BBA Emerging PDF

 Editorial Board Dr. Kirti Singh Assistant Professor, Delhi School of Economics, University of Delhi Dr. Shivangi Jaiswal Assistant Professor, GLA University, Mathura Content Writ...

 Editorial Board Dr. Kirti Singh Assistant Professor, Delhi School of Economics, University of Delhi Dr. Shivangi Jaiswal Assistant Professor, GLA University, Mathura Content Writers Dr. Shruti, Dr. Priya Chaurasia, Mr. Jigmet Wangdus, Mr. Yogesh Sharma, Mr. Ankit Suri, Mr. Gurdeep Singh, Dr. Neerza, CS Monika Saini,Ms. Latika Bajetha Academic Coordinator Mr. Deekshant Awasthi © Department of Distance and Continuing Education ISBN: 978-81-19417-11-7 1st Edition: 2023 E-mail: [email protected] [email protected] Published by: Department of Distance and Continuing Education Campus of Open Learning/School of Open Learning, University of Delhi, Delhi-110007 Printed by: School of Open Learning, University of Delhi  DISCLAIMER Corrections/Modifications/Suggestions proposed by Statutory Body, DU/ Stakeholder/s in the Self Learning Material (SLM) will be incorporated in WKH QH[W HGLWLRQ +RZHYHU WKHVH FRUUHFWLRQVPRGL¿FDWLRQVVXJJHVWLRQV ZLOO EH uploaded on the website https://sol.du.ac.in. Any feedback or suggestions can be sent to the [email protected]. Printed at: Taxmann Publications Pvt. Ltd., 21/35, West Punjabi Bagh, New Delhi - 110026 (5000 Copies, 2023) © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  Contents PAGE Lesson 1 : Introduction to the Indian Banking System 1.1 Learning Objectives 1 1.2 Introduction 2 1.3 Overview of Banking System in India 2 1.4 Major Banking Reforms in the Last Decade 6 1.5 Payment Bank 10 1.6 Monetary Policy Committee 11 1.7 MCLR Based Lending 11 1.8 Innovative Remittance Services 11 1.9 Summary 13 1.10 Answers to In-Text Questions 15 1.11 Self-Assessment Questions 15 1.12 Suggested Readings 16 Lesson 2 : Issues in Financial Reforms and Restructuring 2.1 Learning Objectives 17 2.2 Introduction 18 2.3 Challenges and Issues in Financial Reforms 23 2.4 Assessing Non-Performing Assets (NPAs) in Indian Banking 25 2.5 Previous Methodologies for the Recovery 29 2.6 Impact of Gross NPAs on a Bank’s Bottom Line 33 2.7 Introduction to Bad Banks, Functioning of Bad Banks, National Asset Reconstruction Company Ltd. (NARCL) 35 2.8 Summary 38 2.9 Answers to In-Text Questions 41 2.10 Self-Assessment Questions 42 PAGE i © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) PAGE 2.11 References 42 2.12 Suggested Readings 42 Lesson 3 : Introduction to Neobanks 3.1 Learning Objectives 43 3.2 Introduction 44 3.3 Traditional Banks, Neobanks & Digital Banks 45 3.4 The Rise and Growth of Neobanks 48 3.5 Operating Model of Neobanks 51 3.6 Risk, Challenges and Opportunities 53 3.7 Regulation of Neobanks 56 3.8 Global and Indian Neobanks 60 3.9 Summary 63 3.10 Answers to In-Text Questions 64 3.11 Self-Assessment Questions 65 3.12 References 65 3.13 Suggested Readings 66 Lesson 4 : Merger and Acquisition in Banking 4.1 Learning Objectives 67 4.2 Introduction to Merger and Acquisition (M&A) 68 4.3 %HQH¿WV RI 0HUJHUV LQ WKH %DQNLQJ 6HFWRU  4.4 Synergies Accruing Out of Mergers 81 4.5 Regulatory Mechanisms Surrounding M&A in Banking 83 4.6 Case Studies of Recent Banking Mergers and Related Outcomes 87 4.7 Future Trends and Outlook for M&A in Banking 93 4.8 Summary 94 4.9 Answers to In-Text Questions 96 4.10 Self-Assessment Questions 96 4.11 References 97 4.12 Suggested Readings 98 ii PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  CONTENTS PAGE Lesson 5 : Leasing and Hire Purchase 5.1 Learning Objectives 99 5.2 Introduction 100 5.3 Concepts of Leasing 100 5.4 Types of Leasing 101 5.5 Advantages of Leasing 103 5.6 Limitations of Leasing 105 5.7 Lease Evaluation 107 5.8 Concepts of Hire Purchase 110 5.9 Difference Between Hire Purchase and Leasing 113 5.10 Choice Criteria Between Leasing and Hire Purchase 114 5.11 Summary 116 5.12 Answers to In-Text Questions 118 5.13 Self-Assessment Questions 119 5.14 Suggested Readings 120 Lesson 6 : Venture Capital 6.1 Learning Objectives 121 6.2 Introduction 122 6.3 Evolution of Venture Capital 125 6.4 The Venture Investment Process 128 6.5 Steps in Venture Financing 130 6.6 Incubation Financing 132 6.7 Summary 134 6.8 Answers to In-Text Questions 135 6.9 Self-Assessment Questions 135 6.10 References 135 6.11 Suggested Readings 136 Lesson 7 : Credit Ratings 7.1 Learning Objectives 138 PAGE iii © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) PAGE 7.2 Introduction 139 7.3 Types of Credit Rating 140 7.4 Advantages of Credit Rating 141 7.5 Disadvantages of Credit Rating 142 7.6 Credit Rating Agencies 143 7.7 Methodology of Credit Rating Agencies 144 7.8 International Credit Rating Practices 145 7.9 Credit Rating Agencies in India 147 7.10 Provisions Governing Credit Ratings 148 7.11 Summary 151 7.12 Answers to In-Text Questions 152 7.13 Self-Assessment Questions 152 7.14 References 153 7.15 Suggested Readings 153 Lesson 8 : Securitization 8.1 Learning Objectives 154 8.2 Introduction 155 8.3 Features of Securitization 156 8.4 %HQH¿WV RI 6HFXULWL]DWLRQ  8.5 Parties Involved in Securitization 160 8.6 Process of Securitization 162 8.7 Instruments of Securitization 165 8.8 Types of Securities 167 8.9 Securitization in India 168 8.10 Summary 174 8.11 Answers to In-Text Questions 175 8.12 Self-Assessment Questions 176 8.13 References 176 8.14 Suggested Readings 177 Glossary 179 iv PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi L E S S O N 1 Introduction to the Indian Banking System Dr. Shruti Assistant Professor Shri Ram College of Commerce University of Delhi Email-Id: [email protected] STRUCTURE 1.1 Learning Objectives 1.2 Introduction 1.3 Overview of Banking System in India 1.4 Major Banking Reforms in the Last Decade 1.5 Payment Bank 1.6 Monetary Policy Committee 1.7 MCLR Based Lending 1.8 Innovative Remittance Services 1.9 Summary 1.10 Answers to In-text Questions 1.11 Self-Assessment Questions 1.12 Suggested Readings 1.1 Learning Objectives ‹ To provide a brief overview on the structure of banks. ‹ To comprehend the role of various banking reforms in shaping the overall banking industry. ‹ To acquaint students on emerging role of differentiated banks like payment banks. PAGE 1 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes ‹ To comprehend the role of Monetary Policy Committee, MCLR Based Lending & Innovative Remittance Services. 1.2 Introduction Banks play an important role in shaping the economy of the country. Banks provide a range of services like savings accounts, loans, insurance and payments not only to the privileged group, but the vulnerable groups can also be benefited. By providing these essential financial services to the weaker section of society, the banking sector, on the one hand, helps them to come out of poverty, while on the other hand, transfers the resources from the surplus units to the deficit units. In India, the Reserve Bank of India (RBI) plays an important role in regulating the banking Industry. RBI is a central bank whose main objective is supervising and monitoring various public and private banks. RBI and the government promptly bring out various policies and regulations to provide the banks with overall financial stability and resilience. Over the years, the structure of the banking system in India has undergone a huge transformation. The increase in digital adoption among large masses has prompted the use of ‘digital banking’, which provides access to banking services 24*7 without physically visiting the bank branch. India is slowly taking an important lead in the global financial technology sector. Thus, considering the considerable significance of the banking system in the country, this lesson aims to develop a better understanding of the overall banking sector, various banking reforms taken on a time-to-time basis, emerging bank types (like payment banks, innovative remittance types) and some important banking related concepts such as MCLR and the role of monetary policy committee in India. 