Commercial Banking - 1
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COMMERCIAL BANKING Chapter 3
Evolution & Origin of Commercial Banking The
word bank is used in the sense of a commercial bank. The word bank has a German origin though some people believe that it has come from a French word ‘Banqui’ and yet others believe that it has come from the Italian word ‘Banca’. Whatever it is, it referred to a bench for keeping , lending and exchanging of money or coins in the market place by money lenders and money changers. There was no such word as banking before 1640, although the practice of safe keeping and savings flourished in the temples of Babylon as early as 2000 BC. In India also reference of banking system could be found in the ancient Jain Temples and literary works like that of Chanakya etc.
The first bank called the ‘Bank of Venice’ was established in Venice, Italy in 1157 to finance the monarch in this wars. The bankers of Lombardy were famous in England, but modern banking began with the English Goldsmiths only after 1640. The First Bank in India was Bank of Hindustan started in 1770 by Alexender and Co. But the first bank in modern sense was established in the Bengal Presidency as the Bank of Bengal in 1806. It was merchant bankers who first evolved the system of banking by trading in commodities than in money. Their trading activities required the remittance of money from one place to another. For this they issued ‘hundis’ to remit funds. In India such merchants were known as ‘SETHS’ The next stage in the growth of banking was the ‘goldsmith’ His business was such that he had to take special precaution against theft of gold and jewelry and if he seemed to be an honest person merchants and neighbours started leaving their bullion, money and ornaments in his care. As this practice spread the goldsmiths started charging something. As an evidence for receiving valuables he issued a receipt – these acted like cheques and were used as a medium of exchange. The GSm also lending money (Coins of G& Silver) as not all of them were demanded back at the same time.
Meaning of Bank A
Bank is an institution which accepts deposits from the public and in turn advances loans by creating credit. It is different from other financial institutions in that they cannot create credit though they may be accepting deposits and making advances.
Commercial
Banks: Are those banks which perform all kinds of banking functions such as accepting deposits, advancing loans, credit creation and agency functions. They are also called joint stock banks because they are organised in the same manner as JSCs.
Role of Commercial Banks in a Developing Country Mobilizing Financing Financing Financing Financing Financing
Saving for Capital Formation Industry Trade Agriculture Consumer Activities Employment Generating
Activities. Help in monetary Policy
Functions of Commercial Banks Accepting
Two Essential Functions Borrowing & Lending
Deposits (Savings, Current and Fixed Dep.) Advancing Loans (1.Cash Credit – bank advances loans
to businessmen against certain specified securities. The amount of loan is credited to the current account of the borrower, and the borrower can withdraw money through cheques., 2.Call loans – These are very short term loans advanced to the bill brokers for not more than 15 days. They are advanced against first class bill or securities. Such loans can be recalled in very short notice. 3.Overdraft – A bank often permits a business man to draw cheques for a sum greater than the balance lying in his current account. 4. Discounting BOE – If a creditor holding a BOE wants money immediately, the bank provides him the money by discounting the BOE…)
Credit
Creation
( Credit creation is one of the most important functions of commercial banks. Like other business organisations they also aim at earning profit, for this they accepts deposits and advance loans by keeping a small cash in reserve for day to day transactions. When a bank advances a loan, it opens an account in the name of the customer and does not pay him in cash but allows him to draw the money by cheque according to his needs. Thus by granting a loan the bank creates credit of deposit.)
Financing
Foreign Trade :
of payment etc.)
Agency
Services Miscellaneous Services
( Accepting foreign bills
Commercial Banking in India
Management of Commercial Banks in India TOPICS For Discussion
Commercial banking in India an overview Opportunities and Challenges Management in Commercial banks Liquidity management in Commercial banks Management of Deposits Management of Primary & Secondary Reserves Management of Loans (Priority sector Lending and Working Capital Financing) ALM Management of NPA Management of Income in Commercial Banks Profitability and Productivity in Commercial Banks Performance Evaluation of Commercial Banks
Commercial banking in India In
over 5 decades since independence banking system in India has passed through certain distinct phases: ◦ ◦ ◦ ◦ ◦
Evolutionary Phase (prior to 1950) Foundation Phase (50s to 70s) Expansion Phase ( 70s to Mid 80s) Consolidation Phase ( Mid 80 – to 90s) Reformatory Phase ( Since Liberalisation)
Evolution Phase
Enactment of the RBI Act in 1935 gave birth to a new category of banks called Scheduled Banks in India but some of these banks were already been in existence since 1881. Prominent Scheduled banks were: Allahabad bank 1865 , Oudh Comercial bank 1881, Ajodhya Bank 1884, PNB 1894, Nedungaddi bank 1899 During 1901-1914 12 more banks were established, prominent among them were BOB 1906, Canara Bank 1906, Indian Bank in 1907, BOI in 1908, Central Bank of India 1911 During the war period not much of a development took place, there was a heavy rush on banks and the banks faced serious crisis… many succumbed to the pressure and perished. But after the wars and the independence as many as 20 scheduled banks came into existence. UBI was formed in 1950 by the merger of 4 existing commercial banks, In a span of 5-7 years the figure rose to 81 but by 1968 23 were either liquidated or amalgamated into new banks leaving 58 scheduled banks in operation.
