Banking in India

06 February 2013 13:36

Bank: A financial institution which accepts different forms of deposits and lends them to the prospective borrowers as well as allows the depositors to withdraw their money from the accounts by cheque is a bank Non-Bank Institutions: If the financial institution has all the same functions but does not allow depositors to issue cheque and withdraw their money from deposits then it is a non-bank institution NBFC: Is a company registered under the Companies Act 1956, engage in business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by govt. or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, sale/purchase/construction of immovable property NBFC can not accept demand deposits (which are payable on demand), like saving and current accounts Can not issue cheques to its customer Deposit insurance facility of DICGC is not available for NBFC depositors unlike in case of banks (it means Public deposits with them are unsecured). In case a NBFC defaults in repayment of deposit, the depositor can approach Company Law Board or Consumer Forum or file a civil suit to recover the deposits NBFC have to get registered with RBI (under RBI Act 1934). However to obviate dual regulation, certain category of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI such as: Venture capital fund, merchant banking companies, stock broking companies register with SEBI Insurance company holding a valid certificate of registration issued by IRDA NIDHI companies under the Companies Act 1956 Chit companies under the Chit Funds Act 1982 Housing finance companies regulated by National Housing Bank A company incorporated under the Companies Act, 1956 and desirous of commencing business of the NBFC should have a minimum net owned fund (NOF) of Rs 2 crore. NBFCs registered with RBI have been reclassified (since 2006) as: Asset Finance Company (AFC) Investment Company (IC) Loan Company (LC) Provisions for accepting deposits are: An NBFC maintaining a required NOF and CRAR and complying with the prudential norms can accept public deposits maximum up to 4 times of NOF Can offer the maximum 11% rate of interest Minimum Investment Grade Credit Rating (MIGR) is essential, may get itself rated by any of the four rating agencies namely, CRISIL, CARE, ICRA and FITCH Are allowed to accept/renew public deposits for a minimum period of 12 months and maximum period of 60 months Can not accept deposits from NRI except deposits by debit to NRO account of NRI provided such amount do not represent inward remittance or transfer from NRE/FCNR (B) account There is no ceiling on raising of deposits by RNBCs (Residuary Non-Banking Company). A RNBC can accepts deposits for a minimum period of 12 months and maximum period of 84 months Reserve Bank of India: Set up in 1935 (under the RBI Act, 1934), nationalised in 1949 and emerged as a central banking body of India Issuing agency of the currency and coins other than rupee one currency and coin (which are issued by the Ministry of Finance with the signature of the Revenue Secretary on the note) Distributing agency for the currency and coins issued by GOI Announces the credit and monetary policy for the economy Stabilising the rate of inflation Stabilising the exchange rate of rupee Keeper of the foreign currency reserve Agent of the GOI in the IMF Performing a variety of developmental and promotional functions under which it did set up institutions like IDBI, SIDBI, NABARD, NHB Credit and Monetary Policy: The policy by which the desired level of money flow and its demand is regulated is known as the credit and monetary policy. In India it has been announced twice in a financial year before the starting of the busy and the slack seasons. Now the RBI keeps modifying this as per the requirement of the economy There are many tools by which the RBI regulates the desired kind of credit and monetary policy- CRR, SLR, Bank Rate, Repo Rate, Reveres Repo Rate, PLR, EXIM Interest Rate, Small Saving Scheme Interest Rate (SSSs) Cash Reserve Ratio (CRR): Is the ratio (fixed by RBI) of the total deposits of a bank in India which is kept with the RBI in cash form. Following the recommendations of the Narasimham Committee on the Financial System (1991) the Govt. started two major changes concerning the CRR Reducing the CRR was set as the medium term objective and it was reduced gradually from its peak of 15% in 1992 to 4% by Feb 2013 Payment of interest by the RBI on the CRR money to the scheduled banks started in financial year 1999-2000. Though the RBI discontinued interest payments from mid 2007 Statutory Liquidity Ratio (SLR): Is the ratio (fixed by RBI) of the total deposits of a bank in India which is to be

