BANKING SECTOR REFORMS

● Post-nationalisation era witnessed tremendous progress in deposit

mobilisation and branch expansion by Indian public sector banks
● Started innovative banking to diversify their activities beyond accepting
& lending
● Despite of this, there was a huge decline in productivity & profitability
of banks.Mounting NPA’s was a major problem.
NARASIMHAM COMMITTEE
● Formed to cure all the evils of the Indian Banking System in India
● Made suggestions and recommendations for improvement of the banking
system
● Submitted the report in Nov 1991 and their recommendations were
implemented from 1991-1992 onwards.It includes:

PRUDENTIAL ACCOUNTING STANDARDS:

Introduced with a view to provide transparency in accounting and

reporting procedures of banks so that the annual reports of banks
exhibit a true and fair view of its financial position.
PRUDENTIAL ACCOUNTING STANDARDS
a) INCOME RECOGNITION
● Banks should classify assets into performing and non-performing assets
for the purpose of recognizing income
● Performing assets generates income;non-performing assets do not.
● Banks should recognize their income from performing assets on accrual
basis & income from non performing assets on cash basis
● Further, if an asset becomes NPA, banks should cancel the interest
already credited in respect of such assets to income accounts on accrual
basis by passing a reverse entry.
PRUDENTIAL ACCOUNTING STANDARDS
b) ASSET CLASSIFICATION

● STANDARD ASSETS- Do not cause any problems to the bank. Fetch a

regular income and are treated as performing assets.Carries only normal
risk
● SUB-STANDARD ASSETS-Classified as NPA for a period not exceeding
12 months. The current net worth of the borrower, guarantor or the
market value of security is not enough to recover the asset in full.
Substandard assets have credit weakness and if not cured, there is every
possibility of incurring loss to the bank
PRUDENTIAL ACCOUNTING STANDARDS
● DOUBTFUL ASSETS- Remained NPA for a period exceeding 12 months.
Has all the weakness of sub-standard assets plus some more additional
risks.
● LOSS ASSETS- NPA accounts where bank or internal auditor has
identified loss, but that amount has not been written off wholly or
partly.Considered irrecoverable and has no realizable value of security.
PROVISIONING REQUIREMENTS
Banks are asked to keep adequate provision for each categories of assets.

Sub standard assets- 10% of total o/s is required

Doubtful assets- 100% to the extent of the debt not covered by realisable
value of security; Secured portion provision should be made on basis of period
for which it remained doubtful.

For loans upto 1 year-20%, 1-3 years: 30%, more than 3 yrs- 50%

Loss assets- 100% of amount o/s

CAPITAL ADEQUACY NORMS
● Laid down by RBI to strengthen the capital base of banks, in April 1992
● All banks were required to have a capital adequacy ratio of 4% by March
1993, 8% by March 1996 , 9% from March 2000

Capital Adequacy Ratio (CAR)= Share Capital x 100

Risk adjusted value of assets

All the assets of banks have been assigned risk weights as under:

● All claims on banks and financial institutions have been assigned a risk
weight of 20%
● Advances covered by guarantee of DICGC/ECGC have been assigned a
risk weight of 50%
CAPITAL ADEQUACY NORMS
● Investments in shares, bonds issued by banks and other institutions
would carry 100% risk weight
● Advances against term deposits, Life Insurance Policies, National Saving
Certificates Indira Vikas Patra where adequate margin is available would
carry Zero risk weight
NARASIMHAM COMMITTEE( Other recommendations)

● Privatisation of Public sector banks

● Establishment of Debt Recovery Tribunals ( DRT)
● Entry of Private Sector Banks
● Branch Rationalisation
● Consortium Advances
● Board for Financial Supervision (BFS)
● Internal Control
● Disclosure on Defaulting Borrowers
● Department of Supervision
NON PERFORMING ASSETS
● Assets that has failed to produce any income
● Credit given whose, interest and/or principal remains unpaid
● Assets turns NPA if not paid for a period of 90 days
● If any one advance turn NPA, all other advances given to the same person
will be treated as nonperforming, even if they have a performing status
REASONS/CAUSES OF NPA’s
INTERNAL FACTORS EXTERNAL FACTORS

