Burning Issues of Banking Sector

8 BURNING ISSUES OF BANKING  LOANS & NPA

RBI’s 6-member statutory MPC decides policy rate (=repo rate) to keep
inflation within 2-6%CPI (All India) but who decides lending rates of
individual banks, & how? Ans.
8.1 BANKS’ LENDING RATES
Government began nationalization of private banks, and ‘administered interest
1969
rates’ on them.
M.Narsimham suggested deregulation: Govt should not dictate / administer
1991
individual banks’ interest rates & RBI should only give methodology to banks.
2003 RBI introduced _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ (BPLR).
RBI introduced BASE Rate + Spread system; update frequency on individual
2010
banks’ discretion.
- RBI introduced _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ (MCLR) +
Spread system. Banks to calculate on monthly basis. It consists of CRR
Cost, Operating Cost, Marginal cost of funds (Repo Rate, Deposit Interest)
2016 etc.
- Benefits? Better transmission of Monetary Policy; transparency &
accountability to borrowers. Although RBI’s Janak Raj internal study group
(2017) showed MCLR did not yield all benefits so new method…
- NEW loans (not existing loans) to be linked with “_ _ _ _ _ _ _ _ _ Benchmark
+ Spread” system. 1 Category of Loans = 1 External Benchmark.
2019, - Individual bank free to pick any one External Benchmark such as RBI repo
1st April rate (6.50%) or 91-day T-bill yield (6.56%) or 182-day T-bill yield (6.73%) or
any other benchmarks by Financial Benchmarks India Pvt. Ltd.
- Benefits? Same benefits which MCLR couldn’t fully deliver.

Table 1: Type of Loans based on Lending Rates

Fixed Interest Loan (निश्चित ब्याज ऋण) _ _ _ _ _ _ _ _ _ _ _ Interest Loan (िलायमाि)
e.g. Short-term crop loans upto Rs.3 lakh e.g. (External Benchmark) + Spread = 12%
rupees for farmers at fixed Interest 7%. This But benchmark is regularly updated. So
interest rate will not be changed throughout resultant interest rate may increase or
the loan tenure. decrease throughout the tenure of loan.
Teaser Loan: A sub-type of _ _ _ _ _ _ _
interest rate loan, wherein initial years have
low interest, but afterwards- higher interest
rate. While RBI has not banned Teaser
loans but has put stricter regulations on it
from 2011.

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 Table 2: Type of Borrowers
Prime Borrower has capacity to repay loans.
doesn’t have the capacity to repay loan. Giving teaser rate home
Subprime loans to sub-prime borrowers was among the reasons for Sub-prime
Borrower Crisis in USA (2007-08), which ultimately led to Global Financial
Crisis (GFC).
has borrowed too much money than his ability to pay it back. An
Overleveraged
Overleveraged company has high ratio of Debt (Bonds/loans) to
Borrower
Equity (Shares).
When a weak bank keeps giving new loans to a subprime /
Zombie Lending
overleveraged borrower.
MCQ. Why is the offering of "teaser loans" by commercial banks a cause of economic
concern? (Asked in UPSC-Pre-2011)
1. The teaser loans are considered to be an aspect of sub-prime lending and banks may
be exposed to the risk of defaulters in future.
2. In India, the teaser loans are mostly given to inexperienced entrepreneurs to set up
manufacturing or export units.
Answer Codes: (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 or 2
MCQ. What is/are the purpose/purposes of the 'Marginal Cost of Funds based Lending Rate
(MCLR)' announced by RBI? (Asked in UPSC-Pre-2016)
1. These guidelines help improve the transparency in the methodology followed by
banks for determining the interest rates on advances.
2. These guidelines help ensure availability of bank credit at interest rates which are fair
to the borrowers as well as the banks.
Answer Codes: (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2

8.2 NPA: अिजजक परिसंपत्तियां

8.2.1 NPA / TBS Problem: Three Stages of
1. Till mid-2000s: Boom period in global economy. Indian Corporates were taking large
amount of loans & became overleveraged.
2. From 2007-08: Subprime & Global Financial Crisis (GFC): Indian goods-services exports
declined. UPA government’s policy paralysis & judicial activism, environment activism
projects got delayed. Companies began facing difficulties finishing projects & repaying
loans.
3. By 2013: ~1/3rd of the bank loans were owned by “_ _ _ companies” i.e. companies with
interest coverage ratio less than 1 = not generating enough revenue even to repay the
loan interest.
Thus, balance-sheets of (1) some _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ & (2) Public Sector
Banks (PSB) became weak. It is called “Twin balance sheet syndrome (TBS)” [दोहरे तल
ु नपत्र
की समस्या] by Economic Survey 2015-16.

