Money and Banking Chapter of Economy is a very important chapter. While the money part includes the aspects related to currency and digital payment system of India, the Banking part includes the structure of the banking sector and general issues related to it.
Money and Banking News and updates
RBI’s proposal for regulation of the Microfinance sector- Explained, pointwise
Recently, the Reserve Bank of India has released a Consultative Document on Regulation of Microfinance sector. The document aimed to address the concerns related to the over-indebtedness of microfinance borrowers and empowering them. The document proposes that there should be no prepayment penalty and collateral for all microfinance loans. The introduction of regulation is much needed, as the Microfinance Institutions loan portfolio has reached Rs 2.31 lakh crore at the end of FY2020, touching the lives of 5.89 crore customers.
The microfinance sector has grown rapidly in India over the past few decades. Currently, the microfinance sector is serving around 102 million accounts (This includes banks and small finance banks) of the poor population of India. But still, there are certain inherent challenges associated with the Microfinance sector.
What are Microfinance Institutions?
These are organizations that offer financial services to low-income populations. They provide services such as micro loans(all loans that are below Rs.1 lakh), micro-savings, and microinsurance.
Microfinance Institutions provide small loans to people who do not have any access to banking facilities. Their area of operation includes rural areas and among low-income people in urban areas.
The Non-Banking Financial Company -Micro Finance Institutions (Reserve Bank) Directions, 2011 of the Reserve Bank of India (RBI) is regulating all the Non-Banking Finance Company (NBFC)-MFIs in India
Salient provisions of RBI document on Regulation of Microfinance sector
The suggested framework in the Document is intended to be made applicable to the microfinance loans provided by all entities regulated by the Reserve Bank. After the consultation, the RBI will release the overall guidelines for the regulation of the Microfinance Sector.
- A common definition of microfinance loans: there is no common definition for microfinance loans available from various microfinance entities in India. The document aims to provide one common definition for all regulated microfinance sector entities.
- Capping the outflow on account of repayment of loan obligations of a household to a percentage of the household income. Further, borrowers can determine the period of repayments as per their requirements.
- A Board approved policy for household income assessment.
- There should be no pre-payment penalty; no collateral requirement, and greater repayment frequency for all microfinance loans.
- Alignment of pricing guidelines for NBFC-MFIs with guidelines for NBFCs.
- Introduction of a standard simplified fact sheet on the pricing of microfinance loans. Further, MFIs need to display minimum, maximum and average interest rates charged on microfinance loans on their websites for greater transparency.
- Aligning pricing guidelines for NBFC-MFIs with guidelines applicable to NBFCs
Need for RBI document on Regulation of Microfinance sector
- Decade-old rules and regulations: At present, Microfinance Institutions are governed by NBFC-Micro Finance Institutions (Reserve Bank) Directions, 2011. So the new document is much needed to govern the growth and misuse of Microfinance Sectors.
- Increased share of banks and small finance banks: After 2015 the banks and small finance banks started increasing their operations in Microfinance Sector. At present, only 35% of the Microfinance sector lies with the MFIs, the rest are with banks and small finance banks. This resulted in the following difficulties,
- The RBI’s 2011 directions did not cover around 70 percent share in the microfinance portfolio.
- This created a non-level playing field among the Microfinance Sector.
- The issue of Over-indebtedness and Multiple Lending: small borrowers are able to get multiple loans from several lenders, contributing to their over-indebtedness.
So, for creating a level playing field and cover all the regulated entities (REs) engaged in the microfinance sector, a new regulation is necessary.
Significance of RBI document on Regulation of Microfinance sector
- Provides a new interest rate regulatory system for MFIs: The regulations provide a more market-based interest system. Further, the transparent pricing mechanism will provide competition among players in the microfinance sector to bring down the interest rates.
- The centrality of the borrower: Further, the new document places the borrower (i.e Customer) at the center of the microfinance sector. It empowers the borrowers to make an informed decision, the framework.
- At present, with the rise in competition in the microfinance sector, the interest rates are not getting lower.
- The document also protects the microfinance borrowers from over-indebtedness (As the document mentions that the payment of interest/loan will not exceed 50% of monthly income)
- No prepayment penalty: This will aid the borrower(low-income households) and provide greater flexibility in repayment of the loan.
- Venture into other types of loans: As the consultative document removed the time limit of the loan, the institutions in the microfinance sector now can provide other types of loans. Such as affordable housing loans, loans for renewable energy, sanitation requirements, etc.
- Provides overall growth of the microfinance sector: With these guidelines, more and more small finance banks and banks can venture into the microfinance sector and provide benefits to a rural and low-income population.
- Facilitates financial inclusion: The borrower will have a wide variety of institutions to cater to his/her needs specifically. This will help in financial inclusion.
Challenges with the microfinance sector in India
- Sustainability of MFIs: MFIs generally lack access to capital. Many Microfinance Institutions are socially-oriented institutions and have little access to financial capital. So, they charge high rates of interest to attain sustainability. This was passed on at higher interest rates from their clients (who are “interest insensitive”).
- Impact on profits: The SLR and CRR requirements of Microfinance Institutions hampers short-term profits of microfinance sectors. Along with the operating expenses, their profit margin is very less.
- Impact of COVID-19 pandemic: The pandemic has impacted the microfinance sector more compare to other credit institutions. Their loan collections have taken a hit, and loan disbursals are yet to observe any meaningful growth.
Suggestions to improve the microfinance sector
The consultative document provides holistic reform in the microfinance sector. Along with that, certain measures can be taken to improve the sector further. Such as,
- Introduction of Digital technologies: Like regular banking, the MFIs also have to embrace complete digital formats for providing loans. This will improve digital literacy also among the public as MFIs focus on the low-income population.
- Creation of Social Impact Scorecard: The RBI should encourage all the entities in the Microfinance sector to create a Social impact scorecard and to update it regularly. This will be helpful to measure the societal change and also help in framing government policies for the low-income populations based on their specific needs.
- Creation of authenticated customer data: If the consultative policy turned into policy, then the MFIs cannot charge payment of interest/loan exceeding 50% of monthly income. Since the MFIs function for the low-income population, the field officers might face challenges in calculating the exact income of the household. So, apart from approving the household income, the board should also create an authenticated data of households, by including all revenue sources of low-income populations.
- Verification after loan: Many times people will get the loan and use them for commercial purposes like buying mobile phones, paying interest to the moneylender, etc. The MFIs have to verify and update the loan has been properly used for the stated purpose and not for any other purpose.
The RBI’s Consultative Document on Regulation of Microfinance sector alters the complete functioning of the microfinance sector in India. The guidelines provide much-needed reforms and pave the way to recover the microfinance sector from the dreadful Covid-19 pandemic. But along with that, the RBI may introduce other suggestions to ensure the smooth functioning of MFIs.
Significance of SC Ruling on Personal Guarantors for Corporate Loans
Synopsis – The Apex Court has dismissed all challenges to the liability of personal guarantors for corporate loans under the insolvency code.
The Supreme Court upheld a government notification of 2019 issued under the Indian Insolvency and Bankruptcy Code (IBC).
- This allows banks to initiate insolvency proceedings against personal guarantors who are usually promoters and top officials of debt-laden companies.
- Also, approval of a resolution plan for the corporate debtor does not end the personal guarantor’s liability.
Central Government’s 2019 notification – It made personal guarantors a separate category of individuals. They can be approached for recovery for defaults. They can do it under the IBC as part of the insolvency proceedings against defaulting corporate entities.
This gives additional powers to lenders [financial institutions or banks] under IBC, to recover their money.
- In response to the 2019 notification– There were more than 40 petitions filled, where petitioners had challenged the validity and operationalization of the central notification.
- However, the SC dismissed all the petitions stating that the government right.
Significance of Ruling
- Firstly, the SC judgment will boost recovery efforts of banks involving piles of bad loans.
- This will enable banks to take simultaneous action against corporate debtors and personal guarantors.
- As a result, the promoters [as the provider of personal guarantees] have to deal with their own insolvencies and not become an impediment/roadblock to the insolvency proceedings of the corporate debtor.
- Secondly, by roping in guarantors, there is a greater chance that they would “arrange” for the payment of the debt to the creditor bank to save themselves.
- Thirdly, as guarantors can be approached even if an insolvency proceeding is ongoing, Banks can enhance recovery. Because most banks agree to ‘haircuts’ when negotiating a resolution plan with a new promoter for the defaulting company.
The judgment provided the much-needed teeth to banks and financial institution far as recovery action with respect to personal guarantees was concerned.
SC Ruling on Personal Guarantor’s Liability for Corporate Debt
What is the News?
The Supreme Court has upheld the government’s move to allow lenders to initiate insolvency proceedings against personal guarantors.
Who is a personal guarantor?
- To showcase their intent to repay the bank loan on time, the promoters of some big business houses submit a personal guarantee to the lenders. It secures them loans easily and timely.
- It is sort of like an assurance from the owner or the owners of the company that the money borrowed by their company for various purposes shall be repaid on time as per the agreed schedule.
- Furthermore, it is different from the collateral. Indian corporate laws say that individuals such as promoters are different from businesses and the two are very separate entities. Thus, a promoter can give a guarantee for the company it is running
What is the issue?
- In 2019, the Government issued a notification. It allowed creditors, usually financial institutions and banks, to make a move against personal guarantors under the Indian Bankruptcy and Insolvency Code(IBC).
- The intention was to hold the guarantor promoters liable for the defaulting companies against loans.
- However, the notification was challenged by the promoters, claiming that it was always a management board that ran the company. Therefore, the promoters alone should not be held liable for the default on debt repayment.
What has the Supreme Court said?
- The Supreme Court has upheld the notification issued by the Government.
- The court said that there is a close connection between personal guarantors and their corporate debtors. Hence, it was this connection that made the government recognise personal guarantors as a separate category under the IBC.
Significance of this judgment:
- This judgment assumes significance as it will now allow lenders to go after personal guarantors even while bankruptcy proceedings against the ailing companies are pending. This will speed up the process for the recovery of dues.
Source: The Hindu
RBI to transfer Surplus Profit to Central Government
What is the News?
The RBI (Reserve Bank of India) Central Board has approved the transfer of Rs. 99,122 crore as surplus to the central government.
RBI’s Transfer of Surplus to Government:
- The Reserve Bank of India(RBI) transfers its surplus profits to the Government every year. It is according to the provisions of Section 47 of the Reserve Bank of India Act, 1934.
- Section 47 says that surplus profits of the RBI are to be transferred to the government. Surplus profit is the profit left after making various contingency provisions for bad and doubtful debts, depreciation in assets, contributions to staff, and superannuation funds, etc.
RBI transfer to Government for 2020-21:
- RBI has decided to transfer the surplus for the nine-month period of June 2020 to March 2021.
- This was because RBI in 2020 has changed its accounting year to April-March from the earlier period of July-June.
- Further, RBI has transferred the amount by keeping into account the Bimal Jalan Committee. The committee recommended that the RBI maintain a minimum Contingency Risk Buffer of 5.5% of its balance sheet.
Significance of this RBI Transfer to Government:
- The RBI’s transfer to the government is above the budgeted expectations. The budget had estimated to receive a surplus of about ₹50,000 crores from the RBI for 2021-22.
- Reason: This was because of the higher earnings of RBI from open market operations as well as receipts from foreign currency sales,
- Moreover, this is the highest ever transfer by the RBI to the Government in an accounting period barring 2018-19.
- In 2018-19, RBI transferred ₹1.76 lakh crore to the government which included a one-time transfer of extra reserves.
Impact of this Transfer: The higher-than-expected transfer will help the Government to absorb losses as:
- The government is expecting a sharp fall in tax collections due to the severe second wave of COVID-19 which has forced lockdowns in several States.
- The government is also likely to find it challenging to meet its privatization and disinvestment target of $24 billion.
- The revenue from the Goods and Services Tax(GST) is also likely to fall.
- Moreover, the government is also under pressure as it has no option to cut expenditure given that it needs to increase investment and spur growth.
Source: The Hindu
RBI’s Economic Measures to Tackle 2nd Wave of Covid-19
What is the News?
The Reserve Bank of India(RBI) has announced measures to help India to tackle the unprecedented Covid-19 crisis during the second wave.
Measures announced by the RBI:
On-Tap Liquidity Facility:
- RBI has opened a Rs 50,000-crore on-tap liquidity window with a tenor of up to three years.
- Banks can borrow from this facility at the repo rate of 4% till March 31, 2022.
- Banks can lend the amount to a range of entities linked directly and indirectly to the healthcare sector.
- These loans will be classified under priority sector lending till the repayment or maturity whichever is earlier.
- Further, Banks are expected to create a ‘Covid loan book’ under the scheme.
- By creating such a loan book, banks can park surplus liquidity up to the size of the ‘Covid loan book’ with the RBI. The banks will get 40 bps higher than the reverse repo rate for these funds.
Liquidity Support for Small Finance Banks(SFBs):
- RBI will conduct a special three-year long-term repo operation (SLTRO) worth Rs 10,000 crore at a repo rate for small finance banks.
- SFBs will, in turn, use these funds to lend to the small business units. This includes micro and small industries and unorganised sector entities adversely affected during the current wave of the pandemic.
- The lending cap of these funds is fixed up to Rs 10 lakh per borrower.
Wider ‘Priority Sector’ Benefits for SFBs:
- SFBs will be permitted to provide fresh lending to smaller Micro Finance Institutions(MFIs) (with asset size of up to Rs 500 crore).
- Further, there will be concessions on interest rates and repayments. This facility is also available up to March 31, 2022.
Resolution framework 2.0 for individuals, small businesses and MSMEs:
- The RBI mentions few criteria for eligibility to Individuals, borrowers and MSMEs for Resolution Framework 2.0. Such as
- Individuals, borrowers and MSMEs with aggregate exposure up to Rs. 25 crore
- Also, they must not avail of loan restructure under any previous frameworks
- Those who were classified as ‘standard’ on 31 March 2021
- The restructuring under this new framework can be invoked till 30 September 2021. After invoking the restructuring will be implemented within 90 days.
Credit to MSME Entrepreneurs:
- In February 2021, the banks were allowed to deduct credit disbursed to new MSME borrowers from their net demand and time liabilities (NDTL). This is used to calculate the cash reserve ratio (CRR)
- To further incentivise the MSMEs this exemption is widened. Thus, it is made available for exposures up to Rs 25 lakh and credit disbursement up to the fortnight ending October 1, 2021.
- This facility will now be extended till December 31, 2021.
Overdraft(OD) facility for states
- The RBI also announced certain relaxations in Overdraft(OD) facilities of State Governments. This is to facilitate better management of their financial situation in terms of cash flows and market borrowings.
- Accordingly, the maximum number of days of OD in a quarter is increased from 36 to 50 days.
- Further, the number of consecutive days of OD is also increased from 14 to 21 days.
Source: Indian Express
RBI Joins “Network for Greening the Financial System”
What is the News?
Reserve Bank of India(RBI) has joined the Network for Greening the Financial System (NGFS) as a Member.
About Network for Greening the Financial System(NGFS):
- Firstly, NGFS was launched at the Paris One Planet Summit in December 2017.
- Secondly, it is a group of Central banks and financial supervisors. The NGFS aims to accelerate the scaling up of green finance and develop recommendations for central banks’ role in climate change.
- Thirdly, it is located at the Bank of France headquartered in Paris.
- Fourthly, as of April 2021, the NGFS consists of 90 members and 13 observers.
- Significance for RBI: As Green Finance has assumed significance in the context of climate change. So the RBI expects to benefit from the membership of NGFS by learning and contributing to global efforts on Green Finance.
Source: Hindu Businessline
New Umbrella Entity for Payment System – Explained, Pointwise
The RBI in August last year released a framework for setting up New Umbrella Entity or entities. These Entities will carry out various payment services, similar to the ones being provided by the NPCI right now.
Recently the Reserve Bank of India said that it is not in favour of having direct and supervisory control over the New Umbrella Entities. Instead, the RBI wants agencies such as the National Payments Corporation of India (NPCI) or a newly formed body to take over the role.
However, creating a regulatory agency is not only time and money consuming but also reduces RBI’s power to control the entity itself.
What is New Umbrella Entity?
In February 2020, RBI proposed to create an alternative umbrella organisation for retail payments. This is to prevent the monopoly of the National Payment Corporation of India(NPCI). Presently NPCI is taking care of all retail payments systems in India.
As envisaged by the RBI, New Umbrella Entities will be a not-for-profit company. They will set up, manage and operate new payment systems. New payment systems include wallet transactions, Aadhaar-based payments, and remittance services, UPI transactions, ATMs, white-label PoS, etc.
