Chap02 Indian Banking System

8/8/2019 Chap02 Indian Banking System

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Chapter 2 : INDIAN BANKING SYSTEM

2.1. Indian Banking System

2.2. Reforms in Banking Sector

2.3. 10 years of Reforms


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The word 'Bank' is said to be derived from French word "Bancus" or " Banque", i.e., a bench. It isbelieved that the early bankers, the Jews in Lombardy, transacted their business on benches in the

market place. Others think it is derived from German word "Back" meaning a Joint stock fund.

The modern banking System started with the opening of Bank of England in 1694. Bank of Hindustan

was the first bank to be established in India, in 1770. The earliest institutions that undertook banking

business under the British regime were agency houses which carried on banking business in addition

to their trading activities. Most of these agency houses were closed down during 1929-32. Three

presidency banks known as Bank of Bengal, Bank of Bombay and Bank of Madras were opened in

1809, 1840 and 1843 respectively at Calcutta, Bombay and Madras. These were later merged into

Imperial Bank of India in 1919 following a banking a crisis.

The first bank of limited liability managed by Indians was Oudh Commercial Bank started in 1881.Earlier between 1865 and 1870, only one bank, the Allahabad Bank Ltd., was established. Subsequently

the Punjab National Bank started in 1894 with its office at Anarkali Market in Lahore (now in Pakistan).

Swadeshi movement, which started in 1906, prompted formation of a number of commercial banks

such as the Peoples Bank of India Ltd., the Bank of India Ltd., the Central Bank of India, the Indian

Bank Ltd. and the Bank of Baroda Ltd. Banking crises between 1913-1917 witnessed the failure of 588

banks. The Banking companies (Inspection Ordinance) came in January-1946 and the Banking

Companies (Restriction of Branches) Act was passed in February- 1946. The Banking companies Act

was passed in February 1946, which was later, amended to be known as Banking Regulation Act

1949.

Meanwhile, the RBI Act 1934 was passed and the Reserve Bank of India became the first CentralBank of the country. w.e.f. 01.04.1935, it tookover the Central Banking activities from the Imperial Bank

of India. The RBI was nationalised on 1.1.1949. The Imperial Bank of India was partially nationalised to

form the State Bank of India in 1955. In 1959, subsidiaries of the SBI namely, 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 and State Bank of Travancore were established.

On July 19th 1969, the Govt. of India took over the ownership and control of 14 major banks in the

Country with deposits exceeding Rs. 50 crore each. Again on 15th April 1980, six more banks with total

time and demand liabilities exceeding Rs. 200 crore were nationalised. On 4th Sept. 1993, one of the

nationalised banks namely New Bank of India was merged with another nationalised bank i.e. Punjab

National Bank.

At the end of June 2004, there were 286 schedule commercial banks in the country, with a network

of 67,097 branches. Scheduled commercial banks are banks that are listed in the second schedule to

the Reserve Bank of India Act, 1934, and may further be classified as public sector banks, private

sector banks and foreign banks. Industrial Development Bank of India was converted into a banking

company by the name of Industrial Development Bank of India Ltd. with effect from October 2004 and

is a scheduled commercial bank. Scheduled commercial banks have a presence throughout India, with

nearly 70.2% of bank branches located in rural or semi-urban areas of the country.

2.1

THE INDIAN BANKING SYSTEM


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There are 27 public sector banks in India. They include the SBI and its associate banks and 19

nationalised banks. Nationalised banks are governed by the Banking Companies (Acquisition and

Transfer of Undertakings) Act 1970 and 1980. The banks nationalised under the Banking Companies

(Acquisition and Transfer of Undertakings) Act 1970 and 1980. The banks nationalised under the Banking

Companies (Acquisition and Transfer of Understandings) Act 1970 are referred to as 'corresponding

new banks'. At the end of June 2004, public sector banks had 46,715 branches and accounted for74.7% of the aggregate deposits and 70.1% of the outstanding gross bank credit of the scheduled

commercial banks.

In July 1993, as part of the banking reform process RBI permitted the introduction of "new" private

sector banks. There are nine "new" private sector banks operating at present.

At the end of June 2004, there were around 33 foreign banks with 200 branches operating in India,

accounting for 4.7% of aggregate deposits and 7.3% of outstanding gross bank credit of scheduled

commercial banks. The Government of India permits foreign banks to operate through (i) branches; (ii)

a wholly owned subsidiary or (iii) a subsidiary with aggregate foreign investment of up to 74% in a

private bank. The primary activity of most foreign banks in India has been in the corporate segment.

However, some of the larger foreign banks have made consumer financing a significant part of their

portfolios. These banks offer products such as automobile finance, home loans, credit cards and

household consumer finance. The GoI in 2003 announced that wholly-owned subsidiaries of foreign

banks would be permitted to incorporate wholly-owned subsidiaries in India. Subsidiaries of foreign

banks will have to adhere to all banking regulations, including priority sector lending norms, applicable

to domestic banks. In Mach 2004, the Ministry of Commerce and Industry, GoI announced that the

foreign direct investment limit in private sector banks has been raised to 74% from the existing 49%

under the automatic route including investment by FIIs. The announcement also stated that the aggregate

of foreign investment in a private bank from all sources would be allowed up to a maximum of 74% of

the paid up capital of the bank. The RBI notification increasing the limit to 74% is however still awaited.

PRE-REFORMS DEVELOPMENT

1. Lead Bank Scheme

On the recommendations of FKF Nariman Committee, the Lead Bank Scheme was introduced in

December 1969. Under the scheme the country was divided into 338 districts and they were distributed

among major scheduled banks mostly in Public Sector to play the 'Lead' role. At the end of 2003, 582

districts were covered under the scheme.

2. Co-operative Banks

Co-operative banks were started to cater the needs of the rural areas and small borrowers with

focus on financing the farm sector. These are established under State Cooperative Societies Acts of

different states and include: -

a) Cooperative Banks which has a three tire set up: -

i) State Cooperative Bank, which is the apex cooperative bank at the State level.

ii) Central Cooperative Bank at District level.

iii) Primary Cooperative Bank at the grass root level.


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b) Cooperative Credit Societies viz. Land Development Banks. E.g. State Land Development

Bank (SLDB) and Primary Land Development Bank (PLDB) and Land Mortgage Bank. They

provide long-term credit for agriculture.

c) Primary agriculture credit Societies (PACS), large sized Adivasi Multi purpose Societies

(LAMPS), Farmers Service Society (FSS) etc.

The RBI regulates these banks since 1st March 1966. In light of the liquidity and insolvency

problems experienced by some cooperative banks in fiscal 2001, the RBI undertook several interim

measure to address the issues, pending formal legislative changes, including measures related to

lending against shares, borrowings in the call market and term deposits placed with other urban

cooperative banks. The RBI is currently responsible for supervision and regulation of urban co-operative

societies, the National Bank for Agriculture and Rural Development, state co-operative banks and

district central co-operative banks. The Banking Regulation (Amendment) and Miscellaneous Provisions

Bill, 2003, which was introduced in the Parliament in 2003, proposed the regulation of all co-operative

banks by the RBI. The Bill has not yet been ratified by the Indian Parliament and is not in force.

3. Regional Rural Bank (RRB)

On the recommendations of Narasimham Committee, the concept of Regional Rural Bank (RRB)

was introduced in India. Initially 5 RRBs started in UP, Rajasthan, Haryana, Bihar and West Bengal

on 2nd October 1975. Each RRB has the maximum authorised capital of Rs. 5 crore and an issued

capital of minimum Rs. 25 lacs and maximum Rs.1 crore. The share capital of an RRB is subscribed

by Central Government, State Govt. and Sponsoring Bank in the ratio of 50:15:35 respectively. There

were 196 RRBs in all, which came down to 102 after nation wide amalgamations. PNB sponsored

RRBs were 19 in number, which after amalgamation came down to 9 covering 6 states. At the end of

June 2004, RRBs have 14,433 branches, which accounts for 3.6% of aggregate deposits and 2.9% of

gross bank credit of SCBs.

4. Some Important Financial Institutions :A) National Bank for Agriculture and Rural Development (NABARD)

It was established on 12th July 1982 as an apex bank for agriculture and rural development in

accordance with the recommendations of The Committee to Review Arrangements for Institutional

Credit for Agriculture and Rural Development (CRAFICARD) set up by the RBI under the chairmanship

of Sri B. Sivaraman. It took over the functions of erstwhile Agriculture Credit Department (ACD), Rural

Planning & Credit Cell (RPCC) of RBI and Agricultural Refinance and Development Corporation (ARDC).

