Indian banking-sector-reforms


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Indian banking-sector-reforms

  1. 1. CHAPTER-1 INTRODUCTION & OVERVIEW A retrospect of the events clearly indicates that the Indian banking sector has come far away from the days of nationalization. The Narasimham Committee laid the foundation for the reformation of the Indian banking sector. Constituted in 1991, the Committee submitted two reports, in 1992 and 1998, which laid significant thrust on enhancing the efficiency and viability of the banking sector. As the international standards became prevalent, banks had to unlearn their traditional operational methods of directed credit, directed investments and fixed interest rates, all of which led to deterioration in the quality of loan portfolios, inadequacy of capital and the erosion of profitability. The recent international consensus on preserving the soundness of the banking system has veered around certain core themes. These are: effective risk management systems, adequate capital provision, sound practices of supervision and regulation, transparency of operation, conducive public policy intervention and maintenance of macroeconomic stability in the economy. Until recently, the lack of competitiveness vis-à-vis global standards, low technological level in operations, over staffing, high NPAs and low levels of motivation had shackled the performance of the banking industry. However, the banking sector reforms have provided the necessary platform for the Indian banks to operate on the basis of operational flexibility and functional autonomy, thereby enhancing efficiency, productivity and profitability. The reforms also brought about structural changes in the financial sector and succeeded in easing external constraints on its operation, i.e. reduction in CRR and SLR reserves, capital adequacy norms, restructuring and recapitulating banks and enhancing the competitive element in the market through the entry of new banks. The reforms also include increase in the number of banks due to the entry of new private and foreign banks, increase in the transparency of the banks’ balance sheets through the introduction of prudential norms and increase in the role of the market forces due to the deregulated interest rates. These have significantly affected the operational environment of the Indian banking sector. 1
  2. 2. To encourage speedy recovery of Non-performing assets, the Narasimham committee laid directions to introduce Special Tribunals and also lead to the creation of an Asset Reconstruction Fund. For revival of weak banks, the Verma Committee recommendations have laid the foundation. Lastly, to maintain macroeconomic stability, RBI has introduced the Asset Liability Management System. A LOOK AT PAST The Indira Gandhi government had nationalised 14 commercial banks through the Banking Companies (Acquisitions and Transfer of Undertakings) Ordinance in 1969. The 1970 and 1980 Acts brought about after the nationalisation of 14 and 6 banks respectively were first amended in 1994 to allow government to reduce its equity in them to up to 49 per cent. The 20 nationalised banks became 19 subsequently after New Bank of India merged with Punjab National Bank. Only six of these 19 banks have so far accessed the market and to gone for public issues meet its additional capital needs. The government holds majority or entire equity of 19 nationalized banks currently. Till now, banks could reduce equity only up to 25 per cent of the paid up capital on the date of nationalisation. Some banks like the Bank of Baroda have returned equity to the government in the past, but that has been within the prescribed 25 per cent cap. The Nationalisation Act provides that the PSU banks cannot sell a single share. This is the reason why banks have been tapping the market to fund their expansion plans. Also the Act originally provided that the government must mandatorily hold 100 per cent stake in banks. The 1994 amendments brought it down to 51 per cent, to help induction of public as shareholders. At this stage, the government provided that all shares, excluding government shares could be transferred. This was necessary to permit the transfer of shares when public shareholders sold their stake in banks. The amendments remove restrictions on the transfer of government shareholding. 2
  3. 3. CHAPTER - 2 2.1 REFORMS IN BANKING SECTOR Introduction As the real sector reforms began in 1992, the need was felt to restructure the Indian banking industry. The reform measures necessitated the deregulation of the financial sector, particularly the banking sector. The initiation of the financial sector reforms brought about a paradigm shift in the banking industry. In 1991, the RBI had proposed to from the committee chaired by M. Narasimham, former RBI Governor in order to review the Financial System viz. aspects relating to the Structure, Organisations and Functioning of the financial system. The Narasimham Committee report, submitted to the then finance minister, Manmohan Singh, on the banking sector reforms highlighted the weaknesses in the Indian banking system and suggested reform measures based on the Basle norms. The guidelines that were issued subsequently laid the foundation for the reformation of Indian banking sector. The main recommendations of the Committee were: i. Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a period of five years ii. Progressive reduction in Cash Reserve Ratio (CRR) iii. Phasing out of directed credit programmes and redefinition of the priority sector iv. Deregulation of interest rates so as to reflect emerging market conditions v. Stipulation of minimum capital adequacy ratio of 4 per cent to risk weighted assets by March 1993, 8 per cent by March 1996, and 8 per cent by those banks having international operations by March 1994 vi. Adoption of uniform accounting practices in regard to income recognition, asset classification and provisioning against bad and doubtful debts vii. Imparting transparency to bank balance sheets and making more disclosures viii. Setting up of special tribunals to speed up the process of recovery of loans ix. Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount x. Restructuring of the banking system, so as to have 3 or 4 large banks, which could become international in character, 8 to 10 national banks and local banks confined to specific regions. Rural banks, including RRBs, confined to rural areas 3
  4. 4. xi. Abolition of branch licensing xii. Liberalising the policy with regard to allowing foreign banks to open offices in India xiii. Rationalisation of foreign operations of Indian banks xiv. Giving freedom to individual banks to recruit officers xv. Inspection by supervisory authorities based essentially on the internal audit and inspection reports xvi. Ending duality of control over banking system by Banking Division and RBI xvii. A separate authority for supervision of banks and financial institutions which would be a semi-autonomous body under RBI xviii. Revised procedure for selection of Chief Executives and Directors of Boards of public sector banks xix. Obtaining resources from the market on competitive terms by DFIs xx. Speedy liberalisation of capital market xxi. Supervision of merchant banks, mutual funds, leasing companies etc., by a separate agency to be set up by RBI and enactment of a separate legislation providing appropriate legal framework for mutual funds and laying down prudential norms for such institutions, etc. Several recommendations have been accepted and are being implemented in a phased manner. Among these are the reductions in SLR/CRR, adoption of prudential norms for asset classification and provisions, introduction of capital adequacy norms, and deregulation of most of the interest rates, allowing entry to new entrants in private sector banking sector, etc. Keeping in view the need of further liberalisation the Narasimham Committee II on Banking Sector reform was set up in 1997. This committee’s terms of reference included review of progress in reforms in the banking sector over the past six years, charting of a programme of banking sector reforms required to make the Indian banking system more robust and internationally competitive and framing of detailed recommendations in regard to make the Indian banking system more robust and internationally competitive. This committee constituted submitted its report in April 1998. The major recommendations are: i. Capital adequacy requirements should take into account market risks also 4
  5. 5. ii. In the next three years, entire portfolio of Govt. securities should be marked to market iii. Risk weight for a Govt. guaranteed account must be 100 percent iv. CAR to be raised to 10% from the present 8%; 9% by 2000 and 10% by 2002 v. An asset should be classified as doubtful if it is in the sub-standard category for 18 months instead of the present 24 months vi. Banks should avoid ever greening of their advances vii. There should be no further re-capitalization by the Govt. viii. NPA level should be brought down to 5% by 2000 and 3% by 2002. ix. Banks having high NPA should transfer their doubtful and loss categories to ARCs which would issue Govt. bonds representing the realisable value of the assets. x. International practice of income recognition by introduction of the 90-day norm instead of the present 180 days. xi. A provision of 1% on standard assets is required. xii. Govt. guaranteed accounts must also be categorized as NPAs under the usual norms xiii. There is need to institute an independent loan review mechanism especially for large borrowal accounts to identify potential NPAs. xiv. Recruitment of skilled manpower directly from the market be given urgent consideration xv. To rationalize staff strengths, an appropriate VRS must be introduced. xvi. A weak bank should be one whose accumulated losses and net NPAs exceed its net worth or one whose operating profits less its income on recap bonds is negative for 3 consecutive years. To start with, it has assigned a 2.5 per cent risk-weightage on gilts by March 31, 2000 and laid down rules for provisioning; shortened the life of sub-standard assets from 24 months to 18 months (by March 31, 2001); called for 0.25 per cent provisioning on standard assets 1.2 Reduction of SLR and CRR (from fiscal 2000); 100 per cent risk weightage on foreign exchange (March 31, 1999) and a minimum capital adequacy ratio of 9 per cent as on March 31, 2000. The South East Asian countries introduced banking reforms wherein bank CRR and SLR was reduced, this increased the lending capacity of banks. The markets fell precipitously because banks and corporates did not accurately measure the risk spread that should have been 5