Foundation Phase The
focus was on class banking and security rather than on purpose. The emphasis of the banking system during this period was on laying the foundation for a sound banking system in the country Consequently the phase witnessed the development of necessary legislative framework and as a result the BANKING REGULATION ACT was passed in 1949 to conduct and control operations of the commercial banks in India. During the period number of Commercial banks declined remarkably.. From 566 banks in 1951 to 281 in 1961.
The
major factor for this change was the consolidation and strengthening of the banking structure and the organisation drive started by the RBI after the enactment of BRAct 1949, with a view to improving the quality of banking services and widening the geographical and functional spread of their activity.
Expansion Phase This phase witnessed socialisation of banking in 1968. Commercial banks were viewed as agents of change and social control on banks Since inadequacy was felt in this front, 14 banks were nationalised in 1969 and another 6 in 1980. This period also witnessed the birth of RRBs in 1975 and NABARD in 1982 which had priority sector as their focus of activity. Although number of commercial banks declined from 281 in 1968 to 268 in 1984, no. of scheduled banks shot up from 71 to 264. As many as 50,000 bank branches were set up of which 3/4th were in rural and semi urban areas. In fact so rapid was the growth in these areas that the banking industry had hardly any time to consider other issues and consequently with growth came inefficiency and loss of control. As a result profitability came under strain.
Backdrop: In the early decades the banking system in India came to suffer from the following weaknesses: ◦ The banking system was localised in a few metropolitan and urban cities, neglecting the vast and potential rural areas as unbanked ◦ The banking system remained confined to industry and trade, ignoring the vital interests of the priority and neglected sectors, including agriculture and small scale industries and artisans. ◦ Enormous concentration of economic power existed in the banking sector. A few business houses were in effective control of powerful banks. Thus commercial banks contributed to the enormous growth of big business houses, leading to emergence of industrial monopolies. ◦ In view of the above weaknesses it was necessary to align bank credit flows into broader areas. ◦ Priority Sector Lending became the principle focus. ◦ The other focus was to make the banks vibrant and potent instrument of development and making them a mass institution. ◦ Thus the scheme of social control was introduced in 1968 with the main objectives of achieving a wider spread of bank credit, rectifying sectoral and regional imbalances, and directing credit flows to priority sector.
Objectives
of Nationalisation of Banks
◦ To control the commerical heights of the economy ◦ To extend banking facilities to unbanked and underbanked centres, specially in rural areas ◦ To ensure an increased flow of assistance to the neglected sectors ◦ To foster the growth of new and progressive entrepreneurs ◦ To give a professional bent to bank management with a view to removing the control of a few.
Consolidation Phase This
was a phase of realisation and consolidation of losses. The phase began in 1985 when a series of policy initiatives were taken with the objectives of consolidating the gains of branch expansion undertaken by the banks and the relaxation of the tight regulation. Although number of scheduled banks increased from 264 in 1984 to 276 in 1980 branch expansion of the banks slowed down. Hardly 7000 branches were set up during this period. For the first time serious attention was paid to improving housekeeping, customer services, credit management, staff productivity and profitability.
However,
this phase had to witness the worst days in the Agriculture and Rural debt portfolio. By this time 90% of the commercial banks were in the public sector and closely regulated in all its facets: Like prices of assets and liabilities were regulated by RBI, Prices of services were fixed uniformly by the IBA Composition of assets were also somewhat fixed in as much 63.5% of the bank funds were mopped up by the CRR & the SLR and the remaining was to be directed towards the priority sector. Salary structure was negotiated by the IBA
Thus
there was no autonomy in vital decisions, and drive towards efficiency was almost non existent.
