Pgdba - Fin - Sem Iii - Fi & B

FINANCIAL INSTITUTIONS AND BANKING (SEMESTER – III) QUES NO. 1 DESCRIBE THE FUNCTIONS PERFORMED BY THE FINANCIAL SYSTEM. The financial system plays a critical role in the development processes of a country. The significance of the financial system for an economy arises from at least three major sources. Firstly, it performs various transformation functions relating to intermediation of funds in the economy. Secondly, it provides the mirror image of the underlying real economy and the basic macro-economic balances. Thirdly, it is one industry whose basis of operation is underpinned in public trust. The strength of this bond between the banking system and people in general depends on how the financial viability of banking system is perceived. The organization and conduct of financial markets should be such that they reflect the underlying fundamentals of the economy. The financial system as a whole must remain sound and stable in order to enjoy a high level of public confidence. Until recently, the improvement in various transformation functions of the financial system was the focal point of reform initiatives in many developing countries. The basic issue was how to create a competitive environment for the financial system and to put in place a policy regime which would lead to improved allocative efficiency of the financial sector and enhancement of saving and investment activities of the economy for attaining faster rates of economic growth. As financial markets developed and matured, the two-way interaction between the financial and non-financial policies grew in importance. In the recent years, the increased market exposure of the financial system and its vulnerability to macro-economic shocks have highlighted the need for greater internal controls and the need for strengthening prudential norms and regulations. In an environment of rising importance of cross border capital flows, perceptions and expectations play major roles in shaping events and this consideration can be particularly heightened if the financial system is perceived to be weak and unsound. It is not surprising that financial reform initiatives globally have now moved to the strategic considerations of ensuring continued stability of the financial system. In India, since the formal announcement of the first initiative of financial sector reform in the Union budget of 1991-92 to the Second Report of the Narasimham Committee in 1998, a considerable ground has been covered in putting in place a financial system which can meet the requirements of a more competitive and open economy. By and large, financial reforms in India have proceeded in four major directions.

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First, setting the policy conditions right and removing the operational constraints of the financial system. What the reform process has tried to achieve is to lower the share of pre-empted resources in the total resources of the banking system through gradual liberalisation of the cash reserve ratio and the statutory liquidity ratio. The second directional change has been in the area of creating a more competitive environment in financial sector through reform measures such as relaxation of entry and exit norms, reduction in public ownership in banking industry and letting banks access capital market for meeting their fund requirement. The objective is to bring out the best result in terms of pricing and quality of banking services over a period of time. The third important direction of reform has been the strengthening of market institutions and allowing greater freedom to financial intermediaries. These reforms have taken the form of gradual liberalisation of interest rates, development of money, capital and debt markets and giving operational flexibility to banks in the management of their assets and liabilities subject, of course, to prudential guidelines. In simple terms, these changes imply greater degree of exposure of individual financial institutions to the domestic and international economic environment. The fourth important element of reform concerns the "safety" aspects of the financial system. This is the core of the challenges facing the financial system at present. When the reform process was started in 1992, there was a massive problem of cleaning the balance sheets of banks which had deteriorated over the years. Successive reform initiatives in this area have been aimed at prescribing certain prudential standards for the financial system and addressing certain structural weaknesses which could minimise their recurrence in future. Measures such as income recognition norms, asset classification, meeting minimum capital adequacy standards through recapitalisation and devising a supervisory framework are steps in the direction of ensuring the safety of the financial system.

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QUES NO. 2: WHAT ARE THE FUNCTIONS OF THE RBI AND BRIEFLY COMMENT ON THE CHANGES ADOPTED BY THE RBI WHILE ANNOUNCING THE MONETARY AND CREDIT POLICY SINCE LIBERLIZATION? India's Central Bank - the RBI - was established on 1 April 1935 and was nationalized on 1 January 1949 to provide the nation with a safer, flexible, and stable monetary and financial system. The Preamble prescribes the objective as: "to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage." The Reserve Bank of India is responsible for the following: •

Conducting the nation's monetary policy.

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Supervising and regulating banking institutions and protecting the credit rights of consumers,

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Maintaining the stability of the financial system and

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Providing certain financial services to the government, the public, financial institutions, and foreign official institutions.

In performing the above responsibilities the RBI undertakes the following functions: 1. Banker of Banks: The foremost function of the central bank to act as a banker of banks. This is the prerogative of the central bank in each country to function as a banker of the banks and the RBI in India provides the above service to the financial institutions. By serving as a "banker's bank" the RBI helps assure the safety and efficiency of the payments system, the critical pipeline through which all financial transactions in the economy flow. 2. The government's bank Another important RBI responsibility is servicing the nation's largest banking customer—the Indian government. As the government's bank or fiscal agent, the RBI processes a variety of financial transactions.

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3. Monetary Authority: •

Formulates, implements and monitors the monetary policy.

•

Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors.

The most flexible, and therefore most important, of the monetary policy tools is open market operations—the purchase and sale of government securities by the RBI. When the RBI wants to increase the flow of money and credit, it buys government securities; when it wants to restrict the flow of money and credit, it sells government securities.

4. Regulator and supervisor of the financial system: •

Prescribes broad parameters of banking operations within which the countrys banking and financial system functions.

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Objective: maintain public confidence in the system, protect depositors interest and provide cost-effective banking services to the public.

5. Manager of Exchange Control: •

Manages the Foreign Exchange Management Act, 1999.

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Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.

6. Issuer of currency: •

Issues and exchanges or destroys currency and coins not fit for circulation.

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Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality.

7. Developmental role •

Performs a wide range of promotional functions to support national objectives.

CHANGES ADOPTED BY RBI WHILE ANNOUNCING THE MONETARY AND CREDIT POLICY SINCE LIBERLIZATION: In reality, while there are growing tendencies towards globalization, the conduct of monetary policy depends on a number of factors that are unique to a country and the context. Given policy goals, the

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contours of the monetary policy are shaped by the macroeconomic structure of the economy and its institutional setting. Other important factors that have a decisive role are the degree of openness of the economy, the stage of development of financial markets, payment and settlement systems and the technological infrastructure. Against this backdrop, the specific features of the monetary policy in India can be explained as below: First, although there is no explicit mandate for price stability, the conduct of monetary policy has evolved around the objectives of maintaining price stability and ensuring adequate flow of credit to the productive sectors of the economy for sustaining overall economic growth. The relative emphasis between price stability and growth depends on underlying macroeconomic conditions. In essence, monetary policy in India strives for a judicious balance between price stability and growth. The democratic processes in India work in favour of price stability which, in some ways, amounts to an informal mandate to the central bank for maintaining an acceptable level of inflation. Second, the monetary policy framework in India is guided by a ‘multiple indicator’ approach wherein besides monetary aggregates, information pertaining to a range of rates of return in different financial market segments along with the movements in currency, credit, the fiscal position, merchandise trade, capital flows, the inflation rate, the exchange rate, refinancing and transactions in foreign exchange – which are available on a high frequency basis – is juxtaposed with data on output and the real sector activity for drawing policy perspectives. The transition to a multiple indicator approach has been a logical outcome of monetary policy reforms. It has provided necessary flexibility to the RBI to respond more effectively to the changes in domestic and international economic and financial market conditions. In a medium-to long-term perspective, the impact of money supply on inflation, however, cannot be ignored and for the purposes of policy, the Reserve Bank still continues to announce projections of money supply compatible with the outlook on GDP growth and expected inflation. Third, liquidity management is carried out through open market operations (OMO) in the form of outright purchases/sales of government securities and reverse repo/repo operations, supplemented by the newly introduced Market Stabilization Scheme (MSS). The Liquidity Adjustment Facility (LAF), introduced in June 2000, enables the Reserve Bank to modulate short-term liquidity, of a temporary nature, under varied financial market conditions in order to ensure stable conditions in the overnight (call) money market. The LAF operates through reverse repo and repo auctions, thereby setting a corridor for the short-term interest rate consistent with the policy objectives. The LAF operations, combined with strategic OMO consistent with market liquidity conditions, have evolved as the principal operating procedure of the monetary policy of the Reserve Bank.