Its paid up capital was Rs. 100 crore which was enhanced to Rs. 500 crore, contributed by the

Government of India (GOI) and RBI in equal propor tions. Currently it is Rs. 2000 crore, contributed by

GOI (Rs. 550 crore) and RBI (1450 crore). NABARD operates throughout the country through its 28

Regional Offices and one sub-office, located in the capitals of all the states/UTs. It has 336 District

Offices. It provides refinance assistance to State Cooperative Agriculture and Rural Development Banks

(SCARDBs), State Cooperative Banks (SCBs), RRBs, Commercial Banks and other financial institutions

approved by RBI in respect of credit to agriculture, SSI, and other allied activities in rural areas. Investment

credit is given to individuals, partnership concerns, companies, State-owned Corporations or cooperative

societies, production credit is generally given to individuals. It also grants advances to state Govt. for

maximum 20 years for subscribing directly or indirectly to share capital of cooperative societies. It

undertakes and coordinates all promotional activities for rural development viz. policy formulation,

research and training and also supervises the same.


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B) Export Import Bank of India (EXIM Bank)

It was established on 1.1.1982 as an apex bank for export- import activities, financing, facilitity &

promoting foreign trade of India) wholly owned by Govt. of India. At present, its paid up capital is Rs.

500 crores. It borrows from open market through issue of shares and debentures and also from RBI. It

is the principal Financial Institution in the country for coordinating working of institutions engaged in

financing exports & imports.

It provides financial assistance to exporters and importers directly and also indirectly as refinance

(of term loan, export credit etc.), export bill rediscounting, guarantee cum refinance to banks and other

notified financial institutions for their advances to this sector and coordinates the working of other

institutions engaged in financing export import activities. It also provides investment finance to Indian

companies and undertakes activities like buying selling or other dealings of foreign exchange. It also

undertakes forfaiting. It is also engaged in various activities relating to overseas entities. A special fund

called "Export Development Fund" has been established for research, training, market survey etc. with

regard to foreign trade. The Bank is involved in promotion of two way technology transfer through the

outward flow of investment in Indian joint ventures overseas and foreign direct investment flow to India.It is also a partner Institution with European union and operater for fecilitating promotion of joint ventures

in India through technical & financial collaboration with medium size firm of the European Union.

C) National Housing Bank (NHB)

It was established on 9.7.1988 as wholly owned subsidiary of RBI. Its authorised capital can be

raised to Rs. 500 crores. Its paid up capital at present is Rs. 100 crore. It is an apex financial institution

for monitoring, regulating and promoting housing finance. It issues directions to HFCs to ensure their

growth on sound lines, make loans and advances and render any other form of financial assistance to

schedule banks and HFCs and formulation schemes for the purpose of mobilization of resource and

extention of credit for housing. It has since established guidelines for deposit acceptance, interest

rates, terms and conditions of sanction of loans, capital funding, debt equity ratio etc. for Housing

Finance Companies (HFCs). It also provides refinance as well as equity support to HFCs. Home loan

account scheme was introduced by NHB on 1.7.89 to be operated through the commercial and

cooperative banks. But this scheme stands discontinued now.

D) Housing and Urban Development Corporation Ltd (HUDCO)

It was set up in 1970 as a Govt. of India undertaking for financing and undertaking housing and

urban development. It provides loans to public institutions viz. State Housing Boards, Cooperative

Societies etc.

E) Housing Development Finance Corporation (HDFC)

It was incorporated on 17.10.77 under Companies Act. 1956. The FI caters to the needs of residential

housing. HDFC Bank is its subsidiary.

F) Industrial Development Bank of India (IDBI)

It is India's premier Development Financial Institution (DFI) and 10th largest development bank of

the world. It was established on 1.7.64 as wholly owned subsidiary of RBI. Its ownership was transferred

to Govt. of India on 16.2.76, which now holds 72% of shares. Its authorised capital is Rs. 1000 crores


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which can be increased further to Rs. 2000 crores. During 1995-96, it issued 17.31 lakh shares to the

public at a premium of Rs.120 per share. Besides owned funds, its resources are loans from RBI and

Govt. SLR bonds, retail bonds, deposits and foreign currency loans and bonds. It provides financial

assistance to industry directly as well as indirectly by way of refinance. SIDBI and IDBI Bank are its

subsidiaries. It has co-sponsored a number of financial institutions e.g. National Stock Exchange of

India, Over the Counter Exchange of India, Discount & Finance House of India, etc. IndustrialDevelopment Bank of India was converted into a banking company with the name of Industrial

Development Bank of India Ltd. within the meaning of the Bank Regulation Act and the Companies Act

with effect from October, 2004. It is currently able to carry on banking operations in addition to the

business being transacted by it as a term lending institution. IDBI Ltd. & IDBI Bank stands amalgamated.

G) Industrial Finance Corporation of India (IFCI) Ltd.

It was established in July 1948 for catering to medium and long-term credit needs of industry in

setting up new industrial projects, renovation, modernisation, diversification and expansion of existing

units particularly in circumstances, when normal banking accommodation is inappropriate and / or

when there is no recourse to capital issue. It also grants loans in foreign currencies for import of capitalgoods only. It also undertakes promotional services viz., Technical Consultancy Services (TCS), Risk

Capital Assistance, up gradation of managerial skill, R&D in Banking and Industrial Economics. It has

promoted several specialised institutions viz. Tourism Finance Corporation of India (TFCI), ICRA Ltd,

Risk Capital and Technical Finance Corporation Ltd (RCYC) etc. It is also nodal agency for administration

of "Sugar Development Fund" and " Jute Modernisation Fund" set up by Govt. of India. It became a

public limited company on 1.7.1993. IDBI, LIC and other retail investors subscribe majority of its share

capital. They command nearly half of its paid equity capital (Rs. 352.81 crore as on 31.3.97). It has

issued fully paid up preference capital of Rs. 100 crores during 1997-98.

H) Industrial Reconstruction Bank of India (IRBI)

It was established in 1971 as Industrial Reconstruction Corporation of India and reconstituted in

1986 as Industrial Reconstruction Bank of India with authorised capital of Rs. 200 crores. It was set up

as principal credit and reconstruction agency for revival / rehabilitation of sick industrial units. It also

coordinates similar activities of other institutions. In 1991, it was allowed to finance the going concerns.

IRBI now advances term loans, hire purchase, equipment leasing etc. and also undertake merchant

banking business. It also raises resources from public through bond issue and other instruments. In

March 1997, IRBI was incorporated as Industrial Investment Bank of India Ltd. (IIBI) under Indian

Cos. Act, 1956. GOI has now started process of closure of IIBI.

I) Industrial Credit and Investment Corporation of India (ICICI)

It was established in 1955 as private sector development bank for encouraging and assisting

industrial investment in private sector and also promoting participation of private capital, both internal

and external in industrial investment. Major Indian subscribers are LIC, GIC and its subsidiaries, UTI

and banks. Its resources are rupee loans of Govt. of India, IDBI, lines of credit from World Bank,

borrowings from domestic / international capital markets etc. It has also entered into Rs. 167 crores


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structured deal of asset securitisation with Telco against latter's receivables of truck leasing and hire

purchase business. It has merged with its banking arm ICICI bank.

J) Small Industrial Development Bank of India (SIDBI)

It was established under SIDBI Act. 1988 on 2.4.90 as subsidiary of IDBI taking over the latter's

activities relating to SSI. It is now the apex institution for small industries. It has recently introducedfactoring services for SSIs. Its share capital stood at Rs. 450 crore as on 31.3.1997.

Under SIDBI Amendment Act, 2000, 51.1% shares held by IDBI transferred to select PSBs, LIC,

GIC, etc.

K) Infrastructure Development Finance Co. (IDFC)

It was set up in 1997 as a non government company for financing infrastructure sector with authorised

capital of Rs. 5000 crore and initial capital based of Rs. 1600 crore- comprising of Rs. 1000 crores as

paid up capital and Rs. 600 crores as long term subordinated debt. Out of the initial paid up capital of

Rs. 1000 crores, Rs. 600 crores have already been contributed by domestic FIs and remaining Rs. 400

crores is tobe received from overseas agencies.

L) Power Finance Corporation (PFC)

It was incorporated on 10.7.1986 as prime DFI, dedicated to growth and development of power

sector

M) LIC

It is largest institutional investor in this country and invests under Section 27-A of the Insurance

Act, 1938.

N) GIC

Besides being a holding company of 4 Public Sector Insurance Companies, GIC has made

investment in socially oriented sectors. It is the Indian Reinsurer for non-life insurers in both publicand private sector.

O) UTI

It is a statutory public sector investment institution set up in 1964. It mobilises community savings

through the sale of its units under various schemes and invests them in the shares & debentures of the

companies. The profit so earned is distributed among the investors in the form of dividend.

P) DFHI

It was set up in April 1988 with an authorised capital of Rs. 200 crores, subscribed by RBI (10.5%),

PSU Banks (62%) and FIs (26.6%). It facilitates the softening of short-term liquidity imbalances by

developing & co-ordinating an active Money Market.

Q) DICGC

The Deposit Insurance Corporation was established on 1.1.1962 and took over the Credit Guarantee

Corporation of India Ltd. in July 1978. Its name was changed to DICGC. The RBI wholly owns its share

capital Rs. 50 crores. Recently, many Banks including PNB have opted out of the credit guarantee

schemes. The name has been changed as BDIC through Finance Bill 2002-03. The deposit insurance

scheme covers all commercial banks including RRBs and Co-op. Banks. Every depositor of the bank


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is entitled to repayment of his deposits held in the same right and capacity in all branches of the bank

upto maximum Rs. 1 lac @ premium of 10 paise per Rs. 100 p.a.

