INDIAN BANKING SYSTEM

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Contents
HISTORY OF BANKING SYSTEM IN INDIA ......................................................................................2
1.0 Introduction ............................................................................................................................................... 2
2.0 Evolution.................................................................................................................................................... 2
2.1 Phase I: Pre-Independence (Before 1947) ............................................................................................................................ 2
2.1.1 Bank of Hindustan ......................................................................................................................................................... 2
2.1.2 Imperial Bank of India ................................................................................................................................................... 3
2.1.3 Other Pre-Independence Banks .................................................................................................................................... 3
2.2 Phase II: Post-Independence (1947 – 1990) ......................................................................................................................... 4
2.2.1 Pre-Nationalization Phase (1947 – 1968) ..................................................................................................................... 4
2.2.2 Nationalization of Banks (1969 – 1990) ........................................................................................................................ 5
2.3 Phase III: Liberalization (1991 – Present).............................................................................................................................. 6
2.3.1 Problems in the Indian Banking System ........................................................................................................................ 6
2.3.2 Indian Economic Crisis (1991) ....................................................................................................................................... 6
2.3.3 Narasimham Committee I (1991).................................................................................................................................. 7
2.3.4 Narasimham Committee II (1998)................................................................................................................................. 9
2.3.5 Major Committees on Financial System - Pre and Post 1991 Reforms ...................................................................... 11
2.3.6 Lead Bank Scheme ...................................................................................................................................................... 12
3.0 Structure Of Banking System In India ........................................................................................................ 13
3.1 Classification of Banks in India ............................................................................................................................................ 13
3.1.1 Commercial Banks ....................................................................................................................................................... 13
3.1.2 Co-operative Banks ..................................................................................................................................................... 14
3.1.3 Non-banking Financial Institutions (NBFIs) ................................................................................................................. 17
All-India Financial Institutions (AIFIs) ................................................................................................................................... 17
National Bank for Financing Infrastructure and Development (NaBFID) ............................................................................ 18
Primary Dealers .................................................................................................................................................................... 18
3.1.4 Non-banking Financial Companies (NBFCs) ................................................................................................................ 19
3.1.5 Regional Rural Banks ................................................................................................................................................... 31
3.2 Risk-based Internal Audit (RBIA) ......................................................................................................................................... 33
3.3 Universal Vs Niche Banking ................................................................................................................................................. 35
Universal Banks .................................................................................................................................................................... 35
Types of Universal Banking Services .................................................................................................................................... 37
Niche or Differentiated Banks .............................................................................................................................................. 38
3.4 Priority Sector Lending ........................................................................................................................................................ 42
4.0 Miscellaneous .......................................................................................................................................... 53
4.1 Balance Sheet ...................................................................................................................................................................... 53
4.2 FEOA, FIU, & CRILC .............................................................................................................................................................. 54
4.2.1 Fugitive Economic Offenders Act, 2018 ...................................................................................................................... 54
4.2.2. Financial Intelligence Unit – India (FIU-IND) .............................................................................................................. 56
4.2.3 Central Repository of Information on Large Credits (CRILC) ...................................................................................... 57
4.3 Banks’ lending rate.............................................................................................................................................................. 58
Base Rate .............................................................................................................................................................................. 59
MCLR (Marginal Cost of Funds Based Landing Rate) ........................................................................................................... 59

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HISTORY OF BANKING SYSTEM IN INDIA

1.0 Introduction

• The history of banking in India dates back to the 17th century, when the Madras Bank was
founded in the year 1683, in British India.
• The bank was founded and largely managed by European traders, who worked closely with
the East India Company.

The evolution of the Indian Banking System can be divided into the following phases:

Evolution of Banking in India

Phase I Phase II Phase III

(Before 1947) (1947 - 1990) (1991 - Present)

Pre-Nationalization
(1947 - 1968)

Post Nationalization
(1969 - 1990)

2.0 Evolution

2.1 Phase I: Pre-Independence (Before 1947)

2.1.1 Bank of Hindustan

• Modern banking in India originated in the mid-18th century.
• The Bank of Hindustan was one of the first banks in India, which was established in 1770.
• The first paper notes were issued by the private banks such as Bank of Hindustan, during
late 18th century.

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• Via the Paper Currency Act of 1861, the British Government of India was conferred the
monopoly to issue paper notes in India.
• The Bank of Hindustan was liquidated in 1832.

2.1.2 Imperial Bank of India

• During the British rule in India, the East India Company established three banks known as
the Presidency Banks:
▪ Bank of Calcutta (1806)
▪ Bank of Bombay (1840)
▪ Bank of Madras (1843)
• The Imperial Bank of India came into existence on 27 January 1921 through the
reorganisation and amalgamation of the three Presidency Banks into a single banking
entity.
• The Imperial Bank of India was later nationalized, and on 1 July 1955, the Imperial Bank of
India was transformed into the State Bank of India.

2.1.3 Other Pre-Independence Banks

Some of the other banks that were established during the pre-independence period were:
• Oudh Commercial Bank (1881) – First commercial bank in India
• Allahabad Bank (1865) – Oldest still running joint stock bank in India until it's merger in
2020
• Punjab National Bank (1894) – Second largest government-owned bank in India
• Bank of India (1906)
• Bank of Baroda (1908)
• Central Bank of India (1911)
• Reserve Bank of India (1935)
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2.2 Phase II: Post-Independence (1947 – 1990)

2.2.1 Pre-Nationalization Phase (1947 – 1968)

1950s – Post-independence
• After independence, commercial banks were limited to urban, industrializing areas and
catered to the needs of only the rich and the industrial class.
• The reason for this was nexus between banks and industrial houses. Banks had a board of
directors, which composed mainly of industrial class.
• This board of directors had the powers to make policy decisions and appoint CEO for day-
to-day administration.
• Policies were made to favour business houses and day to day administration was made to
support this objective.
• Banking for the poor did not exist due to control of business houses.

1958 – Refinance Corporation for Industry Ltd. (RCI)

• Since banks needed to be refinanced for term loans forwarded by them for industrial
development, a new scheme was developed in 1958, whereby Refinance Corporation for
Industry Ltd. (RCI) was set up to refinance banks for industrial lending.
• RCI was later merged with IDBI.

1960s – Shift from Traditional Role

• Banks were traditionally involved in orthodox deposit banking and short-term credit.
• Industrial financing for long term accounted for a small fraction of total bank credit.
• Since mid 1960s, there has been a departure from this traditional role towards term lending
and underwriting of securities.
• As per the recommendations of the Shroff Committee, in 1953, banks undertook
underwriting of new corporate securities.

1962-63 – Small-scale Industries and Agriculture

• Banks were also encouraged to forward credit to small-scale industries and agriculture.

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• Regarding SSI, RBI introduced a new policy in 1962, whereby banks could take credit at
concessional rates from RBI if they would forward more credit to SSI.
• Agricultural Refinance Corporation (ARC) was set up as a subsidiary of RBI in 1963 for
providing medium- and long-term finance to financial institutions and banks to promote
credit in agriculture by refinancing.

2.2.2 Nationalization of Banks (1969 – 1990)

Nationalization in 1969

• The nexus of industrial houses in banks survived till 1969, when it was broken through
nationalisation of banks whereby majority shareholding passed to the hands of government.
• Under nationalization, 14 major banks were purchased by the government and brought
under its control.
• This was done under the radical ideology which had developed in that decade, to target
inequality and poverty directly by state policy.
• The following banks were nationalized in 1969:
o Allahabad Bank (now Indian Bank)
o Bank of Baroda
o Bank of India
o Bank of Maharashtra
o Central Bank of India
o Canara Bank
o Dena Bank (now Bank of Baroda)
o Indian Bank
o Indian Overseas Bank
o Punjab National Bank
o Syndicate Bank (now Canara Bank)
o UCO Bank
o Union Bank of India
o United Bank of India (now Punjab National Bank)
• At present, there are 12 nationalized banks in India.

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Nationalization in 1980

• A second round of nationalizations of six more commercial banks followed in 1980.

• The stated reason for the nationalization was to give the government more control of credit
delivery.
• The following banks were nationalized in 1980:
▪ Punjab and Sind Bank
▪ Vijaya Bank (Now Bank of Baroda)
▪ Oriental Bank of Commerce (now Punjab National Bank)
▪ Corporation Bank (now Union Bank of India)
▪ Andhra Bank (now Union Bank of India)
▪ New Bank of India (now Punjab National Bank)

2.3 Phase III: Liberalization (1991 – Present)

Background

2.3.1 Problems in the Indian Banking System

• In order to increase its control over the banking sector, the Government had nationalized 14
major private sector banks in 1969.
• This raised the number of scheduled bank branches under Government control.
• However, the poor performance of the public sector banks was increasingly becoming an
area of concern.
• The continuous rise of non-performing assets (NPAs) of banks posed a significant threat to
the stability of the financial system.
• Hence, banking reforms were made an integral part of the liberalization process.
• The financial sector reforms started in 1991 had provided the necessary platform for the
banking sector to operate on the basis of operational flexibility and functional autonomy
enhancing productivity, efficiency and profitability.

2.3.2 Indian Economic Crisis (1991)

• The 1991 Indian economic crisis resulted from a balance of payments deficit due to excess
reliance on imports and other external factors.
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• The 1990-91 Gulf War had led to a sharp increase in oil prices and a fall in remittances
from the Indian workers working overseas.
• This led to a sharp depletion in India’s forex reserves.
• The Chandra Shekhar government could not pass the budget in February 1991 after Moody
downgraded India's bond ratings.
• The ratings further deteriorated due to the unsuccessful passage of the budget.
• This made it impossible for the country to seek short term loans and exacerbated the
existing economic crisis.
• The World Bank and IMF also stopped their assistance, leaving the government with no
option except to mortgage the country's gold to avoid defaulting on payments.
• The crisis, in turn, paved the way for the liberalization of the Indian economy, since one of
the conditions stipulated in the World Bank and IMF loan, required India to open itself up to
participation from foreign entities in its industries, including its state-owned enterprises.

In the light of these events, two expert Committees were set up in 1990s under the chairmanship
of M. Narasimham, former RBI Governor, which are widely credited for spearheading the financial
sector reforms in India.

2.3.3 Narasimham Committee I (1991)

Purpose
• The first Narasimhan Committee (Committee on the Financial System – CFS) was
appointed by then Finance Minister, Manmohan Singh, on 14 August 1991.
• The purpose of the Committee was to study all aspects relating to the structure,
organization, functions and procedures of the financial systems and to recommend
improvements in their efficiency and productivity.

Recommendations
Some major recommendations of the Narasimham Committee I were –

1. Reduction in CRR and SLR:

• Since both, CRR and SLR were extremely high, the Committee recommended that the
CRR and SLR should be reduced.

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• Accordingly, CRR was brought down to 3-5%, from 15%, and SLR was brought down to
25% from 38.5%.

2. Deregulation of Interest Rates:

• The Committee believed that interest rates in India were regulated and controlled by the
Government.
• The Committee was of the view that the existing structure of administered interest rates
was highly complex and rigid.
• The Committee advocated allowing market forces to determine interest rates.