  6. 6. reflected in their lending activities. Nor did they manage such risks or provide for them in their balance sheets. And followed the South East Asian Crisis. The monetary policy perspective essentially looks at SLR and CRR requirements (especially CRR) in the light of several other roles they play in the economy. The CRR is considered an effective instrument for monetary regulation and inflation control. The SLR is used to impose financial discipline on the banks, provide protection to deposit-holders, allocate bank credit between the government and the private sectors, and also help in monetary regulation. However bankers strongly feel that these along with high non-performing assets (on which banks do not earn any return) 10 percent CRR and 25 percent SLR (most banks have SLR investments way above the stipulation) are affecting banks' bottomlines. With an effective return of a mere 2.8 per cent, CRR is a major drag on banks' profitability. The Narasimham Committee had argued for reductions in SLR on the grounds that the stated government objective of reducing the fiscal deficits will obviate the need for a large portion of the current SLR. Similarly, the need for the use of CRR to control secondary expansion of credit would be lesser in a regime of smaller fiscal deficits. The committee offered the route of Open Market Operations (OMO) to the Reserve Bank of India for further monetary control beyond that provided by the (lowered) SLR and CRR reserves. Ultimately, the rule was Reduction in the reserve requirements of banks, with the Statutory Liquidity Ratio (SLR) being brought down to 25 per cent by 1996-97 in a period of 5 years. The recent trend in several developed countries (US, Switzerland, Australia, Canada, and Germany) towards drastic lowering of reserve requirements is often used to support the argument for reduced reserve levels in India. The arguments for higher or lower SLR and CRR ratios stem from two different perspectives one which favours the banks, and the other which favours the bank reserves as a monetary policy instrument. The bank perspective seeks to maximise "lendable" resources, the banks' control over resource deployment, and returns to the banks from the "preempted" funds. It is also claimed that the low returns from the forced investments in government securities adversely affect the bank profitability - the cost of deposits for banks, which averages at 15-16 per cent, was much greater than the (earlier) returns on the government 6
  7. 7. securities. This argument is sometimes carried further to state that RBI makes profits on impounded money, at the cost of bank profitability. To some extent, this argument has been weakened by the increase in interest on government securities to 13.5 per cent. Some problems with the stated aim of reducing SLR and CRR are: 1. The supporting condition of smaller fiscal deficits is not happening in reality 2. Open market operations have not been used to any significant extent in India for monetary control. The time required for gaining experience with the use of such operations would be much more than 5-6 years. 3. A commitment to a unidirectional movement of these vital controls irrespective of the effects on, and the response of, other economic factors (such as inflation), would be unwise. This scenario thus indicates that despite the stated aim of reductions in SLR and CRR, RBI may be forced to revert to higher reserve levels, if the economic indicators become unfavourable, and RBI has already indicated as much. Bank investment are, therefore, not likely to stabilize in the near future. The RBI had announced an increase in interest rate on CRR balance to 6% from the present 4%. This will certainly boost the profits of banks, as they have to maintain a minimum balance of 8% with the RBI. 1.3 Minimum Capital Adequacy Ratio The committee recommended a Stipulation of minimum capital adequacy ratio of 4 per cent to risk weighted assets by March 1993, 8 per cent by March 1996, and 8 per cent by those banks having international operations by March 1994. Later, all banks required attaining the capital adequacy norm of 8 per cent, as per the Basle Committee Recommendations, by March 31, 1996. Capital Adequacy 7
  8. 8. The growing concern of commercial banks regarding international competitiveness and capital ratios led to the Basle Capital Accord 1988. The accord sets down the agreement to apply common minimum capital standards to their banking industries, to be achieved by year-end 1992. Based on the Basle norms, the RBI also issued similar capital adequacy norms for the Indian banks. According to these guidelines, the banks will have to identify their Tier-I and Tier-II capital and assign risk weights to the assets. Having done this they will have to assess the Capital to Risk Weighted Assets Ratio (CRAR). The minimum CAR that the Indian banks are required to meet is set at 9 percent. • Tier-I Capital, comprising of Paid-up capital Statutory Reserves Disclosed free reserves Capital reserves representing surplus arising out of sale proceeds of assets • Tier-II Capital, comprising of Undisclosed Reserves and Cumulative Perpetual Preference Shares Revaluation Reserves General Provisions and Loss Reserves The Narasimham Committee had recommended that the capital adequacy norms set by the Bank of International Settlements (BIS) be followed by the Indian banks also. The BIS norm for capital adequacy is 8 per cent of risk-weighted assets. Inadequacy? The structural inadequacy that is said to be responsible for the stock scam was the compartmentalisation of the capital and money markets; and the availability of "illegal" arbitrage opportunities. Such interconnections between various parts of the financial system will continue to develop as the demands made by the rest of the economy on the financial system increase in the next two decades. Also, a short-term danger of the new provisioning and capital adequacy norms arises from the inefficiency of the Asset Reconstruction Fund (ARF), or some alternative arrangement. The need to make massive provisions obviously 8
  9. 9. results in a depletion of capital. But the capital adequacy norm means the banks have to find additional, costly money to refurbish the capital base. In this situation, the banks are being forced to accept the minimum possible amounts from sub-standard and bad loans. Where time and legal efforts might have forced them to pay more, errant loanees are now getting away with token payments which the funds starved banks are only too willing to accept. Thus, the need for ARF is now paramount. The banking sector specialists have traditionally claimed that capital plays several roles in all "depository institutions", such as banks. However, these roles can vary significantly between the public sector banks and those in the private sector. The justification for capital adequacy norms for banks is brought out by the following arguments:  Capital lowers the probability of bank failure more capital means added ability to withstand unexpected losses, and more time for the bank to work through potentially fatal problems. At the same time, the Indian public sector banks may attract more "punishments" in the form of politically motivated "loan waivers", "loan melas", and non-performing assets.  Capital increases the disincentive for the bank management to take excessive risk: If significant amount of their own funds are at stake, the equity-owners have a powerful incentive to control the amount of risk the bank incurs. This may remain true for the public sector banks only if the government acts as a vigilant shareholder. However, the government's ability to play such a role effectively is suspect. The Indian banks have traditionally shown risk-aversion, but the recent stock scam showed that the banks are perhaps being forced to take excessive risks to improve the profitability. Since management control will remain with bureaucrats - banking or government - the source of capital would not make much difference in the Indian scenario.  Capital acts as a buffer between the bank and the deposit guarantee corporation (funded by the tax-payer): while this is true for the private banks, the governmentowned capital in the public sector banks is itself taxpayer money. 9
  10. 10.  Capital helps avoid "credit crunches": a well-capitalized bank can continue to lend in the face of losses. Similar losses might force a poorly capitalized bank to restrict credit (to increase capital ratios). In an economic downturn, wellcapitalized banks may provide a vital source of continuing credit.  Capital increases the long-term competitiveness: more capital allows a bank to build long-term customer relationships, and respond to positive as well as negative changes in the economic environment. New opportunities can be quickly made use of by lending appropriately. If the bank is not constrained by capital, it can give valuable time to customers with temporary repayment problems. It can thereby recover more from the loans, which would otherwise have to be called in. The Dilemma The foregoing discussion clearly brings out two conclusions: (a) increasing the capital base of the nationalised banks is necessary, especially in view of the large quantities of nonperforming assets; and (b) however, increase in capital owned directly by the government has several attendant problems' The situation is complicated by the fact that " private management" does not provide an answer in India, because of the size of the institutions involved. Also, talent and expertise in bank management is available mainly in the existing nationalised banks. One short-term fallout of the capital adequacy norms has been the massive increases in investments by the banks in government securities. Since the risk-weight of government securities is zero, investments in them do not add to the capital requirements. The banks are therefore choosing to deploy funds mobilised through deposits in these long-term gilts. In the first ten months of 1993-94, for example, the investments in government securities shot up by 18.8 per cent while bank credit grew at only 6.6 per cent. Despite a strong growth in aggregate deposits of 13.8 per cent, credit grew by only 6.65 per cent, while investments surged by 18.8 per cent. The problem with this practice of the banks is that it can upset the balance of maturity patterns between deposits (many of ' which are short-term) and investments (which have 10 year maturities). Now, banks would have to develop much 10