R) ECGC

ECGC offers protection to Indian exporters from the risks inherent in selling goods on credit to

foreign buyers.

S) NORTH EASTERN DEVELOPMENT FINANCE CORPORATION LTD. (NEDFi)

t North Eastern Development Finance Corporation Ltd. (NEDFi) was incorporated under the

Companies Act, 1956, on August 9, 1956 with its registered office at Guwahati, Assam, for the

development of industries, infrastructure, animal husbandry, agri-horticulture plantation,

medicinal plantation, sericulture plantation, aquaculture, poultry and dairy in the North Eastern

states of India.

t NEDFi has been promoted by All India Financial Institutions - Industrial Development Bank of

India, ICICI Ltd., Industrial Finance Corporation of India, Small Industries Development Bank

of India, Insurance companies - Life Insurance Corporation of India, General Insurance

Corporation and its subsidiaries, Investment company - Unit Trust of India and Bank - State

Bank of India.

t NEDFi's authorized share capital is Rs. 500 crore and its initial paid up capital is Rs.100 crore.

t The Management of NEDFi has been entrusted upon the Board of Directors comprising of

eminent persons from the NE region and outside having wide experience in Industry,

Econonmics, Finance and Management. At present, the Board has ten members.

T) SME Rating Agency of India Ltd. (SMERA)

t Set up by SIDBI in association with Dun & Bradstreet (D&B), Credit Information Bureau

(India) Limited (CIBIL) and leading public and private sector banks on 5th September, 2005.

t Provides SME ratings that are comprehensive, transparent and reliable so as to reflect their

intrinsic strength.

U) Stock Hoding Corporation of India (SHCIL)

This was incorporated in 1986 jointly by IDBI, IFCI, ICICI, IRBI, LIC, UTI & GIC.

V) Khadi & Village Industries Corporation (KVIC)

It was established by an Act of Parliament in 1956 for development of Khadi and Village industries

in rural area. GOI dissolved KVIC with effect from 14.10.2004.

W) Securities & Exchange Board of India (SEBI)

It was established as an autonomous body on 31.01.1992 on the recommendation of NarsimhamCommittee. All stock exchanges in India are regulated by it. SEBI deals with all aspects of capital

market. Presently, there are 23 stock exchanges in the country. OTCEI (Over the Counter Exchange of

India) promoted by ICICI, UTI, SBI, Capital Markets Ltd., Canbank Financial Services Ltd, GIC and LIC

was incorporated on 20.09.1990. National Stock Exchange promoted by IDBI, ICICI, IFCI, GIC, LIC,

SBI, SBI Capital Markets Ltd., SHCIL and ILFS commenced trading on 30.06.1994.


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With effect from Ist February 1969, the Govt. imposed "Social Control" on banks. Soon after thefirst nationalisation of 14 major banks on 19th July 1969, the Govt. appointed the Saraiya Commission

in 1969, to examine the banking system and recommended ways to make it efficient in working in

coordination with Govt. policies for national economic development. One of the main recommendations

of the committee was related to the reconstruction of the banking system into 8 or 9 banks, consisting

of 3 all India banks SBI and 2 of the nationalised banks plus 5 or 6 regional banks with overlapping

jurisdiction over the neighbouring areas. This was not accepted. However, almost all the

recommendations of the commission regarding bank's operations so as to simplify the credit procedure

and rationalise the internal control system and organisational management, were accepted.

Accordingly, section 19 of the BR act. 1949 was amended to allow the banks to form subsidiaries.

Owing to 1991 crisis of balance of payment, the Govt. appointed Narsimham Committee on 14th

August 1991. It submitted its report, known as its first report, on 16th Nov.'1991. The first phase of

banking sector reform started during 1992-93 was based on twin principles of "Operational Flexibility"

and "Functional autonomy".

NARASIMHAM COMMITTEE I REPORT

The main recommendations are as follows: -

i) SLR & CRR

SLR to be brought down to 25% over a period of 5 years.

The interest of SLR securities should be market oriented.

CRR to be reduced progressively and interest rate on CRR to be fixed at the level of bank's

one-year deposit.

ii) PRIORITY SECTOR LENDING

The target of priority sector lending to be reduced to 10% of total credit.

Priority sector credit to be redefined, and subsidy in development programmes may be withdrawn

iii) INTEREST RATES

Interest rates on Govt. securities to be in line with market rates.

iv) CAPITAL ADEQUACY

Banks to achieve Capital Adequacy Norms of as under:

Foreign banks- achieve 8% norm by March 1993

Indian Banks having branches abroad to achieve 8% by March-94.

Other Indian Banks to reach 4% by March 93 and 8% by March 96.

2.2

REFORMS IN FINANCIAL / BANKING SECTOR


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xi) Legislative Measures:

The banking companies (Acquisition and Transfer of Undertaking) Act 1970 / 1980 to be

amended to raise Paid up capital and raise equity from the market.

Banking Regulation Act to be amended to give effect to transparency and disclosure.

RBI Act 1934 to be amended to allow the to banks perform all types of banking business.

The second phase of reforms :

The second phase of reforms envisaged greater autonomy to Priority Sector banks with respect

to recruitment and promotion of staff, better asset liability management, lesser external

intervention and pressures etc. The focus of the banks will, therefore, be on profit maximisation,

NPA recovery management and diversification through merger, acquisition and participation

with peers in the market.

NARASIMHAM COMMITTEE REPORT (II)

t RBI should withdraw from 91 days T Bill market. Inter-bank and call money and term money

markets should be restricted only to banks and primary dealers.

t Minimum shareholding by the Govt./RBI in the equity of Nationalised bank and SBI should be

brought down to 33%. RBI directors should be withdrawn from bank boards.

t 5% risk weight be considered for market risk for government and approved securities. Govt.

guarantee advance those have turned sticky should be treated as NPA.

t Banks should attain a minimum CRR of 9% by 2000 AD and 10% by 2002 AD.

t Accrual of interest for income recognition should be done in 90 days instead of 180 days

t Minimum start up capital needs for foreign banks should be raised from $ 10 million to $ 25 million.

This capital should be brought in one go and no in phases. Foreign banks should be allowed to set

up subsidiaries or joint ventures in India and these should be treated on par with other private

banks.

t Bank Chairman should be given a minimum of three years at the helm. Need to delink salaries of

bank and FIs chiefs and whole time director from the Civil Services pay scale.

t All loans in doubtful / loss category should be identified and their realisable value determined.

These assets could be transferred to an Asset reconstruction Company which would issue NPA

swap bond to the banks

t SBIs associate banks should be constituted on the lines of Nationalised Banks with CMD and two

whole time directors. No need for SBI Chairman to be ex-officio Chairman of these banks.

t The start up requirements of Rs. 100 crore for new private sector banks should be hiked. Restriction

on promoters voting right (at present 10%) should be done away with provided the promoter group

does not hold more than 14% of equity.


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REPORTS OF OTHER IMPORTANT COMMITTEES

VERMA COMMITTEE REPORT ON WEAK BANKS

The committee was constituted on 8.2.1999 for suggesting of weak banks. The committee submitted

report on 3.10.1999. The major recommendations are as under: -

1. OPERATIONAL : Cut staff strength by 25% through VRS

If VRS scheme fails cut wages across the board

Effective five year wage freeze

Close down subsidiaries of these banks, sell off foreign branches

Set up Govt. owned ARF manage by private sector AMC

2. ORGANISATIONAL :

Rationalise branch network

Reconstruct Bank Boards

CMD should have long tenure Appoint 2 EDs in big bank

3. SYSTEMIC :

RBI to set up a special wing to supervise weak banks

Nodal body to monitor progress of weak banks

Debt Recovery tribunals to work on war footing

4. FINANCIAL :

Spend Rs. 5500 crore over next 3 years on

Rs. 300-400 crores on technology up gradation

Rs. 1100 - 1200 crore on VRS

Rs. 1000 crore on NPA buy out

Rs. 3000 crore for capital adequacy

Three weak banks identified were UCO Bank, Indian Bank and United Bank of India. The Committee

identified key problems for their dismal performance and suggested ways for improvement. Out of 3

weak banks, two banks viz. UCO Bank and United Bank of India came out of the weak banks' category

during 2000-2001. Dena Bank, however, appears to be the latest entrant. However, during the year

ended March '2002, all these banks have shown net profit.

GHOSH COMMITTEE 1993

This committee was appointed by RBI at the instance of Govt. of India under the chairmanship

of Mr. A. Ghosh (the then Dy. Governor of RBI) to enquire into various aspects of frauds and

malpractices in banks.

