Although some form of banking, mainly of the money-lending type, has been in existence in India since ancient times, it was only over a century ago that proper banking began. The earliest institutions which undertook banking business under the British regime were agency houses which carried on banking business, in addition to their trading activities. Most of these agency houses were closed down between 1929-32. Following serious financial troubles, three presidency banks were later amalgamated into Imperial Bank of India in 1919.
The modern banking system started in India in the beginning of the 19th century. Bank of Hindustan (1770) was the first bank to be established (Alexander and Co.) at Calcutta under European management. Other bank set up were Bank of Bengal (1806). Bank of Bombay (1840) and the Bank of Madras (1843) were called Presidency Banks. The first purely Indian bank was the Punjab National Bank (1894) but in 1881 the first bank with limited liability to be managed by an Indian board, namely, the Oudh Commercial Bank founded. Subsequently, the Punjab National Bank was established in 1894. Swadeshi movement, which began in 1906, encouraged the formation of a number of commercial banks. Banking crisis during 1913- 1917 and failure of 588 banks in various states during the decade ending in 1949 underlined the need for regulating and controlling commercial banks. The Banking Companies (Inspection Ordinance) was passed in January 1946 and the Banking Companies (Restriction of Branches) Act in February 1946.
Post-Independence Period (1947-1991)
The Banking Companies Act was passed in February 1949, which was subsequently amended to read Banking Regulation Act.
Nationalization of Banks
With a view to bring commercial banks into the mainstream of economic development with definite social obligations and objectives, the Government issued ordinance on 19 July 1969 acquiring ownership and control of 14 major banks in the country, with deposits exceeding Rs 50 crore each. Six more commercial banks were nationalized from 15 April 1980. The objectives of public sector banking system were outlined on 21 July 1969.
Nationalization was done to check the concentration of economic power in few hands. In the private sector banking, a small number of shareholders could determine the patterns of allocation suitable for their own needs. Secondly, Nationalization was essential for bringing about sectoral and regional balances, and to correct the urban bias. Finally, banks were considered to be an instrument of social transformation and not only a means of profit maximization.
Credit Expansion Policy of Banks
Priority Sector Lending
- Priority sector refers to those sectors of the economy which may not get timely and adequate credit in the absence of this special dispensation. Typically, these are small value loans to farmers for agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low income groups and weaker sections.
- Extension of credit to small borrowers in the hitherto neglected sectors of the economy has been one of the key tasks assigned to the public sector banks in the post-nationalisation period.
- Priority Sector includes the following categories:
- Micro and Small Enterprises
- Export Credit
- Renewable Energy
- Social infrastructure
To achieve this objective, banks have drawn up schemes to extend credit to small borrowers in sectors such as agriculture, small-scale industry, road and water transport, retail trade and small business which traditionally had very little share in the credit extended by banks. Taking into account the need to provide financial resources through bank credit to weaker sections for specific needs, consumption credit (with certain limits) has been included in priority sectors. Presently 40% of the credit extension should go towards priority sector lending.
Credit to Weaker Sections
With a view to augment credit flow to small and poor farmers, commercial banks were advised by the Reserve Bank of India to provide at least 10 percent of their net bank credit or 25 percent of their priority-sector advances to weaker sections comprising small and marginal farmers, landless labourers, tenant farmers and share-croppers, artisans, village and cottage industries, beneficiaries of Scheme of Urban Micro Enterprises (SUME), the Integrated Rural Development Programme, and Scheme for Liberation and Rehabilitation of Scavengers, scheduled castes and scheduled tribes and beneficiaries of Differential Rate of Interest (DRI) Scheme.
Credit Flow to Agriculture
Banks were initially given a target of extending 15 percent of the total advances as direct finance to the agriculture sector to be achieved by March 1985. This target was subsequently raised to 18 percent to be achieved by March 1990. In terms of the guidelines issued by the Reserve Bank of India in October 1993, both direct and indirect advances for agriculture are taken together for assessing the target of 18 percent with the condition that lending for indirect agriculture does not exceed one-fourth of the total agriculture lending target of 18 percent of the net bank credit.
Advances to SC/ST Borrowers
People belonging to the scheduled castes and scheduled tribes are recognised as the most vulnerable sections of the society. Banks have been asked to make special efforts to assist them with adequate credit to enable them to undertake self-employment ventures to acquire income-generating capital assets so as to improve their standard of living.
Recently Micro-Finanace has become important part of credit extension policy of banks for weaker sections. The aim is Financial Inclusion.
Targets And Sub-Targets For Banks Under Priority Sector
Domestic scheduled commercial banks (excluding Regional Rural Banks and Small Finance Banks) and Foreign banks with 20 branches and above
Foreign banks with less than 20 branches
Total Priority Sector
40 percent of Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.
40 percent of Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, to be achieved in a phased manner by 2020.
18 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.
Within the 18 percent target for agriculture, a target of 8 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher is prescribed for Small and Marginal Farmers.
7.5 percent of ANBC or Credit Equivalent Amount of off-Balance Sheet Exposure, whichever is higher.
Advances to Weaker Sections
10 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher
Banking Sector in India
Joint-stock banks having Rs.5 lakh or more as capital and reserves are called scheduled banks by Reserve Bank of India. Included in the Second Scheduled on the RBI Act, these banks are registered as a limited liability, joint stock company under the Indian Companies Act.
Apex Bank of India
Public Sector Banks
State Bank of India and its associate banks (Though associate banks do not exits today due to their merger with the SBI)
Regional Rural Banks sponosred by Public Sector Banks
Indian Private Banks
The co-operative banking sector has been developed in the country to the suppliment the village money lender. The co-operatiev banking sector in India is divided into 4 components
- State Co-operative Banks
- Central Co-operative Banks
- Primary Agriculture Credit Societies
- Land Development Banks or Agricultural Development Banks
- Urban Co-operative Banks
- Industrial Finance Corporation of India (IFCI)
- Industrial Development Bank of India (IDBI)
- Industrial Credit and Investment Corporation of India (ICICI)
- Industrial Investment Bank of India (IIBI)
- Small Industries Development Bank of India (SIDBI)
- SCICI Ltd.
