Banking Environment and Obligations

Agenda• Introduction• Phase I – Early phase from 1786 to 1949 of Indian Banks• Phase II – Nationalization of Indian banks and upto 1991 prior to

Indian banking sector reforms• Phase III – Indian Financial and Banking sector reforms after 1991• Issue of new banking licenses

New Banking License

• RBI declared in its annual policy (2009-10) about new licenses being issued for opening up banks in India

• The issue of new licenses has come after the year 2000• RBI has published a discussion paper which gives the basic

guidelines about the prospective candidates for the new banking licenses

• RBI aims to have an in-depth discussion with all the stakeholders before finalizing the blue print of the guidelines

Role and Management of Banking Sector

• Three primary functions in an economy― The operation of payment system― Mobilization of savings― Allocation of savings to investment projects

• Exerts a +ve influence on overall economy by― Allocating capital to highest value use― Limiting the risks and costs involved

• Management : State Vs Market― State co-ordination (repressive policies) ensure a better economic outcome by

Channeling savings to strategic projects that would otherwise not receive funding Creating a branch infrastructure in rural areas that would not be build by profit-maximizing

private banks― Market co-ordination (liberal policies)

Repressive policies have a –ve effect on volume and productivity of investments Giving importance to market forces increases financial development and leads to higher

economic growth

Financial Structure1. Commercial Banks

a. Public Sectorb. Private Sectorc. Foreign Banksd. Cooperative Institutions

i. Urban Cooperative Banksii. State Cooperative Banksiii. Central Cooperative Banks

2. Financial Institutionsa. All-India Financial Institutions (AIFIs) b. State Financial Corporations (SFCs)c. State Industrial Development Corporations (SIDCs)

3. Non Banking Financial Companies4. Capital Market Intermediaries

Phase I – Early phase from 1786 to 1949 of Indian Banks

• The General Bank of India was setup in 1786• East India Company established Bank of Bengal (1809), Bank of Bombay (1840), Bank of

Madras (1843) as independent units called Presidency Banks― Amalgamated in 1920 to form the Imperial Bank of India ― Started at private shareholders bank, mostly European shareholders

• In 1865 Allahabad Bank was established and first time a bank was established exclusively by Indians

• Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore• Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara

Bank, Indian Bank, and Bank of Mysore were set up• Reserve Bank of India came in 1935 so as

― To regulate the issue of bank notes― To keep reserves with a view to securing monetary stability in India and― To operate the currency and credit system in the best interests of the country

Phase I – Early phase from 1786 to 1949 of Indian Banks

• During this phase the growth was very slow• Banks experienced periodic failures between 1913 and

1948 reasons TBD WW II, Depression• To streamline the functioning and activities of commercial

banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965)

• Reserve Bank of India was vested with extensive powers for the supervision of banking in India as the Central Banking Authority

Phase II – Nationalization of Indian banks

• Two main objectives of nationalization were― Rapid branch expansion― Channeling of credit in line with the priorities of the five-year plans

• To achieve these goals, the newly nationalized banks received quantitative targets for the expansion of their branch network and for the percentage of credit they had to extend to certain sectors and groups in the economy, the so-called priority sectors, which initially stood at 33.3%.

• Following the Nationalization Act of 1969, the 14 largest public banks were nationalized which raised the Public Sector Banks' (PSB) share of deposits from 31% to 86%

• Six more banks were nationalized in 1980, which raised the public sector's share of deposits to 92%.

• The second wave of nationalizations occurred because control over the banking system became increasingly more important as a means to ensure priority sector lending, reach the poor through a widening branch network and to fund rising public deficits

• However, the policies that were supposed to promote a more equal distribution of funds, also led to inefficiencies in the Indian banking system

Phase II – Nationalization of Indian banks

The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country• 1949 : Enactment of Banking Regulation Act• 1955 : Nationalisation of State Bank of India• 1959 : Nationalisation of SBI subsidiaries• 1961 : Insurance cover extended to deposits• 1969 : Nationalisation of 14 major banks• 1971 : Creation of credit guarantee corporation• 1975 : Creation of regional rural banks• 1980 : Nationalisation of seven banks with deposits over 200 crore

Why New Banks in India?

• For growth to be truly inclusive requires broadening and deepening the reach of banking

• Access of banking facility to the poor will provide them opportunities to build savings, make investments, avail credit, and more important, insure themselves against income shocks and emergencies

• A larger number of banks would foster greater competition, and thereby reduce costs, and improve the quality of service

• Also new banking licenses will promote financial inclusion, which ultimately support inclusive growth

Candidates for Banking License in 2001

• NBFC with good track record (AAA or equivalent rating)• Large industrial houses were not permitted • Individual companies connected with industrial houses were

allowed to hold up to 10% equity • The candidates should not be in any way related to real estate

business, because it is a very volatile business• Any entity which has the required capital and is in accordance

with the above conditions can apply for the banking license

Performance of the Banks starting after liberalization

• 10 new banks were setup after 1993 and 2 more after 2000 policy

• Only two of the privatized bank in 1993 have succeeded, other have been merged with parent company or with other privatized bank

• Banks established in 2000 have performed fairly• Only those banks that had adequate experience in broad

financial sector, financial resources, trustworthy people, strong and competent managerial support could withstand the rigorous demands of promoting and managing a bank