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8.2.2 NPA related definitions in Banking Sector
Loan account where borrower is repaying the principal and interest in
Std. Assets
timely fashion.
If loan principal / interest unpaid for 1-30 days from its due date, then
SMA-0
such loan account is classified as Special Mention Account-0.
SMA-1 31-60 days
SMA-2 61-90 days
 If loan principal or interest is not paid for more than _ _ _ _ _ _ from its
due date, then such loan account is classified as Non-Performing
Asset (NPA). For the farm loans, NPA is not counted on number of
days but on number of cropping seasons.
 Indian Commercial Banks’ NPA is over ₹10 lakh crores (absolute
NPA
figures); and over 10% of total lending. [As of 31/3/2018].
 NPA Size: PSB > PvB > Foreign Banks.
 Provisioning: As per RBI norms, banks must set aside funds to cover
losses against their NPA. Such ‘provisioning of funds’ decreases the
profitability of the Bank. Gross NPA MINUS Provisioning = NET NPA.
Substandard When loan account remains in the NPA classification for 12 months/>
asset
Doubtful When loan account remains in substandard classification for 12 months/>
asset
When a bank, its auditor or RBI declares that given doubtful asset has little
Loss Asset
/ no salvageable value.
When loan is written off from the ‘asset-side’ of the bank balance sheet, to
Loan write-
save corporation tax. Loan write-off doesn’t waive bank’s right to recover
off
that bad loan, it’s merely an accounting exercise for tax-benefits.
Restructured When principal / interest rate / tenure of the loan is modified. Banks may
loan do it when borrower facing difficulty in repaying loans.
Stressed NPA + Loans Written-Off + Restructured Loans = Stressed Assets
Asset
OTS with If bank allows the client to pay 60% of dues and forgoes 40% as loss, then
Haircut we say bank has offered “Onetime Settlement (OTS) with 40% haircut”
- Banking: When a borrower taking a new loan to pay off his old loan.
- Patents: When drug patent expires after 20 years, pharma-company
Evergreening
makes minor modifications in the old drug’s molecule to register new
patent, thus keeping its monopoly rights on the production.
8.3 RBI “3R” FRAMEWORK FOR REVITALIZING STRESSED ASSETS

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8.3.1 Rectification (सध
ु ाि)
- 2015: RBI ordered the Banks to conduct Asset Quality Review (AQR) and begin
rectification of bad loans i.e. Bank doesn’t change in loan interest, tenure or terms, but
asks client to rectify his irregularity in loan-repayment.
- In genuine case, additional loan may be given. Bank may also try to find a new partner /
investor for reviving the project.
8.3.2 Restructuring (पि
ु र्जठि)
 Restructuring = Changing the Loan interest (%) or tenure or ownership.
 _ _ _ for Infrastructure loans: RBI allowed banks to extend infra-loan tenure upto 25
years, and even reduce loan interest rate. But such Interest rate will be reviewed each 5
years.
 CDR: Corporate Debt Restructuring: loan can be restructured if 75% of the lenders
approve.
 _ _ _ : Strategic Debt Restructuring (िणिीनतक ऋण पि
ु र्जठि): Bank’s Debt (Loan) is
converted to Equity (Shares with Voting Rights) & bank sells it to highest bidder 
company’s ownership may change. Scheme unsuccessful as it required the approval of
existing shareholders.
 _ _ _ - Scheme for Sustainable Structuring of Stressed Assets (तंर्हाली आश्ततयो की
संधािणीय संिििा): Only unsustainable portion of Debt (Loan) converted to equity
(Preferential Shares without voting rights) & sold off to investors, in such manner that
company’s ownership is not changed.
 JLF- Joint lenders forum (ऋणदाताओ का संयक्
ु त मंि): Consortium of the lenders, who
will work out aforementioned restructuring methods. But, proved unsuccessful because
PSB Officials would not vote positively due to the fear of Media & 4C [Courts, CBI, CAG
and CVC]. RBI stopped above schemes from 31 March 2018. Now banks can restructure
loans only under the provisions of Insolvency and Bankruptcy Code (IBC) 2016.
8.3.3 Recovery (वसल
ू ी)
Bank liquidates loan-defaulter’s assets under either of the following acts:
 SARFAESI Act 2002 (सरफेसी अधिननयम) OR
 Insolvency and Bankruptcy Code 2016 (शोिन-अक्षमता एवं ददवाललयापन संदहता 2016): If
75% of the lenders don’t agree for restructuring / resolution plan, then assets will be
liquidated.
(UPSC-Prelim-2017) ‘Scheme for Sustainable Structuring of Stressed Assets (S4A)’ is
related to:
a) procedure for ecological costs of developmental schemes.
b) scheme of RBI for reworking the financial structure of big corporates with genuine
difficulties.
c) disinvestment plan for Central Public Sector Undertakings.
d) Provision in ‘The Insolvency and Bankruptcy Code’.

8.4 SARFAESI ACT 2002: ORIGIN, OBJECTIVE & LIMITATIONS

 1991: Narsimhan-I Committee on banking sector reforms observed that borrowers
obtain stay orders from ordinary courts = banks have difficulty recovering NPA. So, _ _ _