Need for New Umbrella Entity:
- Enhance competition: At present, the NPCI is the only entity handling the payment system. So, it is not for sure that the transaction costs are the lowest, or they cannot be reduced further. Similarly, the competition will also provide a variety of product offerings in the payment system.
- The monopoly of NPCI: Private players in the payments space have expressed few concerns with the NPCI. Further, the NPCI is the only entity managing all retail payments systems in India. So, the New Umbrella Entities will enhance the competition and improve the service delivery in the retail digital payment ecosystem.
Functions of New Umbrella Entities
As per the RBI, the following will be the functions of these NUEs;
- They will develop new payment standards, methods, and technologies.
- They will operate in clearing and settlement systems. Furthermore, they will also identify and manage relevant risks. This includes risks related to settlement, liquidity, credit, and operation.
- New Umbrella Entities will also preserve the integrity of the retail payment system.
- These entities will monitor the system both nationally and internationally to prevent shocks, frauds, and challenges that affect the system in general.
RBI framework related to the New Umbrella Entities
The RBI in its framework mentioned certain guidelines for New Umbrella Entities. These are,
- Capital: The pan-India new umbrella entity(NUE) or entities will focus on retail payment systems with a minimum paid-up capital of Rs 500 crore.
- However, the RBI will not permit any single promoter or group to hold more than 40% investment in the NUE. Also, the NUE should maintain a minimum net worth of Rs. 300 crore at all times.
- Ownership: Further, the promoter or the promoter group of the NUE should be ‘owned and controlled by residents’ with 3 years of experience in the payments ecosystem.
- Governance: The entity has to follow corporate governance norms set by the RBI. The RBI will retain the right to approve the appointment of directors and nominate a member on the entities’ board.
- Foreign Investment: As long as the NUE’s comply with the other guidelines the Foreign Investment is allowed.
Need for the New regulator/NPCI to regulate New Umbrella Entities
- The quantum of digital transactions in the country: The retail transfers in the country expanded enormously. For example, in 2020-21 alone Rs. 165 lakh crores of money transferred in 27 billion transactions. This requires a regulator to oversee the transactions and ensure proper service delivery.
- RBI is not having the capacity: RBI will need a huge upfront cost to create a regulatory body for these NUEs. So the RBI thinks it can be left to NPCI or any new regulator.
- Better functioning of NUEs: The new regulator/NPCI can handle the customer queries, granting licenses, monitoring the functions of the NUE in a better way.
Challenges with vesting the regulatory control of NUE to NPCI or a new regulatory body
- Various challenges with letting NPCI regulate NUEs:
- Many of the New Umbrella Entities are also the shareholders of the NPCI. So, if the regulatory control is vested with them, then there will be a conflict of interest between developing the NUE and controlling NUE.
- Further, the NPCI is seen as a competitor to the NUEs. So letting them regulate might diminish the competition.
- Also, the NPCI is performing very well in promoting the digital leap of India. Asking it to take over the regulatory function will also reduce its capacity and hamper India’s digital progress.
- Various challenges associated with creating a new regulator:
- Creating a new regulator with enough capacity, manpower and regulatory capability from the top-down is a great challenge.
- Delay in creating the regulator or hurrying it to work faster will pave way for the New Umbrella Entity to exploit the loopholes.
- Other challenges: By leaving the power of regulation to NPCI or a new body will distant the RBI from the digital payment ecosystem. As the digital payment ecosystem is considered as the future of the economy, thus it is important that it is regulated directly by a capable body like RBI.
- The question of data privacy and data theft: The new regulator/NPCI will have to strengthen the data security infrastructure right from the beginning as digital payments are already increasing in the country. For example, the recent data breach in BHIM and Mobikwik payment apps.
- Ambiguity in the function of the regulator: There is no clarity on RBI’s relationship with the regulator post the formation. For example, will the RBI have regulatory control over the regulator? If the regulator is independent, then it may not function as efficiently as the RBI.
Solutions to regulate New Umbrella Entities:
- Create a new body or restructuring the NPCI: The RBI can set up a new regulator for NUEs, or it can restructure the NPCI board to avoid conflict of interest.
- The RBI has to take up the regulatory responsibility of NUEs. Because;
- The RBI can use the existing capacity to generate enough infrastructure to regulate these NUEs.
- Also, the cost of setting up the infrastructure for the regulator will be the least for a regulator like RBI than the new regulator. As there is enough manpower, capital, technological capability available.
- So, the RBI has to set up a separate branch/division to regulate these New Umbrella Entities.
- The multiplicity of the regulator: India so far has created too many regulatory bodies in the financial space such as RBI, SEBI, PFRDA, IRDAI, etc. So, the government has to perform the review and consolidation of these regulatory bodies. This will ensure consistent and predictable signals to the market. Further, limited regulators can work cohesively and efficient manner.
- Building privacy by design: The government has to pass the Data Protection Bill. This will make NUE store data within India and provide users the right to privacy in the digital space. Further, the government has to strengthen the RBI’s digital capability.
The New Umbrella Entities are transforming India’s retail payment system from cash to cashless transactions. With further digitization, their operations are going to expand. So regulating them is a necessary step to infuse checks and balances in the retail digital payment space. But, the RBI has to take responsibility for that, instead of transferring power to others.
Introducing National Digital Currency in India – Explained, Pointwise
There is uncertainty over the legal status of digital currencies in India. An unofficial estimate mentions that Indian investors holding around $1.5 billion (Rs 10,000 crore) in digital currencies. The inter-ministerial committee (IMC) suggested a ban on private digital currencies, but it favors RBI-backed National Digital Currency or central bank digital currency (CBDC).
The draft Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 aims to prohibit all private cryptocurrencies. The Bill also aims to lay down the regulatory framework for the launch of an “official digital currency”.
What is the CBDC or National Digital currency?
A Central Bank Digital Currency (CBDC), or national digital currency, is simply the digital form of a country’s fiat currency. Instead of printing paper currency or minting coins, the central bank issues electronic tokens. This token value is backed by the full faith and credit of the government.
The growth of cryptocurrencies such as Bitcoin, Dogecoin, Ethereum etc raised challenges to fiat currencies. Along with their other vulnerabilities made the central bank of each country explore the possibility of introducing their own digital currencies.
According to the Bank for International Settlements, more than 60 countries are currently experimenting with the CBDC. There are few Countries that already rolled out their national digital currency. Such as,
- Sweden is conducting real-world trials of their digital currency (krona)
- The Bahamas already issued their digital currency “Sand Dollar” to all citizens
- China started a trial run of their digital currency e- RMB amid pandemic. They plan to implement pan-china in 2022. This is the first national digital currency operated by a major economy.
National Digital Currency in India
With the growth of digital currencies worldwide, various start-ups dealing with cryptocurrency have come up in India, such as Unocoin in 2013 and Zebpay in 2014. Further, their volatility is a cause of concern for India.
So the government-appointed SC Garg Committee for suggestions. The committee recommended banning cryptocurrencies and allow an official digital currency. Further, the committee also drafted a bill Banning of Cryptocurrency & Regulation of Official Digital Currency Bill.
- The panel recommended banning anybody who mines, hold, transact or deal with cryptocurrencies in any form. Further, the panel recommend a jail term of one to 10 years for exchange or trading in digital currency.
- The panel also proposes a monetary penalty of up to three times the loss caused to the exchequer or gains made by the cryptocurrency user whichever is higher.
- The panel also recommended completely banning all private cryptocurrencies in India.
- However, the panel said that the government should keep an open mind on the potential issuance of cryptocurrencies by the Reserve Bank of India.
Post submitting the panel report and the draft bill the government held discussions with stakeholders and conduct Inter-ministerial discussions. The government decided to provide a 3-6 month exit period prior to banning the trading, mining, and issuing of cryptos. The RBI also already started working on CBDC.
Challenges with non-state digital currency
- Safety and security of cryptocurrencies: This is one of the key issues with cryptocurrency. Mt Gox bankruptcy case is a highlight of this. Mt gox is a Tokyo-based cryptocurrency exchange. After the cyberattack, several thousands of bitcoin went lost and the company is yet to settle the claim.
- No investor protection: Since the cryptocurrency transactions are anonymous in nature, there is no investor/consumer protection in cryptocurrencies.
- Conflict of interest: Globally, crypto-currency exchanges act as both custodian and a regulator. So, their own interest and consumer protection get into conflict.
- Non-regulation: There are some cryptocurrency regulators who often indulge in money laundering and terrorism financing. Further, they are immune to the Central Bank regulation of various countries.
- The volatility of cryptocurrency: Many cryptocurrencies have only a limited amount of coins. For example, Bitcoins fixed the maximum possible number as 21 million. This creates an increase in demand with each passing day and creates instability in exchange rates. This made the cryptocurrency more volatile in nature.
Advantages of rolling out National Digital Currency
- Improving efficiency in the financial system: As the currency in digital form, it can provide an efficient way for financial transaction. Further, digital currency also solves the challenges with Cash and coins. Cash and coins require expenses in storage and have inherent security risks like the recent heist in the RBI currency chest.
- Reducing systemic risk: There are about 3,000 privately issued cryptocurrencies in the world. According to IMF, the key reason for considering national digital currency is to counter the growth of private forms of digital money. There is a possibility of these companies going bankrupt without any protection. This will create a loss for both investor and creditor. But the National Digital currency has government backing in case of any financial crisis.
- Opportunity to private players: As the state-backed digital currency can provide investor/consumer protection, the private can confidently invest in the associated infrastructure without any doubts over its regulation. This will improve the services to people.
- Reduce volatility: The national digital currency will be regulated by the RBI. So, there will be less volatility compared to other digital currencies.
- Helps in better macroeconomic management: Current RBI’s work on inflation targeting can be extended to national digital currency also. Since India is planning to ban other cryptocurrencies, the RBI can better regulate digital and fiat currency. Thus upgrading to digital currency and balancing the macroeconomic stability.
Challenges in rolling out National Digital Currency
- Potential cybersecurity threat: India is already facing many cyber security threats. With the advent of digital currency, cyberattacks might increase and threaten digital theft like Mt Gox bankruptcy case.
- Lack of digital literacy of population: Introduction of digital currency is technological advancement. But as per Digital Empowerment Foundation in 2018 report, around 90% of India’s population is digitally illiterate. So, without creating enough literary awareness introduction of digital currency will create a host of new challenges to the Indian economy.
- Challenge in regulation and taxation: Introduction of digital currency also creates various associated challenges in regulation, tracking investment and purchase, taxing individuals, etc.
- Threat to Privacy: The digital currency must collect certain basic information of an individual so that the person can prove that he’s the holder of that digital currency. This basic information can be sensitive ones such as the person’s identity, fingerprints etc.
- The government can follow the western concept of treating digital currency as property and imposing capital gains tax.
- Enhance digital literacy: The government has to create enough awareness campaigns and inform people about identifying fraudulent methods. This will reduce India’s digital divide.
- Creation of adequate cybersecurity methods: Before the introduction of National Digital currency the government has to create certain important things, such as,
- Training of law enforcement agencies on handling any threats
- Creating a policy of basic information assessed while issuing, verifying someone’s digital currency.
There is no doubt that the introduction of National Digital currency prevents the various threats associated with the private-owned cryptocurrencies and take India the next step as a digital economy. But the government has to create necessary safeguards before rolling out.
“Asset Reconstruction Companies” – Sudarshan Sen Committee Set-up
What is the News?
The Reserve Bank of India(RBI) has set up the Sudarshan Sen committee to review the working of Asset Reconstruction Companies (ARCs) Comprehensively. It will recommend suitable measures for enabling them to meet the growing requirements.
Headed by: The committee will be headed by Sudarshan Sen, the former executive director, Reserve Bank of India (RBI).
About Asset Reconstruction Company (ARC):
- Asset Reconstruction Company (ARC) is a specialized financial institution that buys the Non-Performing Assets (NPAs) from banks and financial institutions. It helps banks in cleaning up their balance sheets.
- Thus, it helps banks to concentrate on normal banking activities. Banks, Instead of going after the defaulters, can focus on selling their bad assets to the ARCs at a mutually agreed value.
- Legal Basis: SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, 2002 provides the legal basis for the setting up of ARCs in India.
- Functions under: ARCs function under the supervision and control of the Reserve Bank of India (RBI).
Read Also:-What is a Bad Bank & What is Bad Bank .
Capital Requirements for an ARC:
- As per the SARFAESI Act, ARCs should have a minimum net owned funds of Rs. 100Cr.
- The ARCs also have to maintain a capital adequacy ratio of 15% of its risk-weighted assets.
- The amount of Risk-weighted assets helps to determine the minimum capital that a bank must hold to reduce the risk of insolvency.
What are the resolution strategies of an ARC? As per the SARFAESI Act, an ARC can:
- Restructure or reschedule the loan
- Enter into settlements,
- sell or lease the borrower’s business,
- take over or change the management, and
- Also, engage in security interest enforcement (sell, take possession, or lease the owned asset).
- But enforcement or security interest can only be conducted when at least 75% of secured creditors and the ARC are in agreement.
What are sources of funds for ARCs?
An ARC can issue bonds, debentures, and security receipts to meet its funding requirements.
Read Also:-IDBI Bank out of “PCA framework
It is a receipt that an ARC issues to a Qualified Institutional Buyer (QIB). Whereas, QIB receives the title, right, or interest in the financial asset that ARC buys. It also means these Security receipts are backed by discounted bad debts that an ARC owns.
Whereas, ARC uses this fund to make an upfront payment to buy the discounted bad debts.
Furthermore, an ARC can only raise investments from Qualified Institutional Buyer (QIB).
How are ARCs different from the IBC?
- The Insolvency and Bankruptcy Code (IBC) aims at the resolution and reorganization of insolvent companies. Whereas, ARCs are set up for clearing up NPAs.
- ARCs primarily deal with recovery. Whereas, the IBC seeks a resolution of insolvency. Further, in the IBC Process, creditors can make insolvency resolution an economically viable process and entities can apply for insolvency, bankruptcy, or liquidation.
Source: The Hindu
India on US’s “Currency Watch list”
What is the News?
The US treasury places India along with 10 other countries on its currency watch list.
What is Currency Manipulator:
- Current Manipulators are countries engaging in “unfair currency practices” by deliberately devaluing their currency against the dollar.
- The practice would mean that the country in question is artificially lowering the value of its currency. By that, it aims to gain an unfair advantage over others.
- This is because the devaluation would reduce the cost of exports from that country. Thus, more exports will result in a reduction in trade deficits.
Criteria: US places a country on Currency Watch List if it is meeting any two of the below three criteria. This includes:
- A “significant” bilateral trade surplus with the US — at least USD 20 billion over a 12-month period.
- A current account surplus equivalent to at least 2% of gross domestic product (GDP) over a 12-month period.
- “Persistent”, one-sided intervention — when net purchases of foreign currency totals at least 2% of the country’s GDP over a 12-month period. Further, it is conducted repeatedly, in at least six out of 12 months.
Impact: The designation of a country as a currency manipulator does not immediately attract any penalties. However, it lowers the confidence about a country in the global financial markets.
Why was India included in the Currency watch list?
- India has met two of the three criteria — the trade surplus criterion and the “persistent, one-sided intervention” criterion.
- Further, the other 10 countries on the list with India are China, Japan, Korea, Germany, Ireland, Italy, Malaysia, Singapore, Thailand, and Mexico. All of these, except Ireland and Mexico were on the December 2020 list.
Source: The Hindu
A Balanced Approach Under IBC Amendment Ordinance 2021
Synopsis: The new Insolvency and Bankruptcy Code amendment ordinance 2021 shows a shift from a creditor-centric approach towards a more balanced approach. Under the new approach, both promoters and creditors are incentivized to reach a more acceptable solution.
- The President has promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance 2021.
- It marks a shift from earlier approaches against the promoter and focussed on the creditor. Under this, the creditor was given the main control over the insolvency process while the promoter hardly had any say.
About the amendment:
- It tries to address the structural weakness in IBC by allowing a pre-packaged insolvency resolution process (PPIR).
- PPIR is a form of restructuring that allows creditors and debtors (or promoters) to work on an informal plan within the IBC structure.
- It is done before the commencement of insolvency proceedings.
- Once accepted by creditors, the plan must be presented to the National Company Law Tribunal (NCLT) for approval.
- The process is available only for MSMEs (Micro, small and medium enterprises).
Difference from earlier approach:
- The amendment has made the process less promoter averse. Now PPIR will ensure promoters are able to retain their control over their business.
