Unit 3: Bank Lending,

Banking Sector Reforms &

Trends
Introduction
• A bank is a licensed financial institution that can receive deposits and provide
loans.
• Banking is essentially a business dealing with money and credit and like any other
business activity banking is profit oriented.
• The bulk of a bank’s income is derived from loans and advances.
• Banks extend loans and advances to traders, industrialists, businessmen against
the security of some assets or on the basis of personal security of the borrower.
In either case banks run a risk of default in repayment
• Therefore banks have to follow a cautious policy and sound lending principles
while lending.
• Banks in India have to consider national interest along with own interest while
determining lending policy.
Principles of Sound Lending
1. Safety
This is the most important guiding principle of a banker. Bank’s
business deals with the public deposits. Bank has to ensure the safety
of the funds lent. Safety means the borrowers should be in a position to
repay the loan along with interest Otherwise, the banker will not be in
a position to repay the deposits and bank may lose the public
confidence.
Bank follows lending policy to maximize earnings but it has always to
be defensive at the same time because it cannot afford to lose the
people’s money. The advance should be granted to reliable borrower.
2. Liquidity
• Liquidity means a bank’s ability to meet the claims of its customers.
Banks should ensure that the money lent is not locked up for a long
time. A bank would remain liquid with liquid advance.
• This is an important aspect of banking, which distinguishes it from insu
rance finance or industrial finance. It is the capacity of a bank to honor
its obligations
• . A banker does the business on borrowed funds; it should ensure
liquidity while lending money. At the time of need, a banker should
be able to convert assets into cash to meet the demand of depositors,
because depositors have faith in a bank on the basis of its liquidity.
3. Profitability
Commercial banks are profit earning concerns so bank must earn sufficient
income to pay interest to the depositors, meet establishment charges,
salaries to staff, earn income for the future, and distribute dividends to the
share-holders etc.
The difference between the lending and borrowing rates constitutes the
gross profit of the bank. A bank should possess liquidity, with surety of
profit; banks should not ignore the safety or liquidity.
4. Security
Security means any valuable given to support a loan or advance. A
large variety of securities may be offered against loans from gold or
silver to immovable property. The security accepted by a banker as a
loan cover must be adequate easy to handle, readily marketable and
free from encumbrances. A banker must realize it only as a cushion to
fall back in case of need.

5. Suitability
Banker should concentrate lending activity on purpose desirable from
the point of view of economic health of the nation. Finance to
gambling is not a part of banking business. Due consideration should
be given to control inflation and raising the standard of living of the
people.
6. Risk Diversification
Every loan has its own risk. So it is better to give an advance for different
purposes and segments to spread the risk. For safety of interest against
contingences, the banker follows the principle of “Do not keep all the eggs in
one basket.”
Bank should avoid concentrating the funds in a few customers or segments.
The advances should be spread over a reasonably wide area, number of
borrowers, number of sectors, geographical area and securities. Another
form of diversification is maturity diversification. Under this, the loan
portfolio is concentrated over different maturity periods. So that, a certain
amount of loans matures at regular intervals which can be utilized to meet
the depositor’s demand.
7. Purpose
A banker should inquire the purpose of the loan. Safety and liquidity of
loan depend on the purpose of loan. Loan may be required for
productive purposes, trading, agriculture, transport, self-employment
etc. Loan for productive purpose would increase the chances of
recovery. On the other side, loan for non-productive purpose would
have lots of uncertainty about recovery. After nationalization, the
purpose of a loan has assumed more significance.

8.Nature of Business
There may be innumerable types of businesses and the repaying
capacity of a borrower dependson the nature of the business. So,
banker should consider this while granting the loan.
9. National Policies
In a developing country like India, banks are also required to fulfill
some social responsibilities. Government policies and national interests
impose certain social responsibilities on commercial banks. Sometimes
to cater to social responsibility, advances are given at concessional rate
to the weaker and neglected sectors. The lending policies of banks are
to be modified from time to time to suit the needs of the economy.
Types of Loans and Advances
• Secured Loans- Secured loan refers to loans where you have to
pledge collateral. A prime example of secured loans would be home
loans. In the case of a home loan, your house acts as a security to the
lender. In case you default on your loan, the lender holds the right to
seize your property to recover the loan dues.
• Unsecured Loans - An unsecured loan is a loan where you don’t have
to pledge collateral. Your loan eligibility and interest rate is decided
based on your creditworthiness – your income, repayment capacity
and credit score. A cash loan or personal loan would be the best
example for unsecured loans.
• Interest rates for unsecured loans could be slightly higher than
secured loans because of the higher risks involved due to the absence
of collateral.
FORMS OF ADVANCES

