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ECONOMIC INDICATORS
Parameters 2010-11 2011-12Inflation as measured by variation in WPI (YOY basis) $@ Projected end March 2013 at 7%
8.98% 6.89%
M3 @Projected growth for 2012-13 at 15%
15.9% 13%
FX (USD bn) Reserve # 304.82bn 294.4bnGDP # (factor cost constant prices)@ Projected for 2012-13 at 6.5%
8.5% 6.5%
Manufacturing Growth # 8.3% 2.8%
Agriculture Growth # 6.6% 2.5- 3%Savings( as % of GDP) #Investments (as % of GDP)# Exports US $ terms #billion 245.56 303.7Imports US $ terms # billion 350.70 488.6Aggregate Deposit Growth of SCB@ projected to grow during 2012-13
15.8% 17.4%
Non-food Credit Growth of SCB@ projected non-food credit is to grow 17% in 2012-13
21.2% 19.3%
@ Source –Union Budget 2012 and monetary policy 12.$ As per revised estimates of CSO# Economic survey 2011-12
Chapter -1
Current Economic Scenario
“By 2030 India could become the 3rd largest economy after China and U.S. India also has the potential to record the fastest growth over the next 30 to 50 years. Of course, India’s growth could be higher than 5% over the next 30 years and close to 5% even in 2050 if development progresses successfully. In fact, India could be ahead of the U.S. in 2055 and be No. 1 in 2067.”
- Goldman Sachs BRIC report 2003
1. ECONOMIC SCENARIO - An overview - Since independence, India has made all
round progress in every sphere of economic activity. We take legitimate pride in the
fact that progress
has been sustained
in the framework of
a democratic policy
and an open society
deeply committed
to fundamental
human freedoms
and law of the land.
India’s economic
structure is
considerably
diversified - with
vast reservoir of
scientific,
technological and
managerial skills.
There has also been
significant
improvement in nation’s educational and health status as measured by school
environment, literacy rate and life expectancy at birth. Self-reliance has been basic
1
objective of economic planning in India since independence. However, 2011-12 has
been exceptionally challenging for the global economy in general and India in
particular as what started off as turmoil in the global market particularly Euro is now
snowballing in Indian economy which has been facing unprecedented inflation.
Economic fall out of this is (a) GDP slowdown, (b) Dollar appreciation, (c) Falling
forex reserve, (d) Widening gap in balance of payment, (e) Increasing fiscal deficit,
(f) Threat of rise in unemployment and job cut (g) pressure on stock market and (h)
Sinking business confidence index. It has fall out on banking system also namely (a)
Rise in delinquency of loan, (b) Falling NIM and profitability and (c) fear of stability
of financial system. In its recently released Financial Stability Report, RBI has hinted
that foreign institutional investment in stock may dip due to uncertainty in US and
Europe, Banks may have to grapple with more bad loans and current account deficit
may widen (ET 23.12.2011).
2. GDP
While global economy may have to settle for a slower growth of 3.25-3.50%,
India’s GDP had been growing at 8% plus for five years in a row - 8.4% in 2003-04,
8.3% in 2004-05, 9.2% in 2005-06, 9.7% in 2006-07 and 9% in 2007-08. However
due to unprecedented economic and financial crises globally, growth has slow down
to 6.7% in 2008-09, 7.4% in 2009-10, 8.4% in 2010-11 and 6.5% in 2011-12 and
expected to be 5.5% ( good in context of sluggish global economy) in 2012-13.
Slowdown in 2011-1 2 is attributed to poor growth in agriculture, forestry and fishing
(2.5%), manufacturing (3.9%) and construction (4.8%). Finance Minister recently
cited three reasons for this slow down: Global problems, high inflation and declining
investments.
Among BRICS countries, growth in China fell from 8.1% in Q1 of 2012 to 7.6%
in Q2. Growth in Brazil and South Africa also moderated significantly in Q1. World
Economic Outlook has revised global growth in 2012 marginally downward to 3.5%.
DR. C. Rangrajan, Chairman, Prime Minister’s Advisory Council outlined five
measures that can trigger investments: (a) if economy continues to grow at 8.5% that
it self may stimulate growth, (b) inflation should be tamed to a reasonable level as
quickly as possible, (c) fiscal deficit to be contained at budgeted level (d) target
2
for the infrastructure of this year should be fulfilled, (e) priority must be given for
completing these targets be it railway freight corridor or roadways projects. It is
now being debated that RBI should cut rates as keeping blind eye to growth and only
focussing on inflation is not in interest of the country.
3. Foreign Exchange Reserve
India’s forex reserves covered 7.1 months imports at the end of March, 12. Due
to many adverse factors such as falling growth, rising commodity prices, surging
trade deficit, spiraling inflation, rising interest rates and plunging value of Indian
rupees, Forex reserves have been on pressure. India is now fourth largest holder of
Forex reserve in Asia after China, Japan and Taiwan. A debate is going on if such a
huge Forex reserve is necessary. The traditional indicators of adequacy of reserves
are based on trade, debt and monetary indicators or even the “Guidotti Rule” or
“Liquidity at Risk” rule suggested by Alan Greenspan, they need to be supplemented
with what can be described as multiple indicators to assess the adequacy of the
reserves of any country at a given juncture. It should however be kept in mind that
there are many unquantifiable benefits of keeping high reserves like maintaining
confidence in monetary and exchange rate policies, enhancing the capacity to
intervene in foreign exchange markets, limiting external vulnerability so as to absorb
shocks during time of crises; providing confidence to the markets that external
obligations can always be met and reducing volatility in foreign exchange markets.
Thus comfort level of reserves is decided not only with current situation but also
with possible future eventualities. As is known, RBI is investing FX reserve into safe
treasury securities of developed countries at a significantly lower interest rate than
what India incurs on its liabilities. Economist Shri Bhaskar Datta, has opined that
accumulation of FX reserve is ‘embarrassment of riches’. It means that increase in
domestic money supply, which invariably results into increase of aggregate domestic
demand, thereby adding ‘demand-pull inflation’. There are suggestions that (a)
a part of these reserves can be placed with banks which in turn can lend it to
corporate, which are otherwise raising ECBs from external financial market. This
will earn higher returns to RBI, (b) GOI can utilize FX reserve to import large array
of non-food items to increase domestic availability and cool off inflation. (c)
3
RBI/GOI to move toward full capital account convertibility. The GOI and RBI has
recently decided to form a SPV with $ 5 billion as subsidiary of India Infrastructure
Finance Company based in London to lend fund to Indian Companies to finance its
infrastructure. GOI is also considering a proposal to for creating a price stabilization
fund for petroleum products by using a part of our reserves.
4. Foreign Direct Investment-
The foreign direct investment brings with it the crucial managerial skill,
technology, brand name and experience of the global player. FDI has three
components- fresh equity investment, reinvestment of profits or a part of it instead of
repatriating the same and investments brought in for paying workmen’s compensation
for relocation and other such purpose not related to equity investment. FDI inflow in
India was US$ 22.8 billion in 2006-07, US$34.8 billion in 2007-08, US$ 37.8 billion
in 2008-09, US$ 37.8 billion in 2009-10, US$ 34.8 billion in 2010-11 and US$ 46.8
billion in 2011-12. India has emerged as a preferred destination for foreign investors
and is ranked 3rd, next only to Brazil and China and US is ranked 4th as per
Bloomberg Survey (ET 22.09.10). Investment commission has recommended two
pronged strategy to increase foreign direct investment: (a) Increasing visibility in
countries like France, Spain, Canada and Taiwan which has little investment in India
and (b) focusing on US, UK, Netherlands and Japan. Investment commission further
identified as many as 93 potential foreign companies for investment across various
sectors. Expert panel under the chairmanship of UTI AMC Chairman Shri U. K.
Sinha has proposed to remove the distinction between various forms of foreign
investors such as foreign institutional investors, private equity or non-resident Indians
and suggested to replace it with qualified institutional investor model. The new model
will pave way to foreign individual investor to invest directly in stock market by
opening a dedicated trading account with registered depository participants.
5. Manufacturing & service sector
Manufacturing and service sector holds key to growth and job. IIP (Index of
Industrial production) of June, 12 indicated sharp decline in factory output to 1.8%
against 9.5% in the previous year. Output of capital goods and non durable goods
dipped sharply. Investment Commission in its report to the Government of India
4
has suggested that inflexible labour laws, poor infrastructure and ambiguity in
outlining the priority sectors has acted as impediments in building large firms,
attracting foreign direct investment and reaping the economies of scale. Economist
also feel that drastic fall in industrial output may prompt the Reserve Bank to
consider revisiting high interest rates in next review of monetary policy in September,
12.
6. Inflation
Headline inflation as measured by wholesale price index (WPI) eased to 7.2% as
on Dec. 12. RBI has revised its forecast for March 13 from 6.5% to 7%. Food
inflation was 10.6% in Nov. 12 and pulses, vegetables, milk, egg meat and fish prices
are still under pressure. Overall inflation scenario continues to be above RBI comfort
level with manufactured non-food product inflation inching up and food prices
remaining stubborn. It is generally believed that deficient monsoon rains and rising
global crude prices are expected to accelerate price pressure in the moths ahead. RBI
believes that current inflation pressure will persist due to disappointing monsoon,
adjustments in administered fuel prices, the depreciated exchange rate and
infrastructure bottlenecks. Current level of inflation is also considered ‘spiraling’ out
of control to hurt investments and economic growth due to tightening of monetary
policy. The higher inflation differential between India and major trading partners is a
source of pressure on competitiveness of Indian exports. Thus containing inflation is
essential to external balance of payment position as well as to growth in long run. It
is felt that revival of consumption demand, change in consumption pattern in favor of
protein rich items like egg, milk, fish, meat etc. where price increase has been high,
rising international commodities prices including crude oil, rise in excise and
custom duties due to roll back of fiscal stimulus and inflationary expectation are
putting pressure on inflation. World over central banks are concerned of inflation
and view is to ‘take care of inflation and growth will take care of itself’.
7. Interest Rate Instance
In quarterly policy of March 12, RBI said that despite deceleration in growth,
inflation risks remain, which will influence both the timing and magnitude of future
rate action. It is opined that (a) combination of weakened exchange rate and high oil
5
prices present upside risk to broader inflation, (b) dip in core inflation reflects
demand pressure in the economy and weak investment activities, (c) credible fiscal
consolidation will be an important factor shaping the inflation out look and (d)
current account deficit is likely to remain high and financing it may continue to be a
challenge. CRISIL Research opined that lending rates are unlikely to ease much
during 2012-13 in view of continued tightness in liquidity, increased government
borrowings and high cost of funds for banks.
9. Liquidity
Liquidity position in the current quarter (July- Oct, 12) is well within RBI comfort
levels with bank on average borrowings Rs. 42600 crores through the repo window.
Further CRR cut by 25 bps effective 22nd September, 2012 will add further liquidity
of Rs. 17000 crores in the system. With falling incremental credit deposit ratio from
93% in March, 12 to 83% in March, 13 and sluggish demand of credit, liquidity
position of banks is predicted to remain comfortable. It may be recalled that in order
to help the banks to overcome liquidity constraints in future, RBI has introduced
Marginal Standing Facility (MSF) at 2% of NDTL at 1% over repo rate and Liquidity
Adjustment Facility (LAF) through repurchase agreement (REPO) against collateral
of GOI bonds.
10. M3
M3 includes (a) currency with the public, (b) demand deposits with banks, (c)
time deposits with banks and (d) other deposits with Reserve Bank. M3 growth (net
of conversion) at 15.9% during 2010-11 was lower than the Reserve Bank’s indicative
trajectory of 17 per cent due to slow deposit growth and acceleration in currency growth. The
higher currency demand slowed the money multiplier. Consequently, M3 growth slowed
despite a significant increase in reserve money. This suggests that money supply growth was
not a contributing factor to inflation.
11. Trade deficit- Exports and Imports
Foreign Trade Policy 2004-09 has targeted growth of Export from $ 63.50 billion
as on March end 2004 to $ 200 billion by March end 2011 to achieve 1.5% of global
market share. CAGR envisaged is 21% for five years. Exports for 2011-12 have
crossed $ 303.7 billion with growth rate of 21%. Import during this period $ 488.6
billion with trade deficit of $185 billion which was quite high and is area of concern.
6
Exports in July 12, declined by 14.8% to $ 22.4 billion, sharpest contraction in three
year, in the wake of falling demand from US and Europe. Imports too declined by 8%
in July 12. Given the current global economic scenario and over whelming
protectionist sentiments in India’s traditional export market, high level of trade deficit
is going to adversely affect competitiveness of import dependent exports and will
continue to pose a great challenge to RBI in managing sliding rupee.
12. Current Account deficit
For most of its post-impendence economic history, India has seen a deficit in its
current account. However for brief period of 2001-02 to 2003-04, India witnessed a
current account surplus. The surplus during 2001-02 was US $ 11.76 billion, in
2000-01 it was US $ 5.86 billion US $ and in 2003-04, it was US $ 8.7 billion.
However again from 2004-05 current accounts turned deficit largely on back of rising
oil prices. Current account deficit could end 45% of GDP in 2012-13. The bloating
current account deficit has raised alarm bell for variety of reasons- (a) external debt
is now higher than forex reserve and (b) short term debts on residual maturity basis is
as high as 43% of total external debt as on June, 12, A rising current account deficit
would lead to depreciating currency, which may lead to higher interest rate and
consequent slow down in the economy. A slowdown could hurt both Indian Inc. as
also the government which could see lower tax growth and consequent higher deficit.
Looking to the healthy foreign exchange reserves crises is not in sight but continuous
increase in deficit is moving our economy into the zone of discomfort.
13. Fiscal & Revenue deficit
Fiscal deficit - excess of government expenditure over receipts less borrowing
– is measure of amount the government needs to borrow to meet its expenditure.
Fiscal deficit of 2011-12 rose to 5.9% of GDP ( budget 2012 propose to bring it
down to 5.3% in 2012-13) and considering off balance sheet items like oil and
fertilizer bonds and consolidated deficit of state government, the actual deficit turns
out to be almost 11% of GDP. Far more alarming is the more than four fold increase
in the revenue deficit, which is difference between revenue receipt and revenue
expenditure. Revenue deficit can only be financed by one of three sources: domestic
borrowing, borrowing overseas or printing money. Each of these comes with a
7
downside - raising interest rates, crowding out the private sector an adding the debt
burden in the case of the first two and adding to inflationary pressure in the case of
the third. Also revenue deficit does not result in the creation of any assets. It merely
adds to the interest and repayment burden without creating the wherewithal from
where the debt could be services. It may be noted that GOI invoked the emergency
provisions of the Fiscal Responsibility and Budget Management (FRBM) act to seek
relaxation from fiscal targets and to launch stimulus packages from December 2008.
FM P. Chidambaram presented (BL 30.10.12) fiscal consolidation plan under which
fiscal deficit will be brought down to 3% by 2016-17 in phased manner. Experts are
skeptical to this as they feel that unless government is able to control expenditure
particularly subsidies containing fiscal deficit will not be possible.
14. Deposits and Credit growth
For six long years, Indian Banks have no problem in mobilizing larger sum as
fresh deposits than the previous year but trend reversed since 2011-12 when deposit
growth was less than credit expansion. The problem has accelerated in 2012-13 as
YOY deposit growth in December, 12 was only 11.1% against credit growth of
15.1% .There are strong evidence of investors making use of other options which are
fetching higher returns to them such as bonds issues of NBFC raising approximately
Rs. 6400 crores by offering returns in the range of 10-13%. Further CD ratio at all
time high at 78.1% for year ending 2012 and incremental CD ration touching 201%
during 2011-12, suggests chocking of resources for corporate in ECB and public
issues mobilization markets and forcing them to borrow from banks at what ever rate
money is available. With this back ground, RBI has also raised repeated concern
about credit growth surpassing deposit growth and it has indicated the banks to
increase deposit and restrain credit growth and further advised them that deposit and
advances growth will be have to be aligned with each other.
15. Savings growth-
Driven by the surge in household savings in financial assets, the gross
domestic savings rate in the economy hit a historic high of 37.7% in 2007-08 but
plunged to 32% in 2008-09 due to world wide crises. It could recover marginally in
2010-11 but to expect to fall further in 2011-12 as economic conditions have been
8
far from conducive. Persistent inflation and slowing growth have eaten into the
incomes of households and corporate and economists apprehends that we may enter
into the phase of sub-30% savings rate. Further analysis provides that India financial
savings declined second year in row to 7.8% in 2011-12 meaning thereby households
save more in physical assets like gold, real estate etc., than in financial assets like
bank deposit, mutual funds, post office savings etc. The sharp fall in financial savings
further means that India has to depend more on overseas flows to funds its capital
needs. It may be noted that rise in savings/GDP ratio is not good enough to guarantee
growth unless household saves more in financial assets than to physical assets.
16. India’s current outlook
Citing corruption inadequate reforms, high inflation and slow growth, Global
Rating agency Fitch joined Standard & Poor in lowering India’s outlook to negative
from stable. New outlook reflect combination of deteriorating growth potential and
widening deficits even though global rating companies reaffirmed India’s long term
foreign and local currency rating at ‘BBB’ and short term foreign currency as ‘F3’.
17. Business Confidence Survey
Business confidence in India plunge to two year low as companies grapple with
problem such as high interest rates, frustration with governance, land acquisition
issues and eroding pricing power in inflationary environment. The survey conducted
by FICCI showed that companies are worried about performance of economy and
corporate sector in next six months. (ET 29.08.2011) The Reserve Bank’s IOS
conducted during March 2011 also indicated some moderation in business
expectations for the quarter ended June 2011. A weak business sentiment now could,
in other word, depress growth next year or the year after that if it persists but not in
the current year.
18. Current global economic scenario:-
We have very complex global economic environment at the moment. It is now
clear that global financial and economic outlook is unsettled and uncertain. The latest
assessment by major international agencies projecting sharp contraction in global
trade volumes in 2009 has exacerbated the uncertainty. The current assessments
project little chance of global economic recovery in 2009 but there are enough green
9
shoots indicating revival of Indian economy. It is expected that 2009-10 worst year
following global melt down will be behind us and economy will start growing.
19. U S Recession as threat:-
Decoupling, theory that the rest of the world does not have to catch a cold if the
US sneezes, which was all the rate last year could easily go down as on the of the
shortest live buzzword of economic theory. A new buzzword has started doing the
round is recoupling. According to this theory, the rest of the world is still umbilically
attached to the sate of the U S economy may be a lot more for Europe and somewhat
less of Asia. It is opined that last year problem of US were mostly domestic based on
housing but as signs of recession deepen, Europe, at least will not be able to escape
the ill effects and will take a but on domestic growth. The alternative growth engines,
China and India, despite their large domestic consumption, will not be able to fill the
gap created by US. While India may be reasonably shielded from the impact, China’s
export based economy may follow the American drummer.
20. European Banking Crisis
The banking sector in euro zone has come under extreme stress in recent months
due to its exposure to sovereign debt. The heavily exposed euro zone banking system
could suffer dramatically as a result of sovereign default as many of them hold large
amount of sovereign debut of countries such as Greece, Ireland, Italy, Portugal and
Spain. Worries over the health of Europe’s banks have led to downgrading of many
banks.
21. India among top five global brands:-
The Future Brand’s latest country brand index (CBI) has ranked India among the
top five countries for value for money, authenticity, history, best brand for art and
culture and business. The over all CBI index is toped by the United States, followed
by Canada and Australia.
22. Harnessing demographic dividend:-
Economists predicts that in 2020, the average age of an Indian will be 29 years,
compared to 37 for China and US, 45 for West Europe and 48 for Japan. Economists
tracking India’s demographic profile estimate that dependency ratio, defined as the
ration of dependent population (<15 & >64 years) to working age population (15 to
10
64 years), which is currently 0.6 will see a sharp decline and by 2030, India’s
dependency ration should be just over 0.4. It will continue to decline over the next 30
years or so and this constitutes the demographic dividend for India. Higher younger
population will lead to higher savings, higher investments and high per capita GDP.
Clearly, there is an unprecedented opportunity for India to become on of the world’s
most prosperous country and that too in just on generation.
POLICY CHANGES
From larger perspective, moot point is to revive confidence in the Indian economy
through growth enhancing measures. With GOI not able to put through economic
reforms (deferment of FDI is one such instance), it is RBI responsibility to fight the
battle alone through monetary and fiscal measures.
Given the structural characteristics, India is perhaps entering a new combination
of growth and inflation of 7 and 8 percent respectively. It is in this context obligatory
for RBI to move to rate easing path as early as possible so that confidence of market
is restored and growth comes automatically. Good point is that RBI governor has
started the process by 50 bps cut in repo rate vide monetary policy April 2012 with a
rider that he can not commit when and how fast further cuts would happen.
Chapter-2
11
Banking Sector Reforms and emerging issues
“We in India, have been adhering to a cautious and calibrated approach in our reforms so far and there is merit in adopting a ‘road map approach’ building on the strengths that we have already developed…The basic feature of Indian approach are gradualism; co-ordination with other economic policies, pragmatism rather than ideology; relevance to the context; consultative process; dynamism and good sequencing so as to be able to meet the emerging domestic and international trends. ”
-Dr. Y.V.Reddy- Governor, Reserve Bank of India.
Economist, former finance secretary and governor of RBI, Sri M. Narismhan was
the architect of financial sector reforms. His two reports of 1991 and 1998 form the
foundation of banking reform in India and are still regarded as the blue print of future
banking landscape. These reforms have provided necessary platform to the banking
sector to operate on the basis of operational flexibility and functional autonomy, thereby
enhancing efficiency, productivity and profitability. Further vulnerability of the banking
sector as revealed by the global financial crisis such as inadequate loss-absorbing
capital; insufficient liquidity buffers; excessive build-up of leverage; procyclicality of
financial markets; focus on firm-specific supervision and neglect of macro-prudential
supervision of system-wide risks; moral hazard from too-big-to-fail institutions; weak
governance practices; poor understanding of complex products; and shortcomings in risk
management etc. have to be addressed through reforms. India has been able to face all
these challenges in the reform process through gradualism; coordination with other
economic policies; pragmatism rather than ideology; relevance to the context;
consultative processes; dynamism and good sequencing, so as to be able to meet the
emerging domestic and international trends.
An attempt has been made in this paper to map reforms of the banking sector
since adoption of Narismhan Committee recommendations, their implications and also
lay down emerging agenda of reforms under consideration of the government of India
/Reserve bank of India.
REFORMS –
Enhanced competition and entry of private sector banks – In tune with the
Narsimhan Committee I recommendation, RBI has relaxed norms for issuing
12
license to new banks with objective to induce greater competition, reduce cost,
improve quality of service, promote financial inclusion that would ultimately
support inclusive growth. Many new private sector banks have been set up out
of which YES Bank is the latest offering. As competition mounted, Public Sector
Banks, which operated on the comfort of sovereign guarantee, were forced to
keep pace with private sector counter parts by upgrading their work process
through technology and also becoming customer focused. Banks are replicating
the story clearly seen in telecom and aviation sectors. While presenting Budget
of 2010-11, finance minister announced that more banking licenses will be issued
to private sector players and non banking finance companies to enhance
competition and help financial inclusion. As per policy paper released by RBI
(BL 30.8.2011) only entities/group in the private sector, owned and controlled by
residents, can promote banks but those having real estate and capital market
activities will not be eligible. New bank can only be set with wholly owned non
operative holding company with minimum capital of Rs. 500 crores and it will
have to hold minimum 40% capital for five years. Aggregate non-resident share
holding from FDI, FII and NRI will be restricted to 49% in first five years. At
present we have, 12 new generation private banks, 26 Public sector banks, 15
old private banks, 31 foreign banks, 85 regional rural banks, 31 foreign banks,
4 local area banks, 1721 urban cooperative banks, 31 state cooperative banks
and 371 district central cooperative banks.
Branch licensing- RBI has permitted opening of branches in tier 3 to tier 6
cities (population up to 50000 as per 2001 census) without prior authorization
under general permission. However banks will have to obtain prior authorization
for opening branches in tier 1 and tier 2 centers. Banks will have to plan their
branch expansion in tier 3 to tier 6 cities in such a manner that at least 1/3 rd of
newly opened branches are opened in under banked districts of under banked
states as notified by the RBI.
Road map for entry of foreign banks- RBI has notified ‘roadmap for presence
of foreign banks in India and guidelines on ownership and governance in private
banks.’ As per the roadmap, foreign banks wishing to establish a presence in
India for the first time could either choose to operate through branch presence, or
set up 100% wholly owned subsidiary (WOS) following the ‘one mode presence
criterion’. In phase-I, foreign banks already operating in India will be allowed to
13
convert their existing branches to WOS. In phase-II, WOS of foreign banks will
be accorded full national treatment, including opting for going public, subject to
26% of the capital being held by resident Indians at all times. RBI has also
allowed some flexibility in individual stake and subject to RBI approval this stake
can exceed 10%. However, if foreign banks’ assets in India (both on and off
balance sheets items) exceed 15% of the system, RBI may deny licenses to new
foreign banks. RBI vide Monetary Policy April 2009 decided to keep on hold
branch licensing of foreign banks in view of current global financial market turmoil
and uncertainties surrounding the financial strength of banks around the world. It
was indicated in the Monetary Policy Statement of April 2010 that drawing
lessons from the crisis, a discussion paper on the mode of presence of foreign
banks through branch or wholly owned subsidiary (WOS) would be prepared by
September 2010. RBI floated the discussion paper on presence of foreign
banks in India in January 2011 soliciting views/comments from all stakeholders,
including banks, non-banking financial institutions. RBI has stated in Monetary
Policy statement May 2011 that the comprehensive guidelines on the mode of
presence of foreign banks in India are being formulated, keeping in view the
suggestions/comments on the discussion paper, received from all concerned.
Capital and functional autonomy – Percy Mistry committee report
recommended that government give up its ownership by 2014 and Raghuram
Rajan Committee recommended that government to give up its ownership at
least in few banks. The Standing Committee on finance has cleared the proposal
to bring down the government stake in PSBs from 51% to 33% but GOI has
decided to keep the government equity to 51% minimum. The recommendation
of Dr. C. Rangrajan that holding of public sector undertaking like LIC, ONGC etc.
be included in 51% government ownership has also not found favour from the
government. In final stimulus package of 2008-09 and also in 2009-10 , GOI has
approved capital infusion by way of preferential capital in ten public sector banks
-mostly mid sized banks so as to help them in improving CRAR as most of these
banks have hit the threshold limit of 51% and more dilution would mean going
below the thresh hold level. RBI has also permitted banks to raise long term
funds through bond for infrastructure finance to overcome problem of assets
liability mismatch. Further a proposal for comprehensive amendment of the
Banking Regulation Act, 1949 and the Banking Companies (Acquisition &
14
Transfer of Undertakings) Act, 1970 & 1980 was introduced in the Parliament by
way of The Banking Law Amendment Bill 2011 which will include a new section
to override the provisions of the Competition Act, 2002 and to exempt the
applicability of such provisions to amalgamations /reconstitutions/ mergers/
acquisitions, etc. of different categories of banks meaning that such
mergers/acquisitions would not need permission from Competition Commission
of India; voting right to investors as per their share holding in private sector banks
which currently is capped to 10% and current cap of 1% maximum investment in
public sector bank is proposed to be raised to 10%, enabling banking companies
to issue preference shares subject to regulatory guidelines by the Reserve Bank;
formation of a depositor education and awareness fund; facilitating consolidated
supervision; and a provision for supersession of boards of directors by the
Reserve Bank; and increase in the quantum of penalties. The proposals relating
to the amendment of the Banking Companies (Acquisition & Transfer of
Undertakings) Act, 1970 & 1980 include raising the authorised capital of
nationalized banks and enabling them to raise capital through “rights issue” or by
issue of bonus shares.
Setting up of Holding company: Budget 2012 proposes to set up an holding
company to hold government stake in banks, a move that will overcome the
trouble of periodic capital investment into publics sector banks that upsets fiscal
calculations. This initiative may also eliminate the embarrassment of knocking at
the doors of Life Insurance Corporation at it did last year to bail out the
government by investing policy holders’ fund , a move that also raised the issue
of corporate governance standard in India. The proposed structure may be by
way of corporate set up by an act of parliament so that it is away from the glare
of regulator.
Redefining NBFC structure: As per draft recommendation vide notification of
2010, any change in control or transfer of NBFC –ND ( non deposit taking NBFC)
or NBFC (D) ( deposit taking NBFC) beyond 25% of paid up capital will need RBI
approval, CRAR to move to 15% , assets classification norms at par with banks
would be applicable and benefits of SARFESAI would be available to NBFCs.
NBFCs with assets of Rs. 1000 crores and above would be subject to
comprehensive supervision including inspection at predetermined intervals.
15
Issue of preference shares/ other hybrid instruments- RBI has permitted
banks to raise capital through preference share route so that government holding
in banks is not diluted below 51%. Present legislation also caps the maximum
tenure for which preference shares can be issued. RBI has recently allowed
banks to issue hybrid instruments like perpetual bonds, as it will not require any
legislative change. RBI has also permitted banks to issue these bonds with “call”
and “step-up” option. Perpetual bonds are those in which investor does not have
the right to ask for the money back but the issuer has the right to pay back
investor. Typically insurance companies and pension funds subscribe to these
bonds. Banks are now scouting with the finance ministry for tax benefits on these
bonds, as these are long-term instruments.
Deregulation of lending interest rates – All lending rates (except for export
credit, loan to staff members and lending under interest subvention of
Government of India) have been de-regulated. Banks have introduced floating
and fixed interest rate products and are more aggressive in their offering.
Deregulation of deposit interest rates – Interest rates on deposits are
deregulated ( RBI deregulated savings deposits in October, 2011 and Non-
resident Indian deposits in December, 2011) and banks enjoy complete interest
rate freedom. Banks are also free to offer differential interest rate on high-ticket
deposit of Rs.15 lakh and above.
Base Rate: Under RBI directive, Base rate system was introduced w.e.f. 1st July,
2010. Banks have been advised to declare their base rate each quarter and they
can not lend below base rate. Further base rate will be applicable across the
board and bank will not be in a position to discriminate between old and new
borrowers. RBI has also made lending rate disclosure mandatory for banks to
bring greater transparency and has also advised banks to announce Base Rate
after taking into consideration (a) the cost of deposit , (b) adjustment for
negative carry of cash reserve ratio and statutory reserve ratio, (c) unallocatable
overhead cost for banks and (d) average return on net worth.
Phasing out of statutory preemption – The SLR requirement has been brought
down from 38.5% in 1991-92 to 23% in 2012 and CRR has been brought down
from 15% in 1991-92 to 4.25% in 2012. After passing of Reserve Bank
(amendment) bill 2006 legislative cap of 3% CRR and 25% SLR has been
16
removed. However RBI has decided that no interest will be paid to banks on
minimum CRR limit of 3%.
Capital Adequacy - CRAR of 9 % prescribed with effect from end March 2000
against 8% laid down in Basel II. .
Credit Delivery – Credit authorization scheme (CAS) has been withdrawn.
Selective Credit Control (SCC) has been relaxed excepting sugar. Norms for
assessment of Maximum Permissible Bank Finance (MPBF) as per 2nd method of
lending has been relaxed. Mandatory formation of consortium has been
dispensed with. Banks have been given freedom to decide norms of assessment
of MPBF and they enjoy complete freedom to decide their credit policy as per
approval of their board.
Exposure norms– RBI has advised banks to fix exposure norms for individual
as well as group so as to keep the exposure within prudential limits. It has also
advised the banks to fix exposure for industry specific risk for prudential credit
risk management as per international best practices. RBI vide monetary policy
April 2012 advised bank fix individual exposure to NBFC having more than 50%
gold loans.
Income Recognition and Prudential Norms – With a view to adopting the
international best practices in regard to Income recognition, asset classification
and provisioning, number of policy changes have been made viz. prescription of
provisioning requirement of 0.25% to 1% in respect of standard (or performing)
assets, reduction of the time period for classification of doubtful assets from 18
months to 12 months from March 31, 2005, introduction of 90 days norms for
classification of non performing assets w.e.f. March 31, 2004, stipulating 70%
minimum provision coverage ratio by 30th September 2010. The provisioning
norms are more prudent, objective, transparent, uniform and standardized as per
global norms to avoid subjectivity.
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act –Securitisation and Reconstruction of
Financial Assets and enforcement of Security Interest Act 2002 allows setting up
of Asset Reconstruction Companies (ARC) by banks with unprecedented powers
to take over the management of a defaulting company or take over and sale
distressed loans. The Act provides for 60 days notice to borrower to discharge
17
the liability in full failing which a bank can take possession of
mortgaged/hypothecated assets and sale them for liquidation of dues.
Assets Reconstruction Companies – ARCs set up under Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest Act
have been empowered to take over NPA from banks, engage in innovative
corporate finance such as merger, sale of brands or plants, inject new capital,
convert distressed companies into new companies and even take out an IPO.
ARC will have to work within RBI guidelines and subject to registration/license
from RBI. ARCs should have minimum owned funds of Rs. 100 crores and
maintain minimum capital adequacy of 15% at all times. ARCs are hardly a
successes story since they have been able to buy only a fraction of NPAs and
banks are complaining that they are not offering right price to them. This
problem is expected to be solved with setting up of few more ARCs because it
will increase competition.
Central Registry of Securitization Asset Reconstruction and Security Interest of India - A Central Electronic Registry, incorporated under section 25
of the Companies Act, 1956, as the Central Registry of Securitisation Asset
Reconstruction and Security Interest of India (CERSAI) to give effect to the
provisions of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest (SARFAESI) Act, 2002 has been set up as not-
for-profit company in which Central Government is holding 51% share . The
objective of the central registry is to prevent frauds in loan cases involving
multiple lending from different banks on the same immovable property. The
registry became operational from March 2011 and its jurisdiction covers the
whole of India. As many as 166 lending institutions are placing their mortgage
related information with this registry.
Transparency in financial statements – RBI has advised banks to disclose
certain key parameters such as Capital to Risk Assets Ratio, percentage of
NPAs, movements of NPAs, movements of provisions towards NPAs, movement
of provisions held towards depreciation of investments, the total amount of
standard/sub-standard assets subjected to Corporate Debt Restructuring ,
maturity pattern of deposits, borrowings, investments and advances, foreign
currency assets and liabilities, lending to sensitive sectors, Net value of
investment, Return on Assets, Profit per employee and interest income as
18
percentage to working funds etc. Further the Joint Parliamentary Committee
2001 wanted the annual reports of banks to carry the RBI’s comments arising
from its inspection reports to ensure greater transparency and to make sure that
the shareholders get a fair idea of the operations of a bank. After failure of
Global Trust Bank, the demand has been made again which if placed up front
might help the ordinary depositor and shareholder of the danger ahead.
Accounting Standards – RBI has unveiled new accounting norms for banks,
which seek to move towards full compliance by banks with the accounting
standards issued by Institute of Chartered Accountants. The new norms seek to
bring intangible assets within the purview of the Banking Regulation Act. The
accounting standard 24 and 28 has been made effective from 1st April 2004.
Penal Action- The RBI has decided to publish penal actions against the bank.
The banks will have to publish such penalties in the note on account of their
balance sheets with effect from 1st November 2004.
Scheme of Banking Ombudsman- Banking Ombudsman has been introduced
since 1985 to look into and resolve customer grievances. RBI has further
widened the scope of the banking ombudsman scheme to cover all individual
cases/grievances relating to non-adherence to the fair practices code evolved by
IBA and adopted by individual banks and also the credit cards/ATM cards.
Complainants have been permitted to file eComplaint after down loading the
complaint form from RBI site.
Hiving off of regulatory and supervisory control – Board for Financial
Supervision (BFS) was set up under the RBI in 1994 after bifurcation of
regulatory and supervisory functions. An independent Department of Banking
Supervision (DBS) has been set up in RBI to assist the board.
Risk Management Systems – In view of the diverse financial and non-financial
risks confronted by banks in the wake of the financial sector deregulation, RBI
has put the risk management system in place. Banks have been asked to adopt
sophisticated techniques like VaR, Duration and Simulation model-based
approaches as also credit risk modeling techniques as part of risk management
measures.
Risk Based Supervision (RBS) – RBI has issued detailed guidelines for RBS
and have advised banks to develop risk assessment processes in accordance
with their risk profile and control environment which will subjected to review and
19
supervisory intervention by RBI as necessary. The emphasis will be on
evaluating the quality of risk management and the adequacy of risk containment.
The transaction based internal/external audit would be replaced by Risk Based
Internal Audit (RBIA) system.
Prompts Corrective Action – RBI has evolved a framework of Prompt
Corrective Action (PCA) with various trigger points. The framework is based on
three parameters viz. capital adequacy, asset quality and profitability. The
framework contemplates a set of mandatory and discretionary actions by
regulator (RBI) for dealing with banks that cross the trigger points.
Regulation Review Authority – The purpose of this Authority is to provide an
opportunity to the public at large to seek justification for and suggest deletion or
modification of any regulation, circular or return issued, or required by the
Reserve Bank. Anyone can apply to the Regulations Review Authority – a
citizen, a non-resident Indian, an institution (including banks), an association, an
academic or even an RBI employee. It is not necessary for the applicant to be
an affected party. The applicant may simply put down the details on a plain white
paper and give his suggestions stating justification, in as much detail as possible,
with an illustration to enable the Authority to take an expeditious view on the
application.
Appointments of business correspondents- Banks are now allowed to
outsource lending and deposit taking activities NGOs, micro-finance agencies,
post offices, NBFCs, Agents of small savings schemes/insurance companies,
individuals who owns petrol pumps, individual public call office (PCO) operators,
individual kirana/medical/fair price shops, cooperative societies, retired bank
employees, ex-servicemen and retired government employees, so as to reach
rural and remote areas. RBI has clarified that institutions for profit can also be
appointed business correspondents as earlier notion was that banks will appoint
only non-profit organizations. Under the scheme banks will have to prescribe
suitable limits for receipt and payment by business correspondent and
transaction done through agent will have to account for either on the same day or
next working day. Banks will be responsible to customer for any act of omission
or commission for their agent. BC model is considered as extremely vital for
achieving the goals of financial inclusion.
20
Inclusive growth drive- GOI and Reserve Bank are working in tandem to push
the agenda of inclusive growth and to bring villages of population of 2000 and
above within banking fold. GOI has announced setting up a fund of Rs. 800
crores to compensate banks for cost incurred in reaching credit to unbanked
areas. This will be in addition to existing Rs. 1000 crores financial inclusion fund
and financial inclusion technology funds set up with NABARD. RBI and GOI has
identified 72395 villages that will be covered in another two years. Public sector
banks have been asked to prepare the financial inclusion plan(FIP) to tap the
fortune of ‘bottom of pyramid’.
Bancassurance- Insurance business by Indian banks- GOI issued notification
that insurance is permissible business under Banking Regulation Act section 6
(1) (o) followed by RBI guidelines dated 8th August 2000 for entry into insurance
business with risk sharing model and with fee based business. While few banks
have started insurance business through subsidiary route, other banks have
entered in the business through agency route or under referral model.
Money Laundering and Financing of terrorism – India has been sharing the
increasing international concern on the use of the financial system for money
laundering and financing of terrorism. RBI has set out the policy, procedures and
controls to be introduced by banks. These include strict adherence to “Know Your Customer” (KYC) procedures for prevention of misuse of banking system
for money laundering and financing of terrorist activity, reporting of suspicious
transaction and developing in built system in the banks to monitor cash
transaction above thresh hold limit.
Guidelines on securitization of standard assets - RBI has issued guidelines
for securitization of standard assets with a view to have ‘fit and proper criteria’ on
continuous basis. RBI has also decided to prescribe a minimum lock in period
and minimum retention criteria for securitizing the loans originated and
purchased by banks so as to avoid sub prime like situation in India.
Code of conduct for credit cards- In view of growing complaints against
various malpractices for issuing of credit cards, RBI has decided that code of
conduct for issue and transparency in service charges evolved by IBA in
consultation with leading banks will be adopted by all credit card issuers. There
is also debate of introducing anti-tying regulations, which will prohibit banks to
force customers from buying unwanted products/services.
21
Setting up of Banking Codes and Standards Board of India- In annual policy
of April, 2005, RBI has proposed to set up a Banking Codes and Standards
Board of India on model of the mechanism in the UK in order to ensure that
comprehensive code of conduct for fair treatment of customers are evolved and
adhered to. The said board has been established in February 2006 under the
chairmanship of former RBI deputy governor Mrs. K J Udeshi. It is now
mandatory for every bank to adopt a compensation policy to make up for losses
incurred by customers due to mistakes committed by bank employees once it
signs the charter of the Banking Codes and Services Board (BCSB). The gamut
of retail banking services, including savings accounts, term and demand
deposits, credit cards, debit cards, foreign exchange remittances, and loan
accounts will have to be covered by the compensation policy.
Tax Sops for Fixed deposits- Union Budget 2006 has permitted fixed deposit of
five years above as eligible investment for tax exemption under 80 C (prescribed
ceiling is Rs. 100,000) bringing it at part with NSC/PPF etc. Government has
further relaxed the rules and allowed payment of money to second joint depositor
in event of death of first depositor before lock in period of five years. It is
expected tax sops on deposits will help the banks to garner larger share of
savings from households.
Bank’s investment in non-finance companies: RBI issued guidelines (BS
13.12.2011) for capping investments by banks in non-finance companies to 10%
of company’s paid up capital or 10% of bank’s paid up capital and reserves. The
investment already made by banks in ‘held for trading’ category would be
included in this cap.
Core investment companies to register with RBI- Investment companies with
assets size of Rs. 100 crores are considered systemically important and have
been asked to get them registered with RBI. As per notification such companies
will have to obtain RBI registration within six months. It is stipulated that leverage
ratio (ratio of outside liability to tangible net worth) should not exceed 2.5 and
these companies must maintain minimum capital ratio where by the adjusted net
worth shall not be less than 30% of risk weighted assets.
Corporate Governance – An adequate institutional and legal framework is in
place in India for effectively implementing a code of sound corporate governance
in banks. The statutes have built in legal provisions that prohibit or strongly limit
22
activities and relationships that diminish the quality of corporate governance in
banks. As a major step towards strengthening corporate governance in banks,
banks have been asked by RBI to place before their Board of Directors the
Report of the Consultative Group of Directors of banks and FIs (Dr. Ganguly
Group) set up to review the supervisory role of Boards of banks. The
recommendations include the responsibility of the Board of Directors, role and
responsibility of independent and non-executive directors, etc. With number of
banks now listed on stock exchange and accountable to shareholders, it is
necessary to focus on corporate governance in letter and spirit as quality of
decision making will be crucial in enhancing share-holders’ value.
Financial stability and development council- As a follow up of budget
proposal of 2010-11 to set up Financial Stability and Development Council
(FSDC), GOI through Securities and Insurance Law amendment ordinance
(2010) has set up a monitor macro prudential supervision authority including
supervision of large financial conglomerates and to deal with inter regulatory
coordination. Finance Minister has clarified that government will maintain
autonomy of all regulators and ordinance will play its role only when there is
conflict of interest among two regulators on hybrid products. FSDC has been
made functional to deal with financial stability, financial sector development,
inter-regulatory coordination, financial literacy, financial inclusion, macro
prudential supervision including functioning of large financial conglomerates.
Banking out of purview of Competition Commission of India - The GOI has
finally decided that banking sector including the mergers and acquisitions of
banks will be out of purview of the Competition Act 2002.
Prepayment penalty in home and other loans- The practice of banks imposing
pre payment charges in home, auto and other loans was under scrutiny by
competition commission of India as it is alleged that it restricts the choice of
borrowers to move to other bank and is against competitive opportunity for
borrowers. RBI vide monetary policy of April 2012 mandated that bank can not
charge prepayment charges in case of floating rate home loans.
EMERGING ISSUES-
Financial sector legislative reforms commission (FSLRC)- Finance Minister in
budget speech February 2010 has announced that government will rewrite financial
sector laws through FSLRC. The aim is to simplify and streamline the legal
23
framework to possibly suggest a completely new regulatory structure. GOI has now
floated a consultation paper citing response from various regulators. The commission
mandate will be to examine the kind of inconsistencies and overlap in financial sector
laws and workout standard principle based financial regulation.
Financial Sector Assessment Program (FSAP) - A comprehensive self
assessment of the financial sector in 2009 under a committee on Financial Sector
Assessment Chairman Dr Rakesh Mohan and Co-chairman Shri Ashok Chawla was
done based on the IMF-WB methodology. RBI has now decided to set up a task
force to take steps for implementation of the recommendation of G 20 working
groups viz. Enhancing Sound Regulations and Strengthening Transparency and
Reinforcing International Cooperation and Promoting Integrity in Financial Markets
and will also suggest an implementation schedule.
Basel III- Banks will have to adhere to internationally agreed phase-in period
(beginning January 1, 2013) for implementation of the Basel III framework. As per
proposal, banks will be required to keep 7% core capital i.e equity, reserves and
surplus and systemically important banks will have to keep additional 2.5% additional core capital. There are further suggestions for making provision for
additional capital as ‘counter cyclical provision’ to overcome situation like global
crisis of 2009-10. The Reserve Bank is studying the Basel III reform measures for
preparing appropriate guidelines for implementation. It is taking steps to disseminate
information on Basel III and help banks prepare for smooth implementation of the
framework.
FII cap in PSU banks- Presently a cap of 20% exists for subscription in banks equity
for foreign institutional investors. GOI is considering to raise this cap up to 24% as in
most of the banks FII cap has hit the upper ceiling. As per legal provision, FII cap
below 26% will be non-controversial as neither the FII will get a birth in board nor
does it have authority to block any move by calling extra-ordinary general meeting. It
may be recalled that Indian Bank Association has recommended to government to
hike the FII cap and also to keep ADR/GDR out of purview of FII cap.
Regulatory oversight over credit rating agencies- It is argued that all credit rating
agencies whose ratings are used for regulatory purposes should be subject to a
regulatory oversight regime that includes registration and that requires compliance
with substance of the IOSCO code of conduct Fundamentals. It is argued further
24
that RBI should look into cumulative default rate and transition matrix of the rating
agencies to continue accreditation.
Regulation over Micro finance institutions - Commercials banks who have lent
more than Rs. 18000 crores to MFIs are facing great stress due to regulatory
restrictions put forth by AP Act on interest rate restrictions, periodicity of repayment
not earlier than month and restructuring obligations. Central government is
contemplating legislation to ensure regulatory frame work and to overcome threat of
NPA which is already high in agriculture sector.
Size Matters- Urge to Merge - After merger of Global Trust bank with Oriental Bank
of Commerce and IDBI Bank with parent IDBI, the experts opine that more mergers
and amalgamations will take place in the next 4-5 years to create Mega-banks. The
banking sector is now moving from a regime of “large number of small banks” to
“small number of larger banks.” Hardening yields and consequent fall in value of
securities and lesser treasury income coupled with higher requirement of capital due
to Basel III are the main triggers of merger and consolidation. Otherwise also there
are sufficient reasons for consolidation in the banking sector like increased efficiency
resulting from economies of scale, reduced intermediation cost, greater capacity to
access the capital market and greater capacity to meet competition with international
players. It may be recalled that Narsimhan Committee - I recommended mergers
and acquisitions of banks so as to make 4-5 world-class banks that would compete
in global market. Indian Banks Association report on M & A in banking has
suggested corporatization that would make all bank coming under Companies Act
1956 and therefore under common legal framework. It has also recommend
amendment of section 72A of Income Tax Act to extend the benefit of set off of
accumulated losses and un-absorbed depreciation.
Depositors’ protection fund- This fund is to be set up by crediting deposits
remaining unclaimed for more than ten years and fund to be used for promotion and
protection of depositors’ interest. The unclaimed deposit kitty of banking sector was
Rs 2400 crores as on December 31, 2011 (BS 30.07.2012).
Transforming Deposit Insurance system- RBI is examining the transforming the
Deposit Insurance and Credit guarantee Corporation (DICGC) from a ‘pay box’
system to a one attending to all aspects of the bank failure resolution process. Non-
involvement of DICGC in the failure resolution process is considered a major area of
concern. ‘Pay box’ system in banking parlance means that deposit insurer serves
25
only as an agency to reimburse depositors. Central government budget proposal
2002-03 proposed to covert DICGC into BDIC (Bank deposit Insurance Corporation).
Separate Common Insolvency Code for banks- Committee on financial sector
assessment has suggested that a separate common and comprehensive insolvency
code for banks. Separate code is considered vital in view of financial global
uncertainty and legal complexities. So for PSBs are concerned there are no
solvency issues as sovereign is more than 50% shareholder but for private sector
banks this kind of legislation is considered necessary.
Bank’s entry into Merchant trading -The RBI has proposed an amendment in the
Banking Regulation Act, 49 to allow banks to become members of stock exchanges
and undertake merchant trading- to do trading on behalf of others. This will be
followed by an amendment in Securities Contract Regulation Act that will permit
banks to conduct this business. As per present rules, bank’s can take exposure up
to 5% in equity market. It may be recalled that RBI recently announced to consider
relaxation in 5% norms on case-to-case basis.
Removal of cap on 10 year fixed deposit- Banks are requesting RBI to remove
cap on more than 10-year deposits so that they have no asset-liability management
problem to finance long term loans like housing and infrastructure. Present
guidelines permits to accept deposits more than 10 years only from minors and that
too under certain conditions.
Changes in financial system- High level panel on financial sector reforms chaired
by Professor Raghuram G Rajan has recommended (ET 7.4.2008) that the
government should liberalize the interest rate regime of priority sector lending, sell
loss making small state run banks, encourage takeover of banks and reduce the
oversight that the government maintains on state banks in addition to the controlling
their boards. The committee has also made a strong case of removing the
restrictions on opening of bank branches and ATMs and for rewriting financial sector
regulations. It has also recommended that government should legislate to remove
the oversight of bodies such as CVC over public sector banks for better and speedy
decision making.
Exemption from Company Bill provisions- The Reserve Bank of India has sought
exemption from the provisions of the new company bill 2008 following the strong
conflict with the Banking Regulation Act 1947. For example new Company Bill has
not made any specific provisions for banks as was the case in erstwhile Companies
26
Act 1956. Among major items which will get affected without a suitable amendment
to the Companies Bill is the preparation of bank balance sheet. While public deposit
by companies as treated as borrowing for banks they are only deposits. Similar
problem is in case of off balance sheet items /contingent liabilities. While it is normal
for companies to have preference share, banks usually maintain preference shares
at exceptional cases and that too with RBI approval. Derivative items which are
hedging products are some time shown off balance sheet or on balance sheet if they
are marked to market for losses. Corporate debt restructuring which is unique to
banks and not to companies is other stumbling block. Another problem is exclusion
of government nominee director in company bill from the category of independent
director.
International financial reporting system (IFRS):- RBI has recently constituted a
task force to address implementation issues of IFRS convergence with banking
system by April, 1, 2013. It may be mentioned that banks will also have to adhere to
various risk reporting dead lines including transition to internal-rating based (IRB)
based approach for credit risk by March 31, 2014. Leading multinational bank
outside India are implementing Basel II initiatives that are IFRS compliant for loan
loss provisioning.
Priority sector lending: Committee headed by Mr. M.V.Nair, Chairman & Managing
Director, Union Bank of India has recommended to revise priority sector targets of
foreign bank to 40% ( present 32%), to do away with sub-target of direct and indirect
agriculture targets, introduce sub-target of 9% of ANBC for marginal and small
farmers and 7% of ANBC for micro and small enterprise and to increase the quantum
of education loan to Rs. 15 lakhs for study in India and Rs. 25 for study overseas and
one property per individual ( instead of Rs. 25 lakhs) as housing loan. RBI vide
monetary policy of April 2013 announced adoption of the recommendations .
Summing UpFinancial sector reform is a continuous process that needs to be in tune with the
emerging macroeconomic realities and the state of maturity of institutions and markets.
So far, India’s approach to financial-sector reforms has served the country well, in terms of aiding growth, avoiding crises, enhancing efficiency and imparting resilience to the system. It is expected that ongoing reform process will help us to build
globally competitive banking sector in India.
27
Chapter –3
RBI Monetary Policy
“Monetary policy space needs to be created through fiscal adjustment and structural measures to improve supply conditions and boost the investment climate so that revival is supported in a non inflationary manner.”
- RBI Quarterly review of monetary policy
Monetary Policy- an overview
The monetary policy statements of the RBI governor are window of policy
changes of the central bank in India. The broad objectives of the monetary policy in
India relate to maintenance of a reasonable degree of price stability and the need to
bring about adequate expansion of credit to foster faster growth. But the relative
emphasis on these objectives has differed in various phases of India’s development. In
the ultimate analysis, monetary policy has to be evaluated in an integrated framework in
terms of inter-relationship among money, credit, output and prices. It is seen that the
monetary policy statement has of late been more multidimensional than focusing merely
on monetary aggregates. It contains policy perspectives in respect of growth of
economy, inflationary expectations, fiscal position, trade and capital flows, exchange
rate scenario, interest rate instance and over all lending direction for banks. Till 1997-
98 monetary policy in India used to be conducted with broad money (M3) as an
intermediate target. The aim was to regulate money supply consistent with two
parameters namely (a) the expected growth in real income and (b) a projected level of
inflation. However questions were raised about the appropriateness of such a framework
vis-à-vis the changing interrelationship between money, output and prices in the wake of
the financial sector reforms and the opening up of the economy. In line with this thinking
RBI has switched over to a multiple indicator approach under which interest rates or rate
of return in different markets (money, capital and government securities markets) along
28
with data such as on currency, credit extended by banks and financial institutions, fiscal
position, trade, capital flows, inflation rate, exchange rate, refinancing and transactions
in foreign exchange available on high frequency basis are juxtaposed with output data to
draw policy perspectives. Since, April, 2005 RBI has started quarterly review in
accordance with international best practices.
Changes in operating procedure of Monetary Policy
In July 2010 RBI constituted a working group to review the operating procedure of
monetary policy under Chairmanship of Mr. Deepak Mohanty, Executive Director. Based
on the recommendations, following changes to the operating procedure of the monetary
policy has been made:
First, the weighted average overnight call money rate will be the oper-ating target of monetary policy of the Reserve Bank.
Second, there will henceforth be only one independently varying policy rate, and that will be the repo rate. This transition to a single indepen-dently varying policy rate is expected to more accurately signal the monetary policy stance.
Third, the reverse repo rate will continue to be operative, but it will be pegged at a fixed 100 basis points below the repo rate. Hence, the re-verse repo rate will no longer be an independent variable.
Fourth, a new Marginal Standing Facility (MSF) will be introduced. Banks can borrow overnight from the MSF up to one per cent (now ex-tended to two percent as per monetary policy 2012) of their respective net demand and time liabilities or NDTL. The rate of interest on amounts accessed from this facility will be 100 basis points above the repo rate.
As per the above scheme, the revised corridor will have a fixed width of 200 basis points. The repo rate will be in the middle. The reverse repo rate will be 100 basis points below it, and the MSF rate 100 basis points above it.
RBI ANNUAL POLICY 2012-131. Economic indicators- Projections for 2012-13
29
Assuming a normal monsoon and turnaround in IIP growth , GDP is projected to
grow at 7.3% ( Lowered forecast to 6.5% in July, 12 in 1st quarter review)
Inflation rate 6.5% (expected to remain range bound) – Raised to 7% in 1st quarterly review
Consistent with growth and inflation M3 projected at 15%
2. Monetary measures - Bank rate stand adjusted to 9% (at par with MSF)
CRR stays 4.75% Reduced to 4.50% w.e.f.22.09.2012. Further reduced to 4.25%
w.e.f.
Repo rate reduced by 50 bps to 8% with immediate effect
Reverse repo rate stand adjusted to 7% (100 bps below repo rate)
Marginal standing facility at 9% (100 bps above repo rate)
SLR reduced to 23% w. e. f. August 11, 2012 (vide First Quarter review of
monetary policy 2012)
3. Policy stance Adjust policy rates to levels consistent with the current growth moderation
Guard against risks of demand led inflationary pressures re-emerging
Provide a greater liquidity cushion to the financial system
4. Risk factors The outlook for global commodity prices, especially of crude oil is uncertain. This
will have implications for domestic growth, inflation and the fiscal and current
account deficits.
The fiscal deficit since 2008-09 has remained very high and there had been
significantly high slippage in 2011-12. Even though Union Budget envisages a
reduction in fiscal deficit in 2012-13, several upside risks to the budgeted fiscal
deficit remains having implication for inflation.
Fiscal deficit has led to large borrowing requirements of the government. The
budgeted net borrowing through dated securities for 2012-13 at Rs. 4.8 trillion
programme of government have the potential to crowd out credit to the private
sector.
Inflation in protein based items continues to be in double digit with little sign of
trend reversal. This has risk factor for food inflation.
6. Expected Outcome
30
Major outcomes are expected from policy action:-
Stabilize growth around its current post crisis level,
Contain risks of inflation and inflation expectations re-surging and
Enhance the liquidity cushion available to the system
7. Important announcement - Financial stability is on top of the agenda. RBI stress tests revealed that
banks’ capital adequacy remained above regulatory requirements but
deterioration in asset quality is major risks faced by banks.
Financial inclusion plans (FIP) will now focus on more in number and value of
transactions in no frill accounts and credit disbursed through information and
communication technology (ICT) based BC outlet. Banks have been directed
to disaggregate plans at controlling office and branch levels.
SLBC has been mandated to prepare roadmap covering all unbanked
villages of population less than 2000 and notionally allot these villages to
banks for providing banking services in a time bound manner.
Priority sector classification will be re examined in the light of Nair committee
recommendations and feed back received by RBI.
Based on recommendation of Rakesh Mohan committee on Financial sector
assessment, RBI in consultation with NABARD has conducted the exercise
and have identified cooperative banks not meeting licensing criteria. RBI will
be initiating action accordingly.
UCB to grant loan loans up to 15% of total assets to meet housing loan upto
Rs. 25 lakhs as per priority sector norms.
Banks have been directed not to levy foreclosure charges/penalties on
floating rate home loans.
Banks have been directed to have board approved transparent policy on
pricing of liabilities and they should also ensure that variation in interest rates
on single term deposit of Rs. 15 lakhs and above and other term deposit in
minimal.
Banks have been directed to initiate steps to allot Unique customer
identification code to all of its customers and complete the exercise by end
April 2013.
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Banks to offer a ‘basic savings bank deposit account’ with certain minimum
common facilities and without the requirement of minimum balance to all their
customers.
Banks have been directed to reduce their regulatory exposure ceiling in a
single NBFC having gold loan to the extent of 50% or more and also fix
internal sub limit on their exposure to NBFC having gold loan in excess of
50%.
Banks have been directed to complete the process of risk categorization and
compiling/updating profiles of all of their existing customers in a time bound
manner and in any case not later the end March 2013.
Banks have been mandated to put in place robust mechanism for early
detection of signs of distress and measures including prompt restructuring in
case of all viable accounts to protect economic value of assets and also to
maintained system generated data on segment wise NPA accounts, write
offs, compromise, recovery and restructured accounts.
Banks have been directed to have board approved policy on classification of
unclaimed deposits; grievances redressal mechanism for quick resolution of
complaints and period review of such accounts.
Raised provision for restructured standard loan by .75% to 2.75% (3rd
quarterly review). Mahapatra committee recommended to raise provisioning
of restricted loan to 5%.
Way Ahead The global financial turmoil has reinforced the importance of putting special
emphasis on preserving financial stability. At the same time, RBI has responsibility to
ensure price stability as persistent high inflation creates uncertainty for investors and
drive inflationary expectations. Hence, the central task for the conduct of monetary
policy has become increasing complex, very sophisticated and forward looking
warranting a continuous up gradation of monitoring scan and technical skills. The
current challenge is to strike an optimal balance between preserving financial stability,
anchoring inflation and sustaining the growth momentum. It also require complementary
measures by Government of India by initiating meaningful efforts in fiscal discipline,
controlling excessive borrowing by government, contain subsidy by raising administered
prices of diesel and urea and go ahead with pending legislation of economic reforms.
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Chapter-4
Foreign Trade Policy 2009-2014“India has not been affected to the same extent as other economies of the world,
yet our exports have suffered a decline the last 10 months due to contraction in demand in the traditional markets. The protectionist measures being adopted by some of these countries have aggravated the problem.”
Shri Anand Sharma-Commerce Minister
33
Highlight Growth target of 15% for
next two year and 25% growth rate after two years and expect to double India’s exports of goods and services by 2014.
Export target of $ 200 billion set for 2010-11.
Extension of sops for export oriented units till march 2011.
Obligation under export promotion capital goods scheme relaxed.
Permission for tax refund scheme for jewellery sector.
No fee on grant of incentives to cut transaction costs.
Plan for diamond bourses in the country.
Single-window scheme for farm exports.
Twenty-six new markets added to focus market scheme. Sops under focus market scheme hiked from 2.5 percent to 3 %.
Number of duty-free samples for exporters raised to 50 pieces from 15.
Zero duty under technology upgrade scheme.
Introduction- The Foreign Trade Policy 2009-14
was announced on 27th August 2009 at a time when
the world was emerging from the shadow of
challenging economic period, worst we have seen
last seven decades. Economics and markets
throughout the world were in turmoil, causing sharp
contraction in international trade, adversely
impacting global investment flows and world
witnessed an unprecedented contraction of over
12%.
The objectives of the Foreign Trade Policy
2009-14 are:-
1) To double India’s percentage share of global
trade by 2014;
2) To arrest the declining exports and reverse the
trend;
3) To encourage exports through mix of measures
including fiscal incentives, institutional changes,
procedural rationalization and efforts for enhance
market access across the world and
diversification of export markets and
4) To provide a special thrust to the employment
oriented sectors which have witnessed job
losses in the wake of recession, especially in the
field of textile, leather and handicrafts.
Strategy -The key strategies are:
1) Unshackling of controls;
2) Creating an atmosphere of trust and transparency;
3) Simplifying procedures and bringing down transaction costs;
4) Adopting the fundamental principle that duties and levies should not be exported;
5) Identifying and nurturing different special focus areas to facilitate development of
India as a global hub for manufacturing, trading and services and
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6) Market diversification strategy to reach out non traditional destinations in Africa ,
Latin America and Asia since our traditional market witnessed a sharp contraction.
Special focus initiativesSectors with significant export prospects coupled with potential for employment
generation in semi-urban and rural areas have been identified as thrust sectors, and
specific sectional strategies have been prepared. Further initiative in other sectors will be
announced from time to time. For the present, Special Focus Initiatives have been
prepared for agriculture, handicrafts, handlooms, gems and jewelry and leather and
footwear sectors. Twenty six markets have been added to focus market scheme in
Foreign Trade Policy of 209-14 and sops under focus market scheme hiked from 2.5%
to 3%.
Package for AgricultureThe Special Focus Initiatives for agriculture include:
(a) A new scheme called Vishesh Krishi Upaj Yojana has been introduced to boost
exports of fruits, vegetables, flowers; minor forest produce and their value added
products.
(b) Duty free import of capital goods under EPCG scheme.
(c) Capital goods imported under EPCG for agriculture permitted to be installed
anywhere in the agri export zone.
(d) ASIDE funds to be utilized for development for agri-export zones also.
(e) Import of seeds, bulbs, tubers and planting materials has been liberalized.
(f) Export of plant portions, derivatives and extracts has been liberalized with a view
to promoting export of medicinal plants and herbal products.
Single window scheme for farm exports has been proposed in FTP of 2009-14.
Gems & Jewelry(a) Duty free import of consumables for metals other than gold and platinum allowed
upto 2% of FOB value of exports.
(b) Duty free re-import entitlement for rejected jewellery allowed upto 2% of FOB
value of exports.
(c) Duty free import of commercial samples of jewellery increased to Rs.1 lac.
(d) Import of gold of 18 carat and above shall be allowed under the replenishment
scheme.
FTP 2009-14 has proposed permission for tax refund scheme for jewellery sector
and to open diamond bourses in the country.
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Handlooms & handicrafts(a) Duty free import of trimmings and embellishments for handlooms and handicrafts
sectors increased to 5% of free on board (FOB) value of exports.
(b) Import of trimmings and embellishments and samples shall be exempt from CVD.
(c) Handicraft Export Promotion Council authorized to import trimmings,
embellishments and samples for small manufacturers.
(d) A new handicraft special economic zone shall be established.
Leather & footwearDuty free entitlements of import trimmings, embellishments and footwear
components for leather industry increased to 3% of free on board (FOB) value of
exports. Duty free import of specified items for leather sector increased to 5% of free on
board (FOB) value of exports. Machinery and equipment for effluent treatment plants for
leather industry shall be exempt from customs duty. FTP 2009-14 has proposed allow
re-export of unused leather subject to 50% duty.
Export promotion schemesTarget Plus:
A new scheme is accelerate growth of exports called ‘Target Plus’ has been
introduced. Exporters who have achieved a quantum growth in exports would be entitled
to duty free credit based on incremental exports substantially higher than the general
actual export target fixed. (Since the target fixed for 2004-05 is 16%, the lower limit of
performance for qualifying for rewards is pegged at 20% for the current year).Rewards
will be granted based on tiered approach. For incremental growth of over 20%, 25% and
100%, the duty free credits would be 5%, 10% and 15% of FOB value of incremental
exports.
Vishesh Krishi Upaj Yojana
Another new scheme called Vishesh Krishi Upaj Yojana (Special Agricultural
Produce Scheme) has been introduced to boost exports of fruits, vegetables, flowers,
minor forest product and their value added products. Vishesh Krishi Upaj Yojna (VKUJ)
has been further expanded to cover village and cottage industries to promote export of
soybean, coconut oil, fruits, vegetables, flowers, and forest produce, dairy, poultry and
other value added products. Export of these products shall qualify for duty free credit
entitlement equivalent to 5% of FOB value of exports. The entitlement is freely
transferable and can be used for import of a variety of inputs and goods.
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‘Served from India’ SchemeTo accelerate growth in export of services so as to create a powerful and unique
‘served from India’ brand instantly recognized and respected the world over, the earlier
DFEC scheme for services has been revamped and recast into the ‘Served from India’
scheme. Individual service providers who earn Rs.5 lac, and other service providers who
earn foreign exchange of at least Rs.10 lacs will be eligible for a duty credit entitlement
of 10% of total foreign exchange earned by them. In case of stand-alone restaurants, the
entitlement shall be 20%, whereas in the case of hotels, it shall be 5%. Hotels and
restaurants can use their duty credit entitlement for import of food items and alcoholic
beverages.
Export Promotion of Capital Goods (EPCG)(a) Additional flexibility for fulfillment of export obligation under EPCG scheme in
order to reduce difficulties of exporters of goods and services.
(b) Technological up-gradation under EPCG scheme has been facilitated and
incentivised.
(c) Transfer of capital goods to group companies and managed hotels now
permitted under EPCG.
(d) In case of movable capital goods in the service sector, the requirement of
installation certificate from Central Excise has been done away with.
(e) Export obligation for specified projects shall be calculated based on concessional
duty permitted to them. This would improve the viability of such projects.
(f) Import duty for capital goods under EPCG has been brought down to 3% from
5%. So exporters can import machinery which otherwise they could have
imported at 12.5% duty.
FTP 2009-14 proposes to relax obligation under export promotion of capital goods
scheme.
New status holder categorizationA new rationalized scheme of categorization of status holders as Star Export
Houses has been introduced as under:
Category – Total performance over three years
One Star Export House : Rs.15 crore
Two Star Export House : Rs.100 crore
Three Star Export House : Rs.500 crore
Four Star Export House : Rs.1500 crore
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Five Star Export House : Rs.5000 crore
Start Export Houses shall be eligible for a number of privileges including fast-
track clearance procedures, exemption from furnishing of bank guarantee.
Export oriented units (EOUs) (a) EOUs shall be exempted from service tax in proportion to their exported goods
and services.
(b) EOUs shall be permitted to retain 100% of export earnings in export earners
foreign currency accounts.
(c) Income tax benefits on plant and machinery shall be extended to DTA units,
which convert to EOUs
(d) Import of capital goods shall be on self-certification basis for EOUs.
(e) For EOUs engaged in textile and garment manufacture left over materials and
fabrics up to 2% of CIF value or quantity of import shall be allowed to be
disposed of on payment of duty on transaction value only.
(f) Minimum investment criteria shall not apply to brass hardware and handmade
jewelry EOUs (this facility already exists for handicrafts, agriculture, floriculture,
aquaculture, animal husbandry, IT and services).
Free trade and warehousing zone (FTWZ)(a) A new scheme to establish Free Trade and Warehousing Zone has been
introduced to create trade-related infrastructure to facilitate the import and export
of goods and services with freedom to carry out trade transactions in free
currency. This is aimed at making India into a global trading-hub.
(b) FDI would be permitted upto 100% in the development and establishment of the
zones and their infrastructure facilities.
(c) Each Zone would have minimum outlay of Rs.100 crores and five lac sq.mt. Built
up area.
(d) Units in the FTWZs would qualify for all other benefits as applicable for SEZ
units.
Import of second-hand capital goodsImport of second-hand capital goods shall be permitted without any age
restrictions. Minimum depreciated value for plant and machinery to be re-located into
India has been reduced from Rs.50 crore to Rs.25 crore.
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Services export promotion councilAn exclusive Services Export Promotion Council shall be set up in order to map
opportunities for key services in key markets, and develop strategic market access
programs, including brand building, in co-ordination with sectoral players and recognized
nodal bodies of the services industry.
Common facilities centerGovernment shall promote the establishment of common facility centers for use
by home-based service providers, particularly in areas like engineering & architectural
design, multi-media operations, software developers etc. in State and district level
towns, to draw in a vast multitude of home-based professionals into the services export
arena.
Procedural simplification and rationalization measures(a) All exporters with minimum turnover of Rs.5 crores and good track record shall
be exempt from furnishing bank guarantee in any of the schemes, so as to
reduce their transactional costs.
(b) All goods and services exported, including those from DTA units, shall be exempt
from service tax.
(c) Validity of all licenses/entitlements issued under various schemes has been
increased to a uniform 24 months.
(d) Number of returns and forms to be filed have been reduced. This process shall
be continued in consultation with Customs and Excise.
(e) Enhanced delegation of powers to Zonal and Regional Offices of DGFT for
speedy and less cumbersome disposal of matters.
(f) Time bound introduction of Electronic Data Interface (EDI) for export
transactions. 75% of all export transactions to be on EDI within six months.
FTP 2009-14 has proposed setting up of inter-ministerial group to address issues
raised by exporters.
Pragati MaidanIn order to showcase our industrial and trade powers to its best advantage and
leverage existing facilities, Pragati Maidan will be transformed into a world-class
complex. There shall be state-of-the-art, environmentally controlled, visitor friendly
exhibition areas and marts. A huge Convention Centre to accommodate 10000
delegates with flexible hall spaces, auditorium and meeting rooms with high-tech
39
equipment, as well as multi-level car parking for 9000 vehicles will be developed within
the envelop of Pragati Maidan.
Legal AidFinancial assistance would be provided to deserving exporters, on the
recommendation of Export Promotion Councils, for meeting the costs of legal expenses
connected with trade-related matters.
Grievance redressalA new mechanism for grievance redressal has been formulated and put into
place by a Government resolution to facilitate speedy redressal of grievances of trade
and industry.
Quality policy(a) Director General of Foreign Trade (DGFT) shall be a business driven,
transparent and corporate oriented organization.
(b) Exporters can file digitally signed applications and use Electronic Fund Transfer
Mechanism for paying application fees.
(c) All DGFT offices shall be connected via a central server making application
processing faster. DGFT HQ has obtained ISO 9000 certification by
standardizing and automating procedures.
Biotechnology parks
Biotechnology parks to be set up which would be granted all facilities of 100% EOUs.
Co-acceptance introduced as equivalent to irrevocable letter of credit to provide wider
flexibility in financial instrument for export transaction.
Special stimulus package 2010
In an effort to boost the country’s merchandise exports and sustain growth, the
government in January 2010 offered stimulus worth Rs. 500 crores to select export
sectors. The high light of the stimulus package are:
(a) The stimulus is for sectors like engineering products, electronic goods, rubber,
chemicals, plastics, machine tools, electrical and power equipments, steel tubes,
auto components and cotton woven fabrics etc.
40
(b) 225 new products were included in the Focused product Scheme and special
focused products scheme.
(c) China and Japan have been added in the market linked focus programme under
which exportes are provided additional benefits.
(d) Benefits under mrket linked focus product scheme have been extended to export of
1837 new products.
(e) Some of the sectors included in MLFPS are steel tubes, earth moving equipment,
iron and steel structures, three wheelers, transmission towers, steel pipes and
compressors.
(f) Additional support would be given for export of handicrafts under Market Access
initiative scheme by Export Promotion Council for Handicrafts to set up warehouses
in Latin America.
Annual supplement of foreign trade policy 2010-11
(1) Higher support for market and product diversification
Additional benefit of 2% bonus, over and above the existing benefits of 5%/2% under
focus product scheme, allowed for about 135 existing products like handicrafts item, silk
carpet, Toys and Sports goods, leather product and leather footwear, Handloom
products etc. which have suffered due to recession in exports. Further 256 products
have been added under focus product scheme for 2% benefits.
(2) Support for technological up gradation
Zero duty EPCG scheme valid up to 31.3.11 has been extended for one more year up
to 31.3.2012 and in order to give boost to technological up gradation, the benefit has
been extended to cover paper and paper board, ceramic products, refractory, glass
and glassware, plywood and allied products, sport goods toy etc.
(3) Benefit and flexibility to status holders
1% status holder scheme has been extended by one more year up to 31st March 2012.
(4) Stability and continuity of foreign trade policy
Duty entitlement passbook (DEPB) scheme has been extended till 30.06.2011. It has
however, been indicate that scheme will not be extended further. Interest subvention of
41
2% pre-ship credit to export namely handloom, handicraft, carpet and SMEs have been
allowed till 31.3.11 as per budget proposals. The facility has now been extended for
Jute, textile, engineering and leather.
(5) Procedure simplification
Exporters have been given flexibility to get high value EPCG authorization, club
advance authorization with authorization of annual requirement, chartered engineer
certificate for advance authroisation has been waived.
(6) EDI initiative
In order to reduce the cost and time, the scope and domain of EDI has been
continuously broadened. An e-RCMC scheme has been commenced and many other
initiatives are proposed to make the EDI more cost effective and convenient.
(7) Sector specific measures
Sector specific measures for leather, handloom, textile, gems and jewellery, handicraft,
service sector and agriculture have been initiated to make the export of these sectors
competitive.
Export optimism
Our exports have faced contraction of 4.7% in 2009-10 due to global recession
and subsequent protectionist policies of developed countries but cheerful news is that
during 2011-12 export grew 21% and crossed $300 billion mark.
Looking Forward
At present, our exports to Europe, US and Japan amount to 36%, 18% and 16%
respectively of India’s total export of $168 billion in 2008-09. Export in 2011-12 grew
21% reaching $303.7 billion thus surpassing target of $300 billion. Asia, Latin America
and Africa are main contributor to this growth and signing of CECA and FTA with Asian
countries is set to raise Asia’s share in our exports to 55% by 2014.
Time has come to have a re-look to export basket in view of dramatic change in
world trading pattern. Slow recovery of US and recession in Euro zone has added further
dimension to this change. This shift has also taken place from export of traditional
items like textiles, clothing, food and chemical to high end products like I.T., automobiles
and intermediates. Other important pattern in export growth is that China has emerged
as third major destination of exports. Hence focus should shift to China specific strategy.
It is also known that FDI has played a dominant role in export growth of China. FDI
42
funded units have several advantages over domestic industries in promoting exports
particularly they act as catalyst of R & D and technology transfer.
Chapter-5
Changing complexion of Bank Credit Emerging opportunities, issues and challenges
“At the rate at which the economy is growing, a 10% growth looks inevitable for next 25 years. If the economy grows at this rate, the banking system’s assets have to grow 25-30%. If this happens, the banking system in the
43
next five years will be three times bigger than what it is today. Some banks may be four to five time bigger than what they are today.”
Shri O.P.Bhatt- Former Chairman, SBICREDIT GROWTH (% YOY)
2008-09 26th Feb. 2010Non food credit growth 19.6 15.9
1. Agriculture 21.2 24.42. Industry 28.1 20.13. Retail Loans 6.6 4.73.1 Housing 6.4 8.33.2 Advance against fixed deposit 6.8 1.63.3 Credit card outstanding 7.9 -28.33.4 Education 33.8 31.23.5 Consumer durables -22.6 -1.34 Services 18.7 15.04.1 Transport Operator 17.0 19.54.2 Professional Services 22.4 36.94.3 Trade 14.4 19.45 Real Estate Loans 58.8 0.96 Loans to NBFC 37.0 25.8
Introduction
The banking reforms and policy changes taking place in India during the last one
decade are gradually changing banking landscape and credit market. First visible
change is that banks are now more customers focused, who is not only more demanding
(better pricing of loan) but also for more convenience (hassle free documentation and
less paper work), more comforts (prompt sanction and flexibility in use of loan) and more
innovations (tailor made products). Second change is that deregulation has made the
banks free to formulate their own schemes and products as per their market segment
and this has forced them to redesign business process and lending policies and
procedures to meet changing expectations of the customers and the market. Thirdly,
introduction of risk management practices and target implementation of Basel III
recommendations have brought in more professional approach in credit delivery process
which is now more risk focused and has made pricing of loan-products dependent on
risk perception of the borrower and likely hood of default. Fourth visible change is that
banks are moving from so called lazy banking to busy banking by aggressively
expanding credit to retail, agriculture and MSME segments. Fifth visible change is that
banks are gradually becoming super market where they will not only lend but also offer
44
whole gamut of financial products including third party products so that customer gets
opportunity to select best product at competitive price. Sixth, autonomy given to public
sector banks by government in the area of HR and other operational matters has come
as a boom. The four year breather given by RBI for opening up banking sector for
foreign banks must be utilized by them to thoroughly restructure their credit policies to
put them on par with new private and foreign banks. Seventh, retail banking would
benefit immensely from the Indian demographic dividend and mortgages are likely to
cross Rs. 400,000 crores by March 2020, Eight, the bottom of the pyramid or ‘next
billion’ segment would emerge as largest numbers and will accentuate the demand of
low cost banking solutions, and Finally, banking sector is growing much faster than
GDP as loan-GDP ratio grew from 31% in 2004 to 54% in 2009 but concern is on assets
quality.
All these changes are on the one hand creating new business opportunities and on
the other hand also creating new challenges.
Credit Scenario- emerging opportunities Shift to farm sector- The liberalization in industrial goods and services has
bypassed agriculture, where growth rates have been far lower. As a result, share of
agriculture in national income has dropped from around 40% in early 80s to 20%
today. And due to this, economic gains of the country remained unequally distributed
among society as 2/3rd of our population continues to be dependent on sharply
declining national income. Liberalization of industry and service sector has made
them globally competitive. In agriculture, however, government has been chief
demand stimulus by offering assured off take of products at prices higher than
market driven. Having realized that credit is one of the constraining factor of growth
of agriculture and in many cases farmers have reported to have committed suicide
due to huge indebtedness to local money lenders, GOI directed public sector banks
in June 2004 to initiate steps to double the agriculture credit within three years with
the result agriculture lending by scheduled commercial banks (SCB) has tripled
during the last three years and touched Rs. 190,000 crores from Rs. 88,000 crore.
During 2009-10, banks agriculture credit growth has been substantially higher at
24.4% as on 26 Feb 10 against 21.2% as year ago. To achieve this target, banks
are adopting new business models like using infrastructure of post offices, NGOs,
rural kiosks and e-chaupal. Further many banks have started using low cost
45
technology like biometric ATM to reach out rural population. RBI has also initiated
other measures to encourage agriculture financing like easing of NPA norms for
agriculture (crop loan), relaxation in service area approach, granting 2% subvention
on 9% regulated interest rate of farmers’ credit card up to Rs. 3 lakhs, extending of
debt waiver and debt relief scheme up to 30th June 2010. The agricultural loan, which has been bane of banks, has overnight turned into a boon.
