Note4Students

Banking Sector in India is crippled with multidimensional problems like mounting NPAs, Twin Balance sheet Syndrome (TBS), Merging banks causing structural problems, loss of employment, difficulty in recognizing defaulters, falling short of adhering BIS norms. Financial Sector is very much important for UPSC and the current government gives so much importance to the Banking Sector.

Background/ Introduction

1. Reforms in banking sector started even before independence with passing of The Reserve Bank of India Act, 1934 (RBI Act).
2. Later Nationalization of banks, consolidation, diversification, liberalization of the banking industry in 1980s and 1990s were part of the ongoing reforms.
3. From the 1991 economic crisis India has grown significantly in terms of economic development. So has its banking sector Government of India (GOI) set up various committees with the task of analyzing India’s banking sector and recommending legislation and regulations to make it more effective, competitive and efficient. Two such expert Committees were set up under the chairmanship of M. Narasimham. They submitted their recommendations in the 1990s in reports widely known as the Narasimham Committee-I (1991) and the Narasimham Committee-II (1998) Report.
4. Narasimham committee Recommendations revolved around:
5. Autonomy in Banking.
6. Reform the role of RBI.
7. Tighten Provisioning norms- Capital adequacy ratio, Asset classification (NPAs).
8. Entry for foreign banks.
9. SARFASI Act 2002.

Certain Facts:

1. AS per KPMG-CII report, India’s banking sector expanding rapidly and has the potential to become fifth largest banking industry in the world by 2020 and third largest by 2025.
2. The share of gross NPAs in India could inch up to 10.2% by March 2018, from 9.6% in March 2017, according to the FSR-Financial Stability report.

Current Problem in Banking Sector

1. With changing global economic situations, demand for speedy, secure and efficient service delivery from customers, Information and Communication revolution, big bang long gestation infrastructure projects, the problems of Banking system undergone drastic changes:

(a)Twin balance sheet:

1. The public sector banks are burdened with the high non-performing assets (NPAs) while some of the corporate houses are also under stress due to sluggish global demand. This has been called the “TBS problem” or “Twin Balance Sheet Syndrome“.
2. This leads to incomplete transmission of the monitory policy, unwillingness of banks to lend credit on account of rising NPAs affecting Credit growth in turn economic activity.

(b)Non-performing Assets:

1. When the borrower stops paying interest or principal on a loan for 90days or more considered as NPA.
2. According to RBI’s recent data, the gross non-performing assets (NPAs) of public sector banks are just under Rs 4 lakh crore which is alarming. Reasons for NPAs:
3. Bad lending practices
4. Delay in environmental clearances leading to
5. Wilful defaulters due to crony capitalism.
6. Global, regional and national Financial crises.
7. Poor performance across different sectors like Infra, Steel, Discom etc.
8. Not adhering provisioning norms- BASEL I, II, III.
9. Failure of SARFASI, ARC.

(c)Requirements of Reserve ratio:

1. RBI policy mandates reserve ratios CRR 4%, SLR 20%. And compulsory Primary Sector lending for social sector projects affects the credit expansion of banks.

(d)Increasing Competition and funding sources

1. Strengthening of Bond Market, External Borrowing sources,
2. Indian PSBs not competitive.

Crisis in Management

Measures taken by RBI and Government:

1. Debt Recovery Tribunals (DRTs)

1. To decrease the time required for settling cases.

Amendments to the SARFAESI Act: The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016 includes

1. The SARFAESI Act allows secured creditors to take possession over collateral, against which a loan had been provided, upon a default in repayment.
2. This process is undertaken with the assistance of the District Magistrate, and does not require the intervention of courts or tribunals.
3. The Bill provides that this process will have to be completed within 30 days by the District Magistrate
4. Bill empowers the District Magistrate to assist banks in taking over the management of a company, in case the company is unable to repay loans.
5. Act creates a central registry to maintain records of transactions related to secured assets.