● Non compliance with norms of lending ● Industrial sickness

● Poor credit appraisal system ● Diversion of fund
● Poor-post credit follow up ● Willful default
● Absence of qualified personnel ● Economic recession
IMPACT OF NPA’s
● Paralyses economic growth
● High cost of funds
● Low profitability
● Bank’s reluctance to lend
PREVENTION OR REMEDIES OF NPA’s
● Proper selection of loan proposals keeping in view the principles of lending
● Financing of economically viable schemes
● Extending need based financing
● Ensuring proper end-use of loans
● Conducting proper post sanction follow-up of loans
● Keeping constant touch with the borrowers and inspection of the
accounts
● Upgradation of credit appraisal skills in the banks
● Setting up recovery cells in bank’s lead-offices.
CONSORTIUM BANKING
● Financial requirements of corporate borrowers are so big that it cannot
be met by a single financial institution.
● A single bank financing huge loan can be very risky
● Consortium banking is several banks joining together, according to their
capacities, in meeting the credit needs of large borrowers and share the
credit risk
● Also known as participation loans or joint financing
ADVANTAGES
● Limited resources required
● Diversification of risk
● Benefit of technical and financial expertise
● Reduced administrative expenses
● Profitability to smaller banks
NON BANKING ASSETS (NBA)
● As per Banking Regulation Act, 1994, a banking company cannot acquire
immovable property,but can lend against such assets
● If a borrower fails to repay the loan, bank is allowed to take possession
of such assets.
● Non- banking assets are those assets acquired by banks in settlement of
debts due from customers
● Purchased by a bank when a borrower fails to repay the loan and offers
to the bank, an asset, to settle the dues
● Offered in addition to the collateral security
● Banks should show these assets in the balance sheet as Non-banking
Assets; should be disposed within 7 years.
BASEL NORMS
● Set of norms for banks aimed at mitigating the risk & strengthening the
capital structure of banks of member countries
● Basel is a city in Switzerland, headquarters of Bank of International
Settlement(BIS)
● BIS was established in 1930 in Basel and it fosters cooperation among
different central banks, with a common goal of financial stability and
common standards of banking regulations
● Basel Committee on Banking Supervision (BCBS) was established by
central bank governors of Group Ten Countries at the end of 1974, to
enhance financial stability by improving the quality of banking supervision
worldwide and also to serve as a forum for regular cooperation between
its member countries
BASEL NORMS
● Currently, Basel Committee comprises 45 members from 28 countries
consisting of central banks and authorities with formal responsibility for
the supervision of banking business.
● RBI is a member of the committee
● There are 3 sets of regulations formulated to ensure that financial
institutions have enough capital to meet obligations and absorb
unexpected losses.
BASEL 1
● Defined capital requirement & structure of risk weights for banks.
● Groups bank’s assets into five risk categories, as percentages, based on
the nature of borrower.( 0%, 10%, 20%,50%,100)

0% - cash,bullion,central bank & govt debt

50% -residential mortgages

100% - pvt sector debt, real estate,plant & equipments etc.