MSMEs: a new focus – MSMEs have been playing a critical role in developed and
developing economies. There are more than 13.4 million MSMEs in India at the end
of March 2009 contributing around 45% of manufactured output, 40% of exports
and provides employment to 60 million persons ( B S 30.3.10) . MSMEs also act as
the seedbed for the development of entrepreneurial skills and innovation. Thus role
of MSME in economic development of the country is well established. In order to
encourage banks to aggressively finance the MSME sector, Performance and credit
rating scheme of SME has been launched on 7th April, 2005 and six credit rating
agencies – Crisil, Icra, Dun & Bradstreet, Onicra, Care and Fitch – have agreed to do
their credit rating. A separate rating agency-SMERA- a joint venture of Sidbi and Dun
and Bradstreet has also been set up. SMERA has signed MOU with almost all the
banks. It has also been decided that 75% of the fee paid by SSI for rating will be
reimbursed by the government subject to maximum Rs. 25,000/-. RBI has also
decided to set up a debt structuring mechanism for SMEs on the line of CDR. RBI
further permitted the bank to do second time restructuring as a exceptional
regulatory measure to overcome the problem of global slowdown. Dr. K C.
Chakrabarty Deputy Governor of the Reserve Bank of India ( Business Line
12.10.2009) said ,” to day, there is no bank in this country which will refuse money.
Every bank is sitting on tones of money. Being from the Reserve bank, I can tell you
there is no dearth of credit. The problem is MSMEs don’t require credit, they require
money.” As per RBI data, MSME credit rose by 26.9% during 2008-09 reaching
outstanding of Rs. 2.59 lakh crores .Big corporate have multiple options for financing
and are very demanding in price and bank are therefore finding better opportunity in
MSME by way higher returns.
Retail lending - The retail loan growth was subdued to 4.7% in end of Feb 2010
from 6.6% in 2008-09. The decline is contributed by decline in advance against fixed
deposit, negative growth in credit card and consumer durables loans. Housing
46
loan market has grown 8.3% followed by car loan financé. With changed interest
rate scenario due to introduction of base rate and RBI continuous reservation on
teaser rates, retail loans growth during 2010-11 is expected to be sluggish. But
banks do not want to give up on retail lending considering that the business is
lucrative as risk is diversified; spread is better and cost of operation is less. It is
expected that banks will restructure innovative retail products to retain the growing
class of clients with high disposable incomes and to harness demographic dividend.
Bank credit through Micro finance institutions (MFI)- The term micro-finance is
defined ‘as provision of thrift, credit and other financial services and products of very
small amounts to the poor in rural, semi-urban and urban areas for enabling them to
raise their income levels and improve living standards.’ MFI also provide other non
credit services also such as capacity building, training, marketing the produce of
SHGs, micro-insurance etc. It is now huge industry in India with more than Rs. 1000
crores lending by commercial banks to MFIs. Many bankers are amazed at the
success of the micro-finance as much as even private sector is reporting substantial
disbursement under micro-finance. And, the success is not only about delivery of
credit but also almost 100% recovery, which is unheard in priority sector lending.
Since formal credit institutions like banks cannot directly reach to the poorer
sections, there was a need to search for alternative methods of financing to the rural
poor. Budget of 2005-06 has empowered micro-finance institutions (MFIs) as
intermediary between banks and beneficiaries and has proposed to enhance the
target of credit linkage to 2.5 lakh SHG during 2005-06. However recent events of
putting caps of interest rate, fixing periodicity of repayment not earlier than monthly
interval and restructuring obligations through A P Act, has raised concern over MFI
future prompting the Central government to speed up microfinance act.
Micro-mortgage- Micro-mortgage is evolving area. NHB study has found that there
are over 40 housing developers across India offering housing units/apartments at
cost between Rs. 3 lakhs to Rs. 10 lakhs which are affordable to house holds
earning as little as Rs. 7500 per month. But customer of this segment is not able to
buy house due to financial constraints giving opportunities to micro-mortgage
companies. It is understood that besides Dewan Housing and Finance co. and Gruh,
many other companies like MAS Financial Services, Micro Housing Finance
Corporation etc. are targeting micro-mortgage market. Given that micro-mortgage is
47
collaterised, affordable and commercially sustainable, market is poised for
significant growth.
Exports and imports business- Export growth during 2004-05 has been 24.41%
and exports have reached US $ 79.59 billion by March end 05. Exports are
targeted to reach US $ 195 billion by March end, 09. Imports have shown a growth of
35.62% and have reached US $ 106 billion. GOI has taken slew of measures to
improve exports by establishment of special economic zone (SEZ), agri-export zone,
export hardware technology park (EHTP) etc. Opening of economy has opened
huge avenues to banks for export and import business.
Financing infrastructure – As per RBI data, bank’s lending to infrastructure sector
rose by 52% to Rs. 56,709 crores as on March end 2005 from Rs. 37,224 crore a
year earlier. Roads, transport, communication, ports, energy, hospital, telecom,
healthcare, educational institution and storage facilities for farm sector including cold
storage form infrastructure. Tourism infrastructure financing is the next big thing.
Infrastructure is core strength of our economy. In the past government did
infrastructure financing but limited budget resources have opened option for private
sector and hence financing avenues have now opened for banks. Infrastructure is
capital intensive and high cost oriented. Funds requirement of this sector is huge.
Working capital requirement is relatively less. Repayment period is long including
gestation period, which creates problem in asset & liability mismatch. To overcome
ALM problem, RBI has permitted banks to raise long-term funds through bonds for
infrastructure financing. Securitization and take out financing has emerged as other
suitable option to banks for infrastructure financing. According to Centre for
Monitoring Indian Economy report, infrastructure spending is likely to grow more than
double to Rs. 8.34 lakh cores in 2006-07 from Rs. 3.95 lakh crores in 2003-04.
Banks are banking on the growth prospects of this emerging sector.
Corporate credit – Till now this segment was meeting its demand through external
commercial borrowings, foreign currency convertible bonds, local bonds placements
with financial institutions, mutual funds, insurance companies, commercial papers
etc. As per RBI data (BS dated 14.01.2010) , resource flow from domestic sources
(other than bank borrowing) to corporate up t0 October 09 was higher at Rs.230,000
crores from other sources and from banks was lower by Rs.107,801 crores. Since
advances to highly-rated corporate require less risk weight under Basel II norms,
they are quite attractive to banks for financing. Competition among banks is very
48
fierce but bulk financing and other benefits are very strong incentives for the banks to
look toward this sector aggressively even on sub-PLR pricing. It is estimated that
biggest intake could come from power, infrastructure, metal, telecom, auto and auto
ancillaries, coal and coal related industries, textile, port and shipping.
Capital Market product-Guarantee to stock and commodity dealers is becoming big
business. These guarantees are issued in favor of stock exchanges on behalf of
brokers to meet shortfall in margins, which broker has to deposit with exchanges for
trading in equities or commodities. As per industry practices besides guarantee
commission at 0.75% to 2.50% plus processing charges, banks get cash cover up to
50% of the guarantee. While direct lending in the capital market is considered as
high-risk activity, guarantees are comparatively considered safe by banks as
exchanges rarely invokes the bank guarantee.
Service sector- Service sector has emerged as most important segment of the
economy. It is contributing about 60% of GDP at current prices. Actually service
sector is key to India’s growth process. It is the sector that has huge opportunities to
lend. There are certain reasons, which have blocked seamless flow of credit to this
sector. One is lack of primary security like stock by which banks are traditionally
drawing comforts. There are also psychological blocks because projects like TV
serials, software etc. is such that their viability is difficult to judge. The rate of
obsolescence is high and salvage from sale of product is almost zero. Another
problem is of customization of financial products as each segment of service sector
is having its own uniqueness and old structural way of assessing working capital
finance and pricing of loan is not workable. In selected financing of amusement
parks, educational institutions, travel agency, hotels, IT sector etc. banks’ past
experience is not good. The perceived risk in financing service sector is high but
return (interest) is capped due to PLR plus pricing. Venture capital is one route.
Hybrid products like interest plus royalty is another way of pricing risky ventures. The
challenge before banks is to either innovate or lose market. This requires proper
lending policies that not only factor in methodology to assess credit and pricing the
products but also to launch customized products after assessing risks factors for
various segments of service sector.
Commodity finance business- A credit revolution is sweeping the countryside, as
commodity financing becomes the new buzzword among banks. As per data
49
available, the banks during 2004-05 have lent more than Rs. 10,000 crores to
farmers, traders and exporters against farm produces stored in warehouses. India’s
commodity trading is worth Rs. 400,000 crores annually and still a long way to get
the saturation. Collateral managers now assist banks in undertaking due diligence
(credit risk), guaranteeing quality and safety of the commodity (operational and
performance risk), proper documentation (legal risk) and insurance (default risk).
Banks are in process of establishing tie-up with commodity exchanges to lend to
farmers and traders. National Collateral Management Services Ltd. (NCMSL) has
been by National Commodities And Derivate Exchange Ltd. (NCDEL) , IFFICO and
Audit Control Expertise, Genava, with objective of creating a safe and liquid
warehouse receipt market in India. Looking to the size of the commodity market,
there is huge business opportunity waiting for the banks. The commodity financing
will be part of priority sector and agricultural lending.
Trade in commodity future- The contour of the commodities market are set to be
redrawn with GOI and RBI finalizing proposal to allow banks to trade in commodity
future and to make warehouse receipt eligible security. GOI has proposed to amend
Banking Regulation Act 1949 to enable bank to get into commodity futures and also
the Negotiable Instruments Act 1881 to make warehouse receipt a negotiable
instrument. It may be mentioned that Banking Regulation Act permits banks to trade
only in bullion. Warehouse Regulation Act is also in process that would create a
regulatory authority for accreditation of warehouse and setting standard to be made
applicable for scientific grading, packing, storage, preservation and certification of
commodities. It is also proposed to introduce demat warehouse receipts. Banks
have also taken up stake in commodity exchange and are ready to set up trading
desks.
Channel financing or Supply Chain Financing- SCF is emerging as one of the
fastest growing segments in the banking sector. SCF is an innovative finance
mechanism by which bank meet the various funds requirements of
suppliers/distributors, thus helping them seamless cash flow along the arteries of the
enterprise. Under channel financing, the suppliers/distributors can leverage on the
relationship with reputed companies in sourcing low cost credit with support from his
counterparts. It is a more advanced and sophisticated version of the age old working
capital financing. It covers the entire gamut of financing of both the suppliers and
vendors side. Under the SCF model, banks are looking at value chain around
50
manufacturing companies to finance the suppliers and distributors of their value
chain. This type of financing helps all the parties of the value chain as production and
material movement becomes smoother backed by ready and cheap financing.
Under SCF, the bank opens a line of credit for supplier in consultation/
recommendation of the manufacturing company. The line of credit is very specific to
the products, which vendor supplies to the manufacturing company. After supply, the
manufacturer routes the payment through an escrow account which gives comfort to
the banker. On distribution side, banks finance the distributors on the
recommendation of the manufacturer. Often there is arrangement of escrow account
kind of mechanism where the sale of the distributors is routed through the bank.
Under SCF following credit facilities are available-
1. Discounting of trade bills accepted by the dealer/distributor.
2. Limited overdraft facility to dealer/distributor for his business dealing with
large corporates.
Risk free income- Basel II implications are forcing banks to move to risk free
income like insurance and mutual funds. In the credit areas, banks are innovating by
leveraging on their credit dispensation strength to augment risk free income through
variety of ways like-
o Originator of loan- Banks will mobilize loan but will not carry in their books.
Earn income as originator. LIC has huge corpus of funds but cannot directly
lend. Here, the originator has an opportunity to lend.
o Monitoring fee- Transfer loan to SPV or other banks through securitization
process but continue to earn fee-based income for monitoring of loan. Even in
case of sale of distressed assets to ARC, bank has an opportunity to earn
monitoring fee, as they know the assets better than the buyer.
o Take out finance- In case of infrastructure projects; the loan is taken up by
other institution after a specified period to over-come the problem of assets
liability mismatch.
o Financial advisor- Banks are now offering discretionary portfolio management
services- investment in art, philanthropy, real estate, and funds within country
and in offshore funds - for its affluent customers, all under one roof.
o Information Service- Under SCF mechanism bank generate all data of
shipment from suppliers to the manufacturer and from manufacturer to
51
distributors and offers information service like data of product, brand, dealer
wise dispatch and payment to and from customers.
Issues & Challenges-
Credit Risk Management- Credit Risk is also known as default risk. The credit risk
depends on both external and internal factors. The external factors are the state of
the economy, wide swings in commodity/equity prices, foreign exchange rates and
interest rates, trade restrictions, economic sanctions, government policies etc. The
internal factors are deficiencies in loan policies/administration, absence of prudential
credit concentration limits, inadequately defined lending limits for loan officers/Credit
Committees, deficiencies in appraisal of borrowers’ financial position, excessive
dependence on collateral and inadequate risk pricing, absence of loan review
mechanism and post sanction surveillance etc. The effective credit risk
management necessitates that banks’ have to be prudent to keep on reading not
only Indian economy but also the entire globe that have bearing on the money
market, capital market, stock market, commodity market and forex market and
integrate its lending operations proactively in terms of market realities. They should
also put in place proper mechanism to address various risks arising out of deficiency
in lending policy, incorrect product structuring, inadequate loan screening, loop holes
in documentation, ineffective post sanction monitoring/follow-up and weakness in
collection/ recovery mechanism. In fact in segment like retail lending, channel
financing etc. banks are going through learning curve and there is strong need to put
in place effective policies of sanction and monitoring of loan and keep them updated.
CRISIL has recently stated (BS 04.05.06) that Indian companies have begun to
show a downward movement of creditworthiness. It may be recalled that modified
credit ration (MCR) being prepared by CRISIL has shown a decline for the first time
in three years. This may be a warning signal for the banks to keep track on asset
quality.
Pricing- Competition among banks to tap the low risk borrowers is driving down the
price. Loans to corporate and public sector undertakings are at sub-PLR. In certain
segments, such as home loan and car, the competition is so steep that banks are
offering loan at interest rates, which are almost 200-450 basis points below the PLR.
52
Even processing charges or documentation charges are waived. Till Basel II
becomes actually effective, there is incentive for banks to arbitrage interest income
by roping in high-risk borrowers. Even mid-segment borrowers have started
demanding sub-PLR loans. The competition among banks in this segment is hotting
up forcing the bank to put in place Sub-PLR interest rate policy so that bank may
not lose prime customers in mid-segment. All this has made loan pricing a very
complex process. As a rule pricing should be done scientifically on risk grading of the
borrower on plus (or minus) PLR basis but market compulsions are such that banks
are forced to lend at rates dictated by market leader, otherwise there are chances of
losing business.
Marketing - Walk in business is the thing of past. The customers are now demanding
on price (interest rates), on product (quality), place (home delivery, internet banking),
packaging (brand affinity), people (customer service), partnering (business alliances,
direct selling agents), and promotion (discount, freebies etc.) Due to this, old
business model of ‘capturing customer through aggressive selling’ has given way to
new business model of ‘captivating the customer through innovation’. In the area of
credit, banks are under pressure to devise new products, develop delivery channel
including e-channel, building brands, partnering alliance and appointing direct selling
agents, giving promotional offers, and reorienting man-power to make them customer
friendly. For public sector banks, it is a challenging task but there is not other option.
Capacity building- Developing skill level of credit officer, marketing and IT people
and designing training programme to develop these skill is a major HR challenge.
Introduction of Basel II, which requires risk rating of borrower through highly technical
tools, has made this task even more challenging. It is believed that banks will have to
invest lot of resources and money in building this capacity in new environment where
they will be required to be Basel II compliant not only from regulators perspective but
also from perspective of international investors.
NPA management- The growth in Non-performing assets of Indian Banks has largely
followed a cyclical pattern in relation to the growth in credit off take. A study of RBI
has indicated that NPA growth follows credit growth with a lag of two years. This is a
kind of warning to banks to watch out NPAs following good year of credit growth.
53
Approach to lending- There was the time when assessment of working capital
meant to be on 2nd method of lending suggested by the Tandon committee and
assessment of term loan used to be based on intricate calculation of IRR, DSCR,
discounted cash flow, NPV etc. Even for term loan to a farmer for bullock or a crop
loan to a farmer, the detailed cash flow statement coupled with cash surplus was
calculated to decide eligibility. The approach to lending has now changed with bank’s
having freedom to decide assessment methodologies on their own. For example,
banks are now having mix of 2nd method of lending, turnover method and cash flow
method depending upon cut off points and nature of activity for financing traders,
manufacturers and service sector. In case of crop loan or Kisan Credit Card (KCC)
the scale of finance approach is adopted which permits sanction of loan based on
land holding and cropping pattern multiplied by scale of finance fixed for that
particular crop. Even scale of finance approach is now being made discretionary to
allow finance as per quality of land, method of cultivation or status of labour (hired or
family). All retail products like housing loan, car loan, education loan, personal loan
etc. are customized and assessment of quantum of loan is simple as much as fixed
percentage of take home pay or income from business or profession. While the
simplification of the process has made the task of assessment of need based finance
easy, it has made product development a cumbersome process where not only
product features but also its feasibility has to be critically examined before it is
launched.
Credit rating of borrowers-CRISIL has recently launched bank loan rating. In
addition to commenting on the timely payment of principal and interest, the rating will
give an opinion on the extent of recoverability of the loan post default, by capturing
the impact of covenants, security and other repayment protection provided specifically
to lenders. These ratings can be on behest of borrower or lender. The rating will
strengthen the banks’ confidence in borrower. The rating would also support Indian
banks in implementation of Basel II by offering an opinion in loan specific risk and can
be used by the bank in pricing, capital allocation and portfolio management.
Business process re-engineering- The drive for greater customer convenience is
forcing banks to re-engineer their lending process such as setting up of Retail Assets
54
Central Processing Centre (RACPC), Small and Medium Credit Cell (SMECC),
entrusting job of due diligence to Credit Verification Agencies etc.
Assets securitization- With proposed amendment in Security Contract Regulations
Act, bank will be able to issue assets based securities (ABS) -both performing and
non-performing- which will be at par with any other securities like security or debt and
will be tradable in stock exchange. It will help the banks to overcome problem of
assets liability mismatch, enhance their liquidity and lower the cost of loan, as funding
cost will go down.
Product development- In a buyers market, the customer satisfaction is a key to
success of new products. Since customers’ needs are repetitive, multiplicative and
dynamic in nature, the product development aims at exploring and satisfying these
needs in a continuous manner. Weaning out existing non-profitable product is part of
this process. To meet this challenge, each and every bank is continuously launching
new products in the area of retail loan, corporate loan, agricultural loan, SME loan,
merchant credit etc. Some of the very popular products are home loan, car loan, loan
against rental, loan against mortgage of immovable properties, farmer’s credit-card,
artisan’s credit card, trade finance products for business-men, project loan for
corporate etc. With all pervasive use of technology certain e-product like e-home loan,
e-education loan and e-car loan are also emerging in the market.
Low cost delivery model- It is expected that ‘bottom of pyramid’ or ‘next billion’
segment would emerge as largest numbers of borrowers and will through a challenge
of low cost delivery model.
Business alliances- Joint venture/alliances with project developers, manufacturers,
marketers, outsourcing partners, builders, promoters, educational institutions,
hospital, insurance companies, mutual funds etc, who together embody the extended
enterprise has become the order of the day. The objective is to develop a mutually
supportive, value-creating mode; bringing together complimentary forces of alliance
partners to create more value together than one can deliver separately. Banks are
entering into business alliances with tractor, car and four wheeler manufacturers as
their preferred financiers. Banks are also outsourcing non-critical job pertaining to
marketing of financial products and recovery and follow up of loans through direct
55
selling agents and recovery agents. This is not only adding to operational efficiency
but also enabling the bank to focus on its core activity more efficiently and effectively.
Lenders liability and fair practices code- Transparency is buzz word in lending.
RBI is insisting on banks to put in place anti-tying measures not only to ensure that
lender does not resort to unfair trade practices but also to ensure that proper
grievance redressal mechanism is in place. It is, therefore, essential that interest rate,
method of compounding, penal interest, prepayment penalty, rebate for prompt
payment, right of borrowers like copy of loan documents, statement of account, right
of privacy i.e. not sharing his personal profile to business associate/other agencies
are in place to address reputation and legal risk arising out of banking business.
Due diligence of the loans-With fraud and forgeries on rise, due diligence assumes
greater importance in context of credit management. To safeguard from frauds and
forgeries, credit officials are required to meticulously follow lending policy, lenders’
liabilities and best practices code, basic principles of lending, KYC norms etc., for
customers acceptance and identification. They should also strictly monitor the end
use of loans and other internal control measures so as to ensure that post credit
sanction due diligence process is effective enough to check malpractices, if any.
Looking ahead-
During the last one decade or so, India has made rapid strides in economic
growth, foreign trade, services and more arguably, in industry. When economy is
growing at 8% or so, banking industry is expected to grow at 24% as normal multiplier of
GDP to credit is about three times. However impending inflation, increase in money
supply and increase in interest rates, credit growth slipped to 16.6% in 2009-10 from all
time high growth of 30% in 2004-05. So improving credit growth is biggest challenge
that banks are facing at present.
Chapter -6
56
Cash Flow AnalysisReading Borrower’s Health
Introduction A successful banker was once asked about secret of his decision-making. He
replied that before taking any lending decision he wanted the prospective borrower to
satisfy him on two basic points: firstly how he is going to pay back the money and
secondly what should he (banker) do to know that his plans on which repayment
depends are really materialising. Obviously there should be a system for the banker to
know about the health of his borrower’s business. Cash flow is one of the tools to have
this information and more precisely borrower’s ability to meet his obligations as and
when they mature. Unfortunately, the system has not been given due importance in
credit appraisal in Indian context.
Liquidity and SolvencyLiquidity refers to borrower’s ability to meet his current obligations i.e. how fast
the current assets are converted into cash to pay for current liability. Solvency on the
other refers to borrower’s ability to service the debt i.e. ability to meet interest cost and
repayment of term loan. A borrower may have enough assets but may not have enough
cash to meet his obligation (for the reasons which we shall analyse afterwards). Thus,
there is a need to look into liquidity in depth.
Liquidity and ProfitabilityGenerally speaking the health of a borrower is gauged by his ability to earn. But
sometime a borrower though showing profits may not be in a position to meet his
obligations because profits always does not mean liquidity. Profitable companies can be
cash broke and unprofitable companies may have rich cash loads. A borrower in
distress may resort to window dressing to hide his real state of affairs by resorting to
certain accounting conventions. The changes in valuation of inventory (last in first out
(LIFO) to first in first out (FIFO) or vice-versa), under provision of liability, revaluation of
assets etc. are usually adopted practices to inflate/manipulate profits. Hence there is a
need to know what cash is exactly generated by the borrower from operations to see his
ability to service the debt and to meet current obligations.
57
Cash Generation – What does it represent ?Refer cash generation most probable reply would be “profits add back
depreciation”. Let us analyse the statement with the help of a simple example:
Sales 100
Cost of sales* (80) *excluding depreciation
Depreciation (10)
Profit 10
So, profit plus depreciation means that cash generation is 20. Does it represent the
cash generated? In fact, it is not so because :-
(a) Sales include sales on credit, which very often are not realised in all.
(b) Cost includes expenses, which very often not paid in all.
(c) Profit includes tax and other items though provided but not paid.
Hence, there is a need to look beyond what we normally conceive as cash generated.
Cash Flow Statement –a source of vital information
Cash flow statement provides information regarding sources (where got) and
uses (where gone) of cash. In other words, it provides information of movement of cash
between two balance sheets dates. A reference to “Cash Flow – Flow Chart” will
provide information to the readers that how Profit & Loss and Balance Sheet can be
used to recast cash flow statement. The ability to understand Profit & Loss statement as
it relates to Balance Sheet which relates to cash flow can provide under noted valuable
information to the banker: -
(a) Whether operating cycle is generating enough cash to meet out cost of
operation (ability to meet current obligations)?
(b) Surplus available after operating cycle is enough to meet out interest and
dividend obligation. In other words whether company borrows money to meet
this obligation?
(c) What surplus is left to meet out term liability due (solvency)?
(d) Is there any surplus left for meeting cost of expansion? (Investment in fixed
assets for expansion, inventory built up etc.)?
(e) At what time, cash flow turns negative and how it is financed (short term loan
or long term loan)?
(f) Overall cash management shows management efficiency i.e. how cash is
managed? (excess, adequate, inadequate).
58
With study of 3-4 years of cash flow statement, a banker can find out cash
management position and can see whether cash position is improving or deteriorating.
Pertinent here is that cash flow cannot be manipulated by accounting conventions and
there is no way to hide significant flows from a banker. It should be taken for granted
that a company not generating cash will eventually fail because external sources (bank
loan, equity of long term loan) are like fair weather friends whose help is available only
when borrower is in a position to service them. No investor would like to risk his money
if he finds that the borrower will not be able to repay it. It should, however, be noted that
cash consuming operating cycle does not always mean ‘sickness’. It is true for growing
organisations also because, both need outside finance for their survival. The difference
is that, while former needs to make up money eaten up during operation later requires
it to meet growing wants i.e. increased inventory, receivables etc. Here, the banker’s
perception is crucial to differentiate between growing and weak organisations and to
decide whether he would like to put more money.
Cash Flow Statement – FormatCash flow statement can be prepared either directly from books of account or
indirectly from financial statements. In practice, cash flow is rarely drawn from cash-
book directly. It is usually derived from Profit & Loss statement and Balance Sheet.
There are number of ways to categorise sources and uses in cash flow statement. One
of the most useful and effective way is to categorise sources and uses of cash flow in
four major heads: (Refer Table – 3).
1. Operating Cash flow
a) Operating cycle
b) Quasi operating cycle
2. Financing Cash Flow
3. Investment flow
4. Financing (ST/LT) flow
Statement – How to prepare Indirect MethodPreparation of cash flow statement from Profit & Loss A/c and Balance Sheet is
done through derivation technique i.e. information for sources and uses of cash is
derived from these sources. Though the procedure is simple, it requires certain basic
knowledge. For better understanding to prepare the cash flow from P&L A/c and Balance
Sheet and to interpret the information effectively, it would be better to approach the
subject with the help of a case study.
59
Balance Sheet & P&L A/c of ABC Company Ltd. are reproduced below for
preparation of cash flow:-
TABLE 1 : ABC Co. Ltd. – Condensed Balance Sheet as on 31st March
LIABILITIES 1996 1997 ASSETS 1996 1997
Net Worth 11945 19994 Fixed Assets 8290 14680
Term Liabilities 2658 7655 Non Current Assets Nil Nil
Current liabilities Bank borrowing
Payable
Other current liability
16943
21106
21497
20957
20853
10974
Current Assets Cash
Inventory
Other current assets
Debtors
2470
35435
5318
22636
2442
28227
4988
30096
74149 80433 74149 80433
TABLE 2 INCOME STATEMENT for the year ended 31st March 1997
Sales 71700
Other Income 3000
Cost of sales - 51000
Depreciation - 4800
Selling expenses - 10300
Interest - 5900
Tax - 500
Dividend - 1800
Retailed earnings 400
Step – I: Prepare worksheet for change in balance sheet between the two dates. The
change in balance sheet items of ABC Co. Ltd. has been rearranged in work sheet I-
( Work sheet – I )ABC Co. Ltd. Statement of changes in balance sheet between 1996 to 1997
Fixed Assets (6390)
Inventory 7208
Debtors (7460)
Other current assets 330
Net Worth (1) 8049
Term Liability 4997
Bank Borrowing 4014
60
Payable (253)
Other current liabilities (10523)
Cash 28
(Figures in bracket indicate use; other source)Step – II Prepare worksheet II after rearranging figures from Profit and Loss Account
and merging it with Work Sheet – 1. :-
Work sheet – II (In Rs.)Sales 71700
Other Income 3000
Cost of sales (51000)
Depreciation (b) (4800)
Selling expenses (10300)
Interest (5900)
Tax (500)
Dividend (1800)
Fixed Assets (b) (6390)
Inventory 7208
Debtors (7460)
Other current assets 330
Equity (a) 7649
Term liability (c) 4997
Bank borrowing 4014
Payable (253)
Other current liability (c) (10523)
Cash (d) 28
Step – III Following adjustments have been made while preparing Work sheet No. II :-
(a) Change in net worth is effect of two things; retained profits and increase in
equity. In other words, increase in net worth more than profits retained
represents increase in its equity. In case of ABC Co. Ltd., increase in equity
is Rs.7649 (8049 – 400).
(b) Depreciation is not actually an outflow in itself; but is related with investment
in fixed assets. For calculating total outflow, depreciation is added back. In
61
case of ABC Co. Ltd., total outflow of cash in fixed assets was Rs.11190
(4800 + 6390).
(c) Current portion of term liability included in current liability needs
readjustment to know how much cash flow is associated with loan term and
how much with short term. In case of ABC Co. Ltd., figures balance sheet
have been shown after making readjustment.
(d) Increase in cash is use and decrease in cash is source.
Step – IV Incorporate the data in the format. Cash flow is now ready. (Refer Table 3).
TABLE 3 : CASH FLOW STATEMENT 1996-97 : ABC Co. Ltd.
OPERATING
CYCLE
SALES
DEBTORS
COST OF SALES
INVENTORIES
CREDITORS
71700
- 7460
- 51000
7208
- 253
64240
- 44045
QUASI
OPERATING
CYCLE
CASH FROM OPERATIONSELLING EXP.
OTHER INCOME
TAX
OCA
OCL
- 10300
3000
- 500
330
- 10523
20195
- 17993
FINANCING COST CASH FROM OPERATING CYCLEINTEREST
DIVIDEND
- 5900
- 1800
2202
- 7700
LONG TERM
FLOW
SOURCES + USES
CASH AFTER FINANCING COSTFIXED ASSETS
NON-CURRENT ASSETS
- 11190
0
- 5498
- 11190
FINANCING FLOW
SOURCES + USES
CASH AFTER LONG TERM FLOWLT LOAN
ST LOAN
EQUITY
4997
4014
7649
- 16688
16660
62
INCREASE ( + ) DECREASE ( - ) IN
CASH
- 28
Now, we can interpret the data available from cash flow statement. It is self-
revealing and need little efforts for interpretation.
Operating cycle has generated enough cash and after meeting operating
expenses, ABC Co. Ltd. is left with surplus of Rs.2202. This surplus is, however, not
enough to pay for interest and dividend, the same was paid by raising short-term bank
borrowing. The investment cost (purchase of fixed assets) has been met by raising
equity and long term loans. LT source (Equity and LT) was also used for financing
dividend. This is not a healthy proposition. The chargeable current assets (current
assets – OCA) of ABC Corporation has gone down by Rs.582 whereas the bank
borrowing has gone up by Rs.4014 indicating irregularity in the account. If data for 3-4
years is available and it looks like that ABC Co. Ltd. has such a state of affairs on
continuous basis, it is certain that the company is facing the liquidity crunch. To
conclude, all is not well with their cash management.
TWO MORE INDICATORS1. Cash generated to total debt ratio: - In place of PBT/Total outside liability ratio,
cash generated from operation to total outside liability ratio is more reliable to judge
debt servicing capacity of a borrower. ABC Co. Ltd., has cash generation to debt
ratio of 3.64%, whereas PBT/Debt ratio is 8.66%. Obviously debt servicing capacity
of ABC Co. Ltd., is only 3.64% which is not enough even to take care of financing
cost.
2. Common size cash flow:- To have comparative analysis percent-wise cash flow
is very often prepared to make the analysis easy.
TABLE 4 : COMMON SIZE CASH FLOW : ABC CO. LTD.
SOURCES Amount % USES Amount %
Cash from operating cycleBank borrowingCash------------------------------
Loan term loanEquity
2202
4014
28
--------------4997
7649
(11)
(22)
(00)
---------(27)
(40)
Financing cost (a) Interest
(b) Dividend
-----------------------------
Investment in Fixed Assets
5900
1800
-----------11190
(31)
(09)
-------(60)
63
18890 (100) 18890 (100)
It is clear that cash generated from operation (11%) was not enough to meet
financing the cost (40%). The ABC Co. Ltd. has raised bank loan (22% of total sources)
to meet the financing cost. A part of Financing cost was financed by long term sources
(Equity [40 – 11 – 22 = 7 ] ). Utilisation of this money for payment of dividend/interest is
not a healthy symptom. This speaks for inherent cash weakness of the company.
Investment in fixed assets (60%) was financed by Equity (40%) and Long term loan
(27%).
COMPARING WITH FUNDS FLOWIt is worthwhile to make a reference to funds flow analysis. The objective here is
to focus how the cash flow analysis is superior to fund flow analysis.
Fund flow statement of ABC Co. Ltd. can be drawn as under:
SOURCES USESNet fund generated Short term
Profit
Depreciation
400
4800 5200
Bills payables
OCL
Debtors
253
10523
7460 18236
Short term sources
Inventory
Bank borrowing
OCA
Cash
4014
7208
330
28 11580
Long Term 11190
Long term sources
Equity
Term loan
7649
4997 12646
_____
29426
_____
29426
Through this traditional analysis everything looks normal for the company. No
diversion is evident and long term sources are more than long term uses. In other
words, cash flow provided us more deeper insight in financial state of affairs of the
company rather than what is available from fund flow.
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SUMMING UPBy a systematic study of cash flow statement, a banker can easily identify
strength and weakness of a borrower. This is better indicator of borrower’s solvency and
liquidity. It highlights weakness of the borrower and can be used as instrument to identify
incipient sickness because liquidity crunch always precedes to losing profitability.
-000-
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Chapter-7Loan Syndication
OriginThe Narasimham Committee on the Financial System, appointed by the RBI in 1991,
examined, among the other things, the idea of starting loan syndication. The report of
the committee states, “While the structured consortium did indeed provide, some comfort
to the borrowing clientele in the sense that it saved them from the responsibility of
approaching several institutions for arranging their finance, it had two principal
drawbacks. When the consortium rejected an application, the borrower did not have any
further option. Secondly, even though the formal nature of the consortium has been
diluted and is now in theory voluntary in effect it is mandatory and militates against the
participating institutions developing a sense of accountability and responsibility for a
large portion of their portfolio. As a first step, we recommend that the system of
consortium lending be done away with. In its place, where the institutions and borrowers
agree a system of loan syndication or participation with other DFIs and commercial
banks could be considered”. But this idea of formation of Loan Syndication was not
well appreciated. Therefore, the Trade and Industry continued to voice their concerns
over the difficulties faced by them in complying with the RBI guidelines on lending
discipline for assessing the quantum of working capital to be provided to a borrower by
the banking system. Such difficulties arose mainly on account of the consortium
lending. Hence, the RBI decided to revise the system of lending under consortium
arrangement to overcome the difficulties of trade and industry. Accordingly, in 1993, it
appointed a committee under the chairmanship of Shri J V Shetty, Chairman and
Managing Director, Canara Bank to review the system of consortium lending. The
Committee examined various alternatives to the system of consortium lending, besides
suggesting liberal and flexible approach in the system of consortium lending. These
alternatives include inter bank participation certificates, commercial paper, debentures,
securitisation of debts and syndication of credit. The committee found the scope for
introducing these alternatives alongwith the consortium lending. Accordingly, the loan
syndication became part of lending system.
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Market sizeLoan Syndication market is presently estimated to Rs. 300000 lakh crores business.
Initially market was dominated by investment banks and state owned State Bank
sponsored SBI cap but gradually PSBs have also developed expertise and now three
PSBs namely Bank of India , Bank of Baroda and Punjab National Bank figures among
top ten loan syndicators. Even smaller banks like Uco Bank, Allahabad Bank,
Corporation Bank and Indian Overseas Bank are now venturing into this business
segment to leverage on customer relationship which they have built up over the years
and to earn fee income. However key to success is building capabilities to originating
the loans and selling down to other banks. Both need strong marketing abilities and
credit evaluation and assessment skills.
What is Loan Syndication?Banks may evolve appropriate mechanism for adoption of sole bank/multiple
bank/consortium or syndication opportunity framing necessary ground rules on
operational aspects. It shall be noted that the level of individual bank’s share shall
continue to be governed by the norm for single borrower / group exposure. Banks in
their own interest, should endeavor and ensure to have effective system for appraisal,
flow of information on borrower among participant banks, commonality in approach and
sharing of lendable resources, etc., under the single window concept. As syndication is
an internationally practiced model for financing credit requirements, banks are free to
adopt syndication route, irrespective of the quantum of credit involved, if the
arrangement suits to the borrower and the financing banks. With the withdrawal of
guidelines on consortium lending, the process of credit decisions will be further speeded
up; this will also afford greater mobility to the borrowers in accessing credit at
advantageous cost. Thus, the recent guidelines of the RBI have given a signal for the
Loan Syndication to be formed.
Process Involved in Loan Syndication?The process of loan syndication starts when a prospective borrower approaches a bank
of his choice and requests it to arrange for the required credit, on his behalf. The bank,
here, is referred as Lead Manager or Mandated Bank, which first prepares Information
Memorandum in consultation with the borrower. This information Memorandum
furnishes details of the project and credit requirements. It also discusses about the
terms of the offer made by the borrower such as interest, repayment period, security etc.
The Mandated bank takes out the required copies of the Information Memorandum and
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distributes among the prospective lenders requesting each one to participate in the
credit offer. Each prospective bank makes an independent evaluation of the borrower,
project and credit offer. If necessary, it may collect additional information from the other
sources as well. After sometime, the Mandated Bank convenes a meeting of
prospective banks to discuss the syndication strategy relating to co-ordination,
communication and control within the syndicated process and finalize the deal timing,
charges towards management expenses and cost of credit, share of each participating
bank in the credit, etc. In the meeting, banks agreeing to participate in the credit offer
form Loan Syndication and someone within the group is appointed as an Agent Bank
(referred as Agent). Agent and prospective credit institutions enter into an agreement,
which sets a limit for agency services. The Mandated bank or Agent communicates the
terms and conditions of the credit to the borrower who then offers his written consent to
the same. The borrower then gives a prior notice of his funds requirements and
accordingly, requests the Loan Syndication for disbursement. Before the disbursement,
the Agent has to get the documents executed on behalf of all banks for which there may
be a single set of documents or each bank may prescribe a separate set of documents.
Generally, a single window concept is followed in documentation. After documentation,
each bank deposits it’s share in credit with the Agent who then disburses the amount to
the borrower. Subsequently, the borrower makes the repayment of loan to the Agent ,
the participating banks are entitled to get their share in it on pro-rata basis. Once the
entire dues are paid, the loan syndication comes to an end. The process of re-
establishment of the loan syndication is followed when the borrower makes the fresh
request.
Functions of the Mandated Bank and Agent BankThe Mandated Bank has to obtain a letter (called the Mandate Letter) from the borrower
to arrange for the loan and also necessary details of the offer such as amount of loan,
interest rate, repayment period, security, etc. The Mandated Bank then prepares the
Information Memorandum in consultation with the borrower and sends the same to
prospective credit institutions, which may be interested in it. The Mandated Bank
obtains the written consent of credit institutions to join the loan syndication. It is also
expected to play a key role in forming the Loan Syndication and look after its work until
the Agent Bank is appointed. If the same bank is appointed as Agent, it has to offer
agency services.
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The Agent Bank, wherever appointed, is expected to perform only those duties, which
are prescribed in the Agreement entered with the syndicate members. This Agreement
in turn protects the interest of member banks and sets a boundary for the agent to
perform duties. The agent is expected to exercise the required skill, care and diligence
befitting its assignment. He has to disclose relevant facts of the credit to the Principal
(member banks). He is not to sub-delegate his authority and make secret profit out of
the agency services. As per the agreement, the participating banks are expected to
deposit their share with the Agent who, in turn, makes the entire amount available to the
borrower, when needed. Similarly, repayment amount of the borrower is deposited in
the Agent’s account and who then distributes among the members on pro-rata basis.
This account should be of the nature of a trust account so that the syndicate can protect
itself against insolvency or misappropriation by the agent. In order to have the right to
claim from the recipient (borrower) about any amount mistakenly paid; the Agent
incorporates a clause in the loan document. Further, the Agent may want to limit his
liability by incorporating a separate clause in this respect which grants immunity against
liability for any default or omission except in the case of its gross negligence and default
or willful misconduct of the agents, etc.
Relationship among Syndicate Members The group is generally small and, therefore, the members can consult one another.
They would like to resolve differences, if any, through mutual consultations. Since each
member has reasonably a large share, there is no need to insist on majority decision,
every time. Each member is capable for taking the matter with the borrower directly and
protects his interest. In case of default, the majority of the members can instruct the
Agent to initiate recovery. When enforcement of securities becomes necessary, each
member can pursue its own remedies as it pleases. As and when the borrower makes
the payments to the Agent, each member has to get its pro-rata share in it. In any case,
the relationship among the members has to be cordial and informal so that the
syndication of credit works effectively. But the relationship between agent and member
banks has to be formal and in line with the agreement entered between the two.
Methods of Loan SyndicationThere are two methods of syndication – direct lending and through participation. In
respect of ‘direct lending’, all the lenders sign the loan agreement independently with the
borrower and agree to lend upto their respective share. The obligations of the syndicate
members are several and they do not underwrite one another. As against this, in
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‘through participation’ method, the lead bank is the only lending bank, so far as the
borrower is concerned, that approaches the other lenders to participate in the loan. This
normally takes place without the knowledge of the borrower. The lead bank grants a
certain portion of the loan to each participant as agreed. It also agrees to pay to the
participants a pro-rata share of receipts from the borrower. There can be four types of
participation (a) Substitution – There is an agreement between the borrower and the
lead bank and other participants to permit the lead bank to disburse the loan on behalf of
the participants, (b) Undisclosed agency - Here, the lead bank is appointed as agent by
the syndicate before the loan is signed, but does not disclose this fact to the borrower. It
is, therefore, the principal as far as the borrower is concerned. (c) Sub-loan – Under
this method, each participant grants a loan directly to the lead bank on the condition that
the lead bank repays only to the extent of receipts from the borrower, (d) Assignment –
The lead bank assigns a proportion of the loan and of the benefit of the loan agreement
to the participants in consideration of the purchase price of pro-rata share of the loan to
be contributed by them.
Preparatory WorkIn terms of the RBI guidelines, each bank is expected to do necessary preparatory work
before the loan syndication is formed. To start with, there has to be a written policy of
loan syndication in which each bank has to indicate its loan policy and business
strategies. In particular, it has to spell out its policy in regard to loan amount ceiling for
formation of syndication, exposure limits for individual or group borrowings, charges for
agency services and for preparation of Information Memorandum etc. It should also
decide whether it wants to go in for common set of loan documents of syndication or
develop its own set of loan documents. It has also to work out its preference for ‘direct
method’ or ‘through participative’ method. Further, in case it has to perform certain
agency services under loan syndication, necessary details have to be provided to the
identified branches. If necessary, a specialized branch may be opened for offering
agency services as under the loan syndication. Finally, officers going to scrutinize credit
proposals under loan syndication and follow-up the credit matters need to be trained
besides creating the required infrastructure and technology base for handling of
syndicated loans.
Conclusion
Loan Syndication provides adequate flexibility and is more convenient to both borrowers
and banks. This may, in turn, result into timely and need based credit to corporate
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borrowers. In a competitive environment, it is essential to avoid delays in credit
sanctions for which there have to be certain pressures built within the system of loan
syndication. In other words, members of loan syndication should work with competitive
spirit. In regard to the need based credit, cash budget/cash flow system should be
followed in which the borrower has to spell out his cash requirement precisely. In any
case, benefits of the loan syndication should be mostly shared equally between
borrowers and banks. In the end, success of formation and conduct of loan syndication
very much depends upon seriousness, openness and collective action on the part of
both borrowers and banks.
-000-
Chapter- 8
Documentation and Charging of securities 1. Introduction- Documentation means execution of documents in proper manner and
according to provisions of law. Proper documentation comes to the rescue of the
banks in a court of law. Section 3 of the Indian Evidence Act defines a document as
"Any matter expressed or described upon any substance by means of letters, figures
or marks or by more than one of these means, intended to be used or which may be
used for the purpose of recording that matter". Execution of documents thus interalia
involves a process of taking the signature of the borrowers/guarantors etc. on the
necessary documents after proper stamping and completion of other formalities say
registration connected therewith. The documentation establishes a legal relationship
between the lending banker (creditor) and the borrower (debtor)/guarantor.
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2. Different types of borrowers – Borrowers can be classified into several categories
such as ( a) Individuals in single name and joint names, (b) Firm-sole
proprietorship firm and partnership firm, (c) Hindu Undivided Family, (d) Limited
liability companies/corporations etc. viz. (i) Private limited company, (ii) Public
Limited Company and (iii) local authorities, corporations or undertakings owned by
State/Union Government, (e) Clubs schools non-trading associations and literary
societies, (f) Co-operative societies and (g) Trusts.
3. Mode of creation of charges- Creation of charge on securities is done as per
nature of security through (a) hypothecation (for movable stocks such as goods,
book-debt, plant and machinery) (b) Pledge (for movable stocks) (c) Mortgage in
respect of immovable property, (d) assignment of debts like life policy and (e) lien on
deposit with the bank or post office.
4. Capacity to contract and free consent- Before getting the documents executed, it
is necessary to ensure that the parties executing documents are having capacity to
enter into contract. Similarly bank should ensure that borrower executing the
documents and charging the security or giving guarantee is doing so with his/ her
free will. To ensure this, the branch manager should see that documents are
executed by a major only (a person attain majority at the age of 18 years
excepting when the guardian is appointed by the court, age of majority is 21 years)
and, there is no occasion on which borrower may later claim that he has not signed
the documents with his free will on account of coercion, undue influence,
misrepresentation or mistake. As a matter of abundant precautions, safeguard by
way of witness/ letter of affirmation/public notice etc. are taken when illiterates
execute the documents or third party security is charged to the bank.
5. Checkpoints for effective documentation-- Execution of document is most crucial
part of lending. Any laxity/negligence on the part of branch manager/officer may lend
the bank in trouble when suit is filed and security is enforced. It is therefore essential
that under noted time tested precautions are observed while documents are
executed by the borrowers-
(a) Document should be executed in presence of the Manager/ other responsible
officer.
(b) Documents should be completed in one sitting in the same handwriting in the
same ink.
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(c) Document should be signed by the borrowers in full signature in the same
style throughout the documents. Generally borrowers put their signatures
using right hand. If however, borrower signs in left hand, a small note should
be annexed recording therein that the borrower has signed in left hand. In
case of illiterate borrower, a remark should be made if he/she has put his/her
right thumb or left thumb. In practice right thumb impression is obtained from
lady borrowers and left thumb impression from male borrowers.
(d) All types of correction, insertion, additions, alterations, cuttings, overwriting,
erasing, interlining, deletions etc. should be avoided. Otherwise, these
should be duly authenticated by the borrowers under his/her full signature
near each of such corrections, addition, interlining etc.
(e) Date and place of execution should be mentioned properly. Documents
should not be double dated such as 1/2, 9/10 etc.
(f) When the document runs into several pages, the borrowers should sign such
documents on each and every page. Signature should be obtained on the
documents particularly across the fold in such a manner that the signatures
run on the both pages.
(g) Unless there is a specific requirement, documents should not be got attested/
witnessed.
(h) Documents should be adequately and properly stamped as per state law,
(i) No column should be left blank. Keeping the documents blank or even one or
two column may invalidate the whole documents. Spelling of name and
address of the borrowers should be taken due care. Interest rate is very
crucial and it should be filled correctly stating over or below PLR with
quarter/half yearly/monthly compounding clearly. No credit facility should be
allowed until and unless all the borrowers including guarantors execute all the
documents.
(j) When the borrower happens to be a proprietorship firm/partnership firm, the
documents should be got executed once under the seal of the firm and
another individually. When the borrower happens to be a company, the
documents should be got executed once under the seal of the company with
the designation of the signatory in the company and another individually
under common seal of the company.
(k) Documents are to be preserved very carefully.
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5. Special convenants to meet RBI guidelines/regulatory requirements- Following special convenants should be added –
(a) The borrowing company will not induct a person who is director on the board
of the company which has been identified as a willful defaulter and that in
case, such person is found to be on the board of borrower company, it would
take expeditious and effective steps for removal of the person from its board.
(b) The borrower will not make any major change in the management involving
transfer of ownership without previous permission of the bank in writing.
(c) Certificate / declaration that directors/borrowers are not related to any senior
executive of the bank.
(d) Bank may withdraw sanction without assigning any reason.
(e) The borrower will not have any objection to the bank disclosing its name to
RBI/CIBIL in case of default or otherwise so required by the bank.
(f) Borrower will not to pay commission to guarantors.
6. Documentation -Stamping As per Section 2(11) of the Indian Stamp Act, 1899, a document is deemed to be
duly stamped if it bears an adhesive or impressed stamp of not less than the proper
amount and that such stamp has been affixed or used in accordance with the law for the
time being in force. It is legal requirement that documents must be stamped properly. If
a document is either not stamped or under-stamped, it is not valid. Document
should always be stamped before or at the time of execution of the documents. If the
documents are stamped later than the date of execution, it is not valid in a court of law.
Every adhesive stamp affixed on documents should be cancelled as per Section 12 of
the Indian Stamp Act. Writing name of the executant is considered as sufficient
cancellation. All documents contravening the provisions shall be deemed to be
unstamped and the effect can be remedied by payment of duty and the penalty. All
documents, which are not duly stamped, are inadmissible in evidence unless the duty
and penalty have been paid as provided in Sec. 35 of the Indian Stamp Act. Section 35
of the Indian Stamp Act, while providing for admitting certain not duly stamped
documents in evidence on payment of certain penalties and duties specially excludes
other documents (including promissory notes) from its operation. Thus an under-
stamped DP Note will be inadmissible in evidence for any purpose i.e. the writing therein
cannot be used as an acknowledgement of claim. The rule of strict Inadmissibility of a
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pronote comes into play when a transaction merges into a pronote, which becomes its
only basis. Any evidence of such a transaction is barred under Sec.91 of the Evidence
Act and in such a case any deficiency in stamping the pronote will be fatal to the whole
suit. When any document is executed in more than one state in India then the
stamp duly payable on the document so executed will be higher of the stamp duty
payable.
7. Registration of documents with ROC Under section 125 of the Indian Companies Act, 1956, the following charges are to
be registered compulsorily-
(a) A charge for the purpose of securing any issue of debentures.
(b) A charge on uncalled share capital of the company.
(c) A charge on any immovable property wherever situated or any interest
therein.
(d) A charge on any book debts of the company.
(e) A charge not being a pledge on any movable property of the company.
(f) A floating charge on the undertaking or any property of the company.
(g) A charge on calls made but not paid.
(h) A charge on goodwill or patent or license under a patent on a trademark or on
a copyright or a license under a copyright.
8. Registration of Documents under Indian Registration Act, 1908- The documents,
as per detail below are compulsorily required by Section 17 of the Indian Registration
Act to be registered, at the office of the Registrar or Sub-Registrar within four months
from the date of its execution. A registered document shall operate from the time
from which it would have commenced to operate if no registration thereof had been
required or made and not from the time of its registration (Sec. 47). -
(a) Mortgage of immovable properties (except by deposit of Title Deeds).
(b) Instruments of gifts of immovable properties.
(c) Lease of immovable property from year to year or for any term exceeding one
year or reserving in yearly rent.
(d) Non-testamentary instruments which acknowledge the receipt or payment of
any consideration on account of the creation, declaration, assignments,
limitations, or extinction of any such right, title or interest.
(e) Non-testamentary instruments transferring on assigning any decree or order
of a court or any award when such decree or order or award purports or
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operates to create, declare, assign, limit or extinguish whether in present or in
future, any right, title or interest whether vested or contingent of the value of
Rs.100/- and upwards to or in immovable property.
(f) Other non-testamentary instruments which purport or operate to create,
declare, assign, limit or extinguish whether in present or in future any right
title or interest whether vested or contingent of the value of Rs.100/- and
upwards to or in immovable property.
9. Extension\revival of period of documents According to Section 2(1) of the Limitation Act, 1963, period of limitation means
the period of limitation prescribed for any suit appeal or application by the schedule and
'prescribed period' means the period of limitation computed in accordance with the
provisions of the Limitation Act. There is a legal relation between documents and
limitations act. As long as the documents are within the period of limitation a banker can
institute a suit, prefer an appeal and apply for legal action for recovery. Once the
document has expired by period of limitation, and then the banker will have no legal
course of action to recover the dues from the defaulting borrowers. In other words if the
period of limitation expires then the party entitled to file a suit for enforcement of a right
is debarred from doing so. When the period of limitation as applicable in a particular
case has expired the documents become time-barred. A document can be revived or
its limitation period can be extended by -
(a) Part payment by the borrower himself or his duly authorised agent for this
purpose and also such payment is made before expiry of the documents
(Sec.19 of Limitation Act). Such payments should be in the handwriting or
under the signature of the borrower or his authorised agent.
(b) Obtaining acknowledgement of debt in writing across the requisite revenue
stamp from the borrower before expiration of the prescribed period of
limitation (Sec.18 of Limitation Act).
(c) When a fresh set of documents is taken before the expiry of the original
document, fresh period of limitation will start from the date of execution of the
fresh documents. A time-barred debt can be revived under Sec.25 (3) of
the Indian Contract Act only by a fresh promise in writing and signed by the
borrower or his authorised agent generally or specially authorised in that
behalf. A fresh promissory note/fresh documents executed for the old or a
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barred debt will give rise to fresh cause of action and a fresh limitation period
will be available from the date of execution of such documents.
(d) Section 4 of the Limitation Act states "Where the prescribed period of any
suit, appeal or application on a day when the court is closed, the suit appeal
or application may be instituted preferred or made on the day when the court
re-opens".
(e) As per Section 5 of the Limitation Act, 1963 any appeal or any application
other than an application under any of the provisions or Order XXI of the
Code of Civil Procedure, 1908 may be admitted after the prescribed period if
the applicant or the appellant satisfies the court that he had sufficient cause
for not preferring the appeal or making the application within such period.
SUMMING UPBanker should take utmost care and precaution while getting the documents
executed. They should take care to complete the formalities in connection with the
execution of documents, stamping, subsequent registration etc. according to the
prescribed procedure laid down in respective Acts so that there is no problem in getting
the documents admitted in a court of law later on, if need be, as evidence of claiming
right under such document and such document shall be enforceable against all the
executants. The due date of limitation period should be properly diarised and documents
should be revived well before they get time barred.
Chapter-9
Documentation of Limited Liability Companies1. Company defined-
According to Justice Lindlay by a company is meant an association of many persons
who contribute money or money’s worth to a common stock and employ it for a
common purpose. The common stock so contributed is denoted in money and is the
capital of the company. The persons who contribute it or to whom it belongs are
shareholders. The proportion of capital to which each member is entitled is his share.
Essential features of a company are -
(a) A Company is an artificial person created by law. It can act only through
agents- Board of directors, Managing Directors and Managers- who are
representatives of shareholders.
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(b) It has a perpetual succession. Death, insanity or bankruptcy of shareholders
does not affect its existence.
(c) Existence starts only after completion of formalities as per act.
(d) A Company can own property, own money, is creditor to other people and
can borrow also (subject to limitation).
(e) It has separate entity to its shareholders.
(f) The liability of shareholders is generally limited.
(g) The legal relationship of director and company is of principal and agent.
(h) A company must have it registered Office. It must have a common seal
(public limited only). It must comply various legal formalities and obligations.
2. Private and Public Limited company-As per Companies Act, 1956, there can be a private company or a public
company. Private company means a company which by its articles (a) restrict the
right to transfer its share, (b) limit the number of its members to 50 not including (i)
persons who are in the employment of the company and (ii) persons who, having
been formerly in the employment of the company, were members of the company
while in that employment and have continued to be members after the employment
ceased and (c) prohibits any invitation to the public to subscribe for any shares in or
debentures of the company. A public company is one, which is not a private
company. The difference between a private and public company is –
(a) The minimum number of members in a private company is two while that of a
public company is seven. In a private company, the maximum permissible
number is fifty; but in public company it is unlimited.
(b) In a private company, the articles of association restrict the transfer of share
where in a public company there is no restriction.
(c) A private company is prohibited by its articles of associations to invite
members of the public to subscribe for any shares in or debentures of the
company; but a public company may invite the general public to subscribe its
shares or debentures.
(d) The minimum number of directors in a public limited company is three
whereas in private limited company is two.
(e) A private company can issue its share and debentures without issue of
prospectus but a public company cannot.
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(f) A private company can commence business immediately after obtaining a
certificate of incorporation but a public company has to wait till a certificate to
commence business is granted to it.
(g) A private company must add the word ‘private limited’ with its name where as
public limited company is required to add ‘limited’ with its name.
3. Memorandum of Association-First step in formation of the company is preparation of its memorandum
of association. It is a charter of the company. It contains provisions relating to name
of the company (name clause), address of registered office of the company
(registered office clause), its object (object clause), detail of authorised capital (share
capital clause), liability of the share holders (liability clause) and signatures of
promoter directors (signature clause). While processing loan application of the
limited company, the bank is required to check that (a) the company is authorised to
do business for which advance is required, (b) the company has necessary
borrowing powers (applicable for non trading company) and (c) if the company is
guarantor, unconnected with its business there is specific power in the
memorandum.
4. Articles of Association-The articles of association are regulation of the internal management of the
company and are subordinate to the memorandum. The articles of association define
how the objects of the company will be carried out. A public company may not have
an article of association and in that event table A of the Companies Act shall apply.
While processing the loan application of the company, the banker should study
articles of association to ascertain (a) who is authorised to open account? (b) Who
will execute the documents? (c) Who is authorised to deposit title deeds to create
valid equitable mortgage? (d) How common seal will be affixed? The banker should
also check that (a) company has power to borrow and mortgage the property, (b)
company has affixed common seal wherever required, (c) sealing has been done in
accordance with the procedure as laid down in the article, (d) necessary resolution is
passed in the board naming officer (s) in whose presence, the seal is affixed and (e)
documents have been executed as specified in the article or in the resolution. In a
recent judgement Hon’ble Supreme Court has observed “ so far as the question of
putting up of the seal of the company is concerned, it is a relic of the days when
medieval barons, who could not read or write, used their rings to make a
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characteristic impress. Even in the absence of a seal, the company may still be held
to be liable having regard to the authority of those who executed it.”
5. Certificate of incorporation and certificate to commence business-On registration, a company gets a certificate from the registrar, which is
known as Certificate of Incorporation. From the date of incorporation, a company
becomes a legal person. It is a conclusive proof that all formalities for giving birth of
the company have been completed. A private company can commence business
immediately on receiving certificate of incorporation but a public limited company has
to obtain a certificate of commencing business also.
6. Borrowing powers of a company-Every trading company has an implied power to borrow money and give
security for a loan provided such borrowing is incidental to the conduct of its
business. But non-trading companies do not enjoy such a right unless there is an
express power to that effect in the memorandum of association. The power to
borrow, whether express or implied, may be further restricted by memorandum of
association or articles of association of the company. In case money borrowed plus
money proposed to be borrowed exceed the aggregate paid up capital and free
reserves of the public company approval of the company in general meeting is
necessary (Section 293 (I) (d). Further no public company can borrow unless it has
been granted certificate to commence business (Section 149). The board of directors
of the company can exercise the power to borrow only by means of a resolution
passed in meeting of the board and such resolution must specify the total amount
outstanding at any time up to which moneys may be borrowed by the delegate (Sec
292). The board can delegate powers to Managing Director, Manager or any
employee to execute documents and complete formalities relating thereto.
7. Registration of Mortgages and charges-The Company Act has specified that charge and mortgages on assets of
the company should be registered with the Registrar of the company under section
125. These charges are (a) to secure an issue of debentures, (b) on uncalled share
capital of the company, (c) On immovable property or any interest thereon, (d) on
book-debt of the company, (e) not being pledge on movable property, (f) floating
charge on any property of the company and (g) charge on goodwill/trade mark/patent
of the company. Further prescribed particulars of the charge, together with the
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instruments by which it is created or a certified copy thereof, are to be filed with ROC
within 30 days after creation of the charge with form no. 13 along with either of the
form No. 8 (for fresh or modification of charge), form no. 10 (for secured creditors) or
form no. 17 (for satisfaction of charge). Even when there is any alteration or
modification in terms of sanction like change in interest rate, modification of charge
has to be filed. It is the duty of the company to file charge/modification. Where a
charge is created out of India on property situated out of India, the period of 30 days
will commence after the date the instrument creating charge could have been
received in India in due course of post. Further the charge created out of India,
permission of RBI is required under Foreign Exchange Management Act (FEMA).
The company is required to keep a copy of document by which the charge is created
in its registered office. The copy of instrument creating charge filed by the company
with ROC should be verified to be true copy by a certificate under seal of the
company by a responsible officer or by a person interested in the charge. Non-
compliance/filing of charge is subject to penalties.
Any person (including the financing bank) who is interested in the charge
can also file charge for registration with ROC and recover the fee spent for
registration from the company. In case of delay, company/interested person can
approach ROC, which can allow for extension of 30 days in case company is able to
satisfy for genuineness of the delay. Though the ROC has no jurisdiction to extend
the period for filing for registration beyond the extended period of 30 days, still the
creditor holding the charge unregistered even in the extended time is not without a
remedy. Under section 141 of the Companies Act, company may approach Company
law board, which can condone delay in filing of charge if satisfied. If Company Law
Board also refuses; the company or its creditor to file application under section 637-
(b) to government to condone the delay. Needless to add that even though extension
of time can be sought under the law the branch manager must ensure that charge is
filed with ROC within initial period of 30 days. The object of registration is that
members of the public dealing with the company should have a notice of the
particular properties, which might have been subjected to mortgage or charges. A
charge by way of subsequent mortgage, duly registered under section 125 will have
priority over a charge unregistered there under. Upon registration of charge, the
registrar of companies (ROC) is required to issue a certificate for registration of
charge and this is conclusive proof that charge has been registered and cannot be
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challenged on any ground. ROC is required to maintain the register in which all
charges are to be recorded (section 130). This register should remain open for
inspection by any person on payment of prescribed fee. In case the charge is not
filed as stipulated, the charge is void against the liquidator / any creditor of the
company in the event company goes into liquidation. However where the company is
a going concern the security created by the charge for which charge has not been
filed can be enforced through court as the defaulting company itself cannot deny the
lender the cover of security. This position of company law is in accordance with the
common law that no man can take advantage of his own default. In case charge has
been filed but not registered by the ROC, then charge holder is not responsible, as
there is no fault on his part. (State Bank of India Vs Depro Food Ltd & others 1988
Comp case 375,384 (P & H). However a prudent banker should always ensure that
charge is got registered, necessary certificate of registration of charge has been
obtained or post registration inspection of ROC record has been done to confirm
registration of the charge in bank’s favour. Just as it is obligatory on the part of the
company to file particulars of a charge or modification thereof, the company is also
duty bound to file satisfaction of charge. To protect the interest of charge holder in
the event of a fraudulent attempt by the company to file satisfaction of the creditor’s
charge section 138 (2) stipulates that ROC shall on receipt of satisfaction of charge,
shall send a notice to the charge holder calling upon him to show cause within a time
not exceeding fourteen days specified in the notice why payment or satisfaction not
be recorded as intimated to him. In case no objection is made, ROC will file
satisfaction.
As a part of government’s commitment to governance reforms, GOI under MCA
21 programme has introduced electronic filing of charge with ROC. For usage of e-
Forms for filing of charges bank will have to download it from MCA portal
www.mca.gov.in and the same will have to be digitally signed by both bank
manager as well as Managing Director/Secretary of the company. The relevant
document creating charge in favour of the bank will have to annex with the form after
scanning. The project is expected to go on live from 30th June 2006 by which time
bank officers are expected to understand the system as well as put in place system
of e-filing of the charge form.
8. Documents to be obtained from company-
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(a) Copy of memorandum of association and articles of association certified to be
true and up to date.
(b) A copy of Certificate of Incorporation and Certificate of Commencement of
business (in case of public limited company only).
(c) Certified true copies of the board resolution (i) to open and operate account,
(ii) to borrow money, (iii) to execute documents, (iv) to charge securities, (v)
to pledge shares/deposit title deeds for equitable mortgage and (vi) to put
common seal of the company on executed documents.
(d) Certified true copies of general body resolution (i) under section 293 (I) (d) of
the Act, where the borrowing exceeds the paid up capital and free reserves (in
case of public limited companies only), or (ii) An undertaking on prescribed
format that director will ensure to comply with the provision of the act under
section 293 (I) (d) and (iii) under section 292 (a) for creation of mortgage
over fixed assets of the company.
(e) List of present directors duly certified by secretary along with general body
resolution for their election.
(f) A copy of power of attorney if documents are executed by authorized
signatory under power of attorney.
(g) Confirmation under section 292 (5) that powers of the directors in respect of
the borrowings have not been restricted or withdrawn in general body
meeting.
(h) Certificate / Undertaking that directors of the company are not related with any
senior executive of the bank.
(i) Undertaking that the company will not make any major change in the
management involving transfer of ownership without previous permission of
the bank in writing.
(j) Undertaking that company will not have any objection to the bank disclosing
its name to CIBIL in case of default or otherwise so required by the bank.
(k) Undertaking not to pay commission to guarantors.
(l) Letter of negative lien stating that assets are free and un-encumbered and the
said assets shall not be sold, mortgaged, pledged or hypothecated or any way
encumbered without the previous consent of the bank in writing
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(m) A search report that movable and immovable property offered as security is
not subject to prior charge either registered with ROC or pending for
registration.
9. Execution of documents-(a) All documents to be executed in presence of branch manager or designated
officer.
(b) The documents should be got executed once under the seal of the company
with the designation of the signatory in the company and another individually
under common seal of the company.
(c) The documents to be executed by the person as authorized in the article of
association or as per resolution. They may be managing director, director or
officer.
(d) If Power of attorney holder executes documents, he should sign as
authorized signatory or as attorney.
(e) Demand promissory note (DPN)- as applicable either linked to PLR on
floating interest basis or fixed interest basis has to be executed. Common
seal must be affixed on DPN.
(f) The general letter of hypothecation (GLH) should be stamped as an
agreement. GLH should bear common seal.
(g) Equitable Mortgage- Title deeds will be deposited by the director/ officer of
the company specifically authorized for this purpose in presence of witness
(who will witness deposit of title deed) in pursuance of resolution passed by
the board of directors.
(h) Guarantee-Check that specific power to enter into contract of guarantee has
been provided in memorandum (incase company is doing business
unconnected with the beneficiary) and also check if such powers are vested
to directors. Also obtain a certified true copy of the resolution of board
regarding execution of guarantee and also approved text of guarantee.
Guarantee should bear common seal.
(i) 2nd Charge –The borrower, institution enjoying 1st charge and the bank, will
execute tripartite agreement. Charge deed must bear common seal. A copy
of the 2nd charge agreement to be held by the branch along with confirmation
that the charge has been filed/registered with ROC.
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10. Consortium advances under single window system-To overcome the delay in disbursement of sanctioned limit due to
cumbersome procedure of documentation involving various consortium banks, RBI
suggested introduction of single window concept of lending under which consortium
leader is authorized by the member banks to complete documentation formalities on
their behalf which includes charging of security in favour of consortium banks and
filing/ registration of charge with registrar of companies for all the banks. Draft of
model documents devised by IBA which were later were approved by RBI have been
adopted by all the banks. Sharing of security and rights and responsibilities of all
consortium banks is documented through inter-se agreement.
Following documents have been prescribed under the single window
system-
(a) Letter of authority given by all other member banks individually to a lead
bank.
(b) Letter of authority given by other member banks to second largest bank.
(c) Working capital consortium agreement.
(d) Joint deed of hypothecation.
(e) Inter-se agreement among banks.
(f) Revival letter for the purpose of limitation.
(g) Letter regarding release of working capital pending creation of second
charge.
-000-
Chapter- 10
Monitoring of Potential NPAsIntroduction
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The follow-up of advances which is in vogue in banks aims at assessing the working of
the units financed by them and ensuring the proper end-use of funds. This includes
stock verification, study of ledger data, factory inspection, study of quarterly information
system (QIS), discussion with the borrower, study of market report, etc. From the follow-
up exercise, it is expected to obtain signals of incipient sickness in the units/irregularities
in bank accounts and to take appropriate preventive action. (An exhaustive list of such
signals is given in Appendix I). Unfortunately, the present system follow-up is not
adequate and efficient enough to meet the above expectation. To elaborate, there are
too many signals; one does not know which one to be attended to. Further, although
sickness/irregularity is identified, timely preventive action is not taken. Further, in the list
of priorities of a branch manager, follow-up of advances is generally the last item.
Consequently, preventive action is not taken up, or action is taken with a considerable
delay. Finally, restructured standard assets which is on rise and reflect serious concern
about assets slippage, a proactive approach is necessary. As per estimate (ET
31.07.2010) standard restructured assets of 28 banks rose to Rs. 111,057 crores as on
March 2010 from Rs.65,956 crores as on March 2010 and are triple the size of NPA of
these banks and as high as 49% of net worth of these banks. Thus to overcome these
limitations of the existing system of follow-up of advances, “Credit Monitoring” is
suggested as a tool to supplement the present follow-up system and not supplant the
same.
Suggested Credit Monitoring System (CMS) Credit monitoring is a continuous process and, therefore, an officer in the branch
will have to be identified exclusively for this job, which may be designated as
Credit Monitoring Officer (CMO). He will not be involved in credit sanctions for
which there will be a separate officer who will be responsible mainly for
processing of credit proposals.
CMS should be applicable to all accounts. But initially, it is better to cover bigger
advances say, Rs 10 lacs or more. Similarly, this refers to those accounts, which
are potentially sick SSI units wherein loan default is for less than 12 months.
The CMO will be responsible for studying data/information gathered from various
sources for obtaining signals of incipient sickness of the potential NPA as well as
potential sick SSI units and taking up preventive/remedial action with the help of
Branch Manager and other field staff.
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He will also maintain a profile of the borrowers for which a 'Borrower Profile Card’
is suggested in Appendix II.
Credit monitoring ensures special attention to the high value borrowal accounts
enjoying credit limit in excess of Rs 10 lakhs so that it would be possible to take
early preventive action.
Sources of InformationTo obtain the signals of incipient sickness or an account becoming an NPA, the CMO
has to refer to various sources of information. These includes:
Conduct of cash credit, term loan, bills, Bank guarantee, letter of credit, DPG,
etc. reflecting outstanding exceeding the limit/drawing power, defaults in loan
installments, return of bills, encashment of bank guarantee, devolvement of
letter of credit, diversion of bank fund, etc.
Operations in the ledger account i.e. the borrower deposits entire sale proceeds
in the cash-credit account.
Stock inspection report- irregularity if any.
Factory visit report-observations of adverse nature.
Receivables management to focus age of receivables.
Renewal proposal and process note- observation of appraising officer.
Minutes of the meetings held with the borrower and also with co-banks in the
consortium meetings.
Market reports- adverse report if any.
Compliance of terms and conditions of the last credit sanction
Report of the last statutory audit, RBI inspection report, concurrent audit and
stock audit.
Published annual report of the unit.
Identification of Potential NPA / Sick Units in SSI SectorFrom the above-mentioned sources of information, the CMO has to collect data to
identify signals. Here, he should concentrate on few but useful signals which should
cover operational performance, conduct of borrowal accounts, movement in sock
position, Ageing of book-debt, market reputation, prompt submission of various
statements, non-compliance of terms of the last sanction, diversion of funds, collection of
dues from customers, etc. An attempt has been made to develop a format for
identification of signals as furnished in Appendix III. Signals have to be identified on
monthly basis. For each month , the CMO has to study the accounts allotted to
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him and has to bring such signals, if any, to the notice of the branch manager. In the
same format, it is attempted to put () mark or () mark against each signal. Presence
of a signal is marked by the sign () and the absence of a signal is marked by the sign
(). If there is a repeat occurrence of a signal, preventive action has to be taken up
immediately; otherwise the account may become sick/non-performing soon.
In the format, it is shown that the ABC Industrial Unit does not experience any
signal of sickness in the first four months. But in the fifth month, sales declined.
Consequently, cash credit account was overdrawn, bills account was out order and
there was a default of term loan. In the next month i.e. Month-6, sales once again
picked up but the party did not deposit the entire sale-proceeds in the account. As a
result of this, loan default and irregularly in cash credit and bills account continued. In
addition, funds were also diverted. Now, this is a potential NPA (account is out of order
below 90 days and installments are overdue below 90 days) and, there is still on month
left to prevent slippage and retain as standard asset. For this purpose, preventive action
has to be taken up.
Preventive ActionEach signal calls for certain preventive action. Sometimes, it may be advisable to watch
the signal for some time and thereafter take action. In any case, CMO will not only bring
the presence of signals to the notice of the branch manager and also suggest the type of
action to be taken up. He will instruct the staff at the counter to keep an eye on
transactions recorded in the ledger book. Such action would depend on the nature of
sickness/ irregularity. But certain actions are common which include writing of a letter to
the borrower, discussion with the borrower, visit to the factory-site, keeping a close
watch on the transactions recorded in the ledger book, writing a letter to the higher
authorities to indicate the developments in the account, etc. In Appendix IV, it is
attempted to discuss various actions to be considered to prevent sickness.
ConclusionIt is attempted to show how to obtain signals of sickness or an account likely to become
an NPA. In addition, action points are also suggested. Initially, credit monitoring may
be done for few accounts on pilot basis. Thereafter, other accounts may be covered. It
also calls for creating awareness on credit monitoring among the staff-members for
which, the branch managers have to take initiative.
Appendix I
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Checklist of follow-up measures to obtain signal of incipient sickness
A. Stock Inspection-irregularities.
B. Ledger Book- irregularities or adverse features.
C. Adverse market reports.
D. Adverse features obtained from financial statements.
E. Discussion with the Borrower in problem areas.
( Measure specific signals are given in Chapter 19-Due diligence in credit management)
Appendix IIBorrower’s Profile Card
Name ------------------------------------- Branch --------------------- RO/ZO :------------------
Constitution ---------------------------- Type of A/c : SS I/Corporate /Trading /ServiceIndustry (Code/Sub-code): ------------------------------- Products ---------------------------
Contact Person : Name------------------------ Guarantor : Name ---------------------------
Address -------------------- Address-----------------------
--------------------
------------------------ Tel.No. -------------------- Tel.No
------------------------
Fax No. -------------------- Fax No.-----------------------
e-mail -------------------- e-mail -----------------------
Associated Firm (if any): -------------------- Position of A/c : Sick/CDR/Recalled/ BIFR/DRT/Decreed/Others
Introducer : --------------------------- Bank Rating : -------------------------------------------
Single/Multiple (Lead Bank -------------------) Since when dealing with our
Bank------------------Year ------------
Date of Last Sanction: CC ----------------------- Renewal Date----------------------------
TL --------------------- Sanctioning Authority :Branch/ZO/CO
Others ---------------------
Securities : Primary -------------------- Expiry Date of Insurance Policy -----------
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Collateral ------------------ Expiry Date of Documents:------------------
M-1 M-2 M-3 M-4 M-5 M-6 Limit/BP OB OB OB OB OB
OBS.No. Credit Facility Limit/DP ------ ------ ------ ------ ------ --------
1. Cash Credit (Hyp)--------- ------ ------ ------ ------ ------ ---------
2. Cash Credit (Pled)--------- ------ ------ ------ ------ ------ ---------
3. Bills ----------------- ------ ------ ------ ------ ------ ---------
4. Other s (Short term)-------- ------ ------ ------ ------ ------ ---------
5. Term Loan ----------------- ------ ------ ------ ------ ------ ---------
6. Non Fund Based ---------- ------ ------ ------ ------ ------ ---------
Limits
Appendix IIIIdentification of Potential NPA
( for presence of a signal for absence of a signal)
S.No.
SignalMonthM-1 M-2 M-3 M-4 M-5 M-6
1 Fall in sales/cash losses/erosion in networth x x x x x
2 Overdrawals in cash credit account x x x x
3 Bills A/c out of order x x x x
4 Other short-term loan – default x x x x
5 Term loan-default : Int/Prin. x x x x
6 Development of DPG/LC/BG x x x x
7 Delay/Non submission of stock statement x x x x
8 Incomplete documentation in terms of
creation/ registration of charge, mortgage, etc.
x x x x x x
9 Non fulfillment of terms of last sanction x x x x X x
10 Diversion of funds x x x x
11 Payment from customers held up x x x x
12 Adverse market report x x x x X x
13 Unfavourable factors affecting the unit x x X x x x
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14 Others (specify) - - - - - -
Appendix IVCredit Monitoring Steps
(1) Identify the potential NPAs where loan default is for two months.
(2) Study the causes – whether default is due to inherent weaknesses or due to
temporary liquidity or cash flow problem.
(3) Offer contingency help immediately in the form of ad-hoc limits if cash flow mis-
matches are genuine.
(4) If limits are found to be inadequate leading to loan default during the year, ask
the borrower to submit the renewal proposal and enhance the limit suitably.
(5) If cheques are drawn on parties not related to business or heavy cash drawal
and no corresponding increase in stock, pass cheques for payment after a
detailed scrutiny. Borrowers should be advised to state the purpose of the
cheque for which it is drawn.
(6) Visit the factory immediately, if the stock statement is not submitted and verify
the securities.
(7) Collect the interest on monthly basis. Frequent visits are called for wherever
there is a default of interest payment.
(8) Keep the documents live, obtain balance confirmation, do rectification of
audit/inspection irregularities .
(9) Rectify /attend to the observation of concurrent auditor, statutory auditor, branch
inspector, credit audit, regional manager’s report, etc.
(10) Read the local news-paper daily, ascertain the position of accounts with other
banks, exchange information about the borrower in the consortium meeting, etc.
(11) Initiate any other steps to prevent slippage in standard asset.
-000-
Chapter- 11
Recovery Measures
1. INTRODUCTION
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NPA of the banking system is moving up. Gross NPA of PSB stood at Rs. 123 lakh
crores at the end of Jun, 12 and have seen an addition of Rs. 11000 crores in last 15
months (ET 23.08.12). In this chapter, it is attempted to discuss about various recovery
measures adopted by banks and financial institutions (FIs) to recover dues including
NPA. Over the years, many initiatives have been taken by the Reserve Bank of India
and the Government of India in introducing new measures in the light of the problems
experienced by banks and FIs In addition, these banks and FIs have also tried to
come-out with innovative ideas for NPA reduction. Data in respect of all these measures
is not available and hence, it is difficult to point-out which of the measure is most
effective. But experience suggests that each measure is unique in terms of its
effectiveness. Hence, it is worth to review such recovery measures. For our
convenience, these can be classified into non-legal and legal measures.
NON-LEGAL MEASURES1. Reminder system
2. Visit to Borrower’s Business Premise/Residence
3. Recovery camps
4. Road shows
5. Appointment of Professional Recovery Agents
6. Holding on operations
7. Rehabilitation of sick units
8. Corporates Debt Restructuring
9. Loan compromise
10. Lokadalat or Loknayalaya
11. Circulation of List of Defaulters
12. Appropriation of subsidy or exercising the right to set-off
13. Recalling of Advances
14. Write-off
15. Recovery through Specialized Branches (Recovery branches)
LEGAL MEASURES15. Recovery through Judicial Process (Filing of suit)
16. Debt Recovery Tribunals
17. National Company Law Tribunal
18. Merger and Amalgamation
19. Financial Reconstitution
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20. Recovery under Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002.
