1.

BAD BANK
What is Bad Bank:
 A Bad Bank is an Asset Reconstruction Company (ARC).
 Once it is formed, banks divide their assets into two categories (a) one with non-performing assets and other
risky liabilities and (b) others with healthy assets, which help banks grow financially.
 ARC or Bad Bank buys bad loans from the commercial banks at a discount and tries to recover the money from
the defaulter by providing a systematic solution over a period of time.
 The bad bank will manage these Non-Performing Assets in suitable ways, some may be liquidated, others may be
restructured, etc.
 RBI, too, came up with a suggestion to form two entities to clean up the bad loan problems ailing PSBs -PAMC
(Private Asset Management Company) and NAMC (National Assets Management Company).
 PAMC would be formed by roping in banks and global funding companies.
 This would invest in areas where there’s a short-term economic viability.
 NAMC would be formed with government support, which would invest in bad assets with short-term stress but
good chances of turnaround and economic benefit.
Benefits of setting up a bad bank
 The major benefit of forming a bad bank is asset monetization. It’s the process of turning a non-revenue-
generating item into cash.
 Bad assets would stay in the risky category, while the good one stays in the other category, saving them from
mixing together.
 Since 40% of the NPA is concentrated only in 60 firms, so better we create a centralized agency PARA, which will
work as a Bad Bank and absorb the losses from the PSBs.
 Since a bad bank specializes in loan recovery, it is expected to perform better than commercial banks, whose
expertise lies in lending.
 The recent IBC amendments make it complex for foreign players to take part in resolution.
 Experts believe a vehicle like AMC or ARC that could address the stressed loan issue, till the bankruptcy code
stabilizes, could be beneficial.
 A single government entity will be more competent to take decisions rather than 28 individual PSBs.
 Capacity building for a complex workout can be better handled by the government which has regulatory control
and has management skill sets in public sector enterprises.
 Foreign investors with both risk capital and risk appetite would be more in a government-led initiative, knowing
that regulatory risks would stand considerably mitigated in various stages of resolution, including take-outs.
Challenges with Bad Bank:
 A banking institution has to keep in mind its choices of assets to be transferred into the risky category, business
case, portfolio strategy, and the operating model.
 Each of these choices must be made while considering the impact on funding, capital relief, cost, feasibility,
profits, and timing.
 The government support is also necessary to help banks understand regulatory and tax-related issues.
 Once the NPA problem is settled, the Bankers may become complacent and again resume reckless lending.
 A one-size-fits-all approach to designing a bad bank can be very expensive and less effective.
 At least Rs. 25,000 to Rs. 30,000 crore of capital will be required to set up a bad bank in the initial stages.
Way Forward:
 Bad Bank should be based on a set criterion as any such exercise creates a moral hazard that should be
eschewed.
 There have to be strict performance criteria for the banks selling such assets.
 The criteria for buying assets should be transparent and a pecking order must be drawn up where probably the
restructured assets get priority.
 A competitive approach should prevail among the banks so that they work hard to qualify for the sale of bad
assets to the bad bank. This, in fact, will ensure better governance standards too.
 Set up a bad bank to deal with NPAs at some of the weaker PSBs, instead of one that picks up NPAs from all
PSBs.
 It would prove less controversial if the government had a majority stake in it..
 The government must infuse more capital into the better-performing PSBs.
 It must also create, through an act of Parliament, an apex Loan Resolution Authority for tackling bad loans at
PSBs.
The resolution of bad loans and restoring the health of PSBs is among the biggest challenges the economy faces today. It’s
a challenge that requires a response on multiple fronts. A bad bank cannot be the sole response. The most efficient
approach would be to design solutions tailor-made for different parts of India’s bad loan problem and use Bad Bank only as
a last resort once all other methods fail.
 2. Insurance Industry
Insurance refers to a contract or policy by which an individual or any firm or entity receives protection from financial loss
or from any other kind of damage. This insurance is provided either by an insurance company or by the state. It is basically
a form of hedging and risk management system against uncertain loss.
The concept of insurance is not new to India and the idea of insurance can be found in the ancient texts of Manusmriti,
Dharmashastra and Kautilya's Arthashastra. However, the beginning of the modern insurance industry in India can be
traced back to 1818, when Oriental Life Insurance Company was established for providing life insurance services to the
European community.
The first Indian insurer company was the Bombay Mutual Life Assurance Society, established in 1870. The Triton Insurance
Company Limited established in 1850 was the first general insurance company in India. The National Insurance Company,
established in 1906 is the oldest existing insurance company which is still in business in India. In 1912, the life insurance
companies act, and the provident fund Act was enacted for the regulation and control of the insurance sector in India.
At present, the only public sector company which provides life insurance cover in India is the Life Insurance Corporation of
India (LIC). At present, there are around 52 insurance companies in India out of which 24 are in the life insurance business
and other are doing business in the non life Insurance sector.
Life Insurance Corporation of India (LIC)
 LIC was established in 1956 by an act of Parliament of India which nationalised the private insurance industry in
India.
 LIC was created by merging around 245 insurance companies and other provident societies.
 The Life Insurance Corporation of India (LIC) handles the largest number of insurance policies in the world.
Reasons for the establishment of Life Insurance Corporation of India (LIC)
 In 1955, a matter regarding the fraud by private insurance agencies was raised in the Parliament by Amol Barate.
After the investigation on this issue, Ramkrishna Dalmia was imprisoned for 2 years. In 1956, Life Insurance
Corporation of India came into existence.
 The nationalization of life insurance Corporation of India was influenced by the industrial policy resolution of
1956, which emphasized on nationalization of important sectors of the economy.
 The other important reason was to expand the social security services to all the sections of the society.
 It also aimed to mobilize the savings of common people for investing it in the planned development of the
nation.
Objectives of Life Insurance Corporation of India LIC
 To spread the life insurance cover throughout the country especially in the rural areas with particular emphasis
on socially and economically backward sections of the society. It aims to provide sufficient financial cover against
death at appropriate costs.
 To make insurance linked savings attractive for the people and to increase the mobilization of people s savings.
 To fulfill the primary obligation towards policyholders at the same time keeping in mind the interest of the
community as a whole along with fulfilling the responsibilities towards national priorities.
 To meet the different life Insurance needs of people and community as a whole keeping in line with the changing
social and economic environment of the country.
 To act as the trustee of funds of the insured public at individual and collective capacities.
 To promote a sense of participation, job satisfaction and pride among the employees of LIC through dedicated
discharge of their duties for achieving the corporate objective.
Salient features of the Life Insurance Corporation of India (LIC)
 The central office of LIC is at Mumbai and the seven other zonal offices are at Mumbai, Delhi, Chennai, Kolkata,
Kanpur, Hyderabad and Bhopal. It has 100 divisional offices in the important cities and around 2048 branches all
over the country.
 LIC also operates in the international market with its offices at England, Mauritius, and Fiji etc.
 The slogan of LIC in Sanskrit is Yogakshemam Vahamyaham which means your welfare is our responsibility .
 LIC has greatly contributed through its investments in the five year plans. In the second five year plan (1956-
1961) its contribution was rupees 184 crores which increased to 7,52,633 crores for (2012- 2015).
 LIC commanded monopoly in the Indian Life Insurance sector and by 2006, it contributed around 7% of India's
GDP. However, the Indian government started liberalization of Insurance sector after August 2000, and the
monopoly of LIC in the life Insurance sector ended.
 LIC subscribes to the shares, bonds, and debentures of several companies and corporations and provides them
term loans. It acts as a downward stabilizer of the share market as due to the continuous flow of fresh funds it
has the capability to buy shares even when the share market is comparatively weak.
General Insurance Corporation of India (GIC)
General Insurance refers to those insurance policies which do not come under the ambit of the life insurance sector. It
includes the non life insurance sector such as fire, automobile and homeowners policies, accidents or loss from a financial
event etc.
The General Insurance Corporation of India (GIC) is a state owned reinsurance company in India. The GIC had the
monopoly in the reinsurance sector until the insurance market was opened for foreign direct investment in 2016 and
foreign reinsurance players entered Indian market which included the companies from Germany, France, and Switzerland.
The evolution of general insurance can be traced back to the establishment of Triton insurance company limited in 1850 in
Calcutta during the British Raj. In 1907, Indian Mercantile Insurance Limited was established as the first company to
transact all the different classes of general insurance business in India. In 1957 the general insurance Council was formed
to frame the code of conduct to ensure sound business practices and fair conduct in the general insurance sector in India.
Later on, in 1968 the Insurance Act was amended for regulating the financial investments and for setting the minimum
solvency margin. In 1972, the General Insurance Business (Nationalisation) Act was passed which nationalised the general
insurance business in India.
Agriculture insurance company of India Limited (AICIL)
Agriculture insurance company of India Limited AICIL established on 20th December 2002 under the Companies Act 1956 is
a government owned Crop Insurance Company which serves the needs of farmers. It is the largest crop insurer in the world
in terms of the number of farmers served and provides crop Insurance schemes around 20 million farmers. It started its
operation from first April 2003 and provides its services in around 500 districts of India. The company is headquartered out
of New Delhi.
Objectives and vision of the AICIL
 To provide financial stability to the farmers in rural India to accelerate the economic growth of the country.
 To developed farmer friendly and rural oriented insurance schemes and products for all the agricultural and
allied risks.
 To provide a protective net over agricultural and allied activities from natural threats and risks.
 To design and develop agricultural insurance products in a scientific manner with sound insurance principles for
dealing with the diverse requirements of farmers.
 To improve the delivery and service of agricultural insurance schemes for bringing the remotest and poorest
farmers under the agricultural insurance cover in a cost effective manner.
 To promote awareness about agricultural insurance schemes as the principal a risk mitigation tool.
 To encourage the farmers for adopting scientific and progressive farming techniques, inputs, and higher
technology.
 One of its goals to stabilize farm income especially in the disaster years.
Salient features of the AICIL
 AICIL started business operations from 1st April 2003 and it took over the responsibility to implement the
National Insurance Scheme (NAIS) from the General Insurance Corporation of India (GIC).
 AICIL was designated as the implementing agency of the country wide crop insurance program NAIS by the
government.
 AICIL as 17 regional offices across India in the state capitals.
 AICIL is a public sector company in which the GIC holds 35% stake and the National bank for Agriculture and Rural
Development (NABARD) the holds 30 % shares. The National Insurance Company Limited, Oriental Insurance
Company Limited, United Insurance Company Limited and the New India Assurance Company Limited hold 8.75
% stake each.
Schemes offered by the AICIL
AICIL provides area based Crop Insurance schemes across the country. It provides insurance services to farmers based on
the place where he/ she cultivates crops and what crop is cultivated. Different Crop Insurance schemes provided by AICIL
are as follows:
 Pradhan Mantri fasal Bima Yojana
 Restructured weather based Crop Insurance Scheme
 Unified package Insurance Scheme
 National agriculture insurance
 Biofuel tree/ plant insurance
 Cardamom plant and yield insurance
 Pulpwood tree insurance policy
 Rainfall Insurance Scheme for coffee (RISC) 2011
 Rubber plantation insurance
 Varsha Bima / Rainfall insurance
 Weather insurance (RABI)
 Coconut farm Insurance Scheme
Future products to be provided by the AICIL
 Sugarcane insurance
 Tea insurance
 Basmati rice insurance
  Aromatic and medicinal plants insurance
 Contract farming insurance
Shortcomings of the AICIL
 The CAG report has mentioned that the central government and the state governments did not maintain the
database of insured farmers. AICIL also did not maintain any comprehensive data of insured farmers under its
schemes.
 The CAG report mentions that two out of three farmers are not aware of the availability of Crop Insurance
schemes.
 The fund houses and banks have been responsible for delayed disbursements of the loan and insurance amount
which has resulted in denying or delaying the insurance coverage to the farmers.
 There was a lack of an effective mechanism for monitoring the implementation of the Crop insurance schemes.
 AICIL failed to verify the claims of private insurance companies before releasing the funds.

There are many types of insurance and many insurance companies. All these insurers have to follow certain basic
principles of insurance. These principles of insurance are as follows:
4.1) Principle of insurable interest: There must be a relationship between the insured and the beneficiary.
4.2) Principle of utmost good faith: The insured party must provide true, accurate and full information to the insurer.
4.3) Principle of indemnity: Insurance contract is for providing protection to the insured party against risk and
unforeseen losses, it is not for making profit by the insured party.
4.4) Principle of contribution: Insured can claim the compensation from all insurers or from any one insures only to
the extent of actual loss.
4.5) Principle of subrogation: After compensating the insured for the loss suffered by him on his insured property,
then the ownership right on such property shifts to the insurer.
4.6) Principle of loss minimization: In case of any uncertain event or mis-happening, insured must always try to
minimize loss of his insured property.
4.7) Principle of Causa Proxima: As per this principle if there is more than one cause for the loss occurred, then most
near or proximate cause should be taken into consideration while deciding the liability of the insurer under insurance
contract. Principle of Causa Proxima doesn‟t apply to life insurance contract.
These principles help to maintain integrity in all the insurance contracts. In the absence of these principles people may
use insurance process to gamble or speculate for any uncertain future event.