• Loans - the banker advances a lump sum for a certain period at an

agreed rate of interest. The entire amount is paid on an occasion
either in cash or by credit in his current account which he can draw at
any time. The interest is charged for the full amount sanctioned
whether he withdraws the money from his account or not. The loan
maybe repaid in instalments or at the expiry of a certain period. The
loan maybe given with or without security.
FORMS OF ADVANCES
• Cash credit – it is an arrangement by which the customer is allowed
to borrow money upto a certain limit. This is a permanent
arrangement and the customer need not draw the sanctioned
amount at once, but can draw the amount as and when required.
Cash credit is an active and running account to which deposits and
withdrawals may be effected frequently. Interest is charged only for
the amount withdrawn. Cash credits are usually made against pledge
or hypothecation of goods. Sometimes it is also provided against
personal security. If the customer does not use the full amount of
cash credit, a commitment charge is made by the bank on the
unutilised portion.
FORMS OF ADVANCES
• Overdraft – this is an arrangement between a banker and his
customer wherein the latter is allowed to withdraw over and above
his credit balance in the current account upto an agreed limit. This is
only a temporary accommodation usually granted against securities.
The borrower is allowed to draw and repay any number of times
provided the total amount overdrawn does not exceed the agreed
limit. The interest is charged only fot the amount drawn and not the
entire amount sanctioned.

• A cash credit is used for long term by businessmen, whereas

overdraft is made occasionally for short duration in the current
account only.
FORMS OF ADVANCES
• Bills discounted and purchased – banks grant advances to customers
by discounting bill of exchange or pronote. The amount after
deducting the interest from the amount of the instrument, is credited
in the account of the customer.
Different Types of Secured Loans in India

• Home Loan - Home loans are secured loans that are utilised to purchase
land or property. There are different types of home loans available in India,
namely land purchase loans, home construction loans, home improvement
loans, etc.
• 2. Gold Loan - Gold loans are loans secured against gold ornaments or
coins or bullion. The borrower pledges gold ornaments to the lender in
exchange for funds as per the applicable loan-to-value norms. Gold loan
interest rates could be lower than personal loans.
• 3. Loan Against Property - A loan against property or LAP is a secured loan
sanctioned against a property pledged as collateral. The LAP amount
doesn’t have any end-use restrictions, meaning, you can use the amount
for any financial requirement.
Different Types of Secured Loans in India
• Loan Against Insurance Policies - Certain types of life insurance policies like
endowment plans and traditional policies could qualify as security for a loan
against an insurance policy. The maximum loan amount could be up to 90% of the
policy’s surrender value (not its sum assured).
• 5. Loan Against Mutual Funds and Shares - Mutual funds and shares can also be
pledged as collateral in exchange for funds. Lenders could sanction up to 65% of
the NAV of eligible shares and equity funds, and up to 85% of eligible debt funds
as a loan. The loan funds could be used for any purpose; however, the pledged
shares or fund units cannot be redeemed unless the loan is cleared in full. That
said, the unpledged fund units and shares would continue earning interest as per
performance.
• 6. Loan Against PF/EPF - If you have a Provident Fund (PF) account, it is possible
to get a loan against your PF account. Such loans are considered as a premature
withdrawals and no additional interest rate would be charged. However,
premature PF withdrawal is only allowed for certain predefined requirements like
medical emergency, home purchase, wedding, unemployment, etc. subject to
terms and conditions.
Different Types of Secured Loans in India
• Loan Against Fixed Deposit - A loan against FD is a type of loan where you can
secure funds using your fixed deposit as collateral. You can borrow a certain
percentage of the total deposit amount, typically up to 90-95% of the deposit,
depending on your bank’s policies. The interest rate on such a loan is usually up
to 2% higher than the applicable FD rate.
• 8. Vehicle Loan - Vehicle loans are usually secured loans that help you finance
your dream vehicle like a car, bike or electric vehicle. The concerned vehicle
works as collateral against your loan.
• 9. Car Loan - If you’re planning to purchase a car, you can opt for car loans.
Lenders could offer up to 85% of the car’s ex-showroom price as a loan as per
their terms and conditions. That said, car loans could further be classified as new
car loans and used car loans.
• 10. Two-wheeler Loan - You can opt for two-wheeler loans to purchase a
motorcycle or a scooter of your choice. You can get up to 85% financing of the
on-road value of the two-wheeler as a loan, wherein the vehicle would be
pledged as collateral.
Different Types of Unsecured Loans in India
• Personal Loans - Personal loans are unsecured loans that can be used to
meet any type of financial requirement – from emergencies and home
renovation to fund a vacation or wedding. Pre-approved customers and
applicants with stable income and high credit score can get personal loans
at the lowest applicable rates.
• 2. Cash Loan - A cash loan is similar to a personal loan; however, eligible
applicants can get such a loan in a few minutes through the lender’s mobile
application in a 100% paperless process. They too, like personal loans, can
be used for any requirement with no end-usage restrictions whatsoever.
• 3. Education Loans- Education loans are used to fund higher education in
India or abroad. They cover not just the tuition fees of the educational
institutions but also the accommodation and other living expenses borne
by the students during the course of study. But while education loans are
typically unsecured in nature, lenders could ask for collateral or guarantor
to approve certain education loan applications involving high loan
quantum.
Different Types of Unsecured Loans in India
• Agricultural Loans - Agricultural loans are available for different kinds of
farming-related activities. Financial institutions offer monetary aid to farmers all
across the country.
• Flexi Loans - A flexi loan is a financing facility wherein the borrower avails of a
certain amount and pays interest only for the amount used.
• Credit Card Loans - Loans on credit card are linked to a user’s credit card account
that may or may not be linked to the card’s credit limit. The loan repayment EMIs
are typically clubbed with the card’s monthly bill. While these loans could be
availed of quickly involving zero paperwork and used for any financial
requirement, their interest rates are typically much higher than personal loan
rates. Thus, they should be used only as a last option and for as low an amount as
possible.
• Short-term Business Loans - Short-term business loans are unsecured loans that
are useful for meeting the daily expenses or diversification of a business,
organisation or entity.
Different Types of Unsecured Loans in India

