POINTS TO BE COVERED RBI. Lending Rate regimes BASEL. Narasimhan Committee NPA. Questions

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2 POINTS TO BE COVERED RBI Lending Rate regimes BASEL Narasimhan Committee NPA Questions

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6 FUNCTIONS OF RBI Issue of currency Banker to government Banker to banks/ Regulator of banking system Role of RBI in inflation control Formulate monetary policy Manager of foreign reserve Clearing house functions

7 INTRO TO CURRENCY From coin to currency It s the RBI which prints the currency notes and also distributes them The Mahatma Gandhi Series were introduced in 1996 The currency notes are printed at Dewas in Madhya Pradesh Nasik in Maharashtra Mysore in Karnataka Salboni in West Bengal SPMCIL BRBNMPL

8 INSTRUMENTS OF CREDIT CONTROL Quantitative or General Methods Bank Rate (dear and cheap money policy) Cash Reserve Ratio (VRR; credit squeeze and expansion) Statutory Liquidity Ratio Open Market Operations Repo and Reverse Repo Qualitative or Selective Methods Rationing of Credit Regulating credit for consumption purposes Variation of Margin requirements Moral Suasion and Direct action

9 MONEY SUPPLY/MONETARY AGGREGATES M0 = Reserves + Currency in Circulation M1=currency held by public + demand deposits with the banks M2 = M1 + Post-Office Savings deposits M3 = M1 + Time Deposits with the banks M4 = M3 + Post office savings deposits

10 NATIONALIZATION OF THE BANKS 1 st round banks 2 nd round banks Reasons Concentrated in the hands of the rich Concentrated in the urban areas Loans not reaching the needy Providing institutional credit

11 LENDING RATE Primary Lending Rate (PLR) Base Rate Regime (BRR) Cost of funds Operating expenses Minimum rate of return (profit) Cost for the CRR Marginal Cost of funding based Lending Rate (MCLR) Marginal cost of funds Negative carry on account of CRR Operating costs Tenor premium

12 BASIC CONCEPTS TO UNDERSTAND BASEL Capital- Tier I and Tier II Total Capital=Tier I + Tier II Tier I= core capital (paid up capital, disclosed reserves, reserves arising as a result of sale proceeds etc) Tier II= sub-ordinate capital (debt capital instruments, revalued reserves, long term unsecured loans etc) Risks=Credit, Market and Operational

13 BASIC CONCEPTS TO UNDERSTAND BASEL Risk Weighted Assets=loans are allocated certain risk weights (loans such as personal loans are given higher risk weights) CAR (Capital Adequacy Ratio) or CRAR (Credit to Risk weighted Assets Ratio) (in simple terms it represents the ability of the bank in meeting the needs of creditors and depositors)

14 BASEL NORMS Basel is a place in Switzerland BIS & BCBS Basel-I 1998 Credit Risk and RWA (Risk Weighted Asset) CAR of 8% of RWA Adopted by India 1999

15 BASEL NORMS (CONTD ) Basel-II Introduced in types of risks- Credit, Market & Operational 3 pillars- CAR, Supervisory Review, Market Discipline

16 BASEL NORMS (CONTD ) Basel- III 2010 CAR-9% Tier-1 7% RWA Capital Conservation buffer

17 URJIT PATEL RECOMMENDATIONS CPI to be taken as measure of inflation Inflation target -2% to 6% Jan 2016>6% >4% Monetary Policy Committee (1+4) Bi-monthly monetary policy

18 NPA Concept of NPA Definition of NPA Types of NPA Problems with high NPA Measures to reduce

19 PAYMENTS AND SMALL FINANCE BANKS

20 QUESTIONS What is/are the purpose/purposes of Marginal Cost of Funds based Lending Rate (MCLR) announced by RBI (2016) a) These guidelines help improve the transparency in the methodology followed by the banks for determining the interest rates on advances b) these guidelines helps ensure the availability of bank credit the interest rate which are fare to the borrowers as well as the banks Select the correct answers using the code given below a)1 only b) 2 only c) Both 1 and 2 d) Neither 1 nor 2