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 _ _ _ _ _ _ _ _ _ _ _ _ (DRT: ऋण वसल
ू ी न्यायाधिकरण) were set up (1993)- ordinary courts
can’t interfere in the loan recovery process.
 1998: Narsimhan-II Committee observed that DRTs need to be strengthened with a law,
so, Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest (SARFAESI) Act enacted (2002). [प्रनतभत
ू ीकरण और ववत्तीय आस्स्तयों का पन
ु र्गठन
और प्रनतभनू त दहत को प्रभावी करने का अधिननयम 2002]
 Under SARFAESI act, Banks and Housing Finance Companies (NBFCs) can attach the
mortgaged assets when loan is not repaid. They can change board of directors in such
companies, can auction such assets, can also sell such assets to Asset Reconstruction
Companies (ARC, NBFC). SARFAESI not applicable on farm loans.
 If loan-defaulter wants to obtain a stay order, he cannot go to ordinary courts. He will
have to approach for DRT. If DRT doesn’t help then  higher appeal to Debt Recovery
Appellate Tribunal (DRAT), but DRAT will require him to deposit minimum 50% of the
loan dues (to discourage frivolous appeals).  higher appeal to high court.
Limitations of SARFAESI Act
 The DRTs & DRATs are understaffed. 1 lakh+ cases pending (2016), so, case will go on
for years and the debtor will remain in possession of asset. This leads to erosion of asset-
value (machinery, vehicles) even when DRT allows auction.
 In some businesses, auction or liquidation may not yield the best return for the banks
(e.g. hotel resort in remote area, where no other hoteliers are keen to invest). In such
cases, if the loans were restructured, banks could salvage more value. But, SARFAESI
act doesn’t facilitate arbitration ( मध्यस्थता) So, Govt. came up with a new law IBC 

8.5 INSOLVENCY AND BANKRUPTCY (I&B) CODE 2016: शोधि-अक्षमता एवं

ददवाललयापि संदहता 2016

 Individual, Partnership firm or Company defaults on a business loan of ₹ 1 lakh or more,

then, lenders approach National Company Law Tribunal (NCLT: राष्ट्रीय कंपनी कानन
ू
अधिकरण), to initiate proceedings under the I&B Code.

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 NCLT will grant moratorium (पाबंदी) of 180-270 days so no other lender can unilaterally
attach assets under SARFAESI Act.
 Within that period, an _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ (IP: शोिन-अक्षमता संबि
ं ी पेशव
े र) will
make a resolution plan e.g. reduce loan interest, extend loan tenure, or IP could even find
another investor to finance the pending project etc.
 If 75% of the Lenders (ऋणदाता) agree with such _ _ _ _ _ plan, then it will be set in
motion, otherwise, IP will _ _ _ _ _ (पररसमापन) the assets to recover the dues.
 Appeal Structure?
A. If borrower is individual / partnership firm: Appeal @DRT of SAFAESI Act. OR
B. If Borrower is a Company: Appeal @NCLT of the Companies Act.
 I&B Code is not applicable to following defaulters:
A. _ _ _ _ _ _ _ _ _ _ Defaulter (जान-बझ
ू कर बकाएदार): A borrower who has the
capacity to repay, but he’s not repaying the loan. E.g. Vijay Mallya was declared
willful defaulter by SBI (2017). OR
B. _ _ _ _ _ _ _ _ _ _ Defaulter (असमथग बकाएदार): A borrower whose loan account is
in NPA for more than a year, and he has no capacity to repay even partial loan
amount.
Above two categories of borrowers are not eligible for I&B resolution process. Their assets
will be directly liquidated under SARFAESI Act.

8.5.1 Insolvency and Bankruptcy Board of India (IBBI)

 भारतीय शोिन-अक्षमता एवं ददवाललयापन बोर्ग is the _ _ _ _ _ _ _ body that monitors and
implements I&B Code 2016.
 IBBI composition: One Chairman (M.S.Sahoo), 1 nominated member from RBI, other
members from Government’s side. Total 1 chairman + 9 member = 10 people.
 IBBI’s administrative control rests with the Ministry of Corporate Affairs (MCA).
 Chairman has 5 years / 65 age tenure, whichever earlier. Also eligible for
reappointment.
 IBBI selects Insolvency Professionals Agencies (IPAs). These IPAs enroll and supervise
the members practicing as Insolvency Professionals (IPs). Presently, 3 organizations
given “IPA” status viz. 1) ICAI (Chartered Accounts) 2) ICSI (Company Secretaries) and
3) Institute of Cost Accountants.
 IBBI also selects Information Utility (IU) organization to maintain database of
borrowers. In 2017, NeSL: National E-Governance Services Ltd (owned by consortium
of SBI, LIC etc.) was the first to get the IU status. It is compulsory for the lenders to share
data with IU. IU helps lenders in two ways:
1) by looking @borrowers’ credit history, lenders can make informed decisions
about whether to give loan or not, and how much interest to charge?
2) This database helps establishing documentary proofs during NCLT / DRT / judicial
/ liquidation proceedings.
8.5.2 Banking Regulation (Amendment) Act 2017: बैंककं र् त्तवनियमि (संशोधि) अधधनियम
 I&B Code resolution process can start only AFTER a bank / NBFC files a motion at NCLT.
But, Public Sector Bank (PSB) officials fear Media, CBI, CVC, CAG & Courts - hence
were reluctant to even file motion @NCLT.

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 I&B Resolution plan can work only if 75% of lenders approved. But even in such voting,
PSB-executives will shy away from voting positively. To solve these problems,
Government first issued an ordinance and then passed a bill for amending Banking
Regulation Act. This amendment increased RBI’s powers to force the banks to begin
process under I&B Act.