  11. 11. better investment management skills, especially when interest rates are deregulated, and significant open market operations are started. Growth In Investments In Government Securities by Banks 1991-92 1992-93 1992-93 1993-94 36441 [Up to Jan 93] 32364 [Up to Jan 94] 37187 9291 [19.6 %] 26390 [14.0 %] 20966 [13.8 %] 9999 [8.0 %] [21.0 %] 15131 15460 [16.7 %] 11042 [6.6 %] 19857 [12.2 %] [18.8 %] Aggregate deposits growth Bank credit growth Investments Source: Reserve Bank of India Bulletin [1994] Supplement - Report on Trends and Progress of Banking in India 1991-92 [July - June]; Jan 1993. The Narasimham Committee II, 1998, suggested further revision i.e. CAR to be raised to 10% from the present 8%(1998); 9% by 2000 and 10% by 2002 Illustration 1 1.4 Prudential Norms To get a true picture of the profitability and efficiency of the Indian Banks, a code stating adoption of uniform accounting practices in regard to income recognition, asset classification and provisioning against bad and doubtful debts has been laid down by the Central Bank. Close to 16 per cent of loans made by Indian banks were NPAs - very high compared to say 5 per cent in banking systems in advanced countries. Magnitude of the problem According to the latest RBI figures, gross NPAs in the banking sector stands at Rs 45,563 crore which is about 16 per cent of the total loan assets of the banks. The net NPAs (gross 11
  12. 12. NPAs minus provisioning) stands at Rs 21,232 crore which is about 7 per cent of loans advanced by the banking sector. Though in percentage terms, the NPAs have come down over the last 5-6 years, in absolute terms they have grown, signifying that while new NPAs are being added to banks' operations every year, recovery of older dues is also taking too long. What is ever greening or rescheduling of loans? Sometimes, to avoid classifying problem assets as NPAs, banks give another loan to the company with the help of which it can pay the due interest on the original loan. While this allows the bank to project a healthy image, it actually makes the problems worse, and creates more NPAs in the long run. RBI discourages such practices. Asset Quality - Increased Transparency Apart from the interest rate structure, the net interest income is also affected by the asset quality of the bank. Asset quality is reflected by the quantum of non-performing assets (NPAs) – the higher the level of NPAs, the lower will be the asset quality and vice versa. Courtesy the nationalization agenda and the directed credit, most of the public sector banks were burdened with huge NPAs. While the government did contribute to write-off these bad loans, the problem still remains. NPAs expose the banks to not just credit risk but also to liquidity risk. Considering the implications of the NPAs and also for imparting greater transparency and accountability in banks operations and restoring the credibility of confidence in the Indian financial system, the RBI introduced prudential norms and regulations. The prudential norms which relate to income recognition, asset classification and provisioning for bad and doubtful debts serve two primary purposes – firstly, they bring out the true position of a Bank’s loan portfolio, and secondly, they help in arresting its deterioration. The asset quality of the bank and its capital are closely associated. If the assets of the bank go bad it is the capital that comes to its rescue. Implies that the bank should have adequate capital to face the likely losses that may arise from its risky assets. In the changed business environment, where banks are exposed to greater and different types of risk, it becomes essential to have a good capital base, which can help it sustain unforeseen losses. As stated 12
  13. 13. earlier, the one major move in this direction was brought about by the Basle Committee, which laid the capital standards that banks have to maintain. This became imperative, as banks began to cross over their national boundaries and begin to operate in international markets. Following the Basle Committee measures, RBI also issued the Capital Adequacy Norms for the Indian banks also. INCOME RECOGNITION  The regulation for income recognition states that the Income on NPAs cannot be booked. Interest income should not be recognized until it is realized. An NPA is one where interest is overdue for two quarters or more. In respect of NPAs, interest is not to be recognized on accrual basis, but is to be treated as income only when actually received. Income in respect of accounts coming under Health Code 5 to 8 should not be recognized until it is realized. As regards to accounts classified in Health Code 4, RBI has advised the banks to evolve a realistic system for income recognition based on the prospect of realisability of the security. On non-performing accounts the banks should not charge or take into account the interest. Income-recognition norms have been tightened for consortium banking too. Member banks have to intimate the lead-bank to arrange for their share of recovery. They will no more have the privilege of stating that the borrower has parked funds with the lead-bank or with a member-bank and that their share is due for receipt. The new notifications emanated after deliberations held between the RBI and a cross-section of banks after a working group headed by chartered accountant, PR Khanna, submitted its report. The working group was set after the RBI’s Board for Financial Supervision (BFS) wanted divergences in NPA accounting norms by banks from central bank guidelines to be addressed. The working group had identified three areas of divergence: non-compliance with RBI norms; subjectivity arising out of the flexibility in norms; and differences in the valuation of securities by banks, auditors and RBI. ASSET CLASSIFICATION 13
  14. 14. While new private banks are careful about their asset quality and consequently have low nonperforming assets (NPAs), public sector banks have large NPAs due to wrong lending policies followed earlier and also due to government regulations that require them to lend to sectors where potential of default is high. Allaying the fears that bulk of the Non-Performing Assets (NPAs) was from priority sector, NPA from priority sector constituted was lower at 46 per cent than that of the corporate sector at 48 per cent. Loans and advances account for around 40 per cent of the assets of SCBs. However, delay/default in payment of interest and/or repayment of principal has rendered a significant proportion of the loan assets non-performing. As per RBI’s prudential norms, a NonPerforming Asset (NPA) is a credit facility in respect of which interest/installment has remained unpaid for more than two quarters after it has become past due. “Past due” denotes grace period of one month after it has become due for payment by the borrower. The MidTerm Review of Monetary and Credit Policy for 2000-01 has proposed to discontinue this concept with effect from March 31, 2001. Regulations for asset classification Assets should be classified into four classes - Standard, Sub-standard, Doubtful, and Loss assets. NPAs are loans on which the dues are not received for two quarters. NPAs consist of assets under three categories: sub-standard, doubtful and loss. RBI for these classes of assets should evolve clear, uniform, and consistent definitions. The health code system earlier in use would have to be replaced. The banks should classify their assets based on weaknesses and dependency on collateral securities into four categories: Standard Assets: It carries not more than the normal risk attached to the business and is not an NPA. Sub-standard Asset: An asset which remains as NPA for a period exceeding 24 months, where the current net worth of the borrower, guarantor or the current market value of the security charged to the bank is not enough to ensure recovery of the debt due to the bank in full. 14
  15. 15. Doubtful Assets: An NPA which continued to be so for a period exceeding two years (18 months, with effect from March, 2001, as recommended by Narasimham Committee II, 1998). Loss Assets: An asset identified by the bank or internal/ external auditors or RBI inspection as loss asset, but the amount has not yet been written off wholly or partly. The banking industry has significant market inefficiencies caused by the large amounts of Non Performing Assets (NPAs) in bank portfolios, accumulated over several years. Discussions on non-performing assets have been going on for several years now. One of the earliest writings on NPAs defined them as "assets which cannot be recycled or disposed off immediately, and which do not yield returns to the bank, examples of which are: Overdue and stagnant accounts, suit filed accounts, suspense accounts and miscellaneous assets, cash and bank balances with other banks, and amounts locked up in frauds". The following Table shows the distribution of total loan assets of banks in the public private sectors and foreign banks for 1997-98 through 1999-2000. It is worth noting that the ratio of incremental standard assets of SCBs to their total loan assets increased from 83.1 per cent in 1998-99 to 97.2 percent in 1999-2000. In other words, the ratio of incremental NPAs of SCBs to their total loan assets declined significantly from 16.9 per cent in 1998-99 to 2.8 percent in 1999-2000. Classification of Loan Assets of SCBs (Percentage distribution of total loan assets) Assets Public Private Foreign SCBs A. Standard 1997-98 84.0 91.3 93.6 85.6 1998-99 86.1 91.2 92.4 85.3 1999-2000 86.0 91.5 93.0 87.2 1997-98 5.0 5.8 3.9 4.9 1998-99 4.9 6.2 4.0 5.0 B. Sub-standard 15
  16. 16. 1999-2000 4.3 3.7 2.9 5.1 1997-98 9.1 0.9 1.7 1.8 1998-99 4.0 0.9 2.0 1.9 1999-2000 1.7 0.8 1.9 1.6 1997-98 1.9 0.9 1.2 1.8 1998-99 2.0 0.9 2.0 1.9 1999-2000 1.7 0.8 1.9 1.6 C. Doubtful D. Loss E. Total Assets (Rs. Crore) 1997-98 284971 36753 30972 352696 1998-99 325328 43049 31059 399436 1999-2000 380077 58249 37432 475758 Note: Addition of percentages for B to D may not add up to 100 minus the percentage share of standard assets (A) due to rounding. Illustration 2 The asset classification norms have resulted in a huge quantity of assets being classified into the sub-standard, doubtful, and loss assets. As at 31 March 1993, the total of NonPerforming Assets (NPAs) for the public sector banks (SBI, its seven associates, and 20 nationalised banks) stood at Rs 36,588 crores. Of these, the sub-standard assets account for Rs 12,552 crores, doubtful assets Rs 20,106 crores, and loss assets Rs 3,930 crores (RBI Bulletin, 1994). For the future, the banks will have to tighten their credit evaluation process to prevent this scale of sub-standard and loss assets. The present evaluation process in several banks is burdened with a bureaucratic exercise, sometimes involving up to 18 different officials, most of whom do not add any value (information or judgment) to the evaluation. PROVISIONING NORMS 16
