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EXECUTIVE SUMMARY
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--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.
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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 interestrates. These have significantly affected the operational environment of
the Indian banking sector.
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.
The East-Asian crisis has demonstrated the vital importance of financial
institutions in sustaining the momentum of growth and development. It is
no longer possible for developing countries like India to delay the
introduction of these reforms of strong prudential and supervisory norms,
in order to make the financial system more competitive, more transparent
and more accountable.
The competitive environment created by financial sector reforms has
nonetheless compelled the banks to gradually adopt modern technology
to maintain their market share.Thus, the declaration of the Voluntary
Retirement Scheme accounts for a positive development reducing the
administrative costs of Public Sector banks. The developments, in general,
have an emphasis on service and technology; for the first time that Indianpublic sector banks are being challenged by the foreign banks and private
sector banks. Branch size has been reduced considerably by using
technology thus saving manpower.
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The deregulation process has resulted in delivery of innovative financial
products at competitive rates; this has been proved by the increasing
divergence of banks in retail banking for their development and survival.
In order to survive and maintain strong presence, mergers and
acquisitions has been the most common development all around the
world. In order to ensure healthy competition, giving customer the best of
the services, the banking sector reforms have lead to the development of
a diversifying portfolio in retail banking, and insurance, trend of mergers
for better stability and also the concept of virtual banking.
The Narasimham Committee has presented a detailed analysis of various
problems and challenges facing the Indian banking system and made
wide-ranging recommendations for improving and strengthening its
functions.
TABLE OF CONTENTS
CH.NO. TITLE
PAGE NO
CHAPTER - 1 REFORMS IN THE INDIAN BANKING SECTOR
1.1 Introduction 01
1.2 Reduction of SLR and CRR 04
1.3 Minimum Capital Adequacy Ratio 07
1.4 Prudential Norms 11
1.5 Disclosure Norms 17
1.6 Rationalisation of Foreign Operations in India
19
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1.7 Special Tribunals and Asset Reconstruction Fund
23
1.8 Restructuring of Weak Banks 26
1.9 Asset Liability Management System
29
1.10 Reduction of Government Stake in PSBs
32
1.11 Deregulation of Interest Rate
39
CHAPTER - 2 DEVELOPMENTS IN THE INDIAN BANKING SECTOR
2.1 Introduction 42
2.2 Voluntary Retirement Scheme 43
2.3 Universal Banking 52
2.4 Mergers and Acquisition 56
2.5 Banking and Insurance 62
2.6 Rural Banking 65
2.7 Virtual Banking 71
2.8 Retail Banking 73
CHAPTER 33.1 The SCAM Story 74
3.2 Public Sector OR Private Sector Point of
Views 76 3.3 And today... the
news say. . . 83
3.4 Future whats ahead 86
4
CH.NO. TITLE
PAGE NO
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3.5 Conclusion 88
List of Illustrations and Visual Aids
Illustration
No.
Title Page no.
12
3456
78910
Trends in CRR and SLRGrowth In Investments In GovernmentSecurities by BanksClassification of Loan Assets of SCBsIndian Banks: Trend in ROECapital Contributed by GovernmentIncome and Expenses Profile of banks
VRS trends in BanksICICI pre merger and post mergerscenarioComparison of classes of banksLendings in Rural India
610
15223741
50606170
List of Annexures
Annexure 1: List of banks 90
Annexure 2: Questionnaire 93
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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
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1.1 Introduction
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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 10national banks and local banks confined to specific regions. Rural
banks, including RRBs, confined to rural areas
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
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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
committees 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
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
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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 monthsvi.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 identifypotential 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 itsincome 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);
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called for 0.25 per cent provisioning on standard assets (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.
Only a few of these mainly constitute to the reforms in the banking sector.
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REFORMS
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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 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
11
1.2 Reduction of SLR andCRR
http://www.asci.org.in/publications/ascijl/v24/v24_2_moh.htm#Reserve%20Bank%20of%20Indiahttp://www.asci.org.in/publications/ascijl/v24/v24_2_moh.htm#Reserve%20Bank%20of%20India7/29/2019 banking sector reforms in indian economy
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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
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.
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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.
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Trends in CRR and SLR 1993 2001
14
0
5
10
15
20
25
30
35
40
May-
93
Nov-
93
May-
94
Nov-
94
May-
95
Nov-
95
May-
96
Nov-
96
May-
97
Nov-
97
May-
98
Nov-
98
May-
99
Nov-
99
May-
00
Nov-
00
May-
01
Percentage
ofDTL
SLR CRR
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Illustration 1
The committee recommended a Stipulation of minimum capital adequacy
ratio of 4 per cent to risk weighted assets by March 1993, 8 per cent byMarch 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
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
15
1.3 Minimum Capital AdequacyRatio
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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
results in a depletion of capital. But the capital adequacy norm means thebanks 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
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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 government-owned capital in the
public sector banks is itself taxpayer money.
