• After the state has exhausted the limit of SDF, it gets normal WMA. The interest rate for SDF is one percentage point less than the repo rate.
• The number of loans under normal WMA is based on a three-year average of actual revenue and capital expenditure of the state.
• The RBI has raised the Ways and Means Advances, or WMA, limit by 30% for all States and UTs to enable them to tide over the crisis caused by COVID-19 outbreak.

BAKING INDIA – PART 2

 

COMMERCIAL BANKS

• Commercial banks may be defined as any banking organization that deals with the deposits and loans of business organizations. Commercial banks issue bank cheques and drafts, as well as accept money on term deposits.
• Commercial banks also act as moneylenders, by way of instalment, loans and overdrafts.
• Commercial banks also allow for a variety of deposit accounts, such as current, savings, and time deposit.
• These institutions are run to make a profit and are owned by a group of individuals.
• They lend to all sectors ranging from rural to urban.
• These banks do not charge concessional interest rates unless instructed by the RBI.
• Public deposits are the main source of funds for these banks.
• They have a unified structure and are owned by the government, state, or any private entity.

SCHEDULED COMMERCIAL BANKS (SCB)

• Governed by the Banking Regulation Act-1949.
• Scheduled banks are those mentioned in the 2nd schedule of RBI Act, 1934.
• Scheduled commercial banks (SCBs) account for a major proportion of the business of the scheduled banks.
• Private sector banks include the old private sector banks and the new generation private sector banks– which were incorporated according to the revised guidelines issued by RBI regarding the entry of private sector banks in 1993.

 

1.1 PUBLIC SECTOR BANKS

• These are banks where the majority stake is held by the Government of India. Examples of public sector banks are: SBI, Bank of India, Canara Bank, etc.

 

EMERGENCE OF STATE BANK OF INDIA (SBI) GROUP

• State bank group implies, State bank of India and its associates.
• Prior 1955, SBI was known as “Imperial Bank of India”.
• Imperial Bank of India created in 1921 by amalgamating 3 Presidency banks of – Bengal, Bombay and Madras.
• Post – independence, the economic model of Five-year plan necessitated a reorganisation of banking. Following this, on July 1, 1955 as per the SBI act 1955, the SBI constituted and it took over the business and undertaking of Imperial Bank.

 

• By enacting SBI Act, 1955 the government partially nationalized Imperial Bank of India and renamed it as SBI.
• In 1959, by enacting SBI (Associates) Act, 1959 the government brought 8 banks of former princely states under SBI as its associates. They were –
  • State bank of Bikaner
  • State bank of Jaipur
  • State bank of Hyderabad o State bank of Indore
  • State bank of Mysore
  • State bank of Saurashtra
  • State bank of Patiala
  • State bank of Travancore
• State bank of Bikaner and Jaipur were merged and known as SBBJ (State Bank of Bikaner and Jaipur)
• 2008 – State bank of Saurashtra was merged with state bank of India.
• Now the number of associate banks is 5.
• SBI associates and Bharatiya Mahila Bank was merged with SBI w.e.f. April 1, 2017.
• SBI is the largest public sector bank in India.
• To unload RBI from its administrative work and to endow it with only regulatory functions, RBI’s shareholding was transferred to the government of India.

 

2019: Global top banks – 100 banks ???? China (18 banks), USA (12 Banks), Japan > France >…..India (only 1 bank: SBI at Rank 55).

 

The Union Cabinet in 2017, had approved the merger of five associate banks along with Bharatiya Mahila Bank with SBI. The five banks were State Bank of Bikaner and Jaipur, State Bank of Hyderabad, State Bank of Travancore, State Bank of Mysore and State Bank of Patiala. At present, there are 12 Public Sector Banks in India including SBI.

 

1.2 NATIONALIZATION OF THE BANKS

• In India, the banks which were previously functioning under the private sector were transferred to the public sector by the act of nationalization and thus the nationalized banks came into existence.
• Post-independence, the GOI adopted a planned economic development model for the country. Nationalisation was in accordance with the national policy of adopting the socialistic pattern of society.
• The first major step was Nationalization of the Imperial Bank of India in 1955 via the State Bank of India Act.
• SBI was made to act as the principal agent of RBI and handle banking transactions of the Union and State Governments.
• After that, in a major process of nationalization, seven subsidiaries of the SBI were nationalized via the SBI (Subsidiary Banks) Act, 1959.
• In 1969, a major phase of nationalization was carried out and 14 major commercial banks in India were nationalized.
• The second phase of nationalization Indian Banking Sector Reform was carried out in 1980 with six more banks.

 

1969 – 14 banks nationalized 1980 – 6 more banks nationalized The nationalized banks controlled about 91% of banking assets 1990 – Narsimhan Committee Reformss New Economic Policies (NEP)

Golden anniversary (50 years) of the bank nationalisation – First round of bank nationalisation was done in 1969 (2019-1969)

• These 14 banks Nationalized in 1969 are shown in the below table.

Sr.	Bank
1.	Central Bank of India
2	Bank of Maharashtra
3	Dena Bank
4	Punjab National Bank
5	Syndicate Bank
6	Canara Bank
7	Indian Bank
8	Indian Overseas Bank
9	Bank of Baroda
10	Union Bank
11	Allahabad Bank
12	United Bank of India
13	UCO Bank
14	Bank of India

 

• The above was followed by a second phase of nationalization in 1980, when the Government of India acquired the ownership of 6 more banks, thus bringing the total number of Nationalized Banks to 20. This step brought 80% of the banking segment in India under Government ownership.
• The private banks at that time were allowed to function side by side with nationalized banks and the foreign banks were allowed to work under strict regulation.
• A few recent events as part of banking sector reforms include:
  • Deregulation of interest rates
  • Differentiated banking – Small and Payment banks
  • Increased autonomy to banks
  • Basel III compatibility of banks
  • Regulation of NBFCs etc.

 

 

1.2.1 REASONS FOR NATIONALIZATION OF BANKS

• Wars with China (1962) and Pakistan (1965) that put immense pressure on public exchequer.
• Two successive years of drought had led to severe food shortages and also compromised national security (PL 480 program).
• Resultant three-year plan holiday affected aggregate demand as public investment was reduced.
• India’s economic growth barely outpaced population growth in 1960-70s and average incomes stagnated.
• Share of the industrial sector in credit disbursement by commercial banks almost doubled between 1951 and 1968, from 34% to 68% whereas agriculture received less than 2% of total credit, though more than 70 percent of the population was dependent upon it.
• Priority Sector Lending – the agriculture sector and its allied activities were the largest contributors to the national income.
• Nationalisation aimed at mobilizing the savings of the people to the largest possible extent and to utilize them for productive purposes.
• Reducing inter and intra-regional imbalance to curb the urban-rural divide
• Controlling private monopolies over financial sectors.
• Ensuring Socio-economic welfare as enshrined in preamble of the Indian constitution.
• Expansion of banking to rural pockets to ensure financial inclusion.
• To shift from ‘class banking’ to ‘mass banking’ (social banking)

 

 

1.2.2 OBJECTIVE OF NATIONALISATION

• To Induce Confidence of Public in Banking Sector
• To provide social orientation like loan to weaker sections of society
• Expansion of banking, Opening accounts in rural areas – financial inclusion
• To reduce inequalities in society.
• Controlling private monopolies
• Reducing regional imbalances
• Developing banking habits
• Priority sector lending to weaker sections – inclusive growth

 

1.2.3 IMPACT OF NATIONALIZATION OF BANKS

• Nationalization of the Banks brought the public confidence in the banking system of India.
• After the two major phases of nationalization in India, 80% of the banking sector came under government ownership.
• After the nationalization of banks, the branches of the public sector banks in India rose to approximately 800 per cent in deposits, and advances took a huge jump by 11,000 per cent.
• Government ownership gave the public implicit faith and immense confidence in the sustainability of public sector banks.
• Indian banking system has reached even to the remote corners of the country.
• More equitable and prioritized disbursement of credit to different sectors of economy.
• Nationalization of banks led to a smooth and streamlined Indian growth process, particularly in the Green revolution.
• Aim of nationalization is to promote rapid growth in agriculture, small industries and export, to encourage new entrepreneurs and to develop all backward areas.

 

 

ECONOMIC SURVEY 2020 – After the 1980 nationalization, PSBs had a 91% share in the national banking market which has reduced to 70% in recent times. Reduced stake has been absorbed by New Private Banks (NPBs) which came up in early 1990s after liberalization

 

ECONOMIC SURVEY 2020 – Allow campus recruitment, lateral entry in higher management positions, make employees ‘part owners’ through Employee Stock Ownership Plan (ESOP). Use Artificial Intelligence (AI), Machine Learning (ML), Big Data Analytics, geotagging of mortgaged assets etc. Setup an organization PSBN Network to implement above ICT-solutions to improve efficiency of PSBs.

 

1.2.4 CRITICAL ASSESSMENT OF NATIONALISATION

• Most of the social objectives were achieved.
• Bank deposits increased significantly.
• Loans to the priority sector increased drastically.
• Nationalisation ensured deep penetration of the banking sector in rural and remote pockets.
• Financial inclusion
• Women empowerment – ensured by extending credits to SHGs which are led by women.

 

1.2.5 DOWN SIDE OF NATIONALISATION OF BANKING

• Efficiency and profitability of Banks declined drastically
• Issue of NPA becoming major roadblock in profitability of banking sector
• Nationalization of banks led to an interest rate structure that was incredibly complex – different rates of interest for different types of loans.
• Nationalization drive has led to lesser competition between the public sector and private sectors banks.
• Bureaucratic attitude and procrastination in the functioning of the banking system.
• Lack of responsibility and initiative, red–tapism, inordinate delays are common features of nationalized banks.
• Ruthless expansion of these banks are now facing the problems of heavy overdue loans and economically unviable branches.
• Political interference led to disbarment of loans which were against the sound banking rules and weakened the economic viability of these institutions.

 

CONCLUSION

• Advocating privatisation of banks is not a panacea.
• India must not make haste in going for the privatisation of banks, rather India must focus on comprehensive governance reforms, resolution of NPAs at earliest and creating a free financial market so that investment can be reinvigorated and wheels of the economy can again get back on track.

 

MERGERS/CONSOLIDATION OF BANKS

• The government has decided that Bank of Baroda, Vijaya Bank and Dena Bank shall be “amalgamated” making the new entity India’s third largest lender after SBI and ICICI.
• The GoI has proposed to merge 10 Public sector Banks into 4 large banks by April 1 2020.

 

1.3.1 CHRONOLOGY

• PJ Nayak Committee (2014) recommended for merger of PSBs
• 2017: Union Cabinet gave in-principle approval for amalgamation of Public Sector Banks
• 2017: State Bank of India merged with 5 of its associate banks and Bharatiya Mahila Bank – State Bank of Bikaner and Jaipur, State Bank of Mysore, State Bank of Travancore, State Bank of Hyderabad, and State Bank of Patiala.
• 2018: Vijaya Bank, Dena Bank and Bank of Baroda (Anchor bank – BoB)

 

1.3.2 BACKGROUND

• Merger was proposed through a ministerial panel called Alternative Mechanismheaded by the Finance
• The idea of bank mergers floated since 1998, when Narasimham Committee II recommended the government to merge banks into three-tiered structure –
  • Three large banks with an international presence at top
  • Eight to ten national banks
  • A large number of regional and local banks.
• P J Nayak committee (2014) – suggested that the government should privatise or merge some PSBs.
• 2017 – Government had approved the merger of SBI’s five associate banks and later of the Bharatiya Mahila Bank (BMB) with SBI.

Economic Survey – points out that constant failure of banks to provide credit to both emerging and existing industries has resulted in stagnation in the economic growth of the nation.

 

• 2018 – Government has constituted an Alternative Mechanism Panel headed by the Minister of Finance and Corporate Affairs, Arun Jaitley to look into merger proposals of public sector banks.
• Government also initiated amalgamation of Regional Rural Banks under Phase 3 consolidation, bringing them down from 56 to 38.

 

In merger, two or more companies/entities are combined together to form either a new company or an existing company absorbing the other target companies. In merger one company acquires the other companies. (e.g. bank B acquires bank C and D and eventually only bank B shall exist).

 

Amalgamation is a type of merger in which two or more companies combine their businesses to form an entirely new entity/company.

E.g. Consolidation of 2 entities Mittal Steel & Arcelor resulting in new entity Arcelor Mittal.Amalgamation is the combination of one or more companies into a new entity (e.g. bank A and bank B combine to form a new bank C).

 

1.3.3 SIGNIFICANCE OF THE MOVE

• Lead to cost cutting and greater efficiency in wake of rising NPAs.
• Improve customer base & enhanced geographical outreach – Facilitate resources diversion to other underserved segments.
• Better diversification of risks and stronger overall profitability contributing to higher credit ratings.
• Help create a globally stronger & competitive financial institutions
• Lead to a bigger capital base & higher liquidity which will help in meeting BASEL III norm
• Enhanced human resource availability.
• Problem of credit lending, based on the twin balance sheet crisis, can be checked by the formation of bigger banks.
• Bigger banks with diverse portfolioshave lesser chances of failure
• However, factors like regional balance, geographical outreach, financial inclusion, systemic risks due to large-sized banks, financial burden and smooth human resource transition have to be looked into while deciding on consolidation.

 

1.3.4 UNDERLYING RATIONALE

• Recommended by several committees – Narasimhan Committee, PJ Nayak committees etc.
• To meet contemporary credit demand
• Reduction in the net NPA ratio of the merged bank and kick start credit creation.
• The merger of weak banks (higher NPAs and low profits) with the strong Banks would prevent the collapse of the weak banks and protect the customers and financial system.
• Would reduce the financial burden on the Govt. on undertaking frequent recapitalisation of the Public Sector Banks.
• Meeting the stringent capital requirements stipulated under the BASEL III Norms.
• Better monitoring and transparency

1.3.5 ARGUMENTS IN FAVOUR OF CONSOLIDATION

• Too many Public Sector Banks (PSBs) – Currently there are 12 PSBs in India which often intricate into each other’s businesses.
• Resolving the NPA issue – The consolidation is being seen as a way out of the NPA issue through the “strong” banks absorbing the strain on the books of weaker banks.
• Increase in business – Consolidation will lead to substantial expansion in customer base and market reach along with offering more services or products to customers.
• Global banks – The consolidation will help create a globally stronger and competitive financial institution. Currently Indian banks are small when compared with their global peers.
• Cost cutting – Consolidation can lead to reduced operating costs for public sector banks – duplicate operations, redundancies, overlapping branches.
• Enhanced geographical reach – For example, Vijaya Bank has strength in the South while Bank of Baroda and Dena Bank had a stronger base in Western India. That would mean wider access for both the proposed new entity and its customers.
• Greater capital and liquidity – bigger capital base and higher liquidity will help in meeting the BASEL III
• Reduction in the government’s burden of recapitalising the public sector banks time and again.
• Enhanced human resource – Merger can lead to availability of a bigger scale of expertise and that helps in minimising the scope of inefficiency which is more common in small banks.
• Employee welfare – The disparity in wages for bank staff members will get reduced and service conditions would become uniform.

1.3.6 ARGUMENTS AGAINST CONSOLIDATION

• Setback to corporate governance perspective – The merger sends out a poor signal of a dominant shareholder i.e. government dictating decisions that impact the minority shareholders.
• Forced mergers of the stronger banks with the weaker banks tend to take a toll on the operations of the strong banks. For instance: Bank of Baroda’s shares took a nosedive in wake of the announcement.
• Meaningless without implementing governance reforms – The new entity will face similar problems unless significant reforms take place in the overall functioning of PSBs.
• Merger could only give temporary relief but not real remedies to problems like bad loans and bad governance in public sector banks.
• Setback to financial inclusion – Consolidation may lead to large scale shutting down of overlapping branches of the entities being merged.
• Systemic risks – There is a global consensus that banks that are “too big to fail” are sources of serious risk to financial stability and consolidation might lead to such a scenario.
• Protests and opposition – Addressing the concerns of unions and shareholders can prove to be a major roadblock.
• Varied work culture – Aligning contrasting HR practices will also pose a challenge to the new management.
• Harmonization of Technology – It is a big challenge as various banks are currently operating on different technology platforms.

 

1.3.7 WAY FORWARD

• The consolidation process among banks should be driven primarily by synergies, efficiency, cost saving, and economies of scale. It is essential to evaluate the merger of banks by assessing the benefits such as cost rationalization, additional business, etc. against the likely future costs.
• Mergers must happen on commercial considerations and must not be politically imposed.
• Governance reforms – More regulatory power to RBI over PSBs and Independence from political interference.
• Allow “non-risky” failures – Failures are the essence of the free market so sometimes we also need measures that allow banks to fail safely without causing systemic shocks.

 

1.4 PRIVATE SECTOR BANKS

• These are banks whose majority of share capital of the bank is held by private individuals. These banks are registered as companies with limited liability. Examples of private sector banks are: ICICI Bank, Axis bank, HDFC, etc.
• In private sector banks, most of the capital is in private hands.
• There are two types of scheduled commercial (private sector) banks in India viz.

 

 

Old Private Banks	New Private Banks
These are those which existed in India at the time of nationalization of major banks but were not nationalized due to their small size or some other reason.	These banks were incorporated as per the revised guidelines issued by the RBI regarding the entry of private sector banks in 1993. At present, there are seven new private sector banks viz. Axis Bank, Development Credit Bank (DCB Bank Ltd), HDFC Bank, ICICI Bank, IndusInd Bank, Kotak Mahindra Bank, Yes Bank.

 

1.5 FOREIGN BANKS

• Foreign banks are present in the country either through complete branch/subsidiary route presence or through their representative offices.
• These banks are registered and have their headquarters in a foreign country but operate their branches in our country. Examples of foreign banks in India are: HSBC, Citibank, Standard Chartered Bank, etc

 

 

RBI POLICY TOWARDS FOREIGN BANKS IN INDIA

• RBI policy towards presence of foreign banks in India is based upon two cardinal principles viz.

1. 1. Reciprocity
   2. Single mode of presence.

• By reciprocity, it means that overseas banks are given near national treatment in India only if their home country allows Indian banks to open branches there without much restrictions.
• By single mode of presence, it means that RBI allows either of the branch mode or a wholly owned subsidiary (WOS) mode in India.
• Some other policy guidelines of RBI towards foreign banks are as follows:

1. 1. Banks have to adhere to mandated Capital Adequacy requirements as per Basel Standard.
   2. They should meet the minimum capital requirement of INR 500 cr.
   3. They should maintain minimum CRAR at 10% .
   4. Priority sector targets for foreign banks in India is 40%.
   5. Further, the foreign banks have to follow other norms as set by the Reserve Bank of India.

SHARE OF FOREIGN BANKS IN INDIA

Foreign Banks account for less than 1% of the total branch network in the country. However, they account for approximately 7% of the total banking sector assets and around 11% of the profits.

 

2. DIFFERENTIATED BANKS IN INDIA

• • Differentiated banks are banking institutions licensed by the RBI to provide specific banking services and products.
  • Main aim for giving license to these banks is to promote financial inclusion and payments.
  • Differentiated banks licensing was launched in 2015.

 

1. SMALL FINANCE BANKS
2. INDIA POST PAYMENT BANKS
3. LOCAL AREA BANKS
4. PAYMENT BANKS
5. WHOLESALE BANKING
6. REGIONAL RURAL BANK

 

• The concept was once discussed in a Paper “Banking Structure in India – The Way Forward”, brought out by the RBI in August 2013.
• RBI granted in-principle approvals to 11 entities for setting up payments banks (PBs) in August 2015 and 10 for Small Finance Bank (SFB) in September 2015.

 

NEED FOR DIFFERENTIATED BANKS

• To broaden the policy goal of financial inclusion
• Tailor made financial solution to cater various sections of society
• They are niche banks that focus and serve the needs of a certain demographic segment of the population.
• Provision of small saving schemes to inculcate saving culture
• Payment services

 

Chronology of differential banks: RRB (1976) → Local Area Bank (1996) → Small Finance Bank & Payments bank (2015) → Wholesale banks (proposed)

 

2.1 REGIONAL RURAL BANKS (RRB)

• RRBs are financial institutions which ensure adequate credit for agriculture and other rural sectors.
• They were conceived as low cost institutions having a rural ethos and pro poor focus, but with expertise of commercial banks.
• It was set up on the basis of the recommendations of the Narasimham Working Group (1975), and after the legislations of the Regional Rural Banks Act, 1976???? statutory backup
• The sources of funds of RRBs comprise of owned fund, deposits, borrowings from NABARD, Sponsor Banks and other sources including SIDBI and National Housing Bank.
• RRBs are at par with commercial banks as far as compliance requirements to CRR and SLR is concerned.
• The RRBs combine the characteristics of a cooperative in terms of the familiarity of the rural problems and a commercial bank in terms of its professionalism and ability to mobilise financial resources.
• Each RRB is owned by three entities with their respective shares as follows:
  • Central Government → 50%
  • State government → 15%
  • Sponsor bank→ 35%

 

• However, PSL target of RRBs is 75% of total outstanding advances (PSL norm is 40% for a commercial bank).