Reformatory Phase Continued financial profligacy (decadence) of the Government coupled with close monitoring and control rendered the banking system on the verge of bankruptcy, and thus drastic reforms were inevitable. In the same period, India, for the first time faced the problem of defaulting on its international commitments and the access to external commercial credit markets was completely denied, International credit ratings had been downgraded and the International financial communities' confidence in India’s ability to manage its economy had been severely eroded. Thus the Govt. had to initiate swift action to restore international confidence. Various macro economic structural reformatory measures were undertaken in the field of Foreign trade, tax system, industrial policy and financial and other sectors…
Banking Sector in India, has gone through a metamorphosis during the last decade. While baking sector contributed to a great extent in creating a vital infrastructure for national building, generating employment opportunities and expanding business, it also, suffered a lot during the course of expansion from deficiencies with regard to their efficiency and quality of operations, controls, mechanism and profitability.
Some extraneous factors which contributed towards this inefficiencies are: ◦ Over regulations led to weakening of the management functions ◦ Directing lending led to stunting of the innovative skills of the bankers ◦ Social control came to be synonymous with political control with loan writing off completely eroding the basic character of banking business ◦ Trade unionism and muscle power lead to day to day interference in individual credit decision making and internal management and poor work culture. ◦ Customer Service was yet another area of concern ◦ Too much expansion and too fast a pace, resulted in an increase in the establishment and overhead costs and coupled with underequipped management profitability strained.
Recommendations of Narsimham Committee – 1 Report In
the light of the above mentioned shortcomings and deterioration in the financial health of the banking system, quick and comprehensive remedial measures became an immediate necessity. Accordingly the GOI constituted in August 1991 a high powered committee under the chairmanship of Shri.N.Narsimham, the then Governor or RBI to examine all aspects relating to the structure, organisation, function and problems relating to the Banking System.
Major Recommendations: Phased reduction in statutory preemptions Interest rates on CRR balances Phasing out of directed credit programme Interest rate deregulation Capital adequacy norms (should attain a CAR of 8% by 98) Income recognition Asset Classification Transparency Tax treatment of Provisions Loan recovery Tackling doubtful debts There should be no further nationalisation of banks
Restructuring
the banks Entry of Private Banks Branch Licensing Foreign Banks Supervision of Banks Control of Banking System
Action on the Recommendations: Phasing
of reduction of Reserve Requirements
◦ SLR: 25% on the basis of incremental NDTL wef. 30.9.94 ◦ CRR reduced to 14% & then to 13% in Credit pol of April, 1996. 12%.. Then 10% finally to 8% by July 99
Interest
Rate on CRR Balances : (4%)
Phasing
out of directed credit programme: Interest rate deregulation: Banks were given the freedom to
have their own reference rate (PLR) instead of floor and ceiling rates, and fix individual borrower’s int rate within a band of PLR.
Capital
Adequacy Norms:
RBI introduced it as per the rec. and as of 31st March 1997 only 2 banks (UCO and the Indian banks) were not able to achieve the norm of 8%
Asset
Classification:
wef 1.4.92 had to implement the guidelines of RBI and classified their loan assets based on record of recovery and also started recognising income based on this. Because of this many banks in the period March 93-March 97 reported huge losses.
Transparency: RBI came up with a different format of bank B/s
and P&L a/c as distinct from the one suggested by the committee, in march 1992. During 96-97 more significant additions such as: break up of capital adequacy ratio, provisions made for the year, NPA % etc were introduced. In 1998 banks were directed to disclose 7 critical ratios relating to productivity and profitability.
Capital Adequacy: Minimum capital to riskweighted-asset ratio
Tax
Treatment of Provisions:
Loan
Recovery:
The limit of admissible deductions was enhanced to 5% of the income and 10% of av. Aggregate advances of rural branches. As recommended the Govt, passed an Act in 1993 for the creation of recovery tribunals for loan accounts with outstanding balances of Rs. 10 L or more, it also established 8 such tribunals and an appellate tribunal in Mumbai which upto March 1998 covered 20 states and 4 UT.
Tackling
of DD:
No steps had yet been taken in regard to creation of an Asset Reconstruction Fund, as recommended by the committee.
Restructuring
of the Banks:
No progress in this respect was made except that on 4.9.93 a loss making bank called New Bank of India merged with PNB.
Private
Banks:
BR(A)Act 1994 was passed to permit private sector banks to enter the banking field. RBI gave licence to 9 pvt banks. By the end of 1994.