Types of Insurance
Insurance is mainly of two types: life insurance and general insurance. Under life insurance, insurer pays certain
amount of money to the insured or his beneficiary upon occurring of a certain event such as death. On the other hand
any insurance policy other than life insurance, are covered under general insurance. General insurance includes health
insurance, fire insurance, marine insurance, property insurance, rural insurance, vehicle insurance and travel insurance
etc.
5.1) Life Insurance policy categorization:
i. Whole Life Plan: A policy which covers entire duration of insured‟s life is known as whole life policy. In this type of
policy annual premium is paid throughout policy term period.

ii. Endowment: Under endowment plans lump sum amount is provided when the policy matures or when the policy
holder dies. There are few endowment plans which provide payment in case of critical illness also.
iii. Money Back Policy: Under money back plan instead of getting lump sum amount at the end of the term, insured
person gets a fixed percentage of sums assured at regular intervals. There is benefit of liquidity in money back policy.
iv. Term Plan: Term plans are the most simple and cheapest type of life insurance policy, which provides coverage for
a specified period known as “term” or until a certain age of the insured. If the insured person dies within the coverage
period then this policy pays the face amount of the policy, but nothing is paid if insured outlives the term of policy.
After the end of term period policyholder has an option to discontinue the policy or to extend it.
v. Unit Linked Insurance Plan (ULIP): Unit linked insurance plan is a combination of risk cover and investment both.
These policies are flexible and protective both at the same time. Premium paid under these policies are used to purchase
investment asset units. These asset units are selected by policyholder.
5.2) General insurance policy categorization: Under general insurance or Non-life insurance following types of
insurance are covered.
i. Health Insurance: Health insurance covers all the medical and surgical expenses incurred by the insured person.
These plans are created after assessing the insured persons current health position, then estimation is made for future
healthcare expenses for the insured person and after all this approximation premiums are decided for the policy.
ii. Accidental Insurance: An accidental insurance policy covers both any sort of disability arising from accident and
death due to accident. Accident should not arise due to the usage of alcohol or drugs.
iii. Property Insurance: Risk to property arising out of fire, theft, burglary and weather damage are covered under
property insurance. Property insurance are further sub divided into earthquake insurance, flood insurance and fire
insurance etc.
 iv. Vehicle Insurance: Vehicle insurance is also known as motor insurance and auto insurance. It is a mandatory policy
which should be taken by every vehicle owner. In case of auto accident this policy mitigates the costs associated with
accident. Vehicle owner has to pay annual premiums to insurer, and then insurer pays full or part of costs arising out of
auto accident.
v. Rural Insurance: Rural insurance is a policy which covers the risk of agriculture and rural businesses. These
policies cover natural calamities, livestock, crop, health and life. One can take policy according to his needs.
vi. Home Insurance: Home insurance covers private homes from any kind of risk and losses.
vii. Travel Insurance: Travel insurance policies cover both, domestic and international as well as short and long
distance travel. These policies cover trip cancellation, medical expenses, flight accident, lost luggage and any other kind
of loss incurred while travelling.
viii. Group Insurance: An insurance policy which covers a particular group of people is known as group insurance.
This group can be a society, employees of an organization or members of a professional association.
ix. Retirement Insurance: Retirement insurance is also known as Pension policies. Pension policies provide stable
retirement income and give financial security to the policy holders.
The main difference between life insurance and general insurance is that, under life insurance the claim is certain and
fixed, but in case of general insurance, claim is uncertain i.e. amount of claim is variable and is ascertained after the
happening of the event.

Insurance Reforms
The insurance industry in India was nationalised after independence. In 1956 Life Insurance Corporation of India was
formed after the nationalisation and merger of 245 insurance companies and other provident societies. In 1972, the
General Insurance Corporation and its four subsidiaries were formed by nationalising 55 Indian general insurance
companies along with 52 general insurance operations of other companies. The premiums in the Insurance sector have
witnessed phenomenal growth. However, a large segment of the population has not been provided insurance cover. The
insurance premium collection is 3 % of the GDP of India.
Problems in the Insurance sector
 The insurance cover in India was very low as only 25 % of insurable people came under insurance cover. This was
inadequate and reforms were necessary to deal with this issue.
 The public sector insurance companies were operating with lower efficiency and were having lower returns in
their Investments.
 The public sector companies enjoyed the monopoly in the insurance market. There was a lack of competition in
the Insurance sector in India. Life Insurance Corporation had a monopoly in the Life Insurance sector. The
General Insurance Corporation failed to promote competition among its four subsidiaries.
 The insurance premiums were comparatively higher and policyholders got lower saving rates on their
Investments.
Malhotra committee on insurance reforms
Due to the above issues in the Insurance sector, the need was felt for reforms in the Insurance sector. This became more
important after the economic reforms of 1991. The R.N. Malhotra committee was set up by the government of India to
give recommendations on reforms in the Insurance sector to make the Insurance sector more efficient and productive. The
committee submitted its report in 1994 and gave the following recommendations.
 The government should bring down its share in the insurance companies to 50%.
 The government of India should take over the holdings of the General Insurance Company and its four
subsidiaries. This was essential so that these subsidiaries can act as independent companies.
 The private sector companies having a minimum paid capital of rupees 1 billion should be allowed to enter the
insurance sector.
 Another important recommendation of the committee was that no company should be allowed to deal both in
the life insurance business and the general insurance business through a single entity.
 The entry of foreign investment should be allowed but foreign companies should only be allowed to enter
through the collaboration with an Indian company.
 The committee recommended for setting up an independent regulatory body for the Insurance sector on lines of
SEBI. The insurance regulatory Development Authority IRDA was later set up by the government.
 The committee recommended for reducing the mandatory investment limit of the Life Insurance Corporation life
fund in the government securities to 50 % from the existing minimum limit of 75 %.
 The Life Insurance Corporation should be converted into a company which is to be registered under the
Companies Act and the functioning of The Life Insurance Corporation LIC should be decentralized.
 The committee recommended that the General Insurance Company and four subsidiaries should not hold more
than five percent shares in any corporation.
 The committee recommended for computerisation of insurance operations and also gave recommendations on
issues related to the long-term insurance plans.
 There should be a specified proportion of business that every company must have in the rural areas.
Steps taken for insurance reforms in India
  The Government of India set up the insurance regulatory and Development Authority IRDA on December 7, 1999.
The IRDA had the responsibility to specify rules and regulations about the Insurance sector in India. It was given
the responsibility to take care of the interests of the insurance policy holders.
 IRDA decided that the paid up equity capital for the life sector and non-life sector companies would be rupees
hundred crores. The paid up capital for the reinsurance business should be 200 crores.
 Now, the insurance companies would be registered under the Companies Act 1956.
 The private sector was now allowed to enter the insurance business.
 Foreign investment was allowed in the Insurance sector. A limit of 26% of foreign investment was specified which
has been recently increased to 49%.
 Every Insurance Company had to keep a deposit of rupees 10 crores or a sum equivalent to 1 of the gross
premium for life insurance and 3 of the total gross premium in the non-Life Insurance segment with the RBI.
Impact of insurance reforms
 There was a spread and deepening of insurance coverage in India. The number of people covered by insurance
increased from 20 million in 2001 to 230 million in 2009. The coverage of insurance in the rural areas improved.
 There were a restructuring and revitalization of public sector insurance companies in India.
 There was rapid growth in the insurance sector due to private sector participation and foreign investment. The
compound annual growth rate was around 17 % on insurance premiums in 2017.
 Insurance reforms have led to easing out of policy regulations and has promoted the entry of different insurance
products such as health insurance etc.
 The Indian insurance industry is expected to grow to $280 billion by 2020, much larger than $84.72 billion for the
financial year 2017.
 The insurance reforms have contributed to the improvements in the savings and investment rates resulting in the
improvement of the overall growth of the economy.
 The number of companies in the Insurance sector increased to 52 in which 24 are dealing in the life insurance
sector while others are involved in the business of non-life insurance sector.
 In annuity and pension products, private players have captured a market share of 33 %.
 Insurance reforms have promoted the use of new technology, new channels of distribution and new products.
Due to the competition with the private sector, public sector insurance companies like LIC have also reformed
itself and are now using new channels of bancassurance, direct marketing, insurance advisors along with the
traditional agents.
 The biggest beneficiary of all these insurance reforms has been the Indian customers. There has been lowering of
insurance premium rates and customers are getting better returns on their Investments.
Challenges and future insurance reforms
 At present, the insurance market is dominated by the product market relationship. Flexible pricing structure, risk
management, and investment decision making need to be focused by the insurance companies.
 The expense ratio of the non-life insurance companies is around 33-35 . This needs to be brought down to the
international standards of 15-20 % to improve the profitability.
 There is a need to educate the rural customers so that the benefits of insurance reach the remotest parts of
India.
 The foreign direct investment in the insurance broking can be increased to 100% under certain conditions. The
government is already working on this idea.
 There is a need to deal with the issues of software technology lags, lack of awareness among employees etc to
get the real benefits of insurance reforms.
 The issues of overstaffing in the public sector insurance companies such as LIC needs to be tackled to improve its
efficiency and productivity.
 There is a need to reduce the amount of investment in the government securities and the public sector insurance
companies should invest in the profit making business to increase their profitability.

3. Insolvency and Bankruptcy Code, 2016 provides a time-bound process for resolving insolvency in companies and
among individuals.
 Insolvency is a situation where individuals or companies are unable to repay their outstanding debt.
 Bankruptcy, on the other hand, is a situation whereby a court of competent jurisdiction has declared a person or
other entity insolvent, having passed appropriate orders to resolve it and protect the rights of the creditors. It is a
legal declaration of one’s inability to pay off debts.
 The Government implemented the Insolvency and Bankruptcy Code (IBC) to consolidate all laws related to
insolvency and bankruptcy and to tackle Non-Performing Assets (NPA), a problem that has been pulling the
Indian economy down for years.
 The Code is quite different from the earlier resolution systems as it shifts the responsibility to the creditor to
initiate the insolvency resolution process against the corporate debtor.
  The recently proposed amendments aim to remove bottlenecks, streamline the corporate insolvency resolution
process, and protect the last mile funding in order to boost investment in financially distressed sectors.

o Ring-fencing the companies resolved under the IBC from regulatory actions during past management
can make the IBC process attractive for investors and acquirers.
Objectives of IBC
 To consolidate and amend all existing insolvency laws in India.
 To simplify and expedite the Insolvency and Bankruptcy Proceedings in India.
 To protect the interest of creditors including stakeholders in a company.
 To revive the company in a time-bound manner.
 To promote entrepreneurship.
 To get the necessary relief to the creditors and consequently increase the credit supply in the economy.
 To work out a new and timely recovery procedure to be adopted by the banks, financial institutions or
individuals.
 To set up an Insolvency and Bankruptcy Board of India.
 Maximization of the value of assets of corporate persons.
Salient features of the Insolvency and Bankruptcy Code, 2016
 Covers all individuals, companies, Limited Liability Partnerships (LLPs) and partnership firms.
 Adjudicating authority:

o National Company Law Tribunal (NCLT) for companies and LLPs

o Debt Recovery Tribunal (DRT) for individuals and partnership firms
Insolvency Resolution Process
 Insolvency resolution process can be initiated by any of the stakeholders of the firm:
firm/debtors/creditors/employees.
 If the adjudicating authority accepts, an Insolvency resolution professional (IP) is appointed.
 The power of the management and the board of the firm is transferred to the committee of creditors
(CoC). They act through the IP.
 The IP has to decide whether to revive the company (insolvency resolution) or liquidate it (liquidation).
 If they decide to revive, they have to find someone willing to buy the firm.
 The creditors also have to accept a significant reduction in debt. The reduction is known as a haircut.
 They invite open bids from the interested parties to buy the firm.
 They choose the party with the best resolution plan, that is acceptable to the majority of the creditors (75 % in
CoC), to take over the management of the firm.
 Establishment of an Insolvency and Bankruptcy Board of India to exercise regulatory oversight over insolvency
professionals, insolvency professional agencies and information utilities.
 Insolvency professionals handle the commercial aspects of insolvency resolution process.
 Insolvency professional agencies develop professional standards, code of ethics and be first level regulator for
insolvency professionals members leading to development of a competitive industry for such professionals.
 Information utilities collect, collate, authenticate and disseminate financial information to be used in insolvency,
liquidation and bankruptcy proceedings.
 Enabling provisions to deal with cross border insolvency.
Achievements of the IBC
 IBC is a vast improvement on the two earlier laws legislated to recover bad loans —the Sick Industrial Companies
(Special Provisions) Act, 1985 (SICA) and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993
(RDDB).
 Speedier Resolution: Before IBC, resolution processes took an average of 4-6 years, after the enactment of IBC,
they came down to 317 days.
 Higher Recoveries: Recoveries are also higher: 43% after the IBC, against 22% before it.
 Due to the institution of IBC, we have seen that many business entities are paying up front before being declared
insolvent. The success of the Act lies in the fact that many cases have been resolved even before it was referred
to NCLT.
 A steady increase in the number of admitted corporate insolvency resolution process (CIRP) cases.

o By the end of March 2019, a total of 1858 cases were admitted for resolution – of which 152 have been
appealed/reviewed/settled, 91 have been withdrawn, 378 ended in liquidation and 94 have ended in
approval of resolution plans.
Challenges for IBC
 Lack of operational NCLT benches: Though the government had, in July 2019, announced setting up of 25
additional single and division benches of NCLT at various places including Delhi, Jaipur, Kochi, Chandigarh, and
Amravati, most of these remain non-operational or partly operational on account of lack of proper infrastructure
or adequate support staff.
  low approval rate of resolution plans: According to the data from the Insolvency and Bankruptcy Board of India
(IBBI), of the 2,542 corporate insolvency cases filed between December 1, 2016 and September 30, 2019, about
156 have ended in approval of resolution plans — a mere 15%.
 High number of liquidations is a cause for major worry as it violates IBC’s principal objective of resolving
bankruptcy.
 Slow judicial process in India allows the resolution processes to drag on, this was the same reason for slow
recovery under SICA or RBBD.
Conclusion
Operationalisation of IBC, till now, has been spoiled by myriad factors ranging from frivolous challenges posed by
operational creditors and promoters to shortage of judges in tribunals. As a result, an important piece of legislation like
IBC, which was expected to usher in a new era of ease of doing business, may fall into the trap of implementation failure.
Timely amendments, which provide more teeth to the Code, can only rescue the process. New amendments of 2019 in IBC
should be closely watched and observed in that light.