21. Other Legal measures.
NON-LEGAL MEASURES1. Reminder SystemThis is the cheapest mode of recovery by sending reminders to the borrowers before the
loan instalment falls due. Generally, response to this arrangement particularly from
honest borrowers is encouraging. But efforts need to be strengthened in banks in
sending reminders on timely basis. Enough care should be taken to prepare a draft-
letter in informal language (preferably regional language) If possible; better quality
stationery may be used to motivate borrowers to open the letter. With the
computerisation of branches, this measure can be heavily relied upon.
2. Visit to Borrower’s Business Premise/ResidenceThis is a more dependable measure of recovery. Visits need to be properly planned.
Involvement of staff at all levels in the bank branch is called for. Costs involved in
recovery need to be kept to the minimum. Frequent visits are called for in case of
hardcore borrowers. Over the years, it is observed that the number of visits is going
down due to cut in workforce in banks. Consequently, the recovery process is affected.
Branches should maintain a record of visits made and recovery amount collected. It is
essential to conduct visits in a planned manner when limited time is available in this
regard.
3. Recovery CampsIn respect of agricultural advances, recovery camps should be organized during the
harvest season. To take maximum advantage, recovery camps need to be properly
planned. It is also essential to take the help of outsiders, particularly, revenue officers in
the state government, local panchayat officials, regional manager in the bank, etc. It
also calls for a professional approach to give a wide publicity of the recovery camp to be
organized in the local area, mobilize as many farmers as possible and motivate the staff
to get involved in the recovery drive. On the spot compromise/settlement should be
encouraged which gives positive signals to the borrowers.
4. Road showsIn case of recalcitrant borrowers, it is a very effective way of creating pressure on the
borrower. During road show, a group of employees calls on the borrower and persuades
him to repay bank’s dues. The timing of road show is strategically fixed during peak
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business hours of the borrowers so that there is moral pressure on him not only from his
neighboring businessmen but also from the customers. Many banks have very
effectively used this tool of recovery, particularly from businessmen and salaried class.
There are certain do and don’t for the road show. The road show must be organized in
peaceful and non-violent manner. It should be within normal business hours and should
not be organized either in the late evening or early morning. Manager should watch over
the activity of his other officers and see that no body takes law and order in his hand.
Confrontation or show down with the borrower should be avoided.
5. Appointment of Professional Agencies for RecoveryRecently, IBA has framed model policy for banks on matters concerning the
appointment of outside professional agencies whose services can be utilized to
ascertain the whereabouts of the borrowers, enforcement of securities and recovery of
money lent. It is observed that there is some hesitancy on the part of public sector
banks in engaging them for recovery purposes due to unpleasant experiences in certain
cases. But looking to rising magnitude of NPA, banks have little option but to engage
professional agencies for recovery and enforcement of securities. This should, however,
be done after examining the credentials of the agencies and following guidelines. It is
also essential for the bank to keep a constant vigil on their practices so that there is no
occasion of alleged harassment or intimidation of any kind, either verbal or physical,
against any person in their debt collection efforts, including acts intended to humiliate
publicly or intrude the privacy of the borrowers/guarantors/ or their family members . In a
land mark judgment given by Supreme Court Hon’ble Justice A.R. Lakshmananan and
Altamas Kabir has observed that “‘we are governed by a rule of law. The recovery
could be done only through legal means. The banks cannot employ goondas to take
possession.” As per draft guidelines of RBI circulated on 30 th November 2007, RBI has
suggested that Indian Institute of Banking and Finance will introduce test for recovery
agents which will have training period of minimum 100 hours and appoints of recovery
agents after one year will be subject to their passing such tests.
6. Holding on operationsHolding on operations gives respite to the borrowers and help them to run the
business till finalization of rehabilitation or restricting package. The facility can be
permitted in NPA or potential NPA accounts which show warning signals.
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7. Rehabilitation of Sick Units At present, there are two types of sick units financed by the banks and the financial
institutions. These include:
a) Industrial units in the small scale sector.
b) Industrial units in the Non-small scale sector.
As per the Government of India definition, a small scale industrial unit is the one in which
case, the investment in the plant and machinery (original costs) does not exceeds
Rs.100 lakhs ( enhanced to Rs. 500 lakhs for certain specified items) and in the case of
ancillary units the same should not exceed Rs.25 lakhs. All those accounts, which fulfill
this definition, are treated as the units in small sector. All other industrial accounts are
treated as units in the non-small scale industrial sector. Reserve Bank of India has
defined a 'weak’ unit in the non-SSI sector. Sick Industrial Companies (special
provisions) Act (SICA) also defines a 'sick’ unit in the non-SSI sector.
Definition of a Sick Unit in the SSI SectorSSI and Tiny/Decentralized unit – Any borrowal account which becomes sub-standard
when interest or principal is overdue for more than 6 months or, its accumulated losses
exceed 50% of net worth and the unit has been in commercial production for atleast 2
years, is considered as sick unit.
Definition of a Sick Unit in Non-SSI Sector i.e., Weak CompanyAccording to the RBI definition “an industrial unit will be classified as 'weak' at the end of
any accounting year if it has accumulated losses equal to or exceeding 50 per cent of its
peak net worth immediately preceding 5 years”. This definition is applicable to all those
units in the non-SSI sector and not falling under the purview of the Sick Industrial
Companies (Special Provisions) Act, 1985.
The section 3 of the Sick Industrial Companies (Special Provisions) Act 1985 defines a
sick company as under:
“A Sick Industrial Company means an industrial company registered as a company for not less than 5 years and has accumulated losses equal to or exceeding its net worth”. Causes of SicknessCauses of industrial sickness have to be viewed from the general background of
industrial economy. At a point of time, the problems of industries are not uniform.
However, factors generally responsible for the problems can be divided into external and
internal. External factors are those over which the unit has no direct control and, internal
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factors are those which are within the control of the management of the concern.
Sickness can originate right from the stage of conception to the stages of crystallization
of the concept and/or implementation of the project.
(A) Rehabilitation of Sick Units not falling under the purview of the SICAIn general, a sick unit is defined by considering its capacity to generate internal funds. A
sick unit fails to generate internal surplus on a continuing basis and depends on its
survival on frequent infusion of external funds. Thus the nursing programme is for
raising the unit’s capacity to generate adequate internal surplus. A certain portion of
internal surplus could then be used for reducing the irregularity in the account. A
suggested approach to nursing of sick SSI unit is given in chapter-13.
(B) Rehabilitation of Sick Companies as under Sick Industrial Companies Act (SICA) -Where an industrial company (defined under Sec 3 of Industrial Development and
Regulation Act of 1951) has become sick, the Act provides for a reference to the Board
within 60 days of finalization of audited financial statements for determination of
measures that may be adopted. Such measures may include merger, financial
reconstruction sale or lease of a part or whole of activity, change of management, take
over of ownership etc. It is obligatory for the sick companies to refer their cases to the
Board. Financial institutions, RBI and the Government may refer the companies to the
Board for Industrial and Financial Reconstruction, referred to as the Board hereafter.
The Board determines whether the company has become sick and then registers the
case. After registration the Board decides the strategies to be adopted for revival. The
scheme is then prepared. The written suggestions and consent from all concerned
parties are obtained. Thereafter, the legal formalities as stated under the relevant Acts
(such as Companies Act 1956, Foreign Exchange and Regulation Act etc.) are
completed. After the formalities are completed, the scheme is sanctioned which then will
be binding on all the concerned parties. Where the sanctioned scheme is implemented,
the Board may call for any information from the company for assessing the progress in
implementation of the scheme and effects of the scheme on overall performance of the
company. If necessary, the Board may appoint a Special Director on the Company’s
Board to safeguard the interest of financial institutions. For any misuse of funds, the
Board can take legal action. Thus, it is hoped that the Board consists of members who
have special knowledge and professional experience of not less than 15 years. There is
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a provision to appoint 14 members on the Board. With the above arrangements it is
hoped that the Board would be able to deal with the matters of rehabilitation more
effectively. The Industrial Reconstruction Bank of India (IRBI) performs a similar job but
it does not possess as much statutory powers as that of the Board. Under the Act of
1985, the Board and Appellate Authority are deemed to be the civil courts and all
matters of rehabilitation are dealt with legally to safeguard interest of sick companies
and public. Nursing or rehabilitation programme varies from unit to unit. But it is
essential that important aspects of nursing or rehabilitation have to be highlighted in the
programme. In this context, a broad outline on nursing or rehabilitation is already
discussed earlier.
To conclude on rehabilitation, though enough arrangements are made in terms of
formulation of policy guidelines, rehabilitation schemes, creation of sufficient number of
institutions to look after revival of sick units, the success rate is very low. Hardly, 5 per
cent of total sick units are fully revived. This is mainly due to lack of seriousness on the
part of entrepreneurs, lack of co-ordination between banks and financial institutions,
substantial delay in release of subsidies/relief from the government, etc. But our efforts
in rehabilitation of sick units need to be strengthened. It is cheaper to revive a sick unit
than starting a fresh one on its closure. Further, chances of recovery of bank dues are
high if sick units are revived successfully.
8. Corporate Debt Restructuring (CDR) BodyA need was felt to create a special agency to facilitate debt restructuring because there
has been some hesitancy on the part of banks and financial institutions to implement
RBI guidelines on debt restructuring. Recently, a three-tier body, viz., CDR has been set
up to co-ordinate the corporate debt-restructuring programme. CDR consists of forum,
Group and Cell. While the Forum evolves broad policy-guidelines, the Group takes
decisions on the proposals recommended by the Cell. Initially, the borrower approaches
his Lead Bank/FI with a request to restructure debt, which in-turn puts up the proposal to
the Cell. The CDR covers only multiple banking accounts enjoying credit facilities
exceeding Rs 20 crore. Cases of DRT, BIFR and doubtful and loss accounts and suit-
filed cases are outside the purview of the CDR. Even cases of willful default can be
considered excepting cases of willful default or diversion of funds with malafide intention.
Thus, standard and sub-standard accounts are only eligible to seek CDR shelter.
Decisions of the group are based on the `super majority’ principle. If 75 per cent of the
secured creditors by value and 60% by number agree to the rehabilitation plan, it is
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binding on the other banks/FIs. The CDR is a voluntary system based on debtor-creditor
agreement and inter-creditors’ agreement. No banker/borrower can take recourse to
any legal action during the `stand-still’ period of 90-180 days. While the arrangements
under CDR seem to be feasible from the debt restructuring perspective, its success
depends upon the cooperation extended by borrowers and bankers, on the one hand,
and understanding among banks and FIs, on the other. Doubts are raised about the
implementation of these agreements taking into the present working of the loan
consortium arrangements. RBI has constituted a committee under chairmanship of Mr
Vepa Kamesha, Deputy Governor, RBI to look into operational difficulties of the scheme
and to suggest measures to make the scheme effective. Total debt restructuring is
expected to reach Rs.1.5 lakh crores at the end of March, 12 from Rs. 1.1.lakh crores at
the end of March, 11.
9. Loan compromiseIn general, it is experienced that filing of suits and recovery of dues of banks through the
process of courts is a cumbersome, expensive and time consuming task without any
fruitful results in many cases. One of the main reasons attributed for non-recovery of
dues through the process of law/court is lack of proper follow-up and timely and proper
action. Hence, it would be worthwhile to think of other ways to tackle the situation. The
tradition of amicable settlement through panchyat and arbitration, leads to think as to
why bank loan disputes cannot be settled without having a recourse to the court.
A compromise in bank loan means agreeing to a borrower’s request of accepting a part
of outstanding of dues in the books of the bank as full and final payment or allowing for
the non-compliance of the terms of the loan, after analyzing the alternative courses of
action, genuineness and capacity to repay. It is also called as voluntary debt reduction
or scaling data of dues. In the situation, where the borrower’s ability/capacity is repaying
the bank’s dues and the bank’s ability to recover the same by other means are limited; a
compromise proposal can work well.
Compromise proposals can be entertained at different stages, which include (a) pre-
litigation stage, and (b) post litigation/decree stage. At the pre-litigation stage,
concessional measures such as reschedulement, rephasement, rehabilitation, etc. can
be used which would allow some breathing time and build/strengthen the repayment
capacity of the borrower. However, when such measures initiated in the account do not
yield any fruitful result and the borrower incurs heavy cash losses, it is better to go in for
a compromise or scaling down the dues. Similarly in other cases, where business loss
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has crept in due to one or other genuine reasons and the borrower is not a willful
defaulter and requests for minor concessions such as waiver of penal interest,
concession in interest rate, etc, the borrower’s offer can be accepted for compromise. In
these cases, reschedulement of unpaid loan installments can also be considered.
Compromise at post-litigation/decree stage can also be entertained so that the
borrower’s business or activity is uninterrupted. In order to avoid cost, labour and time
involved in litigation matters and to have better image in market, borrowers offer a lump-
sum amount and request the bank to withdraw the suits against them. At times, it
becomes necessary, in some cases, to settle outside the court through an amicable
agreement and, the antecedents of the defendant are such that courts take a
sympathetic view and award a lenient decree against the defendants. Sometimes, after
obtaining decree, if a third party comes forward to purchase the assets, the bank may
consider the case for compromise. It is also possible for the bank that it may go in for
compromise if the decreed asset would not fetch more than the claim the amount. In all
cases, where suits have been already field, whatever compromise is to be made, must
be sorted out through court in the form of a consent decree, so that it will be binding on
all defendants. If parties do not fulfill the promise, remedy through court or Debt
Recovery Tribunal will always open to the banks.
There can be two types of compromise. The Reserve Bank of India and the
Government of India worked out One Time Settlement Schemes covering loan
outstanding upto Rs. 5 crores (subsequently raised to Rs. 10 crores) and Rs. 25000
respectively. In addition, each bank is given an autonomy to evolve One Time
Settlement (OTS) Scheme. It is necessary to create awareness on OTS and mobilize as
many compromise proposals as possible. There should not be any delays in arriving at
compromise. Such proposals should be prepared carefully keeping in mind the bank
guidelines. Otherwise, this may become a vigilance case. It is better to involve all staff
members in mobilizing compromise proposal. Care should be taken that the recovery
through compromise does not give a wrong signal to a good borrower. Over the years,
banks have succeeded to recover through compromise substantially. But there is
enough scope step up the recovery drive through this measure.
If decided to go in compromise, all issues must be sorted out through the court in the
form of a consent decree, so that it will be binding on all defendants. In case of more
than one judgement debtor, the consent of one and all is required for compromise. In
any case, the compromise has to be decided on the basis of merit of each case.
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In view of the fact that huge amount is being blocked in non-performing assets for quite
a long period with all kinds of risks and uncertainties, compromise for settlement of debt,
viz., by allowing certain concessions to borrowers, has to be encouraged and for that
purpose, a cost-benefit analysis can be done which on one hand takes into account the
loss which may arise in case compromise is accepted and the benefit which may accrue
if the compromise is not made, on the other. In general, it is experienced that the banks
will be advantageous position in opting for an amicable settlement rather than for legal
approach. Besides, such compromise would avoid all legal complications, time lapses
and other inherent risks of individual loans.
Every branch manager has to formulate a compromise proposal in the light of broad
guidelines issued by the bank. The proposal should contain major items which include
means or capacity of the party, determination of amount covering outstanding amount,
other charges, etc. efforts already made for recovery, staff accountability, etc. The
proposal recommended should be referred to the sanctioning authority which examines
several factors including fulfillment of terms and conditions of sanctioning of loan
compromise, any laxity in conduct and post-disbursement supervision of the account,
any act of commission or omission on the part of staff leading to the debt proving
irrecoverable, enough recovery efforts put in, valuation of securities, interest to be
charged in respect of settlement though installment, etc.
Loan compromise should be considered as a last resort of recovery. It should be a
voluntary exercise. It calls for a professional approach in preparing the compromise
proposal for which each bank is given autonomy by the Reserve Bank of India. In
addition, compromise schemes introduced by the Government of India (upto Rs
25,000/-), the Reserve Bank of India (in the first instance upto Rs 5 crores and then for
Rs 10 crores), should be implemented as per the guidelines covering the eligibility
criterions, the cut-off date, and nature and extent of concessions. Decisions on
compromise proposals should be taken by adopting a committee approach. In this
regard, banks have been advised to set up a Settlement Advisory Committee. Though
there are many schemes of compromise, success in recovery is limited due to lack of
awareness of such schemes by small farmers, small traders etc; due to stricter vigilance
norms the staff is hesitant to entertain compromise cases; difficulties in fixing staff
accountability before recommending a proposal; etc. Efforts should also be made not to
encourage good borrowers to seek compromise. In any case, due to high NPAs, banks
have to depend on loan compromise as an effective measure of recovery.
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10. Lokadalat or LoknyayalayaThe concept of Lok Adalat was introduced in 1982 as part of strategy of legal aid. By
now, it is known for effecting mediation and counselling between the parties and to
reduce burden on the court, especially for small loans. Large number of Lok Adalats is
being organized in different parts of the country from time to time and it has got
recognition and patronage, particularly, every segment of the society. Based on
experience of several states, a Central Act known as Legal Services Authorities Act,
1987 was passed providing legal basis for the Lok Adalats and Legal Authorities to the
compromise arrived at between the parties through such Lok Adalats. Several people of
particular localities / various social organizations are approaching Lok Adalats which are
generally presided over by two or three senior persons including retired senior civil
servants, defence personnel and judicial officers. They take up cases which are suitable
for settlement of debt for certain consideration. Parties are heard and they explain their
legal position. They are advised to reach to some settlement due to social pressure of
senior bureaucrats or judicial officers or social workers. If the compromise is arrived at,
the parties to the litigation sign a statement in presence of Lokadalats which is expected
to be filed in court to obtain a consent decree. Normally, if such settlement contains a
clause that if the compromise is not adhered to by the parties, the suits pending in the
court will proceed in accordance with the law and parties will have a right to get the
decree from the court.
To arrive at compromise with the party, banks may provide remission of interest, etc. In
this context, certain guidelines have been formulated by banks in consultation with the
Indian Banks Association (IBA). Accordingly, the bank-suits involving claims upto Rs 5
lakhs (now raised to Rs 20 lakhs) may be brought before the Lokadalat. There should
be decree for the interest claimed before suit. Now a days, even non-suit filed cases in
the doubtful and loss categories can be considered for settlement. Debt Recovery
Tribunals can also organize Lokadalats. Lokadalats have to finalize settlements in terms
of broad guidelines of the concerned bank.
In general, it is observed that banks do not get the full advantage of the Lokadalats. It is
difficult to collect the concerned borrowers willing to go in for compromise on the day
when the Lokadalat meets. In any case, we should continue our efforts to seek the help
of the Lokadalat.
11. List of Defaulters of RBI and of CIBIL
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Currently, the RBI circulates the list of defaulters among Financial Institutions (FIs) and
Banks which is found useful in avoiding wilful defaulters. The RBI has defined a wilful
defaulter for the first time. It has provided the broad parameters for identification of wilful
defaulters whose list will be circulated among banks and FIs. Auditors of companies
have to report in their certificate about diversion of funds, if any. In addition, on January
30, 2001, Credit Information Bureau of India Limited (CIBIL) was set up to provide
critical data required by any credit institution before arriving at credit decision. CIBIL
was set up jointly by State Bank of India, HDFC, Dun and Bradstreet and Trans Union.
Credit Information Bureaus, like credit rating agencies, are critical for the operation of the
financial system and, in many ways, have a privileged relationship with the regulator.
Banks/FIs to obtain the consent of all their borrowers for dissemination of credit
information to enable CIBIL to compile and disseminate credit information. CIBIL now
has a database of 8 million records of credit history of individual consumers taken from
various banks, financial institution, micro-finance companies and non-banking finance
companies. CIBIL also plans to broaden its scope to store information on buyers of
insurance and services like telecom and other utilities. FI/Banks/NBFC who are
members of CIBIL can determine on line whether a prospective borrower is a disciplined
borrower or a serial defaulter on payment of fee of Rs 10 per borrower.
11. Appropriation of Subsidy or Exercise of Right of Set-offIn some of the sponsored schemes, namely, SEEUY or SUME, the amount of subsidy is
kept in deposit accounts to be appropriated after a specified lock-in-period. In such
cases where subsidy is available and the account is likely to become NPA, the subsidy
amount should be appropriated (keeping in view the requirements of lock-in-period) in
the loan account and necessary action should be initiated for recovery/write off of the
balance amount. Where readily encashable securities such as Fixed Deposits, LIC
policies, Govt. Securities etc. are available and borrowers are not responding to request
for regularization of accounts, such securities should be encashed after giving due
notice to the borrowers, guarantors etc.
12. Recalling of AdvancesWhen rigorous follow up efforts do not yield any fruitful result and circumstances so
warrant that the their loan amount to be realized at once and/or facility to be terminated
in the interest of the bank, a final recall notice has to be served asking the party to adjust
the irregularity in the account immediately. Wherever necessary, the party is also
informed about the bank’s intention to terminate the facility after the specified time limit.
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As far as possible, issuing of legal notice should be restricted to once only and in case of
small advances, recall notice through an advocate may be avoided unless the
circumstances require such a course of action. Recall notice should be sent if the
borrower is a willful defaulter, bank liability is significantly uncovered, death of the
borrower, dissolution of partnership firm, siphoning of funds, borrower refusing to renew
the credit limit, etc. All normal recovery efforts should have been made to pursue the
borrower and guarantor to repay the dues which include personal contacts, persuasion,
serving demand notice, bringing local influence, proposal for transfer to recalled
advance, etc. The proposal should be submitted to the appropriate sanctioning authority
at least six months before expiry of Limitation period. As per the Credit Guarantee Fund
Trust, requirement of a recall notice to borrower/guarantor should be issued providing
therein a 30 days’ time for adjustment of the account. The notice should be served
properly. On serving a recall notice and getting the approval of the higher authorities, the
accounts should be transferred to recalled-category to exercise utmost care for effecting
recovery, and to have special control over accounts. Branch managers should initiate
appropriate course of action for recovery depending upon the case. In respect of
genuine borrowers, the action points include persuasion, personal contracts,
reschedulement, remission of penal interest, one-time settlement and write off wherein
the amount is small and chances of recovery are almost nil. But in respect of willful
defaulters, it is better to file a suit. While sending a proposal to recall the advance to the
higher authorities, necessary information should be provided in the prescribed formats.
Such information includes statement of account, Confidential Report (CR) of borrowers
and guarantors, latest stock position, valuation of securities, present activities, reasons
for stopping operations, efforts made for recovery, etc. Interest application in the
account should be stopped as per prudential norms but must be calculated each month
but for the purposes of filing suit, Credit Guarantee Fund Trust, etc interest and other
charges may be debited to a separate account i.e. sundries or suspense account. Any
recovery made from the recalled advances, the amount to be shared with the Credit
Guarantee Fund Trust on pro-rata basis. Corresponding entries have to be made in the
party’s recalled advance account. Thus, the exercise of recalling of advances is one of
the recovery strategies, which are found effective in respect of genuine borrowers who
avoid facing legal action through the courts.
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13. Write off If it is going to be unremunerative either to file suit and/or continuing the account in the
bank's books, it is advisable for the bank to go in for waivement of legal action and/or
writing off dues. By waiver of legal action, banks may take a decision not to pursue
recovery through a Court of Law. But for write off, the banks can decide to close the
account by transfer of funds from their profits to the loan account. Waivement of legal
action is suggested when (i) the means of the borrower are negligible, (ii) borrowers are
below the poverty line, (iii) cost of recovery is higher, (iv ) beneficiaries are absconding,
(v) it is difficult to obtain periodic balance confirmation of debt cum-acknowledgement of
debt, and (vi) securities are already sold by the borrower. Write off is proposed under
certain circumstances such as (i) borrowers are adjudicated as insolvents and the bank
has already realized part of the dues as a secured creditor, (ii) Revenue authorities
under the State Public Recovery Act have recovered some amount and there no further
chances of any recovery (iii) both borrower and guarantor are untraceable after selling
their assets, and (iv) decrees remain unexecuted several times due to reasons beyond
the control of the bank. Decisions to waive legal action or write off are taken at
controlling office on recommendation of the Branch Manager. If permission of the
Credit Guarantee Fund Trust is required, the same may be obtained. For write off,
various factors are considered which include (i) means or capacity of the borrower and
guarantor (ii) the amount to be written off (iii) efforts of recovery already put in and, (iv)
staff accountability. The write off exercise is internal and the branch staff should keep
the matter confidential. Even after write off, recovery efforts should continue and if any
amount recovered in this regard, the same may be shared with the Guarantee Fund
Trust on pro-rata basis. Finally, the branch managers should comply with the entire
bank guidelines in respect of write off.
14. Recovery Through Specialized (Recovery) branchesTo deal with the matters related to tribunals, certain expertise is required. Such
expertise is also needed to effect recovery from core NPAs. In this regard, a few public
sector banks have set up Recovery Branches, which are exclusively concerned, with
the NPAs with a total liability of Rs. 10 lakhs and above. These branches undertake
certain activities which include creation of data base of NPAs, monitoring of the NPAs,
recovery from NPAs through compromise, follow-up of the decreed accounts etc. and
additional attention to the matters related to special tribunals. These branches are set
up without creating any burden to the bank by using the unutilized premises. A senior
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executive heads these branches. Officers working earlier in rehabilitation cell in the
controlling office are generally posted to these branches. Each branch is provided with a
computer to create the database. These handle suit filed accounts, recalled advances
and the cases in which legal proceedings are yet to be initiated. The number of
accounts in these branches is in the range of 60 to 90. These branches should keep a
close contact with the advocates and court authorities. Execution of decree or DRC
certificate is their prime task. These branches experience a few problems. To
elaborate, response to compromise proposals from borrower is not encouraging.
Consequently, these branches have to go through the lengthy procedures for court
settlements. In decreed accounts, details of assets of the judgement debtor are not
available in most of the cases since the time lag between the date of filing and the award
of a decree is more than 10 years. As a result of this, execution is found to be difficult.
Finally, it is essential to create the required expertise by providing at least one law officer
in the recovery branch. Even after the transfer of accounts to the recovery branches, the
original branches should continue to put in their efforts for recovery and assist the
recovery branches in finalizing the compromise deals. While transferring the accounts,
the original branches should ensure necessary details of net worth, securities,
whereabouts of the key partners/directors and guaranteers, etc. In this regard, they may
also prepare a fresh inspection report on the accounts to be transferred to the recovery
branches. Taking into account the increasing number of NPAs and complexities of
recovery, these branches may engage professional recovery agencies on fee basis. But
it should be ensured that these agencies should not follow unlawful measures. Similarly,
to know about the details of the properties of the borrowers/ guaranteers, services of a
professional detective agency may also be hired provided their fees are reasonable.
Lastly, wherever good clients are available in the local area, they may also be
persuaded to take over the recalled/decreed accounts to effect recovery.
15. Help of informers: With defaulters employing new means to siphon off funds and
conceal assets, banks are also reinventing ways and means to identify assets own by
defaulters to take recourse to attachment and auction. Madras high court vide its 2007
judgment has considered legality in engaging informers while ruling that if borrows can
find newer methods of evading repayment of bank loan, banks are justified in devising
newer methods of recovery.
16. Other Measures
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It is suggested to review the existing system of staff incentives for recovery from
hardcore NPAs/de-recognized interest. Incentives may also be offered to lawyers who
can manage to get a decree in a record time. Close monitoring of suit-filed cases with
dealing advocate is also called for. Certain banks are having system of periodical review
with the advocates, which has been very effective. Finally, in respect of small advances,
loan write-off may be considered, if the chances of recovery are not fair and cost of
litigation is disproportionately high to possible recovery
LEGAL MEASURES17. Recovery through Judicial ProcessWhen bank’s are convinced that all other non-legal recovery measures would not bring
any positive result and the documents may become time barred or have fear that the
securities charged might be alienated to the determent of the bank, bank has to resort
to legal action. Before taking a decision to file a suit, the bank shall ensure that there
are sufficient securities available in the account and the borrowers and guarantors are
having adequate attachable assets to satisfy the decree against them. The purpose of
obtaining decree serves the purpose only when it is capable of being executed.
Enough care has to be taken at early stage of recovery through courts. These stages in
chronological order include summon servicing, submission of a written statement,
recording the evidences, arguments, framing of issues, decision and order. Firstly, the
permission to file suit has to be obtained from the competent authority in the bank.
Thereafter, the branch manager to file suit should contact the approved advocate.
Before filing the suits, branch manager should ensure that documents are live, securities
are properly charged to the bank, fresh financial report on borrower / guarantor is
obtained, and a complete list of witnesses is prepared. The banker should exercise the
right of set off / appropriations, if any liquid security/balance in other account is
available. The plaint prepared by the advocate is checked up thoroughly as to the
correctness of facts and figures. All parties and guarantors are to be sued. Names and
addresses and securities should be stated properly and, suit should filed in the court of
the specified jurisdiction. A notice of demand to the borrower and the guarantor should
be issued before commencing any legal action. In respect of a suit against the
government, statutory notice should be sent in accordance with the provisions of Section
80 of CPC.
In particular, to serve the summons, address and other details of the defendant should
be collected by the branch manager. Bank's advocate should be contacted time and
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again to impress upon him to complete court formalities relating to hearing, submission
of statement, etc. The branch manager should brief the advocate on banking aspects.
After the decree is awarded, the details of the same should be read carefully.
There can be different kinds of decree such as a) simple mortgage decree which is for
the realization of money charged on immovable property by sale, b) for recovery of
possession of land; c) for recovery of any property other than land or money; d) for
ordering to do some act other than payment of money or to stop from doing some i.e.
under this may be classified decrees for specific performance of contracts, execution of
documents, injunction, etc.
If it is a conditional decree, condition must be fulfilled before execution. A decree which
is on the face of it a nullify cannot be executed. It must not be barred by limitation.
Execution of decree shall be in different forms such as delivery of property, appointing a
receiver or in such other manner as the nature of relief granted, attachment and sale and
by arresting of Judgment Debtor (JD). Execution by arrest is not available as a matter of
right and arrest or detention cannot be ordered unless it is proved to the satisfaction of
the court that the borrower is unwilling to pay inspite of adequate means to pay. The
burden of proving this is on the decree holder. Court may refuse simultaneous
execution against the person and property of the debtor.
According to Article 136 of Limitation Act, 1963 the period of limitation is 12 years for the
execution of any decree other than those granted and mandatory injunctions or order of
any civil court. But an execution application made within 12 years, may carry the
execution proceedings beyond 12 years for the purpose of final completion. Money
payable under a decree shall be by depositing into court, payable outside court directly
to the decree holder or his/her banker, or as the court directs.
Further, the execution may also be applied against the Judgment Debtor. If the
Judgment Debtor dies before satisfaction of the decree / order, the decree holder may
apply for execution against his legal representatives. The legal representative shall be
liable only to the extent of the property if the deceased debtor, which has come to his
hand and has not been fully disposed off. The court may compel such legal
representatives to provide such account as it thinks fit. Similarly, the application for
execution is to be paid by the decree holder. If he is dead, the legal representatives may
apply for execution.
As soon as the accounts are decreed, it should be ensured whether the decree is in
conformity with the claims made by banks in the plaint. In case of any major
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discrepancy from bank’s normal claim, steps should be taken for revision / appeal within
a reasonable time, say one month from the date of decree. As soon as decrees are
awarded , execution petition should be filed within three months of the date on which
certified copies are made available to the bank branch. In decreed accounts where
certain agricultural land is to be attached, bank may participate in the auction for which
necessary permission from the competent authorities within the bank is needed. In case
securities are attached before judgment and / or after execution of decree and kept in
bank’s custody, due care should be taken as to keep them in tact. When a case is
decided partly or wholly against the bank, desirability of filling of an appeal or otherwise
should be considered. If there is a default clause, which states “whenever borrower
fails to pay three consecutive installment, decree becomes absolute or otherwise” steps
for execution of decree for whole amount should be initiated on occurrence of the
default. The judgment debtor which does not pay in terms of the decree, alternative
steps for execution, by attachment and sale of the properties and/or by arrest of the
judgment debtor etc. as may be deemed for, should be taken promptly. Insolvency law
enables a creditor, who has obtained a decree to realize his debt by serving insolvency
notice of not less than a month. A debtor who fails to comply the notice within the
specified period, Bank can proceed against him for adjudicating him as an insolvent. If
the property to be attached which is situated outside the jurisdiction of the court, which
has passed the decree, it should be got transferred to the other concerned court in
whose jurisdiction the property is located.
Quite often, banks have to proceed against their borrowers in a court of law where no
security is available. It takes a long time to obtain a decree like in other cases, and then
proceed for execution of the decree so obtained. In such case, the Code of Civil
Procedures 1908, order 37 offers a quick remedy known as summary procedure suit,
which banker can use. The procedure of summary suit can be availed in applicable
cases (such as bills of exchange, promissory notes, etc.) and in case of secured
advance, the procedure is not advisable as security held by the bank is not enforceable
under the order 37. But under the Limitation Act 1963, there is no difference in the
period of limitation between summary suits or other suits. As part of procedures the
summons of the suit is issued first and when the defendant appears, the plaintiff is to
serve on defendant summons for judgment. When the summons of the judgment is
served, the defendant has to obtain the leave court to defend the case. If the defendant
does not turn up for hearing, the claim of the bank is presume to be admitted.
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There are certain difficulties in respect of recovery through the courts. The time
consumed in the entire process is very long. The long pending civil suits hamper the
settlement of the new cases. Even after a long waiting period in majority of the cases,
courts go on circumstantial evidences and technicalities of the case. Even where the
securities can be enforced, the process takes a considerable time. When banks finally
realize their dues, the amount recovered is much less than the amount lent, if inflation is
taken into account. Further, suits filed by banks do not get any priority in the courts and
they have to wait for their turn for the same to come up for hearing when securities
deteriorate in value and recovery, if at all, is negligible. When it is decided to execute
the decree awarded, there may not be a purchaser or he may offer such a low price,
which may not cover the amount of default resulting in a loss to the bank. Lastly, three
is a feeling amongst defaulters that they can hold up recovery as much as possible or
extract as much monetary concessions as possible.
18. Debt Recovery Tribunals (DRTs)The proposal for setting up of special Tribunals for recovery of debts due to banks and
financial institutions (FIs) was the important legal development in the country. This
proposal was very much in line with the recommendations of the Tiwari Committee and
the Narasimham Committee. The need was felt for creation of such Tribunals due to
considerable delays in disposal of cases by the courts. As on September end 1990,
more than 15 lac cases of public sector banks were pending in various courts. These
Tribunals are set up under the Recovery of Debts due to Banks and Financial Institutions
Act, 1993.
Under the Act, two types of Tribunals are set up i.e. Debt Recovery Tribunal (DRT) and
Debt Recovery Appellate Tribunal (DRAT). The DRTs are vested with competence to
entertain cases referred to them, by the banks and FIs for recovery of debts due to the
same. Each DRT consists of a Presiding Officer who is appointed by the Central
Government who is or has been or is qualified to be a District Judge. But DRAT
constitutes of only one person who is / has been / or is qualified to be, a High Court
Judge or, he must have, for at least three years, held a post in the Indian Service Grade
I or, he must have worked as the Presenting Officer of DRT for at least three years. The
order passed by a DRT shall be appealable to the Appellate Tribunal but no appeal shall
be entertained by the DRAT unless the applicant deposits 75% of the amount due from
him as determined by it. However, the Affiliate Tribunal may, for reasons to be received
in writing, waive or reduce the amount of such deposit.
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Under the 'debt’ means “any liability (includes of interest) which is alleged as due from
any person to a bank or a FI during the course of any business activity undertaken by
the bank or the FIs or the consortium under any Law for time being in force, in cash, or
otherwise further secured or unsecured, or whether payable under a decree or order of
any civil court, otherwise substituting on and legally recoverable on the date of
applications”.
Any case involving debt exceeding Rs 10 lakhs can be referred to Tribunal. However,
the Central Government may reduce this ceiling, if need arises. Every suit or other
proceeding pending before any court immediately before the date of establishment of a
Tribunal under this Act being a suit or a preceding, the course of action whereon it is
based is such that it would have been, if it had arisen after such establishment, within
the jurisdiction of such Tribunal shall stand transferred on that date to such Tribunal.
Under the Act, banks, All Indian Financial Institutions and RRBs are eligible to approach
the Tribunal.
There may be three propositions relating to procedures. First, the Tribunal and the Appellate Tribunal shall not be bound by the procedures laid down under CPC, 1908. Second, they will be guided by the principles of 'natural justice'. Third, subject to other provisions of this statute and of any rules, they shall have made to regulate own procedure, including the places at which they shall have their sittings.An important power conferred on the Tribunal is that of making an interim order (whether
by way of injunction or stay) against the defendant to debar him from transferring,
alienating or otherwise dealing with or disposing of any property and the assets
belonging to him without prior permission of the Tribunal. This order can be passed
even while the claim is pending.
After the claim is upheld by the Tribunal, it issues a certificate to the Recovery Officer
and the latter has various powers in execution include attachment, sale, arrest,
appropriation as Receiver and power to require the defendant (debtor) to remit the
money to the Recovery Officer. Under the Act, the Recovery Officer possesses the
powers as that of an Income Tax Officer for recovery debts due to the banks and FIs.
The Act provides the Tribunal and Appellate Tribunal the powers of a Civil Court in
several maters. These include summoning of witnesses, discovery and production of
documents, receiving evidence on affidavits and issuing commissions. The Act also
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requires both tribunals to dispose of the applications or appeals within a period of 6
months.
The special machinery in the form of debt recovery tribunals and recovery officer will
help in expediting the hearing, determinations and recovery of bank claims which
generally wait in the queue for years even for reaching a stage of hearing. The
requirement of depositing of 75% of the claim amount for appeal will prevent endless
tribunal appeals.
Procedures to be followed under the Act are simple. To start with, the concerned bank
or FI is expected to make an application to the Tribunal within the specified geographical
limits. The application should be accompanied by such statements or evidence and by
the prescribed fees. On receipt of the application, the Tribunal shall issue summons
requiring the defendants should cause within 30 days of the service of the summons or
to stay the relief prayed for should not be granted. The Tribunal after giving the
applicant an opportunity of being heard, passes such orders on application as it thinks fit
to meet ends of justice. The Tribunal may make an interim order whether by injunction
or stay and debarring the defendant from the sale or transfer of assets. Thereafter, the
Tribunal issues a recovery certificate and passes on to the Recovery Officer for recovery
of the amount of debts as specified therein. The Recovery Officer should send a notice
in writing and requiring the defendant or his related parties to pay the amount within the
specified period. On receipt of money, the receipt will be issued. If the defendant fails to
make the payment, the Recovery Officer will then seize the property and arrange for
sale. He can even arrest the defendant if the circumstances so warrant. The aggrieved
party may make an appeal within 45 days from the date of the order to the Appellate
Tribunal, which will then pass an order, confirming, modifying or canceling the order,
appealed against. There is a requirement of deposit of 75% of the claim amount though
this can be waived or reduced at the discretion of the Appellate Tribunal.
At present, there are 29 DRTS and 5 Appellate Tribunals in the country. In order to
provide the required infrastructure to DRTs, the RBI has asked banks and FI within the
jurisdiction of the DRT should set up a Local Advisory Committee to interact with the
Presiding Officer periodically and provide the required infrastructure.
In January 2000, the Act was amended. The major amendments include: the
Government has powers to appoint more than one Recovery Officer in the DRT. The
Recovery Officer requires the debtor to declare in affidavit the particulars of his assets.
DRT can pass an order for recovery of the amount and issue certificates in case of the
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decrees which have been passed but has not executed. A party aggrieved by order of
Recovery Officer can file an appeal before the DRT within 30 days from the date, the
order is issued to him. As on June 2004, 35,700 cases involving Rs. 66,568 crores were
pending with DRT. The amount recovered was just Rs. 7,845 crores.
DRTs are criticized in respect of recovery made considering the size of NPAs in the
country. In general, it is observed that the defendants approach the High Court
challenging the verdict of the Appellate Tribunal which leads to further delays in
recovery. Validity of the Act is often challenged in the court which hinders the progress
of the DRTs. Lastly, much needs to be done for making the DRTs stronger in terms of
infrastructure.
19. National Company Law Tribunal As per the announcement made in the Budget 2001-02, Sick Industrial Companies Act
(SICA) will be repealed and Board for Industrial Finance and Reconstruction (BIFR) will
be wound-up. As an alternative arrangement, it is proposed to set up National company
Law Tribunal (NCLT) by amending the Companies Act, 1956. In August 2001, the Bill
was introduced in the Parliament. Accordingly, NCLT is expected to consolidate the
powers of BIFR, High Court and Company Law Board to avoid multiplicity of forums. In
matters of rehabilitation of sick units, all concerned parties are supposed to abide by the
orders of NCLT. There shall be 10 benches, which will deal with rehabilitation,
reconstruction and winding-up of companies. It is estimated to complete the entire
process during a period of 2-3 years as against 20-25 years presently taken. The
Tribunal will have, in addition, powers of contempt of court.
A rehabilitation and revival fund will be constituted to make an interim payment of dues
to workers of a company declared sick or is under liquidation, protection of assets of sick
company and rehabilitate sick companies. While NCLT will be acting on the lines of
BIFR in the matters of rehabilitation, viability of the projects will be assessed on `cash
test’ and not in the present practice of 'net-worth’. Another important change will be in
respect of time limit for completing each formality relating to rehabilitation and winding-
up. Though the Bill is well drafted to ensure NCLT to become more effective than BIFR
in respect of rehabilitation and winding-up, doubts are raised about the implementation
of the Bill taking into account the present political set up.
20. Merger and AmalgamationMerger and Amalgamation are the two distant terms. A merger is a combination of two
companies whereby only one survives. But an amalgamation involves combination of
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two or more companies whereby an entirely new company is formed. When two
companies of the same size combine, usual mode is amalgamation. When two
companies of different size combine merger is preferred.
Combination of the companies takes place for a number of reasons. Some of the
important reasons are given below.
Operating Economics :Duplication of facilities is eliminated and all operations can be consolidated to
achieve economies on overhead cost. Particularly in case of horizontal merger,
operating economies can be best utilized. In cases of vertical merger, economies in
distribution and purchasing are achieved. There are few operating economies in
conglomerate merger.
Management AcquisitionIf a firm lacks aggressive and competent management, it has two alternatives, either
to gradually stagnate or to combine with another company having efficient and
effective management.
GrowthSometimes, it is easier and cheaper to have a growth by merger rather than internal
growth. The numerous costs and risks involved in development of new products can
be avoided by acquisition of another unit.
Debt CapacityIn a country like ours where tax rate is high the debt funds are cheaper than the
equity funds. If a company borrows more, the expected future earnings and dividend
per share will increase when all other things remaining the same. The debt capacity
of the combined entity is greater than the sum of the individual debt capacities of the
two companies involved in combination.
DiversificationA merger is also done with diversification in view. A Company may be able to
reduce the instability of earnings by increasing the product line. But increasing
product line is an expensive affair for a small firm with low equity base. A large firm
also may not like to undertake risk of a new product line and may prefer acquisition
rather than developing the product itself.
Taxation
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In an economy like ours, where rate of corporate taxation is very high at higher slabs
of profit generation, avoidance of tax is another cause of merger. A financially sound
company in a very high corporate tax bracket has an incentive in saving tax by taking
over sick units and, a sick unit can be made viable through merger. Merger helps in
minimizing competition, pooling of resources, effecting general economies in
production, distribution and overheads. Given below are legal provisions of merger,
tax concessions available, mechanism for merger, provisions for approval clearance
of merger, etc.
Provisions of Merger Under Companies Act 1956Provisions are laid down u/s 390-396 where transfer/purchase of shares are
approved by not less than 9/10th of value of shares of transfer company,
merger/amalgamation can be done without recourse to the court.
In case a merger/amalgamation is effected through the court, the court shall direct a
meeting where 3/4th majority approves the arrangement, it shall be binding on all on
approval by the court. The court will make an order only where the transaction
appears just and fair and where the court is satisfied that sanction of the majority has
not been obtained by fraud and improper means.
The scheme is also subjected to careful scrutiny as per standards laid down
justifying judicial interference. The court sees to it that the scheme is reasonable
and fair to all parties.
Concessions under Income Tax ActUnder Sec. 72-A of the Act, voluntary amalgamation of a sick company with a sound
company allows the latter to carry forward and set off accumulated losses and
unabsorbed depreciation of the former. The Act grants deductions to the sound
company in respect of depreciation allowance, capital expenditure etc., in addition to
exemption from liability to capital gains tax for both the sick unit and its share
holders. There is also no liability to tax any deemed profits representing the amount
of balancing charge or any claim for terminal depreciation in case of the sound
company (i.e. amalgamating company). All benefits are subject to amalgamation
falling within definition of amalgamation contained in this Act.
Conditions for Availing of BenefitsThe amalgamating company should be an industrial company and the amalgamated
company may/may not be and industrial company. The benefits to set off losses and
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depreciation allowance to amalgamated company is subject to satisfaction of the
following conditions:
Accumulated loss of amalgamating company in the immediately preceding
year in which amalgamation is effected must exceed 5 per cent of aggregate
amount of paid up share capital and reserves of that company as on that
date.
Amalgamating company was not financially viable before amalgamation.
Financial viability should be determined by financial experts.
Amalgamation should facilitate rehabilitation/revival of business of
amalgamating company.
In case amalgamating or amalgamated company owns an industrial
undertaking registered under MRTP Act 1969, the amalgamation must be
approved by the Government under MRTP Act unless it is exempted from
such approval.
For merger with its foreign majority company, the amalgamated company
must conform to provisions of Foreign Exchange Management Act.
Assessee should fulfil such other conditions as Central Government may
specify.
Procedures for Clearance of Merger ProposalsAn application for the purpose of Income Tax Act should be made in prescribed form
to Secretary, Department of Industrial Development. Company should supply
information regarding steps taken for rehabilitation and revival of the unit which
should be accompanied by a certificate.
21. Financial ReconstructionThe essence of a rehabilitation programme for a sick unit involves rescheduling its
maturing obligations and matching them with the liquidity expected to be generated in
future and maintenance of the resultant capital structure through the period of
reconstruction. The steps involved in the reconstruction programme have been
discussed in the following paragraphs.
The assets and the liabilities, after reconstruction, should properly match and the post
reconstruction equity and debt should be capable of being adequately serviced in future
by internal generation of the unit. This may call for reduction of the existing preference
capital, rescheduling of existing loans, conversion into equity, reduction, write off or
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combination of such measures, consistent with the continued operation of the unit on a
viable basis.
In considering such measures, liabilities have to be scaled down if they are not
represented by adequate tangible assets. Assets for the purpose of reconstruction
should be valued at a reasonable price considering the unit as a going concern.
Industrial reconstruction includes change of management. Banks, financial institutions
and the Government will have to play a vital role in this regard. The existing
management may have to be reconstituted and they may take over the management of
the company under the Industrial (Development and Regulation) Act.
The plan of reconstruction consists of projected balance sheet, projected income
statement, statement of sources and uses of funds, capital expenditure programme and
management inputs and other proposed corrective measures in non-financial areas.
Statement of sources and uses of funds should suggest the changes in funds generated
from operations at different intervals during reconstruction period.
Capital Expenditure Programme involves :
Revised capital expenditure to achieve projected production and sales.
Matching payment of its dues with expected liquidity at future dates.
Postponement of specific liabilities.
The extent of capital restructuring necessary for the unit is determined by its need for
funds during the period of reconstruction arising out of :
Payment of dues to pressing creditors.
Acquisition of additional current assets.
Capital expenditure programme.
Future losses.
Past liabilities such as workers' dues; arrears of taxes, excise, electricity bills etc.
other creditors - secured and unsecured.
Even after reconstruction many sick units will continue to incur cash losses and creditors
will have to finance the losses, and past liabilities are never reduced. Consequently,
financial institutions will withdraw their support.
The sick unit has an imbalanced capital structure, high debt equity ratio and adverse
total external liability to net worth. Therefore, it is desirable to consider the financial
reconstruction to off load burden of external liabilities not matched by existing productive
assets. Banks and financial institutions must scale down the liabilities by write off. For
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the purpose of capital reconstruction, assets should be valued on current price
considering the unit as a going concern.
The involvement of the Government comes in the form of take-over of the management
under I (D&R) Act 1951. In this case, the Government appoints authorized persons to
carry on the business of the company. Following major changes take place after the
Government take over:
Existing management vacates the office.
Shareholders become dormant.
Government appoints new management.
Newly appointed management is accountable to the Government.
On the other hand in case of reconstruction involving the bank and financial institutions,
responsibility is equally with them and the entrepreneurs. Financial institutions are
responsible for appointing suitable management of yield desired result. Normally
reconstruction under both the above styles commences with the infusion of fresh funds
with an altered management set up.
Difficulties faced at the time of framing acceptance capital structure are due to the lack
of support from different agencies involved in such reconstruction. In the absence of
this, it becomes difficult to initiate reconstruction programme. The major handicap that a
sick unit poses before a reconstruction agency is huge over burden of accumulated
liabilities and past losses.
22.Recovery under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002The Act covers the following three areas viz.
(i) Registration and regulation of Securitisation Company (SCO) and Asset
Reconstruction Company (ARC)
(ii) Enforcement of Security Interest by banks and financial institutions without court
intervention, and
(iii) Establishment of Central Registry of securitisation and reconstruction of financial
assets and creation of security interest under the act.
The Act provides for setting up of Securitisation Company (SCO) and Asset
Reconstruction Company (ARC). Such company before commencement of business
should obtain a certificate of registration from RBI. The networth of the company should
not be less than Rs. 100 crores or an amount exceeding 15% of the total financial assets
acquired or to be acquired. The SCO or ARC can acquire financial assets of any bank
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or FI by issuing a bond or any other security on mutually accepted terms between the
SCO/ARC and the bank/FI. On acquisition of financial asset by SCO/ARC from bank/FI,
the SCO/ARC shall become the deemed lender and all rights of such bank/FI shall vest
in the SCO/ARC in relation to the financial assets. Any suit, appeal or other proceedings
pending at the time of acquisition of assets shall be continued by SCO/ARC. The
SCO/ARC can issue security receipt of institutional buyers for subscription. The
SCO/ARC can provide for proper management of the business of the borrower, sale or
lease of a part of whole of the business of the borrower, reschedulement of payment of
debts by the borrower and settlement of dues payable by the borrower.
The Act also provides for enforcement of security by Banks/FIs in their favour without the
intervention of court/tribunal. For this, the borrowal accounts should have been
classified as NPA and the Banks/FIs issue a notice to the borrower requesting to repay
the liabilities in full within 60 days from the date of notice. The banks/FIs are entitled to
exercise all the rights of enforcement of securities subject to the above compliance.
Such enforcement of security can be in the form of taking over possession/management
of the secured assets and appointing any person including SCO/ARC to manage the
secured assets. If the banks feel that there could be resistance in taking possession of
the charged assets, bank can submit an application in writing to the District
Magistrate/Chief Metropolitan Magistrate in whose jurisdiction; the secured assets
situate, to take possession of the assets and documents and forward to the secured
creditor (bank). In the case of joint financing of financial assets, the secured creditor can
exercise the rights only if agreed upon by creditors whose share in the account is
minimum 75% by value. In case borrowers raise any objection or make a representation,
the bank will have to consider such objections on merit and will have to communicate
within one week of receipt of such representation. No cause of action will be available to
the borrower merely on the ground that his objection has not been accepted by the bank.
The bank is, therefore, free to take the possession of the movable or immovable secured
assets after complying with the procedure after expiration 60 days of notice and after
reply of the objections, if any. However after taking possession by the secured creditors,
the borrowers may make an application to DRT which shall be dealt by DRT as
expeditiously as possible and to be disposed of within 60 days. If the application is not
disposed within period of 4 months, any party may make an application to the DRAT for
directing the DRT for expeditious disposal of the application. Aggrieved by the decision
of DRT, borrower can appeal to DRAT only after depositing with it 50% of the amount
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due as claimed by the bank or determined by the DRT, which ever is less, however,
DRAT may reduce the amount up to 25%of the debt if satisfied.
For the purpose of registration or transactions of securitisation and reconstruction of
financial assets and creation of security interest under the act, the Government of India
may set up a Central Registry and its branches opened in different places duly defining
the territorial limits of such branches. Any transaction relating to securitisation,
reconstruction of financial assets, and creation of security interest is to be recorded in
the Central Register kept at the Head Office of the Central Registry. The filing of such
transaction with Central Registry is to be made on payment of a fee prescribed within 30
days. The failure to register security interest with Central Registry attracts penalty in the
form of fine of Rs. 5000 per day.
The Act arms the lenders with powers to directly initiate recovery procedures by taking
possession of the secured assets of the borrowers which would include the transfer of all
underlying assets. The lender could, in effect, attach, sell or auction any of the assets
taken over by them. They can also decide to take over the management of the assets,
appoint any person to manage the assets taken over and also order settlement of dues
from any person who has acquired the secured assets from the borrower.
The new law would not only help in recovering the existing NPAs of the Banks/FIs, but
also curb the instincts toward willful defaults in future. The legislation protects banks/FIs
from unnecessary legal hassles from defaulting companies and also from cross
legislation among the FIs since many companies had secured loans from multiple
financial institutions.
The Act empowers lending institutions with enhancement rights in the recovery of NPAs.
Under the Act, lenders have recourse to several options in dealing with non-performing
advances without judicial intervention.
The provisions of the Act shall not apply in case of loans upto Rs. 1.00 lacs and in
respect of any security interest created in agriculture land. Likewise the cases where the
amount due is less than 20 per cent of the principal amount and interest thereon, the
same is outside the purview of the Act. The new law is viewed as an important step
forward towards addressing the need for a viable legal framework to undertake
securitisation and/or asset reconstruction in India. The legislation could be used by
competitors to buy out assets of ailing rivals though it would also open up secondary
market and put pressure both on borrowers and lenders to settle their disputes. The Act
will provide greater flexibility to the Indian financial system in managing its non
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performing assets more effectively and efficiently. The Act is expected to correct the
imbalance between borrowers and lenders in this country, a consequence of which has
been the accumulation of non-performing assets on a massive scale. By allowing banks
to sell off assets charged to them without having to seek the permission of a court of law,
the Act empowers banks to realize their dues expeditiously, avoiding the endless delays
in the legal system.
23. Other Legal MeasuresOther Legal measures mainly include the recovery under State Finance Corporation Act,
1951, Co-operative Societies Act, 1950 and recovery under state act of sponsored
scheme cases.
Section 29 of the State Finance Corporation Act, 1951 empowers State Finance
Corporations (STCs) to take-over the management or property or both of the industrial
concern which has defaulted loan installments covering interest and principal. This right
applies to the property mortgaged, pledged, hypothecated or assigned to the Financial
Corporation. On take-over of the property, the corporation gets all the rights of the
owner. This also refers to goods manufactured or produced wholly or partly from goods
forming part of the security held by it. On receipt of sale proceeds of the property, the
corporation is entitled to reimburse first all costs/expenses incurred in holding the
property and arranging for subsequent sale and recovery of dues. If any surpluse left
over, the same shall be paid to the person entitled thereto. Where Financial Corporation
has taken any action against and industrial concern under provisions of sub-section (I),
the Financial Corporation has shall be deemed by the owner of such limited company for
the purpose of suits by or against the concern, and shall then and be sued.
Despite the above wide ranging powers, the Financial Corporations has not been able to
recover much effectively because of non-cooperation from the management of the
industries concern. Workers also agitate and prevent any take-over of the property.
Thus, what is important is to create a conducive recovery environment and not just
vesting the additional powers to the Financial Corporation as discussed above.
Recovery under the Maharashtra Co-operative Societies Act, 1960 is also possible.
Credit institutions in co-operative sector have to apply to the Registrar to seek his
assistance in recovery of dues from the members. The Registrar, after receiving
necessary particulars, will make such inquiries, as he deems fit, and then grant a
certificate for the recovery amount due as arrears. The certificate granted by the
Registrar shall be final and a conclusive proof and the same shall be enforceable
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according to the law like land revenue. Credit institutions in co-operative sector are
taking full advantage of the facility provided under the Act. As discussed above, the
recovery process is also slow in this context, because of recovery climate which is not
conducive besides lack of co-operation from defaulting members.
In certain states there is separate law to deal with small loan and agricultural loans.
Banks may take advantage of these legal recourses and file recovery certificates with
the designated officers. A regular follow-up of the certificate file cases is essential.
CONCLUSIONThe list of recovery measures may go on when we refer to additional innovative
strategies adopted by banks and FIs, in this regard. Thus, there is no dearth of schemes
for recovery. Adequate numbers of institutions are set up to assist in recovery matters.
Both the RBI and the GOI are busy in announcing new policy guidelines relating to
recovery from NPAs. Banks are feeling pressure on asset quality due to (a) massive
credit expansion in past fours years (b) Rising delinquency in retail loans, (c) Slow down
in the economy and consequential problem with sectors like real estate, MSME etc. (d)
slow down in exports and (e) massive restructuring done during 2008-09 which may add
fresh NPA in coming years. Fitch has forecasted that 15 to 25% of banks’ restructured
loan (whopping Rs. 1.23 lakh crores were restructured during 2008-09) may turn NPA
during 2010-11 (ET 13.01.2009). To arrest this trend, enough care has to be taken to
prevent slippage in standard assets more particularly in restructured loans and upgrade
the NPA loan under sub-standard category. More importantly, recovery drive should be
taken up on a war-footing. For this purpose, banks will have to take advantage of all the
possible recovery measures by involving their staff and other outside agencies. In
addition, there should be coordinated efforts by banks and FIs in recovery in those cases
where both of them are involved. Recovery function in banks and FIs needs to be
strengthened by inducting a professional approach. There should be adequate staff in
the field to contact defaulters time and again. Staff involvement in recovery drive has to
be ensured by offering sufficient incentives to them. Active lawyers may also be
rewarded properly. Assistance from the professional agencies should liberally be sought
for. Above all, judicial machinery has to become more efficient to dispose off cases
pending before them for years together. Similarly, DRTs have to gear-up to assist
banks and FIs in their recovery effort. Lastly, the Government of India has to facilitate
the process of seizure of assets of the defaulters and their subsequent sale for which the
Central Registry should be set up immediately. Lastly, in view of the proposed stricter
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NPA identification norm of 90 days introduced since March 2004, it is high time for banks
and FIs to look quality of credit rather than quantity and take effective and timely steps to
check delinquency as soon as symptoms of NPA are visible.
Chapter-12
Loan Compromise – An effective recovery measure
IntroductionIn general, it is experienced that filing of suits and recovery of dues of banks through the
process of courts/DRTs is a cumbersome, expensive and time consuming, and task
without any fruitful results in many cases. One of the main reason attributed for non-
recovery of dues through the court/DRT is lack of proper follow-up and timely and proper
action. Hence, it would be worthwhile to think of other ways to tackle the situation. The
tradition of amicable settlement through panchayat and arbitration, leads to think as to
why bank loan disputes cannot be settled without having a recourse to the court/DRT.
Of late, loan compromise as a recovery measure is becoming popular. Hence, it would
be appropriate to know all about loan compromise.
Salient Features of Loan CompromiseLoan compromise in a bank means agreeing to a borrower’s request of accepting a part
of outstanding of dues in the books of the bank as full and final payment or allowing for
the non-compliance of the terms of the loan, after analyzing the alternative courses of
action, genuineness and capacity to repay. It is also called as voluntary debt reduction
or scaling down of dues. In the situation, where the borrower’s ability/capacity in
repaying the bank’s dues and the bank’s ability to recover the same by other means are
limited, a compromise proposal can work well.
Compromise proposals can be entertained at both stages of loan, which include (a) pre-
litigation stage, and (b) post litigation/decree stage. At the pre-litigation stage,
concessional measures such as reschedulement, rephasement, rehabilitation, etc. can
be used which would allow some breathing time and build/strengthen the repayment
capacity of the borrower. However, when such measures initiated in the account do not
yield any fruitful result and the borrower incurs heavy cash losses, it is better to go in for
a compromise or scaling down the dues. Similarly in other cases, where business loss
has crept in due to one or the other genuine reasons and the borrower is not a willful
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defaulter and requests for minor concessions such as waiver of penal interest,
concession in interest rate, etc. his offer can be accepted for compromise.
Compromise at post-litigation/decree stage can also be entertained so that the
borrower’s business or activity is uninterrupted. In order to avoid cost, labour and time
involved in litigation maters and to have better image in the market, borrowers offer a
lump-sum amount and request the bank to withdraw the suits against them, which may
be entertained. At times, it becomes necessary, in some cases, to settle outside the
court through an amicable agreement and, the antecedents of the defendant are such
that courts/DRTs take a sympathetic view and award a lenient decree against the
defendants. Sometimes, after obtaining decree, if a third party comes forward to
purchase the assets, the bank may consider the case for compromise. It is also possible
for the bank may go in for compromise if the decreed asset would not fetch more than
the claim the amount. In all cases, where suits have been already field, whatever
compromise is to be made, must be sorted out through court in the form of a consent
decree, so that it will be binding on all dependents. If parties do not fulfil the promise,
remedy through court or DRT will always open to the banks.
Types of CompromiseThere can be two types of compromise. The Reserve Bank of India and the
Government of India independently introduced One Time Settlement Schemes covering
loan outstanding upto Rs. 5 crores (subsequently raised to Rs. 10 crores) and Rs. 25000
respectively. Now, both these schemes are not in operation since they were purely
temporary measures. Hence, each bank is given autonomy to evolve its own One
Time Settlement (OTS) Scheme, well suited to profit position. What is important? It is
necessary to create awareness on OTS and mobilize as many compromise proposals as
possible. There should not be any delays in arriving at compromise. Such proposals
should be prepared carefully keeping in mind the bank guidelines. It is better to involve
all staff members in mobilizing compromise proposal. Care should be taken that the
recovery through compromise does not give a wrong signal to good borrowers. Over the
years, banks have succeeded to recover through compromise substantially. But there is
enough scope to step up the recovery drive through this measure.
How to Formulate Compromise ProposalTo start with, a borrower should express his interest in loan compromise in writing. He
may also indicate the terms of compromise, well suited to his expectations. But branch
manager may not agree. Hence, he has to formulate a compromise proposal in the light
of broad guidelines issued by the bank. The proposal should contain major items which
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include means or capacity of the party, determination of amount covering outstanding
amount, other charges, etc. efforts already made for recovery, staff accountability, etc.
More importantly, the securities offered to the bank need to be valued by an approved
valuer. The branch manager has to carry out a cost: benefit analysis which on one hand
takes into account the loss that may arise in case compromise is accepted and the
benefit which may accrue if the compromise is not made, on the other. The proposal
recommended should be referred to the sanctioning authority which examines several
factors including fulfillment of terms and conditions of sanctioning of loan compromise,
any laxity in conduct and post-disbursement supervision of the account, any act of
commission or omission on the part of staff leading to the debt proving irrecoverable,
enough recovery efforts put in, valuation of securities, interest to be charged in respect
of settlement though installment, etc. Decisions in respect of loan compromise should be
taken by a committee consisting senior executives excepting small loans where powers
are delegated to branch heads. After receiving the necessary sanction of the proposal,
the branch manager is expected to ask the borrower to fulfil the terms including the
down payment. In general, one time settlement is preferred to settlement in
installments. In case of suit filed accounts, the settlement is put through the court and a
consent decree is drawn. In non suit filed cases, it is better if the terms of settlement is
drawn through a memorandum of understanding and if the amount is payable in
instalment, post dated cheques are obtained from the borrowers so that there is
adequate pressure on him to keep his promise and in case of dishnour of cheques bank
may have option to proceeds legally under section 138 of Negotiable Instruments Act,
1885. In case of small borrowers, bank are also offering fresh loan so that the borrowers
can start their activity afresh.
ConclusionLoan compromise should be considered as a last resort of recovery. It should be
a voluntary exercise. It calls for a professional approach in preparing the compromise
proposal. In terms of amount involved in NPAs, success of banks in recovery through
loan compromise is limited due to lack of awareness of such schemes by small farmers,
small traders etc; stricter vigilance norms because of which the staff is hesitant to
entertain compromise cases; difficulties in fixing staff accountability before
recommending a proposal; etc. The Compromise proposals from willful defaulters should
not be entertained. These need to be addressed. Thus, appreciating the growing
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importance of loan compromise, DRTs have rightly started organising the Lokadalats
which dispose off small cases through compromise. It is desired to keep up this tempo.
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Chapter-13
REHABILITATION OF SICK SSI UNITS I. Identification of a Sick SSI UnitAs per the Government of India definition, a small-scale industrial unit is the one in which
case, the investment in the plant and machinery does not exceed Rs.100 lakhs
(enhanced to Rs. 500 lakhs for certain specified items) and in the case of ancillary unit
the same should not exceed Rs.25 lakhs. Identification of a sick SSI unit has to be
done keeping in mind the official definition as provided by the Reserve Bank of India.
Accordingly, any borrowal account, which becomes sub-standard when interest or
principal is overdue for more than 3 months or, its accumulated losses exceed 50% of
net worth and the unit has been in commercial production for at least 2 years, is
considered as sick SSI unit.
II. Causes of SicknessCauses of industrial sickness have to be viewed from the general background of an
industrial economy. At any point of time, the problems of industries are not uniform.
However, factors generally responsible for sickness can be divided into external and
internal. External factors are those over which the unit has no direct control. But,
internal factors are those which are within the control of the management of the unit.
Sickness can originate right from the stage of conception of an idea to set up the unit till
the stage of crystallization of the concept and/or implementation of the project.
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Normally, no account falls sick all of a sudden. Before the account falls sick, we do get signals from various sources which include:a) Ledger Book
b) Stock Inspection
c) Discussion with Borrowers
d) Market Reports
e) Financial Statements
A systematic study of the balance sheet and profit & loss account gives the following signals:
(a) Unsatisfactory trend in profits.(b) Rise in debts.(c) Shortage of working funds.(d) Unsatisfactory position of equity.(e) Diversion of short term funds for long term uses.(f) Building up of unproductive assets(g) Unhealthy accounting practices
Given below are the important points form a balance sheet of a potential sick unit which can give some indication of sickness;
Balance Sheet of a Potential Sick SSI UnitSr.No. Liabilities Assets
1. Current Liabilities Current Assets
a) Short term borrowings would be
high and indiscriminate -
irregularity in the cash credit for
the last two months
Current assets would stand
depleted and, whatever exist would
consist of:
b) There would be some unpaid
statutory liabilities such as
wages, bonus etc.
a) Dead stock and non-moving
inventory
c) Supplies would remain unpaid
for a long period
b) Over due debts mostly
irrecoverable
d) Considerable amount of
contingent liabilities would exist
mostly due to law suits
c) Negligible cash and bank balance
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2. Term Liabilities Fixed Assets
Last two monthly loan
installments would remain
unpaid and would continue
These would appear inflated and
non-realizable
3. Equity Intangible Assets
It is gradually reducing Those including losses and
capitalized expenses would be
prominent
III. Rehabilitation of Sick SSI Units In general, a sick SSI unit is defined in terms of its capacity to generate internal funds. A
sick unit fails to generate internal surplus on a continuing basis and depends on its
survival on frequent infusion of external funds. Hence, need for rehabilitation or nursing
is very much felt. Details of rehabilitation or nursing are discussed as under:
1. Objectives of Nursing Programme: To enable the unit to operate at a profitable level.
To adjust the irregularity in the account, if any, according to a phased programme.
Thus, the nursing programme involves two aspects i.e., (i) preparation of feasibility
report before implementing the nursing programme and (ii) careful monitoring of the
performance of the unit during the nursing period.
2. Features of Nursing Programme: The programme should be carefully drawn and all doubts must be clarified before
chalking out the same. It must be supported by the bank and the borrowers.
As the unit is already heavily debt burdened, the programme should be based on
well-calculated break even point. Under nursing, the unit should operate at a much
higher level than before and in this regard, the following questions must be
answered:
Is it possible to operate at a higher level under present market
conditions?
Will present plant and machinery allow manufacturing output at
higher level of activity?
Can present organization cope with increased level of activity?
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To be able to operate at higher level, additional finance will be necessary and
especially in cases where the net worth of the unit has become almost negative.
In such cases, the end use of funds must be carefully monitored.
The repayment programme must be carefully worked out, enough funds must be
available to the unit to operate at the desired level with a view to ensuring
continued internal generation of surplus.
The nursing programme should be decided by the concerned authorities within a
reasonable time. The longer the decision-making period, the greater would be
magnitude of the problem.
3. Decision on NursingKeeping in view all the possible outcomes, risk involved and the irregularity in the
account, bank decision should aim at promoting the business activity and not the
borrower as an individual. The decision should be based on likelihood of possible
recovery. Finally, bank can support the borrower provided he has equal interest in
coming out of the sickness. In other words, banks decision to nurse a unit could be
justified if it can:
Generate adequate activity and employment
Control the business activity effectively
Commit additional funds, if necessary
Elicit co-operation from workers, suppliers of materials, etc.
4. Preparation of Nursing Programme(A) Assessment of Feasibility of the Project :The programme should be finalized after a detailed study of the sick unit and
understanding the problems of the unit. In this context, the following points should be
kept in mind;
(i) `Is the project feasible i.e. to operate above the break-even point?
(ii) Are the prevailing market prices remunerative? Is it necessary to change
the pricing policy?
(iii) Are raw materials available to produce goods at the desired level of
activity?
(iv) Are there any constraints such as power, transport bottlenecks, paucity of
space, skilled workers etc?
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(v) Are of the existing machineries able to cope with the increased level of
activity?
(vi) Is the borrower prepared to accept the financial discipline being imposed
by the bank?
If all the above questions are positively answered, the project is feasible and should be
considered for nursing programme.
(B) Assessment of Additional Funds: Additional funds are required for the following:
(i) Statutory liabilities payments to creditors to be paid,
(ii) Payments to other creditors
(iii) Minimum funds required to purchase machineries to raise the
productive capacity to the desired level
(iv) Minimum working capital requirements till cash cycle gets into
motion.
(v) Operating deficits in the short run arising as per cash flow
estimates and any other shortage therein to be provided for.
Sources of Funds include:(i) Additional capital contribution from the borrower and deposits from the friends
and relatives
(ii) Disposal of excess stock or fixed assets not required,
(iii) Speedy recovery of outstanding bills/ book-debts ,
(iv) Internal generation of funds
(v) Additional working capital limits
(vi) Additional term loan for acquisition of fixed assets
(C) Preparation of Cash Flow Estimates; Bank will have to prepare a cash flow
statement showing cash flow estimates during the rehabilitation period. The
estimates should be prepared on the basis of the realistic considerations. The
nursing programme must also have a provision to sanction ad-hoc limit in case the
process of credit sanction takes a long time and in the meanwhile, the unit may need
a small amount for certain immediate payments.
(D) Arrangements made with other creditors: Before finalizing the nursing
programme, bank may seek co-operation from the creditors for supply of raw
materials. It must be ensured that supply of raw materials will continue on regular
basis and at economical price. Bank must ensure that the creditors will continue to
grant normal credit to the borrowers.
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(E) Marketing Arrangements : While finalizing the nursing programme, bank have to
study the marketing problems and offer suggestions. Such suggestions would
include;
A product that has lost its name in the market with the trader but not with the
ultimate users is easy to re-establish by restoring confidence of the former.
If existing sales-agents are not interested in continuing or not needed because of
high cost, there could be two options; either to appoint other suitable selling
agents or to create a wide network of selling agents who could be used to realize
the overdue debts under gradual collection arrangements through steady
supplies of the product to such parties.
(F) Arrangement for Recovery of Overdue Debts and Disposal of unwanted Assets: In some cases, it is possible that certain assets which are unwanted, should
be disposed off. We have to identify such assets in consultation with the borrower.
We must ensure that the borrower will make all efforts to recover overdues from
customers. Before deciding on whether to nurse the unit or not, we should know
what could be the realizable amount from the disposal of unwanted assets.
(G) Freezing of Existing Bank Borrowings: This system is suggested for smooth
banking operations. Cash credit balance against dead stock, including non-moving
inventory and over due debts, should be separated and frozen. Interest thereon
should also be kept separate and frozen. For the purpose of deciding on the new
financial arrangements, the current assets, which are in use, should only be
considered. The distinction between frozen and operating accounts gives
operational control through security of transactions at the lender’s end.
(H) Arrangements made with Other Financial Institutions and Equity Holders for additional funds; In case of the borrowers having facilities with more than one
credit institution, the nursing programme could be finalized with the consent of the
consortium bankers. The possibility of issuing additional equity shares should also
be examined. Under the nursing programme, the stake of other lenders should be
finalized.
(I) Arrangements for Management Performance : It is often thought of replacing
the old management with new management to overcome the failure of the former.
For ensuring the performance, the action can be as drastic as removing the entire
top management. This is suggested in case of mis-management, mis-use of funds,
wrong inheritance and other similar situation. Lenders have a right to participate in
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management and decision making. The critical positions are finance, purchases,
sales and production. Success of these executives should be measured on the
basis of growth of the borrowers’ business and safeguarding of lenders’ interest.
5. Guidelines on MonitoringHaving decided to nurse that unit, the bank has to undertake the follow-up activities
mentioned in the succeeding paragraphs.
1. Developing Information System : For the purpose of nursing, it is necessary that
information is collected periodically. Such information to be collected depends on the
individual case. Statements and returns normally collected from borrowers would
include:
Stock Statements
Weekly/Monthly/Quarterly budgets and actual figures for
production, sales, purchases, overhead expenditure etc.
Monthly cash flow statements
Operating Statement
Balance Sheet
The follow up action starts with the collection of necessary information from the
borrower. Before nursing the unit, we must indicate information required so that the
borrower can develop his own information system.
2. Review of Performance: We have to review the performance of the borrower
regularly, say monthly. Such review performance should aim at examining whether
there has been improvement in the working of the unit. We have to ensure that;
There is not much variance between the projected and actual figures of
production and sales
The funds are used as agreed upon. If the cash budget system is
introduced, we should see that the cash is managed as expected.
3. Monitoring Areas of Weakness: Review of the account reveals the areas of
weakness. A detailed study of such areas would suggest the line of action. For
instance, if marketing was observed as a major area of weakness, the steps should be
taken to improve, such as arrangements with salesmen/dealers, product design, pricing
strategy etc.
In several cases, weakness may be in the organization itself. The organization can
be strengthened by an appointment of the professional personnel. The bank may also
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nominate one of its executives as a director to observe policy decisions that are being
taken.
In regard to financial weakness, following alternatives are available:
To provide additional credit facilities
To convert excess short term credit into term loan
To modify short term credit facilities
To reduce interest rate and other charges
To rephase the term loan instalment so that a longer repayment period is
granted
To adjust a certain portion of the sale proceeds towards the irregularity in
the account
To grant repayment holiday for a definite period
There could be some small units, which have become sick on account of external factors
like lack of power supply, water, raw materials, etc. Such units may be referred to the
State level Co-ordination Committee, which has been set up at the state level with
representatives of banks, term lending institutions, state government etc.
REBHABILITATION OF SICK SSI UNITS - Dos and Don'tsBanks are expected to handle the sick SSI units as per the guidelines of the RBI. Their
work starts from the day when a sick unit is identified and concludes when the account is
either found potentially not viable or is nursed to bring back to health. It is attempted to
offer certain tips in the form of Dos and Don’ts :
1. Early identification of the sick unit is necessary for the effective cure of sickness.
But it is observed that branches commit a lot of delay in identifying sick unit and
also in reporting to the regional office, the reason being a fear-element in their mind
i.e reporting of more and more sick units to the controlling office which might
undermine their performance. In this regard, to ensure the early identification of the
sick unit by bank branches, suitable arrangements need to be made. One of such
arrangement may be to educate and motivate field staff for timely identification of
sick units. For this purpose, each bank may have to prepare a booklet containing a
few success stories narrating how early identification helps in rehabilitating a sick
unit .
2. For identification of a sick unit, audited balance sheet is a must to ascertain the level
of accumulated losses and networth. If audited balance sheet is not available due to
certain genuine difficulties, the branch manager may accept a provisional balance
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sheet duly signed by the entrepreneur. Even this is not possible, the manager may
visit the SSI unit and prepare a report. On the basis of conduct of accounts and the
factory inspection report, the manager may form an opinion that the unit had
become sick and proceed to assess causes of sickness and viability.
3. After identification of the sick unit , a viability report has to be prepared by the
borrower himself or with the help of some outside consultant. In most of the cases,
outside consultant's help is sought for. But in the context of consultant's report,
bank's experience is not satisfactory. Quite often, it is experienced that the reports
of the consultants may not reveal major weaknesses of the project, and
assumptions made in their report for estimating sales, bank finance, etc., are found
to be unrealistic. Hence banks have to make many changes in the project report
which almost leads to preparing the same afresh. So, it is necessary to make
arrangements for ensuring a consultation with outside consultants in the matters of
formulation and implementation of the project report at various stages.
4. For the preparation of rehabilitation scheme and implementation of the same,
coordinated efforts of banks and financial institutions are called for. Despite several
guidelines from the RBI on consortium advances, much is desired to put these
guidelines into practice. Consequently, the process of rehabilitation of sickness
suffers. To strengthen the consortium arrangements, it is suggested that there
should be a fair understanding among the members of consortium to ensure that :
(i) Appraisal should be at one stage instead of carrying out the same at each
institutional level.
(ii) Documentation should be completed at one stage.
(iii) There should be free exchange of information regarding outstanding
balances, position of securities etc.
(iv) There should be regular review meetings with the borrowers.
(v) There should be common terms and conditions.
Besides strengthening consortium arrangements, it is also necessary to adopt a time
bound programme for preparation and implementation of the rehabilitation package for a
sick unit. Efforts should be made to complete these tasks in a period of six months to
safeguard the interest of sick units.
5. For effective preparation and implementation of the rehabilitation package,
attitudinal changes are desired both in banks and sick companies, so that full trust is
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established. Consequently, the companies are enabled to disclose their problems
with the branch managers more openly and quickly.
6. For effective co-ordination, 'Sick Units Cell' set up at the head office and zonal
offices of the bank, need to be strengthened to offer the required support and
guidance to the branches.
7. For monitoring, the information from sick units is necessary. Despite good efforts
on the part of the bank, the required information is not coming forth. In this context,
it is suggested that reliefs and concessions offered to them under rehabilitation
package may be withdrawn, when information is not submitted. But the same may
be restored once the information is made available to the banks.
8. It is reported in several studies that SSI units fall sick mostly on account of
managerial deficiencies. Mismanagement or misuse of funds is common. Banks
may take a stern action in cases when there is a deliberate attempt to make the unit
sick by siphoning of funds. To deal with such cases, the existing loan agreements
of banks may be reexamined. It is suggested to insert a separate clause for penal
action against those responsible for siphoning banks funds. One more suggestion
may be made here. In case of total failure of units , promoters of such companies
should be black listed from obtaining fresh industrial licences as well as bank
finance treating them as willful defaulters.
9. It is not necessary to nurse every sick unit. Branch managers should be choosy in
this regard. Willful defaulters and cases where unit is not considered potentially
viable due to demand recession and no scope for diversification, need not be
considered for nursing. There should be proper compliance of the RBI/bank
guidelines as regards reliefs and concessions. Bank managers should not
recommend beyond the stipulated norms.
10. It should not lead to a situation that a sick unit remains under nursing for a long time.
The unit can be nursed for a maximum period of seven years and concessions in
interest rate, etc., should be given upto five years. In rare cases, a second dose of
nursing can also be considered which should be for a short period of one year. It
should be the policy of the bank to withdraw concessions and recall advances even
during the period of rehabilitation if funds are siphoned off. In any case close
monitoring of performance of sick units is a must.
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Chapter-14
SUCCESS STORIES ON REHABILITATION OF SICK SSI UNITS – LESSONS
INTRODUCTION
Industrial sickness can be defined as a phenomenon whereby a large number of units
are unable to meet their dues to banks and financial institutions or service their debts
due to deteriorating financial position for a variety of internal and external causes.