- Earlier, the control was given to a resolution professional. He/she was appointed to manage the affairs of the company during the insolvency process.
- The promoters did not have control due to cases of corruption, crony capitalism, and other fraudulent activities tagged with them. This undermined the creditor’s interest and sanctity of the resolution process.
- Further, the new process doesn’t give the scope of open bidding that was available earlier. This might hinder price discovery and value maximization for creditors.
Benefits of the new amendment:
- More powers to Promoters: They get to hold on to their firms, and exit the process with more manageable obligations.
- Prevents Closure of Genuine Firm: With greater promoter control, the genuine firms will not get closed, like the ones who are not performing due to pandemic stress or other genuine barriers.
- Further, the IBC process suffers from a liquidation bias. Around 46.5 % of all cases under IBC have ended up in liquidation. While only 13.1% witnessed a resolution.
- Creditor Incentivisation: As past data shows that liquidation value is only a fraction of the creditor’s claims and the majority of IBC cases end up in liquidation.
- The new process can help the creditors get better value for their debt. Especially economic distress when there are limited buyers of stressed assets.
- Better Coverage: The PPIR process doesn’t fall under the central bank’s restructuring framework. It covers all financial creditors as opposed to RBI’s restructuring schemes which deal only with banks.
- Prevents future scrutiny: PPIR involves approval by a judicial seal that prohibits any future questioning by investigative agencies.
- The PPIR process gradually should made available to all corporate debtors.
- The government can also relax the terms of Section 29A of IBC in order to widen the list of possible buyers.
- The section disqualifies those who had contributed to the downfall of the corporate debtor or were unsuitable to run the company.
Source: Indian Express
RBI sets up “Regulations Review Authority 2.0”
What is the News?
Recently, the Reserve Bank of India(RBI) announced the setting up of a new Regulations Review Authority(RRA 2.0).
About Regulations Review Authority(RRA):
- The RBI earlier set up the first RRA for a period of one year from April 1, 1999. This is for reviewing the regulations, circulars, reporting systems, based on the feedback from the public, banks and financial institutions.
About Regulations Review Authority(RRA 2.0):
- Regulations Review Authority(RRA 2.0) will streamline the regulatory instructions, reduce the compliance burden of the entities under regulations. The RRA 2.0 will achieve this by simplifying procedures and reduce reporting requirements wherever possible.
- Headed by: M Rajeshwar Rao, Deputy Governor of RBI has appointed as the head of the Regulations Review Authority 2.0.
- Duration: The authority will be set up for a period of one year from May 1. But, RBI can extend its tenure.
Terms of Reference of RRA 2.0: The terms of reference of RRA 2.0 include:
- Firstly, making regulatory and supervisory instructions more effective by removing redundancies and duplications.
- Secondly, to obtain feedback from regulated entities on simplification of procedures and enhancement of ease of compliance.
- Thirdly, RRA will reduce the compliance burden on regulated entities by streamlining the reporting mechanism; revoking obsolete instructions if necessary.
- Fourthly, to examine and suggest the changes required in the dissemination process of RBI circulars/ instructions.
- Sixthly, to engage internally as well as externally with all regulated entities and other stakeholders to facilitate the process.
Source: The Hindu
What is a “Currency Chest”?
What is the News?
A Private Security Guard in Chandigarh has stolen Rs 4 crore from a Currency Chest of Axis Bank.
What is a Currency Chest?
- Firstly, A currency chest is a place where the Reserve Bank of India (RBI) stocks the money meant for banks and ATMs.
- Secondly, Administered by: The RBI administers these chests. Even though these chests are usually situated on the premises of different banks.
- Thirdly, Belongs to: The money present in the currency chest belongs to the RBI. But the money kept in the strong room outside the currency chests belongs to the bank.
- Fourthly, Security arrangement for the chests? The security of currency chests varies from one bank to the other where the chests are situated. The Reserve Bank of India (RBI) reimburses the security expenses to the bank as per the set norms.
- Fifthly, Recovery Procedure if stolen: As per the set guidelines, the bank in which the currency chest is situated is liable to fulfil the loss of the currency chest.
Source: Indian Express
Rupee depreciation and its management
Synopsis: Rupee depreciation and its impact and solutions to protect from currency volatility risks.
Background of Rupee depreciation
- Recently, the rupee fell sharply by 105 paise. It is considered as one of the biggest single-session falls in 20 months.
- Currently, the rupee stands at 74.47 against the US dollar.
What are the reasons for rupee depreciation?
A combination of factors are responsible for rupee depreciation, such as
- One, concerns over Covid-19 has created uncertainty in the market. This affected the FDI(Foreign Direct Investment) and FII(Foreign Institutional Investment). So the rupee weakens further.
- Two, RBI’s Government Securities Acquisition Programme (G-SAP) that seeks to buy bonds worth Rs 1 lakh crore might be one of the reasons. It is a quantitative easing policy followed by RBI. The policy supported the government’s increased borrowing Programme through the infusion of liquidity.
- Three, the strengthening of the dollar against the euro also contributed to rupee depreciation.
- Four, RBI’s status-quo on policy rates is not helping to increase demand in the local economy. This will further impact the rupee.
- Further, the value of the rupee will also be impacted by the high bond yields in the US and the inflow of dollars into the US.
What are the impacts of Rupee depreciation?
It has both positive and negative impacts. For instance,
- Depreciation has a positive impact for an NRI. As they are sending money back home they will get more rupees per dollar.
- Similarly, Depreciation will have negative impacts on fuel costs and education cost in abroad. For example,
- One, A depreciating rupee increases the cost of crude import. A rise in cost of crude raises fuel prices and inflation. Crude import accounts for almost 20% of India’s imports.
- Two, higher education in the US might cost an annual fee of US$ 50,000. A 5% depreciation in the rupee (For example, from 72.5 to 76.125) will raise the cost for one year from Rs 36.26 lakh to Rs 38.06 lakh (Net loss Rs 1.8 lakh)
How to eliminate the Rupee depreciation and currency risk?
There are multiple options to cover the currency volatility risk. They are,
- Investing in international funds that invest in global markets through fund of funds. While the Indian investors invest in rupees, in the fund of funds the money gets invested in dollars at the current exchange rate. In case of rupee depreciation, this fund will fully protect against the currency depreciation risk.
- In this case, if a person planning for a quick investment (4-5 months) in foreign currency, there are two options to eliminate currency risk.
- One, creating a deposit account in the US and transferring the fund abroad.
- Two, going for a currency hedge in the exchanges by investing in future contracts that will mature in 4-5 months. For example,
- A future contract worth $50,000, maturing in July at the rate of 74.5, will pay Rs 37.25 lakh.
- If in December, the rupee depreciates to $77, Then the contract will yield a profit of Rs 1.25 lakh.
Source: Indian Express
New RBI Developmental and Regulatory Policies
What is the News?
Recently RBI released a Statement on Developmental and Regulatory Policies. Under the new RBI policy, the RBI extended fresh support of ₹50,000 crores to the All India Financial Institutions for new lending in FY22. This will help to mitigate the impact of the pandemic and aid economic revival.
RBI policy on Assistance to Financial Institutions:
- NABARD: It will get a special liquidity facility(SLF) of ₹25,000 crores for one year. This is to support agriculture and allied activities, the rural non-farm sector, and non-banking financial companies-microfinance institutions(NBFC-MFI).
- National Housing Bank(NHB): It will get a ₹10,000 crores Special liquidity facility(SLF) for one year. This is to support the housing sector.
- SIDBI: It will get a ₹15,000 crores Special liquidity facility(SLF) for one year. This is to support funding of micro, small and medium enterprises (MSMEs).
Note: All these three facilities will be available at the prevailing policy repo rate.
RBI policy on Banks Lending to NBFCs as PSL:
- Bank lending to NBFCs (other than microfinance institutions) for the sectors that contribute significantly to the economy in terms of export and employment. This will continue as priority sector lending(PSL) till September 30, 2021.
RBI policy on Asset Reconstruction Companies(ARCs):
- RBI will constitute a committee to undertake a comprehensive review of the working of Asset Reconstruction Companies (ARCs).
- As the ARCs grew in number and size the RBI decided to form a committee to study them. Especially their potential for resolving stressed assets was not yet realised fully.
- Hence, the committee will recommend suitable measures to meet the growing requirements of the financial sector.
About Asset Reconstruction Company (ARC):
- Asset Reconstruction Company(ARC) is a specialized financial institution. They will buy the Non-Performing Assets (NPAs) from banks and financial institutions. Further, they will clean up the balance sheets of banks and financial institutions. This helps banks to concentrate on normal banking activities.
- Legal Basis: Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 provides the legal basis for the setting up of ARCs in India.
- Regulated by: ARCs function under the supervision and control of the Reserve Bank of India.
Cut in rate on small saving schemes withdrawn by Finance Minister
Synopsis – The Union government rolls back interest cut on small saving schemes interest rates, blaming the decision on an oversight.
- The finance ministry has reversed its decision to cut interest rates on small savings accounts, citing an error.
- Reversing a rate cut of up to 110 basis points (1.1 percentage points) announced the day before.
- Interest rates on savings deposits have been cut from 4% to 3.5%. The rate of interest in PPF was cut from 7.1% to 6.4.
Reason for the sudden withdrawal of an order
- Due to the elections– The government is attempting to contain the implications of a decision that will affect ordinary citizens in the upcoming elections in West Bengal, Assam, and three other states.
Impact of sudden withdrawing of orders –
- Negative effect on the picture of the bureaucracy’s working – The abrupt rollback decision would damage the bureaucracy’s image.
- Bank aspect- The rollback would make the government’s annual borrowing program of 12.05 lakh crore more difficult. Because the central bank has complained about high small savings rates as a barrier to lower interest rates.
Any deviation or reversal from routine administrative decisions should be scrutinised by the Election Commission
Source – The Hindu
Bad Bank for strengthening the banking sector
Synopsis: Indian banks have started to recover post the pandemic phase. Moreover, the banks will strengthen after the creation of a bad bank as promised in the budget.
- During the pandemic, NPA(Non-Performing Assets) was expected to rise. Thus, Indian banks have written off their balance sheets.
- A write-off is an accounting term through which the book value of an asset is declared to be zero.
- An NPA is a bank loan that is subject to late repayment or is unlikely to be repaid by the borrower in full.
- However, later at the end of the year, a positive recovery was observed. Restructuring requests were reduced and Provision Coverage Ratios (PCR) improved.
- PCR is the ratio of provisioning to Gross Non-Performing Assets.
- It indicates the extent of funds a bank has kept aside to cover loan losses.
- In the recent budget 2021, the government announced a dedicated bad bank.
Reasons behind improvement in the banking system at the year-end
Before the pandemic, banks held substantial capital and built a sizable buffer for dealing with the NPAs. This prevented major degradation of their balance sheets during the pandemic. Further many other reasons were behind this performance.
- Before the pandemic, the RBI instilled a prudent degree of financial discipline in the market. This included decreasing exposure in riskier assets and devising a system of ratings for the borrowers.
- A surge in disposable income and spending capacity of middle-class people will be witnessed. This would cause the valuation of personal financial assets in Asia to reach $69 trillion by 2025. Therefore, bringing more business to India as well.
- Further, the robust monetary management skills of RBI and budget announcements created a sense of positivity in the sector.
- A bad bank will be created under an Asset Reconstruction Company (ARC)-Asset Management Company (AMC) structure.
- National Asset Reconstruction Company (NARC) will acquire stressed assets in an aggregated manner from lenders. National Asset Management Company (NAMC) will act as a resolution manager for the acquired assets.
Benefits of Bad Bank:
- Firstly, banks will get the recovered value of the stressed asset and their balance sheet will not appear stressful. This will improve their valuations.
- Secondly, banks will get more lending leverage as:
- Less provisioning is done for stressed assets if a robust bad bank exits
- Bad Banks generally pay 85% in sovereign receipts and remaining in cash. This can be used for giving more loans.
- Thirdly, it will drive the consolidation of stressed assets and help in faster decision-making.
- Fourthly, banks will get more management space as recovery work will be undertaken by bad banks. This would allow them to focus more on credit growth.
- Finally, as per some experts, transferring Rs. 400 assets to bad banks work out to around Rs 526 for the economy (a multiplier of around 1.3). Further, benefits worth Rs 2.2 lakh can be witnessed at just a 20% recovery rate.
- The Banks have realized the growth potential of the sector. They are constantly developing new business models, rationalizing costs, and providing superior services to attract more customers.
- Along with this, the focus should on creating a favorable environment for the development of.. that includes:
- Keeping majority ownership in the private sector
- Putting together a strong and independent board
- Linking AMC compensation to their performance
Source: Indian Express
Effectiveness of Inflation Targeting in India – Explained, Pointwise
RBI adopted the Inflation Targeting on the recommendations of the Urjit Patel committee in 2016. Almost 5 years have passed since its adoption. The RBI has also announced a formal review of its inflation targeting method. Hence, there is a requirement for an elaborate review to examine the performance of this method. In this article, we will analyze the performance of Inflation Targeting in India so far.
What is Inflation Targeting (IT)?
- Inflation Targeting is a method that focuses on adjusting monetary policy to achieve a specified annual rate of inflation.
- Types of inflation targeting:
- Strict inflation targeting(SIT) – Under this, the central bank only focuses on keeping inflation, close to a given inflation target.
- Flexible inflation targeting(FIT) – Under this, apart from inflation, the central bank is also concerned about other variables like the stability of interest rates, exchange rates, output and employment ratios.
- Monetary Policy – It is the macroeconomic policy laid down by the central bank that focuses on the management of money supply and interest rates.
- Inflation – It refers to a sustained/continuous rise in the general price level of goods and services in an economy over a period of time.
- Headline inflation – It is a measure of total inflation in an economy. In India, Consumer Price Index Combined (CPI -C) represents Headline Inflation.
- Core inflation – It is the inflation level after subtracting the food and fuel inflation from the Headline Inflation.
- Repo Rate – It is the rate at which RBI provides short-term loans to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
- Shut Period – It is the period for which the securities cannot be traded
Background of Inflation Targeting
- The Finance Act, 2016 amended the Reserve Bank of India Act, 1934 (RBI Act) . The amendment facilitated a statutory and institutionalized framework for a Monetary Policy Committee(MPC).
- MPC was entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level i.e. inflation targeting.
- A flexible inflation target (FIT) of 4% was decided with a deviation of +or- 2%. Further, headline consumer price inflation was chosen as the key indicator.
- This agreement between the center and the RBI on inflation targeting is set to end on 31st March 2021.
Need of inflation targeting
- Inflation targeting advocates the objective of price stability in actual monetary policy arrangement.
- Adopting price stability creates a stable non-inflationary environment for resource allocation in the economy.
- Since the RBI sets a certain inflation rate as a goal. The central bank made people believe that prices will continue to rise. This has few advantages like,
- The inflation targeting benefits the economy by making people buy things in the present (before they cost more).
- It boosts investment. As investors invest now because they are confident that the investment will give them a higher return when they sell later.
- A credible central bank and stable inflation lower the country’s risk premium and cost of borrowing in an open economy.
- It also made the RBI more accountable to the government. As the RBI needs to give a proper explanation in case it breaches the inflation targeting tolerance range (2-6%).
Performance of Inflation Targeting so far
- In these 5 years periods (2016-2021) after inflation targeting was introduced, RBI managed to keep inflation in control.
- The inflation rate has remained within the prescribed band of 2% to 6%. According to the RBI, Inflation was above 9% before the introduction of Inflation Targeting in India.
- Also, the RBI has been successful in anchoring inflationary expectations. As the estimated response coefficient to RBI is higher for India than it is for other countries.
The estimated response coefficient is the relationship between the Bank response and the unexpected rise in Inflation.
- However, sometimes the band was breached as well. In June 2020, the upper threshold of 6% was breached due to COVID-19 lockdown.
Issues in inflation targeting
- Assumption of correct output level: The model of Inflation targeting is based on the assumption that inflation means overheating the economy (i.e. output or production is greater than natural level output/production.)
- However, it is impossible to observe the level of output in an economy. Hence, setting policy rates based on the assumption that the economy is overheated, is unscientific.
- Limited power of RBI: The belief that RBI can successfully control inflation using Inflation targeting is not completely true. During the lockdown, food inflation peaked even when the inflationary targeting mechanism was in force. It was mainly due to supply chain disruption during the lockdown.
- Adverse impact on other sectors: The cases of IL&FS, PMC Bank, PNB and YES Bank suggest that poor management and maladministration in the financial sector can escape RBI scrutiny as they tend to focus more on inflation targeting.