21 QUESTIONS With reference to India economy, consider the following (2015) 1. Bank rate 2. Open market operations 3. Public debt 4. Public revenue Which of the above is/are component/components of Monetary Policy? a) 1 only b) 2, 3 and 4 c) 1 and 2 d) 1, 3 and 4

22 QUESTIONS Basel III Accord or simply Basel III, often seen in the news, seeks to (2015) a. develop national strategies for the conservation and sustainable use of biological diversity b. improve banking sector s ability to deal with financial and economic stress and improve risk management c. reduce the greenhouse gas emissions but places a heavier burden on developed countries d. transfer technology from developed Countries to poor countries to enable them to replace the use of chlorofluorocarbons in refrigeration with harmless chemicals

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

24 QUESTIONS The terms Marginal Standing Facility Rate and Net Demand and Time Liabilities, sometimes appearing in news, are used in relation to (2014) (a) (b) (c) (d) banking operations communication networking military strategies supply and demand of agricultural products

25 QUESTION In the context of Indian economy; which of the following is/are the purpose/purposes of Statutory Reserve Requirements? (2014) 1. To enable the Central Bank to control the amount of advances the banks can create 2. To make the people s deposits with banks safe and liquid 3. To prevent the commercial banks from making excessive profits 4. 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. (a) 1 only (b) 1 and 2 only (c) 2 and 3 only (d) 1, 2, 3 and 4

26 QUESTIONS Which of the following measures would result in an increase in the money supply in the economy? (2012) 1. Purchase of government securities from the public by the Central Bank 2. Deposit of currency in commercial banks by the public 3. Borrowing by the government from the Central Bank 4. Sale of government securities to the public by the Central Bank Select the correct answer using the codes given below : (a) 1 only (b) 2 and 4 only (c) 1 and 3 (d) 2, 3 and 4

27 QUESTION If the interest rate is decreased in an economy, it will (2014) (a) (b) (c) (d) decrease the consumption expenditure in the economy increase the tax collection of the Government increase the investment expenditure in the economy increase the total savings in the economy

28 QUESTIONS The Reserve Bank of India regulates the commercial banks in matters of (2013) 1. liquidity of assets 2. branch expansion 3. merger of banks 4. winding-up of banks Select the correct answer using the codes given below. (a) 1 and 4 only (b) 2, 3 and 4 only (c) 1, 2 and 3 only (d) 1, 2, 3 and 4

29 QUESTIONS An increase in the Bank Rate generally indicates that the: (2013) (a) market rate of interest is likely to fall (b) Central Bank is no longer making loans to commercial banks (c) Central Bank is following an easy money policy (d) Central Bank is following a tight money policy

30 QUESTIONS In the context of Indian economy, Open Market Operations refers to: (2013) (a) borrowing by scheduled banks from the RBI (b) lending by commercial banks to industry and trade (c) purchase and sale of government securities by the RBI (d) None of the above

31 QUESTIONS Priority Sector Lending by banks in India constitutes the lending to: (2013) (a) agriculture (b) micro and small enterprises (c) weaker sections (d) All of the above

32 QUESTIONS Which one of the following groups of items is included in India s foreign-exchange reserves? (2013) (a) Foreign-currency assets, Special Drawing Rights (SDRs) and loans from foreign countries (b) Foreign-currency assets, gold holdings of the RBI and SDRs (c) Foreign-currency assets, loans from the World Bank and SDRs (d) Foreign-currency assets, gold holdings of the RBI and loans from the World Bank