 

1. 50% Centre
2. 35% Sponser bank
3. 15% state government

 

RRB Viz-a-viz COMMERCIAL BANKS

• Ownership – they are owned by three different entities – Central govt, state govt and sponsor bank.
• Regulation – They are regulated by NABARD
• Statutory Background – RRBs have a separate law behind them viz. RRB Act, 1976.
• Statutory pre-emptions – RRBs don’t need to maintain CRR and SLR like other banks.

 

2.1.1 Objectives of the RRB

To develop the rural economy by providing, for the purpose of development of agriculture, trade, commerce, industry and other productive activities in the rural areas, credit and other facilities, particularly to small and marginal farmers, agricultural labourers, artisans and small entrepreneurs, and for matters connected therewith and incidental thereto.

 

POLICY OF CURRENT GOVERNMENT ON RRB

• The Modi Government has put hold on further amalgamation of the Regional Rural Banks.
• The focus of the new government is to improve their performance and explore new avenues of investments in the same.
• Currently, there is a bill pending to amend the RRB Act which aims at increasing the pool of investors to tap capital for RRBs.

 

2.1.2 NEED FOR RRBS

• To ensure adequate credit in rural areas during the lockdown due to the COVID-19
• RRB helps to bring the financial inclusion in the primary level of the nation
• To provide banking services to rural and semi-urban areas.
• Locker, debit and credit card facilities to the countryside
• To enhance employment opportunities by promoting trade and commerce in rural areas.
• To support entrepreneurship in rural areas.
• Pension and MGNREGA wages distribution

 

2.1.3 ISSUES WITH RRBS

• Organisational problem – multi agency control of RRBs led to a lack of uniformity in their performance.
• Recruitment process as well as training of staff of RRB hasn’t received sufficient attention
• Problems of loan recovery
• Mounting losses resulting into non-viability
• Management Problems pertain to involvement of three agencies.

The Cabinet Committee on Economic Affairs has given its approval for continuation of the process of recapitalization of RRBs by providing minimum regulatory capital to RRBs for 2020-21 for those RRBs which are unable to maintain minimum CRAR of 9%, as per the regulatory norms prescribed by the RBI

 

2.2 SMALL FINANCE BANKS (SFB)

• According to RBI guidelines, small and payment banks are ‘niche’ or ‘differentiated’ banks with a common objective of increasing financial inclusion.
• These are private financial institutions for the objective of financial inclusion without any restriction in the area of operations, unlike the RRBs or Local Area Banks.
• They can provide basic banking services like accepting deposits and lending to the unbanked sections such as small farmers, micro business enterprises, micro and small industries and unorganised sector entities.
• They were proposed by the Nachiket Mor Committee of RBI as one of the differentiated banking systems for credit outreach and announced in the annual Budget of 2014.
• Currently, SFBs constitutes 0.2% of the total deposits of all scheduled commercial banks and makes up 0.6% of the total lending undertaken by the scheduled commercial banks in India.
• Some of the operational Small Finance Banks in India are: Ujjivan SFB, Janalakshmi SFB, Equitas SFB, AU SFB, and Capital SFB.
• They focus and serve the needs of a certain demographic segment of the population.
• SFBs was recommended by the Nachiket Mor committee on financial inclusion.

 

2.2.1 OBJECTIVE OF THE SFB

• To increase financial inclusion by provision of savings vehicles to under-served and unserved sections of the population
• Supply of credit to small farmers, micro and small industries, and other unorganised sector entities through high technology low-cost operations.
• The purpose of the small banks will be to provide a whole suite of basic banking products such as deposits and supply of credit, but in a limited area of operation.
• The provision of savings vehicles
• Supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganised sector entities, through high technology-low cost operations.

 

2.2.2 NEED FOR SFB

• To cater large population – India has the second-largest unbanked population in the world where more than 200 million people do not have a bank account and many rely on cash or informal financing.
• Priority sector lending – SFBs play a key role in the priority sector lending space as their main focus is the unserved and underserved segment.
• Financial inclusion of women – To provide loans to women. female customers can avail full banking solutions.
• Social Impact – The SFBs are now looking beyond the simple metric of “income improvement” to other indicators of positive social impact,
• SFBs not only serve to provide banking solutions but empower the socio-economic progress of its consumers.
• RBI states that small banks will act as a savings vehicle to these segments of the population.

 

2.2.3 GUIDELINES FOR SFB

• They cannot set up subsidiaries to undertake non-banking financial service activities.
• 75% of its ANBC should be advanced to the priority sector as categorized by RBI.
• It must have 25% of its branches set up in unbanked areas.
• Minimum capital requirement – 100 crore.
• Promoter contribution – at least 40% for first 5 years
  • Excess shareholding – brought down to 90% by end of 5 th year, 30% by end of 10 th year and to 26% in 12 years from commencement of business.
• Foreign shareholding as per current FDI policy.
• Voting rights – same as according to existing guidelines for private banks.
• Entities other than promoters would not hold share in excess of 10%.
• They must comply with the corporate governance guidelines, including ‘fit and proper’ criteria for directors as issued by RBI.
• They will be subject to all prudential norms and regulations of the RBI as applicable to existing commercial banks – maintaining CRR and SLR.
• It can transform into a full-fledged bank, but only after RBI’s approval.

 

 

Q. What is the purpose of setting up Small Finance Banks (SFBs) in India? (CSE-2017) To supply credit to small business units To supply credit to small and marginal Farmers To encourage young entrepreneurs to set up business particularly in rural areas. Select the correct answer using the code given below: 1 and 2 only 2 and 3 only 1 and 3 only 1, 2 and 3

SMALL FINANCE BANKS Vs PAYMENT BANKS

 

Parameters	Small Finance Banks	Payment banks
Examples	Total 10. Capital Small Finance Bank (Punjab), Ujjivan (Karnataka), Utkarsh (UP). etc	The RBI as of date has given licences to 11 payments banks of which six are currently operational. These include Aditya Birla Payments Bank, Airtel Payments Bank, India Post Payments Bank, Fino Payments Bank, Jio Payments Bank and Paytm Payments Bank.
Eligibility	Min.100cr.   Capital Resident Indian, Local Area Bank, NBFC, Micro-finance, with 10 years exp. in banking / finance	Min.100cr.   capital resident Indians, NBFCs, mobile telephone companies, supermarket chains, cooperatives & companies controlled by resident Indians
Area	The RBI Committee gave selection preference to North East & Central India clusters where Universal Banks’ penetration is poor.	Anywhere
Selected by	Usha Throat (Former RBI Dy.Gov)	Nachiket Mor (Ex-RBI Board Member)
CRR, SLR, Repo, FDI	Same as Indian private banks	Same as Indian Private Banks, but caveats in SLR – 75% in G- Sec or T Bills and 25% can be FD in Any Bank.
Rural Penetration	Must have 25% branches in unbanked rural areas.	No need but 25% access points must be in rural areas like Business correspondence (BC).
Target Consumers	Unserved, Underserved Farmers, Micro, Small industries	Promoting Small savings Remittance of migrant labours, low income households, unorganized sector, small business.
Accept Deposits	Yes, without any restrictions	No NRI deposits, Fixed deposit, Recurring Deposit. Can accept only Demand Deposits and max. balance Rs. 1 lakh per year per customer
Debit cards	YES	YES
Credit cards	YES	No (because can’t “loan”)

 

 

2.3 PAYMENT BANKS

• According to RBI guidelines issued in 2014, payment banks are ‘niche’ or ‘differentiated’ banks with a common objective of increasing financial inclusion.
• Payments Banks can accept demand deposits (only current account and savings accounts).
• They would initially be restricted to holding a maximum balance of Rs 1 lakh per customer. Based on performance, the RBI could enhance this limit.
• The banks can offer payments and remittance services, issuance of prepaid payment instruments, internet banking, functioning as business correspondent for other banks.
• Payments Banks cannot set up subsidiaries to undertake NBFC business.

 

• Payments banks will be entitled to issue ATM or debit cards to their customers but cannot issue a credit card.
• Similar to commercial banks, reserve ratios will be applicable to the Payments banks.
• Payment banks can provide the Facility of utility bill payments to its customers and the general public.
• Payments banks can become a business representative of any other bank, but it will have to comply with the guidelines of the RBI.
• The Payments Banks would be required to use the word ‘Payments’ in its name to differentiate it from other banks.
• Payments banks cannot provide loans or lending services to customers.

 

According to the RBI data, almost 60% of the people of the country are still not connected with the banking sector.

 

2.3.1 OBJECTIVES

Increase financial inclusion by providing small saving accounts, payment remittance services to migrant labourer, low income households, small businesses, other unorganized sector entities and other users by enabling high volume – low value transactions in deposits and payments/remittance services in a secured technology – driven environment.

2.3.2 WHO CAN PROMOTE A PAYMENTS BANK?

• Non-bank PPIs, NBFCs, corporate’s, mobile telephone companies, supermarket chains, real sector cooperatives companies and public sector entities. Even banks can take equity in Payments Banks.

 

CONCLUSION

The setting up of the payments banks will not only increase the financial inclusion in the country but also strengthen the weaker section of the country so that they can also give their contribution in the economic development of the country.

Q. Find the correct Statement(s) about Payment Banks? (CSE-2016) Mobile telephone companies and supermarket chains that are owned and controlled by residents are eligible to be promoters of Payment Banks. Payment Banks can issue both credit cards and debit cards. Payment Banks cannot undertake lending activities. Codes: 1 and 2 only 1 and 3 only 2 only 1, 2 and 3

2.4 INDIA POST PAYMENT BANKS (IPPB)

• IPPB is a financial service provider that will operate under the country’s postal department.
• Started in 2017, IPPB has been incorporated as a public sector company under the department of posts, with 100% government equity and is governed by the RBI.
• It will focus on providing banking services to people in rural areas, by linking all the 1.55 lakh post office branches with IPPB This will create the country’s largest banking network with a direct presence at the village level.
• Range of products – savings and current accounts, money transfer, direct benefit transfer, bill and utility payments, enterprise and merchant payments.
• It will offer three types of savings accounts – regular, digital and basic – will attract an interest rate of 4% per annum.
• It will also provide access to third-party financial services such as insurance, mutual funds, pension, credit products and forex.
• It will not offer any ATM debit card. Instead, it will provide its customers a QR Code-based biometric card.
• The government – owned payments bank will be able to accept deposits of up to Rs. 1 lakh from customers.
• But they do not have the rights to use these funds to advance risky loans at higher interest rates.

 

2.4.1 SIGNIFICANCE OF IPPB

• Furthering goal of achieving financial inclusion.
• Efficient utilization of a wide network of branches of India’s age-old postal department across India.
• IPPB offers savings, remittance, and payments services to the rural and unorganised sectors.
• Digital services are expected to make financial services more accessible.
• Payments bank idea will help reinvigorate the postal system.

2.4.2 CHALLENGES FACE BY THE IPPB

• Charges and restrictions – There are 80 different charges and restrictions which could prove to be challenges in its objective of financial inclusion.
• Severe restrictions imposed by the RBI on deployment of funds by IPPB
• IPPB is likely to face stiff competition from private companies.
• First wave of new payments banks that commenced business last year (Airtel, Paytm) have not made any significant changes
• Striking down of certain provisions of Aadhaar by SC has made Aadhar based KYC authentication difficult.
• Promoting IPPB as well as maintaining balance with DoP work by staff
• Department of Post (DoP) staff needs to be trained in digital operations.
• Limited manpower in post offices– Clients might find it difficult to withdraw cash from rural post offices because these are managed by one or two people, who are unlikely to have a lot of money with them.
• Limited accessibility– IPPB is unable to offer ATM cards yet. As a result clients can’t use the united payments interface service.
• Limited appeal– For Urban customers who have easy access to private banks offering purely digital accounts with more services, interest rates of up to 6 per cent and latest technologies like UPI.

 

2.5 LOCAL AREA BANK

• Introduced in India in the year 1996 based on Budget-1996 by the then Finance Minister, Dr. Manmohan Singh.
• Unlike RRBs, they’re not set up by Union or State governments or by any special act of the parliament, but by private entities, simply applying to RBI under Banking Regulation Act.
• Each Local Area bank is registered as a public limited company under the Companies Act, 1956. However, they are licensed under the Banking Regulation Act, 1949.
• Earning profit is the main objective of Local Area Banks
• They are Non-Sch. Banks – CRR, SLR, PSL applicable.
• Only RBI regulates
• Present in Maximum 3 geographically contiguous districts. only 1 urban centre per district.

 

 

2.6 LEAD BANK SCHEME

• The Lead Bank Scheme was introduced in 1969 in which aims at providing adequate banking and credit in rural areas through an ‘service area approach’, with assignment of lead roles to individual banks (both in public sector and private sector) – one bank assigned for one area
• A bank having a relatively large network of branches in the rural areas of a given district and endowed with adequate financial and manpower resources has generally been entrusted with the lead responsibility for that district.
• On the recommendation of the Gadgil Study Group and Banker’s Committee, the Scheme was introduced by RBI. The commercial banks did not have adequate presence in rural areas and also lacked the required rural orientation which was hindering the growth of rural areas.

 

Q. The Services Area Approach was implemented under the purview of_______ (CSE-2019) Integrated Rural Development Programme Lead Bank Scheme Mahatma Gandhi National Rural Employment Guarantee Scheme National Skill Development Mission

OBJECTIVES OF LEAD BANK SCHEME

• to identify those regions which unbanked and underbanked in districts and to extend banking facilities to such areas
• to help in removing regional imbalances through appropriate credit deployment.
• It was observed in the studies by the committee that there are certain credit gaps in various sectors which need to be addressed and a credit plan is needed.
• to identify economically viable and technically feasible schemes.
• The structural and procedural changes in the banking sector were needed.
• Development of co-operation amongst financial and non-financial institutions.

 

Govt. constituted Usha Thorat committee which highly favoured the further continuance and revitalization of the scheme for the sake of the financial inclusion in the country.

 

3. CO – OPERATIVE BANKS

• In India, the history of Cooperatives begins with the Cooperative Credit Societies Act, 1904 which led to the formation of Cooperative Credit Societies in both rural and urban areas.
• In independent India, with the onset of planning, the cooperative organizations gained more leverage and role with the continued governmental support.
• Co-operative bank is a financial entity which belongs to its members, who are at the same time the owners and the customers of their bank. Co-operative banks are often created by persons belonging to the same local or professional community or sharing a common interest.
• Co-operative banks played an important role in national development. Initially set up to supplant indigenous sources of rural credit, particularly money lenders, today they mostly serve the needs of agriculture and allied activities, rural-based industries and to a lesser extent, trade and industry in urban centres.
• Cooperative banks are the primary financiers of agricultural activities, some small- scale industries and self-employed workers.
• These banks are cooperative credit institutions that are registered under the Cooperative Societies Act 1912. These banks work according to the cooperative principles of mutual assistanc
• Indian cooperative structures are one of the largest such networks in the world with more than 200 million members. It has about 67% penetration in villages and funds 46% of the total rural credit.

Anyonya Co-operative Bank Limited (ACBL) is the first co-operative bank in India located in the city of Vadodara in Gujarat.

Banking activities of Urban Cooperative Banks are monitored by RBI.

However, registration and management activities are managed by the Registrar of Cooperative Societies (RCS). These RCS operate in single- state and Central RCS (CRCS) operate in multiple states.

 

3.1 FEATURES OF COOPERATIVE BANKS

• Customer owned entities
• Democratic member combers
• Profit allocation
• Principle of mutual assistance
• Financial inclusion
• Principle of one person-one vote

 

3.2 SOURCES OF FUNDS (RESOURCES)

• Ownership funds
• Deposits or debenture issues.
• Central and state government
• Reserve Bank of India (RBI)
• NABARD
• Other co-operative institutions

A high powered committee chaired by former Deputy Governor of RBI, R. Gandhi has recommended the merging and converting some of the cooperatives banks to small finance banks

3.3 TIERS OF CO-OPERATIVE BANKS

1. State Co-Operative Bank-SCBc
2. District Central Co-Operative Bank
3. Primary Credit Societies-PCSs

 

URBAN CO-OPERATIVE BANKS (UCB)

• Primary credit societies (PCSs) in urban areas that meet certain specified criteria can apply to RBI for a banking license to operate as urban co-operative banks (UCBs).
• They are registered and governed under the co-operative societies acts of the respective states and are covered by the Banking Regulation Act, 1949 – thus are under dual regulatory control.
• The managerial aspects of these banks are controlled by the state governments, while the matters related to banking are regulated by RBI.
• Well managed primary UCBs with deposits of over Rs. 50 crore are also allowed to operate in more than one state subject to certain norms.
• As they are covered by the RBI Act, 1934 (2nd Schedule) they have certain rights and obligations – rights of obtaining refinance and loans from the RBI and obligations such as maintenance of cash reserves, submission of returns to the RBI etc.

DCCBs & SCBs:

• As their names implies, they operate at the district and state levels.
• One district can have no more than one DCCB with a number of DCCBs reporting to the SCB.
• They were under supervision of the RBI – later on this function was delegated to the NABARD.

 

3.4 ADVANTAGES OF COOPERATIVE BANKS

• Effective alternative to the traditional defective credit system of the village money lender.
• Provides cheap credit to masses in rural areas.
• Discouraged unproductive borrowingpersonal consumption and have established the culture of productive borrowing.
• Cooperative credit movement has encouraged saving and investment, instead of hoarding money
• Cooperative credit is available for purchasing improved seeds, chemical fertilizers, modern implements, etc
• Cooperatives Banks offer higher interest rates on deposits.

 

 

3.5 ISSUES WITH CO-OPERATIVE BANKS

• Issue of dual regulatory control – the UCBs come under the RBI and the Registrar of Co-operative Societies (RCS) of the respective states while the DCCBs and SCBs come under the NABARD, the RBI and the
• Close links between politicians and co-operatives and the fact that the RCS functions under the state government, in practice this dual (or triple) custody of the co-operative banks led to poor supervision and control.
• Most co-operative banks are lacking in skill and expertise.
• Recruitments are politicised as are appointments at most levels.
• Income recognition and prudential norms are still due in this sector.
• Co-operative banks have been in the news mostly for fraudulent dealsg. PMC bank crisis.
• Patchy growth of cooperative societies across the map of India. It is said these have grown maximally in states of Gujarat, Maharashtra, Tamil Nadu whereas the other parts of India don’t have a heightened presence.
• The state partnership has led to excessive state control and interference. This has eroded the autonomous characters of many of these.
• Their main focus being credit so they have reduced to borrower-driven entities and majority of members are nominal and don’t enjoy voting rights.
• Credit recovery is weak especially in rural areas and it has a sustainability crisis in some pockets.
• There is a lack of risk management systems and lack of basic standardised banking models. There is a widening gap between the level of skills and the increasing computerization of banks.

3.6 COMMERCIAL BANKS Vs COOPERATIVE BANKS

PARAMETER	COMMERCIAL BANK	CO-OPERATIVE BANK
Banking Reg. Act 1949	Applicable since 1949	Applicable since 1966.
Act	Are joint stock companies they are governed by the Banking Regulation Act, 1949.	Governed by the Co-operative societies Act, 1904.
Regulator	RBI	RBI, NABARD, State Registrar of Cooperative Societies
CRR, SLR, BASEL-III	Yes	Yes, but, RBI could keep different slabs/ norms.
Repo, MSF borrow	Eligible	Yes, but only selected category of Cooperative Banks
PSL Lending	Yes 40-75%	Only Urban Cooperative Banks
Who can borrow?	Anyone	First preference to members
Vote power	Based on Shareholding, like a Commercial Company	According to Cooperative Society norms, members will have vote power
Profit Motive	Yes, purely profit motive, so lending rates may be higher than Cooperatives	Yes, but, RBI could keep different slabs/ norms.
Presence	All India & overseas	Mainly in GJ, MH, Andhra, TN

 

4. WHOLESALE & LONG TERM FINANCE BANKS (WLTF)

• WLTF banks will focus primarily on lending to the infrastructure sector and small, medium and corporate businesses.
• Released by RBI in 2017
• These banks will provide refinance to lending institutions and shall be present in capital markets in the form of aggregators
• Can’t accept deposits less than 10 crores, can give loans only to large corporates & infrastructure projects.
• They will also mobilise liquidity for banks and financial institutions directly originating priority sector assets, through securitisation of such assets and actively dealing in them as market makers.
• They may also act as market-makers in securities, such as, corporate bonds, credit derivatives, warehouse receipts, and take-out financing, etc.

 

5. MUDRA BANKS

• The GoI launched (April 2015) the Micro Units Development and Refinance Agency Bank (MUDRA Bank) with the aim of funding these unfunded non-corporate enterprises. This was launched as the PMMY (Prime Minister Mudra Yojana).
• MUDRA bank is a subsidiary of SIDBI.
• According to the GoI, large industries provide employment to only 1.25 crore people in the country while the micro units employ around 12 crore people.
• There is a need to focus on these 5.75 crore self-employed people (owners of the micro units) who use funds of Rs. 11 lakh crore, with an average per unit debt of merely Rs. 17,000.
• Under this banking model, the micro units can avail up to Rs. 10 lakh loan through refinance route (through the Public and private sector banks, NBFCs, MFIs, RRBs, District Banks, etc).

