Banking Banking SystemSystem

in in IndiaIndia

Indigenous bankersIndigenous bankers Individual bankers like Shroffs, Seths, Sahukars, Individual bankers like Shroffs, Seths, Sahukars,

Mahajans, etc. combine trading and other Mahajans, etc. combine trading and other business with money lending.business with money lending.

Vary in size from petty lenders to substantial Vary in size from petty lenders to substantial shroffsshroffs

Act as money changers and finance internal Act as money changers and finance internal trade through hundis (internal bills of exchange)trade through hundis (internal bills of exchange)

Indigenous banking is usually family owned Indigenous banking is usually family owned business employing own working capitalbusiness employing own working capital

At one point it was estimated that IBs met about At one point it was estimated that IBs met about 90% of the financial requirements of rural India90% of the financial requirements of rural India

RBI and indigenous RBI and indigenous bankers bankers

IB should have their accounts audited by IB should have their accounts audited by certified chartered accountantscertified chartered accountants

Submit their accounts to RBI periodicallySubmit their accounts to RBI periodically As against these obligations the RBI promised As against these obligations the RBI promised

to provide them with privileges offered to to provide them with privileges offered to commercial banks includingcommercial banks including Being entitled to borrow from and rediscount bills Being entitled to borrow from and rediscount bills

with RBIwith RBI The IBs declined to accept the restrictions as The IBs declined to accept the restrictions as

well as compensation from the RBIwell as compensation from the RBI Therefore, the IBs remain out of RBI’s purviewTherefore, the IBs remain out of RBI’s purview

BANKING SYSTEM IN BANKING SYSTEM IN INDIAINDIA

ORGANISEDBANKS IN INDIA-

RBI

SCHEDULED BANKS(285)

NON-SCHEDULED BANKS (4)

COMMERCIAL BANKS

CO-OPERATIVE BANKS

URBAN CO-OPERATIVE

BANKS-52

STATE CO-OPERATIVE

BANKS- 27

PRIVATE SECTORBANKS-25

PUBLIC SECTOR BANKS-28

FOREIGN BANKS-29REGIONAL RURAL

BANKS- 96

SCHEDULED BANK: SCHEDULED BANK: which is registered in Second Schedule of the which is registered in Second Schedule of the

RBIRBI Must be carrying on a business of banking in Must be carrying on a business of banking in

IndiaIndia Must have paid-up capital and reserve of an Must have paid-up capital and reserve of an

aggregate value of not less than Rs.5 aggregate value of not less than Rs.5 lakh(100cr.-for New)lakh(100cr.-for New)

It must satisfy RBI- not in a manner detrimental It must satisfy RBI- not in a manner detrimental to the interest of depositorto the interest of depositor

NON SCHEDULED BANK:NON SCHEDULED BANK: Which is not included in Second Schedule of RBIWhich is not included in Second Schedule of RBI Not entitled to facility of borrowing & Not entitled to facility of borrowing &

rediscountingrediscounting

Co-operative BanksCo-operative Banks

CENTRAL CO-OPERATIVE

BANK- 369

PRIMARY AGRICULTURAL CO-OPERACTIVE CREDIT SOCIEY

DISTRICT CENTRAL

CO-OPERATIVEBANKS

STATECO-OPERATIVE

BANK -31

SCHEDULED SCHEDULED COMMERCIAL BANKSCOMMERCIAL BANKS

PUBLIC SECTOR BANKSPUBLIC SECTOR BANKS SBI & Associates (SBI Act, 1955)SBI & Associates (SBI Act, 1955) Nationalised Banks (1969-1980)Nationalised Banks (1969-1980)

PRIVATE SECTOR BANKS:PRIVATE SECTOR BANKS: Post Reform Period 24 banks in pvt. Post Reform Period 24 banks in pvt.

Sector BanksSector Banks Initial minimum paid up capital from Initial minimum paid up capital from

Rs.100 to Rs.200 crore.Rs.100 to Rs.200 crore.