8.6 BORROWERS’ DATABASE & TRACKING

8.6.1 Public Credit Registry (ऋण की सावजजनिक िश्जतरी)
Presently, multiple organizations keep borrowers’ database / credit history viz.
1) Under the I&B code, Insolvency and bankruptcy board of India (IBBI) has
authorized the National e-governance services Ltd (NeSL) to act as an
Information Utility (IU).
2) Under the Credit Information Companies Regulation Act (CICRA 2005), RBI has
given license to CRISIL (oldest CIC-1987), CARE, FITCH India, ICRA, Brickwork
Ratings , SMERA etc. as Credit Rating Agencies [ऋण पात्रता-मूलयांकन एजेंसी].
3) RBI has its own “Central Repository of Information on Large Credits (CRILC)” for
Loans above Rs 5 cr. Banks & NBFCs have to submit weekly updates in this
portal.
But, not all of these databases are under the direct control of RBI. Each has their own
methodology for data collection & tabulation. Not all of these databases are covering
all individual and corporate borrowers of India. So, RBI’s _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
Committee (2017-18) recommended setting up a Digital Public credit registry (PCR)
with following features:
1) PCR will be setup under RBI, using data from SEBI, Corporate Affairs Ministry,
GST authorities, IBBI, Banks, NBFCs etc.
2) PCR will help lenders to get complete 360-degree profile of borrower on real time
basis.
3) PCR will help RBI in early detection of systematic stress, checking the efficacy of
monetary policy & other big data analytics.
2018: RBI issued tender to select a company for developing PCR portal. _ _ _ _ _
Company won the tender/contract. [Update when IT-Company is finalized]
[Asked in UPSC-CDS-2016-II] [Asked in UPSC-CDS-2018-1]
Which one of the following is/are credit The Reserve Bank of India has recently
rating agency/ agencies in India? constituted a highlevel task force on
(a) CRISIL Public Credit Registry (PCR), headed by
(b) CARE (a) Sekar Karnam
(c) ICRA (b) Vishakha Mulye
(d) All of the above (c) Sriram Kalyanaraman
(d) Y. M. Deosthalee

8.6.2 Legal Entity Identifier (LEI) Number: (कािि

ू ी इकाई पहिाि िंबि)
 Even if a company is blacklisted by Indian banks, it could apply for loans overseas, and
those overseas bankers may not be aware of company’s history. So, there should be a
global “Aadhar card” number for companies, and they must be forced to quote that
number during every financial transaction.

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 After Sub-Prime Crisis and Global Financial Crisis (GFC), the _ _ and its Financial
Stability Board (FSB) came up this LEI concept- a 20-digit alphanumeric code.
 LEI’s Global Boss: Global Legal Entity Identifier Foundation (GLEIF), Frankfurt, Germany.
LEI’s Indian agent: Clearing Corporation of India.
 RBI had ordered the large borrowers (who have taken loans above Rs.1,000 crore from
Indian banks) to obtain LEI number by 31/8/2018, then gradually smaller companies must
obtain LEI-number in a phased manner.
 Companies must quote this LEI-number in their financial transaction. RBI has power to
issue such directives under: Payment and Settlement Systems Act, 2007 & Banking
Regulation Act 1949.
Even if a borrower has obtained LEI, his name is in PCR, yet one day he
runs away from India, then what to do? Ans. 

8.7 FUGITIVE ECONOMIC OFFENDERS ACT, 2018 (भर्ोडा आध्जक अपिाधी

अधधनियम)
 This act targets economic offenders accused of cheque dishonor, loan / investment /
chit-fund scam, money laundering etc. worth ₹ _ _ _ _ crores /> & left India to avoid
facing prosecution / arrest.
 Special courts under the PMLA (Prevention of Money-laundering Act, 2002) will order
the villain to appear within 6 weeks, if not then he’s declared “Fugitive Economic
Offender” his Indian & _ _ _ _ _ _ & Benami properties will be attached (जब्ती).
 Once property attached- the _ _ _ _ _ _ _ _ _ will oversee its administration /
liquidation(पररसमापन).
 No ordinary civil court / tribunal can give stay order. Villain can make appeal only in High
Court and Supreme Court. (उच्च न्यायालय और सवोच्च न्यायालय).
If Borrowers don’t repay, SARFAESI auctions give little recovery, CRR-
SLR insufficient to repay deposits then bank collapse imminent. Then,
how to protect the depositors? Ans. 
8.8 DICGCI ACT: OBJECTIVE & LIMITATIONS
- 1961: Deposit Insurance and Credit Guarantee Corporation Act (ननक्षेप बीमा और प्रत्यय
र्ारं टी ननर्म)- mandates that all types of banks must buy insurance on their deposit
accounts from DICGCI- 100% owned by_ _ __ . One of RBI Dy. Governor acts as
chairman of DICGCI. HQ: Mumbai.
- When a bank shuts down, DICGCI will pay upto ₹_ _ _ _ _ _ insurance to every deposit
holder for his principal and interest.
- Further, DICGCI also provides guarantee cover to bank loans granted to Priority Sector
Borrowers, except home loans. With setting up of SIDBI (1990) & National Credit
Guarantee Trustee Company Ltd. [NCGTC, 2016] this credit guarantee work is
fragmented among many institutes, but we need not PHD over it.
Limitation of DICGCI
 If a customer had deposited more than ₹1 lakh rupees in a single commercial /
cooperative bank, then he gets only ₹1 lakh from DICGCI. And for remaining amount he
must wait till RBI / Cooperative Registrar liquidates the bank.