3. Phasing out Directed Credit Programmes:

• Directed credit programmes compelled banks to set aside funds for the needy and poor
sectors at concessional interest rates.
• Since they were reducing bank profitability, the Committee recommended that these
programmes must be discontinued.
• The Committee also proposed that the priority sector must be redefined, and the credit
target for the redefined sector must be fixed at 10% of aggregate credit.

4. Establishment of Special Tribunals:

• The proportion of bad debts and NPAs of public sector banks and development financial
institutions was very concerning.
• The Committee proposed the establishment of Assets Reconstruction Fund (ARF) to assist
banks in getting rid of bad debts.
• Debt Recovery Tribunal (DRT) was established in 1993 to facilitate recovery of loans by
banks and financial institutions.

5. Structural Reorganization of the Banking Sector:

• The Committee proposed a significant reduction in the number of public sector banks
through mergers and acquisitions to increase efficiency in banking operations.
• The Committee recommended that the banking system must evolve towards a broad
pattern consisting of:
▪ 3 or 4 large banks (including SBI), with international presence;
▪ 8 to 10 national banks;
▪ A large number of local banks and rural banks
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• The Committee also proposed that there should be no further nationalization of banks.

6. Freedom to Banks:
• The Committee believed that the Indian banking system was over-regulated and over-
administered.
• It said that supervision should be based on evolved prudential norms and regulations.
• The Committee proposed that there must be greater emphasis on internal audit and internal
inspection systems of banks.

7. Elimination of Dual Control:

• Banks were under the dual control of the RBI and the Banking Division of the Ministry of
Finance.
• The Committee recommended that the RBI must be the primary agency for the regulation of
the banking system.
• It also recommended that a quasi-autonomous body must be set up under RBI for
supervising banks and financial institutions.

2.3.4 Narasimham Committee II (1998)

Purpose
• The second Narasimhan Committee (Committee on Banking Sector Reforms) was
appointed by then Finance Minister, P. Chidambaram, in December 1997.
• The Committee was tasked with the progress review of the implementation of the banking
reforms since 1992, with the aim of further strengthening the financial institutions of India.

Recommendations
Some major recommendations of the Narasimham Committee II were –

1. Stronger Banking System:

• The Committee recommended for merger of large Indian banks to make them strong
enough for supporting international trade.
• However, it cautioned that large banks should merge only with banks of equivalent size and
not with weaker banks, which should be closed down if unable to revitalize themselves.

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2. Narrow Banking:
• Some of the public sector banks at that time had accumulated a high percentage of NPAs.
• For successful rehabilitation of such banks, the Committee recommended “narrow
banking”, wherein banks were allowed to place their funds in short-term, risk-free assets.

3. Autonomy in Banking:
• Greater autonomy was proposed for the public sector banks in order for them to function
with equivalent professionalism as their international counterparts.
• The Committee recommended a review of functions of banks boards with a view to make
them responsible for enhancing shareholder value through formulation of corporate strategy
and reduction of the government equity.

4. Reform in the Role of RBI:

• The Committee recommended that the RBI withdraw from the 91-day treasury bills market
and that interbank call money and term money markets be restricted to banks and primary
dealers.
• The Committee also proposed a segregation of the roles of RBI as a regulator of banks and
owner of banks, as it could lead to a possible conflict of interest.

5. Non-performing Assets (NPAs):

• The Committee highlighted the need for 'zero' NPAs for all Indian banks with international
presence.
• The Committee recommended creation of Asset Reconstruction Funds or Asset
Reconstruction Companies to take over the bad debts of banks, allowing them to start on a
clean-slate.
• The Committee wanted banks to bring down their NPAs to 3% by 2002.
• The recommendations led to the introduction of the Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.

6. Capital Adequacy Norms:

• To improve the inherent strength of the Indian banking system the Committee
recommended that the Government should raise the prescribed capital adequacy norms.
• The Committee targeted raising the capital adequacy ratio to 9% by 2000 and 10% by 2002
and have penal provisions for banks that fail to meet these requirements.
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7. Entry of Foreign Banks:

• The Committee suggested that the foreign banks seeking to set up business in India should
have a minimum start-up capital of $25 million as against the existing requirement of $10
million.
• It said that foreign banks can be allowed to set up subsidiaries and joint ventures that
should be treated on a par with private banks.

2.3.5 Major Committees on Financial System - Pre and Post 1991 Reforms

Tandon Committee
• The Tandon Committee was formed in 1974 with the objective of framing guidelines for
commercial banks for follow-up and supervision of bank credit for ensuring proper
end-use of funds.
• There was an urgent need to direct bank credit to the newly developed ‘priority sector’ in
1968, and also to ration credit due to its scarcity.
• The Committee submitted its report in August 1975.
• The Tandon Committee Report emphasized the need to correlate bank credit to the
business/ production plans and own resources of borrowers.
• Entailed a shift from 'security based' to 'need based' approach to bank credit.
• The new norms formed the basis of bank lending for working capital requirements.

Khan Committee

Khan Committee was formed by RBI in 1997 to examine the role and operations of Development
Financial Institutions (DFIs). The Committee made the following recommendations –
• Gradually move towards Universal Banking
• Developing a function based regulatory framework and risk based supervisory framework
• A super regulator to coordinate and supervise multiple regulators
• Phasing out SLR and reducing CRR to international standards

Bimal Jalan Committee

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• The RBI constituted a committee under the chairmanship of Bimal Jalan in October 2013, to
examine the criteria, business plans and corporate governance practices of applicants
applying for new bank licenses.
• The Committee submitted its report to the RBI on 25 February 2014. Accordingly, two
companies were granted license –
▪ Bandhan Financial Services Private Limited (now Bandhan Bank), a microfinance
institution (MFI), founded by Chandra Shekhar Ghosh
▪ Infrastructure Development Finance Company Limited (now IDFC First Bank), a
finance company under Department of Financial Services, Government of India.

2.3.6 Lead Bank Scheme

What is LBS?
• The RBI launched the Lead Bank Scheme (LBS) in December 1969 to mobilise deposits
and step-up lending to weaker sections of the economy.
• The genesis of this scheme can be traced back to the Prof. D.R. Gadgil Study Group.
• The Study Group drew attention to the fact that commercial banks did not have adequate
presence in rural areas and also lacked the required rural orientation.

Area Approach
• The Gadgil Study Group recommended the adoption of an 'Area Approach' to evolve plans
and programmes for the development of an adequate banking and credit structure in the
rural areas.
• The Nariman Committee, set up by the RBI in 1969 endorsed the idea of ‘Area Approach’,
recommending that in order to enable the Public Sector Banks to discharge their social
responsibilities, each bank should concentrate on certain districts where it should act as a
'Lead Bank'.
• Under this scheme, a Lead Bank is designated for a district to identify and address
bottlenecks in the provision of financial services, and to conduct public outreach
programmes such as financial literacy camps in the district.
• The Lead Bank is expected to assume a leadership role for coordinating the efforts of the
credit institutions and the Government.

Committees under LBS

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The performance of the credit plans is reviewed in the various fora created under the Lead Bank
Scheme as shown below:

1. At Block Level Block Level Bankers’ Committee (BLBC)

2. At District Level District Consultative Committee (DCC) & District Level
Review Committee (DLRC)
3. At State Level State Level Bankers’ Committee (SLBC)

High Level Committee on Lead Bank Scheme

• In view of the several changes that had taken place in the financial sector, the Lead Bank
Scheme was last reviewed by the High-Level Committee headed by Smt. Usha Thorat, the
then Deputy Governor of the Reserve Bank of India in 2009.
• The Committee recommended increasing the scope and coverage of the scheme and also
suggested a sharper focus on financial inclusion.

3.0 Structure Of Banking System In India

3.1 Classification of Banks in India

3.1.1 Commercial Banks

Meaning
• Commercial banks are institutions that accept deposits from the general public and
advance loans with the purpose of earning profits.
• The commercial banking sector in India is quite diverse.
• Based on the ownership pattern, banks can be broadly categorised into public sector
banks, private sector banks and foreign banks.
• While the State Bank of India, Nationalised banks and Regional Rural Banks (RRBs) are
constituted under respective enactments of the Parliament, the private sector banks and
foreign banks are considered as banking companies as defined in the Banking Regulation
Act, 1949.

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Commercial
Banks

Public Sector Private Sector

SBI Domestic Foreign

Nationalised Local Area

Universal Differentiated
Banks Banks

Payments
RRBs
Banks

Small Finance
Banks

Features
• Commercial banks are governed by the RBI as per the provisions of the Banking
Regulation Act, 1949.
• Priority Sector Lending (PSL) is applicable to commercial banks.
• Both CRR and SLR are applicable to commercial banks, small finance banks, payment
banks and RRBs
• Commercial banks can use Marginal Standing Facility (MSF) and Liquidity Adjustment
Facility (LAF)
• RRBs can also avail MSF and LAF since December 2020.
• Voting power is dependent upon shareholding.
• Prudential norms relating to Income Recognition and Asset Classification, Capital
Adequacy, Exposures, etc. are applicable to commercial banks.

3.1.2 Co-operative Banks

Meaning
• A co-operative bank is a small-sized, financial entity, where its members are the owners
and customers of the Bank.

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• Co-operative credit institutions are an important segment of the banking system, as they
play a vital role in mobilising deposits and purveying credit to people of small means.
• Traditionally, the co-operative institutional structure in India is divided into two categories
viz. ‘rural’ and ‘urban’ with the rural cooperatives having a federal structure.
• The present structure is graphically represented below.

Features
• Co-operative banks are registered under the respective State Co-operative Societies Act or
Multi State Cooperative Societies Act, 2002, and governed by the provisions of the
respective acts.
• While regulation of State Cooperative Banks and District Central Cooperative Banks vests
with the Reserve Bank, their supervision is carried out by National Bank for Agriculture and
Rural Development (NABARD).
• Members can cast only one vote, irrespective of the number of shares held.
• PSL is applicable to UCBs.
• Both CRR and SLR are applicable to cooperative banks.
• Since August 2018, MSF is applicable to Scheduled Primary (Urban) Cooperative Banks;
and LAF and MSF are applicable to Scheduled State Cooperative Banks.

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• Prudential norms relating to income recognition, asset classification, provisioning and

capital adequacy ratio are applicable to urban co-operative banks as well.

3.1.2.1 Rural Co-operative Banks

• Rural cooperatives occupy an important position in the Indian financial system.

• These were the first formal institutions established to purvey credit to rural India.
• Thus far, cooperatives have been a key instrument of financial inclusion in reaching out to
the last mile in rural areas.

Structure of Rural Co-operative Credit Institutions

The structure of rural co-operatives is bifurcated into short-term and long-term.

Short-term Co-operative Structure

• The short-term cooperative structure is a three-tier structure with State Cooperative Banks
(StCBs) at the apex (State) level, District Central Cooperative Banks (DCCBs) at the
intermediate (district) level and Primary Agricultural Credit Societies (PACS) at the ground
(village) level.
• The short-term structure caters primarily to the various short / medium-term production and
marketing credit needs for agriculture.