Narsimham Committee II Rep It
was again reconstituted in the year 1997 to suggest measures to strengthen the banking sector of the country. The committee submitted a report on April 1998 Main recommendations of the committee are as follows:
Major Recommendations
Merger of Strong PSBs & Recapitalisation scheme for weak banks Government should have a lesser role & greater autonomy should be allowed Functions of boards and managements need to be reviewed Moving away from excessive concentration on asset mgt. to ALM with a view to modifying their liability in consonance with their desired asset structure. Thee is a need to review minimum prescription for Capital Adequacy. In this regard the committee recommended that minimum CAR be raised to 10% by 2002. By now most of the banks have a CAR of 11% or higher. The committee also felt the need to lay down prudential and disclosure norms and sound procedures for the purpose of supervision and disclosure. There should be greater specialisation by banks in various niche areas like Retail, agriculture, SSI, Industry etc. Banks should place greater reliance on non fund based business such as advisory and consultancy services, guarantee and custody services There is a need for PSBs to speed up computerisation and focus on relationship banking. Need for professionalising and depoliticising of bank boards
Should have thrust on greater financial intermediation with large companies. Accessing securities debt domestically and from financial markets abroad. (There should be an integration of NBFCs lending activities into the financial services) A review of recruitment procedures, training and remuneration policies in PSBs should be carried out. BSRB should be abolished Should concentrate on mgt of credit risk and better mgt of NPAs.
Action on the Recommendations: In
conformity with the committees recommendations, announced a package of measures in October 1998:
Increase in the min CAR from 8 to 9% and 10% by March 02 Recognising of market risk and thereby prescribing of a risk weight of 2.5% in Govt. approved securities by March 2000 The Govt. started contemplating a reduction in its share holdings in PSBs from 51% to 33% 100% risk wt for foreign exchange Moving towards tighter asset classification, income recognition and provisioning norms. (Asset to be classified as doubtful if it remained in substandard category for more than 18 mts instead of 24 mts wef. 31st March 2001)
the
RBI
Banks have now to classify a minimum 75% of their investments in approved securities has current investments. This has been done with a view to adopt prudent accounting standards. Also banks and FIs investment I Tier II bonds issued by other banks or financial institutions will be subjected to a ceiling of 10% of the bank’s/ FIs total capital (this was done to avoid cross holdings)
Verma Committee Report:
(On ring uctu nks) r t s Re k ba a e of w
The NC-II rep. defined a weak bank as one whose accumulated losses and NPA exceeds its net worth and whose adjusted operating profits (op profits – income on recapitalisation bonds) was negative for three consecutive years. Based on this the Verma Committee on Restructuring of Weak Banks set up by the RBI in Feb, 99 identified 3 banks as weak banks. (UCO, UBI and Indian Bank)
The Committee, for this purpose identified 7 parameters covering 3 areas for classifying a bank as weak. These are: ◦ Solvency ( CAR & Coverage Ratio) ◦ Earning Capacity ( ROA and Net Int Margin) ◦ Profitability (Ratio of operating profit to average working funds, ratio of cost to income and ratio of staff cost to net interest income plus all other income)
Major problem that still haunts the industry is the growing proportion of NPA reaching astronomical figures of about 1Lakh Crore. NPA consists of assets under three categories:
◦ Sub-standard (is one which remains an NPA for ≤ 12 months) ◦ Doubtful assets (are those which remain NPA for >12 months) ◦ Loss assets (are those, which have been identified as loss by the bank or internal/external auditors or by the RBI inspection but the amount has not been written off)
Based on the recommendations of both the NC-II & the Verma Committee the following measures have been taken to address the problems of the Banking Industry:
More and more debt recovery tribunals and appellate tribunals were to be set up, and empowered them to facilitate expeditiious adjudication and recovery of banks and FIs dues. Accordingly, comprehensive amendments have been carried out in the recovery of debts due to Banks and FIs Act, 1993 by issue of an ordinance. (As many as 29DRTs & 5 ATs have been set up so far) A credit information bureau has been set up to curb the growth of fresh NPAs Changes in legislative provisions have been made to accord necessary flexibility and autonomy to the boards of banks to enable them to take decisions on corporate strategy and be responsible to the share holders, customers, employees and the public at large. In order to reduce the staff cost of PSBs Govt. has introduced the VRS scheme
Transparent guidelines have been formulated for banks investment in shares and financing of equities BSRB has been abolished and banks have accordingly been advised to frame their own recruitment strategies. The Deposit Insurance Credit and Guarantee Corporation has been converted into the Bank Deposit Insurance Corporation to make it an effective instrument for dealing with depositors risk and for dealing with distressed banks. Banks have set up separate recovery departments and their legal cells are being strengthened.