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

34 Money and Banking Money Is something that is usually accepted as payment of conducting trade and settling a debt. The barter system suffers from double co-incidence of wants hence the money becomes the intermediary stage which allows the trade to take place. Features of money o Medium of exchange o Valuation of goods/services (across time and region) o Used for making deferred payments o Assets usually stored are valued in money terms Money supply in India- RBI has recently shifted to a new methodology to calculate the money supply in India (recommendation of Y V Reddy committee) RBI o M0=currency in circulation + banker s deposit & other deposits with RBI o NM1=currency & coins in circulation + demand deposits with the banks + other deposits with RBI o NM2=NM1+short-term term deposits with the banks o NM3=NM2+long-term term deposits with the banks + borrowings of banks from financial corporations o It was set up on the recommendations of the Hilton Young Commission in 1935 and laterit was to Mumbai in o Initially it was Privately Owned and was located in Kolkata. o Since Nationalization in 1949, the Reserve Bank is fully owned by the Government of India. Functions Issue of currency- RBI is the sole authority to print and issue the currency notes (except Rs 1 note). The printing will be done in order to infuse/replace old series note, replacing soiled notes etc Banker to government- RBI will represent the government at international financial institutions, raise revenues for the government and maintain the Public Debt of India

35 Banker to banks/ Regulations of banking system-rbi will lay down broad guidelines from setting up of the bank to functioning and closing down. Role of RBI in inflation control- Government has given the function of controlling inflation to RBI MPFA was signed between GoI and RBI As per this the RBI has to maintain Inflation at 4% (+/- 2%) If inflation goes above 6% or below 2% for three successive quarters then the RBI has to give an explanation to the government listing out-causes and the framework to bring inflation under control Every 6 months it has to bring out a report stating-present level and future movement of inflation Manager of foreign reserve-the forex reserves (gold+sdr+basket of foreign currencies) are maintained by RBI Clearing house functions- In settling inter-bank cheque transactions RBI plays the role of clearing house Formulate monetary policy- the main objective of the policy is to vary the flow of money in the economy Qualitative tools Quantitative tools Quantitative tools o Bank Rate (BR)- the rate at which RBI lends long term loans to the banks. The increase in the rate is called as dear money policy and reductioncheap money policy o Cash Reserve Ratio (CRR)- the ratio of Net Demand and Time Liabilities (NDTL) that the banks will keep with RBI (the NDTL refer to the time deposits and demand deposits collected by the bank). It is also referred to as Variable Reserve Ratio (VRR). If increased will be referred to credit squeeze and if reduced credit expansion o Statutory Liquidity Ratio (SLR)- it is the percentage of NDTL that the banks has to keep with itself either in the form of liquid cash/gold/government securities

36 o Open Market Operations (OMO)- RBI will issue government securities (or G-securities or Gilt Edged Securities) to the primary dealers in order to raise the revenues for the government G-securities-are classified into two types based on the maturity-treasury bills (maturity period is lesser than a year) and dated securities (maturity period greater than 1 year) o Repo and Reverse Repo- Repo is the rate of interest that RBI charges the banks on the short term loans that it gives. The reverse repo is the rate of interest that banks will charge RBI on the short term loans. Repo stands for repurchasing order which in technical sense is a discounting rate and not rate of interest as RBI discounts the value of the collateral rather than collecting interest for the loans that it gives under repo. Qualitative tools o Rationing of credit- RBI tries to regulate portion of the loans to be given to certain specified sectors. Under Priority Sector Lending (PSL) the loans are given to agriculture, education, export credit, housing etc (recently the RBI has added social infrastructure, renewable energy and medium enterprises in the PSL) o Restrict Credit and Vary the margin rates- under this RBI can ask the banks to restrict the flow of credit to a segment or vary the margin (down payment) values so that the higher demand for this will not add to inflation. o If banks do not follow the guidelines then RBI can go for moral suasion and direct action Use of these tools o If RBI needs to control inflation (it will reduce the liquidity) Increase the rates such as repo, CRR,SLR Sell more government securities o If RBI wants to promote growth (it will infuse liquidity) Lower repo, CRR, SLR Repurchase the g-securities Monetary Policy Transmission (MPT)- RBI lowers the policy rate (repo rate) so that the banks can pass on this benefit to the consumers but with the previous method of Base rate regime, the banks did not transfer the full reduction to the