 

• The products offered-

TYPES OF LOAN	COVERAGE OF LOAN
1. Shishu	loan up to Rs. 50,000
2. Kishor	Rs. 50,000 to Rs 5 lakh
3. Tarun	Rs. 5 lakh to Rs. 10 lakh

 

• Though the scheme covers the traders of fruits and vegetables, in general, it does not refinance the agriculture sector.
• There is no fixed interest rate in this scheme. As per the GoI, presently, banks are charging the interest rates between Base Rate plus one per cent to 7 per cent per annum.
• Interest rates on the loans are supposed to vary according to the risk involved in the enterprises seeking loans.
• There is no general subsidy offered on interest rates except if the loan is linked to some other government scheme.
• The loans are basically for people having a business plan in a Non-Farming Sector with Income generating activitieslike the following:
  • Manufacturing
  • Processing
  • Trade
  • Service Sector
  • Or any other fields whose credit demand is less than ₹10 lakhs.

 

Q. Pradhan Mantri MUDRA Yojana is aimed at______(CSE-2016) bringing the small entrepreneurs into formal financial system providing loans to poor farmers for cultivating particular crops providing pensions to old and destitute persons funding the voluntary organizations involved in the promotion of skill development and employment generation

 

FUND OF FUNDS FOR START-UPS (FFS)

Established by GoI and managed and operated by SIDBI. Fund size is Rs.10,000 crore and would be built over the 14th and 15th Finance Commission cycles till 2025. FFS would not invest directly in Start-ups, but would participate in the capital of Alternate Investment Funds (AIF) registered with SEBI for investing in equity and equity linked instruments of various Start-ups at early stage, seed stage and growth stages.

 

6. INTERNATIONAL FINANCIAL INSTITUTION

• These are those banks that are established by more than one country and provide international finance.
• They are an important pillar of the Global Financial System and sometimes work as important bridges between developed and developing countries in matters of development finance.
• Currently, the world’s largest International Financial Institution is European Investment Bank.
• The IFIs can be multilateral, regional or bilateral.
• Examples of multilateral IFIs include the World Bank, African Development Bank, Asian Infrastructure Investment Bank (AIIB).
• Examples of regional IFIs include Asian Development Bank (ADB).
• Examples of bilateral IFIs include French Development Agency.

7. DIFFERENT TYPES OF LOANS

At present, interest rates on loans are linked to a bank’s marginal cost of fund-based interest rate, known as the Marginal Cost of Lending Rate (MCLR).

Fixed Interest	Floating Interest	Teaser Loan
The fixed interest rate on loans means repayment of loans in fixed equal instalments over the entire period of the loan. In this case, the interest rate doesn’t change with market fluctuations.	Floating interest rate implies that the rate of interest varies with market conditions. The drawback with floating interest rates is the uneven nature of monthly instalments.	A sub-type of floating interest rate loan, wherein initial years have low interest, but afterwards higher interest rate. While RBI has not banned Teaser loans but has put stricter regulations on them from 2011.

 

 

Q. Why is the offering of “teaser loans’’ by commercial banks a cause of economic concern ? (CSE-2011) The teaser loans are considered to be an aspect of subprime lending and banks may be exposed to the risk of defaulters in future. In India, the teaser loans are mostly given to inexperienced entrepreneurs to set up manufacturing or export units. Which of the statements given above is/are correct? 1 only 2 only Both 1 and 2 Neither 1 nor 2

 

8. TYPES OF BORROWERS

• Prime Borrower – Borrower has the capacity to repay loans.
• Subprime Borrower– Such borrower doesn’t have the capacity to repay loan. Giving teaser rate home loans to subprime borrowers was among the reasons for the Subprime Crisis in the USA (2007-08), which ultimately led to the Global Financial Crisis.
• Overleveraged Borrower– Such a company has borrowed too much money than its ability to pay it back. An Overleveraged company has a high ratio of Debt (Bonds/loans) to Equity (Shares).
• Zombie Lending– When a weak bank keeps giving new loans to a subprime / over leveraged borrower.

 

9. BAD BANKS (PARA)

• To resolve the twin problems of ‘balance sheet syndrome’ (banks and corporate sector), the Economic Survey 2016-17 has suggested the Government to set up a public sector asset rehabilitation agency (PARA) – charged with the largest and most complex cases of the ‘syndrome’.
• Such initiatives were successfully able to handle the ‘twin balance sheet’ (TBS) problems in the countries hit by the South East Currency Crises of the mid-1990s.
• Coordination problem as in this case, the debts would be centralised in one agency.
• It could be set up with proper incentives by giving it an explicit mandate to maximize recoveries within a defined time period.
• It would separate the loan resolution process from concerns about bank capital.
• As per the Survey, gross NPAs has climbed to almost 12 percent of gross advances for public sector banks at end-September 2016. At this level, India’s NPA ratio is higher than any other major emerging market, with the exception of Russia .
• The consequent squeeze of banks has led them to slow credit growth to crucial sectors – especially to industry and medium and small scale enterprises (MSMEs) – to levels unseen over the past two decades. As this has occurred, growth in private and overall investment has turned negative.
• This all implies that a decisive resolution is urgently needed before the TBS problem becomes a serious drag on growth.

 

 

CH-3 BANKING IN INDIA – PART 3

NON-BANKING FINANCIAL INSTITUTIONS (NBFIs)

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition ofshares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature.

 

NBFI

1. Primary Dealers
2. AIFI
   1. EXIM
   2. NABARD
   3. SIDBI
   4. NHB

 

3. NBFC

 

ALL INDIA FINANCIAL INSTITUTION (AIFI)

• All India Financial Institutions (AIFI) is a group composed of Development Finance Institutions (DFI) and investment institutions that play a pivotal role in the financial markets. Also known as “financial instruments”, the financial institutions assist in the proper allocation of resources, sourcing from businesses that have a surplus and distributing to others who have deficits – this also assists with ensuring the continued circulation of money in the economy. AIFI were set up by respective acts of Parliament.

 

EXPORT-IMPORT BANK OF INDIA (EXIM)

• EXIM of India is the premier export finance institution in India, established in 1982 under Export-Import Bank of India Act 1981.

• EXIM Bank is India’s leading export financing institute that engages in integrating foreign trade and investment with the country’s economic growth.

 

• EXIM Bank is a wholly-owned subsidiary of the Indian Government.

 

• EXIM Bank is an important government organisation working in the field of exports. It plays a crucial role in helping Indian companies do business abroad and bring in foreign exchange.

 

 

Financial Products By EXIM

• Buyer’s credit – it is a credit facility programme that encourages Indian exporters to explore new regions across the globe. It also facilitates exports for SMEs by offering credit to overseas buyers to import goods from India.

 

• Corporate banking – it offers a variety of financing programmes to augment the export-competitiveness of Indian companies.

 

• Lines of credit – it offers extended a line of credit to Indian exporters to help them expand to new geographies and uses line of credit as an effective market-entry tool.

 

• Overseas investment finance – it offers term loans to Indian companies for equity investments in their overseas joint ventures or wholly-owned subsidiaries.

 

• Project exports – encourages project exports from India and helps Indian companies secure contracts abroad.

 

 

Services offered By EXIM

• Marketing advisory services – helps Indian exporters in their globalisation ventures by assisting in locating overseas distributors/partners, etc. Also, assists in identifying opportunities abroad for setting up plants, projects or acquiring companies.

 

• Research and analysis – conducts research in the field of international economics, trade and investment, country profiles to identify risks, etc.

 

• Export advisory services – it offers information, advisory and support services enabling exporters to evaluate international risks, exploit export opportunities and improve competitiveness.

 

Term deposit scheme

 

Concessional Finance Scheme (CFS)

• Under the CFS, the GoI has been supporting Indian Entities bidding for strategically important infrastructure projects abroad since 2015-16 (got extension upto 2023)

 

• The Scheme is presently being operated through the EXIM Bank of India, which raises resources from the market to provide concessional finance.

 

• CFS enables India to generate substantial backward linkage induced jobs, demand for material and machinery in India and also a lot of goodwill for India.

 

 

• Under the Scheme, MEA selects the specific projects keeping in view strategic interest of India and sends the same to Department of Economic Affairs (DEA) for further considerations.

 

 

NABARD

• National Bank for Agriculture and Rural
  Development (NABARD) is an apex development financial institution in India to provide finance for agriculture and rural development. Established in 1982 on the recommendations of Sivaraman Committee. It is a statutory bodyestablished in 1982 under Parliamentary act – NABARD Act, 1981.Its headquarter is located in Mumbai.
• NABARD today is fully owned by the Government of India. The authorized share capital is about 30,000 crore.
• It is responsible for the development of the small industries, cottage industries, and any other such village or rural projects.
• NABARD operates Rural Infra. Development fund (RIDF) from PSL shortfalls from SCBs.
• The Bank has been entrusted with “matters concerning policy, planning and operations in the field of credit for agriculture and other economic activities in rural areas in India”.
• NABARD also has a portfolio of Natural Resource Management Programmes involving diverse fields like Watershed Development, Tribal Development and Farm Innovation through dedicated funds set up for the purpose.
• It is one of the premier agencies providing developmental credit in rural areas. It does not grant Direct credit to Rural Households.
• NABARD is active in developing financial inclusion policy and is a member of the Alliance for Financial Inclusion (global network of financial inclusion policymakers, Founded in 2008)
• NABARD is also known for its “SHG Bank Linkage Programme” (1992) which encourages India’s banks to lend to SHGs.

 

Refinance facility by NABARD is available to ????

State co-operative agriculture and rural development banks (SCARDBs),

State co-operative banks (SCBs),

Regional rural banks (RRBs),

Commercial banks (CBs) and

Other financial institutions approved by RBI.

 

 

1.2.1 FUNCTIONS OF NABARD

• The major functions of NABARD include promotion and development, refinancing, financing, planning, monitoring and supervision.
• Promotional and developmental initiatives in the areas of farm, off-farm, micro finance, financial inclusion, Convergence with Govt sponsored programmes.
• Supporting the financial inclusion efforts of RRBs and Cooperative Banks
• Loans to State Governments for developing rural infrastructure and strengthening of the Cooperative Credit Structure
• Refinance to Rural Financial Institutions for investment credit (long term loan) and production and marketing credit (short term loan) purposes for farm and off-farm activities in rural areas.
• Assist in policy formulation of GoI, RBI and State Governments on matters related to agricultural credit and rural development
• Credit Planning and Monitoring, Coordination with various agencies and institutions.

 

 

THE NABARD (AMENDMENT) BILL, 2017 (PASSED IN 2018)

• Amendment in Act enabled Union Government to increase the authorized capital of NABARDfrom Rs. 5,000 crore to Rs. 30,000 crore.
• Transfer of the RBI’s share to the central government – Under the 1981 Act, the central government and the RBI together must hold at least 51% of the share capital of NABARD. The Bill provides that the central government alone must hold at least 51% of the share capital of NABARD.
• Micro, small and medium enterprises (MSME) – Under the 1981 Act, NABARD was responsible for providing credit and other facilities to industries having an investment of upto Rs 20 lakh in machinery and plant. The Bill extends this to apply to enterprises with investment upto Rs 10 crore in the manufacturing sector and Rs five crore in the services sector.
• Further, banks providing loans to small-scale, tiny and decentralised sector industries are eligible to receive financial assistance from NABARD. The Bill extends these provisions to the MSME.

1.2.3 CONTRIBUTION OF THE NABARD IN INDIAN GROWTH

• Refinance – Short term and long term Loans – Crop loans are extended to farmers for crop production by financial institutions.
• Rural Infrastructure Development Fund- for supporting rural infrastructure projects.
• Long-Term Irrigation Fund (LTIF)
• NABARD Infrastructure Development Assistance (NIDA) to complement RIDF.
• Warehouse Infrastructure Fund (WIF)
• Direct Lending to Cooperative Banks
• Kisan Credit Card Scheme for Farmers – designed by NABARD in association with the RBI in 1998 for providing crop loans.
• Tribal Development – the Tribal Development Programme
• Umbrella Programme on Natural Resource Management (UPNRM) in 2007, works at enhancing investments in rural areas, creating business opportunities and enabling rural communities to sustainably utilise their natural resources.
• Microfinance Sector – NABARD had launched the SHG-Bank Linkage Programme in 1992. Over 23 lakh SHGs were credit-linked during 2017-18 financial year.
• E-Shakti – launched in 2015 in a bid to digitize SHGs
• Skill Development – Promoting an entrepreneurial culture among the rural youth and encouraging them to start enterprises in the rural off-farm sector has been NABARD’s strategy for over three decades.
• Marketing Initiatives – For providing marketing opportunities to rural artisans and producers, NABARD has traditionally facilitated their participation in exhibitions across the country.
• Producer Organizations Development Fund (PODF) for POs & PACS

 

PRODUCER ORGANISATION (PO) – It is a legal entity formed by primary producers, viz. farmers, milk producers, fishermen, weavers, rural artisans, craftsmen. A PO can be a producer company, a cooperative society or any other legal form which provides for sharing of profits/benefits among the members.

 

PRIMARY AGRICULTURAL CREDIT SOCIETY (PACS) – It is a basic unit and smallest co-operative credit institution in India. It works on the grassroots level (gram panchayat and village level). It provides credit to farmers in the form of term loans and recovers the amount after harvesting of crop from the cultivator.

 

1.2.4 CHALLENGES TO THE NABARD

• Cost of financing by NABARDhas gone up since market borrowings of NABARD add up to 80 per cent of its resources.
• The north-eastern stateshave been getting little share of the NABARD’s credit funds. The northeast gets 1% of the credit, leading to farmers trapping in the net of money-lenders.
• The penetration of banks in insurgency-hit statesand areas is less and it should ramp

 

CONCLUSION

• More than 75 per cent people of India reside in rural India and depend on agriculture. Rural infrastructure investments help in raising the socio-economic status of the rural people through increased income levels and quality of life.
• NABARD being an apex institution for providing credit facilities and capacity building to Indian rural economy, it has great opportunities for poverty reduction, socio-economic empowerment of rural India and ensure inclusive development.

RURAL INFRASTRUCTURE DEVELOPMENT FUND

Fund is maintained by the NABARD. Banks which are not able to meet their targets of PSL are required to keep the shortfall in RIDF.

The RIDF was set up by the government during 1995-1996 for financing ongoing rural infrastructure projects.

Domestic commercial banks contribute to the fund to the extent of their shortfall in stipulated priority sector lending to agriculture (mandated – 18%).

The scope of RIDF has been widened to include activities such as rural drinking water schemes, soil conservation, rural market yards, rural health centres and primary schools, mini hydel plants, shishu shiksha kendras, anganwadis and system improvement in the power sector. At present, there are 37 eligible activities under RIDF as approved by GoI. The eligible activities are classified under three broad categories i.e. Agriculture and related sector, Social sector, Rural connectivity.

 

Eligible Institutions:

State Governments / Union Territories

State Owned Corporations / State Govt. Undertakings

State Govt. Sponsored / Supported Organisations

Panchayat Raj Institutions/Self Help Groups (SHGs)/ NGOs (provided the projects are submitted through the nodal department of State Government, i.e Finance Department)

NABARD releases the sanctioned amount on reimbursement basis except for the initial mobilisation advance @30% to North Eastern & Hilly States and 20% for other states.

 

Long Term Irrigation Fund (LTIF)

Government has announced creation of a dedicated LTIF in NABARD with an initial corpus of Rs. 20,000 crore for funding and fast tracking the implementation of incomplete major and medium irrigation projects.

The Long Term Irrigation Fund (LTIF) aims to bridge the resource gap and facilitate completion of these projects during 2016-2020.

Q. Which of the following grants/grant direct credit assistance to rural households? (2013) Regional Rural Banks NABARD Land Development Banks Select Answer Codes below: 1 and 2 only 2 only 1 and 3 only 1, 2 and 3

EXIM (1982)	NABARD (1982)
Export-Import Bank of India	National Bank For Agriculture And Rural Development
Fully owned by Government of India (100%)	Since 2018, NABARD is 100% owned by the government. (earlier RBI had minor stakes)
Promotes cross border trade and investment, helps importers-exports with loans and foreign currency.	Regulatory authority: Cooperative and RRB. NABARD provides indirect refinance to farmers, artisans etc. Operates RIDF from PSL shortfalls from SCBs.
Exim operates Concessional Finance Scheme	NABARD Amendment Act 2017 ???? 1) Increased capital 2) facilitated transfer of RBI shares to Govt 3) MSME definitions updated.

1.3 NATIONAL HOUSING BANK (NHB)

• NHB is an apex financial institution for housing set up in 1988under the NHB Act, 1987.
• Originally owned by RBI (100%). But in April 2019, RBI sold 100% to the Government.
• NHB has been established with an objective to operate as a principal agency to promote housing finance institutions both at local and regional levels and to provide financial and other support incidental to such institutions and for matters connected therewith.
• NHB registers, regulates and supervises Housing Finance Company (HFCs), keeps surveillance through On-site & Off-site Mechanisms and co-ordinates with other Regulators.

NHB Residex – It is a set of benchmarks that aims to track housing price indicators across Indian cities. It is designed by a technical advisory committee comprising Government representatives, lenders and property market players.

 

Q. Find Correct Statement/s (CSE-2004) NHB, the apex institution of housing finance in India, was set up as a wholly owned subsidiary of RBI. Small industries development bank of India was established as a wholly owned subsidiary of the Industrial development bank of India (IDBI). Both A and B Neither A nor B

 

1.4 SMALL INDUSTRIES DEVELOPMENT BANK OF INDIA (SIDBI)

• SIDBI set up in 1990 under an Act of Parliament, acts as the Principal Financial Institution for Promotion, Financing and Development of the MSME sector as well as for coordination of functions of institutions engaged in similar activities
• Shareholding in SIDBI– GOI (15.4%) + SBI (16.73%) + LIC (14.25%) + NABARD (10%) + Others (43.62)
• Initiatives by SIDBI – Udyog Aadhar (MSME), Udyami Mitra portal, Guarantee fund, Small Enterprises Development Fund (SEDF).
• SIDBI is one of the four AIFI regulated and supervised by the RBI (other three are EXIM Bank, NABARD and NHB)
• The Small Industries Development Bank of India – SIDBI announced that the SIDBI Assistance to Facilitate Emergency response against COVID-19 pandemic (SAFE PLUS) will be offered collateral free and disbursed within 48 hours.
• The loans will be offered at an interest rate of five percent. The limit of SAFE loans has been enhanced from 50 lakh rupees to two crore rupees.
• The scheme was launched to provide financial assistance to MSMEs engaged in manufacturing of hand sanitizers, masks, gloves, head gear, bodysuits, shoe-covers, ventilators and goggles used in dealing with COVID-19 pandemic.

 

1. FINANCING
2. PROMOTION
3. DEVELOPMENT
4. CO-OPREATION

 

NHB (1988)	SIDBI (1990)
National Housing Bank	Small Industrial Development Bank of India
Originally owned by RBI (100%). From 2019 NHB is 100% owned by Govt.	Owned by – SBI, LIC, IDBI other public sector banks, insurance companies etc.
Finance to banks and NBFCs for housing projects. Regulator of Housing Finance Companies (NBFCs) RESIDEX index to monitor residential real estate prices.	Operates Credit Guarantee fund, Small Enterprises Development Fund (SEDF). Operates Udaymimitra.in for loans to small entrepreneurs & SME via schemes like Mudra, Stand- up-India.

 

PRIMARY DEALERS

• A primary dealer is a firm that buys government securities directly from a government, with the intention of reselling them to others, thus acting as a market maker of government securities.
• The government may regulate the behaviour and number of its primary dealers and impose conditions of entry.
• They deal in the “primary” market, directly buy G-sec from RBI’s E-Kuber platform and sell it in the secondary market.
• Total 21 primary dealers licensed by RBI (14 of them are Banks). E.g. Standard Chartered Bank, HSBC (Hong Kong), SBI, Kotak etc.

 

 

NON-BANKING FINANCIAL COMPANIES (NBFCs)

• A NBFC is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature.
• NBFC does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property.

 

• NBFCs provides financial services without meeting the legal definition of a bank.
• NBFCs have broadened and diversified the range of products and services offered by a financial sector.
• The RBI has decided to merge three categories of NBFCs into a single category to provide greater operational flexibility to non-banking lenders.

Systemically Important NBFCs ???? NBFC whose asset size is of ₹ 500 cr or more are considered as systemically important NBFCs. Example. Power Finance Corporation Limited (PFCL), Rural Electrification Corporation Limited (RECL), IL&FS, etc.

 

NBFC Classified into

1. Asset Finance Companies
2. Investment Companies
3. Loan Companies

3.1 HOW NBFCS ARE DIFFERENT FROM BANKS

• They can only accept time deposits and not demand deposits.
• NBFCs do not form part of the payment & settlement system & cannot issue cheques to its customers.
• No deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation of India is available to depositors of NBFCs, unlike in case of banks.
• In general, an NBFC is not required to maintain Reserve Ratios. However, deposit taking NBFCs are required to maintain at least 15% of its public deposits as liquid assets.
• NBFCs can deposit depositors’ money in the share market unlike banks.