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Fourth, notwithstanding concerted reforms undertaken since the 1990s, e.g. freeing monetary policy from the burden of automatic monetisation and a significant marketisation of the government’s borrowing programme, monetary policy in India continues to be constrained by the fiscal dominance. Debt management considerations of ensuring a smooth passage of the borrowing programme of the government, at minimum costs and roll over risks, make the overall monetary management difficult when large and growing borrowing year after year puts pressure on the absorptive capacity of the market and on liquidity management. In this context, the Fiscal Responsibility and Budget Management Act of 2003 which envisages a vacation of primary financing of the fiscal deficit by the Reserve Bank from 2006-07 would enhance the flexibility for monetary management. Fifth, the predominance of publicly-owned financial intermediaries has its implications for monetary policy. Cross holdings and inter-relationships in the financial sector emphasized in planned development were to achieve the social goals of the "joint family" headed by the Government. These are being gradually revamped consistent with the needs of a market economy. Sixth, a factor that further complicates the transmission mechanism of monetary policy is the limited size of the Indian financial system. Although India is essentially a bank-based economy, commercial credit penetration in the Indian economy is still relatively low. Concerns about credit to agriculture and small- and medium- enterprises usually relate to inadequacy, constraints on timely availability, high cost, neglect of small and marginal farmers, low credit-deposit ratios in several States and continued presence of informal credit markets with high interest rates. It is in this context that the monetary policy in India continues to take cognizance of the need for ensuring financial inclusion of all segments of population, interests of depositors and for promoting a conducive credit culture. Seventh, the Indian financial system still shows some signs of stickiness in interest rates. Consequently, apart from the efforts to ensure reduction in existing high levels of revenue and fiscal deficits, rationalizing administered interest rates on contractual savings to impart efficiency and operational flexibility to the financial sector is amongst the priorities in policy. Eighth, monetary management in India is somewhat constrained by the lack of comprehensive and timely information in some areas relative to the demands of a fast growing and increasingly globalizing economy. One lacuna is the absence of credible data on the labour market. Employment data essentially pertain to the organized sector which constitutes less than 10 per cent of the total labour force. There is also considerable ambiguity about the very definition of ‘employment’ given the prevalence of under-employment and disguised unemployment. In the absence of data on the

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natural rate of unemployment, it is difficult to assess with reasonable level of confidence the underlying conditions. Similarly, an assessment of the inflationary conditions in the economy is constrained by the lack of a comprehensive measure of consumer price inflation. The multiple consumer price indices, on the basis of occupational classification and residence (rural/urban), compound the problem, especially when differences in weighting diagrams of the commodity baskets lead to differences in inflation numbers. Ninth, the financial system in India, however, has a relatively low vulnerability to asset bubbles. There is limited exposure of bank lending to the sensitive sectors, including real estate. While the demand for housing is strong, overall exposure is moderated by assigning higher risk weights to housing loans than required under the Basel norm. The share of housing loans in the overall loan portfolio stood at about 10 per cent in March 2004 and net non-performing assets were 1.4 per cent of the net outstanding loans as compared with 2.8 per cent of the aggregate portfolio. An Assessment An assessment of expectations vis-à-vis outcomes suggests that monetary policy in India has performed reasonably well in terms of its objectives. First, compared to many developing countries, India has been able to maintain a moderate level of inflation. Historically, inflation rates in India have rarely touched double digits and when they did, it was the result of supply shocks from agricultural commodity prices or international oil prices. Second, monetary policy has been reasonably successful in dampening the volatility of output and imparting to the economy a growing resilience. The trend rate of GDP growth has risen steadily to around 6.0 per cent for about 25 years, and India has emerged as one of the fastest growing economies in the world. Third, monetary policy has been successful in ensuring financial stability in India through a decade and a half when frequent visits of financial crises led to debilitating losses in growth and welfare in large parts of the developing world. This period was also marked by pressures from within such as geo-political tensions, drought and international sanctions. While we might have enjoyed an element of luck, we believe that we also benefited from exercise of sound judgment and enhancement of skills at all levels. It is useful to note that the Reserve Bank has been engaged in the development of sound and efficient financial intermediaries and markets so as to provide solid foundations for effective transmission of monetary policy.

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Fourth, success has been achieved in turning around and strengthening the external sector. Restrictions on imports have been virtually abolished and current account convertibility has been instituted since 1994. The capital account is virtually open for non-residents. An exchange rate policy of focusing on managing volatility with no fixed rate target, while allowing the underlying demand and supply conditions to determine the exchange rate movements over a period in an orderly way, has stood the test of time. India’s external sector management has been endorsed by the growing international investor confidence in the face of sub-investment grade sovereign ratings. Today, India holds the sixth largest stock of reserves in the world, sufficient to cover its entire external debt. Since 2002, India has turned creditor to the IMF and is engaged in pre-paying bilateral and multilateral debt. The conduct of monetary policy is getting increasingly sophisticated and forward looking, warranting a continuous upgradation of monitoring scan and technical skills. Flexibility and timeliness in policy response coupled with transparency and accountability hold the key to further enhance credibility. Above all, the monetary authority has to address dilemmas, which exert conflicting pulls at every stage, and blend the desirable with the feasible. We have to recognize that judgments are involved at different stages which call for both knowledge and humility.

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QUES NO. 3: IDENTIFY THE PROBLEMS FACED BY DEVELOPMENT FINANCE INSTITUTIONS AND SUGGEST REMEDIES TO OVERCOME THEM: The Development financial institutions (DFIs) are in the process of great change in the context of the ongoing financial sector reforms and the emerging competitive financial system. DFIs were set up when the capital markets were relatively underdeveloped and were incapable of meeting the longterm financing needs of the economy adequately. With the widening and deepening of markets for long-term funds, the justification for further prolonging the role of subsidized credit from DFIs has weakened; more so because prolonged concessional finance by the Government has been deemed to be neither sustainable nor desirable. This is consistent with the process of financial sector reforms, with its focus on allocative efficiency and stability. With the withdrawal of concessional sources of finance of DFIs and blurring of distinction between DFIs and banks, DFIs not only have to raise resources at market-related rates but also have to face a competitive environment on both asset and liability sides. Moreover, structural changes in the financial system coupled with the industrial slowdown in recent years have adversely impacted the volume of business and profitability of DFIs. In view of this changed environment, DFIs are in the process of adjusting and diversifying their business in terms of clients, activities and products. The DFI sector in India comprises diverse entities like term-lending institutions, investment institutions, specialised DFIs and refinance institutions. Of these, nine DFIs, viz., Industrial Development Bank of India (IDBI), IFCI Ltd., Industrial Investment Bank of India Ltd. (IIBI), Small Industries Development Bank of India (SIDBI), Export Import Bank of India (Exim Bank), Tourism Finance Corporation of India Ltd. (TFCI), Infrastructure Development Finance Company Ltd. (IDFC), National Bank for Agriculture and Rural Development (NABARD) and National Housing Bank (NHB), fall within the regulatory and supervisory domain of the Reserve Bank.. In contrast to the rising trend in financial assistance sanctioned and disbursed by the DFIs during 1996-2000, the sharp decline recorded thereafter. Lack of demand for new projects, virtual exhaustion of unutilized capacities for meeting the increased demand for industrial products, competition from low rates provided by the commercial banks and delays in implementation of projects, have all contributed to the substantial decline in the financial assistance sanctioned and disbursed by select allIndia DFIs. Part of the decline, however, was also due to the merger of ICICI with ICICI Bank on March 30, 2002. Furthermore, the recent spurt in the growth of services sector may not have generated commensurate demand for project finance as a number of service industries are human

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capital-intensive with somewhat limited requirement of long-term finance. The deterioration in the financial performance of the DFIs as a group can be attributed to declines in spread and non-interest income and rise in other expenses, with IFCI and IIBI accumulating high nonperforming assets (NPAs) and related provisioning leading to their declining profitability and erosion of capital. If these two institutions are excluded, all DFIs, however, are seen to have registered positive operating and net profit, as was the case in the previous year. The increase in NPAs in a number of DFIs can be ascribed to the slow economic recovery and sectoral bottlenecks. It's a known fact that the banks and financial institutions in India face the problem of swelling non-performing assets (NPAs) and the issue is becoming more and more unmanageable. In order to bring the situation under control, some steps have been taken recently. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 was passed by Parliament, which is an important step towards elimination or reduction of NPAs. The problem gets further aggravated due to high fiscal deficit, poor infrastructure facilities, sticky legal system, cutting of exposures to emerging markets by FIIs, etc. Under such a situation, it goes without saying that banks are no exception and are bound to face the heat of a global downturn. One would be surprised to know that the banks and financial institutions in India hold non-performing assets worth Rs. 1,10,000 crores. Bankers have realized that unless the level of NPAs is reduced drastically, they will find it difficult to survive Policy Initiatives for Financial Institutions The focus of Reserve Bank's policy initiatives for select all-India FIs has, in recent years, been on the twin objectives of enhancing their stability and efficiency. Thus, the emphasis was on strengthening the prudential regulatory and supervisory framework of the DFIs, improving their accounting and auditing standards, enhancing transparency and developing their technological infrastructure, while simultaneously introducing flexibility in their operations. Prudential Norms Capital Adequacy: DFIs have been permitted to extend guarantees in respect of infrastructure projects in favour of other lending institutions, provided that the bank issuing the guarantee takes a funded share in the infrastructure project at least to the extent of 5 per cent of the project cost and undertakes normal credit appraisal, monitoring and follow-up of the project.