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 Statutory Liquidity Ratio (SLR): Is the ratio (fixed by RBI) of the total deposits of a bank in India which is to be maintained by the bank with itself in non cash form prescribed by the Govt. to be in the range of 25% to 40% The CFS (Committee on Financial System) has recommended the govt. not to use this money by handing G-Secs to the banks. In its place a market based interest on it should be paid by the govt. it was being advised The govt. of India has removed the 25% floor for the SLR by an amendment (2007) providing the RBI a free hand in fixing it The ratio now stands at 24% Bank Rate: The rate of interest which the RBI charges its clients on their long-term borrowing is the Bank Rate. The clients are the Central & State Governments, Banks, Financial Institutions, Cooperative banks, NBFC, etc. It has a direct impact on the interests banks charge on different kinds of loans they forward Repo Rate/Rate of Repurchase/Rate of Discount: The rate of interest the RBI charges from its clients on their short term borrowing is the Repo Rate. @ present 7.75% (Feb 2013) This was started in December 1992 In practice it is not called an interest rate but considered a discount on the dated govt. securities which are deposited by the institution to borrow for the short term. When they get their securities released from the RBI the value of the securities is lost by the amount of the current repo rate. Banks usually use this route for one-day borrowing to fulfil their short term liquidity crunch It has direct impact on the nominal interest rates of the bank's lending Reverse Repo Rate: The rate of interest the RBI pays to its clients who offer short term loan to it. 7% at present This was started in November 1996 as part of Liquidity Adjustment Facility (LAF) by the RBI In practice FI's operating in India park their surplus funds with the RBI for short term period to earn money Marginal Standing Facility: Operationalised on the lines of the existing LAF in May'2011 under which all Scheduled Commercial Banks can avail overnight funds, up to 1% of their Net Demand and Time Liabilities (NDTL) outstanding at the end of the second preceding fortnight. The facility is availed at an interest rate which is 100 basis points above the LAF repo rate or as decided by RBI from time to time. At present it is 9% The RBI on Feb'2012 increased the Bank Rate by 350 basis points from 6% to 9.5%, realigned the Bank Rate with MSF Rate The Bank Rate acts as the penal rate charged on banks for shortfall in meeting their reserve requirements (CRR and SLR) Base Rate: Is the interest rate below which Scheduled Commercial Banks will lend no loans to its customers. The Base Rate System is aimed at enhancing transparency in lending rates of banks and enabling better assessment of transmission of monetary policy This (Base Rate) is not applicable to Differentials Rate of Interest (DRI) loans Loans to banks own employees Loans to banks depositors against their own deposits Banks are required to review the Base Rate at least once in a quarter and publish the same for the general public Today there are 27 public sector banks in India out of which 19 are nationalised Regional Rural Bank: First set up in 2nd October 1975 To provide credit to weaker section of the society at concessional rate of interest who previously depended on private money lending To mobilise rural savings and channelize them for supporting productive activities in the rural areas Following the suggestion of Kelkar committee, the govt. stopped opening new RRBs (1987) Bhandari committee, Basu committee (restructuring and strengthening of RRBs): The obligation of concessional loans abolished and the RRBs started charging commercial interest rates on its lending The target clientele was set free now to lend to any body At present there are 82 RRBs in India even though the amalgamation process is going on Financial Sector Reforms: The process of economic reforms initiated in 1991 had redefined the role of the govt. in the economy A high level Committee on Financial System (CFS) was set up on August 14, 1991 to examine all aspects relating to structure, organisation, functions and procedures of the financial system. Based on its recommendations, a comprehensive reform of the banking system was introduced in the fiscal 1992-93. The CFS based its recommendation on certain assumptions 'the resources of the banks come from the general public and are held by the banks in trust that they are to be deployed for maximum benefit of the depositors'. The assumption automatically implied: Even the govt. had no business to endanger the solvency, health and efficiency of the nationalised banks under the pretext of using banks, resources for economic planning, social banking, poverty alleviation, etc. The govt. had no right to get hold of the funds of the banks at low interest rates and use them for financing its consumption expenditure and thus defraud the depositors Narasimham Committee-I's suggestion: Ensuring a degree of operational flexibility Internal autonomy for public sector banks in there decision making process Greater degree of professionalism in banking operation Recommendations of CFS: On Directed Investment: The RBI was advised not to use CRR as a principle instrument of monetary and credit control, in place it should rely on Open Market Operations (OMOs) CRR should be progressively reduced from the present 15% to 3-5% RBI should pay interest on the CRR of banks above the basic minimum at a rate of interest equal to the level of