- National Bank for Agriculture and Rural Development (NABARD)
- Export-Import Bank of India
- National Housing Bank
Reserve Bank of India
The Reserve Bank of India (RBI) was established under the Reserve Bank of India Act, 1934 on 1 April 1935 and nationalized on 1 January 1949. The Bank is the sole authority for issue of currency in India other than one rupee coins and subsidiary coins and notes. As the agent of the Central government, the Reserve Bank undertakes distribution of one-rupee notes and coins, as well as small coins issued by the Government. The Bank acts as banker to the Central government, State governments, commercial banks, state co-operative banks and some of the financial institutions. It formulates and administers monetary policy with a view to ensuring stability in prices while promoting higher production in the real sector through proper deployment of credit. RBI plays an important role in maintaining the stability of exchange value of the rupee and acts as an agent of the Government in respect of India’s membership of International Monetary Fund. The Reserve Bank also performs a variety of developmental and promotional functions. Apart from these, RBI also handles the borrowing programme of the Government of India.
Regional Rural Banks (RRBs)
RRBs were set up in 1975 after the Narasimham Committee Report. Initially, five RRBs were established at Moradabad and Gorkhapur in Uttar Pradesh, Bhiwani in Haryana, Jaipur in Rajasthan, and Malda in West Bengal on October 2, 1975. RRB are in all states except Sikkim and Goa.
The equity/shareholding pattern of RRBs is
- Central Governemt – 50%
- State governments – 15 %
- Sponsor banks (Eg SBI, PNB etc.) – 35%
While Centre and sponsor banks have been infusing capital, state governments have been found wanting in providing their share.
RRBs are scheduled banks, its area of operation is limited to one or more districts of a state. They usually pay 1% or 2% higher rate of interest in comparison to commercial banks. RBI is the regulatory authority of RRBs and their inspection is undertaken by NABARD.
Since April 1987, no new RRB has been opened keeping in view the recommendations of Kelkar Committee. After the ongoing process of merger and acquisitions, number of RRBs has come down continuously – as on March-end, 2011, the total number of RRBs stood at 82; this fell to 64 in March 2013 and 57 in March 2014. As for now, the process of further amalgamation of RRBs has been put on hold by Ministry of Finance.
- The RRBs are sponsored by public sector banks to meet credit and other financial facilities in rural areas. They provide cheap credit facility to small and marginal farmers, agriculture labourers, artisans and small entrepreneurs.
- They were established to take the banking services to the door steps of rural masses, especially in remote rural areas with no access to banking services.
- These banks were also intended to mobilise rural savings and channelise for supporting the productive activities in the rural area.
RRB Amendment Act 2015
The parliament in an efort to revamp the RRBs passed the RRB Amendment Act to amend the RRB Act, 1976.
Main provisions of the act are:
- Total Authorized Capital of RRBs is to be raised to Rs. 2000 crores in place of 5 crores earlier.
- The Total Authorized Capital of Rs. 2000 crores is to be divided into 200 crore shares of Rs. 10 each.
- RRBs have been allowed to raise capital from private investors by issuing shares. But on condition that combined shareholding of Union+ State+ Sponsor bank should not fall below 51%.
- States can buy more shares, to increase their shareholding above 15%.
- RRB can appoint Board of dicooperative outside union-state and sponsor bank nominated people. One person cannot become director in maximum 2 RRBs.
- Director’s tenure limit: 3 years. Maximum two terms allowed.
Advantages over the previous Act of 1976
- The Act aims at expanding the Total Authorized Capital of the RRBs thereby increasing their operational capabilities.
- The Act also divides the total capital into smaller shares to increase their tradability in the shares market. Now due to cheap cost of shares more people will buy them thereby infusing capital in the RRBs.
- By allowing independent directors the Act tries to bring in efficient management and accountability into the functioning of the RRBs.
- The Act allows states to raise their share in the RRBs thereby having more say in decision making of these banks.
Co-operative banks in India also perform fundamental banking activities but they are different form commercial banks. Commercial banks have been constituted by an Act passed by parliament while co-operative banks have been constituted by different State under various Acts related to co-operative societies of various states.
Co-operative bank organisation in India has three tier set up.
Three Tier Structure
Primary Credit Societies
These societies provide short term credit facilities to agriculture sector. Minimum 10 persons of a village (or are) can form a primary credit society. These PCSs are also called Primary Agriculture Credit Societies(PACS). These societies grant short-term loans (generally one year period) for productive activities but this period can be extended upto 3 years under special circumstances.
Central (or District) Cooperative Bank
The working area of these banks is limited to one district only.Central Co-operative Bank can be divided in two parts:
- Co-operative Banking Union
- Mixed Central Co-operative Bank
The membership of Co-operative Banking Union is given to co-operative societies only, while the membership of mixed central co-operative bank can be granted to both co-operative societies and individuals. Generally all states in India are having central co-operative banks with mixed membership and are providing sufficient financial assistance to both PSCs and individuals.
Central Co-operative Banks get loans from State Co-operative bank and give loans to Primary Credit Societies. The duration of such loans vary from one year to three years. In this way Central Co-operative Bank plays a bridge and Primary Credit Societies.
State Cooperative Banks
It is the apex co-operative bank of the state. It grants loans to central co-operative bank and regulates their activities. State co-operative bank gets loans form RBI. Hence, SCB acts as a link between RBI and Central co-operative banks. State Co-operative Bank raises its current capital by shares and loans. RBI generally provides loans to SCB on interest rate, one or two per cent lower than bank rate. At present 28 State Co-operative Banks are working in the country.
Difference between Commercial Bank and Central Cooperative Bank
- Commercial bank can establish its branches in any district/state of the country while, contrary to it, co-operative bank can operate its activities only within limited area. For example, District Co-operative Bank can perform banking activities within the boundaries of the concerned district.
- Similarly, Primary Credit Societies can perform banking services within concerned villages. Co-operative banks can not open their branches in foreign countries while commercial banks can do that.
- Banking Regulation Act 1949 is fully applicable to all commercial banks while it is partially applicable to co-operative banks. In other words, RBI has partial control over cooperative banks.