  17. 17. Banks will be required to make provisions for bad and doubtful debts on a uniform and consistent basis so that the balance sheets reflect a true picture of the financial status of the bank. The Narasimham Committee has recommended the following provisioning norms (i) 100 per cent of loss assets or 100 per cent of out standings for loss assets; (ii) 100 per cent of security shortfall for doubtful assets and 20 per cent to 50 per cent of the secured portion; and (iii) 10 per cent of the total out standings for substandard assets. A provision of 1% on standard assets is required as suggested by Narasimham Committee II 1998. Banks need to have better credit appraisal systems so as to prevent NPAs from occurring. The most important relaxation is that the banks have been allowed to make provisions for only 30 per cent of the "provisioning requirements" as calculated using the Narasimham Committee recommendations on provisioning (but with the diluted asset classification). The nationalised banks have been asked to provide for the remaining 70 per cent of the "provisioning requirements" by 31 March 1994. The encouraging profits recently declared by several banks have to be seen in the light of provisions made by them - Rs 10,390 crores pertaining to 1992-93, and the additional provisions for 1993-94. To the extent that provisions have not been made, the profits would be fictitious. 1.5 Disclosure Norms Banks should disclose in balance sheets maturity pattern of advances, deposits, investments and borrowings. Apart from this, banks are also required to give details of their exposure to foreign currency assets and liabilities and movement of bad loans. These disclosures were to be made for the year ending March 2000 In fact, the banks must be forced to make public the nature of NPAs being written off. This should be done to ensure that the taxpayer’s money given to the banks as capital is not used to write off private loans without adequate efforts and punishment of defaulters. 17
  18. 18. # A Close look: For the future, the banks will have to tighten their credit evaluation process to prevent this scale of sub-standard and loss assets. The present evaluation process in several banks is burdened with a bureaucratic exercise, sometimes involving up to 18 different officials, most of whom do not add any value (information or judgment) to the evaluation. But whether this government and its successors will continue to play with bank funds remains to be seen. Perhaps even the loan waivers and loan "melas" which are often decried by bankers form only a small portion of the total NPAs. As mentioned above, much more stringent disclosure norms are the only way to increase the accountability of bank management to the taxpayers . A lot therefore depends upon the seriousness with which a new regime of regulation is pursued by RBI and the newly formed Board for Financial Supervision. RBI norms for consolidated PSU bank accounts The Reserve Bank of India (RBI) has moved to get public sector banks to consolidate their accounts with those of their subsidiaries and other outfits where they hold substantial stakes. Towards this end, RBI has set up a working group recently under its Department of Banking Operations and Development to come out with necessary guidelines on consolidated accounts for banks. The move is aimed at providing the investor with a better insight into viewing a bank's performance in totality, including all its branches and subsidiaries, and not as isolated entities. According to a banker, earlier subsidiaries were floated as external independent entities wherein the accounting details were not incorporated in the parent bank's balance sheet, but at the same time it was assumed that the problems will be dealt with by the parent. This will be a path-breaking change to the existing norms wherein each bank conducts its accounts without taking into consideration the disclosures of its subsidiaries and other divisions for disclosure. As per the proposed new policy guidelines, the banks will be required to consolidate their accounts including all its subsidiaries and other holding companies for better transparency. # Result: This will require the banks to have a stricter monitoring system of not only their own bank, but also the other subsidiaries in other sectors like mutual funds, merchant 18
  19. 19. banking, housing finance and others. This is all the more important in the context of the recent announcements made by some major public sector banks where they have said they would hive off or close down some of their under performing subsidiaries. 1.6 Rationalisation of Foreign Operations in India Liberalizing the policy with regard to allowing foreign banks to open offices in India or rather Deregulation of the entry norms for private sector banks and foreign sector. Entry of New Banks in the Private Sector As per the guidelines for licensing of new banks in the private sector issued in January 1993, RBI had granted licenses to 10 banks. Based on a review of experience gained on the functioning of new private sector banks, revised guidelines were issued in January 2001. The main provisions/requirements are listed below : • Initial minimum paid-up capital shall be Rs. 200 crore; this will be raised to Rs. 300 crore within three years of commencement of business. • Promoters’ contribution shall be a minimum of 40 per cent of the paid-up capital of the bank at any point of time; their contribution of 40 per cent shall be locked in for 5 years from the date of licensing of the bank and excess stake above 40 per cent shall be diluted after one year of bank’s operations. • Initial capital other than promoters’ contribution could be raised through public issue or private placement. • While augmenting capital to Rs. 300 crore within three years, promoters need to bring in at least 40 percent of the fresh capital, which will also be locked in for 5 years. The remaining portion of fresh capital could be raised through public issue or private placement. • NRI participation in the primary equity of the new bank shall be to the maximum extent of 40 per cent. In the case of a foreign banking company or finance company (including multilateral institutions) as a technical collaborator or a co-promoter, equity participation 19
  20. 20. shall be limited to 20 per cent within the 40 per cent ceiling. Shortfall in NRI contribution to foreign equity can be met through contribution by designated multilateral institutions. • No large industrial house can promote a new bank. Individual companies connected with large industrial houses can, however, contribute up to 10 per cent of the equity of a new bank, which will maintain an arms length relationship with companies in the promoter group and the individual company/ies investing in equity. No credit facilities shall be extended to them. • NBFCs with good track record can become banks, subject to specified criteria • A minimum capital adequacy ratio of 10 per cent shall be maintained on a continuous basis from commencement of operations. • Priority sector lending target is 40 per cent of net bank credit, as in the case of other domestic banks; it is also necessary to open 25 per cent of the branches in rural/semiurban areas. "Our industry did not oppose the entry of private bankers because we knew they will not be able to reach out to the rural markets” states, G.M. Bhakey, president of the State Bank of India Officers Association. "Even after privatisation not more than 10 per cent of the Indian population can afford to open accounts in private banks." Can the keenly supported private and foreign banks cater to the banking needs of the people in India fairly? Takeover and merger dramas are in progress in the world of private sector banks now and time only can tell how many will live to render safe banking services in the days to come. The bad debt figures even in the two to three year old new private sector banks have crossed over 6% to the total advances, while the trends in the old private banks are still higher, despite the fact that they have no social commitment lendings in their portfolios. In any case, the private banks, in the Indian context, cannot be the alternative to our welldeveloped public sector banks. They are there in the country to fill the private pockets with their typical selectivity of business and costly operations. All those who beat their drums for the privatisation parade, which is much on the move after globalisation, to denationalise our public sector banks, do so with vested interests. 20
  21. 21. ICICI bank, HDFC bank, GTB, IndusInd, BOP and UTI Bank have come out with IPOs as per licensing requirement. Their technological edge and product innovation has seen them gaining market share from the slower, less efficient older banks. These banks have targeted non-fund based income as major source of revenue, with their level of contingent liabilities being much higher then their other counterparts viz. PSU and old private sector banks. The new private banks have been consistently gaining market shares from the public sector banks. The main problems concerning the nationalized / state sector banks are as follows: A. Large number of unprofitable branches B. Excess staffing of serious magnitude C. Non Performing Assets on account of politically directed lending and industrial recession in last few years D. Lack of computerization leading to low service delivery levels, non-reconciliation of accounts, inability to control, misuse and fraud etc E. Inability to introduce profitable new consumer oriented products like credit cards, ATMs etc. The private’ edge  Technology- The private banks have used technology to provide quality service through lower cost delivery mechanisms. The implementation of new technology has been going on at very rapid pace in the private sector, while PSU banks are lagging behind in the race.  Declining interest rates- in the present scenario of declining interest rates, some of the new private banks are better able to manage the maturity mix. PSU Banks by and large take relatively long-term deposits at fixed rates to lend for working capital purposes at variable rates. It therefore is negatively affected when interest rates decline as it takes time to reduce interest rates on deposits when lending has to be done at lower interest rates due to competitive pressures. 21