Long-term Co-operative Structure

• The long-term cooperative structure has the State Cooperative Agriculture and Rural
Development Banks (SCARDBs) at the apex level and the Primary Cooperative Agriculture
and Rural Development Banks (PCARDBs) at the district or block level.
• These institutions were conceived with the objective of meeting long-term credit needs in
agriculture.

3.1.2.2 Urban Co-operative Banks

Urban co-operative banks play a significant role in providing banking services to the middle- and
lower-income groups of society in urban and semi urban areas.

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• The primary (urban) co-operative banks (UCBs), like other co-operative societies, are
registered under the respective State Co-operative Societies Act or Multi State Cooperative
Societies Act, 2002 and governed by the provisions of the respective acts.
• With a view to bringing primary (urban) co-operative banks under the purview of the
Banking Regulation Act, 1949, certain provisions of the Banking Regulation Act, 1949 were
made applicable to co-operative banks effective March 1, 1966.
• With this, these banks came under the dual control of respective State
Governments/Central Government and the Reserve Bank.
• While the non-banking aspects like registration, management, administration and
recruitment, amalgamation and liquidation are regulated by the State/ Central Government,
matters related to banking are regulated and supervised by the Reserve Bank under the
Banking Regulation Act, 1949 (as applicable to co-operative societies).
• In February 2021, the RBI constituted a committee headed by former deputy governor N S
Vishwanathan to examine issues in the urban cooperative banking sector.
• As per the recommendation of the Committee, in July 2022, the RBI prescribed a four-tier
regulatory structure for UCBs, in an effort to strengthen the sector. (this is covered in
RBI247- July 2022)

3.1.3 Non-banking Financial Institutions (NBFIs)

NBFIs can be divided in the following categories –

• All-India Financial Institutions (AIFIs)
• Primary Dealers (PDs)
• Non-banking Financial Companies (NBFCs)

All-India Financial Institutions (AIFIs)

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AIFIs

EXIM NABARD NHB SIDBI NaBFID

• AIFIs constitute institutional mechanism entrusted with providing sector-specific long-term

financing.
• AIFIs play a crucial role in the financial markets through credit extension and refinancing
operation activities and cater to the long-term financing needs of the industrial sector.
• Prior to 2022, there were four AIFIs regulated and supervised by the Reserve Bank:
▪ Export-Import Bank of India (EXIM Bank)
▪ National Bank for Agriculture and Rural Development (NABARD)
▪ National Housing Bank (NHB)
▪ Small Industries Development Bank of India (SIDBI)
• In October 2021, the RBI decided to implement the Basel III capital framework for all AIFIs.

National Bank for Financing Infrastructure and Development (NaBFID)

• The National Bank for Financing Infrastructure and Development (NaBFID) Act came into
force w.e.f. April 19, 2021.
• Accordingly, NaBFID has been set up as a Development Financial Institution (DFI) to
support the development of long-term infrastructure financing in India.
• In March 2022, the RBI announced that NaBFID shall be regulated and supervised as an
AIFI, making it the fifth AIFI after EXIM Bank, NABARD, NHB and SIDBI.
• NaBFID will commence its business operations in the first quarter of FY 2023-24.

Primary Dealers
Meaning
• In 1995, the Reserve Bank introduced the system of Primary Dealers (PDs) in the
Government Securities Market.
• PDs are controlled/ regulated by RBI. They are registered entities with the RBI who have
the license to purchase and sell government securities.

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Role of Primary Dealers

• PDs buy government securities directly from the RBI, aiming to re-sell them to other buyers.
• In this way, the PDs create a market for government securities.
• PDs play an active role in the Government securities market by underwriting and bidding for
fresh issuances and acting as market makers for these securities.

Registration Requirements under SEBI

• PDs are required to meet registration and such other requirements as stipulated by the
Securities and Exchange Board of India (SEBI), including operations on the Stock
Exchanges, if they undertake any activity regulated by SEBI.

Eligibility
The following classes of institutions are eligible to apply for Primary Dealership –
i. Subsidiary of scheduled commercial bank/s and AIFI/s dedicated predominantly to the
securities business and in particular to the government securities market.
ii. Subsidiaries/ joint ventures set up by entities incorporated abroad under the approval of
Foreign Investment Promotion Board (FIPB).
iii. Company incorporated under the Companies Act, 1956 and engaged predominantly in the
securities business and in particular the government securities market.

3.1.4 Non-banking Financial Companies (NBFCs)

Meaning
• Non-Banking Financial Companies (NBFCs) are the financial institutions, which are not
banks but perform bank like functions especially the financial intermediation by
mobilising the funds and extending credit.
• They play a critical role in the financial system by providing last mile credit intermediation,
absorbing and diversifying risks by catering to segments not serviced by banks and
pioneering innovative financial products.
• Thus, a ‘financial institution’ that is a company is an NBFC.
• The term financial institution means any non-banking institution that carries on as its
business (or part of its business) any of the following activities (‘financial activities’):
▪ Lending or financing for activities other than its own

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▪ Acquisition of shares/stocks/bonds/debentures/securities issued by Government or local

authority
▪ Leasing or hire-purchase
▪ Insurance business
▪ Chit business
▪ Collection of money
▪ Acceptance of deposits
• It does not include any institution whose principal business is that of agriculture activity,
industrial activity, purchase or sale of any goods (other than securities) or providing any
services and sale/purchase/construction of immovable property.
• An NBFC is a company registered under the Companies Act, 1956 of India, engaged in the
business of loans and advances, acquisition of shares, stock, bonds, hire-purchase
insurance business or chit-fund business.

Types of NBFCs/Activities Regulated by

1. Venture Capital Fund, Merchant Securities and Exchange Board of India
Banking Companies, Stock (SEBI)
Broking Companies, Mutual
Funds, Collective Investment
Schemes (CIS)
2. Insurance Companies Insurance Regulatory and Development
Authority (IRDA)
3. Pension Funds Pension Fund Regulatory and
Development Authority (PFRDA)
4. Mutual Benefit Companies, Nidhi Ministry of Corporate Affairs (MCA)
Companies
5. Chit Funds State Governments

How are NBFCS different from banks?

• NBFCs cannot accept demand deposits.
• NBFCs do not form part of the payment and settlement system and cannot issue cheques
drawn on itself.
• Deposit insurance facility of DICGC is not available to depositors of NBFCs.

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Requirements for registration with RBI

In order to register as an NBFC with the RBI, a company should –
• be a company registered under Section 3 of the Companies Act, 1956
• have a minimum Net Owned Funds (NOF) of Rs. 2 crores

Sources of funding for NBFCs

NBFCs obtain funds from the following sources –
• External commercial borrowing – limited level
• Issuance of bonds
• Borrowing from clients
• Borrowing from banks
• Borrowing from NABARD, NHB, SIDBI, etc.

Classification of NBFCs
Broadly, NBFCs can be categorised in the following ways –
i. Based on deposit acceptance
ii. Based on activity
iii. Based on size

• Liability: In terms of the type of liabilities, NBFCs can be classified as Deposit and Non-
Deposit Accepting NBFCs.
• Size: Non deposit (ND) taking NBFCs can be classified by their size into systemically
important (SI) [An NBFCs-ND is categorised as systemically important (i.e., NBFC-ND-SI) if
its asset size is ₹ 500 crore or more] and other non-deposit holding companies (NBFC-
NDSI and NBFC-ND)
• Activity: NBFCs can also be classified based on the kind of activities they conduct.

Classification of NBFCs based on Deposit Acceptance

NBFCs accepting public deposit (NBFCs-D)

• NBFCs-D are subjected to certain bank-like prudential regulations on various aspects such
as income recognition, asset classification and provisioning; capital adequacy; prudential
exposure limits and accounting / disclosure requirements.
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• Presently, the maximum rate of interest an NBFC can offer is 12.5%.

• The NBFCs are allowed to accept/renew public deposits for a minimum period of 12 months
and maximum period of 60 months. They cannot accept deposits repayable on demand.
• NBFCs also have to maintain SLR @ 15 % as a percentage of deposits. However, there is
no CRR prescription for NBFCs.

NBFCs not accepting public deposit (NBFCs-ND)

• NBFCs-ND are regulated in a limited manner.
• However, with the opening up of foreign direct investment in NBFCs and the opportunities
for credit growth in the economy, the sector has witnessed the entry of some large
companies in the category of NBFC-ND.
• In view of the above, NBFCs-ND with an asset size of Rs. 500 crores and above are
classified as Systemically Important (NBFC-ND-SI), and are required to comply with
exposure and capital adequacy norms.

Classification of NBFCs based on Activity

Based on their activities, NBFCs can be classified as –
• NBFC Investment and Credit Company (NBFC-ICC)
• Infrastructure Finance Company (IFC)
• Systemically Important Core Investment Company (CIC-ND-SI)
• Infrastructure Debt Fund NBFC (IDF-NBFC)
• NBFC - Micro Finance Institution (NBFC-MFI)
• NBFC - Factors (NBFC-Factors)
• Mortgage Guarantee Companies (MGC)
• NBFC - Non-operative Financial Holding Company (NBFC-NOFHC)
• Account Aggregators (AA)
• Peer-to-Peer (P2P) Lending Platforms
• Housing Finance Companies (HFC)

Note:
• To provide NBFCs with greater operational flexibility, in 2019, the RBI decided to merge the
three categories of NBFCs viz. Asset Finance Companies (AFC), Loan Companies (LCs)
and Investment Companies (ICs) into a new category called NBFC - Investment and Credit
Company (NBFC-ICC).
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• NBFC-MFI is a non-deposit taking NBFC with minimum NOF of Rs. 5 crores.

