Indian Banking System Nationalization and development of banking India Nationalization of RBI in 1949. RBI was established in 1935 according to RBI Act 1934 on the basis of recommendation of Hilton Young Commission Banking Regulation Act 1949 - provided extensive regulatory powers to RBI and with that it became possible for it to carry out various structural reforms in banking system Emergence of SBI - through State Bank of India Act 1955. By merging Imperial Banks of Madras, Bengal and Bombay in 1921- Imperial Bank of India - nationalized in 1955 and renamed State Bank of India Emergence of nationalized banks By Banking Nationalization Act 1969 government nationalized o 14 banks with deposits of more than 50 crore in 1969 o 6 banks with deposits of more than 200 crore in 1980 Objectives of nationalization: o To prevent the concentration of economic power with high profile customers o To spread banking across the country o To cater to requirements if agricultural sector o To make banking industry serve social purpose o To develop a pool of professional bankers o To mobilize the savings of large mass of population Emergence of RRBs - Regional Rural Banks o First set up on Oct 2, 1975 with the aim to take banking servicers to the doorstep of rural masses specially in remote areas with no access to banking services o Duties: To provide credit to weaker sections of society at concessional rate of interest To mobilize rural savings and channelize the, for supporting productive activities in rural areas Banking sector reforms 1. Narsimham committee - I (1990) o Aims: Ensuring a degree of operational flexibility Internal autonomy for Public Sector Banks in decision making Greater degree of professionalism in banking operation Recommendations: RBI was advised not to use Cash Reserve Ratio(CRR) as principle instrument of monetary policy but to rely on open market operations increasingly CRR should be progressively reduced from 15% to 3% RBI should pay interest on CRR of banks Directed credit programme(compulsion of priority sector lending) for agriculture and small scale industry should be gradually phased out and should focus on now weakest sections of the society 1
Interest rates to be broadly determined by market forces and RBI having sole authority to simplify structure of interest rate To tackle the menace of highly non performing assets (NPAs) of banks and financial institutions, the committee suggested setting up of ARC - Asset Reconstruction Companies Narsimham Committee - II (1998) Merger of strong banks which have a multiplier effect on the economy. Weak and unviable banls should be closed 3 tier banking structure suggested: Tier 1-2 to 3 banks of international orientation Tier 2-8 to 10 banks of national orientation Tier 3 - large number of local banks Norms for Capital Adequacy Ratio - suggested to increase to 10% Legal framework of loan recovery should be strengthened Net NPAs for all banks suggested to be cut down to below 5% by 2000 and 3% by 2002 Board for financial regulation and supervision(bfrs) should be set up for the whole banking, financial and Non Banking Financial Companies in India Non Performing Assets(NPAs) If interest or installments of principle remain overdue for a period of more than 90 days in respect of term loan, in case of bill purchased, in respect of overdraft or other accounts Interest or installments due for 2 harvest seasons but for a period not exceeding two half years in case of advance granted for agricultural purposes Types of NPA: a. Sub standard assets: remaining NPA for less than or equal to 12 months b. Doubtful assets: remaining NPA for period of more than 12 months c. Loss assets: where the loss has been identified by the bank, auditors or RBI inspectors but the amount has not been written off Reasons for emergence of NPA: a. Increased interest rates in recent past b. Lower economic growth c. Aggressive lending by banks in past especially during the good times d. Country macroeconomic situation - worsening e. Switchover to system based identification of NPAs ARC - Asset Reconstruction Company They buy NPAs from banks and try to extract maximum money out of it Have to register with the RBI ARCIL - India's first and largest ARC ARC will issue security receipts of worth equal to NPA Only QIB(Qualified Institutional Buyers) can buy these security receipts QIB: a. Scheduled commercial banks b. Foreign institutional investors c. Mutual funds 2
d. Insurance companies Capital Adequacy Ratio It is a measure of bank's capital It is the ratio of total capital to total risk weighted assets Basel Accords These are norms of sound banking practices laid down by - Basel Committee on Banking Supervision These are called Basel Accords as BCBS maintains its secretariat at BIS(Bank for International Settlement) in Basel, Switzerland Basel III (Dec 2010): o Objectives: To improve the banking sector's ability to absorb shocks arising from financial and economic stress Improve risk management and governance Strengthen banks' transparency and disclosure RESERVE BANK OF INDIA Functions of RBI. o General central banking systemissue of curency notes. bankers to the government. exchange management and control. credit control. agricultural finance. Collection and publication of data. o Developmental and promotional functionmobilisation of saving and extending banking to the unbanked areas. providing security to the depositors. development of agriculture credit institution. advisor to the government. helping the development of specialised institutions of industrial finance. MONETARY POLICY It is macroeconomic policy tool used to influence interest rates, inflation, credit availabilitythrough chnges in supply of money available in the economy. OBJECTIVESaccelerating growth of economy price stability exchange rate stabilisation balancing saving and investment generating employment. 3
1. Qualitative credit--- repo rate reverse repo rate marginal standing facility base rate 2. Quantitative credit---- bank rate cash reserve ratio statutory liquidity ratio open market operation TWO TYPES OF MONETARY POLICY- 1. Contractionary- higher rate of interest which decreases the total money supply(to control inflation) 2. Expansionary- lowering the rate of interest which increases the total money supply(to beat recession and slowdown) QUANTITATIVE METHODS BANK RATE- It is the interest rate which the RBI charges on its long term lendings to government of india,state government.financial institutions and non-banking financial institution. CASH RESERVE RATIO- It is the ratio (fixed by RBI) of the total deposits of a bank which is to be kept with RBI in the form of cash. High CRR- sucks the money from market which decrease liquidity Low CRR- inject the money into market which increase liquidity. STATUTORY LIQUIDITY RATIO(non-cash) It is the ratio of its total deposits which a commercial bank has to be maintained with itself at itself at any given point of time in the from of liquid assets (cash in hand, current balances with other banks and first class securities like government dated securities) High SLR- it will reduce commercial banks' ability to create credit. Thus eased inflationary measures. OPEN MARKET OPERATIONS These are the operations which involves the sale and purchases of the government securities by RBI vis-a-vis the banking system in order to expand and contract the amount of money in banking system. During recession RBI directs the bank to give more loans and RBI buys government securities to move money in market and vice-versa. QUALITATIVE AND SELECTIVE CREDIT CONTROLS these are the controls that designed to regulate both volume of loans and purposes for which loans are given by commercial banks. MARGINAL STANDING FACILITY under this banks can borrow overnight upto 1% of their net demand and time liabilty from RBI at an interest rate 1% higher than the current repo rate. it is the last resort for banks. minimum amount which can be accessed through MSF is 1 crore and multiples of 1 crore. BASE RATE 4
it is the interest rate below which a scheduled commercial banks will lend loans to its customers. it is determined by RBI. all categories of loans are priced with reference to the base rate only except DRI(differential rate of interest). DRIit is lending programme launched by government in 1972 which makes it obligatory upon all public sector banks in india to lend 1% of the total lending of the preceding year to "POOREST AMONG THE POOR" at an interest rate of 4% per annum. Priority sectors- agriculture small and medium enterprises small housing loans (10lakhs) self help groups distressed urban poor muslims, christians, sikhs, budhhists and parsis included in PSL(with effect from 2007) INDIAN BANKS need to lend 40% to PSL every year of their total lending. FOREIGN BANKS need to fulfill 32% PSL target-12% export, 10%small and medium enterprise, 12%other areas 5