- Co-operative banks work on principles of co-operation while commercial banks adopt pure commercial principles in their operation. That is the reason why co-operative banks succeed in getting financial assistance from RBI on concessional rate.
Problems of Banks
The three decades after nationalization saw a phenomenal expansion in the geographical coverage and financial spread of the banking system in the country. As certain rigidities and weaknesses were found to have developed in the system, during the late eighties the Government of India felt that these had to be addressed to enable the financial system to play its role in ushering in a more efficient and competitive economy.
- Profitability and efficiency levels have been very low especially in the case of public sector banks not speaking of the quality of service. Government policies like high reserve requirements (CRR, SLR) and high-priority sector lending have also affected the profitability of the banks in India.
- The banking system was burdened with NPAs (Non-performing assets) of around 17 percent (in actual terms it could have been more considering the loose asset classification framework which existed then).
- Regulation had a stranglehold on all aspects of the banking sector including the entry of players, interest rates, and credit allocation to name a few.
- The loan meals, priority sector lending, and a host of such schemes contributed to the low profitability of the banking sector.
- Absence of professionalism, poor customer service, and lack of prudential accounting norms are some of the major problems.
Banking Sector Reforms
The banking sector in India though in a relatively healthy state compared to the banking sector in several economies, has some issues that are preventing it from functioning with full efficiency. These problems can be classified as
- Financial problems
- Problems related with Governance
- Structural Problems
As per the economic survey 2014-15 the banking sector in India is reeling under Double Financial Repressioni.e. repression on the asset side as well as liability side.
Financial Repression on the Asset Side
Financial Repression on the asset side is due to NPAs (Non-performing assets), SLR requirements and Priority sector lending.
SLR (Statutory Liquidity Ratio) requirements- The Statutory Liquidity Ratio is a requirement on banks to hold a certain share of their resources in liquid assets such as cash, government securities (G-secs) and gold. In principle, the SLR can perform a prudential role because any unexpected demand from depositors can be quickly met by liquidating these assets.
In practice, the SLR has become a means of financing (at less than market rates presumably) a bulk of the government’s fiscal deficit, suggesting that SLR cuts are related to the government’s fiscal position.
The SLR is a form of financial repression where the government pre-empts domestic savings at the expense of the private sector. Real interest rates are lower than they would be otherwise.
The Economic survey presents the case for gradually reducing this requirement- both to free up capital for the banks and to make the market for government bonds more liquid.
Also, SLR reductions could allow banks to offload G-secs and reap the capital gains which could help recapitalize them, reducing the need for government resources, and helping them raise private resources at better returns compared to G-secs.
PSL (priority sector lending) requirements – According to several studies the PSL has failed to achieve the intended benefits of financial inclusion and is instead being misused thereby leading to asset-side repression on banks. The findings of these studies are
- The PSL is being utilized by rich farmers more compared to the poor ones (the number of high value loans (Rs.10 lakh and above) are on a constant rise).
- There is no mechanism to monitor the end use of the loan and hence several of such loans are being used for non-productive consumption.
- Most of the agricultural loans are in March instead of the sowing times of Rabi and Kharif. This is so because the banks do not readily forward loans to farmers until the yearly deadline.
- Most of the PSL are in relatively rich states like Haryana Punjab etc. and not in more needy states like Odisha, Arunachal etc.
These facts suggest that PSL needs to be restructured
- The Non-Performing Assets of banks at 5.1% are well within the Basel norms. But their recent increase is an alarming trend that needs to be curtailed.
- Most of the NPAs are on account of default by big borrowers.
- Also, the inadequate bankruptcy laws, overburdened Debt Recovery Tribunals, ineffective implementation of the SARFAESI act add to the problems.
Deregulate: As the banking sector exits the financial repression on the liability side, aided by the fall in inflation, this is a perfect opportunity to relax asset-side repression.
First, SLR requirements can be gradually relaxed. This will provide liquidity to the banks, depth to the government bond market, and encourage the development of the corporate bond market. The right sequence would be to gradually reduce SLR and then provide incentives for a deeper bond market.
Second, PSL norms can be re-assessed to slowly make the priority sector more targeted, smaller, and need-driven as proposed by the Nachiket Mor committee.
Independent Renegotiation committee-Appointment of an Independent Renegotiation Commission with political authority and reputational integrity to resolve some of the big and difficult cases. When the next boom and bust comes around, India needs to be better prepared to distribute pain between promoters, creditors, consumers, and taxpayers. Being prepared for the cleanup is as important as the being prudent in the run-up.
Financial Repression on the Liability Side- High inflation and limited return on banks’ assets has ensured that the rates maintained by banks fetched households a negative real rate of return on deposits. Hence banks are receiving fewer deposits as people move towards physical assets.
Recently due to falling Inflation, the repression on the liability side has eased somewhat.
- In India, theshare of banks towards total credit advanced in economy stands at 95%. This exposes them to high risks due to defaults.
- Also, Public Sector Banks account for over 80% of these credits thereby increasing the risk factor for them further.
- The Capital Markets and Private Banks have failed to give any competition to the Public Sector Banks in credit market.
More banks and more kinds ofbanks must be encouraged. Healthy competition from capital markets is essential too which will require policy support from the government. For ex- making mandatory a share of credit from capital markets for big borrowers.
Governance related problems
*See PJ Nayak committee on governance reforms.
PJ Nayak Committee on reforms in the governance of Bank Boards
In Public Sector Banks (PSBs) government owns a minimum of 50% shares thereby having majority voting power. This means that government has major say in matters of appointments and decision making in PSBs. Such government influence often leads to lack of autonomy on part of banks and is often responsible for poor performance of PSBs.
Therefore the PJ Nayak Committee recommends reforms in governance of Bank Boards of PSBs. Main recommendations of the committee are
- Repeal followinglaws-
- Bank Nationalization Act 1970, 1980.
- State Bank of India Act 1955.
- SBI Subsidiaries Act 1959.
Because above acts require Government to keep shareholding >50%, and appoints MDs and board directors.