Types of NBFCs based on their Activities

1. Asset Finance An AFC is a company which is a financial
Company (AFC) institution carrying on its principal business of
financing real/physical assets supporting
economic activity and income arising therefrom is
not less than 60% of its total assets and total
income respectively.
2. Investment Company IC means any company which is a financial
(IC) institution carrying on as its principal business the
acquisition of securities.
3. Loan Company (LC) LC means any company which is a financial
institution carrying on as its principal business the
providing of finance whether by making loans or
advances or otherwise for any activity other than
its own but does not include an Asset Finance
Company.
4. Infrastructure IFC is a non-banking finance company which
Finance Company deploys at least 75 per cent of its total assets in
(IFC) infrastructure loans, has a minimum Net Owned
Funds of ₹ 300 crore, and has a minimum credit
rating of ‘A ‘or equivalent with a CRAR of 15%.
5. Systemically CIC-ND-SI is an NBFC carrying on the business
Important Core of acquisition of shares and securities which
Investment Company satisfies the certain prescribed conditions.
(CIC-ND-SI)
6. Infrastructure Debt IDF-NBFC is a company registered as NBFC to
Fund - Non- Banking facilitate the flow of long-term debt into
Financial Company infrastructure projects. Only Infrastructure
(IDF-NBFC) Finance Companies (IFC) can sponsor IDF-
NBFCs.
7. Non-Banking NBFC-MFI is a non-deposit taking NBFC having
Financial Company - not less than 85% of its assets in the nature of
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Micro Finance Qualifying assets (explained at the end) which

Institution (NBFC- provides Collateral free loans to small borrowers.
MFI)
8. Non-Banking NBFC-Factor is a non-deposit taking NBFC
Financial Company – engaged in the principal business of factoring i.e.
Factors (NBFC- financing of receivables.
Factors)
9. Mortgage Guarantee MGC are financial institutions for which at least
Companies (MGC) 90% of the business turnover is mortgage
guarantee business or at least 90% of the gross
income is from mortgage guarantee business and
they Provide mortgage guarantees for loans.
10. NBFC- Non-Operative NOFHC is financial institution through which
Financial Holding promoter / promoter groups will be permitted to
Company (NOFHC) set up a new bank. It’s a wholly-owned Non-
Operative Financial Holding Company (NOFHC)
which will hold the bank as well as all other
financial services companies regulated by RBI or
other financial sector regulators.
11. Account Aggregators They Provide service of retrieving, consolidating,
(AA) organising and presenting financial information of
its customer. They can only provide account
aggregation services where they act as
intermediaries between companies seeking
financial information of its customers and those
holding that data (financial information providers).
12. Peer-to-Peer (P2P) Carries on the business of a P2P lending platform
Lending Platforms i.e., providing loan facilitation services to
participants on the platform. They only provide
platform to connect lenders and borrowers and
there is no lending from its own books.
13. Housing Finance They carry on the business of providing finance
Companies (HFC) for housing and housing projects.

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Exemptions from RBI Regulation

• It is quite clear from the definition of NBFCs that even entities such as insurance companies
and stock broking companies are NBFCs.
• However, these entities are regulated by other regulators.
• Therefore, to avoid dual regulation, the RBI has exempted various categories of NBFCs
which are regulated by other regulators/ government from registration and/or other
requirements.

Regulation of NBFCs

Earlier Regulations
Regulations – 1963
• RBI acquired regulatory and supervisory powers over NBFCs with the insertion of Chapter
III-B in the RBI Act in 1963.
• The insertion was made because the then existing enactments relating to banks did not
provide for any control over companies or institutions, which, although are not treated as
banks, accept deposits from the general public or carry on other business which is allied to
banking.
• The changes were needed for ensuring more effective supervision and management of the
non-banking companies or institutions.

Regulation – 1997 Onwards

• The regulation of NBFCs started by RBI in 1963 failed to properly regulate the deposit
taking activity of NBFCs and in 1996 we observed the failure of a large NBFC (CRB
Capital).
• Thus, some important amendments were carried out in 1997 like:
▪ Categorisation of NBFCs into (i) public deposit accepting, (ii) non-public deposit
accepting but engaged in loan, investment, hire-purchase and equipment leasing,
and (iii) non-public deposit accepting core investment companies that acquire
securities/ shares in their own group companies comprising not less than 90 per cent
of their total assets but not trading in these securities/ shares
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▪ Compulsory registration with RBI and maintenance of minimum Net Owned Fund
(NOF) for companies satisfying the ‘principal business’ criteria.
▪ Maintenance of liquid assets by NBFCs accepting public deposits
▪ Creation of a Reserve Fund by all NBFCs by transfer of 20 per cent of their net profit
every year
▪ Powers of RBI to determine Policy and issue directions to NBFCs
▪ Conduct of Special Audit of the accounts of NBFCs etc.
• The Reserve Bank tightened the regulatory structure over the NBFCs, with rigorous
registration requirements, enhanced reporting, and supervision.
• The Bank also took a policy stance to not register new public deposit accepting NBFCs and
encourage the existing ones to convert to non-deposit taking NBFCs.
• Further, in 1999 capital requirement for fresh registration was enhanced from ₹ 25 lakh to ₹
2 crore.
• In 2006, considering the increasing significance of the sector, the Reserve Bank introduced
differential regulation and classified NBFCs with asset size of ₹ 100 crore and above as
‘Systematically Important NBFC-ND (NBFC-ND-SI)’.
• Prudential regulations such as capital adequacy requirements and exposure norms were
made applicable to them.

Revised Regulatory Framework – 2014

The regulatory framework for the sector was reviewed in 2014. The key changes in the revised
regulatory framework were as follows:

• Requirement of minimum NOF of ₹ 2 crore for legacy NBFCs.

• Revision of the threshold of systemic importance from ₹100 crore to ₹ 500 crore and
inclusion of multiple NBFCs within the same group.
• Differentiated regulatory approach based on customer interface and source of funds.
▪ At one end of the spectrum, entities with asset size less than ₹500 crore and not
accessing public funds with no customer interface were exempted from prudential
and business conduct regulations.
▪ At the other end, entities accessing public funds with customer interface were
subjected to full slew of regulations.

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• Harmonization of asset classification norms for Deposit taking Non-Banking Financial

Company (NBFC-D) and Systemically Important Non-Deposit taking Non-Banking Financial
Company (NBFC-ND-SI) with banks.
• Review of corporate governance and disclosure norms leading to constitution of Board
Committees (Audit Committee, Nomination Committee, and Risk Management Committee)
and rotation of audit partners every three years applicable for NBFC-D and NBFC-ND.

Regulations – 2019
In 2019, certain amendments enumerated below were again carried out to Chapter III-B of the RBI
Act, which strengthened RBI’s supervisory powers.

• Reserve Bank may notify different amount of NOF to different categories of NBFCs with
minimum NOF between ₹ 25 lakh and ₹ 100 crore
• RBI can remove Directors of NBFC (other than Government owned NBFCs)
• RBI can supersede the BOD of NBFC (other than Government owned NBFCs
• RBI can remove or debar an auditor of NBFC for a max. period of 3 years at a time
• Resolution of NBFCs through amalgamation, reconstruction, splitting into various activities,
etc.

Recent Regulations – 2021

• Failure of any large and deeply interconnected NBFC is capable of transmitting shocks into
the entire financial sector and cause disruption.
• Under the circumstances, regulatory framework for NBFCs needs to be reoriented to keep
pace with the changing realities.
• The Reserve Bank of India (RBI) has proposed to tighten rules for major non-bank lenders
to prevent a collapse in one of them from affecting the financial system.

The RBI has proposed to classify the non-banking financial companies (NBFCs) into four
categories, depending on their systemic importance and potential risk to the stability of the
financial system. The triggers for such an action are:

i. Comprehensive Risk Perception: Once an NBFC crosses the thresholds for identified
parameters (size, leverage, interconnectedness, complexity, and supervisory inputs), it
should be subject to proportionately higher regulation.
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ii. Size of Operations: If the balance sheet size of an NBFC breaches a certain threshold, as
identified by the Reserve Bank, it should be regulated at a higher pedestal, as it will have
higher in-built degree of systemic significance.

iii. Activity of NBFCs: Certain NBFCs are unlikely to pose any systemic risk on account of
their activities and hence could be regulated relatively lightly. For eg NBFCs that do not
have either access to public funds or NBFCs like NBFC-P2P lending platforms, NOFHC
(bank holding company) that don’t pose systemic risk.

Scale-based Framework
• Over the years, the NBFCs sector has undergone considerable evolution in terms of size,
complexity, and interconnectedness within the financial sector.
• In order to align the regulatory framework for NBFCs keeping in view their changing risk
profile, the RBI introduced a revised regulatory framework for NBFCs, in 2021.

The framework can be understood in the form of a pyramid –

Base Layer NBFCs:

• NBFCs with assets of up to Rs. 1,000 crores (from earlier Rs. 500 crore)

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• The Base Layer shall comprise of (a) non-deposit taking NBFCs below the asset size of
₹1000 crore and (b) NBFCs undertaking the following activities- (i) NBFC-Peer to Peer
Lending Platform (NBFC-P2P), (ii) NBFC-Account Aggregator (NBFC-AA), (iii) Non-
Operative Financial Holding Company (NOFHC) and (iv) NBFCs not availing public funds
and not having any customer interface.
• RBI has raised the net-owned funds requirement for these NBFCs to ₹20 crore from ₹2
crore earlier and also proposed that they can transition to the new regulation over a period
of five years.
• The existing non-performing loan classification norm for these NBFCs will be changed to 90
days from 180 days now.

Middle Layer NBFCs:

• The Middle Layer shall consist of (a) all deposit taking NBFCs (NBFC-Ds), irrespective of
asset size, (b) non-deposit taking NBFCs with asset size of ₹1000 crore and above and (c)
NBFCs undertaking the following activities (i) Standalone Primary Dealers (SPDs), (ii)
Infrastructure Debt Fund - Non-Banking Financial Companies (IDF-NBFCs), (iii) Core
Investment Companies (CICs), (iv) Housing Finance Companies (HFCs) and (v)
Infrastructure Finance Companies (NBFC-IFCs).
• The regulatory regime for this layer shall be stricter compared to the base layer.
• RBI has proposed no changes to the existing capital requirement for these NBFCs, which
currently stands at 15% with minimum tier-I of 10%.
• The regulator has suggested that NBFCs with 10 or more branches will be required to
adopt core banking solution.
• It has also put certain restrictions on lending. These NBFCs cannot provide loans to
companies for buyback of securities.

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Upper Layer NBFCs

• Going further, the next layer can consist of NBFCs which are identified as systemically
significant.
• This layer will be populated by NBFCs which have large potential of systemic spill-over of
risks and have the ability to impact financial stability.
• These NBFCs will have to implement differential standard asset provisioning and also the
large exposure framework as applicable to banks.
• Scheduled commercial banks are on a Basel III framework which provides for minimum
requirements for Common Equity Tier 1 (CET 1) capital.
• It is felt that CET 1 could be introduced for NBFC-UL to enhance the quality of regulatory
capital.

Top Layer
• This layer is currently empty.
• However, RBI can move an NBFC to this category if it feels that there is an unsustainable
increase in the systemic risk spill-overs from specific NBFCs in the upper layer.
These NBFCs will be subject to higher capital charge, including capital conservation buffers.

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3.1.5 Regional Rural Banks

Introduction
History
• Regional Rural Banks (RRBs) were established in 1975 under the provisions of the
Ordinance promulgated on 26th September 1975 and followed by the Regional Rural Banks
Act, 1976.
• RRBs were established with a view to develop the rural economy and to create a
supplementary channel to the 'Cooperative Credit Structure' with a view to enlarge
institutional credit for the rural and agriculture sector.

Meaning
• An RRB is a hybrid bank combining features of commercial banks and cooperative banks.
Commercial banks have limited presence in rural areas due to less opportunities there,
while cooperative banks are not that professional in their functioning.
• There is a sponsor commercial bank over RRB, which provides it Human Resource
Management (HRM) practices, technical and human training etc., to inculcate
professionalism.
• Like cooperative banks, RRBs operate in a selected and limited area only.
• M Swaminathan is considered the father of RRBs.
• RRBs are regulated by RBI and supervised by NABARD.
• Prathama Bank, with head office in Moradabad, Uttar Pradesh was the first RRB. It was
sponsored by Syndicate Bank and had an authorised capital of Rs. 5 crores.