2. 4R SOLUTION

1. Economic Survey 2016-17 gives 4R solution to solve TBS problem – Recognize, Recapitalize (Eg Indradhanush), Resolution and Reform. Economic Survey 2016-17  Volume II stress more upon last R i.e. Reform.

3.INDRADHANUSH

1. Indradhanush framework for transforming the PSBs represents the most comprehensive reform effort undertaken since banking nationalization in the year 1970 to revamp the Public Sector Banks (PSBs) and improve their overall performance by ABCDEFG.

1. A-Appointments: Based upon global best practices and as per the guidelines in the companies act, separate post of Chairman and Managing Director and the CEO will get the designation of MD & CEO and there would be another person who would be appointed as non-Executive Chairman of PSBs.
2. B-Bank Board Bureau: The BBB will be a body of eminent professionals and officials, which will replace the Appointments Board for appointment of Whole-time Directors as well as non-Executive Chairman of PSBs
3. C-Capitalization: As per finance ministry, the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore out of which 70000 crores will be provided by the GOI and the rest PSBs will have to raise from the market.
4. D-DEstressing: PSBs and strengthening risk control measures and NPAs disclosure.
5. E-Employment: GOI has said there will be no interference from Government and Banks are encouraged to take independent decisions keeping in mind the commercial the organizational interests.
6. F-Framework of Accountability: New KPI(key performance indicators) which would be linked with performance and also the consideration of ESOPs for top management PSBs.
7. G-Governance Reforms: For Example, Gyan Sangam, a conclave of PSBs and financial institutions. Bank board Bureau for transparent and meritorious appointments in PSBs.

 

4. BANKRUPTCY & INSOLVENCY CODE 2015

1. The Code creates time-bound processes for insolvency resolution of companies and individuals.  These processes will be completed within 180 days.  If insolvency cannot be resolved, the assets of the borrowers may be sold to repay creditors.
2. The National Company Law Tribunal (NCLT) will adjudicate insolvency resolution for companies.  The Debt Recovery Tribunal (DRT) will adjudicate insolvency resolution for individuals.
3. The Code creates an Insolvency and Bankruptcy Fund.

Other Major reforms

Payment and Postal Banks on recommendation of Nachiket Mor Committee to acheive Financial Inclusion and reduce banks burden.

Economic Survey 2016-17 suggests setting up of a centralised Public Sector Asset Rehabilition Agency (PARA)

the Agency will look after the largest, most difficult Cases, and make Politically Tough Decisions to reduce Debt

‘Scheme for Sustainable Structuring of Stressed Assets (S4A) by RBI for resolution of large stressed assets.

Startegic Debt Restructuring involves transferring equity of the company to lenders also enable a change in management control.

1. The Banking Regulation (Amendment) Bill, 2017
2. It seeks to amend the Banking Regulation Act, 1949 to insert provisions for handling cases related to stressed assets.
3. The central government may authorise the Reserve Bank of India (RBI) to issue directions to banks for initiating proceedings in case of a default in loan repayment. These proceedings would be under the Insolvency and Bankruptcy Code, 2016.
4. also be applicable to the State Bank of India, its subsidiaries, and Regional Rural Banks.

Merging of SBI subsidiaries as well as other PSBs to

1. improve efficiency in service delivery
2. to become single biggest lender of bigger infrastructure projects and
3. to achieve top ranking in global ranking.

Marginal Cost of Fund Based Lending Rate (MCLR)

The MCLR rate is the minimum rate below which the banks are not allowed to lend, except in some case allowed by the RBI. It is an internal reference rate for the bank. The MCLR method was introduced in the Indian financial system by the Reserve Bank of India in the year 2016. The MCLR system has replaced the base rate system that was introduced in the year 2010.

Why MCLR was Introduced?

To effectively implement monetary policy, since MCLR is more sensitive to policy rates like Repo rate and Reverse Repo Rate.