4. BANK TWIN BALANCE SHEET

Twin Balance Sheet Problem (TBS) deals with two balance sheet problems. One with Indian companies and the
other with Indian Banks.
Thus, TBS is two two-fold problem for Indian economy which deals with:
1. Overleveraged companies – Debt accumulation on companies is very high and thus they are unable to pay
interest payments on loans. Note: 40% of corporate debt is owed by companies who are not earning enough to
pay back their interest payments. In technical terms, this means that they have an interest coverage ratio less
than 1.
2. Bad-loan-encumbered-banks – Non Performing Assets (NPA) of the banks is 9% for the total banking system of
India. It is as high as 12.1% for Public Sector Banks. As companies fail to pay back principal or interest, banks are
also in trouble.
Origin of Twin Balance Sheet Problem in India

 Origin of TBS problem can be traced to the 2000s when the economy was on an upward trajectory.
 During that time, the investment-GDP ratio had soared by 11% reaching over 38% in 2007-08. Thus non-food
bank credit doubled and capital inflows in 2007-08 reached 9% of GDP. Due to such a boom in the economy,
firms started taking risks and abandoned their conservative debt/equity ratios and leveraged themselves up to
take advantage of the upcoming opportunities.
 But Global Financial Crisis (2007-08) reduced growth rates and thus revenues from the investment. Projects that
had been built around the assumption that growth would continue at double digit levels were suddenly
confronted with growth rates half that level.
 Firms that borrowed domestically suffered when RBI increased interest rates to avoid inflation increasing
financial costs.
 Environment and land clearances in infrastructure sector delayed the projects.
 Thus higher cost, lower revenues, greater financial costs-all squeezed corporate cash flow leading to NPAs in
the banking sector.
Peculiarities of India’s Twin Balance Sheet Problem (TBS):
 In other countries, corporates over expand during the boom and accumulate obligations which they find difficult
to repay. It leads to default and the situation is reached where high NPA levels have triggered banking crises.
 In India, there have been no bank runs, no stress in the interbank market, no need for any liquidity support and
GDP growing at a good pace since the TBS problem first emerged in 2010. Yet the problem has reached to this
scale where it threatens the stability of the entire banking system.
 The reason for this is that major NPAs are concentrated in Public Sector Banks which have the full backing of the
government.
Earlier steps to address the problem of NPA or TBS
India had taken different steps to tackle the NPA or TBS problem which already covered in a different
article. Insolvency and Bankruptcy code too was in the same direction. Briefing the important schemes again.
1. 5/25 Refinancing of Infrastructure Scheme
 This scheme offered a larger window for the revival of stressed assets in the infrastructure sector and eight core
industry sectors.
 Under this scheme, lenders were allowed to extend amortisation periods to 25 years with interest rates adjusted
every 5 years, so as to match the funding period with the long gestation and productive life of these projects.
 The scheme thus aimed to improve the credit profile and liquidity position of borrowers, while allowing banks to
treat these loans as standard in their balance sheets, reducing provisioning costs.
 Issues faced: However, with amortisation spread out over a longer period, this arrangement also meant that the
companies faced a higher interest burden, which they found difficult to repay, forcing banks to extend additional
loans (‘evergreening’). This, in turn, has aggravated the initial problem.
 2. Private Asset Reconstruction Companies (ARCs)
 ARCs acquire NPAs from banks or financial institutions and try to resolve them.
 ARCs are a product of and derive their asset resolution powers from the SARFAESI Act.
 The issue faced: ARCs have found it difficult to recover much from the debtors. Thus they have only been able to
offer low prices to banks, prices which banks have found it difficult to accept.
3. The Strategic Debt Restructuring (SDR) scheme
 The SDR scheme was introduced in June 2015, under which banks could take over firms that were unable to pay
and sell them to new owners.
 The issue faced: By December 2016, only two sales have been materialised as many firms remained financially
unviable.
4. Asset Quality Review (AQR)
 The RBI emphasised AQR, to verify that banks were assessing loans in line with RBI loan classification rules. Any
deviations from such rules were to be rectified by March 2016.
5. The Scheme for Sustainable Structuring of Stressed Assets (S4A)
 An independent agency hired by the banks will decide on how much of the stressed debt of a company is
sustainable. The rest (unsustainable) will be converted into equity and preference share.
 The issue faced: Only one case has been solved under this scheme so far.
Why did the above measures fail to solve the TBS problem?
 Loss recognition: Banks do not recognise stressed assets and continue giving loans. They are reluctant to conduct
the asset quality review for their assets.
 Coordination problems: Difficulty in deciding compensation by different banks on Joint Lenders Forums which
has not achieved much success.
 Court cases: Public Sector Banks are reluctant to write down loans as bank managers are afraid of accusation of
favouritism.
 Lack of Capital: Indradhanush Scheme promised to infuse Rs 70,000 crore into Public Sector Banks by 2018-19.
But this amount is not enough and banks need atleastRs 1.8 lakh crore more.
Questions over the sustainability of Indian strategy: Phoenix Scenario vs Containment Scenario
 The Indian strategy is based on the two scenarios:
1. Phoenix Scenario – Growth will decrease the bad debt by raising demand and investment cycle.
2. Containment Scenario – In this case, one needs to contain the bad loans in nominal terms and slowly their
share would reduce in bank sheets.
 Earlier both scenarios seemed feasible but now they are failing as per the recent data. So some new innovative
methods are needed to resolve this problem.
What is the solution to the Twin Balance Sheet Problem?
India has till now pursued a decentralised approach where individual banks have taken decisions on its own to
resolve NPAs. This approach has not resolved the problem and time have now come to create a centralised
agency called Public Sector Asset Rehabilitation Agency (PARA).

Why does India need a Public Sector Asset Rehabilitation Agency (PARA)?
 It will be able to resolve not only NPA problems but also bad debts of the companies, thus resolving TBS Problem.
 The centralised agency would help in fixing the problem faster and the decision will be taken swiftly.
 It could solve the coordination problem since debts would be centralised in one agency.
 The stressed debt is heavily concentrated in large companies and such bigger cases can be resolved by an
independent agency.
 Failure of Banks and private ARCs in resolving NPA problem till now.
 An international experience like of East Asian countries has shown that centralised agency can resolve Twin Bet
Problem.
Working of PARA
 PARA would purchase loans from banks and then work them by different ways like converting debt to equity and
selling the stakes in the auction.
 After taking off the loans from Public Sector Banks, the government would recapitalize them. Similarly, once the
financial viability of the over-indebted enterprises is restored, they will be able to focus on their operations,
rather than their finances and will be able to consider new investments.
Funding of PARA
 RBI may transfer some of the government securities to PARA.
 Government funding in the form of securities.
 Rest of the money may come from capital markets.
Conclusion
Twin Balance Sheet Problem (TBS) is a major problem that Indian economy is facing today. The past mechanisms
of resolving this problem in the form of decentralised approach have failed. There is no point of delaying this
 problem because the delay is very costly for the economy as impaired banks are scaling back their credit while
the stressed companies are cutting their investments. The time has come to adopt the strategy that East Asia
adopted during their crises period. The centralised agency in the form of PARA would allow debt problems to be
worked out quickly. The time has come for India to consider the same approach.
India is facing four balance sheet challenge.

What is the 'four balance sheet challenge'?

In his latest paper named 'India’s Great Slowdown', Arvind Subramanian mentions the new ‘Four balance sheet
challenge’. The Four Balance Sheet challenge includes the original two sectors - infrastructure companies and banks,
plus NBFCs and real estate companies.

Where do the roots lie?

The roots of India's Four balance sheet challenge can be traced back to the Twin balance sheet problem.
Subramanian discussed the twin balance sheet challenge in great detail in the Economic Survey of 2016-17.
Twin balance sheet problem was a result of India's over-leveraged companies and bad loan-saddled public
sector banks. During the boom period of the mid-2000s, state-run banks kept on lending while the corporate
sector — especially infra companies — saw a period of robust growth fuelled by easily available credit.

How banks and infra companies failed?

India Inc started taking on more risks and accumulating more debt on its books. But as clearances for land
and environment started showing signs of delay and financing costs began to escalate, debt servicing
became an issue for companies. The failure on the part of the infrastructure companies to service debt
reflected in the stress that started building on the balance sheets of state-run banks.

What caused the 'four balance sheet challenge'?

After the unexpected collapse of NBFC behemoth IL&FS, the markets began taking note of the wider issues
that plagued the shadow banking sector. It carried a debt of Rs 90,000 crore on its books. NBFCs were a
major participant in financing the real estate sector's growth. But, when demand tapered, debt servicing by
builders became difficult and the NBFC balance sheets started accumulating stress resulting in what became
a four balance sheet problem.

5. RECENT FINANCIAL SCAMS

What is the issue?
 Major financial sector scams (PNB, IL&FS, PMC bank) came to light in the recent period.
 Apart from poor governance and fraudulent practices, a common thread in all these has been supervisory failure.
What is the challenge to financial regulation?
 The country’s leading financial sector regulator, the RBI, is seen to be responding only after the event of a fraud.
 Like in IL&FS, in the PMC case too, there appears to be shortfalls on the part of the management and the board
of the bank.
 This was evident as the bank’s loan exposure to a single firm, HDIL, alone constituted 73% of its assets.
 Moreover, several dummy accounts were created to conceal this.
 But these escaped the regulator’s monitoring as the issue of dual control by the RBI and state governments
remains a concern.
 It has been cited as a hurdle by the RBI for its inability to effectively supervise cooperative banks.
 This poses limitations in superseding the board of directors or removing directors of these banks, unlike in
commercial banks.
What are the larger concerns?
 India remains an economy where the large banks continue to focus on bigger cities and towns.
 Given this, the role of co-operative banks in ensuring credit delivery to the unorganised sector and last mile
access remains a point of concern.
 This is especially true in terms of poor credit delivery to the small businesses.
 A recent RBI report shows that fund flows to the commercial sector had declined by close to 88% in the first 6
months of the 2019-20 fiscal.
 This would have surely hurt small businessmen, traders and the farm sector.
What is the way forward?
 A remarkable feature since 1991 liberalisation has been the resilience of India’s financial sector.
 This may also have to do with the dominance of government-owned institutions or lenders and a strong central
bank.
 If this record is to be continued, the RBI will have to play a better supervisory role.
 The RBI has already started building an internal cadre for supervision of banks and other entities aimed at
enhancing its oversight capabilities.
 This will have to be complemented by legislative changes which could lead to greater regulatory control and
powers for the RBI over cooperative banks.
 Besides the banks and lenders with national or regional presence, India needs efficient other players -
cooperative banks, small finance and payment banks.

CASE STUDY- IL& FS

 The Infrastructure Leasing and Financial Services (IL&FS) trouble exposes the weakness in India’s financial
regulatory architecture.
 It calls for appropriate reforms in regulatory mechanisms as the consequences are widespread.
What happened to IL&FS?
 Infrastructure Leasing and Financial Services (IL&FS) is a large infrastructure finance company.
 Some of its subsidiaries defaulted on their debt as a consequence of which its credit was
sharply downgraded recently.
 If tax-payer money is used to save IL&FS, it would be another drain on the Union Budget.
 Notably, the Centre's fiscal is already burdened by mismanagement and regulatory failures in the banking sector.
What went wrong?
 There were shortfalls in ensuring institutions in place to monitor and regulate systemic risks.
 IL&FS is a non-bank financial company regulated by the RBI.
 But the RBI does not have all the information to understand risk to other financial firms arising from its debt.
 Pension funds, provident funds, mutual funds and insurance companies hold the debt of IL&FS subsidiaries.
 But RBI does not regulate these and hence will not have the full picture.
 The RBI may know only about bank loans to the conglomerate.
 But the ripple effects of financial shocks can be felt across sectors and not just financial markets.
What does it call for?
 The failure of one company can create a risk to the financial system as a whole as witnessed from bankruptcy of
Lehman Brothers.
 Such “systemic risk” needs to be monitored, as, if a firm is large, it is considered “too big too fail”.
 Even if not too big, if deeply integrated with the business of other firms, it may be “too networked to fail”.
 In either case, such firms and their real-time networks need to be monitored.
 For better response, the regulator must know who will get hit if such firms fail, by how much, and what will be
the consequences.
 Such firms can be put under enhanced supervision and at all times there needs to be a full picture of their assets
and liabilities.
 To ensure financial stability, this job needs to be given to an agency with powers to monitor risk-cutting across
sectors.
What are the proposed reforms?
 Regulation - Financial Sector Legislative Reform Commission recommended in 2012, legislative and architectural
reforms for financial regulation.
 This included a body that would monitor systemic risk.
 The Financial Data and Management Centre would have the legal powers to collect all regulatory data along with
sectoral regulators.
 The 2016-17 Budget announced the setting up of such a data centre and consequently a draft bill was proposed.
 However, concerns raised by financial regulators are delaying the process of implementation.
 So as of now, if there is a trouble, the regulators will be let off but the government will have to bear the
consequences.
 Resolution - Financial firms, both bank and non-bank, need to have an orderly mechanism for crisis resolution.
 The resolution corporation was proposed to be set up through the Financial Resolution and Deposit
Insurance Act.
 This would have watched the company, and examined whether it is systemically important.
 It would have asked it to prepare a living will if needed, and then stepped in before the firm defaulted.
 But the opposition to the legislation led to the withdrawal of the Bill.
What next?
 Given the above, the options are now limited and the firm can be forced sold.
 But again the question of 'whom to' remains as the LIC is already buying up all the weak remains in the financial
sector.
 Otherwise, IL&FS can be taken through Insolvency and Bankruptcy Code.
 This would mean its subsidiary firms that are non-financial firms could be sold one by one through the
bankruptcy process.
 But none of these are easy or fast solutions; the regulatory mechanisms need a relook.

CASE STUDY: PNB

One of the branches of State-owned Punjab National Bank (PNB) has recently detected fraudulent transactions
worth over Rs 11,000 crores.
What is Letter of Understanding (LoUs)?
 LoU is an assurance given by one bank to another to meet a liability on behalf of a customer.
 It is similair to a letter of credit or a guarantee.
 It is used for overseas import remittances and involves four parties — an issuing bank, a receiving bank, an
importer and a beneficiary entity overseas.
 According to norms, they are usually valid for 180 days.
 LoUs are conveyed from bank to bank through “Society for Worldwide Interbank Financial Telecommunication”
(SWIFT) instructions.
 Notably, till now, there is no record of a breach in SWIFT instructions anywhere in the world.
What has happened with PNB?
 PNB has alleged that two of its employees had “fraudulently” issued LoUs and transmitted SWIFT instructions to
the overseas branches of Indian Banks.
 This was done to raise buyer’s credit for the firm of a diamond merchant without making entries in the bank
system.
 The bank has alleged that one such fraudulent LoU issuance took place on January 2018, the trail of which
revealed the entire design.
 These LoUs were mostly issued to two Hong Kong branches of Indian Banks and was for the aforesaid diamond
merchant.
 The details on whether LoUs were backed by collateral or the quantum of liability that the bank faces against
these LoUs aren’t out yet.
How will the fraud impact PNB?
 Hong Kong branches of Allahabad Bank and Axis Bank have given money to the beneficiary entity on behalf of
Modi’s firms.
 As a result, PNB will have to settle the LoUs with these branches according to the norms of the Hong Kong
Monetary Authority.
 Market sentiment has already been impacted and PNB stock fell 9.81% in a single day, which consequently saw
investors loose over Rs 3,000 crores.
 The bank may have to set aside higher provisioning in the next few quarters if it unable to recover the money
from the accused firms.
 The fraud has been unearthed at a time when Indian banks are reeling under a pile of stressed assets of about Rs
10 lakh crore.
 Also, higher provisioning and a rise in bond yields, has resulted in losses for most public sector banks in the
previous quarter.