Area of Operation
• The area of operation of the RRBs is limited to few notified districts in a State.
• The RRBs mobilise deposits primarily from rural/semi-urban areas and provide loans and
advances mostly to small and marginal farmers, agricultural labourers, rural artisans and
other segments of priority sector.

Shareholding Pattern
The Central Government holds 50% in each of the RRBs, while their respective sponsor banks
hold 35%. The balance 15% in RRBs is held by the respective State Governments.
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The above holding can be changed as follows:

CG + sponsor bank = 51%
SG = 15%
Remaining- can be raised from the market
The stake of State government can be reduced below 15% by consulting with that state.

Sources of Funds of RRBs

• The sources of funds of RRBs comprise of owned fund, deposits, borrowings from
NABARD, Sponsor Banks, and other sources, including SIDBI and National Housing Bank.

CRAR Norms
• Capital to Risk (Weighted) Assets Ratio (CRAR) norms are also applicable to RRBs. The
income recognition, asset classification and provisioning norms as applicable to commercial
banks are applicable to RRBs. (CRAR is to be covered in Basel norms)

Amalgamation of RRBs
The RBI in 2001 constituted a Committee under the Chairmanship of Dr V S Vyas on “Flow of
Credit to Agriculture and Related Activities from the Banking System” which examined relevance
of RRBs in the rural credit system and the alternatives for making it viable.

• The consolidation process thus was initiated in the year 2005 as an off-shoot of Dr Vyas
Committee Recommendations.
• The first phase of amalgamation was initiated Sponsor Bank-wise within a State in 2005
and the second phase was across the Sponsor banks within a State in 2012.
• The process was initiated with a view to provide better customer service by having better
infrastructure, computerization, experienced work force, common publicity and marketing
efforts, etc.
• The amalgamated RRBs also benefit from larger area of operation, enhanced credit
exposure limits for high value and diverse banking activities.
• As a result of amalgamation, number of the RRBs has been reduced from 196 to 56 as on
31 March 2015.
• The number of branches of RRBs increased to 20,024 as on 31 March 2015 covering 644
districts throughout the country.

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Recapitalization of RRBs
• Dr. K.C. Chakrabarty Committee on “Recapitalization of RRBs for improving CRAR” had
recommended recapitalization of 40 out of 82 RRBs for strengthening their CRAR to the
level of 9 % by 31 March 2012.
• According to the Committee, the remaining RRBs were in a position to achieve the desired
level of CRAR on their own.
• Accepting the recommendations of the Committee, the GOI along with other shareholders
decided to recapitalize the RRBs by infusing funds to the extent of `2,200 Crore, with
proportion being 50:35:15 for GOI; Sponsor Bank and State Government respectively.

Regional Rural Banks (Amendment) Act, 2015

• The Regional Rural Banks (Amendment) Act, 2015, came into effect from 4th February
2016.
• The Act raises the amount of authorised capital to Rs. 2,000 crore and states that it cannot
be reduced below Rs. 1 crore.
• The Act allows RRBs to raise capital from sources other than the existing shareholders -
central and state governments, and sponsor banks. Here, the combined shareholding of
the central government and the sponsor bank cannot be less than 51%.
• For the sponsoring banks, they can provide various initiating assistance to the RRBs
beyond the initial five years (previously, the sponsoring bank’s responsibility will be over in
five years).
• The Act states that the central government may by notification raise or reduce the limit of
shareholding of the central government, state government or the sponsoring bank in the
RRB. For this, the central government may consult the state government and the sponsor
bank.

3.2 Risk-based Internal Audit (RBIA)

What is RBIA?
• An effective Risk-Based Internal Audit (RBIA) is an audit methodology that links an
organization’s overall risk management framework and provides an assurance to the Board
of Directors and the Senior Management on the quality and effectiveness of the
organization’s internal controls, risk management and governance related systems and
processes.

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• The essential requirements for a robust internal audit function include sufficient authority,
proper stature, independence, adequate resources and professional competence.

Who is it applicable to?

• The introduction of Risk-Based Internal Audit (RBIA) system was mandated for all
Scheduled Commercial Banks (except Regional Rural Banks) in 2002.
• In 2021, RBI decided to adopt the RBIA framework for the following Non-Banking Financial
Companies (NBFCs) and Primary (Urban) Co-operative Banks (UCBs) as well:
▪ All deposit taking NBFCs, irrespective of their size;
▪ All Non-deposit taking NBFCs (including Core Investment Companies) with asset
size of ₹5,000 crore and above; and
▪ All UCBs having asset size of ₹500 crore and above.
• Such entities were required to implement the RBIA framework by March 31, 2022.

Role of RBIA Framework

• The RBIA Guidelines are intended to enhance the efficacy of internal audit systems and
processes followed by the NBFCs and UCBs.
• Further, in order to ensure smooth transition from the existing system of internal audit to
RBIA, the concerned NBFCs and UCBs may constitute a committee of senior executives
with the responsibility of formulating a suitable action plan.
• The internal audit function should broadly assess and contribute to the overall improvement
of the organization’s governance, risk management, and control processes using a
systematic and disciplined approach. The function is an integral part of sound corporate
governance.
• Historically, the internal audit system in NBFCs/UCBs has generally been concentrating on
transaction testing, testing of accuracy and reliability of accounting records and financial
reports, adherence to legal and regulatory requirements, etc.
• However, in the changing scenario, such testing by itself might not be sufficient. Therefore,
in addition to selective transaction testing, an evaluation of the risk management systems
and control procedures in various areas of operations is needed. This will also help in
anticipating areas of potential risks and mitigating such risks.

Who formulates the RBIA Policy?

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• The Board of Directors (the Board) / Audit Committee of Board (ACB) of NBFCs and the
Board of UCBs are primarily responsible for overseeing the internal audit function in the
organization.
• The RBIA policy shall be formulated with the approval of the Board and disseminated
widely within the organization.

Risk Assessment
• The risk assessment process should include identification of inherent business risks in
various activities undertaken, evaluation of the effectiveness of the control systems for
monitoring the inherent risks of the business activities.
• The risk assessment may make use of both quantitative and qualitative approaches. While
the quantum of credit, market, and operational risks could largely be determined by
quantitative assessment, the qualitative approach may be adopted for assessing the quality
of overall governance and controls in various business activities.

Note:
• NBFCs being financial service intermediaries are exposed to risks arising out of
counterparty failures, funding and asset concentration, interest rate movements and risks
pertaining to liquidity and solvency.
• Further, the inter-connectedness of NBFCs with other participants in financial markets has
increased over time with greater access to public funds. Consequently, risks of the NBFC
sector can easily be transmitted to the rest of the financial system and vice-versa.
• While regulations for NBFCs are simpler and lighter as compared to banks, there is a
continuous evaluation done to ensure that NBFC regulations commensurate with the
systemic impact that NBFCs can cause and certain financial market activities do not remain
out of the regulatory purview.

3.3 Universal Vs Niche Banking

Universal Banks

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Introduction

• A universal bank is nothing but a commercial bank with additional authority to act as an
investment house.
• It is a system through which banks offer their regular, retail, and high net worth customers a
bouquet of comprehensive financial services, including customized or tailored investment,
retail, and commercial services.
• Universal banking helps service provider to build up long-term relationships with clients by
catering to their different needs.
• The client also benefits as he gets a whole range of services at lower cost and under one
roof.

Universal Banking in India

• The Narasimham Committee II (1998) gave an introductory remark on the concept of
Universal Banking, as a different concept than Narrow Banking.
• The Committee suggested that DFIs should convert ultimately, into either commercial
banks or NBFCs.
• In 1997, the RBI set up a Working Group under the chairmanship of the then Chairman and
Managing Director of IDBI, Shri S. H. Khan, to review the role, structure and operations of
Development Financial Institutions (DFIs) and commercial banks in emerging operating
environment and suggest changes.
• The concept of Universal Banking was conceptualized in India after the Khan Working
Group recommended it as a different concept.
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• The Group held the view that DFIs should be allowed to become banks at the earliest.
• The thrust of the Group was on a progressive move towards universal banking and the
development of an enabling regulatory framework for this purpose.
• In January 1999, RBI released a Discussion Paper on “Harmonizing the role and operations
of Financial Institutions and Banks”, in order to bring clarity on the roles of banks and
Financial Institutions.
• The feedback on the Paper indicated that while the universal banking was desirable from
the point of view of efficiency of resource use, there was a need for caution in moving
towards such a system.
• ICICI Bank was the first financial institution in India, that adopted universal banking.

Types of Universal Banking Services

Universal banking services in India are broadly categorised into three types based on their
functionality. They are as under:

1. Investment Banking Services

• Such banks typically focus on providing services to various private investors and
organisations.
• Also known as merchant banking, these banks generally offer their clients assistance with
asset management, investment advisory services, raising capital, mergers and acquisitions,
securities underwriting and securities trading, among other facilities.

2. Wholesale Banking Services

• Wholesale banking refers to banking services sold to large clients, such as corporations,
other banks, and government agencies.
• These services usually involve lending and borrowing funds on a large scale, compared to
retail banking services that deal with comparatively smaller loan amounts for individual
customers.

3. Retail Banking Services

• Retail banking is the most common type of universal banking service available globally.
• It is the type of banking that general bank customers and account holders are provided
with.
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• Retail banking is a way for individual consumers to manage their money, have access to
credit, and deposit their money in a secure manner.

Niche or Differentiated Banks

Introduction and History

• Differentiated banks are banking institutions licensed by the RBI to provide specific banking
services and products.
• Differentiated banks are distinct from universal banks as they function in a niche segment.
• The differentiation could be on account of capital requirement, scope of activities or area of
operations.
• As such, they offer a limited range of services / products or function under a different
regulatory dispensation.
• In a sense, Urban Co-operative Banks (UCBs), Primary Agricultural Credit Societies
(PACS), Regional Rural Banks (RRBs) and Local Area Banks (LABs) could be considered
as differentiated banks as they operate in localized areas.
• The main aim for giving license to differentiated banks is to promote financial inclusion.

Background

• The concept of differentiated banks was first discussed in 2007 in an RBI Technical Paper,
when it was felt that the time was not yet opportune for such banks.
• However, in 2008, the Committee on Financial Sector Reforms (Chairman: Dr. Raghuram
G. Rajan) had envisaged differentiated banks to further financial inclusion, by examining the
relevance of small banks in the Indian context.
• The Committee on Comprehensive Financial Services for Small Businesses and Low-
Income Households (Chairman: Shri Nachiket Mor), 2013 espoused the concept of
differentiated banks to further the cause of financial inclusion and deepening the strategies,
using the functional building blocks of payments, deposits and credits.
• Thereafter, the concept was once again discussed in a Paper “Banking Structure in India -
The Way Forward”, published by the RBI in August 2013.
• The Paper looked into various aspects of the banking structure, licensing of banks, banking
models and suggested a transition path for some banks.
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• The RBI granted in-principle approvals to 11 entities for setting up payments banks (PBs) in
August 2015 and 10 entities for Small Finance Banks (SFB) in September 2015.