- RBI has kept the interest rates high to manage inflation. This has discouraged private investment thereby reducing employment and export potential.
- High real repo rates for almost three years 2017-2019 are the primary cause of the GDP growth decline in India. The GDP declined from 8 percent (pre-IT) to 5 percent (post IT) due to high real repo rates.
- Global Nature of inflation: Inflation is global in nature as the price level of a good is determined by millions of producers across the world. Research by economic experts has also pointed out the international influence on the inflation level. Further, they mention points like,
- No one producer or one country can influence the price of any item or the general price level.
- For instance, The average inflation rate among EM (emerging markets) targeters during 2000-04 were 4 percent, and it was 3.8 percent among the non-targeters.
Suggestions to improve the inflation targeting
- The Reserve Bank of India (RBI) in its Currency and Finance (RCF) report has called for aligning the shut period with global practices. The RBI predicts that this will provide better monetary policy transmission.
- Shut down period is the period, in which MPC members maintain complete silence, i.e. no media coverage. It is observed before a few days of a policy decision, till few days after the decision. It ensures no sudden volatility in the market and effective market transmission.
- At present the shut period is seven-day after the release of the monetary policy committee (MPC) resolution. The RBI wants to reduce this to 3 days after the resolution.
- In order to enhance accountability and credibility, the transcripts of the MPC meetings may be recorded. Further, the transcripts may be released in the public domain with a lag of 5-7 years.
- The government has to change the Inflation targeting from headline to core inflation. This will provide advantages like,
- More than 50% basket of headline inflation comprises commodities that the RBI policy rate cannot affect. Especially fuel inflation.
- Food inflation is now in single digits than earlier double digits.
- Improvement of Regular measurement of CPI. This includes a frequent update of the basket and its weights along with changing times.
- Expansion in the ambit of MPC is also needed.
- For instance, the inclusion of liquidity issues (liquidity adjustment facility, changes in reverse repo, and OMOs) in the discussion may result in greater transparency and effective procedures.
The RBI’s Currency and Finance report has indicated the central bank’s preference to maintain flexible Inflation Targeting in the range of 2-6% for the next five years. This will build confidence in the broader economy that is still prone to both supply shocks and sudden demand shrinkage. Nonetheless, some reforms are desired in the Inflation targeting procedure to achieve optimum outcomes.
Why Nationalisation of Banks was a Right Step?
Synopsis: Privatisation of PSBs will not be a solution for India’s banking sector distresses. The Nationalisation of Banks proved to be fruitful at the time of need. But now, it requires reforms and not privatization.
The Union government announced that they want to privatize the Public Sector Banks (PSBs) in the recent budget. The government believes that this move will improve efficiency. However, it is not clear whether privatization brings efficiency or reduces associated risks.
The notion that only private banks are efficient is not correct. Many private banks failed around the world. Private corporate entities also have such large volumes of NPAs.
Moreover, bank nationalization helped in a revolution of India’s banking sector.
How the nationalization of banks helped in a revolution for India’s banking sector?
The nationalization of 14 private banks in 1969, followed by six more in 1980, transformed the banking sector. It created jobs, extended credit to the agriculture sector, and benefitted the poor.
- Firstly, the nationalization of banks helped in promoting more equitable regional growth, which is quite evident from RBI data. In 1969, rural areas had only 1,833 bank branches. It increased to 33,004 by 1995 and continued to grow further in the next decades.
- Secondly, this resulted in reduced dependence on moneylenders in rural regions. Nationalized banking also improved the working conditions of employees in the banking sector. This happened because the state ensured higher wages, the security of services, and other fringe benefits.
- Thirdly, the Public Sector Banks played a huge role in making the country self-sufficient by supporting the green, blue, and dairy revolutions. They have also contributed considerably to infrastructural development.
- Fourthly, public sector banks in India are presently earning significant operating profits. The profits were ₹1,74,390 crore in 2019-20 and ₹1,49,603 crore in 2018-19.
What should be done instead of privatising the public sector banks?
PSBs handled by the private sector could result in denial of convenient and economical banking services to the common man. The risks of monopoly will only complicate the issue.
- Firstly, giving such a huge network of assets to private enterprises or corporates may turn out to be an irrational move. The government should strengthen the PSBs instead.
- Secondly, it would be unfair to blame Public Sector Banks alone for the alarming rise of NPAs. Strict actions are required to recover large corporate stressed assets, which is a key concern for the entire banking sector.
- Thirdly, the actions must include strong recovery laws and taking criminal action against wilful defaulters. The government has not shown a firm willingness to implement these measures till now.
- Fourthly, there is an urgent and vital need to bring in a suitable statutory framework to consider wilful defaults on bank loans a criminal offense.
- Lastly, a system to examine top executives of Public Sector Banks across the country will also help in improving accountability. But privatization of PSBs is not the ultimate remedy for the problems of the banking sector in India.
Defaults by large corporate borrowers, imposed through the impractical Insolvency and Bankruptcy Code, have resulted in a pile of write-offs, putting a big dent on the balance sheets of PSBs. This has not only affected the profitability of the banks but has also become an excuse to declare inefficiency.
Source: click here
Privatization of PSBs – Explained, Pointwise
The Government has fast-paced the privatization of PSBs(Public Sector Banks). Recently NITI Aayog released its last round of consolidation plans. In that, the NITI Aayog listed 6 banks for the privatization plan.
On the other hand, the employee unions of Public Sector Banks have gone on a two-day strike against privatization. Further, A joint platform of 10 Central trade unions also observed last Monday as “anti-privatization day”.
But the government refused to stop the Privatization of PSBs. The government stated that some PSBs are incurring losses, and it can no longer take care of them. In this article, we will analyze the important aspects of the Privatization of PSBs.
What is the government plan on the Privatization of PSBs?
During Union Budget 2020-21 presentation, the government announced a new policy for strategic disinvestment of public sector enterprises. This policy provides a clear roadmap for disinvestment in all non-strategic and strategic sectors. The Banking Sector falls under the strategic sector.
The government aims to keep a bare minimum presence in the strategic sector. The final number of Public Sector entities in strategic sectors(including banking) will be determined by a group of ministers.
In 2019, after a massive consolidation exercise, the no. of PSBs reduced from 28 to 12. Recently the NITI Aayog consolidation plan left 6 PSBs out of the Privatization plan.
The NITI Aayog suggested privatizing all the PSBs except the SBI, Union Bank, Punjab National Bank, Canara Bank, Indian Bank, and Bank of Baroda. Further, the government also decided to perform privatization of two PSBs in the next fiscal year.
The PSB workers opposed the Privatization of PSBs right from the beginning. Nearly 10 lakh PSB employees, officers, and managers protested for two days against the Privatization of PSB plans last week.
Contribution of PSBs so far
According to RBI data, there were only 1,833 bank branches in rural areas in the country in 1969. But after the nationalization in the 1970s, the rural branches increased to 33,004 by 1995 and continued to grow over the next decades. This provided various benefits to economic development. Such as,
- PSBs expanded agricultural credit, short-term agricultural credit (‘crop loans’). According to an estimate, the PSBs in 2017-18 account for a total of Rs 622,685 crores of Agricultural credit. Further, The PSBs also played a huge role in making the country self-sufficient by supporting the green, blue, and dairy revolutions.
- The PSBs pioneered the concept of ‘priority sector lending. This provided credit to certain priority sectors which were earlier deprived of credit such as housing, etc.
- The Differential Rate of Interest (DRI) loans are the brainchild of public sector banking. Under this poorest section of people will receive the loan at a very marginal interest rate.
- The PSBs extended loans to women’s self-help groups under various programs. This contributed to women’s empowerment in India.
- PSBs also funded rural infrastructure projects through the Rural Infrastructure Development Fund.
In conclusion, the PSBs provided access to a formal banking network for all and facilitated financial inclusion in India.
The rationale behind the Privatization of PSBs
- The problem of NPAs: The banking system is overburdened with non-performing assets (NPAs). The majority of which lies in the public sector banks. For example, In 2020 the amount of NPAs with the PSBs was about Rs 5.47 lakh crore. This is more than twice the amount of NPAs in Private sector banks(Rs 2.04 lakh crore).
- Issue of Dual Control: At present PSBs are under the dual control of RBI and Dept. of Financial Services of Min of Finance.
- The RBI handles the governance side of the PSBs under the RBI Act, 1934
- On the other hand, the Dept of Financial Services under the Finance Ministry maintains the regulation of PSBs under the Banking Regulation Act, 1949.
- Thus, RBI does not have the powers to revoke a banking license, shut down a bank, or penalize the board of directors for their faults. The Privatization will provide the powers to RBI to control them effectively.
- Reduced performance: The PSBs in the past failed to perform effectively when compared to Private banks. This will result in a loss for the government at the end of the day.
For example, The PSBs had almost 71% of the overall lending ratio in 2005. But in 2020 their overall lending ratio came below 57% due to intense competition from the Private banks.
- Public sector bank boards are still not adequately professionalized. Further, the Bank Board Bureau is not fully functional. So the government still decides board appointments. This creates an issue of politicization and interference in the normal functioning of Banks.
- A difference of Incentives: PSBs are disrupted by government schemes like farm loan waivers etc. On the other hand, Private banks are profit-driven. The shareholders maintain effective control over banks’ functions. So, they can improve the balance sheet of the PSBs after privatization.
Arguments against the Privatization of PSBs
The supporters of PSBs provide many arguments against the privatization of PSBs. Such as,
- The credibility of Private Sector Banks: The Private sector bank is not always efficient. On a global level, there are many private banks that have failed, thus challenging the idea of private banks are efficient. For example, the recent YES Bank problem in India.
- Reason for NPA’s: The present NPA problem lies majorly with the PSBs. But the NPA’s increased due to the credit provided to the private corporate entities. So the private corporate entities have to be regulated and not the PSBs.
- Against inclusive banking: The Private Sector focussed on profit motive might restrict the credit to rural, agricultural, women, poor sections of society, etc. Thus, after Privatised PSBs the remaining PSBs have to take care of all of such credits. This might stress the remaining PSBs also.
- Governance and policy issue of RBI: Restructuring schemes such as strategic debt restructuring and schemes for sustainable structuring of stressed assets, initiated by RBI, are the major reasons for delayed recognition of bad loans from banks. This is applicable to all banks irrespective of ownership (public as well as private) of the banks.
For these reasons only the Former governor of RBI, Raghuram Rajan also opposed the Privatization of PSBs. He also mentioned that India at present needs changes in banking regulation.
- Proper implementation of the recommendations: The government must properly implement the recommendations of various committees. Such as,
- Recommendation of PJ Nayak Committee:
- Though the government approved the Bank Board Bureau, the government has to provide enough support for proper functioning.
- The government can split the Chairman and Managing Director roles. Further, the state can allow them a fixed tenure of 3 to 5 years.
- Recommendations of Narashimham committee
- The government can review the Banking Regulation Acts.
- India can explore the concept of Narrow Banking. Under this weak PSBs will be allowed to place their funds only in the short term and risk-free assets. This will improve the performance of PSBs.
- Recommendation of PJ Nayak Committee:
- Apart from that, The government has to create strong recovery laws and taking criminal action against wilful defaulters.
- The government has to rectify the challenges in the Insolvency and Bankruptcy Code. This will provide a faster resolution process.
- In the meantime, the government can explore alternate steps such as the concept of Bad Banks.
The majority of the Committees appointed by the government including the PJ Nayak Committee supported the reduction of government stake in PSBs. So, the government has to strike a balance on how much privatization of PSBs is essential for financial inclusion and credit to essential sectors like infrastructure, rural, etc. Instead of providing arbitrary numbers, the government have to provide the rationale behind the bare minimum presence in the strategic sectors including PSBs
IDBI Bank out of “PCA framework”
What is the News?
Reserve Bank of India(RBI) has taken out IDBI Bank from the prompt corrective action(PCA) framework. But it is still subject to certain conditions and continuous monitoring.
What is Prompt corrective action(PCA) Framework?
- PCA is an RBI framework. Banks with weak financial metrics are put under the PCA framework by the Reserve Bank of India(RBI).
- Aim: It aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector.
When was the PCA framework introduced?
- The RBI introduced the PCA framework in 2002. It is a structured early-intervention mechanism for banks that become undercapitalised due to poor asset quality, or vulnerable due to loss of profitability.
When does RBI invoke PCA?
- The PCA framework is invoked when banks breach any of the three key regulatory trigger points namely
- Capital to risk-weighted assets ratio
- Net non-performing assets(NPA) and
- Return on assets(RoA).
What are the restrictions on Banks when PCA is invoked? There are two types of restrictions:
Mandatory Restrictions: It includes:
- Restrictions on Dividends
- Restrictions on Branch expansion
- Restrictions on Management compensation among others.
Discretionary Restrictions: It includes
- Curbs on lending and deposits.
- Recommending the bank owner to bring new management and board among others.
Source: Indian Express
Cryptocurrencies in India
Source: The Hindu
Syllabus: GS 3. Indian Economy and issues relating to planning, mobilization, of resources, growth, development, and employment.
Synopsis: The government should ensure a smart regulation of cryptocurrencies instead of shutting them out.
The government has given a statement to bring a law on cryptocurrencies. It is a positive step. Considering the fact that there is a doubt about the legality of cryptocurrencies in India.
- The doubt exists despite the government has suggested that it does not consider cryptocurrency to be a legal tender.
- The reason behind this disapproval is that such currencies are highly volatile, used for illegal Internet transactions.
- Also, these currencies cannot be regulated as it is completely lying outside the domain of the state.
RBI’s decision on cryptocurrencies
- The RBI sent a circular to banks and asked them not to provide services for those trading in cryptocurrencies in 2018.
- However, the Supreme Court found the circular to be disproportionate. This is for the reason that virtual currencies were not banned in India.
- RBI also not able to provide strong evidence that units regulated by RBI were harmfully impacted by the exchanges dealing in virtual currencies.
What is the challenge in regulating cryptocurrencies in India?
The Minister of State for Finance Anurag Thakur highlighted the difficulty in the regulation of cryptocurrencies.
- Regulatory bodies like RBI and SEBI etc don’t have a legal framework to directly regulate cryptocurrencies.
- Cryptocurrencies are difficult to regulate as they are neither currencies nor assets or securities or commodities issued by an identifiable user.
- Cryptocurrencies have a growing client base in India despite having legal uncertainty. Their attraction may only grow now as Bitcoin has hit new peaks in price and is gaining influential followers such as Tesla founder Elon Musk.
Suggestions on cryptocurrency:
- Smart Regulation of the cryptocurrency is a much better option than getting banned directly. Because a ban on blockchain-based technology (having scattered record) cannot be implemented practically.
- For example, China has banned cryptocurrencies and has a controlled internet; even then trading in cryptocurrencies were happening in a small amount.
- The inter-ministerial committee has recommended an outright ban. On the other hand, it highlighted the need for an official digital currency and for the promotion of the underlying blockchain technology. So, the government can ban the cryptocurrency and release an official digital currency.
The way forward
The government must resist the idea of a ban and push for smart regulation.
Privatisation of banking sector: Issues and analysis
Source: The Indian Express
Syllabus: GS -3 Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.
Synopsis: The government has decided to privatise two public sector banks. The move will give the private sector a key role in the banking sector.
The government has announced the disinvestment policies for four strategic sectors including banking, insurance, and financial services. The government will have a bare minimum presence in these sectors.
- Earlier, the government merged ten PSU banks into four.
- The government is now left with 12 state-owned banks, from 28 earlier.
- The government will select 2 banks for privatization, based on the NITI Aayog’s recommendations. These recommendations will be considered by a core group of secretaries on disinvestment.
What were the reasons for the nationalization of Private banks?
In the Mid-1960s, the commercial banking sector was most profitable, especially after the consolidation of 566 banks in 1951 to 91 in 1967. However, some issues were present in this sectors at that time:
- Branches were mostly opened in the urban areas. Rural and semi-urban areas were not served by commercial banking.
- Banks were not willing to take any social responsibilities. They were more concerned with the profits and afraid to diversify their loan portfolios.
- Nationalisation was done with an intention to align the banking sector with a socialistic approach of the government.
Thus, from 1969, the process of nationalization of the 14 largest private banks started.
Why government is privatizing the PSBs?
However, at present, PSBs are suffering from many issues:
- First, Public Sector Banks continue to have high Non-Performing Assets and stressed assets as compared to private banks.
- Second, banks are expected to report higher NPAs and loan losses after the Covid-related regulatory relaxations are lifted. As a result, the government would need to inject funds into weak public sector banks.