Once, those acts are repealed Government should setup a Bank Investment Company (BIC), under Companies act, 2013 as a “Core investment company”. Government should transfer its shares of PSBs, to BIC. Consequently al the PSBs to be registered as subsidiaries of BIC and they are to become “Ltd.” Companies.
The government should sign an agreement of autonomy with the BIC and allow it to vote on important appointments and decisions by involving all the shareholders. (In UK, Government has setup UKFI (UK Financial investment ltd.) for the same purpose.)
Until BIC is constituted, a Bank Boards Bureau involving senior bankers to be setup for appointments and other functions of BIC.
Implications of these reforms
The appointments will be based on performance and talent thereby ensuringbetter performance and management of PSBs.
Presently, the PSBs are open to scrutiny by not just RBI but also by CVC, CAG, RTI etc. This excessive oversight affects decision making as the managers are afraid to take bold business oriented decisions. Falling of government share below 50% will ensure that banks are free from oversight of multiple agencies.
Due to government ownership PSBs also suffer from‘fiscal repression’ i.e. they are directed to invest in Government Securities which though safe yield very low returns thereby affecting their profitability.
Also they suffer fiscal repression due to loan waivers, advancing cheap loans to government agencies etc.
Governance reforms will free banks of these fiscal repressions.
Domestic Systematic Important Banks
In 2009 Financial Stability Board (FSB) was setup. It is an international body affiliated with the G-20 that monitors global financial health. FSB highlighted that each country has certain banks which are big and important in terms of huge client base, large size of assets and liabilities, cross border and cross-sector functioning (like insurance, mutual funds etc.)
These banks are so big and important that economy cannot afford their failure and hence in case of poor performance the government is forced to offer them a bailout package. Consequently, these banks become confident they’re“too big to fail”so they will always be rescued by market-forces or the government and will continue to indulge in grey-areas and reckless practices.
Hence, we need to identify such systematically important banks (SIB) at Domestic and global level. We must force them to have additional capital/backup against financial emergency, so that taxpayer money not wasted in rescuing them during crisis.
Following the guidelines of FSB, RBI has to identify Domestic Systematically Important Banks every year. These banks have to maintain additional capital and are also open to additional regulatory oversight by RBI. This will ensure that these banks do not enter into any grey areas and shoddy practices (like the one exposed by Cobrapost Sting operation) and do not need bailout packages that consume taxpayers’ money.
The banks depending on their size have to maintain an additional capital ranging from 0.2% to 1% of their Risk Weighted Assets.
At the beginning of the 1990s many public sector banks became unprofitable and undercapitalized. The root cause of this was the excess emphasis given to social banking goals like widening the reach of banking services. The crucial elements like capital adequacy, profitability and low NPAs which are sine qua non for sound and efficient banking were given a back seat. About all, governmental protection acted as a disincentive leading to lethargy in the bank managements.
Opined the committee “the deterioration in the financial health of the system has reached a pointwhere unless remedial measures are taken soon, it could further corrode the real value of and return on the savings entrusted to them and even have an adverse impact on depositor and investor confidence”.
Important Committees on Banking Sector Reforms
Narasimham Committee Recommendations
Against this backdrop, the committeeon the financial system headed by Mr. M. Narsimhan was constituted on 14 August 1991 to examine all aspects of the financial sector and suggest reforms so as to transform the sector from a highly regulated one to a market-oriented one. It submitted a report to the Finance Ministry and it was laid on the table of the Parliament on December 17, 1991. Its suggestions included:
- Deregulation of entry reducing thereserve preemption levels,
- Interest rate deregulation,
- Review of priority sector lending,
- Institution of capital adequacy andprudential norms,
- Improving accounting practices,
- Allowing public sector banks to access the capital market,
- Setting up of ARF (Asset Reconstruction Fund),
- Relaxing the branch licensing policies,
- Granting autonomy in the recruitment of staff,
- Curbing excessive regulation and regulation of NBFCs et al.
Second Report of Narasimham Committee
A high-level Committee, under the Chairmanship of Shri M. Narasimham, was constituted by the Government of India in December 1997 to review the record of implementation of financial system reforms recommended by the CFS in 1991
The Committee has submitted its report to the Government in April 1998.
The second report of the Narasimham committee has reiterated many of its previous recommendations. It has also suggested some new ones in the light of seven years of post-reform experience.
- Significant among these is the one relating to reduction of government of India’s stake to 33 per cent in public sector banks.
- This the appointment of chairmen and managing directors shall be left to the boards of banks.
- Stock options to the employees of banks going public have also been suggested.
- As regards weak banks (banks whose accumulated losses and net NPAs exceed capital funds or in the case of public sector banks whose operating results less income from recapitalization bounds reveal losses for three consecutive years) their transformation into narrow banks has been suggested as a short-term measure. These banks would deploy 100 percent of their money in low or no risk investments. This approach it is argued would lead to rehabilitation of weak yet potential banks.
- Gradual increase in capital adequacy ratio has been proposed so as to make it 9 per cent by the year 2000 and 10 per cent by the year 2002.
- As regards the norms of income recognition from accrual of interest 90 days cycle has been recommended against the present 180 days. A provision of one per cent for standard assets is made applicable. Extension of tax-deductibility has been recommended for the provisions made since these provisions affect the balance sheets of banks.
- The committee has also mooted the concept of NPA swap bonds. The assets identified as doubtful or loss making can be transferred to an asset reconstruction company (ARC), which in turn issues NPA swap bonds to the banks. The ARC shall be entitled to file suits in debt recovery tribunals for recovery.
- Depoliticisation of appointments of chairmen is one of the significant recommendations aimed at improving the flexibility and autonomy of banks. This would encourage professionalism in the bank management and board appointments. The review of the functions of the boards and the management has also been suggested. Greater emphasis shall be accorded to the concept of enhancement of shareholder value avers the committee.
- Considering the bloated work force and its concomitant cost implications the committee recommends that the present system of industrywise wage settlements shall be given way to bank-wise settlements. To reduce the surplus staff the committee has mooted the implementation of golden handshake.