Types of Differentiated Banks

Small Finance Banks

• Small finance banks (SFBs) are a type of niche banks that can provide basic banking
service of acceptance of deposits and lending.

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• The aim behind these is to provide financial inclusion to sections of the economy not being
served by other banks, such as small business units, small and marginal farmers, micro
and small industries and unorganised sector entities.
• They are established as public limited companies in the private sector under the
Companies Act, 2013.
• The minimum paid-up voting equity capital for SFBs is Rs. 200 crores.
• SFBs will be required to extend 75 % of their Adjusted Net Bank Credit (ANBC) to the
sectors eligible for classification as priority sector lending (PSL) by RBI.
• Individuals/professions with 10 years of experience in finance, NBFCs, micro finance
companies, and local area banks are eligible to set up SFBs.
• Capital Small Finance Bank is India's first small finance bank, founded in April 2016 as a
microfinance lender, with its headquarters in Jalandhar.

Payments Banks

• Payments banks are new model of banks, conceptualized by the RBI, which cannot issue
credit.
• These banks can accept a restricted deposit, which is currently limited to ₹2,00,000 per
customer and may be increased further.
• These banks cannot issue loans and credit cards.
• Both current account and savings accounts can be operated by such banks.
• Payments banks can issue ATM cards or debit cards and provide online or mobile banking.

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• The minimum required paid-up equity capital for opening a payments bank according to RBI
is Rs. 100 crore.
• Bharti Airtel set up India's first payments bank, Airtel Payments Bank, with its headquarters
in New Delhi. It was launched in 2017.

Proposed Differentiated Banks

Custodian Banks

Custodian Banks are specialized financial institutions mainly responsible for safeguarding a firm’s
or individual’s financial assets and are typically not engaged in conventional retail lending.

Wholesale & Long-Term Finance Banks

• In April 2017, RBI proposed to float a new type of differentiated banks called wholesale and
long-term finance (WLTF) banks.
• The report of the Committee on Comprehensive Financial Services for Small Businesses
and Low Income Households, chaired by Dr. Nachiket Mor (‘Nachiket Mor Committee
Report’) had envisaged a class of differentiated banks called Wholesale Banks.
• Extending the Committee’s recommendations on Wholesale Banks, the Wholesale and
Long-Term Finance (WLTF) banks will focus primarily on lending to infrastructure sector
and small, medium & corporate businesses.
• They will also mobilize liquidity for banks and financial institutions directly originating priority
sector assets, through securitization of such assets and actively dealing in them as market
makers.
• They may also act as market-makers in securities such as corporate bonds, credit
derivatives, warehouse receipts, and take-out financing etc.
• These banks will provide refinance to lending institutions and shall be present in capital
markets in the form of aggregators.
• WLTF banks may also offer services related to equity / debt investments, and forex / trade
finance to their clients.
• These services, although similar in nature to the services offered by financial institutions
traditionally known as ‘Investment Banks’, would be ancillary to the primary activities of

pg. 41
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WLTF banks, which is deposits / loan products for wholesale clients and financing of
infrastructure sector and core industries.

3.4 Priority Sector Lending

What is Priority Sector Lending (PSL)?

• The RBI decides to allot funds to predetermined priority sectors of the economy that may
require credit and financial assistance.
• Under PSL, the RBI directs banks to dedicate funds for specific sectors of the economy like
agriculture, MSMEs, education and housing for the part of the population that is sometimes
unable to get it.
• The goal of PSL is to provide credit to the weaker sections of the society.
• PSL guidelines are applicable to all Commercial Banks, Regional Rural Banks (RRBs),
Small Finance Banks (SFBs), Local Area Banks (LABs), and Urban Co-operative Banks
(UCBs).

Categories under Priority Sector

The categories under priority sector are as follows:

i. Agriculture
ii. Micro, Small and Medium Enterprises
iii. Export Credit (not applicable to RRBs and LABs)
iv. Education
v. Housing
vi. Social Infrastructure
vii. Renewable Energy
viii. Others

Agriculture

The lending to agriculture sector includes Farm Credit (Agriculture and Allied Activities), lending
for Agriculture Infrastructure and Ancillary Activities

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1. Farm Credit – Individual Farmers

Loans to individual farmers [including Self Help Groups (SHGs) or Joint Liability Groups
(JLGs) i.e., groups of individual farmers, (provided banks maintain disaggregated data of such
loans) and
Proprietorship firms of farmers, directly engaged in Agriculture and Allied Activities, viz. dairy,
fishery, animal husbandry, poultry, bee-keeping and sericulture. This will include:

1. Crop loans including loans for traditional/non-traditional plantations, horticulture

and allied activities.
2. Medium and long-term loans for agriculture and allied activities.
3. Loans for pre- and post-harvest activities.
4. Loans to distressed farmers indebted to non-institutional lenders.
5. Loans under the Kisan Credit Card Scheme.
6. Loans to small and marginal farmers for purchase of land for agricultural purposes.
7. Loans against pledge/hypothecation of agricultural produce (including warehouse
receipts) for a period not exceeding 12 months subject to a limit up to ₹75 lakh against
NWRs/eNWRs and up to ₹50 lakh against warehouse receipts other than
NWRs/eNWRs. (Negotiable warehouse receipt)
8. Loans to farmers for installation of stand-alone Solar Agriculture Pumps and for
solarisation of grid connected Agriculture Pumps.
9. Loans to farmers for installation of solar power plants.

2. Farm Credit – Corporate Farmers, Farmer Producer Organisations (FPOs)/(FPC)

Companies of Individual Farmers, Partnership Firms and Co-operatives of Farmers
engaged in Agriculture and Allied Activities

1. Loans for the following activities will be subject to an aggregate limit of ₹2 crore per
borrowing entity: Crop loans to farmers which will include traditional/non-traditional
plantations and horticulture and loans for allied activities, Medium and long-term loans for
agriculture and allied activities.
2. Loans for pre- and post-harvest activities.

pg. 43
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3. Loans up to ₹75 lakh against pledge/hypothecation of agricultural produce (including

warehouse receipts) for a period not exceeding 12 months against NWRs/eNWRs and up
to ₹50 lakh against warehouse receipts other than NWRs/eNWRs.
4. Loans up to ₹5 crore per borrowing entity to FPOs/FPCs undertaking farming with
assured marketing of their produce at a pre-determined price.
5. UCBs are not permitted to lend to co-operatives of farmers.

3. Agriculture Infrastructure

Loans for agriculture infrastructure will be subject to an aggregate sanctioned limit of ₹100
crore per borrower from the banking system.

4. Ancillary Services
Following loans under ancillary services will be subject to limits prescribed as under:
1. Loans up to ₹5 crore to co-operative societies of farmers for purchase of the produce of
members (Not applicable to UCBs)
2. Loans up to ₹50 crore to start-ups that are engaged in agriculture and allied services.
3. Loans for food and agro-processing up to an aggregate sanctioned limit of ₹100 crore per
borrower from the banking system.

Who are Small and Marginal Farmers (SMFs)?

SMFs include the following:
i. Farmers with landholding of up to 1 hectare (Marginal Farmers).
ii. Farmers with a landholding of more than 1 hectare and up to 2 hectares (Small Farmers).
iii. Landless agricultural labourers, tenant farmers, oral lessees and share-croppers whose
share of landholding is within the limits prescribed for SMFs.
iv. Loans to Self Help Groups (SHGs) or Joint Liability Groups (JLGs), i.e., groups of
individual SMFs directly engaged in Agriculture and Allied Activities, provided banks
maintain disaggregated data of such loans.
v. Loans up to ₹2 lakh to individuals solely engaged in Allied activities without any
accompanying land holding criteria.

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vi. Loans to FPOs/FPC of individual farmers and co-operatives of farmers directly engaged
in Agriculture and Allied Activities where the land-holding share of SMFs is not less than
75%.

Micro, Small and Medium Enterprises (MSMEs)

Classification of MSMEs
Enterprise Investment in plant and Turnover
machinery
Micro Enterprises Less than ₹ 1 crore Less than ₹ 5 crore
Small Enterprises Less than ₹ 10 crore Less than ₹ 50 crore
Medium Enterprises Less than ₹ 50 crore Less than ₹ 250 crore

All bank loans to MSMEs conforming to RBI guidelines qualify for classification under PSL.

Export Credit

(Note: Export Credit is not applicable to RRBs and LABs.)

Export credit under agriculture and MSME sectors are allowed to be classified as PSL in the
respective categories viz. agriculture and MSME.

Export Credit (other than in agriculture and MSME) will be allowed to be classified as priority
sector as per the following table:

Domestic banks / WoS

of Foreign banks/ SFBs/
UCBs
Incremental export credit
over corresponding date
of the preceding year, up
to 2 % of ANBC or
CEOBE whichever is
Foreign banks with 20 Foreign banks with
branches and above less than 20 branches
Incremental export credit Export credit up to 32 %
over corresponding date of ANBC or CEOBE
of the preceding year, up whichever is higher.
to 2 % of ANBC or
pg. 45
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higher, subject to a CEOBE whichever is

sanctioned limit of up to ₹ higher.
40 crore per borrower.

(ANBC = Adjusted Net Bank Credit; CEOBE = Credit Equivalent amount of Off-Balance Sheet
Exposure)
(WOS = Wholly owned subsidiary)

Education

Loans to individuals for educational purposes, including vocational courses, not exceeding ₹ 20
lakh will be considered as eligible for priority sector classification.

Housing

i. Bank loans to individuals for purchase/ construction/ repairs of dwelling units as per limits
prescribed below are eligible for priority sector classification:

Location Purpose Loan Amount Overall Cost

of Dwelling
Unit
Metropolitan Purchase/ Up to ₹ 35 lakh Up to ₹ 45
(population construction lakh
more than 10 Repairs Up to ₹ 10 lakh
lakh)
Other Purchase/ Up to ₹ 25 lakh Up to ₹ 30
construction lakh
Repairs Up to ₹ 6 lakh

ii. Housing loans to banks’ own employees will not be eligible for classification under the
priority sector.
iii. Bank loans to any governmental agency for construction of dwelling units or for slum
clearance and rehabilitation of slum dwellers subject to dwelling units with carpet area of
not more than 60 sq.m.
pg. 46
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iv. Bank loans for affordable housing projects for dwelling units with carpet area of not more
than 60 sq.m.

Social Infrastructure
Bank loans to social infrastructure sector as per limits prescribed below are eligible for priority
sector classification:

i. Bank loans up to a limit of ₹5 crore per borrower for setting up schools, drinking water
facilities and sanitation facilities including construction/ refurbishment of household toilets
and water improvements at household level, etc.
ii. Loans up to a limit of ₹10 crore per borrower for building health care facilities including
under ‘Ayushman Bharat’ in Tier II to Tier VI centres.
iii. In case of UCBs, the above limits are applicable only in centres having a population of less
than one lakh.