- Third, Governance reforms have not been able to improve the financial position of public sector banks.
The profitability, market capitalization, and dividend payment record of PSBs are not improving, despite efforts of reform by the government.
How are the private banks performing currently?
- Private banks’ market share in loans has risen to 36% in 2020, while public sector banks’ share has fallen to 59.8% in 2020 (from 74.28% in 2015).
- They are expanding their market share through new products, technology, and better services. They have attracted better valuations in stock markets.
- For example, HDFC Bank has a market capitalization of Rs 8.80 lakh crore while SBI commands just Rs 3.50 lakh crore.
- However, everything is not well within private sector banking as well. CEOs of ICICI and Yes bank are facing the investigation for doubtful loans and other illegal activities. Lakshmi Vilas Bank merged with DBS Bank of Singapore after operational issues.
- Moreover, an Asset quality review of banks in 2015, found that many private sector banks were under-reporting NPAs.
Thus, the privatization drive this time should be thoughtful. Lessons should be learnt from the past. An adequate mechanism to ensure accountability must be established in the commercial banking sector.
Why RBI kept interest rates Unchanged?
Source- The Hindu
Syllabus- GS 2 – Government policies and interventions for development in various sectors and issues arising out of their design and implementation.
Synopsis- Monetary Policy Committee [MPC] has kept the benchmark interest rates unchanged. It is proceeding with an accommodative stance of monetary policy.
- MPC is keeping the rates unchanged to sustain the present economic growth.
- There are many factors that are providing space to MPC for keeping an accommodative stance of monetary policy.
What are the factors behind not changing the policy rates?
- First, retail inflation has been reduced in December, below the RBI’s upper tolerance threshold of 6%.
- Second, while the economy is on the path of revival, it still needs support from every angle.
- Third, the COVID-19 vaccine and budget proposal for infrastructure are boosting confidence in the economy.
What are the concerns for growth and inflation dynamics?
- Farmer’s agitation- The agitation involves farmers from key crop-growing States including Punjab, Haryana, and U.P. is a cause for concern. Prolong agitation has the potential to disrupt farm output.
- The Centre alone borrow 12-lakh crore at the gross level in the coming financial year, the debt manager faces the difficult task.
Steps taken by the Central Bank as the government’s debt manager –
- The enhanced held-to-maturity (HTM) limit for banks was extended till March 31, 2023. The facility would be provided to the banks buying debt issued by the Centre and States.
- Allowing retail investors to buy G-Secs [government securities] directly through the Reserve Bank [Retail Direct].
- The vaccine campaign would boost the economic turnaround, the budget proposals and expenditure plans have raised hopes for a more robust recovery.
- The RBI needs to keep its focus over inflation as the interest rates are too low. It may boost the consumption in the near future.
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Bad Banks – pros and cons
Source: The Hindu
Syllabus: GS 3 – Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.
Synopsis: The centre is proposing to set up Bad Banks or Asset Reconstruction Company to acquire bad loans from banks.
There is a persisting issue of bad loans in the Indian banking sector and the COVID-19 pandemic induced lockdown worsened the situation. Setting up the bad Banks will help Banking sector in dealing with this crisis.
International Experience of bad bank
- It helps in combining all bad loans of banks under a single exclusive entity. Countries like the US, Germany, and Japan have used this concept.
- The US implemented the Troubled Asset Relief Program (TARP) after the 2008 financial crisis. It was moulded around the idea of a bad bank. The US Treasury earned nominal profits under the TARP.
What are the problems with a bad bank?
According to the former RBI governor Raghuram Rajan, transferring bad assets from one pocket of the government to another will not lead to success. The reasons are,
- First, bad banks are backed by the government. The government will pay the high cost for stressed assets (to make bad bank profitable). It is not good for fiscal health of the country.
- Second, there is a bad loan crisis in PSUs because they are managed by the bureaucrats. Bureaucrats are not like private banks and cannot offer the same commitment to lenders and ensure profitability. If a Bad bank is allowed to manage by bureaucrats, then there is no point to create a bad bank at all.
- Third, bad banks do not address the root problem. The reason behind the bad loan accumulation is lack of focus on the quality of credit provided by banks. Establishing a bad bank might create a mindset that there is a system in place to recover the loans. This can lead to careless lending by banks in a larger manner and worsen the present bad loan crisis.
Will bad banks help in reviving the credit flow in the economy?
Some experts believe a bad bank can help free capital of over ₹5 lakh crore that is locked in by banks as provisions against these bad loans. This will give banks the freedom to use the freed-up money to give more loans.
- This gives the impression that banks have unused funds lying in their balance sheets. They could use these funds only if they could get rid of their bad loans.
- Many public sector banks may be considered to be technically broke. In reality, Their liabilities are far exceeding the assets they have. So, a bad bank could help them reduce their liabilities by purchasing bad loans.
The way forward
- A new bad bank set up by the government can improve banks capital safeguards by freeing up capital. It could help banks feel more confident to start lending again.
Govt. releases new guidelines for banks under “Foreign Contribution (Regulation) Act”
What is the News?
Union Home Ministry has announced new guidelines for banks, under the Foreign Contribution (Regulation) Act. These guidelines are related to the donations received by non-governmental organizations (NGOs) and associations.
What are the new FCRA guidelines?
- The donations received in Indian rupees by the NGOs and associations from any foreign source should be treated as a foreign contribution. Even if that source is located in India at the time of such donation.
- It will include the contributions by foreigners of Indian origin like OCI or PIO cardholders, in Indian rupees(INR).
- As per the existing rules, Banks need to report any receipt or utilization of any foreign contribution, by any NGO, association, or person. Banks should submit these reports to the Central government within 48 hours.
- Rules cover all NGOs, whether they are registered or granted prior permission under the FCRA.
- Any violation by the NGO or by the bank of these rules of FCRA may invite penal provisions under the FCRA Act, 2010.
Foreign Contribution (Regulation) Act:
- FCRA was enacted in 1976 and amended in 2010. It regulates foreign donations and ensures that such contributions do not adversely affect internal security.
- Coverage: It is applicable to all associations, groups, and NGOs which intend to receive foreign donations.
- Exemption: Members of the legislature and political parties, government officials, judges, and media persons are prohibited from receiving any foreign contribution.
- However, in 2017 the FCRA was amended through the Finance Bill. This amendment allowed political parties to receive funds from,
- The Indian subsidiary of a foreign company or
- A foreign company, in which an Indian holds 50% or more shares.
- However, in 2017 the FCRA was amended through the Finance Bill. This amendment allowed political parties to receive funds from,
- Registration: It is mandatory for all such NGOs to register themselves under the FCRA. The registration is initially valid for five years, and it can be renewed subsequently if they comply with all norms.
- Amendment of FCRA Rules: In September 2020, the FCRA Act was amended by Parliament and a new provision was added. It makes it mandatory for all NGOs to receive foreign funds in a designated bank account at the State Bank of India (SBI) New Delhi branch.
Source: The Hindu
Need for New 4-tier Regulations for NBFCs
Source: click here
Syllabus: GS 3
Synopsis: The RBI’s plan to tighten regulations on large NBFCs is critical for financial stability.
The RBI has planned an important change in its regulatory approach towards India’s non-banking financial companies (NBFCs). It plans to monitor larger NBFCs almost as closely as it monitors banks.
What was the need for a change in the regulatory framework?
- The size of NBFC has increased from just about 12% of banks in 2010 to a quarter of the banking sector.
- The growth has been facilitated by the lighter regulations on sourcing funds from home loans to micro-finance and large infrastructure projects.
- However, These lighter regulations revealed a systematic risk. For instance, IL&FS’s payment defaults resulted in a large scale economic crisis in 2018.
What is RBI’s proposed regulatory structure?
The RBI has introduced a four-tiered regulatory structure. By this, RBI is striking a balance between the need for low regulations and less systemic risks in the sector.
- First, For smaller NBFCs, regulations are light, on the basis of a largely ‘let it go’ approach.
- Second, For the largest NBFCs, it is imposing tougher ‘bank-like’ capitalization, governance, and monitoring norms. It is with an aim to reduce a systemic risk due to the nature of their operations.
- Third, the top tier will be activated only when a certain large player poses ‘extreme risks’. NBFC categorized in this tier will face the toughest regulations.
- The banking sector is in despair over the past two years (PMC Bank, Yes Bank, Lakshmi Vilas Bank). Thus, a complete restart of the omission tool for NBFCs is critical to keep the confidence and maintain financial stability.
- It is hoped that the plan for the regulation of NBFCs is official soon. This would ensure the new economic recovery is not hampered by funding constraints.
4-tier structure for regulation of NBFCs
Why in News?
Reserve Bank of India (RBI) has proposed a tighter regulatory framework for non-banking financial companies (NBFCs) by creating a four-tier structure. The intensity of regulations will be greatest at the top layer and lowest at the base layer.
Objective: It is to keep the big NBFCs in good financial health. It has become important after the failure of extremely large NBFC like IL&FS.
Four Tier Structure:
Base layer: This layer will include the large number of small NBFCs in the country and will subject to the least regulation. It is because they have a limited impact on systemic stability. The proposals for this set of NBFCs include:
- Entry-level net owned funds required to be raised to Rs 20 crore from Rs 2 crore.
- NPA classification norm of 180 days will be harmonized to 90 days.
- Disclosure requirements will be widened by including disclosures on types of exposure, related party transactions, customer complaints.
Middle Layer: It will consist of NBFCs that currently fall in the ‘systemically important’ category along with deposit-taking non-bank lenders. Housing Finance Companies, Infrastructure Finance Companies, Infrastructure Debt Funds, Core Investment Companies. The proposals for this set of NBFCs include:
- It will be subjected to tighter corporate governance norms.
- No changes proposed in the capital-to-risk-assets ratio (CRAR) of 15% with a minimum Tier-I ratio of 10%.
- These NBFCs cannot provide loans to companies for buy-back of securities.
- NBFCs with 10 or more branches will be required to adopt core banking solutions.
Upper Layer: It will include about 25-30 NBFCs and will be subjected to bank-like regulation.
- It will have to implement differential standard asset provisioning and also the large exposure framework as applicable to banks.
- The concept of Core Equity Tier-1 will be introduced for this category and is proposed to be set at 9%.
- They will also be subject to a mandatory listing requirement.
Top Layer: This layer will be empty for now and will be populated with NBFCs, where the RBI may see an elevated systemic risk.
Source: Indian Express
Too Big To Fail: Domestic Systemically Important Banks (D-SIBs)
Why in News?
Reserve Bank of India(RBI) has retained SBI, ICICI and HDFC Bank in Domestic Systemically Important Banks (D-SIBs) list or banks that are considered as “Too Big To Fail”.
- Domestic Systemically Important Banks(D-SIBs): D-SIBs are banks that are Too Big To Fail(TBTF). According to RBI, banks become D-SIBs due to their size, cross-jurisdictional activities, complexity and lack of substitute and interconnection. Banks, whose assets exceed 2% of GDP are considered part of this group.
- Significance of D-SIBs:
- Failure of such banks will result into significant disruption to the essential banking services to banking system and the overall economy.
- D-SIB tag also indicates that in case of distress, the government is expected to support these banks.
- They are also subjected to higher levels of supervision so as to prevent disruption in financial services in the event of any failure.
- D-SIB Framework: The Reserve Bank had issued the framework for dealing with D-SIBs in 2014. It requires the RBI to disclose the names of banks designated as D-SIBs starting from 2015. RBI places DSIBs in one of the 5 buckets based on their systemic importance scores(SISs).
- As part of this framework, these three banks have to maintain additional Common Equity Tier(CET) 1 compared to other commercial banks.
- CET 1: It is a component of Tier 1 capital that includes ordinary shares and retained earnings.
Establishment of Bad Banks – associated Issues and Significance
As a result of the Covid-19 pandemic induced economic slowdown, the commercial banks are about to witness the spike in NPAs, or bad loans. To deal with it, Reserve Bank of India (RBI) Governor is considering the proposal for the creation of a bad bank.
What is a Bad Bank?
A bad bank is an asset reconstruction company (ARC), involved in management and recovery of bad loans or NPAs of other banks.
Generally, these Banks are initially funded by the government and gradually, banks and other investors start to co-invest in them.
What are the functions of Bad banks?
Commercial and Public Sector Banks (PSBs) sell their NPAs to the bad bank. The bad bank manages the NPAs/bad loans and finally recovers the money over time. The takeover of bad loans is normally below the book value of them. These banks are not involved in activities like lending and taking deposits.
For example, consider a steel plant’s loan with SBI, turned into an NPA. Bad bank purchases this NPA from the SBI. After that, the bad bank appoints domain experts to manage the assets of the plant with an aim to maximize revenues and cut losses. This is called reconstruction and increases the economic value of the plant. When the bad bank sells this plant, it will recover more money.
The first bad bank was created in 1988 by the US-based Mellon Bank. After that, a similar concept has been implemented in other countries including Finland, Sweden, France and Germany.
Concept of Bad bank in India:
- The idea gained momentum when the RBI held asset quality review (AQR) found several banks showing a healthy balance sheet but have suppressed or hidden bad loans.
- Sunil Mehta panel on NPA’s (Non-Performing Assets) proposed Sashakt India Asset Management company, for resolving large bad loans in 2018.
- The Bad bank proposal was also discussed during the Financial Stability and Development Council (FSDC) meeting, but the government preferred a market-led resolution process instead of a bad bank.
Difference between Bad Bank and ARC (Asset Reconstruction Company):
|Bad Bank||Asset Reconstruction Company|
|A bad bank is simply a corporate structure that isolates liquidity and high-risk assets held by a bank or a financial organisation, or perhaps a group of such lenders.||ARCs are registered with RBI under Section-3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.|
|Bad Banks if established can take over all types of stressed assets||ARCs will only buy those pools of stressed assets if they see business-viability of those pools.|
|Currently the Bad banks are at conceptual stage and yet to be materialized||Currently, there are many licensed ARCs in India|
Why a bad bank is required?
First, Banks have difficulty in solving these cases due to lack of expertise, coordination, capital etc. Even the private ARCs have also failed to recover the loans.
Second, The RBI fears a spike in bad loans after the Covid-19 pandemic and the six-month moratorium announced to tackle the economic slowdown. This creates a necessity of Bad banks.
Third, the panel led by KV Kamath, has said companies in sectors such as wholesale trade, retail trade, textiles and roads are facing stress. So, setting up a bad bank is crucial to revive these sectors.
Fourth, Bad banks are targeted banking system with domain experts to focus particularly on NPAs Bad banks can be more effective, quicker in restructuring of the loans.
The Financial Stability Report points that the gross NPAs of the banking sector are expected to shoot up to 13.5% of advances by September 2021, from 7.5% in September 2020, under the baseline scenario. So, the Bad banks are essential considering the Indian conditions.
Advantages of having Bad bank:
First, Bad banks will improve credit mobilization culture in the economy: By holding the defaulters accountable the Bad Banks will ensure the accountability of borrower to pay the loan at any cost.
Second, Bad Banks will improve monetary Policy Transmission. NPAs were one of the major reasons for the lack of monetary policy transmission (MPT) in India. Even though RBI has reduced policy rates, Banks don’t reduce lending rates, to recover the cost of NPAs with them. If bad banks can manage their NPAs, their financial health will improve and facilitate MPT in the economy.
Third, Bad Banks can take bold decisions compare to commercial Banks. In General, the price at which NPAs are sold comes under the preview of CVC, CBI and CAG. Banks were hesitant to reveal and disposal of stressed assets fearing adverse reports by these institutions. A bad bank that can maximize recovery due to professionalism and hence will be less hesitant.
Fourth, Higher prices for stressed assets can be realized by bad banks.
Challenges associated with bad banks:
First, the major challenge associated with the Bad bank’s establishment is regarding what kind of loans will be taken over by bad banks, and at what cost? This is aggravated when the commercial banks were reluctant in the past for haircuts. If a PSB accept the NPA sale at lower price to Bad Bank then that loss is incurred by that PSB (I.e., the government)
Second, the stake of government in Bad bank is criticised for political influence in decision making. Especially when the majority of the NPAs are associated with the Public Sector Unit.
Third, the establishment of bad banks may not incentivise banks to focus on the quality of credit provided, monitor loans, and protect against ever-greening of loans. Banks might perform lending activities in the mindset that there is a system in place for recovering the loans.
Fourth, larger systemic issues will not be addressed. A bad bank does not address the structural weaknesses in public sector banks such as management etc.
For these reasons, many economists including the former RBI Governor opposed the establishment of Bad Bank in India.