- While the economic reform has been making considerable progress the legal system has maintained status quo. The committee felt that banking sector is in need of an appropriate legal framework to help enforce the contracts and protect the interests of secured creditors especially in bankruptcy proceedings. The experience with the debt recovery tribunals has not been encouraging. These apart the relevance of continued existence of different laws e.g. RBI Act. Banking regulation Act, Sick Industrial Companies Act and SBI Act etc. is proposed for review.
Nachiket Mor committee
The Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households, set up by the RBI in September 2013, 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:
The Committee further lays down a set of four design principles namely;
- Neutrality, and
PJ Nayak Committee
The P J Nayak Committee or officially the Committee to Review Governance of Boards of Banks in India, was set up by the Reserve Bank of India (RBI) to review the governance of the board of banks in India. The Committee was set up in January 2014. The Committee was chaired by P J Nayak, the former CEO and Chairman of Axis Bank.
- 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.
- After the above actsare repealed, the government should set up a Bank Investment Company (BIC) as a holding company or a core investment company.
- The government to transfer 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. As a result of this, all the PSBs (public sector banks) would become ‘limited’ banks. BIC will be autonomous and have the power to appoint the Board of Directors and make other policy decisions.
- Until the BIC is formed, a temporary body called the Bank Boards Bureau (BBB) will be formed to do the functions of the BIC. Once BIC is formed, the BBB will be dissolved.
- The BBB will advice on appointments to the board, banks’ chairman and other executive directors.
Arguments in favour of the recommendations
- The chairman’s pay will be linked to the profits. So, he/she will focus on marketing, improving customer base and advertisements.
- The banks will be under only RBI supervisionand not the CVC, RTI and CAG. This will make the banks more amenable to taking calculated risks. In nationalised banks, because they are subject to supervision from CAG, RTI, etc. bold decisions are not taken by the management.
- Generally, national banks invest their profits in government securities only. Hence, they do not make huge profits because government securities are considered safe bets. This is also because government owns majority shares in them which indirectly controls where they invest in. This is also called ‘fiscal repression’. This can be avoided because private banks invest in securities that give higher returns than G-secs.
- Nationalised banks could be forced to bailout loss-making entities (like the case with UTI and IDBI).
- Nationalised banks were also forced to give cheap loans to FCI and also waive off farmers’ debts.
Arguments against the recommendations
- Some people argue that lowering the government share to below 51% will make the banks only ‘profit-motive’. In India, financial inclusion in rural areas is less and if banks run only for profits, no branches will be set up in villages.
- When the oversight of the CAG and CVC are gone, there is a possibility of fraud.
Universal Banking - Khan Committee
Around the same time of second phase of reforms, Khan Committee headed by S.H. Khan of IDBI also came up with recommendations for universal banking. If the players in the financial system need to become globally competitive the boundaries between commercial banks and DFIs(Development Financial Institutions) shall be demolished. A regulatory framework to enable such harmonization needs to be evolved.
The committee proposed mergers between banks and DFIs as also between banks inter se. The rationale for this stems from the fact that in the post liberalization era DFIs are increasingly operating on commercial lines as opposed to developmental considerations.
To facilitate free competition the committee has recommended the institution of a super regulator who shall supervise various regulating agencies to ensure institution-neutral regulatory treatment - a thorough revamp of the multiple legislative framework governing DFIs, banks and recovery process. Off-site supervision as opposed to on-site supervision shall deserve the attention of supervisors reckons the committee. As regards the reserve pre-emptions like the Narasimham committee it also suggested for slashing the requirement to international levels. As far as the priority sector lending is concerned, the committee opines that subjecting the whole banking sector to directed lending is undesirable. On the contrary, it has also observed that priority sector lending is expected to continue and suggested inclusion of infrastructure lending into priority sectors.
This committee was set up to review the system of supervision of the banks. This committee recommended a new rating methodology popularly called CAMEL
Insolvency and Bankruptcy Code 2016
In India, the legal andinstitutional machinery for dealing with debt default has not been in line with global standards. The recovery action by creditors, either through the Contract Act or through special laws such as the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, has not had desired outcomes. Similarly, action through the Sick Industrial Companies (Special Provisions) Act, 1985, and the winding up provisions of the Companies Act, 1956 have neither been able to aid recovery for lenders nor aid restructuring of firms. Laws dealing with individual insolvency, the Presidential Towns insolvency Act, 1909, and the Provincial Insolvency Act. 1920, are almost a century old. This has hampered the confidence of the lender. When lenders are unconfident, debt access for borrowers is diminished. This reflects in the state of the credit markets in India. Secured credit by banks is the largest component of the credit market in India. The corporate bond market is yet to develop.
The objective of the new law is to promote entrepreneurship, availability of credit, and balance the interests of all stakeholders by consolidating and amending the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner and for maximization of value of assets of such persons and matters connected therewith or incidental thereto.
The law aims to consolidate the laws relating to the insolvency of companies and limited liability entities (including limited liability partnerships and other entities with limited liability), unlimited liability partnerships, and individuals, presently contained in a number of legislations, into a single legislation. Such consolidation will provide for greater clarity in law and facilitate the application of consistent and coherent provisions to different stakeholders affected by business failure or inability to pay thedebt.
The salient features of the law are as follows:
- Clear, coherent,and speedy process for early identification of financial distress and resolution of companies and limited liability entities if the underlying business is found to be viable.
- Two distinct processes for the resolution of individuals, namely- “Fresh Start” and “Insolvency Resolution”.
- Debt Recovery Tribunal and National Company Law Tribunal to act as Adjudicating Authority and deal with the cases related to insolvency, liquidation, and bankruptcy process in respect of individuals and unlimited partnership firms and in respect of companies and limited liabilities entities respectively.
- Establishment of an Insolvency and Bankruptcy Board of India to exercise regulatory oversight over insolvency professionals, insolvency professional agencies, and information utilities.
- Insolvency professionals would handle the commercial aspects of the insolvency resolution process. Insolvency professional agencies will develop professional standards, and a code of ethics and be the first-level regulator for insolvency professionals members leading to the development of a competitive industry for such professionals.
- Information utilities would collect, collate, authenticate and disseminate financial information to be used in insolvency, liquidation, and bankruptcy proceedings.
- Enabling provisions to deal with cross-border insolvency.