Renewable Energy

Bank loans to renewable energy sector as per limits prescribed below are eligible for priority sector
classification:

i. Bank loans up to a limit of ₹30 crore to borrowers for purposes like solar based power
generators, biomass-based power generators, wind mills, micro-hydel plants and for non-
conventional energy based public utilities.
ii. For individual households, the loan limit will be ₹10 lakh per borrower.

Weaker Sections

Priority sector loans to the following borrowers will be considered as lending under Weaker
Sections category:

i. Small and Marginal Farmers

ii. Artisans, village and cottage industries where individual credit limits do not exceed ₹1 lakh

pg. 47
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iii. Beneficiaries under Government Sponsored Schemes such as National Rural Livelihood
Mission (NRLM), National Urban Livelihood Mission (NULM) and Self Employment Scheme
for Rehabilitation of Manual Scavengers (SRMS)
iv. Scheduled Castes and Scheduled Tribes
v. Beneficiaries of Differential Rate of Interest (DRI) scheme
vi. Self Help Groups
vii. Distressed farmers indebted to non-institutional lenders
viii. Distressed persons other than farmers, with loan amount not exceeding ₹1 lakh per
borrower to prepay their debt to non-institutional lenders
ix. Individual women beneficiaries up to ₹1 lakh per borrower (For UCBs, existing loans to
women will continue to be classified under weaker sections till their maturity/repayment.)
x. Persons with disabilities
xi. Minority communities as may be notified by Government of India from time to time.

PSL Targets for Banks

The targets and sub-targets set under PSL, to be computed on the basis of the ANBC/ CEOBE as
applicable as on the corresponding date of the preceding year, are as under:

Domestic
commercial
banks (excl. Foreign
Small
RRBs & SFBs) banks with Regional
Categories Finance
& foreign banks less than 20 Rural Banks
Banks
with 20 branches
branches and
above
Total 40 % of ANBC or 40 % of ANBC 75 % of ANBC 75 % of
Priority CEOBE or CEOBE or CEOBE ANBC or
Sector whichever is whichever is whichever is CEOBE
higher higher; out of higher; whichever is
which up to However, higher.
32% can be in lending to
the form of Medium

pg. 48
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lending to Enterprises,
Exports and Social
not less than Infrastructure
8% can be to and
any other Renewable
priority sector Energy shall
be reckoned
for priority
sector
achievement
only up to 15
% of ANBC.
Agriculture 18 % of ANBC or Not applicable 18 % ANBC or 18 % of
CEOBE, CEOBE, ANBC or
whichever is whichever is CEOBE,
higher; out of higher; out of whichever is
which a target of which a target higher; out of
10 % is of % is which a
prescribed for prescribed for target of 10
Small and SMFs % is
Marginal prescribed
Farmers (SMFs) for SMFs
Micro 7.5 % of ANBC Not applicable 7.5 % of 7.5 % of
Enterprises or CEOBE, ANBC or ANBC or
whichever is CEOBE, CEOBE,
higher whichever is whichever is
higher higher
Advances 12 % of ANBC or Not applicable 15 % of ANBC 12 % of
to Weaker CEOBE, or CEOBE, ANBC or
Sections whichever is whichever is CEOBE,
higher higher whichever is
higher

pg. 49
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Categories Primary Urban Co-operative Banks

Total Priority
Sector 40 % of ANBC or CEOBE, whichever is higher, which shall
Micro stand increased to 75 % of ANBC or CEOBE, whichever is
Enterprises higher, with effect from March 31, 2024.

Micro
7.5 % of ANBC or CEOBE, whichever is higher
Enterprises
Advances to
Weaker 12 % of ANBC or CEOBE, whichever is higher.
Sections

The targets for lending to SMFs and for Weaker Sections have been revised upwards from FY
2021-22 onwards as follows:

Small and Marginal Weaker Sections

Financial Year
Farmers Target * Target ^
2020-21 8% 10%
2021-22 9% 11%
2022-23 9.5% 11.5%
2023-24 10% 12%
* Not applicable to UCBs
^ Weaker Sections target for RRBs will continue to be 15% of ANBC or CEOBE,
whichever is higher.

Note:
• All loans to units in the KVI (Khadi and Village Industries) sector will be eligible for
classification under the sub-target of 7.5 % prescribed for Micro Enterprises under priority
sector.
• All efforts should be made by banks to reach the level of 13.5 % of ANBC (erstwhile target
for direct lending to agriculture sector).

Priority Sector Lending Certificates (PSLCs)

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• Priority Sector Lending Certificates (PSLCs) were introduced in 2016.

• PSLCs are a mechanism to enable banks to achieve the PSL targets and sub-targets by
purchase of these instruments in the event of shortfall.
• This also incentivizes surplus banks as it allows them to sell their excess achievement over
targets thereby enhancing lending to the categories under priority sector.
• Under the PSLC mechanism, the seller sells fulfilment of priority sector obligation and the
buyer buys the obligation with no transfer of risk or loan assets.
• PSLCs allow banks sitting on surplus loans to a priority sector to sell certificates to banks
that haven’t met their targets, pocketing a sizeable fee for this trade.
• PSLCs are traded through the CBS portal (e-Kuber) of RBI.
• There are four kinds of PSLCs:
▪ PSLC Agriculture
▪ PSLC SF/MF (Small and marginal farmers)
▪ PSLC Micro Enterprises
▪ PSLC General
• PSLCs have a standard lot size of ₹ 25 lakh and multiples thereof.

On-lending to Priority Sectors

• On-lending means loans sanctioned by banks to eligible intermediaries for onward lending
for creation of priority sector assets.
• Banks can provide funds to registered NBFCs for on-lending to priority sector categories of
agriculture, housing, micro and small enterprises subjected to conditions.
• Bank credit to NBFCs (including HFCs) for on-lending will be allowed up to an overall limit
of 5 % of an individual bank’s total PSL in case of commercial banks.
• In case of SFBs, credit to NBFC-MFIs and other MFIs (Societies, Trusts, etc.) which are
members of RBI recognized ‘Self-Regulatory Organisation’ of the sector, will be allowed up
to an overall limit of 10 % of an individual bank’s total PSL.
pg. 51
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Monitoring of PSL Targets

• To ensure continuous flow of credit to priority sector, the compliance of banks will be
monitored on ‘quarterly’ basis.
• The data on priority sector advances is required to be furnished by banks at quarterly and
annual intervals as per the reporting format.
• In respect of RRBs, the data on priority sector advances, in the above format, must be
furnished to NABARD at quarterly and annual intervals.
• In respect of UCBs, the data on priority sector advances in the reporting formats shall be
furnished at quarterly and annual intervals, to the Regional Office of Department of
Supervision (DoS), RBI.

Non-achievement of Priority Sector Targets

• Banks having any shortfall in lending to priority sector shall be allocated amounts for
contribution to the Rural Infrastructure Development Fund (RIDF) established with
NABARD and other funds with NABARD/NHB/SIDBI/ MUDRA Ltd., as decided by RBI from
time to time.

• With effect from March 31, 2021, all UCBs (excluding those under all-inclusive directions)
will be required to contribute to Rural Infrastructure Development Fund (RIDF) established
with NABARD and other funds with NABARD / NHB / SIDBI / MUDRA Ltd., against their
PSL shortfall.

• The interest rates on banks’ contribution to RIDF or any other funds, tenure of deposits, etc.
shall be fixed by RBI of India from time to time.

• The mis-classifications reported by the RBI’s DoS (NABARD in respect of RRBs) would be
adjusted/ reduced from the achievement of that year, to which the amount of
misclassification pertains, for allocation to various funds in subsequent years.
• Non-achievement of priority sector targets and sub-targets will be taken into account while
granting regulatory clearances/approvals for various purposes.

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4.0 Miscellaneous

4.1 Balance Sheet

Balance Sheet of a Central Bank

A central bank’s balance sheet typically centres around the three traditional central banking
functions of:
i. Issuer of Currency
ii. Banker to Government
iii. Banker to Banks

Liabilities Assets
Currency Gold
Deposits, of Loans and Advances, to
Government Government
Banks Banks
Loans (including securities) Investments, in
Other Liabilities Government Securities
Capital Account Foreign Assets
Paid-up Capital
Reserves Other Assets
Total Liabilities Total Assets

Balance Sheet of RBI

Liabilities Assets
Capital Assets of Banking Department (BD)
Reserve Fund Notes, Rupee Coin, Small Coin
Other Reserves Gold - BD
Deposits Investments-Foreign-BD
Risk Provisions Investments-Domestic-BD
Contingency Fund Bills Purchased and Discounted
Asset Development Fund Loans and Advances
Revaluation Accounts Investment in Subsidiaries

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Other Liabilities Other Assets

Liabilities of Issue Department Assets of Issue Department (ID) (As
backing for Notes Issued)
Notes Issued Gold - ID
Rupee Coin
Investments-Foreign-ID
Investments-Domestic-ID
Domestic Bills of Exchange and other
Commercial Papers
Total Liabilities Total Assets

Balance Sheet of Scheduled Commercial Banks

Liabilities Assets
Capital Cash and Balances with RBI
Reserves & Surplus Balances with Banks and Money at
Deposits (Demand and time) Call and Short Notice
Borrowings Investments
Other Liabilities and Provisions Loans and Advances
Fixed assets
Other assets
Total Liabilities Total Assets

4.2 FEOA, FIU, & CRILC

4.2.1 Fugitive Economic Offenders Act, 2018

Introduction

• The Fugitive Economic Offenders Act was passed on 25 July 2018.

pg. 54
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• The Act empowers any special court (set up under the Prevention of Money Laundering
Act, 2002) to confiscate all properties and assets of economic offenders who are charged in
offences and are evading prosecution by remaining outside the jurisdiction of Indian courts.

Who is a Fugitive Economic Offender (FEO)?

An FEO is a person –
• against whom an arrest warrant has been issued for committing any offence listed in the
Schedule to the Fugitive Economic Offenders Bill, and the value of the offence is at least Rs
100 crore; and
• has left the country and refuses to return, in order to avoid facing prosecution.

Economic Offences

The Bill lists 55 economic offences in the Schedule, which include:

• counterfeiting government stamps or currency,
• dishonouring cheques,
• benami transactions,
• transactions defrauding creditors,
• tax evasion, and
• money-laundering.

Confiscation
• The Special Court may confiscate properties of an FEO which are proceeds of crime,
benami properties, or any other properties.
• These properties may be in India or abroad.
pg. 55
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• Upon confiscation, all rights and titles in the property will vest in the central government,
free from encumbrances (claims or rights in the property).
• The central government may dispose these properties after 90 days.
• The FEO does not have the right to file or defend any civil claims.
• The Act adopts the principle of non-conviction-based confiscation for corruption related
cases under the provisions of United Nations Convention on Corruption (ratified by India in
2011).