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Asset Classification in respect of Projects Under Implementation In order to ensure that the loan assets relating to projects under implementation are properly valued, they have been classified, on the basis of their project cost and their date of financial closure. Compromise Settlement of Chronic NPAs The DFIs were advised to implement the revised guidelines for compromise settlement of chronic NPAs that had earlier been issued to public sector banks. These guidelines will provide a simplified, non-discretionary and non-discriminatory mechanism for achieving the maximum realisation of dues from the stock of NPAs within a stipulated time. Investments In view of certain suggestions and queries by some of the DFIs, the Reserve Bank issued further clarifications / modifications in July 2002 on a number of issues relating to investments. Exposure Norms Exposure Norms have been issued. This is expected to correctly reflect the degree of credit concentration. Supervision and Audit Consolidated Accounting and Consolidated Supervision The consolidated supervision of financial intermediaries has acquired special significance in the Indian context due to the emergence of complex group structures. The primary objective of consolidated supervision is to evaluate the strength of an entire group taking into account all the risks (including those arising from the operations of related entities) that may affect the supervised entity in the group. This is regardless of whether these risks are carried in the books of the supervised entity or the entities related to it. Failures of large and established international banks in the past on account of the operations of their subsidiaries illustrate the magnitude of such risks.

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Rotation of Auditors Instances of auditors being appointed by certain FIs for a long period were examined by the Reserve Bank, and FIs were advised to ensure rotation of the partner of the audit firm conducting audit, if the firm continues for more than four years. Modification of Audit Review and Reporting System The submission of the monthly concurrent audit report by the FIs to Reserve Bank has been replaced with half-yearly reviews of the investment portfolio of FIs. Such reviews need to include the major irregularities, if any, observed in the concurrent audit report of the treasury transactions during the half-yearly reporting period. Supervisory Rating System for the FIs A supervisory rating model for the FIs has been developed based on capital adequacy, asset quality, management, earnings, liquidity and systems (CAMELS). The basic purpose of assigning the supervisory rating is to provide a summary measure of the performance and health of the FI concerned for requisite supervisory intervention. On-site inspection The Reserve Bank has been undertaking on-site inspection of nine FIs. Off-site Surveillance System The FIs presently submit the off-site returns, viz., Financial Institutions Division -Off-Site Monitoring and Surveillance System (FID-OSMOS) to the Reserve Bank. The review of the performance of the FIs based on the off-site returns submitted by them is being presented to the Board for Financial Supervision (BFS) on a quarterly basis. Other Policy Developments Connected Lending

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Matters relating to "connected lending" by FIs have been engaging the attention of the Reserve Bank and in consultation with the Government of India, detailed guidelines were issued to FIs. Transactions in Dematerialised form The Reserve Bank has over a period of time, been encouraging the holding of government securities in dematerialized mode. Restructuring of Financial Institutions Around the world, the FIs, mostly established and supported by the Government, have diversified / restructured due to changes in their operating environment in recent years, in many countries. The financial liabilities of two major FIs, viz., IDBI and IFCI Ltd., were restructured with the intervention of the Government of India to bring down the cost of funds of these FIs. The CEO of ICICI made clear what this means in terms of emphasis: “When we were set up, our role was to meet long term resource requirements of the industry. With liberalisation the role has slightly changed. It became developing India’s debt market, financing India’s infrastructure development, etc. With globalisation, I think, the role is set to change further. Now we have to stress on profitability, shareholder value, corporate governance, while at the same time not losing sight of our goals – the goals that were originally set for us – and the goals that were set up in the interim with liberalisation.” Unfortunately, the emphasis on those goals would remain only with regulation. But regulation is diluted by liberalisation.

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QUES NO. 4: WHAT ARE THE DIFFERENT KINDS OF BANKS AND WHAT IS THE DIFFERENCE IN THEIR OPERATIONAL METHODOLOGY, PURPOSE ETC? There are various types of banks which operate in our country to meet the financial requirements of different categories of people engaged in agriculture, business, profession, etc. On the basis of functions, the banking institutions in India may be divided into the following types: Types of Banks

Central Bank (RBI in India)

Public Sector Banks Private Sector Banks Foreign Banks

Commercial Banks

Specialized Banks (NABARD, IDBI, Exim)

Development Banks

Co-operative Banks

Primary Credit Societies Central Co-operative Banks State Co-operative Banks

A) CENTRAL BANK A bank which is entrusted with the functions of guiding and regulating the banking system of a country is known as its Central bank. Such a bank does not deal with the general public. It acts essentially as Government’s banker, maintain deposit accounts of all other banks and advances money to other banks, when needed. The Central Bank provides guidance to other banks whenever they face any problem. It is therefore known as the banker’s bank. The Reserve Bank of India is the central bank of our country. The Central Bank maintains record of Government revenue and expenditure under various heads. It also advises the Government on monetary and credit policies and decides on the interest rates for bank deposits and bank loans. In addition, foreign exchange rates are also determined by the central bank. Another important function of the Central Bank is the issuance of currency notes, regulating their circulation in the country by different methods. No other bank than the Central Bank can issue currency.

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B) COMMERCIAL BANKS Commercial Banks are banking institutions that accept deposits and grant short-term loans and advances to their customers. In addition to giving short-term loans, commercial banks also give medium-term and long-term loan to business enterprises. Now-a-days some of the commercial banks are also providing housing loan on a long-term basis to individuals. There are also many other functions of commercial banks, which are discussed later in this lesson. Types of Commercial banks: Commercial banks are of three types i.e., Public sector banks, Private sector banks and Foreign banks. (i) Public Sector Banks: These are banks where majority stake is held by the Government of India or Reserve Bank of India. Examples of public sector banks are: State Bank of India, Corporation Bank, Bank of Boroda and Dena Bank, etc. (ii) Private Sectors Banks: In case of private sector banks majority of share capital of the bank is held by private individuals. These banks are registered as companies with limited liability. For example: The Jammu and Kashmir Bank Ltd., Bank of Rajasthan Ltd., Development Credit Bank Ltd, Lord Krishna Bank Ltd., Bharat Overseas Bank Ltd., Global Trust Bank, Vysya Bank, etc. (iii) Foreign Banks: These banks are registered and have their headquarters in a foreign country but operate their branches in our country. Some of the foreign banks operating in our country are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, American Express Bank, Standard & Chartered Bank, Grindlay’s Bank, etc. The number of foreign banks operating in our country has increased since the financial sector reforms of 1991. C) DEVELOPMENT BANKS Business often requires medium and long-term capital for purchase of machinery and equipment, for using latest technology, or for expansion and modernization. Such financial assistance is provided by Development Banks. They also undertake other development measures like subscribing to the shares and debentures issued by companies, in case of under subscription of the issue by the public. Industrial Finance Corporation of India (IFCI) and State Financial Corporations (SFCs) are examples of development banks in India.

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D) CO-OPERATIVE BANKS People who come together to jointly serve their common interest often form a co-operative society under the Co-operative Societies Act. When a co-operative society engages itself in banking business it is called a Co-operative Bank. The society has to obtain a licence from the Reserve Bank of India before starting banking business. Any co-operative bank as a society is to function under the overall supervision of the Registrar, Co-operative Societies of the State. As regards banking business, the society must follow the guidelines set and issued by the Reserve Bank of India. Types of Co-operative Banks There are three types of co-operative banks operating in our country. They are primary credit societies, central co-operative banks and state co-operative banks. These banks are organized at three levels, village or town level, district level and state level. (i) Primary Credit Societies: These are formed at the village or town level with borrower and nonborrower members residing in one locality. The operations of each society are restricted to a small area so that the members know each other and are able to watch over the activities of all members to prevent frauds. (ii) Central Co-operative Banks: These banks operate at the district level having some of the primary credit societies belonging to the same district as their members. These banks provide loans to their members (i.e., primary credit societies) and function as a link between the primary credit societies and state co-operative banks. (iii) State Co-operative Banks: These are the apex (highest level) co-operative banks in all the states of the country. They mobilise funds and help in its proper channelisation among various sectors. The money reaches the individual borrowers from the state co-operative banks through the central cooperative banks and the primary credit societies. E) SPECIALISED BANKS

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There are some banks, which cater to the requirements and provide overall support for setting up business in specific areas of activity. EXIM Bank, SIDBI and NABARD are examples of such banks. They engage themselves in some specific area or activity and thus, are called specialised banks. Let us know about them. i. Export Import Bank of India (EXIM Bank): If you want to set up a business for exporting products abroad or importing products from foreign countries for sale in our country, EXIM bank can provide you the required support and assistance. The bank grants loans to exporters and importers and also provides information about the international market. It gives guidance about the opportunities for export or import, the risks involved in it and the competition to be faced, etc. ii. Small Industries Development Bank of India (SIDBI): If you want to establish a small-scale business unit or industry, loan on easy terms can be available through SIDBI. It also finances modernisation of small-scale industrial units, use of new technology and market activities. The aim and focus of SIDBI is to promote, finance and develop small-scale industries. iii. National Bank for Agricultural and Rural Development (NABARD): It is a central or apex institution for financing agricultural and rural sectors. If a person is engaged in agriculture or other activities like handloom weaving, fishing, etc. NABARD can provide credit, both short-term and long-term, through regional rural banks. It provides financial assistance, especially, to co-operative credit, in the field of agriculture, small-scale industries, cottage and village industries handicrafts and allied economic activities in rural areas.