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 DICGCI doesn’t cover NBFCs. 2002: UTI (a Government owned mutual fund company)
made big losses. DICGCI not liable to protect UTI-clients. So, Government had to pay
₹14,561 crores bailout package.
 Therefore, Financial Sector Legislative Reform Commission (FSLRC) under Justice B.N.
Srikrishna (2011-13) recommended a new organization called Resolution Corporation
(RC) via FRDI Bill.

8.9 FRDI BILL 2017: OBJECTIVE & WITHDRAWAL

 Financial Resolution and Deposit Insurance (FRDI) Bill (ववत्तीय समािान और ननक्षेप बीमा)
aimed to transform the DICGCI into a Resolution Corporation (RC). All financial
intermediaries (Banks and NBFCs) will have to buy insurance from RC, to protect their
depositors.
 RC will monitor these Banks and NBFCs, if they come in ‘imminent financial risk’, RC will
draft a resolution plan e.g. merging it with another entity, or finding new investors for
infusing additional capital etc.
 However, incase of weak bank, if such investor couldn’t be found & merger with another
bank was not possible, then RC could even use the weak-bank’s depositors’ money to
infuse equity (share) capital into the Weak-Bank. This was called “Bail-In” provision -
highly criticized by media and Opposition parties. 2018-Aug: Government withdrew the
bill. So, we need not do further PHD over FRDI or its Bail-in provisions.

8.10 A BAD BANK CALLED “PARA”

 Former Chief Economic Advisor (CEA) Arvind Surbamanian’s Economic Survey 2016-17
had proposed a bad bank named “Public Sector Asset Rehabilitation Agency” (PARA:
सावगजननक क्षेत्रीय पररसंपदा पन
ु :प्रनतष्ट्ठापन एजेंसी).
 PARA will buy bad loans from PSBs, try to salvage the maximum value from loan-
restructuring / liquidation-auction and absorb the losses.
 Arvind S. also suggested RBI to give additional dividend to Govt. to start this bad bank &
finance its losses. Ofcourse, this idea was not implemented. But, media attention landed
on Urjit Patel- why he’s unable to solve NPA problem & could Bad Bank solve this
problem!!? So, Urjit responded by tightening Prompt Corrective Action (PCA) framework.

8.11 PROMPT CORRECTIVE ACTION (PCA) FRAMEWORK

 2002: RBI Governor Bimal Jalan designed it. (त्वररत सि
ु ारात्मक कारग वाई रूपरे खा)
 2017: Urjit Patel toughened PCA norms further.
 2018: _ _ _ _ _ _ announced separate ‘Prompt Corrective Action (PCA) Framework’
framework for Regional Rural Banks (RRBs).
 In PCA framework, all Commercial Banks are monitored for Asset Quality (NPA), Capital
Sufficiency (BASEL-III), Profitability (Return on Assets: RoA)- and are classified into Risk
threshold #1, #2, #3. Higher the number, higher the risk. Then, accordingly, RBI will take
corrective actions such as:
1. RBI giving strict warning, conducting deeper audit & supervision.
2. Restricting bank’s directors’ salaries and dividend distribution to its investors.
3. Restricting bank’s branch expansion & lending operations.
4. Forcing merger / shutdown of a weak bank (under Banking regulation Act 1949).

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 If a PCA-listed bank wants to get ‘whitelisted’, it’ll have to reduce its _ _ _ , obtain
additional _ _ _ _ _ , improve its _ _ _ _ _ .
 As of Dec-2018: 11 out of 21 Public Sector Banks in PCA list. So, Govt. wanted RBI to
lift/ease PCA-restrictions. But Urjit did not oblige.

8.12 BASEL-III NORMS (बेसेल-3 मािदं ड)

 Bank for International Settlements (BIS) is an international institution made up of 60
countries’ Central Banks. HQ @ BASEL, Switzerland. Its committee on banking
supervision set norms in 1988 (I), 2004 (II), 2011(III) to ensure global financial stability.

Figure 1: we need not bother with Tier-1 Tier-2 Capital etc.

 From 1/4/2013, RBI began phased implementation of BASEL-III norms in India:

 First, a bank needs to calculate its _ _ _ _ _ _ _ _ _ _ _ _ _ _ (RWA: जोखखमपण
ू ग संपवत्त).
 Against these RWA, (Universal) Scheduled Commercial Banks (SCB) must keep:
o “Minimum Capital to Risk Weighted Assets Ratio” (_ _ _ _) at 9% or higher
from 31/3/2019.
o Capital Conversation Buffer (CCB) from 31/3/2020.
o Counter Cyclic Capital Buffer (CCCB): whenever RBI notifies.
 Each member country’s Central Bank can prescribe different ratios depending on their
country’s situation.
 As NPA ↑ = bank’s asset quality degrades = its Risk-weighted assets (RWA) will ↑; then
bank must arrange more capital to comply with these ratios, norms and buffers.
 If a bank can’t comply with BASEL norms, then RBI puts it in _ _ _ list. In worst case, bank
will have to merge/ sell off its business to another bank or shut down.
 BASEL Norms also apply on Differential Commercial Banks (_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ),
Cooperative Banks, AIFI (_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ) and certain
category of NBFCs, but RBI can prescribe separate norms / limits / deadlines for them.