REGIONAL RURAL REGIONAL RURAL BANKSBANKS

Bank with local knowledge and familiarityBank with local knowledge and familiarity Organisation ability to mobilize deposits, Organisation ability to mobilize deposits,

access to money market and modernized access to money market and modernized outlookoutlook

ORGANISATION- Separate body corporate ORGANISATION- Separate body corporate with perpetual succession and common with perpetual succession and common seal- may establish its branchesseal- may establish its branches

CAPITAL- Authorised-1 cr.- paid up-50laks-CAPITAL- Authorised-1 cr.- paid up-50laks--50% subscribed by Central Govt.--50% subscribed by Central Govt.-15%State Govt. – 35% by Sponsor Bank 15%State Govt. – 35% by Sponsor Bank

FOREIGN BANKS: Registered FOREIGN BANKS: Registered outside India- to operate in India the outside India- to operate in India the minimum capital requirement of US minimum capital requirement of US $25 million, spread over 3 branches, $25 million, spread over 3 branches, that is, US$ 10million for the 1that is, US$ 10million for the 1stst and and 22ndnd bank respectively and bank respectively and US$5million for the 3US$5million for the 3rdrd branch branch The no. of licences fixed is 12 per year The no. of licences fixed is 12 per year

both for new and expansion by existing both for new and expansion by existing banksbanks

Development Oriented Development Oriented BankingBanking

Historically, close association between banks Historically, close association between banks and some traditional industries- cotton textiles and some traditional industries- cotton textiles in the west, jute textiles in the eastin the west, jute textiles in the east

Banking has not been mere acceptance of Banking has not been mere acceptance of deposits and lending money; included deposits and lending money; included development bankingdevelopment banking

Lead Bank Scheme- opening bank offices in all Lead Bank Scheme- opening bank offices in all important localitiesimportant localities

Providing credit for development of the districtProviding credit for development of the district Mobilising savings in the district. ‘Service area Mobilising savings in the district. ‘Service area

approach’ approach’

Progress of banking in Progress of banking in India (1)India (1)

Nationalisation of banks in 1969: 14 Nationalisation of banks in 1969: 14 banks were nationalisedbanks were nationalised

Branch expansion: Increased from 8260 in Branch expansion: Increased from 8260 in 1969 to 71177 in 20061969 to 71177 in 2006

Population served per branch has come Population served per branch has come down from 64000 to 16000down from 64000 to 16000

A rural branch office serves 15 to 25 A rural branch office serves 15 to 25 villages within a radius of 16 kmsvillages within a radius of 16 kms

However, at present only 32,180 villages However, at present only 32,180 villages out of 5 lakh have been coveredout of 5 lakh have been covered

Progress of banking in Progress of banking in IndiaIndia (2) (2)

Deposit mobilisation:Deposit mobilisation: 1951-1971 (20 years)- 700% or 7 times1951-1971 (20 years)- 700% or 7 times 1971-1991 (20 years)- 3260% or 32.6 times1971-1991 (20 years)- 3260% or 32.6 times 1991- 2006 (11 years)- 1100% or 11 times1991- 2006 (11 years)- 1100% or 11 times

Expansion of bank credit: Growing at Expansion of bank credit: Growing at 20-30% p.a. thanks to rapid growth in 20-30% p.a. thanks to rapid growth in industrial and agricultural outputindustrial and agricultural output

Development oriented banking: priority Development oriented banking: priority sector lendingsector lending

Progress of banking in Progress of banking in India (3)India (3)

Diversification in banking: Banking Diversification in banking: Banking has moved from deposit and lending tohas moved from deposit and lending to Merchant banking and underwritingMerchant banking and underwriting Mutual fundsMutual funds Retail bankingRetail banking ATMsATMs Internet bankingInternet banking Venture capital fundsVenture capital funds FactoringFactoring

Profitability of Banks(1)Profitability of Banks(1)

Reforms have shifted the focus of Reforms have shifted the focus of banks from being development banks from being development oriented to being commercially oriented to being commercially viableviable

Prior to reforms banks were not Prior to reforms banks were not profitable and in fact made losses for profitable and in fact made losses for the following reasons:the following reasons: Declining interest incomeDeclining interest income Increasing cost of operationsIncreasing cost of operations

Profitability of banks (2)Profitability of banks (2)

Declining interest income was for the Declining interest income was for the following reasons:following reasons: High proportion of deposits impounded for High proportion of deposits impounded for

CRR and SLR, earning relatively low CRR and SLR, earning relatively low interest ratesinterest rates

System of directed lendingSystem of directed lending Political interference- leading to huge NPAsPolitical interference- leading to huge NPAs

Rising costs of operations for banks was Rising costs of operations for banks was because of several reasons: economic because of several reasons: economic and politicaland political

Profitability of Banks (3)Profitability of Banks (3)