CASE STUDY- PMC

 The RBI has slapped restrictions on Punjab and Maharashtra Cooperative Bank Ltd (PMC Bank).
 It has also appointed an administrator and superseded its board of directors.
What are the implications of the decision?
 The PMC bank is a leading urban cooperative bank headquartered in Mumbai.
 The decision sent shock waves among thousands of its depositors.
 Panic-stricken customers rushed to bank’s branches across the state and were unable to withdraw more than Rs
1,000.
 The Bank has a deposit base of Rs 11,617 crore and operations across 7 states.
 It has been put under the scanner by the RBI after “irregularities” were disclosed to RBI.
 It ranks among the top 10 cooperative banks in the country.
 Moreover, the RBI restrictions will remain in force for 6 months.
 Given these, the unrest among customers is likely to continue.
What went wrong?
 Reporting - With a deposit base of just over Rs 11,000 crore, PMC bank reported a net profit of Rs 99.69 crore in
2018-19 as against Rs 100.90 crore in 2017-18.
 The bank showed 3.76% (or Rs 315 crore) of advances (Rs 8,383 crore) as gross nonperforming assets (NPAs) in
March 2019.
 This was a good performance considering that public sector banks recorded over 10% gross NPAs.
 But, it was learnt that the bank had suppressed the problematic assets and under-reported them.
 With this, the total bad loans could be between Rs 2,000-2,500 crore.
 Though this was not flagged in the Annual Report of 2018-19, the RBI was following it in the wake of huge
divergence in bad loan reporting.
 HDIL - The bank was funding a clutch of companies, mainly in the troubled real estate sector, led by Housing
Development & Infrastructure Ltd (HDIL).
 Rakesh Kumar Wadhawan is the Chairman of HDIL and his son Sarang Wadhawan is the Vice Chairman and MD.
 Notably, the Wadhawans of HDIL group had close links with PMC Bank for a long time.
 PMC had given loan to Wadhawan even after HDIL defaulted on its loans to other banks.
 Notably, commercial banks have already declared HDIL a defaulter.
 HDIL was also taken to National Company Law Tribunal (NCLT) for insolvency proceedings.
 Recently, NCLT admitted an insolvency plea moved by the Bank of India against HDIL in connection with a Rs 522-
crore loan default.
 PMC, however, claimed that the loan was much lower than Rs 2,500 crore quoted in the media.
 The loans given to HDIL and other entities were suppressed by the PMC despite defaults.
What should be done?
 The RBI-appointed administrator of PMC Bank is expected to take appropriate measures to bring the bank back
on track.
 Going by the RBI’s actions on the co-operative banking front, one option is for PMC Bank to be merged with
another bank.
 Notably, between 2004 and 2018, the RBI has merged 72 cooperative banks in Maharashtra alone.
 Across the country, the number of urban co-operative banks has fallen from close to 1,920 to around 1,550 in the
last 15 years.
 If the bank is liquidated, which is less likely, depositors will get Rs 1 lakh irrespective of the amount they had
deposited.
 Small depositors need not worry as the bank has Deposit Insurance and Credit Guarantee Corporation cover,
under which deposits up to Rs 1 lakh are covered.
 The bank has also claimed it has enough assets to cover the liabilities.

CASE STUDY- YES BANK

Within months of a small cooperative bank fallout in India, major private player Yes Bank (India's fifth largest
private sector bank) has also come under the RBI action for mounting bad loans. In order to save Yes Bank from
collapsing and to preserve people’s trust in the Indian banking system, RBI has taken several measures.
What steps RBI has taken?
 First, the Reserve Bank of India has taken over the YES Bank management.
 It has imposed a moratorium whose cash withdrawal limit has been capped at Rs 50,000.
 The RBI used the instrument of moral suasion on the SBI to acquire the Yes bank.

o Moral Suasion – is a qualitative control method of the RBI.

o Moral Suasion means the use of compulsion or informal suggestion by the RBI on Commercial banks
for the condition of Credit Policy.
 The RBI announced a draft ‘Scheme of Reconstruction’ that entails the State Bank of India (SBI) investing capital
to acquire a 49% stake in the restructured private lender.
Why Yes bank collapsed?
 Domino effect of IL&FS crisis: Yes Bank illustrates the widening damage from India’s shadow banking crisis,
which has left the Bank with a growing pile of bad loans.

o Yes Bank’s total exposure to Infrastructure Leasing & Financial Services(IL&FS) and Dewan Housing
Finance Corp (DHFL) was 11.5% as of September 2019.
 Rising NPA's: Apart from these, Yes Bank suffered a dramatic doubling in gross non-performing assets over the
April-September 2019 to ₹17,134 crores.

o Due to this, Yes Bank was unable to raise capital to shore up its balance sheet.
 Vicious cycle: Decline in the financial position of Yes Bank has triggered invocation of bond covenants by
investors (redeeming of bonds), and withdrawal of deposits.

o The bank was facing regular outflow of liquidity. It means that the bank was witnessing withdrawal of
deposits from customers.
 Governance issues: The bank has also experienced serious governance issues and practices in recent years which
have led to a steady decline of the bank.
 o For instance, the bank under-reported NPAs to the tune of Rs 3,277 crore in 2018-19.
Effect of Yes bank Crisis
 This revived the theory of India's Lehman Moment.

o The government took over IL&FS in 2018 in an effort to reassure creditors after the defaults. Also, in
2019, the RBI seized control of another struggling shadow lender, Dewan Housing Finance Corp., to
initiate bankruptcy proceedings.
o The Yes Bank crisis could trigger a domino effect that could lead to the collapse of various other
financial institution.
India's Lehman Moment
 The IL&FS default spooked the markets and raised fears of a Lehman-like crisis, referring to the collapse of the US
investment bank Lehman Brothers in 2008-09.
 The event rocked global stock markets and led to the biggest financial crash (Global financial crisis) since the
Great Depression 1929.
 The Yes Bank Crisis reflects badly on RBI egregious on two counts:

o The unjustifiable delay: After being sluggish in identifying governance faultlines among IL&FS, DHFL,
and now Yes Bank, RBI was slow to act.
o Erosion of depositor faith: Even after RBI's takeover of Yes Bank, the news of limiting withdrawals at Rs
50,000, has led to long queues of people claiming their money back.
 Capping withdrawals for depositors for Punjab and Maharashtra Cooperative Bank was bad enough. Using the
same principle for Yes Bank will only serve to erode the faith of depositors in private banks in general and the
banking regulator in particular.
 The choice of SBI as the investor to effect the bailout reflects the paucity of options the government.
o Owing to the recent announcement of the merger of banks, the majority of PSBs are in a transition
period. After the merger, PSB will be reduced from 21 to 12.
o Thus, the onus has fallen on India's largest bank (SBI) to play the role of a white knight (in economic
terms it means a firm that saves a weaker firm from economic crisis) for Yes bank.
 It will also have adverse impacts on the Banking sector.

o One, people will gravitate towards public sector banks which are already reluctant to provide credit.
o Two, private banks will be forced to offer higher deposit rates, keeping the cost of credit higher.
o Thereby banks will not be able to cater the credit requirement which is a prerequisite to realise the
dream of becoming a $5 trillion economy by 2024-2025.
 Effect of Indian Economy: Collapse of Yes Bank is highly undesirable, at a juncture when the growth in the Indian
economy has dropped to 5%.
Way Forward
 Yes Bank crisis is not exactly new or unique and its problems with mounting bad loans reflect the underlying
woes in the financial sector ranging from real estate to power and non-banking financial companies.
 Thus, Yes Bank crisis should be seen as a good opportunity for the various stakeholders:

o For RBI to review its Prompt Corrective Action framework.

o For the Government to carry out governance reforms in the financial sector.
o For commercial banks and shadow banking institutions to implement prudential norms in events of
providing loans.

What is Prompt Corrective Action (PCA)?

 PCA is a framework under which banks with weak financial metrics are put under watch by the RBI.
 The RBI introduced the PCA framework in 2002 as a structured early-intervention mechanism for banks that
become undercapitalised due to poor asset quality, or vulnerable due to loss of profitability.
 It aims to check the problem of Non-Performing Assets (NPAs) in the Indian banking sector.
 The framework was reviewed in 2017 based on the recommendations of the working group of the Financial
Stability and Development Council on Resolution Regimes for Financial Institutions in India and the Financial
Sector Legislative Reforms Commission.
 PCA is intended to help alert the regulator as well as investors and depositors if a bank is heading for trouble.
 The idea is to head off problems before they attain crisis proportions.
 Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to
restore the financial health of a bank.
 The PCA framework deems banks as risky if they slip some trigger points - capital to risk weighted assets ratio
(CRAR), net NPA, Return on Assets (RoA) and Tier 1 Leverage ratio.
 Certain structured and discretionary actions are initiated in respect of banks hitting such trigger points.
 The PCA framework is applicable only to commercial banks and not to co-operative banks and non-banking
financial companies (NBFCs).
 It may be noted that of the 21 state-run banks, 11 are under the PCA framework.
Non Performing Asset
A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue
for a period of 90 days. Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.
Capital Adequacy Ratio (CAR)
The CAR is a measure of a bank's available capital expressed as a percentage of a bank's risk-weighted credit
exposures. The Capital Adequacy Ratio, also known as capital-to-risk weighted assets ratio (CRAR), is used to
protect depositors and promote the stability and efficiency of financial systems around the world.
PCA Measures
 RBI can place restrictions on dividend distribution, branch expansion, and management compensation.
 Only in an extreme situation, would a bank be a likely candidate for resolution through amalgamation,
reconstruction or winding up.
 RBI may place restrictions on credit by PCA banks to unrated borrowers or those with high risks, but it doesn’t
invoke a complete ban on their lending.
 RBI may also impose restrictions on the bank on borrowings from interbank market.
 Banks may also not be allowed to enter into new lines of business.
Challenges and Issues
 PCA is an exceptional action and impacts the rating of the bank as well as consumer confidence. This is
detrimental in the long run as it impacts the credit history of the bank and raises questions about its
management.
 PCA can accelerate the loss of market share and cause further decline of the position of the public sector banks in
the financial system in favour of private banks and foreign banks.
 PCA is seen by government as hindering economic growth therefore is arguing for easier lending policies by
relaxing the PCA norms and aligning them to global norms.
 The tussle between RBI and government can negatively impact the image of India as an investment destination.
Way Forward
 Narasimham Committee (1998) on structural reforms recommended the merger of Indian banks; consolidated
banking industry will be able to better deal with NPA crisis.
 Government should address the core issue of Governance impacting the Banking Sector.
 A formal agency such as Public Sector Asset Rehabilitation Agency (PARA), can be instituted to resolve the large
bad debt cases; this step was taken by East Asian countries after they were hit by severe TBS problems in the
1990s.
 The Insolvency and Bankruptcy Code (IBC) mechanism needs to be strengthened to meet global standards with
active involvement of the government, regulators, lenders, borrowers and the judiciary.

6. BANK MERGERS
The government plans to merge 10 public sector banks into four. This would take the number of banks in the
country from 27 in 2017 to 12.

New mergers include:

1. Punjab National Bank, Oriental Bank of Commerce and United Bank of India will combine to form the nation’s
second-largest lender.
2. Canara Bank and Syndicate Bank will merge.
3. Union Bank of India will amalgamate with Andhra Bank and Corporation Bank.
4. Indian Bank will merge with Allahabad Bank.

Why merger is good? – Benefits for various stakeholders:

For Banks:
1. Small banks can gear up to international standards with innovative products and services with the accepted level
of efficiency.
2. PSBs, which are geographically concentrated, can expand their coverage beyond their outreach.
3. A better and optimum size of the organization would help PSBs offer more and more products and services and
help in integrated growth of the sector.
4. Consolidation also helps in improving the professional standards.
5. This will also end the unhealthy and intense competition going on even among public sector banks as of now.
6. In the global market, the Indian banks will gain greater recognition and higher rating.
7. The volume of inter-bank transactions will come down, resulting in saving of considerable time in clearing and
reconciliation of accounts.
8. This will also reduce unnecessary interference by board members in day to day affairs of the banks.
 9. After mergers, bargaining strength of bank staff will become more and visible.
10. Bank staff may look forward to better wages and service conditions in future.
11. The wide disparities between the staff of various banks in their service conditions and monetary benefits will
narrow down.

For economy:
1. Reduction in the cost of doing business.
2. Technical inefficiency reduces.
3. The size of each business entity after merger is expected to add strength to the Indian Banking System in general
and Public Sector Banks in particular.
4. After merger, Indian Banks can manage their liquidity – short term as well as long term – position comfortably.
5. Synergy of operations and scale of economy in the new entity will result in savings and higher profits.
6. A great number of posts of CMD, ED, GM and Zonal Managers will be abolished, resulting in savings of crores of
Rupee.
7. Customers will have access to fewer banks offering them wider range of products at a lower cost.
8. Mergers can diversify risk management.

For government:
1. The burden on the central government to recapitalize the public sector banks again and again will come down
substantially.
2. This will also help in meeting more stringent norms under BASEL III, especially capital adequacy ratio.
3. From regulatory perspective, monitoring and control of less number of banks will be easier after mergers.

Concerns associated with merger:

1. Problems to adjust top leadership in institutions and the unions.
2. Mergers will result in shifting/closure of many ATMs, Branches and controlling offices, as it is not prudent and
economical to keep so many banks concentrated in several pockets, notably in urban and metropolitan centres.
3. Mergers will result in immediate job losses on account of large number of people taking VRS on one side and
slow down or stoppage of further recruitment on the other. This will worsen the unemployment situation further
and may create law and order problems and social disturbances.
4. Mergers will result in clash of different organizational cultures. Conflicts will arise in the area of systems and
processes too.
5. When a big bank books huge loss or crumbles, there will be a big jolt in the entire banking industry. Its
repercussions will be felt everywhere.

Way ahead:
Merger is a good idea. However, this should be carried out with right banks for the right reasons. Merger is also
tricky given the huge challenges banks face, including the bad loan problem that has plunged many public sector
banks in an unprecedented crisis.

Committees in this regard:

1. Narasimham committee (1991 and 1998) suggested merger of strong banks both in public sector and even with
the developmental financial institutions and NBFCs.
2. Khan committee in 1997 stressed the need for harmonization of roles of commercial banks and the financial
institutions.
3. Verma committee pointed out that consolidation will lead to pooling of strengths and lead to overall reduction in
cost of operations.