Today, industrial sickness is not peculiar to any country or any industry. In advanced
countries, treatment given to cure industrial sickness is different from that of developing
countries. In advanced countries, with better security systems and abundant capital, the
approach to sickness is to restore a unit to normalcy through restructuring devices within
a short time or else, close it down. Such easy and straight forward options are not
available for large labour abundant economies like India which can ill afford large scale
unemployment either of labour or of valuable productive assets caused by sickness.
Further, substantial funds of banks and financial institutions are blocked. Since,
industrial sickness is increasing at a faster rate, everyone is concerned. In India, around
10 per cent of bank credit is blocked in sick units. Sickness in the small scale industries
is much severe. There has been an incremental rise of around 30 per cent in the
number of sick units in this sector. So, banks, financial institutions, Government and
entrepreneurs are deeply worried of unprecedented growth in sick units and look for
remedial measures.
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To combat industrial sickness, a number of measures have been undertaken in India.
These measures include uniform definition of a sick company, common criterions for
assessing viability of the sick company, concessions to be granted in interest rate,
promoters’ contribution etc. by banks under rehabilitation package, concessions from
government to a sick company (in respect of electricity, sales tax, excise duties,
transportation rates, etc.), coordinated efforts by forming consortium of banks and
financial institutions, creation of a separate Board for Industrial Finance and
Reconstruction etc. This list of measures can go on.
NEED FOR THE STUDY
Despite the above mentioned measures, sickness in industries is on the rise. To
elaborate, the rate of success in rehabilitation of sick units is less than 10 per cent of
total sick units under rehabilitation scheme. This low rate of success has become a
source for demotivation. No one would like to take initiative in rehabilitation activities.
So, to motivate both financial institutions and entrepreneurs in rehabilitation exercise, it
is worthwhile to bring to their notice of those units which were sick at one time and, due
to hard work and the right approach of banks and financial institutions, the same were
successfully rehabilitated. By studying such units, the banks and financial institutions
would not only get motivated but also gain confidence in the task assigned to them. But
such success stories or live cases are not readily available. Further, lessons from such
success stories are yet to be drawn for the benefit of entrepreneurs, banks, financial
institutions and the Government. Keeping these felt needs in mind, the author attempted
to collect such rare cases from banks and financial institutions in India. In all, 15 cases
were gathered. The analysis of these cases was done to draw lessons on rehabilitation.
III. ABOUT SUCCESS CASES
It was decided to collect as many success stories as possible. It was also decided to get
the cases prepared by banks and financial institutions. Therefore, banks and financial
institutions were contacted. Initially, Small Scale Industry Department in each of these
institutions was requested to identify at least one successfully rehabilitated unit and
provide details of the concerned branch manager / officer responsible for handling the
same. Fifteen institutions (14 banks plus 1 financial institution) provided the details.
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Thereafter, the concerned branch managers/officers in each of these 15 institutions were
approached to write a success story of the identified unit incorporating the following:
1. Identification data i.e. location, year of establishment, constitution, products,
industry, credit facilities enjoyed, etc.
2. Factors responsible for motivating the entrepreneur to start the unit.
3. When did the unit start experiencing problems ?
4. When was it declared as a sick unit ?
5. Causes of sickness
6. Details of the rehabilitation package.
7. Implementation of the package
8. Strategies adopted by the entrepreneur to revive the unit
9. Progress shown during the post implementation period
10. Involvement of the entrepreneur, banks and others in the successful
rehabilitation
11. Latest position of credit facilities
12. Any other useful information to discuss about the progress of the unit after
rehabilitation
The units included in the sample are as under :
1. A tiny unit in the SSI sector (1)
2. Ancillary unit (1)
3. Unit financed under Technocrat scheme (1)
4. Export oriented unit (1)
5. Unit financed under IDBI Rehabilitation Scheme (1)
6. Units in which death of a key director and takeover of management by his
relative (2)
7. Units taken over by professionals (3)
8. Units experiencing project over run and falling sick at the infant stage (2)
9. Unit experiencing strained labour relations (1)
10. Units affected by recession in industry (2)
11. Unit was first considered for recovery through the court but subsequently it was
decided to rehabilitate (1)
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Other characteristics of the units in the sample are discussed below :
A. Eight out of 15 units came into being during 1970’s. All of the units are relatively
old being in operations for the last 8 years or so.
B. Units in the sample are located in different parts of the country. Four of them are
in Maharashtra. Others are from Tamil Nadu (3), Karnataka (2), Gujarat (2),
West Bengal (2), Kerala (1) and Uttar Pradesh (1).
C. All units are engaged in manufacturing activities. Most of them i.e. 7 out of 15
are in engineering industry. Other industries in which units are engaged include
electronics, textile, garment and hosiery, paper, flour mill etc.
D. Most of them i.e. 11 out of 15 units are private limited companies. Four are
proprietorship concerns.
E. All the units have sought finance from banks, state financial institutions, and
other government sponsored financial institutions except 3 units which raised
term finance from term lending institutions.
FINDINGS OF THE STUDY
1. Estimated period required for declaration as a sick unit from the date of occurrence of cash losses:
It was attempted to work out estimated period taken by the bank to declare each
one as a sick unit from the date of occurrence of cash losses for the first time. It
was found that the period varied from one case to another. Most of the cases i.e.
9 out of the total, were declared `sick’ within a period of just a year or two from
the data of occurrence of cash losses in the books, for the first time. In other
cases, the period was around 3-4 years. It was also found in these cases that
occurrence of cash losses was continuous and therefore, their equity was eroded
by more than 50 per cent in a short period of 2-3 years.
2. Causes of Sickness
Major causes of sickness of units include project over-run, demand recession,
labour problems, unfavourable government policy, death of a key director, non-
availability of raw materials and other inputs, managerial deficiencies etc. In two
cases, sickness occurred mainly on account of external forces on which they had
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no control. Such external forces include death of a key director and liberal import
policy of the government. In other four units, sickness was due to partly internal
causes (lack of understanding among directors, strained labour relations, non-
availability of raw materials on timely basis due to improper planning, slow
recovery of dues from customers etc.) and partly external causes (market
recession, unfavourable government policy, stiff competition etc.). In remaining
cases, i.e. 9 units, sickness was on account of internal causes and project over-
run was quite common. The project over-run was due to improper planning and
ineffective co-ordination and control. In 2 out of 9 units, sickness arose when
workers went on a strike due to unhealthy attitude of the entrepreneur. On the
whole, it was found that 12 units fell sick due to internal causes and managerial
deficiencies in key functional areas was predominantly found.
3. Nature of Rehabilitation Assistance
Banks / State Financial Corporations prepared the rehabilitation scheme keeping
in mind norms set for concessions, reliefs etc. by the RBI. The nature of
assistance was not common. Concessions and reliefs are in the form of waiving
of penal interest rate, funding of unpaid interest on cash credit and term loan and
of uncovered portion of irregularity in the cash credit account, rephasement of
overdue installments of term loan, meeting of cash losses till the unit breaks
even, relaxing terms and conditions such as low or nil margin longer moratorium,
lower interest rate, assessing working capital on need basis and low contribution
from promoters. In most of the cases, certain concessions were common which
included funding of overdue interest, rephasement of overdue installments,
creation of Working Capital Term Loan (WCTL) and irregularity in the cash credit
to meet cash losses. In one case, interest charged until the commencement of
business was refunded because the unit became sick mainly due to application
of interest. In this case, there was a project over run by two years. In two cases,
promoters’ contribution was as low as 5% of the total working capital limits. In
other two cases, the penal interest was waived. Additional sanction of working
capital on ‘need basis’ was commonly observed. Similarly, in many cases, fresh
sanction of term loan was accorded by financial institutions for the purpose of
modernisation of machineries. In two cases, change of management was
considered as a part of rehabilitation.
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All units were found to be happy with the rehabilitation package which was well
suited to meet their requirements. To work out the right kind of package, it is
necessary for a banker to have a thorough understanding of the sick units. This
understanding should not only relate to working of the units but also of their
financial structure and projected cash flows. Thus for revival of sickness, it is
desired to work out the most appropriate package of rehabilitation.
4. Strategies adopted by the units for revival
Units in the sample adopted different strategies for revival keeping in mind the
main causes of sickness. These strategies are discussed as under :
(a) Diversification : Seven out of 15 units went in for diversification in
different forms. Three units changed the product line since demand for the
existing product/s was inadequate. For this kind of diversification, existing
resources (machineries, materials and workforce) were utilized. The other type
of diversification was of shifting from manufacturing activities to job-work. This
need was felt necessary because, the manufacturing as an activity, was found
uneconomical. This observation was made in two units. One unit diversified its
concentration from exports market to local market in view of the fact that the
demand for exports was declining sharply. In other unit, there was a shift in
concentration from local market to exports market.
(b) Change of Management: Change of management as well as ownership was
inevitable on the death of an entrepreneur. In one unit, upon the death of the
entrepreneur his wife stepped in. She was found to be equally competent
and highly committed. Naturally, she was able to revive the unit. In another
case, a son of an entrepreneur was inducted on the death of the latter. In this
case also, incoming entrepreneur was highly competent and adopted modern
methods of management. Therefore, the unit was fully revived. In three
cases, professionals were introduced to revive the units. In the context of
change of management it is worth referring to one unit in which case, a newly
inducted management decided not to accept any remuneration from it until
bank loans were fully repaid. One more unit is interesting to refer here. Bank
filed the court case for the recovery since the management was not
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competent. But, when the management was changed, bank withdrew the
case from the court and rehabilitated the same. There was a positive
response to the efforts put in by the new management. Thus, the unit was
revived.
(c) Finance : There are two units which became sick due to shortage of
funds. Having realized the need for funds, the concerned entrepreneurs
managed to bring in additional funds from friends and relatives. These funds
were not withdrawn until the units were fully revived.
(d) Technical Aspects : In one unit, rejection of finished goods was on
the higher side. It was rightly decided by the entrepreneur to modernise
machineries and, when the same was done, it was revived. In another unit, there
was project over-run since the required machinery was not made available in
time. The machinery was imported one. Consequently, the unit became sick but
the entrepreneur decided to go in for a second hand machinery which was locally
available. With some minor repairs, the machinery started functioning. With this
arrangement, the unit was revived. In one unit, cost of production was on the
higher side. With the introduction of improved technology, the cost reduced.
Subsequently, the unit was revived.
(e) Labour : In one case, workers went on strike for a long time due to
unsatisfactory attitude of the entrepreneur. On the death of the
entrepreneur, his son was inducted to the unit who adopted
altogether a different approach towards workers. He was able to
pursue the workers to come for the work. He also counselled them
adequately. Consequently, the unit was revived. In another case,
productivity of the workers was very low. The entrepreneur rightly
decided to offer incentives on the basis of output. This was proved to be
a major source of inspiration. Consequently, the productivity of workers
improved significantly. Thus, the revival of the health of the unit could
take place. It is worth to know that in the same case, the concerned court
authorities granted retrenchment of workers which also proved to be a
useful remedy for revival. Entrepreneur of the unit presented his case so
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well before the court authorities that his request was considered here, a
lot of home work relating to economics of retrenchment was done.
(f) Others : There are some more strategies adopted for revival. One unit
decided to purchase a generator to overcome the power shortage. This was a
right decision leading to the revival of the unit. In another case, shortage of raw
material (raw steel) was the main cause of sickness. The unit rightly decided to
become a subsidiary of a mini steel plant. This led to revival of the unit. To
improve the quality of the product, one entrepreneur hired the services of a
consultant who suggested various ways for improving the quality. When the
consultant’s report was implemented, the quality of the product improved. Thus,
the unit was revived.
The above mentioned strategies are few in number. There can be some more
strategies depending upon the nature of sickness. For selection of the right
strategy, it is necessary to diagnose causes of sickness correctly.
5. Time factor- In the context of revivals of sick units, time factor is the most
important one. The revival can take place if decisions are taken at the right point
of time. It is necessary to have a time bound programme for different aspects
of rehabilitation which include detection of sickness, conducting a viability study,
preparation of proposal for rehabilitation, implementation of the proposal and
monitoring of the project. It was found in the units , under the study, that
entrepreneurs paid sufficient importance to the time factor. They were found to
be eager to get their units revived soon. Therefore, the proposals were
submitted on timely basis. Banks and financial institutions also adopted a time
bound programme which is broadly indicated for various items of work as under :
- Conducting of viability study : 1 month
- Preparation of rehabilitation scheme : 1 month
- Disbursement : 1 month
The above mentioned time schedule was followed in most of the cases. Thus, it can
be concluded that for revival of sickness both entrepreneurs and bankers have to
adopt a time bound programme to carry out different aspects of rehabilitation.
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6. Profile of Entrepreneurs-It is interesting to study the background of
entrepreneurs. They were found to be hard working which was evident right from
the stage of detection of sickness till its cure. They were found to be highly
committed and therefore, they were prepared to sacrifice even their gains. They
didn’t expect any return from the unit until it was revived. Their integrity was
undoubtedly of higher order. This was considered as a basis for providing
financial assistance to the units. It was also found that there was a fair
understanding among the directors of the units and, therefore, decisions were
taken promptly. Further, the group of directors was well balanced in terms of
expertise. Entrepreneurs were found to be open to banks and financial
institutions. This helped in establishing a better rapport between the two. They
were found to be cooperative to the financial institutions in supplying the required
information and complying with necessary formalities. They were found to be
risk takers and, therefore, decisions were taken promptly. They were also found
to be aware of modern methods of management and practiced the same.
Finally, the entrepreneurs had pleasing manners and therefore, they were given
better treatment by all the outside parties.
7. Role of Banks and Financial Institutions-It is worthwhile to talk about the role
of banks and financial institutions. In all cases, it was observed that there was a
good understanding between the entrepreneurs and the banks. Bankers’ attitude
towards entrepreneurs was quite satisfactory. Banks were found to be more liberal
and helpful while chalking out the rehabilitation package. They were found to be
very quick in decision making. In one case, the required sanction was given within a
period of just one week. Further, at the time of preparation of the scheme, they had
total perspective of the units. Therefore, they suggested to modernise management
besides replacing old machinery. They took up risk on many occasions. Upon the
death of an entrepreneur, his immediate successor (wife) was considered to take
over the unit. Banks gave the required assistance even under those circumstances.
In one unit when the court granted the decree, the bank rightly considered it for
rehabilitation taking into account the benefits of rehabilitation. With the change of
management, the unit started operating nearly at full capacity. It also became a
profit making company.They were consistent in their approach to rehabilitation all
through the period of revival. They were not only a financier but also a counselor to
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the unit. Their advice on money matters was very much rewarding to the units.
There was a good team of banks and financial institutions which shared the related
work. Coordination between banks and financial institutions was of high order and
therefore, credit decisions were taken timely. Finally, bankers were found to be alert
during the period of post sanction. They maintained a close supervision of the
factory and operations in the bank account. Consequently, the end-use of bank
funds was fully ensured.
V. LESSONS FROM SUCCESS STORIES
1) Rehabilitation of a sick unit should be considered as a rare occasion and
therefore, every one concerned with it should be serious in dealing with the
related matters. Their seriousness should also be seen right from the stage of
identification of a sick unit till the same is successfully rehabilitated.
2) On occurrence of a sickness, everyone gets affected. May be, some are badly
affected while others may suffer marginally. Therefore, all those involved in
rehabilitation exercise have to necessarily make sacrifice. This applies even to
the promoters, government and workers.
3) In addition to the required sacrifice expected from all the concerned parties, it is
equally important to adopt a right strategy for revival of sickness. Selection of the
strategy primarily should depend upon the nature of sickness. It is also
necessary to consider cost implications, competence of management, moods of
workers etc. so that the strategy so selected for revival is widely welcomed.
4) For early revival, all work related to rehabilitation has to be time bound. For
which, the role and responsibility of banks, financial institutions, entrepreneurs
and the government should be properly spelt out so that it is possible to avoid
delays in preparation and implementation of the scheme.
5) Rehabilitation is basically a team work and therefore, members of the team
including entrepreneurs, consultants and the government have to put in co-
ordinated efforts to implement the project. In particular, co-ordination between
banks and financial institutions on one hand and banks and government, on the
other, has to be ensured.
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6) Banks and financial institutions are expected not only to supply timely and
adequate finance under rehabilitation but also to offer counselling services to the
entrepreneurs at various stages of rehabilitation. This need is very much felt in
the case of small sized firms.
7) To complete the process of rehabilitation, it normally takes 5 to 7 years. It may
happen that the unit under rehabilitation may suffer due to natural calamities
including death of a key partner/director. In that case, all other parties have to
adopt a sympathetic approach to the firm and extend necessary co-operation.
8) Wherever, default in repayment of loan is deliberate one, stern action is expected
by banks and financial institutions including filing a suit immediately. There
should not be any delay in this regard.
CONCLUSION
Mere introduction of rehabilitation scheme or a package of concessions will not
assure successful revival of a sick unit unless attitude of banks, financial
institutions, government, healthy companies etc. is positive. Similarly, sick
companies should look at rehabilitation as `one time opportunity’ given to them
during their life-span and, therefore, they should endeavour to regain their lost
strength with a high degree of commitment and professional approach. When
these expectations are fulfilled, the present rate of success in rehabilitation can
be enhanced effectively. There are already many success stories in this regard.
So, let everyone march on for reviving each eligible sick unit as early as possible
to make our industrial economy more healthy.
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Chapter-15
DRTs and Lok Adalats
IntroductionBanks and financial institutions are increasingly finding that Debt Recovery Tribunals
(DRTs) do really help in dealing with non-performing assets. For instance, DRT at
Bangalore is ranked number One by the Ministry of Finance which has disposed off
nearly 3500 cases valued at over Rs. 1900 crores since its inception in 1994. As of
March 31, 2004 DRTs in the country have admitted 56988 cases wherein the amount
involved is Rs. 108655 crores. The cases disposed off and the amount involved in them
stood at 23393 and Rs. 18656 crores respectively. Though the overall recovery through
DRTs is yet to be stepped, there is a considerable progress in their performance. This is
mainly due to several initiatives taken by the DRTs. One such initiative is that DRTs
have started holding ‘Lok Adalats’ or ‘Lok Nyayalayas’ to dispose off small value cases.
For instance, the first Lok Adalat in Maharashtra for compromise settlement of bad loans
of banks and financial institutions under the aegis of the DRT was held in Mumbai on
September 29, 2004. To facilitate both banks and borrowers to gain the full advantage
of the Lok Adalats organised by DRTs, it is necessary for them to know more about this
initiative.
The Origin of Lok AdalatsThe concept of Lok Adalat was introduced by the then Chief Justice of India, Shri P N
Bhagwati in the year 1982 as a part of legal aid. By now, it has become a usual feature
of the legal system for effecting mediation and conciliation between the parties and to
reduce burden on the Courts/DRTs specially for small loans. Large number of Lok
Adalats are being organised in different parts of the country from time to time and it
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has got recognition and the patronage of practically every segment of the society.
Based on the experience of several States, a Central Act known as Legal Services
Authorities Act 1987, has been passed providing legal basis for the Lok Adalats and
Legal Authorities to the compromise arrived at between the parties through such Lok
Adalats. Since these Adalats are yet to take a legal shape, they are based on the social
movement only. Several organisations including DRTs, banks and financial institutions
are holding Lok Adalats, which are generally presided over by two or three senior
persons of status and experience including retired Senior Civil Servants, Defence
Personnel and Judicial Officers.
Procedures at Lok AdalatsThey take up the cases which are brought to them by any organisation for consideration.
Parties are heard and they are explained their legal position. They are also advised
about the merits of their cases in accordance with law. They are further counselled to
reach some settlement. Wherever social pressure of senior bureaucrats, judicial officers
or social workers can work, the same is also tried. If the compromise is arrived at, it is
reduced to writing and the parties to the litigation are expected to sign. The Lok Adalats
not being a legal entity do not normally sign the deed of settlement. After the
compromise is arrived at and signed in presence of Lok Adalats, it is to be filed in courts
and a consent decree is to be obtained. Normally, such settlements do contain a clause
that, if the compromise is not adhered to by the parties, the suit pending in the court will
proceed in accordance with the law and the parties will have a right to get decree from
the court. At the time of the session of Lok Adalats, in case some of the parties to the
dispute are not present, they are directed to be present in court for executing the
compromise as arrived at before in the Lok Adalat.
Banks and Lok Adalats – General GuidelinesTo arrive at compromise banks may have to reduce the rate of interest as per their
compromise scheme. To maintain some uniformity in this regard, banks in consultation
with Indian Banks’ Association originally formulated certain guidelines. These guidelines
are :-
1. The bank suits involving claims upto Rs. 20 lakhs may be brought before the Lok
Adalats.
2. Both suit filed and non-suit filed cases can be referred to, Lok Adalats.
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3. Settlement with regards to waivement of interest or sacrifice of principal may be
decided as per delegated authority of the bank official attending the Lok Adalat and
as per recovery management policy of the bank.
4. The defendant should pay half the court fees as cost to the bank and party should
bear rest of the cost as would be proposed by Lok Adalats.
5. The future interest may be agreed to as would be proposed by the Lok Adalats
having regard to Section 34 of CPC.
6. As per merits of each case, considering the total amount and financial condition of
the debtor, six monthly or yearly instalments may be agreed as would be proposed
by the Lok Adalats with a default clause providing for whole amount becoming due
in case of any two defaults.
7. The sick units declared may be given concession in interest as per the existing bank
rules and regulations.
Strength of the Lok AdalatsLok Adalats have had notable success with more than 10 million cases settled through
mechanism. The reasons for these successes need to be identified. First, Lok Adalats
have an element of conciliation and mediation which is lacking in the courts. Second,
Lok Adalats have the counterpart of pre-trial hearings, and have thus settled 50000
disputes at a prelitigative stage itself. Third, Lok Adalats rules are binding on everyone
and no appeals are possible. Fourth, lawyers are not required in Lok Adalats and
consequently, delays have come down fairly. Fifth, Lok Adalats can dispense with
cumbersome court procedures since they autonomous bodies. In this way, there are
many more benefits of the Lok Adalats.
Recent ChangesRecognising the growing importance of Lok Adalats in compromise settlement especially
in respect of small loans, the Central Government in August 2004 has enhanced the
monetary ceiling for referring case for compromise settlement of dues of banks and
financial institutions using the forum of Lok Adalats to Rs. 20 lakhs as against Rs. 5
lakhs earlier. The scope of the Adalat is now expanded to cover both suit filed and non-
suit filed cases in the ‘doubtful’ and ‘loss’ categories with an outstanding balance upto
Rs. 20 lakhs.
Looking AheadThere are twenty nine DRT and 5 DRAT across the country. With the unique advantages
of the Lok Adalats, DRTs have to change their mind-set to dispose off cases of small
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borrowers by organising the same more frequently and also at district and block levels.
This in turn helps DRTs to concentrate more on high value and complicated cases.
DRTs can be merely a facilitator to impress upon both borrowers and banks to settle
disputes on the spot. Further, Lok Adalats are more customers friendly in terms of
procedures for loan settlement besides there is no cost involved in having access to
them. Hence, both borrowers and banks have to take the fullest advantage of the forum
created by the government. But this should be the collective effort of DRTs, banks and
small borrowers to strengthen this forum. More importantly, officers representing the
banks should have sufficient powers to accept the compromise proposal worked out at
the Lok Adalat within the broad compromise policy guidelines of each individual bank
and abide the suggestions of the presiding officer. Borrowers in-turn will have to
appreciate the bank formalities and policy guidelines and agree to the directions of the
Lok Adalats. Towards this end, a need for training and education to DRTs, banks and
borrowers is clearly felt.
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Chapter - 16
Recovery procedure under Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002(SARFAESI)
“The act does not provide a magic wand to remove the sickness in the industry, it can,
at the best, be looked upon as a transient phase in the culture of financing.”
-Justice B P Banerjee
INTRODUCTIONDuring the recent past, many legal reforms have been introduced by the Government
and the Reserve Bank of India for facilitating banks and financial institutions (FIs) to
recover their Non Performing Assets (NPAs). These reforms include setting up of
Board for Industrial and Financial Reconstruction (BIFR), Debt Recovery Tribunals
(DRTs) etc., besides enacting a new act entitled, "Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 (conveniently called as
Securitization Act.
The Act empower the banks and FIs to recover their dues in NPA accounts without
intervention of the court by issuing notice to the defaulting borrowers and guarantors
calling upon them to discharge the dues in full within 60 days. The act further provides
that in case the borrower fails to comply with the 60 days demand notice given by the
bank to repay the dues, the bank can-
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(a) Take possession or the management of secured assets of the borrower, and can
transfer the same by way of lease, assignment or sale for realizing the secured
assets without intervention of court/DRT,
(b) Appoint any person to manage the secured assets which has been taken over the
secured creditor (bank), and
(c) Instruct at any time by notice in writing to any person who has acquired any of the
secured assets from the borrower and from whom any money is due or become due
to borrower to pay it to the secured creditor.
After receipt of 60 days notice by the bank, the borrower shall not deal with the assets,
which are charged, to the bank. However, dealing with the said assets in the ordinary
course of business of the borrower is permitted.
The Security Interest (enforcement) Rules 2002 notified by the government provides the
manner in which the secured creditor shall take possession of the securities and
procedure for disposal of such securities.
Section 17 (2) of the original act provided that the borrower can file an appeal with the
DRTs against any of the aforementioned actions of FIs/Banks taken under the act
provided 75% of the demanded money is deposited by the borrower with the DRT. The
said stipulation regarding deposit of 75% demand money was struck down by the
Hon’ble Supreme Court in Mardia Chemical case, and thereafter it was felt necessary
that law be amended to bring it in conformity with the orders of the Hon’ble Supreme
Court. So the President of India promulgated an ordinance named ‘Enforcement of
Security Interest and recovery of Debts Laws (amendment) Ordinance 2004’ which was
later converted into amendment bill and has since became an act.
Through this amendment sub-section (2) of section 17 that was declared invalid by the
Supreme Court has been deleted and reference to appeal contained in section 17 is
changed to an application. The amendments of 2004 now
(a) Empower banks to take over the management of the business of the borrower,
including the right of transfer by way of lease, assignment or sale or realizing the
secured assets,
(b) Banks are under obligation to consider representation of the borrower and reply
within seven days of such representation and if on examining the representation
made by borrower/guarantor, the banks is satisfied that there is a need to make any
changes or modification in the demand notice, the bank shall modify the notice
accordingly and serve a revised notice or pass such other suitable orders as deemed
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necessary, within seven days from the date of receipt of the representation or
objection.
(c) But mere issuance of 60 days notice or reply of the queries or rejection of objection
of the borrower by the bank will not be a cause of action for filing an application in
the DRT,
(d) However a right has been provided to the borrower for making an application/petition
in DRT for challenging the action of the bank for enforcing the security interest once
bank take over management control or take possession of the assets but before they
are sold,
(e) DRTs have been mandated to decide the case within 60 days. If the case is not
decided by DRT even within four months, the borrower or bank can approach the
appellate tribunal (ADRT ),
(f) The appellate tribunal shall entertain no appeal unless the borrower deposit 50% of
the amount of debt due to him as claimed by the secured creditor or determined by
DRAT. DRAT may reduce the amount to 25% of the debt also.
Since Sarfaesi Act has given wide powers to seize, maintain and sell secured assets of
NPA borrowers to banks, there is urgent need for understanding procedures by
authorized officers (who are empowered to seize and sell the assets) so that provision of
the act are effectively used for benefit of the banks.
RECOVERY PROCEDURES It is attempted here to discuss procedures to be adopted by banks and FIs for
enforcement of security interest by referring to (1) Relevant provisions of the Act 2002
and subsequent amendment of 2004, (2) Central Government Rules and (3) RBI
guidelines issued as on 12th December, 2002. It is also kept in mind the possible
queries that may be put forth by branch managers or authorized officials on their actions
as indicated under the Act. The prescribed system is as under-:
1. Each bank/FI has to set up a separate cell to co-ordinate the work relating to
recovery under the Act.
2. Each bank/FI should appoint an authorized officer (AO) who should not be less than
a Chief Manager. Different banks have authorized different level of officers say
Regional manger or Zonal manager. The authorized officers (A0) are vested with the
following powers-
(a) To issue demand notice to borrower(s)/guarantor(s) u/s 13 (2) of the act.
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(b) To takes steps for substituted service of notice by affixing the same on the
conspicuous part of the secured assets or / and paper publication (rule3).
(c) To take possession of assets (both movable and immovable) and execute
panchanama for having taken possession of movable assets.
(d) To take inventory of movable assets and keep all movables in safe custody by
him or through agents.
(e) To approach the Chief Metropolitan Magistrate or the District Magistrate in writing
to take possession of any secured assets and forward such assets to him,
wherever needed in case AO faces any problem in discharge of his
responsibility. Bombay high court in a land mark judgment has ruled that no
notice or hearing needs to be given to a borrower or a third party when assistant
is taken from the Chief Metropolitan Magistrate to take possession of secured
assets under securitization act. High court has further ruled that the magistrate
has simply to look into two aspects first whether the secured asset falls within his
territorial jurisdiction and second whether the bank had given notice to the
borrower under section 13 (2) of the act to repay the amount due.
(f) To take steps for protection, preservation and insurance of the secured assets
taken into custody.
(g) To take possession or recover dues from 3rd parties, other than borrower after
issuing due notices containing direction, prohibitions, or taking possession of title
deeds.
(h) To affix possession notice on the property taken into possession and issue public
notice in news paper for having taken over possession of the secured assets.
(i) To fix reserve price after obtaining estimated value of secured assets by bank’s
approved valuer.
(j) To issue 30 days sale notice to the borrower/guarantor.
(k) To issue newspaper advertisement setting out the terms of sale through public
tender or public auction.
(l) To sell the secured assets in one or more lots by obtaining quotations, inviting
tenders, holding public auctions or by private treaty to recover maximum price.
(m) To receive sale money and issue certificate of sale.
(n) To publish photographs of borrowers along with demand notice or notice of
taking possession or notice of sale.
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3. Authorized officer will have to first identify NPA accounts to whom the notice has to be
sent. NPA accounts of Rs. 1 lakh and above and loan overdue being more than 20% of
principal amount, are only covered under the act. In case of consortium / multiple
finance, consent of creditors representing at least 75% of value of amount outstanding is
required before issuance of notice. Secured assets must not be agricultural land. AO
should also confirm/check that documents are not time-barred and remain within
limitation till sale process is completed.
4. Thereafter a notice under section 13 (2) of 60 days should be served to
borrowers/guarantors by a registered post with A.D./ Speed post/ Courier/ Fax/ email/
etc. and in case borrower/guarantor is found avoiding service of notice, then notice can
be served by affixing on the door, or publishing in two local newspapers (one must be
vernacular).
5. If the full payment is made by the borrower during the notice period, no further action
is called for. If he makes part payment, the bank/FI can retain the right to seize the
asset to claim the balance amount. During the notice period, Bank/FI can entertain a
request for compromise from the borrower. If the borrower makes part payment in such
a way that loan installments remain due for a period of less than 3 months or irregularity
is less than three months as on the end of the notice period, the bank/FI cannot take
further action since it is a performing loan asset as on expiry of the notice period.
6. In case borrower makes a representation/objection/reply for consideration of the bank,
the AO should consider objection/representation with due application of mind. AO is
duty bound to respond to the borrower if he does not accepts his objections with reasons
within one week of receipt of such objections. Such communication rejecting the
objection will not give any cause of action to borrower/guarantor to file application with
DRT.
7. In case borrowers/guarantors fail to make payment in terms of notice within 60 days,
AO may decide to take possession of secured assets (both movable and immovable).
8. Procedure of taking possession and disposal of movable assets by the AO is as
under-
(a) AO should take possession in presence of two witnesses.
(b) He should prepare a panchnama under his signature and signed by two
independent witnesses for taking possession of movable assets.
(c) He should prepare an inventory of all movable assets taken into possession
and should deliver a copy to borrower or guarantor as applicable.
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(d) He should keep the movables immediately to a nearby godown for storage
and protection and Inform insurance company and arrange for insurance if
not already available.
(e) He should take adequate steps for preservation, protection and safety of the
seized assets.
(f) He should get the assets valued by the bank’s approved valuer and fix
reserve price.
(g) If the borrower agrees to bring in a potential buyer who is ready to pay
minimum fixed price, assets can be sold through private treaty with the
consent of borrower.
(h) He should issue 30 days notice for sale mentioning outstanding dues,
description of assets, reserve price, mode of sale and proposed date and
time of sale through (i) public tender, (ii) public auction or (iii) private treaty.
If the proposed sale is by inviting tender from public, then AO has to publish a
notice in two leading newspapers –one in vernacular language- giving all
details and also mention earnest money to be deposited. He may also
mention that the sale is subject to confirmation by bank.
(i) AO should do actual sale on date, time and venue given in notice/paper
advertisement. Excepting sale by public auction or public tender, terms of
sale should be first settled with the borrower/guarantor and the prospective
purchaser. AO may accept sale price from the person offering maximum price
and deliver the goods and issue certificate of sale.
(j) If the assets are of perishable nature, AO should sale the assets immediately
after taking possession.
(k) If the secured asset is a debt or a share in a corporate body, the Authorized
Officer can directly send a notice to the debtors to make payment to the
bank/FI or transfer shares in bank’s name, as the case may be. AO can
recover dues from 3rd parties other than borrower after issuing due notices
containing direction or prohibitions. For example, if the secured assets are
leased or rented, AO may direct the lessee / tenant to pay the lease rent/
monthly rental to bank. In case of advance against book-debts, AO may
prohibit the debtors to pay to the borrower and direct them to pay to the bank.
(l) Assistance of empanelled advocates may be taken where AO may feel any
difficulty.
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9. Procedure for taking possession and disposal of immovable secured assets by AO is
as under-
(a) AO shall take possession of secured assets (either constructive or actual) by
delivering a possession notice to borrower/guarantor or by affixing the
possession notice on the outer door of the property.
(b) Possession notice should be published in two leading news papers one of
which should be in vernacular language.
(c) If actual possession and custody of the secured asset is taken, then AO will have
to take prudent care of the property by taking steps for preservation, protection,
security, safety and insurance.
(d) AO should get the property valued by an approved valuer and thereafter fix the
reserve price.
(e) Assistance of empanelled advocates may be taken where AO feels any difficulty.
(f) If the borrower agrees to bring in a potential buyer who is ready to pay minimum
reserve price, assets can be sold through private treaty with the consent of
mortgagor (Borrower/guarantor).
(g) AO should send 30 days sale notice to the borrower/guarantor advising them
interalia amount of debt, description of secured assets, mode of sale, reserve
price, terms of depositing earnest money (25%), encumbrances if any on the
secured assets, date, time and place of public auction or tender. Notice of sale
should also be affixed on the property and published in two leading news paper-
one vernacular- having wide circulation in the area where property is situated.
AO must also mention that the sale is subject to confirmation by bank. It should
be clearly mentioned in sale notice that the proposed sale is on ‘as is where is ‘
basis and the bank will not be liable for any charges, dues, levies, taxes,
encumbrances or adverse possession what so ever, neither the bank shall be
liable for the clear and marketable title of the borrower on the charged securities
as the secured assets.
(h) AO should do wide publicity of notice of sale. He/branch officials should contact
potential buyers so that they receive sufficient offers in terms of sale notice.
(i) AO should accept the bid of highest bidder only if it is above reserve price and
accompanied by the earnest money. Balance amount has to be paid by the
bidder within 15 days. The secured asset should only be sold above the reserve
price fixed by the AO.
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(j) When full bid amount is paid, the sale will be confirmed and a sale certificate will
be issued.
(k) In case of default in payment of balance amount by the bidder, the property will
be put to sale again and same procedure of sale will apply. The earnest money
deposited will be forfeited and credited to borrower’s account.
(l) If there is no bidder due to reserve price being high, the AO may reduce the
reserve price by 10 %to 15% and put the secured assets for sale 2nd time after
complying with the procedure noted above.
(m) If excess money is received over and above the banker’s claim, the same should
be credited to the borrower’s account or refunded to him. If there are preferred
creditors (workers’ dues, statutory dues, etc.), the payments should be paid to
them first before the settlement of bank/FI dues.
(n) In case the company is in liquidation, the amount realized from the sale of the
secured assets shall be distributed in accordance with the provision of section
529 A of the Companies Act (workmen’s dues paripassu charge).
(o) Where the property is subject to any encumbrances, the purchaser is expected to
deposit extra amount to discharge encumbrances or meet contingencies.
(p) The Authorized Officer may prefer the sale of movable assets to immovable
assets for early recovery of NPAs.
10. Suit for recovery of balance amount should be filed with Debt Recovery Tribunals
(DRTs)/ appropriate court as per jurisdiction for recovery of shortfall, if any, on sale
of the secured assets.
11. After initiating action under Sarfaesi Act and before actual sale of secured interest, if
is found that documents are getting time barred, bank/ FI must file suit in DRT/civil
court explaining the circumstances.
12. AO may take over the management of the business of borrower under section 13 (4)
of the act. When the business is taken over, the AO may appoint as many as director
or administrator as required. A notice of taking over management and appointment of
directors/administrators should be published in two leading daily newspapers- one in
vernacular- having wide circulation in the area. The directors/persons in control will
vacate the office immediately on publication of the notice and hand over the office to
directors/administrators appointed by the A.O. and they will take into their custody all
property, effects and actionable claim of the business of borrower. The management
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shall be restored as soon as debts are realized in full. No proceedings for winding up
or appointment of receiver shall lie without consent of the A.O.
13. Wrongful seizure of assets may cause penalties. AO should take care.
14. AO is under obligation to make disclosure of all vital facts to the buyer of the
property. In a land mark judgment of Haryana Financial corporation vs Rajesh Gupta
Supreme Court has held that ‘mere perusal of the provisions of the Transfer of
Property act will show that it was incumbent upon the corporation to disclose the
buyer about the non existence of an independent passage to the unit, It was also the
duty of the corporation to inform the buyer that the passage mentioned in the
revenue record was not fit for movement of vehicles. The corporation also failed to
show the buyer the entire documentation as required by law.’
Interference by High Court
In land mark judgement (ET 3.8.2010) Supreme Court has asked High Courts
not to interfere with the debt recovery proceedings initiated by banks against the
defaulters as it will have serious adverse impact on the right of lenders to recover
their dues. It further directed that alternative remedies available to the borrowers
must be exercised under DRT act and SARFEASI Act before the High Court
exercise its discretion to interfere with the proceedings.
Advocates can not sign securitization notice on behalf of bank
In an important judgment Andhra Pradesh High court ( Sampoorna Battu
v. ICICI Bank) has held that only authorized person ( Chief Manager or above)
can sign the notice and noted that issuance of notice by the bank’s advocate
has no locus standi and even subsequent countersigning will not be a remedy to
rectify the defect. (BS 11.01.13)
SICA Act
Section 35 of Sarfaesi act gives its provisions an overriding effect over
anything to the contrary contained in any other law that obviously includes the
Sick Industrial Companies ( special provisions) Act 1985 (SICA). But in Noble
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Aqua case Odisha High court ruled otherwise against which State Bank of India
appealed to Supreme Court. What perhaps has queered the pitch for the
secured creditors is Section 37 of the Sarfaesi Act that goes on to say that the
act is in addition to and not in derogation of any other law in force. This forces
banks to stop Sarfaesi proceedings against Sick companies. With more and
more corporate moving to CDR, it is time to policy makers to lay down rules to
make the Sarfaesi override SICA so that instead of yielding to mirage of CDR
banks actually take advantage of Sarfeasi and enforce recovery.
Change in or Take Over of the Management of the Business of the Borrower
The Reserve Bank of India notified these guidelines effective April 21, 2010,
framed under Section 9(a) of the Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) to enable
the Securitisation Company or Reconstruction Company (SC/RC) to realise their
dues from the borrowers, by effecting change in or takeover of the management of
the business of the borrower and related matters.
Object of the Guidelines
The objective of these guidelines is to ensure fairness, transparency, non-
discrimination and non arbitrariness in the action of Securitisation Companies or
Reconstruction Companies and to build in a system of checks and balances while
effecting change in or takeover of the management of the business of the borrower
by the SC/RCs under Section 9(a) of the SARFAESI Act. The SC/RCs shall follow
these guidelines while exercising the powers conferred on them under Section 9(a)
of the SARFAESI Act, 2002.
Powers of SC/RC and Scope
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A SC/RC may resort to change in or takeover of the management of the business of
the borrower for the purpose of realization of its dues from the borrower subject to
the provisions of these guidelines. The SC/RCs resorting to take over of
management of the business of the borrower shall do so after complying with the
manner of takeover of the management in accordance with the provisions of Section
15 of the SARFAESI Act. On realization of its dues in full, the SC/RC shall restore
the management of the business to the borrower as provided in Section 15(4) of the
SARFAESI Act
Eligibility conditions to exercise power for change in or takeover of management
a) A SC/RC may effect change in or take over the management of the business of
the borrower, where the amount due to it from the borrower is not less than 25%
of the total assets owned by the borrower; and
b) Where the borrower is financed by more than one secured creditor (including
SC/RC), secured creditors (including SC/RC) holding not less than 75% of the
outstanding security receipts agree to such action.
Grounds for effecting change in or takeover of management
SC/RC shall be entitled to effect change in management or take over the
management of business of the borrower on any of the following grounds:
a) the borrower makes a willful default in repayment of the amount due under the
relevant loan agreement/s;
b) the SC/RC is satisfied that the management of the business of the borrower is
acting in a manner adversely affecting the interest of the creditors (including
SC/RC) or is failing to take necessary action to avoid any events which would
adversely affect the interest of the creditors;
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c) SC/RC is satisfied that the management of the business of the borrower is
not competent to run the business resulting in losses/ non repayment of dues
to SC/RC or there is a lack of professional management of the business of
the borrower or the key managerial personnel of the business of the borrower
have not been appointed for more than one year from the date of such
vacancy which would adversely affect the financial health of the business of
the borrower or the interests of the SC/RC as a secured creditor;
d) the borrower has without the prior approval of the secured creditors (including
SC/RC), sold, disposed of, charged, encumbered or alienated 10% or more
(in aggregate) of its assets secured to the SC/RC’4
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(e) there are reasonable grounds to believe that the borrower would be
unable to pay its debts as per terms of repayment accepted by the borrower ;
(f) the borrower has entered into any arrangement or compromise with
creditors without the consent of the SC/RC which adversely affects the
interest of the SC/RC or the borrower has committed any act of insolvency;
(g) the borrower discontinues or threatens to discontinue any of its
businesses constituting 10% or more of its turnover;
(h) all or a significant part of the assets of the borrower required for or
essential for its business or operations are damaged due to the actions of the
borrower,
(i) the general nature or scope of the business, operations, management,
control or ownership of the business of the borrower are altered to an extent,
which in the opinion of the SC/RC, materially affects the ability of the
borrower to repay the loan;
(j) the SC/RC is satisfied that serious dispute/s have arisen among the
promoters or directors or partners of the business of the borrower, which
could materially affect the ability of the borrower to repay the loan,
(k) Failure of the borrower to acquire the assets for which the loan has been
availed and utilization of the funds borrowed for other than stated purposes or
disposal of the financed assets and misuse or misappropriation of the
proceeds;
(l) Fraudulent transactions by the borrower in respect of the assets secured to
the creditor/s.
Policy regarding change in or takeover of management
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Every SC / RC shall frame policy guidelines regarding change in or takeover of the
management of the business of the borrower, with the approval of its Board of
Directors and the borrowers shall be made aware of such policy of the SC/RC. Such
policy shall generally provide for the following:
(i) The change in or takeover of the management of the business of the
borrower should be done only after the proposal is examined by an
Independent Advisory Committee to be appointed by the SC/RC consisting of
professionals having technical / finance / legal background who after
assessment of the financial position of the borrower, time frame available for
recovery of the debt from the borrower, future prospects of the business of
the borrower and other relevant aspects shall recommend to the SC/RC that
it may resort to change in or takeover of the management of the business of
the borrower and that such action would be necessary for effective running of
the business leading to recovery of its dues;
(ii) The Board of Directors including at least two independent directors of the
SC/RC should deliberate on the recommendations of the Independent
Advisory Committee and consider the various options available for the
recovery of dues before deciding whether under the existing circumstances
the change in or takeover of the management of the business of the borrower
is necessary and the decision shall be specifically included in the minutes.
(iii) The SC/RC shall carry out due diligence exercise and record the details of
the exercise, including the findings on the circumstances which had led to
default in repayment of the dues by the borrower and why the decision to
change in or takeover of the management of the business of the borrower has
become necessary.
(iv)The SC/RC shall identify suitable personnel / agencies, who can take over
the management of the business of the borrower by formulating a plan for
operating and managing the business of the borrower effectively, so that the
dues of the SC/RC may be realized from the borrower within the time frame.
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(v) Such plan will also include procedure to be adopted by the SC/RC at the
time of restoration of the management of the business to the borrower,
borrower’s rights and liabilities at the time of change in or takeover of
management by the SC/RC and at the time of restoration of management
back to the borrower, rights and liabilities of the new management taking over
management of the business of the borrower at the behest of SC/RC. It
should be clarified to the new management by the SC/RC that the scope of
their role is limited to recovery of dues of the SC/RC by managing the affairs
of the business of the borrower in a prudent manner.
Procedure for change in or takeover of management
(a) The SC/RC shall give a notice of 60 days to the borrower indicating its
intention to effect change in or take over the management of the business of
the borrower and calling for objections, if any.
(b) The objections, if any, submitted by the borrower shall be initially
considered by the IAC and thereafter the objections along with the
recommendations of the IAC shall be submitted to the Board of Directors of
the SC/RC. The Board of Directors of SC/RC shall pass a reasoned order
within a period of 30 days from the date of expiry of the notice period,
indicating the decision of the SC/RC regarding the change in or takeover of
the management of the business of the borrower, which shall be
communicated to the borrower.
LOOKING AHEAD
As per RBI data, out of 61,263 notices issued by PSBs involving an outstanding of Rs. 19,744
crores, PSBs have recovered only Rs.1784 cores from 24,092 borrowers. It is a good
beginning, but we have a long way to go. Now banks will have to capitalize on the benefits of
the act. Hence, what is important is to identify eligible accounts immediately. Notice should
be served to them immediately. Banks/FIs should give priority for seizure of secured assets in
those accounts where secured assets are likely to fetch potential buyers easily or borrowers
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are found cooperating. There should be utmost care in preserving the assets, which are
seized. In particular, authorized officers should take reasonable care to comply with the
provision of the act and RBI guidelines. It calls for a professional approach from authorized
officers in seizure and sale of secured assets. Such measures will definitely send strong
signals to willful defaulters. Thus, one can hope that banks/FIs will succeed in bringing down
the level of NPAs by enforcing security interest. It will also create a congenial repayment
climate in the country by dissuading willful default.
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Chapter-17
SARFAESI Act 2002 - FAQIntroduction
With the recent judgment delivered by the Supreme Court in respect of ICICI
Bank and Mardia Chemicals, banks are now busy in seizure of secured assets and sale
under the Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest (SARFAESI) Act, 2002. While waiving the condition under 17 (2)
under the SARFAESI Act to deposit 75% of the bank-claim by the aggrieved borrower
with the Debt Recovery Tribunal (DRT), the Apex Court took a note of the Lenders’
Liability – Best Practices Code of the Reserve Bank of India besides making it obligatory
on the part of banks to provide clarification to a borrower to whom notice is served
under 6 of the Act. Though banks are now allowed to proceed with their arrangements
to sell the assets seized under the Act, most of the borrowers are rushing to the DRT to
seek justice for which no deposit of the banker’s claim is called for. Consequently,
banks are prevented to sell the assets until the DRT decides on the petition filed by the
aggrieved borrower. Hence, these banks made a request to the Government to amend
the SARFAESI Act and the Recovery of Dues to Banks and Financial Institutions Act,
1993. While performing the tasks, banks would like to seek clarification on various
matters concerning the seizure and sale of assets. In this chapter , it is attempted to
provide clarification on various bank procedures through frequently asked questions.
Questions and AnswersQ1. Can any officer in banks seize assets?
Ans. No, only the authorized officers appointed under section 13 (12) can seize
secured assets. Each bank/FI has appointed authorized officers under provision of
this section. In public sector banks, officer in SMG IV and above and not below the rank
of Chief Manager can be appointed as the authorized officer.
Q.2. How do we serve notice?
Ans. As under section 6 of the Act, notice of 60 days (from the date of receipt of
notice) should be served properly, i.e., by a registered post with A.D., affixing the notice
on the door, or publishing in the local newspapers. Notice to all the parties is necessary
if the number is more than one. Simultaneous action may also be taken against the
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guarantor. The notice has to be delivered at the place where the borrower/ guarantor,
actually and voluntarily resides or carries on business or personally works for gain and
where the borrower is corporate, the demand notice has to be served at registered office
address.
Q.3. Is it necessary to seek permission from the Court/DRT for serving the notice in
respect of suit filed/DRT cases?
Ans. In terms of the proviso to amended section 19 of the DRT Act, the bank, may if
so chooses move an application for permission of DRT for withdrawal of the recovery
suit pending before DRT for enabling the bank for taking action under securitisation act .
It should be noted that withdrawal of DRT suit may have implication from limitation point
of view and before taking such a decision a banker must carefully examine all inns and
out. However if the notice under section 13 (2) of the Securitisation Act was issued
before 11th November 2004 in a borrowal account in respect of which the recovery
proceedings are already pending before DRT, there is no need for withdrawal of the
recovery suit.
Q.4. Is it necessary that documents to be valid on the date of serving notice?
Ans. Yes, not only the date of serving notice but also on the date of sale of seized
assets.
Q.5. What is expected to be done by the authorized officer during the notice period?
Ans. If the full payment is made by the borrower during the notice period, no further
action is called for. If he makes part payment, the bank can retain the right to seize the
asset to claim the balance amount. If the borrower makes part payment in such a way
that loan installments remain due for a period of less than 3 months as on the end of the
notice period, the bank cannot take further action since it is now a performing loan asset.
During the notice period, bank may entertain a request for compromise from the
borrower.
Q.6. What are the procedures to be followed for seizure of the assets?
Ans. On expiry of 60 days notice period, Authorised Officer (AO) may take following
actions for seizure and sale of movable and immovable assets-
(a) AO should take possession of movable secured assets in presence of two
witnesses. He should prepare a panchnama under his signature and signed
by two independent witnesses for taking possession of movable assets. He
should prepare an inventory of all movable assets taken into possession
and should deliver a copy to borrower or guarantor as applicable. He should
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keep the movables immediately to a nearby godown for storage and
protection and inform insurance company and arrange for insurance if not
already available.
(b) AO shall take possession of immovable secured assets (either constructive
or actual) by delivering a possession notice to borrower/guarantor or by
affixing the possession notice on the outer door of the property. Possession
notice should simultaneously be published in two leading newspapers one
of which should be in vernacular language.
(c) AO should take adequate steps for preservation, protection and safety of the
seized assets. AO should take sufficient care of the assets seized including
insurance cover, posting a security guard, etc. and should get the assets
valued by the bank’s approved valuer and fix reserve price.
(d) If the borrower agrees to bring in a potential buyer who is ready to pay
minimum fixed price, assets can be sold through private treaty with the
consent of borrower.
(e) AO should issue 30 days notice for sale mentioning outstanding dues,
description of assets, reserve price, mode of sale and proposed date and
time of sale through (i) public tender, (ii) public auction or (iii) private treaty. If
the proposed sale is by inviting tender from public, then AO has to publish a
notice in two leading newspapers –one in vernacular language- giving all
details and also mention earnest money to be deposited. He may also
mention that the sale is subject to confirmation by bank.
(f) AO should do actual sale on date, time and venue given in notice/paper
advertisement. Excepting sale by public auction or public tender, terms of
sale should be first settled with the borrower/guarantor and the prospective
purchaser. AO may accept sale price from the person offering maximum price
and deliver the goods and issue certificate of sale.
(g) If the assets are of perishable nature, AO should sale the assets immediately
after taking possession.
(h) Assistance of empanelled advocates may be taken where AO may feel any
difficulty.
Q.7. What are the types of possession of assets?
Ans. There can be of two types of possession – physical and token. For example -
receiving a key of a flat is a token possession. If the secured asset is a debt or a share
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in a corporate body, the Authorized Officer should send a notice to the borrower asking
him to direct the debtors to make payment to the bank or transfer shares in its name, as
the case may be. AO can recover dues from 3rd parties other than borrower after issuing
due notices containing direction or prohibitions. For example, if the secured assets are
leased or rented, AO may direct the lessee / tenant to pay the lease rent/ monthly rental
to bank. In case of advance against book-debts, AO may prohibit the debtors to pay to
the borrower and direct them to pay to the bank.
Q.8. Whether it is mandatory under the Act to take physical possession of the property
before sale is affected?
Ans. NO. In respect of immoveable property it is NOT mandatory under the act to take
physical possession of the concerned immoveable property before sale is affected.
Q.9. Whether judgment of the Supreme court in the Transcore prohibits taking symbolic
possession of immovable property and speaks of actual physical possession u/s 13 (4)
of the act.
Ans. NO, the judgment of the Supreme court in Transcore did not prohibit taking
symbolic possession of immoveable property and did not speak only of physical
possession under section 13($) of the act.
Q.10- Who should value the assets under possession of the bank?
Ans. Get valuation of the assets in possession through an approved valuer of the
bank.
Q.11. Can we allow the borrower to use assets after possession?
Ans. Yes, on possession of assets, the bank may appoint a manager to manage such
assets. In that case, this matter should be published in the local newspaper. A copy of
the Panchanama should be affixed on the asset.
Q.12 Can the asset be sold immediately?
Ans. No, sell the asset only after serving a notice period of 30 days to the borrower, so
that he gets one more opportunity.
Q.13. What are the types of sale?
Ans. AO may adopt any of the following methods to sale the secured assets-
(a) Obtaining quotations from parties dealing in secured assets or otherwise
interested in buying such assets.
(b) Inviting tender from public, or
(c) Holding public auction, or
(d) By private treaty.
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Q.14. If excess money is received through sale of the assets, to whom this belongs?
Ans. If excess money is received over and above the bank’s claim, the same should
be passed on to the borrower. If there are preferred creditors in respect of workers’
dues, statutory dues, etc. the sale proceeds should be utilized to pay to them first
before the settlement of bank dues.
Q15. Whether claim of statutory dues such as state sales tax, electricity, royalty
payment etc. have priority over dues of secured creditors?.
Ans. In Centre Bank of India Vs. State of Kerala , Hon’ble Supreme Court has ruled
that claim of secured creditors over borrower’s assets have priority over statutory dues
such as sales tax, lease rent, power dues etc.
Q.16. What should be done after receiving the amount on sale of the asset?
Ans. Issue a Certificate of Sale to the purchaser on receipt of full payment as per
terms of sale.
Q.17. What are the procedures to be followed for the sale of immovable assets?
Ans. The purchaser has to pay a deposit of 25% of the amount of the sale price on the
date of auction - sale and the balance should be paid within the next 15 days. Once
entire sale amount is received, the sale should be confirmed and sale certificate should
be issued. On default of payment within the specified period, the earlier deposit of 25%
should be forfeited and the same should be credited to the borrower’s loan account and
the property may be considered for re-sale.
Q.18. To whom the banks should approach for shortfall in recovery though the sale of
the secured assets?
Ans. Debt Recovery Tribunals (DRTs) or competent court ( as per jurisdiction) should
be approached for recovery of shortfall, if any, on sale of the secured assets.
Q.19. If found difficult to take actual possession of secured the asset, whose help may
be sought for by A.O.?
Ans. To approach the Chief Metropolitan Magistrate or the District Magistrate in writing
to take possession of any secured assets and forward such assets to him, wherever
needed in case AO faces any problem in discharge of his responsibility. Bombay high
court in a land mark judgment has ruled that no notice or hearing needs to be given to a
borrower or a third party when assistant is taken from the Chief Metropolitan Magistrate
to take possession of secured assets under securitization act. High court has further
ruled that the magistrate has simply to look into two aspects first whether the secured
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asset falls within his territorial jurisdiction and second whether the bank had given notice
to the borrower under section 13 (2) of the act to repay the amount due.
Q.20. What is the cut-off limit of loans to be considered under the SARFAESI Act?
Ans. Debts of Rs. 1 lakh and above and overdues being more than 20% of principal
amount are only to be considered under the Act.
Q.21. Which assets should not be considered for seizure?
Ans. The following are not eligible under the Act:
* Agricultural land and tools of farmers
* Pledged assets
* Unsecured assets/ clean loans/undrawn limits
* Unpaid stock
Q.22 Is it possible to seize the assets in the absence of borrower?
Ans. Yes, it is possible.
Q.23. Can we consider collateral securities?
Ans. The Act refers to all the assets, which are secured – both primary and collateral.
Q.24Is it necessary to seize the assets of the borrower first and then a guarantor?
Ans. It is not necessary. Simultaneous action is also possible.
Q.25. In consortium advances, who can serve a notice?
Ans. It is desired if joint action is initiated when members of the consortium join the
lead institution and serve a notice.
Q.26. If there are no bidders despite organizing public auction repeatedly, what should
be done?
Ans. If there is no option, It is advisable to file suit with DRT to save limitation.
Q.27. Can the bank seize the assets when the borrower approaches Corporate Debt
Restructuring Body for debt recast?
Ans. No. The bank can do so only after the restructuring period.
Q.28. Whether in a case where second charge holder resorts to enforcement of security
interest, should he satisfy the dues of first charge holder from the sale proceeds of the
secured assets?
Ans. Yes the dues of the first charge holder have to satisfied. The 1st charge holder
should also be consulted before taking steps for sale.
Q.29. While taking possession of stock, how a part of them under lien to unpaid seller is
to be identified?
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Ans. The AO is expected to know from verification of purchase register of the borrower,
which is paid up, and which is not paid stock. Unpaid stock cannot be taken over.
Q.30. What are the prospects of recovery under the Act in future?
Ans. Chances of recovery are expected to be bright if the SARFAESI Act and DRT
Act are amended to prevent the aggrieved defaulter in approaching DRT to fight on
trivial issues and thus bargaining more time to settle bank dues.
Q.31- Can the bank publish photographs of borrowers/guarantors along with possession
or sale notice?
Ans. In case of Ku. Archana Chauhan v. State Bank of India, Jabalpur w.p. no. 3319/
2006 dated 7.3.2006, it has been held that publication of photographs of the borrowers
can not be said to be impermissible mode. Action cannot be said to be arbitrary or lillegal
in any matter. It can not be said to be defamatory publication made.
Q.32- Whether High Court can direct one time settlement?.
Ans-It is held by Ho’nble High Court of Chennai in a land-mark judgment dated
07.07.05 that court under article 226 of constitution can not reschedule the loan. It held
that court must exercise restraint in passing such an order.
Q33. – Whether tenancy created by the borrower after creation of mortgage in favour of
the banks would be valid?
Answer-Madras High court vide judgment dated 23rd February 2007 in the matter of
Shree Lakshmi Products Vs. SBI, Coimbatore has held that tenancy created after
mortgage in contravention of section 65 A of Transfer of property act would not be
binding upon the bank and provision of SARFEASI Act 2002 will prevail over the local
law in case of conflict and such tenancy right shall stand determined once action u/s
13(4) has been taken by the bank.
Q34. Whether bank can take steps u/d 14 of the act after completion of sale of
immovable property?
Ans. Yes, bank can take steps under section 14 of the act after completion of sale of
immoveable property.
Q35. Whether pre deposit condition of 25% for hearing the matter before DRAT can be
relaxed for sick company?
Answer: The Delhi High Court dismissed the petition filed by Swadeshi Cement Ltd
against the order of DAT to deposit 25% in advance to hear the appeal filed by the
company and declared that sick company are not entitled to such benefits when Asset
Care Enterprise invoked the SARFEASI act the company.
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Looking AheadThis chapter on frequently asked questions makes a modest attempt to offer
clarifications on bank procedure prescribed under SARFESAI Act 2002 for seizure and
sell of secured assets so that authorized officers can exercise their powers in fair,
reasonable and fearless manner. In case of doubt, authorized officer must take legal
advice to avoid complications.
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Chapter- 18
Asset Reconstruction Companies
Introduction
The downturn in the economy in 2008-09 has caused large scale loan defaults that
resulted in huge non performing assets which added more than Rs. 11000 crores as
fresh NPA during 2008-09. The NPAs of commercial banks increased from Rs.55,800
crores as on March 2008 to Rs. 66,900 crores as on March 31, 2009 . (TOI 15.07.2009)
This NPA level is despite massive debt waiver of Rs. 65000 croes in agriculture during
2008-09. Hence, it is necessary to reduce the level of NPA on a war-footing through
various measures. In this regard, certain innovative measures were thought of.
Creation of Asset Reconstruction Company (ARC), also known as Assets Management
Companies (AMC) is one such measure. ARCs set up under Securitisation and
Reconstruction of Financial Assets and Enforcement of Security Interest (SARFESAI)
Act have been empowered to take over NPA from banks, engage in innovative corporate
finance such as merger, sale of brands or plants, inject new capital, convert distressed
companies into new companies and even take out an IPO. ARC will have to work within
RBI guidelines and subject to registration/license from RBI. Accordingly all ARCs
should have minimum owned funds of Rs. 100 crores and to maintain minimum capital
adequacy of 15% at all times. GOI is also considering allowing the ARCs to have 49%
foreign direct investment.
Many more developments are likely to take place in the matters of recovery of NPAs
through ARCs. Hence, an attempt is made, in this chapter , to discuss both conceptual
and operational aspects of ARCs, besides examining the relevant issues. Let us start
with the recommendations of the Narasimham Committee Report.
The Second Narasimham Committee on ARC
In India, the Committee on Banking Sector Reform (1998) appointed by the Reserve
Bank of India, suggested for the first time to set-up an ARC for take-over of NPAs of
weak banks. According to the Committee, for reducing the NPAs of weak banks, there
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can be two approaches. In the first approach, all hard-core NPAs (doubtful and loss)
should be identified by each bank. Securities backing these NPAs should be assessed
to arrive at realizable/ marketable value. Such NPAs should then be transferred to the
ARC which would issue NPA Swap Bonds, as consideration for the assets (NPAs)
taken-over. The amount of bonds should be equal to the sum of realizable value of the
assets transferred. If the volume of NPAs is very large, each weak bank may set-up it’s
own ARC as a subsidiary. Or, a group of weak banks with moderate size of NPAs, may
promote an ARC jointly. Such ARC may be set-up either in the public sector or in the
private sector. In case, banks decide to set-up an ARC, it is essential that they spare
their staff required for take-over of assets and their subsequent sale. This arrangement
ensures that the institutional memory on NPAs is made available to the ARC. In
addition, there is some rationalization of staff in the banks, whose assets are sought to
be transferred to the ARC. For speedy and effective recovery, the ARCs should be
permitted to file suits in Debt Recovery Tribunals (DRTs). In case it is attempted to
create an ARC in the private sector, the Committee envisages certain problems. For
instance, there may not be many takers for the assets representing NPAs in the banks
because, most of them may not be backed by fixed assets like land and building or,
their market value may be negligible.
In the second approach, the reduction of NPAs is suggested without creating an ARC.
Here, NPAs will be reduced by making provisions/write-offs. This can be done if the Tier
I capital is very large. Otherwise, Tier II capital can be raised by issuing bonds so as to
meet the shortfall in the Capital Adequacy Ratio arising out of huge provisions and write-
offs to be made. If banks are likely to experience difficulties in getting subscription to
these bonds, the government may guarantee the same. Further, these bonds may be
considered as ‘approved securities’ by GIC, LIC or Provident Funds and ‘SLR
investment’ by banks. An alternative measure to widen the capital base is to seek
budgetary support by banks, which seems to be difficult at this stage. Thus, with the
increased capital it is possible to reduce net NPA amount and it’s percentage to the total
advances. The Committee, in the end, advises that banks and FIs should sit together to
work out the approaches as outlined above.
Process of Asset Reconstruction
To get a fair understanding of the processes of the asset reconstruction, let us take
an example. Forward Bank has hard-core NPAs of Rs. 2000 crores as on 31-03-02.
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This bank would like to sell these NPAs to the ARC. Accordingly, it makes an
assessment of the realizable or market value through an independent valuer, which is
arrived at a certain amount, say, Rs. 1400 crores. The bank approaches the ARC for
the sale of NPAs. The ARC purchases these NPAs at Rs. 1600 crores, i.e. realizable
value. It issues NPA Swap Bonds worth Rs. 1600 crores to the Forward Bank. The
bond would carry a fixed interest rate of say, 7.5 per cent equal to the rate on
recapitalization bonds. The Forward Bank will then provide for the entire loss of Rs. 400
crores (Rs. 2000 – 1600 crores) in the profit and loss account. Or, this can be
amortized if the profits are not adequate. Further, it’s networth will decline by Rs. 400
crores since loans and advances will be reduced by Rs. 2000 due to write-off (Rs. 400
crores) with addition to investment portfolio (Rs. 1600 crores). The bank will continue to
receive interest on bonds each year until the date of maturity. Then, these bonds will be
redeemed on maturity by the ARC. Alternatively, there can be periodical redemption of
bonds. After the purchase of NPAs, the ARC will recover the maximum amount from
NPAs over a period of time. If the amount so received is more than the purchase-value,
the business turns out to be profitable one. This is quite possible since the ARCs are
supposed to be professional experts in recovery from the NPAs. Thus, the above
arrangement is found to be beneficial to both banks and ARC.
Lessons from International Experiences
In the international scenario, a bank resolution or bank rehabilitation agency takes
control of problems of banks, and therefore, operates under a much broader mandate
than an asset management company. Generally, a bank resolution agency focuses on
winding up insolvent banks, including asset management. The approach was introduced
in the US, with the Resolution Trust Corporation (RTC) which was formed in 1989 to
liquidate insolvent savings banks as well as with the Federal Deposit Insurance
Corporation (FDIC). In the resolution made, these agencies were also incharge of
disposing of all assets, including non-performing assets. In Japan, the Deposit
Insurance Corporation (DIC) offers adequate support for troubled banks and bank
liquidation. Loan work-outs are carried out by the resolution and collection bank (a DIC
subsidiary). In Ghana, a Non-Performing Assets Recovery Trust (NPART) was set-up
in 1989 to deal with the recovery and disposal of bad debts and other collaterals.
NPART was authorized to sue for recovery and collect proceeds from debts. On the
Ghana model, Tanzania and Uganda also set-up NPART in 1988 and 1995 respectively.
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In Mexico, the Deposit Insurance Company, through its loan work-out subsidiary, was
put incharge of assets management. China, in view of high NPAs, has set-up ARCs –
even selling of assets to foreigners at steep discounts. In Malaysia, ‘Dahantra’, a
restructuring agency, has done well in disposing of three-fourths of assets which it
acquired. Thus, encouraged by the experiences of these countries, India should go
ahead in setting up many more ARCs. But there are several issues relating to the
organizational aspects.
Organizational Aspects of ARCs
Sometime in 2000, the Finance Minister for the first time proposed to set-up an ARC
mainly for the weak banks. Subsequently, it was thought that the scope of the ARCs
should be enlarged to cover all public sector banks. In the long run, even banks in the
cooperative sector and NBFCs may also be targeted. In any case, the country requires
several ARCs and not just one, to represent each of the major geographical areas.
These shall be set-up in the private sector so that more flexibility in their organizations
can be ensured. Alternatively, banks can jointly set-up a subsidiary to act as an ARC.
Whatever may be the form of organization, adequate capital has to be provided to the
ARC. But such support is not likely to come from the Government. The other issue
refers to the stamp duties to be paid on purchase of loan assets by ARCs. This would
be a major burden. But, if proposed to set-up an ARC as a cooperative unit or a trust,
there is a way out. Alternatively, ARCs may be exempted from the payment of stamp
duties recognizing the dire need to reduce NPAs of banks. Regarding the staff, we
should not go in for merely deputationists from banks and financial institutions since they
have already demonstrated their inability to recover the NPAs. Hence, it is essential that
ARCs should induct a pool of professionals on full time basis. It can also be debated
whether the investment made in ARCs could be given the SLR status. It is also
important that ARCs have a definite period of tenure, after which they should be
liquidated. Usually, one may insist a life period of say 5-7 years. Further, to achieve the
basic objectives, cost control occupies an important place. Lastly, the prices at which
assets are transferred should be based on market prices. The ARCs should not be
compelled to take-over assets at prices other than what it’s management feels. In
particular, they should have more autonomy and wide powers to manage NPAs. In this
regard, the recent enactment on Securitization and Reconstruction of Financial Assets
has spelt out the role and functions of ARCs.
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Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
This Act empowers banks and financial institutions to take-over the assets from
defaulters by serving a notice of sixty days, without any intervention from the court. On
take-over, these assets shall be managed, leased out, or sold to liquidate loans. But this
is not an easy job. Hence, services of ARCs have to be hired. The important provisions
of Sarfaesi Act in reference to ARC are as under-
1. Unfettered right to the lenders acting in majority (>75% by value) to enforce security
rights without intervention of court.
2. No single investor to have majority control over ARCs.
3. Additional right of ARC which is not available to lender i.e. sale or lease of
businesses by superceding board powers.
4. Enables foreign investor participation.
5. Measures for reconstruction-
(a) Change in or takeover of management of business of the borrower
(b) Sale or lease of part or whole business of the borrower
(c) Rescheduling of payment of debt
(d) Enforcement of security interest
(e) Settlement of dues payable by the borrower
(f) Taking possession of the secured assets
6. Enforcement of security interest
(a) Can be enforced without intervention of court.
(b) Borrower to discharge liability within 60 days notice.
(c) Secured creditors have right to take possession, take management control of
secured assets including right to transfer.
(d) In consortium right can be exercised if more than 75% borrowers agree to
proceeds under the act.
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It will be observed that under Sarfaesi, ARCs are vested with the rights of a
‘deemed lender’ in respect of take-over of assets and subsequent sale or management
of assets. Though the ARCs are given wide powers, still doubts are raised about their
effectiveness. Since Central Registry is not set-up, it is difficult to sell assets though
taken over from loan defaulters. But one thing is certain that the need for promotion of
ARCs in India is very much felt. Though their role and responsibility have been spelt,
what is required is to create a conducive environment and work-out arrangements for
setting up more such ARCs.
Setting up of ARCs
Several players have applied to RBI for registration in order to commence
business. First ARC known as ARCIL has been registered as private sector entity with
51% equity in the hands of private sector banks. It is registered with RBI under section 3
of the SARFESAI act 2002 as Securitisation and Reconstruction Company, which
commenced business from August 29, 2003. The company is an associate member of
IBA. In two and half year operation, ARCIL has acquired bad loans from 32 banks of
over Rs.22,000 crores at an average acquisition cost of 23% of total dues (Business
Standard 12th May 2006) . ICICI bank is the biggest seller of 134 bad loan of Rs. 8450
crores followed by SBI, which sold 181 bad loans of Rs. 2,468 crores. So far only 6 out
of total 19 nationalized banks have sold their bad loans to ARC (Economic Times
14.04.2005). ARCIL has also ventured in acquiring retail housing loans of Rs. 1000
crores of National Housing Bank and ICICI bank. (FE 25.8.2008) Theoretically ARCIL
has reduced the NPA of banking industry by 13%. UTI has promoted the second ARC
known as ASREC. The company received RBI license in October 2004. It has acquired
NPAs from 11 banks/FIs having gross value of Rs.1109.50 crores consisting of 164
accounts. Out of this ASREC recovered Rs.70.67 crores through resolution. Other
ARCs are (a) India SME asset Reconstruction Company Limited (ISARC) promoted by
SIDBI, (b) Assets Care Enterprise (ACE) Ltd. Promoted by IFCI, and (c) Reliance Asset
Reconstruction Company promoted by Reliance ADA group. ARCs are hardly a
successes story since it has been able to buy only a fraction of NPAs and banks are
complaining that they are not offering right price to them. This problem is expected to
be solved with setting up of few more ARCs because it will increase competition.
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Conclusion
Recent Inspection of RBI of ARCIL has suggested serious deficiencies in asset
reconstruction business in general and ARCIL in particular. First there is issue of poor
corporate governance that enabled the major shareholders to collude in off loading their
bad loans to ARC. Second issue is of technical nature about business model of ARCs
about acquiring bad loans and then realizing them. Typically NPLs are acquired by
ARCs under a trust structure and security receipts representing interest in underlying
securities issued to qualified Institutional buyers with ARCs acting as trustees. The
proceeds thus realized is used to pay sellers of NPLs. Since sellers are also bank or
financial institutions, the model is akin to a cozy deal between bank and ARCs,
reminiscent of incestuous relationship between financial players that was hall mark of
2008 financial crisis. In other words bank get NPL off the book by selling to a trust
which in turn is funded by them. So instead of impaired loans they now hold securities
representing the same impaired assets. Third is that ARCs are no better equipped to
handle the NPLs than the banks them selves. The securitization Act 2002 was expected
to make drastic changes in recovery landscape but it has not happened. Hence
the success of the ARCs will depend upon the seriousness of the government in
implementing the Act. Further, Debt Recovery Tribunals (DRTs) will have to be made
strong to offer necessary help to ARCs in recovery of dues. Lastly, banks and financial
institutions have to realize that, for recovery from hard-core NPAs, the need for the
services of ARCs clearly exists. All the more important is to create awareness on the
role and responsibility of bank officers under the Act, the functioning of ARCs, etc. for
which the need for strengthening our efforts in training and education is clearly felt.
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Chapter- 19
Due Diligence in Credit Management
IntroductionOf late, due diligence in credit management is reemphasized in banks due to increasing
irregularities and frauds. This is evident from the RBI circular of August 24, 2004
wherein deficiencies commonly observed in credit management, are explained. In this
backdrop, there is a felt need to strengthen the system of due diligence in credit
management in banks. Towards this end, it is attempted to develop a checklist for the
benefit of credit officers in banks. The checklist is based on the study of RBI guidelines,
Loan Policy prepared in banks, Lenders Liabilities – Best Practices Code in banks and
Basic Principles of Bank Lending. Though this seems to be comprehensive checklist,
there is scope to expand the same based on experiences of banks.
Check-listI. Pre-sanction Formalities
Fulfill the KYC norms for opening a savings / current account by a potential
borrower. Obtain photograph, IT PAN, sales tax/excise registration number, shop
and establishment registration number, etc. of the person authorized to operate
the account.
Give a loan application forms only if found eligible under the concerned bank
scheme. Help the borrower to complete the loan application form.
Receive the loan application form duly filled-in which should be submitted along
with: -
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o Project proposal, past and projected financial statements (audited
balance sheet, and profit & loss account) and cash flow statement; xerox
copies of the relevant certificates; bio-data of the promoter, etc. The
project proposal should contain the required details.
o Issue a receipt for the loan application form being received and enter in
the Loan Applications Received Register.
As part of credit appraisal, scrutinize documents including partnership deed,
certificate of incorporation, articles of association, resolution of the board to raise
borrowings, trust deed, certificate of registration, etc. (as the case may be) and
verify the registered office/business office address.
Obtain the market report of the borrower and reference letter from referees.
Collect the details of existing borrowing arrangements with the other banks, if
any.
Check list of willful defaulters from RBI/CIBIL web site.
Do compliance of guidelines relating to take-over of the loan account from the
other bank/s. Obtain credit report and no lien/no charge letter.
Borrower should be asked to give a certificate stating details of current account
opened with other bank(s). Otherwise obtain undertaking that they are not
keeping current account with any other bank.
Assess the financial status of associated companies, if any, and call for their
audited financial statements.
Scrutinise details of the guarantors which include their relationship with the
borrower, net worth, business activities, securities to be offered, etc.
Prepare a process note for loan sanction which should include:
Background of the promoters
Position of the present business activities
Proposed business activities
Project cost and sources of funds – details
Interview the applicant and record the conversation in brief.
Check that proposal is within the exposure norms as applicable to the
individual/group/industry.
If the proposal is under sensitive sector examine exposure norms and guidelines
under bank’s credit policy and RBI restrictions if any.
Do rating of the borrower under bank’s risk grading system.
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Approve the projected figures as stated in the proposal, which should be based
on convincing assumptions, and verify certificates of auditors and architects.
Examine the market conditions to approve business estimates.
Assessment of feasibility of the project – technical, commercial, financial and
managerial aspects. Interpretation of the financial statements and cash flow
statements through key ratios – D:E, CR, DSCR, BEP, IRR, etc. Examine the
financial standing of the project and profitability of the borrower.
Do social cost: benefit analysis.
Conduct pre-sanction inspection to verify information as furnished in the loan
application form and assess the antecedents of the promoters/guarantors. Also
verify the details of the securities to be offered; proof of the residence, lease
deed, sales deed, rent agreement, etc.
Sanction credit facilities keeping in mind the lending powers delegated. If
proposed limit fall under authority of higher office, recommend the proposal to
them. Issue a letter of sanction to the borrower stating the terms and conditions
and obtain his written consent.
If decided not to sanction, state reasons thereof. Observe the time limit set for
loan sanction.
Prepare a set of documents for execution.
Disburse the loan amount only after fulfillment of all terms and conditions. In
particular, promoters’ contribution should be deposited first before disbursement
of the amount. The term loan amount should be disbursed as per the progress of
the project. End use of firms should be satisfied.
Conduct inspection of the factory/business premises within a month from the loan
disbursement to ensure the end use of borrowed funds.
II. Post-sanction FormalitiesAs part of post sanction formalities, (A) Conduct of Stock Inspection, (B) Follow-up the
transactions in Loan Ledger, (C) Discuss with the Borrower, (D) Study the Market
Reports, (E) Analyze the Financial Statements and cash flow statement, (F) Review and
Renew the Working Capital Limits, (G) Rehabilitate Sick Units, (H) Recover from Non-
performing Advances. Due diligence in respect of these post-sanction formalities is
suggested as under :
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F. Stock InspectionBy comparing the stock statement of a borrower with his stock register to confirm that
the stock position as declared by him is in accordance with the books of accounts. If
there is a major variation, it is a bad signal.
In case of large borrowers verification of stock includes:
(a) stock kept at the factory premises;
(b) finished stock at the sales depots of the company;
(c) raw materials sent to outsiders for conversion or processing; and
(d) stock in transit
Besides physical verification of stock, it is essential to see :
(a) purchase price of raw materials as indicated in the invoices;
(b) position of stock in process and finished stock as on the given date duly
certified by the production manager; and
(c) pricing policy of the company and methods of valuation of stock adopted.
Following tips may be of great use-
Conduct inspection periodically. Banks are having policy of inspection on
monthly/ quarterly intervals depending upon health (risk grading) of the
borrowing units.
Do sufficient homework before inspection. After inspection, calculate the
drawing power and note down in the loan ledger. Note down adverse
observations in Inspection Register.
Do ABC analysis. Do 100% verification of high value less number of stocks and
30% verification of low value high number of stocks.
The physical verification of stock ensures the end use of loans. If the stocks are
not adequate, it indicates that the funds are not fully utilized for the agreed
purpose.
Any major variation in stock value as per the stock statement on one hand and
books of accounts on the other gives an indication of misappropriation of stock or
diversion of funds.
If the stock not belonging to the company is stored in the factory godown, it
indicates that the company is indulging in malpractices.
If the stock statements are deliberately not submitted for a long time, it shows
that a major portion of the stock does not exist.
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If the company has maintained excess stock, it also indicates that the company is
indulging in trading also.
If the company has taken a dual finance from two different banks on the same
stock, it indicates dishonesty of the borrowers.
It is difficult to ensure the quality of stock. But, if there is no movement of certain
finished goods, it shows that the stock is outdated, slow moving, obsolete or
unsaleable.
It is advisable to get the stocks checked/ valued by stock auditors or internal
technical officers of Valuation Cell. Gradually, dependence on external valuers
should be reduced.
During inspection, the presence of bank board, book-keeping and maintenance
of registers, insurance cover, etc. should be looked into.