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QUES NO. 5: WHAT IS INTERNATIONAL BANKING AND HOW DO BANKS CONTRIBUTE TO THE GROWTH OF INTERNATIONAL BUSINESS? Until lately, banking systems were domestically oriented. National policy objectives embodied in the mobilisation of domestic saving, the adequate provision of credit with directed lending targeted at specific sectors of the economy, extending the geographical spread of the banking function and raising resources for financing public sector deficits primarily guided the conduct of banking activity. With the growth in commerce, first within the country and then globally, banking started transcending first the regional boundaries and then the national boundaries. That is how “international banking” started. Even today, International banking caters to “International Trade” to a major extent. International banking revolves around the following: 1. International Trade 2. Tourism 3. Remittance of Funds from one place to another place. 4. Syndication of Loans globally for large business houses and multinationals, 5. Accessing international markets for equity / borrowing in the form of bonds etc for corporate houses / multinationals 6. Foreign exchange management etc In the nineties, banks have become more global in their reach and in the diversification of their portfolios. They operate with greater freedom than before. Furthermore, there is more universal banking today than in the past. Banks' balance sheets have become more vulnerable to external shocks. The Banks contribute to the growth of International Business by offering a complete range of correspondent banking services to Individuals, Corporate, banks and financial institutions. The services offered are as under:

INTERNATIONAL TRADE: Banks offers full range of cross border trade services to its correspondent banks like

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Advising and confir ming of docu mentar y letters of credit

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Confir mation/ re-issuance of standb y LCs and guarantees

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Docu mentar y collections / open account transactions

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Pa yme nt processing and distribution

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Advising and confir ming of docu mentar y credits.

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Foreign exchange involved in re mittance of proceeds fro m the i mporting countr y to the exporting countr y.

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Negotiation of documents

TOURISM:

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International Travellers’ cheques

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International Mone y Orders

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Foreign

xchange

involved

in

encash me nt

of

travelers

cheques

and

International Mone y orders / De mand Drafts / Telegraphic Transfer / Swift re mittance etc.

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Credit Card business and International bills settle me nt under credit cards.

REMITTANCE OF FUNDS FROM ONE PLACE TO ANOTHER PLACE BESIDES TOURSIM / INTERNATIONAL TRADE:

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Routine transfer from persons e mplo ye d abroad

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Donations / charit y re mittances

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Re mittances for disburse ment of loans (inward for borrowing countr y)

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Re mittances for repa yment of loans (outward for borrowing countr y)

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Re mittances for pa yme nt of interest (outward for borrowing countr y)

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Re mittance of ro yalt y, dividend (outward for re mitting countr y)

SYNDICATION OF LOANS GLOBALLY FOR CORPORATE HOUSES:

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•

This does not involve an y funds and it is a non-fund based activit y earning non-interest income.

ADDRESSING INTERNATIONAL MARKET FOR EQUITY / BORROWING IN THE FORM OF ADR / GDR AND EURO BONDS ETC.

•

This again does not involve an y funds and it is a non-fund based activit y earning non-interest income.

FOREIGN EXCHANGE MANAGEMENT: This is common to all the activities listed above, which involves funds. Such activities are called fund based activities of the bank. Unlike s yndication and / or accessing international markets for GDR/ADR, Euro bonds etc, which are nopnfund based activities.

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QUES NO.: 6 WHAT ARE THE DIFFERENT ACTIVITIES COVERED UNDER PRIORITY SECTOR AND WHAT ARE THE DIFFERENCES IN COMPLIANCE REQUIREMENTS BETWEEN INDIAN BANKS AND FOREIGN BANKS? The following activities are covered under priority sector: 1. Direct Finance to Farmers for Agriculture Purposes like: a. Short-term loans for raising crops etc b. Medium and Long-term Loans provided directly to farmers for financing production and development needs etc 2. Indirect Finance to Agriculture like: a. Credit for financing the distribution of fertilizers, pesticides, seeds, cattle feeds, etc b. Loans to Electricity Boards for reimbursing the expenditure already incurred by them for providing low tension connection from step-down point to individual farmers for energizing their wells. c. Loans to farmers through PACS, FSS and LAMPS d. Deposits held by the banks in Rural Infrastructure Development Fund (RIDF) maintained with NABARD e. Subscription to Bonds issued by Rural Electrification Corporation (REC) exclusively for financing pump set energisation programme in rural and semi-urban areas and also for financing system improvement programme (SI-SPA) f.

Subscriptiont o bonds issued by NABARD with the objective of financing exclusively agriculture / allied activities.

3. Loans to Small Scale and Ancillary Industries 4. Indirect finance in the small scale Industrial sector. 5. Loans for setting up Industrial Estates 6. Loans and advances to KVI sector 7. Loans and advances to Small Road & Water Transport Operators (SRWTO) 8. Loans and advances to retail traders dealing in essential commodities (fair price shops) and consumer co-operative stores with credit limits not exceeding Rs 10 Lakhs.

9. Loans and advances to small business for providing services except for professional services. 10. Loans and advances to professional & self employed persons. 11. Loans and advances to state sponsored organizations for scheduled castes / scheduled tribes. 12. Loans and advances to individuals for educational purposes.

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13. Direct & Indirect Housing Finance. 14. Loans and advances to Self-Help Groups (SHGs)/NGOs/Microcredit 15. Loans and advances to Food and Agro based processing sector 16. Loans and advances to software industry with credit limit upto Rs 1 crore. 17. Loans and advances for venture capital funds / companies registered with SEBI.

DIFFERENCES IN COMPLIANCE REQUIREMENTS BETWEEN INDIAN BANKS AND FOREIGN BANKS: Targets for priority sector lending by scheduled commercial banks (excluding RRBs) 1

Main Targets for All Scheduled Commercial Banks excluding Foreign Banks

1.1 The scheduled commercial banks are expected to enlarge credit to priority sector and ensure that priority sector advances constitute 40 percent of net bank credit and that a substantial portion is directed to the weaker sections. 1.2 Within the overall main lending target of 40 percent of net bank credit, it should be ensured that: (i) 18 percent of net bank credit goes to agricultural sector, (ii) 10 percent of net bank credit is given to the ‘weaker sections’ and (iii) 1 percent of previous year’s total advances is given under the Differential Rate of Interest (DRI) scheme. 2

SUB-TARGETS FOR ALL SCHEDULED COMMERCIAL BANKS EXCLUDING FOREIGN BANKS

2.1 Direct/Indirect Agricultural Lending (i) Taking into consideration the fact that ultimate objective of agricultural credit whether 'direct' or 'indirect' is to help the agricultural production, the lendings under the 'direct' and 'indirect' categories of agricultural advances will be clubbed for the purpose of computing performance of banks vis-à-vis the sub-target of 18 percent. (ii) However, to ensure that the focus of the banks on the direct category of agricultural advances does not get diluted; the lendings under the indirect category should not exceed one-fourth of the agricultural sub-target of 18 percent, i.e. 4.5 percent of net bank credit. (iii) Advances under the 'indirect' category in excess of 4.5 percent of net bank credit would not be reckoned in computing performance under the sub-target of 18 percent. However, all agricultural advances under the categories 'direct' and 'indirect'

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will be reckoned in computing performance under the overall priority sector target of 40 percent of the net bank credit. 2.2 Small Scale Industries In order to ensure that credit is available to all segments of the SSI sector, banks should ensure that (a) 40 percent of the total credit to small scale industry goes to the cottage industries, khadi & village industries, artisans and tiny industries with investment in plant and machinery upto Rs. 5 lacs; (b) 20 percent of the total credit to small scale industry goes to SSI units with investment in plant and machinery between Rs. 5 lakhs and Rs. 25 lakhs; and (c) The remaining 40 percent goes to other SSI units with investment exceeding Rs. 25 lakhs. 2.3 DRI Advances (i)

It should be ensured that not less than 40 percent of the total advances granted under

DRI scheme go to scheduled caste/scheduled tribes. (ii) At least two third i.e. 662/3 percent of DRI advances should be granted through rural and semi-urban branches. Under the DRI Scheme, financial assistance is provided at concessional rate of interest (4 percent per annum) to selected low income groups, for productive endeavours. 2.4 Weaker Sections (i) In order to ensure that more under-privileged sections in the priority sector are given proper attention in the matter of allocation of credit, it should be ensured that the advances to the weaker sections reach a level of 25 percent of priority sector advances or 10 percent of net bank credit. (ii) The weaker sections under priority sector include the following: (a) Small and marginal farmers with land holding of 5 acres and less and landless labourers, tenant farmers and share croppers. (b) Artisans, village and cottage industries where individual credit limits do not (c) (d) (e) (f) (g)

exceed Rs. 50,000/Beneficiaries of Swarnjayanti Gram Swarojgar Yojana (SGSY) Scheduled Castes and Scheduled Tribes Beneficiaries of Differential Rate of Interest (DRI) scheme Beneficiaries under Swarna Jayanti Shahari Rojgar Yojana (SJSRY) Beneficiaries under the Scheme for Liberation and Rehabilitation of

Scavangers (SLRS). (h) Advances to Self Help Groups

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3

Targets for Foreign Banks 3.1.1 With a view to reducing the disparity between the domestic banks and the foreign banks operating in India in regard to their priority sector obligations the minimum lending to priority sector by the foreign banks shall be 32 percent of their net credit. 3.1.2 However, keeping in view that the foreign banks have no rural branch network, the composition of priority sector advances in their case will be inclusive of export credit provided by them. 3.1.3 Within the overall target of 32 percent to be achieved by foreign banks, the advances to small scale industries sector should not be less than 10 percent of the net bank credit and the export credit should not be less than 12 percent of the net bank credit. [The net bank credit should tally with the figures reported in the fortnightly return submitted under section 42(2) of the Reserve Bank of India Act, 1934. Outstanding deposits under the FCNR(B) and NRNR Schemes are excluded from net bank credit for computation of priority sector lending target/ sub-targets]

4.