• Payday Loan - A payday loan is a short-time loan typically with a

smaller ticket-size, wherein the lender gives the loan at a higher rate
of interest. The tenure of payday loans is generally shorter than
personal
• Overdraft - A bank overdraft allows eligible customers to withdraw
money or make eligible transactions up to a predefined limit even if
their account balance is zero. The interest is charged only on the
utlised overdraft amount and not the entire overdraft limit. However,
certain types like overdraft against FD and insurance policies are
considered secured loan options.
Priority Sector Lending

• Priority Sector refers to those sectors which the Government of India

and the Reserve Bank of India consider as important for the
development of the basic needs of the country. They are assigned
priority over other sectors. The banks are mandated to encourage the
growth of such sectors with adequate and timely credit.
• The Priority Sector Lending classifications and guidelines released by
the RBI are intended to align with emerging national priorities and
bring a sharper focus on inclusive development, building a consensus
among all stakeholders.
• It enables better credit penetration to credit deficient areas, increases
lending to small and marginal farmers and weaker sections, boosts
credit to renewable energy, and health infrastructure and allied sectors
that need credit boost, which is otherwise difficult to avail.
• The goal of a PSL initiative is to provide credit to the weaker sections
of the society, as opposed to funding only profitable sectors or spaces
that are solely important to economic growth. All sectors considered
as a priority are able to easily access financial support like apply for
loans that the banks are required to allot at a lower interest rate.
• The following fall into the priority sectors under the policy:
agriculture (including micro financing groups like SHGs, JLGs,
individual farmers, and other institutions dedicated to individuals
working in the sector), micro, small and medium scale enterprises
(MSMEs) and SSIs, Educational and Small Scale Industrial loans,
Housing loans and other micro credit finances.
• When banks overreach their PSL targets and need additional funding
to raise funds for the priority sectors, they are able to issue PSL
certificates (PSLCs) only to the extent of the amount banks are
allowed to lend in that specific sector. These certificates can be
traded on RBI’s e-Kuber platform.
Different Categories of the Priority Sector
• Agriculture
• Micro, Small and Medium Enterprises
• Export Credit
• Education
• Housing
• Social Infrastructure
• Renewable Energy
• Others
Advances against various securities
• Advances against goods
• Advances against documents of title to goods
• Advances against stock exchange securities
• Miscellaneous securities
Advance against Securities
•A loan against securities is a valuable financial instrument
that allows individuals and businesses to unlock the value of
their investment without liquidating them. This method
provides quick access to funds, often at lower interest rates,
while enabling borrowers to maintain their investment
portfolios.
Features
• Loan against security is a secured loan. Debentures, shares, bonds or
mutual funds are offered as collateral.
• The tenure of the loan against security is one year, but it can be easily
renewed.
• The rate of interest usually ranges from 9-15%. The rate varies from
bank to bank.
• The processing fee is usually charged at the rate of 2% of the loan
amount. The loan amount depends on the security the borrower is
offering.
• The margin amount of 50% of the prevailing market price of shares
should be offered as security.
RESTRICTIONS ON LOANS AND
ADVANCES