  22. 22.  NPAs- The new banks are growing faster, are more profitable and have cleaner loans. Reforms among public sector banks are slow, as politicians are reluctant to surrender their grip over the deployment of huge amounts of public money.  Convergence- The new private banks are able to provide a range of financial services under one roof, thus increasing their fee based revenues. Appendix 1 List of Banks operating in India. 1.7 Special Tribunals and Asset Reconstruction Fund Setting up of special tribunals to speed up the process of recovery of loans and setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount was one of the crucial recommendations of the Narasimham Committee. To expedite adjudication and recovery of debts due to banks and financial institutions (FIs) at the instance of the Tiwari Committee (1984), appointed by the Reserve Bank of India (RBI), the government enacted the Debt Recovery Tribunal Act, 1993 (DRT). Accordingly, DRTs and Appellate DRTs have been established at different places in the country. The act was amended in January 2000 to tackle some problems with the old act. DRTs, a compulsion! One of the main factors responsible for mounting non-performing assets (NPAs) in the financial sector has been the inability of banks/FIs to enforce the security held by them on loans gone sour. Prior to the passage of the DRT Act, the only recourse available to banks/FIs to cover their dues from recalcitrant borrowers, when all else failed, was to file a suit in a civil court. The result was that by the late ’80s, banks had a huge portfolio of accounts where cases were pending in civil courts. It was quite common for cases to drag on interminably. In the interim, borrowers, more often than not, stripped their premises of all 22
  23. 23. assets so that that by the time the final verdict came, there was nothing left of the security that had been pledged to the bank. The Advantage DRTs, it was felt, would do away with the costly, time-consuming civil court procedures that stymied recovery procedures since they follow a summary procedure that expedites disposal of suits filed by banks/FIs. Following the passage of the Act in August 1993, DRTs were set up at Calcutta, Delhi, Bangalore, Jaipur and Ahmedabad along with an Appellate Tribunal at Mumbai.However, DRTs soon ran into rough weather. The constitutional validity of the Act itself was questioned. It was only in March 1996, that the Supreme court modified its earlier order — staying the operation of the Delhi High Court order quashing the constitution of the DRT for Delhi — to allow the setting up of three more DRTs in Chennai, Guwahati and Patna. Subsequently, many more DRTs and ADRTs have been set up. Recent Developments The recent amendment (Jan 2000) to the DRT Act addresses many of the lacunae in the original act. It empowers DRTs to attach the property on the borrower filing a complaint of default. It also empowers the presiding officer to execute the decree of the official receiver based on the certificate issued by the DRT. Transfer of cases from one DRT to another has also been made easier. More recently, the Supreme Court has ruled that the DRT Act will take precedence over the Companies Act in the recovery of debt, putting to rest all doubts on that score. 1.8 Restructuring of Weak Banks How to deal with the weak Public Sector Banks is a major problem for the next stage of banking sector reforms. It is particularly difficult because the poor financial position of many of these banks is often blamed on the fact that the regulatory regime in earlier years did not place sufficient emphasis on sound banking, and the weak Banks are, therefore, not responsible for their current predicament. This perception often leads to an expectation that all weak Banks must be helped to restructure after which they would be able to survive in the new environment. 23
  24. 24. Keeping in view the urgent need to revive the weak banks, the Reserve Bank of India set up a Working Group in February, 1999 under the Chairmanship of Shri M.S. Verma to suggest measures for the revival of weak public sector banks in India. THE VERMA PRESCRIPTION…a brief  Identification of weak banks by using benchmarks for 7 critical ratios  Recapitalisation of 3 weak banks conditional on their achieving specified milestones  Five-year freeze on all wage-increases, including the 12.25% increase negotiated by the IBA  A 25% reduction in staff-strength, either through VRSs or through wage-cuts  Branch rationalisation, including the closure of loss-making foreign branches  Transfer of non-performing assets to an Asset Reconstruction Fund  Reconstitution of bank boards to include professionals, industrialists and financial experts  Independent Financial Restructuring Authority to monitor implementation of revival package The major recommendations/points of the Working Group, which submitted its Report in October, 1999, are listed below: Seven parameters covering three areas have been identified; these are (i) Solvency (capital adequacy ratio and coverage ratio), (ii) Earning Capacity (return on assets and net interest margin) and (iii) Profitability (ratio of operating profit to average working funds, ratio of cost to income and ratio of staff cost to net interest + income all other income).  Restructuring of weak banks should be a two-stage operation; stage one involves operational, organisational and financial restructuring aimed at restoring competitive efficiency; stage two covers options of privatisation and/or merger. 24
  25. 25.  Operational restructuring essentially involves building up capabilities to launch new products, attract new customers, improve credit culture, secure higher feebased earnings, sell foreign branches (Indian Bank and UCO Bank) to prospective buyers including other public sector banks, and pull out from the subsidiaries (Indian Bank), establish a common networking and processing facility in the field of technology, etc.  The action programme for handling of NPAs should cover honouring of Government guarantees, better use of compromises for reduction of NPAs based on recommendations of the Settlement Advisory Committees, transfer of NPAs to ARF managed by an independent AMC,etc.  To begin with, ARF may restrict itself to the NPAs of the three identified weak banks; the fund needed for ARF is to be provided by the Government; ARF should focus on relatively larger NPAs (Rs. 50 lakh and above).  A 30-35 percent reduction in staff cost required in the three identified weak banks to enable them to reach the median level of ratio of staff cost to operating income.  In order to control staff cost, the three identified weak banks should adopt a VRS covering at least 25 percent of the staff strength; for the three banks taken together, the estimated cost of VRS ranges from Rs. 1100 to Rs. 1200 crore.  The organisational restructuring includes delayering of the decision making process relating to credit, rationalisation of branch network, etc.  Experts have also suggested the concept of narrow banking, where only strong and efficient banks will be allowed to give commercial loans, while the weak 25
  26. 26. banks will take positions in less risky assets such as government securities and inter-bank lending. The three identified banks on committee recommendations were UCO bank, United Bank of India and Indian Bank. In August 2001, the government of India directed UCO Bank to shut down 800 branches and also 4 international operations in line with the Verma committee recommendation on sick banks. Three more PSBs declared sick are Dena Bank, Allahabad Bank and Punjab and Sindh Bank. UCO bank had been posting losses for the past eleven years. 1.9 Asset Liability Management System The critical role of managing risks has now come into the open, especially against the experience of the recent East Asian crisis, where markets fell precipitously because banks and corporates did not accurately measure the risk spread that should have been reflected in their lending activities. Nor did they manage such risks or provide for them in their balance sheets. In India, the Reserve Bank has recently issued comprehensive guidelines to banks for putting in place an asset-liability management system. The emergence of this concept can be traced to the mid 1970s in the US when deregulation of the interest rates compelled the banks to undertake active planning for the structure of the balance sheet. The uncertainty of interest rate movements gave rise to interest rate risk thereby causing banks to look for processes to manage their risk. In the wake of interest rate risk came liquidity risk and credit risk as inherent components of risk for banks. The recognition of these risks brought Asset Liability Management to the centre-stage of financial intermediation. ALM framework rests on three pillars ALM Organisation: The ALCO consisting of the banks senior management including CEO should be responsible for adhering to the limits set by the board as well as for deciding the business strategy of the 26
  27. 27. bank in line with the banks budget and decided risk management objectives. ALCO is a decision-making unit responsible for balance sheet planning from a risk return perspective including strategic management of interest and liquidity risk. Consider the procedure for sanctioning a loan. The borrower who approaches the bank, is appraised by the credit department on various parameters like industry prospects, operational efficiency, financial efficiency, management evaluation and others which influence the working of the client company. On the basis of this appraisal the borrower is charged certain rate of interest to cover the credit risk. For example, a client with credit appraisal AAA will be charged PLR. While somebody with BBB rating will be charged PLR + 2.5 %, say. Naturally, there will be certain cut-off for credit appraisal, below which the bank will not lend e.g. Bank will not like to lend to D rated client even at a higher rate of interest. The guidelines for the loan sanctioning procedure are decided in the ALCO meetings with targets set and goals established ALM Information System ALM Information System for the collection of information accurately, adequately and expeditiously. Information is the key to the ALM process. A good information system gives the bank management a complete picture of the bank's balance sheet. ALM Process The basic ALM process involves identification, measurement and management of risk parameters. The RBI in its guidelines has asked Indian banks to use traditional techniques like Gap Analysis for monitoring interest rate and liquidity risk. However RBI is expecting Indian banks to move towards sophisticated techniques like Duration, Simulation, VaR in the future. 1.10 Reduction of Government Stake in PSBs This is what the finance minister said in his budget speech on February 29, 2000; "In recent years, RBI has been prescribing prudential norms for banks broadly consistent with international practice. To meet the minimum capital adequacy norms set by the RBI and to enable the banks to expand their operations, public-sector banks will need more capital. With the Government 27