DEPOSIT by Foreign Banks WITH SIDBI towards shortfall in priority sector lending

4.1 In the event of failure to attain the stipulated targets and sub-targets, the foreign banks will be required to make good the shortfall in the achievement of the targets / sub-targets by depositing for a period of one year, an amount equivalent to the shortfall with the Small Industries Development Bank of India (SIDBI) at the interest rate of 8 percent per annum or as may be decided by the Reserve Bank from time to time. 4.2 The shortfall in achieving the priority sector lending target ad the sub-targets should be computed as on the last reporting Friday of March every year and made good by placing a deposit with SIDBI as stated above. The deposits should be placed before the end of April of that year. 4.3 In regard to the above, it is to be clarified that in the event of failure on the part of foreign banks to achieve any of the stipulated sub-targets in respect of advances to SSI sector and export credit, even if they achieve the overall target of 32 percent, the shortfall should be made good by placing with SIDBI a deposit of an amount equivalent to the shortfall in each of the sub-targets. Also, in the event of failure on the part of banks to achieve one of the sub-targets or both the sub-targets, and also the overall target of 32 percent, the shortfall in achieving the sub-targets and the overall target should be made good by placing with SIDBI a deposit of an amount

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equivalent to (i) aggregate shortfall in the sub-targets, or (ii) the shortfall in the overall target, whichever shortfall is higher. In case the shortfall is in achievement of the overall target only and not in the sub-target, banks should make good the shortfall in achieving the overall target. 4.4 The outstanding balances of these deposits placed with SIDBI may be reckoned as part of their priority sector advances during the currency of the deposits, as indirect finance to SSIs. The amount of deposits should, however, be shown separately in the returns on priority sector advances submitted to RBI. 5.

Contribution by banks TO Rural Infrastructure Development Fund (RIDF)

5.1 Domestic scheduled commercial banks having shortfall in lending to priority sector / agriculture are allocated amounts for contribution to the Rural Infrastructure Development Fund (RIDF) established in NABARD. Details regarding operationalisation of the RIDF such as the amounts to be deposited by banks, interest rates on deposits, period of deposits etc., are decided every year after announcement in the Union Budget about setting up of RIDF. The contributions to be made by banks are communicated to the banks concerned separately. 5.2 Shortfall in lending to priority sector / agriculture is taken into account while making allocations to banks under RIDF, which amount has to be deposited with NABARD at a certain rate of interest. In the case of RIDF-I to VI, the rate of interest on deposits placed in the Fund was uniform for all banks irrespective of the extent of their shortfall. Effective RIDF-VII, the rate of interest on RIDF deposits was linked to the banks’ performance in lending to agriculture. Accordingly, banks will receive interest from NABARD on contribution to RIDF-VIII at rates of interest inversely related to the shortfall in agricultural lending, as indicated below: Sr. No.

Shortfall in lending to agriculture in Rate of interest on the entire terms of percentage to Net Bank Credit deposit to be made in RIDF VII (i.e. Target minus achievement)

(Percent per annum)

1

Less than 2 percentage points

8.0

2

2 to 4.99 percentage points

7.0

3

5 to 8.99 percentage points

6.0

4

9 percentage points and above

5.0

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QUES NO. 7: WHAT IS CDR AND HOW DOES IT OPERATE? Corporate Debt Restructuring (CDR) 1. The need for evolving an appropriate mechanism for corporate debt restructuring in the country, on the lines of similar mechanism prevalent in countries like the U.K., Thailand, Korea, Malaysia, etc. was engaging the attention of the Government of India, Reserve Bank of India, banks and financial institutions. Based on the extensive discussions the Government of India and RBI had with banks and financial institutions, the scheme of Corporate Debt Restructuring was finalized for implementation by banks. 2. The objective of the CDR framework is to ensure a timely and transparent mechanism for restructuring of the corporate debts of viable corporate entities affected by internal or external factors, outside the purview of BIFR, DRT and other legal proceedings, for the benefit of all concerned. CDR will apply only to multiple banking accounts/syndicates/consortium accounts with outstanding exposure of Rs.20 crore and above with the banks and financial institutions. 3. It would be observed that the CDR Empowered Group would examine the viability and rehabilitation potential of the corporate and approve the restructuring package. It is advised that banks should ensure that their representatives in the Empowered Group are at a sufficiently senior level, preferably Executive Director level, with necessary authorisations from their Boards to make commitments including sacrifices, on behalf of their banks towards debt restructuring. 4. Since the debtor corporates will have to accede to the Debtor-Creditor Agreement, either at the time of original loan documentation (for future cases) or at the time of reference to CDR Cell, banks may ensure proper documentation for the purpose. 5. All standard and sub-standard accounts subjected to CDR process, would continue to be eligible for fresh financing of funding requirements, by the lenders as per their normal policy parameters and eligibility criteria.

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Corporate Debt Restructuring (CDR) System Structure CDR system in the country will have a three tier structure : •

CDR Standing Forum

•

CDR Empowered Group

•

CDR Cell

1.1 CDR Standing Forum : 1.1.1 The CDR Standing Forum would be the representative general body of all financial institutions and banks participating in CDR system. All financial institutions and banks should participate in the system in their own interest. CDR Standing Forum will be a self empowered body, which will lay down policies and guidelines, guide and monitor the progress of corporate debt restructuring. 1.1.2 The Forum will also provide an official platform for both the creditors and borrowers (by consultation) to amicably and collectively evolve policies and guidelines for working out debt restructuring plans in the interests of all concerned. 1.1.3 The CDR Standing Forum shall comprise Chairman& Managing Director, Industrial Development Bank of India; Managing Director, Industrial Credit & Investment Corporation of India Limited; Chairman, State Bank of India; Chairman, Indian Banks Association and Executive Director, Reserve Bank of India as well as Chairmen and Managing Directors of all banks and financial institutions participating as permanent members in the system. The Forum will elect its Chairman for a period of one year and the principle of rotation will be followed in the subsequent years. However, the Forum may decide to have a Working Chairman as a whole-time officer to guide and carry out the decisions of the CDR Standing Forum. 1.1.4 A CDR Core Group will be carved out of the CDR Standing Forum to assist the Standing Forum in convening the meetings and taking decisions relating to policy, on behalf of the Standing Forum. The Core Group will consist of Chief Executives of IDBI, ICICI, SBI, Bank of Baroda, Bank of India, Punjab National Bank, Indian Banks Association and a representative of Reserve Bank of India.

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1.1.5 The CDR Standing Forum shall meet at least once every six months and would review and monitor the progress of corporate debt restructuring system. The Forum would also lay down the policies and guidelines to be followed by the CDR Empowered Group and CDR Cell for debt restructuring and would ensure their smooth functioning and adherence to the prescribed time schedules for debt restructuring. It can also review any individual decisions of the CDR Empowered Group and CDR Cell. 1.1.6 The CDR Standing Forum, the CDR Empowered Group and CDR Cell (described in following paragraphs) shall be housed in IDBI. The administrative and other costs shall be shared by all financial institutions and banks. The sharing pattern shall be as determined by the Standing Forum. 2.2 CDR Empowered Group and CDR Cell 2.2.1 The individual cases of corporate debt restructuring shall be decided by the CDR Empowered Group, consisting of ED level representatives of IDBI, ICICI Limited and SBI as standing members, in addition to ED level representatives of financial institutions and banks who have an exposure to the concerned company. In order to make the CDR Empowered Group effective and broad based and operate efficiently and smoothly, it would have to be ensured that each financial institution and bank, as participants of the CDR system, nominates a panel of two or three EDs, one of whom will participate in a specific meeting of the Empowered Group dealing with individual restructuring cases. Where, however, a bank / financial institution has only one Executive Director, the panel may consist of senior officials, duly authorized by its Board. The level of representation of banks/ financial institutions on the CDR Empowered Group should be at a sufficiently senior level to ensure that concerned bank / FI abides by the necessary commitments including sacrifices, made towards debt restructuring. 2.2.2 The Empowered Group will consider the preliminary report of all cases of requests of restructuring, submitted to it by the CDR Cell. After the Empowered Group decides that restructuring of the company is prima-facie feasible and the enterprise is potentially viable in terms of the policies and guidelines evolved by Standing Forum, the detailed restructuring package will be worked out by the CDR Cell in conjunction with the Lead Institution. 2.2.3 The CDR Empowered Group would be mandated to look into each case of debt restructuring, examine the viability and rehabilitation potential of the Company and approve the restructuring