1.3 Overview of Banking System in India The banking system plays an important role in a national economy. The main function of the banking system in any economy is to mobilise public savings to allocate growth and development activities. Banking institutions are indispensable for the money market. Commercial banks and cooperative banks have grown significantly in the past decade among the financial institutions in the organised segments. The existence of Regional Rural 2 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES Banks (RRB) is also playing an important role in rural areas. Besides the Notes banks above, we have special banking institutions known as ‘Development Banks’, catering to specific industries, agriculture and foreign trade. Reserve Bank of India (RBI) is the central bank in India which take most of policy regulation and initiatives related to financial institutions, including banks. The structure of the banking system is outlined in Figure 1.1 below: Reserve Bank of India (RBI) RBI is an apex governing body of banks established w.e.f. April 1, 1935, with the primary objective of supervising and regulating various financial institutions, including scheduled and non-scheduled banks. RBI function to strengthen the policy framework of the banking system. Apart from this, the Reserve Bank of India, through the constitution of the Monetary Policy Committee (MPC), sets policy repo rates for the banks and strives to balance growth and inflation. Figure 1.1: Structure of banking system in India Scheduled Commercial Banks (SCB) Scheduled banks are listed as per the II schedule of the RBI Act, 1934. Banks have to comply with certain criteria to be listed as scheduled banks. Scheduled Commercial Banks (SCB) are subjected to a minimum fulfilment of Section 42(6) of the RBI Act, which states the following two important conditions i.e., firstly, there is a requirement of minimum paid-up capital and reserves of a value which RBI prescribes from time-to-time basis; secondly, PAGE 3 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes banks should always run in the interests of its depositors, and lastly, it must be a corporation, not a partnership or a single owner firm. Since 1969, such banks have shown fast growth due to the nationalisation of the big banks. RBI provides them with credit and many other facilities. RBI has mandated all the scheduled commercial banks to keep some amount from their demand and time deposits in the form of the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). There are two major categories of Scheduled banks, i.e., Scheduled Commercial Banks (SCBs) and Scheduled Cooperative banks. Public Sector Banks (PSB) PSBs are the nationalised banks representing a large proportion of the banking industry. PSBs have been a key player in the Indian financial system post-nationalisation of the State Bank of India in 1955, followed by another major nationalisation drive in 1969 and 1980. A commercial bank has a dual function, i.e., extending loans and advances and, at the same time, accepting various types of deposits (such as savings bank accounts, current accounts, fixed deposits etc.). The government upholds a major stake in these banks. Some examples of key players are the State Bank of India (SBI) (including all its subsidiaries), Canara Bank and Bank of Baroda. Private Sector Banks In Private sector banks, there is a major stake of the private individuals or corporations. Private Sector Banks play a strategic role in the growth of joint sector banks in India. For instance, HDFC Bank, ICICI Bank, Axis Bank and Kotak Mahindra Bank are examples of such banks. Foreign Banks These are the banks which have major stakes in foreign bodies or institutions. Some examples of such banks are Barclays Bank, Bank of America and Bank of Ceylon, etc. Regional Rural Banks (RRBs) Regional Rural Banks (RRBs) are the scheduled commercial banks recognised per the Regional Rural Bank Act, 1976. They have ownership from the Central Government, state government and sponsor banks. These banks are created to serve the banking needs of people, especially in the rural area. 4 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES Scheduled Cooperative Banks (SCB) Notes These small-sized banks are regulated by the Banking Regulations Act, 1949 and the Cooperative Societies Act, 1955. Scheduled Cooperative Banks (SCB) do not seek profits in the long run. In these banks, members are the owner as well as the customers. Thus, Cooperative banks provide the opportunity of last mile credit coverage with an interest rate usually lesser than local money lenders. Based on the location of these Cooperative Banks, there can be Urban Cooperative Banks (UCB) and Rural Cooperative Banks (RCB). Non-Scheduled Commercial Banks Unlike Scheduled Commercial Bank (SCB), non-scheduled banks are not covered under the second schedule of RBI. Development Banks Besides these regular banks, we also have development banks in the country. The setting up of Development Banks in India was the most outstanding development in the sphere. Development Banks (DB) are altogether different sets of banks which do not provide regular banking services such as deposit and credit; instead, their main purpose is to serve the large public interest. These banks usually extend medium to long-term credit facilities to industrial and agricultural sectors. Besides, such banks have another important role: providing project-related guidance, guarantees for term loans, subscriptions to shares & debentures, underwriting new issues, upgradation of managerial skills through training programmes, etc. The primary advantage of development banks is that they do not take public deposits like traditional banks; instead, they raise funds directly from the government or multilateral institutions. The structure of development banks includes both all India and state-level institutions. The establishment of the Industrial Finance Corporation of India (IFCI) marked the beginning of the era for development banks in India. IFCI came into existence in 1948 to offer usually long-term credit to industrial enterprises when normal retail banks could not fulfil their credit requirement. Similar to the structure of IFCI, State Financial Corporations (SFCs) were established under SFC Act in 1951. Though the scope of SFCs is mainly restricted to certain states. Besides SFCs, there are State Industrial Development Corporations (SIDCs). The main purpose of these SIDCs is to promote PAGE 5 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes industrial development. Though SIDCs focus on promotional activities parts such as identification of projects, feasibility studies, training and surveys. Later, the establishment of India’s Industrial Credit and Investment Corporation (ICICI) is yet another steppingstone in the diversification of the development banks in the country. ICICI mainly provides services such as underwriting the issue of capital, foreign currency loans from the World Bank to private industry and so on. In 1964, Industrial Development Bank (IDBI) was formed as a subsidiary of the RBI. These institutions serve an important role in the economic development of the country. It not only functions to provide finance but also coordinates all the activities of the financing institutions. Another institution, the Small Industries Development Bank of India (SIDBI), was established as a part of IDBI. SIDBI’s main aim is to fulfil the credit requirement of small and medium enterprises. Besides, SIDBI also assists in refinancing loans and advances, discounting bills, providing seed capital, services like factoring, leasing etc. In 1982, India’s first Export-Import bank (EXIM) was set up under the EXIM Act, 1981. The main function of such banks is to facilitate the country’s export and import. It aids in refinancing the banking services for foreign trade. National Bank for Agriculture and Rural Development (NABARD) is another important development bank. These banks were established in the year 1982. NABARD serves as an apex body for providing credit facilities to institutions mostly engaged in developmental activities related to agriculture and allied businesses in rural areas. Development banks could be instrumental in the planned economic growth of various industrial sectors. 1.4 Major Banking Reforms in the Last Decade The Indian banking sector has significantly transitioned in the last few decades. With many IT-based financial services, banking services have become more accessible, especially in far and remote areas. Basically, ‘banking sector reforms’ pertain to policy initiatives and measures to improve the banking industry’s efficiency and overall financial stability. These reforms intend to strengthen the financial infrastructure and thereby promote economic growth. There were many committees constituted from time to time by the government, along with RBI, for suggesting policies and regulations for the banking industry. Some of the key reforms taken are mentioned below: 6 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES Banking Sector Reforms Since 1991 Notes In a pre-reform era, there were some notable changes in the banking sector, such as the nationalization of 14 SCBs in 1969, followed by six more banks in 1980. In 1975, Regional Rural Banks (RRB) were established to facilitate low-cost credit requirements by the people in rural counterparts. Economic reform in 1991, followed by the constitution of two major committees viz., Narasimham Committee-I (1991) and Narasimham Committee-II (1998), were the steppingstones for the growth and development of the banking sector in India. These committees provided some important suggestions for the banking industry. Some of these recommendations are mentioned below: Functional Autonomy and Competition: The basic approach is the banking system, a market-oriented one. The Committee opined that the Public Sector Banks (PSB) should become functionally autonomous. They further suggested that dual monitoring of banks by the Ministry of Finance and RBI should be abolished as they viewed that