37 borrowers. Hence RBI has done away with BRR and instead introduced MCLR (Marginal Cost of Funds based Lending Rate). Base Rate Regime (BRR)- it replaced the Primary Lending Rate Regime, wherein, the banks were supposed to consider various factors such as cost of capital, operational costs, profits etc in order to decide on the lending rate. The banks could not lend below this rate unless it is either to a employee of a bank or under special scheme etc Marginal Cost of funding based Lending Rate (MCLR)- RBI in order to provide for efficient monetary transmission has gone ahead with replacing BRR with MCLR. Under this the banks are forced to factor in variation in the policy rate or any rate change announced by RBI under Monetary policy which leads to a change in the lending rate for the banks. Hence MCLR will be leading to efficient MPT. How MCLR is better than BRR- in calculation of lending rate under BRR, the banks used to take only the cost of funds (term deposits, demand deposits etc) but under MCLR they are forced to take marginal cost of funding i.e. cost of funds (not only term deposits and demand deposits but also the repo rate) and also consider CAR, hence whenever there is a change in say Repo rate, banks are forced to vary their lending rate hence will lead to better Monetary Policy Transmission Banking Reforms- Narasimhan Committee (1) Recommendations 1991 o No further branch licensing o No further nationalization o PSL to be brought down to 10% o Phased reduction of SLR & CRR o Computerization of the banks o Debt Recovery Tribunals to be set up o Setting up of Asset Reconstruction Companies o Private sector entry to be allowed o Banks should be allowed to raise the capital by issue of shares o Four tier structure of the banks-3 to 4 large banks, 8 to 10National Banks, Local banks, Rural Banks

38 Banking Reforms- Narasimhan Committee (2) Recommendations 1998 o Setting up of Credit Information Bureau o Merger of strong banks to make a mega bank o Weak banks should be called as narrow banks o Greater autonomy to bank boards o Regulator should not be the owner Nationalization of banks 1 st round banks (which had NDTL over Rs 50 cr) 2 nd round banks (which had NDTL over Rs 200 cr) Reasons o Concentrated in the hands of the rich-these banks were owned by industrialists o Concentrated in the urban areas-there banks were majorly concentrated in urban areas as in rural areas mobilization of deposits is very low o Loans not reaching the needy- most of the credit was accessed by rich customers whereas customers such as (farmers, poor) did not get access to institutionalized credit o Providing institutional credit- especially in rural areas there was presence of huge unorganized money lending which led to farmers falling into debt trap Merger of SBI with its Associates and BMB Recently, the board of SBI has approved the merger of SBI with associate banks (SB Travancore, SB Jaipur and Bikaner, SB Mysore, SB Patiala, SB Hyderabad). The merger will throw up some advantages but also there are some concerns Some of the features are The merger will lead to creation of an asset with value of the asset base of Rs 30 trillion The merger of the banks/consolidation of the banking sector is exempt from CCI act 2003 The formation of big banks was recommended by Narasimhan Committee (but the recommendation said 4 to 5 big banks)

39 The merger will lead to SBI being one of the top 50 banks in the world Before merger After merger Value of the assets 21.5 lakh cr lakh cr Number of branches Around Total employees About 2,70,000 Advantages The merged entity will become the biggest bank in terms asset base The merged entity will have biggest number of employees in a bank The merged entity can utilize the economies of scale i.e. the operating costs will come down (it is expected that the cost to income ratio will come down by 100 bps) The merged entity will have highest coverage in terms of bank branches The merged entity will have huge financial reserves and lowering of margins will increase the profits As per one of the surveys, the savings because of the merger are to the tune of Rs 3500 crore Concerns The merged entity will have more exposure to risks in the market The problem with merger is the exposure the merged entity will have in the form of pension and provident fund outlays The working culture will vary which may result into harmonization problems The employees are concerned with some employment issues-seniority, transfers, promotions etc The accounting treatment/standards followed are different in SBI and associate banks which might cause in problem in harmonization of accounts But the biggest concern with the merger is that SBI is already the biggest in terms of the asset base and with merger the asset base will only increase (the second largest bank in terms of asset base is ICICI-Rs 7 lakh crore). This may lead to a worrying trend in case