The essential idea of the new law is that when a firm defaults on its debt, control shifts from the shareholders/promoters to a Committee of Creditors, who have 180 days in which to evaluate proposals from various players about resuscitating the company or taking it into liquidation. When decisions are taken in a time-bound manner, there is a greater chance that the firm can be saved as a going concern, and the productive resources of the economy (the labor and the capital) can be put to the best use. This is in a complete departure from the experience under the SICA regime where there were delays leading to the destruction of the value of the firm.
The vision of the new law is to encourage entrepreneurship and innovation. Some business ventures will always fail, but they will be handled rapidly and swiftly. Entrepreneurs and lenders will be able to move on, instead of being bogged down with decisions taken in the past.
A key innovation of the Insolvency and Bankruptcy Code is the fourpillars of institutional infrastructure:
- The first pillar of institutional infrastructure is a class of regulated persons, the ‘Insolvency Professionals’. They would play a key role in the efficient working of the bankruptcy process. They would be regulated by ‘Insolvency Professional Agencies’.
- The second pillar of institutional infrastructure is a new industry of `Information Utilities'. These would store facts about lenders and terms of lending in electronic databases. This would eliminate delays and disputes about facts when default does take place.
- The third pillar of institutional infrastructure is adjudication. The NCLT will be the forum where firm insolvency will be heard and DRTs will be the forum where individual insolvencies will be heard. These institutions, along with their Appellate bodies, viz., NCLAT and DRATs will be adequately strengthened so as to achieve world-class functioning of the bankruptcy process.
- The fourth pillar of institutional infrastructure is a regulator viz., ‘The Insolvency and Bankruptcy Board of India’. This body will have regulatory oversight over the Insolvency Professional, Insolvency Professional agencies, and information utilities.
The Insolvency and Bankruptcy Code is thus a comprehensive and systemic reform, which will give a quantum leap to the functioning of the credit market. It would take India from among relatively weak insolvency regimes to becoming one of the world's best insolvency regimes. It lays the foundations for the development of the corporate bond market, which would finance the infrastructure projects of the future. The passing of this Code and implementation of the same will give a big boost to ease of doing business in India.
Finance minister Arun Jaitley launched a seven-pronged plan - Indradhanush - to revamp the functioning of public sector banks. The seven elements include appointments, board of bureau, capitalization, de-stressing, empowerment, the framework of accountability, and governance reforms.
The government had already announced that the post of Chairman and Managing Director in Public Sector Banks to be split into (a) MD and CEO; and (b) Non-Executive Chairman. As per Govt claims, this approach is based on global best practices and as per the guidelines in the Companies Act so as to ensure appropriate checks and balances in day to day functioning of these banks. The selection process for both these positions has been made more transparent and meritocratic.
Under the new process of selection for MD & CEO, even Private sector candidates were also allowed to apply for the position of MD & CEO of the five top banks i.e. Punjab National Bank, Bank of Baroda, Bank of India, IDBI Bank, and Canara Bank. The three-stage screening was done for the MD’s position culminating in a final interview by three different panels. Five MDs & CEOs were appointed earlier.Appointments of the MD & CEOs of five more banks - Bank of Baroda, Bank of India, Canara Bank, IDBI Bank, and Punjab National Bank and the Non-executive Chairman of 5 banks were announced now on 14th August 2015.Each of these appointments is likely to be for three years subject to certain other conditions.
Bank Board Bureau
We are aware that the announcement for Bank Board Bureau (BBB) was made in the Budget speech for the year 2015-16. Nofurther details have been issued. BBB will be a body of eminent professionals and officials, which will replace the Appointments Board for the appointment of Whole-time Directors as well as non-Executive Chairman of PSBs. The BBB would broadly follow the selection methodology as approved in relevant ACC guidelines. They will also constantly engage with the Board of Directors of all the PSBs to formulate appropriate strategies for their growth and development. BBB will comprise of a Chairman and six more members of which three will be officials and three experts (of which two would necessarily be from the banking sector). The Search Committee for members of the BBB would comprise the Governor, RBI, and Secretary (FS), and Secretary (DoPT) members. The members will be selected in the next six months and the BBB will start functioning from the 01st of April 2016.
Although PSBs have been under stress, they are still adequately capitalized and meeting all the Basel III and RBI norms.Now, the Government of India has shown its intent to adequately capitalize all the PS banks to have a safe buffer over and above the minimum norms of Basel III during the next few years.
Therefore, GoI has made an exercise to estimate the capital requirements based on a credit growth rate of 12% for the current year and 12 to 15% for the next three years depending on the size of the bank and its growing ability.It has been presumed that the emphasis on PSBs financing will reduce over the years by the development of a vibrant corporate debt market and by greater participation of Private Sector Banks.Based on this exercise, it is estimated how much capital will be required this year and in the next three years till FY 2019.After excluding the internal profit generation which is going to be available to PSBs (based on the estimate of average profit of the last three years), the capital requirement ofextra capitalfor the next four yearsup to FY 2019 is likely to be about a huge amount of Rs.1,80,000 crore.Out of the total requirement, the Government of India proposes to make available Rs.70,000 crores out of budgetary allocations for four years as per the figures given below:
Financial Year 2015 -16
Rs. 25,000 crore
Financial Year 2016-17
Rs. 25,000 crore
Financial Year 2017-18
Rs. 10,000 crore
Financial Year 2018-19
Rs. 10,000 crore
Rs. 70,000 crore
We estimate that PSB’s market valuations will improve significantly due to
- far-reaching governance reforms;
- tight NPA management and risk controls;
- significant operating improvements; and
- capital allocation from the government.
Improved valuations coupled with value unlocking from non-core assets as well as improvements in capital productivity, will enablePSBs to raise the remaining Rs.1,10,000 crore from the market. Moreover, the government is committed to making extra budgetary provisions in FY 18 and FY 19, to ensure that PSBs remain adequately capitalized to support economic growth.The Banks can also raise capital from the capital markets.