Look into the level of operations, orders in hand, turnover of staff, labour
situation, payment of rent and statutory dues, break-down/shutdown, pollution
control, etc.
Carry out age wise classification of receivables. Obtain the list of major
customers and examine the credit offered to them which should be in line with
market practices. Inquire the reasons for bills returned unpaid.
G. Stock Audit Bank very often entrust stock & book debt audit to firm of Chartered accountants. Following areas are generally entrusted to audit firms to be looked into:-
o Physical verification of inventory.
o Study on inventory control practices, proper up keep and requisite
record/books.
o Basis of valuation- whether in line with standard practices and stipulations of
the bank.
o System study to segregate non-moving or obsolete inventory.
o Age wise analysis of book debits.
o Examine genuineness of the trade transaction passing through book
debts/receivable.
o Comments on maintenance of plant and machinery.
o Status of registration of ROC charge.
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o Insurance status of stock/plant and machinery.
o Any other information found relevant.
B. Follow-up of Transactions in Ledger Book Poor turnover in an account indicates that, either the sales are being routed
through other banks or have, in fact, been dropped. In either case, the bank
should make an enquiry. Poor turnover indicates poor health.
Cheques for large and round amount, post-dated cheques and cheques
frequently issued in favour of those parties not related to business, may need to
be examined carefully. A dialogue with the borrower should be initiated to find
out the reasons for the same and take remedial steps.
Frequency of returning of cheques should be examined. If it is high, it indicates
liquidity problem of the borrower or otherwise he is engaged in overtrading.
The Bills Account reveals major transactions of the business. Frequent return of
bills may mean that the borrowers’ goods are being rejected by purchasers or the
purchasers are sending payments directly to the borrower. When the bills are
received back, the borrower is promptly advised that they have been returned by
the collecting branch for the reason, `payment not forthcoming’ and that he
should regularize his account.
If there has been irregularity in the account for a longer period, it indicates that
outflows are in excess of inflows of cash.
If there are no operations in the account during a part of the year, it indicates that
the unit has stopped working during that period. This is a signal for analysing the
reasons for the inactive operations in the account.
The behaviour of the account during the year would help bank in getting the
signal. The actual drawings should be related to the business requirements. It is
expected that the unit normally requires more funds during the busy season. It is
also expected that the unit has to maintain a minimum level of stock during the
off-season and, therefore, it requires minimum funds. Any variation in these
expectations would throw a signal.
If there is a heavy withdrawal of cash without convincing reasons, this is a signal
of misuse of funds.
C. Discussion with the Borrower on adverse featuresThe following are the signals of incipient sickness of the unit :
Major breakdown in plant and machinery
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Labour strike
Frequent changes in management
Sudden death/illness of a partner/director
Disputes among the partners/directors
Repeated reconstitution of the firm/board
Frequent requests from the borrower for enhancement of credit limits or granting
excess drawing
D. Study the Market Reports The following are the adverse developments relating to a borrowal account as
market reports or news in the newspaper:
Recession in the industry
Unfavourable position of the inputs
Unsatisfactory report about the party
Sharp fall in prices (output)
Unfavourable changes in government policy as regards excise, imports and
exports, price fixation by the government, etc.
Routing transactions through other bank/s or legal action by other bank in sister
concern or group account .
E. Analyse the Financial Statements Several weaknesses in financial health of the unit can be understood from
analysis of financial statement like :-
Unsatisfactory trend in profits
Sales below projected level
Rise in book debts
Shortage of working funds
Unsatisfactory position of equity or withdrawl of funds by partners or proprietor
Diversion of short term funds for long term use
Building up of unproductive assets
Unhealthy accounting practices
F. Review and Renew the Working Capital Limits Ask the borrower to submit the renewal proposal before the credit limits expire.
Review the performance during the current year in terms of SWOT analysis.
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Scrutinise the proposal to enhance the credit limits in terms of assumptions in the
estimating projected sales, inventory levels, credit requirement, conduct of the
accounts, stock inspection and industry prospects.
Comply with the guidelines of the Bank in respect of exposure limits, sensitive
sectors
Review or renew the facility in terms of lending powers or otherwise refer to the
sanctioning authority.
Decide on the credit proposal timely, particularly before the expiry of the limits.
Non review of accounts for more than 90 days will make the account NPA as per
prudential norms.
Consider to sanction ad-hoc limit if enhancement is going to take time to meet
pressing payments of wages, bonus, purchase of raw material, electricity, taxes,
etc.
G. Rehabilitation a Sick Unit It is essential to take-up the following steps to rehabilitate a sick unit :
Identify a sick unit as per the official definition.
Ask the borrower to submit the proposal to rehabilitate the unit.
Study the causes of sickness, internal and external
Prepare the rehabilitation scheme keeping in mind the guidelines of the
RBI/Bank.
Sanction the scheme by funding irregularity, uncharged interest and sanction of
need based limit.
Implement the rehabilitation scheme- necessary contribution from borrower to be
ensure.
Monitor the progress during the post implementation of the scheme.
Review the progress in rehabilitation of the unit in terms of the loan repayment
with interest.
Initiate legal action if the rehabilitation efforts fail.
(For detailed procedure of rehabilitation of sick unit refer to Chapter-13)
H. Recovery from Non-Performing Advances (NPAs) Several steps relating to recovery from NPAs shall include the following :
Bank should formulate a Recovery Policy.
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Bank should set the targets for recovery from NPAs and also for prevention of
potential NPAs. A separate Recovery Department / Cell should be set up in the
bank to co-ordinate recovery efforts.
Send a reminder to the defaulters on timely basis, pay a visit to their business
premise/residence.
Entertain a compromise proposal as per the broad policy guidelines of the bank.
Recall the advance.
File suit against the borrowers in the Civil- court/DRT/Certificate case .
Serve a notice of 60 days under the SARFAESI Act and take action of sale and
seizure of assets or take over of management.
Initiate action under Transfer of Property Act by entrusting the work to the private
auctioneers.
Organise ‘recovery camp’ and reward those recovering the highest amount.
Initiate any other steps to strengthen recovery efforts and upgrade the quality of
potential NPAs.
(For detailed recovery measure refer to chapter -11)
ConclusionIn this chapter , it is attempted to put in one place various items of due diligence in credit
management. But this may not be considered as an exhaustive list. Hence, credit
officers may take into account additional item of due diligence based on their experience
and common sense. This exercise of developing the check-list is felt necessary to
counter operational risk in large scale credit expansion particularly in Agriculture, SSI
and Retail loans. Due diligence will also help the bankers in checking slippage of NPA or
controlling potential NPA. Towards this end, it is appropriate to reiterate that non-
compliance of principles of lending and bank guidelines would deteriorate the quality of
loan portfolio and allowing the credit risk to go up. Hence, due diligence in credit
management must receive due care.
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Chapter-20
Negotiation Skills and Strategies for Banking Business
Getting a best deal
In a negotiation situation two parties negotiate for a best possible out come say
price. The process starts with the negotiation preparation, common negotiation mistakes,
whether to make a first offer or not, respond to offers from the other party, structuring
your initial offers, finding out how far you can push the other party, strategies for
haggling effectively and to how to maximize not only your outcome but also the value of
outcome of other parties. It is well known that negotiators who focus only on claiming
value reach worse outcomes than do those who cooperate with the other side to improve
deal for both parties. There are also occasion when negations are not the answer to the
problem. A banker should learn to distinguish between the times when he should be
playing the negotiation game and times when he should be changing the game.
Customer driven marketCredit is now market driven. Borrowers are not only negotiating interest rates,
service charges, free- remittance facility but also terms and conditions of loan
aggressively. They are demanding flexible repayment terms, floating interest options,
collateral free loans, sub-PLR interest rates, top up or ad-hoc finance, less paper work
and formalities, fast sanction and disbursement. In deposit front, there is demand of new
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products and services, which not only brings convenience but also better returns and
cost. Banks are now selling third party products like insurance and mutual funds, which
not only requires proactive selling but also good negotiation skill and marketing
strategies. Even in finalizing the terms of loan sanction, rehabilitation and compromise
negotiation skills are essentials, which provide competitive edge to branch managers. In
HR and IR matters, negotiation skills play an important role. It is, therefore, essential for
every bank officer to acquire and develop negotiating skills, which would help him or her
to do banking business efficiently and effectively.
Negotiation tips- Negotiation is about achieving a mutually acceptable outcome to a situation in which
the parties involved initially have differing aims. Do not negotiate unless this is either
necessary, or some advantage may be obtained by doing so. Three stages are
involved in negotiation: preparation, the negotiation itself, and implementation.
Before embarking on negotiation, there is a need to assess the parties’ relative
strengths/weakness and possible outcome, improvement in bottom line etc.
Establish what the other party’s case is and what they are seeking to achieve. If
possible, one objective should be to help the other party to feel satisfied with the
outcome.
Value time, schedules and deadlines. A good negotiator will not beat around the
bush or adopt delay tactics or waste time talking about mundane matters. It is
professional to get down to business and address key issues.
Exchange factual data in advance of negotiations. This may influence the outcome
or prevent delay and confusion during negotiation.
Consider the possible existence of a hidden agenda – underlying issues, which may
influence the conduct and outcome of the negotiations.
Negotiations are influenced by their style and pace, by the composition of the
negotiating team, and by the arrangements for seating and refreshments.
The subject, scope and purpose of the meeting should be made clear before
negotiations commence.
Be focused on the problem or issue. Logical arguments are the key to smooth
negotiations.
The first speaker influences the progress of negotiation significantly.
It is important to be firm yet polite when making a stand or presenting a point.
Be patient and let the process of negotiations takes its course.
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When considering concessions, introduce the condition first and do not give details
of the concessions until the other party shows some willingness to negotiate on the
condition. Clearly specify advantages and disadvantages.
Put ego aside and concentrate on the matter at hand. It is finding an amiable solution
that’s important not self worth or position.
Avoid the psychological traps and have the magnanimity to admit when you are
wrong. Be open minded during negotiations.
Never threaten or manipulate the opposite party- it is completely unethical and unfair.
Normally, avoid emotional commitment, but display of emotion may occasionally be
beneficial provided that they are sincere and used consciously.
A continuous session should rarely exceed two hours, a formal presentation for 15 to
20 minutes, and an informal introduction for two to three minutes.
Effective negotiators are good listeners; they ask questions more than they make
statements.
Aim for solutions that are interest based and not what individual desires or aims are.
It is best to consider any situation as a whole rather than from a personal view point.
Do not accept weak solutions or temporary solution. Try to negotiate a plausible
settlement.
There is a positive advantage in making it easy for the other side to move, rather
than challenging them on a win/lose basis.
Compromise should be seen as constructive, not weakness. It is a win-win game.
The closer a negotiation is to reaching agreement, the more sensitively the
discussion needs to be handled.
Some record of the outcome of negotiations, however informal, is desirable in order
to ensure a common understanding of what has been agreed.
Before finalizing an agreement, check that all aspects have been agreed particularly
dates for implementation, review or completion; and definitions of terms.
An agreement is not successful until it has been effectively implemented.
Periodic and jointly agreed summaries of progress can secure a phased agreement
and prevent reversion to earlier argument.
Humor, can be used to reduce tension and help create a bond between the parties.
The main options of handling breakdown are to take unilateral action to enforce an
outcome, or to seek third party intervention. The most powerful and risky form a third
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party resolution is arbitration – where both parties bind themselves in advance to
accept the arbitrator’s solution – or legal action through the courts or tribunals.
Face-to-face discussions are not the only form of negotiation: effective use can also
be made of correspondence and the telephone. Video conferencing is now an
effective way of negotiation in cost effective manner.
Telephone discussions may be used to settle minor or simple negotiating points
extremely quickly.
Although some people are better natural negotiators than others, negotiating skills
can be acquired or improved by practice, coaching and training.
Chapter-21
Loan Default and Profitability of BanksIntroduction
Verma Committee on Restructuring of Weak Public Sector Banks, appointed by
the Reserve Bank of India, as part of assignment, identified weak banks, strong banks
and potential weak banks based on the study of seven efficiency parameters. These
parameters include capital adequacy ratio, coverage ratio, return on assets, net-interest
margin, operating profits to average working funds, cost to income, and staff cost to net
interest income plus other income. Accordingly, three banks were identified as weak
banks when none of the seven efficiency parameters were met. As against this, two
banks were considered as strong banks when all parameters were complied. But in
respect of six banks most of the parameters i.e. five or six of the total parameters i.e.,
seven, were not fulfilled. Hence, they were considered as potential weak banks. This
paper attempts to extend the study conducted by the Verma Committee more
specifically to ascertain whether enough signals of weakness were indicated much
before the event.
Study Plan
The present study considers 1998-99 as the year of event when the Verma
Committee identified weak banks, strong banks and potential weak banks. Since the
data relating to banks are not available on uniform basis for the earlier years, there is a
slight change in the set of parameters as considered by the Verma Committee.
Accordingly, this study considers nine efficiency parameters, which are computed, based
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on the data collected from the Reserve Bank of India publication i.e., Report on Trend
and Progress of Banking in India. The parameters includes :
Capital Adequacy Ratio
Net Non Performing Assets/Net Advances
Net Profit / Total Assets
Gross Profit / Working Funds
Net Interest Income (Spread)/Total Assets
Interest Income / Total Assets
Interest Expended / Total Assets
Intermediation Cost / Total Assets
Provisions and Contingencies / Total Assets
The above parameters focus on two major concerns of banks i.e. loan default and
profitability where as the Verma Committee covered all aspects of financial health. The
study aims at pointing out signals of loan default and deterioration in profitability prior to
the year of event.
Initially, it was attempted to find out whether the above parameters were interdependent
for which regression analysis was carried out. As seen from Table 1, the correlation
coefficient is positive in respect of four pairs i.e. Net profit/Total assets and Capital
Adequacy Ratio; Net profit/Total assets and Gross profit/Total assets; Net profit/Total
assets and Interest spread/Total assets; and Net profit/Total assets and Interest
income/Total assets. And in regard to other four pairs i.e. Non-performing assets/Total
advances and Capital Adequacy Ratio; Non-performing assets/Total assets and Net
profit/Total assets; Net profit/Total assets and Intermediation Cost/Total assets; Net
profit/Total assets and Provisions and Contingencies/Total assets, it is negative
marginally. The remaining pair i.e., Net profit/Total assets and Interest Expanded/Total
assets is the least correlated one due to the fact that interest obligations directly depend
on deposits and borrowings and not on profit. Barring this pair, all pairs are fairly
correlated. Hence, it would be an interesting exercise to study the behaviour of the
above-mentioned ratios for three groups of banks (weak, strong and potential weak)
before the year of event i.e. 1999. For this purpose, a mean value of each ratio (Table
1) was computed. The following observations are made from the study of these mean
values.
Observations:
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The level of non-performing assets discriminated between two groups. For instance,
the average ratio of non-performing assets/total advances of weak banks, strong
and potential weak banks for the year 1998-99 was 15.73, 6.36 and 9.25 percent
respectively. Though weak banks and potential weak banks attempted to reduce
the ratio over the years, the level of NPAs was considerably high. As against this,
strong banks kept NPAs at low level.
Return on total assets is also a discriminator between the two groups. For weak
banks, the average ratio of net profit/total assets was negative for the entire period,
though it was attempted to reduce it from 3.73% (negative) in 1995-96 to 1.24%
(negative) in 1998-99. As against this, strong banks maintained an average annual
return of 1.19 percent on total assets. Potential weak banks witnessed a positive
ratio though it was very low. In 1998-99, banks in all the three groups have not
performed well and, therefore, the ratio behaved typically.
Any change in the return on total assets depends upon corresponding change in net
profit on one hand and size of total assets on the other. And, net profit is the sum
of gross profit less provisions and contingencies. Since the return on total asset
discriminates one group from another, interest spread and provisions and
contingencies should also be related to total assets. The average gross profit/total
assets ratio varied from one group to another very widely. In 1989-99, the average
ratio was 0.10 (negative), 2.20 and 0.95 percent respectively for weak banks, strong
banks and potential weak banks. Over the years, weak banks attempted to reduce
gross loss substantially. As against this, strong banks experienced slight reduction
in the gross profit ratio but it’s level still remained as high as 2.20 percent in 1998-
99. The potential weak banks also succeeded in improving the position but their
ratio was very low as compared to industry average figures. But in 1998-99, the
average ratio of potential weak banks exceeded the sample average ratio. Thus, all
groups tried to show a higher gross return on total assets. But, what really matters
is the level of the ratio.
The size of interest spread also decides net profit. Weak banks in the sample
maintained just half the spread of strong banks as seen from the average ratio of
interest spread/total assets which was 1.69 per cent in 1998-99 for weak banks as
against 3.31 per cent for strong banks. For potential weak banks, it was moderate
being at 2.56 per cent which was lower than industry average i.e. 2.81 per cent. In
1998-99, all banks witnessed a decline in interest spread as compared to 1997-98
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figures. It is interesting to note that weak banks improved the position of spread
over the years whereas strong banks and potential weak banks, witnessed some
deterioration in it. But for weak banks, low interest spread is a matter of concern.
Interest spread is the net of interest income less interest expended so, weak banks
tried to attack both items i.e. interest income and interest expended. But in respect
of strong banks and potential weak banks, while there was some success in
augmenting interest income, it was found difficult to check interest expended.
Relatively speaking, all groups experienced high interest expended as compared to
industry average figures throughout the period i.e. 1995-99. Here again, what
matters is the level of interest income of weak banks.
All the three groups were able to check intermediation cost i.e., operating expenses.
There was a marginal difference in the average ratio of intermediation cost/ total
assets in 1998-99 which was 2.79 per cent and 2.73 percent for weak banks and
strong banks respectively. It was 2.19 per cent for strong banks. Both weak banks
and potential weak banks have to learn from strong banks in restricting the
intermediation cost. For the year 1998-99, the average ratio of strong banks was
much lower than both sample average and industry average.
Non-performing assets have to be provided for. Though the data on provisions
made for NPAs are not available, some idea may be obtained from provisions and
contingencies as stated in the income statement. Accordingly, the average ratio of
provisions and contingencies/total assets witnessed a declining trend in respect of all
three groups during the period i.e. 1995-99. This is because of reduction in the
gross NPA percentage which was 12.77 for all three groups in 1995-96 and then
declined to 10.69 in 1998-99. There was a steep fall in the ratio of weak banks and
potential weak banks in 1998-99 over 1995-96 figures. This suggests that these
banks were able to make a good recovery from NPAs during the period.
The average Capital Adequacy Ratio in 1998-99 also discriminates weak banks from
strong banks very distinctly when the same was 3.43 per cent and 12.28 percent
respectively. For potential weak banks, this was 10.57 per cent as against industry
average ratio of 10.82 percent. Weak banks were far behind the minimum
prescribed norms of 8 percent. Over the years, while weak banks continued to
observe a low ratio, strong banks not only maintained high capital adequacy ratio but
also improved its level.
Conclusion
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From the above observations, a few issues arise. Weak, strong and potential weak
banks were adequately discriminated by loan default on one hand and profitability on the
other. Though banks in all three categories reduced the NPA percentage and improved
the position of profitability, what matters is their levels. In other words, weak and
potential weak banks were saddled with high NPAs and low profitability. Even today, the
problem persists. Hence, corrective strategies have to be thought of.
Table- 1 :Correlation Coefficient (r) of Parameters
Sr. No. Parameter r
1. Non-performing assets/Total assets and Net
profit/Total assets
- 0.84
2. Non-performing assets/Total assets and Capital
Adequacy Ratio
- 0.86
3. Net profit/Total asset and Capital Adequacy Ratio 0.98
4. Net profit/Total assets and Gross profit/Total assets 0.83
5. Net profit/Total assets and Interest Spread/Total
Assets
0.85
6. Net profit/Total Assets Interest Income/Total Assets 0.86
7. Net profit/Total Assets & Interest Expended/Total
Assets
- 0.09
8. Net profit/Total Assets Intermediation Cost/Total
Assets
- 0.61
9. Net profit/Total Assets and Provisions and
Contingencies/Total Assets
- 0.77
-000-
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Chapter-22
Retail Banking – New Paradigm“The purpose of business is to attract and retain a customer”.
-Peter Drucker
1. Post reform development – Marketing StrategyLiberalization and de-regulation process started in 1991-92 has made a sea change
in the Indian banking system. From totally regulated environment, banks moved into
a market driven competitive environment. The traditional banking approach to
depend upon walk in customer has given way to
super market where all financial need of the
customers are satisfied under one roof. If we look to
the evolution of marketing, we find that different
strategies have evolved over a period of time for
production, distribution and promotion of products. It
started with mass marketing model - where mass production of goods was done with
the hope that low cost and price would automatically create a big market. Later on,
producers shifted to product variety model that was based on assumption that much
variety across the shelf will eventually win a customer. And last one is target
marketing where the producer/financial service provider identifies variety of market
segments, selects one or more of them and than resorts to relationship marketing by
strategically positioning its products to the target customers. The same pattern is
evolving in bank marketing in India.
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2. Retail Banking- Customer focus2.1. Berry recommended five strategies for practicing marketing- (a) Developing a
core service around which to build a customer relationship, (b) Customizing the
relationship to the individual customer, (c) Augmenting the core service with
extra benefits, (d) Pricing services to encourage customer loyalty and (e)
Marketing to employees so that they will perform well for customers.
2.2. The traditional marketing mindset is ‘command and control’ mindset that relies
on selling to passive customers who demand and perceptions can influence and
manipulated. However in the information age, marketing people has to evolve
strategy of ‘connect and collaborate’ with customers to create, deliver and share
value by establishing long term relationship.
2.3. First law of good customer relationship is ‘take good care of your customers’.
Good office ambience and interiors not only make customer relax and upbeat
but also have them feel welcome, taken care and important.
2.4. Since all banks offer more or less the similar products and replication of the
product is very easy, it is the customer service that makes the difference. The
customers these days are becoming more and more demanding on price,
product and convenience. They are well informed and seek financial advice
before they buy a product. They have no loyalty with any institution and ready to
switch over to any bank as and when they get a better deal. Banks’ are gearing
themselves to become customer centric where all focus is on building
sustainable long-term customer relationship.
2.5. With little to distinguish between different players, banks are searching for newer
ways to reach out to the customers. A few banks have now launched home
delivery service that provide home delivery of cash and demand drafts and
home pick up of cash and cheques etc. These are measures to retain customers
and enhance their loyalty.
2.6. Relationship Banking plays a crucial role in strategy building. The emphasis
here is on viewing the customer-relationship as long term mutually beneficial
rather than confining to a particular loan or deposit transaction. Bank now tries
to meet total financial requirements of the customer to get repeat business. In
order to promote lifetime relationship, bank does offer relationship concession
(reduction in interest), relationship discount (concession in service charges), free
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counseling and investment advice which customer can value in terms of their
loyalty.
2.7. In competitive environment, customer can choose what they consider best. In
choosing their banks customers are influenced by the image of the bank and the
perceived quality of service. The bank that provides better service or perceived
to be better than others gets customers. Good customer service in itself works
like a ‘brand’ for the bank. It speaks of the service standard.
2.8. A perception of good service relates to courtesy, promptness, employee
attitudes, physical facilities, customers’ recognition, speed, clarity and
communicative skills and host of such features. It gets manifested in the care,
concern, commitment and sensitivity shown by the bank staff. A delighted
customer helps the bank in acquiring new customers. Such a customer is an
unpaid salesperson of the bank.
2.9. Relationship banking requires sales force with complete knowledge of product
with pleasing attitudes and genuine concern of customer’s problem. However to
offer correct product to the customers, bank staff need to have complete
knowledge of the products and skill in marketing the products. He must
understand customer’s need so that the he can offer to him best product
available and not the one, which he is having. He should know how to greet
customers, meet their needs and handle their doubts and complaints. As
knowledge and skill development requires lot of orientation and attitudinal
changes, banks are training/retraining their human resources to build up these
competencies and capabilities.
2.10. The research has shown that cost of acquiring a new customer is six
times more than that the cost of retaining a customer (Gruen, 1997) and hardly
14% customers leave an organization for competitive reasons whereas 68%
leave for indifferent approach. Therefore all attention is now on retaining
customers by pampering them through better price (better interest rate,
concession in service charges etc.), more convenience (instant sanction, easy
documentation, focused service, customer friendly staff etc.) better quality
(product variety) and extras like freebies or add on (zero processing charge,
free car insurance, free home insurance etc.) In fact for retaining customers, a
bank has to constantly reinvent itself. Captivating (instead of capturing)
customer is new mantra of retail banking.
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2.11. Customers are also becoming less tolerant of mistakes. The retention
strategy involves encouraging and entertaining complaints proactively to create
customer friendly image. Banks are providing call center or toll-free help line to
enable the customer to make queries and register grievances.
2.12. A new dimension in customer service is ethical practices. Responsible
ethical behavior is now seen as an essential part of customer relationship.
Banks are publishing best practices code in support of their commitment to
ethical business practices.
2.13. De-selection of customer is also an important issue, which is often
ignored in context of social banking. According to Market Line Associates, the
top 20% of typical bank customers produce as much as 150% of over all profit,
while the bottom 20% of customers drain about 50% from bank’s bottom line
and the revenues from the rest just enough for meeting their expenses. De-
selection involves deliberately losing few customers, which are considered
unimportant/loss making. For example banks are changing focus from number
of savings bank accounts to value of accounts and in the process weeding out
those accounts where customer persistently fail to maintain minimum balance.
2.14. De-selection should be differentiated from ‘Customer on trial’ – customer
doing trial of a product or service or a bank. Strategic marketing involves
converting such customers into a higher spending, more frequent referring
advocate. See FIVE rupee magic – HLL sells number of products at Rs. 5 like
Pepsodent, Pond’s talk, Pond’s cold cream, Rin, Taaza, Fair & Lovely, Clinic
Plus and Lux. The strategy is to induce first user customer by offering a product
as cheap as Rs 5 to penetrate the market and then converting these buyers into
permanent customers by offering value for their money. A bank has recently
introduced Rs. 5 Saving Bank ‘no-frill’ account to capture customers by an
entry-level product.
2.15. Income that a customer generates to the bank directly or through referral and
recommendation model refers to “Life time value of a customer”. Such
customers are specifically targeted for business development. CRM plays a
crucial role in fully harnessing the value of existing as well as potential
customers. CRM is a new face of marketing.
2.16. The basic concept of CRM is that it aids businesses by use of technology and
human resources to gain insight into the behavior of customer. Many CRM
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software solutions are now available to create Customer Information System
(CIS), Data warehousing, Data mining and Sales Force Automation (SFA). CRM
can help the bank in (a) acquiring newer more profitable customers, (b) selling
more products to the exiting more profitable customers and (c) reducing
customer churn by retaining more profitable customers.
2.17. Speed and time are critical factors in customer service. Internet banking,
mobile banking, ATM, tele-banking etc. are all offered to take care of speed and
time. Technology today is a key facilitator to any time, anywhere and anyhow
banking. IT is building competitive advantage for banks.
2.18. Demographic and psycho-graphic changes of people are causing demand shift
in a very big way and these are key drivers of demand side of retail products.
Mapping customer needs is important for product development so that actual
requirement of the customer is known and can be satisfied. The process starts
with the mapping the customer’s behavior by analyzing various activities that he
performs while selecting, purchasing, using and disposing a product and then to
locate gaps from where he derives value. In a classic case of car loan, a
customer asked the bank why the bank wanted him to retain a car for seven
year by offering him seven-year product. In fact, a short-term loan say, one to
two year would have served his purpose.
3. Retail Banking –Product focus3.1. The term product in bank means a set of services designed to varied needs,
motives, styles, values etc., of bank customers. It is wants-satisfying commodity
created and delivered for customer’s satisfaction. Like any other physical
product, the structure of the bank products consists of different components like
core component, augmented component, ancillary service component etc. It
may be deposit-based product or a credit based product. For example, no frill
home loan is a core product, other facility like personal insurance, life insurance,
house hold insurance, flexi-repayment plan etc., is augmented component and
pre credit/ post credit counseling, tax planning and advise in selection of
property etc. is ancillary service component. The product development is key to
successfully face competition.
3.2. The marketing of financial products is totally different to marketing of physical
products (You can not sell a home loan, they way you sell soaps) due to nature
of financial products i.e. intangibility of product and its inseparability from
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provider. Intangibility means buyers can not compare service the way they can
compare the goods by looking to its appearance, feel, weight, smell, size,
shape, price, packaging and brand. They can observe the difference only by
measuring expected vis a vis the perceived benefits. To enable customers to
measure benefits, bank has to create product visibility through aggressive
advertising, mouth publicity and by creating professional ambience. To
overcome problem of inseparability, the bank has to project it self as robust,
reliable and user-friendly service system.
3.3. To create a distinction in the market, the bank has to design services strategies
to build credibility and professional relationship among customers. For example
many banks have started offering home delivery and home pick up service of
cash, drafts/cheques and other banking products like utility bill payment which
for past many years was the exclusive domain of retail shops like provision
stores. This is helping the banks to increase penetration, cut retailing cost and
improve customer base. A bank with tie-up of a telecom company has
leveraged technology by offering eSettlement product so that customer can
settle the bills minus cash from comfort of his home. However banks has to take
care of credibility of third party by ensuring that outsourcing agent maintain
service standard.
3.4. Since banks operate in buyers market, customer satisfaction is key to success
of new products. Basically the customer’s needs are repetitive, multiplicative and
dynamic in nature. The product development strategy aims at exploring and
satisfying these needs in a continuous manner. Alfred P. Sloan once said ‘ we
must design not just cars we would like to build but, more important, the car that
our customers would want to buy.’
3.5. Each product has its life cycle. Product innovation is a necessity so that before
life cycle of the product is over, there is new product to take its place. The bank
should, therefore, aim at creating new products or modify existing products
after mapping customer’s need. Creation/ modification of products can be done
either through value creation (innovate or die) or value addition (new features) or
value affordability (cheap or no frill products). Opening of Savings Bank account
with only RS.5/- is a classic example of value affordability.
3.6. While development of new product is important, it is equally important to wean
out obsolete/low demand/loss making or low profit products. Like any thing else,
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each product has its life cycle. Typical life cycle is- introduction, growth,
maturity and decline. But very often most banks do not examine their products
to check if they are selling too many products, identify weak ones and kill
unprofitable ones. Merge, milk, sell, or kill are four options for product
management.
3.7. Merging products than dropping them is an option, which is exercised when a
bank finds that a product targeted for deletion is having customers that might
grow in future. So products are merged and new features are promoted to
initiate migration of customers to new brand.
3.8. Milking strategy is adopted for those products where it is found that the product
is popular with a small segment. So a bank drops all sales promotion
expenses and allows the product to die its natural death and meantime available
sales potential is exploited by providing bare minimum support.
3.9. Unprofitable brands/products are either sold or killed to save money for
marketing profitable products. Large banks often dispose off products that no
longer meet their financial targets although these may be profitable to smaller
banks. The legal safe guards in respect of sale of products are taken to ensure
that the brands/products do not return as rivals.
3.10. Failed products are also dropped or killed. Failed product is one that does not
meet the expected need and wants of the customers. In Indian context, Gold
Deposit scheme is a classic case, which failed due to Indian psychic that people
do not want to dismantle their ornaments. Stock invest scheme is other product
which lost its utility due to reduction in allotment time of primary issue and has
therefore been withdrawn by RBI.
3.11. The race for becoming a ‘one-stop financial supermarket’ is hotting up like
never before and even smaller banks are now talking about becoming the
destination for all kinds of financial products. While developing own products is
an expensive proposition and is a time consuming process, third party product is
sold aggressively by taking benefit of established and recognized brand in
segments where the bank itself possesses no experience. It is also important
that while selling third party products, bankers must convey unconditionally to
the customers that they are only selling some thing for which responsibility to
service and performance lies with the third party. Selling of third party products
also help the bank to cross sell its own products.
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3.12. The bank has to deal with diverse nature of customers- rural and urban, rich
and poor, high net worth to middle class, retail and institutional. In order to
assess the need properly, customer segmentation is done so that instead of
one-product fits all approach, individual solution by way of tailor made products
are offered. Identification of market segment is also crucial from product pricing,
promotion and distribution point of view.
3.13. With all pervasive use of technology various e-products are now in the market
that leverage innovations and convenience for customers. Internet is a key
driver of technological change and has brought major transformation in delivery
process. But, at the same time, it has opened serious security concern. Product
development needs to address all these related issues in a holistic and
integrated manner so that customer accepts the product with out any hesitation.
3.14. In order to promote the product in a highly competitive market, it is most
appropriate to use creative marketing tool to simulate impulsive buying by
potential customers. Opening of savings bank account with zero balance is one
such innovation made by banks to garner accounts of salaried people in bulk.
Other ways of product promotion are offering freebies, add on etc. Cross selling,
UP selling, Ask-selling, Soft-selling, freebies, adds on, and piggy-ride are other
strategies to push sales. While implementing sales promotion plans marketers
should decide amount and nature of incentive/concession, which is eligible, how
to advertise, when it should start and how long it should last.
3.15. Direct marketing (selling 1:1) is a very powerful tool and can be very
successfully utilized for selling products like credit cards, mutual funds, life
insurance etc. There are number of stories of successful insurance agents
giving their presentation before family members and telling about families which
are able to face crisis due to insurance. TV and other media advertising, which
increases product visibility, further supplement direct selling. However,
customer privacy these days is getting utmost important and even RBI has
cautioned banks not to use personal information for soliciting customer either
directly or through alliance partners/ direct selling agents without express
condition or disclosure to the customers. So bank, while resorting to direct
marketing, must design their strategy in such a way that no irritation is caused to
customer by their unsolicited telephone call or SMS or email.
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3.16. In order to create product affinity among customers brand building is done as a
strategy so that customer can identify the product by way of log or punch lines or
product name. For brand marketers the need to develop able, stable and
durable brands is extremely critical for creating product affinity. In India name of
most of the financial products is linked to the name of the bank. This technique
is advantageous for product identification as well as product differentiation.
3.17. Product pricing is another important element of marketing strategy. Based on
trade off between price and quality, KOTLER predicted nine marketing mix
strategies on pricing - premium strategy, overcharging strategy, rip-off strategy,
penetration strategy, average strategy, borax strategy, super-value strategy,
good value strategy and cheap value strategy. The bank may adopt any one or
more strategies as considered appropriate depending upon bank’s policy of
profit maximization, market-share leadership, product quality leadership or
survival strategy.
3.18. Transparency is new buzzword of marketing strategy. Banks that charge
hidden cost by fine print may lose competitive advantage as such a strategy
may create customer confusion.
4.Retail Banking-Multiple delivery channels4..1 One customer multiple channel is now order of the day. From traditional physical
branches/extension counters to ATM/internet/Tele-banking/mobile banking
/smart cards/ touch screen/kiosk/call centers various delivery channels are now
available for the customers to choose from. These channels now offer
24X7X365 banking on any time anywhere and anyhow basis and have added a
new chapter in convenience banking. The determination of proper channel for
selling a product is very crucial from product management angle. The decision
depends upon marketing strength of the bank vis a vis the availability of
channel.
4..2 While offering a range of delivery channels, it is necessary that banks integrate
physical channel with electronic channel effectively and offer a seamless
service. The customer must be able to deal with a coordinated informed
organization, whether he access it through a branch, a call center, the internet or
any other channel.
4..3 There is now a deliberate paradigm shift to wean away customers from branch
to other channels not only to substantially lower cost but also to become high
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revenue generating profit centers that, apart from increasing visibility, can now
cross-sell and up-sell products.
4..4 Banking with these new channels is a unique shopping experience to the
customers, which shifts focus from eye contact to e-contact. These channels
provide time and place advantage to the customers. Further bank has to build
integrated delivery channels with both vertical and horizontal integration. In
order to do so bank has to install an enabling and compatible multi-channel
platform which would support and seamlessly integrate both the existing and
future delivery channels.
4..5 ATM is most successful delivery channel followed by telephone banking and
Internet banking. As ATM is becoming more and more user friendly, banks have
started dispensing third party products like railway ticket, movie tickets, refilling
mobile etc. As per conducted by AC Nielson ORG-MARG for NCR nearly 90%
ATM users prefer to receive information on new product and services through
ATM.
4..6 Internet Banking provides numerous facilities to retail customers like utility bill
payment, online shopping, ticketing, share trading, down loading statement of
account, knowing balance, knowing status of cheque issued, electronic fund
transfer, transfer to PPF account, request for draft/cheque book etc. For trade
and commerce Internet banking provide facilities such as on-line opening of
letter of credit, on-line bill loading, account sweeping, account pooling, fund
management etc. It also enables the bank to provide multi-branch banking with
multi-city cheque-book facility. Internet is now USP of retail loan.
5. Retail Banking- Joint Ventures/Business Alliances5..1 An U.S. market study of Anderson Consulting found that 58% of the financial
sector’s most dynamic companies – the ‘value captures’ that generates both
high growth and high share-holders return- are built around business alliances.
5..2 To captivate customers joint ventures/alliances with product developers,
manufacturers, marketers, outsourcing partners, builders, promoters,
educational institutions, hospitals, insurance companies etc. who together
embody the extended enterprise has become the order of the day. The
objective is to develop a mutually supportive, value-creating chain; bringing
together complementary competencies of alliance partners to create more value
together than one can deliver separately.
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5..3 NABARD/Commercial banks have entered into collaboration agreement with
corporate like TATAS, ITC, and Hindustan Lever etc., for contract farming thus
opening new vistas for rural credit financing.
5..4 Bancaassurance model is totally based on business alliance between bank and
insurance companies, as Banking Regulation Act does not permit the bank to
enter into insurance business directly. To boost fee based income, banks are
entering into business alliances with insurance companies- both life and general
and are exploiting business opportunities by selling insurance products to their
existing customers. SBI Life has reported that total premium collection of Rs. 27
crores from bancaassurance business out of total premium collection of Rs. 51
crores in Q1 of 2004-05.
5..5 Mutual fund is other area where synergies of bank and mutual fund companies
are exploited through business alliance. HDFC mutual funds has reported that
they have tie up with ICICI Bank, HDFC Bank, Canara Bank, Citibank and
Standard Chartered Bank to sell its mutual funds product and as much as 27%
of the mobilization is now coming through this channel.
5..6 Manufacturers, dealers and financiers are stitching their wits together in
marketing through collaboration and alliances. Collaboration agreements with
tractor/car manufacturers and automobile dealers are churned daily which
creates mutually supportive business mode. While for manufactures/dealers it
provides opportunity to boost sales, for the bank it is an opportunity to finance.
Even in second hand car market, dealers are collaborating with banks to finance
buyers.
6. Retail Banking- A New ParadigmRetail banking is for ‘fittest, fasted and smartest’. It has become totally customer
centric. The man who cares his customers will eventually win. Size, location or
past history does not matter any more. What matters- how quickly a bank can
adapt itself to the changing world at Internet speed that itself is fast changing.
The emerging retail banking paradigm is -
There is visible shift of focus from product to customer. Best marketing secret
is to love your customers, to cherish them, to appreciate them, to listen them
and be honest with them.
Banks need to be passionate about nurturing customer relationship. Long-
term success comes from deeper and more honest customer relationships.
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Banks need to constantly anticipate and adapt as per customer’s changing
need and demand. Product innovation and renovation is key to success.
Banks need to take speedy actions and decisions as new generation
customer value time.
Banks need to integrate physical channel with electronic channel effectively
so that new generation customers feel comfortable.
Bank need to forge strategic partnership with dealers /manufacturers/
builders/promoters etc to harness synergies of alliance partners.
Bank need to do regular strategic marketing audit of their business to make
sure that they continue to be customer oriented.
-0-0-0-
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Retail Loan-StatisticsType March
1996March 2004
Housing 6303 51981Consumer 1476 8274Shares bonds etc.
1933 2020
Real estate 1173 5577Fixed deposits 12000 26346Personal loan 12559 35165Total 35454 129363
Amount in Rs. crores.RBI report on trend and progress of banking
Chapter-23
Retail Loan – Opportunities and Challenges
“The market is bigger than we have ever dreamt.” Jack Welch
1. Retail Banking- post reform developmentAfter introduction of financial sector reforms in 1992, banks are facing numerous
challenges like increasing competition from private and foreign banks, low productivity,
high operational costs, pressure on spreads and focus on NPA management due to
tightening of prudential norms. But they are awash with liquidity. Corporate clients are
now demanding loan at Sub-PLR due to new avenues available to raise borrowing
overseas at much cheaper rates. This has forced the banks to look for new avenues for
growth and survival by repositioning themselves in new business segments of economy
where opportunities are more and risk is less. Retail customers who represent huge
untapped market for credit has suddenly become a new business mantra for banks.
2. Retail loan- new business opportunities Welcome to new India, where living off debt is
well-accepted norm of life. If recent statistics (see box) on consumer finance are any indication, last few
years have been trend setting. The conservative,
cautious, thrifty and debt-averse middle class of past
seems to have given way to a new middle class
(population about 32 million) that is free from all
inhibitions regarding conspicuous consumption. It has
no stigma of borrowing for consumer spending. Indian
Corporate has been dreaming for a long time to tap this huge market of middle class
that is hungry for consumer durables but short of cash. The cheap retail loan has made
their dream come true.
3. Retail loan- market size
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RURAL GAME“49% (or 32,538) of all scheduled commercial bank branches are rural, 31 per cent (or 13 crores) of the total deposit accounts and 43 per cent (2.2 crores) of total credit accounts are in rural branches. Over 6.42 crore Kisan credit cards have been issued by banks."
The retail assets crossed Rs. 149,000 crores in 2004 from Rs. 42,000 crores in
1999 according to industry estimates. Home loan market constituted 47% (Rs.60,
000.00) in 2004-05 followed by car loan 22.3% and personal loan 8.1% ( Economic
times 07.05.2005). Present penetration level of retail loans is only 6.5% of our GDP,
compared with 10.2% in Thailand, 49.3% in Malaysia and 68.4% in South Korea. (The
Asian Banker) Thus untapped potential of retail loan in our country is very high. The
over all demand for car loans and two wheelers has seen a 25-30% growth since
January 04. Consumer durable loans have grown consistently more than 20-25% since
2000 while two wheeler loans have grown 30%. Car finance too has grown 30%. Seeing
big opportunity banks have become very aggressive in retail loan with the result market
volume is building up by leaps and bounds. The feisty private sector banks like HDFC
bank and ICCI bank have already occupied much of the retail space. Public Sector
banks are carving out space for themselves through (a) Wider reach (branch network),
(b) Large customer base, (c) Strong brand presence, (d) Large product portfolio, (e)
Multiple delivery channels and (f) Leveraging technology (to handle large volumes).
4. Retail loan- Going Rural India’s smaller cities and towns are beginning to assert themselves in the credit
market place as among the top 100 cities, the
share of non-metros in total bank credit increased
to 28% in 2003-04 from 15% in 2001-02 (See box).
Further per capita income in rural India is Rs. 9481
where as in urban India it is Rs.19, 407 but in rural
place no body pays for drinking water, primary
health care or home rent. So disposable income in
rural India is really high. As per NCEAR survey
over a third of our middle class (annual household income of Rs. 2 lakhs to Rs. 10 lakhs)
live in rural areas and another sixth reside in small towns of population less than 5 lakh.
Further as per survey the number of middle and high-income household in rural India is
expected to grow from 80 million to 111 million by 2007. In urban India the number of
middle and high-income households is expected to grow from 46 million to 59 million.
Consumer growth is taking place at fast pace in 17113 villages with population of more
than 5000. Of these 9989 villages are in 7 states, namely Andhra Pradesh, Bihar,
Kerala, Maharashtra, Tamilnadu, Uttar Pradesh and West Bengal. All this data indicates
the amount of buying power of great rural India. It also indicates existence of enormous
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business opportunities particularly for retail loans. With more than 40000 rural and semi
urban branches having powerful bonding with the customers and their implicit faith,
banks are uniquely positioned to exploit this opportunity. Some of the major challenges
of the rural marketing are –(a) scattered nature of population, (b) diversity, (numerous
languages and dialects, caste, culture and religion) (c) poor connectivity leading to high
distribution cost and (d) communication problem (low literacy and limited reach of mass
media). Going rural is new market mantra for public sector banks.
5. Retail loan - as driver of economic growthThe spurt of retail credit in sectors like consumer finance, automobiles, two-
wheelers, financial services, home loans, education and credit card indirectly helps the
economy by pushing up the sales of the products and services involved. Government
has increasingly pushing lending to this segment because it has multiplier effect on the
growth of the economy.
6. Retail loan- New Marketing ParadigmThe basic nature of financial products of intangibility and inseparability from the
bank creates many a hurdle for the bank service marketers. Intangibility makes it difficult
for the provider to communicate to customers in very precise terms. It also poses
problems for the customers as they find it difficult to differentiate and evaluate the
services of various providers. In order to create a distinction in the market, the players
have to:-
(a) Designing services strategies – It is aimed to build credibility and professional
relationship among customers. Credibility is built over a period of time by ways of
fulfilling the promises through competitive performance.
(b) Tangibilisation of services- the customer do no see or touch anything to decide
before buying financial products. In order to create trust of customers, the bank
has to tangibilise its service product by providing proof of performance through
advocacy (mouth publicity) or advertisement and through pleasant and
professional ambience at the service counters.
(c) Developing delivery system- it has to establish a robust, efficient, reliable and
user-friendly delivery channels.
(d) Information technology is changing the way the services are designed,
managed and delivered. Advances in IT have enabled banks to offer variety of
new services. In doing so, many traditional services are becoming obsolete. For
example, electronic fund transfer is making demand draft obsolete and ATM card
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has made traveler’s cheques out of date. It also adds to competitive advantage
to banks.
The customer is the focus of this new marketing paradigm, which works on
premises of -
a) Loyalty-It is less expensive to keep an existing customer than to acquire a new
one.
b) Scope –It is easier and more profitable for a company to sell to a satisfied
customer.
c) Efficiency- Business should bear in mind that some customers are more
profitable than others.
7. Retail loans – Shifting focus The focus of retail banking has constantly been evolving; in early 90s it was
product focus, in late 90s it was sales focus, in 2000 it was price focused and today it is
customer focused. To have competitive advantage, a banks are -
(a) Shifting focus from product to customer,
(b) Keeping developing products as per need and demand of the customers,
(c) Developing efficient appraisal and risk assessment skill among managers for
speedy decision and sanction,
(d) Exploiting customer base and available delivery channels by aggressively
pushing the products,
(e) Forging strategic partnership/alliance with business partners such as builders,
auto dealers etc. to extract maximum competitive advantage and
(f) Continuously working for innovation and creativity for product development.
8. Retail Loan – New Business Process Walk in business is the thing of the past. The new business process of retail
loans is to captivate customers by offering best of breed products through multiple
delivery channel and joint venture/business alliances. The New Business Process
comprises of: -
(a) Best of breed products- The product development is key to successfully face
competition. It is a continuous process. The objective should be to remain one
step ahead of competitors. With all pervasive use of technology various eProduct
are now in the market that leverage technology for convenience of customers.
(b) Multiple delivery channels- One customer multiple channel is now order of the
day. From traditional physical branches/extension counters to ATM/internet/tele-
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banking/mobile banking /smart cards/ touch screen/kiosk/call centers various
delivery channels are now available for the customers to choose from. These
channels now offer 24X7X365 banking on any time anywhere and anyhow basis.
There is now a deliberate paradigm shift to wean away customers from branch to
other channels not only to substantially lower cost but also to become high
revenue generating profit centers that, apart from increasing visibility, can now
cross-sell and up-sell products.
(c) Joint Venture/Alliances- To captivate customers joint venture/alliances with
product developers, manufacturers, marketers, outsourcing partners, builders,
promoters, educational institutions, hospitals, insurance companies etc. who
together embody the extended enterprise has become the order of the day. The
objective is to develop a mutually supportive, value-creating mode; bringing
together complementary competencies of alliance partners to create more value
together than one can deliver separately.
9. Retail Loan- Designing StrategiesDesigning strategies is most important part of retail marketing. A strategy is a
road map to sell products. Strategies differentiate a bank with its competitors. It helps to
build competitive advantage. The strategies can be classified into various categories like
operational strategies that includes both structural and infrastructure decision, marketing
strategies includes pricing, placement and delivery decisions, human resource strategy
includes the skill levels of the sales people hired and the type of training they require, IT
strategy includes IT infrastructure to deliver the service as per expected standards and
service strategies like six sigma, quality circle, zero defect program etc.
10. Planning for the future - Emerging issues, strategies and challenges1. “Generation Next” segment (350 million young Indian between age group of 15-34
years see life and life-style very differently)- This is going to be the target in
immediate future. It is currently urban phenomenon but it would not be too long when
it will emerge in rural India also. They are tech-savvy and prefer electronic channel.
They seek financial information from variety of sources and are very fickle shoppers.
Banks will have to leverage technology and develop ebased products to tap this
segment.
2. “Rural segment” is one from where fresh demand of retail loan is being generated.
PSBs are in real advantage as they have good network of rural and semi-branches
where competition is less and opportunities are more.
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3. “Never use” category”-customer who has never availed/bought financial products
are being targeted through various promotional offers. This category holds huge
untapped potential. Loan mela/bazaar/road shows are creative product promotional
tools to create impulsive buying in new customers. Property melas and exhibitions
cut short the process of customer acquisition on two counts; the properties are pre-
vetted hence need no scrutiny and the customer just walks in. Such melas attracts
tremendous foot -fall – potential customers- drums up huge business volume at low
cost. Banks should learn art to organize loan bazaar/mela/road shows so as to
exploit local potential and establish a better product visibility.
4. “Brand building” for wider reach and product affinity is a strategic tool. Brand in
broad term includes all means of identifying a product by way of log, or punch lines
or product name. Brands communicate a value proposition to the customer and
consequently strategy should be to strengthen the brand with appropriate investment
Retail manager should be trained to project brand value (competitive advantage in
pricing, less paper work, speedy sanction etc.) to the customers. They should avail of
each and every opportunity to explain products features to develop customer brand
affinity. Remember that one satisfied customer brings eleven new customers.
5. Product innovation and renovation- Replication of product is very easy. Retail
loan managers will have to be market sensitive and they will have to seize each and
every opportunity to redesign a product as per market need or to introduce new one
with minimum of time. For this regular interaction of marketing team and corporate
planner is essential so that based on feed back innovation and renovation is done
on regular basis. Remember that first mover will always have advantage over
followers. Freebies and add-ons like zero processing fees, free insurance with car or
housing loan, no prepayment penalty,
concession in interest and charges to loyal
customers etc. are other innovative ways to
captivate customers.
6. Cross selling and up selling is a very
successful way of improving volumes. As a
strategy existing customers should be offered
products where profit margins are more e.g.
offering car loan, furnishing loan etc. to existing
housing loan customers. Further based on contribution of the customers to bank,
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SCB CreditOutstanding
March1997 @
March2002@
TotalCredit
284.4 656.0
Personal loan 19.20 46.50
% Of total 6.75% 7.00%@ Amount in thousand crores of rupees- CMIE data
TOP FIVE GOLD LENDERS ( In crores)
1. Muthoot Finance Rs. 7342 2. Indian Overseas Bank Rs. 5,220 3. Indian Bank Rs.39204. Manappuram Rs.2,5605. South Indian Bank Rs. 2360
(IMaCS industry report -2010 update)
differential-pricing strategies such as discount in interest, as relation ship waiver has
to be evolved.
7. Personal loan segment of retail loan has seen maximum growth. Total personal
loan outstanding of SCBs increased from Rs. 19200 crores in 1997 to Rs.46500
crores in 2002 (see box). The market is gradually saturating and fresh
disbursements are largely by way of roll over or on repayment of previous loan.
Banks will have to target business from other segments of retail loan.
8. Car finance industry record sales of 2.5 lmillion units in FY 2011:- Discounts
finance schemes, low interest rate, festive season offer and new launches like teaser
rates offer have worked wonders to Indian auto industry during 2010-11 which
clocked car sales to clock record high of 25 million units. However during 2011-12
the car sales is likely to stabilize at 12-15% growth due to higher borrowing cost and
surging prices. From banker perspective, a car loan customer is much better risk
than an unsecured personal loan or a credit card. However lack of clarity in
repossession of vehicle from defaulters due to Supreme Court judgment and
consequential delinquency of loan has caused many banks to go slow in financing
this segment.
9. Gold Loan: A gradual shift from pawn-brokers to organized lenders by people who
raise money against gold or
ornaments is expected to double
the holding of three specialized
companies in the business to 200
tonnes or over a third held by
Reserve Bank of India by the end
March, 2011. Indian households
estimated to have 18000 tons of
gold and out of this hardly 1000 tons is pledged. Hence gold loan potential is huge.
There are NBFC like Muthoot and Manappuram Gold in gold loan business in
addition to banks. LTV ratio (excluding making charges) is around 75% . Normally
NBFC sells/auction gold after 15 months and recognize a loan as NPA after 12
months. Looking great opportunity, banks are targeting the market very
aggressively. One nationalized bank, recently decided to set up exclusive outlet for
gold loans so as to compete with the NBFCs head on. Bank is also planning to put
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of assaying machine so that dependence on jewellers is reduced and loan is
sanctioned without delay.
10. Two wheeler financing: - Over the last decade the two-wheeler industry was the
highest value creators recording annual share holder return of over 40%. One of the
drivers of the growth was strong sales growth at over 15% for last five years which
provided immense business opportunity of financing. From bank’s perspective
serving this customer segment is an operationally intensive exercise covering
locations much beyond city limits and being dependent on correspondents banking
relationship. The customers typically belong to lower and middle class which tend to
borrow irrespective of repaying capacity and very often overleveraged by borrowing
and spending. As per reports (BS 18.02.2008), two wheeler lending has declined
more than 15% during 2007-08 over previous year. Recent norms on appointment of
recovery agents, lack of clarity in repossession of vehicles and growing delinquency
in two wheeler loans have forced banks to go slow in this segment.
11. Housing loan has large potential- House today is better affordable through loan.
Tax breaks have spurred credit demand. As per feedback of Assocham (BL
5.11.2007) the age group for property registration for personal use has been 30-38
years in most cases from 50-58 earlier. GOI move to give 1% interest subvention
on home loan up to Rs. 25 lakhs and cover them under priority sector has made
the banks to push harder this segment. The SARFAESI Act has increased level of
comfort as bank can now go for foreclosure of loan without intervention of court.
Given the fact that the total shortage of dwelling units at the beginning of the
Eleventh Plan period 2007- is estimated to be nearly 2.5 crore, the opportunity of
housing finance sector is huge. Rural and Semi-Urban sector is almost untapped.
Housing loan growth slowed to 12.1% during 2011-12 from 16% in 2010-11 due to
high property prices and high interest rates. With expectations of fall in interest rates,
banks are now bullish in home loan market. To meet competition focus will have to
shift on customer’s convenience and tailor made products to garner larger share of
housing loan pie. One innovation of Citibank’s Home Credit, Standard Chartered’s
Home Saver and HSBC Smart Home in which home loan is linked with a over-draft
account with the result interest obligation get reduced to the extent of credit balance
in OD adjusted against principal loan outstanding in the home loan. Second home
loan seeker is other segment where demand is emerging. Credit assessment in this
will be entirely different process, as bank will have to factor in possible rental income
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while considering repayment capacity. Third segment is up gradation to bigger
house, which is emerging market due to rise in income of professionals.
12. Teaser rates home loans: Teaser rates or terraced loan scheme launched by SBI
and later followed by many banks helped them to capture at a bigger size of the
market and also expand the market size. It may be noted that as per scheme interest
is fixed slightly lower to market rate initially for two/three years on fixed basis and
subsequently linked to market determined rates.
13. Switching of loan particularly in housing sector has significant inertia. RBI
directives to banks not to charge pre-payment charges has given opportunity to
home loan borrowers to switch to other lenders if they find that they are able to get
loan at a better prices. PSBs should get ready to tap this opportunity.
14. Women segment- Loan schemes like loan for purchase of gold ornaments have
been specially targeted for women segment. India consumes gold worth 800 tonnes
annually and gold jewelry market is estimated to be about Rs.45,000 Crores
(Business standard 29th September 04). A few south based banks have already
leveraged the potential of this segment. Other PSBs should develop and position this
product to target segment to exploit business opportunity.
15. Educational Loan- Loan to students for pursuing higher education is fast emerging
retail loan segment. Education loan portfolio stood Rs. 2976 crores as on June, 30,
2010 covering 1.71 lakhs students. (B S September 13,2010) As per a study
(Business Line 7.3.2011) hardly 5% students pursuing higher education in India
takes education loan against about 60% in US taking recourse to such loans.
However gradually education loan segments have started increasing many fold
mainly due to easy availability, collateral free, tax break on loan repayment and
inclination to self-finance the study. For banks loan provide the opportunity to catch
customer when they are young and that too for the lifetime. Some banks have
started offering loan for financing fee of coaching classes as considerable cost is
incurred by students in preparing for entrance examinations.
16. Travel Loan or Holiday loan - Banks have now cashing on people’s urge spurge on
foreign holidays by offering ‘travel loan’. Till now, it was prerogative of few foreign
banks, but lately public sector banks have also started granting such loan. Banks are
tying up with travel companies to tap potential travellers. Banks charge lower
interest on travel loan as these loans are typically sanctioned to high net worth
people with lesser probability of defaults.
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17. IPO Loan- with capital market at its peak and number of IPOs on line, banks have
started aggressively selling IPO loan to retail customers. It is upcoming segment and
has immense potential.
18. Bancassurance offer opportunities of cross selling of retail loan products by
bundling with insurance products. Banc assurance has started taking strong roots in
our country and there are expectations that average collection through banking
channel will rise to 50% in next five years. This product offers vast cross selling
opportunity to banks by bundling with their own financial products besides building
fee-based income.
19. Joint venture/business alliances have become order of the day. They provide
mutually supportive, value creating mode by bringing together complementary
competencies of alliance partners to create more value together. While private sector
banks have successfully embraced this model, PSBs are also gradually looking to
this business mode not only for business development but also for due diligence and
recovery.
20. Due diligence of retail loans: - Instances of resorting to multiple financing by
unscrupulous borrowers are very common. Instances of housing loan on the basis of
fake documents and impersonation have also been reported. To safe guards from
frauds, sanctioning/disbursing officials are required to meticulously follow KYC
policies of customer acceptance and identification and other systems of internal
control. It is interesting to learn that a PSB has recently unveiled its plan to use credit
verification agencies to improve due diligence of retail loans.
21. ‘People with right soft skill’ is the requirement of retail banking. They should have
not only complete knowledge of the products but must have pleasing attitude and
genuine concern of customers’ problem. Regular training of retail people is essential
to make them successful sales person.
22. Consumer lending blues- After aggressive growth in the past few years’ banks
have now started feeling the pinch as NPA in retail loan is on rise. Banks have also
started receiving reprimand from Reserve Bank and court for use of strong arm
tactics of recovery agents. The problem is symptomatic of a deeper systemic rot that
afflicts retail lending in India. Poor institutional mechanism for recovery of dues as it
takes a long time to recover debts through judicial process. It is in this context to
emphasize that field staff should be educated to exercise high degree of diligence
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by not only rigidly following KYC polices in identification of borrowers and screening
loan applications but also monitoring recovery.
23. PDC management-Banks to take recourse of Section 138 of Negotiable Instrument
Act are taking PDC in all retail loans. From timely presentation of cheques to timely
and prompt legal action, it is necessary that awareness in legal aspects be created
among mangers so that provisions of the act are fully harnessed for benefit of the
bank. Physical handling of huge volume of cheques is compelling banks to consider
alternate like ECS (electronic clearing system) or credit to receive monthly
installments as this arrangement is cost and time effective.
24. Fair practices code- With RBI insisting on banks to put in place anti-tying
measures, there is growing demand that lender do not resort to unfair trade
practices. It is, therefore, essential that interest rate, method of compounding, penal
interest, prepayment penalty, rebate for prompt payment, right of borrowers like copy
of loan documents, statement of account, right of privacy i.e. not sharing his personal
profile to business associate/other agencies should be explained to prospective
customer and bank should put in place a grievance redressal mechanism to sort out
problem.
25. Credit counseling- In retail credit cases of multiple credits is very common. Other
problem is revolving credit of credit cards from multiple issuers. Once a borrower is
in distress, it is very difficult for him to come out unless proper guidance is given to
him. Credit counseling centers educate such people on financial education, credit
counseling and debt management. Borrowers in distress may call to these centers
to take guidance to reschedule debts, work out repayment plan or scaling down of
debt or one time settlement.
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Taking a Loan: RememberMany people take loans when they don’t need them. Avoid that.Apply for loans, don’t take loans that banks call up and offer. Clarify the loan amount because you might land up being charged interest on a higher amount. Clarify how the bank will go about recovery. Know your rights. In difficulty, call the bank to renegotiate the repayment terms.
26. Sale of impaired assets - ARCs deal only with purchase of high value assets. The
retail loan portfolio, which consists of housing and car loan, necessitates setting up
of ARCs to deal with impaired assets of retail loans.
SUMMING UP-In the years to come, customers will be more demanding, competition will be more
intense and dealings need to be more transparent. While the delivery is not going to be a
major challenge, surely the quality maintenance will be. It is a great challenge for the
banks. Managing service quality warrants a perfect understanding of customer need,
designing products which customer appreciates, developing and monitoring the process
that delivers the service or product, training sales people and measuring customer
satisfaction. This is possible only when day-to-day experiences are critically analyzed
and products and policies are aligned to market demand.
Chapter –24Retail Banking - S T P Marketing
“Banks have to move from the old fashioned, one size fits all products to customer
segmentation and customization.”
1. Retail Marketing –Captivating the customer through innovationsWalk in business is the thing of the past. The customers are now more demanding on
price (better interest rates), product (quality), place (home delivery, internet banking
etc.), packaging (brand affinity), people (customer service), partnering (business
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alliance/joint venture) and promotion (discount, freebies etc.). They are well informed,
seek financial advice and collect product information from variety of sources like financial
planners, TV, press, ready to bear risk, sensitive to price as well as quality of product
and explores/negotiate best possible deals. They have no loyalty with any institution
and as and when they get better offer (price or quality), they are ready to switch over to
any bank. Intense competition among banks has complicated the matter further as each
one tries to have larger share of the pie by one or the other means. Due to intense
competition, the old retail business model of ‘capturing customer through aggressing
selling’ has changed to new business model of ‘captivating the customer through
innovation’. The key element to achieve this strategy is customer segmentation as one-
product fits all approach is no longer feasible.
2. Service Marketing- DifferenceThe marketing of financial products is totally different to marketing of physical
products (You can not sell the financial products they way you sell soaps) due to nature
of financial products i.e. intangibility of product, perishable nature of service and its
inseparability from its provider. Intangibility means buyers can not compare service the
way they can compare the goods by looking to its appearance, feel, weight, smell, size,
shape, price, packaging and brand. This also means that they cannot evaluate it
objectively. But they can observe the difference by measuring expected vis a vis the
perceived service. In order to enable customers to measure benefits, bank has to create
product-value visibility through aggressive advertising, mouth publicity and by creating
professional ambience. Services are also perishable and consequently can not be
produced in advance and kept as inventory like manufactured goods. Services are
difficult to patent and subject to copy by the competitors easily. To overcome the
problem of inseparability and to deliver service effectively, banks have to project it self
as robust, reliable and user-friendly service delivery system.
3. Marketing Strategy- EvolutionIf we look to the evolution of marketing, we find that different strategies have evolved
over a period of time for production, distribution and promotion of products. It started
with mass marketing model - where mass production of goods is done with the hope that
low cost and price would automatically create a big market. Henry Ford used to joke,
‘you can have any colour car as long as it was black’. Later on producers shifted to
product variety model which was based on assumption that many variety across the
shelf will eventually win a customer. And last one is target marketing where the
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producer/service provider identifies variety of market segments, selects one or more of
them and than resorts to relationship marketing by strategically positioning its products
to target customers.
4.1 Market Segmentation
Market segmentation is the division of the market into distinct groups of buyers who
might require different products or market mixes due to their different need and wants.
Once segmentation is done, bank can focus on particular segment of customers with
common needs and wants. The basis of market segmentation can be -
a) Geographical segmentation such as states, region, countries etc. where
producer can pay attention to geographical differences. For example there may
be greater need of woolen garments for northern India rather than west or east.
b) Demographic segmentation is dividing the market based on demographic
variable such as age, sex, occupation, family size, life cycle etc. For example
ready-made garment market can be divided into kids, ladies and adult.
c) Psychographic segmentation is dividing the market by life-style or socio-
economic status or personality characteristic. For example, banks customer can
be divided into HNWI (high net worth individuals), Senior Citizens (Customers of
60 years and above) etc.
d) Behaviour segmentation is dividing the market based on customer’s
knowledge of product, usage, attitudes and responses. For example, soap
market is segmented on perceived value of beauty, hygiene and health.
a) Transactional segmentation is process of relating a customer to a service,
which he is most likely to use. For example, young customers (age 20 to 40
years) may use more ATM, Customer in age group 35- 45 years may avail
more housing loan and so on. In credit card business, it is possible to reduce
cost and improve payment by segmenting customer based on transactional
segmentation. A good risk might receive a polite reminder, a habitual but
dependable late payer might have his reminder delayed and poor risk might
get a strongly worded reminder with a threat of canceling card.
4.2 Indian Banking & segmentation-The bank has to serve both rural and urban customers, small and large
entrepreneur, high earning and low earning customers, retail and institutional etc.
Hence segmentation is possible in many ways. However based on behavior and
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“Women bank account holder constitutes only 17.3% of total accounts. Rural women have a better share in comparison to semi urban and urban women. Regional rural banks have mobilized more accounts from women than other banks. “
- Economic Times 20.07.2005
attitude of customer to product and delivery channel preference, customer
segmentation can be done in under-noted five categories: -
(a) Time pressed life-style customers- Catch them young! Is business practice. These customers suffer from time but willing to buy products to
meet life-style need, ready to spend more but not willing to visit bank to know
products. Bank need to have well trained staff to market products to this
segment.
(b) Middle-class customers- They adore traditional banking with personal
touch, can spare time to visit the bank, conscious of interest cost and has no
stigma of borrowing for consumer spending. Estimated market size is 30
million.
(c) Senior citizens/retired – Catch them old! Is new buzz word. 30% of bank
fixed deposit is held by Senior Citizen. They are drawing pension from banks
and keeping their deposits both in savings and fixed deposit. Availing loans
like pension loans and against deposits in exigencies. Banks are offering ½%
to 1% higher interest to senior citizens.
(d) Young generation IT Savvy Customers- Comfortable with new technology,
like plush interior and good ambience in branches, show least loyalty to
relationship and switch banks very often, cost as well as product conscious.
4.3 Women segmentWomen controls or influence 65% of world’s annual consumer spending of
$18.4 trillion. And in the next five years,
women’s incomes will grow from $13 trillion to $
18 trillion, outstripping China and India’s
combined economies. (TOI 06.03.2010)
Therefore “the customer is queen” is new
buzzword in marketing. Study reveals that the
key decision-makers in home are young women
of 18-35 years. With increasing education and
more and more women taking up jobs, she is
one who either takes decision on all-important
buying matters or has major say in decision process. She is price sensitive and
quality conscious as well. She is innovator and early adopter of new products.
The marketers are responding to the queen customer with respect. There is
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upward trend of women-oriented financial products. Take for example Mahila
credit card, which is specially targeted to lady customers as women are
considered high spenders, default rate among them is low and among defaulters
list women defaulters are very few. The card offers free all-women health
check-up facility at select hospitals and health clinics. It is believed that women
spend more on credit card than men. There is a famous anecdote about a man
who did not report the loss of credit card of his wife because he thought that ‘thief
was spending much less than his wife’. As per market estimates, women who are
independent career women or women of high strata of society own 14% of credit
cards. Loan for purchase of jewelry is another women centric product. Banks
have also started customizing savings account for them with added services like
minor’s account under their guardianship; add on debit card for their children etc.
Banks are also adding colours to their Locker room by providing array of beauty
products at the dressing table in the locker room to serve women customers.
Other privileges offered to women customers are invitation to events like
cookery events, fashion show etc. Recently one bank has offered free ‘all risk’
insurance cover to women account holders for risk of loss of jewelry either by
snatching or theft or burglary while at home or during travel, hotel stay etc.
Micro financing through self-help group is also preferred to women due to their
better repayment culture.
4.4 Student segment Student is also an important segment. “Catch them young” is watchword
of the bankers. Opening of account with Rs. 11 in the name of minor student is
one product, which was recently launched by a bank. Some banks are offering
credit card to student pursuing higher education and offering spends now and
pay later facilities. Education loan is very popular product for student pursing
management and technical courses.
4.5 Islamic Banking: Considering that India has the second highest muslim population in the
world, Islamic banking has huge potential. The key difference between
Conventional banking and Islamic banking is that while conventional banking
offers interest on deposit, Islamic banking work on principle of sharing of profit.
Islamic banking is offered by leading banking in west. In India, Islamic banking
has not taken off due to lack of clarity of legal and regulatory issues. But recent
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judgment of Kerala High court is likely to pave the way for establishment of first
Islamic bank in Kerla.
4.6 Segmentation by valueBusiness has varying level of customer profitability. Normal customer
profit analysis shows that only 40 per cent customers generation 100 per cent
profits. Another 30 per cent produced modest profit while the bottom 30 percents
generates negative returns and so nullified the profit produced by the middle 30
percent. Segmentation by value lies at the heart of an effective customer strategy
for banks where customers contributing maximum profits are segmented into a
high priority segments and are rewarded by better service or value added
products technology backed products or by both.
4.7 Pre-requisites of effective segmentationUseful market segments must have following characteristics-
a) Measurability- the size and purchasing power or impact on credit quality
of the segment can be measurable.
b) Accessibility- the segment can be effectively reached and served.
c) Substantiality- the segment is large or profitable enough.
d) Actionability –Effective programme can be designed for attracting and
serving the segment.
e) Responsiveness-The target customers are likely to respond.
f) Acceptability-The management can be held acceptable for result.
g) Testability-Requires constant testing of strategies and practices.
5. TargetingOnce segmentation is complete, the producer/service provider has to select the
segment, which it wishes to target. The process starts with evaluation of market
segment by collecting data of potential sales, growth and profit for all the
segments and also to find out which segments is attractive enough keeping in
view its own product profile vis a vis the potential competition. Lastly, the
targeted segment must be within his objectives and resources i.e. if the segment
is as per objective, if it has enough resources in comparison with its competitors.
Once evaluation exercise is done, the producer/service provider has to choose
one or more segments to decide it target market. A target market is a set of
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buyers with common characteristics, which a producer/service provider wants to
serve. The following strategies are implementing for market targeting-
a) Undifferentiated marketing i.e. differences between market segments are
ignored and the market is approached as a whole with a single product.
This strategy focuses on common needs of customers and product is
designed to appeal to the largest possible number of buyers. Such a
strategy provides cost economies but fail to satisfy all buyers.
b) Differentiated marketing i.e. several market segments are targeted with
separate marketing mixes for each segment. It is extremely popular
model as it tries to satisfy need of all buyers. Since it increases cost, the
segment should be large enough to provide economies of scale.
c) Concentrated marketing i.e. to concentrate on one or more segment
where one finds more opportunities as per its SWOT analysis.
6. Positioning- Once a company decides a segment to enter, it has to decide how to enter into
it. If it is an established segment and competitors have already taken position in that
segment, it has to study competitors position vis a vis its own position before
entering into that market. Market positioning is a process through which a company
occupies a clear, distinctive and desirable place in the market. Positioning is unique
in the sense that it is not the actual attributes of the product that is important but
perceived quality that attract a customer. The positioning strategies are based on
product attributes, usage occasions, users, product categories etc. For example,
NIRMA used price as its weapon and due to this mighty Hindustan Lever had to
crumble. Body shop did not highlight any product attribute like beauty or cleanliness
but made different positioning statement that they do not test their shampoos or
soaps on animals. Amul ice creams with use of real milk and Anchor toothpaste with
100% vegetarians positioned themselves in the market. The key elements of
positioning consists of Pricing, Branding, Promotional policy, Product advertising
policy and Customer Service standards.
7. Bonding with the customers through branding While products are created in the factory, brands are created in the mind.
Branding is a process of building a brand. Positioning is about putting the brand in
the mind of the customer. In fact branding and positioning is two sides of the same
coin; one without the other does not serve its purpose. One cannot do branding
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without positioning. And for success of a brand, passionate customer relationship is
more important as brands die not because of look but for lack of customer-
relationship.
8. Challenge Ahead-“One size fits all approach” is no longer feasible and has to give way to innovation
through customer segmentation and product customization. Towards going closer to
the customer in identified market segments, banks are establishing SBUs (strategic
business units) such as Corporate Account Group, International Banking division,
Retail banking boutique, Agricultural Finance branches etc. Each SBUs aim to target
the customers with products suitable for them. The challenge before the banks is to
design cost effective quality products that attract customers of various segments and
then position them in the market through brand building.
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Chapter-25
Retail Loan A Risk Management Perspective
“Good shoppers know that you should not do grocery shopping when you are hungry, because you end up buying more than you need. Similarly, contractors will usually wait till it stops raining to fix that roof leak. Financial crisis cycles, like business cycle, are endemic to banking. Lesson is that there is dire need of timely and effective action to avoid turmoil.”
-Anonymous
1. Retail Loan- Risk Management Perspectives - The retail loan portfolio of the banks
in past few years has grown up very fast (CAGR over 30%) and it now constitutes
about 21% of total loan portfolio. The credit expansion has been shifting from metro to
tier 2/3 cities also. However, high growth in retail loan has started inviting concern of
various stake holders such as investors, regulators, bankers etc. over different matters
and certain important issues raised are-
Are Indian borrowings beyond their means?
Is the average customer leveraged too much beyond his capacity?
Whether the growth is too high to cause concentration risk?
Whether assets quality is compromised in volume led retail lending?
Whether the portfolio may deteriorate with aging?
And whether it is likely to crowd out industrial credit?
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RETAIL LOAN NPAAS % OF
OUTSTANDING LOANS
Category %Consumer durable
6.6%
Credit cards 6.3%Other personal loans
2.6%
Home loans 1.9%Total 2.5%
2. Exponential Growth in Retail Credit necessitates sound policies of Risk Management- Despite exponential growth in past four
years, the retail loan as percentage of GDP is quite low at
6.5% in India in comparison to other countries say 10.2% in
Thailand, 68.4% in South Korea, 75% in USA and 49.3% in
Malaysia. Low penetration level suggests significant
untapped potential of retail loan in India. In fact, low interest
rates, fiscal incentives/tax concession and easier product
availability had been key driver of retail loan boom in the
recent past and significantly contributed in credit
expansion and profitability of the banks. The retail loans
are considered safe as risk is diversified among large number of individual borrowers
located across the geographical dimensions as wide as the network of bank branches.
The default rate (NPA) (see box) in retail loan is only 2.5% as against 7.4% of
average NPA of the total credit portfolio. However CRISIL in its report (ET 5.1.2009)
stated that gross NPA of retail loan may rise to 4% as March 2009 from 2.7% in March
2007 and has thus cautioned for careful in expansion of retail loans . Following issues
from risk management perspective need to be addressed objectively. Firstly, too much
focus on retail loan may disturb the portfolio balance and consequently create
concentration risk. Secondly, fast expansion of retail loans has brought in its fold a set
of borrowers who have no regular employment, no collateral to offer and many of them
resorted to multiple borrowings thus falling under high credit risk category. Thirdly,
information about credit history of borrower is crucial to safeguard against
fraud/forgery which is very often not available. Fourthly, rising inflation may create
problem in servicing of loan by the salaried class who are considered highly leveraged.
Fifthly There is excessive increase in prices of gold and real estate outrunning
inflation rate say for example housing prices climbed at 16-25% and gold prices has
risen even faster rate at 14-40%. (RBI annual report 2011-12) Any adverse
(downward) movement in assets price will increase credit risk. In this back drop RBI
had observes that though lending to housing and commercial real estate had slowed
down but close vigil is still necessary as housing prices inflation has not moderated.
Moody’s Investors Services in report on Asia Banking Outlook 2006 has noted surge in
retail loan but has shown apprehension as ‘these loans are, as yet, untested in a
negative credit cycle.’ All this necessitates that bank should not only put in place a
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system to recognize such risks on continuous basis but also initiate measures to put
risk management practices in more effective and integrated manner.
3. Retail Loan- Systemic Risk out of macro - economic shock- Basel Committee II
has cautioned that over exposure to housing and other retail sectors could create
bubbles in the market as a consequence of over spending by the salaried class
followed by defaults and cautioned the banks against limit less financing. In this
context, It is argued that large number of Indian house hold are over-leveraged and
while their salaries are not inflation linked, the home and other loan which are on
floating basis are. It is also argued that while corporates are protected by limited
liability clause, house-holds have no such protection. A high inflation situation, as
existing in India at present, may increase loan default. When this happened in UK and
US in the 1980s; the negative effect was exacerbated by a sharp fall in the real estate
prices. The demand for housing dropped as interest rates rose and default in previous
loan also shot up. CRISIL has conducted a study of variable home loan market
(Economic times 24.11.04) and has observed that close to 90% loans are under
variable rate and 150-200 bps rise in interest rate will adversely impact the repayment
capacity of the borrowers who opted for tenure of 15 years and above. It has made a
forecast that NPA may rise if interest rises by 200 bps or more as about one-fourth of
the borrowers are already using more than 50% of their salary to repay loans.
4. Retail Loan and Credit Risk management -Retail loans are basically consumption
loans and are largely unsecured (excepting housing loans). They run the risk of
becoming bad as repayment depends upon discretion of the customer (Moral hazard)
with no security in the hand of the bank to fall back and time consuming and
prohibitive legal process. In case of housing loan, the risk is fall in real estate prices
which has seen huge increase in past few years. While economists and bankers differ
on impact of rising inflation on future growth of retail loan, they are all are concerned
that rising interest rate in consequence of increasing inflation may impair asset quality.
The effective credit risk management necessitates that various risks arising out of
deficiency in lending policy, incorrect product structuring, inadequate loan screening
and documentation, ineffective post sanction monitoring/follow-up and weak
collection/recovery mechanism are adequately and timely addressed. And like
traditional lending, the bankers while taking lending decision of retail loans, should
strictly adhere to the five ‘Cs’ of credit i.e. character, capacity, and credit, convenants
and collateral. As risk mitigating measure, the Reserve Bank of India vide mid term
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review of monetary policy of November, 10 (2010-11) advised banks (i) that the
home loan borrowers will have to pay at least 20% margin ( ceiling on loan to value
ratio raised to 80%) (ii) To increase standard provisioning of home loan under teaser
rates from 0.4% to 2% and (iii) to increase risk weight on home loan of Rs. 75 lakhs
and above from 75% to 125%. Further NHB, is promoting a separate company as
Mortgage Guarantee Corporation to guarantee payment of principal and interest of
housing loan with a view to mitigate default risk. Like wise there is proposal to set up
Credit Guarantee fund for education loans so that bank can bank upon such funds in
case of defaults. Finally there is inherent emotional connect of home loan and gold
loan borrowers with the assets and they will not easily let their assets slip out of their
hands by willful defaults.
5. Retail loan and assets price risk- RBI has recently shown concern over fast
increase in prices of stocks and real estates. In fact such worries haunt the central
banks world over. However in built safe guards in financing against stocks or for real
estate if followed properly can surely mitigate such risk. For real estate lending if
backed by adequate and conservatively valued collateral will ensure that banks are
adequately protected if property prices fall. Indian banking has to learn a lesson from
recent sub-prime crises of US. These sub-prime crises have put loss in value of
American homes “between” 13% to 20% of USD 23 trillion. Sub-prime loans are those
which were pushed to people who can not afford to repay. Many loans were secured
by homes. Since home prices were steadily rising could take secured loan on the
same house and service the past debt. As long as prices rose, there was no default.