 

 

Q. With reference to the Non-banking Financial Companies (NBFCs) in India, consider the following statements: (CSE-2010) They cannot engage in the acquisition of securities issued by the government. They cannot accept demand deposits like Savings Accounts. Which of the statements given above is/are correct? 1 only 2 only Both 1 and 2 Neither 1 nor 2

 

Q. The main functioning of the banking system is to: (UPSC-CDS 2013) accept deposits and provide credit provide credit and subsidies accept deposits and subsidies accept deposits, give credit and subsidies

 

 

 

3.2 SIGNIFICANCE OF NBFCs

1. Mobilization of funds/resources
2. Capital formation
3. Employment generation
4. Development of financial market
5. Provision of long term credit
6. Attracting foreign grants

 

NBFCs ARE DIFFERENT FROM BANKS IN FOLLOWING MANNER –

Parameters	Commercial bank	NBFCs
Registration	Banking Regulation Act 1949	Companies act 1956
Supervision	RBI	Varies: Mutual funds-SEBI, Insurance Company – IRDAI etc
Entry capital	INR 500 cr.	INR 5cr for Micro-Finance, 2 cr for others; 200 cr. For reinsurer etc.
Investment	They can keep depositor’s money in RBI approved securities but not in shares directly.	Can invest client’s money in the share market. E.g. Mutual Funds, Insurance Companies.
Loan Rate	Decided as per RBI’s methodology from time to time (BPLR, MCLR and now External Benchmark Lending rate)	Varies & depends on nature of business
Recovery	Loan recovery powers under SARFAESI Act.	Only Housing Finance Companies have SARFAESI powers. Gold Loan company can auction gold
Consumer Complaints Redressal	RBI’s Ombudsman, Bank’s Internal Ombudsman	RBI’s separate Ombudsman for NBFCs starting the NBFC-D in 2018.
Payment and Settlement system of the RBI	Integral part of system.	Not a part of the system.
Foreign Investment	Allowed up to 74% for private sector banks	Allowed up to 100%
Prudential Norms	CRR, SLR, applicable	NBFC-D: SLR required but RBI can prescribe different slabs / norms. CRR not applicable on any NBFC.
Deposit Insurance Facility	Available	Not available

 

3.3 CIC – ND – SI is a NBFC

• With asset size of Rs 100 cr & above.
• Holds not less than 90% of its net assets in the form of investment in equity shares, preference shares, bonds, debentures, debt or loans in group companies.
• It does not trade in its investments in shares, bonds, debentures, debt or loans in group companies.
• It accepts public funds.

 

Systemically important NBFCs (NBFCs-SI) are those with an asset size of Rs 500 crore or more.

NBFCs-ND are categorized into two broad categories viz.,

NBFCs-ND (those with assets of less than Rs. 500 crore) and

NBFCs-ND-SI (those with assets of Rs. 500 crore and above).

 

 

NBFCs complementary to the banking sector

• Customer-oriented services;
• Simplified procedures;
• Attractive rates of return on deposits;
• Flexibility and timeliness in meeting the credit needs of specified sectors.

 

 

3.4 NBFCs REGULATED BY RBI

NBFC	Characteristics
Investment and Credit Company	New category in 2019 – by merging previous NBFC categories viz. Asset Finance Companies, Loan Companies, Investment Companies. E.g. SREI Equipment Finance
Core Investment Company (CIC)	They do long term investment in Companies. E.g. Tata / Birla / Reliance Capital & Infrastructure Leasing & Financial Services Limited(IL&FS). IL&FS is owned by SBI, LIC and Corporates from Japan and Abu Dhabi. 2018- In controversy because it couldn’t repay interest to lenders.
Infrastructure Finance Company (IFC) Infrastructure Debt Fund (IDF)	Give loans for infrastructure projects. E.g. Rural Electrification Company ltd. (REC): PSU under Power Ministry. L&T IDF, Kotak IDF, IDFC IDF (“IDFC First” has separate license for Bank).
Asset Reconstruction Companies (ARC)	They buy bad loans / NPA from Banks & other NBFCs, and try to salvage value from the underlying assets. E.g. Anil Ambani’s Reliance ARC.
Factoring Companies	They lend short term money to clients against their invoices / accounts receivable. E.g. IFCI Factors, Siemens Factoring.
Gold Loan Companies	e.g. Muthoot gold loan, Manappuram Gold. RBI decides their Loan to Value ratio.
Micro Finance Institutions	MFI regulated by RBI and Ministry of Corporate Affairs
MUDRA (2015)	A non-deposit taking NBFC owned by SIDBI. It gives indirect loans to Micro enterprises through PM Mudra Yojana. (Discussed in detailed in Banking – part 2)
Fintech Companies- P2P Lenders	Similar to Olx and Quikr connecting sellers of second hand goods with buyers, the P2P lending websites connect borrowers and lenders. E.g. Faircent.com, Cashkumar.com
Fintech Companies-Account Aggregators (AA)	They manage information about a customer’s financial assets & display it to him or to a third party (like loan giver, credit rating company, App like Google play etc.)
Residuary NBFCs	Any NBFC that is not regulated by any other regulator- falls under RBI’s purview

 

3.5 NBFCs REGULATED BY SEBI

Mutual Funds (MF)	They pool clients’ money and MF-manager invests it in shares/bonds using his own discretion & expertise. E.g. SBI’s Shariah Equity Mutual Fund
Stock Broker	They help clients buy – sell shares and bonds (debentures) depending on his instructions E.g. India bulls, Karvy etc.
Real estate investment trusts (REITs) and Infrastructure investment trusts (InvITs)	Pool & invest money in real estate / infra projects e.g. IRB.
Investment Banks: (US term) & Merchant Banking Companies: (UK term)	Merger & Acquisition, Wealth Management of rich people: E.g. Kotak Mahindra, Citigroup, Bank of America, DSP Merrill Lynch, Morgan Stanley, SBI capital (separate license)
Venture Capital Fund VCF	Help start-up companies via equity finance e.g. IFCI.

 

3.6 NBFCs REGULATED BY OTHERS

IRDAI	Insurance Regulatory and Development Authority (IRDAI) regulates: 1) Life Insurance companies e.g. LIC, HDFC Standard Life Insurance 2) General (Non-Life) insurance companies e.g. IFFCO-Tokio General Insurance.
PFRDA	Pension Fund Regulatory and Development Authority (PFRDA) regulates all Pension Funds, except EPF & other statutory funds.
National Housing Bank (NHB)	Housing Finance Companies such as DHFL, Muthoot Housing finance etc. (endowed SARFAESI Powers). They were regulated by NHB but after Budget-2019, this category was handed over to RBI for regulation.
Ministry of Corporate Affairs	1.NIDHI Companies: Mutual benefit club, only members can borrow. 2. Microfinance Companies
State Registrar of Chit Funds	Chit fund is a type of collective investment scheme with monthly contributions & borrowing by contributing members e.g. Shriram Chits. (Detailed in financial inclusion)

 

NBFCs CLASSIFIED INTO TWO CATEGORIES:

On the basis of deposits :

 

NBFC-D	NBFC-ND
Deposit accepting NBFC Incorporated under Companies act, 2013 Allowed to accept/renew public deposits for a minimum period of 12 months and maximum period of 60 months. Examples: Loan companies, Investment companies, Asset Finance Companies	Non-Deposit taking NBFCs Permitted only to lend and not take any public deposits. E.g.: NBFC-MFI: NBFC Micro Finance Institutions

 

NBFC

1. Non Deposit accepting
2. Systemically Important NBFCs
3. Deposit accepting
4. Residuary NBFCs

 

 

3.7 REGULATIONS RELATING TO DEPOSIT TAKING NBFCs

• Allowed to accept and/or renew public deposits for a minimum period of 12 months and maximum period of 60 months.
• Cannot accept demand deposits (i.e., the saving and current accounts).
• Cannot offer interest rates higher than the ceiling rate prescribed by the RBI.
• Cannot offer gifts, incentives or any other additional benefit to the depositors.
• Should have minimum investment grade credit
• Their deposits are not insured.
• The repayment of deposits by NBFCs is not guaranteed by RBI.
• Need to maintain Capital Adequacy Ratio (CAR) norm as prescribed by the RBI.

 

 

3.8 EXEMPTED NBFCs TO ELIMINATE DUAL REGULATION

• Venture capital fund, merchant bank, stock broking firms (SEBI registers and regulates them);
• Insurance company (registered and regulated by the IRDA);
• Housing finance company (regulated by the National Housing Bank);
• Nidhi company (regulated by the Ministry of Corporate Affairs under the Companies Act, 1956);
• Chit fund company (by respective state)

 

3.9 CATEGORIES OF NBFCs

• Asset Finance Company – Principal business is financing physical assets such as automobiles, tractors, housing etc.
• Investment Company –Principal business is acquisition of securities.
• Loan Company –Principal business of providing loans
• Infrastructure Finance Company –NBFC that deploys at least 75% of its total assets in infrastructure loans
• Infrastructure Debt Fund –NBFC to facilitate the flow of long term debt into infrastructure projects
• NBFC-MFI – Provides Microfinance

3.10 MICRO FINANCE INSTITUTIONS

• Microfinance (called microcredit)​ is a type of banking service provided to unemployed or low-income individuals or groups who otherwise would have no other access to financial services
• In 2010, on recommendations of H. Malegam Committee (by RBI), RBI created a new NBFC category called Micro Finance Institution (MFI).
• MFI gives small loans to the poor without collateral, flexible EMI.
• MFIs are regulated by RBI and Ministry of Corporate Affairs
• Households whose annual income is not more than ₹ 25 lakh (rural) or ₹ 2 lakhs (urban) are eligible to borrow from MFIs.
• However, maximum borrowing should not be more than ₹ 1.25 lakh.
• g. of MFI – Bandhan (West Bengal), Disha (Gujarat), Cashpor (UP), Ujjivan (Karnataka).

 

Q. Microfinance is the provision of financial services to people of low-income groups. This includes both the consumers and the self-employed. The service/ services rendered under microfinance is/are : (CSE-2011) Credit facilities Savings facilities Insurance facilities Fund Transfer facilities Select the correct answer using the codes given below the lists ? 1 only 1 and 4 only 2 and 3 only 1, 2, 3 and 4

ECONOMIC SURVEY 2020 ON MFI

Post-2000, MFIs moved from purely pursuing social goals to the double bottom-line approach of achieving social and financial returns. Survey also appreciated the role of MFI in Helping the weaker section because Majority of its borrowers are women (97%), SC/ST(30%) and minorities (29%)

 

1. Economic Survey in India is published officially, every year by the___(CSE-1998)

1. Reserve Bank of India
2. Planning Commission of India
3. Ministry of Finance, Govt. of India
4. Ministry of Industries, Govt. of India

 

• To promote financial inclusion through direct interaction between small lenders and small borrowers together with addressing consumer protection, during 2017-18, RBI introduced following two new categories of the NBFC:

 

New types of NBFCs

1. Peer to Peer (P2P)
2. Account Aggregators(AA)

 

Today, the NBFC sector accounts for 17 per cent of bank assets and 0.26 percent of bank deposits with a balance sheet size of Rs. 20.7 lakh crores.

 

3.11 CONTEMPORARY PROBLEMS WITH NBFCs

• Multiple regulatory bodies – RBI doesn’t regulate
  all the NBFC. Other institutions such as NHB, SEBI, IRDAI, etc. are also involved depending on the type of NBFC.
• Difficulties in access to credit – There is a reversal of interest rate cycle as interest rates are now going up both domestically and also in the international market.
• Asset-liability mismatch – in the operations of NBFCs as these firms borrow funds from the market for short term and lend it for long term.
• It has led to a situation where the NBFCs are facing a severe liquidity crunch in the short term.
• Mutual fund among the biggest fund providers to NBFCs via commercial papers and debentures. Now these investors are getting reluctant to lend post the IL&FS crisis.

 

• Riskier Lending Pattern – NBFCs are less cautious while lending. For instance, NBFCs have grown their portfolio of small and micro loans in a big way where there are risks of lack of credit history, scale and historically high NPAs.
• The unsecured loan segment is also on the rise in the NBFC segment.
• Cascading effect of IL&FS default – Default followed by downgrade of IL&FS recently has created a liquidity squeeze for the entire non-banking financial company (NBFC) sector.
• Delayed Projects – Many infrastructure projects financed by NBFCs are stalled due to various reasons like delayed statutory approvals, problems of land acquisition, environmental clearance, etc. which has impacted their financial health.

WAY FORWARD FOR NBFC SECTOR

• Better Regulatory Regime – The Financial Sector Legislative Reform Commission (FSLRC) recommendation of creating a body with powers to monitor risk-cutting across sectors should be implemented.
• Timely Project clearances – Ensuring timely clearances, especially to infrastructural projects is a must to minimise cost inflation of these projects.
• Expanding the “Plug and Play” approach to other sectors can be a possible solution.
• RBI must encourage NBFCs to securitise their assets that can be purchased by banks.
• RBI must revisit lending restrictions placed on banks under Prompt Corrective Action and consider allowing them lending to NHB.
• RBI may also open a special window for mutual funds to get refinance against collateral.
• A coordinated and consultative approach at this point of time to address the various problems of the sector is critical to national economic health and stability.

 

3.12 INFORMAL FINANCIAL INTERMEDIARIES

• These intermediaries provide loans without KYC, PAN or Aadhar card, formal documentation but require property/vehicle/home/goods/crop/gold etc. as collaterals.
• They charge very high compound interest rates & use muscle power for recovery, hence their NPA is minimal.
• They do not fall under regulatory ambit of RBI/SEBI. However, State Governments have individual laws to regulate themg. Bombay Moneylenders Act 1947, Gujarat (2011).
• These laws require such informal lenders to register, impose ceiling on the interest rate & prohibit strong-arm tactics.

 

SUBTYPES OF BANKING

BRANCH BANKING

• Branch banking involves business of banking via branches. The branches are set up under Section 23 of Banking Regulations Act, 1949.
• The advantage of branch banking is that it helps in better management, more inclusion and risk diversification.
• The disadvantage of branch banking is that it might encourage outside local influences.

 

UNIT BANKING

• It is a limited way of banking where banks operate only from a single branch (or a few branches in the same area) taking care of the local community.
• In comparison to branch banking, the size of unit banks is very small.
• Due to small size and due to unit structure; the decision making in unit banks is very fast.
• The management in unit banks enjoy more autonomy and more discretionary powers.
• However, due to single units, the risk is not distributed or diversified.

 

MIXED BANKING

• Mixed Banking is the system in which banks undertake activities of commercial and investment banking together.
• These banks give short-term and long-term loans to industrial concerns.
• They thuspromote rapid industrialization. They may however pose a grave threat to liquidity of a bank and lead to bad debts.

 

CHAIN BANKING

• Chain banking system refers to the type of banking when a group of persons come together to own and control three or more independently chartered banks.
• Each of these banks could maintain their independent existence despite common control and ownership.
• The banks in the chains were assigned specific functions so there was no loss of profits and overlapping of interests.

RETAIL BANKING

• Retail banking means banking where transactions are held directly with customers and there are no transactions with other banks or corporations.
• The banks provide all kinds of personal banking services to customers like saving accounts, transactional accounts, mortgages, personal loans, debit and credit cards etc.
• However, due to increasing use of new technology, the operational costs for banks have gone up

 

RELATIONSHIP BANKING

• Relationship banking is a banking system in which banks make deliberate efforts to understand customer needs and offer him products
• It helps banks to gather critical soft information about the borrowers, which helps them to determine creditworthiness of such clients.
• Clients can often renegotiate their loan terms and hence result in inefficient investments for banks.

 

CORRESPONDENT BANKING

• Correspondent banking prevalent in over 200 countries is a profitable way of doing business by banks in foreign countries in which they don’t have physical presence or limited operational permissions.
• Correspondent banks thus act as banking agents for a home bank and provide various banking services to customers where otherwise the home bank does not operate.
• It helps customers to perform banking operations at ease even in places where their banks don’t have physical presence.

 

SOCIAL BANKING

• Social banking is a concept where banking services are oriented towards mass welfare and financial inclusion of the poor and vulnerable segments of society.
• RBI has taken some praiseworthy initiatives to make financial inclusion a reality for the remotest segments of Indian population. Some of these are:-
• It is mandatory for banks to open 25% of new branches in rural areas which don’t have access to formal banking, Basic Savings Bank Deposit Account has been introduced for all, KYC documentations have been considerably relaxed and simplified for small accounts.

 

VIRTUAL BANKING

• Virtual banking is performing all banking operations online. This has served as a great revolution in the banking market as banks have to continuously struggle for perfection to live up to competition and stay ahead of it.
• As banks don’t have physical offices, they find the options very cost-effective. The banks thus pass these benefits to customers in the form of waiving of account fee or higher rates of interest.

 

NARROW BANKING

• Narrow Banking is very much an antonym to Universal Banking.
• Narrow Banking means Narrow in the sense of engagement of funds and not in activity.
• So, simply, Narrow Banking involves mobilizing the large part of the deposits in Risk Free assets such as Government Securities.

 

ISLAMIC BANKING

• Islamic banking is banking or banking activity that is consistent with the principles of sharia and its practical application through the development of Islamic economics.

 

SHADOW BANKING

• Shadow banking is a set of activities and institutions. They operate partially (or fully) outside the traditional commercial banking sector. They are not fully regulated by the RBI.
• A shadow banking system can be composed of a single institution or multiple entities forming a chain. They mobilize funds by borrowing from banks, issuing Commercial Papers (CP) and Bonds (Non-convertible debentures)
• Shadow banking system’s assets are risky and illiquid. If there is a ‘bank run’ like situation, these shadow banks can’t honour the obligations as we saw in the ILFS crisis (2019)

 

 

TABLE1: FSLRC’s regulatory architecture

Present	Proposed	Functions
RBI	RBI	Monetary policy, regulation and supervision of banks; regulation and supervision of payments system.
SEBI FMC IRDA PFRDA	United financial agency (UFA)	Regulation and supervision of all non-bank and payments related markets.
Securities Appellate Tribunal (SAT)	FSAT	Hear appeals against RBI, the UFA and FRA.
Deposit Insurance and Credit Guarantee Corporation (DICGC)	Resolution Corporation	Resolution work across the entire financial system.
Financial Stability Development Council (FSDC)	FSDC	Statutory agency for systemic risk and development.
New entities	Debt Management Agency	An independent debt management agency.
	Financial Redressal Agency (FRA)	Consumer complaints.

 

 

FINANCIAL SECTOR REFORMS

• Reforming the financial sector-banking, insurance, pension reforms- is crucial to make them generate resources, gain efficiencies, innovate new products and serve the economy and people well.
• It involves adoption of best practices in regulation and other areas like micro finance etc.
• The need is particularly felt in the wake of the global financial crisis brought about essentially by the financial sector that ruined the real economy related to production.

 

 

REASONS FOR THE FINANCIAL SECTOR REFORMS

• To increase the efficiency of financial resource mobilizations and generate higher levels of growth.
• To ensure overall macroeconomic stability.
• Financial sector reforms are an integral part of the New Economic Policies of 1991 – era of L-P-G.
• Regulatory reforms– setting up of the FSDC is crucial for better supervision and clear demarcation of the jurisdiction.
• The roadmap for financial sector reforms has been defined by the RH Patil, Percy Mistry & Raghuram Rajan reports.
• Recommended by committees such as Chakravarty Committee (1985), Vaghul Committee (1987) and most notably by Narasimham Committee I (1991).
• Debt market– The bond market in India remains limited in terms of nature of instruments, their maturity, investor participation and liquidity.

 

Recommendations Of B. N. Shrikrishna Committee On FSLRC

• FSLRC submitted its report to the Ministry of Finance on March 22, 2013, containing an analysis of the current regulatory architecture and a draft Indian Financial Code to replace the bulk of the existing financial laws. The Draft Indian Financial Code:
• Consumer protection: Regulators should ensure that financial firms are doing enough for consumer protection. The draft Code establishes certain basic rights for all financial consumers and creates a single unified Financial Redressal Agency (FRA) to serve any aggrieved consumer across sectors.
• Micro-prudential regulation: Regulators should monitor and reduce the failure probability of a financial firm.
• Resolution: In cases of financial failure, firms should be swiftly and sufficiently wound up with the interests of small customers. A Unified Resolution Corporation, dealing with various financial firms, should be created to intervene when a firm is close to failure.
• Capital controls: While the FSLRC does not hold a view on the sequencing and timing of capital account liberalisation, any capital controls should be implemented on sound footing with regards to public administration and law.
• Systemic risk: Regulators should undertake interventions to reduce the systemic risk for the entire financial system. The FSLRC envisages establishing the Financial Stability and Development Council (FSDC) as a statutory agency taking a leadership role in minimizing systemic risk.
• Development and redistribution: Developing market infrastructure and process would be the responsibility of the regulator while redistribution policies would be under the purview of the Ministry of Finance.
• Monetary policy: The law should establish accountability mechanisms for monetary policy. An executive Monetary Policy Committee (MPC) would be established to decide on how to exercise the RBI’s powers.
• Public debt management: The draft Code establishes a specialised framework for public debt management with a strategy for long run low-cost financing. The FSLRC proposes a single agency to manage government debt.
• Contracts, trading and market abuse: The draft Code establishes the legal foundations for contracts, property and securities markets.

 

COMMITTEE ON FINANCIAL SYSTEM (CFS)

• High level Narasimham Committee I (1991) setup by the government.
• Task of the committee was to examine the structure, organization, function and procedure of the financial system in India.
• Committee had made assumptions which were basic to the banking Such as “the resources of the bank come from the general public and held by the banks in trust that they are to be deployed for maximum benefits of the depositors”
• On the basis of such assumptions committee gave several recommendations, which became basis for reforms introduced in the banking system in 1991-1992

 

AIM OF CFS

1. Ensuring operational flexibility
2. Internal autonomy for PSB in their decision making process
3. More professionalism in banking operation.