Main recommendations accepted by RBI w.e.f. 26.9.93 are;

Photographs of operators should be obtained while opening new deposit accounts

Bank to nominate a senior level officer as 'Compliance Officer' who should ensure and report

that various items of work in different departments are carried out strictly in accordance with

The committee used the following 7

parameters for identification of banksstrength/weakness :

1. Capital Adequacy Ratio 8% or more

2. Coverage ratio 0.50% ore more

3. Return on assets Median level

4. Net Intt. Margin do

5. Profit/ Av. Working fund do

6. Cost/Income do

7. Staff cost/ Income do


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system and procedures laid down by bank. He should ensure that all RBI/Board instructions

are meticulously observed.

Bank should provide desk cards (Job-Work) for different type of works to help the employees

understand and observe their duties.

Cash and other valuables must be kept in joint custody. Currency Chest Transactions should

be reported to RBI on the same day.

No official should exceed his delegated authority except in every emergent circumstances

Cash should not be received other than in the cash department and cashier should not be

allowed to make entries in passbook.

The paying cashier before making payment must ensure that the token number and signature

of the person are obtained without fail

PADMANABHAN COMMITTEE 1995

Appointed by RBI in 1995 to suggest changes in the approach and style of inspection and

follow up by the Central Bank, under chairmanship of S. Padmanabhan (Former Chairman of

Indian Overseas Bank)

Recommendations are yet to accepted by RBI. The major recommendations are;

i) On going supervision

Shift from the current system of periodical inspection to on going or continuous supervision

ii) CAMEL Rating Model

Each bank should be raised on a five score scale A to E indicating in descending order the

soundness and strength of the bank

For Indian Banks the rating will be based on six parameters (C.A.M.E.L.S): i) Capital Adequacy,ii) Asset Quality, iii) Management, iv) Earnings, v) Liquidity and vi) Systems and control

For foreign banks the raring will be based on four parameters (C.A.C.S.): i) Capital Adequacy,

ii) Asset Quality, iii) Compliance & iv) Systems and control

Penodicity of supervision should be discriminatory based on bank's rating

CAMELS

RBI has approved a plan to rate the banks on the basis of CAMELS - a rating method on a scale

of 1 to 100.

CAMELS COMPONENTS WEIGHTAGE

1# Capital to Risk Weighted Asset Ratio (CRAR) 70

2# Quality of Capital 10

C :- CAPITAL ADEQUACY 3# Ability to assess capital market 10

4# Asset growth and risk profile 10

1# Ratio of net NPAs to net advances 40


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A :- ASSET QUALITY 2# Adequacy of lending policy 20

3# Management of Investment portfolio 20

4# Debt Recovery 10

5# Adequacy of provisions 10

1# Working of Board 20

M :- MANAGEMENT 2# Technical Competence 20

3# Effectiveness of Management in laying down policies 20

4# Adequacy of Control 20

5# Achievement of Corporate Mission 10

6# Effectiveness of various committees 10

1# Return on Assets 40

2# Return on Equity 20

E :- EARNINGS 3# Net Interest Margin 10

4# Ratio of non-interest income to non-interest expenses 10

5# Ratio of retained earnings to net profit 10

6# Operating profit as percentage to total assets 10

1# Liquidity of Appraisal - Stock Approach 30

2# Liquidity of Appraisal - Flow Approach 30

L :- LIQUIDITY 3# Effectiveness of Asset Liability Management 20

4# Access to markets 10

5# Compliance of CRR 10

S :- SYSTEMS AND 1# Adequacy of Internal Inspection 30CONTROLS

On the basis of weightages attached to each of the components, the banks would be provided

with a composite ranking under 4 categories from A to D. While category A denotes a sound institution,

category D implies serious financial, operational and managerial weaknesses

RASHID JILANI COMMITTEE (May 1992)

This committee was set up on 15th May 1992 under the chairmanship of Mr. Rashid Jilani,

Chairman Punjab National Bank, to suggest alternate method of lending in place of the present

cash credit system. The committee's main recommendations include:

Permitting Authorised Dealers to initiate Cross Currency Position Overseas

Allowing Banks to lend and borrow short term funds upto six months in overseas market

Permitting exporters to retain 100% of their export earning in foreign currency in India

Setting up off shore Banking unit in Bombay

Giving banks greater freedom to use derivative product for their asset liability management.


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SHERE COMMITTEE (1995)

Shere Committee, headed by Smt. KS Shere, Principal Legal Advisor, RBI was set up on

Aug-1995 to study all aspects of Electronic Fund Transfer

Its chief recommendations are :

To start with EFT can be introduced by framing regulations under RBI Act 1934. The committeehas suggested a model EFT agreement tobe entered into between banks themselves and

banks and their customers

A comprehensive EFT legislation may be enacted after gaining some experience

Amendment to RBI Act to pave the way for development of multiple EFT system in different

segments like ATMs, EFT POS and other consumer payment systems

An amendment to Bankers Book of Evidence Act to accord status to admissible evidence to

computer print outs and other electronic records.

Implementation

RBI is framing regulations under Sec 58 of RBI Act 1934 to implement the EFTS pending

introduction of the proposed Electronic Funds Transfer Act, Computer Misuses Act and

amendments to RBI Act 1934 and Bankers Book Evidence Act 1891

SARAF COMMITTEE (June 1994)

Set up in June 1994 and known as "Committee on technology issues in the banking industry"

Chairman WS Saraf, ED RBI

Recommendations are :

To set up Electronic Fund Transfer System

To start Electronic Clearing Service Decentralisation of cheque clearing

Introduction of Delivery Vs Payment system in SGL transaction in Govt. securities

Introduction of Cheque Truncation system

Promoting Card Culture

MICR clearing at all places with more than 100 bank branches

Establishment of an institute on Banking Technology

KALIA COMMITTEE (November 1994)

The Working Group on Non government Organisation (NGOs) and self help group (SHGs)was set up in Nov. 1994 under Chairmanship of Shri S. K. Kalia.

MALEGAM COMMITTEE (1995)

Malegam committee was Set up in 1995 by SEBI (Securities and Exchange Board of India) to

review the existing disclosure requirements for companies making public issues" under the

chairmanship of Mr. YH Malegam (Past President of Institute of Chartered Accountants of

India). It submitted its report on 29.6.1995


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Recommendations (Accepted by SEBI) are :

Companies must quantify audit qualifications into actual figures

DR. A.C. SHAH COMMITTEE

This committee is also known as Working Group on Non-Banking Financial Companies.

Chairman Dr. AC Shah

Recommendations accepted by RBI are :

In order to be eligible to accept deposits from public, NBFCs should adhere to the following :

a) All non banking financial companies (NBFCs) having a net worth of Rs. 40 lacs and above

must get themselves registered with RBI

b) The total amount of deposits to be mobilised is to be restricted to certain times of network,

c) They must maintain liquidity ratio @ 10% (i.e. 10% of their deposit liability to be kept in cash/

approved securities)

d) They should get their debt instruments rated by rating agency compulsory

J.V. SHETTY COMMITTEE (January 1993)

"Committee to Review the system of lending under Consortium Arrangement" was set up

under Chairman of JV Shetty (CMD Canara Bank)

Recommendations (Accepted by RBI) are:

Where a borrower enjoys fund based working capital credit limit from the banking system for

Rs. 50 crores and above, Consortium should be made obligatory.

There is no ceiling on the number of banks in a consortium.

VAZ COMMITTEE (1993) (Chairperson Miss I.T. Vaz, ED, RBI)

Also called in-house group to "Review the role of RBI in laying down norms for bank lending forWorking capital purpose"

Recommendations (Accepted by RBI) are :

In case of units availing fund based working capital LIMIT OF LESS THAN Rs, one crore, the

working capital is to be computed minimum 20% of their projected turnover

Banks are given free hand to fix inventory norms etc.

SODHANI COMMITTEE (November 1994) (ChairmanMr. O. P. Sodhani (the then ED, RBI)

Sodhani committee, also known as "Export Group on Foreign Exchange Markets in India" was

set up in Nov. 1994.Recommendations are :

Permitting Corporate to cancel and rebook option contract and hedge genuine exposure using

options

Permitting banks to decide their open position limits

A company can come out with public issue only if it has been in commercial operation for two

years or more and its post issue capital is minimum Rs. 5 crores. However, there is no ban for

any company to go for public issues through OTCEI


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Process of public issue need be strengthened further by allowing book building process prior

to offer to public

Companies with an issue size of Rs. 100 crores or more would be allowed to use the book

building process for that part of the issue which can be allotted on a firm basis as per present

guidelines

The lead manager to participate upto 5% of the issue size on firm allotment basis.