Based on good history, credit rating agencies gave good ratings to derivatives and
bonds issued by securitizing these loans. The banks that initially sanctioned these
loan did not carry it in their books and sold them to investors. When bubble burst,
default began and banks are forced to foreclose loans. Additional supply of houses
and resultant expectation that prices would come down further, together push down
prices further. This feeds into vicious circle of default.
6. Retail Loan and Concentration Risk- Retail loan as percentage of Gross Bank
Credit now constitutes about 21% and is largely concentrated in urban and metro
centers. As stated earlier that credit growth during 2004-05 has been significantly
higher at 26% (previous year 14.6%) and banks are aggressively seen increasing their
lending not only to corporate but also to other sectors like agriculture. Further, banks
particularly PSBs are taking steps to diversify retail loans in rural and semi urban
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areas to leverage their strength of Semi-urban and rural branches where opportunities
are more and competition is less. The increase in risk weight of retail loan and cap on
unsecured loan are other measures initiated by the regulator to counter exponential
retail credit growth.
7. Retail Loan and Interest rate risk- Interest Rate Risk is another area to address. In
the past two-three years banks have built up housing loan portfolio, which carries 7.5%
to 9.5% interest. Since 10% to 15% of these loans are on fixed rate basis, any
increase in interest rates may cause loss to banks. To mitigate interest rate risk, banks
are now putting ‘force majeure’ clause in the home loan agreement to reset interest
rate in case of extreme volatility in interest rates. Banks have also started offering
product with interest reset clause after every 5 years. Since housing loans are far large
tenure say 15 to 25 years and cause assets liability mismatch, interest rate risk
management is most important aspect of retail lending.
8. Retail Loan-Teasure rates:- In the recent past many banks offered housing loans
under fixed-cum-floating rate option under which banks fixed interest rates at 8% to
8.5% for one to five years and subsequently borrowers would shift to floating rate
under which interest would be aligned to market rate. The product has been
subsequently extended to car loans also. RBI has recently shown concern and
cautioned banks against risks in offering such loans as borrowers might experience
payment shocks when interest rates goes up as excessively low interest rates skew
the risk reward matrix by making projects that are actually not viable appears viable-till
interest rate reverse and the same project ceases to be viable. It is therefore
necessary that banks as risk mitigation should look into borrower’s capability of
servicing debt after interest rates aligned to normal rates. They should also keep
necessary cushions in margin and repayment conditions so that repayment capability
of the borrowers is not compromised. RBI to further show its concern on expected
rise in delinquency of such loan has raised standard provisioning from 0.4% to 2%
vide policy announcement of 2nd November, 2010.
9. Retain loan and pre-payment penalty- Penalty on mortgage prepayment has
become a contentious issue between banks and the customers who look out for ways
to bring their cost of borrowings by switching over to other banks. In last two year since
2008, when the central bank cut policy rates by more than five percentage points, most
banks did not pass on the reduction in interest rates to home loan customers but
reduced rates for new borrowers. RBI has recently directed the banks not to levy
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prepayment penalty on floating rate loans in larger interest of customers. With this
possibility of borrowers switching to other lenders have incrased exposing the banks to
both ALM risk and profitability.
10. Retail loan and operational risk- Operational risk is another area of concern as
fraud/forgery in retail loan is on rise. It is estimated that 28 PSBs have reported home
loan frauds of Rs. 600 crores between 2002 to 2006. Cases of multiple financing are
also reported. The competition in retail loan segment is very fierce and there is acute
pressure on the retail managers to perform. The retail is volume driven business and
while there can be genuine mistakes yet there are instances of acute negligence or
misuse of authority by the retail managers. To obviate these happenings, banks have
to put in place rigid due diligence standards on customer identification and acceptance
system .Recent announcement of budget 2010-11 to set up e-loan data registry will
also be helpful to banks to satisfy before sanctioning home loan that no other lender is
having claim over the property. It is also essential that only officers of proven
intelligence and integrity are selected/assigned handling of retail loans. The CIBIL,
which has developed database of credit history/report of the borrowers and also
mortgage default, will go a long way in mitigating operational risk/credit risk. Experian
Credit Information Company Indi launched a new product named ‘trigger’ which is by
way of daily alerts about a customer missing a repayment schedule, moving into
default, making application for the same loan with other lenders etc. which could
enable the bank to look into in its own portfolio and monitor the loan. Further in a bid
to overcome the menace of forged/fake title deeds, a central registry for registration of
equitable mortgage of houses has been set up. .
11. Monitoring of Retail Loans- Monitoring is essence of risk management. As earlier
stated, retail loans are
volume driven business
and requires close
monitoring/ follow-up. The
manager should take
timely steps for issuing
demand notice,
reminders,
Inspection/insurance of
assets etc. He should, as soon as first instance of default is noticed, contact the
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“99% of defaults happen in the first six months. Monitor the loan for first six months closely and you will know if the person is a fraud or not.”
- M. Anandan, Managing Director, Cholamandalam Investment and
Finance Company.
borrower (employer where salary tie up is held) to recover over due installment(s). He
should present post dated cheques (PDCs) on due date without fail and initiate legal
action immediately on dishnour of cheques as per provision of Negotiable Instruments
Act. In no case dishonored cheques should be represented and in case borrower
approach the bank for payment, he should be asked to deposit the installment in cash.
Further, where loans backed by assets turns NPA; immediate action for seizure and
sale of assets should be taken under provision of SARFESAI ACT, 2002.
Challenge ahead Emerging markets are following developed markets in consumer revolution. The
consumer is being leveraged through mortgages, auto loan, credit cards, personal loan
and other loans. This has become focus of all banks- both public and private sector.
The retail loan market in India is in early stage of evolution. The retail loan has
contributed significantly in credit growth of the banks in past few years. In fact retail
loan is considered as driver of economic growth. Assets impairment in retail loan in
India so far is much less than other sector and there is no systemic finance bubble as
such. Since retail loan is a different ball game and banks have no previous
experience, it is necessary that banks should have an effective risk management
system. While serious efforts should continue to develop healthy retail loan portfolio ,
the lending policies, product structure, loan appriasal, screening and documentation,
post sanction monitoring and follow-up, collection mechanism all should be geared up
simalteniously to continuously mange the risk.This also necessiciates risk awareness
among retail loan mangers. With setting up of CIBIL credit history of the borrowers will
come handy to manage operational risks. However overreaction to stop retail credit
will cause the banks as well as the economy dearly. Banks need to pull out weeds, not
dig up the garden. And managers should understand that credit quality should not be
compromised due to pressure of competition or pressure to outperform others.
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Chapter-26
Risk Management
236
“The down fall of Barings in February, 1995 revealed that the bank lacked ability to
monitor effectively the trading activities undertaken by Leeson. This was party due to
lack of proper risk management system and also partly due to disregard for proper risk
management procedure.”
1. Risk Management - Meaning and ConceptRisk is intrinsic to banking. It is as old as the banking is. What has changed is the
colour and contour of risk management, as approach has changed from defensive to
strategic. Banks have changed from simple organization to complex ones. Their
geographic reach has spread from local markets to regional, national, and global
markets. Their operations are increasingly automated and reliance on electronic delivery
system has increased. All this has altered the risk profile of banks significantly. These
changes have raised two interrelated challenges for bank management; how to stay
focused to markets and the customers while keeping overall risk exposures within
acceptable ranges. To meet these emerging challenges, Reserve Bank of India has
been preparing Indian Banking system for an integrated risk management framework
since 1999. Managing risk is now core of banking.
2. Sources of Risk-There are many sources from which risk may emanate like (a) Globalization of
business due to integration of Indian economy with the rest of the world, (b) Progressive
liberalization of economic policies leading to surge in new products , (c) Vicious
competitive business environment, (d) Promoters/borrowers, (e) Technology and (e)
Market dynamics.
3. Risk Management process- This encompasses (a) identification, (b)
quantification, (c) management, (d) monitoring and (e) control.
4. Type of risk-The banking risk spectrum cover the following main risks- (a) Credit
risk, (b) Market risk, (c) Liquidity risk, (d) Interest rate risk, (e) Basis risk, (f) Option
risk, (g) Industry risk, (h) Business risk, (i) Country risk, (j) Sovereign risk and (k)
Operational risk.
5. Credit Risk – Credit, for the purpose of risk analysis, not only involve actual outgo
of funds from the lenders to the borrowers but also covers: (a) investment in
securities (which is often named as quasi-credit) and (b) non funded exposures in
form of letter of credit, guarantee, options etc. Credit risk is also known as default
risk. It involves inability or unwillingness of a customer or counterpart to meet
commitments in relation to lending, trading, hedging, settlement and other financial
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transactions. The credit risk depends on both external and internal factors. (A) The
external factors are the state of the economy, wide swings in commodity/equity
prices, foreign exchange rates and interest rates, trade restrictions, economic
sanctions, Government policies etc. (B) The internal factors are deficiencies in loan
policies/administration, absence of prudential credit concentration limits,
inadequately defined lending powers for sanctioning of loan by officers/Credit
Committees, deficiencies in appraisal of borrowers’ financial position, excessive
dependence on collateral and inadequate risk pricing, absence loan review
mechanism and post sanction surveillance etc. New capital accord (BASEL II) has
set new approach for measurement of credit risk from regulatory perspective and
prescribed regulatory capital charge for credit risk, market risk and operational risk.
6. Dilution risk- The ‘word’ dilution with reference to any security implies reduction of
intensity and strength of the relative security. For a tradable/marketable security the
full in realizable value may be construed as dilution risk but Basel lI has described
dilution risk situation with respect to receivable (book debt financing) as security. As
per Basel II the dilution risk refers to the possibility that the receivable amount is
reduced through cash or non-cash credit to the receivables obligor (seller who has
sold goods on credit to a buyer). It is known that in case of financing against
receivable the probability of dilution of security compared to other financing is more.
7. Market RiskMarket risk is the risk arising out of unexpected change in market variables such
as interest rate, currency, commodity & equity prices both on and off balance sheets
item. As per RBI definition market risk covers both the banking book and the trading
book. Basel committee ‘s definition of market risk excludes banking book and include
only the trading book. Market risk in the banking book is referred to by the Basel II
as interest rate risk. Market risk thus include (a) Interest rate risk both Indian rupee
and other currencies in the banking book (b) Price risk in the trading book arising as
result of interest rate, currency, commodity and equity price movement, (c) Liquidity
risk of the institution whether it is funding or trading liquidity and (d) Credit spread
risk unrelated to downgrade.
8. Liquidity RiskThe liquidity risk of banks arises from funding of long term assets by short-term
liabilities, thereby making the liabilities subject to roll over or refinancing risk. The
liquidity risk in banks manifest in different dimensions:
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(a) Funding Risk:- need to replace net outflows due to unanticipated withdrawal/
non-renewal of deposits (wholesale and retail);
(b) Time Risk:- need to compensate for non-receipt of unexpected inflows of
funds, i.e. performing assets turning into non-performing assets; and
(c) Call Risk: - due to crystallization of contingent liabilities and failure of
borrowers to pay.
ALM system has been introduced to measure cash flow mismatches at different
time buckets. In addition to ALM system banks are required to fix prudential limits for (a)
cap on inter-bank borrowing, (b) cumulative mismatches across all time buckets, and (c)
duration of liabilities and investment portfolio.
9. Interest Rate RiskIt is the risk arising from the impact of the fluctuation of interest rates on the
profitability as well of the assets and liabilities structure of the balance sheet.
Deregulation of interest rates has exposed banks to the adverse impact of interest rate
risk. Interest rate risk (IRR) refers to potential impact on Net Interest Income (NII) or Net
interest Margin (NIM) or Market value of equity caused by unexpected changes in
interest rates. Different type of interest rate risk are-
A. Basis RiskMarket interest rates of various instruments seldom change by the same degree
during a given period of time. The risk that the interest rate of different assets,
liabilities and off-balance sheet items may change in different magnitude is termed
as basis risk. The degree of basis risk is fairly high in respect of banks that create
composite assets out of composite liabilities.
B. Option RiskSignificant changes in market interest rates create another source of risk to
bank’s profitability by encouraging prepayment of cash credit/term loan and exercise
of call/put options on bonds/debentures and /or premature withdrawal of term
deposits before their stated maturities. It is known that bank in India has traditionally
been selling in built option while accepting deposit and granting loan.
10. Industry RiskIndustry risk analysis is concerned with SWOT profile of the industry within the
economy vis-à-vis economic trends and the key success factors for the industry. The
Industry risk includes: -
(a) Business cyclicality, earnings stability and diversify of earnings base.
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(b) Economic parameters such as inflation, energy requirements.
(c) International competitive situation, demand projections and maturity of market
or life cycle of the product.
(d) Basic financial characteristics of the business.
(e) Cost structure in terms of raw materials, labour, and plant capacity.
(f) Competitive structure.
(g) Ease of entry/ exit.
11. Business RiskThis is defined as the inability of the business or project to service its debt in time.
This inability strikes about inadequate income generation capacity of the business,
which is affected by the following variables: -
(a) Nature of business or the product it sales
(b) External economic or market environment
(c) Internal manufacturing organization
(d) Products mix.
12. Country RiskIn broad terms, country risk is that uncertainty which is created when funds cross
international frontiers. Management of cross-border lending and international
investment risk calls for country risk analysis periodically as comprehensive as
possible. It is defined as risk of a foreign borrower failing to service his foreign
currency debt obligations for reasons beyond the usual risks that arise in relation to
lending. There are two basic differences between domestic and foreign loans. One is
that repayment of international loans must route through exchange markets and
therefore, lending banks should assess prospects for exchange rates and controls on
capital flows. Another difference is that unlike in domestic loans, there is no
established common legal system to act as an ultimate arbitrator to settle claims. It is
because of these factors that assessment of country risk is critical for banks to
safeguard their international exposures.
13. Sovereign RiskIf the borrower belongs to the public sector, the risk is usually referred to as
"Sovereign Risk". Public sector comprise of all state owned agencies and institutions.
While terming a borrower as public sector, there is an underlying assumption that the
state will, ultimately, take responsibility for the financial obligations of the borrower
concerned.
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14. Operational RiskManaging operational risk is becoming an important feature of sound risk
management practice in modern financial markets in the wake of phenomenal
increase in the volume of transactions, high degree of structural changes and
complex support systems. The most important type of operational risk involves
breakdowns in internal controls, corporate governance and legal risk. Such
breakdowns can lead to financial loss through error, fraud, or failure to perform in a
timely manner or cause the interest of the bank to be compromised. Generally,
operational risk is defined as any risk, which is not categorized as market or credit
risk, or the risk of loss arising from various types of human or technical error. It
includes legal risk but excludes strategic and reputation risk. The sources can be
fraud, incompetence, transaction mistake, execution error, people risk, exceeding
limit, security risk, technology risk, system failure, programming error,
telecommunication error, and product failure. In home loan alone public sectgor
banks have reported frauds amount to Rs. 599 croes ( BS 24.2.2009) between 2002
to 2006 mainly fake titled deeds, impersonation and inflated valuation reports.
Legal risks primarily arise either due to lack of clarity of the documentation of the
product or the act of the counterparty. Change in legal environment due to legislative
changes and court interpretations/proceedings also result in legal risk. Broadly legal
risks may result in (a) claim against institution, (b) fines, penalties and punitive
damages, (c) unenforceable contracts resulting from defective documentation and
(d) loss of institutional reputation. Another important area is legal risks arising out of
outsourcing of certain activities by banks. In case outsourced activities legal risks
may arise owing to breach of confidentiality or any fraud hat may be committed by
bank’s agent making the bank liable for his acts and omissions including
misrepresentation to the customers and breach of any law committed by the service
provider. Legal audit, internal controls and internal audit are used as the primary
means to mitigate operational risk. Banks could also set operational risk limits, based
on the measures of operational risk. Insurance is also an important mitigation of
some forms of operational risk. Risk educations for familiarizing the complex
operations at all levels of staff also reduce operational risk. Under Basel Committee
II guidelines, RBI has asked the bank to provide capital charge for operational risk
equivalent to 15% of their average gross income of previous three years.
Challenge ahead-
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The risk situation in Indian Banks is no different from the bank world over.
In fact, it is more complicated. The nationalized banks and SBI and its associates
contribute more than 80% of banking business. With adoption of Basle II from
March 2008, risk management and risk measurement has come into sharp focus.
Each bank is now required to educate and train all officers/employees so that they
are made to understand the process of generation of risk, its quantification,
mitigation and management. Risk management, cutting across all hierarchical levels
and activities in banks, has become part of every body job. While people at branch
level are required to take calculated risks, the top- management level the risk is
required to be monitored and managed. Further MIS is core of risk management and
has to be generated in timely and accurately. It is going to be a very big challenge
for public sector banks having far flung rural branches many of which are still not
under CBS. Thus, banks should attach considerable importance to improve the
competency of their work force to identify measure, monitor and control the overall
level of risks by proactive management.
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Chapter-27
Bank MarketingMaking of a Successful Sales Person
“People buy not because they understand your product or service but because
they feel that you understand them”.
Bank MarketingMarketing in most credit institutions including banks is new phenomenon. Before
that marketing was synonymous to advertising and public relation and role of
marketing was more tactical than strategic. However due to fierce competition
generated by entry of new generation private sector bank marketing has become a
strategic tool of product promotion and business development and all banks whether
in public sector or private sector have full fledged marketing department to effectively
put in place all the 7Ps’ of ‘marketing mix’ (a term coined by Kotler) - product, price,
place, promotion, people, process and physical evidence. To put in marketing terms,
it is not only necessary for a bank to have right product but also to have right price,
delivered by right people, using right processes, packaged in right manner and at a
right place. The sales person is a very crucial part of marketing mix.
Making of a sales person- sales skills‘People with right soft skill’ is the requirement of
marketing. A sales person should have pleasing
personality, attractive mannerism, positive attitude,
good communication and negotiation skill and genuine
concern of customers’ problem. He should be
attractive, smart, simple, serious, reliable, trust-worthy,
optimistic, positive, efficient, outgoing, aggressive, passionate and energetic. He
should have high level of energy and abounding self-confidence to win and hold
passionate desire to perform. In fact, marketing is for the fittest, fastest and smartest
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person. Fit and fast sale person must know and truly identify with his company and
know its product, customers, competitors, responsibilities and art of making sales
presentations. He should value relationship and follow ethical practices to offer value
for money to its customers. He should be fast enough to respond to customer’s
demand and satisfy his queries accurately and promptly. He should be smart
enough to greet the customer with smile, treat the customer with all the comfort he
expects and meet his product/service wants and needs. A smart salesperson is one
who checks and makes his selling style and language a perfect fit.
Making of Sales person- Kotler’s modelSelling is an art. It pre-supposes that sales person understands customer’s need
and is competent to offer effective solution. It is a customer problem solving
approach. This approach assumes that (a) customer have latent needs that provides
opportunity to the bank, (b) they like suggestions and (c) they will be loyal to the
sales persons if they satisfy their long-term interest. Kotler’s model consists of: -
(i) Prospecting the customerFirst step in selling is to identify a prospective customer. Current
customers are best source to develop a lead. Other sources like
associations of traders, pensioners’, and industries’, residents’ etc. can
assist the bank in identifying prospecting customers. Data sources like
newspaper; magazine, directories, bulletin etc are other important sources
to find out details of the prospective customers who can be approached. A
sales person should have ability to convert all these information into a data
warehouse to approach and market his products to the potential customers.
(ii) Learning and approaching a potential customer There is small piece of wisdom that I learnt from practical experience as
a sales man- and that is salesman never sales! Then what is he selling
about? In my experience, the best salesman is one who makes the buyer
buy. I used to tell my sales staff, “Don’t try to sell, but try to help your
prospective customer to buy”.1 A sales person must, therefore, learn as
much as possible about potential customers’ needs, habits, preferences,
personal characteristics, buying styles and buying decision process.
Approach is concerned with attitude, manners and appearance of the sales
person and relates to his ability to communicate with the prospective
1 My Master Pujaya Parthasarthi Rajagopalchari- page 78 Volume I Down Memory Lane
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customer. The sales person should decide best approach i.e. how
(personal visit, or telephone or letter), when (time of visit) and where (office
or residence) to contact the prospective customer.
(iii) Preparing for presentationFirst impression is the last impression. Success of a sales person lies in
opening lines and his follow up remarks. The spoken worlds are the most
powerful tool that creates sale. Sales person must prepare himself fully
before he actually meet the customer to make presentation.
(iv) PresentationPresentation signifies conveying product features, benefits and qualities
to the prospective customers to stimulate buying. Kotler suggested AIDA
approach i.e. getting attention, holding interest, arousing desire and
obtaining action. Sales presentation can be of three types - (a) Canned
approach based on memorized sales talk covering the points about product
features. It is based on stimulus response theory that suggests that by
proper use of words, pictures, action and terms, and sales person can
prompt customer to buy the product (b) Formatted approach is also based
on stimulus response thinking but lays emphasis on first identifying buyers
need and buying style and thereafter approaching him. For example, if the
customer is cost conscious, the sales person should offer him low cost
and no frill products. (c) Need satisfaction approach is based on search of
customer’s need. In this approach, the customer is encouraged to come out
with his requirement and based on his need, the product is tailor made.
Other way of identifying customer’s need is mapping his behavior and
identifying gap from which customer derives value. With introduction of
technology, sales presentation has become very scientific and focused,
which not only saves time and resources of the sales person but also
enable the target customer to understand the product better.
(v) Question and Answer session-A common complaint about sales person is that they talk too much. A
good sales person should, therefore encourage customer to raise questions
so that all the doubts/objections are cleared to his/her total satisfaction.
Customers may raise objections because he may find certain gaps either in
his understanding or in the adequacy of information or just the fact that he
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does not like the sales person. Sales person should know and appreciate
that objections are natural behavior from consumers and cannot be wished
away. These objections and doubts can be classified into two categories-
(a) psychological resistance that includes resistance to interference,
preference for existing brands, tendency to resist change, dislike to decide
new things, pre determined ideas and unpleasant past experience. (b)
Logical resistance that includes objection or doubt for price, quality, delivery
schedule, or product features. A successful sales person is one who
understands the objections clearly and addresses them to the best of
satisfaction of the customer. For this, it is important that the sales person
should have thorough product knowledge and should effectively and clearly
communicates its features/ benefits to the prospective customers. He
should answer all the objections in such a way that all doubts are
reasonably clarified and customer is prompted to buy the product. Handling
objections is a very tricky business and most difficult part of the
salesmanship. Negotiation skill plays a major part in handling objections
tactfully and firmly. Above all sales person should always be encouraged
and motivated to face challenges, as it will enable him to stay focused and
deliver result. The sales person must be a creative learner. He must be
willing to experiment and to learn from his mistakes.
(vi) Closing the dealOnce presentation is made and objections are satisfied, sales person
should fetch the orders. It is his ultimate object. It is his moment of truth.
Closing requires confidence, competence and capability to read closing
signals from the customers and decide right timing of obtaining order. Finer
details like terms and conditions, repayment period, interest-rate, option
fixed or floating etc. should be repeated once again so that there remains
no ambiguity. Most selling is persuasive today. In a demand led market
where the supply of goods and services is on over drive, persuasion is the
name of the game. When a sales person feel that the customer is avoiding
or postponing a buying decision, he should tactfully lure him by freebies,
discount etc. He can also tactfully say that offer will lapse if not availed or it
is lifetime opportunity, which the prospective customer should not miss. He
should say ‘thanks’ once the deal is over.
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(vii) Post sales follow-up A sale never really ends with the physical closure. The experience of the
product or service is therefore just as important if not more to the selling
process. Post sales follow-up is an exercise of establishing long-term
relationship with the customers so that sales man remains in touch with
post sales issues and get the repeat orders. For banks, follow-up also
means to look into cash-flow problem of the customer so that debt is
rescheduled or extension is allowed if it is so required. Follow up also
means to provide post credit counseling so that sales person remains in
touch with the customer and exploit the opportunity for cross selling or up
selling. It is the duty of sales person to check that customer is totally
satisfied with the product and in case he/she is having any problem that is
sorted out to his/her full satisfaction. A sales person should keep on
calling his customers to stay in touch, not necessarily to sell more.
Selling over Phone With mobile penetration on the rise, banks are opting to sell their
products over phone. Selling of credit card, life policies, mutual funds are very
common. The benefit of the selling over phone is that it allows the bank to sell
products at low cost where deputing the sales persons is cost prohibitive. As
general impression is not very good for this channel as selling over phone is
susceptible to misselling, bank has to be careful in recording such sales to
overcome the issues arising out of complaint of misselling or legal non
compliance. Sales persons while selling the products over phone must keep in
mind some basic principles namely:-
(a) Sales person should clearly tell her name, address and location from where
she is calling. This will add to the confidence of the buyer in the sales person.
(b) Sales person should specify the terms and conditions of the products
clearly. It is advisable to speak slowly so that customer understands the
things properly.
(c) Sales person should not give any false promise to induce sale. Benefits and
exclusions must be clearly spelt out.
(d) To meet regulatory requirements, banks are required to record conversation
that takes place through the call centre. Sales person should keep in mind
that he is morally as well as legally bound to be fair with the customer.
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No Kidding“Buying a car may be an adult decision but it’s the kids who decide models, variants, features and colours when a family goes vehicle shopping.”
- A study of Turner India ET 22.04.2006
(e) Typically the online sale is offered by a written confirmation offer where
customer is given choice to refuse to accept the product if he does not like it.
This cardinal principle must be complied in both letter and spirit so that
customer confidence in selling over phone is established.
(f) RBI has asked banks to disclose to their customers fees and other
commission earned by selling mutual funds/insurance policies etc. This has
been done to protect the customers from reckless selling of financial products
without protecting their interest.
Decision Influencing Although a consumer may get
information for a product or service through
multiple sources of communication
(including 1:1 with sales person), he/she
many times consults others before taking
the buying decision. These persons may
be housewives, kids, elders-in-family
(village elders in rural areas). (See Box) A
smart sales person always remains active and agile to watch such influence. The
sales person should study and analyze social and cultural habits that influence
the purchase decision and approach the marketing by addressing their priorities
and concerns. In Indian context, housewives play an important role in decision
making particularly in big-ticket loans like housing, car, insurance etc. Sales
person should be aware of their liking (including disliking) and so that their
concerns are addressed satisfactorily. Fair practices code
Many a time customers are complaining of too much intrusion in their
private life by the sales persons like unsolicited telephone call by Credit Card
Company or an insurance agent. With consumer awareness increasing for
privacy and RBI insisting for anti-tying measures, banks are putting in place fair
practices code for their salesperson. These practices include maintaining do not
call list, checking the calling per month, respecting privacy of the customer,
identifying hours and day of calling, putting complaint handling process and
response time in place. A sales person should be sensitive of these fair practices
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to avoid dislike of the customer. Ethics, caring and service are now foundation of
selling.
Selling to internal customers People create, deliver and sustain value for the organization.
Organizations that adopt a disciplined and integrated approach to the
management of people can harness their organizational intellect and transform it
into economic value. In order to leverage employee intellect towards value
creation, enterprises need to create a sales culture. Bank staff is bank’s ‘brand’
that greets the customers at the counter, entertain request for opening account or
processing a loan application, answers queries or solve problems etc. The
challenge before public sector banks is to make each and every employee a
sales person. This requires a whole lot of selling to internal customers to change
their mindset and ramping up belief that marketing is support function which
whole organization need in present day banking.
Behind every successful investor is a sound advisor The easy and passive products like fixed deposits are no longer attractive to
customers given the low rate of interest. Wealth management and private
banking is fast emerging as lucrative preposition for banks since customers are
now looking to invest in alternate products like insurance and mutual funds,
which gives higher yields with tax shield. Since these products comes with higher
risks, the bank need to educate customers so that potential investor understand
the inherent risk of these products fully. The IRDA and AMFI - who are
regulatory/advisory bodies for ensuring fair practices in marketing of these
products - has mandated that the value proposition and risks of insurance and
mutual funds products have to clearly explained by the sales person to
prospective investor and for that the sales person must be duly accredited for
selling such products after qualifying/passing the prescribed test. And with this
object banks have started recruiting people from finance and marketing
background to offer advisory services to customers in addition to customary
selling. These financial advisors are not merely the sales person but in true sense financial ‘guides’.
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Chapter-28
Customer Centric Banking Walking with the Customer
“Unless you have good idea that adds value to a customer, there is no point in
proceeding further. Your product or service must provide one of the following benefits -
reduce cost, reduce cycle time, improve productivity or improve free time of user of the
product. Most failures are due to negligence of this cardinal principle.”
- N. R. NARAYANA MURTHY
In sellers’ market businessmen were hardly bothered to keep the customers
happy. However, with change of sellers market to buyers market, whole approach to the
business (including banking) has changed. What is important is to recognize that
following the crowd will probably not enable an organization to outperform the crowd-if
one does what his competitors do, he can not be expected to perform better than others
do. That is why exceptional performers have always been willing to avoid following
conventional wisdom and attempts to do things differently. To walk with the customer is
a tool that enables an organization to explore better ideas to act. To know the concept,
let us first examine some applications: -
AN AUTOMOBILE COMPANY offering night servicing of car and two wheeler where
car or two wheeler is picked up in the night and delivered in the morning so that
vehicle owner does not face any inconvenience for going to office/business place.
GILLETTE GII PLUS TWIN BLADE SAVING system introduced new lubrastrip to
lubricate the face while one shave.
TTK Prestige introduced two innovations in its product range of pressure cookers- a
visual pressure indicator that indicates when pressure has been released within the
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cooker and a silicon gasket that need not be replaced during the life time of a cooker
–about 11 years. By this innovation, TTK steamed ahead in the cooker segment by
35% during 2003-04.
INDIAN POST offer of Business Post as complete solution for bulk mailing of
invitation cards, share holders notices, bills, etc. by offering services like pick up,
insertion, gumming, addressing, franking and mailing the letters.
BRITAN’S FINANCIAL SERVICE AUTHORITY (FSA) go-ahead to first Islamic bank
in Britain to open its first branch in London and work as per Islamic Sheriat Law i.e.
not to pay interest and Tobacco and Alcohol sector will be out of bound. The bank
will allow 1.89 million British Muslims access to banking strictly as per sheriat law.
MARTIN LOTTERY AGENCY Ltd. rolled out a scheme in which company will
mobilize small savings from its on-line lottery sale. The company would have
investment advisory staff at each out-let with separate counter and each winner will
be given investment counseling.
WALKING WITH THE CUSTOMER- A STRATEGIC TOOL The objective of the walking with the customer approach is to have competitive
advantage –the ability to earn above normal economic returns over a sustained period of time- by offering products, which add value to the customer in terms of
Convenience, Cost and or Quality.
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As one walk with the customer from very beginning of identification of his need
and is with him right through while selecting, buying, using and disposing the product,
one can identify great deal of happening that can be used for creating value for the
customer and can lead to competitive advantage for the organization. The walking with
the customer is however, different to what a customer feels about the product, its
intrinsic value or price but it is about understanding the whole process of behaving and
feeling exactly like what customer would do. It is thus a process of mapping the customer’s behavior by analyzing various activities that he performs while selecting, purchasing, using and disposing a product and then to locate gaps from where he derives value. The next strategy is to close the gap by introducing product innovation or renovation. The concept is simple yet a powerful strategy for a
customer centric approach. In service industry like banking walk becomes a strategic
tool for growth and survival.
Application in Banking Industry A question is often raised: - Is banking today is different from any other
consumer goods business? In addition to accepting deposit and lending, the banks
are offering various products/facility like collection of telephone/electricity/insurance bills,
selling insurance policies/bonds/mutual funds, collecting income tax, disbursing salaries,
home delivery of cash/draft and home/office pick up of cash/cheque etc. All this
multifarious banking is targeted to customer acquisition either by developing a new
product or by value addition in the existing product. Thus, increasing focus on customer
acquisition has made the banking similar to that of consumer goods business.
Let us see application of this concept in Indian banking and financial sector: -
(a) Having realized that for opening new accounts prospective customers have to
face lot of inconvenience both in terms of time and dislocation of work for
visiting a photographer, a bank provided digital Camera to its staff to take
photographs of the persons intending to open account.
(b) Home delivery and pick up facility of cash/cheque/draft recently introduced by
few banks.
(c) Following innovations and renovations in Home-loan products have been
introduced-
Get loan approved first and select the property later to enable the
customer to select the property as per his financial resources,
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Short-term bridge loan –against mortgage of existing house to enable the
borrower to buy a bigger house and loan will be repaid from sale proceed
of old house.
Top up offer of consumer loan up to 10% of housing loan to its existing
borrowers at same rate of interest and at same security.
Over-draft facility against security of house to provide liquidity against
assets which customer till now felt as an unproductive.
New home loan product in which excess funds in borrower’s saving
bank or current accounts is automatically swapped in Home loan account
to reduce the interest burden. In case of need funds will get reverse
swapped to savings /current account so that customer can withdraw the
money.
(c) Cash back offer of credit card companies- ICICI Bank has taken lead in credit
card number through this offer.
(d) Money transfer facility from card to card- from debit card to credit card or
vice versa. An innovative C2C product.
SYNERGISTIC BANKINGWith customers loyalty shifting to cheaper loans, flexible repayment plans, better
terms and freebies, it is duty of each and every employee of the organization to make
collective efforts to identify new opportunities to increase business through walking with
the customer strategy..
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Chapter-29
Selling of third party productsEmerging opportunities for banks
“ Banking is laid back whereas third party products like insurance and mutual funds are
sold aggressively. Bank people do not sell their own credit cards. The skill development
requires lot of orientation, attitudinal change and training of the employees.”
1. Welcome to the world of selling of third party product- This bit of information is real. In days of Raj, scotch was stored in the vaults of
some foreign banks. Warehousing was an issue and by agreeing to keep in their
vaults these banks earned the fee income. Scotch has not returned to bank vaults for
sure, but something on those lines is happening. Now walk into any supermarket,
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bank, post office, ATM, Internet kiosk, Credit Card Company or departmental store to
pick up an insurance product virtually off the shelf. As competition is hotting up, the
alternate delivery channel is developing on win-win concept. The barrier between
product and service is also disappearing. One can now buy toothpaste and have
dental insurance and buy a home loan and have life insurance cover too. Banks are
not staying behind and now across the board selling products ranging from mutual
funds (MFs) to insurance to equity to government securities on another party’s
behalf.
2. Selling of third party products- A new business model for banks There are many reasons for this venture by banks. The race for becoming a
one-stop financial supermarket is hotting up like never before and even smaller
banks are now talking about becoming the destination for all kinds of financial
products. Another reason is that developing own products is an expensive
proposition and is a time consuming process. Through this process, banks get the
benefit of associating with another recognized brand in segments where the bank
itself possesses no experience. Another reason is that with spread under pressure,
banks are looking for alternative income. Fee based income by selling third party
product is an answer to the problem. Selling of third party products also help the
bank to cross sell its own products to its customer thus utilizing surplus staff in
productive purpose. This can also helps the bank in improving market share by
retaining the existing customers and by providing those right options as knowing
what a customer requires is more important than what the bank is having. This also
helps bank in developing customer’s loyalty. Vast net work of the branches is bank’s
real strength, which adds tremendous value to this sort of business.
3. Bank as Super MarketIn many countries, banks have virtually become super markets selling
chocolates, coffee and pharma products. In India also, a bank has tied up with
BARISTA to promote concept known as BANKCAFE-where customers can refresh
them-selves with coffee & snacks while doing the banking business.
4. LimitationsThe marketing of third party products like insurance is push business whereas
traditionally banking is laid back business. This is due to cultural differences of banks
and insurance. This takes us to marketing that occupies center stage in undertaking
this business. Banks are required to develop marketing skills in the employees
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selected for the job. The training has a crucial role. In competitive environment,
selling of third party products presupposes certain service standard, particularly
selling to up market customers. The ambience of branches will have to be upgraded
and will have to be manned by forward looking and committed employees.
5. Skills required to sell third party productsHowever to offer correct product to the customers, bankers need to have skill in
knowing the products, to have speed in marketing the products, and to have pool of
well defined attractive products. They must also understand customer’s investment
need so that he can offer him best product available and not the one, which he is
having. It is also important that while selling third party products, bankers must
convey unconditionally to the customers that they are only selling some thing for
which responsibility to service and performance lies with the third party. But since
banks own credibility is at stake, they should do proper check up about service
standard of alliance partner. It should also be remembered that new age customer’s
look for convenience and informed advice from branch officials and they prefer banks
that display this attitude at the front desk. This requires lot of orientation, attitudinal
change and training of the employees. Banks in all countries that have ventured in
selling third party products like insurance have faced the task of transforming their
staff into effective salesman through systematic training and attitude orientation.
Banks in India have excellent training facilities that can be geared up to meet the
requirement.
6. Regulatory complianceIn a move to curb mis-selling of financial products and ensure transparency, the
RBI has mandated that banks should disclose to their customers details of the
commission and other fees received by them while selling mutual funds and
insurance policies. This has been done to ensure that bank should not recklessly
push products which earn them higher commission without bothering whether the
product is beneficial to the customer or not.
7. Emerging Opportunities in IndiaWith liberalisation of financial sector, many new opportunities are emerging in
India for selling third party products - mainly financial products. This are :-
(a) Bancassurance is globally a big business. According to a report of IRDA,
premium collected through banc assurance was Rs. 21947 croes in 2009-10
which is 7.31% of the total premium income of life and non-life insurance
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companies. Further 28% of new premium income insurers got through bank
assurance channel. India’s insurance sector is likely to touch about $400
billion in premium income by 2020 making the country of the top-three life
insurance and top 15 non-life insurance markets by 2020 as per survey of
FICCI and Boston Consulting Group. In last few years many public sector
banks in India have ventured into both life and non life segment. Bank
assurance model is low cost model and helps the bank in capturing business
leveraging on its own distribution capacity. As per survey conducted by
Watson Wyatt World Wide private insurer’s premium income will rise to 40%
by March 2010 from Bankassurnce business. Private insurers paid Rs.205
crores as commission for banc assurance during 2008-09. Of late taking
advantage of regulatory permission, banks are taking equity stake in
insurance company and entering into bankassurnce model to sell their
products which in turn help insurance companies to reduce their operational
cost. It ultimately works as WIN WIN model for both of them.
(b) Credit protection insurance is a big business worldwide which provide
protection to loan liabilities. After home loan, it is insurance market for home
loan repayment that is booming in India. Borrowers are scurrying for home
loan covers, where the life insurer repays the entire loan amount in event of
the death of the borrower and prevent the bank from taking away the
financed property. Education loans are also covered under credit protection
plan.
(c) Credit insurance is other segment which is catching fast. Under credit
insurance seller of goods/services are offered protection against any default
of payment by buyer. Where sellers are not insisting for letter of credit or
bank guarantee, credit insurance helps to overcome crisis when buyer
defaults. Many non-life insurance companies are offering this product which
can be marketed by banks under bankassurance.
(d) Assets under the management of mutual funds on October 2007 end have
crossed the Rs. 5 lakhs crores mark. Funds industry estimates indicate that
banks now brings in about 40% of retail mutual funds investments up from
20% a couple of years ago. Funds are entering into distribution pacts with
public sector banks to reach out small investors who are already availing
traditional banking services from banks.
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GOLD COINS & BARS SOLD
2010-11
In Kg.
SBI 2610IOB 1392Indian Bank 1150Andhra Bank 305Source: Business Line 14.5.2011
(e) Selling of Gilt also offers good business opportunity which many banks have
already started enchasing. Banks are also selling RBI Relief Bonds.
(f) Selling credit cards, debit cards and e-card is another area where banks are
utilising synergy of their existing customers to build business.
(g) After fake stamp paper scam, new business opportunity of stamp franking
has emerged as numbers of state governments are now selling stamp paper
through banks.
(h) Finance Ministry has mandated rural and urban branches of the public sector
banks to generate minimum 150 and 50 subscription under new pension
scheme every year. This has been done to ensure that all citizen in
unorganised sector and underprivileged are given opportunity to get pension.
Although mandated yet it is an opportunity for banks to promote the scheme
and earn extra money.
(i) Banks now see opportunity in selling gold coins and bars. According to
World Gold Council consumption of gold for
jewellery plunged 20%, while investor
demand for gold increased 51% in second
quarter of 2009. India is now largest
consumer of yellow metal and imported 944
tonnes of gold worth $59 billion in 2011-12.
A good number of banks have started
selling this product to earn extra fee based
income. Buyers find investment in gold as attractive option since interest
income in fixed deposit is comparative low to increase in the price of gold in
the recent past. Since gold coins and bars are hallmarked, buyers feel
secured.
(j) Banks are now offering new channel that is being developed by share
brokers in alliance with the bank where three in one services of saving bank
account, depository services and internet based trading account are offered.
8. Market Size(a) HDFC mutual fund has tied up with ICICI Bank, HDFC Bank, Canara Bank,
Citibank and Standard Chartered Bank to sell its mutual funds products. As
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per press release of HDFC, as much as 27% of the mobilisation of business
is now coming through this channel.
(b) LIC expects that sales of its products through banks will touch Rs. 600 clrores
by end of March 2006. LIC has signed MOU with 34 banks for sale of its
products through bancassurance.
(c) In Q3 of 2004-05 SBI Life total premium collection was Rs. 360 crores. SBI
Life is looking for No. 2 slot in life insurance business. It is at present selling
its product through 5000 branches.
(d) Bajaj Alliance Life, which has tied up with Standard Chartered Bank,
Syndicate Bank, Indusind bank and Centurion Bank, mobilised about 26% of
premium income through bancassurance mode.
(e) Aviva bancassurance success is stupendous as it earns 68% income through
this mode.
(f) Export Credit Guarantee Corporation of India Ltd. (ECGC) has signed
corporate agency agreements with 11 leading banks in the country to sell
export credit guarantee cover.
(g) The Bank of Rajasthan has reportedly surpassed the Rs. 100 crores mark in
its stamp franking business by end March, 2005.
(h) Birla Sun life offered advance commission of Rs. 600 crores to Syndicate
Bank which in turn will buy 6% in the company.
(i) Metlife has sold 30% stake to Punjab National Bank for life insurance.
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Chapter-30
"Know Your Customer"-Guidelines
“There is need to sensitizing front office staff so as not to antagonize customers.”-DR A. K. Khandelwal- CMD, Bank of Baroda
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Key elements of Policy and procedure to open new accounts
1. Formalities preferably completed in bank premises.
2. Ascertain purpose of account and likely amount and kind of transaction intended. Banks may fix thresh hold limit for likely transaction in the account to monitor turnover.
3. Account holder with account of minimum 6 months must introduce an account.
4. Introducer to confirm that he knows the account holder for a reasonable time and also to confirm his/her occupation and address.
5. Obtain photograph of all account holders/partners/directors. In case of legal person, verify relevant documents and verify status of the persons acting on its behalf.
6. Obtain copy of PAN, Driving license, Voter Identity card etc.
7. Corroborate information from independent sources to check authenticity.
8. Send letter of thanks to account holder and introducer.
9. Don’t issue cheque book unless address is confirmed.
10. Keep tab on the account of politically exposed persons.
11. Banking facility on Internet will be subject to existing regulatory framework. Only banks physically present in India can offer internet facility to resident Indian only.
1. KYC- Concept and Coverage‘Know Your Customer’ (KYC) principle, has
been laid down by RBI to put in place systems and
procedures (a) to control financial frauds, (b) to
identify money laundering and suspicious activities,
and (c) to do scrutiny/monitoring of large value
cash transactions. Customer means any person
availing any type of banking facility who may not
necessarily maintain a bank account. This includes
foreign-exchange transactions and accounts as
well. The key elements of KYC policy are (a)
Customer identification policy, (b) Customer
acceptance policy, (c) Policy of monitoring of high
value cash transaction and (d) Risk management.
2 . “ Know Your Customer" (KYC) -guidelines
2.1 KYC Policy for opening accounts
(a) "Know Your Customer” (KYC) procedure is
the key principle for identification of an
individual/corporate opening an account.
The customer identification entails
verification through an introductory
reference from an existing account holder or
a person known to the bank or on the basis
of documents provided by the customer. No
banking relationship should be accepted
until and unless the customers’ identity is
established to full satisfaction of the bank.
(b) The prescribed procedure (see box) for opening and operation of new accounts
include verification of bonafide and identification of individual/ corporate
opening new deposit accounts. These guidelines contains procedure of
verification on the basis of documents like passport, driving license etc. and
system of corroboration of information from independent sources.
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(c) Unique Identification Authority of India (UIDAI) is likely to commence eKYC
authentication service for opening of account which will pave the way of identity
of account holder and his address proof and RBI as well as GOI is likely to
approve AADHAAR as valid ID proof for opening accounts. Facility is likely to
minimize operational problem in opening accounts and is also likely to bio-metric
identification of the account holder.
(d) Looking to the problem of low-income group customers, RBI has permitted
banks to open accounts of those customers, who are not in a position to submit
address or identity proof, on the basis of introduction of an existing customer
having minimum six months old account with satisfactory turnover, provided
introducer has been subjected to KYC procedure and subject to annual deposit
limit of Rs. 1 lakh, monthly withdrawal can not exceed Rs. 10000 and balance
does not cross Rs. 50,000/- . RBI has also advised that individuals who do not
have an individual proof of residence can now open an account by producing
utility bill of close relative as a proof of residence along with a declaration of
close relative that prospective customer is living with him. It has been clarified
that the customer acceptance policy procedure should not lead to denial of
banking services to the general public.
(e) RBI has also advised banks not to open accounts or close an existing account
where bank is unable to apply appropriate customer due diligence standard i.e.
bank is unable to verify customer’s identity or documents required. Further to
build safeguard decision to close account or not to open account must be taken at
higher level after giving due notice to the customer indicating reason.
(f) RBI has advised banks to identify politically exposed persons who are resident
outside India and verify their source of funds before accepting deposits.
Politically exposed persons are individuals who are or have been entrusted with
prominent public functions in foreign countries such as head of states, senior
politicians, senior government, judicial or military officers, important political
party officials and senior executives of state owned companies. It is may be
recalled that globally politically exposed persons are seen as high risk category
particularly if they originates from countries having high level of corruption. RBI
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has further advised that decision to open the account of politically exposed person
should be taken at senior level.
(g) The RBI has advised banks to conduct extra due diligence of accounts operated
by NGOs to monitor and reduce risks of money laundering. Further through an
amendment in PMLA 2002, charitable trusts, non-government organizations,
educational institutions or societies have been mandated to disclose the source of
their funds and has also been mandated that large monetary transactions may be
scrutinized.
(h) RBI has advised banks to obtain a declaration from the account-holder to the
effect that he is not enjoying any credit facility with any other bank or obtain a
declaration giving particulars of credit facility enjoyed by the intending customer
with any other bank(s). Besides, in the latter case, the concerned lending bank(s)
were required to be duly informed so that suitable precautionary measures, where
necessary could be taken by them.
(i) Banking facility on Internet is subject to the existing regulatory framework. Banks
having physical presence in India only are allowed to offer banking service over
Internet to residents in India and any cross border transactions are subject to
existing exchange control regulations. Banks to establish identity and also make
enquiry about integrity and reputation of the prospective customer. Internet
account should be opened only after proper introduction and physical verification
of the identity of the customer. Similarly Credit/Debit/Smart/Gifts cards should
also be issued on compliance of KYC guidelines.
(j) RBI has also advised banks to subject locker hirer to KYC norms and where it is
found that locker remain inoperative for more than one year in medium risk
category or more than three year in high risk category, bank should break open
the locker after serving notice to the customer. These guidelines have been issued
on the background of instances that not only arms and ammunition but also
bombs were found in the lockers.
(k) RBI is also working on brining prepaid cards, gift vouchers travel, expenses cards
and food coupons under KYC and AML guidelines. Institutions issuing these
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Suspicious transactionsRed-alert signals
1. A customer submitting unusual or suspicious identification documents that cannot be readily verified.
1. A customer’s home or business phone disconnected or letter of thanks returned back with vague remarks.
2. Watch cash transactions which are out of business or income profile of the account holder.
3. Watch if customer is found splitting transactions to avoid filing of mandatory reports. Bank to check series of transaction with aggregate below cut off date.
4. Watch charity or relief organization linked transactions. Also accounts operated through power of attorney and accounts of politically exposed persons.
5. Reasonable ground to suspect that proceeds of crime money is deposited even if below cut off limit.
instruments would also be required to file STR with Financial Intelligence Unit of
India.
(l) Banks have been advised to prescribe thresh hold limit for particular type of
accounts and to pay attention to the transactions which exceed these limits.
Transactions that require large amount of
cash inconsistent with the normal and
expected activity of the customer should
particularly attract the attention of the
bank. Very high account turnover
inconsistent with the size of the balance
maintained may indicate that funds are
being ‘washed’ through the account.
(m) RBI has advised banks to revisit (a time
frame has been prescribed) all the
existing accounts where summation of
credit/debit transaction is more than Rs.
10 lakhs or accounts of trusts,
intermediaries or account operated
through mandate to recheck that KYC
guidelines so framed have been followed
and where-ever there is any discrepancy
the same should be got rectified at the
earliest.
2.2 KYC Policy for issuance of TT/DD/MT etc.
(a) KYC policy stipulates that branches
should issue travelers cheques,
demand drafts, mail transfers, and
telegraphic transfers for Rs.50, 000
and above only by debit to customers’
accounts or against cheques and not against cash.
(b) Further, the applicants (whether customers or not) for TT/MT/DD/Traveler
Cheque etc for amount exceeding Rs.50,000 should affix permanent (Income
tax) account number on the applications.
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(c) Some time to bye pass the requirement, customers resorts to splitting of the
transaction, which send warning signals to the bank. The branch officials
should be vigilant to check such transactions where they find that
transactions are splitted up to avoid compliance.
2.3 KYC policy for monitoring high value transactions
(a) The branches are also under obligation to monitor transactions of a
suspicious nature (See Box) and to report such transactions to law
enforcement agencies and to freeze such accounts as per their direction and
also report to their corporate office within seven days of arriving at the
conclusion that that a transactions or series of transaction including
attempted transaction are of suspicious nature.
(b) The branches are required to keep a close watch of cash withdrawals and
deposits for Rs.10 lakhs and above in deposit, cash credit or overdraft
accounts and record details of these large cash transactions in a separate
register.
2.4 KYC policy for terrorism finance and money laundering
(a) It is estimated that the size of money laundering worldwide through the
banking sector, is more than US $ 500 bn to US $1 tn annually. Given the
staggering volume of this crime, broad international cooperation between
regulatory and law enforcement agencies is important to identify source of
illegal money, trace the funds to specific criminal activities and confiscate
such assets. Post September 11, the issue that bank supervisors the world
over a grappling with is “How to root out the menace of money laundering?”
The law being enacted typically require a bank to “know the customer” to be
confident that his money is obtained by legitimate means and to report any
suspicious activity. This means bank must know their customers’ customer as
well. RBI has reemphasized that banks can effectively control and reduce
their risks only if they have an understanding of the normal and reasonable
activity of the customer so that they have means of identifying transactions
that fell outside the regular pattern of activity. However the extent of
monitoring will depend on risk sensitivity of the account. Bank should pay
special attention to all complex unusually large transactions and all unusual
patterns, which have no apparent economic or visible lawful purpose.
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(b) Where banks become aware of facts which lead to the reasonable
presumption that money held on deposit drives from criminal activity or that
transactions entered into are themselves criminal in purpose, appropriate
measures, consistent with law, should be taken, for example, to report the
matter to law enforcement agencies, deny assistance, severe relations with
customers and close or freeze accounts.
(c) A FIU (Financial Intelligence Unit) has been set up under Prevention of
Money Laundering Act, 2002 and Banks /FIs are required to keep record of
the dealings above thresh-hold (excepting dealing with corporate clients, PSU
etc. specifically exempted by the government) and to report such transactions
to FIU. Reporting threshold has been fixed at Rs. 10 lakh for cash transaction
and Rs 100 lakhs for non-cash transactions which cover payment through
cheque, demand draft etc. FIU has been entrusted with the responsibility to
track suspicious transactions that involve potential money-laundering or
violation of the Banking secrecy act, Indian Penal Code, Narcotic Drugs &
Psychotropic Substance Act 1985 and Arms Act 1959 etc.
(d) RBI is circulating list of terrorist entities notified by GOI to banks from time to
time. Branches should consult such list before opening new accounts.
However as and when the list is received the existing accounts should also to
be checked and if any account is found existing appropriate measure for
seizure and reporting should immediately be undertaken.
(e) Indian Banks’ Association has listed 23 countries in the high-risk category for
implementation of KYC and AML norms by the banks. These high risk
countries are- Myanmar, Nigeria, Turkmenistan, Ukraine, Guatemala, Cook
islands, St Vincent & the Grenadines, Russia, Angola, Zimbabwe,
Afghanistan, Cuba, Iraq, Libya, Azerbaijan, Moldova, Kazakhstan, Georgia,
Uzbekistan, Belarus, Armenia, Kyrgyz Stan and Tajikistan. Customer living in
these countries will be classified in high risk irrespective of their nationality
and opening their account will need specific approval from higher authorities.
(f) IntegraScreen Group, a Singapore based company has compiled global anti-
money laundering (AML) database having list of high-risk individuals. About
121,000 individuals have been categorized as high risk in this database. Most
foreign banks and few private banks in India have started using this database
to check profile of individuals while opening new accounts.
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(g) IN CBS environment banks can automatically monitor/detect money
laundering, fraud and out-of-profile behavior of the customers and accounts
through software. The software enables the bank to put every transaction
through validation check and helps to detect any abnormal transfer of funds
into undesirable hands. It is estimated that AML software market is about 2
US billion in India.
(h) RBI has asked Indian banks to put in place AML system and submit their
action plan with regard to deployment of AML system by June 2006 and final
report on the solutions and infrastructure installed by December 2006.
3. KYC-Compliance of FCRA 1976(a) Branches should adhere to the instructions on the provisions of the Foreign
Contribution Regulation Act, 1976 regarding opening of accounts or collection
of cheques only in favour of association, which are registered under the Act
with Government of India. A certificate to the effect that the association is
registered with the Government of India should be obtained from the
concerned associations at the time of opening of the account or collection of
cheques.
(b) Branches should exercise due care to ensure compliance and desist from
opening accounts in the name of banned organizations and those without
requisite registration.
(c) Under FCRA 1976 only designated branches of banks are allowed to accept
deposit whose name is given in the application form to government. The act
also make it mandatory for the banks to submit half-yearly statement to
government giving details of the contribution received by associations and
organizations. 4. Risk management and monitoring procedures
(a) Non Compliance of KYC norms may put the bank to various risks such as
reputation (loss of reputation in case of fraud), Operational (loss due to
fraud), legal (legal action against the bank due to fraud) and concentration
(group of borrowal accounts turning bad or chain of deposit accounts found
involved in fraud) risks. KYC policies are essentially measures of preventive
vigilance and are framed to mitigate aforesaid risks.
(b) In order to check possible abuse of banking channels for illegal and anti-
national activities, the internal control system laid down by the bank should
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be strictly followed. Duties and responsibilities allocated at various levels
should be explicit and policies and procedures are managed effectively to
ensure full compliance of KYC programme in respect of both existing and
prospective deposit/borrowal accounts.
(c) An independent evaluation of the controls for identifying high value
transactions should be carried out on a regular basis by the inspection team
of the bank.
(d) Concurrent/internal auditors must specifically scrutinize and comment on the
effectiveness of the measures taken by branches in adoption of KYC norms
and steps towards prevention of money laundering. Such compliance report
should be placed before the Audit Committee of the Board of banks at
quarterly intervals.
(e) RBI decision to put penalty in public domain is a measure, which may trigger
reputation risk.
5. Record Keeping Bank should prepare and maintain documentation on their customer relationships
and transactions to meet the requirements of relevant laws and regulations, to enable
any transaction effected through them to be reconstructed. In the case of
electronic/telegraphic transfer transactions, the records of electronic payments and
messages must be treated in the same way as other records in support of entries in the
account. All financial transactions records should be retained for at least five years after
the transaction has taken place and should be available for perusal and scrutiny of audit
functionaries as well as regulators as and when required.
6. Training of staff It is crucial that all the operating and management staff fully understand the need for
strict adherence to KYC norms. The regular input on KYC should be given to staff
through training as per for their roles so that they understand their responsibility of
implementing KYC policies clearly.
7. Penalties and Restrictions(a) KYC guidelines are issued under Section 35 (A) of the Banking Regulation
Act, 1949 and any contravention of the same attracts penalties under the
relevant provisions of the Act.
(b) Office of the Comptroller of the Currency which regulates and examines
approximately 2,000 national banks and 51 federal branches of foreign bank
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in the US announced on May 13, 2004 that, it has assessed a $ 25 mn civil
money penalty against Riggs bank N.A. for violation of the Bank Secrecy Act
as it has failed to implement an effective anti-money laundering programme
and it did not detect and investigate suspicious transaction and had not filed
suspicious activity report as required under the law.
(c) A prove by US senate’s permanent committee found that HSBC used its US
bank as gateway into the US financial system to provide US dollar services to
clients while playing fast and loose with US banking rules and charges it
giving terrorist, drug cartels and criminals access to the US financial system.
( TOI 19.07.12)
(d) RBI has recently hauled up / fined cross Citi Bnk rs. 25 lakhs for failure to
follow KYC and anti-money laundering rules which led to Rs. 400 crores fraud
in Citi’s Gurgaon branch. (ET 6.7.2011)
(e) Another reported violation is by a south based private- bank in a case of two
FCNR (B) deposits amount to $ 200,000 held by an NRI. RBI as per reports
has proved the negligence and is contemplating imposing fine.
(f) Following IPO scam of IDFC and Yes bank where RBI identified certain
weaknesses on the part of banks in customer identification and acceptance
system. It has decided to impose financial penalties as well as decided to
“indefinitely” put on hold all applications from concerned banks seeking
clearance for various businesses, including opening of new branches.
(g) RBI has advised banks to ensure that information called from the customer is
relevant to the perceived risk, is not intrusive and is conformity with
guidelines issued by RBI. Any other information from the customer should be
sought separately with his or her consent and after opening the account.
Banks should not misuse personal information given to them while opening of
accounts for cross-selling or passing on to subsidiary/business associates. If
obtained specific disclosure should be made to customer that information so
obtained would be used for this purpose.
8. Summing UpKYC is a tool of customer due diligence and preventive vigilance. RBI directive is
mandatory in nature. It creates responsibility on officials to follow laid-down measures in
both letter and spirit before opening of the accounts and also to monitor high
value/sensitive transactions. Looking to the problems of small depositors and micro
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finance institutions, RBI has relaxed KYC norms for opening accounts of small
depositors provided introducer has been subjected KYC norm.
Chapter- 31
Risk Based Supervision“I believe that banking institutions are more dangerous to our liberties than standing armies in the field.”
- Thomes Jefferson
1. Introduction1.1 The prime concern of central banks across the globe is to ensure safety and
soundness of the banking system and for this they are vested with supervisory
powers that include conducting inspection, issuing direction, levying penalties and
putting bank to rehabilitation, moratorium and liquidation. Post 1992 banking in India
is witnessing strong deregulation, tightening of prudential norms, and enhancement
of disclosure standards and adoption of internationally accepted best accounting
practices, consolidation and globalization and increasing use of technology. This has
on the one hand provided massive opportunity of growth to banks but at the same
time enhanced risk which otherwise is essence of banking. This has also thrown
challenge on regulator i.e. Reserve Bank to make the supervisory policies and
process more efficient and sophisticated.
1.2 The traditional system of bank’s supervision of one size fits all approach is
largely based on assessing the accuracy of balance sheet and profit and loss
account and adequacy of internal control measures and is done to fulfill the
obligation of section 22 of BR Act 1949. The current system puts reliance on
transaction testing like adequacy of appraisal, assessing the quality of credit and
adequacy of the provisioning. It is largely done through on site inspection. The
system has merit for determining the current conditions of the operations of the bank
but has limitation that it can not throw light on problem areas that may have adverse
bearing on future performance of the bank.
1.3 The risk based supervision (RBS) has evolved as a more dynamic approach to
bank supervision. It attempts to overcome the aforesaid deficiency. It also attempts
to address the competencies of the bank to identify, measure, monitor and control
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risk arising out of various business activities. Risk management is crucial element of
banking and hence of banking supervision. The RBS can not only promote safety
and soundness of banks but it can also mitigate and offset risks inherent in traditional
form of supervision.
2. RBS- Objectives2.1 The RBS aims to enhance the effectiveness and efficiency of supervisory
capabilities of the central bank. It also aims to direct central banks resources towards
the areas of greater risk to enable it to meet its supervisory objectives in a more
meaningful and effective manner.
2.2 The RBS entails paying supervisory attention in accordance with the risk profile of
the bank. The approach is expected to optimize utilization of supervisory resources
and minimize the impact of crisis situation in the financial system. The RBS is based
on CAMELS approach on on-site examination and off-site monitoring and is forward
looking beyond focusing attention on the rectification of deficiency with reference to
on site inspection.
3 RBS approach-3.1 RBI introduced the concept of RBS in Credit and
Monetary policy of April 01. In August 01, it brought out a
discussion paper entitled ‘Move towards RBS’. Based on the
feed back, RBI has started supervision on pilot basis from
last quarter of 2002-03.
3.2 RBS framework starts from preparation of risk profile of
the bank on 12 identified areas of business and control risks
and then proceeds to (a) determining supervisory cycle, (b) determining supervisory
programme, (c) conducting inspection, (d) reviewing evaluation and (e) follow up
through MAP. The risk profiling is essence of RBS and all supervisory action are
required to be based on risk profile as assessed by the regulator.
4 RBS Pre- approach 4.1 The RBI over a period of time has advised bank to initiate certain measures so
as to prepare for smooth implementation of the RBS.
4.2 The preparations are (a) Setting up of Risk Management Architecture, (b)
Adoption of risk focussed internal audit, (c) Strengthening of management
information system, (d) Selection, training, education and deployment of the staff and
(e) Setting up of the compliance unit and nomination of the compliance officer.
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5 RBS- Risk Profiling5.1 The risk profiling is based on assessment of (a) business risks and (b) control
risks in 12 critical areas of banks functioning. Business risk assessment would
cover (a) capital risk, (b) Credit risk, (c) market risk, (d) Earnings risk, (e)
Liquidity risk, (f) Business strategy and environment risk, (g) operational risk and
(h) group risk. The control risk would cover (i) internal control risk (j)
organization risk (k) management risk and (l) compliance risk. There could be
more than one type of risk under the same assessment.
5.2 Nature of risk relevant to various areas is as under: -
No. Risk category Assessment area Nature of risk
1. Business risk Capital adequacy
(Soundness of
bank)
Adequacy of capital
Composition and quality of
capital
Access to capital market
Shareholders assessment
Economic capital
2. Business risk Credit Risk
(Risk of default or
NPA)
Credit concentrations
Credit quality
Adequacy of provisions
Composition of credit portfolio
Other credit risk like trading
book, off balance sheet items,
country risk etc.
3. Business risk Market risk
(Change of interest
or exchange rate or
price of investment)
Quality of investments
Interest rate risk
Composition of trading book.
Forex risk
Equity price risk
4. Business risk Earnings Risk
(profitability)
Earnings and expenses
Spread and burden
Earnings quality and stability
Budget and profit planning
Fund cost and return
5. Business risk Liquidity Risk Liquidity risk
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(risk of liquidity) Composition of liabilities
Liquidity profile
6. Business risk Business strategy
and environment
risk.
Business strategy
Strategic business initiatives
External environment and macro
indicators
7. Business risk Operational risk People risk
Process risk
Technology risk
Legal risk and Reputation risk
External events
Operating environment
8. Business risk Group Risk Capital and investment
Operations and performance
9. Control Risk Internal Control Risk Risk management system
Internal controls and
housekeeping
Risk based internal audit
Anti money laundering controls
10. Control Risk Organizational Risk External and internal
relationships
Legal structure and ownership
11. Control Risk Management Risk Board of directors-composition
and competencies
Senior management profile
Corporate governance
12. Control Risk Compliance Risk Statutory and regulatory
compliance
Monitoring action plan
compliance
5.3 RBI has developed the risk profile templates to standardize the risk profiling
system. The guidance sheet prepared by RBI facilitates assessment of these
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risks. Through this process, the level of risk – low, moderate and high and
direction of risk - increasing, decreasing and stable is determined.
5.4 The review and updating of the risk profile will have to be done on quarterly
basis.
5.5 Since risk profiling is essence of RBS, it is necessary that in house quality
assessment be done from time to time so that the bank may do independent
evaluation of risk assessment.
6 RBS- Supervisory Cycle- 6.1 The supervisory cycle depends upon the risk profile of each bank. The principle
being higher the risk shorter is the cycle and vice versa.
6.2 The cycle will generally remain at 12 months but can be extended beyond 12
months for low risk banks. In cases of high-risk banks, cycle can be lower than
12 months.
6.3 RBI will prepare a customized cycle programme for each bank after completing
the risk profiling.
7 Supervisory Programme7.1 The objective of this steps is to prepare RBI supervisory programme to set out
the work which bank as well as RBI will undertake during supervisory period. The
work will relate to areas of concern identified through risk profiling.
7.2 While drawing the supervisory programme, RBI will prepare risk matrix based on
business risk and control risk to decide level of monitoring and remedial action. A
typical supervisory risk matrix will be as follows-
7.3 It will also decide tool of supervision that RBI will employ. RBI will suggest action
plan which bank will undertake to rectify the situation during a given period. The
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High Monitoring but little remedial action unless the risk is found excessive.
High Monitoring . Need for immediate remedial action to improve the risk profile.
Low monitoring, little remedial action is necessary.
Moderate monitoring. Need for remedial programme to improve control.
BUSINESSRISK C O N T R O L R I S K S
programme will set out specific linkage to the area of risks so that bank
management can understand and appreciate why particular action has been
recommended.
7.4 The programme will be first discussed with the bank at draft stage and thereafter
listening to the management side, it will be finalized.
7.5 The supervisory tools to be deployed under the programme shall vary from
targeted on-site inspection, commissioned external audit, structured meeting with
the bank and specific supervisory direction etc.
8. Inspection Process8.1 The inspection under the new approach will largely be system based rather than
laying emphasis on underlying transaction and asset valuation.
8.2 The inspection will target high-risk areas from RBI perspective and would focus
on effectiveness of mechanism in capturing, measuring, monitoring and
controlling various risks.
8.3 The inspection process will continue to test transaction and evaluation the extent
of which will depend upon materiality of the activity, integrity of the risk
management system and control process.
9. Monitorable Action Plan (MAP) - 9.1 The follow-up will aim to evaluate progress in corrective action taken by bank.
The major devise in this regard will be MAP.
9.2 The MAP- Monitorable Action Plan- will decide time frame within which specific
action will be taken by bank to remedy a situation. It will also clearly spell out
the key persons responsible for the same. It action and timetable decided by the
RBI is not complied with, RBI would examine further course of action. If satisfied
with the progress, may give further time to improve or make compliance. RBI
may also decided restrictions in branch expansion, new business line, or new
products or may levy penalties.
9.3 Over all objective of the MAP is risk mitigation. It would suggest action from the
regulator if time bound actions be not taken.
9.4 Enforcement process and incentive framework is centre-stage of MAP. If the risk
profile is low or compliance is as per MAP besides longer inspection cycle,
incentive will be by way of less intervention or more autonomy. PCA- Prompt
Corrective Action will be part of MAP.
10. Moving to risk based internal audit (RBIA) —
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10.1 RBS will leverage on the work of internal auditor. So bank will be required to
move to risk based internal audit of their branches where greater emphasis will
be on identifying risk and drawing action plan in mitigating these risks. Internal
auditor will not only offer suggestions to mitigating the current identified risks but
will also anticipate areas of potential risk and will play a key role from protecting
the bank from these possible risks.
10.2Every care has to be taken that the work of risk management department and
risk based internal audit is not over lapping. RBS is expected to be an aid to the
ongoing risk management in bank by providing necessary check and balances in
the system. In other word there should not be duplication of work process. RBS
will look into effectiveness of Risk Management System of the bank and draw
action plan if any deficiency is observed.
10.3RBIA will give insight to RBI for conducting RBS in general and preparing risk
profile in particular.
11. Other issues-11.1 External Auditors are very important part of audit chain. RBI will discuss
and percolate the basis and objective of RBS with them so that they may also
understand underlying process and supplement the RBS.
11.2 RBS is supplementary to the existing system and is not a substitute. The
process requires elaborate discussion and training to change the mindset of
employees.
11.3 HRD issues like training, education, placement and posting are important
for successful implementation of RBS. This will also help in developing
coordinated effort of regulator and bank for smooth transition.
11.4 Good corporate governance and documented policies for accountability
and responsibility are pillar of RBS.
11.5 The setting up of insurance, merchant banking, mutual funds and housing
finance and investment companies as joint venture or subsidiaries has brought
into focus need of consolidated supervision by various regulator like RBI, SEBI
and IRDA.
-0-0-0-
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Chapter- 32
Risk Based Internal Audit- An Outline
Introduction
RBIA is part of bank level preparedness to implement RBS (Move Towards Risk
Based Supervision of Banks – RBI discussion paper, August 3, 2002).
RBI circular of December 27, 2002 provides an outline of RBIA.
Gradual switch over from transaction based branch internal inspection to RBIA.
But internal control/audit through concurrent auditor should continue and become
stronger.
Banks to report to the RBI on quarterly basis regarding the progress on RBIA.
Features of RBIA
Risk Management Committee (RMC)/Department (RMD) and the role of RBIA need to
be distinguished. RBIA is an independent risk assessment at branch level solely for
formulating the risk based audit plan. But the RMD/RMC focusses on areas such as
identification, measurement and monitoring of risks at bank level. Broad policy
guidelines of RMC/RMD on risk management, risk profile of the bank, etc. are examined
for developing RBIA policy.The focus of RBIA is to provide reasonable assurance to the
Board and the top management about the adequacy and effectiveness of the risk
management and control framework in the operations. Also, to indicate potential risk
which a branch is exposed to. The conduct of RBIA will shift emphasis from the present
system of full scale transaction testing to risk identification, prioritization of audit areas
and allocation of audit resources in accordance with the risk assessment.For RBIA,
limited period is allotted which should be utilized mainly for high risk areas. If time
permits, low risk areas may also be covered.Until the switch-over takes place, internal
inspection will continue. In that case, the branch should be inspected first by a team of
internal inspectors and thereafter, the same team should conduct the RBIA. Limited
transaction testing is advised. If major deviations are observed in respect of audit of
sample cases, all transactions will be considered for verification after consulting the
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higher authorities.Switch-over to RBIA is expected in the next 2-3 years. Initially, ELBs
and VLBs may be covered and all other branches thereafter within 2-3 years.
Risk Assessment
Risk assessment is undertaken as part of RBIA solely for the purpose of
formulating the risk based audit plan. Risk assessment may be done at
corporate, branch, portfolio and individual levels, which involves the process to
identify, measure, monitor and control the risks. At present, the RBIA is
proposed at branch level only.
The risk assessment involves;
Identification of both inherent business risks and control risks.
Drawing up a risk–matrix for taking into account both business risk
and control risk. (Risk matrix is shown subsequently)
Risk to be assessed in terms of Level (High, Medium, and Low) and
Direction (increasing, stable and decreasing). The basis of
assessment of risk in terms of Level and Direction should be spelt-out.
Methodology – On site audit – deviations – magnitude – frequency.
Risk Assessment framework in one bank is suggested as under:
Marks
I Business Risk 500
1. Credit Risk 200
2. Earning Risk 80
3. Liquidity Risk 40
4. Business Strategy Risk 80
5. Operational Risk 100
II Control Risk 500
6. Internal Control Risk 400
7. Compliance Risk 100
Total Marks 1000
Level of Risk for Business and Control separately
(In percentage)
Low - Over 80
Medium - 65 – 79
High 64 and Below
Direction : Increasing, stable and decreasing
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Composite (Business as well as Control) Risk Matrix
Inherent Busines
s Risk
HighA
High Risk
B
Very High Risk
C
Extremely Risk
MediumD
Medium Risk
E
High Risk
F
Very High Risk
LowG
Low Risk
H
Medium Risk
I
High RiskLow Medium High
Control Risk It would be possible to identify 5 levels of risk from the above matrix – low,
medium, high, very high and extremely high.
Magnitude and frequency of risk.
While the quantum of credit, market and operational risks could be largely
determined by quantitative assessment, the qualitative approach may be adopted
for assessing the quality of controls in various business activities. Identification of
risk may be done activitywise (business segmentwise) or locationwise
(branchwise). In the initial stage, banks may confine to branchwise risk
assessment.
The risk assessment methodology includes the following parameters:
Previous internal audit report and compliance
Proposed change in business lines or change in focus
Change in management/key personnel
Results of the latest regulatory examination report
Report of external auditors
Business trends and other environmental factors
Time lapsed since last audit
Volume of business and complexity of business activities
Performance variations from the budget
For accurate risk assessment, MIS and data integrity is essential. Hence, the
audit department should be informed by all other departments about introduction of
new product, changes in reporting lines, changes in accounting policies and
practices, etc.
The risk assessment should be done on yearly basis which may updated
periodically in the light of changes in business environment, work process etc.
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Audit PlanBanks have to prepare the annual audit plan. The areas (branches) or activities
identified as high, very high or extremely high risk (based on risk matrix) may be audited
at shorter intervals and at longer intervals for medium or low risk areas/activities.
In one bank, the audit plan is suggested as under:Level of Risk Periodicity of RBIA
Very High Within 6 months
High Within 12 months
Medium 12-15 months
Low 15-18 months
Transaction testing depends upon the risk assessment.
In one bank, the extent by transaction testing is suggested as under:% Testing Level of Risk/Direction
100 High and increasing
50 Medium and stable
10-20 Low and decreasing
RBIA Audit Report FormatRBIA auditor at the minimum must report the following points in his report:- Process by which risks are identified and managed in various areas
- The control environment in various areas
- Gaps, if any, in control mechanism which might lead to frauds, identification of
fraud prone areas
- Data integrity, reliability and integrity of MIS
- Internal, regulatory and statutory compliance
- Budgetary control and performance review
- Transactions testing/verification of assets to the extent considered necessary
- Monitoring compliance with risk based internal audit report
- Variations, if any, in the assessment of risks under the pre-audit plan vis-à-vis
RBIA.
The scope of RBIA should also include review of the systems to ensure compliance with
money laundering controls, identifying potential inherent business risks and control risks
and suggesting steps to mitigate risks.
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Exit meetingThe audit report should be prepared after holding discussion with the Branch
Manager/Management regarding audit findings relating to risk assessment, risk matrix,
positive and negative factors and steps to mitigate risks, as also identify the areas of
potential risks. Banks are expected to develop RBIA report format. Special letter stating
serious irregularities, if noticed during the RBIA, should be sent to the management
immediately and seek instructions therefrom.
Rating of BranchesAs part of RBIA report, branches may be rated in different categories on the basis of
level and direction of risk. In one bank, branches are rated in nine categories - Levels 3
X Directions 3 (1) High increasing (2) High stable (3) High decreasing (4) Medium
increasing (5) Medium stable (6) Medium decreasing (7) Low increasing (8) Low stable
(9) Low decreasing. For each category, reasons should be stated and steps should be
suggested to mitigate risk by branches.
RBIA – OutsourcingWith the permission of the Board, outsourcing can be done for RBIA. But enough care is
needed to ensure that internal control is not weakened due to outsourcing.
RBIA Process1. Pre-audit: - Study of RBIA policy guidelines
- Study of Branch Profile to get an idea about nature of risk i.e.
level and direction.
- Preparation of pre-audit plan.
2. On-site audit: - Assessment of risk based on deviations observed during the
course of audit; Development of Risk Matrix.
3. Post audit: - Implementation of the RBIA report by a branch within the
specified
time. (Monitorable Action Plan – MAP)
- Follow-up of the implementation of the report by the RO/ZO
- Closure of the report by the regional inspectorate on the recommendations of
the RO/ZO
- Audit Committee of the Board to be informed about the gist of the RBIA report.
Organisational Aspects of RBIA- A Task Force of senior executives to be formed to prepare a plan for switch-over
to RBIA during the next 2-3 years.
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- The Task Force to develop RBIA policy guidelines, branch profile format, risk
assessment framework, risk matrix, RBIA report format, Monitorable Action Plan
(MAP) format, etc.
- Regional Inspectorate/Regional Office to develop Branch profile data annually
- Inspectors to be identified to conduct RBIA and necessary training to be imparted
- A Pilot RBIA should be introduced to test the audit tools. Thereafter, the RBIA
should be conducted on full scale.
- Internal audit inspection shall be conducted
alongwith RBIA until the total switch-over is
done.
- The success of RBIA depends upon MIS,
efficiency of internal control/concurrent
audit/IT audit machinery, competence of
inspectors
- As far as possible, RBIA should be
conducted by internal staff only.
- The Task Force is expected to prepare an
annual plan for conducting RBIA. A road-
map has to be prepared for switch-over to RBIA during the next 2-3 years.
-000
Chapter-33
Preventive Vigilance in Banks “Truth has a bad habit. It surfaces and emerges and reemerges like that of Siberian bird
Phoenix who rises from its own ashes.” - Anon
1. Introduction- Banks in India lost about Rs. 1883 crores due to frauds during 2008-
09. Of late, frauds in banking industry are showing unabated spurt year after year.
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2004-05 779
2005-06 1381
2006-07 1194
2007-08 1059
2008-09 1883
Frauds in Banking Sector (Amount
in croes )
ET 31st January 2010
The magnitude is also increasing on account of financial sector reforms and
globalization. e-Banking has added a new dimension of frauds as necessary security
awareness, knowledge and expertise are not available with staff in operation.
Fierce competitions amongst the banks to excel performance and to grab more and
more business from others have made the banks to let loose internal control system,
norms and procedures. Further with the opening up of the financial sector, a desire
for earning quick money has cropped up amongst a section of people who
increasingly design new ways and means to commit frauds. All this has made the
Vigilance an important aspect of banking business management and responsibility of
the apex management to strengthen the fraud management practices.
2. Vigilance a mental state- Vigilance is a mental state and in general parlance refers
to awareness, alertness, watchfulness, fore-sightedness, exercising caution and
prudence on the part of the employees to save the property of the banks from
unscrupulous elements. It is a fight for uprooting corruption and malpractice, which
are harmful to the organization as well as to society. The vigilance protects the
honest persons to stimulate operational efficiency and punishes dishonest persons
as a deterrent measure.
3. Three O’s of Vigilance-3.1 Offenders-Offenders who perpetrate the frauds can be both insiders and
outsiders. The experience has shown that majority of frauds are committed by the
insiders either singly or jointly with outsiders. A recent incident at French Bank,
Societe General S.A. which was defrauded by US $ 3.2 billion by its trader has
exposed vulnerability of bank by insider. Hence strict vigil has to be exercised on
activities of the insiders to check frauds. Further, the bank has to closely observe the
principle of “know your customers” to check perpetration of fraud by the outsiders.
3.2 Objects-Object means target of fraud. Offenders commit frauds by targeting
branches where the system and procedures are not meticulously complied with or
targeting loophole in the system and procedure. The RBI has the identified following
areas as fraud prone: -
Deposit Accounts- opening of fictitious deposits accounts by persons not
properly identified/introduced to the bank followed by deposit of
fake/stolen/forged instruments in such accounts and withdrawals of the
proceeds and fraudulent operations in Impersonal accounts.
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Payment of Demand Drafts and other Transfer Instruments-payment of
altered/forged drafts & Forged inter-branch transfer advice.