this has been the cause of major operational inflexibility and loss of Autonomy in major decision-making by the banks. Besides the functional Autonomy, the Committee recommended the need for healthy competition among banks for their mutual growth. Even foreign banks should be allowed to operate in the country. Profitability: The Committee suggested that public sector banks should be permitted to run various profitable investments. Banks should strive to achieve operational efficiency and thereby profit by reducing their expenditure. Structure of the banking system This Committee suggested some major structural changes in the existing banking system, such as some could take the lead internationally and national banks taking up the role of ‘universal banking’. Regional Rural Banks should work more closely in financing agriculture and allied activities. Capital adequacy and bad debt They suggested increasing the Capital Adequacy Ratio (CAR) to the ‘risk- weighted assets’. To address the issue of bad debts (or non-performing assets), banks should have uniform accounting practices and provisions against different categories of bad debt. These committees aimed at promoting a healthy and competitive environment for the banks. Major reforms were undertaken for the prudential regulation of the banks and other financial PAGE 7 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes institutions, such as income recognition, provisioning norms, setting up of an Asset Reconstruction Fund and risk-based capital adequacy norms. Khan Committee (2005) To strengthen financial inclusion in the country, RBI constituted Khan Committee in the year 2004. The Committee reviewed various difficulties people face accessing microfinance and rural credit in the country. The report has several important recommendations, such as the ‘business correspondent model’, to ease the outreach of banking services in unbanked places. Further, the Committee was given strong NGO/MFI - Bank linkages. Yet another major recommendation of the Committee is a “no-frills” banking account, enabling low-income households to open bank accounts with negligible or no minimum balance. Rangarajan Committee (2008) Rangarajan Committee had several recommendations for the inclusion of people under the banking system. This Committee suggested the formation of the Financial Inclusion Promotion and Development Fund and Financial Inclusion Technology Fund under the National Bank for Agriculture and Rural Development (NABARD). Besides, Committee also emphasized appropriate technology adoption for Business Facilitator/Business correspondent (BF/ BC) models, upscaling the SHG - Bank Linkage Programme, Joint Liability Groups, Micro Finance Institutions – NBFCs, Micro Insurance, and rural credit cooperatives. Raghuram Rajan Committee (2008) Raghuram Rajan Committee on “Financial Sector Reforms” was constituted in 2007 by the government. The Committee was chaired by the former Chief Economist of the International Monetary Fund (IMF). This Committee made noted the need for relaxation in regulation for business correspondents. This Committee recommended integrating modern technologies with the banking sector to limit fraud and promote cost-effective transactions. Nachiket Mor Committee (2014) Nachiket Mor Committee’s (2014) report titled “financial services for small businesses and low-income households” noted some important recommendations like a universal saving account, payments banks and wholesale banks for better credit reach to the masses. The Committee also emphasized the need to 8 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES establish payment banks, small finance banks, and the creation of a universal Notes electronic bank account (Jan Dhan Yojana). JAM (Jan Dhan Aadhaar Mobile) Trinity JAM trinity, which refers to Jan Dhan-Aadhaar-Mobile was a major step by the government of India to connect three domains, i.e., Jan Dhan accounts, mobile numbers and Aadhaar cards of Indians. JAM Trinity can help plug the leakage and corruption related to the government subsidiary. Pradhan Mantri Jan-Dhan Yojana (PMJDY) is a pan-India scheme launched to afford access to various financial services. The scheme was announced by the prime minister of the country in the year 2014 to promote financial inclusion. While ‘Aadhaar’ are 12-digit unique identity number issued to each Indian citizen. These ‘Aadhaar’ number is issued by a Central Government authority named as Unique Identification Authority of India (UIDAI) which collect and store the biometric and demographic information of the resident and Indradhanush Framework The Government of India launched the Indradhanush framework to revitalize and reform public sector banks. The primary goal of this framework is to increase the efficiency, transparency, and governance of public sector banks. The framework recommended seven major areas Appointments, Bank Board Bureau (BBB), Capitalization, De-stressing, Empowerment, Framework of Accountability and Governance reforms. 4R Framework (Recognition, Recapitalization, Resolution and Reforms) The 4R framework was launched in the country in 2017 to address the issue of banks increasing ‘bad loans’. The framework proposed four key elements, which are mentioned below: ‹ Recognition: Identification and classification of stressed assets as NPAs. ‹ Recapitalization: Injecting capital into banks to improve their financial health. ‹ Resolution: Creating processes for the timely resolution of stressed assets through interventions by the Insolvency and Bankruptcy Code (IBC) and other resolution frameworks. ‹ Reforms: Brining structural reforms for improving the governance, risk management, and operational efficiency of banks. PAGE 9 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes National Asset Reconstruction Company Limited (NARCL) The constitution of National Asset Reconstruction Company Limited (NARCL) was declared in the year 2021 by the government to address the issue of increasing Non-Performing Assets (NPA) by the banks. In India, the surge in Non-Performing Assets (NPA) of the banks has posed a major policy challenge. NPA refers to the non-payment of any advance or loan which overdue for more than 90 days. NARCL will constitute a ‘bad bank’ which would try to restructure these bad loans. National Bank for Financing Infrastructure and Development (NaBFID) The government established National Bank for Financing Infrastructure and Development (NaBFID) under NABFID Act, 2021 as one of the development banking institutions. NaBFID facilitates long-term infrastructure financing to many sectors. Central Bank’s Digital Currency (CBDC) The Central Bank’s Digital Currency (CBDC), referred to by RBI as the ‘digital rupee’, is yet another major policy reform in recent times. The government announced the first concept note on CBDC in October 2022. CBDC is expected to be implemented in the upcoming years in the country. It works on block chain technology with the objective to reduce physical cash usage and increase the efficiency and speed of banking transactions. This may, in turn, boost financial inclusion and increase overall bank lending. 1.5 Payment Bank Payment banks are a new category that extends almost all banking services except credit facilities. Thus, the credit risk of payment banks is negligible as they do not deal with loans or issues of credit cards. Payment Banks are small-scale banks which can provide services like demand deposits (up to INR 1 lakh), remittances, transfers/purchases and third-party fund transfers. The target customers of such banks are usually low-income individuals or entities. The need for payment banks in India was mentioned for the first time in 2014 in a Nachiket Mor Committee report on “Comprehensive financial services for small businesses and low-income households”. Through payment banks, RBI aims to widen the spread of financial services, especially in remote and distant areas of the country. Bharti Airtel set up India’s first payments bank, “Airtel Payments Bank”. 10 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES 1.6 Monetary Policy Committee Notes RBI forms the Monetary Policy Committee (MPC) under section 45ZB of the amended RBI Act, 1934. MPC includes six members, of which three officials are from RBI (including the Governor of the RBI), and the Government of India nominates three members. The main purpose of the MPC is to set the policy repo rate in such a manner as to attend to the inflation target between a range of 4 to 6 per cent in the country. MPC can meet at least four times a year. Each member can have one vote; when there is equality of votes between internal and external members, the Governor has a casting vote. The Governor of the RBI is the chairperson “ex officio” of the committee. 