Evolution & Origin of Commercial Banking The
word bank is used in the sense of a commercial bank. The word bank has a German origin though some people believe that it has come from a French word ‘Banqui’ and yet others believe that it has come from the Italian word ‘Banca’. Whatever it is, it referred to a bench for keeping , lending and exchanging of money or coins in the market place by money lenders and money changers. There was no such word as banking before 1640, although the practice of safe keeping and savings flourished in the temples of Babylon as early as 2000 BC. In India also reference of banking system could be found in the ancient Jain Temples and literary works like that of Chanakya etc.
The first bank called the ‘Bank of Venice’ was established in Venice, Italy in 1157 to finance the monarch in this wars. The bankers of Lombardy were famous in England, but modern banking began with the English Goldsmiths only after 1640. The First Bank in India was Bank of Hindustan started in 1770 by Alexender and Co. But the first bank in modern sense was established in the Bengal Presidency as the Bank of Bengal in 1806. It was merchant bankers who first evolved the system of banking by trading in commodities than in money. Their trading activities required the remittance of money from one place to another. For this they issued ‘hundis’ to remit funds. In India such merchants were known as ‘SETHS’ The next stage in the growth of banking was the ‘goldsmith’ His business was such that he had to take special precaution against theft of gold and jewelry and if he seemed to be an honest person merchants and neighbours started leaving their bullion, money and ornaments in his care. As this practice spread the goldsmiths started charging something. As an evidence for receiving valuables he issued a receipt – these acted like cheques and were used as a medium of exchange. The GSm also lending money (Coins of G& Silver) as not all of them were demanded back at the same time.
Meaning of Bank A
Bank is an institution which accepts deposits from the public and in turn advances loans by creating credit. It is different from other financial institutions in that they cannot create credit though they may be accepting deposits and making advances.
Commercial
Banks: Are those banks which perform all kinds of banking functions such as accepting deposits, advancing loans, credit creation and agency functions. They are also called joint stock banks because they are organised in the same manner as JSCs.
Role of Commercial Banks in a Developing Country Mobilizing Financing Financing Financing Financing Financing
Saving for Capital Formation Industry Trade Agriculture Consumer Activities Employment Generating
Activities. Help in monetary Policy
Functions of Commercial Banks Accepting
Two Essential Functions Borrowing & Lending
Deposits (Savings, Current and Fixed Dep.) Advancing Loans (1.Cash Credit – bank advances loans
to businessmen against certain specified securities. The amount of loan is credited to the current account of the borrower, and the borrower can withdraw money through cheques., 2.Call loans – These are very short term loans advanced to the bill brokers for not more than 15 days. They are advanced against first class bill or securities. Such loans can be recalled in very short notice. 3.Overdraft – A bank often permits a business man to draw cheques for a sum greater than the balance lying in his current account. 4. Discounting BOE – If a creditor holding a BOE wants money immediately, the bank provides him the money by discounting the BOE…)
Credit
Creation
( Credit creation is one of the most important functions of commercial banks. Like other business organisations they also aim at earning profit, for this they accepts deposits and advance loans by keeping a small cash in reserve for day to day transactions. When a bank advances a loan, it opens an account in the name of the customer and does not pay him in cash but allows him to draw the money by cheque according to his needs. Thus by granting a loan the bank creates credit of deposit.)
Financing
Foreign Trade :
of payment etc.)
Agency
Services Miscellaneous Services
( Accepting foreign bills
Commercial Banking in India
Management of Commercial Banks in India TOPICS For Discussion
Commercial banking in India an overview Opportunities and Challenges Management in Commercial banks Liquidity management in Commercial banks Management of Deposits Management of Primary & Secondary Reserves Management of Loans (Priority sector Lending and Working Capital Financing) ALM Management of NPA Management of Income in Commercial Banks Profitability and Productivity in Commercial Banks Performance Evaluation of Commercial Banks
Commercial banking in India In
over 5 decades since independence banking system in India has passed through certain distinct phases: ◦ ◦ ◦ ◦ ◦
Evolutionary Phase (prior to 1950) Foundation Phase (50s to 70s) Expansion Phase ( 70s to Mid 80s) Consolidation Phase ( Mid 80 – to 90s) Reformatory Phase ( Since Liberalisation)
Evolution Phase
Enactment of the RBI Act in 1935 gave birth to a new category of banks called Scheduled Banks in India but some of these banks were already been in existence since 1881. Prominent Scheduled banks were: Allahabad bank 1865 , Oudh Comercial bank 1881, Ajodhya Bank 1884, PNB 1894, Nedungaddi bank 1899 During 1901-1914 12 more banks were established, prominent among them were BOB 1906, Canara Bank 1906, Indian Bank in 1907, BOI in 1908, Central Bank of India 1911 During the war period not much of a development took place, there was a heavy rush on banks and the banks faced serious crisis… many succumbed to the pressure and perished. But after the wars and the independence as many as 20 scheduled banks came into existence. UBI was formed in 1950 by the merger of 4 existing commercial banks, In a span of 5-7 years the figure rose to 81 but by 1968 23 were either liquidated or amalgamated into new banks leaving 58 scheduled banks in operation.
