BANKING SERVICES MANAGEMENT.

BC5B10 BANKING SERVICES MANAGEMENT.

SYLLABUS MODULE 1 Banking legislation reforms : Banking Regulation Act 1949 – provision on capital liquidity – powers of RBI – banking sector reforms in India – classification of assets – Investments evaluation – Income recognition – management of non-performing assets.

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BANKING LEGISLATION AND

REFORMS.CHAPTER 1

BANKING REGULATION ACT 1949

According to section 5 (b) of the Act , ‘banking’ means

“ the accepting for the purpose of lending or investment of deposits of the money from the public repayable on demand or otherwise , withdrawable by cheque , draft , order or otherwise.”

BANKING REGULATIONS ACT The banking regulations act (formerly known as the banking

companies act) was passed to consolidate and amend the law relating to banking companies act. It came into effect from 16 march , 1949 and applies to the whole of India.

Prior to enactment of this act the banking companies were governed by the provisions contained in XA of Indian companies act 1913, they were inadequate as it was rapidly growing.

This act has been amended several times. Comprehensive amendment was made in the year 1968 through enactment of Banking Laws (amendment) Act 1968.

RBI – RESERVE BANK OF INDIA

RBI

The Reserve Bank of India, the nation’s central bank, began operations on April 01, 1935. It was established with the objective of ensuring monetary stability and operating the currency and credit system of the country to its advantage. Its functions comprise monetary management, foreign exchange and reserves management, government debt management, financial regulation and supervision, apart from currency management and acting as banker to the banks and to the Government. In addition, from the beginning, the Reserve Bank has played an active developmental role, particularly for the agriculture and rural sectors. Over the years, these functions have evolved in tandem with national and global developments

POWERS OF RESERVE BANK OF INDIA

The RBI considerably controls the working of banks in India. The following provisions of the Banking Regulations Act are important to note : A. ELECTION OF NEW DIRECTORS (12A)

(1) The Reserve Bank may, by order, require any banking company to call a general meeting of the shareholders of the company within such time, not less than two months from the date of the order, as may be specified in the order or within such further time as the Reserve Bank may allow in this behalf, to elect in accordance with the voting rights permissible under this Act fresh Directors, and the banking company shall be bound to comply with the order.

(2) Every Director elected under sub-section (1) shall hold office until the date up to which his predecessor would have held office, if the election had not been held.

B. CASH RESERVE (Sec.18) according to section of the Banking Regulation Act , every non-scheduled bank is required to maintain in India by way of cash reserve with itself or in current account opened with the RBI or the SBI or any other bank notified by the central bank in this behalf or partly in cash with itself and partly in such account or accounts a sum equivalent to at least 3% of its total of its time and demand liabilities in in India.Under sec 42 of the RBI Act, every scheduled bank has to maintain such percentage of the total of demand and time liabilities in India as cash reserve with RBI as may be notified in the gazette of India by the RBI having regard to needs of securing monetary stability in the country.C. LICENCING OF BANKING COMPANIES (Sec.22) no company can carry on business of banking in India unless it holds a license issued for this purpose by the RBI. Granting any license under this section , will be after satisfying the following conditions That the company is or will be in a position to pay its present or future

depositors in full as their claims accrue;

• That the affairs of the company are not being , or are not likely to be , conducted in a manner detrimental to the interests of its present or future depositors;

• In the case of a company incorporated outside India that the carrying on of banking business by such company in India will be in the public interest and that the govt. or law of the country in which it is incorporated does not discriminate in any way against banking companies registered in India.

D. OPENING OF NEW AND TRANSFER OF EXISTING PLACE OF BUSINESS ( Sec. 23)

Without obtaining the prior permission of the Reserve Bank-

(a) no banking company shall open a new place of business in India or change otherwise than within the same city, town or village, the location of an existing place of business situated in India; and (b) no banking company incorporated in India shall open a new place of business outside India or change, otherwise than within the same city, town or village in any country or area outside India, the location of an existing place of business situated in that country or area:

E. POWER TO RECALL FOR INFORMATION RELATING TO THE BUSINESS OF ANY BANKING COMPANY [Sec.27(2)]

The Reserve Bank can at anytime direct a banking company to furnish within the specified time, with such statements and information relating to the business of the banking company as the Reserve Bank may consider necessary.