1.7 MCLR Based Lending MCLR stands for ‘Marginal Cost of Funds based Lending Rate’, which is the bank’s lowest rate of fund lending. MCLR was introduced for the first in India w.e.f. 1st April 2016 for pricing the rupee loan. Banks can use the MCLR rate to estimate interest rates on various loans, such as home loans. The interest rate under various categories is set at a fixed percentage, usually higher than the MCLR. So, when MCLR changes, it will also change the interest rates linked to it. The main purpose of MCLR is to bring transparency and consistency to the interest rates levied on loans by the banks. Simply put, when MCLR increases, it will also increase its interest rate. Financial institutions are not allowed to lend below MCLR. 1.8 Innovative Remittance Services Recently, a broad range of innovative remittance services has been launched by financial institutions worldwide to provide the facility of money transfer in an easy and timely manner. Formal financial remittance mediated through banks often lacks more outreach in remote and rural places. Also, the individual often needs a formal bank account to receive/send money from others. Post- demonetization in India in 2016, there was increased opportunity for digital payment service providers. Some private players like Paytm, Mobikwik and Freecharge using various digital payment applications such as UPI, Aadhaar Payment, BHIM, etc., have made digital transactions much easier and more convenient. These digital payment methods provide an easy money transfer, PAGE 11 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes especially in far and distant places in the country. Especially in COVID, many Indian households are recently using digital payment apps for various activities such as paying for groceries, healthcare, and even insurance. The ease in mobile phone availability and cost-effective data plans have provided a huge thrust for this Industry. Indeed, the Indian government is, through initiatives and schemes, providing support for cashless transactions. There are various innovative methods of remittance in India which are mentioned below: 1. Unstructured Supplementary Service Data (USSD): USSD services are provided by most mobile service providers. An internet data facility is optional to avail of USSD on your mobile. It facilitates the financial inclusion of unbanked people with mainstream banking services, especially those living in rural and unreached areas. 2. AePS (Aadhaar-enabled payment system): This service enables the customer to access banking transactions such as cash deposit/ withdrawal, intrabank/interbank transfer, balance enquiry, etc., by using Aadhaar authentication at branch/Business Correspondents locations. 3. BHIM Aadhaar Pay: Assists payment to merchants by customers using Aadhaar authentication. 4. UPI (Unified payment interface): A single platform for the immediate real-time payment system which can facilitate both Person-to-Person (P2P) and Person-to-Merchant (P2M) transactions. A UPI ID and PIB are required to send and receive the money. 5. BBPS (Bharat Bill Payment System): BBPS is an online payment platform which offers interoperable and easy access to utility bill payment services via a network of agents of registered Agent Institutions (AI). 6. Mobile banking: Mobile banking services enable a customer to access a bank account via a mobile device such as a smartphone or tablet through a mobile app for that bank or other financial institution. The service is generally available on a 24-hour basis and uses the internet or mobile data availability. 7. Mobile wallets: It is a virtual wallet that stores mobile phone payment card details. Mobile wallet enables users to make in-store 12 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES payments conveniently. Examples of popular digital payment apps Notes are the HDFC payZ app, ICICI Pocket and Paytm. 8. Credit card/debit card: This is a Card-enabled fund transfer. Typically, these cards have the logo of Visa or Mastercard. 9. National Electronic Fund Transfer (NEFT): NEFT refers to a funds transfer system which can be used electronically by any individual or organization with a bank branch to any account. NEFT is maintained by the Reserve Bank of India (RBI). 10. Real-Time Gross Settlement (RTGS): Unlike NEFT, Real-Time Gross Settlement (RTGS) are the electronic fund transfer between two banks. RTGS payment systems are done for large-value transactions. 11. Prepaid Payment Instrument (PPI): As per the RBI guidelines under the Payment and Settlement Act, 2005. The Prepaid Payment Instruments (PPIs) offer the facility to use the value stored on these instruments for financial transactions. 12. Immediate Payment System (IMPS): IMPS provides an option for an immediate fund transfer facility that can be operated through basic mobile phones, smartphones, and internet/ ATMs. Unlike other digital payment modes, IMPS services are available 24×7. 1.9 Summary This lesson provides a comprehensive knowledge of the Indian banking system in India. Post-economic reform in 1991, the banking industry underwent major structural changes. There is a large number of public and private sector banks which extends various financial services such as deposit, credit, remittance and insurance. ‘Digitalization’ of banks has provided opportunities for a large proportion of people to access financial services at their ease and convenience. Recently, RBI has announced that Digital Banking Units (DBUs) to be operationalized on a large scale in the country. The Indian government, along with the Reserve Bank of India (RBI), have taken many initiatives to further financial inclusion, especially for poor and economically weaker sections of society. Payment Banks have paved the way to access most of the financial services for low-income earners. Further, we PAGE 13 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes have various innovative remittance methods such as mobile wallet, RTGS, NEFT, AePS, BHIM, UPI and mobile banking, which provide wide options for cashless payment. For the financial stability and economic growth in the country, RBI, through Monetary Policy Committee (MPC), announced the policy repo rate at each quarter of the year. Nonetheless, MPC intends to limit inflation under the prescribed range of 4% to 6%. IN-TEXT QUESTIONS 1. What is the name of the Central Bank of India? (a) Central Bank of India (b) Reserve Bank of India (c) State Bank of India (d) Indian Overseas Bank 2. In which year was the Reserve Bank of Indian established? (a) 1935 (b) 1947 (c) 1940 (d) 1949 3. ____________is the first development financial institution in India. (a) IDBI (b) IFCI (c) ICICI (d) RBI 4. Who is the chairperson of the Monetary Policy Committee of India? (a) Governor of RBI (b) Finance Minister (c) Prime Minister (d) Chief Economic Advisor 14 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi EMERGING BANKING AND FINANCIAL SERVICES 5. Which of the following is an innovative method of remittance? Notes (a) Mobile Banking (b) BHIM (c) UPI (d) All of the above 1.10 Answers to In-Text Questions 1. (b) Reserve Bank of India 2. (a) 1935 3. (b) IFCI 4. (a) Governor of RBI 5. (d) All of the above 1.11 Self-Assessment Questions 1. Explain briefly the main functions of Reserve Bank of India (RBI)? How RBI takes part in affecting the overall growth of the economy. 2. Why do you think RBI is ‘Banker’s bank’? Please elaborate. 3. Describe the basic banking structure in India? Differentiate between scheduled bank and non-scheduled banks? 4. What are the various types of scheduled banks in India? 5. Please discuss the relevance of Development bank in India. Describe the function and role served by following development banks: (a) NABARD (b) EXIM (c) IDBI (d) SIDBI 6. What are the various banking reforms taken in India in recent times? 7. Highlight few important suggestions made by Narasimham Committee I & II. PAGE 15 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes 8. Please elaborate the main features of following Indian government schemes such as: (i) Jan Dhan Yojana (ii) Indradhanush (iii) Bad bank (iv) 4R Framework 9. Elaborate the role and function of payment banks in India? 10. Why do you think Central Banking Digital Currency (CBDC) will promote the financial inclusion among large masses? 11. What do you mean by the term MCLR? 12. What do you mean by the Monetary Policy Committee (MPC)? How is MPC constituted? What are the main objectives of MPC? 13. Describe the various types of innovative remittance methods used in India these days? 14. Explain the following term briefly: (a) Unified Payment Interface (UPI) (b) Mobile Banking 1.12 Suggested Readings ‹ Pathak, B. on Indian Financial System, (5th Ed.) Pearson Publication. ‹ Bhole, L.M., Financial Markets and Institutions (6th Ed.) Tata McGraw Hill Publishing Company. ‹ Khan, M.Y on Financial Services, (9 th Ed.), Tata McGraw Hill Education. ‹ H.R. Machiraju, Indian Financial System, Vikas Publishing House, Delhi. ‹ Jeff Madura, Financial Markets and Institutions, CenGage Learning, Delhi. ‹ RBI website for latest updates on reforms and guidelines related to banks. 