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 RBI should pay interest on the CRR of banks above the basic minimum at a rate of interest equal to the level of banks one year deposit On Directed Credit Programme: Directed credit program should be phased out gradually. Agriculture and small scale industries had already grown to a mature stage and they did not require any special support. Therefore, concessional rates of interests could be dispensed with Concept of PSL should be redefined to include only the weakest sections of the rural community such as marginal farmers, rural artisans, village and cottage industries, tiny sectors etc. The redefined PSL should have 10% fixed of the aggregate bank credit The composition of the PSL should be reviewed after every 3 years On the Structure of Interest Rates: Interest rates to be broadly determined by market forces All controls of interest rates on deposits and lending to be withdrawn Concessional rates of interest for PSL of small sizes to be phased out and subsidies on the IRDP loans to be withdrawn Bank Rate to be the anchor rate and all other interest rates to be closely linked to it The RBI should be the sole authority to simplify the structure of interest rates On Structural Reorganisation of Banks: Substantial reduction in the number of PSBs, to bring about greater efficiency in banking operations Dual control of RBI and Banking Division (of Ministry of Finance) should go immediately and RBI to be made the primary agency for the regulations of the banking system PSBs to be made free and autonomous Every PSBs to go for radical change in work technology and culture The appointment of CMD of Bank, not to be on political consideration but on professionalism and integrity Asset Reconstruction Companies/Fund: To tackle the menace of the higher NPAs of the banks and the FI's, the committee suggested setting up of the asset reconstruction companies/funds Banking Sector Reforms: Narasimham Committee-II's suggestion: i. Need for a stronger banking system for which mergers of the PSBs and the financial institutions (AIFIs) were suggested- stronger banks and the DFIs (Development Financial Institutions i.e. AIFIs) to be merged, while weaker and unviable once to be closed ii. A three tier banking structure was suggested after mergers a) Tier-I to have 2-3 banks of international orientation b) Tier-II to have 8-10 banks of national orientation c) Tier-III to have a large number of local banks iii. Higher norms of Capital to Risk - Weighted Adequacy Ratio (CRAR) suggested increased to 10% iv. Budgetary recapitalisation of the PSBs is not viable and should be abandoned v. Legal framework of loan recovery should be strengthened vi. Net NPAs of all banks suggested to be cut down to below 5% by 2000 and 3% by 2002 vii. Licensing to new private banks was suggested to continue with viii. Board for Financial Regulation and Supervision (BFRS) should be set up for the whole banking, financial and NBFCs in India New Rules for Opening Banks: Eligible Promoters: Entities/groups in private sector, owned and controlled by residents, with diversified ownership, sound credential and integrity and having successful track record of at least 10 years. RBI has barred groups having even an exposure of 10% (by way of assets or income or both) in real estate and or broking activities over the past three years Corporate Structure: New banks will be set up through wholly owned non-operative holding company (NOHC), which will be registered with the RBI as a non-banking finance company. The idea is to separate the bank from other business activities of the group and protection to the bank's depositors Capital Requirement: 500 Crore. NOHC will hold a minimum 40% of capital for five years from the date of licensing and aggregate non resident share holding will not exceed 49% for the first five years Corporate Governance: 50% of the director of the NOHC should be independent directors Business Model: Realistic and Viable and should address how the bank proposes to achieve financial inclusion. 1/4th of the branches should be in unbanked rural areas Listing on Stock Exchange: The bank shall get its shares listed on the stock exchanges within two years of licensing