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package within a specified time frame of 90 days, or at best 180 days of reference to the Empowered Group. 2.2.4 There should be a general authorisation by the respective Boards of the participating institutions / banks in favour of their representatives on the CDR Empowered Group, authorising them to take decisions on behalf of their organization, regarding restructuring of debts of individual corporates. 2.2.5 The decisions of the CDR Empowered Group shall be final and action-reference point. If restructuring of debt is found viable and feasible and accepted by the Empowered Group, the company would be put on the restructuring mode. If, however, restructuring is not found viable, the creditors would then be free to take necessary steps for immediate recovery of dues and / or liquidation or winding up of the company, collectively or individually. 3.3 CDR Cell 3.3.1 The CDR Standing Forum and the CDR Empowered Group will be assisted by a CDR Cell in all their functions. The CDR Cell will make the initial scrutiny of the proposals received from borrowers / lenders, by calling for proposed rehabilitation plan and other information and put up the matter before the CDR Empowered Group, within one month to decide whether rehabilitation is prima facie feasible, if so, the CDR Cell will proceed to prepare detailed Rehabilitation Plan with the help of lenders and if necessary, experts to be engaged from outside. If not found prima facie feasible, the lenders may start action for recovery of their dues. 3.3.2 To begin with, CDR Cell will be constituted in IDBI, Mumbai and adequate members of staff for the Cell will be deputed from banks and financial institutions. The CDR Cell may also take outside professional help. The initial cost in operating the CDR mechanism including CDR Cell will be met by IDBI initially for one year and then from contribution from the financial institutions and banks in the Core Group at the rate of Rs.50 lakh each and contribution from other institutions and banks at the rate of Rs.5 lakh each. 3.3.3 All references for corporate debt restructuring by lenders or borrowers will be made to the CDR Cell. It shall be the responsibility of the lead institution / major stakeholder to the corporate, to work out a preliminary restructuring plan in consultation with other stakeholders and submit to the CDR Cell within one month. The CDR Cell will prepare the restructuring plan in terms of the general policies and guidelines approved by the CDR Standing Forum and place for the consideration of the Empowered Group within 30 days for decision. The Empowered Group can

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approve or suggest modifications, so, however, that a final decision must be taken within a total period of 90 days. However, for sufficient reasons the period can be extended maximum upto 180 days from the date of reference to the CDR Cell. 4. Other features: 4.1 CDR will be a Non-statutory mechanism 4.1.1 CDR mechanism will be a voluntary system based on debtor-creditor agreement and intercreditor agreement. 4.1.2 The scheme will not apply to accounts involving only one financial institution or one bank. The CDR mechanism will cover only multiple banking accounts / syndication / consortium accounts with outstanding exposure of Rs.20 crore and above by banks and institutions. 4.1.3 The CDR system will be applicable only to standard and sub-standard accounts. There would be no requirement of the account / company being sick, NPA or being in default for a specified period before reference to the CDR Group. However, potentially viable cases of NPAs will get priority. This approach would provide the necessary flexibility and facilitate timely intervention for debt restructuring. Prescribing any milestone(s) may not be necessary, since the debt restructuring exercise is being triggered by banks and financial institutions or with their consent. In no case, the requests of any corporate indulging in wilful default or misfeasance will be considered for restructuring under CDR. 4.1.4 Reference to Corporate Debt Restructuring System could be triggered by (i) any or more of the secured creditor who have minimum 20% share in either working capital or term finance, or (ii) by the concerned corporate, if supported by a bank or financial institution having stake as in (i) above. 4.2 Legal Basis The legal basis to the CDR mechanism shall be provided by the Debtor-Creditor Agreement (DCA) and the Inter-Creditor Agreement. The debtors shall have to accede to the DCA, either at the time of original loan documentation (for future cases) or at the time of reference to Corporate Debt Restructuring Cell. Similarly, all participants in the CDR mechanism through their membership of the Standing Forum shall have to enter into a legally binding agreement, with necessary enforcement and penal clauses, to operate the System through laid-down policies and guidelines.

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4.3 Stand-Still Clause 4.3.1 One of the most important elements of Debtor-Creditor Agreement would be 'stand still' agreement binding for 90 days, or 180 days by both sides. Under this clause, both the debtor and creditor(s) shall agree to a legally binding 'stand-still' whereby both the parties commit themselves not to taking recourse to any other legal action during the 'stand-still' period, this would be necessary for enabling the CDR System to undertake the necessary debt restructuring exercise without any outside intervention judicial or otherwise. 4.3.2 The Inter-Creditors Agreement would be a legally binding agreement amongst the secured creditors, with necessary enforcement and penal clauses, wherein the creditors would commit themselves to abide by the various elements of CDR system. Further , the creditors shall agree that if 75% of secured creditors by value, agree to a debt restructuring package, the same would be binding on the remaining secured creditors.

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QUES NO. 8: IDENTIFY THE REASONS FOR THE GROWTH OF NON-PERFORMING ADVANCES IN THE BANKING SECTOR AND SUGGEST REMEDIES FOR IMPROVING THE QUALITY OF ADVANCES. Non Performing Advance is defined as an advance where payment of interest or repayment of installment of principal (in case of Term Loans) or both remains unpaid for a period of two quarters or more. An amount under any of the credit facilities is to be treated as 'past due' when it remains unpaid for 30 days beyond due date. Granting of credit facilities for economic activities is the main raison d'etre of banking. In the banking sector non-performing assets (NPAs) is the key issue. The amount of gross and net NPAs have been on the rise, although the rate of their growth has been below the overall rate of expansion of advances. Apart from absolute size, the distribution of non-performing assets is skewed across banks. Still a large number of public sector banks have net non-performing assets ranging between 10 to 20 per cent of net advances. The Narasimham Committee has underlined the need to reduce the average level of net NPAs for all banks to 3 per cent and to zero for banks with international presence. This is an important requirement for our banking system and is crucial to maintaining the viability of the system in future. A two-pronged strategy identified by the Committee viz., to reduce the backlog NPAs and improving the management efficiency and stricter enforcement of prudential norms, have to be acted upon to deal with this challenge. Originating factors for the NPAs 1. The high level of NPAs is a historical legacy mainly due to lacunae in credit recovery system, largely arising from inadequate legal provisions on foreclosure and bankruptcy, long drawn legal procedures and difficulties in execution of the decrees awarded by the Court. The Indian legal system is sympathetic towards the borrowers and works against the banks' interest. Despite most of their loans being backed by security, banks are unable to enforce their claims on the collateral, when the loans turn non-performing, and therefore, loan recoveries have been insignificant. 2. The dues to the banking sector are generally related to the performance of the unit/industrial segment. In a few cases the cause of NPA has been due to internal factors (to the banks) such as weak appraisal or follow-up of loans but more often than not, it is due to factors such as management inefficiency of borrower units, obsolescence, lack of demand, non- availability

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of inputs, environmental factors etc. Wherever the unit/segment is doing well the credit relationship is generally maintained except in cases of willful default / misappropriation / diversion of funds. The problems to the unit/ segment arising out of various internal/ external factors were felt to be originating point for NPAs in banks. 3. There is a general perception that the prescription of 40% of the net bank credit to priority sectors have led to higher level of NPAs, due to credit to these sectors becoming sticky. REMEDIES FOR IMPROVING THE QUALITY OF ADVANCES Steps/initiatives taken by RBI to contain NPAs Recognizing the fact that the origin of non-performance could be at the initial stage of loan decision making, RBI had impressed upon banks, from time to time, to strengthen credit appraisal and credit supervision. After sanction and disbursal of credit, banks are required to closely monitor the operations of the borrowal units and accounts by way of obtention of periodic stock/operations statements, draw downs, end use, etc. In cases of incipient sickness, detailed guidelines have been issued to banks to take steps for avoiding sickness, nursing back the sick units, etc. Problem accounts above a certain outstanding balance are required to be monitored individually by designated senior officials of banks. In respect of accounts where the classification of asset worsens, banks are required to take prompt steps to recover the dues and staff accountability is required to be examined. Banks have also been advised to take decisions regarding filing of suits expeditiously and to effectively follow-up the cases of suit filed and decreed accounts. During periodic discussions with bank management, special emphasis is given on monitoring of large NPA accounts at the highest level in the banks and also on reduction of NPAs, through upgradation, recovery and compromise settlements. RBI has advised and accordingly banks' Boards lay down policies in regard to credit dispensation, recovery of credit, etc. Banks have constituted Recovery Cells, Recovery Branches, NPA Management Departments and fix recovery targets. Policies evolved and steps taken in this regard are critically examined during the annual on-site inspection of banks. The Off-site returns also provide RBI an insight into the quality of credit portfolio at quarterly intervals. Introduction of prudential norms on income recognition, asset classification and provisioning during 1992-93 and other steps initiated apart from bringing in trasparency in the loan portfolio of banking industry have significantly contributed towards improvement of the pre-sanction appraisal and post sanction supervision which is reflected in lowering of the levels of fresh accretion of non- performing advances of banks after 1992.