F. POWER TO INSPECTION (Sec. 35)

Reserve Bank at any time may, and on being directed so to do by the Central Government shall, cause an inspection to a banking company and its books and accounts to find out whether or not the affairs of the banking company are conducted in the interest of the depositors. If the report find the affairs of the company are detrimental to the interests of the depositors then the same may be given in writing :

Prohibit the banking company receiving fresh deposits

Direct the RB to apply under section 38 for the winding up of the banking company

G. POWER TO GIVE DIRECTONS (Sec 35 A)

The Reserve Bank may from time to time issue directions to banking companies generally or to any banking company particularly. The Reserve Bank shall do so when it deems it necessary to issue such directions:

(a) in the [public interest]; or in the interest of banking policy; (b) to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or (c) to secure the proper management of any banking company generally.

H. RESERVE BANK’S APPROVAL NECESSARY FOR THE AMENDMENT OF PROVISIONS RELATING TO APPOINTMENT OF MANAGING DIRECTORS etc. (Sec. 35B)

the appointment or re-appointment or termination of appointment or remuneration of a Chairman, Managing Director or any other Director, whole-time or otherwise or of a manager or a chief executive officer by whatever name called, whether that provision be contained in the company's memorandum or articles of association, or in an agreement entered into by it, or in any resolution passed by the company in general meeting or by its Board of Directors shall have effect unless approved by the Reserve Bank.

I. POWER OF RESERVE BANK TO REMOVE MANAGERIAL AND OTHER PERSONS FROM OFFICE (Sec.36AA)

Where the Reserve Bank is satisfied that in the public interest or for preventing the affairs of a banking company being conducted in a manner detrimental to the interests of the depositors or for securing the proper management of any banking company it is necessary so to do, the Reserve Bank may, for reasons to be recorded in writing, by order, remove from office, with effect from such date as may be specified in the order, 2[any Chairman, Director,] chief executive officer(by whatever name called) or other officer or employee of the banking company.

J. POWER TO APPOINT ADDITIONAL DIRECTORS (Sec.36AB)

If the Reserve Bank is of [opinion that in the interest of banking policy or in the public interest or] in the interests of the banking company or its depositors it is necessary so to do, it may, from time to time by order in writing, appoint, with effect from such date as may be specified in the order, one or more persons to hold office as additional Directors of the banking company. A person so appointed as additional director shall hold office at the pleasure of the Reserve Bank not exceeding three years at a time.

K. FURTHER POWERS AND FUNCTIONS OF THE RESERVE BANK (Sec. 36)

(a) caution or prohibit banking companies or any banking company in particular against entering into any particular transaction or class of transactions, and generally give advice to any banking company;   (b) on a request by the companies concerned and subject to the provision of section 1[44A], assist, as intermediary or otherwise, in proposals for the amalgamation of such banking companies; (c) give assistance to any banking company by means of the grant of a loan or advance to it under clause(3) of sub-section (1) of section 18 of the Reserve Bank of India Act, 1934 (2of 1934); (d) The Reserve Bank shall make an annual report to the Central Government on the trend and progress of banking in the country, with particular reference to its activities under clause(2) of section 17 of the Reserve Bank of India Act, 1934 (2 of 1934), including in such report its suggestions, if any, for the strengthening of banking business throughout the country. (e) The Reserve Bank may appoint such staff at such places as it considers necessary for the scrutiny of the returns, statements and information furnished by banking companies under this Act, and generally to ensure the efficient performance of its functions under this Act.

Banking Sector In India Reserve Bank India

Scheduled banks

Commercial banks

Co-operative banks

Foreign banks(4

0)

Regional rural

banks(196)

Urban co-

operatives

(52)

State co-operative

(16)

Public sector banks(27)

Private sectors banks(30)

State bank of India(8)

Other nationalized banks(19)

Old(22)

New(8)

LIST OF PUBLIC SECTOR BANKS STATE BANK OF INDIA AND ITS SUBSIDIARIES

1. State Bank of India 2. State Bank of Bikaner & Jaipur 3. State Bank of Hyderabad 4. State Bank of Indore 5. State Bank of Mysore 6. State Bank of Patiala 7. State Bank of Saurashtra 8. State Bank of Travancore

OTHER NATIONALIZED BANKS Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharastra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank

Indian Overseas Bank Oriental Bank of Commerce Punjab & Sind Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank

Some of Public Sector banks have issued equity shares for general public and are listed on various stock exchanges. The listed public sector banks are;

State Bank of India

State Bank of Bikaner and Jaipur

State Bank of Travancore

Bank of Baroda

Bank of India

Oriental Bank of Commerce

Dena bank

Corporation bank

LIST OF PRIVATE SECTOR BANKS:

Old private sector banks **Bank of Madurai Ltd Bank of Rajasthan Ltd Bareilly Corporation Bank Ltd Bharat Overseas Bank Ltd City Union Bank Ltd Development Credit Bank Ltd Ganesh Bank of Kurundwad Ltd Karnataka Bank Ltd Lord Krishna Bank Ltd Nainital Bank Ltd SBI Comm & Int Bank Ltd Tamilnad Mercantile Bank Ltd The Benares State Bank Ltd

The Catholic Syrian Bank Ltd The Dhanalakshmi Bank Ltd The Federal Bank Ltd The Jammu & Kashmir Bank Ltd The Karur Vysya Bank Ltd The Lakshmi Vilas Bank Ltd The Nedungadi Bank Ltd The Ratnakar Bank Ltd The Sangli Bank Ltd The South Indian Bank Ltd The United Western Bank Ltd The Vysya Bank Ltd

*since merged with HDFC Bank **since merged with ICICI Bank  

NEW PRIVATE SECTOR BANKS

Bank of Punjab Ltd Centurion Bank Ltd Global Trust Bank Ltd HDFC Bank Ltd ICICI Banking Corporation Ltd IDBI Bank Ltd IndusInd Bank Ltd *Times Bank Ltd UTI Bank Ltd

LIST OF FOREIGN BANKS:

ABN-AMRO Bank N.V. Abu Dhabi Commercial Bank

Ltd. American Express Bank Ltd. Arab Bangladesh Bank Ltd. ANZ Stanchart Bank Bank International Indonesia Bank of America NT&SA Bank of Bahrain and Kuwait

BSC Bank of Ceylon Banque Nationale De Paris Barclays Bank PLC

Chase Manhattan Bank Chinatrust Commercial Bank Cho Hung Bank Citibank N.A. Commercial Bank of Korea, Commerzbank AG Credit Agricole Indosuez Credit Lyonnais Deutsche Bank AG Dresdner Bank AG Fuji Bank Ltd.

Hongkong Bank ING Barrings Bank N.V. Krung Thai Bank Mashreq Bank Oman International Bank

S.A.O.G. Overseas Chinese Banking Corp.

Ltd. Siam Commercial Bank Societe Generale Sonali Bank State Bank of Mauritius Ltd. Sumitomo Bank Ltd.

Sumitomo Bank Ltd. The Bank of Nova Scotia The Bank of Tokyo-Mitsubishi Ltd. The British Bank of Middle East The Development Bank of

Singapore Ltd. The Sakura Bank Ltd. The Sanwa Bank Ltd. Toronto-Domonion Bank Bank Muscat International SAOG, Morgan Guaranty Trust company

of New York KBC Bank, NV

Banking reforms and it’s impact.

Growth phases in banking sector

In over five decades since dependence, banking system in India has passed through five distinct phase, Evolutionary Phase (prior to 1950) Foundation phase (1950-1968) Expansion phase (1968-1984) Consolidation phase (1984-1990) Reformatory phase (since 1990)

Reformatory Phase (1991 Onwards)

Reasons for the formation of the reforms-

Continued financial profligacy of the Government coupled with close monitoring and control

Decline in productivity and profitability Economic crises of 1991 Economy suffered from serious inflationary

pressures, emerging scarcities of essential commodities and breakdown of fiscal discipline.

REFORMS IN BANKING SECTOR - Phase I

A retrospect of the events clearly indicates that the Indian banking sector has come far away from the days of nationalization. The Narasimham Committee laid the foundation for the reformation of the Indian banking sector. Constituted in 1991, the Committee submitted two reports, in 1992 and 1998, which laid significant thrust on enhancing the efficiency and viability of the banking sector. As the international standards became prevalent, banks had to unlearn their traditional operational methods of directed credit, directed investments and fixed interest rates, all of which led to deterioration in the quality of loan portfolios, inadequacy of capital and the erosion of profitability.