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MCQ. (UPSC-Prelim-2016) Objective of BASEL-III norms?

a) Develop national strategies for biological diversity.

b) reduce the GHG emissions but places a heavier burden on developed countries.
c) transfer technology from developed Countries to poor countries to replace
chlorofluorocarbons in refrigeration.
d) improve banking sector’s ability to deal with financial and economic stress and improve
risk management.

8.12.1 Recapitalization of PSBs [सावजजनिक क्षेत्र के बेंको का पि

ु :पज
ूं ीकिण]
- If a bank doesn’t have enough capital to comply with BASEL-III norms it can issue debt
(bonds) and equities (shares) to gather new capital.
- 2015: Projected that Public Sector Banks (PSBs) will require ₹ 1.8 lakh crore additional
capital by 31/3/19 to comply with BASEL-III norms.
- So, Finance Ministry’s _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _came up with _ _ _ _ _ _ _ _ _
PLAN for phased-recapitalization of PSBs with ₹ 70,000 crores from 2015 to 2018.
Individual PSB will get funding based on outcomes / performance.
- 2017: It became clear ₹70,000 crores was insufficient for BASEL-III compliance. So,
Modi Govt. announced ₹ 2.11 lakh crore recapitalization package.
Component Amt in ₹ Cr.
PSBs to mobilize equity (share) capital from private investors. However, 58,000
investors shy away from smaller banks with weak balancesheets, so BMB
& 5 Associated Banks merged with SBI (2017). Vijaya & Dena to be
merged with BoB (2019, 1st April)
Government’s budget support to PSBs 18,000
Government to issuing Bank Recapitalization Bonds (RCB) in the 1,35,000**
market with following features:
- These bonds will have interest rate of ~7%, mature @ 2028-2033.
- Non-transferable to third party, Non-convertible into shares.
Total 2,11,000*
2018-Dec: Even this ₹2.11 lakh crore package was found insufficient, so, Govt. sought
supplementary grants from Parliament to infuse additional ₹41,000 crores in PSBs. Thus,
total ~₹_ _ _ _ _ lakh crores mobilized help PSBs in BASEL-III compliance.
**Critiques argue that PSBs themselves are forced to buy these Bonds using public deposits,
and thus Bank Recapitalization Bonds are merely a ‘creative-accounting’ practice to comply
with BASEL-III norms, but we need not bother with such “B.Com / Controversy in News” for
UPSC.

MCQ. With reference to the governance of public sector banking in India, Find Correct
Statement(s):(Asked in UPSC-Pre-2018)
1. Capital infusion into public sector banks by the Government of India has steadily
increased in the last decade.
2. To put the public sector banks in order, the merger of associate banks with the
parent State Bank of India has been affected.
Answer Codes: (a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2.

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8.12.2 BASEL-III related Misc. Terms
8.12.2.1 Counter-cyclical Capital Buffer Norms (CCCB)
 Part of BASEL-III norms. It requires banks to create capital buffer during the boom
period in economy, so that such buffer can be used during the bust/slowdown.
 RBI must announce this norm 4 quarters (=1 year) in advance. So far RBI has not
required Indian Banks to keep CCCB.

8.12.2.2 Liquidity Coverage Ratio & High-Quality Liquid Assets (HQLA)

 BASEL-III norms require the banks to keep enough in High Quality Liquid Assets (HQLA)
so that bank can survive a 30 days high stress scenario of cash outflow / bank run. If a
Bank has enough HQLA assets to survive this test, we say this Bank has Liquidity
Coverage Ratio (LCR) of 1 (or 100%).
 RBI implemented deadline came gradually Jan 2015: 60%, ..+ 10% each year…. Jan’19:
100% or more.

8.12.2.3 D-SIB: Domestic Systematic Important Banks

 In 2010, G-20’s brainchild Financial Stability board (HQ: BASEL) asked countries to
identify Systematically Important Financial institutions and put framework to reduce risk
in them. [Side note: Same parents responsible for birth of _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ]
 Each year in August, RBI identifies banks that ‘too big to fail’ (=if they fail, it’ll severely
hurt the economy)’ and labels them as Domestic Systematic Important Banks (D-SIB),
& orders them keep additional equity capital against their Risk Weight Assets (RWA).
 Presently, 3 D-SIBs in India: _ _ _ _ _ _ _ _ _ _ _ _ (Latest Entry).

8.13 BANKING SECTOR: GOVERNANCE / ADMINISTRATIVE REFORMS

8.13.1 Gyan-Sangam-I, 2015, Pune
FinMin’s Dept of _ _ _ _ _ _ _ _ _ _ _ (ववत्तीय सेवा ववभार्) organized a workshop of financial
regulators, Public Sector Bank, Insurance Companies etc. It resulted in 3 outcomes:
1) PSBs’ CMD post bifurcated into 1) separate chairman and 2) separate MD&CEO so that
banks can function in more professional and accountable manner.