• RBI issues the statutory and other regulations that banks have to
follow while issuing loans and advances.
• These regulations are meant for all the Scheduled Commercial Banks,
excluding Regional Rural Banks.
• These regulations are announced by means of a Master Circular that
is issued every year
PURPOSE
• These guidelines are issued by RBI in exercise of powers conferred by
the Banking Regulation Act, 1949.
• Banks should implement these instructions and adopt adequate
safeguards.
• The purpose is to ensure that the banking activities undertaken by
them are run on sound, prudent and profitable lines.
RESTRICTIONS ON LOANS AND
ADVANCES
• LOANS AND ADVANCES AGAINST SHARES, DEBENTURES AND BONDS
Advances to individuals
• Purpose of the Loan – To meet contingencies, personal needs, subscribing
to new or rights issues or purchase in the secondary market.
• Amount of advance - should not exceed the limit of Rupees ten lakhs per
individual if the securities are held in physical form and Rupees twenty
lakhs per individual if the securities are held in dematerialised form.
• Margin - Banks should maintain a minimum margin of 50 % of the market
value of equity shares / convertible debentures held in physical form and
25% if in dematerialised form.
RESTRICTIONS ON LOANS AND
ADVANCES
• LOANS AND ADVANCES AGAINST SHARES, DEBENTURES AND BONDS
Advances to Share and Stock Brokers/ Commodity Brokers
• Banks and their subsidiaries should not undertake financing of 'Badla'
transactions.
• They may be provided need based overdraft facilities / line of credit
against shares and debentures held by them as stock-in-trade
• Ceiling of Rs 10 lakh/Rs 25 lakh for individuals is not applicable here and
the advances would be need based.
• Banks may grant working capital facilities to stock brokers registered with
SEBI and who have complied with capital adequacy norms prescribed by
SEBI.
• A uniform margin of 50 % shall be applied on all advances / financing of
IPOs / issue of guarantees on behalf of share and stockbrokers
Example of Badla
• Suppose A wants to buy shares of a company but does not have enough
money now. If A values the shares more than their current price, A can do a
badla transaction. Suppose there is a badla financier B who has enough
money to purchase the shares, so on A's request, B purchases the shares
and gives the money to his broker. The broker gives the money to
exchange and the shares are transferred to B. But the exchange keeps the
shares with itself on behalf of B. Now, say one month later, when A has
enough money, he gives this money to B and takes the shares. The money
that A gives to B is slightly higher than the total value of the shares. This
difference between the two values is the interest as badla finance is
treated as a loan from B to A. The rate of interest is decided by the
exchange and it changes from time to time.
RESTRICTIONS ON LOANS AND
ADVANCES
• LOANS AND ADVANCES AGAINST SHARES, DEBENTURES AND BONDS
Bank Finance for Market Makers
• Market Makers approved by stock exchange would be eligible for grant of
advances by scheduled commercial banks
• A uniform margin of 50 per cent shall be applied on all advances /
financing of IPOs / issue of guarantees on behalf of market makers
• A minimum cash margin of 25 per cent (within the margin of 50%) shall be
maintained in respect of guarantees issued by banks for capital market
operations.
• Banks may accept, as collateral for the advances to the Market Makers,
scrips other than the scrips in which the market making operations are
undertaken
BASEL NORMS
• Basel norms or Basel accords are the international banking
regulations issued by the Basel Committee on Banking Supervision.
• The Basel norms is an effort to coordinate banking regulations across
the globe, with the goal of strengthening the international banking
system.
• It is the set of agreement by the Basel Committee of Banking
Supervision which focuses on the risks to banks and the financial
system
Basel Committee on Banking Supervision
• The Basel Committee on Banking Supervision (BCBS) is the primary global
standard setter for the prudential regulation of banks and provides a forum
for regular cooperation on banking supervisory matters for the central
banks of different countries.
• It was established by the Central Bank governors of the Group of Ten
countries in 1974.
• The committee expanded its membership in 2009 and then again in 2014.
The BCBS now has 45 members, consisting of Central Banks and authorities
with responsibility of banking regulations.
• It provides a forum for regular cooperation on banking supervisory
matters.
• Its objective is to enhance understanding of key supervisory issues and
improve the quality of supervision worldwide.
Why these norms??
• Banks lend to different types of borrowers, and each carries its own risk.
• They lend the deposits of the public as well as money raised from the
market, i.e., equity and debt.
• This exposes the bank to a variety of risks of default and as a result they fall
at times. Therefore, Banks have to keep aside a certain percentage of
capital as security against the risk of non recovery.
• The Basel Committee has produced norms called Basel Norms for Banking
to tackle this risk.
• Till date 3 Basel Norms have been released which are collectively called
Basel Accords.
WHY THE NAME BASEL?
• Basel is a city in Switzerland.
• It is the headquarter of the Bureau of International Settlement (BIS),
which fosters cooperation among central banks with a common goal
of financial stability and common standards of banking regulations.
• It was founded in 1930.
• The Basel Committee on Banking Supervision is housed in the BIS
offices in Basel, Switzerland.
Basel I Norms
• In 1988, the Basel Committee on Banking Supervision (BCBS)
introduced capital measurement system called Basel Capital Accord,
also known as Basel-I.
• It focused only on credit risk.
• Credit risk is the possibility of a loss resulting from a borrower’s
failure to repay a loan or meet contractual obligations. Traditionally,
it refers to the risk that a lender may not receive the owed principal
or interest.
• It prescribed minimum capital requirement at 8% of the Risk
Weighted Assets (RWAs) for banks
• RWA means assets with different risk profiles.
• For example, an asset backed by collateral would carry lesser risks as
compared to personal loans, which have no collateral.
• India adopted Basel - I norms in the year 1999. Under Basel – I, the
RBI issued guidelines to maintain CRAR (Capital to Risk Assets Ratio)
or CAR (Capital Adequacy Ratio) of 9% by every Schedule Commercial
Banks.
• CRAR – It is defined as the proportion of bank’s total risk-weighted
assets to capital, that are held in the form of shareholders equity and
certain other defined class of capital.
Tier 1 Capital: It refers to a bank’s core capital, equity, and the
disclosed reserves that appear on the bank’s financial statements.
• In the event that a bank experiences significant losses, Tier 1 capital
provides a cushion that allows it to weather stress and maintain a
continuity of operations.