The government has recently announced the decision to further recapitalize PSBs to the tune of Rs.2,11,000 crore, through recapitalization bonds of Rs. 1,35,000 crore and budgetary provision of Rs.18,139 crore (the residual amount under the Indradhanush plan) over two financial years, and the balance through capital raising by banks from the market. The government has so far infused capital of Rs.59,435 crore in PSBs under Indradhanush. The capital infusion is aimed at supplementing the achievement of regulatory capital norms by PSBs through their own efforts and, in addition, based on performance and potential, augmenting their growth capital. The government has announced that a differentiated approach would be followed, based on the strength of each bank.
Under the State Bank of India Act, 1955, and the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980, the Board of Directors of the bank is responsible for general superintendence, direction, and management of the affairs and business of the bank. Further, the Companies Act, 2013 provides that the directors of a company shall act in good faith and in the best interests of the company, its employees, and the shareholders. Under the Banking Regulation Act, of 1949, the Reserve Bank of India (RBI) has the power to remove managerial and other persons from office for, inter alia, securing proper management of any banking company.
The infrastructure sector and core sector have been the major recipient of PSBs’ funding during the past decades. But due to several factors, projects are increasingly stalled/stressed thus leading to an NPA burden on banks.In a recent review, problems causing stress in the power, steel, and road sectors were examined. It was observed that the major reasons affecting these projects were delays in obtaining permits/approvals from various governmental and regulatory agencies, and land acquisition, delaying Commercial Operation Date (COD); lack of availability of fuel, both coal and gas; cancellation of coal blocks; closure of Iron Ore mines affecting project viability; lack of transmission capacity; limited off-take of power by Discoms given their reducing purchasing capacity; funding gap faced by the limited capacity of promoters to raise additional equity and reluctance on part of banks to increase their exposure given the high leverage ratio; the inability of banks to restructure projects even when found viable due to regulatory constraints. In the case of the steel sector the prevailing market conditions, viz. global over-capacity coupled with a reduction in demand led to a substantial reduction in global prices and softening in domestic prices added to the woes.
A meeting was held on 28th April 2015 in Mumbai first with all the banks and concerned Ministries to understand the problems for each sector. Subsequently, meetings were held with project promoters of steel, power, and road sectors at various levels to understand further the pain points of each and every sector. Some of the actions proposed/undertaken after these meetings are as follows:
- Project Monitoring Group (Cab. Sectt.)/Respective Ministries will pursue with concerned agencies to facilitate the issue of pending approval/permits expeditiously.
- Pending policy decisions to facilitate project implementation/operation would be taken up by respective Ministries/Departments.
- Ministry of Coal/PNG will evolve policies to address the long-term availability of fuel for these projects.
- Respective Discoms will be provided hand-holding towards enabling early reforms.
- Promoters will be asked to bring additional equity in an attempt to address the worsening leverage ratio of these projects. Wherever the promoters are unable to meet this requirement, the Banks would consider viable options for a substitution or taking over management control.
- The possibility of changing the extant duty regime without adversely impacting the downstream user industry would be considered by the Government. The decision to increase import duty on steel has already been taken.
- RBI has been requested to consider the proposal of the Banks for granting further flexibility in the restructuring of existing loans wherever the Banks find viability.
Strengthening Risk Control measures and NPA Disclosures
Besides the recovery efforts under the DRT & SARFASI mechanism the following additional steps have been taken to address the issue of NPAs:
- RBI has released guidelines dated 30 January 2014 for “Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalizing Distressed Assets in the Economy” suggesting various steps for quicker recognition and resolution of stressed assets;
- Creation of a Central Repository of Information on Large Credits (CRILC) by RBI to collect, store, and disseminate credit data to banks on credit exposures of Rs. 5 crore and above,
- Formation of Joint Lenders Forum (JLF), Corrective Action Plan (CAP), and sale of assets. - The Framework outlines the formation of JLF and corrective action plan that will incentivize early identification of problem cases, timely restructuring of accounts that are considered to be viable, and taking prompt steps by banks for recovery or sale of unviable accounts
- Flexible Structuring of Loan Term Project Loans to Infrastructure and Core Industries: RBI issued guidelines on July 15, 2014, and December 15, 2014 – Long term financing for infrastructure has been a major constraint in encouraging larger private sector participation in this sector. On the asset side, banks will be encouraged to extend long-term loans to the infrastructure sector with flexible structuring to absorb potential adverse contingencies, (also known as the 5/25 structure).
- Wilful Default/Non-Cooperative Borrowers: RBI has now come out with a new category of borrower called Non-Cooperative borrower. A non-cooperative borrower is a borrower who does not provide information on its finances to the banks. Banks will have to do higher provisioning if they give fresh loans to such a borrower.
- Fresh exposure to a borrower reported as non-cooperative will necessitate higher provisioning. Banks/FIs are required to make higher provisioning as applicable to substandard assets in respect of new loans sanctioned to such borrowers as also new loans sanctioned to any other company that has on its board of directors and of the whole time directors/promoters of a non-cooperative borrowing company or any firm in which such a non-cooperative borrower is in charge of the management of the affairs.
- Asset Reconstruction Companies: Taking further steps in the area, RBI has tightened the norms for Asset Reconstruction Companies (ARCs), vide guidelines dated August 5, 2014, where the minimum investment in Security Receipts should be 15% which was earlier 5%. This step will increase the cash stake of ARCs in the assets purchased by them. Further, by having more cash up front, the banks will have a better incentive to clean their balance sheet.
- Establishment of six New DRTs: Government has decided to establish six new Debt Recovery Tribunals (DRT) (at Chandigarh, Bengaluru, Ernakulum, Dehradun, Siliguri, Hyderabad) to speed up the recovery of bad loans of the banking sector
The Government has issued a circular that there will be no interference from Government and Banks are encouraged to take their decision independently keeping the commercial interest of the organization in mind. A cleaner distinction between interference and intervention has been made. With autonomy comes accountability, accordingly, Banks have been asked to build robust Grievances Redressal Mechanisms for customers as well as staff so that the concerns of the affected are addressed effectively in time bound manner.
The Government intends to provide greater flexibility in hiring manpower to Banks. The Government is committed to providing required professionals as NoDs to the Board so that well-informed and well-discussed decisions are taken.