16 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi L E S S O N 2 Issues in Financial Reforms and Restructuring Dr. Priya Chaurasia Assistant Professor Shri Ram College of Commerce University of Delhi Email-Id: [email protected] STRUCTURE 2.1 Learning Objectives 2.2 Introduction 2.3 Challenges and Issues in Financial Reforms 2.4 Assessing Non-Performing Assets (NPAs) in Indian Banking 2.5 Previous Methodologies for the Recovery 2.6 Impact of Gross NPAs on a Bank’s Bottom Line 2.7 Introduction to Bad Banks, Functioning of Bad Banks, National Asset Recon- struction Company Ltd. (NARCL) 2.8 Summary 2.9 Answers to In-Text Questions 2.10 Self-Assessment Questions 2.11 References 2.12 Suggested Readings 2.1 Learning Objectives ‹ Students would be familiar with banking reforms as it was to develop a more diverse, efficient, and competitive financial system, with the ultimate goal of increasing resource-allocative efficiency through operational flexibility, better financial viability, and institutional strengthening. ‹ Understanding the importance of restructuring in banking systems. PAGE 17 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes 2.2 Introduction The Indian Banking system is the backbone of the Indian Financial System as it provides Financial Inclusion to many households. The backbone of any economy, banks are essential to igniting and maintaining economic growth, particularly in developing nations like India. This industry supports one of the fastest-growing large economies across the world. So, this industry must be technologically advanced, transparent, responsible, and efficient. It’s a need of the Indian economy to have a strong banking sector and in India banking is not only about the economic function of depositing and lending but it is also attached to some social functions such as financial literacy, financial inclusion, inclusive growth, and economic development. As we know, an efficient financial sector enables the smooth mobilization of money supply, increases household savings and investment, and also ensures their proper utilization in productive sectors. The financial sector constitutes commercial banks, non-banking financial institutions, investment funds, money market, insurance, pension companies, real estate, microfinance institutions, development banks, etc. Financial Sector Reforms The Financial sector refers to the part of the economy which consists of firms and institutions that have the responsibility to provide financial services to the customers of the commercial and retail segment. The financial sector can include commercial banks, non-banking financial companies, investment funds, money market, insurance and pension companies, and real estate etc. As the foundation of the economy, the financial sector is crucial for the allocation and mobilisation of financial resources. Steps done to reform the banking system, capital markets, government debt markets, foreign currency markets, etc. are referred to as financial sector reforms. To mobilise household savings and ensure their correct use in productive sectors, a financially sound sector is required. Before 1991, the Indian financial sector was suffering from several lacunae and deficiencies which had reduced the quality and efficiency of their operations. Reforms in the banking sector where a financially stable sector is necessary for the mobilisation of household savings and the verification of their appropriate application in productive sectors. Therefore, necessary at the time. 18 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES Reasons for Financial Sector Reforms in India Notes ‹ India acquired a number of disadvantages and issues as a result of colonial legacies after gaining independence. Both social and economic developments in the nation were behind. India created a system of planned economy based on the Mahalanobis model to achieve the objective of rapid economic development. Midway through the 1980s and the beginning of the 1990s, this model had already begun to reveal some of its flaws. ‹ To promote economic growth, the government adopted a fiscal activism approach, and significant amounts of public spending were funded by significant borrowing at low-interest rates. India’s financial markets were hence relatively underdeveloped and weak. ‹ Fiscal activism has resulted in an annual increase in the fiscal deficit. The economy was negatively impacted by inflationary tendencies and other aspects of the automatic monetization of the fiscal deficit policy. ‹ Due to the nationalisation of banks, the government now has total authority over them, which has curtailed the influence of market forces in the financial sector. Before 1980, the growth rate was roughly 3.5% annually, and by the middle of the 1980s, it had risen to almost 5%. This growth rate was proving insufficient to solve the economic and financial problems of the country. ‹ Issues with red tape and a lack of professionalism in the banking industry were to blame for the rise in non-performing assets. ‹ There were difficulties with the financial sector’s lack of effective regulation. The technologies used in the financial system and its institutional structures were outdated. ‹ India was dealing with several economic issues in 1991. The Foreign Exchange Reserves of India were under stress as a result of the Middle East conflict and the collapse of the USSR. India was currently experiencing a balance of payment crisis, making reforms necessary. ‹ India received a colonial heritage that was rife with different social and economic injustices after gaining freedom. PAGE 19 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes ‹ The shortcomings of the planned economic development strategy, which was based on the Mahalanobis model, became apparent in the 1980s. ‹ The government increased borrowing at favourable rates to accomplish a number of economic goals, but this has left India’s financial systems vulnerable and underdeveloped. ‹ Increased red tape and bureaucratic oversight led to an increase in non-performing assets. ‹ Turbulent international events such as the war in the Middle East and the fall of the USSR increased the pressure on the Foreign Exchange Reserves of India. Strategies Adopted for Financial Sector Reforms ‹ India chose to implement financial reforms gradually rather than using shock therapy. To maintain the continuity and stability of India’s financial industry, this was required. ‹ India incorporated International best practices at the same time adjusted it as per the local requirements. ‹ The first generation of reforms ensured flexibility to operate with functional autonomy in order to develop an effective and lucrative financial sector. ‹ The second generation of reforms was implemented to improve the structural stability of the financial system. ‹ India embraced the consensus-driven liberalisation strategy because it was essential for a democracy. Narasimham Committee Report, 1991 The Narasimham committee was set up in August 1991 to provide detailed suggestions on the Indian financial system, including the stock market and banking industry. The committee’s principal suggestions are as follows: ‹ The committee suggested lowering the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR) to 10% and 25%, respectively, over time. 20 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES ‹ Recommendations on priority sector lending: The committee Notes suggested defining priority sector to include marginal farmers, small companies, cottage industries, etc. ‹ Deregulation of interest rates: The committee suggested that the interest rates that banks charge be deregulated. In order to give banks, the freedom to choose their own interest rates for consumers, this was necessary. ‹ The creation of tribunals for the recovery of debts from non- performing assets, etc., was advised by the committee. On asset quality classes, it offered recommendations. ‹ The committee suggested that new private banks be allowed to operate in the financial sector. ‹ It was created to provide reforms for India’s financial sector, particularly the banking and capital markets. It suggested lowering the Statutory Liquidity Ratio (SLR) to 25% over time and the Cash Reserve Ratio (CRR) to 10%. ‹ It suggested fixing at least 10% of the credit for priority sector lending to marginal farmers, small businesses, cottage industries, etc. ‹ It suggested deregulating interest rates in order to give banks the necessary independence to decide on interest rates for consumers. Reforms in the Banking Sector ‹ Banks now have more financial resources to lend to the agricultural, industrial, and other sectors of the economy as a result of the reduction in CRR and SLR. ‹ The administered interest rate structure system has been eliminated, and the RBI is no longer in charge of setting interest rates for deposits made by banks. ‹ Permitting local and foreign private sector banks, including HDFC Bank, ICICI Bank, Bank of America, Citibank, American Express, etc., to build branches in India. ‹ Lok Adalats, civil courts, tribunals, and the Securitization and Reconstruction of Financial Assets and the Enforcement of Security PAGE 21 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes Interest (SARFAESI) Act were used to address disputes with non- performing assets. ‹ To allow banks to give more freedom, the selective credit control system that had reinforced the influence of the RBI was eliminated. ‹ From 39% to its present level of 19.5%, the SLR has decreased. The cash reserve ratio has been reduced from 15% to 4%. Banks now have more financial resources to lend to the agricultural, industrial, and other sectors as a result of the SLR and CRR reduction in different economic sectors. ‹ Modifications to administered interest rates: Previously, banks’ interest rates were determined by the RBI, under a system known as an administered interest rate structure. ‹ The primary goal was to offer financing to the government and a few key sectors at reduced interest rates. The system has been abandoned, and the RBI is no longer in charge of determining interest rates for bank deposits. However, the RBI controls interest rates for smaller loans up to Rs. 2 lakh, where they must not exceed prime lending rates. ‹ Capital Adequacy Ratio: The capital adequacy ratio measures how much paid-up capital and reserves a bank has in comparison to its deposits. The capital adequacy of 8% on the risk-weighted asset ratio system was introduced in India. ‹ Allowing private sector banks: As a result of financial reforms, we now have HDFC Bank, ICICI Bank, IDBI Bank, Corporation Bank, and other private banks were established in India. This has brought much needed competition in the Indian money market which was essential for the improvement of its efficiency. Foreign banks have also been allowed to open branches in India and banks like Bank of America, Citibank, and American Express opened many new branches in India. ‹ The following three avenues were available for foreign banks to conduct business in India: ‹ As branches of international banks. 22 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES ‹ Being a subsidiary of a foreign bank that is entirely controlled by Notes that bank. ‹ A branch of a foreign bank that is subject to the 74% foreign investment cap. ‹ Non-Performing Asset (NPA) reforms: Loans that have had unpaid instalments for 90 days or more are considered non-performing assets. RBI introduced the Recognition Income Recognition Norm. These standard states that if the bank’s assets’ revenue is not received within two-quarters of the previous date, the income is not acknowledged. Through Lok Adalats, civil courts, Tribunals, and other means, recovery of bad debt was enforced. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act was brought to handle the problem of bad debts. ‹ The elimination of direct or selective credit controls: Previously, the RBI controlled the supply of credit by adjusting the margin used to provide loans to traders against the stocks of sensitive commodities and stockbrokers against shares. Since the direct credit control system was removed, banks are now freer to extend credit to their clients. ‹ Promoting microloans for financial inclusion: The government created a microloan programme, and the Reserve Bank of India provided instructions for it. The most important model for microfinance has been the Self-Help Group Bank linkage programme. This program is executed by the scheduled Commercial Bank and RRBs. 2.3 Challenges and Issues in Financial Reforms Challenges include Non-Performing Assets (NPAs), recapitalization, an increase in bank fraud, asset quality challenges, and human resource problems that are hindering industry performance and endangering future economic growth. This will have effects on both banks and the economy. Financial inclusion in India has the following obstacles: ‹ Low income and inability to offer collateral security. ‹ The barrier to financial inclusion is still the scarcity of bank branches in rural areas. PAGE 23 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes ‹ A greater reliance on unregulated lending. ‹ Complicated financial terms, conditions, and several product offerings. One of the foundations of the Transforming India project is financial inclusion, and banks play a significant part in this through programmes like the Jan Dhan Yojana, Direct Benefit Transfer, and Mudra Yojana. Aadhaar, Digi locker, India Stack, and other recent government initiatives are establishing an unprecedented “publicly accessible, unified digital infrastructure” through which users can authorise financial firms to access their data. However, the industry is battling several novel challenges that are putting its resiliency and tenacity to the test. Although India’s financial system has achieved remarkable heights and adopts a solid method that is applicable considering the current worldwide Despite positive economic outlook, there have been problems with the Indian financial system. The following are some of the most recent issues that continue to have a significant impact on India’s financial system: ‹ NPAs: The rise of Non-Performing Assets (NPAs), including bad loans or problems in the agricultural and corporate sectors. Currently, the nation’s NPAs total more than 10 lakh crores, with the business sector accounting for more than 70% of the total. ‹ Bad Loan problem: After the 2008-09 global financial crisis, there was push in lending to infrastructure and capital goods sectors. But as the economy slowed down, demand decreased and capacity remained idle, making it harder for businesses to pay off their debt. ‹ Under the weight of Rs. 10 trillion in stressed assets, which included Rs. 7.8 trillion in defaulted loans and Rs. 2.2 trillion in restructured loans over nearly half a decade, the Indian banking sector collapsed. ‹ Recapitalization: In order to bring state-owned banks up to capital adequacy norms, recapitalisation of banks entails putting extra capital into them. It means an infusion of capital into banks to enable them to meet the mandatory capital adequacy norms set by the Reserve Bank of India from time to time. ‹ Increase in Bank Fraud: The increasing number of frauds, including accounting fraud, demand draft fraud, uninsured deposits, fraudulent loans, and others. 24 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES ‹ Lack of banking for the underserved and rural population: It is Notes approximately 69% of India’s total population. According to a World Bank estimate, 1.4 billion Indians lack access to formal banking. ‹ Asset Quality: One of the most important factors in assessing a bank’s general health is asset quality. For banks, loans made to individuals and businesses are assets. The interest earned on these assets is a substantial source of income and profit for banks, and the likelihood that the loans won’t be returned is their biggest risk. As the credit risk rises, the loan’s “asset quality” decreases. ‹ Human Resource Challenges: The banking sector has been struggling with significant attrition, a sizable staff emigration rate, and scale and speed recruitment issues. ‹ Illiteracy and Lack of Awareness of Government Schemes: Lack of reach in rural areas, where technical enablement and use of financial services remain a big challenge. These challenges are dragging down the industry’s performance and threatening future economic growth. This will have implications for both banks as well as for the economy. Therefore, the Central Government and RBI introduced various reform attempts to solve these issues and seize new chances. Therefore, the Central Government and RBI introduced various reform attempts to solve these issues and seize new chances. 2.4 Assessing Non-Performing Assets (NPAs) in Indian Banking NPA expands to Non-Performing Assets (NPA). Any advance or loan that is more than 90 days past due is considered a non-performing asset in India, according to the Reserve Bank of India. When an asset stops bringing in money for the bank, it is said to be no longer performing. NPAs must be further divided into sub-standard, doubtful, and loss assets by banks. NPA refers to loans made by Indian banks and other active financial institutions that have interest payments and principal balances that have been past due for an extended period of time. PAGE 25 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes Banks mostly rely on interest from advances and loans as well as principal payments for their income. The Reserve Bank of India defines an NPA as a credit facility whose interest and/or principal instalments have been “past due” for a predetermined amount of time. The asset is typically categorised as a non-performing asset if loan payments have not been made for 90 days. Banks are obligated to group non-performing assets into one of the following categories according to how long they have been non-performing: 1. Sub-standard Assets Sub- standard assets are non-performing assets that have been due for anywhere from 90 days to 12 months. They are regarded as having typical risk levels when it comes to non-performing assets. 