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2) Indradhanush plan for bank recapitalization (Rs.70,000 crores) tied with governance
reforms in PSBs.
3) Finance Ministry setting up an autonomous body- Bank Board Bureau (BBB).
8.13.2 Bank Board Bureau (BBB), 2016
- BBB selects top officials (MD, CEO, Chairman and full-time Directors) for PSBs, LIC and
other public sector financial institutions. Actual appointment done by FinMin’s
Department of Financial Services. (Just like UPSC selects candidates suitable for IAS but
DoPT notifies appointment.)
- BBB also helps the banks in governance reforms, raising capital for BASEL-III etc.
- BBB has 1 Part-Time Chairman, 3 Part-Time Members and 3 Ex-officio Members (from
Govt & RBI side)
- 2018, April: Bhanu Pratap Sharma (retd.IAS) replaced Vinod Rai (retd.IAS, CAG) as the
new chairman of BBB.
8.13.3 Enhanced Access and Service Excellence (EASE: बढी पहुंि औि सेवा उत्कृष्टता)
Agenda 2018
- 2017, October: Government announced ₹2.11 lakh crore package for recapitalization of
PSB. But critiques argued such relief measures will just make the PSBs lazy &
undisciplined (moral hazard). So,
- 2017, November: First Public Sector Bank (PSB)-Manthan organized by Dept of
Financial Services (DFS) at Gurugram. Based on the participants’ inputs…
- 2018, January: FinMin’s Dept of _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ released EASE framework
with 6 pillars to make PSBs Responsive and Responsible viz.
1. Customer Responsiveness.
2. Responsible Banking: Reduce NPA, prevent frauds.
3. Credit Off Take: Try to reach out to potential borrowers for home, auto, education,
loans.
4. Help MSME entrepreneurs via SIDBI’s Udyamimitra.com portal. Approve/reject loans
in not more than 15 days.
5. Deepening Financial Inclusion & Digitalization.
6. Employees’ Human Resource Management (HRM): improve with training,
performance linked promotion-salaries-posting-transfers etc.

Implementation? Each whole-time director of a PSB will be entrusted with one pillar of the
framework. Their performance will be checked by the PSB’s board of directors. An
independent agency will be tasked to check public perception.

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 Table 3: Points for assembling Mains Answers Rapidly

Eco.Survey-2015: “4R” framework Eco.Survey-2014: “4D” framework

Recognition: of bad loans via asset Disinter "Digup graves, recover money": using
quality review (AQR)
Resolution: via ALPHABETICAL soup: Differentiate among PSB: Profit Maker PSB:
______________ Capitalize for BASEL-III whereas Loss Maker
PSB: Merge or Privatize 

... [although scrapped post-I&B code]

Recapitalization: for BASEL-III norms Diversify: Allow more number and variety of
 Indradhanush, Bank Recap Bonds & Banks. _ _ _ _ _ _ _ _ allowed. Wholesale Bank
other measures: Total ₹_ _ _ _ lakh proposed.
crore mobilized.
Reforms: Governance & Deregulate: Lower SLR, Promote Corporate
Administration of PSB _ _ _ _ _ _ _ _ Bond market so they borrow less from Banks
e.g. Tri-Party Repo mechanism.

8.14 MISC. BANK CONTROVERSIES / ISSUES

8.14.1 PNB, LoU, SWIFT, Nostro & Nirav Modi

PNB (Mumbai Branch): Give foreign currency loan to our client for purchase of goods
(diamonds, airplanes, whatever), if he doesn’t pay, we’ll pay.
- If such bank guarantee given to another bank in a foreign country, it’s called Letter of
Undertaking/ Letter of Credit: internal difference not important.
- if such bank guarantee given to same bank (PNB)’s overseas branch, it’s called Letter of
Comfort.
- Bank earns commission / fees from client for issuing such letters / guarantees.
- The foreign currency thus loaned, goes into PNB’s Nostro (Latin:Ours) account, & Nirav
uses the dollars to buy diamonds in HongKong.
- PNB Scam: PNB-Mumbai’s corrupt manager kept issuing LoUs to diamond merchants
Nirav Modi & Mehul Chowkasi without due-diligence or collaterals for 7 years, worth
~₹12,000 crores. And 2018-January duo left India.
- PNB officials couldn’t detect scam because LoUs were generated through SWIFT
platform, which was not integrated with their Core Banking Solution (CBS) server.
8.14.2 Financial Messaging Systems
Within India Globally
Structured Financial Messaging System Society for Worldwide Interbank financial
(SFMS) telecommunication (SWIFT)
designed by Tata Consultancy Services By a Cooperative organization in _ _ _ _ _
(TCS) for IDRBT (=Research arm of RBI) La Hulpe city (1973).
to serve the messaging function in NEFT, To serve the messaging function for Banks,
RTGS, and other inter-bank, intra-bank e- NBFCs & brokers who may / may not have
transactions platforms within India. direct bank relations / settlement systems
with each other due to international
borders.

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8.14.3 IL&FS, Shadow Banking, NBFC Liquidity Crisis

- Infrastructure Leasing & Financial Services (IL&FS) is a Systemically Important Non

Deposit Taking Non - Banking Finance Company (NBFC - ND - SI) Setup in 1987
HQ@Mumbai.
- Shareholders: LIC > Japan’s Orix group > Abu Dhabi’s group > Central Bank of India >
SBI.
- Challenge? 1-2-3 of above diagram.