 

RECOMMENDATIONS OF CFS

On directed investment

• RBI was advised by the committee to use OMO as the principal instrument of monetary and credit control instead of CRR.
• Progressive reduction of
• RBI should pay interest on the CRR of the banks above the basic minimum requirement.
• Cut SLR to minimum level in next 5 years.
• Committee advised the Govt. to meet their borrowing requirements from the market so that banks can get economic benefit from SLR.

On directed credit (concessional loans) program

• These recommendations were related to priority sector lending (PSL) by banks.
• Gradual phase out of Directed credit programme.
• Directed credit should be temporary in nature as they were to help a certain weaker section.
• Redefining the concept of PSL to include only weakest sections like marginal farmers, rural artisans, village and cottage industries etc.
• “Redefined PSL” should have 10% fixed aggregate bank credit.
• Review of the composition of PSL after every 3 years.

On the Interest rates structure

• Determination of interest rates by market forces
• Removal and withdrawal of all kinds of control on interest rates of deposits and loans.
• Phasing out concessional interest rates for PSL.
• Bank rate to anchor rate and all other interest rates to linked with it (such as Repo Rate and Reverse Repo Rate and MSF)
• RBI will be the sole authority to simplify interest rate structure.

On structural reorganization of bank

• Reduce PSB (through merger and acquisitions) so, greater efficiency in banking operations.
• RBI to be made primary agency for regulation of banking system and do away dual control (RBI & Ministry of finance’s banking division)
• Made PSBs – free and autonomous
• RBI to examine all the guidelines and directions issued to the banking system in context of independence and autonomy.
• Every PSB must adopt technology and culture change so it can become competitive internally.
• Appointment of chief executive of a bank (CMD) must be on professionalism and integrity and not on political considerations.

1. Administered interest rate structure
2. Quantitative restrictions on credit flows
3. Low productivity and efficiency of PSUs
4. Deteriorating portfolio quality
5. Mounting pressures of the NPAs
6. Imposition of stringent regulations by the RBI
7. High reserve ratios requirement (CRR, SLRetc)

 

Asset Reconstruction Companies Fund (ARC)

• Concept of ARC was taken from the USA.
• Objective of setting up of ARC to tackle Non-performing assets problem of banks and financial institutions.
• Committee had opined that, worsening state of affairs of PSBs was due to use and abuse of banks by government officials, bank employees and trade unions.

 

MAJOR RECOMMENDATIONS ACCEPTED BY GOVT.

• Opening of new private sector banks permitted in 1993
• Introduction of capital adequacy norms with international standards.
• Simplification of banking regulation.

 

Q. The Narasimham Committee for financial sector Reforms has suggested reduction in____(CSE-1995) SLR and CRR SLR, CRR and Priority Sector Financing SLR and Financing to capital goods sector CRR, Priority Sector Financing and Financing to capital goods sector

 

 

KNOW YOUR CUSTOMER (KYC)

KYC is the due diligence and bank regulation that financial institutions and other regulated companies must perform to identify their clients and ascertain relevant information pertinent to doing financial business with them.

BANKING SECTOR REFORMS

• The government had started a comprehensive reform package in the financial system in 1992-93, notably after recommendations of CFS in 1991.

BANKING SECTOR IN PRE-REFORM ERA

OBJECTIVES OF BANKING SECTOR REFORMS

BANKING REFORMS

1. OPERATIONAL FLEXIBILITY
2. GOVERNANCE
3. REGULATORY REFORMS
4. STRUCTRUAL CHANGES
5. EXCHANGE STABILITY AND EFFICIENCY
6. COUSTOMER ADVOCACY
7. COMPETITVENESS

 

NARASIMHAM COMMITTEE I – 1991

• The Narasimham Committee was established under former RBI Governor M. Narasimham in August 1991. Committee recommended –
• Reduce CRR (10% not 14) and SLR (25% not 38.5)
• Interest rates should be deregulated
• Reduction in priority sector lending (PSL) rate
• More autonomy to Public Sector Banks
• Debt Recovery Tribunals (DRT) should be established
• Banking Ombudsman should be established
• Adoption Basel Norms
• More laws (legal framework) for loan recovery should be strengthened
• Rationalize branches and staffs of PSBs.
• License to new private banks (domestic + foreign) continue.
• Depoliticization of bank’s board under RBI supervision.
• Board for financial regulation and supervision (BFRS) should be setup for whole banking, financial and NBFCs (like a financial super regulators)

 

 

Actions on recommendations of Narasimham Committee I:

• The SLR was brought down from 38.5% to 28% in five years. The CRR was also brought down from 14% to 10% by 1997.
• Except for a few sectors, banks were given autonomy to decide interest rates.
• The banks were given autonomy on PSL rate, except a few sectors.
• More freedom was given to banks to open branches (25% branches in rural areas).
• Rapid computerization of the banks was adopted.
• RBI started helping the commercial banks to improve the quality of their performance.
• The government also enacted Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act, 1993, Debt Recovery Tribunals with an Appellate Tribunal for quicker recovery of bad debts (1993). Later enacted SARFAESI Act 2002.
• Banking Ombudsman scheme was launched (1995)
• More private banks were allowed.
• BASEL Norms were adopted.
• In 1993, RBI invited applications and 10 banks were given License in which 6 survived: ICICI, HDFC, UTI (became Axis bank in 2007), IDBI, Indus and DCB Bank.

 

The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act) is an Indian law. It allows banks and other financial institutions to auction residential or commercial properties (of Defaulter) to recover loans.

 

NARASIMHAM COMMITTEE II – 1998

• In 1998 the government appointed another committee, known as the Banking Sector Committee (chairman – M. Narasimham) to review the banking reform progress and design a programme for further strengthening the financial system of India.
• It suggested following recommendations:
• Review of banking laws – an urgent need for reviewing and amending main laws governing Indian Banking Industry.
• Implementation of SARFAESI Act 2002 – Act allows banks and other financial institutions to auction residential or commercial properties of Defaulter to recover loans.
• Committee recommended faster computerization, technology up gradation, training of staff, depoliticizing of banks, professionalism in banking, reviewing bank recruitment, etc. Implementation of Voluntary Retirement Scheme, Payment and Settlement Act
• License to New Banks – In 2003- 2004 two banks Kotak Mahindra and Yes Bank given License
• Narrow Banking – Those days many public sector banks were facing a problem with the Thus, it recommended the ‘Narrow Banking Concept’ where weak banks will be allowed to place their funds only in the short term and risk-free assets.
• Capital Adequacy Ratio – recommended that the Government should raise the prescribed CAR to improve the inherent strength of the banking. This will help improve their absorption capacity.
• Bank ownership – committee recommended a review of functions of boards and enabled them to adopt professional corporate strategy. Committee argued that the government. Control over the banks in the form of management and ownership not commensurate with bank autonomy.

Currently, the Capital Adequacy Ratio (CAR) for Indian banks is at 9 percent – Govt. accepted BASEL Norms.

NACHIKET MOR COMMITTEE – 2013

• The Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households, set up by the RBI.
• Committee was mandated with the task of framing a clear and detailed vision for financial inclusion and financial deepening in India.
• In its final report, the Committee has outlined six vision statements for full financial inclusion and financial deepening in India.

 

FOUR PRINCIPLES

1. STABILITY
2. TRANSPARENCY
3. NEUTRALITY
4. RESPONSIBILITY

 

SIX VISION STATEMENTS

 

RECOMMENDATIONS OF COMMITTEE

• Completely transparent balance sheet accurately reflecting both the current status and the impact of stressful situations on this status
• Payments Banks are envisaged as entities that would focus on ensuring rapid out-reach with respect to payments and deposit services.
• Wholesale Consumer Banks and Wholesale Investment Banks would not take retail deposits but would instead focus their attention on expanding the penetration of credit services.
• The extant Priority Sector Lending norms be modified in order to allow and incentivize providers to specialise in one or more sectors of the economy and regions of the country, rather than requiring each and every bank to enter all the segments.
• The committee has suggested a fixed term of 5 years for the chairman/managing director of a bank.

 

 

Financial Incusions

1. Remittances
2. Savings
3. Credit
4. Insurance
5. Bank Account

 

 

6.6 P. J NAYAK COMMITTEE – 2014

• The P J Nayak Committee (Committee to Review Governance of Boards of Banks in India 2014), was set up by the RBI to review the governance of the board of banks in India.

 

Reason for setting up – In nationalised banks, the government owns more than 50% of the shares, which gives it majority voting rights. Because of this, the government can interfere in the boards of such banks and appoint inefficient people to the boards. The appointment of the members might not always be based on merit. This will lead to overall inefficiency.

 

 

OBJECTIVES OF COMMITTEE

• To review the regulatory compliance requirements of boards of banks in the country to evaluate what can be rationalised.
• To examine the workings of the boards of banks including if sufficient time is given to strategy issues, governance, growth and risk management.
• To review RBI regulatory guidelines on bank ownership, ownership concentration and board concentration.
• To study the representation in the banks’ board, to check if the boards have the required mix of capabilities and the required independence to govern, and to inquire into possible conflict of interest in board representation.
• To study any other issues pertinent to the functioning and governance of the boards of banks.

 

RECOMMENDATIONS

• Repeal the Bank Nationalisation Act (1970, 1980), the SBI Act and the SBI Subsidiaries Act. This is because these acts require the government to have above 50% share in the banks.
• Government should set up a Bank Investment Company (BIC) as a holding company or a core investment company.
• The government transferred its share in the banks to this BIC. Thus, the BIC would become the parent holding company of all these national banks, which would become subsidiaries. BIC will be autonomous and have the power to appoint the Board of Directors and make other policy decisions.
• Till the BIC is formed, a temporary body called the Bank Boards Bureau (BBB) will be formed to do the functions of the BIC.
• The BBB will advise on appointments to the board, banks’ chairman and other executive directors.

 

Q. The Chairman of public sector banks are selected by the _________ (CSE – 2019) Banks Board Bureau Reserve Bank of India Union Ministry of Finance Management of concerned bank

 

IMPORTANCE OF YEAR 1991 IN BANKING OF INDIA

• The public sector was born out of a planned economy model, which was underpinned by a Nehruvian-Fabian socialist philosophy.
• Prior to 1991, India was more or less an isolated economy, loosely integrated with the economy of the rest of the world.
• In 1991, India embarked on the path of liberalization, privatization and globalization (LPG). This injected new energy into the slow growing Indian Economy.
• With reference to the Banking sector, it was in this year that the Narasimham Committee I (1991) gave a blueprint of banking sector reforms.
• Accordingly, the government launched a comprehensive financial sector liberalization programme which included interest rates liberalization, reduction of reserved rations, reduced government control in banking operations and establishment of a market regulatory framework.
• Another outcome of liberalization was the dismantling of prohibitions against foreign direct investment.

 

OUTCOMES OF REFORMS THAT IMPACTED THE BANKING SECTOR

• Steps were taken to move to a market determined exchange rate system, and a unified exchange rate was achieved in the 1990s itself.
• The government also released a slew of norms pertaining to asset classification, income recognitions, capital adequacy which the banks had to comply with.
• Current account convertibility (Tarapore committee – 2006) was allowed for the Rupee in accordance with IMF conditions.
• Nationalized banks were allowed to raise funds from the capital markets to strengthen their capital base.
• The lending rates for commercial banks was deregulated, thereby freeing them to lend more or as they saw fit.
• Banks were allowed to fix their own interest rates on domestic term deposits that matured within two years.
• Customers were encouraged to move away from physical cash, as RBI issued guidelines to the banks pertaining to the issuance of debit cards and smart cards
• The process of introducing computerization in all branches of banks began in 1993 in line with the Committee on Computerization in Banks’ recommendations.
• FII (Foreign Institutional Investors) were allowed to invest in dated G-Securities
  The Foreign Exchange Management Act (FEMA) was enacted in 1999 and eliminated the Foreign Exchange Regulation Act (FERA) of 1973. FEMA enabled the development and maintenance of the Indian foreign exchange markets and facilitated external trade and payments
• The National Stock Exchange (NSE) began its operations in 1994.
• RBI began the practice of auctioning Treasury Bills spanning 14 days and 28 days
• Capital index bonds were introduced in India for the first time.

The RBI provided licenses to conduct banking operations to some private banks such as ICICI Bank, HDFC Bank etc.

• New technology and customer-friendly measures were adopted by bankers to attract and retain customers.
• The Banking Ombudsman was established.

 

CAPITAL ADEQUACY RATIO (CRAR)

• Banking is a segment of the service sector in any economy. It is called the back home of the economy because today economies are more dependent on banks than in the past.
• Banks credit creation (loan disbursals) are highly risky business. The depositors’ money depends on the banks, quality of lending.
• In banking system risks are always there and they cannot be made nil because loan forwarded to any entity or individual can become a bad debt – probability of this being 50%
• CRAR also known as Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital to its risk.
• CRAR is decided by central banks and bank regulators to prevent commercial banks from taking excess leverage and becoming insolvent in the process.
• In India, scheduled commercial banks are required to maintain a CAR of 9% while Indian public sector banks are emphasized to maintain a CAR of 12% as per RBI norms.
• CRAR is arrived at by dividing the capital of the bank with aggregated risk-weighted assets for credit risk, market risk, and operational risk.

 

CRAR

1. Credit risk
2. Operation risk
3. Market risk

 

Q. Consider the following statements: (CSE-2019) Capital Adequacy Ratio (CAR) is the amount that banks have to maintain in the form of their own funds to offset any loss that banks incur if the account holders fail to repay dues. CAR is decided by each individual bank. Which of the statements given above is/are correct? 1 only 2 only Both 1 and 2 Neither 1 nor 2

 

 

REASONS FOR MAINTAINING CRAR

• To prevents bank failure
• To enhance capitalisation and resiliency of banking sector
• Capital adequacy allows for financial regulations to become global
• Amount of capital affects returns for the owners (equity holders) of the bank.

 

Central bank provides cushions to banks by following –

CRR – reserve a part of total deposits in cash

SLR – keep part of total deposits with banks themselves

CAR norm

 

BASEL ACCORD

• The Basel Accords (i.e., Basel I, II and now III) are a broader and inclusive set of agreements set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regards to –

 

• The purpose of the accords is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses.
• They are of paramount importance to the banking world and are presently implemented by over 100 countries across the world.
• The BIS Accords were the outcome of a long drawn initiative to strive for greater international uniformity in prudential capital standards for banks’ credit risk.

 

• “CAMELS” model as a tool is very effective, efficient and accurate to be used as a performance evaluate in banking industries and to anticipate the future and relative risk. “CAMELS” ratios are calculated in order to focus on financial performance. The CAMELS stands for Capital adequacy, Asset quality, Management, Earning and Liquidity and Sensitivity.

 

 

THE OBJECTIVES OF THE ACCORD

• To strengthen the international banking system;
• To promote convergence of national capital standards;
• To iron out competitive inequalities among banks across countries of the world.

BASEL I

• Launched in 1988
• Focus on capital adequacy of financial institution
• CRAR – 8% by BIS but 9% by RBI
• It was adopted in 1999 in India
• It was not a legal document
• First international solution for banking risk.
• It is said that Basel-I looked G-10 centric because details of its implementation were left to national discretion.
• India adopted Basel 1 guidelines in 1999.

 

• CAPITAL RISK
• MARKET RISK
• OPERATIONAL RISK

 

BASEL II

• Launched in 2004
• It was to be fully implemented by 2015, however India Adopted in 2009
• Three pillars – minimum capital requirements, supervisory review and market discipline.
• Banks need to mandatory disclose their risk exposure to the central bank.
• 8%by BIS and 9% by RBI as minimum CRAR
• The second Basel Accord is to be fully implemented by 2015.
• The focus of this accord is to strengthen international banking requirements as well as to supervise and enforce these requirements.

BASEL III

• Basel III – A Global Regulatory Framework for more Resilient Banks and Banking systems.
• The third Basel Accord is a comprehensive set of reform measures aimed to strengthen the regulation, supervision and risk management of the banking sector.
• Launched in 2010
• Basel III norms ???? stipulated a Capital to Risk-weighted assets (CRAR) of 8%.
• The buffer will range from 0% to 2.5%.
• Focus on – Minimum capital, supervisory review, market discipline and liquidity coverage ratio.

 

Basel 3 measures are based on three pillars:-

• Improve the banking sector’s ability to absorb shocks arising from financial and economic stress.
• Improve risk management and governance
• Strengthen banks’ transparency and disclosures.

1. ‘Basel III Accord’ or simply ‘Basel III’, often seen in the news, seeks to (2015)

develop national strategies for the conservation and sustainable use of biological diversity

improve banking sector’s ability to deal with financial and economic stress and improve risk management

reduce the greenhouse gas emissions but places a heavier burden on developed countries

transfer technology from developed countries to poor countries to enable them to replace the use of chlorofluorocarbons in refrigeration with harmless chemical

 

 

ENHANCEMENTS IN BASEL III

• Augmentation in the level and quality of capital
• Introduction of liquidity standards
• Modifications in provisioning norms
• Introduction of leverage ratio

 

As per the Reserve Bank of India’s direction, the Basel III capital regulation is being implemented from April 1, 2013, in India in phases, and will be fully adopted by March 31, 2019.

 

RECAPITALIZATION is lending to the bank the resources needed to conform to the capital adequacy norms.

All Indian banks are both Basel I and II compliant.

KEY ELEMENTS OF BASEL III

 

BETTER QUALITY CONTROL

• Better quality capital means the higher loss-absorbing capacity.
• This in turn will mean that banks will be stronger, allowing them to better withstand periods of stress.

 

 

CAPITAL CONSERVATION BUFFER

Another key feature of Basel III is that now banks will be required to hold a capital conservation buffer of 2.5%.

• It is the mandatory capital that financial institutions are required to hold above minimum regulatory requirement.
• It will increase the resilience of banks to losses, reduce excessive or underestimated exposures and restrict the distribution of capital.
• Recently, The RBI board, while deciding to retain the capital adequacy requirement for banks at 9 per cent, agreed to extend the transition period for implementing the last tranche of 0.625 per cent under the capital conservation buffer (CCB), by one year – up to March 31, 2020

COUNTER- CYCLICAL BUFFER

• The countercyclical buffer has been introduced with the objective to increase capital requirements in good times and decrease the same in bad times.
• The buffer will slow banking activity when it overheats and will encourage lending when times are tough i.e. in bad times.
• The buffer will range from 0% to 2.5%.

CLASSIFICATION OF BANK’S CAPITAL

TIER I CAPITAL (CORE CAPITAL) ????

• Tier 1 capital is a term used to describe the capital adequacy of a bank. It is a core measure of a bank’s financial strength. It consists of money kept as Statutory Liquidity Ratio (SLR), in physical cash form as share capital and secured loans. At least 6% of CAR must come from Tier 1 capital. This capital can absorb losses without the bank ceasing its trading operations. It consists financial capital which are in are most reliable and liquid (share capital and disclosed reserves)

 

TIER II CAPITAL (SUPPLEMENTARY CAPITAL) ????

• It includes after tax income, retail earnings of the bank, capital in the form of bonds/hybrid instruments & unsecured loans (getting serviced). It is secondary bank capital (second most reliable form of capital)

 

TIER III CAPITAL (TERTIARY) ????

• It is used to support market risk, commodities risk and foreign currency risk. It includes a variety of debt other than Tier 1 and Tier 2 capitals. It includes a greater number of subordinated issues, undisclosed reserves and general loss reserves compared to tier 2 capital. To qualify as tier 3 capital, assets must be limited to 50% of a bank’s tier 1 capital, be unsecured, subordinated and have a minimum maturity of 2 years.

 

 

DISCLOSED RESERVES are the total liquid cash and the SLR assets of the banks that may be used any time – part of core capital (Tier I).

 

UNDISCLOSED RESERVES are the unpublished or hidden reserves of a financial institution that may not appear on publicly available documents such as a balance sheet, but are nonetheless real assets, which are accepted as such by most banking institutions, but cannot be used at will by the bank – part of its supplementary capital (Tier II)

 

BANK FOR INTERNATIONAL SETTLEMENTS

• The Bank for International Settlements (BIS) is an international organization of central banks which fosters international monetary and financial cooperation and serves as a “bank for central banks.”
• It also provides banking services, but only to central banks, or to international organizations.
• Based in Basel, Switzerland, the BIS was established by the Hague agreements of 1930.
• As an organization of central banks, the BIS seeks to make monetary policy more predictable and transparent among its 55 member central banks.
• The BIS’ man role is in setting capital adequacy requirements to safeguard bank’s operations

 

 

SYSTEMICALLY IMPORTANT FINANCIAL INSTITUTIONS (SIFI)

• In addition to meeting the Basel III requirements, global Systemically Important Financial Institutions (SIFIs) must have higher loss absorbency capacity to reflect the greater risks that they pose to the financial system.
• The Committee has developed a methodology that includes both quantitative indicators and qualitative elements to identify global systemically important banks (SIBs).
• The additional loss absorbency requirements are to be met with a progressive Common Equity Tier 1 (CET1) capital requirement ranging from 1% to 2.5%, depending on a bank’s systemic importance.