2. Doubtful Assets The non-performing assets that are due past more than twelve months are known as sub-standard assets. In comparison to standard assets, they pose significantly higher risk levels. Banks and financial institutions are more sceptical of borrowers with sub-standards of non-performing assets and thus assign them with a haircut (market value reduction). 3. Loss Assets Loss assets are non-performing assets with such extended periods that lenders have given up hope that they would be able to recover their money. They are forced to write it off as a loss on their balance sheets. NPA Provisioning Keeping aside the technical definition, provisioning means an amount that the banks set aside from their profits or income in a particular quarter for non-performing assets, such as assets that may turn into losses in the future. It is a method by which banks provide for bad assets and maintain a healthy books of account. According to the category to which the asset belongs, provisioning is carried out. In the section above, the categories were mentioned. The type of bank affects both asset type and provisioning in addition to asset type. For instance, the provisioning standards for Tier-I banks and Tier-II banks differ. 26 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES GNPA and NNPA Notes Banks are obligated to periodically report their NPA figures to the RBI and to the public. Two metrics in particular aid in our understanding of each bank’s NPA situation. GNPA: GNPA stands for gross non-performing assets. GNPA is an absolute amount. It provides information on the overall amount of gross non-performing assets held by the bank during a specific quarter or financial year, as applicable. NNPA: NNPA stands for net non-performing assets. NNPA subtracts the provisions made by the bank from the gross NPA. Therefore, net NPA gives you the exact value of non-performing assets after the bank has made specific provisions. NPA Ratios Alternatively, NPAs can be calculated as a proportion of total advances. It enables us to estimate the portion of the total advances that are not recoupable. The math is rather easy to understand this way: ‹ The ratio of total GNPA to total advances is known as the GNPA ratio. ‹ Net NPA ratio is used to calculate the ratio to total advances. Reasons for arising Non-performing Assets Given below are some instances that may lead to non-performing assets in the long run: 1. When banks lend to individuals/businesses with poor credit ratings or without proper investigation. 2. When lenders don’t promptly follow up on pending payments with borrowers. 3. Corruption in financial institutions (lenders) in nexus with borrowers (generally businesses). 4. Political pressure on banks (especially PSUs) to lend to struggling sectors/industries. 5. Inefficient collection competencies and recovery efforts by banks. 6. The factors that contribute to Non-Performing Assets (NPA) are as follows: PAGE 27 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes (i) The bank’s lending to the corporations/persons etc. whose creditworthiness is not guaranteed and taking a lot of high risks. (NPA in Banking) (ii) The banks are not able to diminish their losses by a complete understanding of the sufficiency of the bank in terms of the loan or capital loss at a specific time frame. (iii) The funds are being redirected elsewhere by the promoters of the companies. (iv) The banks try to fund projects that are not viable. (v) Not enough means to collect as well as distribute credit information between the commercial banks and (vi) Non-efficient recovery of the debts from the overdue borrowers. Preventive Measures Against Non-Performing Assets 1. Lenders should rigorously scan the credit ratings (from Credit Information Bureau India Limited) of individuals/businesses at the time of evaluating the loan application. 2. Lenders should proactively send reminders to borrowers urging them to make the due payments. 3. Lenders should offer payment plans and settlements to borrowers to facilitate regularizing their loan accounts. 4. Lenders may use alternative dispute resolution procedures, such as Lok Adalats and Debt Recovery Tribunals, in addition to traditional courts, to reach speedy settlements of debts. 5. Lenders should be strict against large non-performing assets. 6. Lenders may employ the services of professional asset reconstruction companies to manage their non-performing assets better. 7. Lenders should circulate the details of defaulters so that others hesitate to lend to these defaulters again. 8. Lenders should implement insolvency and bankruptcy policies to aid distressed borrowers. 9. Borrowers can use corporate debt restructuring. 10. Lenders should be vigilant that borrowers (especially corporates) should not divert their funds (loans) to other subsidiaries or start ups. 28 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES 2.5 Previous Methodologies for the Recovery Notes In Indian banks, the process by which banks and financial institutions recover outstanding debts that have been labelled as non-performing is known as the NPA (Non-Performing Asset) recovery process. Loans are classified as NPAs when borrowers don’t make timely principal or interest payments. Being a bank employee, I am aware of how challenging it is for a bank to deal with a scenario like this. There is an NPA account recovery technique that banks use for circumstances like these. To reduce Non-Performing Assets (NPA) in Indian banks, several measures can be implemented. The measures to reduce NPA are: ‹Banks should enhance their due diligence and credit appraisal processes to assess the borrower’s creditworthiness effectively. Regular monitoring of loan accounts can help identify early signs of potential defaults. ‹ Banks should establish comprehensive risk management frameworks to identify, measure, and mitigate credit risks. ‹ Banks should proactively initiate recovery measures and adopt efficient debt recovery mechanisms. ‹ Promoting financial literacy initiatives can help borrowers make informed decisions and manage their finances effectively. ‹ Banks should maintain high standards of corporate governance and transparency in their operations. ‹ Regulators such as the Reserve Bank of India (RBI) can play a crucial role in monitoring and supervising banks’ asset quality. Debt Recovery Tribunal (2013) By putting these strategies into practice, banks can reduce the risks brought on by Non-Performing Loans (NPAs) and seek to maintain a healthier loan portfolio, thereby guaranteeing the stability and soundness of the banking industry. The development of sub-prime loans on a bank’s books is not a good thing because it affects the size and stability of the balance sheet. Additionally, there is a negative effect on the rate of return on assets. Profitability is decreased since a large number of profits must be set aside for shaky PAGE 29 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes and problematic loans. Banks are even plagued by the rising cost of NPA accounts’ carrying, which could have been put to more profitable use. Additionally, it is desired that the financial institutions maintain a specific capital adequacy level to strengthen their net worth. A group of banks or other financial organisations is worth at least Rs. 20 lakhs. Credit Information Bureau (2000) It was set up to reduce the time required for settling cases Credit Information Bureau (2000). This step is taken to prevent NPA’s by sharing of information on wilful defaulters. Credit Information Companies, also called credit bureaus, are organizations that collect, analyse, and maintain credit data on borrowers, businesses, and organizations. ARC (Asset Reconstruction Companies) It is licensed by the Reserve Bank of India an Asset Reconstruction Company is a specialized financial institution that buys the NPAs or bad assets from banks and other financial entities so that they can balance their books. ARCs buy subprime loans from banks, in other words, which is their line of work. It is established for recovering value from stressed loans by passing courts which was a 2013 measure implemented by the Debt Recovery Tribunal (DRT) to control Non-Performing Assets (NPA). For the swift adjudication and recovery of debts owed to banks and financial institutions, insolvency resolution, bankruptcy of individuals and partnership firms, and related matters, the RDB Act, 1993, establishes Debts Recovery Appellate Tribunals (DRATs), which have appellate jurisdiction, and Debts Recovery Tribunals (DRTs), which have original jurisdiction. While not discouraging borrowers, the Act seeks to protect the interests of banks and other financial institutions as lenders. Because the corresponding provisions have not yet come into effect, the Tribunals have not yet started taking on bankruptcy and insolvency resolution cases. Instances where the amount of debt owed to any bank or financial institution described by the Act or me-consuming process. 