Letters of Credit/Guarantees and Co-acceptances- Opening / issue of Letter
of credit and bank guarantees, co-acceptance of bills without proper
authority and consideration, issue of letter of Credit/ bank guarantees without
recording in the branch books,
Foreign Exchange- Frauds in foreign exchange transactions through non-
adherence of RBI’s prescribed norms and procedures like acceptance of non
resident deposits through middlemen and thereafter allowing/availing of
overdraft against fraudulent discharge of these deposits receipts by forgoing
power of attorney and loan documents of third parties without proper
identification/introduction,
Credit Portfolio- Misutilisation/overstepping of lending/discretionary powers
and non observance of prescribed norms/ procedures in credit dispensation,
submission of false stock/ financial statements to avail of finance,
clandestine removal of goods hypothecated and siphoning of sale proceeds,
manipulation of stock and financial statements and financing against
accommodation bills,
Clearing operations-Collection of an instrument in the accounts of a party
other than its payee, Withdrawal of full amount before realisation of proceeds
and subsequent failure of the party to make good the amount of the
instrument is received back dishonoured, Failure to send the instrument to
the drawee branch, Destruction of the instrument while in transit or at the
drawee branch, Availing the ‘withdrawal against clearing’ facility against
instruments known to have been drawn without funds, One party and its
associate or two different parties having accounts in two branches indulging
in kite flying operations.
Others -Raising unauthorised debits on nominal heads of account,
manipulating and tampering with the books of accounts by passing
unauthorised entries, issue of pay orders/demand drafts without
consideration, fake documentation, Unlimited computer access provided to
vendors and staff not related to the computer operation etc.
3.3 Opportunity-Lack of job knowledge, Non-compliance of system and procedures,
Non-balancing of books, Non-reconciliation of clearing and inter-branch accounts,
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Good model,Bad people
Good model,Good people
Bad model,Bad people.
Bad model, Good people.
Lack of safe keeping of critical stationery items, Casual approach to security alertness
and Poor monitoring of branches by controlling offices provide opportunity to
unscrupulous elements to commit fraud. 4. Quality of management- Every organization has business model, which guides its
business policies. These models are not
fortuitous, but are often chosen by design
and predilection of the person behind the
project. There can be good business
model run by good people; bad model run
by bad people; bad model by good people
and good model by good people. The
quality of model and people running it is
function of quality of management and
ethics and integrity of the people
managing it. While we have business model run with greed, fear, lust and selfishness
like Ramalingraju’s of Satyam, Kenneth Lay’s of Enron, Robert Maxwell’s of Maxwell
communication Corporation and Harshad Mehta of broking firm , we have business
model run by visionaries, patriots and great entrepreneurs.
5. Objective of the Vigilance- The broadly the vigilance aims to achieve the following
objectives-
(a) Checking/preventing fraud and forgery,
(b) Protecting honest employees,
(c) Punishing dishonest employees,
(d) Simplification of the system and procedures,
(e) Review of system and procedures to plug loopholes,
(f) Bringing about fairness and purity in service,
(g) Bringing awareness among employees to create a corruption free
organisation /society.
6.Vigilance Management- Vigilance activities can be grouped under following heads
from management perspectives-6.1.Educative Vigilance – Educative Vigilance aims to achieve awareness of
rules and regulation, system and procedures etc. among employees. This is
done by conducting training and seminar on vigilance management and by
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highlighting importance of vigilance through articles in house-magazine on
various aspects of vigilance management.
6.2 Preventive Vigilance- It is better to prevent and prepare than to repent and
repair. The objective is achieved by creating alertness and foresightedness
among employees to prevent fraud and forgeries and by creating a sense of
responsibility among employees to observe system and procedures. It is a most
important approach of the Vigilance Management as it treats the cause of
disease rather than to treat the disease.
6.3 Detective Vigilance-This refers to detection of fraud and forgery through
investigation. The objective is to ascertain the causative factors, which facilitated
perpetration of fraud and to identify the persons responsible for the same. It aims
to fix accountability and to initiate measures to recover the involved amount.
6.4 Punitive Vigilance-This refers to process of initiating disciplinary action by
issuing show cause notice & charge sheet, conducting enquiry and awarding
punishment as per disciplinary and appeal regulation of the bank.
7. Preventive Vigilance Action Plan- “ Prevention is better than cure” is an old saying.
Hence, all out efforts should be made to create vigilance awareness among employees
to prevent occurrence of fraud and forgeries. The action plan for preventive vigilance
comprises of the following-
7.1 At corporate level-(a) Recruitment of officers/employees should be carefully verified;
(b) All employees handling various duties should be made aware of the essential
safeguards, which should be observed in the discharge of those duties;
(c) The duties and responsibilities of employees should be clearly laid down
through job cards, instruction manual, computer security policy etc.
(d) The principles of dual custody and concept of checker and maker should be
observed at all times.
(e) All the officers/employees should be transferred at prescribed intervals and
bank must insist on their going on leave periodically.
(f) Monitoring and scrutiny of control returns to find out deviation/non-
compliance/over-stepping of lending /non-lending authority, checking of
unusual variation in deposit/advances & non personal/revenue heads in
weekly, monitoring position of balancing of books, reconciliation of inter-
branch /inter-bank accounts/cash movement etc.
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(g) Posting officers of suspected integrity at non-sensitive assignments.
(h) Scrutiny of Assets and Liability Statement of officer employees.
(i) Causing Surprise Vigilance Inspection at Fraud Prone branches.
(j) Surprise visit of branches by Controlling Authority.
(k) Review of System and Procedure in the light of fraud cases and modification
of the system and procedure to contain frauds.
(l) Conducting regular inspection/concurrent audit/revenue audit/ statutory
audit/system audit/computer audit etc. at branches and following up
rectification of irregularities.
(m) Encouraging and praising performance of individual/branches when frauds
are prevented.
7.2 At branch level-(a) To ensure meticulous compliance and observance of systems and
procedures.
(b) Regular and timely submissions of control returns/ inter branch schedules.
(c) Reporting irregularity in borrower accounts including excess drawings,
drawings against uncleared effects etc. to controlling authority regularly.
(d) Compliance/rectification of Inspection and Audit reports.
(e) Implement job rotation policy of both officers/employees.
(f) Regular reconciliation of inter bank accounts, clearing accounts and doing
regular balancing of books and not allowing any voucher, register, ledger to
remain unchecked by officials/Special Assistant.
(g) Doing rotation of balancing work among employees.
(h) Keeping an eye on life- styles of subordinates. The cases of living beyond
known sources of income must be closely examined and reported to higher
authorities confidentially.
8. Preventive vigilance in computerized branches: - e-Security has become a
center-stage of concern for bankers due to various reasons such as lack of
knowledge of IT security, fear of loss of public faith in case of system break- down,
fear of financial loss due to IT related frauds etc. According to India Fraud Survey
report 2006 brought out by KPMG, financial sector susceptibility to fraud risk and
Indian corporate preparedness to address fraud is very low. It, therefore, calls for an
286
Fraud in Home LoanYear A/C Amou
nt @2002-03 236 282003-04 456 702004-05 H1
380 50
@ Amount in crores
effective preventive action to avoid fraud and forgeries in computerized set up.
Suggestive steps can be as under: -
(a) To ensure compliance of IT security measures in computerized and network
branches as per IT security policy of bank.
(b) To observe principle of ‘least privilege’ and that of ‘maker and checker’.
(c) To do job /duty allocation by proper office-order/memorandum.
(d) To observe proper physical security control such as to keep computer screen
out of sight of visitors, to keep server locked with minimum access, do not
allow visitors into work station area and do not leave computer without
logging out.
(e) Educate people about physical security and tell them that they are part of
security chain.
(f) To check active user list and check that there is no unauthorized user.
(g) To ensure that no single user is allotted more than one password.
(h) To educate employees to keep the password secret and change it
periodically as per norms.
(i) To allow access to the system to soft ward and hardware vendor through
authorised ID/Password and keep an eye on their work.
(j) To follow disaster management and business continuity plan.
(k) To check that time off mechanism is active.
(l) To do data consistency check periodically.
(m) To create e-security consciousness among employees.
9. Retail Loan and Preventive Vigilance- Of late fraud and forgeries in retail loan are
on rise. (See box) Even in housing segment
where banks draw comfort by way of security,
there are instances of multiple financing against
fake title deeds and impersonation. The
fabrication of income documents, balance sheets
etc. are common modus operandi to defraud
banks. Other common modus operandi is misuse
of loan in connivance of builder/dealers. The preventive vigilance is an important tool
to check such fraud and forgeries. This helps the banks in creating alertness,
foresightedness and a sense of responsibility among employees.
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10. KYC- as a tool of Preventive Vigilance- RBI has been reiterating the extant
guidelines and instructions on KYC from time to time to prevent frauds. These
guidelines pertain to identification of new customers- both individual/corporate,
establishing identity of the customers by obtaining PAN, driving license voter identity
card etc., implementing process and procedure to monitor transactions of suspicious
nature in accounts, conducting due diligence and reporting of such transactions,
obtaining credit report of borrowers dealing with other banks before making
advance/taking over accounts, obtaining report of overseas exporters/sellers in
respects of high value imports, etc. The RBI has recently reiterated following
guidelines for strict compliance by the banks -
(a) To do customer identification before opening account either through
introductory reference or through documents such as voter identity card,
PAN, passport, driving license etc.
(b) To obtain photograph of the customers both in deposit and loan accounts.
(c) To record cash transactions –both deposit and withdrawal -of Rs. 10 lakhs
and above in a separate register and to report such transactions including
any other suspicious transaction to controlling office.
(d) To obtain PAN for issuance of travellers cheques, demand drafts, mail
transfers and telegraphic transfer above Rs. 50,000/-.
(e) To ensure compliance of Foreign Contribution Regulation Act 1976 while
opening accounts or collecting cheques by insisting to account holder to
furnish certificate of registration with the GOI.
(f) To train/educate staff for anti money laundering guidelines and implementing
KYC policies consistently.
(g) To ask concurrent auditors/internal inspector to check and report compliance
of KYC norms.
11. Role of Ethics and Value. Ethics and values play a major role in preventive
vigilance. Ethics is framework of values for moral behaviour. It is a code of conduct
for individuals which prescribes do and don’t of doing business. In business of
banking, the essence of ethics lies in integrity and honesty. The current debate on
“Corporate Governance of banks “ is based on growing realization that bank must
not do any illegal or unethical things. The age-old concept of “Honesty is the best
policy” is still a useful and practical guide for survival in this material word. Following
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versus from the Kural, Tiru Valluvar translated in English by Dr. C Rajagopalachari
are relevant :-
(a) Avoid at all times action that is not in accordance with the moral law;
(b) Those who seek to be great should refrain from
everything that might tarnish their good name,
(c) Do not do that which good men would condemn;
even if it means helplessly looking on without
finding food for your starving mother;
(d) Success achieved without minding the
prohibitions of the moral law brings grief in the
wake of achievement;
(e) To seek to further the welfare of the state by
enriching it through fraud and falsehood is like
storing water in an unburnt mud pot and hoping
that it can be preserved.
12. Preventive Vigilance Actions Points- Preventive vigilance action points in fraud
prone areas in credit as well as in operation are given below-
(a) PREVENTIVE VIGILANCE IN LOANS- IMPORTANT ACTION POINTS
Retail Loan Type – Committed by
Nature of Frauds Preventive Vigilance Measures
1) Housing
Loan -
Committe
d by direct
selling
agents /
real estate
Fabrication of income
documents like salary slip,
balance sheet, income tax
return etc.
Verification of salary slip with the
employer.
Salary slip should be crosschecked with
bank statement.
Cross Verification of Balance sheet with
bank statement.
Interview of the borrower to cross check
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‘Do not do that
which your better
sense tells you that
you will afterwards
regret. But if you
have done such a
thing it is well you
at least decide to
refrain from such
folly again.’
agents
/builders
details.
2) Housing
Loan –
Committe
d by
direct
selling
agents/
real estate
agent
/builders /
borrowers
Including income by way of
agriculture, tuition,
coaching, etc to inflate loan
amount .
Agricultural income can only be
considered if it is supported by land
record and income is reported in
income tax return though not taxed.
In case agricultural income is
considered, installment should coincide
with harvesting of crop.
Other income like coaching, tuition etc.
should reflect in income tax return.
3) Housing
Loan –
Involveme
nt of
middle-
men
Disbursed cheques/ drafts
were collected by third party
through fictitious accounts.
Money is withdrawn later
Cheque should be issued in the name
of the banker to builder with bank
account no.
Cheque should not be handed over to
the borrower or to the middlemen. It
should be delivered by hand to builder
at the address recorded in the sale
deed. 4) Housing
Loan -
Stamped
document
s forged
by
customes/
builders.
Coloured Xerox of all
documents with fake
stamps submitted- difficult
to identify/distinguish with
genuine one.
Tracking and sharing of information
among banks about black listed
builders.
The title deeds to be handed over to
advocate by bank only and all his
queries should be routed through bank
only. The fee will also be paid through
bank.
Bank officers should verify genuineness
of the documents independently
through their own advocates/solicitors.
In case of large value loans, bank can
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approach sub-registrar to verify the
genuineness of title deeds/other
documents.
5) Housing
Loan-
Over
valuation
of
property
by
builders /
valuers
To draw higher loans in
connivance with builders.
The value is inflated by
including value of additional
amenities, fixtures, legal
charges, society advance,
maintenance charge etc.
For valuation report over Rs. 25 lacs,
two independent valuers should do it.
Government should introduce certificate
course for approved valuer.
Banks should develop in house
expertise for valuation of properties.
Bank to obtain indemnity from valuer
while approving them so that
unscrupulous valuer can also be made
liable of losses of banks.
6) Housing
Loan-
Multiple
Financing
Fabrication (fake) of
documents that are
produced to different bank
and financial institution to
commit fraud.
Tracking and sharing of information
among banks and housing finance
companies about black listed builders.
Agreement to sale and documents of
title should be in demat form.
(PROPOSED)
Bank/ FI should insist on original
documents of title deed on which
structure is built.
7) Housing
Loan -
Cancellati
on of
booking of
flat/apartm
ent in
collusion
between
customer
and
After availing loan the
booking is cancelled and
loan is refunded to the
borrower directly.
Credit Rating of Builders by CRISIL
should be made mandatory
Bank should check past track record,
financial viability, project execution
capacity, clear titles, customer
satisfaction of previous projects and
technical competence of the builders.
Registration receipt issued by Registrar
of assurance should bear hypothecation
clause. (PROSPOSED)
Bank should obtain tripartite agreement
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builder. with builder bank and borrower stating
that if booking is cancelled, the money
will be refunded to bank only.
8) Housing
Loan -
Sale of
property
by loanee
without
clearing
existing
loan.
Property sold through
duplicate or fake title deed
even though the original
legal title deed is with the
bank.
Banks to represent to RBI and GOI to
enact legislation for creation of
Equitable Mortgage in the office of
registrar of assurances.
Credit Rating of the Builders/realtors
should be stipulated as terms of
sanction.
Internal due diligence like inspection of
property plays crucial role in preventing
such frauds.
9) Housing
Loan -
Misrepres
entation of
end use of
loan
Loan taken for residential
house but commercial
property is constructed.
Banks officer to verify end use of loan in
addition to verification by
architect/engineer as per system.
10) Housing
Loan -
Sale of
property
by builder
without
clearing
dues of
financing
bank/FI.
Builders sold
constructed/semi-
constructed houses but did
not pay the dues of
banks/FI raised for
constructions of the
building.
Construction/ funding of loan should be
closely supervised.
Original title documents should be
called for appraisal at the time of
sanction of loan.
Bank to keep eyes on builder and seek
information for sale of flat/houses on
regular basis.
11) Car Loan-
The
middlema
n, car
Misrepresentation of end
use of loan
Follow KYC for identification and
verification of customer’s profile and
ascertain genuineness of
paper/documents tendered.
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dealer and
proponent
s
connived
in
misutilizati
o-n of the
loan.
Margin money should be realized
through account or by cheque.
Car financing should be through
approved dealers only.
12) NRI
Deposits -
frauds
NRI cheated by
unscrupulous brokers who
gave them forged/altered
FDR, availed loan through
power of attorney without
borrower’s consent.
Publicity voucher- no agent can solicit
deposit.
Follow KYC guidelines.
Follow procedure for opening and
operation of the account-verify
signatures with care & verify the
genuineness of the loan application.
Hand over FDR to depositor only or
send a registered AD letter to depositor
having handed over FDR to authorized
person. Do not hand over FDR to third
party without authority.
Follow prescribed procedure for
sanction and disbursement of the loan.
PA-Operations can be permitted to
resident on the basis of PA for
withdrawals for local payments. Also
subject to RBI permission local resident
can make payment for investment on
the basis of PA. Loan through PA -
Satisfy fully about genuineness of the
documents.
No third party advance against NRE
deposit on the basis of P. A. can be
allowed.
13) Opening LC opened against 100% KYC- knows your customer’s need
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Letter of
credit-
Imports
cash margin for the
customer keeping current
account only. Bank felt no
need to look into borrower’s
need, reliability and why
customer has not
approached his banker from
whom he was availing
regular credit facilities.
100% cash margin was
taken as comfort for not
appraising the proposal
properly.
reliability and ability- check that he is
engaged in the same trade.
Do not normally open LC for customer
who are not availing credit facilities and
only maintaining current account. In
case customer is availing facilities with
other bank, ascertain reason of not
availing facility with that bank before
opening letter of credit.
Make thorough scrutiny of the LC
proposal like a credit proposal.
Satisfy that importer will be able to retire
bills including payment of custom
duties.
Validity of import license, identity etc. to
be proved reasonably.
Large value imports- obtain credit report
of overseas seller from overseas banker
or reputed credit agency that exporter is
engaged in purchase/sale of goods
sought to be exported to India and is
good for ordinary business
engagements.
14) Negotiatio
n of bills
under
Inland
letter of
credit
Branch negotiated bill
drawn against letter of credit
without confirming
genuineness of the letter
of credit.
Branch should seek confirmation of the
authorized signatory on the letter of
credit from or nearest source of issuing
bank before negotiating bills.
Confirmation must be obtained through
bank’s own accredited official and not
through the beneficiary or any other
third party.
Follow KYC -verify antecedents,
business records, financial health and
reputation of the party.
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15) Imports
Bills –fake
Bank made FX remittance
against forged import
documents-documents
included import license,
EXIM scrip, EC copy of bill
of entry, Airway bill,
Certificate of origin etc.
Same custom and clearing
agent in all bills-bank raised
no query. Partial remittance
was made against each
license and small balance
remained undrawn- License
was returned to importer –
hence none of the original
license reaches RBI with R
returns.
Risk of fake bill is higher in import bills
received on collection basis. Hence
follow KYC rigidly.
Check business bonafides of your
importer customers.
Direct bills received by importer from
overseas sellers- exercise caution.
Importer bills by buyer banker through
seller banker only- exception upto US$
25000 provided BM is fully satisfied by
financial standing and past track record.
Non-existing imports – Manager to
exercise caution through various means
such as (a) Indian customer banking for
a reasonable long time. (b)Customer
has availed credit facilities from the
bank. (c) Bank has any time in the past-
examined balance sheet of the
customer. (d) Customer is an
established dealer/trader/user of the
imported goods. (e) Place of the
business, godown etc. has been visited
by bank’s officials (f) Sales are routed
through account.
In case of doubt, bank should ask for
detailed verification importer’s book of
accounts, inspection of place of work,
enquiry with business customers to
check business bonafides, and
comprehensive opinion report from
bankers of overseas seller.
Proof of imports-obtain bill of entry-
counterfeit bill of entry in case of fake
import- do careful scrutiny- Check
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inconsistency/inaccuracy to verify
genuineness-send few bills of entry to
custom and seek confirmation- keep
correspondence on record for
verification by RBI/auditors.
16) Fraud
through
exports
bills
Export bills supported by
fictitious materially altered
documents- availed packing
credit by inflating stocks-
availed advances against
false/altered cash incentive
claims-availed large credit
without valid documents-
Borrower dealing with the
bank for over seven years-
earned confidence of the
staff- he was himself taking
the documents to FX branch
and than taking back
documents to be sent by
their courier.
Verify that documents represents
genuine transactions- carefully verifies
RR/MTR/BL to check that it is genuine.
Verify standing and creditworthiness of
the borrower and his prospective buyer.
In case of Pre-accepted bills –
confirmation should be obtained from
the drawee (buyer).
See that bill facility is not
disproportionate to the business need of
the borrower.
Observe usual safeguards such as
verifying documents, see approval of
the carrier, follow up remittance of the
overdue bill.
17) Fake
guarantee
The guarantees were
issued (a) by misusing the
round seal and letterhead of
the bank (b) by forging the
signature of the bank’s
officials and (c) by bank
officials without recording in
book of accounts. The firm
met it obligation, hence
there was no question of
invocation of the guarantee.
After fulfillment of the
contract, the guarantees
Conduct proper pre credit appraisal to
ensure that the customer is in a position
to discharge guarantee in case it is
invoked. Bank should refrain in issuing
guarantee for those who are enjoying
credit facilities with other bank.
All guarantees must carry branch code,
date and serial number of the
guarantee.
Proper recording in books of account
should be done including passing of the
liability voucher.
Guarantee should be issued only under
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were returned to
beneficiary. The
government department did
not verify the genuineness
of the guarantees from the
bank.
signature of two officials.
Paragraph for seeking confirmation
from controlling office should be added
in guarantee bond or otherwise
guarantee should accompany a letter
from bank advising the beneficiary to
seek confirmation from controlling office
of the issuing bank.
(b) PREVENTIVE VIGILANCE IN BANKING OPERATIONS-IMPORTANT
MEASURES-
Sl.no
Fraud prone areas Preventive vigilance measures
18) Fake entries in GL to adjust
unauthorized clean advances
by using others passwords.
Password should not be shared.
No one should be given more than one password
and ID.
Maker and checker concept should be
implemented.
Manager should check audit trail of transactions
daily.
19) Alteration in sanctioned limit
by using some one else
password.
Keep the password secret.
Follow maker and checker norm.
Manager or DBA should check active ID list
periodically.
Manager should check non-financial audit trail.
20) Transfer of balance to other
account by using staff
password by the software
vendor.
Software vendor should be allotted separate
password and in no case manager or DBA
should allow him to use his/her password to
access the system.
Proper record of long in and log out should be
maintained.
As soon as vendor finishes his/her work, his/ her
ID should be disabled. In case of need in future,
ID can be restored.
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Data if required by the vendor should be sent to
company’s head office directly by branch through
floppy mailer.
21) Misappropriations of cash
showing it in transit or
keeping fewer notes in
packets.
Manager should observe dual custody norm
carefully. They should not share their keys with
others.
Manager should verify cash each day and do
sample checking of cash packets before cash is
finally closed.
Duplicate set of keys must be properly lodged
with the other branch/bank.
Officers unconnected with its custody should
periodically verify cash.
22) Parallel banking-
misappropriation of cash
deposited by the customers
by the cashier.
Pre scrolling norms must be followed
meticulously. Cash department should not accept
cash unless pre scrolling is done.
A notice should be displayed in the branch
prominently in cash counter stating that (a) cash
should be deposited at the cash counter only and
during business hours and (b) customer should
ensure that counterfoil of the pay in slip is
countersigned by the Head Cashier/Officer above
thresh hold limit say Rs.3, 000/- in addition to the
signature of the receiving cashier.
Do job rotation of cashier as per extant rules.
23) Forged withdrawal in
inoperative and dormant
Accounts- Instances of
replacing signature cards by
forged card also reported.
Signature cards of all inoperative accounts
should be kept separately in joint custody.
Withdrawal in dormant/inoperative accounts will
not be allowed without permission of branch
manager, who will satisfy that transaction is
genuine and is in order before granting
permission.
In case of doubt the account holder should be
contacted over phone or in person before a
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withdrawal is passed.
24) Fraud through forged or
chemically altered drafts and
mail transfer.
1. Follow normal precautions for opening and
operation of the account in which draft is
collected. Also follow KYC norm of issuing draft
above Rs. 50,000/- either through account or by
cheque (NOT AGAINST CASH) and to obtain
PAN.
2. Draft issuing branch should follow following
precautions-
(a) Exercise care by issuance of draft on
proper series and Issuance of Non-MICR
drafts on MICR centers properly.
(b) Observe system of using reverse carbon
paper on back of draft
(c) Observe procedure of putting slash
(transverse line) marked after each word
while writing amount in words.
(d) Observe system of writing the words
under rupees.
(e) All cuttings or over-writings should be
authenticated without fail.
(f) Do punching of cages in draft and affix
transparent adhesive sticker on amount in
figure.
(g) Officers should to take care to put stamp
of authorized signature number below
signature of authorized officials in draft or
advice.
(h) Affix account payee crossing
(unless otherwise requested by the
customer).
(i) Dispatch draft advice to paying branch on
the date of issue it self.
(j) Small value drafts of Rs. 100 or below –
299
fully satisfy about identity of the purchaser
and genuineness of the purpose.
3. Paying branches should follow following
precautions-
(a) Check that draft is complete in all respect
with regards to its contents and text. High
value draft should be subject to closer
scrutiny and passing by at least two
officials.
(b) Overwriting and cutting must receive due
attention. In case of doubt, issuing branch
must be contacted.
(c) Authorized signatures must be
checked/verified very carefully. In case of
doubt, issuing branch must be contacted
before draft is paid.
(d) Check reported loss series without fail
before a draft is passed.
(e) In case of large cash payment, exercise
due care and diligence.
25) Opening of new accounts in
fictitious name and then
withdrawing therefrom the
proceeds of cheques, drafts,
dividend warrants etc.
deposited (which may be
forged or materially altered).
Prospective account holder should visit
personally for opening the account (where ever
possible) and where there is no face to face
contact proper care to be taken while dealing with
such customers so that identity is verified to the
satisfaction of the bank. Account opening
formalities should be completed in bank’s
premises and the documents should not normally
be taken out for execution.
Where it is absolutely necessary to make
exemption of the above rules, banks may take
precaution such as deputing an officer to verify
the particulars, obtaining signed photograph on
suitably formatted verification sheet, forwarding
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by registered acknowledgement due mail a copy
of account opening form and accompanying
instructions to the client for necessary verification
before any operation are conducted in the
account.
Customers should establish identity through
Electoral card, Identity card, Passport, Driving
license, Credit card, Sales Tax No., PAN no, and
information should be corroborated from
independent sources. Also Obtain recent
photograph (no photograph is required for term
deposit up to Rs. 10,000/- . Obtain and record
PAN number.
Account holder having satisfactory SB/CT
account for at least 6 months can introduce new
accounts. The introducer, except under
unavoidable circumstances, should sign the
account opening form in presence of the bank
officials. Introduction should not be treated as
formality but as a measure of preventing opening
of fictitious accounts.
Complete mailing address of the account holder
should be obtained. Obtain confirmation of
address of account holder and introducer by
sending letter of thanks under Registered
acknowledgement due post. Do not issue
checkbook unless address of account holder and
introducer is confirmed. Only cash transactions
should be permitted till address of introducer or
account holder is confirmed.
Obtain information regarding purpose of opening
of account and likely amount and kind of
transactions intended. Prepare a risk profile of
customer as per KYC norm.
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Follow “Care new Accounts” for cash
deposit/transfer / Withdrawal etc.
26) Collection of cheque, drafts,
and dividend warrants etc. in
accounts of the party other
than its actual payee. Also
indulging in kite flying by
granting accommodation
against uncleared cheques.
If the account is opened after the date of
instrument intended to be deposited in the
account, address indicated on the dividend
/interest warrant/refund orders must be
independently verified with that recorded with the
branch to ensure genuineness of the instruments
and person depositing it. In case address is
mentioned the depositor should be asked to
tender its counterfoil to verify the address.
Account payee cheques should be collected only
for the named payee and not in third party
account.
Internal inspector should specifically be asked to
look into advances allowed by the manager
against uncleared effects and furnish comment in
their inspection reports.
Computer operations should be checked to
ensure that effects are cleared only as per
clearing cycle in consistent with time prescribed
by the clearing house.
27) Fraudulent withdrawal by
obtaining new cheque book
on false ground through
forged requisition slip or letter
forging the signature of the
account holder.
Request of fresh cheque book should be
examined carefully. It should be checked that
requisition slip is genuine and belongs to the
cheque book issued to the account holder earlier.
In case of delivery of chequebook to a third
person, the signature of the person authorised to
collect chequebook should be confirmed on
requisition slip. An intimation cum
acknowledgment letter should be sent to the
account holder at the recorded address if the
chequebook is delivered to third party.
In case chequebook is sent at new address by
302
post at the request of the account holder, the
intimation of having sen5t the chequebook at new
address should also be sent at old address.
Proper care about custody of passbook should
be taken. In branch undelivered passbook should
be kept in a box under lock and key.
Banks may fix internally some limit of cash
payment and in case cash payment exceeds
these limits, due precautions should be taken
before cash payment
-0-0-0-
Chapter-34
Security Issues in Computerized Environment“The cyber crime world is thriving and is among the largest illegal revenue
earning industry today.”- Vallier Mc Niven- US Treasury Advisor
-1. Introduction1.1 Paradigm shift in Banking: Computerization has brought in advantages in terms of
reach, efficiency, convenience, speed and economy in banking through host of e-
banking solutions like ATM, Mobile banking, Internet banking, Tele-banking, Electronic
Clearing System, Electronic Fund Transfer, Payment of Utility Bills etc. This has made
any time anywhere and anyhow banking possible. About 95.1% of business of Public
Sector Banks is now computerized.
1.2 Information Technology Act, 2000: India has already been ushered into the IT
revolution by enacting the Information Technology Act, 2000. The Act has put in place
law for electronic contract made on electronic medium, addressed the legal requirement
of electronic record keeping and has clearly defined rights and obligation of all the three
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CII-PWC Information System Security Survey
Who determines security policy?
India Global
CIO 43% 57%IT Manager 30% 52%President 33% 41%Security Management
10% 41%
CFO 10% 15%Security Administration
10% 41%
Information Security Officer
13% 35%
Consultant 5% 17%Others 5% 30%
important parties of eContract viz. the originator, the addressee and the intermediary.
The act has created Certifying Authorities (CA) and new arena of public key and private
key. This has paved way for growth of eBanking in India by addressing to various
security and legal issues. The Act has also laid down laws for cyber-policing for safety
of netizen such as it empowers police officers to enter and search public places, like
cyber-cafes without a warrant and arrest suspects when they believe that a cyber crime
is being committed.
1.3 e-Record Management- Recording the business transaction in the electronic form is
fast emerging as an alternative to physical records due to its advantages in terms of
convenience and functionality over paper based record and its legal recognition by IT
Act 2000. To facilitate legal acceptance of electronic records of banks, Negotiable
Instrument Act 1881, Indian Evidence Act, 1872 and Bankers Book Evidence Act, 1891
have also been amended. Amendment in NI Act has included electronic cheque in the
definition of cheque and defined ‘truncated cheque’ for electronic clearing. Amendment
in Indian Evidence Act, 1872 has enabled production of electronic record such as
computer output, whether paper print or information stored, recorded or copied in optical
or magnetic media produced by a computer as evidence in court of law. Further as per
amendment in Bankers Book Evidence Act, 1891 all bankers book like ledger, long-book
and day book now include both physical as well as electronic record.
2. e-Security 2.1 Cause of security concern: Any time anywhere banking has opened risk of any
time anywhere fraud. Boundary less banking has
no law to deal with cyber criminals. e-Security has
now become a centre-stage of concern for
bankers due to various reasons such as lack of
knowledge of IT security, fear of loss of public faith
in case of system breakdown, fear of financial loss
due to IT related frauds etc. Ernst & Young’s
Global Information Security Survey 2002
conducted across 17 countries says that 70% of
Indian Chief Information Officers (CIOs), IT
Directors and Business Executives surveyed
indicated that they expect to experience greater
vulnerability as connectivity increases. It is
304
therefore necessary to put in place an effective IT Security Management Policy (Who
determines security policy?- (see box) so that bank employee can better accept, under
stand, monitor and manage IT related risks. This also means more investment in
employee’s education through training.
2.2 Computer Frauds-Defined: Fraud is defined as an intentional or deliberate
perversion of truth in order to gain an unfair advantage. Financial fraud is intentional or
deliberate act to deceive other persons who suffer a financial loss. Computer frauds are
committed by an unauthorized user (whether insider or outsider) to the computer
networks for causing economic or financial gains to the user or for an economic or
financial loss to the information system (i.e. hardware, software and data) owner (i.e.
bank).
2.3 Types of fraud: The most important types of computer fraud are through
manipulation of input, manipulation of output, or throughput of a computer system. While
in input manipulation, input data such as deposit amounts in ledgers, limits in accounts
are changed; output manipulation is achieved by affecting the output of the system, such
as use of stolen or falsified cards in ATM machines. Throughput manipulation could be
by way of rounding off sums credited to different accounts and siphoning of the rounded
digits to another account. Other types of computer frauds could be by way of
unauthorized access to computers by hacking into systems or stealing passwords,
deliberate damage caused to computer data or programs through Trojan Horse or Logic
Bomb, computer forgery (changing of data or images stored in computers) and
unauthorized reproduction / modification of computer programs. Recently, customers of
a bank received email asking them to provide required data for verifying account
information and many of the customers who responded by giving their PIN number and
password realized later that it was a Spam mail from unknown fraudsters. In another
reported case a Chinese national hacked into 21 online accounts at Singapore Bank
DBS, transferred $ 35,000 into his account, withdrew the money at a bank branch and
then fled to neighboring country Malaysia. It is believed
that hacker might have used a Trojan horse
programme to capture user keystrokes to learn
identification codes and pass words.
2.4 Role of Insiders: As per study conducted by
STANDARD RESEARCH INSTITUTE (1991-97) the
outsiders committed only 13% frauds whereas internal
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STANDARD RESEARCH INSTITUTE (1991-97) SURVEY1. The outsiders committed
only 13% frauds.2. Internal people like users
Committed 37% and system people committed 26% of the frauds.
people like users committed 37% and system people committed 26% of the frauds. This
indicates that disgruntled employees like operators and system administrators commit
most of the frauds. The reason is that these insiders have a good understanding of the
systems and weaknesses in controls and hence are in an advantageous position to
exploit the loopholes easily. Other important reasons of computer frauds are lack of
knowledge, alertness and awareness among employees, laxity in implementation of
security policies, non-compliance of system and procedures, improper allocation of
duties, weak security features of the software and negligence on the part of users
(employees) in password management and in conducting data consistency checks.
2.5 Risk management and IT: -The operational risk is generally associated with failure
of man, machine or the system. With more and more reliance on computer in banking
operation, IT related operational risks have increased. The operational risks are (a)
Error Risk (error made during development/modification of computer program, simple
error in data entry and misuse of tool/facilities resulting into inaccuracy of data, (b)
Computer fraud risk (such risks are more when security and control system is not
properly implemented), (c) Disclosure Risk (accidental or intentional disclosure of
customer’s information is possible, and (d) Interruption Risk (due to failure of the
computer system). With this background, the Basel Committee II has advised banks that
all risks arising out of electronic banking should be recognized, addressed and managed
by banks in a prudent manner.
3. Implementation of IT Security Management: -3.1 IT Security Management –Best Practices: - Best practices are set of
commercially proven approaches to IT security
management that, when used together, strike
at root cause of security problems. The
application of these best practices in a unified
manner helps the banks in designing its
security policy in effective and integrated
manner. 3.2 IT Security Management-Principles:- IT
security management in bank has been
established on the two basic principles, the
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TIPS ON LOGICAL ACCESS CONTROL
1. Check active user ID to ensure that all users ID are authorized one.
2. Do not allot more than one ID to one user.
3. Educate employees to keep the password secret and to change the password periodically.
4. Assign ID & password to hardware and software vendors and keep a close watch on their activities.
5. Do data consistency check periodically.
6. Inspector/Auditors to check compliance IT security measures.
9. Job rotation, delegation of job, checking of reports, assignments of level etc. must be done as per laid down system and procedures.
10. Follow disaster management system.
TIPS ON PHYSICAL ACCESS CONTROL
1. Do not allow visitors into workstation area.
2. Keep computer screen out of sight of visitors.
3. Keep server locked with minimum access. It should be vacuum cleaned and mopped with wet cloth.
4. Do not leave computer without logging out.
5. No smoking in computer/server room. Install Halon based fire extinguishers
principle of ‘least privilege’ and that of ‘maker and checker’. The principle of least
privilege means that user is given access to the
system strictly on the ‘need to know’ basis and
is given only those rights to access data and
programs, which are in line with his duties (job
allocation) and responsibilities. While giving
lesser rights than required may decrease the
efficiency of working, giving more rights has
associated risks of misuse or possible frauds.
Here underlined objective is to keep the
knowledge of the officials handling the computer
transactions limited to their functional
responsibility so that possibility of such officials
causing the security risk is minimized. The job /duty allocation should be done by proper
office-order/memorandum so that there is clarity in responsibility on one hand and
proper record is kept on the other hand for future reference. The principle of ‘maker and
checker’ means that for each transaction, there must be at least two employees
necessary for its creation and validation. While one may create a transaction, the other
should be involved in confirmation or authorization of the same. In this way, the system
exercises dual control in recording / committing transactions.
3.3 Physical Access Control and the Hardware management - The first step in
prevention of frauds in computerized systems involves setting up of proper physical
access control on the hardware. The physical access control means physical protection
and access control of computer and network systems and the devices. Physical controls
are further divided into preventive and detective physical control. Preventive physical
control shall include access control through security guards, installation of code locks,
smart card driven door opening devices or modern biometrics devices (which control the
access on the basis of certain individual characteristics such as finger-prints). Protection
to peripheral units (terminals, printers, and modems) can be provided by keeping them in
room and allowing/restricting physical access only to authorized persons. Detective
physical controls include smoke and fire detectors, closed circuit television, sensor and
alarms. No smoking in computer/server room should be permitted and appropriate type
of fire extinguishers should be installed to have protection from accidental fire. Control/
supervision is also exercised on taking out computer devices or tape/diskette by the
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vendor for maintenance as it may carry important/sensitive data, which may be misused.
Lastly all employees should be educated about physical access control as they are
important element of security chain.
3.4 Logical Access Control and the Software management –If software is
outsourced, it is first customized after due requirement analysis and design control. A
quality audit is also conducted by a reliable software-testing agency. To put in place
logical access control system (i.e. controls over operating systems, database systems
as well as application systems) each user is allotted an USER ID and a PASSWORD as
per his job hierarchy (such as branch manager, DBA, officer, operator, auditor etc.) to
limit his access to the system as per his powers (authority). DBA / branch manager must
periodically check from active user ID list that no unauthorized ID is existing in the
system and IDs of retired employees / transferred employees /deceased employees /
employees on deputation to other branches / employees on long leave have been
disabled. He should also ensure that not more than one ID is allotted to a single user.
Vendors should be allowed access to the system (where hardware and software has
been outsource) subject to proper log in and log out by allotting temporary user ID which
must be suspended/deleted immediately on completion of the job by the vendor. System
Auditors / Internal Inspectors should also do necessary checking while conducting
computer audit to ensure compliance of IT security guidelines.
3.5 Password Management:- The password is a key to commit a transaction in the
system and is a tool of access control. In prevention of frauds, proper password
management by the users is very important. The password management includes
password validation (a user is disabled after say three unsuccessful log in),
password aging (user is obliged to change password periodically say within 30 days)
and password qualification (password is made by mix of alpha, numeric and special (like
+, -, $) characters which can not be anticipated and deciphered by unauthorized
persons). Passwords are kept one way encrypted in the system, so that even a user
with higher rights does not know the passwords of other users. With an average
employee having 12 passwords every year, remembering them has become a difficult
job. The problem gets compounded when the same employee has to access multiple
systems and multiple servers for which he need to have number of passwords. No
doubt, if an employee forgets his password, he can approach the DBA/BM for another
password, but precious time is wasted in doing this exercise in which cost too is
involved. Hence software solution has been developed for an automatic password
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management system. The employee, who has forgotten his password, can log into the
system and can answer the question, which the system will ask If he identifies him-self
right, the system allots him a new password without any human intervention. The user
must be educated to keep his password strictly secret and in that process take all
possible precaution so that his password is not misused. In case it is felt that password
has been compromised, it should be changed immediately. In one reported case, the
perpetrator was able to change the borrower's limits by sharing the password of the
authorized personnel. This suggests that the password cannot just be treated as a
friendly word. This aspect in the Indian work culture needs to be closely looked into and
the system of password management has to be made foolproof. All staff/officers should
be advised that in case of misuse of the password they would be held accountable.
3.6 Data Consistency Checks- Software is designed to keep a chronological record of
the events occurring in the system (i.e. commands executed by the users, actions on
files, messages displayed by the system, resources consumption by the users,
transaction entry and security violations) in the form of audit trails. These can be
retrieved as and when required to know the details of the users. Hard copies of these
trails are also periodically taken, checked and filed for reference. The branch officials /
DBA has to carry out data consistency check as also other checks such as BALANCE
CHECK THROUGH SQL on regular intervals and any discrepancy, even if minor, should
immediately be documented for logical analysis and rectification. The branch in-
charge/DBA/ must ensure that access to SQL modules are made strictly as per office
order; audit trails of SQL access are printed and safely filed.
3.7 IC Check, Check Sum and Hash Total Check- Software solution usually contains
some simple but effective processes like IC check, check sum or hash totals to ensure
protection and integrity of data. DBA/ manager must check periodically that IC check /
check sum / hash total check is not disabled and is effectively used to check data
integrity and consistency.
3.9 Compliance of System and Procedures- The system and procedures as
prescribed by the bank such as assignment of duty through office order, job rotation,
passing of transaction singly /jointly as per delegated authority, recording of entry
number on the voucher, checking of financial and non financial audit trails, checking of
financial audit trails with vouchers, printing of month/quarter end reports etc, should be
meticulously observed. Branch manager must supervise compliance of these
instructions as is done in the manual system. The old disk/tapes should be erased /
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formatted and useless printed reports should be shredded as it may contain
sensitive/important information.
3.10 Additional Security Tools--In net-work environment the following additional
security tools are used- (a) Data Encryption-It scrambles the data before and during transmission and is used
as a tool for data protection. In case encryption is not done it is possible for the other
people to view the page when it is transmitted.
(b) Fire Wall-It is first line of defense from the outside. Firewall acts as security guard for
bank’s internal network, filtering all incoming traffic from the Internet or networking.
© Intrusion Detection System- (IDS)- It scans the net-work for abnormal activity,
unauthorized resource access and security breaches. It protects network from both
inside and outside access (d) Key Management-It acts like “key” to access encrypted data and affords maximum
protection to protect data from unauthorized parties. It is used in conjunction with
encryption to limit the number of eyes reading encrypted file.
(e) Digital Certificates:-It is an electronic identification card that establishes user
credential while doing Internet banking. It verifies the author of the message or if the
message has been tampered in transit.
(f) Virus Detection- It scans the network for virus-both prevention and cure.
(g) Security Solution- Security solutions are also available to zero in more effectively
on indicators with massive amount of data to alert them on potential or ongoing
problems. These solutions provide for analysis and documentation capabilities for
discovering, preventing, remedying and prosecuting inappropriate or malicious behavior.
(h) Zero Interactive Authentication (ZIA) – In order to obviate situations when laptop
or desktop falling into wrong hands either due to theft or remaining unattended, ZIA
manages the authentication process using “authentication token” which user has to
wear (e.g. like a wrist watch) to remain in constant touch with the PC. As long as
laptop/desktop is able to contact the token the computer functions normally and once the
contact is broken all the data inside is automatically encrypted.
(i) Two factor authentication-The two factor authentication requires a customer to go
through a two-step authorization process. After a customer keys in his username and
internet banking password to access to his account, another security screening is
scheduled if the customer wants to carry out a transaction. The second stage of security
screening involves the mobile phone. When a customer clicks on the transaction menus,
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the system generates a one-time use transaction password and sends it to mobile hand
set with the customer using the short messaging service.
3.11 Putting System to Independent Audit- The working group to review the Internal
Control and Inspection /Audit Systems in banks (Jilani Committee) recommended for
EDP audit in checking data integrity, security and control measures such as system
development, system maintenance, application control, data security, data access and
contingency planning. To conduct such test, EDP auditor should frame logical questions
such as –
(a) Is it possible to earn higher rate of interest on a deposit account than authorized?
(b) Is it possible to pre-close a fixed deposit and still earn full interest?
(c) Is it possible to make back dated correction /modification after day end process?
(d) Is it possible to make correction / modification by a user singly?
(e) Is it possible to access program / files / setting meant for higher level by a lower
user?
(f) Is it possible to make changes in parameter setting, master data, transaction data
etc. without reflecting in audit trail?
(g) Is it possible to bypass printing of mandatory audit trails?
(h) Is there any transaction, which is not associated with any ID?
(i) Is there any transaction not associated with any authorized ID?
The EDP audit should cover compliance check on all technology and process related
security aspects to detect violation/ breaches if any. Problem detected should be
appropriately documented to support remedial action. Banks own inspectors / auditors
should also be educated and trained in conducting such audits.
3.12 Business Continuity Plan (BCP) and Disaster Recovery Plan (DRP): - A crucial
element in IT security management is BCP- the ubiquitous terms covering events
ranging from any disastrous event through to
assessment, mitigation and continual readiness to
future disasters and DRP - to adequate duplication of
important files and applications and storing them off-
site for recovery of data either due to sabotage or due
to natural calamity such as flood, fire, earthquake etc.
The event like 9/11 has re-established the need of
proper BCP and DRP policies. KPMG survey of
banks/FIs observed that only 31% of banks/FIs have
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KPMG SURVEYRESPONDENT FROM
BANKING AND F I 1. 31% have documented
and tested BCP.2. 9% did not have any
BCP.3. 30% are developing
plan.4. 17% have local or
partial plan.5. 13% documented but
untested plan.Best BCP is one, which is never implemented.
documented and tested BCP. (See box) The methods commonly used for data
protection are - (I) Tape or floppy back up, (ii) Mirroring, (iii) Data Guarding, (iv)
Duplexing, (v) Partitioning, (vi) Clustering and (vii) Replication. In ALPM and TBM
environment floppy / diskette back up system is generally adopted where two sets of
back up are generally taken each day, while one set is stored in fire proof cabinet at the
branch it-self other is stored off site. The month end, quarter end and half year end back
up is also taken and kept off site as well as on site in the same manner. The back up
floppies / tape should be properly leveled and a record is maintained in back up register
mentioning location where these are kept. The periodical testing of the back up media
should be done to check their correctness and reliability. The floppies / tape should also
be changed periodically to take care of wear and tear. The banks with core banking
solution keep back up by mirroring database off-site.
4.Role of Vigilance: -4.1 No System is 100% Secure- No system is considered 100% foolproof as fraudulent
money transfers has occurred even in a highly automated and secure funds transfer
systems. As technology is taking rapid strides (for fraudsters as well as organizations),
banks are discovering that they have to constantly upgrade and improve their
technological tools. However, these tools can only reduce the possibility of fraud and not
totally rule it out.
4.2.Low Risk and High Profit Business- Computers crimes are considered as low risk
and high profit business as these can be committed by comparatively with much less
investment and high gains (recovery in many cases is an endless and fruitless exercise)
with lower possibility of conviction as courts in India takes years to decide cases
(average time is 15 to 20 years) with very low conviction rate (average 6 %). It is,
therefore, prudent to follow preventive measures to avert potential frauds than to face a
complex process of punitive action.
4.3 Prevention is better than cure- The security built around technology always comes
at a cost. Hence, while finding technological solutions to security or fraud control, bank
cannot ignore the cost of technology and some trade off is always made. Such trade off
is tackled in conjunction with normal vigilance mechanism particularly through preventive
vigilance. The computer preventive vigilance shall include measures such as-
(a) Improving employee’s knowledge through job card, computer manual etc. and
develop innate habit of meticulous observance of system and procedures,
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(b) Conducting system-audit of computer operations at branches to detect cases of
non -compliance and taking corrective measures,
(c) Engaging ethical hackers to check possible security breaches in net work
environment and to plug the loop holes,
(d) Doing job rotation of computer operators/officers as per extant rules to check
growing vested interest,
(e) Circulating case study of computer frauds among branches/ employees to build
foresightedness among employees for close observance of suspicious behavior/
movement of colleagues / outsiders and reporting the same to higher authority
confidentially, and
(f) Conducting seminar / workshop/ training programs in the area of password
management, software and hardware management, physical and logical access
control, disaster management etc.
4.4 Educate Your Customers-Effective security management is done through
combination of measures and educating customer is one of the key components of e-
security. A bank should advise its customer to (a) keep PIN or password of ATM/internet
account safe/confidential, (b) Be wary of unsolicited email or telephone calls asking them
for any personal detail like card number or PIN, (c) Access internet banking account by
typing bank address instead through hyper link and never go to a web site from link in
email and enter personal details and (d) Advise customers to use up to date anti virus
software, security patches and personal fire wall.
4.5 Preventive vigilance- Monitoring of transactions- Monitoring is essential part of
preventive vigilance. It is essential to do day to day monitoring of (a) new accounts (b)
large value transactions especially in new accounts, (c) large value collection especially
in new accounts, (d) transaction in inoperative account, (e) transaction above cut off limit
in staff or staff related account, (f) expenditure variation and (g0 concession in interest,
commission etc. In CBS environment bank can automatically monitor out of profile
transactions through specially designed software.
4.6 Detective and Punitive Vigilance - In a computerized environment, banks are
increasingly exposed to operational-risk as scoundrel believe that their action is near
impossible to detect, if detected near impossible to prove, if proved nearly impossible to
convict and if convicted, amounts nearly impossible to recover. The problem is
compounded in networked banks operating in different nations with different laws.
Despite these limitations, frauds perpetrated from across the globe have been detected
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and amounts recovered by proper combination of technology and vigilance skills. Hence,
while inspectors/auditors continually must carefully watch incidences and plug the holes,
vigilance people should improve their skills and actively follow up cases- both internal
departmental enquiry and court cases- for punitive action.
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Chapter-35
Short Notes on important topicsAgriculture Kisan Credit
Card The Kisan credit Card (KCC) scheme was
introduced in 1998-99 to enable farmers to
purchase agriculture input and draw cash for
their production needs. Till December end
2008 banks have issued 35.08 million kisaan
credit cards (KCC) with sanctioned limit
aggregating to Rs.177607 crore.
All farmers having agricultural land whether
irrigated or un-irrigated are eligible. Fixation of
loan is done on the basis of operational land
holding, cropping pattern and scale of finance.
The validity period of KCC is three years
subject to annual review.
In a study, the RBI has discovered that
farmers are not too keen to have KCC, as
some of them are well to do, some held job,
some are cultivating land under oral lease or
under contract basis, some are not having
land holding certificates and some are share
cropper. The lack of upgradation of land
record, small land holding and illiteracy of
borrowers has been some of the other
problems hindering KCC.
The Vyas Committee has recommended ATM
enabled cards.
Agriculture Rural housing scheme
Golden Jubilee Rural Housing Finance Scheme
(GLRHFS) has been designed to address the problem
of rural housing-Villages/town/cantonment/notified
area upto population of 50000 as per 1991 census is
covered. Loan for construction up to 5,00,000 and
repair /renovation upto 50,000 can be considered.
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Schoolteacher, service holders, progressive farmers
and businessmen can be target group. Loan period is
15 year and margin is 33%, which can be relaxed by
bank.
Agriculture Service area approach
Service area approach (SAA) was introduced in April
1989 to bring about an orderly and planned
development of rural and semi-urban areas of the
country. Under the scheme all rural and semi-urban
branches of the banks in the country were allocated
specific villages for over all development and credit
needs. With a view to provide opportunity to rural
borrower to have wider choice and easy access of
credit facilities, RBI has now decided that allocation of
villages among the rural and semi-urban branches of
banks shall not be applicable for lending excepting
under government sponsored scheme. Further the
requirement of no dues certificate from service area
branches of allocated bank will also stand dispensed
with.
CAPITAL MARKET
INTEREST RATE SWAPS
It is a financial instrument of risk hedging. Depending
upon risk perception of interest rates, a person having
fixed interest loan may swap with floating interest loan
through a financial intermediary say a bank.
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Capital Market Credit Derivatives Market - CDS
A financial derivative is an instrument that allows risk
to be transferred from one party to the other. A credit
derivative is a contract that allows the credit risk (or
the risk of default) of a loan or bond to be separated
and transferred to another entity, independent of the
assets. A simplest form of credit derivative is CDS-
Credit Default Swap in which credit protection buyer
pays to credit protection seller a periodic fixed
payment of fee in return of protection of default.
Reserve Bank has issued draft guidelines for CDS
whereby RBI regulated gentilities may buy credit
protection on bonds they hold. The credit protection
can be sold by banks and finance companies with net
worth of over Rs.500 crores and non performing loans
less than 3% with capital adequacy of 12% for banks
and 15% for non banking companies. Biggest gainers
will be large corporate particularly infrastructure
companies as bank after credit protection cover can
go on making advance as exposure will be taken
against seller of protection and not against the
borrower.
While the proposal in general has met with positive
response, but expert say that inclusion of FIIs will
provide the depth to the market and two way interest
both to sell and buy protection. Another suggestion is
that investor in certificate of deposit and commercial
paper should be allowed by buy protection.
Capital Market Negotiated Dealing Settlement System
Negotiated Dealing System (NDS) is an electronic
platform for facilitating dealing in Government
Securities and Money Market Instruments. NDS
facilitates electronic submission of bids/application by
members for primary issuance of Government
Securities by RBI through auction and floatation. The
system of submission of physical SGL transfer form
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for deals done between members will, on
implementation of NDS, be discontinued. NDS will
also provide interface to Securities Settlement System
(SSS) of Public Debt Office, RBI, and thereby
facilitating settlement of transactions in Government
Securities including treasury bills, both outright and
repo.
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CAPITAL MARKET
OPTIONInstrument of hedging of interest rate risk.
Buyer of option is given option to buy assets while
seller of option is given option to sell assets.
CALL OPTION
When option holder can exercise his right to buy
assets at pre determined price and period after paying
option fee. It is profitable in bullish market.
PUT OPTION
When option holder can exercise his right to sell
assets at pre determined price and period after paying
option fee. It is profitable in bearish market.
LIQUIDITY ADJUSTMENT FACILITY OF RBI
REPO & REVER REPO
RBI conduct REPO to suck liquidity by buying security
with option to seller to buy them back at pre
determined price and date. RBI also conducts
REVERSE REPO infuse liquidity by selling security
with option to buyer to sell back the security at pre
determined price and date. Repo and Reverse repo
are considered as benchmark rate for short-term
deposit.
CAPITAL MARKET
INVERSE FLOATER
It is an innovative instrument. Coupon rate is
inversely related to the direction of interest rate.
Grasim has issued Rs 50 crores inverse floater
carrying yield between 14% and 1 year gilt yield.
Instrument gives investor 40 bps marker over gilt
yield.
Credit Capital Market -Exposure Norms
1. Exposure norms for capital market has been
fixed at 5% of outstanding advances with a
rider that banks having better risk
management practices can be permitted on
case to case basis to have more exposure.
2. RBI has recently permitted HDFC bank to
have capital market exposure up to 10%.
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Credit Credit counselling
3. A credit counselor helps the borrower to:-
(a) To evaluate his/her current financial status,
(b) To make a detailed review of his/her income,
assets and expenses,
(c) To find out personalized outcome to get over the
his/her problem,
(d) To draw detailed debt management plan,
(e) To work with lending bank on voluntary basis to
waive or reduce financial charges such as late
fees, penal interest , finance charges etc,
(f) To formulate a debt restructuring plan mutually
acceptable to borrower as well as the bank.
The objective is to make the borrower feel that in his
hour of crisis there is someone to help him out of the
situation.
Credit Factoring Facility in the area of credit collection and invoice
management.
Discounting of bills.
Credit screening and collection of bills.
Invoice management.
With recourse and without recourse –both.
Export factoring also by ECGC - Special
emphasis for SSI.
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Credit Regulating the warehousing sector
Salient features of Warehousing (Development and
Regulation) Act, 2007:-
Object of the act is to make provisions for the
development and regulation of warehouses,
negotiability of warehousing receipts and
establishment of a warehousing development
and regulatory authority. Act will facilitate the
warehouse receipt as document to title of
goods and raising finance there against would
be easy as it would be tantamount to implied
pledge.
Negotiability of warehouse receipt is
established by law.
Law recognizes the warehouse receipt in
electronic form.
Registration of warehouse is now mandatory.
Existing warehouse will have to obtain
registration within 30 days of the act.
The concept of accreditation agencies for
issuance of certificate of accreditation to
warehouses issuing negotiable warehouse
receipt has been introduced.
Any existing or future warehouse not intending
to issue negotiable warehouse receipt will not
be governed by the law.
Credit FORFAITING Non-recourse discount of export receivable.
EXIM bank offers this facility.
Is done for discount of capital goods or contract of
long-term liability.
Backed by guarantee of importer bank for
payment.
ECGC has offered non-recourse forfaiting product
through banks where ECGC will bear the credit risk
for exporters.
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Credit Teaser Rates These are loans where the interest rate is fixed at
an attractive rate for an initial pre determined
period after which it ceases to be fixed and
becomes floating rate of interest. Banks’ recently
launched special schemes for home loan offering
teaser rates inviting criticism from different
quarters. It is being argued that banks are not
taking care of serviceability of these loans and
there is likely hood of default when the pre
determined period will be over and rate will be
linked to market rates.
The teaser rates have also raised voice of
discrimination from existing borrowers of the bank
who is crying foul as they are paying at least 100
bps more than the new borrowers. Banks
argument is that offering same rates to old
borrowers would crate assets-liability mismatch
and therefore their inability to agree.
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Credit Infrastructure financing
To achieve sustained GDP growth of 9%, GOI has
envisaged investment of around $500 billion in
infrastructure sector in 11th Five year plan (2007-
12). It is believed that infrastructure will be the
next driver of growth and the companies in
infrastructure could grow the same way the
software companies grew in the last decade.
Roads, Transport, Communication, Ports, Energy,
Hospital, Telecom, Healthcare, Educational
Institutional and storage facility for farm sector
including cold storage form infrastructure.
In the past, the government did infrastructure
financing but limited budget resources have
opened option for private sector and hence
financing by banks.
GOI is providing incentive by extending tax
concessions and tax holiday.
Infrastructure Development Finance Company-set
up in 1997- to do infrastructure financing in big
way.
SEZ financing has also come up as opportunity for
banks and financial institutions as many as 154
special economic zones have been approved
which provide opportunity to fiancé captive power
generation, roads, waste disposal and township
development.
Issues-- Infrastructure is capital intensive and high cost
oriented. Working capital requirements are
relatively less. Repayment period is long including
gestation period, which creates problem in Asset Liability mismatch for the banks. RBI vide credit
policy of May 2004 has permitted banks to raise
long terms funds ( not less than 5 years) for
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infrastructure financing through bonds ( not in the
nature of subordinated debts)
Securitisation and take out finance are deemed as
most suitable to bank for infrastructure financing
from ALM angle.
Funds requirements are huge and small and
medium banks find it difficult to meet the
requirement within EXPOSURE NORMS. (15% of
net owned funds of banks for individuals and 40%
of net owned funds of banks and extra 10% for
infrastructure for group). RBI vide credit policy of
May 04 has empowered bank’s board to exceed
limit by 5% of individual/group exposure.
Power sector problem:
Outstanding debt of state power utilities have grown to a staggering R6 lakh crore or 6% of the GDP. Roughly a third of these are loans taken to fund past losses which cannot be serviced through tariff hikes and, hence, are being considered for a benign restructuring by the Centre.
Needless to say, the extreme indebtedness of these utilities is attributable to state governments that don't let regulators increase tariffs in tandem with rising costs, leading to a constantly widening revenue-expenditure gap at the utilities.
This undermines their ability to invest and thwarts India's ambitious plan to multiply its power generation capacity and create a competitive power market.
According to Reserve Bank of India data, outstanding debt of power utilities to banks has grown by 56% in the two years to June 2012 — from R2.1 lakh crore to R3.3 lakh crore.
Over the last one year, the increase in this debt burden was 40%, suggesting an acceleration in the addition to the liabilities, owing mainly to the relentless rise in fuel costs.
Governments pandering to the electorate have either
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stymied or staggered the pass-through of fuel price-driven cost increase, stifling the utilities in the process.
While these are the loans taken from banks, the utilities also owe big amounts to specialised agencies for power sector financing - the Power Finance Corporation (R1.3 lakh crore) and Rural Electrification Corporation (R81,725 crore). That adds up to some R5.4 lakh crore. If liabilities to other institutions like LIC and IDFC and the external commercial borrowings too are included, the total burden would easily be above R6 lakh crore.
According to Crisil, unless big reforms are undertaken to stem losses and spur revenue streams, these liabilities would grow further to R7.3 lakh crore by March 2013. This looks like a reasonable estimate, given that annual losses (after receipt of subsidy) of discoms in the country were R42,415 crore in 2009-10, up 18% over the previous year.
Analysts say many states continue to follow a cautious and staggered approach on tariff hikes despite the hefty increase in electricity purchase costs in recent years. According to Icra, Rajasthan needs to hike tariff by 80%, Madhya Pradesh 65%, Tamil Nadu 55% and Punjab 24% to bridge their discoms' revenue gaps. Such tariff shocks are, of course, not politically feasible, and carefully calibrated tariff hikes are unavoidable, analysts say.
Of course, some states have of late started assessing their discoms' annual revenue requirements (ARR) and followed these with some tariff hikes, which are, again, far below what is required. Though some states have adopted provisions for automatic recovery of increase in fuel costs, implementation remains patchy. Subsidies (meant to facilitate cheaper power to farmers and domestic consumers) account for 20% of discoms' total revenue and delays in their payment are also a stress on their finances. There is the facility of regulatory assets - uncovered revenue deficit proposed to be covered through future tariff hikes — which are aimed at preventing tariff shocks, but this is not fully functional in most cases.
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A recent Crisil report said that the share of bank loans in the total capital employed by state power utilities rose from 60% at the end of 2007-2008 to 72% in 2009-10. This shows the state governments' share in capital employed has shrunk to abysmally low levels. The agency has recommended automatic pass-through of fuel price-driven cost increases and said that all unpaid utility subsidies and regulatory assets should be charged to the state government's account by the RBI beyond a period of six months. Crisil also said that state governments could take over the portion of liabilities incurred to fund losses under a specific arrangement supervised by the RBI.
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Credit Mortgage Guarantee
Company
RBI in its recent credit policy announced
setting up of Mortgage Guarantee Corporation
to guarantee housing loan granted by banks
and financial institutions.
National Housing Bank (NHB) is in discussion
with Canada Housing and Mortgage
Corporation for sharing knowledge in the area
of mortgage guarantee. This concept is in
departure with earlier guarantee scheme of the
government, which could not find favour with
the bank and also with the borrowers.
The funding of India Mortgage Guarantee
Corporation (IMGC) was completed on June
29, 2012 with all four major shareholder
contributing their share viz Genworth (36%),
ADB (13%), IFC (13) and NHB (36%). NHB
has now approached RBI for granting
certificate of registration.
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Credit SOFTWARE The major driver of world economic growth today
is IT. IT enabled service such as Call Centers,
BPO (Business Process Outsourcing) are new
growth areas. India has a good start in software
and has assumed a leadership role.
Presently IT services and product contribute 1.7%
of GDP which is likely to grow upto 7.7% by 2008.
At present IT exports contribute 14% of India’s
export which is likely to increase to 35% by 2008.
NASSCCOM has projected US$ 23 billion by
2008.
India spends 1.1% of GDP on IT whereas USA
spends 5% of GDP on IT. Even domestic market
has good scope.
IT/ITES (IT enabled services) emerging growth
areas are-
(a) Packaged software support and installation,
(b) IT consulting, net work infrastructure
management,
(c) Hardware support,
(d) Network consulting,
(e) Integration
Software exporters can acquire stake in Foreign
company they deal with to the extent of 25% of
the export. They have to seek RBI approval
through AD.
SEZ has provided new growth opportunity to the
industry.
Merger, alliances and takeover have become key
driver of growth in software sector.
Financing software issues-1. Software and IT is classified in four categories (1)
Software services –Staffing services and
programme services at customers location, (2)
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Project Services such as customized software
development, systems solution and integration
and maintenance of the software, (3) Software
projects and packages as standard products, and
(4) IT related services such as call centers,
mentoring, Tele-conferencing etc.
2. MPBF- Cash budget system is ideal but working
capital assessment upto Rs 2 crores can be done
on turnover system i.e. 20% of projected turnover
and for above 2 crores cash budget system will be
adopted and MPBF will be determined based on
peak deficit in cash budget.
3. For working capital limits above Rs. 10 crores,
Cash credit component will be 20% of the MPBF
after excluding export credit and balance as
demand loan.
4. The bank has to fix reasonable margin excluding
export where margin will be NIL.
5. Banks can also provide Equity, Seed money and
Venture capital on case to case basis with
prudential limit of 5% of incremental deposit of the
previous year.
6. Promoter’s background, his qualification and
experience in developing software products is a
crucial factor in appraisal. Other professional
manpower associated with full commitment is also
to be considered seriously. The success of the
project depends upon skills of the professionals.
Hence, bank should critically examine this aspect,
also to examine marketing abilities.
7. Monitoring- to obtain quarterly actual cash flow
statement and compare it with projected
statement, submit GR forms and Softtex forms as
appropriate.
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8. Risk factors are- absence of tangible current
assets, high obsolescence, fixed assets
depreciates rapidly, rate of failure is high, high
manpower turnover, product may turnout non
marketable or overtaken by the same product of
the competitors.
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Credit Medium Scale Enterprise
GOI has approved definition of Medium Scale
enterprises to cover investments in plant and
machinery in an industrial undertaking upto Rs.
10 crores.
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Credit Base Rate RBI has decided effective 1July l 2010 to replace
the BPLR system with base rate and hence the
rate of interest of borrowers will now be linked to
base rate.
Criteria for determination of base rate as
illustrated is cost of funds, cost of compliance of
CRR and SLR, profit margin and mark up for cost
of operation for particular product and premium
for credit risk and tenor of loans.
Banks will not be permitted to lend below base
rate exception being lending against bank’s own
fixed deposit, lending under differential rate of
interest and staff loans.
Stipulation of BPLR as the ceiling rate for loans up
to Rs. 2 lakh stands withdrawn.
Base rate will be revised by banks every three
months.
Existing loans based on the BPLR system may
run till their maturity. In case existing borrowers
want to switch to the new system, before expiry of
the existing contracts, an option may be given to
them, on mutually agreed terms. Banks, however,
should not charge any fee for such switch-over.
Introduction of base rate is likely to change the
entire dynamics of credit, as short term loans
which are presently be sanctioned by banks at
substantial discount to PLR will vanish. It is
expected that PSU like oil companies, fertilizer
companies etc. were raising short term loans at
5% to 6% will have to factor in up to 5% rise in
interest rates.
It is argued that banks are presently mispricing
loan and base rate system would put a stop to
such system. Undercutting of rates to compete
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other banks will not be possible.
Presently when interest rate increases banks
increases the PLR thereby increase the cost of
borrowing but when interest rates falls banks do
not reduce the PLR and due to this benefit of cost
of reduction is not passed to the borrowers. Base
rate system will remove this anomaly.
It is also expected that interest yield of banks
would rise as base rate would end cross
subsidization of interest rates.
Banks are in a fix to decide parameters. For
example to arrive at cost of deposit, bank can use
overnight cost of fund, average cost of funds,
average cost of deposits or marginal cost.
Likewise for profit bank can use net profit or
operating profit. RBI has clarified that banks are
free to decide methodology say cost of funds but
would not be allowed to change. They free till
December 2010 to change the methodology.
Commercial paper all of a sudden is in demand
from corporate who are seeing opportunity to
raise money at much cheaper rate than the
borrowing at base rate.
From Monetary Policy perspective it was
experienced that BPLR system was rigid and
change in policy rates was not reflected in the
change in interest rates.
RBI is likely to introduce sun set clause so that all
borrowers moves to base rate system in the
given time frame.
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Deposit Insurance
Deposit Insurance
Deposit insurance scheme is under review by RBI. It
may be recalled that the Jagdish Capoor committee
recommended to charge premium from banks as per
risk grade i.e. low risk bank should pay less premium
and high risk bank to pay high premium. Until March,
04 banks pay uniform premium of 5 paisa % on total
deposit that was raised to 08 paisa from April, 04 and
will again be raised to 10 paisa from April, 05. The
stronger banks are raising objection to pay equal
premium as it amounts to cross subsidization. IBA
also feels that instead of one size fit all approach the
premium should be risk related. Committee has
recommended having separate fund for cooperative
and commercial banks and higher capitalization of
DICGC at Rs. 500 croroes to be funded by RBI, its
promoter.
Credit Negative amortisation
In rising interest scenario, when EMI is only able to
cover payment of interest, the situation is known as
negative amortization. In such situation borrower is
left with only option of raising the EMI otherwise the
debt can not be repaid.
e-banking Cheque
Truncation
System
Cheque truncation system is being started in the
country with a pilot project in the national capital
region. Banks globally are looking to ways and means
of reducing cost in processing the cheques which
paper based processing system has. Cheque
truncation system is electronic based cheque
presentment through mirror based approach and it
facilitates speedy cheque collection specially
outstation cheques. It may be recalled that
Information Technology Act 2002 couple with
amendment in NI Act has facilitates image based
processing of cheques through cheque truncation
system.
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Foreign Exchange
EXTERNAL COMMERCIAL BORROWING(ECB)
Source of finance of corporate from banks,
insurance fund, foreign equity holder and
international capital market from abroad.
Free to raise from any internationally recognized
source such as bank, export credit agencies,
supply of equipment, foreign collaborators, foreign
equity holders, international capital market etc.
with average maturity 3 to 7 years.
ECB are subject to specific maximum spreads
over six months LIBOR, for the respective
currency.
ECB prepayment is permitted up to US $ 200
million, subject to minimum average maturity of
five years.
ECB can be assessed under two routes:
automatic and approval route.
ECB limit under automatic route is 500 $ million
with average maturity of 5 years.
ECB limit for infrastructure companies is $ 500
million a year with average maturity up to 7 years
for rupee expenditure under the approval rule.
ECB loans are utilised for import capital goods
and services. End use for ECBs was enlarged to
include overseas direct investment in Joint
Ventures (JVs)/Wholly Owned Subsidiaries
(WOS) in order to facilitate corporate to become
global players.
Risk management is done by currency swap and
interest rate swap
Exporter can raise ECBs for tenure of less than
three years in special economic zones. This will
provide opportunities for accessing working capital
loan for these units at internationally competitive
rates.
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Corporates have estimated to raise more than US
$ 11.7 billion through ECB during 2004-05 (ET
22.4.05).
With international interest rates on rise, the
interest of corporate to raise ECB is gradually
waning. The anticipation that cost will further rise
is also hurting ECB.
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Government Business
Turnover commission
A distinctly unglamorous but very lucrative area that
has been opened for banks is government business.
This range from collection of direct taxes at branches
to disbursing government funds and salaries to
handling the account of the railway. The business is
huge and banking industry put the total at around Rs.
15,00,000 crores annually on which the government
pays 1.11 paisa per Rs. 1000 . That work out to Rs.
1700 crores annually out of which half goes to SBI
alone. Quite naturally other banks also want to grab a
bigger pie of this business. With competition coming
from private sector bank, nationalised banks too have
started offering OLTAS.
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Miscellaneous REAL TIME
GROSS
SETTLEMENT
SYSTEM
RTGS started since 26.03.2004 and India crossed a
major milestone in development of systemically
important payment system. Salient features of RTGS
are-
(a) Payments are settled transaction by
transaction for high value and retail
payment.
(b) Settlement of funds is final and
irrevocable.
(c) Settlement is done on real time basis and
the funds remitted can be further used
immediately.
(d) It is fully secure system which uses digital
signatures, public key infrastructure based
encryption for safe and secure
transmission.
(e) It provide for transfer of funds for inter-
bank settlements and customer related
funds transfer.
Present RTGS net work is of 55000 branches
and it handles on an average 80000
transaction per day with a peak of 128295
transactions processed as on March 30, 2009.
Miscellaneous Green Shoots Green shoots is used to refer to signs which indicate
recovery of the economy. It draws the facts that green
shoots which appears above the earth are first visible
sign of growth of plants. Particularly after a recession,
green shoots are welcome as symbols of economy
taking treading path upward. Improvement of
industrial production figure, rise in car sales,
development in infrastructure sector including
steadying of prices of cement and steel have been
seen as green shoots in India.
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Miscellaneous Fake notes The RBI detected counterfeit notes worth Rs.10.54
crores during 2006-07 against Rs. 8.39 crores 2005-
06. Further counterfeit notes worth Rs. 25.79 crores
were recovered till September 2009. Looking to
danger being posed to our economy, it is decided that
outsourcing of printing of notes will be stopped
forthwith. It is has also been suggested that RBI
should introduce easily recognizable
anti[counterfeiting security features in the designs.
Miscellaneous Doorstep Banking
Individual customers can now have cash and other
bank instruments picked up from their home or office
with banking services now available at door steps.
Corporate customers can additionally have cash
delivered against cheque received at the bank’s
counter.
Miscellaneous Quantitative easing
Central bank usually stimulates an economy by
reducing interest rates so that there is less incentive
to save and people borrow and spend more. But in
developed word where interest rates are already near
zero this option is not available. In such a situation,
central bank resorts to pumping money directly into
the economy which process is known as quantitative
easing. It is done by buying bonds – usually
government paper but can also be private bonds-
from banks and financial institutions. The idea is get
more money into the system chasing the same
amount of commodities to drive up the prices. The
flood of money may cause assets prices to rise i.e.
prices of shares, real estate etc. Quantitative easing
may potentially ward off deflation and kick start the
economy.
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Miscellaneous Head line and core inflation
Headline is about estimate total inflation in an
economy where as core inflation measures exclude
food and energy prices. As policy some central banks
follows headline inflation both for framing policy
objectives and also for operational guidance while
other central banks follows core inflation only.
Economist feels that process of stabilising core
inflation is seen as more optimal policy.
Miscellaneous
TIPS
(Treasury inflation protected securities)
First issued in United States, TIPS are special type of
government securities that offers investors protection
from inflation. This is how TIPS works: The principal
increases in line with inflation or decreases with fall in
prices. When instruments mature investor is paid
original principal or inflation adjusted principal which
ever is higher. This under TIPS original principal
amount remains protected.
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Miscellaneous
Mobile Banking
With rapid growth of mobile phone subscribers in
India, banks have been exploring the feasibility of
using mobile phones as an alternative channel for
delivering banking services. Some banks have started
offering information based services like balance
enquiry, transactions enquiry, location of the nearest
ATM/branch, acceptance of transfer of funds
instructions etc. Looking to the fact the technology is
new , RBI has issued following set of guidelines :-
(a) Only banks which are licensed and supervised
in India and have a physical presence in India
will be permitted to offer these services.
(b) The services shall be restricted to customers
only.
(c) Only Indian rupee based domestic services
shall be provided. Mobile service for cross
border transfer of funds is prohibited.
(d) Banks may use the services of business
correspondents to extending this facility
provided BC guidelines are followed.
(e) Guidelines of RBI for Risks and Controls in
computers and telecommunications will be
followed.
(f) KYC and AML guidelines will be followed.
(g) Banks will have to put in place a system of
document based registration with mandatory
physical presence of the customers.
(h) Information security aspects have to be put in
place.
(i) Transfer of funds are subject to cap of
Rs. 5000 per day and Rs. 10000 for
transactions involving purchase of
goods/services.
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NPA Management
NPA Buyout norms
Foreign investors have been showing keen interest to
buy NPA, which has opened market, valued about $
22 billion. Overseas investors are currently limited to
purchase of Indian stock and bonds. RBI in
consultation with SEBI and finance ministry has put
public domain draft rules of NPA securtisation. It is
believed that NPAs are backed by as much as 140 %
collateral in many cases and units are operating that
provide immense business opportunity.
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NPA Management
Recovery Management Policy
Each bank is expected to have a recovery
management policy duly approved by the board
including policy for compromise settlement.
RBI GUDELINES- Past due concept deleted from 31.03.2001.
NPA classification shall be based on actual
recovery as on balance sheet date subject to
following:-
(a) Interest / installment for term loan
remaining over due for more than 90 days
(b) Cash credit / over draft account remaining
out of order for more than 90 days.
(c) Bill purchased or discounted remaining
over due and not paid more than 90 days
(d) Accounts due for review or renewal for
more than 90 days from due date.
However account will be upgraded
immediately after review/renewal if it is
otherwise in order.
(e) Non submission of stock statement for
more than 90 days from due date will
make the drawings irregular and such
irregular drawings for period more than 90
days. However, account will be upgraded
immediately after receipt of stock
statement if the account is otherwise in
order.
NPA identification norms for agricultural advances-(a) Short duration crop will be treated as NPA
if installments of principal or interest
remains unpaid for two crop season
beyond the due dates for example Kharif
crop loan sanctioned in June 2005 will due
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for repayment in March, 2006 and if
remains unpaid two crop seasons beyond
the due dates i.e. 2007 and 2008, it will be
NPA as on March 2008.
(b) Long duration crops where the harvesting
of the crops are made after a period more
than 12 months. In case of sugarcane the
crop season is more than 12 months. The
crop loan for sugar cane given in
November 2005 will fall due on March
2007 and will become NPA on March
2008.
(c) Term loan same norms for short and long
duration crops will apply.
Off balance sheet exposure deemed as credit – Interest rate, forex deals and future
credit exposure come within the single
borrower limit of 15 per cent of capital owned
funds. Further any restructuring of derivative
deals shall be carried out only on cash
settlement basis. Overdue receivables representing positive mark to market ( MTM) value of a derivatives contract will be treated as non performing asset, if these remain unpaid for 90- days or more. In case where a derivative contract is restructured, the MTM value of the contract on the date of restructuring will be cash settled. For this purpose, any change in any of the parameters of the original contract would be treated as restructuring.
Provision w.e.f. 30.6.11 (a) Sub- standard 15%,
Unsecured substandard 25% (b) Unsecured
portion of doubtful advance 100% , Secured
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portion of doubtful up to one year 25%, above one
year to 3 year 40% (c) Restructured Standard 2%
for first two year from the date of restructuring (e)
Loss assets 100%. (d) General provision of 0.40%
on outstanding standard assets, 1% for
residential housing loan of Rs. 20 lakhs and
above, commercial real estate, capital market
exposure exposure and personal loan and 0.25%
for direct financing to agriculture and SME.
Asset Classification under doubtful category –
12 months from the date advance turned sub-
standard.
Restructured accounts
(a) Standard Assets where Principal and
interest (excepting where commercial
production has started and advance has
become sub standard) will continue to be
standard provided interest element in
terms of present value terms has been
provided for (written off).
(b) Sub-standard restructured account will
be upgraded only after one year or when
principal or interest has fallen due which
ever is earlier after satisfactory
performance.
Interest application on monthly basis w.e.f 01.04.02.
State government guaranteed advances would be classified as NPA if interest and
installment remain unpaid for 90 days
irrespective whether the guarantee is invoked
or not.
Central government guaranteed advances
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would be classified NPA only after 90 days of
repudiation of the guarantee by the
government, when the same is invoked.
RBI has advised bank that while selling or
making compromise in NPA banks should
work out net present value of future cash flows
arising from security being sold. The sale price
or compromise should not be below NPV.
Prompt Corrective Action-One of the trigger
points in Prompt Corrective Action mechanism is
level of net NPA. When the trigger point under the
mechanism is activated by the performance of the
bank, the mandatory actions would follow by way
of restriction on expansion of risk weighted assets,
submission and implementation of capital
restoration plan, prior approval of RBI for opening
new branches/new line of business, paying off
costly deposits and special drive for NPA
recovery.
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NPA Provision Coverage Ratio
PCR is the ratio of provision to gross non performing
advances and indicates the extent of funds a lender
(bank) keeps aside to cover loan losses. RBI has
stipulated that minimum PCR of banks should be
70%. RBI has clarified that technical write offs would
be taken into calculation while calculating PCR.