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CONCLUSION As the thrust of the second phase of reform is on improvement in the organizational efficiency of banks, the most critical area in the improvement of profitability of banks is the reduction of NPAs. This issue is intimately connected with the overall stability of the financial system and need to be so recognised for concerted and multipronged efforts. As has been stated earlier in this paper apart from internal factors such as weak credit appraisal, non-compliance and wilful default, there are several external factors such as preponderance of certain traditional industries in the credit portfolio of certain banks, majority of which are suffering from serious inherent operational problems, natural calamities, policy and technological changes which increase the incidence of sickness, labour problems and nonavailability of raw materials and other such factors which are not within the control of banks. While banks cannot be blamed for advances becoming non- performing due to external factors, there is an urgent need that the banks address the problems arising out of internal factors and this may call for organisational restructuring of banks, a change in the approach of banks towards legal action which is generally the last step and not the first step, no sooner the account becomes bad and a clear thrust on improving the skills of officials for proper assessment of credit proposal, risk factor and repayment possibilities. Though there are problems in effecting recoveries and write offs and in compromise settlements, it is of utmost importance that necessary changes are brought about in the related legislations for making recovery process more smooth and less time consuming and also create other alternative channels/agencies for recovery of debt/ reduction of non-performing advances. As the Lok Adalat have proved a very good agency for quick justice and recovery of smaller loans, their use could go a long way as a supplement to the efforts of recovery by the DRTs. The setting up of Asset Reconstruction Company can also play a vital role in reduction of NPAs and thereby provide necessary liquidity to banks through securitisation of banks' loan assets. Government and other authorities could also devise policies having a bearing on the industrial sector, agriculture and trade with a long term perspective to avoid sickness in the industry and adverse impact on borrowers because of sudden shift in the policy. Reduction of NPAs in banking sector should be treated as a national priority item to make the Indian banking system more strong, resilient and geared to meet the challenges of globalisation. It is necessary that public debate is started soon on the problem of NPAs and their resolution. It is hoped that this paper will provide a base and generate a healthy public debate which may be helpful in evolving suitable strategies for satisfactory resolution of the problem.

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QUES NO. 9: WHAT ARE THE DIFFERENT METHODS BY WHICH BANKS ARE REQUIRED TO CLASSIFY THEIR ADVANCES PORTFOLIO?

CATEGORIES OF NPAS Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained non-performing and the realisability of the dues: a) Sub-standard Assets i.e. an asset which has remained NPA for a period less than or equal to 12 months. b) Doubtful Assets i.e. an asset which has remained in the sub-standard category for 12 months c) Loss Assets: An asset where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value. GUIDELINES FOR CLASSIFICATION OF ASSETS 1. Broadly speaking, classification of assets into above categories should be done taking into account the degree of well-defined credit weaknesses and the extent of dependence on collateral security for realisation of dues. 2 Banks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value accounts. 3 Accounts with temporary deficiencies The classification of an asset as NPA should be based on the record of recovery. Bank should not classify an advance account as NPA merely due to the existence of some deficiencies which are temporary in nature such as non-availability of adequate drawing power based on the latest available stock statement, balance outstanding exceeding the limit temporarily, nonsubmission of stock statements and non-renewal of the limits on the due date, etc.

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4 Upgradation of loan accounts classified as NPAs If arrears of interest and principal are paid by the borrower in the case of loan accounts classified as NPAs, the account should no longer be treated as non-performing and may be classified as ‘standard’ accounts. 5 Accounts regularised near about the balance sheet date The asset classification of borrowal accounts where a solitary or a few credits are recorded before the balance sheet date should be handled with care and without scope for subjectivity. Where the account indicates inherent weakness on the basis of the data available, the account should be deemed as a NPA. In other genuine cases, the banks must furnish satisfactory evidence to the Statutory Auditors/Inspecting Officers about the manner of regularization of the account to eliminate doubts on their performing status. 6 Asset Classification to be borrower-wise and not facility-wise i.

It is difficult to envisage a situation when only one facility to a borrower becomes a problem credit and not others. Therefore, all the facilities granted by a bank to a borrower will have to be treated as NPA and not the particular facility or part thereof which has become irregular.

ii.

If the debits arising out of devolvement of letters of credit or invoked guarantees are parked in a separate account, the balance outstanding in that account also should be treated as a part of the borrower’s principal operating account for the purpose of application of prudential norms on income recognition, asset classification and provisioning.

7 Advances under consortium arrangements Asset classification of accounts under consortium should be based on the record of recovery of the individual member banks and other aspects having a bearing on the recoverability of the advances. Where the remittances by the borrower under consortium lending arrangements are pooled with one bank and/or where the bank receiving remittances is not parting with the share of other member banks, the account will be treated as not serviced in the books of the other member banks and therefore, be treated as NPA. The banks participating in the consortium should, therefore, arrange to get their share of recovery transferred from the lead bank or get an express consent from the lead bank for the transfer of their share of recovery, to ensure proper asset classification in their respective books.

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8 Accounts where there is erosion in the value of security

i.

A NPA need not go through the various stages of classification in cases of serious credit impairment and such assets should be straightaway classified as doubtful or loss asset as appropriate. Erosion in the value of security can be reckoned as significant when the realizable value of the security is less than 50 per cent of the value assessed by the bank or accepted by RBI at the time of last inspection, as the case may be. Such NPAs may be straightaway classified under doubtful category and provisioning should be made as applicable to doubtful assets.

ii.

If the realisable value of the security, as assessed by the bank/ approved valuers/ RBI is less than 10 per cent of the outstanding in the borrowal accounts, the existence of security should be ignored and the asset should be straightaway classified as loss asset. It may be either written off or fully provided for by the bank.

9 Advances to PACS/FSS ceded to Commercial Banks In respect of agricultural advances as well as advances for other purposes granted by banks to ceded PACS/ FSS under the on-lending system, only that particular credit facility granted to PACS/ FSS which is in default for a period of two harvest seasons (not exceeding two half years)/two quarters, as the case may be, after it has become due will be classified as NPA and not all the credit facilities sanctioned to a PACS/ FSS. The other direct loans & advances, if any, granted by the bank to the member borrower of a PACS/ FSS outside the on-lending arrangement will become NPA even if one of the credit facilities granted to the same borrower becomes NPA. 10 Advances against Term Deposits, NSCs, KVP/IVP, etc Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and life policies need not be treated as NPAs. Advances against gold ornaments, government securities and all other securities are not covered by this exemption. 11 Loans with moratorium for payment of interest i.

In the case of bank finance given for industrial projects or for agricultural plantations etc. where moratorium is available for payment of interest, payment of interest becomes 'due' only after the moratorium or gestation period is over. Therefore, such amounts of interest do

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not become overdue and hence NPA, with reference to the date of debit of interest. They become overdue after due date for payment of interest, if uncollected. ii.

In the case of housing loan or similar advances granted to staff members where interest is payable after recovery of principal, interest need not be considered as overdue from the first quarter onwards. Such loans/advances should be classified as NPA only when there is a default in repayment of instalment of principal or payment of interest on the respective due dates

12 Agricultural advances

i.

In respect of advances granted for agricultural purpose where interest and/or installment of principal remains unpaid after it has become past due for two harvest seasons but for a period not exceeding two half-years, such an advance should be treated as NPA. In respect of agricultural loans, other than those specified above, identification of NPAs would be done on the same basis as non agricultural advances which, at present, is the 90 days delinquency norm.

ii.

Where natural calamities impair the repaying capacity of agricultural borrowers, banks may decide on their own as a relief measure - conversion of the short-term production loan into a term loan or re-schedulement of the repayment period; and the sanctioning of fresh shortterm loan.

iii.

In such cases of conversion or re-schedulement, the term loan as well as fresh short-term loan may be treated as current dues and need not be classified as NPA. The asset classification of these loans would thereafter be governed by the revised terms & conditions and would be treated as NPA if interest and/or instalment of principal remains unpaid, for two harvest seasons but for a period not exceeding two half years.