SYSTEMICALLY IMPORTANT BANKS

Type of SIB	Who will identify them?
Global Systemically important Bank (G-SIB)	BASEL Committee on banking supervision
Domestic Systemically Important Banks (D-SIB)	Each country’s central bank e.g. RBI for India, People’s bank of China for China. Each central bank is free to decide the parameters for identifying their desi SIBs.

 

D-SIBS

• Recently RBI listed HDFC as Domestic – Systemically Important Bank (DSIB) under the bucket structure identified last year.
• DSIBs are also referred to as “Too Big To Fail” (TBTF) because of their size, cross- jurisdictional activities, complexity and lack of substitute and interconnection.
• Banks whose assets cross 2% of the GDP are considered DSIBs. If these banks fail, they can have a disruptive effect on the economy. D-SIBs are categorised under five buckets.
• According to these buckets the banks have to keep aside Additional Common Equity Tier 1 as a percentage of Risk Weighted Assets (RWAs).
• D-SIBs are closely monitored by the central bank to ensure their better functioning and prevent the indulgence of such banks in any grey areas such as money laundering etc.
• They are domestically identified by Central Banks of a country and globally by BASEL committee on banking supervision (BCBS)
• In 2014: RBI issued guidelines for Domestic Systemically Important Banks (D-SIBs).
• Each year in August, RBI will disclose the names of banks designated as D-SIBs.
• 2015: SBI and ICICI declared as D-SIBs. List will be updated each year in August. HDFC added in – 2017

TOO BIG TO FAIL (TBTF)

• 2009: Financial stability board (FSB) was set up. It is an international body affiliated with G20.
• 2010: FSB observes following:
• Each country has certain “big” banks with huge client base, commanding billions of dollars, run cross-border and cross-sector (insurance | pension etc) investment through their NBFCs. (Non- banking financial companies)
• These NBFCs act as “shadow banks”,because they carry bank-like operations but are not subject to bank-like
• If the parent banks fail, the Government is forced to ‘rescue’ them with a ‘bailout package’ to ensure that the national economy doesn’t collapse and ordinary citizen-clients don’t suffer. E.g. Subprime crisis, US & UK Government had to spend billions of tax-payer money to rescue their large banks.
• Consequently, these banks become confident they’re “too big to fail” so they will always be rescued by market-forces or the government, will continue to indulge in grey-areas and reckless practices.

 

 

 

BANKING IN INDIA – PART4

CONTEMPORARY ISSUES IN BANKING SECTOR

NPA AND STRESSED ASSETS

• A Non-Performing Assets is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days. NPAs are the bad loans of the banks.
• In order to follow international best practices and to ensure greater transparency, the RBI shifted to the current policy in 2004.
• Under it, a loan is considered NPA if it has not been serviced for one term (i.e. 90 days).
• For agriculture loans the period is tied with the period of the concerned crops– ranging from two crop seasons to one year overdue norm.

 

Banks are required to classify NPAs further into:

Substandard assets	Doubtful Assets	Loss Assets
· Assets which have remained NPA for a period less than or equal to12 months.	· An asset which had remained in the substandard category for a period of 12 months.	· Loss asset is considered uncollectable and of such little value that its continuance as bankable asset is not warrented.

 

• In percentage terms, the average gross NPAs of this group of banks rose from 91% in 2016. Projections are that NPA will hover around more than 12% by 2020.
• Public sector banks, which have close to 70% market share of loans, are more affected than their private sector counterparts.

 

NPA + Restructured loan + Written off assets = STRESSED ASSETS

RESTRUCTURED LOANS: Those assets which got an extended repayment period, reduced interest rate, converting a part of the loan into equity, providing additional financing, or some combination of these measures.

WRITTEN OFF ASSETS: When the lender does not count that money, borrower owes to him, then the asset is called written off assets. However, it does not mean that the borrower is pardoned or exempted.

 

 

STATUS OF THE NPA

 

• NPA problem is one of the most severe plaguing the Indian Banking sector posing questions over the stability of Indian Banking System.
• An RBI “Report on the trend and progress of the banking sector”shows that gross non-performing loans of banks improved to 9.1 per cent by the close of September 2019, compared to 11.2 per cent in year 2018.
• According to Economic survey 2018-19, the performance of the banking sector and Public Sector Banks in particular, improved in 2018-19.
• However, the GNPA ratio of NBFC sector deteriorated to 6.5 per cent as in December 2018 from 6.1 per cent in March 2018.

 

IMPROVING HEALTH OF BANKING SECTOR:

• Proportion of standard assets in total advances of commercial banks increased in FY19.
• Recovery of stressed assets improved in 2019 due to IBC.
• Recovery under IBC contributed more than half of the total amount.
• Cases for recovery under various mechanisms grew 27% in volume.
• Decline of all special mention accounts, restructured standard advances, gross NPAs.
• Special Mention Accounts are ones with potential to become a NPA.

 

WAYS TO RECOVER NPAs

• Possession/ sale of collateral.
• Restructure loans to maintain cash flow.
• Convert bad loans into equity.
• Selling of loan on discount to collection agency.

 

 

RISE OF NPA IN INDIA:

• India’s bad loans fifth highest in the world.
• NPA rose drastically in India from 2015.
• RBI tightened norms for NPA recognition in 2015.
• Forced banks to identify standard assets as NPA.
• NPA originated in mid- 2000s due to economic boom.
• Corporations granted loans based on performance.
• Recession led to stagnated economic growth.

 

LEGISLATIONS RELATING TO NPA AND BANKCRUPTCY

• Insolvency and Bankruptcy Code, 2016
• SARFAESI Act, 2002
• Recovery of Debts Due to Banks and Financial Institutions (DRT) Act
• Lok Adalats
• Under Banking Regulation Act 1949
• Fugitive Economic Offenders Act, 2018

 

RBI’S GUIDELINES TO RESOLVE NPA

• Strategic Debt Restructuring.
• Allows banks to change management of defaulter.
• Joint Lenders Forum.
• Lenders evolve resolution plan.
• Lenders can vote on its implementation
• Project Sashakt

 

 

MAJOR REASONS FOR SURGING NPAs

INTERNAL	EXTERNAL	OTHERS
Diversion of funds for expansion, modernisation or for taking up new projects	Exchange rate fluctuations	Pressure due to liberalization- competition, reductions in tariffs etc.
Time and cost overrun	Change in govt. policies	Poor monitoring of credits
Business failures due to Covid-19 and resultant market failures	Price volatility of inputs	Mismatches of funds i.e. using loans granted for short terms for long term transactions
Inefficiency in bank management	Input or power shortage	Inability to raise adequate funds
Slackness in credit management and monitoring	Recession in the economy as a whole	Granting of loans to certain sectors of economy on the basis of govt. directives

 

REASON FOR HIGH NPAs

1. Sectrol Slowdown Such as Infra.
2. Irrational lending byBanks.
3. Slowdfown in global economy
4. Political interference
5. Poor Conviction Rate and Weak Laws

Raghuram Rajan has identified the NPA problem as a major challenge facing the Indian Banking Sector.

 

FORE-CLOSURE means taking over by the lender of the mortgaged property if the borrower does not conform to the terms of mortgage. Securitization is the process of a group of assets, such as loans or mortgages, and selling securities backed by these assets.

POSITIVE EXTERNALITIES OF DECLINING NPA

ON BANKS:

• It increases the profitability & liquidity of the banks as annual return on assets come increases and also the amount given as loan also gets opened which can now be used for some return earning asset otherwise. Banks can grow faster when the availability of credit increases.
• The Monetary Policy Transmission becomes faster for banks to pass on the RBI-induced rate reductions.
• Banks eases credit to small and medium enterprises (SMEs) that are India’s potential for prosperity of an entrepreneurial middle class.

ON BORROWERS:

• Banks may begin lowering interest rates on some products once Non-performing assets decrease.
• As a result, the cost of capital will decrease, making the different businesses financially viable.

 

ON OVERALL ECONOMY:

• Economy will grow as there will be more availability of credit from the security market, which increases employment generation, and development of the country.

WAYS FOR FURTHER IMPROVEMENT

• Managing Risks – Risk management processes still need substantial improvement in PSBs. Compliance is still not adequate, and cyber risk needs greater attention
• Improve the process of project evaluation – and monitoring to lower the risk of project NPAs. Significantly more in-house expertise can be brought for project evaluation.
• Strengthen the recovery process further – Both the out of court restructuring process and the bankruptcy process need to be made faster and strengthened.
• Infusion of Capital – The government must infuse at one go whatever additional capital is needed to recapitalise banks providing such capital in multiple instalments is not helpful.

 

 

SPECIAL MENTION ACCOUNTS (SMA)

• It is a tool for early stress discovery of bank loans.
• Introduced as a corrective action plan.
• Accordingly banks should identify potential stress in the account by creating a new sub-asset category viz. ‘Special Mention Accounts’
• In March 2016, RBI had notified a mechanism for resolving stressed MSME loans of up to Rs 25 crore.
• According to the stress level such loans are categorised into three categories:
• SMA 0 ( Delay up to 30 Days)
• SMA 1 ( Delay up to 31-60 Days)
• SMA 2 ( Delay up to 61-90 Days)

 

NOTE: The loans still remain standard even in these categories and turn bad only after a delay in payment of more than 90 days

 

WILFUL DEFAULTER

• There are many people and entities who borrow money from lending institutions but fail to repay. However, not all of them are called wilful defaulters.
• A wilful defaulter is one who does not repay a loan or liability, but apart from this there are other things that define a wilful defaulter.
• However, a lending institution cannot term an entity or an individual a wilful defaulter for a one-off case of default and needs to take into account the repayment track record.
• The default should be established to be intentional and the defaulter should be informed about the same.
• The defaulter should also be given a chance to clarify his stand on the issue. Also, the default amount needs to be at least Rs.25 lakh to be included in the category of wilful defaults.

 

 

ACCORDING TO THE RBI, A WILFUL DEFAULTER IS ONE WHO–

• Financially capable to repay and yet does not do so;
• One who diverts the funds for purposes other than what the fund was availed for;
• With whom funds are not available in the form of assets as funds have been siphoned off;
• Who has sold or disposed the property that was used as a security to obtain the loan.
• Diversion of fund includes activities such as using short-term working capital for long-term purposes, acquiring assets for which the loan was not meant for and transferring funds to other entities.

 

 

RESTRICTIONS ON WILFULL DEFAULTERS

• Barred from participating in the capital market.
• Barred from availing any further banking facilities and to access financial institutions for five years for the purpose of starting a new venture.
• The lenders can initiate the process of recovery with full vigour and can even initiate criminal proceedings, if required.
• The lending institutions may not allow any person related to the defaulting company to become a board member of any other company as well.

 

 

STRATEGY FOR RESOLUTION OF THE NPAs

• At one hand, while the RBI tried to check the NPAs from rising by announcing new guidelines for the banks, on the other hand, it has also taken several steps to ‘resolve’ the problem.
• Since 2014-15, the RBI has implemented a number of schemes to facilitate resolution of the NPAs problem of the banks are briefly discussed below:

 

5/25 REFINANCING

• This scheme offered a larger window for revival of stressed assets in the infrastructure sectors and 8 core industries.
• Under this scheme lenders were allowed to extend the tenure of loans to 25 years with interest rates adjusted every 5 years, so tenure of the loans matches the long gestation period in the sectors.
• The scheme thus aimed to improve the credit profile and liquidity position of borrowers, while allowing banks to treat these loans as standard in their balance sheets, reducing provisioning costs against NPAs.
• However, with amortisation spread out over a longer period, this arrangement also meant that the companies faced a higher interest burden, which they found difficult to repay, forcing banks to extend additional loans (known as ‘evergreening’ of the loan).
• Resultantly, this in turn has aggravated the initial problem.

ASSETS RECONSTRUCTION COMPANIES (ARCs)

• ARCs were introduced to India under the SARFAESI Act (2002), as specialists to resolve the burden of NPAs.
• But the ARCs (most are privately-owned) finding it difficult to resolve the NPAs they purchased, are today only willing to purchase such loans at low prices.
• As a result, banks have been unwilling to sell them loans on a large scale.
• Since 2014, the fee structure of the ARCs was modified (requiring ARCs to pay a greater proportion of the purchase price up-front in cash to the banks) purchases of NPAs by them have slowed down further – only about 5 per cent of total NPAs were sold during 2014-15 and 2015-16.
• Normally, banks and FIs themselves recover the loans. But in the case of bad debts (sticky loans), it is outsourced to the ARCs who have built-in professional expertise in this task and who handle recovery as their core business.
• ARCs buy bad loans from banks and try to restructure them and collect them.
• ARCs were recommended by Narasimham committee II.
• ARCIL – the first asset reconstruction company was set up recently.

 

PRUDENTIAL NORMS

• Prudential norms consist of –
• Income recognition
• Asset classification
• Provisioning for NPAs
• Capital adequacy norms (capital to risk-weighted asset ratio, CRAR).
• A proper definition of income is essential in order to ensure that banks take into account income that is actually realized (received).
• It helps in classifying an asset as NPA in certain cases. Once classified as NPA, funds must be set apart to balance the bank’s operations so as to maintain safety of operations in case of non-recovery of NPAs.
• Thus, income recognition, asset classification and provisioning norms are inter-related.
• Prudential norms make the operations transparent, accountable, prudent and safe
• Prudential norms serve two primary purposes:
• Bring out the true standing of a bank’s
• Help in prevention of its deterioration.

 

STRATEGIC DEBT RESTRUCTURING (SDR)

• In June 2015, RBI came up with the SDR scheme provide an opportunity to banks to convert debt of companies (whose stressed assets were restructured but which could not finally fulfil the conditions attached to such restructuring) to 51 per cent equity and sell them to the highest bidders – meaning ownership change takes place in it.
• By end-December 2016, only 2 such sales had materialized, in part because many firms remained financially unviable, since only a small portion of their debt had been converted to equity.

 

ASSET QUALITY REVIEW (AQR)

• Resolution of the problem of bad assets requires sound recognition of such assets.
• Therefore, the RBI emphasized AQR, to verify that banks were assessing loans in line with RBI loan classification rules.
• Any deviations from such rules were to be rectified by March 2016.

 

S4A SCHEME

• Scheme for Sustainable Structuring of Stressed Assets
• Introduced in June 2016, in it, an independent agency is hired by the banks which decides as how much of the stressed debt of a company is ‘sustainable’.
• The rest (‘unsustainable’) is converted into equity and preference shares.
• Unlike the SDR arrangement, this involves no change in the ownership of the company.

 

Q. ‘Scheme for Sustainable Structuring of Stressed Assets (S4A)’ is related to____( CSE-2017)

1. Procedure for ecological costs of developmental schemes.
2. Scheme of RBI for reworking the financial structure of big corporates with genuine difficulties.
3. Disinvestment plan for Central Public Sector Undertakings.
4. Provision in ‘The Insolvency and Bankruptcy Code’.

 

 

4R FRAMEWORK OF RBI

 

1. Recognising
2. Resolving and Recovering
3. Recapitalising
4. Reforms

 

RECOGNIZING – NPAs transparently-

• Through Asset Quality Reviews and Joint Lenders’ Forum.
• Banks are now required to acquire Legal Entity Identifier (LEI) number from the borrower and report it to Central Repository of Information on Large Credit.

 

RESOLVING AND RECOVERING value from stressed accounts-

• IBC Code, 2016 has been enacted, which has provided for the taking over management of the affairs of the corporate debtor at the outset of the corporate insolvency resolution process.
• Amendment to the Banking Regulation Act, 1949 to empower the RBI.
• Amendment to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 to make it more effective.
• Project Sashakt – to resolve the problem of NPAs through a market-led approach.

RECAPITALISING – Government of India announced recapitalization of PSBs to the tune of 2.11 lakh crore in October 2017, through infusion of capital by the Government and raising of capital by banks from the markets.

REFORMS in banks and financial ecosystem to ensure a responsible and clean system.

• Comprehensive framework for transforming the PSBs under Mission Indradhanush, 2015.
• PSBs have created Stressed Asset Management Verticals to focus attention on recovery and entrusted monitoring of loan accounts.
• Fugitive Economic Offenders Act, 2018
• The RBI has been aligning the regulatory and supervisory frameworks for NBFCs with that of SCBs.
• Prompt Corrective Action (PCA)
• The consolidation of Banks

PCA FRAMEWORK OF RBI

• Prompt Corrective Action was introduced in 2002 as a structured early- intervention mechanism for banks that become under-capitalised due to poor asset quality, or vulnerable due to loss of profitability.
• The PCA framework deems banks as risky if they slip some trigger points such as capital to risk weighted assets ratio (CRAR), net NPA, Return on Assets (RoA) and Tier 1 Leverage ratio.
• The PCA framework is applicable only to Commercial Banks and not extended to Co-Operative banks, NBFCs and FMIs.

RBI’S PRUDENTIAL FRAMEWORK FOR RESOLUTION OF STRESSED ASSETS (PFRSA)

• PFRSA provides for early resolution of stressed assets in a transparent and time-bound manner by-
• Giving complete discretion to lenders with regard to design and implementation of resolution plans,
• Disincentives for delay in implementation of resolution plan or initiation of insolvency proceedings,
• Making mandatory the signing of an inter-creditor agreement, providing for majority decision- making by all lenders.

 

PROJECT SASHAKT

• Project Sashakt was proposed by a panel led by PNB chairman Sunil Mehta.
• 5-pronged strategy to resolve bad loans –
• Small and Medium Enterprise (SME) resolution approach – Bad loans of up to ₹50 crore will be managed at the bank level, with a deadline of 90 days.
• Bank-led resolution approach– For bad loans of ₹50-500 crore, banks will enter an inter- creditor agreement, authorizing the lead bank to implement a resolution plan in 180 days, or refer the asset to National Company Law Tribunal (NCLT).
• AMC/AIF led resolution approach– For bad loans above Rs.500 crores would be resolved through an independent Asset Management Company (AMC) which would be funded by Alternative Investment Fund (AIF).
• NCLT/IBC approach
• Asset-trading platform

RBI “3R” FRAMEWORK FOR REVITALIZING STRESSED ASSETS

1. Restructuring
2. Rectification
3. Recovery

Rectification	In 2015, RBI ordered the Banks to conduct Asset Quality Review (AQR) and begin process of rectification of bad loans.
Restructuring	It is changing the loan interest (%) or tenure or ownership. – For Infrastructure loans, RBI allowed banks to extend infra-loan tenure upto 25 years, and even reduce loan interest rate. But such interest rate will be reviewed each 5 years – known as 5/25 strategy. – Corporate Debt Restructuring ???? For non-infra corporate loan, RBI permitted loan restructuring if 75% of the lenders approve. – Joint Lenders Forum (JLF) mechanism S4A – Scheme for Sustainable Structuring of Stressed Assets
Recovery	– SARFAESI Act 2002 – Insolvency and Bankruptcy Code 2016 ???? If 75% of the lenders don’t agree for restructuring / resolution plan, then assets will be liquidated.

 

 

IL & FS CRISIS

• Recently an infrastructure financing company, Infrastructure Leasing & Financial Services (IL&FS), an NBFC, defaulted on their loan repayment. (word art)
• IL&FS Group is a vast conglomerate with a complex corporate structure that funds infrastructure projects across the world’s fastest-growing major economy like Chenani-Nashri road tunnel, India’s longest and has raised billions of dollars from the country’s corporate debt market.

 

IL & FS

Confusions over regulators

1. Source and use of funds
2. Ethical issue
3. Complex company structure

 

• IL&FS is a Systematically Important Non- Deposit Core Investment Company (CIC- ND-SI) i.e. any crisis at IL&FS would not only impact equity and debt markets but could also stall several infrastructure projects of national importance.
• Many major corporates, banks, mutual funds, insurance companies, etc. such as LIC, HDFC and SBI have stakes in the IL&FS group.
• Recently an infrastructure financing company, Infrastructure Leasing & Financial Services (IL&FS), an NBFC, defaulted on their loan repayment.

 

NBFC REFORMS

• Earlier, only privately owned NBFCs had to maintain a minimum Capital to Risk Assets Ratio (CRAR) of 15 % (if Tier-1 capital is 10%). Now, the CRAR requirements are applicable to government NBFCs as well, to be achieved by 2021-22.
• It will ensure both types of NBFCs stand on an equal footing on compliance with specific RBI rules and will also help in checking NPAs and bankruptcy.
• RBI allowed banks to provide Partial Credit Enhancement (PCE) to bonds issued by systemically important non-deposit taking NBFCs registered with the RBI and Housing Finance Companies (HFCs) registered with the National Housing Bank. This will help investors regain their confidence in the market, post IL&FS crisis.

PUNJAB NATIONAL BANK (PNB) CRISIS

• NEWS- One of the branches of State-owned Punjab National Bank (PNB) has recently detected fraudulent transactions worth over Rs 11,000 crores.
• PNB has alleged that two of its employees had “fraudulently” issued LoUsand transmitted SWIFT instructions to the overseas branches of Indian Banks.
• This was done to raise buyer’s credit for the firm of a diamond merchant without making entries in the bank system.
• These LoUs were mostly issued to two Hong Kong branches of Indian Banks and was for the aforesaid diamond merchant.