Prior to the implementation of MCLR, different banks are using different methods for calculating base rates. Thus, MCLR aims at:

1. To improve the transmission of policy rates into the lending rates of banks.
2. To bring transparency in the methodology followed by banks for determining interest rates on advances.
3. To ensure availability of bank credit at interest rates which are fair to borrowers as well as banks.
4. To enable banks to become more competitive and enhance their long run value and contribution to economic growth.

Calculation of MCLR

MCLR lending rate is dependent on all the sources of bank borrowing. A bank borrows from multiple sources like, fixed deposits, demand deposits, saving accounts, current accounts. Apart from these, banks also invest in equity, whose return are also considered while calculating MCLR.

The formula prescribed by the Reserve Bank of India for calculation of MCLR is given below:

Marginal cost of funds = Marginal borrowing cost x 92% + return on the net worth x 8%

Thus, marginal cost of borrowings has a weightage of 92% while return on net worth has 8% weightage in the marginal cost of funds.

Here, the weight given to return on net worth is set equivalent to the 8% of risk weighted assets prescribed as Tier I capital for the bank.

The marginal cost of borrowing refers to the average rates at which deposits of a similar maturity were raised in the specified period.

Banks must also maintain a cash reserve ratio of 4%. On this deposit, no interest is earned by the bank. Under MCLR, banks can avail some allowance called Negative Carry on CRR. Negative carry on account of’ Cash reserve ratio (CRR)- Negative carry on the mandatory CRR arises because the return on CRR balances is nil. Negative carry on mandatory Statutory Liquidity Ratio (SLR) balances may arise if the actual return thereon is less than the cost of funds.

Also, the operating costs must be considered and taken care of. There are several expenses of a bank that includes raising funds, opening branches, paying salary to its employees etc. These are not charged to the customers. Operating Cost associated with providing the loan product, including cost of raising funds, but excluding those costs which are separately recovered by way of service charges.

Finally comes the discount or tenor premium. The reset period for the interest rate is called the tenor. It is directly proportional to the reset period i.e. the tenor is higher if the reset period is higher. Tenor Premium- The change in tenor premium cannot be borrower specific or loan class specific. In other words, the tenor premium will be uniform for all types of loans for a given residual tenor.

Thus, MCLR depends on

1. Tenor premium,
2. Operating costs of the bank,
3. Negative carry on Cash Reserve Ratio, and
4. Marginal cost of funds.

Conclusion

1. Banks are the backbone of every economy. The banks are the lifelines of the economy and play a catalytic role in activating and sustaining economic growth, especially, in developing countries and India is no exception.
2. The Indian banking sector is at a critical juncture in its evolution. It is now clear that the slump in credit growth and increase in stressed assets has affected the profitability of all banks, and threatens the very survival of some of them. To maintain impetus of economic growth with achievement of SDGs we need strong banking system.
3. Certain building blocks for the reorientation of the banking structure with a view to addressing various issues such as enhancing competition, financing higher growth, providing specialized services and furthering financial inclusion have been initiated but need to focus on implementation.
4. Vision 2020 of banking system should incorporate Transformed Banking models with emerging technologies like IT revolution,Robotics, Artificial Intelligence and FINTECH solutions to make banking affordable and accessible.
5. In order to achieve more faster and inclusive growth and to make major govt initiatives (–Make in india, Financial Inclusion etc ) overhaul reforms in banking sector is imperative.

Questions

1. Banking Sector in India is crippled with multidimensional problems like mounting Twin Balance sheet Syndrome (TBS), Merging banks causing structural problems, loss of employment, difficulty in recognizing defaulters etc. What are the government initiatives to tackle such problems?
2. Banking Reforms is not a new word to the financial sector. Explain the Banking Sector reforms taken place till now and those which are yet to be rolled out in the immediate future, in detail.

References:

1. Newspapers: The Hindu, Indian express, live mint.

2. Economic Survey 2016-17 and 2017-18.

3. RBI Site

4. PRS legislative

5. Rajyasabha and news on Air.

6. Min of Finance.