Tier 2 Capital: It refers to a bank’s supplementary capital, such as

undisclosed reserves and unsecured subordinated debt instruments
that must have an original maturity of at least five years.
• Tier 2 capital is considered less reliable than Tier 1 capital because it
is more difficult to accurately calculate and to liquidate.
• Tier 1 and tier 2 capital are two types of assets held by banks. Tier 1
capital is a bank's core capital, which it uses to function on a daily
basis. Tier 2 capital is a bank's supplementary capital, which is held in
reserve.
• Banks must hold certain percentages of different types of capital on
hand. Having these types of liquid assets or cash on hand balances
out the risk-weighted assets that banks hold. This increases the
stability of the financial system.
• Under Basel III, a bank's tier 1 and tier 2 assets must be at least 10.5%
of its risk-weighted assets, up from 8% under Basel II.
• Tier 1 capital is the primary funding source of the bank and consists of
shareholders' equity and retained earnings.
• Tier 2 capital includes revaluation reserves, hybrid capital instruments
and subordinated term debt, general loan-loss reserves, and
undisclosed reserves.
• Tier 2 capital is considered less reliable than Tier 1 capital because it
is more difficult to accurately calculate and more difficult to liquidate.
Why Are Different Types of Capital
Important?
• Under the Basel Accord, a bank has to maintain a certain level of cash
or liquid assets as a ratio of its risk-weighted assets. The Basel
Accords are a series of three sets of banking regulations that help to
ensure financial institutions have enough capital on hand to handle
obligations.
• The Accords set the capital adequacy ratio (CAR) to define these
holdings for banks. Under Basel III, a bank's tier 1 and tier 2 assets
must be at least 10.5% of its risk-weighted assets. Basel III increased
the requirements from 8% under Basel II.
Tier 1 Capital
• Tier 1 capital consists of shareholders' equity and retained earnings, which are disclosed on their
financial statements. It is a primary indicator used to measure a bank's financial health.

• Tier 1 capital is the primary funding source of the bank. Typically, it holds nearly all of the bank's
accumulated funds. These funds are generated specifically to support banks when losses are
absorbed so that regular business functions do not have to be shut down.
• Under Basel III, the minimum tier 1 capital ratio is 10.5%, which is calculated by dividing the
bank's tier 1 capital by its total risk-weighted assets (RWA)
• RWA measures a bank's exposure to credit risk from the loans it underwrites.

• For example, assume a financial institution has US$200 billion in total tier 1 assets. If they have a
risk-weighted asset value of $1.2 trillion, the capital ratio is 16.66%:
• ($200 billion / $1.2 trillion)*100=16.66%
• This is well above the Basel III requirements.
Tier 2 Capital
Tier 2 capital includes:
• Undisclosed funds that do not appear on a bank's financial
statements
• Revaluation reserves
• Hybrid capital instruments
• Subordinated term debt
• General loan-loss, or uncollected, reserves
• Under Basel III, the minimum total capital ratio is 12.9%, which
indicates the minimum tier 2 capital ratio is 2%, as opposed to 10.5%
for the tier 1 capital ratio.