TARAPORE COMMITTEE RECOMMENDATIONS

The committee on Capital Account Convertibility headed by Shri SS Tarapore, former Dy. Governor

of RBI set up by the RBI presented its report on 3.6.97. The other member of the committee were SS

Bhalla, MG Bhind, Kir ti Parikh and AV Rajwade. The committee was of the view that capital account

convertibility (CAC) should be phased over a three-year period ending 2000 with the first phase starting

in 1997-98. Second in 1998-99 and the third falling in 1999-2000. CAC means the freedom to convey

local financial assets into foreign financial assets and view versa at market determined exchange

rates. It implies freedom to citizen to buy and sell foreign exchange and utilize it for defined purposes.The committee recommends the phased liberalisation of capital inflows and outflows to allow for the

following:

a) Allowing Indian companies to invest upto $ 50 million in venture abroad

b) Allowing exporters/ exchange earners to keep their entire forex earning in the EEFC account

and giving them full flexibility in the use of such funds

c) Permitting individual residential to invest in financial assets abroad upto $ 25000 in phase 1

(1997-98) and rising upto $ 50000 and $ 100000 over the next two years

d) Allowing SEBI registered Indian funds to invest in securities abroad within a overall limit of $

500 million in phase 1 and rising to $ 2 billion in 1999-2000.e) Giving banks greater freedom to borrow and deploy funds outside Indian in stages

f) Allowing FII portfolio funds tobe invested and repatriated without prior RBI scrutiny

g) Allowing FIIs, NRIs and foreign banks full access to forward cover to the extent of their assets

in India

h) Permitting banks and financial institutions to participate in gold markets abroad

The following preconditions have been suggested by the committee before achieving full float of

the rupee.

1. Reduction of the gross fiscal deficit to GDP ratio to 3.5% by 1999-2000 accompanies by a

reduction in the states deficit as also a reduction in the quasi fiscal deficit

2. The mandated rate of inflation for the three-year period should an average of 3- 5 %. There

should be an early empowering of the RBI on the inflation mandate approved by parliament

and only the Parliament should alter that mandate. Once the mandate is given, the RBI should

be given freedom to attain the target

3. Interest rates should be fully deregulated in 1997-98 and there should be no formal or informal

interest rate controls


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4. The average effective CRR, which was 9.3% in April 1997, should be reduced to 8% in 1997-

98, 6% in 1998-99 and further to 3% in 1999-2000.

5. The NPAs of public sector banks, estimated at 13.7% of the total advances at the end of March

1997 to 12% 1997-98, 9% in 1998-99 and 5 percent in 1999-2000. Drastic measures should

be taken to reduce the level of NPAs.

6. To avoid volatility in exchange rates, the Committee has called for a system under which any

corrections of the real effective exchange rates (REER) can be brought about smoothly. The

Central Bank should have monitoring exchange rate band of plus or minus five percent around

the neutral REER. The REER band should be made public

The high level of NPAs of public sector banks cannot be borne by them if the financial system is

opened upto the forces of international competition. The strengthening of the financial system is the

single most important precondition to the move to CAC. Noting the systemic dangers of some of the

weak banks growing at rates faster that the system. The committee recommends that the weak banks

should act was "narrow banks". The incremental resources of these narrow banks should be restricted

only to investment in government securities and in extreme case of weakness not only should suchbanks not be allowed to increase their advances but there would need to be a severe restraint on their

liability growth.

With a progressive reduction in CRR and decline in NPAs and with other cost/ returns remaining

unchanged, the spreads available to the banking system would increase by Approximate 1.8 percentage

points. Taking account that there would be a squeeze on spreads as a result of financial liberalisation,

the successful; implementation of these signposts would result in return on asserts (ROA) comparable

to the internationally acceptable level of one percent.

Changes on account of recommendations of the Tarapore committee : Exporters/ exchange

earners will be allowed 50% retention of exchange earnings in EEFC account. 100% EOUs/EPS units

will continue to have the existing ceiling of 70%. Indian project exporters will no longer have to approach

RBI for prior approval for a variety of purposes while executing projects abroad. Powers will be delegated

to Authorised Dealers (ADs) in terms of which they can give such approvals. Ads will be allowed to

undertake forfeiting for medium term export receivable Corporate entities will be allowed to open offices

abroad without the need for prior approval from RBI. Capital and current expenditure will be allowed by

ADs without any limit out of EEFC accounts. For other corporate, limits for such expenditure will be

related to the turnover. Banks will be allowed to provide credit/ non-credit facilities to Indian joint venture/

wholly owned subsidiaries abroad. Bank will also be allowed to provide at their discretion, buyers

credit/ acceptances finance for facilitating exports of goods and services from India. The above exposures

will, however, be subject to limit of 5 percent of the unimpaired Tier I Capital. RBI may consider higher

limits on merits. SEBI registered Indian funds managers including Mutual Funds will be allowed toinvert in the overseas market subject to SEBI guidelines. Initially, there will be an overall cap of $ 5000

million; the ceiling for individual funds will be related to size of the funds subject to a maximum, of US

$ 50 Million.

KANNAN COMMITTEE RECOMMENDATIONS

Kannan Committee has suggested that the banks should have the sole discretion to determine

borrowing limits of corporate. Members of committee however differed on the key issues such as whether


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the MPBF concept should be completely done away with and how the change over to a new system

should be made. While some felt that it can be immediately done, others felt that the changeover

would have to be given time. Some of them also felt that Tandon Committee formula for assessment

of working capital requirement should not be abandoned completely but RBI should withdraw its

prescription of 1.33:1 Current ratio and leave it to banks to arrive at a ratio, which may be borrower as

well as industry specific. Any shift away from the existing system of working capital assessment mustkeep in view the size of various banks, their delegation system, exposure limit, corporate policies

rating to financing various industries and products groups etc. Banks and borrowers should be left

free to decide the system they adopt for financing working capital irrespective of the size.

The committee also suggested the following :

a) Definition of an industrial group should be left to the perception of the financing bank

b) System of cash credit should be replaced by a system of loans for working capital

c) Banks should dispose off all the loan applications within 2 to 8 weeks

d) Banks should be allowed to decide policy norms for issue of commercial papers.

e) The uniform formula for MPBF should be abolished and banks should have their own borrowingslimits for corporate

f) Corporate borrowers may be allowed to issue short term working capital debentures of 12-18

months maturity and banks may be subscribe to these debentures

g) Alternatively, the borrowers with credit requirements of Rs. 20 crores or more may be allowed

working capital by way of demand loan to the extent of 100% and borrowers with requirements

of over Rs. 10 crore and upto Rs. 20 crore may have a demand loan component of 75%.

h) Interest rate incentives may be provided to borrowers opting for 100% working capital demand

loan

i) Margins and holdings levels of stocks and receivables as security for working capital facility

may be left to the discretion of the financing bankj) Bench mark current ratio of 1.33:1 and ideal debt equity ratio should be left to the discretion of

the banks

k) QIS & CMA should cease tobe a regulatory requirement

l) Borrowers will have to obtain prior approval for investment of funds outside the business like

inter-corporate deposits, investment in associate concerns and in other investments.

m) Bank should try out the syndicated form of lending

n) A credit information bureau be floated independently by bank

o) Rs. 50 crore mandatory limit fixed for consortium should be done away with.

S.L. KAPOOR COMMITTEE RECOMMENDATIONS

The RBI has accepted 35 out of 106 recommendations of SL Kapoor committee on credit to SSI

Sector for immediate implementations by banks. The RBI has asked banks to:

1. Introduce tri-lingual loan application forms

2. Straightway use the application forms prescribed for credit facilities upto Rs. 2 lacs for facilities

upto Rs. 10 lacs, for facilities upto 15 lacs tobe used for facilities Upto Rs. 50 lacs and for facilities

upto One crore tobe used for facilities beyond Rs. 50 lacs.


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3. Adopt committee approach for sanction of limits and dispose off loan applications in time bound

manner. The prescribed time limit is a fortnight for facilities upto Rs. 25000 and 8 to 9 weeks for

credit facility beyond Rs. 25000

4. For quick disposal of application the apprising official should maintain a checklist and advise the

applicant to submit the additional information that may be required to appraise the application.

5. Necessary help to the applicant may be provided to fill up the application forms properly. Sufficient

number of brochures, schemes instructions of bank and RBI/SIDBI/NABARD/State and Central

Govt. should be made available at the branch

6. Branch Manager may be delegated power to grant adhoc facilities to the extent of 20% of the

sanctioned limit subject to the usual lending discipline

7. Clear guidelines should be set up with the approval of the board of computing the working capital

limits, particularly for borrowers requiring fund based facility beyond Rs. 4 crores

8. Unless there is any contrary specific reason banks should accept the projections of the new units

for the first year of operation as accepted by the term lending institutions

9. As now the flow of credit to the SSI Sector would be assessed by using the date on disbursementinstead of outstanding balances disbursement targets should be fixed along with outstanding

balances. Out of the total fund allocated by banks to SSI sector 40% should be earmarked to the

units with investment in plant and machinery upto Rs. 5 lacs only. 20% to the units having

investments in plant and machinery between Rs. 5 lacs to Rs. 25 lacs

10. More attention is tobe given to the backward states such as Bihar, J&K, Madhya Pradesh and

North Eastern States while fixing the lending targets

11. The limits of composite loans may be enhanced from Rs. 2 lacs to Rs. 5 lacs so that entire

requirement of the unit can be met by single documentation and security creation

12. This facility of composite loan to SSI unit requiring assistance upto Rs. 5 lacs may be given

irrespective of their location13. Single window concept may be implemented. Banks will entertain projects both the term and

working capital loans of borrowers requiring assistance upto Rs. 5 lacs. Similarly for projects

requiring institutional credit of more than Rs. 5 lacs upto Rs. 25 lacs either the bank or the SFCs

should sanction both the term and working capital facility

14. For requirement exceeding Rs. 25 lacs SIDBI should make arrangement with the public sector

banks to have a memorandum of understanding tobe signed by the SFCs with the selected banks

active in different regions of the country for joint financing. Both the term loan and working capital

facility should be shared alongwith sharing of securities on pari-passu basis. However, the borrowers

may be given an option to avail the entire facility from a single agency.