  28. 28. budget under severe strain, such capital has to be raised from the public which will result in reduction in government shareholding. To facilitate this process, the Government has decided to accept the recommendations of the Narasimham Committee on Banking Sector Reforms for reducing the requirement of minimum shareholding by government in nationalised banks to 33 per cent. This will be done without changing the public-sector character of banks and while ensuring that fresh issue of shares is widely held by the public." Banking is a business and not an extension of government. Banks must be self-reliant, lean and competitive. The best way to achieve this is to privatise the banks and make the managements accountable to real shareholders. If "privatisation" is a still a dirty word, a good starting point for us is to restrict government stake to 33 per cent. During the winter session of the Parliament, on 16 November 2000, the Union Cabinet has taken certain decisions, which have far reaching consequences for the future of the Indian banking sector cleared amendment of the Banking Companies (Acquisitions and Transfer of Undertakings) Act 1970/1980 for facilitating the dilution of government’s equity to 33 per cent. Government’s action programme has expressed clearly its programme for the dilution of its stake in bank equity. The Cabinet had taken this decision, immediately on the next day after the bank employees went on strike, is a clear indication of Government of India’s determination to amend the concerned Acts, to pave the way for the reduction in its stake. The proposal had been to reduce the minimum shareholding from 51 per cent to 33 per cent, with adequate safeguards for ensuring its control on the operations of the banks. However, it is not willing to give away the management control in the nationalised banks. As a result public sector banks may find it very difficult to attract strategic investors. SALIENT FEATURES of the proposed amendments  Government would retain its control over the banks by stipulating that the voting rights of any investor would be restricted to one per cent, irrespective of the equity holdings. 28
  29. 29.  The government would continue to have the prerogative of the appointment of the chief executives and the directors of the nationalised banks. There has been considerable delay in the past in filling up the posts of the chairman and executive director of some banks. It is not clear as to how this aspect would be taken care of in future. It is said that the proposed amendment to the Act would also give the board of banks greater autonomy and flexibility.  It has been decided to discontinue the mandatory practice of nominating the representatives of the government of India and the Reserve Bank in the boards of nationalised banks. This decision is in tune with the recommendation of Narasimham committee. However, the government would retain the right to nominate its representative in the boards and strangely a nominee of the government can be in more than one bank after the amendment.  The number of whole time directors would be raised to four as against the present position of two, the chairman and managing director and the executive director. While conceptually it is desirable to decentralise power, operationally it may be difficult to share power at peer level. In quite a few cases, it was observed that inter personal relations were not cordial among the two at the top. It has to be seen as to how the four full time directors would function in unison.  It is proposed to amend the provisions in the Banking Companies (Acquisition and Transfer of Undertakings) Act to enable the bank shareholders to discuss, adopt and approve the annual accounts and adopt the same at the annual general meetings. Paid-up capital of nationalised banks can now fall below 25 per cent of the authorised capital.  Amendment will also enable the setting up of bank-specific Financial Restructuring Authority (FRA). Authority will be empowered to take over the management of the weak banks. Members of FRA will comprise of experts from various fields & will be appointed by the government, on the advice of Reserve Bank of India. The government has been maintaining that the nationalised banks would continue to retain public sector character even after the reduction in equity. 29
  30. 30. This is the reason why the banks would continue to be statutory bodies even after the reduction in government equity below 51 per cent and the banks would not become companies. This implies that they would continue to be subject to parliamentary and other scrutiny despite proposed relaxations. The measures seen in totality are clearly aimed at enabling banks to access the capital markets and raise funds for their operations. The Government seems to have no plans to reduce its control over these banks. The Act will also permit it to transfer its stake if the need arises, apart from granting banks the freedom to restructure their equity. Reserve Bank’s perception; the Reserve Bank has been emphatic in its views on lowering the stake of the government in the equity of nationalized banks: The panel wants government stake to be diluted to less than 50 per cent in order to make banks' decision-making more autonomous. It has said, “in view of the severe budgetary strain of the government, the capital has to be raised from the public, which leads to a reduction in government shareholding.” The process of the transition from public sector to the joint sector has already been initiated with 7 of the public sector banks accessing the capital market for expanding their capital base. Since total privatization is not contemplated, the banks in the joint sector are expected to control the commanding heights of the banking business in the years to come. In the domestic context, the idea behind a reduction in government stake is to free bank employees from being treated as "public servants." Instead, by directly reducing the government stake below 50 per cent, the banks will be free from the shackles of the central vigilance commission. Official sources explained that this has been done to enable banks to clean up their balance sheets so that they can access the capital market easily. In terms of transferring equity, the government is arming itself with powers to sell its stake if it so desires at a later date. 1.11 Deregulation on Interest Rates 30
  31. 31. The interest rate regime has also undergone a significant change. For long, an administered structure of interest rate has been in vogue in India. The 1998 Narasimham Reforms suggested deregulation of interest rates on term deposits beyond a period of 15 days. At present, the Reserve Bank prescribes only two lending rates for small borrowers. Banks are free to determine the interest rate on deposits and lending rates on all lendings above Rs. 200,000. In the last couple of years there has been a clear downward trend in interest rates. Initially lending rates came down, leading to a decline in yields on advances and investments. Interest rates in the banking system have been liberalised very substantially compared to the situation prevailing before 1991, when the Reserve Bank of India controlled the rates payable on deposits of different maturities. The rationale for liberalising interest rates in the banking system was to allow banks greater flexibility and encourage competition. Banks were able to vary rates charged to borrowers according to their cost of funds and also to reflect the credit worthiness of different borrowers. With effect from October 97 interest rates on all time deposits, including 15-day deposits, have been freed. Only the rate on savings deposits remains controlled by RBI. Lending rates were similarly freed in a series of steps. The Reserve Bank now directly controls only the interest rate charged for export credit, which accounts for about 10% of commercial advances. Interest rates on time deposits were decontrolled in a sequence of steps beginning with longer-term deposits and the liberalisation was progressively extended to deposits of shorter maturity. Interest rates on loans upto Rs 2,00,000, which account for 25% of total advances, is not fixed at a level set by the RBI, but is now aligned with the Prime Lending Rate (PLR) which is determined by the boards of individual Banks. Earlier interest rates on loans below Rs 2,00,000 were fixed at a highly concessional level. The new arrangement sets a ceiling on these rates at the PLR, which reduces the degree of concessionality but does not eliminate it. 31
  32. 32. Cooperative Banks were freed from all controls on lending rates in 1996 and this freedom was extended to Regional Rural Banks and private local area banks in 1997. RBI also considers removal of existing controls on lending rates in other Commercial Banks as the Indian economy gets used to higher interest rate regime on shorter loan duration. Income and Expenses Profile of Banks Interest Income Interest Expenses • Interest/discount on advances/bills • Interest on investments • Interest on balances with RBI and other interbank funds • Others • Interest on deposits • Interest on Refinance/interbank borrowings • Others Other Income Operating Expenses • Commission, Exchange and Brokerage • Profit on sale of investments • Profit on revaluation of investments • Profit on sale of land, building and other assets • Profit on exchange transactions • Income earned by way of dividends, etc. • Miscellaneous  Payments to and provisions for employees • Rent, taxes and lighting • Printing and stationery • Advertisement and publicity • Depreciation on Bank’s property • Director’/Auditor’s fees and expenses • Law charges, Postage, etc. • Repairs and Maintenance,  Insurance. • Other expenses Illustration 3 CHAPTER-3 3.1 Public sector OR Private Sector – the point of views About REFORMS in the Indian banking sector 32