As per the Narasimham Committee (1991) As per the Narasimham Committee (1991) the reasons for rising costs of banks were:the reasons for rising costs of banks were: Uneconomic branch expansionUneconomic branch expansion Heavy recruitment of employeesHeavy recruitment of employees Growing indiscipline and inefficiency of staff due Growing indiscipline and inefficiency of staff due

to trade union activitiesto trade union activities Low productivityLow productivity

Declining interest income and rising cost of Declining interest income and rising cost of operations of banks led to low profitability in operations of banks led to low profitability in the 90sthe 90s

Bank profitability: Bank profitability: SuggestionsSuggestions

Some suggestions made by Some suggestions made by Narasimham Committee are:Narasimham Committee are: Set up an Asset Reconstruction Fund to Set up an Asset Reconstruction Fund to

take over doubtful debtstake over doubtful debts SLR to be reduced to 25% of total depositsSLR to be reduced to 25% of total deposits CRR to be reduced to 3 to 5% of total CRR to be reduced to 3 to 5% of total

depositsdeposits Banks to get more freedom to set minimum Banks to get more freedom to set minimum

lending rateslending rates Share of priority sector credit be reduced Share of priority sector credit be reduced

to 10% from 40%to 10% from 40%

Suggestions (cont’d)Suggestions (cont’d)

All concessional rates of interest All concessional rates of interest should be removedshould be removed

Branch expansion should be carried Branch expansion should be carried out strictly on commercial principlesout strictly on commercial principles

Diversification of banking activitiesDiversification of banking activities Almost all suggestions of the Almost all suggestions of the

Narasimham Committee have been Narasimham Committee have been accepted and implemented in a accepted and implemented in a phased manner since the onset of phased manner since the onset of ReformsReforms

Income RecognitionIncome Recognition

Incomes from NPAs not recognised Incomes from NPAs not recognised on accruals basis but on receipt on accruals basis but on receipt basisbasis

If interest debited not recovered If interest debited not recovered within 180 days(2 quarters) then the within 180 days(2 quarters) then the same shall not be recognised as same shall not be recognised as incomeincome

Non Performing Asset(NPA)Non Performing Asset(NPA) For Cash Credit & ODFor Cash Credit & OD

Where the outstanding balance remains Where the outstanding balance remains continuously in excess of the sanctioned continuously in excess of the sanctioned limit/Drawing power ORlimit/Drawing power OR

Where the outstanding balance is less than Where the outstanding balance is less than the sanctioned limit/Drawing power, but there the sanctioned limit/Drawing power, but there is no credits continuously for 6 months ORis no credits continuously for 6 months OR

Where the credits are not enough to cover the Where the credits are not enough to cover the interest debited during the 6 months as on interest debited during the 6 months as on the date of the Balance Sheetthe date of the Balance Sheet

Non Performing Asset(NPA)Non Performing Asset(NPA)(For Loans & Advances)(For Loans & Advances)

Standard Assets:Standard Assets: are those which are not are those which are not NPA as they are regular and performing NPA as they are regular and performing and there are no adverse featuresand there are no adverse features

Sub-Standard AssetsSub-Standard Assets: are those which are : are those which are NPAs for a period Not exceeding Two YearsNPAs for a period Not exceeding Two Years

Doubtful AssetsDoubtful Assets: are those non-: are those non-performing assets which remain as such for performing assets which remain as such for a period, Exceeding 2 yearsa period, Exceeding 2 years

Loss Assets:Loss Assets: are those NPAs where 100% are those NPAs where 100% loss has been identified but not yet written loss has been identified but not yet written off in the books of accountsoff in the books of accounts

Provisioning for Loans & Provisioning for Loans & AdvancesAdvances

Name of AssetName of Asset1.1. Standard AssetStandard Asset2.2. Substandard AssetSubstandard Asset3.3. Doubtful AssetsDoubtful Assets

1.1. Doubtful upto 1 year Doubtful upto 1 year (NPA more than 2 years (NPA more than 2 years but upto 3years)but upto 3years)

2.2. Doubtful for more than 1 Doubtful for more than 1 year but upto 3 years year but upto 3 years (NPA more than 3yrs but (NPA more than 3yrs but upto 5 years) upto 5 years)