40 when there is a crash in the market in the form of higher NPAs, reduction in value or quality of assets etc. This has been observed when Lehman Brothers crashed in To prevent such ripple effect US Federal Reserve has issued a rule wherein the merger of financial entities is prevented in a case when the merged entity has more than 10% liability of the total financial system. As per Dodd-Frank Wall Street Reform (section 622) and Consumer Protection Act, prevent acquisition by banks once reach a specified financial limit/value The merger experience in India The merger of PSEs in India has not been a smooth affair The merger Indian Airlines with Air India led to merged entity suffering losses and the entity has not acquired larger market share (it so happens that the entities before the merger were making profits) The proposed merger between BSNL and MTNL has not materialized as for over 5 years as the trade unions of both entities have not come any agreement Basel Basel is a place in Switzerland which Houses Bank of International Settlement. It also houses, BCBS (Basel Committee on Banking Supervision) of which Indian Central Bank is a member. The BCBS meets and on deliberations issues guidelines and these guidelines are only regarding financial stability of the banks. So far the BCBS has issued the guidelines-basel I, Basel II and Basel III Total Capital- the bank has the capital in two forms - Tier I and Tier II. The Tier I is a form of capital which can absorb the losses without the bank winding up (also referred to core capital- paid up capital, disclosed reserves, reserves arising as a result of sale proceeds etc) and Tier II can absorb the losses but the bank has to wind up (also referred to sub-ordinate capital eg- debt capital instruments, revalued reserves, long term unsecured loans). Risk Weighted Assets=loans are allocated certain risk weights (loans such as personal loans are given higher risk weights and loans given to government will

41 have lower risk weight). All the assets/loans that are issued by the bank will be allocated the risk and the total of these risk weights will give Risk Weighted Assets. CAR (Capital Adequacy Ratio) or CRAR (Credit to Risk weighted Assets Ratio)-in simple terms it represents the ability of the bank in meeting the needs of creditors and depositors. The CAR also represents the capital (Tier I + Tier II) the bank has to absorb the losses Basel I o Was introduced in 1998 and were adopted by India in 1999 and the banking sector in India are BASEL I complaint o Credit Risk- when the banks issue loans, there is a danger that the loans are not repaid hence it is referred to as credit risk o Under Basel I, the CAR has been set at 8% of RWA Basel II o Introduced in 2004 o 3 types of risks have been listed under Basel II Credit Risk- when the banks issue loans, there is a danger that the loans are not repaid hence it is referred to as credit risk Market Risk- banks have to make an investment in gold or government securities as a part of maintaining SLR and are exposed to the market risk as the prices of gold will vary Operational Risk - attributed to internal systems, processes, people and external factors. o 3 pillars have been introduced under Basel II CAR- the CAR has been set at 8% of RWA (The Tier I capital is to maintained at 4% of RWA) Supervisory Review- the banks have to develop and use better risk management techniques in monitoring and managing the three risks

42 Market Discipline- the banks have to mandatorily disclose CAR, risk exposure etc to the central bank NPA Basel III o Introduced in 2010 as a result of 2008 financial crisis o CAR has been increased to 9% of which the tier I capital has been set at 7% of RWA o Tier-1 capital of 7% RWA has two components-4.5% of Tier I capital and 2.5% of capital conservation buffer o RBI has said that the banks in India will be Basel III complaint by March 31, 2019 The banks are the financial institutions whose primary activities are to collect the deposits and give it to borrowers. Hence the banks play a very important role if there needs to be movement from capital surplus sectors (eg-households) to capital deficient sectors (eg-corporates). Once the loan has been issued the borrower needs to make the payment back to the bank. This payment usually consists of two components-principal and interest. If the borrower has made timely payments then such an account is referred to as Standard Asset, otherwise the account is classified as an NPA. NPA definition- can be classified under two heads-based on duration and type Based on type a. In case of term loan- if the payment/repayment remains overdue for a period of greater than 90 days from the end of the quarter b. In case of agriculture loan- if the payment/repayment has remained overdue for period greater than two or one crop seasons from the due date, in case of short term and long term loans respectively Based on duration a. Sub standard- if an account remains as NPA for a period lesser than or equal to 12 months