• If the bank from the example above reported tier 2 capital of $30
billion, its tier 2 capital ratio for the quarter would be 2.5%:

• ($30 billion/$1.2 trillion)*100 = 2.5%

• Thus, its total capital ratio was 19.16% (16.66% + 2.5%). Under Basel
III, the bank met the minimum total capital ratio of 12.9%.
Basel II Norms
• BCBS published the Basel-II norms in 2004 Basel-II was considered to
be a refined and reformed version of Basel-I. It took a three-pillar
approach:
Pillar 1 – Minimum Capital Requirement

• Basel II incorporated operational risk and market risk in addition to

credit risk for capital adequacy purpose.

• Market Risk: Market risk involves the risk of changing conditions in

the specific marketplace in which a company competes for business.

• Operational Risk: Operational risk refers to various risks that can

arise from a company’s ordinary business activities.
• Basel II divides the eligible regulatory capital of a bank into three
tiers. The higher the tier, the more secure and liquid its assets.
• Tier 1 capital represents the bank's core capital and is composed of
common stock, as well as disclosed reserves and certain other assets.
At least 4% of the bank's capital reserve must be in the form of Tier 1
assets.
• Tier 2 is considered supplementary capital and consists of items such
as revaluation reserves, hybrid instruments, and medium- and
long-term subordinated loans.
• Tier 3 consists of lower-quality unsecured, subordinated debt.
Pillar II – Supervisory Review of capital
adequacy
Focuses on bank’s internal processes and systems.
• Does the bank have an internal capital assessment process??
• Does the bank have defined capital targets??
• Does the bank comply with minimum standards and makes required
disclosures??
• Does the bank cover risks ignored under Pillar 1??
Pillar III – Market Discipline & Transparency
• Under this, the banks were needed to develop and use better risk
management techniques in monitoring and managing all the three types of
risks.
• Market Discipline- market mechanism that rewards disciplined banks and
penalizes weak management through primary and secondary markets.
• Transparency- Disclose bank related information timely to the public

Implementation of Basel-II norms were done in India by RBI following a

gradual approach. As per RBI, all SCBs were bound to comply with Basel-II
norms.
Basel III Norms
• The 2007-09 Global Financial Crisis (GFC) revealed several weaknesses in
the capital bases of internationally active banks, definitions of capital
varied widely between jurisdictions, regulatory adjustments were generally
not applied to the appropriate level of capital and disclosures were either
deficient or non-comparable. These factors contributed to the lack of
public confidence in capital ratios during the Global Financial Crisis.
• To address these weaknesses, the Basel Committee on Banking Supervision
(BCBS) published the Basel III Norms in December 2010 with the aim of
strengthening the quality of bank’s capital bases and increasing the
required level of regulatory capital.
• In addition, the BCBS instituted more stringent disclosure requirements.
• According to Basel Committee on Banking Supervision- “Basel III is a
comprehensive set of reform measures, developed by the Basel
Committee on Banking Supervision, to strengthen the regulation,
supervision and risk management of the banking sector”

• The guidelines aim to promote a more resilient banking system by

focusing on four vital banking parameters – Capital, Leverage,
Funding and Liquidity.
Capital
• A bank’s Tier 1 and Tier 2 minimum capital adequacy ratio (including
the capital conservation buffer) must be at least 10.5% of its
Risk-weighted Assets (RWAs). That combines the total capital
requirement of 8% with the 2.5% capital conservation buffer.
• The capital adequacy ratio is calculated by its risk-weighted assets.
The capital used to calculate the capital adequacy ratio is divided into
two tiers: CAR = Tier 1 Capital + Tier 2 Capital/ Risk Weighted Assets.
• In addition, banks have to maintain a capital conservation buffer of
2.5%. Counter- cyclical buffer is also to be maintained at 0-2.5%
• Capital Conservation Buffer: It was introduced to ensure that banks
have an additional layer of usable capital that can be drawn down
when losses are incurred.
• Counter-Cyclical Buffer: The purpose of it is to ensure that banks
build up capital buffers during normal times (i.e., outside period of
stress) which can be drawn down as losses are incurred during a
stressed period/down cycles.
Leverage
• The leverage rate has to be at least 3%. The leverage rate is the ratio
of a bank’s tier 1 capital to average total consolidated assets. Tier 1
capital are those assets that can be easily liquidated if a bank needs
capital in the event of a financial crisis.
• The Tier 1 leverage ratio is thus a measure of a bank’s near-term
financial health.
• The Tier 1 leverage ratio is frequently used by regulators to ensure
the capital adequacy of banks and to place constraints on the degree
to which a financial company can leverage its capital base.
Funding and liquidity
• Basel III created two liquidity ratios: LCR and NSFR
• The Liquidity Coverage Ratio (LCR) will require banks to hold a buffer
of high-quality liquid assets sufficient to deal with the cashflows
encountered in an acute short term stress scenario as specified by
supervisors.
• This is to prevent situations like “Bank run”. The goal is to ensure that
banks have enough liquidity for a 30-days stress scenario if it were to
happen.
Bank Run: It occurs when a large number of customers of a bank or
other financial institution withdraw their deposits simultaneously over
concerns of the bank’s solvency. As more people withdraw their funds,
the probability of default increases, prompting more people to
withdraw their deposits.