3.3. Doubtful for more than 3 Doubtful for more than 3 years(NPA for more than years(NPA for more than 5 yrs)5 yrs)

4.4. Loss AssetsLoss Assets

Provisioning RequirementProvisioning Requirement1.1. No provision is requiredNo provision is required2.2. General prov.10% of General prov.10% of

outstanding outstanding 3.3. 100% to the extent of 100% to the extent of

deficit (deficit=advance –deficit (deficit=advance –security) security) Plus Plus 1.1. 20% of Tangible Security20% of Tangible Security

2.2. 30% of Tangible Security30% of Tangible Security

3.3. 50% of Tangible Security50% of Tangible Security

4.4. 100% of the outstanding100% of the outstanding

Capital Adequacy Norms Capital Adequacy Norms (9%)(9%)

Tier I Capital:Tier I Capital:1.1. Paidup CapitalPaidup Capital

2.2. Statutary and other disclosed free Statutary and other disclosed free reserves including share premiumreserves including share premium

3.3. General Reserve lessGeneral Reserve less Investment in subsidiariesInvestment in subsidiaries Intangible assetsIntangible assets Brought forward and current lossesBrought forward and current losses

Capital Adequacy NormsCapital Adequacy Norms

Tier II capital consists:Tier II capital consists:

1.1. Undisclosed reserves & cumulative Undisclosed reserves & cumulative perpetual preference sharesperpetual preference shares

2.2. Revaluation Reserves at a discount of 25%Revaluation Reserves at a discount of 25%

3.3. Surplus provisions/loss reserves subject to Surplus provisions/loss reserves subject to a maximum of 1.25% weighted Risk Assetsa maximum of 1.25% weighted Risk Assets

4.4. Hybrid Debt Capital instrumentHybrid Debt Capital instrument

5.5. Subordinated DebtSubordinated Debt

Capital Adequacy Capital Adequacy FormulaFormula

Capital Adequacy=Capital Adequacy=Capital Funds Capital Funds * 100* 100

Weighted Risk Weighted Risk AssetsAssets

Other Important TermsOther Important Terms On Balance Sheet ItemsOn Balance Sheet Items: Those Items : Those Items

which appear on the Balance Sheet of a which appear on the Balance Sheet of a Bank & for which RBI has given percentage Bank & for which RBI has given percentage weights to various types of assetsweights to various types of assets

Off Balance Sheet ItemsOff Balance Sheet Items: Those items : Those items which do not appear on the face of the which do not appear on the face of the Balance Sheet like Guarantees, Letter of Balance Sheet like Guarantees, Letter of Credit etc.Credit etc.

Dividend Payout Ratio:Dividend Payout Ratio: Banks should have Banks should have a Capital Adequacy Ratio of atleast 9 for the a Capital Adequacy Ratio of atleast 9 for the a/c yr. for which it proposes to declare a/c yr. for which it proposes to declare dividend subject to a ceiling on DP ratio 40% dividend subject to a ceiling on DP ratio 40%

NPA ManagementNPA Management

The Narasimham Committee The Narasimham Committee recommendations were made, among recommendations were made, among other things, to reduce the Non-other things, to reduce the Non-Performing Assets (NPAs) of banksPerforming Assets (NPAs) of banks

To tackle this the government enacted To tackle this the government enacted the Securitization and Reconstruction the Securitization and Reconstruction of Financial Assets and Enforcement of Financial Assets and Enforcement of Security Act (SARFAESI) Act, 2002of Security Act (SARFAESI) Act, 2002

Enabled banks to realise their dues Enabled banks to realise their dues without intervention of courtswithout intervention of courts

SARFAESI ActSARFAESI Act Enables setting up of Asset Management Companies Enables setting up of Asset Management Companies

to acquire NPAs of any bank or FI (SASF, ARCIL are to acquire NPAs of any bank or FI (SASF, ARCIL are examples)examples)

NPAs are acquired by issuing debentures, bonds or NPAs are acquired by issuing debentures, bonds or any other securityany other security

As a second creditor can serve notice to the As a second creditor can serve notice to the defaulting borrower to discharge his/her liabilities in defaulting borrower to discharge his/her liabilities in 60 days60 days

Failing which the company can take possession of Failing which the company can take possession of assets, takeover the management of assets and assets, takeover the management of assets and appoint any person to manage the secured assetsappoint any person to manage the secured assets

Borrowers have the right to appeal to the Debts Borrowers have the right to appeal to the Debts Tribunal after depositing 75% of the amount claimed Tribunal after depositing 75% of the amount claimed by the second creditorby the second creditor