The main recommendations of the Committee were: Reduction of Statutory Liquidity Ratio (SLR) to 25 per cent over a period of

five years

Progressive reduction in Cash Reserve Ratio (CRR)

Phasing out of directed credit programmes and redefinition of the priority sector

Deregulation of interest rates so as to reflect emerging market conditions

Stipulation of minimum capital adequacy ratio of 4 per cent to risk weighted assets by March 1993, 8 per cent by March 1996, and 8 per cent by those banks having international operations by March 1994

Adoption of uniform accounting practices in regard to income recognition, asset classification and provisioning against bad and doubtful debts

Imparting transparency to bank balance sheets and making more disclosures

Setting up of special tribunals to speed up the process of recovery of loans

Setting up of Asset Reconstruction Funds (ARFs) to take over from banks a portion of their bad and doubtful advances at a discount

Restructuring of the banking system, so as to have 3 or 4 large banks, which could become international in character, 8 to 10 national banks and local banks confined to specific regions. Rural banks, including RRBs, confined to rural areas

Abolition of branch licensing

Liberalizing the policy with regard to allowing foreign banks to open offices in India

Rationalization of foreign operations of Indian banks

Giving freedom to individual banks to recruit officers

Inspection by supervisory authorities based essentially on the internal audit and inspection reports

Ending duality of control over banking system by Banking Division and RBI

A separate authority for supervision of banks and financial institutions which would be a semi-autonomous body under RBI

Revised procedure for selection of Chief Executives and Directors of Boards of public sector banks

Obtaining resources from the market on competitive terms by DFIs Speedy liberalisation of capital market Supervision of merchant banks, mutual funds, leasing companies etc.,

by a separate agency to be set up by RBI and enactment of a separate legislation providing appropriate legal framework for mutual funds and laying down prudential norms for such institutions, etc.

REFORMS IN BANKING SECTOR - Phase II Keeping in view the need of further liberalization the Narasimham Committee II on Banking Sector reform was set up in 1997. This committee’s terms of reference included review of progress in reforms in the banking sector over the past six years, charting of a program of banking sector reforms required to make the Indian banking system more robust and internationally competitive and framing of detailed recommendations in this regard. This committee constituted submitted its report in April 1998. The major recommendations are: Capital adequacy requirements should take into account

market risks also In the next three years, entire portfolio of Govt. securities

should be marked to market Risk weight for a Govt. guaranteed account must be 100

percent

CAR to be raised to 10% from the present 8%; 9% by 2000 and 10% by 2002

An asset should be classified as doubtful if it is in the sub-standard category for 18 months instead of the present 24 months

Banks should avoid ever greening of their advances

There should be no further re-capitalization by the Govt.

NPA level should be brought down to 5% by 2000 and 3% by 2002.

Banks having high NPA should transfer their doubtful and loss categories to ARCs which would issue Govt. bonds representing the realisable value of the assets.

International practice of income recognition by introduction of the 90-day norm instead of the present 180 days.

A provision of 1% on standard assets is required.

Govt. guaranteed accounts must also be categorized as NPAs under the usual norms

There is need to institute an independent loan review mechanism especially for large borrowal accounts to identify potential NPAs.

Recruitment of skilled manpower directly from the market be given urgent consideration

To rationalize staff strengths, an appropriate VRS must be introduced.

A weak bank should be one whose accumulated losses and net NPAs exceed its net worth or one whose operating profits less its income on recap bonds is negative for 3 consecutive years.

Until recently, the lack of competitiveness vis-à-vis global standards, low technological level in operations, over staffing, high NPAs and low levels of motivation had shackled the performance of the banking industry.   However, the banking sector reforms have provided the necessary platform for the Indian banks to operate on the basis of operational flexibility and functional autonomy, thereby enhancing efficiency, productivity and profitability. The reforms also brought about structural changes in the financial sector and succeeded in easing external constraints on its operation, i.e. reduction in CRR and SLR reserves, capital adequacy norms, restructuring and recapitulating banks and enhancing the competitive element in the market through the entry of new banks.

The reforms also include increase in the number of banks due to the entry of new private and foreign banks, increase in the transparency of the banks’ balance sheets through the introduction of prudential norms and increase in the role of the market forces due to the deregulated interest rates. These have significantly affected the operational environment of the Indian banking sector.

Granting of operational autonomy to public sector banks.

Introduction and phased implementation of international best practices and norms.

Setting up of Credit Information Bureau of India Limited (CIBIL) for information sharing on defaulters as also other borrowers.

Introduction of automated screen-based trading in government securities through Negotiated Dealing System (NDS). Setting up of risk-free payments and system in government securities through Clearing Corporation of India Limited (CCIL). Phased introduction of Real Time Gross Settlement (RTGS) System.