Remedies undertaken?
- Under Companies Act: Ministry of Corporate Affairs replaced the IL&FS’s Board
members. Uday Kotak made new Chairman.
- PSBs unable to lend more to IL&FS due to PCA framework. But, RBI relaxed
securitization norms for NBFCs so they can use existing loan papers to issue new
securities to borrow money from market, thus increasing liquidity /money supply for
NBFCs’ biz operations.
- LIC says we’ll not allow IL&FS to collapse (=we may use Policy holders’ money to rescue
it just like IDFC) = “Financial Repression of households”.
8.14.4 RBI Dividend, Reserves, Economic Capital Framework
RBI’s income sources include: From its income, RBI allocates funds for
1. Interest on G-Sec that are not sold in 1. Staff retirement fund, provisions for bad
Open Market Ops. loans, depreciation in assets…
2. Interest on Foreign G-Sec / Sovereign 2. Reserves for contingency (emergency):
Bonds. ~₹ 2.5 Lcr.
3. Interest on Loans given to its other 3. Reserves for Exchange Rate Stability
Banks / NBFCs. (Technically called “Currency & Gold
4. Revaluation of foreign currency and Revaluation Reserve: ~₹7 lakh cr)
gold in RBI reserves.
5. Seigniorage: profits from printing After making these allocations, profit is
money- because face value < intrinsic shared with Union Govt. in form of
value. ‘Dividend’ (RBI Act Section 47).
6. Penalties imposed on errant Banks.

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8.14.5 Section-7 Directive & Urjit Patel’s Resignation

This topic is not very important because UPSC usually avoids “Controversy in News”. Urjit
Patel was unhappy with Government interfering / criticizing his work. Such as:
 Higher Dividend: Govt. demanded higher dividend from RBI to finance the
recapitalization of PSBs for BASEL-III, and to finance its own fiscal deficit & populist
welfare programs. Urjit Patel felt RBI’s higher reserves are necessary to check any
financial crisis. Excessive dividend could increase inflation. He did not oblige.
 BASEL-III-relaxation: These norms will become fully effective on 31/3/2019 but PSBs
don’t have enough capital to comply so they requested Finance Minister (FM) to tell Urjit
Patel to extend the deadline, Urjit Patel did not oblige.
 PCA-relaxation: Urjit Patel vigorously implemented Prompt Corrective Action
framework, so Public Sector Banks’ branch expansion, lending operations were
restricted, they came running to FM. FM asked Urjit to relax PCA. He did not oblige.
 Tight Money Policy: CEA Arvind Subramanian & BJP-Ministers were criticizing RBI’s
“Tight” Monetary Policy depriving MSMEs of cheap loans and thus harming India’s
growth rate. Whereas Urjit Patel deemed tight policy necessary to keep inflation @2-
6%CPI (All India) on durable basis so he did not oblige.
 PNB Scam: Jaitley expressed displeasure that RBI couldn’t detect PNB-Nirav Modi fraud,
whereas Urjit Patel defended that he lacks effective powers under Banking Regulation
Act to take punitive actions against Public Sector Banks.
All these forced Govt. to issue Section -7 Directive to RBI.

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8.14.5.1 Section-7 of RBI
 Section 7(1) of the RBI Act empowers the Government to consult with RBI Governor in _
________.
 In, 2018-October, for the first time in the history of Independent India, Govt began a
Section-7(1) consultation with RBI Governor Urjit Patel, for issues of PCA norms, BASEL-
III deadline, higher dividend to Govt., Cheap Monetary Policy etc.
 If RBI Governor doesn’t positively respond in such Section-7(1) consultation, then
Section 7(2): Government can issue binding direction / orders to RBI _ _ _ _ _ _ _ _ _ to
implement its wishes.
 Although, fearing backlash from Media & Opposition Parties, Govt did not issue any
specific directions to the RBI Board. But, 2018-Dec: Urjit Patel resigned before
completing 3-year term. He is not the first RBI governor to resign & we need not prepare
KBC-GK-names of all the RBI governors who resigned before their term.

8.15 MOCK QUESTION FOR MAINS GSM3 (250 WORDS EACH)

1. “While Insolvency & Bankruptcy Code doesn’t fully cure the Twin Balance sheet
Syndrome, it certainly helps alleviating the pain.” Elaborate. "हालांकक शोिन-अक्षमता एवं
ददवाललयापन संदहता भारत के दोहरे तल
ु नपत्र की समस्या को परू ी तरह से ठीक नहीं करता है ,
लेककन यह ननस्चचत रूप से ददग को कम करने में मदद करता है ." ववस्तत
ृ कीस्जए.
2. Explain the significance of governance reforms in Public Sector Banks (PSBs) for India’s
economic growth. भारत के आधथगक ववकास के संबि
ं में सावगजननक क्षेत्र के बैंकों में शासन
सि
ु ारों के महत्व को समझाइए.
3. What is “Twin Balancesheet Syndrome”? Enumerate the steps taken by RBI to resolve it.
"दोहरे तल
ु नपत्र की समस्या" क्या है ? इसे हल करने के ललए भारतीय ररज़वग बैंक द्वारा उठाए
र्ए कदमों की सधू च दीस्जए.
4. With respect to India’s financial stability, explain the significance of (i) PCR framework (ii)
BASEL-III Norms (iii) Public Credit Registry (iv) Shadow Banks. भारत की ववत्तीय स्स्थरता के
संबि
ं में इन्हे समझाइए: (i) पीसीआर ढांचा (ii) बेसल-III मानदं र् (iii) ऋण की सावगजननक रस्जस्री
(iv) प्रनतछाया बैंक्स.

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