First, laying out a clear road map for Bad Bank is crucial. Government can address the issue in the upcoming budget session.
Second, Exploring the models suggested by former RBI Deputy Governor, Viral Acharya. He suggested two types of Bad banks. The possibility of these two models can be explored before setting up of Bad Bank. The models were:
- Private Asset Management Company (PAMC)– This model is suitable for stressed sectors where the assets are likely to have an economic value in the short run, with moderate levels of debt forgiveness.
- National Asset Management Company (NAMC)– This is for the sectors where the NPA problem is in excess capacity and also of economically unviable assets in the short to medium terms.
The government can roll out the Bad Bank for the PAMC to instil public confidence and assess the performance of Bad banks and later can extended to NAMC category.
Third, K V Kamath Committee also suggested to set up Bad bank to revive sectors such as Trade, Textile, NBFCs, Steel and construction, etc.
The Problem of NPA is huge in India. Without reducing the problem of NPA India cannot become a trillion-dollar economy. The UK Asset Resolution (UKAR), a bad bank has recovered nearly 50 billion pounds of loans in UK. So, the Bad Banks is key to reduce the NPA’s, and it is high time for India to follow the path.
NPAs: A loan whose interest and/or instalment of principal have remained ‘overdue ‘(not paid) for a period of 90 days is considered as NPA.
Stressed assets = NPAs + Restructured loans + Written off assets
Restructured asset or loan: These are assets which got an extended repayment period, reduced interest rate, converting a part of the loan into equity, providing additional financing, or some combination of these measures
Written off assets: These are assets which the bank or lender doesn’t count the money the borrower owes to it. The existing shareholders face a total loss on their investments unless there are buyers in the secondary market who may ascribe some value to these.
RBI constituted Jayant Kumar Dash committee to study Digital lending activities
News: Reserve Bank of India(RBI) has constituted a working group on digital lending — including online platforms and mobile apps.
- Objective: The working group will study digital lending activities in the regulated and unregulated financial sector so that an appropriate regulatory approach can be put in place.
- Composition: The working group comprises six members–four will be from within the RBI and the remaining will be external. Jayant Kumar Dash, executive director at the RBI will head the group that has been advised to submit its report within three months.
- Terms of Reference of the Digital Lending Working Group:
- Evaluation of digital lending activities and assessing the penetration and standards of outsourced digital lending activities in RBI regulated entities.
- Identifying risks posed by unregulated digital lending to financial stability, regulated entities and consumers.
- Suggesting regulatory changes, if any, to promote orderly growth of digital lending.
- Recommending measures, if any, for expansion of specific regulatory or statutory perimeter and suggesting the role of various regulatory and government agencies.
- Recommending a robust fair practices code for digital lending players Suggesting measures for enhanced consumer protection.
- Recommending measures for robust data governance, data privacy and data security standards for deployment of digital lending services.
RBI unveils guidelines for Payment Infrastructure Development Fund
News: Reserve Bank of India(RBI) has announced operational guidelines for the Payments Infrastructure Development Fund (PIDF) scheme.
- Objectives of the Fund:
- To increase the number of acceptance devices multi-fold in the country.
- To benefit the acquiring banks / non-banks and merchants by lowering overall acceptance infrastructure cost.
- To increase payments acceptance infrastructure by adding 30 lakh touch points – 10 lakhs physical and 20 lakh digital payment acceptance devices every year.
- Purpose: The fund will be used to subsidize banks and non-banks for deploying payment infrastructure which will be contingent upon specific targets being achieved.
- Accountability: Acquirers of the subsidy shall submit quarterly reports on the achievement of targets to the RBI.
- The primary focus shall be to create payment acceptance infrastructure in Tier-3 to Tier-6 centres.
- North Eastern states of the country shall be given special focus.
- The fund will also focus on those merchants who are yet to be terminalised(merchants who do not have any payment acceptance device).
- Merchants engaged in services such as transport and hospitality, government payments, public distribution system(PDS) shops, healthcare may be included especially in targeted geographies.
- Duration of Fund: The fund will be operational for three years effective from 1st January, 2021 and may be extended for two more years.
- Funding::It has a corpus of Rs. 345 crore with Rs. 250 crore contributed by the RBI and Rs. 95 crore by the major authorised card networks in the country. The authorised card networks shall contribute in all Rs. 100 crore. Besides the initial corpus, PIDF shall also receive annual contributions from card networks and card issuing banks.
- Advisory Council: An Advisory Council (AC) under the chairmanship of RBI deputy governor BP Kanungo has been constituted for managing the PIDF. The council will devise a transparent mechanism for allocation of targets to acquiring banks and non-banks in different segments and locations.
- Monitoring: Implementation of targets under PIDF shall be monitored by RBI’s Regional Office Mumbai with assistance from card networks, the Indian Banks’ Association, and the Payments Council of India.
Digital technology worsen financial exclusion in rural India
Synopsis- Internet Services’ base payment system is worsening the financial exclusion prevalent in rural India.
Introduction Financial Exclusion in rural India
Internet services have provided much comfort to the user. But for the majority of the rural population digital technology has become troublesome due to a lack of technical knowledge and nexus of service providers, middlemen, government officials, and others.
We need to find solutions so that the fruits of digital technology will be borne by all the rural population.
Introduction of the digital payment based solution in rural India
- Direct Benefits Transfer (DBT) was launched with an aim of improving financial inclusion in 2011. Since 2015, it has become synonymous with the Aadhaar Payments Bridge Systems (APBS).
- Money is transferred to the various beneficiaries of programs under DBT such as maternity entitlements, student scholarships, and wages for MGNREGA.
- To deal with the “last mile challenges” facing beneficiaries in accessing their money; banking kiosks, known as Customer Service Points (CSP) and Banking Correspondents (BC), were promoted.
- These are private individuals who offer banking services through the Aadhaar Enabled Payment Systems (AePS).
- At these kiosks, beneficiaries can perform basic banking transactions such as small deposits and withdrawals.
However, it doesn’t solve the basic issues that are being faced by the lower strata of the rural areas in receiving their own money from their bank accounts.
What are the issues faced by rural population in acessing their payments?
The process of transition from older payment systems and the APBS technology needs to be scrutinised which impact all DBT programmes.
- Lack of technical knowledge– Workers have little clue about where their wages have been credited and what to do when their payments get rejected, often due to technical reasons such as incorrect account numbers and incorrect Aadhaar mapping with bank accounts.
- Lack of accountability– State governments have not set any accountability for APBS and AePS/payment intermediaries and there is no grievance redressal mechanism for the same.
- Lack of consultation– The workers/beneficiaries have rarely been consulted regarding their preferred mode of transacting.
- Creation of new forms of corruption – All the above factors have resulted into new form of corruption. For Example; Massive scholarship scam took place in Jharkhand, where many poor students were deprived of their scholarships owing to a nexus of middlemen, government officials, banking correspondents and others.
Findings of the new report by LibTech India
LibTech India recently released a research report based on a survey of nearly 2,000 MGNREGA workers across Andhra Pradesh, Jharkhand, and Rajasthan. The survey explains the experiences of workers in obtaining wages in hand after they were credited to their bank accounts.
- Access to wages from banks becomes arduous– Rural banks are short-staffed and tend to get overcrowded. Hence, it requires more hours and multiple visits to access wages from banks.
- Technical issues– CSP/BCs appeared to be a convenient alternative to banks due to their proximity. However, an estimated 40 per cent of them had to make multiple visits to withdraw from CSPs/BCs due to biometric failures.
- Too much travel cost is involved – To get their DBT share, MGNREGA workers need to spend too much for travel leading in addition to loss of their daily wage on the day of travel. E.g. the average travel cost for one visit to a bank in Jharkhand is Rs 50 which becomes Rs 100 for two bank visits.
- Passbook related issues– The only way for rural bank users to keep track of their finances is through their bank passbooks. However, more than two-thirds of time workers were denied the facility to update their passbooks at banks, some workers are even charged (45 per cent in Jharkhand) for this free service by CSPs/BCs.
The right to access your own money in a timely and transparent manner is a basic right of every individual that must be protected by the government at any cost.
- There are just 14.6 bank branches per 1 lakh adults in India. This is sparser in rural India. Despite the hardships of access, most workers preferred to transact at the banks. Hence Branch expansion into rural unbanked locations will significantly reduce poverty.
- The technological solutions must be coupled with a governance structure, in which protection of rights and choices of individuals must be fundamental.
Read Also :MAINS QUESTION BANK AND ANSWERS for UPSC
Report on Trend and Progress of Banking in India 2019-20
News: Reserve Bank of India has released the Report on Trend and Progress of Banking in India 2019-20.
- About the report: The report is a statutory publication in compliance with Section 36 (2) of the Banking Regulation Act, 1949.
- Purpose: It presents the performance of the banking sector, including co-operative banks, and non-banking financial institutions during 2019-20 and 2020-21 so far.
- Decline in NPAs: Scheduled Commercial Banks(SCBs) gross non-performing assets (GNPA) ratio declined from 9.1% at end-March 2019 to 8.2% at end-March 2020 and further to 7.5% at end-September 2020.
- Strengthened CRAR Ratio: Capital to risk weighted assets (CRAR) ratio of SCBs strengthened from 14.3% at end-March 2019 to 14.7% at end-March 2020 and further to 15.8% at end-September 2020 partly aided by recapitalisation of public sector banks and capital raising from the market by both public and private sector banks.
- Policy Measures: The Reserve Bank also undertook an array of policy measures to mitigate the effects of COVID-19; its regulatory ambit was reinforced by legislative amendments giving it greater powers over co-operative banks, non-banking financial companies (NBFCs), and housing finance companies (HFCs).
- Decline in UCBs Balance Sheet: The balance sheet growth of Urban Co-operative Banks(UCBs) moderated in 2019-20 on lower deposit accretion and muted expansion in credit; while their asset quality deteriorated, increased provisioning resulted in net losses.
- NBFCs: The consolidated balance sheet of NBFCs decelerated in 2019-20 due to near stagnant growth in loans and advances although some improvement became visible.
- Frauds in Banks: The number of frauds reported by banks in April-September 2020 period declined to Rs 64,681 crore from Rs 1,13,374 crore reported in the same period of the previous year.
RBI launches Digital payments index to track transactions
News: Reserve Bank of India(RBI) has launched a composite Digital Payments Index(DPI).
- Objective: To capture the extent of digitisation of payments across the country given the sharp pick-up in digital transactions seen in the recent past.
- Parameters: The index comprises five broad parameters with varying weights to measure the penetration of digital payments.The five key parameters include:
- Payment enablers (25%).
- Payment infrastructure—demand-side factors (10%).
- Payment infrastructure—supply-side factors (15%).
- Payment performance (45%).
- Consumer centricity (5%).
- These factors include multiple sub-parameters that would help the regulator conduct its study into the digital payment ecosystem.
- Duration of Releasing Index: The index shall be published on RBI’s website on a semi-annual basis from March 2021 onwards with a lag of 4 months.
- Base Year: The index has been constructed with March 2018 as the base period.At a base of 100 for March 2018, the RBI has measured that the index rose to 153.47 and 207.84 in 2019 and 2020 respectively.
Read Also:-CURRENT AFFAIRS 2020-2021
What is Positive Pay Mechanism?
Source: The Indian Express
News: From January 1, 2021, the Reserve Bank of India (RBI) will introduce the ‘Positive Pay System’ for cheque transactions above Rs 50,000 in a bid to enhance safety and eliminate frauds.
- Positive Pay Mechanism: It involves a process of reconfirming key details of large-value cheques.
- Process: Under this, the issuer of the cheque submits electronically through channels like SMS, mobile app and Internet banking, certain minimum details of cheque to the drawee bank, details of which are cross-checked with the presented cheque by Cheque Truncation System(CTS).Any discrepancy is flagged by CTS to the drawee bank and presenting bank who then take redressal measures.
- Cheque Limits: Banks will enable the new system for all account holders issuing cheques for amounts of Rs 50,000 and above.It is mandatory in case of cheques for amounts of Rs 5,00,000 and above.
- Developed by: National Payments Corporation of India (NPCI) will develop the facility of Positive Pay in CTS and make it available to participant banks.
RBI allows RRBs to access LAF, MSF windows
Source: Click here
News: Reserve Bank of India(RBI) has allowed regional rural banks (RRBs) to access the liquidity adjustment facility(LAF), marginal standing facility(MSF) and call or notice money markets with the aim to facilitate better liquidity management for these lenders.
- Liquidity Adjustment Facility(LAF): It is a facility extended by the Reserve Bank of India to the banks to avail liquidity in case of requirement or park excess funds with the RBI in case of excess liquidity on an overnight basis against the collateral of Government securities including State Government securities.
- Marginal standing facility(MSF): It is a window for banks to borrow from the Reserve Bank of India in an emergency situation when interbank liquidity dries up completely.MSF rate is generally higher than Repo rate.
- Call or Notice Market: The call/notice money market forms an important segment of the Indian Money Market.Under call money market, funds are transacted on an overnight basis and under notice money market funds are transacted for a period between 2 days and 14 days.
- Regional Rural Banks: These are financial institutions which ensure adequate credit for agriculture and other rural sectors.They were set up on the basis of the recommendations of the Narasimham Working Group (1975), and after the legislation of the Regional Rural Banks Act, 1976.
- First RRB: The first Regional Rural Bank “Prathama Grameen Bank” was set up on 2nd October, 1975.
- Stakeholders: The equity of a regional rural bank is held by the Central Government, concerned State Government and the Sponsor Bank in the proportion of 50:15:35.
- PSL: The RRBs are required to provide 75% of their total credit as priority sector lending(PSL).
India Post Payments Bank launches its digital payments services ‘DakPay’
Source: Click here
News: Department of Posts (DoP) and India Post Payments Bank(IPPB) has unveiled a new digital payment app ‘DakPay’.
- DakPay: To facilitate easy digital transactions and other banking services through the trusted Postal (‘Dak’) network across the nation to cater to the financial needs(‘Pay’) of various sections of the society.
- Significance: The App is launched as part of its ongoing efforts to provide Digital Financial inclusion at the last mile across India.
- India Post Payments Bank(IPPB): It has been established in 2018;under the Department of Posts, Ministry of Communication with 100% equity owned by Government of India.
- Mandate: To remove barriers for the unbanked & underbanked and reach the last mile leveraging the Postal network.
Farm and Banking Reform
Context: There is some risk necessary to reform Banking and Agriculture sectors.
What are the recently announced reforms in Farming and Banking sector?
- The three farm bills legislated by the government recently, which are in the early stages of implementation.
- The second is a proposal by RBI to let corporates/industry own banks.
Can MSP ensure farm income and Agri-growth?
- No guarantee of income: Farmers don’t get a remunerative price for their products, with the exception of a minority whose produce, mostly wheat and rice, is covered by the Minimum Support Price policy.
- Prevalence of middlemen: Most farmers toil on tiny, suboptimal acreage and have no bargaining power vis-vis the APMC middlemen. Choice in buyers gives them some leeway to bargain for a better price.
- MSP is not a guarantee: even those who get MSP are suffering from a fast depletion of the water table.
- Excessive use of pesticides/fertilisers due to faulty policy: the high prevalence of cancer in rural parts of Punjab and a higher cost of other foods like vegetables and fruits which are in short supply since everyone who can is planting MSP crops.
- Post-harvest loss: every year a lot of wheat and rice rots in the Food Corporation of India’s limited warehouses.
What do the laws propose to do?
- End the monopoly of APMC mandis where farmers had to compulsorily sell their produce.
- End limits on stock-keeping and allow contract farming by the private sector.
What is immediate response of common people?
- The new farm laws have brought the farmers of Punjab and other parts of north India to the streets of Delhi.
- The volume of protest tells us that some of us are afraid of change and unable to see what may be good for all of us a decade from now.
- Farmers will no longer get a remunerative price for their produce
How future will be different for Agriculture?
- Growth in demand for non-cereal foods, like vegetables, fruits and proteins will outstrip demand for cereals.
- Remunerative price for farmers cannot be at the expense of rampant food inflation for the consumer.
What can be the possible consequences if industries house own banks?
- It will channel lending from that bank to its own business at the expense of better, more efficient fund allocation.
- It will be much easier for regulators to track any lending to connected entities than it is for them to track the unofficial connectedness, which has led to the NPA problem.
What is the way ahead?
- Balance the interests of farmers and consumers.
- Bring policy change as the farm reforms are already 10 years late.
- Industry houses are the most obvious source of domestic capital to build such banks.