LCR = Stock of high quality liquid assets/ Total net cash flows over the
next 30 calendar days.
• Net Stable Funding Ratio (NSFR) - The Net Stable Funding Ratio
(NSFR) requires banks to maintain a stable funding profile in relation
to the composition of their assets and their offbalance-sheet
activities.
• NSFR requires banks to fund their activities through stable sources of
finance (reliable over the one-year horizon).
• A sustainable funding structure is intended to reduce the likelihood
that disruptions to a bank’s regular sources of funding will erode its
liquidity position in a way that would increase the risk of its failure
and potentially lead to broader systemic stress
• The minimum NSFR requirement is 100%. Therefore, LCR measures
short-term (30 days resilience) and NSFR measures medium-term (1
year) resilience.
• NSFR = Available Stable Funding / Required Stable Funding

The Basel III capital regulations have been implemented in India since
1st April 2013 in a phased manner
Non-performing Assets
A nonperforming asset (NPA) is a
debt instrument where the
borrower has not made any
previously agreed upon interest
and principal repayments to the
designated lender for an extended
period of time. The
nonperforming asset is, therefore,
not yielding any income to the
lender in the form of interest
payments.
Non-Performing Assets
• NPA expands to non-performing assets (NPA). Reserve Bank of India
defines Non Performing Assets in India as any advance or loan that is
overdue for more than 90 days.
• “An asset becomes non-performing when it ceases to generate
income for the bank,” said RBI in a circular form 2007.
Types/Categories of Non-Performing Assets
• Standard assets
• It is a performing asset that generates constant income and pays back the loans before the due date.
Therefore, these assets have a reasonable risk and are not considered as NPAs.

• Sub-standard asset
• A non-performing asset that is overdue for less than or equal to 12 months is a Sub-standard asset.

• Doubtful assets
• It is an asset that has remained NPA for more than 12 months.

• Loss Asset
• An asset that remains a non-performing asset for more than 3 years, with less than 10% of the amount
is a loss asset. This occurs when a bank faces total loss as it cannot recover the asset.
NPA Provisioning
Provisioning is a method that banks employ to maintain a healthy
book of accounts. Apart from technicalities, it is the primary
responsibility to make adequate provisions for any drop in the
value of loan assets. In a particular quarter, banks set aside a
specific amount of profits for non-performing assets that may turn
into losses in the future. The provisioning also varies from bank to
bank.
Sub-Standard Assets
• Substandard assets are loans that have not been paid back for a short
time, usually less than a year. According to the rules of India’s central
bank, the RBI, if someone hasn’t paid their loan for more than 90
days, banks call it a ‘substandard’ loan. These loans are risky because
the borrower has started missing payments.
• Though banks believe they can get back the money from these loans,
they keep aside a small portion (15%) of the loan amount just in case
they can’t. To get their money back, banks work hard, regularly
checking in with borrowers. If the loan remains unpaid for a full year,
it becomes even more doubtful for banks to get their money back.
Doubtful Assets
• Doubtful assets are loans that haven’t been paid back for over a year.
The RBI, India’s central bank, says that if a loan isn’t paid for a year
after being labeled ‘substandard’, it’s called ‘doubtful’. As more time
passes without payment, banks keep more money aside, expecting
they might not get back the full amount: they keep 20% for 1-2 years,
30% for 2-3 years, and all of it (100%) if it’s unpaid for more than 3
years.
• These loans are very risky, and banks don’t expect to get all their
money back. So, banks keep a close eye on these loans and
sometimes even plan steps to get some money back. But if they still
don’t receive any payment, they consider the loan a complete loss.
Loss Assets
Loss assets are loans that banks believe they can’t get back at all. If the
bank thinks they can only recover less than 10% of a loan, they call it a
‘loss asset’ as per the RBI rules. The bank then sets aside the full
amount of that loan, meaning they expect not to get any of it back.
This is called “writing off” the loan.
Although the bank counts the loan as a total loss, they might still try to
get some money back legally, even if the chances are very slim. Simply
put, loss assets are loans where the bank has given up hope of getting
their money back.
Gross and Net NPA /NPA Absolute Number
• A higher number of NPAs indicates the dysfunctionality of loans and a
decrease in the income of the banks.
• GNPA: GNPA stands for Gross Non-Performing Asset. This number denotes
the total value of NPA in a quarter or a financial year. It is obtained by adding
all the principal amount and interest on that amount.
• NNPA: NNPA is Net Non-Performing Asset. The provision made by the bank is
deducted from the GNPA. It is the exact value obtained after the bank has
made provisions for it.
NPA Ratio
•This ratio denotes the total percentage of the
unrecoverable total advances. Amounts advanced are
the total outstanding amount.
•GNPA Ratio: It is the ratio of Gross NPA to Gross Advances
•NNPA Ratio: It is the ratio of Net NPA to Net advances
 Difference b/w GNPA and NNPA
Basis for Gross NPA Net NPA
Difference
Meaning Sum of Loans defaulted Default loans – Provision
for default
(Substandard + Doubtful + Loss) assets Net NPAs = Gross NPAs –
Provisions
Default Period Ninety days Immediately
Actual Loss Not Actual loss It is Actual loss
Causes Poor Government Policies, Low Provision for unpaid
Industrial Sickness, willful defaults, debts
ineffective recovery
tribunals, Natural Calamities etc.