● Public Sector debt can be placed in 0%, 10%, 20% or 50% category
depending on the borrower.
BASEL 1
● Minimum capital requirements for banks with international presence was
fixed at 8% of risk weighted assets.
● India adopted Basel 1 in 1999
● Risk based Capital Ratio= Capital/ Risk adjusted assets
● Tier 1 capital: core capital that includes shareholders’ equity & retained
earnings
● Tier 2 capital: additional internal & external resources available to bank
● Tier 1 is more perfect form of bank’s capital as it is the money a bank has
stored to keep it functioning
● Bank has to hold at least half of its measured capital in tier 1 form.
BASEL II
● Introduced in 2004, expanded the rules for minimum capital
requirements established under Basel 1 & is the 2nd international banking
regulatory accord.
● Risk based Capital Ratio= Capital/ (Credit risk+Market risk+Operational
Risk)
● There are 3 main pillars for Basel 2
BASEL II- Pillar 1: Minimum Capital Requirements
● Guidelines to measure various types of risks such as credit risk, market
risk and operational risk & the minimum capital required to cover these
risks
● MARKET RISK: Arises out of volatility in value of bank’s investment
portfolio.Banks are statutorily required to invest in liquid assets such as
cash,gold,govt & other approved securities in form of SLR
● OPERATIONAL RISK:Risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events. Eg-
fines, penalties etc.
BASEL II- Pillar 2:Supervisory Review Process
● Deals with regulatory response to the first pillar; ensures that banks
have adequate capital to support all the risks associated with their
business.
● In India, RBI has issued guidelines that banks should have an internal
supervisory process called Internal Capital Adequacy Assessment
Process( ICAAP)
● Through this, banks can assess the capital adequacy in relation to their
risk profiles.
● RBI also stipulated Supervisory Review and Evaluation Process (SREP),
which is an independent review & evaluation to suggest prudent measures
& supervisory actions.
BASEL II- Pillar 3: Market Discipline
● Compliments the first and second pillar
● Market discipline is basically a set of disclosure requirements which will
allow the market participants to gauge the capital adequacy of a bank.
● Eg: disclosing a bank’s capital structure, tier-1 & tier-2 capital and
approaches to assess the capital adequacy.
BASEL III
● Also considered Liquidity risk i.e, risk that arises when a bank fails to
meet its short term obligations
● Introduced in December 2010; continuation of Basel I & II
● Set of reform measures to strengthen the regulation, supervision and
risk management.

AIMS:

● Improve ability of banks to absorb shocks from financial & economic

stress
● Improve risk management & governance
● Strengthen bank’s transparency & disclosures
BASEL III - FEATURES
● MINIMUM CAPITAL REQUIREMENTS- tighter capital requirements as
compared to Basel I & II. Increased minimum common equity Tier 1
capital from 4%-4.5% and minimum tier 1 capital from 4%-6%. Overall
regulatory capital was left unchanged at 8%
● COUNTERCYCLICAL MEASURES- Introduced new requirements with
respect to regulatory capital for large banks to cushion against cyclical
changes on their balance sheets.Banks should set aside additional capital
during credit expansion & capital requirements can be loosened during
credit contraction. Banks are grouped according to size, complexity and
importance. Systemically important banks( banks whose failure creates a
risk for the entire financial system) are subject to higher capital
requirements.
BASEL III - FEATURES
● LEVERAGE & LIQUIDITY MEASURES- safeguards against excessive
borrowings and ensure that banks have sufficient liquidity during
financial stress.
SMALL FINANCE BANKS (SFB)
● Perform lending activities among the weaker sections of the community
and get complete financial inclusion.
● Accepts deposits of any amount, gives loans to farmers, MSME, and
individuals.
● Can be operated by individuals with 10 yrs of experience in banking, NBFC
and Microfinance Institutions
● Can be registered as Public Ltd. Co, under the Companies Act 2013
● Min paid up capital-100 cr
● Provides saving & lending facility, should follow SEBI regulations.
SMALL FINANCE BANKS (SFB)
● Cannot set up subsidiaries to undertake non-banking financial services
● 75% of its Adjusted Net Bank Credit (ANBC) should be advanced to the priority
sector as categorised by RBI
● Maximum loan to a person cannot exceed 10% of total capital funds: 15% for
groups.
● Can undertake financial services like distribution of mutual fund units, insurance
products, pension products etc with the prior approval from RBI
● Promoter’s minimum initial capital contribution to the paid up capital shall be
atleast 40% which can be brought down to 26% within 12 yrs from date of
commencement of operations
● Can be transformed into a full-fledged bank with RBI approval
● 25% of branches should be in unbanked areas.
PAYMENT BANKS
● RBI constituted a committee headed by Dr.Nachiket Mor in Sept 2013 to
propose measures for achieving financial inclusion and increased access to
financial services
● Suggested the introduction of payment banks to cater the banking
requirements of lower income group and small businesses
● Payment bank is a bank line any other bank operating on a small scale
without involving credit risk
● Carry out most banking operations except advancing loan and issuing
credit cards
● Min capital required- 100 cr
● Licensed as payment bank under section 22 of Banking Regulation Act
1949; registered as Public Ltd Co under Companies Act 2013
PAYMENT BANKS- Features
● Must use the term ‘payment bank’ in its name to differentiate it from
other banks
● Objective is to bring financial inclusion
● 25% of branches should be in unbanked areas.
● Can accept demand deposits restricted to Rs. 1 lakh per customer and pay
interests on deposits
● Not allowed to lend money to people or issue credit cards, but can issue
ATM/debit cards, net banking & mobile banking
● Allowed to invest deposits received from customers, only in govt securities
PAYMENT BANKS V/S SMALL FINANCE BANKS
PAYMENT BANKS SMALL FIN. BANKS