7. COMMODITY MARKET IN INDIA- SPOT & FUTURE MARKET

Commodity includes all kinds of goods. FCRA defines "goods" as "every kind of movable property other than actionable
claims, money and securities". Futures' trading is organized in such goods or commodities as are permitted by the Central
Government. At present, all goods and products of agricultural (including plantation), mineral and fossil origin are allowed
for futures trading under the auspices of the commodity exchanges recognized under the FCRA. The national commodity
exchanges have been recognized by the Central Government for organizing trading in all permissible commodities which
include precious (gold & silver) and nonferrous metals; cereals and pulses; ginned and un ginned cotton; oilseeds, oils and
oilcakes; raw jute and jute goods; sugar and gur; potatoes and onions; coffee and tea; rubber and spices.
A person deposits certain amount of say, good X in a warehouse and gets a warehouse receipt. Which allows him to ask for
physical delivery of the good from the warehouse anytime in future. But some one trading in commodity futures markets
need not necessarily possess such a receipt to strike a deal. A person can buy or sell a commodity future on any commodity
exchange based on his expectation of where the price will go.
Futures have something called an expiry date, by when the buyer or seller either closes (square off) his account or
give/take delivery of the commodity. The broker maintains an account of all dealing parties in which the daily profit or loss
due to changes in the futures price is recorded. Squaring off is done by taking an opposite contract so that the net
outstanding is nil. For commodity futures to work, the seller should be able to deposit the commodity at warehouse
nearest to him and collect the warehouse receipt. The buyer should be able to take physical delivery at a location of his
choice on presenting the warehouse receipt. But at present in India very few warehouses provide delivery for specific
commodities traded on futures exchanges.

In India we have a number of small / regional exchanges for trading in different commodities and at national level we have
four commodity exchanges. The commodities are traded both in cash market and in futures markets. It is the futures
markets that take lead in commodity trading as compared to cash markets.

India has a long history of commodity futures trading extending over 125 years. Still, such trading was interrupted suddenly
since the mid-seventies in the fond hope of ushering in an elusive socialistic pattern of society. As the country embarked on
economic liberalization policies and signed the GATT agreement in the early nineties, the government realized the need for
futures trading to strengthen the competitiveness of Indian agriculture and the commodity trade and industry. Futures
trading began to be permitted in several commodities, and the ushering in of the 21 century saw the emergence of new
National Commodity Exchanges with countrywide reach for trading in almost all primary commodities and their products.

Following the absence of futures trading in commodities for nearly four decades, the new generation of commodity
producers, processors, market functionaries, financial organizations, broking agencies and investors at large remaining
unaware at present of the economic utility, the operational techniques and the financial advantages of such trading. Many
of the exchanges like the Multi Commodity Exchange of India (MCX) therefore, felt the need of launching this Commodity
Futures Education Series to provide valuable insights into the rationale for such trading, and the trading practices and
regulatory procedures prevailing at the Exchange. For easy understanding and simplification of various issues and nuances
involved in commodity futures trading, a convenient question-answer approach is adopted. Other national level exchange
like NCDEX & IXE are also conducting such educational programmes.

A future trading performs two important functions of price discovery and price risk management with reference to the
given commodity. It is therefore useful to all the segments of the economy and particularly to all the constituents of the
Commodity Market System.

6.1 Benefits to Consumer & user

available at a future
point of time. He can do proper costing and also cover his purchases by making forward contracts. Predictable pricing &
transparency is an added advantage.
materials in particular can benefit corporate
entities. They can hedge the risk even if the commodity traded does not meet their requirements of exact quality /
technical specifications.
advance indication of the price likely to prevail and
thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market

6.2 Benefits to Investors

In case of stocks, an investor needs to put up the full amount of
the stock value to buy the stock. With commodities, you control commodity futures contracts with a margin, which is
usually between 5% to 10% of the value of the commodity. Investor can effectively hedge the risk in price fluctuations of a
commodity.

provide one more alternative avenue in the investment port for. It may be mentioned here that the Commodities are less
volatile compared to equity market, though more volatile as compared to G-Sec's

difficult. Given the knowledge of the commodity, the investor can be thus clear about what he can expect in foreseeable
future.

the rapid spread of derivatives trading in commodities, this route too has become an option for high net worth and
savvy investors to consider in their overall asset allocation.
 mplies that the commodity markets can be
used as an effective diversification tool, where investors can park their money.

6.3 Benefits to Producers

It is useful to the producer because he can get an idea of the price likely to prevail at a future point of time and therefore
can decide between various competing commodities, the best that suits him.
Farmers for instance, can get assured prices, decide on the crop that they want to take and since there is transparency in
prices, he can decide when and where to sell.
6.4 Benefits to the Economy
As the constituents of the commodity market system get benefited Indian economy in turn is also expected to gain a Lot.
Growth in the commodity markets implies that there could be tremendous benefits to the Indian economy in terms of
business generation and employment opportunities.
Participants in Commodity derivative contracts

Commodity Futures Market: The Economic Perspective

Authentic price discovery and an efficient price risk management are the primary objectives for any futures exchange. The
beneficiaries include not only those who trade in the commodities being offered in the exchange but also those who have
nothing to do with futures trading. It is due to the price discovery and risk management through the existence of the
futures exchanges that a lot of businesses and services are able to function smoothly.
1. Credit accessibility: The absence of proper risk management tools would attract the marketing and processing of
commodities to high-risk exposure making it a risky business activity to fund. Even a small movement in prices can eat up a
huge proportion of capital owned by traders, at times making it virtually impossible to pay back the loan. There is a high
degree of reluctance among banks to fund commodity traders, especially those who do not manage price risks. If in case
they do, the interest rate is likely to be high and the terms and conditions very stringent. This poses a huge obstacle in the
smooth functioning and competition of the commodities market. Hedging, which is possible through futures markets,
would cut down the discount rate in commodity lending.
2. Improved product quality: The existence of warehouses for facilitating delivery with grading facilities along with other
delivery related benefits provides a very strong reason to upgrade and enhance the quality of the commodity to a grade
that is acceptable by the exchange. It ensures uniform standardization of commodity trade, including the terms of quality
standard: the quality certificates that are issued by the exchange-certified warehouses have the potential to become the
norm for physical trade by commercial banks.

What are the types of order in commodity market?

Types of order in the commodity markets
There are different kinds of orders which a member can execute on behalf of the client.
1. Limit order: specifying the price at (or better than) which the trade should be executed.
 2. Market order: Market order should be executed at whatever is the prevailing Market price at touchline on or
after submission of such order. If there is no market price at that point of time, it takes the last traded price and
remains in the system. If there is no LTP (Last Traded Price) then system confirms the order with the same side or
the counter side touchline and if there are no orders at the touchline and no LTP, then system confirms the price
as previous day’s close price.
3. Stop loss Order: this order is generally placed for the purpose of avoiding heavy losses while trading in the
market. Stop Loss Price is kept by the system in suspended or abeyance mode and is activated only on trigger of a
price, as defined by the member?

Orders can be classified based on the period as:

1. End of the session (EOS): are available for execution during the current trading session until executed or cancelled.
All EOS orders will get cancelled at the end of the day during which such orders were submitted.
2. Good till date: which are available for execution till end of the date indicated in the order or till the last
trading day of that contract month, whichever is earlier?
3. Good till cancel: which is available for execution till maturity of the contract, or till it is cancelled by the
Member /user, whichever is earlier.
4. Immediate or Cancel (IOC): orders will get cancelled if not executed on submission of such an order.
Such orders will not remain in the order book.
5. Day Order: are available for execution during the current trading until executed or cancelled. All DAY
orders will get cancelled at the end of the day during which such orders were submitted.

What are Circuit Filters and Security Deposits?

Circuit Filter The sharp fluctuations in the prices can bring about huge losses to the players in the market.
To put a check on such fluctuations circuit filters are introduced. The Exchange notifies such daily circuit filter
limit for futures Contract in terms of percentage of intraday variation allowed in a day with respect to the
close price of previous day. Circuit filter provides the maximum range within which a contract can be traded
during day. Such circuit filter is different for different commodities. The orders, which are in violation of such
circuit filter, are rejected by the system.

What deposits does a member have to keep with the exchange and what exposure the member will get
against it?
Security Deposit
It is given in two stages.
Initial Security Deposit – It’s given at the initial stage which is revised from time to time when the
membership is taken and is considered for giving the exposure to the members.
• Rs. 15 lakhs for Trading cum Clearing Member (Non deposit based) and Rs. 50 lakhs for Trading cum
Clearing Member (deposit based), Professional Clearing Member and Institutional Trading cum Clearing
Member that is available towards exposure limit. This security deposit has a Lock in period of 3 years. In
case a member wants to increase its trading it needs to give additional Security Deposit If the member
maintains Rs. 50.00 lakhs in cash and gives an undertaking for the same, then he can give the BG and/or
FDR of any amount, i.e. 1 : 3 ratio is not required to be maintained. Shares of the approved companies
and/or the warehouse receipts of approved commodities are also accepted as collaterals for additional
margins.
Forms of additional deposit:
• Bank Guarantee – The bank guarantee instrument should be for a minimum period of 1 (one) year and a
maximum period of 3 (three) years excluding claim period of minimum 45 days. The bank on behalf of the
member must issue the bank guarantee. The processing of bank guarantee instruments, its validation and
upload in to the system will take at least 3 working days.
• Fixed Deposit Receipts
Members may submit fixed deposit receipt (FDR) issued by the approved banks for the purpose of additional
deposit. The FDR should be accompanied by the bank lien and members lien letter. The processing of fixed
deposit instruments, its validation and upload in the system will take at least 3 (three) working days and
therefore, the members will be entitled to get additional exposure limit at least after 3 (three) working days
from receipt thereof by the Exchange, if required.

Different types of margins collected by the exchange are as follows:

Ordinary (Initial) Margin: Ordinary margin requirement is calculated by applying the margin percentage
applicable for a contract on the value of the open position of a member in that contract. If a member has net
position in various contracts of the same commodity running concurrently, he is required to pay margin
separately on each of these contracts at client level. Similarly, if a member has open position in various
commodities, the total amount required is calculated as sum total of margin required in respective of each
commodities and contracts separately. The computation methodology in respect of ordinary margin is as
follows: -
Intraday – During the trading session, the margin is calculated on the absolute difference between total
sales in value terms and total buy in value terms in respect of all transactions executed in a contract during
 the day at client level, in addition to previous day’s open position carried forward at the closing price of
previous day.
End of day – At end of the trading session, the margin amount is computed at client level on net position
in a contract in quantitative terms multiplied by the official closing price.

There are two kinds of settlements. Positions can be settled either by way of closing it out at daily settlement price on each
day and due date rate on expiry of contract and/or by way of delivery.
Daily settlement: Each Trading day shall be a settlement for the purpose of avoiding counter party risk. Therefore, all
transactions in contracts shall be subject to marking to market and settlement through the clearinghouse. The Exchange
has the right to effect marking to market and settlements through the clearing house more than once during the course of
a working day if deemed fit on account of the market risk and other parameters.
Member can settle his position anytime by taking the opposite position. Settlement of differences due on outstanding
transactions shall be made by clearing members through the clearing banks. There shall be a daily settlement price in
respect of each future contract.
The settlement procedures can be briefed as Settlement on MCX takes place on a T+1 basis i.e. Daily settlement or daily
Mark to Market Settlement
There are two types of settlements on MCX.
• Marking open position of the member to the daily settlement (close) price for mark–to–market settlement.
Delivery settlement is effected only when delivery is given or taken during contract maturity month and closing out of
residual open position at DDR depending on the delivery option.

What is the settlement period and what is the settlement guarantee fund?
• Settlement period is the cycle, which includes trade Execution to settlement of that trade. Daily Settlement includes
trades done on that day and are settled by way of MTM profit or loss on the next working day i.e. on T+1 basis. The
Exchange maintains the Settlement Guarantee Fund. Whenever a clearing member fails to meet his settlement obligations
to the Exchange arising out of the transactions, or whenever a clearing member is declared a defaulter, the Exchange may
utilize the settlement Guarantee to fulfill the obligations. This helps in building up the confidence of the players in the
market.

8. What is Marked-To-Market (MTM) Settlement and what are Special Margins?

at the end of a trading day and loss / gain on T + 1 day is either debited or credited to Member’s settlement account. This
Notional gain / loss on open positions, at the end of the trading day, are computed with reference to the closing price of
the said contract with the traded price of the contract. For example the traded price is Rs. 100 and the closing price is Rs.
90, then the buyer of the contract shall have to pay for the loss of 10 to the seller of the contract.
ces. In case the price fluctuation in a contract during the
trading session is more than 50% of the circuit filter limit, a special margin equivalent to 50% of the circuit filter limit or as
specified by the Exchange is applied. Such special margin amount is immediately reflected in utilized margin of the
members having outstanding position in that contract and in case the available margin of a member is not sufficient to
cover such special margin required, and then a margin call is sent to the member which is required to be remitted by the
member immediately. In such case, since the available deposit is already exhausted, he is put in square off mode and the
same continues during such trading session till collection of required margin amount is completed or member squares off
his position.
a. Tender Period/Delivery Period Margin: - When a contract enters into tender period/delivery period towards the end of
its life cycle, tender period margin is imposed. Tender margin is mentioned in the contract specification and is applicable

on both outstanding buy and sell position, which continues up to the marking of delivery obligation or expiry of the
contract, whichever is earlier. The delivery period margin is also applied on the marked quantity and is calculated at the
rate specified for respective commodity multiplied by the marked quantity at the expiring contract. When a seller submits
delivery documents, his position is treated as settled considering early pay-in and his tender period/delivery period margin
to such extent is reduced. When a buyer pays money for the delivery allocated to him, his delivery period margin is
reduced on such quantity for which he has paid the amount. If delivery does not happen with respect to certain open
position and is finally settled by way of difference as per the Due Date Rate, the delivery period margin is released only
after final settlement of difference arising out of such closing out as per the Due Date Rate.
Procedure for payment and receipt of delivery of commodity (pay-in and payout)

Settlements is affected on T+1 basis. Pay in & payout of funds for delivery-based settlements is affected on E+2 / E + 3 (E
stands for expiry of contract) basis for delivery of good delivery by the seller or as prescribed in the contract specification.

What should a member do if he has utilized 100% of his margin?