15. The overall interest rate payable by SSI units should be limited to the maximum PLR plus 4% as

existing now. Additional spread over the PLR should be used a premium for guaranteeing the

repayment of the loan. SSI Units with good track record will thus have to pay lower premium and

would derive some advantage out of lower spreads

16. The SSI Units may be allowed to invest overseas upto US $ 20000 based on a simple procedure

17. More specialised branches may be opened to meet the requirement of SSI Units and customer

grievances machinery may be made more effective.


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R.V. GUPTA COMMITTEE ON AGRICULTURE CREDIT

Highlights :

Interest rates on agricultural loans to be fixed by banks

90% of loan applications tobe cleared by local branches

A liquid savings facility in built into loan products

Special agriculture credit plans to accelerate flow of credit

Extension of composite cash credit limit to include farm credit

Abolition of stamp duty on mortgage of farm land

Indicate annual increase in credit flow to agriculture

Modify so as to provide borrowers a choice of banks

The committee recommended the deregulation of interest on farm loans; substituting the agriculture

credit target of 18% of bank's assets portfolio with a system of fixing annual targets. Since smaller

loans revolve higher transaction cost, bankers usually seek larger loans where interest rates are

deregulated the changes will enable them to judge individual cases and fix rates on the basis of the risk

return perception, paving the way for larger loans tobe given. Only by making it viable for banks to lend

to farmers can the roots of agriculture development be cultivated

During cash rich period farmers have a propensity to invest in gold lands etc, to address this issue,

farmers should be offered a liquid savings products with an appropriate return. Which should be in built

in the loan product so as to provide them a cushion during lean periods

The focus of credit appraisal should be on evaluation of the income stream of the borrower and a

comprehensive assessment of credit need staking into account track record credibility, capability as

well as technical viability of the proposal. Agreement and other documents be simplified and all banks

to examine their systems and make modifications within two months and report compliance to the RBI.

RECOMMENDATIONS OF STUDY GROUP UNDER THE CHAIRMANSHIP OF SH. B.D. NARANG

ON LARGE VALUE FRAUDS (RUPEES ONE CRORE AND ABOVE)

The study group was set up in 1998 at the instance of the Board for financial supervision. The

study group submitted its report in March 1999. The group studied frauds reported by commercial

Banks from 1995-1997 and confined itself to those areas which led to the weakening of the internal

control system for prevention and detection of frauds. The group has made following observations:

There is always a time lag between the detection and reporting of a fraud

It is not the lacunae in the rules but the non observance of the same, which leads to the fraud

NADKARNI COMMITTEE RECOMMENDATIONS ON ASSESSMENT OF COST OF PROJECT

A committee under the chairmanship of Shri SS Nadkarni (the then Chairman of IDBI) was set

up to examine the various issues involved in cost overruns of projects.

All financial institutions have agreed to implement the recommendations of this committee.

RECOMMENDATIONS :

1. Inflation Factor : While assessing the project cost, possible escalation in cost on account of

inflation during the implementation period should be provided for. The rate of inflation to be taken

into consideration is the rate of inflation mentioned in RBI Bulletin for the type of commodity as

given below :


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2. Civil Works : Where the period of implementation is within one year the current cost can be

taken into account. However, if the period of implementation exceeds one year, the cost estimate

should be inflated for the period of implementation by using inflation rate for Iron steel and Ferro

Alloys

3. Plant and Machinery : Where quotations are received on firm price basis the same price

should be accepted, and no further escalation in the cost is tobe provided. In case the quotation

is on "Cost plus" basis or only indicative, the inflation rate as applicable for non-electrical machinery

or electrical machinery as the case may be, should be taken into account for inflating the cost.

4. Miscellaneous Fixed Assets : For all the machineries, the cost should be estimated as per the

point 3 above. For furniture and fixtures where prices are not firmed up, the cost should be escalated

for implementation period by using the inflation rate for manufactured products.

5. Pre-operative expenses : The per-operative expenses increase mostly due to the increase in

implementation period. Therefore, at the appraisal stage itself the schedule of implementation

should be scrutinised and finalised on realistic basis.

6. Provision for Contingency : It should be made at a flat rate of 10% on all items excluding MarginMoney for working capital

7. Margin money for Working capital : It should be worked out as per the 2nd method of lending

suggested by Tandon Committee.

NARESH CHANDRA COMMITTEE ON CORPORATE GOVERNANCE

In its report, the Naresh Chandra Committee has commented on the poor structure and composition

of the Board of Directors of Indian companies; scant fiduciary responsibility; poor disclosures and

transparency; inadequate accounting and auditing standards; the need for experts to go thoroughly the

nitty-gritty of transactions among companies, banks and financial institutions, capital markets, etc. The

committee highlighted that in India, companies need to follow very stringent guidelines on corporate

governance :

Major Recommendations of the Committee

(i) Maintaining Auditor's Independence :

t Fees received from any one client and its subsidiaries and affiliates, all together should not

exceed 25% of the total revenues of the audit firm. Where a firm has subsidiary, associate or

affiliated entities, no more than 25% of the revenues of the consolidates entity should come

from a single corporate client with whom there is also an audit engagement.

t Prohibition of any direct financial interest in the audit client by the audit firm, its partners or

members of the engagement team as well as their 'direct relatives'.

t Prohibition of any business relationship with the audit client by the auditing firm, its partners or

any member of the engagement team and their 'direct relatives'.

t Prohibition of service or cooling off period, under which any partner or member of the

engagement team of an audit firm who wants to join an audit client, or any key officer of the

client company wanting to join the audit firm, would only be allowed to do so after two years


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from the time they were involved in the preparation of accounts and audit of that client.

(ii) List of prohibited non Audit Services :

Accounting and book keeping services, related to the accounting records or financial statements

of the audit client;

Internal audit services;

Financial information systems design and implementation, including services related to IT systems

for Actuarial services;

Broker, dealer, investment adviser or investment banking services;

Outsourced financial services;

Management functions, including the provision of temporary staff to audit clients;

Any form of staff recruitment, and particularly hiring of senior management staff for the audit client;

Valuation services and faireness opinion.

In case the firm undertakes any services other than audit, or the prohibited services listed above,it should be done only with the approval of the Audit Committee.

(iii) Rotation of Audit Partners :

The committee did not recommend any statutory rotation of audit firms, but expressed itself in

favour of compulsory rotation of audit partners.

(iv) Disclosures :

Company Management should provide a clear description in plain English of each material liability

and its risk, which should be followed by the auditor's clearly worded comments on the management's

view. This section should be highlighted in the significant accounting policies and notes on accounts,

as well as, in the auditor's report, where necessary.

(v) Replacement of Auditors :

In case an auditor, while being eligible to re-appointment, is sought to be replaced, the explanatory

statement accompanying such a special resolution must disclose the management's reasons for such

a replacement, on which the outgoing auditor shall have the right to comment. The Audit committee will

have to verify that this explanatory statement is 'true and fair'.

(vi) Audit firm to file a 'certificate of independence' :

Before agreeing to be appointed, the audit firm must submit a certificate of independence to the

Audit Committee or to the board of directors of the client company certifying that the firm, together withits consulting and specialised service affiliates, subsidiaries and associated companies are independent

and have arm's length relationship with the client company and have not engaged in any non audit

services listed and prohibited in as above and that they are not disqualified from audit assignments by

virtue of breaching any of the limits, restrictions and prohibitions listed above.

(vii) Empowering Audit Committees :

Audit Committee of the Board of Directors of a company shall be the first point of reference regarding


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appointment of auditors.

To discharge their fiduciary responsibility, the Audit Committee shall discuss the annual work

programme with the auditor and review the independence of the audit in line with the above listed

recommendations.

Audit committee should recommend to the Board of Directors, with reasons, either the appointment/reappointment or removal of the external auditors, along with the annual audit remuneration. Exceptions

to this rule may cover Govt. companies (which follow section 619 of the Companies Act) and scheduled

commercial banks (where the RBI has a role to play).

(viii)Certification of financial reports by the CEO and CFO :

For all listed companies as well as public limited companies, whose paid up capital and free

reserves exceeds Rs. 10 crore, or turnover exceeds Rs. 50 crore, there should be a certification by the

CEO (either the Executive Chairman or the Managing Director) and the CFO (whole time Finance

Director or otherwise), stating the following :

To the best of their knowledge and belief, they have reviewed the balance sheet, profit and lossaccount, all its schedules and notes on accounts, as well as the cash flow statements and Directors'

Report; these statements together represent a true and fair picture of the financial and operational

state of the company and are in compliance with the existing accounting standards and/or applicable

laws/regulations.