Capital helps avoid "credit crunches": a well-capitalized bank can
continue to lend in the face of losses. Similar losses might forcea poorly capitalized bank to restrict credit (to increase capital
ratios). In an economic downturn, well-capitalized 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
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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 non-performing assets; and (b) however,
increase in capital owned directly by the government has severalattendant 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
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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 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
[Up to Jan
93]
1993-94
[Up to Jan
94]
Aggregate deposits growth
36441
[19.6
%]
32364
[14.0 %]
37187
[13.8 %]
Bank credit growth9291
[8.0 %]
26390
[21.0
%]
20966
[16.7 %]
9999
[6.6 %]
Investments 15131 1546011042
[12.2 %]
19857
[18.8 %]
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
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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 netNPAs (gross 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
21
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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 Banks 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 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.
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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 RBIs Board for Financial
Supervision (BFS) wanted divergences in NPA accounting norms by banksfrom 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.
As of now, for income recognition norms, the RBI has suggested that the
international norm of 90 days be implemented in a phased manner by
2002. The current norm is 180 days.
ASSET CLASSIFICATION
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While new private banks are careful about their asset quality and
consequently have low non-performing 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 RBIs prudential norms, a Non-Performing 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 Mid-Term 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:
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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.
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 onNPAs 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
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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 SCBsA. 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
B. Sub-standard
1997-98 5.0 5.8 3.9 4.9
1998-99 4.9 6.2 4.0 5.0
1999-2000 4.3 3.7 2.9 5.1
C. Doubtful
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
D. Loss
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
E. TotalAssets (Rs. Crore)
1997-98 284971 36753 30972 352696
1998-99 325328 43049 31059 399436
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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.
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 Non-Performing 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
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.
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Illustration 3
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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.
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 taxpayers money
given to the banks as capital is not used to write off private loans without
adequate efforts and punishment of defaulters.
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# 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 accountabil ity 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 divisionsfor disclosure. As per the
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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 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.
The Investors Advantage
Getting all these accounts consolidated with that of the parent bank will
provide the investor a better understanding of the banks' performances
while deciding on their exposures. More so, since a number of public
sector banks are now listed entities whose stocks are traded on the stock
exchanges. Some public sector banks are even preparing their accounts
in line with US GAAP norms in anticipation of a US listing. These norms will
therefore be in line with the future plans of these banks as well. The
working group was set up following the need to bring about transparency
on the lines of international norms through better disclosures.
These new norms will necessitate not only that the problems are handled
by the parent, but investors are also aware of what exactly the problems
are and how they affect the bottomlines of the parent banks. Now, under
the new guidelines, this will no longer be an external disclosure to the
parent banks' books of accounts.
Rather, point out bankers, this will very much form an integral part of the
parent's balance sheet.
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For instance, if a subsidiary is not performing well or making losses, this
will reflect in the parent's balance sheet.
Liberalising 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 banks 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,
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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 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/semi-urban 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
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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 well-developed 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.
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 major
beneficiary of this has been corporate clients who are most sought after
now.
The new generation private sector banks have made a strong presence in
the most lucrative business areas in the country because of technology
upgradation. While, their operating expenses have been falling as
compared to the PSU banks, their efficiency ratios (employees
productivity and profitability ratios) have also improved significantly.
The new private sector banks have performed very well in the FY2000.
Most of these banks have registered an increase in net profits of over
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50%. They have been able to make significant inroads in the retail market
of the public sector and the old private sector banks. During the year, the
two leading banks in this sector had set a new trend in the Indian banking
sector. HDFC Bank, as a part of its expansion plans had taken over Times
Bank. ICICI Bank became the first bank in the country to list its shares on
NYSE.
The Reserve Bank of India had advised the promoters of these banks to
bring their stake to 40% over a time period. As a result, most of these
banks had a foreign capital infusion and some of the other banks have
already initiated talks about a strategic alliance with a foreign partner.
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.
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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.
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.
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Illustration 4
Annexure 1
List of Banks operating in India.
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 assets so that that by the time the
final verdict came, there was nothing left of the security that had been
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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 Supremecourt 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.
The truth undiscovered, CURRENT STATUS ANDBANKERS COMPLAINS !
Unfortunately, as a consequence of the numerous lacunae in the act and
the huge backlog of past cases where suits had been filed, DRTs failed to
make a significant dent. For instance, the tribunals did not have powers of
attachment before judgment, for appointment of receivers or for ordering
preservation of property.