13 Government guaranteed advances The credit facilities backed by guarantee of the Central Government though overdue may be treated as NPA only when the Government repudiates its guarantee when invoked. This exemption from classification of Government guaranteed advances as NPA is not for the purpose of recognition of income. 14 Restructuring/ Rescheduling of Loans

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i) A standard asset where the terms of the loan agreement regarding interest and principal have been renegotiated or rescheduled after commencement of production should be classified as sub-standard and should remain in such category for at least one year of satisfactory performance under the renegotiated or rescheduled terms. In the case of sub-standard and doubtful assets also, rescheduling does not entitle a bank to upgrade the quality of advance automatically unless there is satisfactory performance under the rescheduled / renegotiated terms. Following representations from banks that the foregoing stipulations deter the banks from restructuring of standard and sub-standard loan assets even though the modification of terms might not jeopardise the assurance of repayment of dues from the borrower, the norms relating to restructuring of standard and sub-standard assets were reviewed in March 2001. In the context of restructuring of the accounts, the following stages at which the restructuring / rescheduling / renegotiation of the terms of loan agreement could take place, can be identified: a. before commencement of commercial production; b. after commencement of commercial production but before the asset has been classified as sub standard, c. after commencement of commercial production and after the asset has been classified as sub standard. In each of the foregoing three stages, the rescheduling, etc., of principal and/or of interest could take place, with or without sacrifice, as part of the restructuring package evolved. ii) Treatment of Restructured Standard Accounts a. A rescheduling of the instalments of principal alone, at any of the aforesaid first two stages would not cause a standard asset to be classified in the sub standard category provided the loan/credit facility is fully secured. b. A rescheduling of interest element at any of the foregoing first two stages would not cause an asset to be downgraded to sub standard category subject to the condition that the amount of sacrifice, if any, in the element of interest, measured in present value terms, is either written off or provision is made to the extent of the sacrifice involved. For the purpose, the future interest due as per the original loan agreement in respect of an account should be discounted to the present value at a rate appropriate to the risk category of the borrower (i.e., current PLR+ the appropriate credit risk premium for the borrower-category) and compared with the

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present value of the dues expected to be received under the restructuring package, discounted on the same basis. c. In case there is a sacrifice involved in the amount of interest in present value terms, as at (b) above, the amount of sacrifice should either be written off or provision made to the extent of the sacrifice involved. iii) Treatment of restructured sub-standard accounts a. A rescheduling of the instalments of principal alone, would render a sub-standard asset eligible to be continued in the sub-standard category for the specified period, provided the loan/credit facility is fully secured. b. A rescheduling of interest element would render a sub-standard asset eligible to be continued to be classified in sub standard category for the specified period subject to the condition that the amount of sacrifice, if any, in the element of interest, measured in present value terms, is either written off or provision is made to the extent of the sacrifice involved. For the purpose, the future interest due as per the original loan agreement in respect of an account should be discounted to the present value at a rate appropriate to the risk category of the borrower (i.e., current PLR + the appropriate credit risk premium for the borrower-category) and compared with the present value of the dues expected to be received under the restructuring package, discounted on the same basis. c. In case there is a sacrifice involved in the amount of interest in present value terms, as at (b) above, the amount of sacrifice should either be written off or provision made to the extent of the sacrifice involved. Even in cases where the sacrifice is by way of write off of the past interest dues, the asset should continue to be treated as sub-standard. iv) Upgradation of restructured accounts The sub-standard accounts which have been subjected to restructuring etc., whether in respect of principal instalment or interest amount, by whatever modality, would be eligible to be upgraded to the standard category only after the specified period i.e., a period of one year after the date when first payment of interest or of principal, whichever is earlier, falls due, subject to satisfactory performance during the period. The amount of provision made earlier, net of the amount provided for the sacrifice in the interest amount in present value terms as aforesaid, could also be reversed after the one year period. During this one year period, the sub-standard asset will not deteriorate in its classification if satisfactory performance of the account is demonstrated during the period. In case, however, the

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satisfactory performance during the one year period is not evidenced, the asset classification of the restructured account would be governed as per the applicable prudential norms with reference to the pre-restructuring payment schedule. v) General a. These instructions would be applicable to all type of credit facilities including working capital limits, extended to industrial units, provided they are fully covered by tangible securities. b. As trading involves only buying and selling of commodities and the problems associated with manufacturing units such as bottleneck in commercial production, time and cost escalation etc. are not applicable to them, these guidelines should not be applied to restructuring/ rescheduling of credit facilities extended to traders.

c. While assessing the extent of security cover available to the credit facilities, which are being restructured/ rescheduled, collateral security would also be reckoned, provided such collateral is a tangible security properly charged to the bank and is not in the intangible form like guarantee etc. of the promoter/ others.

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QUES NO.10: NBFCs MUSHROOMED IMMEDIATELY AFTER LIBERALIZATION. THERE ARE VERY FEW LEFT IN THE FRAY.IDENTIFY THE REASONS FOR THEIR FAILURE. A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of shares/stock /bonds/debentures/ securities issued by Government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, sale/purchase/construction of immovable property. A non-banking institution which is a company and which has its principal business of receiving deposits under any scheme or arrangement or any other manner, or lending in any manner is also a non-banking financial company (Residuary non-banking company). In terms of Section 45-IA of the RBI Act, 1934, it is mandatory that every NBFC should be registered with RBI to commence or carry on any business of non-banking financial institution as defined in clause (a) of Section 45 I of the RBI Act, 1934. However, to obviate dual regulation, certain category of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI viz. Venture Capital Fund/Merchant Banking companies/Stock broking companies registered with SEBI, Insurance Company holding a valid Certificate of Registration issued by IRDA, Nidhi companies as notified under Section 620A of the Companies Act, 1956, Chit companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982 or Housing Finance Companies regulated by National Housing Bank. The NBFCs, more particularly the leasing and hire purchase finance companies, perform a very important financial intermediation role contributing to the economic development of the country. They supplement the role of banking sector to cater to the increasing financial need of a developing economy and have diversified their activities and expanded intermediation both in the areas of credit and in channelising the savings of the society. They act as agents between the savers and users of funds and offer tailor made services to both the borrowers as also the savers. Reasons for Mushrooming of the NBFCs and failure later-on While the banking sector remained highly regulated in the early 19990s, simplified sanction procedures, flexibility and timeliness in meeting niche credit needs and low cost operations saw the NBFC sector flourish, drawing a number of new entrants in the process. The NBFCs exhibited high

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growth rates in the first half of 1990s especially in their corporate finance portfolio even though many of them lacked the credit appraisal, monitoring and recovery skills required for the same. The mushrooming of NBFCs has been facilitated by the fact that regulations on them were nowhere close to those applicable to Scheduled Commercial Banks - in as much as many of the NBFCs did not even report about their operations to the RBI. Although NBFCs registered with the RBI under 1993 scheme, which was not mandatory, were required to adhere to the prudential norms from March 1995, many of the registered companies failed not only to comply with the norms but also to submit the related half-yearly returns thus defeating the very purpose of registration. When the subsequent recession and tight liquidity conditions saw several companies defaulting, it affected the solvency of several NBFCs as well. The high profile collapse of a large NBFC, which ushered in tighter prudential norms and regulatory changes, led to a period of rationalization and consolidation, with several small payers exiting the business. The compulsory registration by all NBFCs has been mandated in the amended RBI Act in January 1997. The NBFC Industry is dominated by a handful of players today. These include MNC players, captive finance companies and a few large stand-alone finance companies. Banks, especially private sector banks, have also increased their presence in the retail finance sector. The RBI Act was amended in January 1997 by effecting comprehensive changes in Chapter III B and V of the Act vesting more powers with the RBI. The regulatory attention was now focussed on NBFCs accepting public deposit. The RBI has favoured a policy to restrict the short term and the unsecured borrowings of the NBFCs on the strength of their credit rating, the size of NOF and the activities of the companies. While the overall borrowing capacity of NBFCs was restricted by the capital adequacy requirement, maximum ceiling on public deposits which an NBFC can accept is related to its rating and level of NOF. It was observed that some of the NBFCs offered high interest rates for mobilising excessive public deposits and they were unable to service such high-cost funds thus jeopardising the faith of the savers. Liability management and ensuring quality of assets are the two main attributes of any good financial institution. Heavy reliance on public deposits is not a healthy trend. A prudent company should raise resources from a judicious mix of avenues. Besides, it may be noted that Capital to Riskweighted Assets Ratio (CRAR) is not a barometer of the quality of assets of the company. A conscious decision has, therefore, been taken to prescribe different ceilings on public deposits for the NBFCs on the basis of the level of their rating.

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Some of the NBFCs borrowed heavily and the excess liquidity was misallocated in the corporate finance with imprudence and lack of proper credit appraisal and real estate business for an overkill. Because of certain economic reasons, such companies are suffering liquidity crisis at present thus accentuating risk to the depositors' interest. While NBFCs provided to their customers the advantages of quicker decision-making and of servicing of their specific needs, they assumed greater risks and high exposures, notwithstanding the specification of prudential norms for registered NBFCs as early as 1994-95. The quality of assets created by the NBFCs has a direct bearing on the financial viability and depositors' confidence.

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