4.2.2. Financial Intelligence Unit – India (FIU-IND)

Introduction
• Financial Intelligence Unit – India (FIU-IND) is an organisation under the Department of
Revenue, Government of India which collects financial intelligence about offences under
the Prevention of Money Laundering Act, 2002.
• It was set up in November 2004 and reports directly to the Economic Intelligence Council
(EIC) headed by the Finance Minister.
• FIU-IND was set up as the central national agency responsible for receiving, processing,
analyzing and disseminating information relating to suspect financial transactions.
• FIU-IND is also responsible for coordinating and strengthening efforts of national and
international intelligence, investigation and enforcement agencies in pursuing the global
efforts against money laundering and financing of terrorism.

Functions of FIU-IND
The functions of FIU-IND are:
1. Collection of Information: Act as the central reception point for receiving Cash
Transaction reports (CTRs), Non-Profit Organisation Transaction Report (NTRs), Cross
Border Wire Transfer Reports (CBWTRs), Reports on Purchase or Sale of Immovable
Property (IPRs) and Suspicious Transaction Reports (STRs) from various reporting entities.

2. Analysis of Information: Analyze received information in order to uncover patterns of

transactions suggesting suspicion of money laundering and related crimes.

3. Sharing of Information: Share information with national intelligence/law enforcement

agencies, national regulatory authorities and foreign Financial Intelligence Units.

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4. Act as Central Repository: Establish and maintain national data base on the basis of
reports received from reporting entities.

5. Coordination: Coordinate and strengthen collection and sharing of financial intelligence

through an effective national, regional and global network to combat money laundering and
related crimes.

6. Research and Analysis: Monitor and identify strategic key areas on money laundering
trends, typologies and developments.

4.2.3 Central Repository of Information on Large Credits (CRILC)

Introduction
• The RBI set up a Central Repository of Information on Large Credits (CRILC) in 2014, to
collect, store, and disseminate credit data to lenders.
• It helps banks and financial institutions to assess their NPAs and also share this information
with other institutions.
• CRILC was created for early recognition of financial distress, enabling prompt action for
resolution and fair recovery for lenders and as part of a framework for revitalising distressed
assets in the economy.

Applicability
• All Scheduled Commercial banks and All India Financial Institutions (NABARD, EXIM
BANK, NHB and SIDBI) report to CRILC.
• The CRILC database contains information from all SCBs (excluding RRBs) on all credit
instruments for borrowers having aggregate fund-based and non-fund based exposure of
Rs. 5 crore and above.
• From January 2020 onwards, the RBI has decided to bring Primary (Urban) Cooperative
Banks (UCBs) with assets of Rs. 500 crores and above under the CRILC reporting
framework.

Purpose
CRILC serves following purposes:

pg. 57
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i. Supervisory requirement - CRILC facilitates regulatory oversight of the system by giving a

bird's eye view of the system wide credit risk.

ii. Removing Information Asymmetry and ensuring availability of transparent credit

information - It enables banks to take informed credit decisions and facilitates early
recognition of asset quality problems.

Special Mention Account (SMA)

• Banks are also required to report the Special Mention Account (SMA) status of their
borrowers to CRILC.
• Special Mention Accounts are those assets/accounts that shows symptoms of bad asset
quality in the first 90 days itself or before it being identified as NPA.
• The classification of Special Mention Accounts (SMA) was introduced by the RBI in 2014, to
identify those accounts that has the potential to become an NPA/Stressed Asset.
• The classification is based on the duration that principal or interest payment or any other
amount wholly or partially overdue for.

SMA Sub-categories Overdue for

SMA-0 1-30 days
SMA-1 31-60 days
SMA-2 61-90 days

4.3 Banks’ lending rate

• The rate at which commercial banks charge their customers who are most credit worthy.
• The Benchmark Prime Lending Rate or BPLR was introduced by the Reserve Bank in
2003. It is the rate applied by a bank to its most creditworthy customers.
• But the major problem with BPLR was lack of transparency. Banks could lend below the
BPLR to privileged customers.
• This system defeated the purpose of having a prime lending rate, or the rate that banks
charge from its best customers.
• It also resulted in another problem – bank interest rates ceased to respond to monetary
policy changes that the RBI introduced periodically.
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• So, in 2010, the Reserve Bank of India introduced the Base Rate system, which replaced
the BPLR system. It was used as the benchmark rate by banks for lending till June 2010.

Base Rate, MCLR, Sterilization

Base Rate
• In October 2009, the Central Bank decided to move all banks to a new interest rate system,
which would not only be transparent, but also transmit monetary policy signals to the
economy.
• In April 2010, RBI announced its decision to implement the Base Rate from 1 July 2010.
• The Base Rate includes all those elements of the lending rate that are common across all
categories of borrowers.
• Banks are allowed to determine their actual lending rates on loans and advances with
reference to the Base Rate and by including such other customer specific charges as
considered appropriate.
• All categories of loans are required to be priced only with reference to the Base Rate.
• Since the Base Rate is the minimum rate for all loans, banks are not permitted to resort to
any lending below the Base Rate.

MCLR (Marginal Cost of Funds Based Landing Rate)

Background
• Under Base Rate system, all categories of domestic rupee loans were priced only with
reference to the Base Rate.
• For monetary transmission to occur, lending rates have to be sensitive to the policy rate.
• Banks followed different methodologies for computing their Base Rate.
• While some used the average cost of funds method, some adopted the marginal cost of
funds, while others use the blended cost of funds (liabilities) method.
• It was observed that Base Rates based on marginal cost of funds were more sensitive to
changes in the policy rates.
• In this connection, in order to improve the efficiency of monetary policy transmission, the
Reserve Bank encouraged banks to move in a time-bound manner to marginal-cost-of-
funds-based determination of their Base Rate.

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Introduction of MCLR
• Marginal Cost of Funds based Lending Rate (MCLR) is the minimum lending rate below
which a bank is not permitted to lend.
• MCLR replaced the earlier Base Rate System to determine the lending rates for commercial
banks.
• RBI implemented MCLR on 1 April 2016 to determine rates of interests for loans.
• It is an internal reference rate for banks to determine the interest they can levy on loans.

Revised Methodology
All rupee loans sanctioned and credit limits renewed w.e.f. April 1, 2016 will be priced with
reference to the MCLR, which will be the internal benchmark for such purposes.
The MCLR comprises of –
• Marginal cost of funds
• Negative carry on account of CRR
• Operating costs
• Tenor premium

1. Marginal Cost of Funds: The marginal cost of funds comprises of marginal cost of
borrowings and return on networth.

2. Negative Carry on CRR: Negative carry on the mandatory CRR which arises due to return
on CRR balances being nil, will be calculated as under:
Required CRR x (marginal cost) / (1- CRR)

The marginal cost of funds arrived at as above will be used for arriving at negative carry on CRR.

3. Operating Costs: All operating costs associated with providing the loan product including
cost of raising funds will be included under this head.

4. Tenor Premium: These costs arise from loan commitments with longer tenor. The tenor
premium will be uniform for all types of loans for a given residual tenor.

Exemptions from MCLR

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The following categories of loans are exempted from MCLR –

1. Loans covered by schemes specially formulated by Government of India wherein
banks have to charge interest rates as per the scheme, are exempted from being linked to
MCLR as the benchmark for determining interest rate.
2. Working Capital Term Loan (WCTL), Funded Interest Term Loan (FITL), etc. granted
as part of the rectification/restructuring package, are exempted from being linked to
MCLR as the benchmark for determining interest rate.
3. Loans granted under various refinance schemes formulated by Government of India
or any Government Undertakings wherein banks charge interest at the rates
prescribed under the schemes to the extent refinance is available are exempted from
being linked to MCLR as the benchmark for determining interest rate. Interest rate charged
on the part not covered under refinance should adhere to the MCLR guidelines.
4. The following categories of loans can be priced without being linked to MCLR as the
benchmark for determining interest rate:
▪ Advances to banks’ depositors against their own deposits.
▪ Advances to banks’ own employees including retired employees.
▪ Advances granted to the Chief Executive Officer / Whole Time Directors.
▪ Loans linked to a market determined external benchmark.
▪ Fixed rate loans granted by banks. However, in case of hybrid loans where the
interest rates are partly fixed and partly floating, interest rate on the floating portion
should adhere to the MCLR guidelines.

MCLR- Internal benchmarking vs External benchmarking (EBLR)

• Any change in the benchmark rate is mandated to be passed on to the lending rates
for new borrowers on a 1-1 basis (if spread remains unchanged) under EBLR regime.
• For outstanding floating rate loans linked to an external benchmark, banks are mandated
to pass on the changes in the benchmark rate to the existing borrowers within 3
months while the majority of loans are linked to 1-year MCLR (internal benchmark) and are
reset annually.
• The EBLR framework prohibits banks from adjusting their spreads for existing
borrowers for three years in the absence of a significant credit event.
• Under internal benchmark (MCLR) system, transmission to lending rates is indirect
(since lending rates are determined on a cost-plus basis) and is contingent upon changes in
deposit interest rates. However, under the external benchmark system, transmission to

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lending rates is not contingent upon change in deposit interest rates. As and when the
Monetary Policy Committee (MPC) changes the policy repo rate, and with most banks
using the policy repo rate as the external benchmark, lending interest rates will change -
even for existing customers - on a 1-1 basis and that too, at the most within a quarter.
• The framework of EBLR regime, therefore, improves transmission to lending and deposit
rates as benchmarks are exogenous to each bank and adjust automatically to the policy
rate change.

4 external benchmarking mechanisms:

1. The RBI repo rate
2. The 91-day T-bill yield
3. The 182-day T-bill yield
4. Any other benchmark market interest rate as developed by the Financial Benchmarks India
Pvt. Ltd.

Review of MCLR
Banks shall review and publish their MCLR of different maturities every month on a pre-
announced date with the approval of the Board or any other committee to which powers have
been delegated.

Sterilization
• RBI uses instruments of money creation to stabilize the economy from external shocks.
• If foreign investors increase Investment in India due to higher returns, there is flow of
foreign currency in Indian market.
• This foreign currency is exchanged for rupees by the people.
• Finally, RBI is left with more foreign currency and people have more rupees.
• Over supply of rupee leads to inflation in the economy.
• This is controlled by the RBI through OMOs.
• RBI issues government securities in the market to reduce money supply in the economy.
• This operation of RBI is known as sterilization.

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Qualifying asset-
shall mean a loan which satisfies the following criteria:
1. loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not
exceeding Rs. 1,00,000 or urban and semi-urban household income not exceeding Rs.
1,60,000
2. loan amount does not exceed Rs. 60,000 in the first cycle and Rs. 1,00,000 in subsequent
cycles;
3. total indebtedness of the borrower does not exceed Rs.1,00,000 Provided that loan, if any
availed towards meeting education and medical expenses shall be excluded while arriving
at the total indebtedness of a borrower;
4. tenure of the loan not to be less than 24 months for loan amount in excess of Rs. 15,000
with prepayment without penalty;
5. loan to be extended without collateral;
6. aggregate amount of loans, given for income generation, is not less than 50 per cent of the
total loans given by the MFIs
7. loan is repayable on weekly, fortnightly or monthly instalments at the choice of the borrower
8. An NBFC which does not qualify as an NBFC-MFI shall not extend loans to micro finance
sector, which in aggregate exceed 10% of its total assets.

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