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 Differential Rate of Interest (DRI): Lending programme launched by the government in April 1972 Obligatory upon all the public sector banks in India to lend 1% of total lending of the preceding year to 'the poorest among the poor' at an interest rate of 4% per annum Priority Sector Lending: Obligatory for all Indian banks Priority sectors are- Agriculture, Small and Medium Enterprises (SMEs), Road and Water Transport, Retail Trade, Small Business, Small Housing Loans (not more than 10 lakhs), Software Industries, Self Help Group (SHGs), Agro Processing, Small and Marginal Farmers, Artisans, Distressed Urban Poor and Indebted Non- Institutional Debtors besides the SCs, STs and other weaker sections of society Indian banks need to lend 40% to the priority sector every year (public+private) of their total lending. (18% agriculture, 10% of total lending or 25% of the total PSL whichever is higher must be lent out to the weaker sections, 12% to other areas of PSL) Foreign banks have to fulfil 32% PSL target, (12% to export, 10% to SMEs, 10% to other areas) CFS 1991 suggestion: Cut down PSL to 10% Gradual phasing out of PSL Shuffle the sectors covered under PSL every three years Revision in PSL: Nair Committee suggestion: Agriculture and allied activities may be a composite sector within the priority sector. Target would be 18% Small and marginal farmers within agriculture and allied activities is recommended, equivalent to 9% Within the MSE, a sub target for micro enterprises is recommended, equivalent to 7% All loans to women under the PSL may also be counted under loans to weaker sections The loans to housing sector may continue to be under the priority sector. Housing loans to the weaker section ans low income groups may be included in the weaker sections category The loans to education sector may continue to be under the priority sector Non-Performing Assets: NPAs are bad debts of banks/financials institutions defined as follows: Interest and/or instalments or principle remains overdue for a period more than 180 days in respect of a term loan Interest and/or instalments or principle remains overdue for two harvest seasons but for a period not exceeding two and a half years in the case of agricultural loans. NPAs are classified into three types: Sub-standard: Remaining NPAs for less than or equal to 18 months Doubtful: Remaining NPAs for more than 18 months Loss assets: Where the loss has been identified by the bank or internal/external auditors or the RBI inspection but the amount has not been written off SRFAESI Act, 2002: GOI finally cracked down on the wilful defaulters by passing the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 Banks/FI's having 75% 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/FI's having 75% share in the dues
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If the case is already before the BIFR, the proceedings can be stalled if banks/FI's having 75% share in the dues have taken any steps to recover the dues under the provisions of the ordinance The banks/FI's can also sell the security to a Securitisation or Asset Reconstruction Company (ARC), established under the provisions of the Ordinance Capital Adequacy Ratio: The CAR is the percentage of total capital to the total risk-weighted assets, is also known as 'Capital to Risk Weighted Assets Ratio (CRAR)'. Is expressed as a % of a bank's risk weighted credit exposures CAR = (Total of Tier I and Tier II capitals) / Risk Weighted Assets Three major shock absorbers to banks: The provision of keeping a cash ratio of total deposits mobilised by the banks (known as the CRR in India) The provision of maintaining some assets of the deposits mobilised by the banks themselves in the non-cash form (known as the SLR in India) The provision of CAR Two types of capital were measured as per the Basel II norms: Tier I capital, which can absorb losses without a bank being required to cease trading Tier II capital, which can absorb losses in the event of a winding up and so provides lesser degree of protection to depositors The new norms (Basel III) has devised a third category of capital, Tier III capital RBI guidelines regarding the CAR norms in India: Basel I norm of the CAR was to be achieved by the Indian banks by march 1997 The CAR norm was raised to 9% with effect from march 31, 2000 (Narasimham Committee II had recommended to raise it to 10% in 1998) Foreign banks as well as Indian banks with foreign presence to follow Basel II norms w.e.f. march 31, 2008 while other scheduled commercial banks to follow it not later than march 31, 2009. The Basel II norm for the CAR is 12% Reasons for maintaining CAR: Bank capital helps to prevent bank failure, which arises in case the bank cannot satisfy its obligations to pay the depositors and other creditors. The amount of capital affects returns for the owners of the bank Tier I capital: A term