India and UN-Based Better Than Cash Alliance organizes learning on fintech solutions
Source: Click here
News: India and UN-Based Better Than Cash Alliance organized a joint Peer learning exchange on fintech solutions for responsible digital payments at the last mile.
- Better Than Cash Alliance: It was created in 2012 as a partnership of governments, companies and international organizations that accelerates the transition from cash to responsible digital payments.
- Launched by: It was launched by the United Nations Capital Development Fund, the United States Agency for International Development, the Bill & Melinda Gates Foundation, Citigroup, the Ford Foundation, the Omidyar Network and Visa Inc..
- Members: The Alliance has 75 members which are committed to digitizing payments.
- Objectives: The Alliance Secretariat works with members on their journey to digitize payments by:
- Providing advisory services based on their priorities.
- Sharing action-oriented research and fostering peer learning on responsible practices.
- Conducting advocacy at national, regional and global level.
Why Corporate houses should not own banks?
Context: Granting license to corporates to promote banks will be disastrous to the economy as a whole.
- Recently, the RBI constituted an Internal Working Group to determine if large corporate houses can be given licence to promote banks.
- The Internal Working Group recommended to allow corporate houses to operate banks.
What are the concerns associated with this move?
- Experts caution: Former RBI Governor Raghuram Rajan and former RBI Deputy Governor Viral Acharya opined that the recommendations for allowing corporates into banking a “bombshell” and said this proposal needs to be dropped.
- Issue of connected Lending: Business houses owning an in-house bank may lead to self-lending.
- Issue of Credit Quality: Banks cannot make good loans when it is owned by the borrower. Even under the existing financial regime, the RBI was unable to detect at an early stage the connected lending which felled large regulated financial entities like IL&FS, Yes Bank (Rana Kapoor and his entities held 10.6% as on end September 2018), DHFL (promoter holding 39%).
- Growth of monopoly market: India’s business landscape is already starting to resemble a Monopoly board for example, telecommunications and transportation. Allowing corporates to own banks will strengthen this process.
What are the arguments given by RBI’s Internal Working Group in support of giving corporates licence to promote banks?
- Making necessary amendments to the Banking Regulation Act of 1949 to deal with connected lending and linkages between banks and non-financial group entities.
- Strengthening the supervisory mechanism for conglomerates. These measures will be able to regulate corporate owned banks effectively.
What is the way forward?
- The way forward should be to privatise public sector banks by allowing wide and diversified holding of stock by the general public.
- If the government exits banking ownership, it would lead to professional management and broader distribution of wealth. The banks would come under both SEBI and stringent RBI guidelines.
Permitting industrial houses to own banks
Context: Permitting industrial houses to own banks could undermine economic growth and democracy.
- Recently, an internal working group of the RBI has made a far-reaching recommendation to permit industrial houses to own and control banks.
- According to the report, the reason for permitting industrial houses to own and control banks is that industry-owned banks would increase the supply of credit, which is low and growing slowly.
- However, many believe that this step would be a grievous mistake, and it will be a setback to Indian economic and political development.
Why it is a concern?
- Against the recommendations of the experts: The report states that majority of the experts were of the opinion that large corporate/industrial houses should not be allowed to promote a bank.
- The problem of connected lending: This can lead to Over-financing of risky activities, encouraging inefficiency by delaying or prolonging exit and entrenching dominance.
- Regulation of Connected lending is difficult: It is clear from the experience of Indonesia and most advanced countries that regulating connected lending is impossible and the only solution is to ban corporate-owned banks.
- Overburdened RBI: RBI has encountered much difficulty in dealing with banking irregularities at Punjab National Bank, Yes Bank, ILFS and Lakshmi Vilas Bank. Regulation and supervision need to be strengthened considerably to deal with the current problems in the banking system before they are burdened with new regulatory tasks.
- Can delay exiting of inefficient firms: This makes it impossible for more efficient firms to grow and replace them. If industrial houses get direct access to financial resources, their capacity to delay or prevent exit altogether will only increase.
- Can stimulate growth of Monopolies: Already, The Indian economy already suffers from over-concentration. The COVID-19 crisis is aggravating this picture because those with greater resources will not only more easily survive the crisis and they will be able to take over small, medium and large enterprises that have not had the resilience or resources. In this scenario, if large industrial houses get banking licences, they will become even more powerful.
- Will dampen rules-based well-regulated market economy: The power acquired by getting banking licences will not just make them stronger than commercial rivals, but even relative to the regulators and government itself. This will aggravate imbalances leading to a vicious cycle of dominance.
- Affect credit Quality: Indian financial sector reforms have aimed at improving both the quantity and the quality of credit. If India now starts granting banking licences to powerful, politically connected industrial houses, allowing them to determine how credit is allocated, it will effectively abandon the principle of ensuring that credit flows to the most economically efficient users.
- Alternative options do exist: The other powerful way to promote more good quality credit is to undertake serious reforms of the public sector banks.
Mixing industry and finance will set us on a road full of dangers for growth, public finances, and the future of the country itself.
Corporates as Bankers: Bane or boon for economy?
A recent report by an Internal Working Group (IWG) of the Reserve Bank of India has attracted a lot of attention as well as criticism for its recommendations including the one that suggests corporate houses be given bank licences.
Rationale to constitute IWG by RBI:
The IWG was constituted to “review extant ownership guidelines and corporate structure for Indian private sector banks” for important reasons like
- The total balance sheet of banks in India still constitutes less than 70 per cent of the GDP, which is much less compared to global peers such as China, where this ratio is closer to 175%.
- The domestic bank credit to the private sector is just 50% of GDP. But in economies such as China, Japan, the US and Korea it is upwards of 150 per cent.
- India’s banking system has been struggling to meet the credit demands of a growing economy.
There is only one Indian bank in the top 100 banks globally by size. Further, Indian banks are also one of the least cost-efficient. So, RBI Constituted a IWG to look into the ownership guidelines and corporate structure for Indian private banks.
The committee submitted its report last week.
|key recommendations of the IWG:|
· The cap on promoters’ stake in the long run (15 years) may be raised from the current level of 15 per cent to 26 per cent of the paid-up voting equity share capital of the bank.
· Large corporate/industrial houses may be allowed as promoters of banks only after necessary amendments to the Banking Regulation Act, 1949
· Well run large Non-banking Financial Companies (NBFCs), with an asset size of ₹50,000 crores and above, may be considered for conversion into banks subject to completion of 10 years of operations and additional conditions prescribed.
· Payments Banks can be allowed to convert to a Small Finance Bank, after 3 years of experience as Payments Bank.
· Reserve Bank may take steps to ensure harmonisation and uniformity in different licensing guidelines, to the extent possible.
Positives of committee report:
For Banking Sector:
- Dilute the Impact of COVID pandemic: The reforms can Fast track the credit disbursment and distribution to businesses in short term to revive the economy, impacted by the COVID Pandemic.
- Transformation of banking sector in India: If implemented the banks can help in India’s ambition to be a trillion-dollar economy by acceleration of credit to MSME Sector that will also compliment Atmanirbhar Bharat mission.
- Bank for all: In rural India Co-operatives is still the major banker with no other alternative. If payments banks are allowed to convert in to small finance banks, this could potentially increase competition, especially in the micro lending space, leading to increasing efficiency.
- Ensuring robust banking system in India: Since India has very less banks in present, even a smallest bank failure is causing ripples in the entire banking system. To avoid such every time RBI and Government is stepping in to rescue. This can be avoided if recommendations are implemented.
- Can get rid of NPA’s in the long run: The reforms can create a ripple effect and reduce India’s one of long-standing problem in the banking sector. Opening up of more banks will ensure that the underperforming banks either amalgamated or weed out in the long run.
- Digital banking is feasible: At present due to less competition and capital,banks are investing less in the technology in terms of payment, credit behaviour etc. Reforms can ensure private invest in technology and push the Public Sector Banks also.
- Corporate houses will bring capital and expertise to banking.
- Government can focus on other problems instead of rescuing banks frequently with taxpayer’s money. Apart from that Government finances were already strained before the Covid crisis and worsened during the pandemic.
Why the corporate as a promoter of bank being criticized?
One of the most severe criticisms of the report was the recommendation of allowing the large corporate/industrial houses as a promoter of banks. Former RBI Governor Raghuram Rajan and former RBI Deputy Governor Viral Acharya severely criticised the suggestion for various reasons like,
- Poor governance under the present structure is the major problem of Indian banking sector. Ex Despite spotting the fault at early stage in IL&FS, RBI did not step up its governance activities and that resulted in the defaulting of the IL&FS.
- Bank for elites: In the past, Banks were nationalized because they ownership by the private sector was leading to “large concentration of resources in the hands of a few business families”. The allowing of corporate might revive that.
- Financial crisis in India: 2008 Global Financial crisis was a proof of how risky that the private sector banks are? Trusting them to operate at large scale instead of trust worthy and financially stable government-owned banking system might create a financial crisis in long run.
- Issue of Connected Lending: 1997 Asian Financial Crisis was a grave example of mingling of big companies and banks. If we allow corporate as a promoter of banks then the connected lending consequence is unavoidable in India.IWG report itself mentions, “it will be difficult to ring fence the non-financial activities of the promoters with that of the bank”.
connected lending refers to a situation where the promoter of a bank is also a borrower. There is a possibility promoter to channel the depositors money into their own ventures. Connected lending was the key factor behind 1997 Asian Financial crisis.
The recent episodes in ICICI Bank, Yes Bank, DHFL etc. were all examples of connected lending.
- Inadequate to track: Corporate houses are adept at routing funds through a maze of entities in India and abroad. So, they can bypass the checks and balances and flout the norms.
- Can Increase Crony Capitalism: There is a high possibility that few corporates control the lending process and influence the lending process. Thereby reduce the competition and can create a Chakravyuhatype of challenge in Indian Economy.
Is Corporate as Banks is new to India?
In February 2013, the RBI had issued guidelines that permitted corporate and industrial houses to apply for a banking licence. Some houses applied, although a few withdrew thei rapplications subsequently.
Only two entities qualified for a licence, IDFC and Bandhan Financial Services. No corporate was ultimately given a bank licence.
The RBI maintained that it was open to letting in corporate companies to open banks. However, none of the applicants had met ‘fit and proper’ criteria.
In 2014, the RBI restored the prohibition on the entry of corporate houses into banking
- Improve private governance and regulatory capacity:The Committee on Financial Sector Reforms (2008) headed by then RBI Governor observed that it is premature to allow industrial houses to own banks. Though necessary,the reform can wait till private governance and regulatory capacities improve.
- Regulator side:
- Regulator has to enhance the credibility of the system by ensuring every deposit is safe especially with better governance.
- RBI should ensure the checks and balances before allowing corporates to become promoters.
- Instead of debating with the allowing of corporate is good or bad? RBI can move ahead with the other recommendations which are really beneficial for the banking sector and economy as whole.
- From Government side
- Better Legal framework: If permitting corporates as bank promoters than the government not only need to amend the Banking Regulation Act, 1949 but also needs to amend various Acts to curb crony capitalism, liberal whistle blowing policies etc., but they all need strong political commitment.
Though allowing corporate is one of the recommendations of IWG report, there are many other necessary recommendations for reforming the banking sector. RBI needs to reconsider the step to allow corporates, as the report is open for public review till January.
corporate houses in Indian banking
Context: Recently, an Internal Working Group of the Reserve Bank of India (RBI) has recommended that corporate houses be given bank licences.
- Earlier, in 2013, the RBI had issued similar guidelines permitting corporate and industrial houses to apply for a banking licence. However, no corporate was given a bank licence as none of the applicants had met ‘fit and proper’ criteria.
- In 2014, the RBI, reversed its earlier decision and prohibited the entry of corporate houses into banking based upon the Committee on Financial Sector Reforms (2008) suggestion that opined it is premature to allow industrial houses to own banks.
- Now, an Internal Working Group of the Reserve Bank of India (RBI) has once again recommended for providing bank licences to corporate houses.
What are the Pros and Cons of letting corporate houses to operate banks?
- Corporate houses will bring capital and expertise to banking.
- In many countries corporate houses were not bared from banking.
- Interconnected lending: They can use banks to provide finance to customers and suppliers of their businesses.
- Concentration of economic power.
- Exposure of the safety net provided to banks to commercial sectors of the economy.
- Fund diversification: by turning banks into a source of funds for their own businesses.
- Impact of Non entities on banks growth: Banks owned by corporate houses will be exposed to the risks of the non-bank entities of the group.
- Privatisation of Public banks in the long run: For example, Public sector banks need capital that the government is unable to provide. The entry of corporate houses will result in the possibility of cash rich corporate bank acquiring cash trapped public sector banks which is a serious concern about financial stability.
Why Tracing interconnected lending will be a challenge?
- The Internal Working Group suggests that, before corporate houses are allowed to enter banking, the RBI must be equipped with a legal framework to deal with interconnected lending and a mechanism to effectively supervise conglomerates that venture into banking.
However, there are challenges while dealing with interconnected lending.
- Multi sector cooperation required: Monitoring of transactions of corporate houses will require the cooperation of various law enforcement agencies.
- Crony capitalism: Corporate houses can use their political clout to thwart such cooperation.
- No prevention possible: The RBI can only react to interconnected lending ex-post; it will not be able to prevent such exposure.
- Complex process: In case, even if RBI could trace interconnected lending, any action taken on corporate will only cause a flight of deposits from the bank concerned and precipitate its failure.
- Regulator credibility at stake: The regulator would be under enormous pressure to compromise on regulation. Pitting the regulator against powerful corporate houses could end up damaging the regulator.
Why the Internal Working Group of the RBI has recommended so?
- Under the present policy, NBFCs with a successful track record of 10 years are allowed to convert themselves into banks.
- There are corporate houses that are already present in banking-related activities through ownership of Non-Banking Financial Companies (NBFCs).
- The Internal Working Group believes that NBFCs owned by corporate houses should be eligible for such conversion.
- The Internal Working Group argues that corporate-owned NBFCs have been regulated for a while. The RBI understands them well. Hence, some of the concerns regarding the entry of these corporates into banking may get mitigated.
India’s banking sector needs reform but corporate houses owning banks will not be the one that is required as of now.
Context- RBI committee has recommended a series of changes that could transform the banking landscape by paving the way for large industrial conglomerates to set up banks.
What are Non-Banking Financial Companies NBFCs?
These are establishments that provide financial services and banking facilities without meeting the legal definition of a Bank. Hence they are frequently referred to as “shadow banks”.
Significance of NBFCs-
- These organizations play a crucial role in the economy, offering their services in urban as well as rural areas, mostly granting loans allowing for growth of new ventures.
- They alone count for 12.5% raise in Gross Domestic Product of our country.
- However, they are restricted from taking any form of deposits from the general public.
What are recommendations of RBI’s working group regarding NFBCs?
Proposal by RBI’s internal working group-
- The group also suggested giving banking licences to large corporate or industrial houses after necessary amendments to the Banking Regulation Act, 1949.
- It recommended increasing the size of the stake that promoters in private banks can hold to 26% from the current 15% over a 15-year time frame.
- NBFC or shadow bank with assets of Rs 500 billion and above, including those which are owned by a corporate house may be considered for conversion into a bank after 10 years of operations.
- Conversion to Small finance bank SFB-
- Payments banks with three years of experience can be eligible for conversion into a small finance bank.
- SFB and payments banks may be listed within 6 years from the date of reaching net worth equivalent to prevalent entry capital requirement prescribed for universal banks’ or ‘10 years from the date of commencement of operations, whichever is earlier.
- The minimum initial capital requirement for licensing new banks should be enhanced from ₹500 crore to ₹1000 crore for universal banks, and be raised to ₹300 crore from ₹200 crore for SFBs.
- For non-promoter shareholdings a uniform cap of 15% of the paid-up voting equity share capital of the bank instead of a current tiered structure.
- Non-operative Financial Holding Company (NOFHC) should continue to be the preferred structure for all new licenses to be issued for universal banks. However, it should be mandatory only in cases where the individual promoters/promoting entities/ converting entities have other group entities.
- It is a welcome idea to boost economic activity, job creation enhancing liquidity.
- Strict regulations on the use of funds held with the bank and monitoring of related party transactions will be essential, where corporate house is a promoter.
Lakshmi Vilas Bank (LVB) merger with DBS bank
Context: Lakshmi Vilas Bank (LVB) merger with DBS bank is justified
Why RBI decided for merger of Lakshmi Vilas Bank (LVB) amalgamation with DBS bank?
- Erosion of trust in financial institutions: India, over the past two years has seen the collapse of four financial firms: IL&FS, Dewan Housing Finance, Punjab and Maharashtra Cooperative Bank and Yes Bank.