 

IMPACT OF PNB FRAUD

• Hong Kong branches of Allahabad Bank and Axis Bank have given money to the beneficiary entity on behalf of Modi’s firms.
• As a result, PNB will have to settle the LoUs with these branches according to the norms of the Hong Kong Monetary Authority.
• Market sentiment has already been impacted and PNB stock fell 9.81% in a single day, which consequently saw investors loose over Rs 3,000 crores.
• The bank may have to set aside higher provisioning in the next few quarters if it unable to recover the money from the accused firms.
• The fraud has been unearthed at a time when Indian banks are reeling under a pile of stressed assets of about Rs 10 lakh crore.
• Also, higher provisioning and a rise in bond yields, has resulted in losses for most public sector banks in the previous quarter.

 

 

LETTER OF UNDERTAKING (LOU)

• LoU is an assurance given by one bank to another to meet a liability on behalf of a customer.
• It is similar to a letter of credit or a guarantee.
• It is used for overseas import remittances and involves four parties — an issuing bank, a receiving bank, an importer and a beneficiary entity overseas.
• According to norms, they are usually valid for 180 days.
• LoUs are conveyed from bank to bank through “Society for Worldwide Interbank Financial Telecommunication” (SWIFT)
• Notably, till now, there is no record of a breach in SWIFT instructions anywhere in the world.

YES BANK CRISIS

• Within months of small cooperative bank fallout in india, major private player Yes Bank (India’s fifth largest private sector bank) has also come under the RBI action for mounting bad loans.
• In order to save Yes Bank from collapsing and to preserve people’s trust in the Indian banking system, RBI has taken several measures.

 

 

REASONS FOR YES BANK COLLAPSE

• Domino effect of IL&FS crisis – Yes Bank illustrates the widening damage from India’s shadow banking crisis, which has left the Bank with a growing pile of bad loans.
• Rising NPA’s – Yes Bank suffered a dramatic doubling in Gross Non-Performing Assets over the April-September 2019 to ₹17,134 crores. Due to this, Yes Bank was unable to raise capital to shore up its balance sheet.
• Vicious cycle – Decline in the financial position of Yes Bank has triggered invocation of bond covenants by investors (redeeming of bonds), and withdrawal of deposits. It means that the bank was witnessing withdrawal of deposits from customers.
• Governance issues – The bank has also experienced serious governance issues and practices in recent years which have led to a steady decline of the bank. For instance, the bank under-reported NPAs to the tune of Rs 3,277 crore in 2018-19.

EFFECT OF YES BANK CRISIS

• Revival of the theory of India’s Lehman Moment – The government took over IL&FS in 2018 in an effort to reassure creditors after the defaults. The Yes Bank crisis could trigger a domino effect that could lead to the collapse of various other financial institution.
• Erosion of depositor faith – Even after RBI’s takeover of Yes Bank, the news of limiting withdrawals at Rs 50,000, has led to long queues of people claiming their money back.
• People will gravitate towards public sector banks which are already reluctant to provide credit.
• Private banks will be forced to offer higher deposit rates, keeping the cost of credit higher.
• Thereby banks will not be able to cater the credit requirement which is a prerequisite to realise the dream of becoming a $5 trillion economy by 2024–2025.
• Effect of Indian Economy – Collapse of Yes Bank is highly undesirable, at a juncture when the growth in the Indian economy has dropped to 5%.

 

INDIA’s LEHMAN MOMENT

The IL&FS default raised fears of a Lehman-like crisis, referring to the collapse of the US investment bank Lehman Brothers in 2008-09. The event rocked global stock markets and led to the biggest financial crash (Global financial crisis 2008) since the Great Depression 1929.

WAY FORWARD

• Yes Bank crisis should be seen as a good opportunity for the various stakeholders:
• For RBI to review its PCA
• For the Government to carry out governance reforms in the financial sector.
• For commercial banks and shadow banking institutions to implement prudential norms in events of providing loans.

PMC CRISIS

• The Punjab and Maharashtra Cooperative (PMC, HQ-Mumbai, setup 1984) is a Multi- State Scheduled Urban Co-operative Bank. It functions in Maharashtra, Delhi, Karnataka, Goa, Gujarat, Andhra Pradesh and Madhya Pradesh.
• PMC bank loaned large amount to a weak company HDIL, because of its cozy relations with bank directors. Company who couldn’t repay it. NPA became so large, bank might collapse.
• RBI imposed withdrawal limits on the depositors using the powers of Banking Regulation Act 1949. Because ‘bank run’ would have been so high even CRR-SLR can’t fulfill it, if there was no withdrawal limit.
• Merger / closing / liquidation of a cooperative bank requires approval by Government’s registrar of cooperatives so RBI alone can’t do much action.
• Therefore, RBI offered Urban Cooperative Banks to convert their license into Small Finance Bank (SFB) then RBI alone will have supervision powers without interference from Government. But UCB banks not interested, they enjoy the present loopholes.
• Budget-2020 promised to amend the Banking Regulation Act to increase RBI’s powers over cooperative banks.

 

RBI’s Y.H. Malegam Committee (2011) had suggested many reforms on UCBs, but they’re not yet implemented until Government amends the laws.

 

RBI: ISSUES AND INITIATIVES

 

TRANSFER OF FUNDS BY RBI TO CENTRAL GOVERNMENT

• Section 47 of the RBI Act 1934 requires RBI to transfer the profit it earns to the Central Government every year.
• However a part of RBI’s profit every year is used to make provisioning for unforeseen circumstances.
• Accordingly RBI maintains reserves in the form of capital to cover various risks including market risk, operational risk, credit risk and contingency risk.
• components of RBI’s capital reserve include:
• Contingency Fund – set apart for meeting the unforeseen contingencies.
• Asset Development Fund – To fund investments in subsidiaries.
• Currency and Gold Revaluation Account – To cover fluctuations in gold and currency assets that RBI holds.
• Investment Revaluation Account (IRA) – To cover risks associated with fluctuations of interest rates of government securities.
• Foreign Exchange Forward Contracts Valuation Account – To cover risks related to foreign exchange related forward contracts.

 

 

RBI V/S GOVT: HOW MUCH RESERVE SHOULD BE MAINTAINED?

• The surplus maintained by RBI has 2 components:
• Part of net profits every year
• Surplus already accumulated over the years
• While RBI has been keeping a substantial part of its net profits as reserves till 2013, since 2014 RBI has been transferring 100% of its net profit to the government since 2014.

 

 

REVIEW OF ECONOMIC CAPITAL FRAMEWORK

• Economic Capital Framework is a methodology for determining the appropriate level of risk provisions to capital that is to be made under Section 47 of the Reserve Bank of India Act.

• It is argued that RBI has become the most capitalized central bank in the world and has been stocking surplus capital over what is actually required to face contingency situations.
• While the central banks across the world have a surplus capital to the tune of 10-14% of their total assets, RBI 26.8% of its total assets as reserves.
• Usha Thorat Committee (2004): RBI should maintain 18% of its total assets as reserves.
• Malegam Committee (2014): Should transfer all entire net profits annually to RBI.

 

 

BIMAL JALAN COMMITTEE (2019) RECOMMENDATIONS

• Appointed to review the ECF and decide on the optimum surplus capital to be maintained by RBI
• Level of Reserves – The surplus capital should be in the range of 20.8% to 25.4% of the total assets of the RBI. Thus the RBI transferred about 50000 crore of excess surplus capital this year in addition to its annual net profits of about 1.2 Lakh Crore to the central government this year.
• Financial Stability Risk – Risk buffer of 5-6.5% should be dedicated to situations like Global Financial Crisis of 2008.
• New Risk Framework – It recommended a new risk framework including–
• Currency risks (since the RBI keeps huge volume of foreign currency assets)
• Gold Price Risk (RBI has gold reserves)
• Interest rate risk (RBI holds government securities)
• Credit risk (bonds and loans to the commercial banks), Operational risks (due to any potential operational problems)
• Monetary and Financial stability risks (due to weaknesses of the financial institutions like banks, liquidity problems)

 

 

RBI’S BANKING OMBUDSMAN SCHEME

• Quasi-judicial authority created to resolve customer complaints against banks, introduced under the Banking Regulation Act in 1995.
• The Ombudsman is a senior official appointed by RBI. It covers all types of banks.
• Customers can approach Banking Ombudsman for grievance redressal in the following areas:
• Non-payment/ delay in the payment or collection of cheques, drafts, bills etc.
• Non-payment/delay in payment of inward remittances
• Failure/delay to issue drafts, pay orders or bankers’ cheques
• Non-adherence to prescribed working hours
• Refusal to open deposit accounts without any valid reason
• Levying of charges without adequate prior notice to the customer
• Refusal/delay in closing the accounts
• Non-observance of RBI guidelines on engagement of recovery agents by banks
• In 2018, mis-selling of 3rd party products like insurance was added under the purview of Banking Ombudsman
• Ombudsman scheme for NBFCs 2018 – Extended to redressal of complaints against NBFCs in 2018.

 

 

NEW GUIDELINES: INTERNAL OMBUDSMAN

• RBI has tightened the banking ombudsman scheme with the objective to strengthen the grievance redressal mechanism for customers.
• Internal Ombudsman: Commercial banks having 10 or more banking outlets should have an independent internal ombudsman (IO).
• Fixed Term: 3-5 Years
• Removal: The IO can be removed only with prior approval from RBI.
• Compensation limit: Ombudsman redressal is allowed for complaints where the compensation amount for any loss suffered by the complainant is limited to Rs 20 lakh.
• Additionally, maximum compensation of Rs 1 lakh for loss of time and money, harassment and mental anguish suffered by the complainant.

 

 

SECTION 7 OF RBI ACT, 1935

• Section 7 of the RBI Act 1934 empowers the central government to supersede the RBI Board and issue directions to the RBI, after consulting the governor, if they are considered to be “necessary in public interest”.

 

UTKARSH FRAMEWORK 2022

• RBI launched ‘Utkarsh 2022’, the Reserve Bank of India’s Medium- term Strategy Framework to achieve excellence in the performance of RBI’s mandates and strengthening the trust of citizens and other institutions.
• It is a three-year road map for medium term objective which is in line with the global central banks’ plan to strengthen the regulatory and supervisory mechanism.

 

 

NATIONAL STRATEGY FOR FINANCIAL INCLUSION

• This strategy has been released by RBI. Financial Inclusion Advisory Committee of the RBI has drafted it. It will be operational from 2019 to 2024.
• Strategic Pillars of National Strategy for Financial Inclusion:
• Universal Access to Financial Services
• Providing Basic Bouquet of Financial Services
• Access to Livelihood and Skill Development
• Financial Literacy and Education
• Customer Protection and Grievance Redressal
• Effective Co-ordination
• Ministry of finance is preparing an index of financial inclusion.

 

FINANCIAL INCLUSION INDEX

It was launched by the Minister of Finance. The single composite index gives a snap shot of level of financial inclusion that would guide Macro Policy perspective.

 

 

REFORMS AND INITIATIVES IN BANKING SECTOR

 

INSOLVENCY AND BANKRUPTCY CODE 2016

• Operational Creditor – Suppliers, customers, contractors etc.
• Financial Creditors – banks, NBFC, bond & other debt security holders and Home buyers.
• If Individual, Partnership firm or Company defaults on a business loan of INR 1 lakh or more, then, Financial creditors approach National Company Law Tribunal (NCLT) to initiate proceedings under the I&B Code. However, NCLT must accept or reject application within 14 days.
• If NCLT accepts the application, then it will grant moratorium of 180-270 days so no other lender can unilaterally attach assets under SARFAESI Act.
• Within aforesaid period, an Insolvency Professionals (IP) will make a resolution plan.
• IP will present the plan to Committee of Creditors(CoC) made up of the Financial Creditors (FC). In this Committee, FCs’ voting power is based on the quantity of loans given by them.
• If “Specified percentage” of the FCs agree with such resolution plan, then it will be set in motion, otherwise, IP will liquidate the assets to recover the dues.

 

Mechanisms for Appeal
Individual or partnership firm borrower	If borrower is a Company
National Company Law Appellate Tribunal of the Companies Act.	At Debt Recovery Tribunal ???? Debt Recovery Appellate Tribunal of SAFAESI Act 2002
Exemptions under IBC
Willful Defaulter – A borrower who has the capacity to repay, but he’s not repaying the loan	Incapable Defaulter a borrower whose loan account is in NPA for more than a year, and he is not capable of paying even partial loan amount.
Above two categories of borrowers are not eligible for I&B resolution process. Their assets will be directly liquidated under SARFAESI Act 2002.

 

By January 2018, over 525 cases of corporate insolvency have been admitted across all the National Company Law Tribunal (NCLT), as per the Economic Survey 2017-18.

Recently, an ordinance was approved to amend the IBC so as to provide relief for corporates as the COVID-19 pandemic and subsequent lockdown had significantly impacted economic activities.

 

NATIONAL COMPANY LAW TRIBUNAL (NCLT)

• NCLT is a quasi-judicial body in India adjudicating issues concerning companies in the country.
• It was formed on June 1, 2016, as per the provisions of the Companies Act 2013 (Section 408) by the Indian government.
• It was formed based on the recommendations of the Justice Eradi Committee that was related to insolvency and winding up of companies in India.
• Each Bench is headed by a President, 16 judicial members and 9 technical members.
• As of now, the Ministry of Corporate Affairs has established 11 Benches of the tribunal with the Principal Bench at New Delhi.

 

Amendments – Insolvency and Bankruptcy Code

Amendment (2018	– Permits Govt. to modify norms when applying IBC for MSME. – RERA registered building (home & office) buyers are classified as ‘financial creditors’. – So, if builder unable to finish project, unable to repay the loans to banks then homebuyers will have voting power in the I&B resolution process. – It reduced the voting requirements for faster resolution
IBC Code (first) Amendment Act (2019	– Must finish entire process within 330 days, instead of earlier 180-270 days limit. – If too many FCs (e.g. homebuyers): they may appoint a representative for to attend the Committee of Creditors on their behalf, for smoother & systematic conduct of meeting.
IBC Code (second) Amendment Bill 2019)	– IBC complaints can be made only if the loan amount is minimum “specified” or minimum lenders are “specified”. This is to discourage frivolous complaints by borrowers. – If the government had given any license, permit, registration etc. then it will not be cancelled while IBC proceedings are going on. (e.g. if a liquor company’s license was cancelled while ongoing case, then no fresh investor would come and so that business cannot be revived). – provision of Ring-fencing from any risk of criminal proceeding.

 

 

INSOLVENCY AND BANKRUPTCY BOARD OF INDIA (IBBI)

• IBBI is the statutory body that monitors and implements I&B Code 2016.
• IBBI composition (total 10 members) ???? 1 Chairman, 1 nominated member from RBI, 8 members from Government’s side.
• Chairman has 5 years / 65 age tenure, whichever earlier. Also eligible for reappointment.
• IBBI’s administrative control rests with the Ministry of Corporate Affairs (MCA).
• IBBI selects Insolvency Professionals Agencies (IPAs). These IPAs enrol and supervise the members practicing as Insolvency Professionals (IPs). Presently, 3 organizations given “IPA” status viz.
• ICAI (Chartered Accounts)
• ICSI (Company Secretaries)
• Institute of Cost Accountants.
• IBBI also selects Information Utility (IU) organization to maintain database of borrowers. It is compulsory for the lenders to share data with IU. IU helps lenders in two ways:
• By looking the borrowers’ credit history, lenders can make informed decisions about whether to give loan or not, and how much interest to charge?
• This database helps establishing documentary proofs during NCLT/DRT/judicial/liquidation proceedings.

 

 

In 2017, National E-Governance Services Ltd (NeSL) (owned by consortium of SBI, LIC etc.) was the first to get the IU status.

 

 

CROSS-BORDER INSOLVENCY

• Cross-border insolvency has two dimensions:
• foreign creditors should be able to recover money lent to Indian corporates & vice versa.
• During Indian company’s insolvency in India, the Indian lenders should be able to recover money from Indian company’s foreign assets easily, and vice versa.
• IBC sections 234 & 235 have provisions for it, but they are not notified yet, so they are not enforced.
• Ministry of Corporate Affairs Committee (2018) on Insolvency Law (reforms) headed by Injeti Srinivas recommended ????
• We should create a separate law for Cross-border Insolvency.
• More than 40 nation’s use United Nation’s Commission on International Trade Law (UNCITRAL)’s Model Law of Cross Border Insolvency (1997)
• Hence, we can use it as a template while making our own law. Government is working on such bill.

 

 

BANK BOARD BUREAU (BBB)

• It was set up in February 2016 as an autonomous body – based on the recommendations of the RBI appointed PJ Nayak Committee (2014) to improve governance of Public Sector Banks (PSBs).
• It had replaced Appointments Board of Government.
• Banks Board Bureau comprises ???? Chairman (first- Vinod Rai for 2 year term), three ex-officio members (Secretary, Department of Public Enterprises, Secretary of the Department of Financial Services and Deputy Governor of the RBI), and five expert members (two of which are from the private sector)
• Its broad agenda is to improve governance at state-owned lenders.
• Its mandate also involved advising the government on top- level bank appointments and assisting banks with capital-raising plans as well as strategies to deal with bad loans.

 

Q. The Chairmen of public sector banks are selected by the _____ (CSE-2019)

1. Banks Board Bureau
2. Reserve Bank of India
3. Union Ministry of Finance
4. Management of concerned bank

 

FINANCIAL SECTOR REGULATORY APPOINTMENT SEARCH COMMITTEE (FSRASC)

• As per the RBI Act, the central bank should have one governor and four deputy governors -Two from within the ranks and one commercial banker and another an economist to head the monetary policy department.
• This committee recommends on the posts to be filled due to any vacancy in this list.
• It is headed by Cabinet Secretary and includes additional Principal Secretary to the Prime Minister who is a permanent government nominee and 3 other experts.
• The same process is being followed in the selection of Chairman of SEBI and IRDAI.

 

 

INTER CREDITOR AGREEMENT (ICA)

• It is aimed at the resolution of loan accounts with a size of ₹50 crore and above that are under the control of a group of lenders.
• It is part of the “Sashakt” plan approved by the government to address the problem of resolving bad loans.
• It is based on a recommendation by the Sunil Mehta committee that looked into resolution of stressed assets.

 

Q. What was the purpose of Inter-Creditor Agreement signed by Indian Banks and financial institutions recently ? (CSE-2019)

1. To lessen the Government of India’s perennial burden of fiscal deficit and current account deficit
2. To support the infrastructure projects of Central and State governments
3. To act as independent regulator in case of applications for loans of INR 50 cr or more
4. To aim at faster resolution of stressed assets of INR 50 cr or more which are under consortium lending

 

INDRADHANUSH PLAN

• The Public Sector Banks (PSBs) play a vital role in India’s economy. In the past few years, because of a variety of legacy issues including the delay caused in various approvals as well as land acquisition and also because of low global and domestic demand, many large projects have stalled.
• PSBs which have got predominant share of infrastructure financing have been largely affected. It has resulted in lower profitability for PSBs, mainly due to provisioning for the restructured projects as well as for gross NPAs.
• Indradhanush Plan for revamping PSBs, announced by the Govt. on 14 Aug 2015, envisaged capital infusion by the Government of 70,000 crore.

 

• APPOINTMENT – The Govt. decided to separate the post of Chairman and Managing Director. This approach is based on global best practices and as per the guidelines in the Companies Act to ensure appropriate checks and balances.

• BANK BOARD BUREAU (BBB) – The BBB will be a body of eminent professionals and officials, which will replace the Appointments Board for appointment of Whole-time Directors as well as non-Executive Chairman of PSBs.
• CAPITALIZATION – The govt. will inject a total of Rs 25,000 crore of capital into debt-laden state banks. Over the next four years, the government plans to inject Rs 70,000 crore.

 

• DE-STRESSING – The govt will concentrate on distressing the banks’ bad loans.

 

• EMPOWERMENT – govt has said that it will not interfere in the functioning of public sector banks and encouraged them to take decisions independently, keeping the commercial interest of the organization in mind.

 

 

• FRAMEWORK OF ACCOUNTABILITY – The government also announced a new framework of key performance indicators for state-run lenders to boost efficiency in functioning while assuring them of independence in decision making on purely commercial considerations.

 

• GOVERNANCE REFORMS – The process of governance reforms started with “Gyan Sangam”

 

The Indradhanush framework for transforming the PSBs represents the most comprehensive reform effort undertaken since banking nationalisation in the year 1970. Our PSBs are now ready to compete and flourish in a fast-evolving financial services landscape.

 

Mission Indradhanush

1. Framework of accountability
2. Distressing PSBs
3. Governance reforms
4. Capitalization
5. Appointments
6. Empowerments
7. Bank Board Bureau

 

FISCAL PERFORMANCE INDEX (FPI)

• Developed by- Confederation of Indian Industry (CII)
• It assesses the quality of Budgets presented by the Centre and state governments.
• The index has been constructed using UNDP’s Human Development Index (HDI)
• Components– Quality of revenue expenditure; Quality of capital expenditure; Quality of revenue; Degree of fiscal prudence; Debt Index
• Financial performance of states with low-income levels is better than those with higher income.
• High-income states performed poorly mainly on the expenditure quality and own tax receipts index as compared to their low-income counterparts.