43 b. Doubtful- if an account remains as NPA for a period greater than 12 months c. Loss making- once the account has remained as an NPA for a period of 3 years or greater will be classified as loss making by the banks either during internal/external auditing. Otherwise an account will be classified as loss making if the realizable value of the asset come below 10% of the total outstanding debt Ways through which banks can recover NPA s a. Debt Recovery Tribunal (DRT) - the DRTs were set up under section 3 of the Recovery of Debt Due to Banks/Financial Institutions Act Under this expeditious disposal of suits was provided (around 6 months). So far 33 DRTs and 5 DRATs have been set up. Over the period of time the number of cases filed has increased exponentially and as a result of that the cases disposed off have come down (in the last three years DRT has disposed off 20% of the cases filed in each year; at the end of 2015, the outstanding value of the assets stuck up at DRT is around Rs 4,50,000 cr which is more than Gross NPA) b. SARFAESI act Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 was brought in to overcome some of the deficiencies of DRTs. Under this the creditors having greater than 75% exposure (cumulatively) will come together and then issue a notice to the defaulter to make the payments. If the order is not obeyed in 60 days then the underlying security will be taken over by the banks. If it is a company then the banks can change the management/ sell the security to ARC auction. c. Asset Reconstruction companies- Purchase NPA s from the banks at a discounted price and tries to recover/revive the account. The ARCs usually give the banks security receipts when they purchase the loan account. In 2014, RBI allowed ARC s to convert their debt to equity (ceiling of 26%) d. Strategic Debt Restructuring- policy introduced by RBI under which the lenders (banks) first go for CDR (Corporate Debt Restructuring-the loan repayment is rescheduled) & If the company fails to abide by the repayment schedule then take over the management of the company

44 e. Scheme for Sustainable Structuring of Stressed Assets (S4A) (please find the detailed discussion on this at the end of the notes) Why high NPA s In India Basically can be classified under two heads-internal and External a. Slowdown in the domestic economy b. Diversion of funds c. Volatility in the prices of raw materials d. Governance issues e. Willful defaulters f. Inefficient DRTs g. Bad lending practices (ex-poor credit appraisal system) h. Slowdown in the global demand i. Lower exports from India (especially commodities such as Iron/steel, aluminum) Impact of high NPA s a. Will affect the bottom line (profit) of the banks b. Will reduce their lending capacity (volume of loans that are given) c. Will lead to erosion of investors confidence (drop in the share prices) d. The cost of capital will go up (lending rates will be increased for both retail and corporate) e. The higher cost of capital is going to deter the investors f. May lead to inflation g. Twin Balance Sheet Problem Measure taken by the Government and RBI a. CRILC (Central Repository of Information on Large Credits) - has been created by RBI to collect, collate, organize, disseminate data on large borrowers (total borrowing greater than Rs 5 cr). It helps in tracking and reviewing exposure of such borrowers so that remedial measures can be taken timely

45 b. Willful defaulters-rbi has barred the entry of WD s in the capital market, access to the funds (loan accounts) will be cut off, will not be allowed to float a new company for a period of five years RBI has also introduced new terminology-ncbs (Non-Co operative Borrowers) c. Information Technology and Management Information Systems have to be made robust so that they are able to generate reliable and quality information on timely basis d. RBI has issued detailed guidelines regarding revival of MSMEs e. The government has decide to set up 6 new DRTs at Bangalore, Chandigarh, Dehradun, Ernakulum, Hyderabad and Siliguri f. The Government has advised PSBs to constitute Board level committees for monitoring and increase the pace of recovery of NPAs g. The government has proposed Indrdhanush-Appointments, Accountability framework, Banking Board Bureau, Capitalization, Destressing, Empowerment, Governance framework. Measures recommended by Standing committee on finance a. Set up empowered committees at 3 levels-rbi, Banking, Consumer (since the banks are not equipped well to undertake the credit appraisals) b. Naming and shaming of top 30 willful defaulters in order to prohibit the borrowers from defaulting in the future c. CDR (Corporate Debt Restructuring) to be finished in 6 months d. Names of all the companies that have undergone debt restructuring to be made public e. RBI should allow the banks to absorb the written off assets gradually in a staggered manner f. A vibrant bond market should be developed to provide funds for Infra sector g. The loan restructuring to be done in order to preserve the economic value of the asset and taking the temporary inability of the borrower to pay h. Under SDR the banks should mandatorily change the management of the company