(ix) Supervising the work of Auditors :

With appropriate legislative support, three independent Quality Review Boards (QRB) should be

constituted, one each for the ICAI, the ICSI and ICWAI to periodically review the quality of audit, secretarial

and cost accounting firms and pass judgement and comments on the quality and sufficiency of systems,

infrastructure and practices.

(x) Changes in the structure and composition of Board of Directors :

Atleast 50% of the board of directors of any listed company, as well as unlisted public limited

companies with a paid up share capital and free reserves of Rs. 10 crore and above, or turnover of Rs.

50 crore and above, should consist of independent directors. A Nominee director will not be treated as

an Independent director.

The minimum board size of all listed companies, as well as unlisted public limited companies with

a paid up share capital and free reserves of Rs. 10 crore and above, or turnover of Rs. 50 crore and

above should be 7, of which at least 4 should be independent director.

Regarding the remuneration of non executive directors, loss making companies should be permitted

by the DCA to pay special fees to any independent director, subject to reasonable caps, in order to

attract the best restructuring and strategic talents to the boards of such companies.

The present provisions relating to stock options, and to the 1% commission on net profit, is adequate

and does not, at present, need any revision. However, the vesting schedule of stock options should be

staggered over at least 3 years, so as to align the independent and executive directors, as well as


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managers two levels below the Board, with the long term profitability and value of the company.

The DCA should encourage institutions of prominence including their proposed Centre for

Corporate Excellence to have regular training programmes for independent directors. An untrained

independent director should be disqualified under section 274(1) (g) of the Companies Act, 1956

after being given reasonable notice.

(xi) Setting up a Corporate Serious Fraud Office (CSFO) :

A Corporate Serious Fraud Office should be set up in the DCA. This should be in the form of a

multidisciplinary team that not only uncovers the fraud, but is able to direct and supervise prosecutions

under various economic legislations through appropriate agencies.

(xii) Others :

Greater accountability should be provided for with respect to transfer of money by way of inter-

corporate deposits, or advances of any kind, from listed companies to any other company, as a necessary

concomitant of the liberalisation that section 372 A of the Companies Act, 1956 provides.

In order to ensure that proceeds from illegal acts and frauds do not escape recovery, Companies

Act needs to be amended to give DCA the powers of attachment of bank accounts etc.

Managers / promoters should be held personally liable when found guilty of offences. In such

cases, the legal fees and other charges should be recovered from the officers in default, especially if

the offences pertain to betrayal of shareholder's trust, or oppression of minority shareholders.

Consolidated Financial Statements should be made mandatory for companies having subsidiaries.

Outsourcing of non statutory work and tightening the law regarding lapses in secretarial compliance.

Prevent stripping of assets, random scrutiny of accounts, better training for articles and propagation of

an internal code of ethics for companies.

Strengthening the CDA and ROC Infrastructure.

SARKAR COMMITTEE ON ANTI-MONEY LAUNDERING GUIDELINES FOR BANKS IN INDIA

IBA set up a study group under the chairmanship of Shri P. K. Sarkar to study the anti-money

laundering practices and know your customer guidelines being followed in other countries. The major

recommendations of the group are as under :

1. Urgent need to adopt anti-money laundering policy.

2. Each bank's own anti-money laundering policy.

3. A time bound action plan to implement the bank's anti-money laundering policy.4. Adoption of 'Know Your Customer' guidelines by banks.

5. The bank account opening forms should contain information about the financial status of the

customer, his source of income etc.

6. Customers profiles be prepared while opening of accounts and the bank should classify the

account into appropriate risk category (high/low) for monitoring activity / transaction.


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7. Banks should follow uniform norms for activity monitoring, e.g. the threshold may be reduced

to Rs. 5 lacs and be continued to Rs. 10 lacs respectively.

8. Bank should endeavour to track transaction chains in case of suspicion.

9. Bank branches should report all types of suspicious activities / transactions to the Money

Laundering Reporting Officer (MLRO identified at the bank level).

10. Both inward as well as outward remittances (fund transfer etc.) especially the cross border

remittances should be closely monitored.

11. Bank should evolve a suitable system for transaction monitoring, e.g. the threshold limit for

cash remittances and payment of FDRs may be lowered in accounts with high risk perception

from Rs. 50,000 and Rs. 20.000 respectively.

12. Banks should use the latest IT solutions for monitoring transactions above the threshold limits.

13. Banks should report suspicious transactions to RBI.

14. A data bank of suspicious transactions be created and be made available to all banks.

15. IBA / RBI should take up with Govt. of India for expeditious enactment of Prevention of Money

Laundering Bill.

16. Banks should have structured training modules to impart full knowledge of anti-money laundering

guidelines.

17. IBA / RBI may review anti-money laundering measures and suggest suitable changes.

Irani Committee's recommendations on Mergers and Acquisitions

t Statutory recognition be given to mergers without court intervention.

t Approval of shareholders is mandated

t Notices be issued to the Official Liquidator and the Registrar of Companies which would have

the power to file any information before the court that approves the amalgamation.

t Single window concept - to approve M & A in an effective time bound manner.

t Concept of deemed approval is recommended when the regulators do not respond within a

reasonable time.

t Valuation of shares be done by independent valuers rather than by those appointed by court.

t Audit Committee be entrusted with the responsibility of appointing the valuer.

t Anomalies be removed regarding payment of stamp duty.

tFiling of a certified copy of court order should be enough to meet the requirement of law.

t Law recognizes that a listed company can be merged with an unlisted one.

t Requirements of law is met when the M&A is approved by 75% shareholders and creditors

present rather than 75% shareholders and creditors.


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GIST OF THE IMPORTANT COMMITTEES

M. N. Goiporia Customer Service in Banks

Ghosh Frauds and malpractices in Banks, Concurrent Audit

Jankiraman Irregularities in Securities transactions

Dr. C. Rangarajan Mechanisation and Computerisation in Banking

Kalyana Sundram Factoring Services in India

P. R. Nayak Institutional Credit ot SSI sector and related aspects (Annual Projected Turnover

Method)

M. Narasimham I Financial Sector Reforms 1991

M. Narasimham II Banking Sector Reforms 1998

S. Chakraverty To review working of the monetary system

M. Vaghul Money Markets Reforms

R. N. Malhotra Insurance Sector Reforms

J. Raja Chellaiah Tax Reforms

Goswami Industrial Sickness

J. V. Shetty Cosortium FinanceI. T. Vaz Working Capital Lending norms for Banks

Rashid Jilani Revised method of lending in place of Cash Credit System

W. S. Saraf Technology Issues in the Banking Industry

O. P. Sodhani Commitee on Foreign Exchange Markets

D. R. Mehta Committee on IRDP

S. K. Khalia Non Govt. Organisations and Self Help Groups

P. N. Bhagwati Substantial acquisition of Shares & Takeovers Regulation of 1996

Smt. K. S. Shere Legislation on Electronic Fund Transfer

P. R. Khanna (a) Declaring of accounts as out of order on accounts of delay in submission of

stock statement for more than 3 months and delay in renewal of limits for more

than 6 months.(b) Classification of account as doubtful where realisable value of security is

less than 50% of the outstanding.

Y. B. Damle Working Group recommendation of MICR Technology

S. S. Tarapore Capital Account Convertibility, Narrow Banking Recommendations

Kannan Method of lending respective Banks can decide their own method of lending

for assessment of working capital requirements.

S. M. Kelkar Regional Rural Banks

Dr. P. D. Ojha Rural lending & service area approach

R. K. Talwar Customer Service

Basel Capital Adequacy Norms

P. L. Tandon Follow up of Bank Credit

K. B. Chore Review of the cash credit system Implementation of second method of lending

Dantwala Non Banking Finance Companies

G. S. Dahotre Bank Credit for hire purchase & Leasing Companies

S. Padmanaban Inspection and follow up by RBI, Camels Rating

Y. V. Reddy Rationalisation of interest rates on small savings

M. S. Verma Weak Banks Classification 1999


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S. S. Kohli Definition of Sick SSI units, Wilful defaulters

Y. V. Reddy Modificated Liquidity & Monetary Aggregates (M1, M2, M3)

R. H. Khan Universal Bank Recommendations 1998

Rakesh Mohan Infrastructure Finance

S. L. Kapoor Credit Guarantee Fund for SSI, Credit Delivery System for SSI 1998

R. V. Gupta Credit Delivery System for Agriculture 1998Y. H. Malegam Corporate Positioning Restructuring of UTI

R. J. Kamath Revised Education Loan Scheme

C. B. Bhave Reducing Cost of Demat Operations

N. K. Singh Foreign Direct Investment 2002

Zarir Cama Electronic Money

Shetty Consortium Finance

Pannier Selvam On NPAs of Public Sector Banks 1988

Mitra Legal Aspects of Bank Frauds 2001

Kumar Mangalam On corporate Governance 2000

Vasudevan On Technology Upgradation 1999

Abid Hussain Small Scale Enterprises 1997L. C. Gupta On Derivatives 1997

V. S. Vyas Committee on Rural Credit

A. S. Ganguly Committee on flow of Credit to SSI (SME) Sector

A. C. Shah On NBFC

Irani On Mergers & acquisition

Rashid Jilani Internal audit system on PSB's

M. H. Kania Change in certain provisions of SEBI Act.

Lahiri Incouraging FII flows and chaking the vulnerability of capital markets to

speculative flows.