● Can accept only current/savings ● Can accept all types of deposits

deposits ● Provides basic services of accepting
● Customer balance should not exceed Rs. deposits & lending money
1 lakh on deposits ● No restrictions on area of operations
● Cannot give loans
MICRO FINANCE
● Research studies by NABARD indicated that existing banking
policies,systems and procedures and deposit and loan products were
perhaps not most suited to meet the immediate financial needs of the
poor
● It was felt that there was a need for improving the access of the poor to
micro finance rather than micro credit
● Definition- provision of thrift, credit and other financial services and
products of very small amounts to the poor in rural, semi urban and urban
areas for enabling them to raise their income levels and improve living
standards.
FEATURES
● Target group is poor people living in rural, semi urban or urban areas
● Objective- enabling them to raise their income levels and improve living
standards by provision of thrift, credit and other financial services and
products
● Intends to bring the poor within the purview of organised financial sector
MICRO FINANCE V/S MICRO CREDIT
MICRO FINANCE MICRO CREDIT

● Includes activities such as credit, ● Small loan given to unemployed, poor

savings, and insurance to low income entrepreneurs and others living in
individuals for creating social value poverty
● Broader than micro credit ● Covers only one aspect of micro
● Includes group lending, individual finance
lending, agricultural business
development services
SHG- FEATURES
● Small voluntary organisation of poor people, from the same economic
background
● Come together to solve their common problems through self help and
mutual help
● Promotes small savings, savings are deposited in a bank in the name of
SHG
● No. of members limited to 20,
● NGOs, social workers village workers etc help in formation of SHG
● Members are allowed to avail loans against their savings for emergency
consumption and supplementary income generating credit needs.
Micro Finance programs undertaken by Commercial Banks

● Training to bank staff in rural and semi urban areas about various micro
finance programs
● Training to SHGs, NGOs, social workers in micro financing programs
● Financial assistance to NGOs, federations of SHGs for lending to SHGs
● Launching special microfinance schemes
● Provision of value added services in the form of life insurance schemes
designed for beneficiaries of micro finance
● 100 cr Micro Finance Dev elopment Fund was set up in NABARD for:
Cont...
● Training to SHGs, NGOs, social workers in micro financing programs
● Provide funds to micro finance institutions for meeting their initial
expenses in connection with formation
● Meet expenses in connection with creation and nurturing of SHGs
● Design new delivery mechanism of deposits and loan products to
beneficiaries of micro finance programmes
● Promote research, action research, management information systems and
dissemination of best practices in micro finance.
FINANCIAL INCLUSION
● Provision of banking services at reasonable & affordable cost to
disadvantaged & low income sections of the society,who are excluded
from the formal banking channel
● Aims at connecting common people with the banking system and ensuring
their access to banking facilities
● Despite widespread expansion of the banking sector, major proportion of
households in rural areas are still outside the coverage of the formal
banking system
● RBI has undertaken a number of measures such as zero balance accounts,
no frill accounts( accounts with no min balance , as well as charges)
● Aadhaar linked bank a/c fo all adults in India, to prevent the poor people
from falling in debt trap.