Recent banking reforms

Reforms on the way Strict norms pertaining to bad loans and

restructured assets Consolidation and mergers and entry of new

players Continuous bank licensing Converting some urban cooperative banks into

commercial banks Focus on asset–liability management for banks Increased usage of technology in banking Focus on financial inclusion Transparency, improvement in clearing and

settlement practices

INCOME RECOGNITION 

The regulation for income recognition states that the Income on NPAs cannot be booked. Interest income should not be recognized until it is realized. An NPA is one where interest is overdue for two quarters or more. In respect of NPAs, interest is not to be recognized on accrual basis, but is to be treated as income only when actually received. Income in respect of accounts coming under Health Code 5 to 8 should not be recognized until it is realized. As regards to accounts classified in Health Code 4, RBI has advised the banks to evolve a realistic system for income recognition based on the prospect of realisability of the security. On non-performing accounts the banks should not charge or take into account the interest.

Income-recognition norms have been tightened for consortium banking too. Member banks have to intimate the lead-bank to arrange for their share of recovery. They will no more have the privilege of stating that the borrower has parked funds with the lead-bank or with a member-bank and that their share is due for receipt. The new notifications emanated after deliberations held between the RBI and a cross-section of banks after a working group headed by chartered accountant, PR Khanna, submitted its report. The working group was set after the RBI’s Board for Financial Supervision (BFS) wanted divergences in NPA accounting norms by banks from central bank guidelines to be addressed. The working group had identified three areas of divergence: non-compliance with RBI norms; subjectivity arising out of the flexibility in norms; and differences in the valuation of securities by banks, auditors and RBI.

ASSET CLASIFICATION

While new private banks are careful about their asset quality and consequently have low non-performing assets (NPAs), public sector banks have large NPAs due to wrong lending policies followed earlier and also due to government regulations that require them to lend to sectors where potential of default is high. Allaying the fears that bulk of the Non-Performing Assets (NPAs) was from priority sector, NPA from priority sector constituted was lower at 46 per cent than that of the corporate sector at 48 per cent.

Loans and advances account for around 40 per cent of the assets of SCBs. However, delay/default in payment of interest and/or repayment of principal has rendered a significant proportion of the loan assets non-performing. As per RBI’s prudential norms, a Non-Performing Asset (NPA) is a credit facility in respect of which interest/installment has remained unpaid for more than two quarters after it has become past due. “Past due” denotes grace period of one month after it has become due for payment by the borrower. The Mid-Term Review of Monetary and Credit Policy for 2000-01 has proposed to discontinue this concept with effect from March 31, 2001.

Regulations for asset classification Assets should be classified into four classes - Standard, Sub-standard, Doubtful, and Loss assets. NPAs are loans on which the dues are not received for two quarters. NPAs consist of assets under three categories: sub-standard, doubtful and loss. RBI for these classes of assets should evolve clear, uniform, and consistent definitions.  The health code system earlier in use would have to be replaced. The banks should classify their assets based on weaknesses and dependency on collateral securities into four categories:

Standard Assets: It carries not more than the normal risk attached to the business and is not an NPA. An asset that assures future economic benefit is a standard asset.

Sub-standard Asset: a substandard asset is one which has been classified as NPA for a period not exceeding 12 months. Such an asset will have well defined credit weaknesses that jeopardize the liquidation of the debt and are characterized by distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

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Doubtful Assets: An NPA which continued to be so for a period exceeding one year ( more than 12 months)

Loss Assets: An asset identified by the bank or internal/ external auditors or RBI inspection as loss asset, but the amount has not yet been written off wholly or partly. All those assets which cannot be recovered are called as loss assets.

The banking industry has significant market inefficiencies caused by the large amounts of Non Performing Assets (NPAs) in bank portfolios, accumulated over several years.  Discussions on non-performing assets have been going on for several years now.  One of the earliest writings on NPAs defined them as "assets which cannot be recycled or disposed off immediately, and which do not yield returns to the bank, examples of which are: Overdue and stagnant accounts, suit filed accounts, suspense accounts and miscellaneous assets, cash and bank balances with other banks, and amounts locked up in frauds".

Income and Expenses Profile of Banks

Interest Income Interest Expenses • Interest/discount on advances/bills• Interest on investments• Interest on balances with RBI and other interbank funds• Others  

 • Interest on deposits• Interest on Refinance/interbank borrowings• Others

Other Income Operating Expenses • Commission, Exchange and Brokerage• Profit on sale of investments• Profit on revaluation of investments• Profit on sale of land, building and other assets• Profit on exchange transactions• Income earned by way of dividends, etc.• Miscellaneous 

  Payments to and provisions for employees

• Rent, taxes and lighting• Printing and stationery• Advertisement and publicity• Depreciation on Bank’s property• Director’/Auditor’s fees and expenses• Law charges, Postage, etc.• Repairs and Maintenance,

Insurance. • Other expenses