FINANCIAL SECRECY INDEX (FSI) 2020

• Released by- Tax Justice Network (TJN), an independent international network FSI ranks jurisdictions according to their secrecy and scale of their offshore financial activities, every two years.
• It examines how intensely the country’s legal and financial system allows wealthy individuals and criminals to hide and launder money.
• Parameters used in the ranking include automatic exchange of information and registration of beneficial ownership.
• Cayman Island ranked first, moving up two slots from the 2018 ranking. US continued to retain its second position. India ranks 47 out of 133 countries.

 

 

EASE REFORMS INDEX

• Enhance Access & Service Excellence (EASE) reforms index.
• PSB Reforms EASE Agenda is a common reform agenda for PSBs aimed at institutionalizing clean and smart banking. It was launched in 2018, and the subsequent edition of the program ― EASE 2.0 built on the foundation laid in EASE 1.0 and furthered the progress on reforms.
• Public Sector Banks have shown significant improvement in the Action Points of the EASE Reforms Agenda since its introduction.
• In 2018, Finance ministry’s Dept of financial services released EASE framework with 6 pillars to make PSBs more Responsive and Responsible viz.

1. Customer Responsiveness
2. Responsible banking
3. Deepening Financial Inclusion
4. Digitalization and developing personnel for PSB boards
5. Credit Take-off

 

 

EASE 3.0, the Public Sector Bank (PSB) Reforms Agenda 2020-21 for smart, tech-enabled banking.

 

• Implementation ???? Each whole-time director of a PSB will be entrusted with one pillar of the EASE-framework. Their performance will be checked by the PSB’s board of directors. An independent agency will be tasked to check public perception.

 

First ever EASE-ranking released (2019): PNB > BoB > SBI.

“4R” framework (ES-2014)	“4D” framework (ES-2014)
Recognition – of bad loans via asset quality review (AQR)	Disinter – “Dig-up graves, recover money” – using SARFAESI ACT, I&B, SASHAKT
Resolution – through schemes/mechanisms ???? 5/25, CDR, SDR, S4A, I&B, SASHAKT	Differentiate among PSB. Government should recapitalize Profit Making PSB: while merge or privatize Loss Making PSB.
Recapitalization – to comply with BASEL-III norms ???? Indradhanush, Bank Recap Bonds & other measures. Total INR 3.5 lakh crore mobilized.	Diversify – Allow more number and variety of Banks ???? Small Finance Banks, Payments banks allowed. Wholesale Bank also proposed.
Reforms in Governance & Administration of PSB through BBB, EASE, CA Norms, PCR registry, ESOP, PSBN Network	Deregulate – Lower SLR, Promote Corporate Bond market so they borrow less from Banks e.g. Tri-Party Repo mechanism.

 

LEGAL ENTITY IDENTIFIER (LEI)

• RBI has LEI code mandatory for all market participants, other than individuals.
• It is a 20 character global reference number conceived by G20 that uniquely identifies every legal entity or structure that is party to a financial transaction, in any jurisdiction.

Internationally LEI is implemented and maintained by Global Legal Entity Identifier Foundation.

• In India entities can obtain LEI from Legal Entity Identifier India Ltd (LEIL) (only LOU of India), subsidiary of The Clearing Corporation of India Ltd, recognized by RBI under Payment and Settlement Systems Act, 2007.
• Now, banks will report debt details along with LEI to Central Repository of Information on Large Credit. It will help the banks monitor debt exposure of corporate borrowers and will also prevent multiple loans against the same collateral, thus helping reduce NPAs.
• Moreover, it will help regulators like RBI to track global financial transactions and check money laundering.

GLOBAL LEGAL ENTITY IDENTIFIER FOUNDATION

It is a not-for-profit organization established by the Financial Stability Board in June 2014.

It is overseen by the LEI Regulatory Oversight Committee, representing public authorities from around the globe.

It publishes Global LEI Index.

 

SARFAESI ACT 2002

• GoI finally cracked down on the wilful defaulters by passing the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.
• The Act gives far reaching powers to the banks/FIs concerning NPAs
• Banks/FIs having 75 per cent of the dues owed by the borrower can collectively proceed on the following in the event of the account becoming NPA????
• Issue notice of default to borrowers asking to clear dues within 60 days.
• On the borrower’s failure to repay:
• Take possession of security and/ or
• take over the management of the borrowing concern and/or
• appoint a person to manage the concern.
• If the case is already before the BIFR, the proceedings can be stalled if banks/FIs having 75 per cent share in the dues have taken any steps to recover the dues under the provisions of the ordinance.
• The banks/FIs can also sell the security to a securitisation or Asset Reconstruction Company (ARC), established under the provisions of the Ordinance. (The ARC is sought to be set up on the lines similar to the USA, few years ago.)

 

Limitations of SARFAESI Act 2002

• Understaffed DRTs and DRATs results into pendency of cases. More than 1 lakh cases pending (2016), so, case will go on for years and the debtor will remain in possession of asset. This leads to erosion of asset-value (machinery, vehicles) even when DRT allows auction at a later time.
• In some businesses, auction or liquidation may not yield the best returns for the banksg. hotel resort in remote area, where no other hoteliers are keen to invest.
• In such cases, if the loans were restructured, then banks could salvage more value. But, SARFAESI act doesn’t facilitate such arbitration.

 

 

PUBLIC CREDIT REGISTRY (PCR)

• RBI is planning to setup a Public Credit Registry, based on recommendations of Y.M. Deosthalee committee.
• PCR is a database of credit information which is accessible by all the stakeholders.
• It will capture all relevant information in one large database on both individual & corporate borrowers.
• It will be managed by a public authority as RBI and the lenders will have to mandatorily report the loan details.
• PCR will assist RBI in ????
• Credit assessment and pricing by the bank
• Risk-based, countercyclical and dynamic provisioning of bank
• Supervision and early intervention by regulator
• Understanding the transmission of monetary policy working and its bottlenecks
• Restructuring the stressed bank credit

 

SETTING UP OF PSBN NETWORK – ECO. SURVEY 2020

• Government should create a new organization named PSBN (PSB Network), which will act as a Financial Technology Hub and information depository.
• Whenever a borrower applies for a loan to a public Sector Bank (PSB) then details will be sent to PSBN.
• PSBN will verify the credit worthiness and risk profile of the applicant through ???? Artificial Intelligence (AI), machine learning (ML) and Big Data Analytics
• E-KYC-Aadhar Verification ???? cross checking his Aadhar number against Financial data from Ministry of Corporate Affairs, SEBI, Income Tax Department, GST, etc.
• Advantages of PSBN – fraud prevention, reduced the burden of NPAs, quicker decision making, process loan applications faster, cost saving for individual banks as all of them can use a single hub instead of spending on separate servers/technology.

 

FUGUTIVE ECONOMIC OFFENDERS ACT 2018

• The Fugitive Economic Offenders Act, 2018 seeks to confiscate properties of economic offenders who have left the country to avoid facing criminal prosecution.
• Offences involving amounts of Rs. 100 crore or more fall under the purview of this law.
• Some of the offences listed in the schedule of the bill are-counterfeiting government stamps or currency, cheque dishonour for insufficiency of funds, money laundering, transactions defrauding creditors etc.
• The Bill allows the central government to amend the schedule through a notification.

 

WHO IS FUGITIVE ECONOMIC OFFENDER ?

A fugitive economic offender has been defined as a person against whom an arrest warrant has been issued for committing any offence listed in the schedule of the proposed bill.

Further the person has –

• Left the country to avoid facing prosecution.
• Refuses to return to face prosecution.

 

UNITED NATIONS CONVENTION AGAINST CORRUPTION

The United Nations Convention against Corruption is the only legally binding universal anti-corruption instrument.

It was adopted by the General Assembly in 2003 and entered into force on December 14, 2005.

The Convention covers five main areas: preventive measures, criminalization and law enforcement, international cooperation, asset recovery, and technical assistance and information exchange.

 

DICGCI ACT

• Deposit Insurance and Credit Guarantee Corporation came into existence in 1978 after the merger of Deposit Insurance Corporation (DIC) and Credit Guarantee Corporation of India Ltd. (CGCI) after passing of the Deposit Insurance and Credit Guarantee Corporation Act,1961 by the Parliament.
• It serves as a deposit insurance and credit guarantee for banks in India.
• It is a fully owned subsidiary of and is governedby the RBI.
• DICGC charges 10 paise per ₹ 100 of deposits held by a bank.
• The premium paid by the insured banks to the Corporation is paid by the banks and is not to be passed on to depositors.
• DICGC last revised the deposit insurance cover to ₹ 1 lakh on May 1, 1993, raising it from ₹ 30,000 since 1980. The protection cover of deposits in Indian banks through insurance is among the lowest in the world.
• The Damodaran Committee on ‘Customer Services in Banks’ (2011)had recommended a five-time increase in the cap to ₹5 lakh due to rising income levels and increasing size of individual bank deposits.
• Banks, including RRBs, Local Area Banks, foreign banks with branches in India, and cooperative banks, are mandated to take deposit insurance cover with the DICGC.
• Recently, the failure of the Punjab and Maharashtra Co-operative (PMC) Bankreignited the debate on the low level of insurance against the deposits held by customers in Indian banks.

 

Presently, in case of a bank collapse, a depositor can claim an amount up to a maximum of ₹ 1 lakh per account as the insurance cover (even if the deposit in their account is greater than ₹ 1 lakh).

 

 

PROPOSAL FOR INCREASING BANK DEPOSIT INSURANCE LIMIT

• Following the recent fraud at Punjab and Maharashtra Cooperative Bank (PMC Bank), the government is considering a proposal from DICGC to increase the deposit insurance limit.
• DICGC has sent a proposal to the government for increasing the deposit insurance cover to between ₹3 lakh and ₹5 lakh (presently ₹1 lakh since 1993).
• For deposit insurance to increase, DICGC Act needs to be amended.
• Under bank deposit insurance scheme, in case of an unlikely bank failure, deposits up to just Rs 1 lakh is insured and paid back to the depositor.
• There are some exemptions like deposits of foreign governments, deposits of central/state governments and inter-bank deposits.
• DICGC insures all bank deposits, such as savings, fixed, current and recurring.

 

 

FRDI BILL

• The Government has decided to withdraw the Financial Resolution and Deposit Insurance (FRDI) Bill after concerns were raised over the security of bank deposits.
• The Bill was brought in to create a single agency for resolution of financial firms such as banks, insurance companies, non-banking financial companies (NBFCs) and stock exchanges in case of insolvency.

CONTROVERSIAL CLAUSES IN THE BILL

• Bail-in provision– This provision stipulated that if a bank fails, depositors will have to bear part of the liability.
• Insurance on deposits– The Bill proposed to delete the legal provision for the present insurance system wherein deposits are insured up to Rs. 1 lakh and empowered a newly created body the Resolution Corporation to decide the deposit insurance amount.
• The Bill, introduced in August 2017, was referred to a Joint Parliament Committee (JPC) which is consulting all stakeholders.

JOINT PARLIAMENTARY COMMITTEE (JPC)

It is an ad-hoc body.

It is set up for a specific object and duration.

Joint committees are set up by a motion passed in one house of Parliament and agreed to by the other.

JPC recommendations are not binding on the government and have only persuasive value.

 

 

URGE FOR A ROBUST RESOLUTION REGIME

• The current resolution regime is especially inappropriate for private sector financial firms in the light of significant expansion and many of these acquiring systemically important status in India.
• FRDI Bill intended to provide a comprehensive resolution regime that would help ensure that, in the event of failure of a financial service provider, there is quick, orderly and efficient resolution in favour of depositors.
• The provision of a single agency for resolution of financial firms is in line with the recommendations made by the Financial Sector Legislative Reforms Commission (FSLRC), 2011 headed by Justice B N Shrikrishna.
• The Insolvency and Bankruptcy Code, 2016 along with the FRDI bill would have streamlined the procedure for the winding up or revival of an ailing financial sector firm.

 

 

SWIFT SYSTEM

• The Society for Worldwide inter – bank Telecommunication (SWIFT) is a messaging network which connects banks and financial institutions across the world. International transactions of the banks and institutions are ultimately based on this network.
• The network was in news in India after the LoU (Letter of Undertaking) related banking fraud occurred with the Punjab National Bank by February 2018.
• Meanwhile, the RBI has enforced (February 2018) a new guideline under which all banks and financial institutions of India need to link their core banking system to the SWIFT to protect themselves from occurrence of any future financial fraud.

 

BLOCKCHAIN TECHNOLOGY AND BANKING FRAUDs

 

BUSINESS CORRESPONDENT

MEANING	The RBI has allowed banks to appoint entities and individuals as agents for providing basic banking services in remote areas where they can’t practically start a branch. Business Correspondents are instrumental in facilitating financial inclusion in the remotest areas of country. Business Correspondents are hence instrumental in facilitating financial inclusion in the country.
FUNCTIONS	Identification of borrowers, collection of small value deposit, disbursal of small value credit, recovery of principal, collection of interest, sale of micro insurance, mutual fund products, pension products, other third party products and receipt and delivery of small value remittances, other payment instruments, creating awareness about savings and other products, education and advice on managing money and debt counselling, etc.
TYPES OF PRODUCTS	Small Savings Accounts, Fixed Deposit and Recurring Deposit with low minimum deposits, Remittance to any BC customer, Micro Credit and General Insurance.
WHO CAN ACT AS BCs	Individuals like retired bank employees, retired teachers, retired government employees and ex-servicemen, individual owners of kirana / medical /Fair Price shops, individual Public Call Office (PCO) operators, agents of Small Savings schemes of Government of India/Insurance Companies, individuals who own Petrol Pumps, authorized functionaries of well-run SHGs which are linked to banks.

 

Q. What is/are the facility/facilities the beneficiaries can get from the services of Business Correspondent (Bank Saathi) in branchless areas? (CSE-2014) It enables the beneficiaries to draw their subsidies and social security benefits in their villages. It enables the beneficiaries in the rural areas to make deposits and withdrawals. Select the correct answer using the code given below. 1 only 2 only Both 1 and 2 Neither 1 nor 2

VOCABULARY

BASIS POINT

• Changes in interest rates and other variable are expressed in terms of basis points to magnify and express the importance of changes. One basis point is 1% of 1%.

 

WEAK BANK

• A ‘Weak Bank’ has been defined by the Narasimham Committee II as – where a total accumulated losses of the bank and net NPA amount exceed the net worth of the bank.

BANK RUN

• A bank run is a type of financial crisis. It is a panic which occurs when a large number of customers of a bank fear it is insolvent and withdraw their deposits.

 

NO FRILLS (ZERO FRILL) ACCOUNTS

• Account either with nil or very low minimum balance as well as charges that would make such accounts accessible to vast sections of population along with extending financial inclusion policy stance.

 

CORE BANKING SOLUTION

• Core Banking Solution (CBS) is networking of branches, which enables Customers to operate their accounts, and avail banking services from any branch of the Bank on CBS network, regardless of where he maintains his account.
• The customer is no more the customer of a Branch. He/she becomes the Bank’s Customer.

 

Q. The term ‘Core Banking Solutions’ is sometimes seen in the news. Which of the following statements best describes/describe this term? [CSE-2016] It is a networking of a bank’s branches which enables customers to operate their accounts from any branch of the bank on its network regardless of where they open their accounts. It is an effort to increase RBI’s control over commercial banks through computerization. It is a detailed procedure by which a bank with huge non-performing assets is taken over by another bank. Select the correct answer using the code given below. 1 only 2 and 3 only 1 and 3 only 1, 2 and 3

SUBORDINATE DEBT

• It is also known as junior debt. It is a finance term to describe debt that is unsecured or has a lesser priority than that of other debt claim on the same asset.
• A subordinated debt therefore carries more risk than a normal debt. Subordinated debt has a higher expected rate of return than senior debt due to the increased inherent risk.

BANK STRESS TEST

• A stress test is an assessment or evaluation of a Bank’s balance sheet to determine if it is viable as a business or likely to go bankrupt when faced with certain recessionary and other stress situations- whether it has sufficient capital buffers to withstand the recession and financial crisis.
• European banks were recently subjected to such stress tests.

 

EVERGREEENING OF THE LOAN

• Evergreening in banking is a practice of providing a fresh loan to repay an old loan. For example, a bank can lend money to a company to pay another bank’s loan.
• In this way, the first bank can maintain its balance sheet and reduce its non-performing assets (NPAs).

SIPHONING OF FUNDS

• Means that funds were used for purposes that were not related to the borrower and which could affect the financial health of the entity.

 

RECAPITALISATION

• Bank recapitalisation, means infusing more capital in state-run banks so that they meet the capital adequacy norms.
• The government, using different instruments, infuses capital into banks facing shortage of capital.
• As the government is the biggest shareholder in public sector banks, the responsibility of bolstering banks’ capital reserves lies with the government.

LAND DEVELOPMENT BANKS

• This term is used for the banks which provide long term loans to promote use of land, agriculture etc.

 

NPA DIVERGENCE

• Divergence is the difference between RBI’s assessment and that reported by the lender/ banks.
• Divergence takes place when the RBI finds that a lender has under- reported or not reported at all bad loans in a particular year and hence asks the lender to make disclosures if under-reporting is more than10% of bad loans or the provisioning.

PRO-CYCLICAL & COUNTER – CYCLICAL LENDING

• A ‘procyclical lending’ means that the banks keep the lending rates low & reduce buffers during an economic boom and therefore, promote increase in the credit uptake. Similarly, they lend less during a recession.
• Under ‘countercyclical lending’, banks tend to maintain higher buffers during the period of boom, limit lending and thus ‘cool down’ the economy and stimulate the economy when it is in a downturn.

INTEREST RATE SPREAD

• Spread refers to the difference in borrowing rates and lending rates of financial institutions.
• In other words, it is the interest yield on earning assets such as a loan minus interest rates paid on borrowed funds.

 

PEER TO PEER (P2P) LENDING PLATFORM

• P2P lending is a form of crowd-funding which enables individuals to borrow and lend money without any financial institution as an intermediary. The borrower can either be an individual or a legal person.
• All P2P platforms are considered NBFCs and are regulated by the RBI.

CONSORTIUM LENDING

• Consortium lending is a process under which several banks finance a borrower based on common appraisal and documentation, and conduct joint supervision and follow-up exercises.
• Consortium lending has often led to inordinate delay in loan appraisal because of inability of banks to share data with each other in timely manner which delays funding for borrowers.
• It also resulted in adding more non-performing assets (NPAs) to the banking system.

 

INDIAN BANK ASSOCIATION (IBA)

• It is an association of Indian banks and financial institutions formed, in 1946.
• It aims to promote and develop in India sound and progressive banking principles, practices and conventions and to contribute to the developments of creative banking.

 

REPCO BANK

• It is a multi-state cooperative society established in 1969 by the central government for rehabilitation of repatriates from Myanmar and Sri Lanka.
• It is operated only in the South Indian states of Andhra Pradesh, Karnataka, Kerala and Tamil Nadu.
• It is controlled by the Ministry of Home Affairs.

OPERATION TWIST

• It was US Federal Reserve Bank’s monetary policy which involved buying and selling of government bonds to provide monetary easing for the economy.
• On similar lines, RBI also announced a simultaneous sale and purchase of government bonds under the Open Market Operations (OMO) mechanism.

‘NEAR’ MONEY

• Near money functions similar to the money but is not actually money as it is not universally acceptable such as credit cards ‘also known as plastic money), drafts and debit cards.

MORATORIUM PERIOD

• The Moratorium Period is the time during the loan term in which the borrower in not required to repay the loan.
• It is the relaxation time given to the borrowers before beginning with the loan repayment in the form of EMIs. RBI is offering this in COVID-19 pandemic to various segments.

LINE OF CREDIT (LOC)

• Line of Credit is the agreement between the financial institution (bank) and the individual (company or government) with respect to the maximum loan amount that an individual can borrow from a bank any time he wants, provided the loan amount does not exceed the set limit in the agreement.
• Line of credit is the credit limit of customer, i.e. maximum amount of credit the customer is allowed.

KIOSK BANKING

• The Kiosk Banking is the initiative taken by the RBI for those living in villages or other remote areas who are deprived of banking services due to the non-availability of a bank branch in their locality.
• In such arrangement, the person is not required to go the bank to avail the banking ser Instead, the bank comes to the village where the person can make the transactions.

 

HAIRCUTS

• It refers to the difference between the loan amount and actual amount recovered by the Bank from their defaulting customer.
• Under the RBI’s provisioning norms, the banks are required to set aside certain percentage of their profits in order to cover risk arising from NPAs. It is referred to as “Provisioning Coverage ratio” (PCR).

 

BANCASSURANCE

• Bancassurance (banc + assurance) or Bank Insurance Model refers to the distribution of the insurance and related financial products by the Banks whose main business is NOT insurance.
• Bancassurance term first appeared in France in 1980, to define the sale of insurance products through banks’ distribution channels.

SOURCES REFERRED

• Sriram IAS, Ramesh Singh, Vision mains 365 (2018,19), Sanjeev Verma, key concepts in economy (Shankar Ganesh), Mrunal handouts 2020, Vision PT 365 (2018,19,20), RSTV, iastoppers.com, Investopedia, www.rbi.com, www.iasexamportal.com, GK today, NCERT- Macro Economics (Class XII), www.drishtiias.com, https://businessjargons.com, RBI website, IAS baba 2020, https://www.nabard.org/, Vision monthly 2020 – March, April, May, June, Economic survey 2020