When a member utilizes 100% margins, he has the following options: He has to Deposit additional margin in his settlement
account & inform the exchange to debit it, thereby increasing his exposure. Otherwise he is supposed to Square off existing
positions thereby liquidating and hence releasing margins. Members can square off their positions from their terminals as,
on utilizing 100 % margins, the member is put in square off mode.
For trading in the commodity markets the trader needs to have the spot price information. This information is available at
the Trader’s Work Station (TWS) of the members, and can be viewed in the column ‘Underlying Asset’ in Market Watch
Screen.
Even historical data of commodities traded on MCX is also available on the website (www.mcxindia.com) before the
beginning of trading during the following day. It is available in the link “Bhav Copy (Date Wise)” & “Bhav Copy (Commodity
Wise)”.
9. What are the different delivery options?
A contract can have any of the following options
1. Both Option
2. Seller option
3. Compulsory option
Both Options: In case of both option contract delivery will take place only if both buyer and seller give their intention to
take/give delivery. In other words delivery takes place if intention from both buyer and seller is received and is for matched
quantity. Balance open position of member will be closed out at DDR.
Sellers Option: Delivery is based on seller’s choice. If seller gives intention to give delivery, buyer has to take delivery at the
expiry of the contract against outstanding positions. The buyer can intimate to exchange before pay in date of funds about
refusal of delivery and the refusal/failure of Buyer to take delivery will attract penalty. Seller’s not giving intention and
keeps open position at expiry, also attracts penalty.
Compulsory Option: In Compulsory delivery contract all open position at expiry will result in delivery. In case of
failure/refusal from Buyer or Seller, the penalty will be levied to member whoever fails to honor their respective
obligation.
What is a delivery lot?
Delivery lot is the minimum deliverable quantity in units a member can deliver at the time of tendering delivery. The
delivery lots are specified in contract specification of the commodity to be tendered for delivery. The delivery can only be
tendered in multiples of delivery lot.
What is the delivery procedure?
DELIVERY PROCEDURE: AT GLANCE
– Member enters into a contract at certain rate.
– Contract nearing expiry enters into Tender period
– On delivery marking date delivery will be allocated/marked
– Seller member has to deposit goods at the accredited warehouse
• Buyer member have to make pay in of funds on scheduled Pay in day.
• Payout of funds will be made to seller member on scheduled pay out date.
• The details of Buyer will be intimated to Seller to enable to raise invoice. The Seller has to raise the invoice under
intimation to Exchange.
• Buying member can lift delivery after pay in of funds. For lifting delivery from Warehouse the member has to submit
representative details that who will lift delivery. Exchange will issue Delivery order to warehouse on basis of which
warehouse will release goods to Buyer member’s representative.
• Member interested in giving/taking delivery can give their intention during intention period. The seller has to give
documentary evidence of deposit of
• Commodity with exchange-designated warehouse only after delivery is marked and obligation is honored. Buyer has to
submit details of client on which invoice is to be raised. The client of Seller member raises invoice in the name of the client
of Buyer member. Both parties must have LST/CST/VAT registration. In case approximate tax registration is not available, a
commission agent can be appointed for raising the invoice.
Tender Period Margin:-
Commodity markets have an additional margin mechanism to ensure the tendering of the delivery. When a contract enters
into tender period towards the end of its life cycle, tender period margin is imposed. Such margins are applicable on both
outstanding buy and sell side, which continues up to the marking of delivery or expiry of the contract, whichever is earlier.
The tender period margin is calculated at the rate specified for respective commodity multiplied by the net open position
held by a member in the expiring contract. It varies from commodity to commodity for which the member has given
delivery.
Delivery Period Margin:-
When a contract gets closer to the delivery period, delivery period margin is imposed. This is in addition to the normal
margins in place. The delivery period margin is calculated at the rate specified for respective commodity multiplied by the
net open position held by a member in the contract. Such margin is applied on the positions marked by the exchange.
Delivery Marking/Matching:
In the commodity markets the delivery of the commodity has different options. In case of Seller Option contract, the
delivery marking is done to buyer on the basis of intention received from Seller. If the seller has expressed his interest in
delivery of the contract buyer shall have to take the delivery. In case of refusal, buyer will be charged penalty.
In another option of Both Option the marking will be done on expiry of contract after trading hours only if both buyer and
seller give their intention to give or take delivery.
In another case of compulsory option the marking is done on contract expiry date after trading hours to all buyer and
sellers who have not settled as yet i.e. having open position. This means that they have to take/give delivery on
compulsory basis failing which they would be liable to pay penalty.

ROLE OF FMC
What was the NSEL Crisis?
National Spot Exchange of India (NSEL), an electronic trading platform where producers and traders could buy and sell
agriculture and industrial commodities. NSEL had permitted bidding greater than the underlying assets and for longer
durations than its mandated T+10=11 days duration. Therefore, a payment crisis at NSEL. Dues went unpaid to the tune of
Rs. 5,600 crore.
The NSEL was being regulated by APMC(Agricultural Produce Market Committee) because it was a spot exchange not a
futures exchange. But, it was acting as a futures exchange in violation of the rules without proper margin and settlement
systems in place.
Therefore, after this crisis FMC is brought under finance ministry from Consumer affairs. This follows the logic that –
regulations for commodities and stocks are similar since both are securities and involve trading of underlying assets.

The Forwards Market Commission is a statutory entity which is involved in monitoring and regulating the operations,
activities of the Commodities futures market in India.

 It is setup under the Forward Contracts (Regulation) Act of 1952.

 FMC has its headquarters in Mumbai and a regional office in Kolkata.
 It earlier functioned under the Ministry of Consumer affairs, this was prior to the NSEL crisis. Now it functions
under the Department of Economic Affairs of Ministry of Finance.
Objectives of Forward Markets Commission (FMC):
The Forward Markets Commission (FMC), is the chief regulator of the Forwards and Futures market in the
country. The Commission gives regulatory insights to ensure financial integrity, and market integrity. It works
towards protecting and promoting the interest of consumers or non-participants.
The FMC assesses the market situation and takes into account the recommendations made by the Commodity
exchanges for prescribing the rules and regulations of the Exchange. The Commission accords permission for
conducting trade in distict contracts, while monitoring the market conditions continuously. It takes remedial
measures wherever necessary to impose regulatory measures.
Composition:
According to the Forward Contracts(Regulation) Act,1952 the commission should comprise of 2 members and a
Chairman. These all three are appointed by the Central government. Generally, the Chairman is a member of the
Indian Administrative Services and the members are from the Indian Economic Services.
Functions of FMC:
Forward Market Commission functions as a sole institution governing the commodities market in India. It
executes a variety of roles.
1. It counsels the Central Government for matters regarding recognition or withdrawal of the previously accorded
recognition from any of the registered association.
2. It also provides advice on any other matters that arise as a result of the administration of the Forward Contracts
(Regulation) Act 1952.
3. FMC provides suggestions to uplift and improve the functioning of the Commission as well as the
Futures markets.
4. The Commission can cross-check and inspect the accounts as well as any other documents of the registered
associations and their members.
5. It keeps a vigil on the Future commodities market and also exercises its discretionary powers in the interest and
growth of the markets and consumers.
6. FMC is mandated to source, collect and publish the information about trading conditions for
various commodities covered under the purview of the governing act. These details are generally about the
demand, supply and prices.
Commodity exchanges:
There are 22 exchanges in the country. Out of these twenty two, there are 6 National level exchanges involved in
the Forward Commodity trading in India. These important six national exchanges are:
1. MCX (Multi-commodity Exchange of India Limited) located in Mumbai.
2. NCDEX (National Commodity and Derivatives Exchange Limited) situated in Mumbai.
3. NMCE (National Multi-commodity Exchange of India Limited) located in Ahmedabad.
4. ICEX (Indian Commodity Exchange Limited) based in New Delhi.
5. ACEINDIA (Ace Derivatives and Commodity Exchange Limited) located in Mumbai.
6. UCX (Universal Commodity Exchange Limited) located in Navi Mumbai

The recent, Indian Council for Research on International Economic Relations (ICRIER) study suggests the need to
empower the Farmer Producer Organizations (FPOs) to trade in the commodities futures market.
 Farmer Producer Organisation
 The concept of 'Farmer Producer Organizations (FPO)' consists of collectivization of producers, especially small
and marginal farmers so as to form an effective alliance to collectively address many challenges of
agriculture such as improved access to investment, technology, inputs, and markets.
 An FPO is a legal entity formed by primary producers, viz. farmers, milk producers, fishermen, weavers, rural
artisans, craftsmen.
 The FPO can be a production company, a cooperative society or any other legal form which provides for sharing
of benefits among the members. In some forms like producer companies, institutions of primary producers can
also become a member of PO.
 The FPOs are generally mobilized by promoting institutions/ resource agencies (RAs). Small Farmers Agribusiness
Consortium (SFAC) provides support for the promotion of FPOs.
 The resource agencies leverage the support available from governments and agencies like NABARD to promote
and nurture FPOs, but attempting an assembly line for mass production of FPOs has not given the desired results.
Future Market
 Futures contracts are used as hedging instruments in agricultural commodities. Hedging is a common practice
that insures the farmer against a poor harvest by purchasing futures contracts in the same commodity.
 Forward Markets Commission (FMC) was a regulatory authority for commodity futures market in India. Forward
Markets Commission (FMC) has been merged with Securities and Exchange Board of India (SEBI) with effect
from September 28, 2015.
Future Trading in India
 The first futures trade by an Indian FPO took place in 2014 when the Ram Rahim Pragati Producer Company – an
enterprise started by 3,000 women belonging to self-help groups in a tribal area of Madhya Pradesh – hedged
soyabean price risk on the National Commodity and Derivatives Exchange (NCDEX).

o Between April 2016, when NCDEX began making formal efforts to directly engage with FPOs, and May
2018, FPOs had a miniscule 0.004% share of the agri-futures trade at NCDEX. More than half of the FPO
futures trade of ₹50.8 crore was in soybeans, while another third was in maize. Bihar, Maharashtra
and Madhya Pradesh account for 92% of the trade.
 Reasons: The Small farmers often hesitate to trade in the futures market due to their limited capacity as
individuals. Future market is viewed with suspicion and termed as gambling.

o Instead, they depend on traders in traditional marketing channels who charge high commissions, but
provide easy access to credit and market.
o However, FPOs, as aggregates of small farmers, can provide the scale of production needed if they
receive sufficient information and support.
National Commodities and Derivatives Exchange
 The National Commodities and Derivatives Exchange (NCDEX) is an online commodities exchange dealing
primarily in agricultural commodities in India.
 It is a public limited company, established on 23 April 2003 under the Companies Act, 1956.
 The exchange was founded by some of India's leading financial institutions such as ICICI Bank Limited, the
National Stock Exchange of India and the National Bank for Agricultural and Rural Development, among others.
 NCDEX is located in Mumbai but has offices across the country to facilitate trade. Trading is done on 27
commodity contracts as of March 2018. These include 25 contracts for agricultural products. NCDEX is run by an
independent board of directors with no direct interest in agriculture.
Benefits of Future Market
 Efficient Price Discovery for Farmers: Linking farmers with futures market can be mutually beneficial to both.
Farmers, when linked with a consistent, liquid and deep futures market will be able to reap the benefits of
efficient price discovery.
 More Liquidity to Market: Higher farmer participation will provide more liquidity to the market, helping it
achieve its objective of price discovery.
 Removing Middlemen: The trading in futures market will help farmers make their cropping decisions based on
next year’s prices rather than last year’s rates, as well as break the crippling hold of middlemen and traders and
ultimately boost income for agricultural families.
Way Forward
 Learning from the example of China, where the state has helped small land holding farmers by providing
customised products and reducing price distortions, the Government of India should have limited intervention
in prices and procurement of commodities.
 The government needs to identify production centres and build warehouses and delivery centres around them in
order to encourage futures trading in these areas.

INDIAN AGRI FUTURE MARKETS

 The Indian agri - futures remained at low levels forming only 2% of 1.6 billion global agri - futures contracts.
 Agri - future marketing system remains unsupportive of farmers.
What are agri-futures?
 Derivatives are financial instruments with a price that is dependent upon or derived from one or more underlying
assets.
 Futures and options represent two of the most common form of "Derivatives".
 In futures contract buyer has the obligation to purchase a specific asset, and the seller has to sell and deliver that
asset at a specific future date.
 Agri-futures markets are one way to ensure that farmers’ planting and selling decisions are forward - looking, and
not based on past prices.
What are the issues with Indian agri - future markets?
 Governance - They are often disrupted by sudden bans or suspensions by the government as many policymakers
have deep mistrust in the functioning of these markets.
 The basic distinction between feed and food commodities is missing.
 There is less variety of goods to choose from the market.
 Participation - Very few farmers or farmer-producer organisations (FPOs) trade on such markets, due to the
mistrust with the policymakers.
 Implementation - The creation of an all-India spot market/(e - NAM) for farmers is operating at a slow place.
What India can learn from china?
 State participation in the futures markets through the State Trading Enterprises.
 No abrupt suspensions of commodities.
 Focus on choice of commodities, which are not very sensitive from food security point of view.
 The Chinese volume of contracts is much higher in soya, mustard, and corn complexes, which are basically for
feed.
 India being the largest importer of edible oils, especially palm and soya oils, these are promising candidates for
agri - futures provided global players are allowed to trade in these.

8. FINANCIAL SECTOR REFORMS

the story of Indian financial reforms has been divided into four parts viz.

Banking Reforms
Commercial banking constitutes the largest segment of the Indian financial system. Despite the general approach of the
financial sector reform process to establish regulatory convergence among institutions involved in broadly similar
activities, given the large systemic implications of the commercial banks, many of the regulatory and supervisory norms
were initiated first for commercial banks and were later extended to other types of financial intermediaries.
After the nationalization of major banks in two waves, starting in 1969, the Indian banking system became
predominantly government owned by the early 1990s. Banking sector reform essentially consisted of a two-pronged
approach. While nudging the Indian banking system to better health through the introduction of international best
practices in prudential regulation and supervision early in the reform cycle, the idea was to increase competition in the
system gradually. The implementation periods for such norms, were, however, chosen to suit the Indian situation.
Special emphasis was placed on building upthe risk management capabilities of the Indian banks. Measures were also
initiated to ensure flexibility, operational autonomy and competition in the banking sector. Active steps have been taken
to improve the institutional arrangements including the legal framework and technological system within which the
financial institutions and markets operate. Keeping in view the crucial role of effective supervision in the creation of an
efficient and stable banking system, the supervisory system has been revamped.
Unlike in other market countries, many of which had the presence of government owned banks and financial
institutions, banking reform has not involved large scale privatization of such banks. The approach, instead, first
involved recapitalization of banks from government resources to bring them up to appropriate capitalization standards.
In the second phase, instead of privatization, increase in capitalization has been done through diversification of
ownership to private investors up to a limit of 49 per cent, thereby keeping majority ownership and control with the
government. With such widening of ownership most of these banks have been publicly listed, this was designed to
introduce greater market discipline in bank management, and greater transparency through enhanced disclosure norms.
The phased introduction of new private sector banks, and expansion in the number of foreign bank branches, provided
from new competition. Meanwhile, increasingly tight capital adequacy, prudential and supervision norms were applied
equally to all banks, regardless of ownership.