used to describe the capital adequacy of a bank, it can absorb losses without a bank being required to cease trading. It consists of types of financial capital considered the most reliable and liquid Tier II capital: A term used to describe the capital adequacy of a bank, it can absorb losses in the event of a winding up and so provides lesser degree of protection to depositors. It consists of accumulated after tax surplus of retained earnings, revaluation reserves of fixed assets and long term holdings of equity securities, general loan reserves, hybrid capital instruments and sub-ordinate debt and undisclosed reserves Tier III capital: A term used to describe the capital adequacy of a bank, considered the tertiary capital of the banks which are used to meet/support market risk, commodities risk and foreign currency risk. To qualify as Tier III capital, assets must be limited to 250% of a bank's Tier I capital, be unsecured, subordinated and have a minimum maturity of 2 years Disclosed Reserves are the total liquid cash and the SLR assets and of the banks that may be used any time. Undisclosed Reserves are the unpublished or hidden reserves of a financial institution that may not appear on a balance sheet but are nonetheless real assets, which are accepted as such by most banking institutions but can not be used at will of the bank. That is why they are part of its secondary capital (Tier II) The implementation of Basel III capital regulation will kick-start from January 1, 2013 and will be fully implemented by March 31, 2017 Money 1 (M1): Currency & coins with people + Demand deposits of Banks (Current & Saving Accounts) + Other deposits of RBI Money 2 (M2): M1 + Demand deposits of the post offices (i.e. saving schemes money) Money 3 (M3): M1 + Time/Term deposits of the banks (i.e. the money lying in the Recurring Deposits & the Fixed Deposits) Money 4 (M4): M3 + total deposits of the post offices (both, Demand and Time/Term deposits) New Monetary Aggregates: Reserve Money (M0): Currency in circulation + Bankers deposits with the RBI + Other deposits with the RBI Narrow Money (M1): Currency with the Public + Demand deposits with the Banking System + Other Deposits with the RBI M2: M1 + Saving deposits of Post-offices savings banks Broad Money (M3): M1 + Time deposits with the banking system M4: M3 + All deposits with Post Office Savings Banks (excluding National Savings Certificates) Liquidity of Money: As we move from M1 to M4 the liquidity (inertia, stability, spend ability) of the money goes on decreasing and in the opposite direction, the liquidity increases Narrow Money: In banking terminology, M1, is called narrow money as it is highly liquid and banks cannot run their lending programmes with this money Broad Money: The money component M3 is called broad money in the banking terminology. With this money (which lies with banks for a known period) banks run their lending programmes Minimum Reserve: The RBI is required to maintain a reserve equivalent of Rs. 200 crores in gold and foreign currency with itself, of which Rs. 115 crores should be gold. This is known as the Minimum Reserve System (MRS) Reserve Money: The gross amount of the following six segments of money at any point of time is known as the Reserve Money (RM) for the economy or the govt. I. RBI's net credit to the Govt. II. RBI's net credit to the Banks
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II. RBI's net credit to the Banks III. RBI's net credit to the commercial banks IV. Net forex reserve with the RBI V. Govt. currency liabilities to the public VI. Net non-monetary liabilities of the RBI RM= I + II + III + IV + V + VI The ration of M3 to the Reserve Money at any point of time is known as the Money Multiplier Credit Rating: To assess the credit worthiness (credit record, integrity, capability) of a prospective borrower to meet debt obligations is credit rating CRISIL (Credit Rating Information of India Ltd.): Jointly promoted by ICICI and UTI with share capital coming from SBI, LIC, United India Insurance Company Ltd. To rate debt instruments- debentures ICRA (Investment Information and Credit Rating Agency of India Ltd): Set up in 1991 by IFCI, LIC, SBI and select banks as well as financial institutions to rate debt instruments CARE (Credit Analyses and Research Ltd.): Set up in 1993 by IDBI, other financial institutions, nationalised banks and private sector finance companies to rate all types of debt instruments ONICRA (Onida Individual Credit Rating Agency of India Ltd.) SMERA (Small and Medium Enterprises Rating Agency): Set up in September 2005, to rate the overall strength of small and medium enterprises. A joint venture of SIDBI, SBI, ICICI, Dun & Bradstreet, Five PSBs (PNB, BOB, BOI, Canara Bank, UBI) and CIBIL (Credit Information Bureau of India Ltd.)

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