Technical write off or prudential write off are the
amount of non performing loans in the books of the
branches and yet to be written off at head offices.
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NPA Management
Wilful defaulters –redefined
Wilful default would be said to have happened if
the borrowing unit fails to meet repayment
obligations to its lenders even when it has the
capacity to honour it commitments to lender or
diverts funds for the purpose other than they were
availed of. Diversion of funds would be when short
term working capital funds would be for long term
purpose, loan funds are deployed for purpose
other than intended for, or transferring money to
subsidiary or group company.
RBI will share the information with SEBI to prevent
them assessing capital market.
Where banks have identified diversion of funds,
misrepresentation, falsification of accounts and
fraudulent transactions, promoters will be
debarred from accessing finance from all legal
entities and also in floating new entities (including
issue of share capital) for 5 years from the date
their name appear in RBI list.
No additional finance will be granted to the
borrower and bank will initiate criminal action
whereever possible.
Bank will have to give adequate opportunity to
borrowers before declaring them wilful defaulters. As
per RBI directives bank has to form two committees
(I) Committee headed by ED and two senior
executives to approve the borrower as wilful defaulter
(ii) Committee headed by CMD to consider objection if
any raised by the borrower and then taking final
decision to declare him wilful defaulter.
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NPA Management
Credit Information companies
(A) Credit Information Companies (regulation) Act
2005 stipulates that -
Every existing credit institution shall be a member
of at least one credit information company within
three months of the commencement of the act.
Credit information bureaus formed under the act
and duly registered with the RBI can requisition
credit information from their members.
The share of such information by a credit
institution with a duly constituted bureau of which
it is a member is mandatory.
(B) CIBIL( Credit information Bureau of India Ltd)is
first company which has got mandate to act as credit
information company.
CIBIL now has a database of over 90 million
individual borrowers taken from various
banks, financial institution and non-banking
finance companies.
CIBIL has also launched the data base of
mortgaged properties containing the details
of properties against which owners have
availed loan so as to help the lenders share
and access information so as to avoid
fraudulent mortgage of same property to
multiple banks.
CIBIL is sharing more than 2 million credit
information’s each month.
FI/Banks/NBFC/SEBI/IRDA / broker
registered with SEBI/IRDA who is members
of CIBIL can determine on line whether a
prospective borrower is a disciplined
borrower or a serial defaulter on payment of
fee of Rs 10 per borrower.
CIBIL has also put in place data base of
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mortgage default.
CIBIL has also been authorized to maintain
credit history of telecom, insurance
customers, NBFC and micro finance
institutions .
CIBIL has close to 164 members which use
its database.
© RBI has given approval to three more credit
information companies namely Equifax Credit
Information Service, Experian Credit Information
Company and High Mark Credit Information Services.
(a) RBI has issued registration certificate to
Experian credit information company as a
credit information company.
Regulatory Requirement
PROMPT CORRECTIVE ACTION (PCA)
In the backdrop of large-scale crises in banks
resulting into closure, insolvency and losses, RBI has
proposed PCA. It is in the form of trigger points as
under:-
Capital to risk adjusted assets ratio (CRAR) -three
trigger points are proposed (a) CRAR less than
9% but equal or more than 6%, (b) CRAR less
than 6% but equal or more than 3% and (c) CRAR
less than 3%.
NPA-two trigger points have been proposed (a)
Net NPA over 10% but less than 15% and (b) Net
NPA15% and above.
Return on assets (ROA) -single trigger point i.e.
ROA below 0.25%
Compliance of PCA may result into following action:-
Trigger point Net NPA:- Mandatory action(a) Special drive to reduce the NPA and
contain generation of fresh NPA
(b) Review of loan policy
(c) Upgrade credit appraisal skills and
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systems
(d) Strengthen follow-up of suit field and
decreed debts
(e) Putting in place proper credit risk
management policies ,process, procedure,
prudential limit
(f) Reduce loan concentration-individual,
group, sector, industry etc.
Trigger point Net NPA:- Discretionary action(a) Restriction of entry into new lines of
business
(b) Reduce/suspension of dividend payments
(c) Reduce stake in subsidiaries
Trigger point ROA-Mandatory action:-(a) Pay off costly deposits and CDs
(b) Increasing fee based income
(c) Containing administrative expenses
(d) Special drive to reduce the stock of NPAs
and contain generation of new NPA
(e) Restriction on entry into new lines of
business
(f) Reduction/suspension of dividend
payments
(g) Restriction on borrowing from the inter
bank market
Trigger point ROA-Discretionary action:-(a) Capital expenditure only for technological
up gradation and for day to day operations
within board approved limits
Staff expansion or filling up of vacancies only
with prior approval of RBI except recruitment of
specialists
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REGULATORY REQUIREMENT
BANK RATE
(BR)
6 % w.e.f. 29.04.03
In 2004 the RBI completely delinked the standing
liquidity facilities to bank from the BR and repo
rate emerged as the lending rate of the RBI for all
practical purposes. As a result, the importance of
the BR as the monetary policy instrument waned.
A working group headed by Mr. Deepak Mohanty,
Executive Director, RBI has recommended for
reactivating BR by providing bank liquidity under a
new collateralized Exceptional Standing Facility (ESF) at this rate.
Group also recommended that BR be pegged at
50bps above the repo-rate which will also be
upper band to the policy rate corridor.
REGULATORY REQUIREMENT
DO NOT CALL REGISTRRY
The Indian Bank Association and Indian Card
Council have joined hand to set up a data of
telephone numbers whose owners do not wish to
receive telephone call for banking telemarketing.
This will be one stop center for ‘do-not call
registry’ for customers of all the banks.
REGULATORY AUTONOMY
AUTONOMY Financial market regulators like the Reserve Bank
of India, SEBI, and IRDA etc. have their
jurisdiction over different segment of the market.
Their activities are overseen by the government,
though they are suppose to be autonomous –
meaning that government will not interfere with
their day to day functioning or in the rule and
guidelines they make for market participants.
However they are suppose to interact with the
government regularly such as RBI is regularly
intereact with the government in three areas –
matters of appointment, matters of monetary
policy making and matter of finance of public debt.
There have been instances of between the RBI
352
and government for example during five year
plans in 1950 RBI did not approve financial
planning substituted by physical planning and this
led to resignation of then RBI Governor Rama
Rau.
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REGULATORY REQUIREMENT
CAPITAL ADEQUACY RATIO
As bank expands its business it needs more
capital to account far additional risk.
MINIMUM 8 % RAISED TO 9% w.e.f. 31.3.2000
Bench mark of evaluation of soundness and
stability of bank
Capital to Risk Weighted Assets Ratio =Capital
funds *100/Risk Weighted Assets
Tier I Capital to include (a) paid up capital less
investment in subsidiary, intangible assets and
losses (b) reserve and surplus (c) capital reserves
regarding sale proceeds of assets.
Tier II Capital to include (a) Revaluation Reserve
(at discount of 55%), (b) Undisclosed Reserve
(c) General Provision and Loss Reserve including
IFR (d) subordinated debt.
Tier I can not be less than 4. 5% or 50% of
required ratio
Risk Weighted Assets -
(a) Cash/Balance with RBI / advance to government
and banks own staff covered by superanuation
benefits and mortgage of house and Investment
in Government guaranteed security- 0%
(b) Claims with banks 20%
(c) Other investments 100%
(d) Loan and advances including bill purchased /
discounted and other credit facilities 100%
(e) Fixed and other assets 100%
Note: -
1. Advances collateralized by cash margin and
provisions, bank deposits, gold and loans
granted to staff up to 80% are excluded while
computing the total advances.
2. Housing loan collateralized by commercial
properties, exposure to capital market,
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personal loan, capital market exposure etc.
risk weight is 150%.
3. An additional risk weight of 2.5% on the total
investment is also provided.
Credit Conversion Factor
(a) Financial Guarantee 100%
(b) Performance Guarantee
50%
(c) Letter of Credit (documentary) 20%
(d) Counter party Government 0%
(e) Counter party Bank 20%
(f) Counter party others 100%
(g) Forward exchange contracts for less than one
year 2%
(h) Forward exchange contracts for each
additional year 3%
(i) Forex-open position – Uncovered
overnight position
100%
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REGULATORY REQUIREMENT
Basel III Rule written by the Bank of international
settlement’s committee on Banking supervision
whose mandate is to define agenda for global
banking community as a whole.
Main component is capital is common equity and
retained earnings. The new restricts inclusion of
items such as deferred tax assets, mortgage
servicing rights and investment in financial
institutions to no more than 15% of the common
equity components.
While the key capital ratio has been raised to 7%
risky assets, accordingly to the new norms. Tier I
capital that includes common equity and perpetual
deferred stock will be raised from 2% to 4.5%
starting in phases from January 2013 to be
completed by January 2015. In addition bank will
be required to set aside 2.5% as contingency for
future stress bringing the common equity to 7%.
According to RBI, banks in India are not like to be
much impacted by Basel III. As at the end of June
2010, Indian banks are already reached capital
adequacy of 13.4% of which the tier I is 9.3%. As
such Indian banks would not be considerably
stretched by new norms. A further counter
cyclical buffer in the range of 0% to 2.5% of
common equity is to be imposed (depending
upon national circumstances) to protect banking
sector from periods of excess aggregate credit
growth. These capital requirements will be
supplemented by a non-risk based leverage ratio
that will serve to backstop the risk based
measures and higher capital norms for
systemically important banks.
Europe will be most likely region for banks to need
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to raise funds notably in Germany, France and
Spain.
It is argued that whatever capital adequacy
measures are taken, banking system will only
remain foolproof if banking supervision is
proactive and competent. Unfortunately it has not
been so in US and UK in particular.
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REGULATORY REQUIREMENT
CRR Section 42 (1) of Reserve Bank of India Act provide
for maintenance of CRR.
Parliament has passed the bill on 17th May 2006 to
remove the legislative cap of minimum CRR. Now
there is no minimum mandatory limit and RBI is free to
fix limit is wants.
4.50% of NDTL from 22.09.12
Inter bank term liability as term borrowing for period
15 days to 1 year is exempted from CRR requirement.
Following removal of minimum cap of 3%, RBI has
decided not to pay interest on CRR balance kept by
banks with it. RBI earlier used to pay interest @3.5%
over and above the minimum 3% mandatory CRR.
CRR is used by RBI (a) investment with RBI is risk free
(b) RBI controls the liquidity and (c) restricts capacity
of the bank to lend.
REGULATORY REQUIREMENT
SLR Section 24 (a) of Banking Regulation Act
provide for maintenance of SLR by every
banking company.
23% of NDTL vide 1st quarterly review of
monetary policy effective August 11, 2012.
Parliament has passed the bill on 17th May
2006 to remove the legislative cap of
minimum/ maximum SLR.
Restrict the capacity of bank of credit
expansion. It is tool of liquidity management in
the hand of RBI.
RISK MANAGEMENT
Assets and Liability Management(ALM)
ALM is systematic approach that attempt to provide
degree of protection to the bank by measuring,
managing, monitoring and modifying interest rest rate
risk.
GAP MODEL-Difference between risk sensitive
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assets and risk sensitive liability (RSA-RSL) -risk
is managed by keeping gap to zero or near zero-
RSL and RSA are put to time bucket based on
residual maturity.
SIMULATION MODEL-What if analysis of impact
of interest rate changes-forecasting different
scenario-depends on accuracy of forecast.
DURATION MODEL-Duration is calculated at
weighted average maturity of resultant cash flows-
expressed as less or equal to maturity period of
bonds-greater the gap higher is risk.
EaR (Earning at risk) Approved - based on bank’s
perception of movement of interest rate.
Prudential limit is decided by ALCO OR BOARD
based on GAP model (RBI advised bank’s to
maintain on the basis of Simple Gap Statement
and switch over to more technical model in due
course when banks develop expertise.)
Also a tool of Pricing of Loan, decide NIM, fix PLR
etc.
INTRODUCED w.e.f. 1.4.99
Main challenge is non-computerized environment,
which create problem in data creation.
Bank has to cover 100% business.
Prudential norms prescribed only for 1-14 days
and 15-29 days bucket as 20% of mismatch.
RBI in report of Trend & Progress of Banking 2004
has reported that PSBs are having assets liability
mismatch as majority of banks are having
investment in the maturity bracket of 5 years and
above.
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RISK MANAGEMENT
Stress Testing It is a risk measurement tool. It measures the key
movement in market variables that lie beyond the day
to day monitoring but that could potentially occur.
Stress testing evaluates the short-term impact on a
given portfolio of a series of predefined moves, in
particular market variables. It is also known as
creation of ‘worst case scenario’.
In present scenario of financial instability, stress
testing is one tool which can give insight to the bank
to know its vulnerable areas and address the issues
proactively.
A stress test of U S financial industry found that 10
out of 19 largest banks need a combined $75 billion to
weather the continuing recession. ( BS 9.5.2009)
RISK MANAGEMENT
Credit Rating Agencies
(CRAs)
CRISIL -Promoted by ICICI, UTI, HDFC and
number of banks. Number one in rating business.
Other in the line are ICRA –Investment
Information and Credit Rating Agency (1992),
CARE-Credit Analysis and Research Ltd. (1994)
There are three segments which use credit rating.
These are retail investors, financial institutions
and regulators.
Regulatory support like credit rating of CP (RBI) or
Bonds (SEBI) made rating mandatory.
New Basel II guidelines require mandated rating
(IRB) of borrowers for risk-based assessment for
capital adequacy.
CRAs have been extensively used by the
investing community in their investment
decisions. But truth is that these agencies could
never predict a financial crisis may be Mexican
crisis, South East Asian crisis, or Sub-prime crisis.
This has put a question mark on their credibility.
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SEBI has directed that all CRAs (credit rating
agencies) will have to maintain records of the
important factors underlying the credit rating, a
summary of discussions with all stake holders
involved as well as decisions of the rating
committee, including voting details and notes of
dissent, and also if there was any divergence
between the rating assigned by the analytical
model and the actual rating assigned to the
company. The move is expected to bring more
transparency and accountability through uniform
disclosure.
Concerned over companies keeping under wraps
their bad credit ratings and publishing only
favorable ones, SEBI is mulling ways to prevent
rating shopping system. It is considering making it
mandatory to publish even those rating which are
not acceptable to companies and rating agencies
will be responsible to put in place clear and
effective ‘Chinese walls’ between their analytical
and business development teams.
In insurance and banks internal model are gaining
prominence and emerging view is that banks
should rely more on their internal models than to
external ratings.
Regulators’ are using the ratings for prescribing
prudential requirements for the FI and also for
prudential investments prescriptions. The
suggestions for improving effectiveness for this
purpose are:
a. Enhance the transparency of the rating process.
b. Rating decisions should be based on professional
standards.
c. Improve accountability so that CRAs suitably
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rewarded and punished for their decisions.
d. CRAs should also be rated and those who have
poor capabilities be weeded out.
e. Regulators to prescribe standards for the CRAs.
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Chapter –36
Short Notes on Committees/Study groups
Agricultural Financing
R V GUPTA Committee –on
agriculture
Recommendations-
Adequate powers to branch managers.
Chairman and Managing Director to visit rural
branches.
To have flexibility in unit cost and scale of
finance.
Agricultural loan on cash basis only.
Obtaining no dues certificates to be left at
discretion of the bank.
Introduce passbook with authentic record of
land holding –accepted as title deed for
equitable mortgage.
Guarantee where land is available as collateral
is discouraged.
Compulsory rural posting should be done away
with.
Financing through self-help group (SHG).
Interest to be deregulated for small loans.
Rationalise returns – management information
system to be computer based.
Insurance is burden-allow discretion to banks.
To open high-tech agriculture branches.
Modification in Service Area Approach -
borrower should be free to approach any bank.
SLBC to think on greater agenda than distribution
of APP target like area development,
Implementation of new schemes, Impact of
technology absorption, Identification of fresh
schemes.
Agriculture RBI panel for RBI has sent up a sub-committee of Central Board
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MFI of directors to address :-
Issue and concerns of MFI and
To decide ways and means to make
interest rate reasonable.
It may be noted that RBI regulate only those MFI
which are registered with it as NBFC. It however
does not prescribe any lending rates for these
institutions.
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Agriculture Sarangi CommitteeU C Sarangi Chairman NABARD
How small and marginal farmers, tenant
farmers, share croppers etc. can be brought
within the ambit of institutional finance.
Recommendations: Government to give joint and individual loan
to small farmers including tenant farmers,
share croppers currently outside the ambit
of institutional finance via jointly liability
group and thrift and cooperative society.
Intervention solely on farmer’s debts may
not be adequate. GOI need to incentives to
those choosing to engage in more
sustainable farming.
State ineffective money lending act to be
overhauled.
Identified weakness in newer model of
credit delivery like KCC, micro-finance.
Rigid system of commercial banks caused
prevention of small and marginal farmers
from bank credit.
Agriculture V. S. Vyas Committee
An Advisory Committee on Flow of Credit to
Agriculture and Related Activities from the Banking
System (Chairman: Prof.V.S. Vyas) was
constituted by RBI.
Recommendations- Fixation of target to Priority Sector including
Agriculture needs comprehensive review. Until
review is done present target of 18% for
agriculture may continue. Committee has also
identified demand side constraints and cap on
indirect agriculture to achieve agriculture target.
Securitiised agricultural loan should be treated
as direct agricultural loan.
Expanding outreach of banks in rural areas
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need change in mind set of bankers as all over
the world retail lending is treated as most
lucrative. In Indian context, hardly there is a
better avenue other than agriculture.
Franchising village post office for dispensation
of credit in rural areas is also an innovative idea
mooted in budget of 2003-04, commercial
banks should explore this model.
Reducing cost of credit to agricultural
borrowers- KCC should be made ATM enabled.
Non-performing asset (NPA) norms in
agricultural finance be revised as default of two
crop season and setting up of an Agri -risk fund
to mitigate risk of lending in case of genuine
default.
Pilot project of multi-commodity exchange-
bank be exempted from sections 6 and 8 of BR
Act.
Micro-finance institutions (MFIs) would not be
permitted to accept public deposits unless they
comply with the extant regulatory framework of
the Reserve Bank.
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Agriculture Rao Committee on RRB
Recommendations- Possible reorganization of Regional Rural
Banks (RRBs).
Centre to bring its stake to 33% from 50%.
Amalgamation of contiguous RRBs.
Vesting more supervising and regulatory
powers to NABARD.
RRB staff can pick up State Government stake
if they are interested and after that it should be
divested to private sector.
Capital Market BHAGWATI COMMITTEE ON TAKE OVER
SEBI Committee on takeover under chairmanship
of Shri P.N.Bhagwati
Recommendations- Banks should finance take over.
RBI and SEBI to set terms to finance such
take-over.
The acquirer should not strip substantial assets
of the acquired company without permission of
shareholders. (The issue involved in case of
VSNL where TATAs are in dispute with the
government).
Open offer should always be 20% and above
but may be subject to acceptance level of less
than 20%.
Corporate Governance
RBI Consultative Group on Bank Boards
(Ganguli Committee)
Recommendations- Appointment of one more whole-time director
on the boards of large-sized nationalised
banks.
Establishment of appropriate due diligence
procedures for appointment of directors on the
boards of private sector banks.
Setting up of nomination committees of boards
of banks to recommend appointment of
independent/non-executive directors.
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Building and creation of a pool of professional
and talented people for board level
appointments in banks and also maintenance
of the data for the purpose by the Reserve
Bank of India, etc.
369
Credit CHORE COMMITTEE
Shri K.B Chore
of DBOD of RBI
Recommendations-- Annual review for limit of Rs 2 crores and
above.
QIS I to III.
1% penal interest for default.
Fix operating limit on the basis of QIS I .
Peak and non-peak limit.
Adhoc-sanction extra interest 1%.
2nd method only.
Credit JILANI COMMITTEE II
Mr. Rashid
Gillani Chairman
PNB
Recommendations- Shift from cash credit to demand loan.
Bifurcation of cash credit into cash credit and
demand loan.
Borrowers of Rs. 10 crores and above -80%
WCDL and no slip back permitted.
Bank can fix separate rate of interest for
demand loan.
Credit RBI Committee
to Review the
System of
Lending Under
Consortium
Arrangements
J.V. Shetty, EX-CMD, Canara Bank
Purpose to review the system of Lending Under
consortium arrangements and to suggest
improvement therein.
Recommendations- Recommended various alternatives including
inter bank participation certificates, commercial
papers, debentures, securitisation of loans and
syndication of credit.
Suggested substantial modifications in the
system of consortium lending to make it simpler
and more flexible to meet credit needs of trade
and industry quickly.
Recommended enhancement of the threshold
limit for mandatory formation of consortium
from Rs. 5 crores to Rs. 20 crores with
immediate effect and to Rs. 25 crores or above
by March 1996.
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Introduction of syndication for borrowers
enjoying fund based working capital limits of
Rs. 25 crores or above from the banking
system.
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Credit Shanker Acharya Committee
Based on the recommendations made by this
committee on Primary Market, RBI issued
guidelines under which banks can provide funds to
meet genuine requirement of approved market
makers. Advances shall be purely commercial
terms and banks will have to lay down norms for
financing them including exposure limits and
method of valuation. These advances are freed
from the Rs. 10-20-lakh ceiling applicable to
individuals against shares/debentures.
Credit TANDON COMMITTEEJuly 74 Sri PL Tandon Chairman of PNB
Recommendations- Inventory norm for 15 industries
Approach to lending –1st and 2nd method of
lending
No slip back of current ratio
Classification guidelines for current assets and
current liabilities
Bifurcation of demand and loan component
Credit Working Group on Flow of Credit to SSI Sector (Chairman: Dr. A.S. Ganguly
Following the announcement in the mid-term
Review of November 2003, a Working Group on
Flow of Credit to SSI Sector (Chairman: Dr.A.S.
Ganguly) was constituted. .
In order to enable the banks to determine
appropriate pricing of loans to small and medium
enterprises, development of a system of proper
credit records is useful. For this purpose, Credit
Information Bureau of India Ltd. (CIBIL) would work
out a mechanism, in consultation with RBI, SIDBI
and IBA. Further, a mechanism for debt
restructuring on the lines of the Corporate Debt
Restructuring (CDR) has been proposed for
medium enterprises.
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Credit VAGHUL COMMITTEE-Factoring
Recommendations- To solve problem of SSI by discounting invoice
/bills
To offer
(a) Sales Ledger Management services.
(b) Purchase and collection of debt and
credit protection services.
(c) Advisory services.
Customer Service
GOIPORIA COMMITTEE
Recommendations- Opening of branch before 15 minutes.
May I help you counter to be opened.
Change of soiled and mutilated notes-binding
of note packet by rubber band.
Nomination facility.
Issue of fixed deposit (FD) pass book and
obtaining renewal instructions while accepting
fixed deposit or issue reminder for over due
fixed deposit.
Notification re. Interest change in news paper.
Issuance of draft at one counter –pre signed
draft up to Rs.5000/- .
Return dishonored chequed within 24 hours.
Remittance beyond two days-remitting bank to
compensate.
Instant credit upto Rs. 5000/-(Since raised to
Rs.15,000/-) .
Interest on delayed collection at SB rate plus
2%.
Extended non-cash business hours by 2 hours.
Use of cash counting machine.
Opening of special branches for customer
service.
Customer Service
Procedure and performance
Recommendations- To help small depositors, the RBI has asked all
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audit of public services: Banking Operations- S.S. Tarapore
the banks to put in place policy on depositor’s
right.
The policy will encompass all aspects of
deposit operation of all accounts, charges that
can be levied and other related issues.
IBA has been asked to prepare a model code
to help the bank to adopt their own policy.
RBI has also put in place system of imposing
penalty on banks for infringement of customer
right.
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Financial Sector Reforms
NARSIMHAN COMMITTEE – I
Recommendations- No further nationalisation of banks. No bar on private sector banks.
Enhancement of share capital of PSB, by
offering to Mutual Funds, General public and
government undertaking.
Liberal policy for foreign bank and opening of
branches
4 tier banking (a) 3 to 4 large banks (b) 8 to 10
national banks (c) local banks (d) rural banks
Abolition of dual control of government and RBI
Lowering of SLR to 25%
Phasing out commercial interest rate.
Special Tribunal for recovery
Transparency of balance sheet of banks –
disclosure mandatory
Financial Sector Reforms
NARSIMHAN
COMMITTEE –II
Recommendations- Entire portfolio of government security to
marked to market. Government security to
carry 5% risk weight (present 2.5%).
CAR – reach to 8% by 2000 and 9% by 2002.
Recapitalisation is not sustainable option --no
further recapitalisation from government
budget.
Object to reduce net NPA to 5% by 2000 and
3% by 2002.for large NPA accounts- constitute
AMC.
NPA-now move to 90 days default
General provision on standard assets- 1%.
10% PS to weaker section, interest subsidy
element in directed credit be eliminated.
Greater attention to AL management
Weak Bank- where accumulated losses and net
NPA exceeds it net worth or where operating
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profit less income on recapitalisation bond is
negative in consecutive 3 years. –Do study of
weak banks, which are potentially viable, by
financial and operational restructuring.
Greater autonomy to banks by amending RBI
Act, BR Act, Nationalisation Act etc.
Also suggested measures for legal and
legislative frame work like amendment of
transfer of Property act 1882, extension of
special statue like SFC for recovery ,
rationalisation of stamps duty etc.
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Foreign Exchange
Capital Accounts Convertibility –TARAPORE COMMITTEE
India adopted current account convertibility in
1994.
CAC recommended a time bound programme
to make Indian Rupee Fully Convertible by
March 2000.
CAC already done for foreign Institutional
Investors both direct and portfolio
Control still exists for Individual and corporate
to remit capital abroad and inflow and outflow
of capital through bank and NBFC
Pre-condition for CAC(a) Fiscal deficit as % of GDP from 4.5% to
3.5% by 2000.
(b) Mandated inflation rate –3 to 5%.
(c) CRR- reduced to 3%.
(d) NPA- reduced to 5%.
(e) Deregulation of interest rates (still
Saving Bank deposit rate is regulated).
(f) Exchange rate movement –REER (Real
Effective Exchange Rates) to be
declared, published and made public-
band of (+)/ ( -) 5% of REER , RBI
intervention if REER is outside band.
(g) FX Reserve should not be less than 6
months of imports.
(h) FX reserves should be at least 70% of
the currency and in no case less than
40% of the currency in circulation.
Implications (a) Time is too short- high risk of out flow of
capital –pre conditions could not be
achieved within target date i.e. March,
2000
(b) Need of expertise for banks due to
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market risk exposure
(c) With FX above 131 BN USD and Net
NPA around 5% pre conditions are met
partially. Limiting factors are high Fiscal
Deficit. Government is cautiously
moving towards CAC.
(d) Recently individual persons allowed
investing upto USD 25,000.
(e) As per latest credit policy banks can
borrow overseas up to 25% of their Tier
I Capital.
(f) .Residents have been allowed to invest
overseas up to $ 25,000. RBI panel has
recommended allowing resident Indians
to open account overseas and remit $
25,000 annually. RBI has permitted to
remit other amount like $10,000 for
private visit, $5,000 for gift, $5,000 for
donation etc. through the same account.
(g) RBI has announced on 20.3.06 for
setting up of Tarapore Committee II to
suggest comprehensive medium term
frame work with sequencing and timing
to move to capital account
convertibility.
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Foreign Exchange
Capital Accounts Convertibility –TARAPORE COMMITTEE II
2nd Tarapore Committee was appointed in
March 2006 at the behest of the Prime Minister
Dr. Man Mohan Singh to draw a road map of
full convertibility, as conditions now are more
benign.
2nd Tarapore Committee has submitted its
report to the Reserve Bank of India.
It is expected that full convertibility will be a
boon for companies looking for acquisitions
overseas.
The committee is expected to look into the
issues of fiscal deficit, impact of immediately
and sudden convertibility of forex reserves etc.
Foreign Exchange
SODHANI COMMITTEE –LIBERALISE FX RULES
Recommendations- Bank to fix of its own open position of FX
Interest rate of FCNR to be decided by bank
Customers to have option/hedge facility
Bank to have their own gap limit based on
risk/exposure
Human Resource Management
Kanan Committee
on Banking
Education
Chairman
Kannan, CMD,
Bank of Baroda
To look into revision of the examination system for
the banks which is administered by the Indian
Institute Bankers’ (IIB), Mumbai.
Recommendations - The present system of conduction
examinations by the Indian Institute of
Bankers’, (IIB) for banking professionals needs
some changes.
The suggested changes include (a) introduction
of Junior Associate Diploma examinations and
Certificate Associate Examination would; (b)
the committee highlighted the need for
increasing level of specialization at senior level.
It has suggested a Specialised MBA course in
Banking and Finance; (c) the committee also
379
suggested that employees of finance
companies should also be covered by the IIB
examinations.
380
Human Resource Management
KOHLI COMMITTEE
ON HRM
Sri SS Kohili,
CMD PNB
Recommendations- Recommended downsizing of manpower in
PSBs.
To draw manpower plan before implementing
VRS.
Suggested norms for compensation.
Removal of Centralized Recruitment System.
Introduction of ESOP in banks.
Reorienting the transfer placement policy.
Changing performance appraisal norms.
Alterations in the norms of work allocation.
Improving the job profile of employees.
Human Resource Management
Khandelwal committee
The Khandelwal committee has proposed changes
in the way PSBs recruits, compensate, provide
incentives and plan for succession of employees
under their fold.
Recommendations: Bank should do away with the system of
industry wise settlement of wage revision
instead it should be at bank level depending
upon its capacity and profitability.
It observed that salary level up to Scale II is
competitive but senior level salary is not at
per market rates.
Bank can have either variable pay or
incentive scheme to compensate the senior
level executive.
Recruitment, promotion and training are
other issues that need to be addressed.
Bank are likely to face a severe crisis with
almost all senior level executive retiring in
next couple of years with no alternative plan
at place.
381
Awarding ESOP up to 15% to top performer
is other key recommendation of the
committee.
382
Inspection JILANI COMMITTEE ON INTERNAL CONTROL SYSTEM IN BANKS –RASHID JILANI
CMD PNB
To examine the efficacy and adequacy of the
internal control systems in banks and to suggest
improvements in them.
Recommendations- To beef-up Internal Inspection and audit
system.
Computer audit-reliable software, confidentiality
of data is maintained.
Rating of branches –inspection of poor rated
branches within 12 months.
Inspector to check NPA.
Accountability of auditors also.
Efficiency ratio of branches – on floppy to
ascertain risks and updated.
Audit committee of board - scope to be
increased to include fraud, RBI inspection etc.
Inspection PADMANABHAN WORKING GROUP ON BANK SUPERVISION (PWG) 1991
Recommendations- Shift from current system of periodical
inspection to ongoing supervision.
On site Monitoring-target specific critical areas
Supervision based on CAMELS
(a) Capital Adequacy
(b) Assets Quality
(c) Managerial
(d) Earning
(e) Liquidity
(f) System and Control
Focus on (a) Financial Conditions (b)
Operating Conditions and (c) Regulatory
Compliance.
Money Market L.C. Gupta Committee on
Derivatives
Derivatives are financial instruments that derive
their value from the underlying financial assets.
Recommendations:
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Mutual funds should be allowed to trade in
derivatives for hedging but not for speculation.
Stock exchanges should inspect the books of
all its members participating in the derivative
segment at least once a year.
Existing stock exchanges should be allowed to
set up a derivative segment.
384
NPA Management
Pannir Selvam Committee on
NPA
1997
Recommendations- Enlarge the definition of debts to include debt
due to banks and mortgage debt. This will
help avoiding reference to High Court when
the mortgage suits come up before the DRT.
DRTs should have power to appoint
receivers and issue attachments during the
pendency of suits. Government should
specify remedies for contempt of DRTs in
case of disobedience or breach of orders of
the DRTs.
NPA Management
S R IVYER GROUP ON CREDIT INFORMATION BUREAU OF INDIA
Recommendations- Dissemination of information relating to suit
filed accounts regardless of the amount
claimed or such other accounts where borrower
has given consent for disclosure.
Prevent taking advantage of lack of information
by unscrupulous borrower.
NPA Management
SS KOHLI REPORT on willful defaulters.
Recommendations- Suggested amendment in banking law to
enable banks to make public the name of willful
defaulters.
As various acts forbids bankers to disclose
identity of the customers unless it is suit filed
hence suggested amendment in various act
such as SBI Act /BR Act / IDBI act.
Panel has defined willful defaulter as one who
Does not repay despite cash.
Does not purchase assets for which it has
borrowed.
Misrepresents or falsifies records.
Disposes of secured assets without
informing the bank.
Operates an account outside the
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consortium of lenders.
Name of willful defaulters including full time
executive should be circulated among banks /
public and SEBI.
386
Regulatory Requirement
Ganguly Committee
Report of the Consultative Group of Directors of
Banks / Financial Institutions (Dr. Ganguly
Group).
Recommendations-(a) Responsibilities of the Board of
Directors.
(b) Role and responsibility of independent
and non-executive directors.
(c) Training facilities for directors.
(d) Agenda and minutes of the board
meeting.
(e) Committees of the Board
(a) Shareholders' Redressal Committee
(b) Risk Management Committee
(c) Supervisory Committee,
(f) Disclosure and transparency.
Regulatory Issues
Malegam committee
Sub-committee will review the definition of
‘microfinance’ and ‘microfinance institutions’ for
the purpose of regulation , examine conditions
under which loan to MFI can be classified as
priority sector, recommend for money lending
legislation of the states for MFI, recommend for
MFI association and their role in increasing
transparency of operation, and grievance
handling mechanism for adherence to
regulations.
Recommendations Creation of separate category of NBFC- MFIs
A cap on 12% and 24% on margin and interest,
separately.
Creation of one or more social capital funds.
Lending by not more than two MFIs to
individual borrowers.
Creation of one or more credit bureaus
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Reaffirmed priority sector status
Total permitted outstanding to Rs. 50,000 and
increase in annual income limit to Rs. 60000 for
rural and Rs. 120000 for other areas.
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REGULATORY REQUIREMENTS
BASEL II Increased transparency re. Bank’s actual risk
Better monitoring by private investors
Better risk management and capital allocation
Three pillars of accord are -
FIRST PILLAR-Minimum capital required
(a) Minimum 8% requirement.
(b) Measure operational and credit risk.
(c) Inclusion of capital for operational risk
also.
(d) Two approach-Standardized and
Internal Rating Based.
(e) IRB based on internal estimate of
borrowers credit worthiness to assess
credit risk by rating agency.
SECOND PILLAR –Role of regulator
(a) Approval of IRB by regulator
(b) Bank management to bear responsibility
to for keeping adequate capital in
support of risk beyond core capital
THIRD PILLAR – Market Discipline
(a) New disclosure requirement in several
cases
(b) Quantitative/qualitative dimension of
capital structure
Three layered structures have become matter
of debate. IRB approach require several core
input such as PD (Probability of default), LGD
(expected loss rate given a default) and EAD
(expected amount of exposure at default). Such
sophisticated process requires lot of expertise,
technology and resources for banks and
regulators. It is argued that basing capital
requirement on very fine discrimination of credit
risk is not practical.
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In line with Basel Pact, the RBI has asked all
banks to draw a road map to comply BASEL II.
To begin with all banks in India will adopt
Standardized approach for credit risk and Basic
Indicator Approach for operational risk. Once
basic skill is developed and RBI is satisfied
bank can l switch over to Internal Rating Model.
All scheduled commercial banks will be
required to follow BASEL II w.e.f. March 08.
RBI after conducting a simulation study on 50
public and private sector bank has assessment
additional capital requirement of tier I capital of
Rs. 51, 255 crore within March 2009.
As on 30th June 2010, CRAR of commercial
bank was 13.4% of which tier I was 9.3%.
Although Basel III norms are yet to be
calibrated yet RBI is confident that they will not
impact the Indian banking system significantly.
390
Credit Report of the
Committee on
comprehensive
Regulation of
Credit rating
agencies Dr.
K.P. Krishnan)
The Committee was constituted by the Ministry of Finance at the instance of the High Level Coordination Committee on Financial Markets (HLCCFM) to revisit the legal and policy framework for regulating the activities of Credit Rating Agencies (CRAs) in order to take a larger view of the entire policy with respect to banking, insurance and securities market. The Committee submitted its report to the HLCCFM on December 21, 2009.
The Committee has observed that although, prima facie there is no immediate concern about the operations and activities of CRAs in India even in the context of the recent financial crisis, there is a need to strengthen the existing regulations by learning the appropriate lessons from the current crisis. The Committee has taken note of international action in this regard and, inter alia, has recommended that there is a need for enhanced disclosure, continuation of the issuer-pays model, strengthened process and compliance audit, reporting of ownership changes, disclosure of default and transition statistics and strengthening of the regulation of the CRAs in tune with these suggestions.
Priority sector M V Nair
Committee
To re-examine the existing classification and suggest revised guidelines with regard to priority sector lending and related issues.
Major Recommendations of the Committee are:
1. The target of domestic scheduled commer-cial banks for lending to priority sector may be retained at 40 per cent of adjusted net bank credit (ANBC) or credit equivalent of off-balance sheet exposure (CEOBE), whichever is higher.
2. The sector ‘agriculture and allied activities’ may be a composite sector within priority sector, by doing away with distinction be-tween direct and indirect agriculture. The targets for agriculture and allied activities may be 18 per cent of ANBC or CEOBE, whichever is higher.
3. A sub target for small and marginal farmers within agriculture and allied activities is rec-ommended, equivalent to 9 per cent of ANBC or CEOBE, whichever is higher to
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be achieved in stages by 2015-16. 4. The MSE sector may continue to be under
priority sector. Within MSE sector, a sub target for micro enterprises is recommended equivalent to 7 per cent of ANBC or CEOBE, whichever is higher, to be achieved in stages by 2013-14.
5. Banks may be encouraged to ensure that the number of outstanding beneficiary accounts under ‘small and marginal farmers’ and mi-cro enterprises’ each register a minimum an-nual growth rate of 15 per cent.
6. The loans to housing and education may continue to be under priority sector. Loans for construction/purchase of one dwelling unit per individual up to Rs.25 lakh; loans up to Rs.2 lakh in rural and semi urban areas and up to Rs.5 lakh in other centres for re-pair of damaged dwelling units may be granted under priority sector.
7. In order to encourage construction of dwelling units for Economically Weaker Sections (EWS) and Low Income Groups (LIG), housing loans granted to these indi-viduals may be included in Weaker Sections Category.
8. All loans to women under priority sector may also be counted under loans to weaker sections.
9. Limit under priority sector for loans for studies in India may be increased to Rs. 15 lakh and Rs. 25 lakh in case of studies abroad, from existing limit of Rs 10 lakh and Rs 20 lakh, respectively.
10. The priority sector target for foreign banks may be increased to 40 per cent of ANBC or CEOBE, whichever is higher with sub-tar-gets of 15 per cent for exports and 15 per cent for MSE sector, within which 7 per cent may be earmarked for micro enter-prises.
11. The committee recommends allowing non-tradable priority sector lending certificates (PSLCs) on pilot basis with domestic sched-uled commercial banks, foreign banks and regional rural banks as market players.
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12. Bank loans to non-bank financial intermedi-aries for on-lending to specified segments may be allowed to be reckoned for classifi-cation under priority sector, up to a maxi-mum of 5 per cent of ANBC or CEOBE, whichever is higher, subject to certain due diligence and documentation standards.
13. The present system of report-based report-ing has certain limitations and it may be im-proved through data-based reporting. There is a need to address the issues in data report-ing like pre-defined parameters, reference date, periodicity, unit of reporting, etc.
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Customer service
RBI panel on
customer
service
Chairman Mr.
Damodaran Ex
Chief of SEBI
Recommendations: Deposit insurance cover to increase to Rs. 5
lakhs No exorbitant rate for foreclosure of housing
loans Prescription on service charges for basic ser-
vices like remittances Compensation on delayed returns of instru-
ments and loss of title deeds Increasing cap of pre-paid instrument to Rs.
50,000 Intimating customer for breaching minimum
balance and charges for the same
In case of failure of ATM or net customer will not be required to bear loss.
Replacement of ATM card or debit card with Chip based card with a photograph of card holder
Small Scale Industries
KAPUR COMMITTEE-SSI
LOAN-Composite Loan up to Rs. 5 lacs, Loan
by SFC/Banks up to Rs. 25 lacs and above 25
lacs by SFC/BANKS any one
Sectoral allocation- 40% up to Rs.5 lacs, 20%
from Rs.5 to 25 lacs and 40% above Rs. 25
lacs.
Interest Rate –PLR or cost of funds
DICGC-scrap and banks to set up their own
sinking funds.
Adhoc upto 20% by BM.
Phasing out collateral security.
Change in definition of Sick unit.
Committee approach for appraisal.
MOU with SFC in each state by lending by
bank to sanction joint loan-WC by banks only.
PS funds should not be diverted for NABARD,
SIDBI, SFC, SIDC, NSIC, NBH, and HUDCO
BONDS.
Small Scale Industries
NAYAK COMMITTEE –
Recommendations- MPBF 20% of sales-maximum Rs. 5 crores
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P R NAYAKDY GOVERNOR RBI
Both term loan and cash credit loan up to
project of Rs. 20 lacs (working capital Rs. 10
lacs )
Preference to village, tiny and other small
industries
1st method of lending for institution marketing
goods of village, tiny and other small industries.
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MSME Working group to review the working of CGSTMSME
Having regard to the imperative of accelerating the flow of credit to the Micro and Small Enterprises (MSEs) sector, which is very critical for inclusive and equitable growth and larger economic empowerment, it was announced in the (paragraph 114) Annual Policy statement for 2009-10 "to ask the Standing Advisory Committee on MSEs to review the Credit Guarantee Scheme so as to make it more effective.” Following this announcement, a working group was constituted under the Chairmanship of Shri V.K. Sharma, Executive Director, Reserve Bank of India. The terms of reference of the Group were: i) to review the working of the Credit Guarantee Scheme and to suggest measures to enhance its usage and facilitate increased flow of collateral free loans to MSEs; ii) to make suggestions to simplify the existing procedures and requirements for obtaining cover and invoking guarantee claims under CGTMSE Scheme; iii) to examine the feasibility of a whole turnover guarantee for the MSE portfolio; and iv) any other issues. The group has recommended:
The main recommendations of the Group are:
1. Collateral free loans
The limit for collateral free loans to the MSE sector to be increased from the present level of Rs. 5 lakh to Rs.10 lakh and it be made mandatory for banks.
2. Guarantee Fee
a) The guarantee fee for collateral free loans upto Rs.10 lakh to Micro Enterprises to be borne/ ab-sorbed by the CGTMSE subject to the proviso that the Trust be free to adjust the guarantee fee both downwards and upwards based on the modelling of the dynamically evolving distribution of claims. This will ensure that the CGTMSE remains self-fi-nancing and self-sustaining in the long-term.
b) CGTMSE may charge composite, all-in guaran-tee fee of 1% p.a. and appropriately realign down-wards the guarantee fees chargeable to women entrepreneurs, Micro enterprises and units located in North-Eastern Region including Sikkim. The
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Trust may also annually review the Guarantee Fee to be charged on the basis of the pricing/valuation model suggested by the Group.
c) The Government of India to consider exempting both guarantee fee and the income on investments of the Trust from Income Tax, as is the practice in-ternationally for such non-profit credit guarantee or-ganisations.
3. Extent of the Guarantee Cover
Consistent with the recommendation for enhance-ment of the collateral free loan limit from Rs. 5 lakh to Rs. 10 lakh, the guarantee cover upto 85% of the amount in default to be made applicable to credit facilities to Micro Enterprises upto Rs 10 lakh. However, the extent of guarantee cover for credit facilities above Rs.10 lakh upto Rs.50 lakh will be 75% and for credit facilities in excess of Rs.50 lakh upto Rs.1 crore will be 75% upto Rs. 50 lakh and 50% of the amount in excess of Rs. 50 lakh, as per the extant provisions of the Scheme.
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Technology Committee On Technological Issues – W S Saraf - Dec 1994
Recommendations- An electronic funds transfer system is set up –
BANKNET communication network may be
used for the purpose.
Steps are taken by RBI to enact a suitable
legislation on the lines of Electronic Funds
Transfer Act 1978 in USA and Data Protection
Act 1984 in UK.
RBI may explore the feasibility of using
NICNET for electronic reporting of currency
chest transactions
Funds settlement in respect of Govt.
transactions may be delinked from submission
of scrolls and documents to PAO of Govt. dept.
Funds settlement to take place in a prescribed
frame ensuring at T + system
Electronic clearing service is introduced to
effect repetitive low value transactions like
interest, dividend, refund orders, salary,
pension etc.
Bills payment system to introduce to enable
customers of utility services to pay bills by debt
to their accounts in banks.
Cheque transaction system should introduced
initially for Intra-bank cheques of value up to
Rs. 5000. In due course, it may be extended to
Inter-bank instruments. Suitable changes to be
initiated in NI Act.
Universal Banking
KHAN COMMITTEE (Harmonizing the role of DFI and banks for moving
Universal banking –doing all banking activity
both commercial and developmental under one
roof.
CRR to be reduced to 3% and SLR to be
phased out
FII to be allowed to accept short-term deposit.
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towards universal banking)
DFI has no future –allow converting to bank or
NBFC.
Transfer of RBI holding of equity in DFI to
Government-RBI can not be owner as well as
supervisor at the same time.
Doing away with concessional lending.
RBI approach – allow 5 years to DFI to convert into
banks.
Vigilance Expert Committee on Bank Frauds -Chairman:
N. L. Mitra
Recommendations- Suggested both - preventive and curative
aspects of bank frauds.
Recommended for including financial fraud as a
criminal offence.
Suggested for amendments to the (A) Indian
Penal Code by including a new chapter on
financial fraud; (B) Indian Evidence Act to shift
the burden of proof on the accused person and
(C) special provision in the Code of Criminal
Procedure for transferring the properties
involved in the financial fraud and confiscating
unlawful gains.
Preventive measures including the
development of Best Code Procedures by
banks.
Vigilance GHOSE COMMITTEE -High level committee on fraud and malpractice
Recommendations- Introduce Concurrent Audit -substantive
checking-special report to bank.
Photograph of the depositors.
Desk card to employees.
Cash and valuable in joint custody.
Cash should not be deposited other than cash
department.
Advance not to exceed delegated authority.
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Chapter- 37
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Becoming an effective trainer
….true illiterates of the future will be those who do not relearn and retrain. ………Anon
1. Trainer as a sales person1.1There is a little bit of selling that each one of us does all the time. The
priest at the temple is selling the service he knows best. The young man appearing for the interview is selling his candidature to the board. A policeman is selling his skill to control law and order. The teacher sells his wisdom and knowledge to students. The trainer is to do the same job. The selling is, therefore, essential of life.
1.2The trainer as a sales person has to understand his customers (trainees), their wants (training needs), how to map these wants (training need analysis), how to satisfy these needs (training effectiveness), how to measure needs satisfaction (training evaluation) and to take feed back to ensure that training serve its purpose (return on training investment).
1.3The key to the success of any organization lies in how efficiently the organization manages its human resources. The principle applies more aptly to service institutions like banks. The issue is still more relevant to public sector banks as they are striving hard to keep pace with the technological changes and challenges of competition. All this requires creation of new competencies and capabilities in officers/employees on an on-going basis for which a good training system is a must. Training is not one-off ‘repair’ to meet an immediate need but a tool of continuous development. Training not only makes the mangers’ efficient but also makes them effective.
2. Making of a trainer2.1 One may become a trainer by choice (a core faculty or faculty selected
through interview process) or by default (picked up by the management and posted). But once he is in the system, he must consciously try to develop him-self. He has to be a friend, philosopher and guide of trainees. He has to be Fit, Fast and Smart like a sales-man.
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2.2 A trainer should not only be fit to be a teacher but also continue to be fit for teaching. He should have pleasing personality, attractive mannerism, positive attitude and good communication skill. He should develop trust, closeness and rapport with his trainees. He should speak convincingly and listen non-defensively. He should express clearly and logically. He should be ready to guide, help and direct. He should be hugely communicative and maintain a personal touch with trainees while giving them enough space to communicate with him. He should know art of answering questions of the trainees logically and convincingly. He should be conversant with all training methodologies and techniques to deliver what trainee needs and not what trainer has. He should be computer savvy. He should also be a good learner. Above all he should make continuous efforts to keep himself up to date so that he continues to be a fit teacher.
2.3 It is said that reading makes a ready man. Reading is basic requirement of a trainer. In fact trainer must develop habit of rapid reading. As per survey, average reading speed of executives in India is 250 words per minute when in fact it should be 500. President Kennedy is believed to have had a phenomenal speed of 1500 words per minute. He was not born with this capacity; he cultivated this. Poor reading erodes 50% of one’s time. Fastness is thus a special virtue of a trainer.
2.4 Fastness requires setting the priorities right. He should introduce trainees with faculties as well as within group as early as possible. Small anecdotes, jokes, stories etc. create humor and improve involvement. He should be articulate enough to use these tools to break the ice. He should have ability to place first things first such as class- room setting, address system, multi-media, air-conditioning and lighting. He should be fast to pick- signals of passive listening like no questions, blank faces etc. and should encourage them to come out of the shell by putting questions and stimulating interaction. He should be sensitive enough to observe happenings both inside and outside the class and promptly take proactive measures to keep the learning atmosphere in its right earnestness.
2.5 Smartness demands that trainer is not only smartly dressed but also passionate about his profession. A smart trainer is one who checks and makes his training style and language a perfect fit. He should have high
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level of energy and abounding self-confidence to command respect from the trainees. He should dress appropriately. The dress makes a statement about trainer’s personality.
2.6 Effectiveness of the trainer is like developing a brand. Like a successful brand, a trainer should be customer (trainee) driven. He has to deliver what trainee needs. He has to deliver what can be put into practice.
3 Effectiveness ladder3.1 Like advertising, a trainer will fail to deliver if he lacks to connect with the
people (trainees). As learning process of adults is entirely different from that of schoolchildren, a trainer has to be conscious of connecting with trainees to make them active learner.
3.2 The training is known as long-term intangible investment. An effective trainer has to tangibilise the intangibles. He has to make the results visible by change of attitude, improvement of skill and betterment of knowledge of the trainees. He has to quantify the improvement by measuring results.
3.3 Effectiveness ladder starts with identification of training needs. Inspection reports, annual performance appraisal of employees, customer complaints, review meetings, interview for promotions, new product/business line, new recruits, new promotion etc. are events that trigger training needs. Structured pre training survey is the other tool to identify changing training needs of the employees. In addition, there are skill-oriented jobs like computer operations that require regular skill up gradation.
3.4 Once training needs are identified, next step is to analyze these needs and translate into specific topics and modules. In order to evaluate the results, training objectives are simultaneously determined so that aggregate learning outcome is quantified through evaluation process. It is essential that programme objectives are set out from learner’s perspective and should also quantify benefits that are expected of the trainees.
3.5 Next step is to identify programme contents. This is also known as topic planning. A trainer should remember that programme contents are contained in the objectives and conversely programme contents dovetail
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into programme objectives. Hence contents should match training needs. Flexibility is a key to this process. At the start of the progrmme, the contents should be reviewed with the target trainees and depending upon their feedback, a quick adjustment should be done so as to meet expressed need. If necessary, additional sessions can be planned. This process of consultation has one more advantage. It creates commitment and ownership of the participants.
3.6 The subject sequencing, time allocation, training methodology etc. are very crucial for implementation perspective. All these have to be planned in logical and integrated manner. Programme should start from simple, easy to understand and uncomplicated subjects and gradually rise to difficult, hard and complicated subjects. The efforts should be to develop confidence and create interest of trainees and maintain momentum of the programme. Support material like handout, case studies, exercises etc. should be provided to supplement the training efforts or to give group/team assignments.
3.7 The trainer should in between the programme do recap of the training events and should also do mid-term review with a view to do mid-term correction. Experience shows that trainees very often are not able to express their requirement in early stage of the programme and it is only when they are exposed to the subject, they are able to give meaningful suggestions.
3.8 The trainees are other important element of this value chain. A trainer should constantly strive to empower his trainees. He should
Promote self-awareness and self-effectiveness among trainees. Initiate the process to bring down barriers between the participants
and remove inhibitions. Facilitates the process of exploring, knowing and developing
healthy relationship among participants. Motivate the participants for meaningful and productive
participation. Promote free and open exchange of experiences and ideas. Acquaint them with the dynamics of a training group and group
process. Develop respect for group procedures and norms.
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3.9 Training effectiveness can be better measured through standards of performance that participants are required to attain during the process of training. These performances can be measured through entry and exit test. The test process will not only speak about knowledge addition of the participants in general but will also help the trainer to identify the knowledge gaps that he has to fill up. Incentive/prizes are other means to improve enhancement of performance for high flyers. To encourage participation, the trainer should always give appreciation and acknowledgement of good work to trainees.
3.10 Effectiveness ladder requires strategic integration of training system, trainers and the trainees. Trainer’s commitment and passion smoothen the integration process.
4. Develop your brand- standard setting 4.1Setting standards are like building the brands. And like a brand, a trainer
must be value driven. Firstly he should have faith in training as a tool for growth and development. He should have firm belief in humanistic approach in training. He should have commitment to the programme and its objectives. He should have professional commitment to excel. And above all, he should have faith in participatory training.
4.3Session feed back is an important tool that enables the trainer to evaluate his performance. A trainer should not be hesitant to use this tool. He should use this as often as necessary. In order to encourage honest feedback, a trainer should not only guarantee anonymity but also take the feed back in sporting sprit. He should evaluate him-self over a time span. He should constantly aim at improving his performance. He should consult his peers and selected trainees to identify his weaknesses and make conscious efforts to improve upon them.
5. Handling problem situations5.1A trainer may come across a situation when trainees differ from his point
of view. They may also express their dissent vocally. Whatever be the reasons, such situations require high degree of patience and competency from the trainer to handle such awkward situations. He should be tactful as well as strategist.
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5.2A trainer my come across a situation when a participant put repeated questions or make unnecessary/unwarranted suggestions. A trainer should never get provoked on such events. He may tactfully ask the participant to briefly indicate in what ways his contribution is helping the discussion and may involve other participants to bring home the point that questions are unnecessary and are not relevant.
5.3 A situation may arise when participants may involves themselves in counter arguments. Such situations may create unhealthy environment in the classroom and may ultimately affect learning atmosphere. A trainer should tactfully intervene on behalf of the group and state that such discussion is not contributing to the knowledge of the group without ascribing motive even if he is sure what lies behind the confrontation.
5.4A participant may be found unable to make a substantive point due to communication problem or lack of understanding of the subject. In such a situation the trainer should give patient and genuine listening and understand the problem. In case it is observed that problem is due to comprehension of the subject, then the trainer should again explain the subject. If problem is in communication, the trainer should paraphrase the subject to clarify the doubts. The participants can also be encouraged to speak in their regional language so as to enable them to communicate clearly/freely.
5.5Private or cross conversation is a problem very often faced by the trainers. Trainer should draw the attention of the whole group and encourage participants to share their views with the group so that every body is benefited. Or, he can use non-verbal communication to show that behavior has been noticed. He may ignore the behavior as tactical measure also.
5.6A participant may go to an extent where he challenges the trainer. Notwithstanding the motive of the participant, a trainer should not lose his composure. He should not get provoked. He may state is disagreement but acknowledge the contribution of the trainee.
5.7Lack of participation or response is other common problem. This can be overcome by encouraging participation through questions and answers. Teaching through a case study can be of great help in such situations.
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5.8Distraction through movement of the participants or late arrival of participants is other major problem, which is often confronted by the trainer. A trainer should tell to participants about the expected behavior at the start of the course. If body language of the participants says that they are not interested in the session, then the trainer has to change his training style as well as methodology. He may in exceptional cases use administrative measures to check delinquency.
5.9Occasionally one or two participants may try to monopolize the discussion. One reason may be that the trainees have very high level of self-esteem and feel that they are entitled for such domination in the group. The other reason may be to secure leadership among the group. A trainer should keep his cool and should never behave out of emotion. His strategy should be to handle the situation without getting into a direct confrontation with the participants.
5.10 A trainer has cited an incident when he find that his ex-boss is his trainee in a training programme. There may not be any problem with the boss but the trainer may be worried how to teach him. Such a psychological barrier may come very often. Here he is facing the boss; others may have a senior colleague. A trainer should understand that he is not teaching to a boss or subordinate. He is not teaching to a junior or senior. As one can learn from his subordinate, he can learn from his seniors also. A trainer should have confidence (and not fear) to handle such situations in a stress-free manner.
5.11 A trainer was once asked by one of his trainees about mistake he himself committed when he was in field. He could sense that purpose was to distract the trainees from learning path and to embarrass the trainer. A trainer must be ready to face such peculiar situations without losing heart. He should be brave to acknowledge his shortcomings. He should tell the trainees that this is what the training is meant to be where shortcoming of not only his but of others also will be discussed so that mistakes are not repeated.
5.12 A trainer may confront with employees who are not really interested to learn. He may also find employees not interested in training at all. A trainer is like a gardener. He plants the flowers, create a context, provide
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support, and is there to help the trainee in his development. However having done that he does not always expect every effort to bear fruit. He should accept that some peopled do not want to be trained and he may not be able to make a difference in his development. An effective trainer should show empathy in dealing with such people and instead of judging the individual by surface behaviour; the trainer should seriously create conditions, which motivate the people to work. They should be open to personal learning, to receive feedback and ready to learn even from the employees.
5.13 A trainer may confront a situation when he does not know the answer to a problem. In such situation, he may commit to his trainees to come back afterwards. He should honestly honour this commitment. This is his professional obligation.
6. Summing up- playing the value game6.1 If you scan the career history of most admired bankers, you will find that
most of them were trainer at least once in their service career. And, they became successful banker, great speaker and visionary leader because of this. So if you have opted yourself as trainer by choice, you perhaps know the value of this opportunity, or if you are in the training system by chance, it is a Godsend opportunity for you. It is a very good break in your service career. You will not only get love, respect and regard but also experience deep sense of satisfaction by contributing some thing of great value to you and to your organization. In selling perspective, this can be termed as value addition in your personality and value creation in developing human resource.
6.2 It is said that any body can be student but a few can be teacher. “Budding trainers,” it is a lifetime opportunity for you. You have great career ahead. You are in value creation mode. You are in the profession of rendering the greatest service of mankind. Develop your self-fulfilling prophecy and enjoy.
“There are no boring subjects and there are no boring trainees.”
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“Only there are boring trainers.”
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Chapter - 38
Trainers’- as change Managers
“ It is not the strongest of the species that survive, nor the most intelligent but the one most responsive to change.”
-Charles DarwinIntroduction-Paradigm shift in Indian Banking
The changes after liberalisation, privatisation and globalisation in India since l991 has a significant impact on the banking system that has exposed the public sector banks (PSBs) to de-regulated and competitive environment. These changes have brought pressure on business share, pressure on interest spread (NIM) and pressure on financial health of PSBs. The customers expectations and demands have also under gone radical change due to entry of private banks who have started offering variety of value added services with focus on door step delivery and that too round the clock. The challenge and pressure of this new environment has resulted into a sea change in banking business process. Bank’s are innovating new products, offering 7days a week to 24 HRS banking, introducing new delivery channels
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and devising new ways and means to cut cost, to overcome delays, and to offer services at competitive rates. They are becoming more and more professional in their approach by complying with international banking standards in the area of risk management, capital adequacy, loan loss-provisioning, assets quality and corporate governance. The merger, acquisition and business alliances have become new mantra of survival and business growth for banks. Intensive use of information technology is another consequence of this business process re-engineering which has opened new delivery channels through ATM, Tele-banking, e-banking etc. where a customer can do banking to his convenience any time any where and that too without physically visiting the bank. The pressure to cut cost and over come delays in decision making has given way to structural changes as banks have started transforming them-selves into a lean and thin organisation by moving to three tier structure from four tier and right sizing manpower through Voluntary Retirement Scheme and Sabbatical leave scheme and taking measures for improving productivity by re-deploying and re-locating manpower as per business need from surplus to deficit pockets and from controlling offices to branches. In preparing for these changes focus is now on adopting a holistic approach to Human Resource Development by training and retraining existing workforce to enable them to cope with the new environment more efficiently and more effectively.TRAINING –as Human Resource Development process
This paradigm shift is all pervasive and has necessitated for the banks to respond fast, firmly, decisively and innovatively. In order to enable the employees to cope with these changes more efficiently and professionally, banks have to devise appropriate Human Resource Measures to develop ATTITUDE, SKILL and KNOWLEDGE of their employees through appropriate training input with focus on: -
1. To change Attitude (mindset) of the employees in tune with changing times and requirements.
2. To develop Skills in the employees in operational areas such as Product development and marketing skill. Credit management including credit monitoring. Forex management and international trade.
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NPA management including recovery of problem loan. Marketing fee based product and services. New risk management practices. Skill to operate electronic environment/technology driven banking. New internal control and audit skill in the area of e- banking. New focus in customer’s delight.
3. To have faster dissemination of Knowledge among the employees in the area of New concepts like risk management, derivative trading, ALM etc. New products like insurance, cash management, e-loan etc.
4. To identify hidden talents who can be better utilized in the area of their competence for the growth of the organisation.
However to make the training result oriented, it is required to effectively address certain misconception of training such as training is a paid holiday for the employees or a waste of scarce organisational resources by creating necessary awareness about its usefulness as a tool of organisational and individual growth. Training needs and employees -
One parameter by which employees rate their organization is training. As per BES 04, about 40% respondents’ felt that training is one need, which is not being adequately addressed. They felt that organization that is giving training is enhancing their skills and productivity. And most importantly they believe that raining will help them grow- either within the organization or outside- both in terms of job role as well as salary. Naturally, all these things will make the employee to respect the employer they work for more. Preparing for the changes-Convergence of training with Human Resource Development Plan
In order to have convergence of training strategies with Human Resources Development Plan, the trainer has to address the following issues:
To develop an integrated approach to learning -participants explores in training situation what interests them most and the job of the trainer is to provide that opportunity.
To develop an appropriate training method and technique as effective delivery mechanism.
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To act as facilitator -to serve as resource for guidance and information and converting participants from passive listener to active learner.
To give strategic thrust to new dimension of banking business in order to make the training system relevant and participant oriented.
To measure effectiveness of the training. This can be measured by greater organisational effectiveness and improved participants behavior through a well-designed and tested feedback cum evaluation system.
To do training audit- are we doing it right? – To establish standards for training and evaluating it continuously to check if the objectives are achieved. As the training programmme by nature are short-term where impact is invisible, evaluation is difficult and results are intangible, role of the trainer is not only to understand these limitations but also to make continuous and concerted efforts to effectively focus to improve training delivery mechanism based on feedback from training audit.
Training effectiveness –Key drivers The Trainers, the Participants and the Organization are all partners in training efforts. This
requires collaboration at all levels starting from identifying training needs, designing courses, and
nominating trainees and up to follow-up for post training support/placement for measuring results.
The objective is achieved if the training is viewed in the organization on continuous basis as a change
agent of employee’s development and organizational growth. The key drivers to these changes are: -
Key Drivers Measured by Attitudinal change Greater acceptance of the role and
responsibility, willingness to accept change by way of promotion/ job-rotation/transfers, removal of fear syndrome etc. all reflected by change in work culture.
Job Satisfaction By increased involvement of employees and orderly compliance of system and procedure.
Job Enrichment By higher output, improved skill in technology, marketing, and recovery and in functional areas such as credit appraisal, risk management etc.
Boosting employee moral and building commitment.
By improved productivity and confidence in decision-making.
Motivation To get the best out of every individual in the organization measured by improved business per employee/profit per employee/higher
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business share, and improvement in customer base etc.
Unqualified support to business goal
To have a passion for excellence –reflected by business results.
POST VRS-Challenges and Opportunity The post VRS situation in the banking industry has brought both
challenges and opportunities to the trainers. The branch where manpower is in short supply has to be provided manpower by redeployment. Attitudinal shift is required in the mindset of employees to accept this change, which can be done through HR intervention via training. Similarly, vacuum caused by exit of senior level officials has created shortage of skilled officials in the area of treasury management, forex management, credit management, marketing of retail products etc. This requires training of the officers, both existing and promoted, to sharpen their skill in the area where these officers are proposed to be engaged. To tap new business in the area of retail banking, housing finance, cash management, insurance and other value added products, there is need to train the identified officers so that they are well equipped both in knowledge and skill to sell these products by proactively contacting the existing and potential customers. In customer centric environment, the attitude and approach of the employees have to be changed through training so that there is new organization work culture of customer’s concern and organizational prosperity. With increased focus on e banking and other e-based value added products like EFT, ECS etc. There is need to develop skill of the employees to make them fully conversant with its application. Over all in the competitive scenario where there is continuous pressure on spread and profitability, each training programme should focus on the employees to build a new work culture of unqualified support to business goal and employees’ excellence. Summing up
As stated earlier the trainer is a facilitator of the learning process in this value chain and his effectiveness is measured by harnessing of untapped potential of its employees. He has to identify training needs and plan the programme. He is a subject specialist so that he can respond to the doubt and queries of the participants in clear and convincing manner. He is a role model of experienced banker to offer relevance of theory with practice. He is
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a counselor, a friend, a philosopher and a guide to the participants. He is a leader having responsibility to effectively conduct the programme, achieve its objectives, and give direction and support and to bring required changes in Attitude, Skill and Knowledge of the participants. Such a learning process can truly transform an organization into a learning organization i.e. an organization, which can actually develop employee’s commitment for organizational growth.
Trainer is thus a change Manager. To make these changes happen is his job.
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Chapter - 39Innovate or Die
New Mantra of modern day banking
“Knowledge innovation has come to mean the systematic application of new ideas into the marketable goods and services, for the
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success of enterprise, economic vitality and the speedy advancement of society.”
1. ‘Innovate or Die” - New mantra of modern day banking -
1.1 Innovation is application of ideas – new or existing - in new ways or in
new fields or in new products. It helps an organization to cut cost, to
improve profit and also to improve market share.
1.2 Organizations often associate innovation with a product or process. In
fast moving time that we live in, this is not enough. Today innovation
means change in business model it-self.
1.3 Innovation happened when TCS began to offshore information
technology, or when Dhirubhai Ambani told his son , Mukesh, that only
if he can price a call less than the cost of post card will his mobile
business has future, or when Jack Welch set up a call centre at
Gurgaon to answer queries raised by General electric customers in US,
or when Lalit Modi introduced T 20 format in Indian Premier League.
1.4 Winning companies recognize the need of ‘out of box thinking’ and are,
therefore, creating culture where ideas keep flowing continuously.
Those who do not innovate, join the list organizations that drive
themselves to oblivion. ‘Innovation’ is ‘in’ word in corporate
philosophy now.
1.5 Competition, convergence and consolidation are key drivers of banking
these days. Competition breeds innovation and innovation breed’s
competitive advantage. To stay ahead of their competitors, banks are
trying new ideas (innovations) and reinventing existing products
(renovations). ‘Innovate or die’ is new mantra of modern day
banking.
2. Customer is driving innovation – 2.1 Customers buy not because they understand the product or service
but because they feel that the bank understand their needs and wants.
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“High healed shoes were developed for short women who were tired of being kissed on fore-head.”
Customer centric innovation flips traditional ‘design – produce - sell’
model into ‘design – redesign – innovate – produce - market ” model.
In fact it is the changing needs of the customers that drive innovation.
2.2. Innovations come in two forms - the quantum leap type innovation
and incremental innovation. Quantum
leap type innovation in the financial
services industry may not come very
often but incremental innovation is now
order of the day. Engaging with the
customer is first step in the innovation
process, which provides strong insights for value addition (see box).
2.3 ‘Walking with the customer’ is a strategic tool of innovation as
strategically companies are now not generating ideas internally or having
R & D departments to innovate but are open to ideas from customers and
alliance partners. As one walk with the customer and is with him right
through while selecting, buying and using a product, one can identify great
deal of happening that can be used for creating (innovation) new products
or modifying the existing products (renovation). Walking with the
customer is a strategic tool of (a) mapping the customer’s need by
analyzing activities that customer performs while selecting,
purchasing or using a product, (b) locating the gap based on unfulfilled
or expected needs and wants and (c) closing the gap by introducing new
products (innovation) or modifying existing products (renovation) as
per identified needs and wants. Customer thus teaches everything
including what you should innovate.
3. Innovate to stay ahead – A new banking paradigm - Since
each product has its life cycle, banks are required to continuously innovate and
renovate products so that new/renovated product can replace the existing product by
the time its life cycle is over or new product is launched by its competitors. Creation/
modification of products are done either through value creation (new products) or
value addition (new features) or value affordability (less price or no frill products).
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After liberalization, privatization and globalization of banking in India, there is a
paradigm shift in product development with regards to process, pricing, place
(delivery channel), packaging, people and partnering. (Following paragraph will
enlighten the readers with paradigm shift taking place in product development. List is
only illustrative not exhaustive).
4.1 Deposit products – Accepting deposit is basic function of banks. From
core deposit products like savings account, current account and fixed deposit, banks
have gone a long way in offering augmented deposit products like monthly income
plan, reinvestment plan etc. Some emerging innovations are: -
3.1.1. Opening of no-frill savings accounts with zero balance is recent
innovation, which has been introduced at the instance of Reserve Bank of
India for financial inclusion of poorer section of the society. It is built on the
concept of value affordability so that customer can enter the market with
cheap entry-level product and thereafter use the product as per his capacity.
3.1.2. Tax-incentive on term deposit is another recent development. Banks will
have to structure deposit products of specified maturity to attract investors
who were hitherto parking their funds in small savings schemes of post
office, life insurance etc. for tax savings.
3.1.3. Floating rate of deposit products where interest rate is linked to some
benchmark rates like inter-bank call money rate are also entering in the
market. These products assure market related return to depositors. They
also help the bank in mitigating interest rate risk and overcoming ALM
problem.
3.1.4. Flexi-fix deposit with sweep and reverse sweep facility to a deposit
account (Savings/Current) has also become very popular where sum
exceeding minimum balance is auto-sweep to fixed deposit account. To
facilitate withdrawal money is reverse-sweep to savings/current deposit
account as and when required. The balance lying in the flex-fix deposit earns
interest as per fixed deposit rate.
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3.1.5. New deposit products with auto investment facility in mutual funds (debt
funds or equity funds) are also evolving with objective of maximizing return
to the depositors. Since dividend income (in the hand of investors) and
capital gain (long term) is exempted from tax, these products have become
very attractive.
3.1.6. Opening of accounts with zero balance for NRI and salaried class is other
innovation, which the banks have successfully used in mobilizing account of
salaried and NRI customers.
4.2 Retail Credit Products- Given the microeconomic scenario, it is expected that retail
loan segment will grow at 35% CAGR. Seeing big opportunity ahead, banks have
become aggressive in retail loans and attracting customers with innovative offerings.
Some emerging innovations in retail credit products are-
4.2.1 Pre approved housing loan so that customer can select the property of
his/her choice as per his/her financial resources.
4.2.2 Pre approved personal loan so that customer can draw the amount as per his
convenience as and when he needs money.
4.2.3 Pre approved housing properties that save the borrowers from hassles of
going through formalities of title examination and valuation.
4.2.4 Bridge loan against mortgage of existing house to enable the borrower to
buy a bigger house and loan will be repaid from sale proceeds of old house.
4.2.5 Overdrafts against security of house property, which house owner generally,
feel as unproductive.
4.2.6 Variants of personal loan like loan for purchase of jewellery, loan to meet
tax liability, loan to meet festival expenses, loan to meet critical sickness etc.
4.2.7 Home loan with ‘repayment holiday’- to enable the borrower to tide over
unexpected financial needs like tax liability, educational expenses of children or
expenses of critical illness.
4.2.8 New home loan product launched is 110% home loan requirement. Extra
10% is for furnishing the house, which comes along with the home loan.
4.2.9 Overdraft through ATM to privilege customers to meet emergency
requirements is other innovation.
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4.3 Financial Services 4.3.1 e-Commerce is opening up opportunities for bank to act as intermediaries
for authenticating transaction between retailer and consumer through digital
signatures. So far banks are issuing guarantee and letter of credit by giving
assurance to seller that he will get the payment of goods/services sold and
authentication of e-transaction is a logical extension of bank guarantee and letter
of credit business.
4.3.2. Integrated financial services provided by financial advisers who assist
customer in executing long term saving and investment plan to achieve individual
financial goals.
4.3.3 Mobile banking is other innovation which is breaking the barrier of branch
banking, PC based banking and ATM.
4.4 Risk free income- Banks are innovating by leveraging on their credit
dispensation strength to augment risk free income through variety of ways like-
4.4.1 Originator of loan- Banks will mobilize loan but will not carry in their
books. Earn income as originator. LIC has huge corpus of funds but cannot
directly lend. Here originator has opportunity.
4.4.2 Monitoring fee- Transfer loan to SPV or other banks through
securitization process but continue to earn fee-based income for monitoring of
loan. Even in case of sale of distressed assets to ARC, bank has opportunity
to earn monitoring fee, as they know the assets better than the buyer.
4.4.3 Take out finance- Largely resorted to for infrastructure projects where
the loan is taken up by other institution after a specified period to overcome
problem of assets liability mismatch.
4.4.4. Money transfer business- Money transfer is business is growing with
the growth of remittance in India which is estimated at $22 billion annually.
And banks are tying up with money transfer companies like Western Union
Money Transfer to offer this service to their customers.
4.4.5. Financial advisors- from relationship manager to financial advisor to
private banker- all services are for fee. Banks are now offering discretionary
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portfolio management services- investment in art, philanthropy, real estate,
funds within country and in offshore funds - for its affluent customers all
under one roof. Property advisors guide customers about entire process of
selecting and buying a house and handle the cumbersome documentation
formalities and the registration on his behalf.
4.4.6 Gold hedging services- Most Indian gold jewellery manufacturers are
now hedging their gold purchases in Dubai Commodity exchange in absence
of such facilities in India. A few private sector banks have seen business
opportunity here and are offering gold-hedging products. The gold traders and
jewellery exporters are expected to avail gold hedging service, which has very
lucrative market.
4.5. Selling of third party products-4.5.1 Starting from selling free personal accident to holders of credit card,
ATM card and Kisaan Credit cards, banks have gone a long way of cross
selling various insurance products like life insurance to savings banks
account holder, credit protection bundled with education loan, housing
loan and other loan, loss of baggage and other insurance bundled with NRI
accounts. These innovations are offering business avenues of earning fee
based income by selling products on behalf of third party where banks
have no expertise or product offering is not possible due to regulatory
constraints.
4.5.2 Apart from selling insurance and mutual funds, banks now see
opportunity in selling gold coins and bars to earn extra fee based income.
Buyers find investment in gold as attractive option since interest income in
fixed deposit is comparatively low to increase in the price of gold in the
recent past. Since gold coins and bars are hallmarked, buyers feel secured.
4.5.3 Selling of stamp papers, collection of utility bills like electricity,
telephone and school fees, collection of taxes for the state and central
government, payment of pension of government, railway and defense
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pensioners, safe keeping of examination papers, credit/debit cards in
alliance with other banks etc., are fast expanding fee based services.
4.5.4. Prepaid gift card is recent innovation, which is substitution of gift
voucher/ gift cheques. These cards act like a debit card, which can be used
by the recipient of the gift for purchasing any article/good from approved
merchants up to the value of the card. Bank can earn extra fee based
income by selling such cards by way of upfront fee, reload or reassurance
charge, refund charge etc.
4.6 Secondary market for bad loans
RBI has made the beginning by putting in place the policy of buying and selling
distressed assets in policy announcement of 2005.Indian bad loan market is sizeable
and provides immense business opportunity. And the driver of the market is potential
profit.
4.7 New credit products
4.7.1 Commodity Finance Business- Commodity financing business has
brought new revolution in credit business. Banks are innovating products to lend
to farmers and traders in collaboration with commodity exchanges against demat
warehouse receipts of gold, silver and other commodities. Collateral managers are
also designing new products to assist banks in undertaking due diligence (credit
risk), guaranteeing quality and safety of the commodity (operational and
performance risk), documentation (legal risk) and insurance (default risk). India’s
commodity trading is estimated to Rs. 400,000 crores annually and offers good
business opportunity.
4.7.2 Asset based financing (ABF) - Asset base financing started from
transportation segment (preferably truck financing) and is gradually spreading
into financing of bulk machinery like printing machinery, road building
equipments, medical equipments etc. To mobilize business banks are entering into
business alliances with the manufacturers and offering credit to buyers backed by
security of assets crated out of the bank loan.
4.7.3 Channel financing - Channel financing is an innovative finance mechanism
by which banks meets the various funds requirements along with supply chain at
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the supplier’s ends itself, thus helping him in seamless cash flow along the
arteries of the enterprise. Channel finance ensures the immediate realization of
sales proceeds for the client’s supplier, making practically a cash sale. Under
channel financing, the dealer can leverage on the relationship with reputed
companies in sourcing low cost credit with support from their counterparts. Under
channel financing following credit facilities are available-
o Discounting of trade bills accepted by the dealer/distributor.
o Limited overdraft facility to dealer/distributor for his business dealing
with large corporates.
4.7.4 Micro-credit through on line route- Inspired by global efforts, some
websites are providing platform to HNIs and professionals who want to extend
credit to rural entrepreneurs and wants to make difference in the life of rural poor.
These websites employ crowd-funding techniques, informing and encourage
common people online to act as investors in microfinance space aimed at the small
borrowers and tries to seek investment from them where business plan inspire and
suits them. For example Chennai based Rangde lends mainly to women and
Bangalore based Dhanax reaches out to self help group in urban area. They also
encourage people to contribute beyond investing, volunteering time and efforts
with them for the social development.
4.8. Delivery channels
Banks now have multi channel approach, which add convenience to
customers on one hand and cost effectiveness to banks on the other hand. ATMs
are now gradually becoming more popular and offering 24X7 facilities to
customers. While mobile ATMs are bringing service to customer doorstep, there
are specialized ATM for blind, solar powered ATMs for rural areas, Barcode
enabled ATM for payment of bills and so on. Sunday banking and 8 AM to 8
PM banking is other innovation, which has totally transformed the delivery
channel.
5. Captivating the customer through innovation – A new learning curve
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Walk in business is the thing of past. The customers are now not only demanding
on price (interest rates, service charges etc.), they are also demanding on product
(quality), place (home delivery, internet banking), packaging (brand affinity), people
(customer service), partnering (business alliances, direct selling agents), and
promotion (discount, freebies etc.). Due to this old business model of ‘capturing
customer through aggressive selling’ has given way to new business model of
‘captivating the customer through innovation’.
New learning curve is-
Shift focus from product to customer – You need to appreciate that
the Customer is King.
Anticipate and adapt as per customer’s changing need and demand –
You need to continuously innovate or renovate your product to
stay ahead of your competitors.
Take speedy action and decision to have first mover advantage.
Make effective implementation- Idea alone cannot deliver.
5. Looking ahead -
Indians are known to have good culture of innovation but bad for execution.
Hence, bank people should learn not only to innovate but also to implement
innovative ideas into practice. Next big thing is learning to accept change. The
person with the best idea may not win but a person who learns the fastest win. The
lesson is learning the change is as essential as innovation. Next important thing for
innovation is speed. The success of innovation lies in speedy implementation of the
new ideas before the competitors are able to copy them. Lastly deregulation and
liberalization plays a major role in inducing banks to innovate as it increases
competition and allows necessary freedom to practice new ideas. Although
significant progress has been made in India in past 10 years in this regard, yet there is
good scope of further liberalization and deregulation so that banks have full liberty to
offer products and services at par with international standards. The Indian banking
industry is hugely under-penetrated industry and it is expected that with innovation,
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banks will be able to make inroads in the new markets by putting the customers at the
centre of everything they do.
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