Foundation Phase The
focus was on class banking and security rather than on purpose. The emphasis of the banking system during this period was on laying the foundation for a sound banking system in the country Consequently the phase witnessed the development of necessary legislative framework and as a result the BANKING REGULATION ACT was passed in 1949 to conduct and control operations of the commercial banks in India. During the period number of Commercial banks declined remarkably.. From 566 banks in 1951 to 281 in 1961.
The
major factor for this change was the consolidation and strengthening of the banking structure and the organisation drive started by the RBI after the enactment of BRAct 1949, with a view to improving the quality of banking services and widening the geographical and functional spread of their activity.
Expansion Phase This phase witnessed socialisation of banking in 1968. Commercial banks were viewed as agents of change and social control on banks Since inadequacy was felt in this front, 14 banks were nationalised in 1969 and another 6 in 1980. This period also witnessed the birth of RRBs in 1975 and NABARD in 1982 which had priority sector as their focus of activity. Although number of commercial banks declined from 281 in 1968 to 268 in 1984, no. of scheduled banks shot up from 71 to 264. As many as 50,000 bank branches were set up of which 3/4th were in rural and semi urban areas. In fact so rapid was the growth in these areas that the banking industry had hardly any time to consider other issues and consequently with growth came inefficiency and loss of control. As a result profitability came under strain.
Backdrop: In the early decades the banking system in India came to suffer from the following weaknesses: ◦ The banking system was localised in a few metropolitan and urban cities, neglecting the vast and potential rural areas as unbanked ◦ The banking system remained confined to industry and trade, ignoring the vital interests of the priority and neglected sectors, including agriculture and small scale industries and artisans. ◦ Enormous concentration of economic power existed in the banking sector. A few business houses were in effective control of powerful banks. Thus commercial banks contributed to the enormous growth of big business houses, leading to emergence of industrial monopolies. ◦ In view of the above weaknesses it was necessary to align bank credit flows into broader areas. ◦ Priority Sector Lending became the principle focus. ◦ The other focus was to make the banks vibrant and potent instrument of development and making them a mass institution. ◦ Thus the scheme of social control was introduced in 1968 with the main objectives of achieving a wider spread of bank credit, rectifying sectoral and regional imbalances, and directing credit flows to priority sector.
Objectives
of Nationalisation of Banks
◦ To control the commerical heights of the economy ◦ To extend banking facilities to unbanked and underbanked centres, specially in rural areas ◦ To ensure an increased flow of assistance to the neglected sectors ◦ To foster the growth of new and progressive entrepreneurs ◦ To give a professional bent to bank management with a view to removing the control of a few.
Consolidation Phase This
was a phase of realisation and consolidation of losses. The phase began in 1985 when a series of policy initiatives were taken with the objectives of consolidating the gains of branch expansion undertaken by the banks and the relaxation of the tight regulation. Although number of scheduled banks increased from 264 in 1984 to 276 in 1980 branch expansion of the banks slowed down. Hardly 7000 branches were set up during this period. For the first time serious attention was paid to improving housekeeping, customer services, credit management, staff productivity and profitability.
However,
this phase had to witness the worst days in the Agriculture and Rural debt portfolio. By this time 90% of the commercial banks were in the public sector and closely regulated in all its facets: Like prices of assets and liabilities were regulated by RBI, Prices of services were fixed uniformly by the IBA Composition of assets were also somewhat fixed in as much 63.5% of the bank funds were mopped up by the CRR & the SLR and the remaining was to be directed towards the priority sector. Salary structure was negotiated by the IBA
Thus
there was no autonomy in vital decisions, and drive towards efficiency was almost non existent.