46 Recommendation of Economic Survey has recommended 4R strategy a. Recognition- the banks must find the true worth of the asset b. Recapitalization- the banks must be provided funds either by the government or by RBI c. Resolution- the NPAs must either be revived or sold off d. Reforms- the future incentives to the corporate must depend on their performance/credit worthiness The debate as to who should provide for recapitalization has begun. To comply with Basel III norms and to clear all the NPAs from the balance sheets, the banks would require funds to the tune of Rs 1,80,000 and the government has promised Rs cr (of which Rs cr has been provided under budget ) Willful defaulters As per RBI guidelines issued in 2014, a borrower will be deemed as willful defaulter if the borrower has not made the payment/repayment a. Even when the borrower has the capacity/financial reserves to repay b. The loan has been utilized for some other purposes c. The funds have been siphoned off d. If the borrower has disposed off or removed the movable /immovable asset which was given as a collateral/security Once designated as a willful defaulter a. Access to funds will be cut off b. Will not be allowed to enter equity market c. Will not be allowed to float a new company for 5 years As per the standing committee on Finance-as of December 2015, the PSBs had 7686 willful defaulters accounting for a total of Rs cr of loans (21% of the total NPAs). Hence it has recommended naming and shaming top 30 willful defaulters.

47 Bankruptcy code or The Insolvency and Bankruptcy bill 2015 a. Provides for a speedy insolvency resolution (IR)-maximum period of 270 days ( days) b. It will consolidate all the previous laws such as NCLT, SARFAESI, DRT etc c. IR for Individuals and Partnerships will be directed to DRTs (Debt recovery Tribunals). d. IR for Limited Liability Partnerships (LLPs) and Companies will be directed to NCLT (National Company Law Tribunal) e. DRT/NCLT can be approached by lender or the borrower f. Once approached they will appoint a Insolvency Professional (IP, certified, an expert in the insolvency resolution, once appointed all the assets of the company will come under his control) g. The IP will seek information from Insolvency Agencies about the concerned borrower and also set up CC (Creditors committee) and the CC will have to deliberate and decide (whether to liquidate or to recapitalize and revive the company) h. If the decision is not made then extension of 90 days could be given (with approval of majority of creditors by value) i. Even after the extension, if no decision is made then the IP will recommend the authority to liquidate the concerned asset S4A (Scheme for Sustainable Structuring of Stressed Assets) Launched by RBI, to reduce the impact of NPAs Under this the banks will have the option of converting part of the debt into equity thereby reducing the liability on the borrower and also leading to increase in their equity holding in the company Some of the conditions for restructuring a loan under S4A are o The cumulative exposure of all the creditors to the borrower must be over Rs 500 Cr o The project must be up and running (the project should have commenced operations). This is a way to give a second chance to the company to revive the company and also to contribute to the economy o In this case the lenders will separate the debt into- sustainable debt (portion of the loan that can be serviced through the present cash flows) and unsustainable debt. The sustainable debt value should be at least 50%