Thus, 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. Complains
Bank of Baroda's Kannan: "Of the Rs 45,000-crore worth of gross NPAs,
over Rs 12,000 crore is locked up in the courts." So, the only solution to
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the problem of high NPAs is ruthless provisioning. Till date, the banking
system has provided for about Rs 20,000 crore, which means it is still
stuck with net NPAs worth Rs 25,000 crore. Even that is an under
estimate as it does not include advances covered by government
guarantees, which have turned sticky. Nor does it include allowances for
"ever greening"--the practice of extending fresh advances to defaulting
corporates so that the prospective defaulter can make interest payments,
thus enabling the asset to escape the non-performing loan tag. Warns
K.R. Maheshwari, 60, Managing Director, IndusInd Bank: "NPA levels are
going to go up for all the banks." And so too will provisions.
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.
SOME MORE ISSUES
As things stand, the DRT Act supersedes all acts other than The SickIndustrial Companies Act (SICA). This means that recovery procedures can
still be stalled by companies declaring themselves sick under SICA. Once
the fact of their sickness has prima facie been accepted by the Board for
Industrial and Financial Reconstruction (BIFR), there is nothing a DRT can
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do till such time as the case is disposed of by the BIFR. This lacuna too
must be addressed if DRTs are to live up to their promise.
The amendments would ensure speedy recovery of dues, iron out delays
at the DRT end, as well as ensure that promoters do not have the time
and opportunity to bleed their companies before they go into winding up.
Yet the number of cases pending before DRTs and courts make a telling
commentary on the inability of lenders to make good their threat. They
also reflect the ability of borrowers to dodge the lenders.
The main culprit for all this is the law. Existing recovery processes in the
country are aimed at recovering lenders' dues after a company has gone
sick and not nipping sickness in the bud. Since sickness is defined in law
as the erosion of capital of a company for three consecutive years, there
is little to recover from a sick company after it has been referred to the
Board of Industrial and Financial Revival (BIFR).
What's hurting banks now is the fact that these new issues have croppedup even as they have been (unsuccessfully) wrestling with their NPAs
which, together, tot up to a staggering Rs 60,000 crore. The stratagem of
using Debt Recovery Tribunals has failed. Now these banks have to
explore the option of liquidating the assets of defaulting companies (a
litigitinous route), or writing off these debts altogether (which may not
find favour with shareholders). The solution could lie in better risk
management
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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.
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.
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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
41
THE VERMA PRESCRIPTIONa brief
Identification of weak banks by using benchmarks for 7critical 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 orthrough wage-cuts
Branch rationalisation, including the closure of loss-making
foreign branches
Transfer of non-performing assets to an Asset ReconstructionFund
Reconstitution of bank boards to include professionals,industrialists and financial experts
Independent Financial Restructuring Authority to monitorimplementation of revival package
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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.
Operational restructuring essentially involves building up
capabilities to launch new products, attract new customers,
improve credit culture, secure higher fee-based 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.
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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 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.
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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 measurethe 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. Theuncertainty 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.
The necessity
The asset-liability management in the Indian banks is still in its nascent
stage. With the freedom obtained through reform process, the Indian
banks have reached greater horizons by exploring new avenues. The
government ownership of most banks resulted in a carefree attitude
towards risk management. This complacent behavior of banks forced the
Reserve Bank to use regulatory tactics to ensure the implementation of
the ALM. Also, the post-reform banking scenario is marked by interest rate
deregulation, entry of new private banks, gamut of new products and
greater use of information technology. To cope with these pressures
banks were required to evolve strategies rather than ad hoc fire fighting
solutions. Imprudent liquidity management can put banks' earnings and
reputation at great risk. These pressures call for structured and
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comprehensive measures and not just ad hoc action. The Management of
banks has to base their business decisions on a dynamic and integrated
risk management system and process, driven by corporate strategy.
Banks are exposed to several major risks in the course of their business -
credit risk, interest rate risk, foreign exchange risk, equity / commodity
price risk, liquidity risk and operational risk. It is, therefore, important that
banks introduce effective risk management systems that address the
issues related to interest rate, currency and liquidity risks.
Implementation of asset liability management (ALM) system
RBI has issued guidelines regarding ALM by which the banks have to
ensure coverage of at least 60% of their assets and liabilities by Apr 99.
This will provide information on banks position as to whether the bank is
long or short. The banks are expected to cover fully their assets and
liabilities by April 2000.
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 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
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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.
Is it possible ?