Government Debt Markets Reforms

Major reforms have been carried out in the government securities (G-Sec) debt market. In fact, it is probably correct to
say that a functioning G-Sec debt market was really initiated in the 1990s. The system had to essentially move from a
strategy of pre-emption of resources from banks at administered interest rates and through monetization to a more
market oriented system. Prescription of a „statutory liquidity ratio‟ (SLR), i.e. the ratio at which banks are required to
invest in approved securities, though originally devised as a prudential measure, was used as the main instrument of
pre-emption of bank resources in the pre-reform period. The high SLR requirement created a captive market for
government securities, which were issued at low administered interest rates. After the initiation of reforms, this ratio
has been reduced in phases to the statutory minimum level of 25 per cent. Over the past few years numerous steps have
been taken to broaden and deepen the government securities market and to raise the levels the transparency. Automatic
monetization of the government‟s deficit has been phased out and the market borrowings of the central government are
presently undertaken through a system of auctions at market-related rates.
The key lesson learned through this debt market reform process is that setting up such a market is not easy and needs a
great deal of proactive work by the relevant authorities. An appropriate institutional framework has to be created for
such a market to be built and operated in a sustained manner. Legislative provisions, technology development, market
infrastructure such as settlement systems, trading systems and the like have all to be developed.

Forex Market Reforms

The Indian foreign exchange (forex) market had been heavily controlled since the 1950s, along with increasing trade
controls designed to foster import institution. Consequently, both the current and capital accounts were closed and
foreign exchange was made available by the RBI through a complex licensing system. The task facing India in the early
1990s was therefore to gradually move from total control to a functioning foreign exchange market. The move towards
a market-based exchange rate regime in 1993 and the subsequent adoption of current account convertibility were the
key measures in reforming the Indian foreign exchange market. Reforms in the foreign exchange market focused on
market development with prudential safeguards without destabilizing the market [Reddy 2002a]. Authorized dealers of
foreign exchange have been allowed to carry on a large range of activities. Banks have been given large autonomy to
undertake foreign exchange operations. In order to deepen the foreign exchange market, a large number of products
have been introduced and entry of newer players has been allowed in the market.
The Indian approach to opening the external sector and developing the foreign exchange market in a phased manner
from current account convertibility to the ongoing process of capital account opening is perhaps the most striking
success relative to other emerging market economies. There have been no accidents in this process, the exchange rate
has been market determined and flexible and the process has been carefully calibrated. The capital account is
effectively convertible for non-residents but has some way to go for residents. The Indian approach has perhaps gained
greater international respectability after the enthusiasm for rapid capital account opening has dimmed since the Asian
crisis.

Reforms in Other Segments of the Financial Sector

Measures aimed at establishing prudential regulation and supervision and also competition and efficiency enhancing
measures have also been introduced for non-bank financial intermediaries as well. Towards this end, non-banking
financial companies (NBFCs) especially those involved in deposit taking activities have been brought under the
regulation of RBI. Development finance institutions (DFIs), specialized term-lending institutions, NBFCs, urban
cooperative banks and primary dealers have all been brought under the supervision of the Board for Financial
Supervision (BFS). With the aim of regulatory convergence for entities involved in similar activities, prudential
regulationand supervision norms were also introduced in phases for DFIs, NBFCs and cooperative banks.
The insurance business remained within the confines of public ownership until the late 1990s. Subsequent to the
passage of the Insurance Regulation and Development Act in 1999, several changes were initiated, including allowing
newer players/joint ventures to undertake insurance business on risk-sharing/commission basis. The Insurance
Regulatory and Development Agency (IRDA) has been established to regulate and supervise the insurance sector.
With the objective of improving market efficiency, increasing transparency, integration of national markets and
prevention of unfair practices regarding trading, a package of reforms comprising measures to liberalize, regulate and
develop capital market was introduced. An important step has been the establishment of the Securities and Exchange
Board of India (SEBI) as the regulator for equity markets. Since 1992, reform measures in the equity market have
focused mainly on regulatory effectiveness, enhancing competitive conditions, reducing information asymmetries,
developing modern technological infrastructure, mitigating transaction costs and controlling of speculation in the
securities market. Another important development under the reform process has been the opening up of mutual funds to
the private sector in 1992, which ended the monopoly of Unit Trust of India (UTI), a public sector entity. These steps
have been buttressed by measures to promote market integrity.
The Indian capital market was opened up for foreign institutional investors (FIIs) in 1992. The Indian corporate sector
has been allowed to tap international capital markets through American Depository Receipts (ADRs), Global
Depository Receipts (GDRs), Foreign Currency Convertible Bonds (FCCBs) and External Commercial Borrowings
(ECBs). Similarly, Overseas Corporate Bodies (OCBs) and non-resident Indians (NRIs) have been allowed to invest in
Indian companies. FIIs have been permitted in all types of securities including government securities and they enjoy
full capital convertibility. Mutual funds have been allowed to open offshore funds to invest in equities abroad.

Recent Developments
From the vantage point of 2004, one of the successes of the Indian financial sector reform has been the maintenance of
financial stability and avoidance of any major financial crisis during the reform period- a period that has been turbulent
for the financial sector in most emerging market countries.
While the basic objectives of monetary policy, namely, price stability and ensuring adequate credit flow to support
growth, have remained unchanged, the underlying operating environment for monetary policy has undergone a
significant transformation. An increasing concern is the maintenance of financial stability. The basic emphasis of
monetary policy since the initiation of reforms has been to reduce market segmentation in the financial sector through
increase in the linkage between various segments of the financial market including money, government securities and
forex market.
The key policy development that has enabled a more independent monetary policy environment was the discontinuation
of automatic monetization of the government‟s fiscal deficit through an agreement between the government and the
RBI in 1997. The enactment of the Fiscal Responsibility and Budget Management Act (FRBM) has strengthened this
further from 2006; the Reserve Bank will no longer be permitted to subscribe to government securities in the primary
market. The development of the monetary policy framework has also involved a great deal of institutional initiatives to
enable efficient functioning of the money market: development of appropriate trading, payments and settlement systems
along with technological infrastructure.

Let us make in-depth study of the importance and types of financial sector reforms in India since 1991.
Importance:
Financial sector reforms refer to the reforms in the banking system and capital market.
An efficient banking system and a well-functioning capital market are essential to mobilize savings of the
households and channel them to productive uses. The high rate of saving and productive investment are
essential for economic growth. Prior to 1991 while the banking system and the capital market had shown
impressive growth in the volume of operations, they suffered from many deficiencies with regard to their
efficiency and the quality of their operations.
ADVERTISEMENTS:
The weaknesses of the banking system was extensively analyzed by the committee (1991) on financial sector
reforms, headed by Narasimham. The committee found that banking system was both over-regulated and under-
regulated. Prior to 1991 system of multiple regulated interest rates prevailed. Besides, a large proportion of bank
funds was preempted by Government through high Statutory Liquidity Ratio (SLR) and a high Cash Reserve Ratio
(CRR). As a result, there was a decrease in resources of the banks to provide loans to the private sector for
investment.
This preemption of bank funds by Government weakened the financial health of the banking system and forced
banks to charge high interest rates on their advances to the private sector to meet their needs of credit for
investment purposes. Further, the lack of transparency in the accounting practice of the banks and non-
application of international norms by the banks meant that their balance sheets did not reflect their underlying
financial position.
This was prominently revealed by 1992 scarcity scam triggered by Harshad Mehta. In this situation the quality of
investment portfolio of the banks deteriorated and culture of’ non-recovery’ developed in the public sector
banks which led to a severe problem of non-performing assets (NPA) and low profitability of banks. Financial
sector reforms aim at removing all these weaknesses of the financial system.
Under these reforms, attempts have been made to make the Indian financial system more viable, operationally
efficient, more responsive and improve their allocative efficiency. Financial reforms have been undertaken in all
the three segments of the financial system, namely banking, capital market and Government securities market.

Types of Financial Sector Reforms:

We explain below various reforms in these three segments in financial sector initiated since 1991:
1. Reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR):
An important financial reform has been the reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio
(CRR) so that more bank credit is made available to the industry, trade and agriculture. The statutory liquidity
ratio (SLR) which was as high as 39 per cent of deposits with the banks has been reduced in a phased manner to
25 per cent.
It may be noted that under statutory liquidity ratio banks are required to maintain a minimum amount of liquid
assets such as government securities and gold reserves of not less than 25 per cent of their total liabilities. In
2008, statutory liquidity ratio was reduced to 24 per cent by RBI.
Similarly, cash reserve ratio (CRR) which was 15 per cent was reduced over phases to 4.5 per cent in June 2003. It
may be noted that reduction in CRR has been possible with reduction of monetized budget deficit of the
government and doing away with the automatic system of financing government’s budget deficit through the
practice of issuing ad hoc treasury bills to the Central Government.
On the other hand, reduction in Statutory Liquidity Ratio (SLR) has been possible because efforts have been made
by government to reduce fiscal deficit and therefore its borrowing requirements. Besides, reduction in SLR has
become possible because of a shift to payment of market-related rates of interest on government securities.
Since the government securities are free from any risk and now bear market-related interest rates, the banks
may themselves feel inclined to invest their surplus funds in these securities, especially when demand for credit
by the industry and trade is not adequate.
The reduction in CRR and SLR has made available more lendable resources for industry, trade and agriculture.
Reductions in CRR and SLR also made possible for Reserve Bank of India to use open market operations and
changes in bank rate as tools of monetary policy to achieve the objectives of economic growth, price stability and
exchange rate stability.
Thus, Dr. C. Rangarajan, the former Governor of Reserve Bank of India, says, “As we move away from automatic
monetisation of deficits, monetary policy will come into own. The regulation of money and credit will be
determined by the overall perception of the Central monetary authority on what appropriate level of expansion
of money and credit should be depending on how the real factors in the economy are evolving”.
2. End of Administered Interest Rate Regime:
A basic weakness of the Indian financial system was that interest rates were administered by the Reserve
Bank/Government. In the case of commercial banks, both deposit rates and lending rates were regulated by
Reserve Bank of India. Before 1993, rate of interest on Government Securities could be maintained at low levels
through the means of high Statutory Liquidity Ratio (SLR).
Under SLR regulation commercial banks and certain other financial institutions were required by law to invest a
large proportion of their liabilities in Government securities. The purpose behind the administered interest-rate
structure was to enable certain priority sectors to get funds at concessional rates of interest. Thus the system of
administered interest rates involved cross subsidization; concessional rates charged from primary sectors were
compensated by higher rates charged from other non-concessional borrowers.
The structure of administered rates has been almost totally done away with in a phased manner. RBI no longer
prescribes interest rates on fixed or time deposits paid by their banks to their depositors. Banks have also been
freed from any prescribed conditions of premature withdrawal by depositors. Individual banks are free to
determine their conditions for premature withdrawal. Currently, there is prescribed rate of 3.5 per cent for
Savings Bank Accounts.
Note that Savings Bank Account are actually used by the individuals as current account even with cheque-book
facility. Since the banks’ cost of servicing these accounts is high, rate of interest on them is bound to be low.
Besides, there is lower interest rate ceilings prescribed for foreign currency denominated deposits from non-
resident Indians (NRI). Such a lower prescribed ceiling is required for managing external capital flows, especially
short-term capital flows, till we switch over to liberalisation of capital account.
Lending rates of interest for different categories which were earlier regulated have been gradually deregulated.
However, RBI insists upon transparency in this regard. Each bank is required to announce prime lending rates
(PLRs) and the maximum spread it charges. Maximum spread refers to the difference between the lending rate
and bank’s cost of funds.
Interest on smaller loans up to Rs. 2,00,000 are regulated at concessional rates of interest. At present, the
interest rate on these smaller loans should not exceed the prime lending rates. Besides, lending interest rates for
exports are also prescribed and are linked to the period of availment. Changes in prescribed interest rates for
exports have been often used as an instrument to influence repatriation of export proceeds.
Thus, except prescribed lending rates for exports and small loans up to Rs. 2, 00,000, the lending rates have been
freed from control. Banks can now fix their lending rates as per their risk reward perception of borrowers and
purposes for which bank loans are sought.
3. Prudential Norms: High Capital Adequacy Ratio:
In order to ensure that financial system operates on sound and competitive basis, prudential norms, especially
with regard to capital-adequacy ratio, have been gradually introduced to meet the international standards.
Capital adequacy norm refers to the ratio of paid-up capital and reserves to deposits of banks. The capital base of
Indian banks has been very much lower by international standards and in fact declined over time.
As a part of financial sector reforms, capital adequacy norm of 8 per cent based on risk-weighted asset ratio
system has been introduced in India. Indian banks which have branches abroad were required to achieve this
capital-adequacy norm by March 31, 1994. Foreign banks operating in India had to achieve this norm by March
31, 1993.
Other Indian banks had to achieve this capital adequacy norm of 8 per cent latest by March 31, 1996. Banks were
advised by RBI to review their existing level of capital funds as compared to the prescribed capital adequacy
norm and take steps to increase their capital base in a phased manner to achieve the prescribed norm by the
stipulated date.
It may be noted that Global Trust Bank (GTB), a private sector bank, whose operations had to be stopped by RBI
on July 24, 2004 had a capital adequacy ratio much below the prescribed prudent capital adequacy ratio norm. In
this regard, link between capital adequacy and provisioning is worth noting. Capital adequacy norm can be met
by the banks after ensuring that adequate capital provisions have been made.
To achieve this capital adequacy norm, Government had come in to provide capital funds to some nationalized
banks. Some stronger public sector banks raised funds from the capital market by selling their equity. Law was
passed to enable the public sector banks to go to the capital markets for raising funds to enhance their capital
base. Banks can also use a part of their annual profits to enhance their capital base (that is, ploughing back of
retained earnings into investment).
4. Competitive Financial System:
After nationalization of 14 large banks in 1969, no bank had been allowed to be set up in the private sector.
While the importance and role of public sector banks in Indian financial system continued to be emphasised, it
was however recognized that there was urgent need for introducing greater competition in the Indian money
market which could lead to higher efficiency of the financial system.
Accordingly, private sector banks such as HDFC, Corporation Bank, ICICI Bank, UTI Bank, IDBI Bank and some
others have been set up. Establishment of these banks has made substantial contribution to housing finance, car
loans and retail credit through credit card system. They have made possible the wider use of what is often called
plastic money, namely, ITM cards, Debit Cards, and Credit Cards.
In addition to the setting up of private sector Indian banks, competition has also sought to be promoted by
permitting liberal entry of branches of foreign banks, therefore, CITI Bank, Standard Chartered Bank, Bank of
America, American Express, HSBC Bank have opened more branches in India, especially in the metropolitan cities
An important recent step is the liberalisation of foreign direct investment in banks. In the budget for 2003-04, the
limit of foreign direct investment in banking companies was raised from 49 per cent to the maximum 74 per cent
of the paid up capital of the banks. However, this did not apply to the wholly owned subsidiaries of foreign banks.
A foreign bank may operate in India through any one of three channels, namely:
(1) As branches of foreign banks,
(2) A wholly owned subsidiary of a foreign bank,
(3) A subsidiary with aggregate foreign investment up to the maximum of 74 per cent of the paid-up capital.
The above measures are expected to facilitate setting up of subsidiaries by foreign banks. Besides fostering
competition among banks they have also increased transparency and disclosure standards to reach the
international standards. Banks have to submit to RBI and SEBI, the maturity pattern of their assets and liabilities,
movements in the provision account and about non-performing assets (NPA).
RBI’s annual publication ‘Trends and Progress of Banking in India’ provides detailed information on individual
bank’s financial position, that is, their losses, assets, liabilities, NPA etc. which enable public assessment of the
working of the banks.
5. Non-Performing Assets (NPA) and Income Recognition Norm:
Non-performing assets of banks have been a big problem of commercial banks. Non-performing assets mean bad
loans, that is, loans which are difficult to recover. A large quantity of non-performing assets also lowers the
profitability of bank. In this regard, a norm of income recognition introduced by RBI is worth mentioning.
According to this, income on assets of a bank is not recognized if it is not received within two quarters after the
last date.
In order to improve the performance of commercial banks recovery management has been greatly strengthened
in recent years. Measures taken to reduce non-performing assets include restructuring at the bank level,
recovery of bad debt through Lok Adalats, Civil Courts, setting up of Recovery Tribunals and compromise
settlements. The recovery of bad debt got a great boost with the enactment of ‘Securitization and Reconstruction
of Financial Assets and Enforcement of Security Interest’ (SARFAESI). Under this Act, Debt Recovery Tribunals
have been set up which will facilitate the recovery of bad debts by the banks.
As a result of the above measures gross NPA declined from Rs. 70,861 crores in 2001-02 to Rs. 68, 715 crores in
2002-03. But there are substantial amounts of non-performing assets whose recovery is still to be made. Besides,
as a result of introduction of risk-based supervision by RBI, the ratio of gross NPA to gross advances of scheduled
commercial banks declined from 12.7 per cent in 1999-2000 to 8.8 per cent in 2002-03.
6. Elimination of Direct Credit Controls:
Another significant financial sector reform is the elimination of direct or selective credit controls. Selective credit
controls have been done way with. Under selective credit controls RBI used to control through the system of
changes in margin for provision of bank credit to traders against stocks of sensitive commodities and to stock
brokers against shares. As a result, there is now greater freedom to both the banks and borrowers in respect of
credit.
But it is worth mentioning that banks are required to observe the guidelines issued by RBI regarding lending to
priority sectors such as small scale industries and agriculture. The advances eligible for priority sectors lending
have been increased at deregulated interest rates.
This is in accordance with the recognition that the main problem is more of availability of credit than the cost of
credit. In June 2004 UPA Government announced that credit to farmers for agriculture will be available at 2 per
cent below PLR of banks. Further, credit for agriculture will be doubled in three years time.
7. Promoting Micro-Finance to Increase Financial Inclusion:
To promote financial inclusion the government has started the scheme of micro finance. RBI provides guidelines
to banks for mainstreaming micro-credit providers and enhancing the outreach of micro-credit providers inter
alia stipulated that micro-credit extended by banks to individual borrowers directly or through any intermediary
would henceforth be reckoned as part of their priority-sector lending. However, no particular model was
prescribed for micro-finance and banks have been extended freedom to formulate their own model(s) or choose
any conduit/intermediary for extending micro-credit.
Though there are different models for pursuing micro-finance, the Self-Help Group (SHG)-Bank Linkage
Programme has emerged as the major micro-finance programme in the country. It is being implemented by
commercial banks, regional rural banks (RRBs), and cooperative banks.
Under the SHG-Bank Linkage Programme, as on 31 March 2012, 79.60 lakh SHG-held savings bank accounts with
total savings of? 6,551 crore were in operation. By November 2012 another 2.14 lakh SHGs had come under the
ambit of the programme, taking the cumulative number of savings-linked groups to 81.74. As on 31 March 2012,
43.54 lakh SGHs had outstanding bank loans of Rs. 36,340 crore (Table 35.1). During 2012-13 (up to November
2012), 3.67 lakh SHGs were financed with an amount Rs. 6, 664.15 crore.