Reformatory Phase Continued financial profligacy (decadence) of the Government coupled with close monitoring and control rendered the banking system on the verge of bankruptcy, and thus drastic reforms were inevitable. In the same period, India, for the first time faced the problem of defaulting on its international commitments and the access to external commercial credit markets was completely denied, International credit ratings had been downgraded and the International financial communities' confidence in India’s ability to manage its economy had been severely eroded. Thus the Govt. had to initiate swift action to restore international confidence. Various macro economic structural reformatory measures were undertaken in the field of Foreign trade, tax system, industrial policy and financial and other sectors…
Banking Sector in India, has gone through a metamorphosis during the last decade. While baking sector contributed to a great extent in creating a vital infrastructure for national building, generating employment opportunities and expanding business, it also, suffered a lot during the course of expansion from deficiencies with regard to their efficiency and quality of operations, controls, mechanism and profitability.
Some extraneous factors which contributed towards this inefficiencies are: ◦ Over regulations led to weakening of the management functions ◦ Directing lending led to stunting of the innovative skills of the bankers ◦ Social control came to be synonymous with political control with loan writing off completely eroding the basic character of banking business ◦ Trade unionism and muscle power lead to day to day interference in individual credit decision making and internal management and poor work culture. ◦ Customer Service was yet another area of concern ◦ Too much expansion and too fast a pace, resulted in an increase in the establishment and overhead costs and coupled with underequipped management profitability strained.
Recommendations of Narsimham Committee – 1 Report In
the light of the above mentioned shortcomings and deterioration in the financial health of the banking system, quick and comprehensive remedial measures became an immediate necessity. Accordingly the GOI constituted in August 1991 a high powered committee under the chairmanship of Shri.N.Narsimham, the then Governor or RBI to examine all aspects relating to the structure, organisation, function and problems relating to the Banking System.
Major Recommendations: Phased reduction in statutory preemptions Interest rates on CRR balances Phasing out of directed credit programme Interest rate deregulation Capital adequacy norms (should attain a CAR of 8% by 98) Income recognition Asset Classification Transparency Tax treatment of Provisions Loan recovery Tackling doubtful debts There should be no further nationalisation of banks
Restructuring
the banks Entry of Private Banks Branch Licensing Foreign Banks Supervision of Banks Control of Banking System
Action on the Recommendations: Phasing
of reduction of Reserve Requirements
◦ SLR: 25% on the basis of incremental NDTL wef. 30.9.94 ◦ CRR reduced to 14% & then to 13% in Credit pol of April, 1996. 12%.. Then 10% finally to 8% by July 99
Interest
Rate on CRR Balances : (4%)
Phasing
out of directed credit programme: Interest rate deregulation: Banks were given the freedom to
have their own reference rate (PLR) instead of floor and ceiling rates, and fix individual borrower’s int rate within a band of PLR.
Capital
Adequacy Norms:
RBI introduced it as per the rec. and as of 31st March 1997 only 2 banks (UCO and the Indian banks) were not able to achieve the norm of 8%
Asset
Classification:
wef 1.4.92 had to implement the guidelines of RBI and classified their loan assets based on record of recovery and also started recognising income based on this. Because of this many banks in the period March 93-March 97 reported huge losses.
Transparency: RBI came up with a different format of bank B/s
and P&L a/c as distinct from the one suggested by the committee, in march 1992. During 96-97 more significant additions such as: break up of capital adequacy ratio, provisions made for the year, NPA % etc were introduced. In 1998 banks were directed to disclose 7 critical ratios relating to productivity and profitability.
Capital Adequacy: Minimum capital to riskweighted-asset ratio
Tax
Treatment of Provisions:
Loan
Recovery:
The limit of admissible deductions was enhanced to 5% of the income and 10% of av. Aggregate advances of rural branches. As recommended the Govt, passed an Act in 1993 for the creation of recovery tribunals for loan accounts with outstanding balances of Rs. 10 L or more, it also established 8 such tribunals and an appellate tribunal in Mumbai which upto March 1998 covered 20 states and 4 UT.
Tackling
of DD:
No steps had yet been taken in regard to creation of an Asset Reconstruction Fund, as recommended by the committee.
Restructuring
of the Banks:
No progress in this respect was made except that on 4.9.93 a loss making bank called New Bank of India merged with PNB.
Private
Banks:
BR(A)Act 1994 was passed to permit private sector banks to enter the banking field. RBI gave licence to 9 pvt banks. By the end of 1994.