Keeping in view the level of computerisation and the current MIS in banks,
adoption of a uniform ALM Systemfor all banks may not be feasible. The
finalguidelines have been formulated to serve as a benchmark for those
banks which lack a formal ALM System. Banks that have already adopted
more sophisticated systems may continue their existing systems but theyshould ensure to fine-tune their current information and reporting system
so as to be in line with the ALM System suggested in the Guidelines. Other
banks should examine their existing MIS and arrange to have an
information system to meet the prescriptions of the new ALM System. In
the normal course, banks are exposed to credit and market risks in view
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of the asset-liability transformation. Banks need to address these risks in
a structured manner by upgrading their risk management and adopting
more comprehensive Asset-Liability Management (ALM) practices than
has been done hitherto
But, ultimately risk management is a culture that has to develop
from within the internal management systems of the banks. Its
critical importance will come into sharp focus once current restrictions on
banks portfolios are further liberalised and are subjected to the pressure
of macro economic fluctuations.
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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 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 governments
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equity to 33 per cent
Governments action programmehas 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 Indias 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.
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
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the boards and strangely a nominee of the government can be in
more than one bankafter the amendment.
The number ofwhole 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.
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
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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 Banks 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, thecapital 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 marketeasily. In terms of transferring equity, the government is arming itself
with powers to sell its stake if it so desires at a later date.
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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 nationalised 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.
What did they have to say ?
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Union parliamentary affairs minister Pramod Mahajan said:
The amendment is an enabling provision. We are only making it
easier for banks to access funds from the market...It is not the
intention of the government to privatise these banks or enter
into strategic alliances with private sector.
Why should the taxpayers money be used repeatedly for
improving the capital base of the public sector banks?
The Indian Banks' Association had, in its memo to the committee, called
for 100 per cent divestment of the government stake. Banks should be
allowed to access 100 per cent capital from public, either from the
domestic or international capital markets. This will increase the
accountability of banks to shareholders.
Employees of the public sector banks went on a token strike on 15
November, protesting against the governments policy of privatisation of
public sector banks. It was as usual, reported that the strike was total and
successful. The inconveniences caused to millions of customers,
unconnected with the issues involved, went unnoticed, though one or two
TV channels interviewed a couple of people, who could not articulate their
views properly.
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From 1992-93 to 1998-99, the government has injected into the 19 public
sector banks, an amount of Rs.20,446 crore as additional capital. Of this,
three banks-UCO Bank, Indian Bank and United Bank of India, have
received Rs.5729 crore
Capital Contributed by Government
BankCapital Added [Rs in
Crores]
Allahabad Bank 90
Andhra Bank 150
Bank of Baroda 400
Bank of India 635
Bank of Maharashtra 150
Canara Bank 365
Central Bank of India 490
Corporation Bank 45
Dena Bank 130
Indian Bank 220
Indian Overseas Bank 705
Oriental Bank of
Commerce50
Punjab National Bank 415Punjab & Sind Bank 160
Syndicate Bank 680
UCO Bank 535
Union Bank of India 200
United Bank of India 215
Vijaya Bank 65
Total 5700
Source: Reserve Bank of India Bulletin [1994].
Illustration 5
THE STATE BANK STORY
The demand for funds by the SBI is even more acute than even the
Corporation Bank since the SBI Act provides for a minimum 55 per cent
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RBI holding in SBI, and the bank is already close to breaching this
threshold. The immediate beneficiary of this move would be Corporation
Bank where government equity is down to 66 per cent. The bank would be
able to access funds from the market without being hampered by the 51
per cent minimum government holding threshold, which currently limits
the ability of banks to expand beyond a certain level. Since a decision on
the new threshold has been taken in the case of the nationalised banks,
the government is expected to follow suit by moving an ordinance to
reduce the RBI stake in the SBI to 33 %
The issue of reducing government stake in the nationalised banks has
come about on account of demand from the SBI which had demanded
that either RBI as the stakeholder pump in funds for the SBIs massive
expansion plans or permit it to issue shares to the public to raise the
necessary funds.
Both the Banking Regulation Act and the SBI Act provide that government
shares cannot be divested and since the government has decided that it
would no longer support banks through budgetary support, they have nooption but to go to the market to meet their fund requirements.
Though there is no special significance attached to the 33 per cent
threshold in the Company Law which recognised only 26 per cent and
74 per cent as two major thresholds for management and ownership
control the government has opted for 33 per cent on the basis of the
recommendations of the Narasimham Committee. The committee had felt
that this threshold would provide comfort to the employees. The banks,
like insurance companies, have strong unions and, hence, a phased
reduction in government equity was recommended.
The State would continue to be the single largest shareholder in banks
even after its stake had been brought down to 33 per cent.
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The government is also proposing to move an ordinance for demerger of
four subsidiaries of GIC. The law ministry has already cleared both
proposals of