S. S. Tarapore Fuller A/c convertability.

Sarkar Anti money laundring for banks in India.

Naresh Chandra Corporate Governance

B. D. Narang Large value frauds

Kalia Non Govt. Organisation (NGO) and Self-Help Groups (SHG)

Nadkarni Assesment of cost of project

N. Rangachari Panel on Plantation Sector : Banks be allowed to trade in future.

MVS Chalapathi Rao Working group to suggest ammendments in RRB Act, 1976 e.g. scope of

financial services needs to be widened; capital adequecy norms to be introduced

in phases; sponsor should hold minimum 51% shareholding; Operational areaof RRBs be extended to all districts in the country; RRB may have a minimum

5 and maximum 11 board members including chairman; RRBs should be made

subject to regulatory framework at par with commercial banks; Half-yearly

financial audit should be introduced; and so on.

AV Sardesai Committee on restructuring of RRBs (2005) recommended merger between (i)

RRBs of same sponsor bank in the same state and (ii) those of different sponser

banks in the same state. Initial CAR may be kept @ 5%. RRBs may be considered

for currency chest and for collection of taxes.


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1992 93t Narsimham Committee on bank reforms submits report.

t SLR, CRR cut to reduce state pre-emption of loanable funds.

t Number of lending rates cut from six to four.

t Capital Adequacy norms laid down for the first time.

t 364 day treasury-bill introduced with market related rates.

t Other securities' rates raised to bring them close to market rates.

t Guidelines for entry of new private banks issued.

t Deposit rates freed, subject to ceiling.

1993 94

t SBI Act amended to allow the bank to access equity market.

t The number of interest rates cut from 4 to 3. Floor lending and deposit rates brought down.

t Budget provides Rs. 5700 crore to capitalize banks to meet new provisioning norms.

t Prudential norms regarding NPAs laid down.

t Debt recovery tribunals set up.t Malhotra committee report recommends private sector entry into the insurance sector.

1994 95

t Banks free to determine PLRs.

t No minimum lending rate for loans above Rs. 2 lakhs.

t Ad-hoc treasury bills limited by agreement between govt. and RBI, to limit monetisation of govt.

debt.

1995 96

t IDBI Act amended. IDBI raises Rs. 1200 crore through its initial public offering.

t SBI becomes first Indian bank to be listed overseas, following a GDR issue.

t RBI allows setting up of primary dealership firms to deal in govt. securities.

t Six primary dealership firms, promoted by banks and financial institutions, granted licence to operate.

2.3

BANKING & FINANCE 10 YEARS OF REFORMS


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85

1996 97

t CRR cut from 13 % to 10 %.

t PLRs cut. Govt. decides to allow setting up of private sector Local Area Banks, which will operate

in three contiguous non-metro districts.

1997 98

t Interest on Foreign currency deposits deregulated to not more than Libor

t Fixed interest rate regime relaxed.

t Banks freed to assess working capital needs of borrowers.

t RBI Act amended after CRB scam.

t RBI gets sweeping powers to register and regulate NBFCs.

1998 99

t Banks get tougher provisioning norms for government securities, state guaranteed loans.

t Risk weights assigned to government securities, state govt. guaranteed loans, forex open positions.

t NBFC regulations tightened.

t Insurance Regulation and Development ( IRD ) Bill introduced in Parliament.

t Kisan Credit Cards introduced.

t FERA is replaced with FEMA.

1999 00

t IRDA Act passed in Parliament, allows private equity in insurance, caps foreign equity at 26 per

cent of total, sets up Insurance Regulation Development Authority ( IRDA )

t Banks allowed to operate different PLRs for different maturities.

t Times Bank merged with HDFC Bank.

t ICICI and ICICI Bank get listed in NYSE after their respective ADR issues.

2000 01

t Amendments to Banking Companies Acquisition and Transfer of Undertakings Act allow banks to

enter insurance.

t Govt. says it will cut its stake in public sector banks to 33 per cent, but will retain the public sector

character of these banks.


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t State owned banks announce voluntary retirement schemes (VRS ) to shed staff. About 10 to 15

per cent of bank staff apply.

t RBI allows NBFCs to convert themselves into banks. However big industrial groups such as the

Tatas, Birlas and Reliance not allowed to start banks. Large industrial houses not allowed to hold

more than 10 per cent.

t IRDA issues licenses to private insurers initially, 11 joint ventures get licenses.

t Bank of Madura merged with ICICI Bank.

t Global Trust Bank merged with UTI Bank.

t RBI announces cut in Bank Rate to combat slowdown. Announces cut in CRR.

t IDBI Act amended to make film financing an eligible activity for the financial institution.

2001 02

t More DRT's established raising the number of DRTs 29.

t Government has proposed to bring legislation for facilitating foreclosure and enforcement of

securities to enable the banks and FI's to recover the dues.

t Banks allowed to offer higher interest rates to Sr. Citizens.

t PLR norms reviewed and Banks allowed to offer loans below PLR to exporters or other credit

worthy borrowers on the basis of a transparent and objective policy approved by their boards.

2002 03

t Forex reserves top $ 100 billion.

t Tax on securities transaction introduced.

t All UCBs advised to introduce concurrent audit.

t Govt. to buy back 'high interest' govt. bonds from banks.

t Bank Rate 6%, CRR 4.5%, Repo rate 5%.

2003 04

t Fiscal Responsibility and Budget Management (FRBM) Act passed.

tMinimum tenor of retail domestic FD and that of CP reduced to 7 days.

t Composite loan to SSI raised to Rs. 1 crore.

t Banks distributed 413.79 lac KCCs by March 2004.

t Gross NPA of banks down to Rs. 68715 Cr. (8.8%) in 2002-2003.

t Average CAR of PSBs was 12.6% (26 out of 27 had CAR over 10%).

t Foreign banks allowed to raise stake ina private bank upto 74% and to form 100% subsidiaries.


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2004 05

t VAT (Value Added Tax) introduced in the Country.

t Companies made to pay Fringe Benefit Tax (FBT).

t RRB's performance Sponsor bank's liability.

t Agriculture Credit to be doubled in 3 years.

t FDI in insurance sector raised to 49%.

t Bank rate 6%, CRR 5%, SLR 25%, Reverse Repo 6% and Repo Rate 4.5%.

t Govt. introduced a new autonomypackage for PSBs, which have made net profit for past 3 years,

capital adequacy of 9% or more, net NPA of less than 4% and minimum NOF of Rs. 300 crore.

2005 06

t Export crossed $ 100 billion mark by the end of the year.

t GOI enacted 'Right to Information Act, 2005 from 13.10.2005.

t Banks 'PLR were in the range of 10.25% to 10.75% and term deposit rates in 5.25% to 6.25%.

t Concept of 'Financial Inclusion' introduced in Banking Sector.

2006 07

t Micro, Small & Medium Enterprises Development Act, 2006 enacted.

t I.T. benefits under section 80C extended to bank FDs of 5 years and more.

t AD banks allowed to borrow from their overseas branches and corresponding banks upto 50% of

their unimpaired Tier I Capital or $ 10 million, whichever is higher.

t Floor / Ceiling of CRR and SLR abolished. RBI stop paying interest on CRR balances.

PLAN FOR BANKING SECTOR REFORMS IN FUTURE

RBI formulated following road map for Banking sector reforms :

PHASE I : MARCH (2005 TO MARCH 2009)

New banks First Time Presence

Foreign banks wishing to establish presence in India for the first time could either choose to operatethrough branch presence or set up a 100% wholly owned subsidiary (WOS), following the one-mode

presence criterion.

Existing banks Branch expansion policy

For new and existing foreign banks, it is proposed to go beyond the existing WTO commitment of

12 branches in a year. The number of branches permitted each year has already been higher than the

WTO commitments. A more liberal policy for under banked areas will be followed. Branch licensing

procedure will continue to be as per current practice.


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Conversion of existing branches to Wholly Owned Subsidiaries

In the first phase, foreign banks already operating in India will be allowed to convert their existing

branches to WOS while following the one-mode presence criterion. The WOS will betreated on par

with the existing branches of foreign banks for branch expansion of India.

Acquisition of Shareholding in Select Indian Private Sector Banks

In order to allow Indian Banks sufficient time to prepare themselves for global competition, initially

entry of foreign banks will be permitted only in private sector banks that are identified by RBI for

restructuring. In such banks, foreign banks would be allowed to acquire a controlling stake in a phased

manner.

PHASE II : APRIL 2009

The second phase will commence in April 2009 after a review of the e

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Chap02 Indian Banking System

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