  33. 33. The legal infrastructure for the recovery of non-performing loans still does not exist. The functioning of debt recovery tribunals has been hampered considerably by litigation in various high courts. This ultimately leads to one solution i.e. ruthless provisioning, any better ways; it is a major drawback of this ruling. # What is the procedure being a private player (ICICI) in this industry, is it different and more effective as far as recoveries are concerned? At ICICI Considering the effect of high level of NPAs on the efficiency of banks, ICICI follows a certain procedure as far as loan advancements are concerned. Unlike most of the PSBs, the root cause for a high NPA level is considered; being solvency of the borrower. The procedure differs as per the amount of loan; for loan amount of Rs 500000/- and below, the customer profile is scrutanised at the branch level. The Branch Manager and the Assistant Branch Manager evaluate the solvency of the borrower, individually and then approval for the same is forwarded to the concerned department. In cases where the loan amount exceeds Rs 500000/-, the customer profile is further forwarded to the corporate level. After evaluation at this level a confirmation is sent to the respective branch, and then the borrowers offer is confirmed. This system has ensured the low level of NPAs in this private sector bank. At PSBs Today, PSBs need to be given more power to enforce their security rights; the banks cannot sell any collateral of a borrower without the court intervention. Even as far as DRT working is concerned, an issue is resolved in a year and a half inspite of stipulated norms of 6 months. The need to make massive provisions obviously results in a depletion of capital. But the capital adequacy norm means the banks have to find additional, costly money to refurbish the capital base. In this situation, the banks are being forced to accept the minimum possible amounts from sub-standard and bad loans. Thus, the need for ARF is now paramount. # Is the transfers on NPAs to state owned ARF, just about shifting the responsibility to the ARF? What’s the whole point of having something like that, it’s like a better way of declaring losses and turning away from efficiencies? At ICICI Banks should be able to account for it independently. 33
  34. 34. At PSBs Frankly, ARFs seem to be like pointless transfers, its just another committee with more heads made by GOI. Reforms among public sector banks are slow, as politicians are reluctant to surrender their grip over the deployment of huge amounts of public money. # As a private player what are the problems that you face while communicating with the government? At ICICI The government imposes a lot of restrictions on the private players. A PSB anyway needs to open a branch in rural areas; but for private banks need to have branches in certain areas like Amravati or Ratnagiri, the cost of these is not really feasible to these banks but they have no alternative. At PSBs Government does co-operate; the GOI is good, this is no form of defence, please note the following: - Consider the number of customers in private as compared to public sector banks - PSBs have a definite priority sector lending - Maintenance of PPF accounts, taxes, etc - Minimum deposit for credit cards and FD Take the case of UTI returns when all others were down, that’s a government cost. Government intends to reduce its stake to 33% in nationalized banks, please comment on this reform, its positive and negative effects on private players. At ICICI As far as an effect of reducing government stake is concerned, the competition to private players will increase. The ownership pattern and capital structure will change and this will lead to better efficiencies and customer service level; the management approach will be by 34
  35. 35. professionalism. However, being a government rule, it will be gradually implemented so no immediate impact on private players. Introduction of prudential norms, Income Recognition, Asset Classification and compulsory disclosure of accounts has lead to transparency in the working of banks. Any other recommendations as a private bank. At ICICI Besides, banking regulation norms, the government needs to make a certain service level mandatory. This could be: - Customer service increase, i.e. basic training to employees - Decrease NPA level by better evaluation of customer profile - Technological upgradation, this has been implemented in PSBs - Diversified portfolio, not just traditional ‘Banking’ functions At PSBs Any PSB is answerable at the Parliament level to the GOI; thus, disclosure should be higher in PSBs. Consolidation of the Banking industry by merging strong banks is the latest development in the Indian Banking Sector. ICICI has had a recent merger with BoM, ANZ and Stanchart, etc. Please state your views on the overall development of India with this major development in the financial system. At ICICI In a competitive scenario, banks need to increase their emphasis on customer service; the customers have a lot of choices to make. As per Relationship Manager, ICICI, a bank with large network of branches and diversified portfolio will stand in the market. Ultimately, a branch that gives all in ‘one-stop’ will survive. For ICICI and BoM merger, BoM has 277 branches in South India, thus ICICI now stands to create regional balance of branches and high connectivity throughout the country. At PSBs 35
  36. 36. A merger should consider the human aspect, initially Balance Sheets will look good, but then working of two different human cultures, one may look down upon the other. Such trivial issues hamper the working. 3.2 And today…the news says … The following states recent status of the Indian Banking sector. Foreign allies can hold up to 49% in private banks The RBI-SEBI panel has decided that a foreign collaborator can hold up to 49 per cent in a private bank as against 20 per cent allowed earlier. As per earlier norms, a foreign bank or financial institution stepping in as a technical collaborator can pick up a maximum 20 per cent stake directly, while another 20 per cent can come as direct investments by NRIs. Life after VRS: Nationalised banks facing shortage of staff Shedding flab was fine till, of course, shortage of right man for the right job started surfacing. A voluntary retirement scheme, leaner, smarter, and manageable workforce, lower overheads may all have been relevant reasons to get onto best business practices. But what many of these nationalised banks did not consider was acute shortage of manpower (read officers) for supervisory banking functions. Outsourcing administrative services has arrived in the banks. But this is not proving to be a catch-all-solution either. Most banks are rushing in officers to branches where senior officers have left. “Reducing workforce is fine. But post-VRS manning structures had obviously not been clearly forecast. As a fall-out, daily operations that are being affected, will have to be outsourced in the long run,” the sources said. IDBI to focus more on retail banking IDBI is to focus more on retail banking as part of its revised functional strategy for future growth, bank's managing director Gunit Chadha said. He said the rolling out of the bank's RPU underlined the increased focus the bank had placed on retail banking. The RPU has armed the bank with the necessary systems and structure to roll out new products in retail 36
  37. 37. banking and will greatly reduce time to market the new products," he said. A sharp rise A study of the performance of banking sector stocks over the past one year has shown that while several public sector banks have shown a sharp rise in prices, many of their private counterparts are high on the losers list. Leading the gainers list is Corporation bank whose scrip has nearly doubled in the last one year. It is followed by Bank of India with a gain of 75 per cent, and Jammu & Kashmir Bank which, despite a majority holding by the J&K government, is classified as a private bank. "Corporation bank takes only select clients and a lot of effort goes into this selection," says a merchant banker explaining the low NPA levels in the bank. Allahabad Bank gets a sock for hiking CAR The Governement on Wednesday pulled up the CMD of Allahabad Bank, B Samal, and his management team for falsely reporting the bank’s capital adequacy at 11.51 per cent against the actual 8.61 per cent. At a review presided by finance secretary Ajit Kumar here, the bank was asked to turn around or close down 136 loss-making branches. The ministry team also criticised the management for letting standard assets turn NPAs again. On Tuesday, the government had asked UCO Bank to shut down 800 of its loss-making domestic branches besides four international ones. The government is meeting all the weak banks to take stock of their operations, indicating a change in the mindset and a resolve to chide shoddy performers. Indian Bank, however, was the odd man out. Although the government did not promise capital, it complimented the bank for its improved performance in recent months. On sabbatical The scheme launched by PSBs along with VRS, sabbatical has got around 200 optees as of August 2001, comparing this to the VRS response of 11% of the employees in the industry; an observation was that only highly qualified employees opted for this scheme. ATMs in India The BoI is planning to install 225 ATMs in nine major cities. The growth of ATMs in India has been exponential; currently there are over one lakh ATMs in India and the growth rate is 40 %. As far as cost are concerned, Mr. Loney Antony, NCR Corporation India, Country Manager, states that cost of branch transaction is Rs 50 to Rs 100 whereas cost on an ATM is not more than Rs 25. 37
  38. 38. CHAPTER - 4 4.1 THE FUTURE . . . what’s ahead! The Indian Banks even after a decade full of reforms for the sector have a long way to go. Product innovations, better information technology and operating mechanisms not only enhance the income and reduce expenses but also act as a catalyst to retain customers. The question is will this suffice for the future? With the continued integration of the Indian markets with the global markets, the volatility is rising. To survive this dynamism and the risks arising from the same, banks need to have resources in place to understand and manage them on a regular basis. Markets, which have so far witnessed a deluge in the number of banks, will now witness consolidation. With the onset of globalisation in each and every sector, Indian Banks need to be much more sustainable, efficient, transparent in working and also competitive. Now the bank mergers will not be a new phenomenon since synergies are derived from the alliances in the recent mergers. The following seem to be what the Indian Banking sector is heading for: As the economy revives fee based activities and asset quality of banks could improve. After adjusting for Non Performing Loans some public sector banks may have to go in for fresh capital infusion. Banks will have to compete with mutual funds as an alternative to bank deposits. As public sector banks find their margins squeezed, they may become more active in trading to make up for the margin squeeze. The risk profile of these public sector banks may increase as their trading in money and forex markets increase. Thus, a sound risk management i.e. the ALMs need to be in place. As competition compress spreads earned on lending business, banks will have to focus on fee income. Private banks are likely to generate better fee income due to their focus on having adequate technology and having skilled personnel to generate such business. RBI is examining the feasibility of introduction of half yearly audit of accounts by external auditors towards improving the quality of auditing standards further. New arenas for advancing may be surveyed, the housing loan sector has gained a 38