30 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES Corporate Debt Restructuring (2005) Notes It is made to reduce the burden of debts on the company by giving more time to the company to pay back as well as decreasing the rates along with it. It has to pay the obligation back. Corporate debt restructuring is the process of reorganising a company’s outstanding obligations in order to restore its liquidity and maintain its operations. It is frequently achieved through negotiation between financially distressed businesses and their creditors, including banks and other financial institutions, by lowering the total amount of debt the business has and by reducing the interest rate the business pays while lengthening the time it has to repay the obligation. 5:25 Rule (2014) The scheme allowed the Bankers to fix a longer repayment period for loans to infrastructure and core industries say 25 years, based on the economic life or concession Period of the project, with periodic reviews, say every 5 years. Flexible Restructuring of Long-Term Project Loans to Infrastructure and Core Industries is another name for this. This involves refinancing of long-term Restructuring of Corporate Debt (2005). By extending the company’s repayment period and lowering the rates concurrently, it is designed to lessen the burden of debts on the business. The plan permitted the bankers to set a lengthier loan repayment period for projects. A special group of lender banks called the Joint Lender’s Forum was established to hasten decision-making when an asset worth more than Rs. 100 crore or more turns out to be a stressed asset. 2014 saw the release by the RBI of guidelines for the creation of the JLF for the efficient management of stressed assets. Mission Indradhanush (2015) The Indradhanush for PSBs mission aims at revamping the functioning of the Public Sector Banks to enable them to compete with the Private Sector Banks. It aims to boost credit and reduce political meddling in PSB operations in order to revive economic growth. Mission Indradhanush (2015) Indradhanush for PSBs intends to upgrade the operations of public sector banks so they can compete with private sector banks. PAGE 31 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes By lowering political meddling in PSB operations and enhancing lending, it aims to revive economic growth. The Mission Indradhanush is a seven- pronged strategy to address the problems facing public sector banks. The PJ Nayak Committee’s report served as the basis for the goals that Mission Indradhanush achieved. It enables the Joint Lenders Forum (JLF), or just the lender group, to turn a portion of their financing in a struggling business into equity. If a company that has borrowed money from a bank is unable to pay it back, the bank may convert all or part of the debt into stock in the company. Asset Quality Review Asset Quality Review is a unique activity carried out by Reserve Bank of India (RBI) inspectors to examine bank records. A sizable sample of loans is examined to determine whether asset classification matched loan repayment and whether banks had made sufficient reserves. This is a type of preventive intervention that involves the early identification of assets that may end up being stressed in the future. Insolvency and Bankruptcy Code (2016) An act to harmonise and update the laws governing the timely reorganisation and insolvency resolution of businesses, partnerships, and individuals in order to maximise the value of their assets, encourage entrepreneurship, increase credit availability, and balance the interests of all parties involved. It is a One-stop process for solving insolvencies that aims to protect small investors. Process of Recovery of NPA An outline of the NPA recovery procedure in Indian banks is provided below: ‹ Identification and Classification: Based on predetermined criteria, such as the length of non-payment, banks identify loans that have turned into NPAs. ‹ Bank Recovery Efforts: Banks contact borrowers to remind them of past-due payments as the first step in the recovery process. This is carried out to make it easier for the borrower to pay back the loan. 32 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES ‹ Legal Action: Banks may turn to legal action if discussions and Notes restructuring efforts fail. This could entail bringing a lawsuit or starting a recovery process. ‹Asset Seizure and Auction: As a last resort, if the borrower continues to default on payments, banks may seize collateral, or assets provided as security against the loan. ‹ Debt Recovery Companies: To aid in the recovery process, banks may also use specialised debt recovery companies or Asset Reconstruction Companies (ARCs). 2.6 Impact of Gross NPAs on a Bank’s Bottom Line The surge in bad loans for the banking sector resulted in greater provisions, which eliminated earnings and required additional capital infusion. But fresh capital has not been forthcoming with the government on a path of fiscal consolidation and trying to control deficits and because of this lending has slowed down to a trickle. According to the RBI’s Financial Stability Report, banks’ percentage of the money flowing into the commercial sector fell to 38% in 2016–2017. Reduced investments, decreased production, unemployment, a slowdown in the economy, and finally a decrease in the rate of economic growth are the results of this. First, RBI in had directed the banks to take the 12 largest loan defaulters, accounting for one-fourth of the industry’s bad loans, to NCLT. Second, it created a second list of 26 defaulters and determined that banks should identify faulty assets and address them by any available method before filing for bankruptcy. Only those instances that cannot be handled through one of 2023-06-30 Words 873 Characters 7501 Page 1 of 4 the RBI’s current bad loan resolution schemes, like S4A or SDR, should be brought before the NCLT under the bankruptcy code. The NCLT, for instance, chose to remove the board of directors of Unitech Ltd., a prestigious real estate business, and ordering the Ministry of Corporate Affairs to propose 10 directors is a wise move to address the issue of bad loans. PAGE 33 © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  BBA(FIA) Notes Impacts of Non-Performing Assets (NPA) ‹ Banks won’t have enough money for additional development initiatives, which will affect the economy. ‹ Banks will be compelled to raise interest rates in order to preserve a profit margin. ‹ The reduction in new investments could cause unemployment to increase. ‹ Government of India and RBI’s Non-Performing Assets (NPA) Control Measures. ‹ Since non-performing assets are not a recent phenomenon, the Indian government and RBI have made numerous attempts to address the issue. Negative Impact on Balance Sheet The main issue for the banking system in any economy that causes the entire banking system of the nation to tremble is a high level of non- performing assets. The investor’s, depositors’, and stockholders’ level of confidence is also important. Money rotates as a result of this. Due to NPA, profitability has declined Non-performing assets cause the bank to lose more money in addition to reducing its profit. Additionally, banks provide an additional 25 to 30 per cent in provisions for non-performing assets, which have a direct influence on the profitability of the bank. The bank also simulates the amount’s recovery; nevertheless, until the impact of NPAs on bank profitability causes a dent in the bank’s balance sheet, the amount is non-performing. Difficult Liability Management High non-performing assets led the bank to cut deposit interest rates, and advances are anticipated to have higher interest rates going forward. This situation is exceedingly challenging and hurts the banking industry. Decrease Share Holders confidence Not in the banking industry, but shareholders still need to know that their money is secure. They are also interested in increased investment and market capitalization. High non-performing assets decrease investor 34 PAGE © Department of Distance & Continuing Education, Campus of Open Learning, School of Open Learning, University of Delhi  EMERGING BANKING AND FINANCIAL SERVICES confidence, which has a substantial impact on the share price of the Notes company. The Bank in this case stopped paying dividends to shareholders, which was against the investor’s best interests. Banks must conduct a proper review of the proposal at the outset, since this will expose the status of unviable projects as well. The rise in non- performing assets also affects stakeholder and investor expectations. Before accepting the loan, the bank must gather all relevant information regarding the industry, management, and future prospects. Decrease Public Confidence The bank’s bad performance as a result of rising non-performing assets not only hurts investor sentiments but also causes the public to lose faith in the institution, which has a negative impact on deposits. High non- performing assets have an impact on the entire economy. Thus, we can say that the increase in NPAs reduces the profitability of the banks due to their lack of credibility. The capital basis of the publ