48 of the debt. This unsustainable debt can either be converted into equity/ redeemable optionally convertible preference share or optionally convertible debentures, with clearly spelt out terms and the banks are not to tinker with the lending rates in case of sustainable debt. o First an external consultant will study and approve the Techno-Economic Viability (TEV) of the Resolution plan. Then S4A/Resolution Plan will be implemented only when the Overseeing Committee (OC-constituted by IBA in consultation with RBI) approves it. The OC will basically review the processes involved in preparation of resolution plan, etc for reasonableness and adherence to the provisions of the guidelines, and give an opinion on it. Limitations o Change of debt into equity will not always guarantee a turnaround of a company Debt is better as it gets tax breaks and is non-perennial (unlike equity) Conversion of debt into equity was tried in case of Kingfisher Airlines and even then the company could not be saved o It takes into account secured creditors, what about the unsecured creditors? They can still go ahead and play spoilsport o The scheme takes into consideration the current cash flows in deciding sustainable and unsustainable debt but the cash flows in the future depend upon the future business environment o The creditors do not have any power to change the conditions associated with the loan o Only those who have started commercial production will be covered under this but many of the projects are struck up because of lack of regulatory clearances (in power sector) Payment Banks These are specialized/differentiated banks which are stripped down versions of the traditional banks. Under this concept the banks provide the limited services through the mobile phones

49 RBI has issued the preliminary licenses or in-principal-approval (valid for 18 months) to 11 entities to start the payment banks. This has been done in order to drive the Financial Inclusion The Payment Banks can provide the following services-remittance services, demand deposits, internet banking and other specified services The features of Payment banks are o Customers can deposit only up to Rs 1,00,000 o Are allowed to issue only debit/atm cards o No credit cards can be issued o No lending activities can be conducted o Payments and remittance services will be provided o Insurance and mutual funds will be provided to the customers o Initial capital of Rs 100 Cr. Other conditions applicable are o Payments banks are targeting migrant labourers, low income households, small businesses, and other unorganized sector entities. o Eligibility - Existing pre-paid payment instrument issuers, individuals, professionals, NBFCs, corporate business correspondents, telecom companies, super-market chains, real estate sector cooperatives that are owned and controlled by residents and public sector entities may apply. o Promoter s contribution initially must be 40% for the first 5 years. For foreign holding, it is up to 74% of paid-up capital, on a par with private banks. o The banks must maintain CRR, minimum 75% of demand deposits in government bonds of up to one year and maximum 25% in current and fixed deposits with other scheduled commercial banks for operational purposes and liquidity management.

50 Concerns with passage of time, three players - Cholamandalam, Dilip Sanghvi and Tech Mahindra have dropped out of the race. Some of the concerns that have been raised are o Limited scope of activity (no lending) o Profitability concerns o Competitive pressure leading to lower margins o Increasing technological growth List of entities o Aditya Birla Nuvo o Airtel M Commerce Services o Department of Posts o FINO PayTech o National Securities Depository o Reliance Industries o Vijay Shekhar Sharma, Paytm o Vodafone M-Pesa o Dilip Shanghvi o Cholamandalam withdrawn o Tech Mahindra Small Finance Banks Small Finance Bank (SFB) are specialized banks SFBs are allowed to accept deposits and are allowed to give loans. The SFBs will now be able give loans to MSMEs and bring them under the ambit of financial system These will also further the objective of financial inclusion The features and conditions o Minimum capital to be Rs 100 Cr o 75% of the credit must be given in the PSL o Maximum loan size to a single borrower/person cannot exceed 10% & 15% of total capital in case of a group o At least 50% of the loans should constitute loans/advances up to Rs 25 lakh o Must maintain CRR and SLR

51 o With the prior approval of RBI, SFBs can undertake financial services o Must have the word Small Finance Bank in the name o No subsidiaries can be set by these SFBs to take care of non-banking financial service activities o 25% of the branches to be set up in unbanked areas The 10 entities that received the nod for small banks o Au Financiers - Jaipur o Capital Local Area Bank - Jalandhar o Disha Microfin - Ahmedabad o Equitas Holdings - Chennai o ESAF Microfinance and Investments - Chennai o Janalakshmi Financial Services - Bengaluru o RGVN (Northeast) Microfinance - Guwahati o Suryoday Micro Finance - Navi Mumbai o Ujjivan Financial Services - Bengaluru o Utkarsh Micro Finance - Varanasi Some terms Gross NPA-the amount which has been outstanding in the books Net NPA- Gross NPA-interest debited to account but not realized Stressed Asset- NPA+ Restructured loans+ written off assets 5 sectors contributing to 54% of total stressed assets o Mining o Iron and steel o Infrastructure o Aviation o textiles