  39. 39. considerable boosts as per the recent budgetary measures; banks are allowed to lend 3 per cent of their advances to this sector, also infrastructure and film financing remain untapped. With the opening of the insurance sector and recent relaxation of regulation by RBI for entry of banks in this area of business, some of the big banks are expected to enter this business in a big way. Public sector banks with their wide reach and higher confidence levels can take the lead. All banks will have to adapt to new emerging technologies in order to exploit the new business opportunities it offers. It will be a new challenge and will require investment in technology and new systems. Some value-added services may also need to be provided, which will call for innovation standardisation. Virtual Banking will set in as a trend successfully. Today, the banks have to compete with their peers as well as with other financial companies. But tomorrow, competitors might zoom in from completely unexpected industries, as deregulation and new technology blur old boundaries, these rewrites the conventional definition of a bank. Those forces offer as many opportunities as threats. A reinvention or a renewal or a rediscovery, the way you term it, shall root the structural changes in the Indian Banking Sector. 4.2 CONCLUSION 39
  40. 40. A personal view on reforms and developments in the Indian Banking Sector is stated below. The reduction in SLR and CRR has been effective in the sense that the lendable resources of banks have increased. The anticlimax is about the current recession in the economy and decreasing need of investments by the corporate sector. The CRAR requirements are necessary for financial soundness of Indian banks; also; a need to assign risk weightage to government securities seems to be coming up due to increasing investments of banks portfolios. The NPA trend has been fortunately declining in the recent years, initially the NPAs were amounting to total of 16 %, and however banks should note that ever greening of loans would deprove the circumstances in the long run; the asset quality is the determinance of banks profitability today. The present evaluation process of banks states requires around 18 officials for quality inspection; the bureaucracy involved can reduce only by way of better bank supervision. The Disclosure norms shall avoid situations like in case of South East Asian Crisis; with this respect, RBI proves to be a quite proactive institution. Globalisation has but lead to the liberalisation of the Indian Banking sector; like the other sectors opened up, today, the Indian banks need to learn much more from competition; customers and not advances and customer service is the call for the day. The DRT Act supersedes all acts but the SICA which clearly states that companies can very easily stall recovery procedures. It’s a fact in our country that for every law made there is one more to escape from it. However, the conceptualization of this structure needs to be acknowledged. Increasing risks and imprudent liability management constitute to asset liability mismatch. Complacent behaviour of Indian banks with this context has lead to ALM reforms. This shall positively improve and get bankers alert. The ALM framework if correctly implemented shall prove useful. 40
  41. 41. Reduction of government stake seems to be a good decision of RBI, but on deeper analysis, the control strongly remains with the government and it is a truth that bureaucracy has become a side business. We still need to see what happens next ! The corporates can now have a good deal with loans and advances; the interest rate deregulation has been in line with the international standards. The current trend of falling rates shall indeed give the corporate customers fair access with better services. VRS was a government decision and about 11 % of the employees retired. It was no form of a structural change but is a very effective tool to improve efficiency of the Indian PSBs. I think a better plan would have been of investments in technology partially and then a VRS. Currently, lots of banks are facing problems of inadequate staffing; a good manpower planning in advance would not have lead to the current problem. About universal banking, due to increasing competition banks need to strive for customers, thus, offering all at the same desks for corporates as well as individuals i.e. retail banking is required; public sector needs to have a pace in this arena. A merger to improve the overall health, reach and customer base, has given a rise to the trend of mergers globally. The recent merger of ICICI and BoM proves that customer base has to develop for sustainability. Mergers constitute as a cheaper and a quicker form of expansion and Indian banks should explore such an opportunity. The opening of insurance has given banks a new opportunity to make the best out of their resources; how much advantage do our PSBs make is yet to see. As far as rural banks are concerned, GOI has to give personnel better career prospects in order to get them working, better products and convenience and safety has to be guaranteed by the bank. Personalized service in a crude form will help. Lastly, technological upgradation will be what will lead to customer retention on the grounds of accessibility and convenience. 41
  42. 42. APPENDIX Appendix 1 LIST OF PUBLIC SECTOR BANKS State Bank of India and its subsidiaries are : • • • • • • • • State Bank of India State Bank of Bikaner & Jaipur State Bank of Hyderabad State Bank of Indore State Bank of Mysore State Bank of Patiala State Bank of Saurashtra State Bank of Travancore Other nationalized banks are: • Allahabad Bank • Andhra Bank • Bank of Baroda • Bank of India • Bank of Maharastra • Canara Bank • Central Bank of India • Corporation Bank • Dena Bank • Indian Bank • Indian Overseas Bank • Oriental Bank of Commerce • Punjab & Sind Bank • Punjab National Bank • Syndicate Bank • UCO Bank • Union Bank of India • United Bank of India • Vijaya Bank Some of Public Sector banks have issued equity shares for general public and are listed on various stock exchanges. The listed public sector banks are • State Bank of India • State Bank of Bikaner and Jaipur • State Bank of Travancore • Bank of Baroda • Bank of India • Oriental Bank of Commerce 42
  43. 43. • • Dena bank Corporation bank LIST OF PRIVATE SECTOR BANKS: Old private sector banks • • **Bank of Madurai Ltd Bank of Rajasthan Ltd • Bareilly Corporation Bank Ltd • Bharat Overseas Bank Ltd • City Union Bank Ltd • Development Credit Bank Ltd • Ganesh Bank of Kurundwad Ltd • Karnataka Bank Ltd • Lord Krishna Bank Ltd • Nainital Bank Ltd • SBI Comm & Int Bank Ltd • Tamilnad Mercantile Bank Ltd • The Benares State Bank Ltd • The Catholic Syrian Bank Ltd • The Dhanalakshmi Bank Ltd • The Federal Bank Ltd • The Jammu & Kashmir Bank Ltd • The Karur Vysya Bank Ltd • The Lakshmi Vilas Bank Ltd • The Nedungadi Bank Ltd 43
  44. 44. • The Ratnakar Bank Ltd • The Sangli Bank Ltd • The South Indian Bank Ltd • The United Western Bank Ltd • The Vysya Bank Ltd New private sector banks • • Bank of Punjab Ltd Centurion Bank Ltd • Global Trust Bank Ltd • HDFC Bank Ltd • ICICI Banking Corporation Ltd • IDBI Bank Ltd • IndusInd Bank Ltd • *Times Bank Ltd • UTI Bank Ltd *since merged with HDFC Bank **since merged with ICICI Bank LIST OF FOREIGN BANKS: • • ABN-AMRO Bank N.V. Abu Dhabi Commercial Bank Ltd. • American Express Bank Ltd. • Arab Bangladesh Bank Ltd. • ANZ Stanchart Bank 44
  45. 45. • Bank International Indonesia • Bank of America NT&SA • Bank of Bahrain and Kuwait BSC • Bank of Ceylon • Banque Nationale De Paris • Barclays Bank PLC • Chase Manhattan Bank • Chinatrust Commercial Bank • Cho Hung Bank • Citibank N.A. • Commercial Bank of Korea, ** • Commerzbank AG • Credit Agricole Indosuez • Credit Lyonnais • Deutsche Bank AG • Dresdner Bank AG • Fuji Bank Ltd. • Hanil Bank ** • Hongkong Bank • ING Barrings Bank N.V. • Krung Thai Bank • Mashreq Bank • Oman International Bank S.A.O.G. 45
  46. 46. • Overseas Chinese Banking Corp. Ltd. • Siam Commercial Bank • Societe Generale • Sonali Bank • State Bank of Mauritius Ltd. • Sumitomo Bank Ltd. • The Bank of Nova Scotia • The Bank of Tokyo-Mitsubishi Ltd. • The British Bank of Middle East • The Development Bank of Singapore Ltd. • The Sakura Bank Ltd. • The Sanwa Bank Ltd. • Toronto-Domonion Bank • Bank Muscat International SAOG, • Morgan Guaranty Trust company of New York • KBC Bank, NV ** CLOSED INDIAN OPERATION Appendix 2 The personnel in public sector and the private sector bank were interviewed on basis of the following questionnaire (this is customized for ICICI Bank): About REFORMS in the Indian banking sector The legal infrastructure for the recovery of non-performing loans still does not exist. The functioning of debt recovery tribunals has been hampered considerably by litigation in 46
  47. 47. various high courts. This ultimately leads to one solution i.e. ruthless provisioning, any better ways; it is a major drawback of this ruling. # What is the procedure being a private player (ICICI) in this industry, is it different and more effective as far as recoveries are concerned? The need to make massive provisions obviously results in a depletion of capital. But the capital adequacy norm means the banks have to find additional, costly money to refurbish the capital base. In this situation, the banks are being forced to accept the minimum possible amounts from sub-standard and bad loans. Thus, the need for ARF is now paramount. # Is the transfers on NPAs to state owned ARF, just about shifting the responsibility to the ARF? What’s the whole point of having something like that, it’s like a better way of declaring losses and turning away from efficiencies? Reforms among public sector banks are slow, as politicians are reluctant to surrender their grip over the deployment of huge amounts of public money. # As a private player what are the problems that you face while communicating with the government? Government intends to reduce its stake to 33% in nationalized banks, please comment on this reform, its positive and negative effects on private players. Introduction of prudential norms, Income Recognition & Asset Classification and compulsory disclosure of accounts has lead to transparency in the working of banks. Any other recommendations as a private bank. Consolidation of the Banking industry by merging strong banks is the latest development in the Indian Banking Sector. ICICI has had a recent merger with BoM, ANZ and Stanchart, etc. Please state your views on the overall development of India with this major development in the financial system. 47
  48. 48. BIBLIOGRAPHY Magazine and Article: -Business Today 48
  49. 49. -Banking Frontiers -Reserve Bank of India bulletin -Times of India Web: 49