Framework of Accountability
The present system for the measurement of a bank’s performance was a system called SoI – Statement of Intent. Based on certain criteria decided by the Ministry of Finance, the banks used to come up with their annual target figures which were discussed between the Ministry and banks and finalized. The entire exercise took a very long and sometimes the targets for banks used to be finalized only towards the end of the year which is not a desirable thing to do. There are two changes we are making to this:
- A new framework of Key Performance Indicators (KPIs) to be measured for the performance of PSBs is being announced. It is divided into four sections totaling up to 100 marks. 25 marks each are allotted to indicators relating to the efficiency of capital use and diversification of business/processes and 15 marks each is allotted for specific indicators under the category of NPA management and financial inclusion. The total mark to be allotted for quantifiable, measurable criteria is 80.
- The remaining 20 marks are reserved for measurement of qualitative criteria which includes strategic initiatives taken to improve asset quality, efforts made to conserve capital, HR initiatives, and improvement in external credit rating. The qualitative performance would be assessed based on a presentation to be made by banks to a committee chaired by the Secretary, Department of Financial Services.
New Key Performance Indicators For Public Sector Banks
- Operating performance evaluated through the KPI framework will be linked to the performance bonus to be paid to the MD & CEOs of banks by the Government. The quantum of performance bonus is also proposed to be revised shortly to make it more attractive. We are also considering ESOPs for top management of PSBs.
- DFS has issued a circular to PSBs laying down strict timelines for filing complaints of fraud cases with CBI as well as for monitoring each and every case almost on a day-to-day basis.
- Streamlining vigilance process for quick action for major frauds including connivance of staff. RBI issued guidelines in May 2015 to streamline the framework for dealing with loan fraud. Under the new guidelines, a timeframe of six months, red flagging of accounts, constitution of a Risk Management Group (RMG) in banks to monitor pre-sanction and disbursement, nodal officer for filing complaints with CBI, provisioning in four quarters and creation of Central Fraud Registry have been laid down. Department of Financial Services (DFS) has directed PSBs to make CVO the nodal officer for fraud exceeding Rs 50 crore, in consortium lending the lead bank will file the FIR for all banks and CBI has designated one officer for reviewing and monitoring the progress of bank’s fraud cases.
The process of governance reforms started with “Gyan Sangam” - a conclave of PSBs and FIs organized at the beginning of 2015 in Pune which was attended by all stakeholders including the Prime Minister, Finance Minister, MoS (Finance), Governor, RBI, and CMDs of all PSBs and FIs. There was a focus group discussion on six different topics which resulted in specific decisions on optimizing capital, digitizing processes, strengthening risk management, improving managerial performance and financial inclusion. The decision to set up a Bank Board Bureau which was subsequently announced in the Budget Speech of the Hon’ble Finance Minister came out of the recommendations of Gyan Sangam. Also, at this conclave, the Hon’ble Prime Minister made a significant promise to the bankers that there would be no interference from any Government functionary in the matter of their commercial decisions.
The birth of the Basel banking norms is attributed to the incorporation of the Basel Committee on Banking Supervision (BCBS), established by the central bank of the G-10 countries in 1974.
This came into being under the patronage of the Bank for International Settlements (BIS), Basel, Switzerland.TheCommittee formulates guidelines and provides recommendations on banking regulation based on capital risk, market risk, and operational risk.
The Committee was formed in response to the chaotic liquidation of Herstatt Bank, based in Cologne, Germany in 1974. The incident illustrated the presence of settlement risk in international finance. Historically, in 1973, the sudden failure of the Bretton Woods System resulted in the occurrence of casualties in 1974 such as the withdrawal of the banking license of Bankhaus Herstatt in Germany and shut down of Franklin National Bank in New York. In 1975, three months after the closing of Franklin National Bank and other similar disruptions, the central bank governors of the G-10 countries took the initiative to establish a committee on Banking Regulations and Supervisory Practices in order to address such issues. This committee was later renamed as Basel Committee on Banking Supervision.
The Committee acts as a forum where regular cooperation between the member countries takes place regarding banking regulations and supervisory practices.
The Committee aims at improving supervisory know-how and the quality of banking supervision quality worldwide.
Currently,there are 27 member countries in the Committee since 2009. These member countries are being represented in the Committee by the central bank and the authority for the prudential supervision of banking business. Apart from banking regulations and supervisory practices, the Committee also focuses on closing the gaps in international supervisory coverage.
The first set of Basel Accords, known as Basel I, was issued in 1988 with a primary focus on credit risk. It proposed the creation of a banking asset classification system on the basis of the inherent risk of the asset.
Basel II, the second set of Basel Accords, was published in June 2004 – in order to control misuse of the Basel I norms, most notably through regulatory arbitrage. The Basel II norms were intended to create a uniform international standard on the amount of capital that banks need to guard themselves against financial and operational risks. This again would be achieved through maintaining adequate capital proportional to the risk the bank exposes itself to (through its lending and investment practices). It also laid increased focus on disclosure requirements.
The third installment of the Basel Accords (Basel III) was introduced in response to the global financial crisis and is scheduled to be implemented by 2020.
It calls for greater strengthening of capital requirements, bank liquidity, and bank leverage. However, critics argue that these norms may further hamper the stability of the financial system by providing a higher incentive to circumvent the regulations.
The Indian banking systemhas remained largely unscathed in the global financial crisis. This is mainly amongst others, on account of the relatively robust capitalization of Indian banks. The Reserve Bank of India (RBI) had scheduled the start date for implementation of Basel III norms over a 6-year period starting April 2013. The recent requirement for infusion of additional equity in view of the low economic growth and increasing non-performing assets of Indian banks paints a gloomy picture and may cause a delay in the implementation of Basel III norms.
Capital Account Convertibility and Banks
Capital Account Convertibility (CAC)would open the Indian banks to greater competition from international players. Worldwide the accent of the banking sector is on consolidation with a view to creating global finance powerhouses, which provide a complete range of, financial services under one umbrella. But the most important requirement for this would be the size of the balance sheet and a substantial capital base to cushion the wide gamut of on and off balance sheet risks. The proposal put forth by the Narasimham Committee is in tune with this global trend.
 Refer to notes on national and international institutions for details
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