Extension of Swabhimaan Scheme:

Under the Swabhimaan financial inclusion campaign, over 74,000 habitations with population in excess of 2,000
had been provided banking facilities by March 2012, using various models and technologies including branchless
banking through business correspondents (BCs).
The Finance Minister in his Budget Speech of 2012-13 had announced that Swabhimaan would be extended to
habitations with population more than 1,000 in the north-eastern and hilly states and population more than
1,600 in the plains areas as per Census 2001.
Accordingly, about 45,000 such habitations had been identified for coverage under the extended Swabhimaan
campaign. As per the progress received through the conveners of State Level Bankers’ Committee (SLBC), out of
the identified habitations, 10,450 have been provided banking facilities by end of December, 2012. This will
extend the reach of banks to all habitations above a threshold population.
8. Setting up of Rural Infrastructure Development Fund (RIDF):
The Government of India set up the RIDF in 1995 through contribution from commercial banks to the extent of
their shortfall in priority sector lending by banks with the objective of giving low cost fund support to states and
state-owned corporations for quick completion of ongoing projects relating to medium and minor irrigation, soil
conservation, watershed management, and other forms of rural infrastructure.
The Fund has continued, with its corpus being announced every year in the Budget. Over the years, coverage
under the RIDF has been made more broad-based in each tranche and, at present, a wide range of 31 activities
under various sectors is being financed.
The annual allocation of funds for the RIDF announced in the Union Budget has gradually increased from Rs. 2000
crore in 1995- 96 (RIDF 1) to Rs. 20,000 crore in 2012-13. Further, a separate window was introduced in 2006-07
for funding the rural roads component of the Bharat Nirman Programme with a cumulative allocation of Rs.
18,500 crore till 2009-10.
From inception of the RIDF in 1995-6 to March 2012, 462,229 projects have been sanctioned with a sanctioned
amount of Rs. 1, 43,230 crore. Of the cumulative RIDF loans sanctioned to state governments, 42 per cent have
gone to the agriculture and allied sector, including irrigation and power; 15 per cent to health, education, and
rural drinking water supply; while the share of rural roads and bridges has been 31 per cent and 12 per cent,
respectively. The annual allocation of funds under the RIDF has gradually increased from Rs. 2,000 crore in 1995-
6 (RIDF I) to Rs. 20,000 crore in 2012-13 (RIDF XVIII).
As against the total allocation of Rs. 1, 72,500 crore, encompassing RIDFI to XVIII, sanctions aggregating Rs. 1,
51,154 crore have been accorded to various state governments and an amount of Rs. 1, 00,051 crore disbursed
up to the end of November 2012. Nearly 55 per cent of allocation has been made to southern and northern
regions. The National Rural Roads Development Agency (NRRDA) has disbursed the entire amount of Rs. 18,500
crore sanctioned for it (under RIDF XII-XV) by March 2010. During 2012-13 (up to end November 2012), Rs. 5,829
crore was disbursed to the states under the RIDF
The Government of India has decided to introduce a Direct Benefit Transfer (DBT) scheme with effect from 1
January 2013. To begin with, benefits under 26 schemes will directly be transferred into the bank accounts of
beneficiaries in 43 identified districts across respective states and union territories (UT).
Banks will ensure that all beneficiaries in these districts have a bank account. All PSBs and RRBs have made
provision so that the data collected by the Departments/Ministries/Implementing agency concerned can be used
for seeding the bank account details in the core banking system (CBS) of banks with Aadhaar. All PSBs have also
joined the Adhaar Payment Bridge of the National Payment Corporation of India for smooth transfer of benefits.
Termination of Automatic Monetisation of Budget Deficits:
This is significant reforms measure to put a check on the growing fiscal deficit of the Central Government. Before
1997 whenever there was a deficit in Central Government budget this was financed by borrowing from RBI
through issuing of ad hoc treasury bills. RBI issued new notes against these treasury bills and delivered them to
the Central Government.
Since Government incurred deficits year after year, the question of retiring these ad hoc treasury bills did not
arise. In this way there was automatic monetisation of Central Government’s budget deficit resulting in the
increase in reserve money in the economy. With the operation of money multiplier, the increase in reserve
money led to a manifold increase in money supply in the economy which contributed to inflationary tendencies
in the Indian economy. Dr. C. Rangarajan in an important contribution to financial management highlighted the
adverse effects of automatic monetisation of Government’s budget deficits through ad hoc treasury bills.
Since in the eighties and nineties Government borrowed heavily due to large fiscal deficits, expansionary impact
of these deficits had to be countered by RBI by raising CRR and SLR from time to time. Besides, in the context of
heavy borrowing by the Central Government the need to counter the impact on the money supply by raising CRR
to mop up excess liquidity increased so as to control inflation.
In this environment RBI could not use the instrument of open market operations to regulate the money supply
and rate of interest. At a time when Government borrowed heavily in the market to meet its large deficit, the use
of open market operations (i.e. selling Government securities in the open market from its own reserves by RBI)
would have resulted in sharp rise in interest rate.
Dr. Rangarajan succeeded in getting abolished the system of automatic monetisation of ever-rising budget
deficits through the issue of ad hoc treasury bills by the Government. In its place the system of Ways and Means
Advances (WMA) were introduced from April 1,1997. Under this new system of Ways and Means Advance
(WMA) financial limits are fixed to accommodate temporary mismatches in Government receipts and payments
and further that market related interest rate is charged on these advances.
The limit for WMA and rate of interest charged on them are mutually agreed between RBI and Government from
time to time. Further, after 1999 no overdrafts by the Government are permitted for a period beyond 10
consecutive days. Thus, ways and means advances are in fact loans to the Government given by RBI for a short
period of time.
It is important to note that with the abolition of ad hoc treasury bills, the system of 91 days tap treasury Bills has
also been discontinued with effect from April 1, 1997. Accordingly, with the introduction of the system of Ways
and Means Advances (WMA), the conventional concept of budget deficit and deficit financing have also lost their
relevance.
Therefore, the earlier practice of showing budgetary deficit in Government’s budget and the extent of deficit
financing has been abandoned. Instead, at present the magnitudes of fiscal deficit, revenue deficit and primary
deficits are provided in the budget and become key indicators of Government’s fiscal position.
It is clear from above that the new system of Ways and Means Advances (WMA) has given more autonomy to RBI
for conducting its monetary policy. Another related important financial reform is the enactment of’ Fiscal
Responsibility and Budget Management (FRBM)’ Act, which provides a relationship between Government’s fiscal
stance and RBI’s monetary management.
According to FRBM, Central Government will take appropriate measures to reduce fiscal deficit to 2 per cent and
to eliminate entirely revenue deficit in a time-bound manner by March 31, 2008. It has been provided in the law
that revenue deficit and fiscal deficit may exceed targets specified in the rules only on grounds of national
security or natural calamity or such other exceptional circumstances as specified by Central Government.
An important provision of the Act is that the Central Government shall not borrow from RBI except by Ways and
Means Advances. Further, an important feature of FRBM Act is that RBI will not subscribe to the primary issues of
Central Government securities from the year 2006-07.
Pension Reforms:
Since October 2003, a New Pension Scheme (NPS) was introduced by the Central Government for its employees.
Later many States have also joined the scheme for their employees. The New Pension Scheme is a contributory
retirement scheme.
All employees joining Central Government after January 1, 2004 have to join the scheme and contribute to it to
obtain pension after their retirement. Later many states have also joined the scheme for their employees. It is
now also open to private individuals and eight fund managers manage the scheme.
The pension authority was named as Pension Fund Regulatory and Development (PFRDA). Till September 2013,
this pension authority has been functioning under executive authority since October 2003. Now in September
2013, the Indian Parliament passed the Pension Fund Regulatory Development Authority Bill, eight years after it
was introduced in March 2005. This bill seeks to empower PFRDA to regulate the pension scheme (NPS).
The corpus of PFRDA has Rs. 34,965 crore. NPS has been there with us for nine years and to manage such a large
amount of Rs. 35,000 crore was not good to be managed by a non-statutory authority. It should be managed by a
statutory authority. All that this new legislation does is to make the non-statutory authority a statutory authority.
The legislation regarding Pension Fund Regulatory and Development Authority passed by the Parliament is an
important financial reform that will pave the way for foreign investment in the sector. At present the new
pension scheme has about 5.3 million subscribers and the scheme has a corpus of around Rs. 35,000 crore.
The Finance Minister has clarified that foreign investment in the pension sector will be 26% and linked to that in
the insurance sector. The government has already approved 49% foreign investment in the insurance sector.
“I am confident that the Pension Bill will be passed in Rajya Sabha,” Chidambaram said adding that the
government had accepted all but one suggestion of the Standing Committee on Finance that gave its
recommendations on the Bill in August 2011. The PFRDA will notify New Pension System schemes that provide
minimum assured returns, incorporated after the standing committee suggested some sort of guaranteed
returns.
The NPS will also provide for withdrawal for some limited purposes, which was not the case earlier. The reform
will go a long way in increasing the coverage of formal pension and social security plans in India, where only
about 12% of the active workforce has any formal pension or social security plan.
The opening of the pension sector, even at 26%, will encourage foreign investors to put their money, as India has
a huge population that needs social security cover. We do not have much pension products now but once there
are more players, there will be more products which will help to channelize this pension money into the
economy. The Bill will further empower the PFRDA to regulate the NPS and other pension schemes that are not
covered under any Act.