RBI’s learning• The experience with small banks have not been encouraging, only

four of the six banks have continued• Of these remaining four, two of them can barely maintain the

minimum capital and liquidity, and have not progressed much • The remaining two are functioning satisfactorily but their growth

has been restrained due to inadequacies of the small bank model• The Local Area Bank model have weakness such as unviable and

uncompetitive cost structure and inefficient management• The banks should be required to start with sufficient initial capital

so that it can face adverse conditions and compete

The issues covered in RBI’s discussion paper

• Minimum capital requirements for new banks and promoters contribution

• Minimum and maximum caps on promoter shareholding and other shareholders

• Foreign shareholding in the new banks• Eligible Promoters

(A) Whether industrial and business houses could be allowed topromote banks(B) Should Non-Banking Financial Companies be allowed conversion into banks or to promote a bank

• Business Model

Banking Laws Amendment Bill,2011

Private Banks (Proposals)• Shareholders in private banks will have the voting rights in

proportion to their equity shareholding • At present the voting rights are capped at 10% for private banks and

1% for state run banks • RBI should get the power to inspect the books of financial

conglomerates that might be given banking license Impact • Private banks will attract more investment esp. foreign • Private banks such as Kotak Mahindra will benefit, as their

promoters hold more than 10%

Effect on the NBFC Sector

• The total share of NBFCs in the financial sector is 9.1% • The new banking license is going to benefit NBFC’s the most• As these corporations have the experience and the capital to meet

the mandatory requirements • Also, they have the required structure to have the desired

penetration of the banking sector• As the main aim of the RBI is to provide banking facilities to the

rural population of India

Steps taken in NBFC Sector

• 15 member panel has been formed to study the NBFC sector in depth and suggest the regulatory changes

• NBFC have been getting different regulatory treatment in spite of taking deposits from investors

• These steps are taken in accordance with the new banking license, as this will give a closer view of the NBFC sector

Credit Policy to MSME (obligation)

Obligation:• Private Sector Advances (PSA’s) should constitute 20% of Adjusted

Net Banking Credit (ANBC)• An objective of 20% y-o-y growth in credit to MSE’s • In order to ensure that credit is available to all segments of MSE

– 40% of the credit should go to micro (manufacturing) enterprises with investment upto 5 Lakh

– 20% of the credit should go to the micro(manufacturing) enerprises with investment between 5 Lakh and 20 Lakh

• The bank has mandatory prescription of not to take collateral for MSE borrowers for loan upto 5 Lakh and can extend it to 25 Lakh depending on the track record of the company

Contd…...Credit Support to MSME• Banks offer pre-sale (procurement of raw materials etc) and post-sale credit • Bank offer several standardized loan products, characterized by simplified

procedures and customer friendly features like Lakhsmi Gold PowerNayak Committee Recommendation • giving preference to village industries, tiny industries and other small scale

units in that order• Not insisting on compulsory deposit as a „quid pro-quo‟ for sanctioning the

credit• Ensuring that there is no delay in sanctioning and disbursal of credit• Identifying sick MSE units and take urgent action to put them on nursing

programmes• The banks should open more specialized micro,small and medium enterprise

branches

Loan Waivers to Farmers

• In 2008, the government planned to give waiver to the loans of small farmers (40 million), which accounted to Rs 600 billion (increased to 716 billion)

• These loans were waived off because of low rainfall (hence production) in 2008-09 lead to a lot of loss to the farmers

• The marginal farmers (less than 1 hectare land) and small farmers (between 1 to 2 hectare) were given full relief of their debt

• These accounted for about 75% of the total farmers

Contd… • Other farmers were given the waiver of 25% of the remaining loan

amount • Remaining 75% to be paid by them in 3 installments • Banks were given the obligation to implement this process through

their present system • The waived off loan will be paid by the central bank to the banks• The government aims to improve the production by this scheme • This scheme was extended to the first half of 2009• Since the latter half of 2009, the government is providing loans to

the farmers at the discounted rate (around 1% interest)

Scenario in Budget 2011• The loan disbursement in 2011 has been increased to 4.75 Lakh

Crore from 3.75 Lakh crore in 2010• These loans are provided at the discounted rate of near 1%• It has adverse effects on the fiscal deficit target of the government • The aim of the government is to provide affordable credit to the

farmers so that they can procure the best raw material for farming • Since the inception of these loan waiver scheme in 2008, the

agriculture growth in the country is ranging between 2-4%• This shows that the loans have not much positive effect on

agriculture production

Effectiveness of the Loan• There is no evident result which proved that the loan waiver

increased productivity or profitability • A lot of rich farmers received benefits• Farmer eligible to pay loans before, did not pay their full quota of

loans• There was difficulty in generalizing the small farmers, which

affected the penetration of this scheme• A lot of cash and resources of the bank was allocated in the

implementation of this scheme, from which they did not get considerable benefit

Cash Transfer of Subsidy • The government aims to abolish the subsidy on items like Kerosene

and Fertilizers • As subsidies in the current form is not reaching to the desired

population , as the beneficiaries are Tata Tea etc • The government aims to transfer direct cash into the accounts of

the needy• The implementation of this project has been given in the hands of

Mr. Nandan Nilekani • He aims to implement the project in accordance with the UIDAI,

which will give the information of people belonging to BPL • The target is to include all the subsidies (i.e Food, fertilizers,

kerosene, diesel, LPG)

Role of Banks in Cash Subsidy

• The subsidy will account for 1 lakh crore of cash through banking system

• This will give them access to the sizeable amount of zero-cost funds• Also, the banks will have the incentive to open the no-frills account

for the BPL population• Also, it will encourage them to make infrastructural changes in

order to make the banking faciltiy easily accessible to the rural population