- Rise in NPA’s: LVB’s bad loans have mounted to about a quarter of its gross advances, while deposits have shrunk by nearly Rs 6,900 crore in the last one year.
- Failure of bank’s management: They were unable to come up with a credible capital-raising and revival plan, forcing the RBI to seek its merger with another bank.
Why Investors in Lakshmi Vilas Bank (LVB) are unhappy over its amalgamation with Singapore’s DBS Bank?
- The Reserve Bank of India’s (RBI) proposed to write off LVB’s entire paid-up equity capital and reserves, resulting in a zero value of its shares.
- The situation is similar to that of Yes Bank’s AT-1 (additional tier-1) bond investors, who suffered a total write-down of their Rs 8,415 crore holdings as part of a rescue plan.
- The LVB’s shareholders, like Yes Bank’s AT-1 bondholders, are demanding compensation for the forced extinguishing of their investments.
The question of who is more important an Investor or a depositor?
- The RBI’s concern as a banking sector regulator is to first secure the interest of depositors because Banks, unlike regular companies, make money not from owning plants, machinery and property instead, it is derived from deploying other people’s money primarily deposits.
- No bank, however well-capitalised, can survive if depositors decide to pull out money.
Why the choice of amalgamating with DBS is right?
- Unlike public sector banks that are burdened with stressed loans and requirement of fund infusion, DBS has committed to bring in additional capital of Rs 2,500 crore upfront.
- Also, despite being a foreign bank, it has chosen to operate in India through a wholly-owned subsidiary, as opposed to just having branches.
- Has submitted itself to the RBI’s more stringent regulatory requirements, and DBS will be able to add 550-plus branches to its existing 33. This will send a strong signal to other foreign banks to pursue greater growth opportunities
- With Indian banks want for more capital, a foreign bank as desi is most welcome.
lakshmi vilas bank crisis
What are the reason of RBI to put LVB under moratorium and amalgamated with DBS Bank?
The RBI has now decided to impose a 30-day moratorium on Lakshmi Vilas Bank Ltd (LVB) due to the following reasons-
- Continuous Losses: The RBI said the financial position was declining steadily, with continuous losses over the last three years eroding the bank’s net-worth.
- Rising NPAs: Serious governance issues in recent years have led to deterioration in its performance. Almost one fourth of the bank’s advances have turned bad assets. Its gross non-performing assets (NPAs) stood 25.4% of its advances as of June 2020, as against 17.3% a year ago.
- The Tier 1 Capital ratio turned a negative 0.88% at the end of March 2020.
- Low Liquidity: It was also experiencing continuous withdrawal of deposits and low levels of liquidity.
- Unable to raise Capital: The bank has not been able to raise adequate capital to address these issues. The bank management had indicated to the RBI that it was in talks with certain investors, but failed to submit any concrete proposal.
- The capital ratio subsequently worsened to -4.85% by the end of September, tipping the central bank’s hand.
What happen to depositors and shareholders?
- Depositors- The RBI, which put a cap of Rs 25,000 on withdrawals, has assured depositors of the bank that their interest will be protected
- Deposit Insurance and Credit Guarantee Corporation (DICGC) gives insurance cover on up to Rs. 5 lakh deposits in banks.
- Shareholders of LVB– Equity capital is being fully written off. This means existing shareholders face a total loss on their investments unless there are buyers in the secondary market who may ascribe some value to these.
How has the pandemic affected the banking system?
- Worsen NPA -NPAs in the banking sector are expected to increase as the pandemic affects cash flows of people.
- RBI’s Financial Stability Report pointed out in its stress test indicated that the gross NPA ratio of commercial banks could worsen to as high as 14.7% by end of current financial year.
- The COVID-19 pandemic has stress on corporate balance sheets and governments burdened with large debt.
- Lurking around the corner is also the major risk– stress intensifying among households and corporations that has been delayed but not mitigated, and could spill over into the financial sector
Banks now need to adopt a ‘React, Adapt and Lead’ strategy to emerge stronger on the other side of the COVID-19 pandemic. After all, stronger banks and a sound financial services ecosystem will play a key role in the recovery of Indian economy.
Issue of Lakshmi Vilas Bank | 19th November
News: Reserve Bank of India imposed a 30-day moratorium on Chennai based Lakshmi Vilas Bank Ltd (LVB) and put in place a draft scheme for its amalgamation since its financial position underwent steady decline and posted loss for the last 3 consecutive years.
Under these developments, RBI has imposed the following conditions:
- RBI has put a cap of Rs 25,000 on withdrawals from the bank.
- Draft Scheme for amalgamation includes the amalgamation of LVB with DBS Bank India, a subsidiary of DBS of Singapore. Amalgamation will include all business, assets (including tangible and intangible), estates, rights, titles, etc. of LVB.
Background of the LVB issue:
- LVB shifted its focus from SMEs(Small and Medium Enterprises) to large businesses, in 2016-17 and loaned Rs 720 crore against fixed deposits of Rs 794 crore, which later turned into bad loans.
- In 2018, Religare Finvest sued the Delhi branch of LVB to recover fixed deposits worth about Rs 800 crore that the bank invoked to recover those loans.
- RBI put LVB under Prompt Corrective Action (PCA) framework in September 2019 due to which the bank was not able to issue fresh loans or open a new branch anywhere.
- Now RBI has formalised a scheme for its amalgamation as mentioned above.
|What is Prompt Corrective Action (PCA)?|
Why this decision was taken?
- Erosion of the bank’s net-worth: Deposits has undergone a steady decline, with continuous losses over the last three years.
- Experiencing low levels of liquidity: Inability to raise adequate capital from market and due to continuous withdrawal of deposits.
- Increase in Non-performing assets: Almost one fourth of the bank’s advances have turned bad assets. Its gross non-performing assets (NPAs) stood 25.4% of its advances as of June 2020.
RBI’s power of amalgamation
- Under Section 45 of the Banking Regulation Act, a scheme of reconstruction or amalgamation can be prepared by RBI, during the period of amalgamation only.
- Once the moratorium comes into effect, the bank cannot lend, and existing depositors cannot withdraw beyond a specified amount.
- But the practice of imposing a moratorium was seen as disruptive as it carried the risk of undermining depositor confidence in the banks and financial stability.
- Thus, the government empowered RBI under Banking Regulation (Amendment) Ordinance 2020, to prepare a reconstruction scheme without having to first make an order of moratorium on barring deposit withdrawals.
|Types of Private banks in India:|
Issues facing Private Banking Sector:
- Collapse of IL&FS(Infrastructure Leasing & Financial Services) in 2018 had set off a chain reaction in the financial sector, leading to liquidity issues and defaults.
- RBI had earlier this year bailed out Yes Bank through a scheme backed by State Bank of India and other banks
- Punjab & Maharashtra Co-op Bank was hit by a loan scam involving HDIL(Housing Development and Infrastructure Limited) promoters and the bank is yet to be bailed out.
- Most of the old generation Private banks do not have strong promoters, making them targets for mergers or forced amalgamation. For ex: In Karur Vysya Bank, the promoter stake is 2.11%, and in Karnataka Bank, there’s no promoter
- Asset Quality: biggest risk to India’s banks including Private banks is the rise in bad loans or Non Performing Assets(NPAs) along with the slowdown in the economy. This unforeseen COVID-19 Pandemic just increased that further. However, the impact will differ depending upon the sector.
Ex: banks lend to pharmaceuticals and IT seem to have benefited from reduced NPA and those who lend to hospitality, tourism, aviation expect to increase NPA’s further.
- Regulatory challenges : RBI’s CAR (Capital Adequacy Ratio) and other stringent regulations reduce Private sector banks Alternative investment opportunities
- HR challenges: Shortage of experienced and trained private bankers and high attrition levels means that talent is always in short supply
- Infrastructure challenges: Lack of appropriate and adequate physical and IT infrastructure is one of the major challenges facing the PB sector in India. Bank branches are not well equipped to cater to HNIs(High Net Worth Individuals) and UHNWIs(Ultra High Net Worth Individuals)
Solutions and way forward
- RBI constituted KV Kamath Committee tasked to recommend on the financial parameters required for a one-time loan restructuring window for corporate borrowers under stress due to the pandemic can reduce stressed assets and NPAs not only in private banks but in the entire banking system as a whole.
- Narashimham committee recommendation of Introduction of Narrow Banking Concept where weak banks will be allowed to place their funds only in the short term and risk-free assets can be followed in Private banks when they face loss for 4 consecutive quarters instead of RBI step into amalgamation or bailout
- Splitting the Chairman and Managing Director and allocating them fixed tenure of 3 to 5 years as advised by the PJ Nayak Committee can be followed for Private banks.
- Insolvency and Bankruptcy Code should be better utilized and have to complete within the provided timeline.
- Private banks have to improve their Promoters stake or look out for promoters.
With BASEL III norms on the cards Indian Banking sector has to be strengthened especially PSBs but that doesn’t mean the Private can be left out. A mutually strong, competitive private banking is the key to push the entire banking system.
HNIs: In India, those peoples who have more than 2 crores investible surplus are considered high net worth individual (HNI)
NPA’s: A loan whose interest and/or installment of principal have remained ‘overdue ‘ (not paid) for a period of 90 days is considered as NPA.
Stressed assets = NPAs + Restructured loans + Written off assets
Restructured asset or loan: assets which got an extended repayment period, reduced interest rate, converting a part of the loan into equity, providing additional financing, or some combination of these measures
Written off assets: assets which the bank or lender doesn’t count the money the borrower owes to it. The existing shareholders face a total loss on their investments unless there are buyers in the secondary market who may ascribe some value to these.
Moratorium on Lakshmi Vilas Bank
Context: RBI has imposed a moratorium on Lakshmi Vilas Bank and drafted a scheme for a merger.
Why it is a concern?
- Already, India’s banking system is distressed due to the failures of IL&FS, Punjab & Maharashtra Cooperative Bank and DHFL, followed by the bailout of Yes Bank.
- Now, the Reserve Bank of India decision to put in place a draft scheme for the amalgamation of Lakshmi Vilas Bank with DBS Bank India, a subsidiary of DBS of Singapore, has raised concerns about the safety of the financial system.
Why this decision was taken?
- Erosion of the bank’s net-worth: Deposits has undergone a steady decline, with continuous losses over the last three years.
- Experiencing low levels of liquidity: Inability to raise adequate capital from market and due to continuous withdrawal of deposits.
- Increase in Non-performing assets: Almost one fourth of the bank’s advances have turned bad assets. Its gross non-performing assets (NPAs) stood 25.4% of its advances as of June 2020
What has been the regulatory response to these failures?
- The announcement of moratorium by banking regulator.
- Followed by a reconstruction plan.
- Followed by the Capital infusion by banks and financial institutions by investing in the equity capital of the reconstructed entity
Issues faced by old-generation private banks?
- Lack of promoters: For example, the South Indian Bank and Federal Bank have been operating as board-driven banks without a promoter. In Karur Vysya Bank, the promoter stake is 2.11%, and in Karnataka Bank, there’s no promoter making them targets for mergers or forced amalgamation.
Are the depositors and the financial system safe?
- For small depositors, the Deposit Insurance and Credit Guarantee Corporation (DICGC), an RBI subsidiary gives insurance cover on up to Rs 5 lakh deposits in banks.
- Apart from this, additional infusion of capital and the proposed amalgamation will make the combined balance sheet of DBS India and LVB healthy.
What happens to the investors in these banks?
- Equity capital is being fully written off. This means that existing shareholders face a total loss on their investments unless there are buyers in the secondary market.
- The Equity Capital refers to that portion of the organization’s capital, which is raised in exchange for the share of ownership in the company.
- In the case of Yes Bank, too, some individual investors faced a total loss on their investments in AT-1 bonds.
- As per RBI rules based on the Basel-III framework, AT-1 bonds have principal loss absorption features, which can cause a full write-down or conversion to equity.
How far the loan stress caused by the pandemic impact the banking system?
- The impact will differ depending upon the sector, as segments like pharmaceuticals and IT seem to have benefited in terms of revenues whereas sectors like hospitality, tourism, aviation have been hit the most.
- However, due to the Pandemic, the Corporate sector debt that remains under stress has increased (worth Rs 37.72 lakh crore that is 72% of the banking sector debt to industry).
- An expert committee headed by K V Kamath recommended for a one-time loan restructuring window for corporate borrowers under stress due to the pandemic.
Priority Sector Lending (PSL) guidelines
Reserve Bank of India (RBI) released revised priority sector lending (PSL) guidelines to augment funding for COVID-19 impacted companies.
- Aim: To align Priority Sector lending with emerging national priorities and bring sharper focus on inclusive development.
- Key Revised PSL Guidelines:
- Bank finance for start-ups (up to ₹50 crore), loans to farmers for installation of solar power plants for solarisation of grid connected agriculture pumps and loans for setting up Compressed BioGas (CBG) plants have been included as fresh categories eligible for finance under the priority sector.
- The targets prescribed for “small and marginal farmers” and “weaker sections” are being increased in a phased manner.
- The loan limits for renewable energy have been doubled and for improvement of health infrastructure, credit limit for health infrastructure (including those under ‘Ayushman Bharat’) has been doubled.
About Priority Sector lending (PSL)
- Priority Sector lending (PSL): It means those sectors which the Government and RBI consider as important for the development of the basic needs of the country and are to be given priority over other sectors. The banks are mandated to encourage the growth of such sectors with adequate and timely credit.
- Under this, Commercial banks including foreign banks are required to mandatorily earmark 40% of the adjusted net bank credit for priority sector lending.
- Regional rural banks and small finance banks will have to allocate 75% of adjusted net bank credit to PSL.
Categories: a) Agriculture b) Micro, Small and Medium Enterprises c) Export Credit d) Education e) Housing f) Social Infrastructure g) Renewable Energy and h) Others
National Payments Corporation of India (NPCI)
It is a “Not for Profit” umbrella organization for operating retail payments and settlement systems in India, is an initiative of RBI and Indian Banks’ Association (IBA) under the provisions of the Payment and Settlement Systems Act, 2007, for creating a robust Payment & Settlement Infrastructure in India.
It aims in bringing innovations in the retail payment systems through the use of technology for achieving greater efficiency in operations and widening the reach of payment systems.
The ten core promoter banks are State Bank of India, Punjab National Bank, Canara Bank, Bank of Baroda, Union Bank of India, Bank of India, ICICI Bank, HDFC Bank, Citibank N. A. and HSBC.
RuPay, an indigenous payment card of India launched by NPCI for all banks of India.
Developed by National Payments Corporation of India, Unified Payments Interface is an instant real-time payment system, facilitating inter-bank transactions.
Digital payment system in India
What is the role of RBI in the evolution of digital payment in India?
- RTGS- This system enables the transfer of money from one bank account to another on a “real-time” and on “gross” basis.
- Settlement happens in real-time.
- The large value payments on stock trading, government bond trading and other customer payments were covered under the RTGS, providing finality of settlement, thereby reducing huge risks.
- NEFT- NEFT facilitates funds transfer across all computerized branches of banks (member / sub-member of NEFT) across the country.
- Settlement happens in batches, and the system is available around the clock and RTGS will follow from December 2020.
- SEBI T+1 settlement– The market regulator SEBI is considering lowering the settlement cycle for completion of share transactions to T+1 (trade plus one day) to boost liquidity, improve efficiency and reduce payment-related risks to brokers and the system.
NPCI: National Payments Corporation of India (NPCI), an “Not for Profit” umbrella organization for operating retail payments and settlement systems in India, is an initiative of RBI and Indian Banks’ Association (IBA) under the provisions of the Payment and Settlement Systems Act, 2007, for creating a robust Payment & Settlement Infrastructure in India. It aims in bringing innovations in the retail payment systems through the use of technology for achieving greater efficiency in operations and widening the reach of payment systems.
What steps taken by government to promote digital payment?
- Zero merchant discount rate– In a bid to promote digital transactions, the government exempted merchants from paying merchant discount rate (MDR) cost for payments made through RuPay and UPI platforms.
Issues in Zero MDR –
- Discriminatory approach– For now, MasterCard and Visa cards are permitted to charge MDR. This has led the banks to switch to Visa and Master cards for monetary gains.
- The European Central Bank imposed a ceiling on MDR for all to protect consumer interest.
- NPCI must supply retail fee providers at a discounted value. This will result in a fee system community and infrastructure in rural and semi-urban areas in partnership with Fin-Tech firms and banks.
Way forward: Government needs to take corrective action in the next Budget to ensure a level playing field and to relieve the NPCI from such policy-induced market imperfection.