Narsimham Committee II Rep It
was again reconstituted in the year 1997 to suggest measures to strengthen the banking sector of the country. The committee submitted a report on April 1998 Main recommendations of the committee are as follows:
Major Recommendations
Merger of Strong PSBs & Recapitalisation scheme for weak banks Government should have a lesser role & greater autonomy should be allowed Functions of boards and managements need to be reviewed Moving away from excessive concentration on asset mgt. to ALM with a view to modifying their liability in consonance with their desired asset structure. Thee is a need to review minimum prescription for Capital Adequacy. In this regard the committee recommended that minimum CAR be raised to 10% by 2002. By now most of the banks have a CAR of 11% or higher. The committee also felt the need to lay down prudential and disclosure norms and sound procedures for the purpose of supervision and disclosure. There should be greater specialisation by banks in various niche areas like Retail, agriculture, SSI, Industry etc. Banks should place greater reliance on non fund based business such as advisory and consultancy services, guarantee and custody services There is a need for PSBs to speed up computerisation and focus on relationship banking. Need for professionalising and depoliticising of bank boards
Should have thrust on greater financial intermediation with large companies. Accessing securities debt domestically and from financial markets abroad. (There should be an integration of NBFCs lending activities into the financial services) A review of recruitment procedures, training and remuneration policies in PSBs should be carried out. BSRB should be abolished Should concentrate on mgt of credit risk and better mgt of NPAs.
Action on the Recommendations: In
conformity with the committees recommendations, announced a package of measures in October 1998:
Increase in the min CAR from 8 to 9% and 10% by March 02 Recognising of market risk and thereby prescribing of a risk weight of 2.5% in Govt. approved securities by March 2000 The Govt. started contemplating a reduction in its share holdings in PSBs from 51% to 33% 100% risk wt for foreign exchange Moving towards tighter asset classification, income recognition and provisioning norms. (Asset to be classified as doubtful if it remained in substandard category for more than 18 mts instead of 24 mts wef. 31st March 2001)
the
RBI
Banks have now to classify a minimum 75% of their investments in approved securities has current investments. This has been done with a view to adopt prudent accounting standards. Also banks and FIs investment I Tier II bonds issued by other banks or financial institutions will be subjected to a ceiling of 10% of the bank’s/ FIs total capital (this was done to avoid cross holdings)
Verma Committee Report:
(On ring uctu nks) r t s Re k ba a e of w
The NC-II rep. defined a weak bank as one whose accumulated losses and NPA exceeds its net worth and whose adjusted operating profits (op profits – income on recapitalisation bonds) was negative for three consecutive years. Based on this the Verma Committee on Restructuring of Weak Banks set up by the RBI in Feb, 99 identified 3 banks as weak banks. (UCO, UBI and Indian Bank)
The Committee, for this purpose identified 7 parameters covering 3 areas for classifying a bank as weak. These are: ◦ Solvency ( CAR & Coverage Ratio) ◦ Earning Capacity ( ROA and Net Int Margin) ◦ Profitability (Ratio of operating profit to average working funds, ratio of cost to income and ratio of staff cost to net interest income plus all other income)
Major problem that still haunts the industry is the growing proportion of NPA reaching astronomical figures of about 1Lakh Crore. NPA consists of assets under three categories:
◦ Sub-standard (is one which remains an NPA for ≤ 12 months) ◦ Doubtful assets (are those which remain NPA for >12 months) ◦ Loss assets (are those, which have been identified as loss by the bank or internal/external auditors or by the RBI inspection but the amount has not been written off)
Based on the recommendations of both the NC-II & the Verma Committee the following measures have been taken to address the problems of the Banking Industry:
More and more debt recovery tribunals and appellate tribunals were to be set up, and empowered them to facilitate expeditiious adjudication and recovery of banks and FIs dues. Accordingly, comprehensive amendments have been carried out in the recovery of debts due to Banks and FIs Act, 1993 by issue of an ordinance. (As many as 29DRTs & 5 ATs have been set up so far) A credit information bureau has been set up to curb the growth of fresh NPAs Changes in legislative provisions have been made to accord necessary flexibility and autonomy to the boards of banks to enable them to take decisions on corporate strategy and be responsible to the share holders, customers, employees and the public at large. In order to reduce the staff cost of PSBs Govt. has introduced the VRS scheme
Transparent guidelines have been formulated for banks investment in shares and financing of equities BSRB has been abolished and banks have accordingly been advised to frame their own recruitment strategies. The Deposit Insurance Credit and Guarantee Corporation has been converted into the Bank Deposit Insurance Corporation to make it an effective instrument for dealing with depositors risk and for dealing with distressed banks. Banks have set up separate recovery departments and their legal cells are being strengthened.
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