Effects Company Goodwill Profitability and Liquidity

Impact of NPA
• From the shoes of the banks
• Due to higher NPA rates, banks will suffer significant revenue losses that will
potentially affect their brand image.
• Also, due to insufficient funds, banks will have to increase the interest rates
on loans to maintain their profit margin.
• From the shoes of the borrowers
• Banks will be suspicious in sanctioning loans to a borrower whose accounts
are already under NPA.
• It will greatly have a negative impact on the brand image of the borrowers.
Scenario
• Mr. A pledged gold and took a loan. Mr. A did not make the payment
for more than 90 days, banker followed certain steps to recover the
loan. Banker could not get either interest nor principal amount.
• You being a banker say HDFC, what are the steps you are going to take to
recover the loan.
• What is the necessity for banks to take steps to recover loan? Why bank does
this?
• If loan is not recovered, whats your final step to solve the issue?
SARFAESI ACT 2002
The SARFAESI Act full form is – “Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest Act”. The
SARFAESI Act allows banks and other financial institutions for
auctioning commercial or residential properties to recover a loan when
a borrower fails to repay the loan amount. Thus, the SARFAESI Act,
2002 enables banks to reduce their Non-Performing Assets (NPAs)
through recovery methods and reconstruction.
SARFAESI ACT 2002
• SARFAESI allows banks and financial institutions to auction properties when
the borrowers fail to repay their loans.
• Upon loan the banks can seize the securities without intervention of the
court (except agricultural land)
• SARFAESI is effective only for secured loans where banks can enforce the
underlying security
• It enables banks to reduce their Non Performing Assets (NPAs) by adopting
measures for recovery or reconstruction.
• The act also provides for the establishments of Asset Reconstruction
Companies (ARCs) regulated by RBI to acquire assets from banks and
financial institutions
SARFAESI ACT 2002
• It also provides the sale of financial assets by banks and financial
institutions to asset reconstruction companies.
• The Act stipulates four conditions for enforcing the rights by a
creditor:
• The debt is secured
• The debt has been classified as an NPA by the banks
• The outstanding dues are one lakh and above.
• The security to be enforced is not an Agricultural land.
• The borrowers can at any time before the sale is concluded, remit the
dues and avoid losing the security.
Methods of Recovery under SARFAESI Act
Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest Act

• Securitisation
• Securitization is the process of issuing marketable securities backed by a pool of
existing assets such as home or auto loans. An asset can be sold after it is converted
into a marketable security. A securitization or asset reconstruction company can
raise funds from only the Qualified Institutional Buyers (QIBs) by forming schemes
for acquiring financial assets.
• Asset Reconstruction
• Asset reconstruction empowers asset reconstruction companies. It can be done by
managing the borrower’s business by selling or acquiring it or by rescheduling
payments of debt payable by the borrower as per the provisions of the Act.
• Enforcement of security without the interruption of the court
• The Act empowers banks and financial institutions to issue notices to individuals
who have obtained a secured asset from the borrower for paying the due amount
and claim to a borrower’s debtor to pay the sum due to the borrower.
SARFAESI ACT 2002
• In case any unhealthy/illegal act is done by the Authorised Officer, he
will be liable for penal consequences.
• The borrowers will be entitled to get compensation for such acts.
• For redressing the grievances, the borrowers can approach the DRT
(Debt Regulatory Tribunal) and thereafter the DRAT (Debts Recovery
Appellate Tribunal) in appeal. The limitation period is 45 days and 30
days respectively
Early Warnings of NPA
• The EWS are those which clearly indicate or show some signs of credit
deterioration in the loan account. They indicate the potential
problems involved in the accounts so that remedial action can be
initiated immediately. In fact most banks have EWS for identification
of potential NPA’s.
• Under the "Early Alert" system, for internal monitoring
purpose, banks may designate a time limit for overdue accounts to
determine the threshold for a proactive intervention - well before the
account becomes NPA. The EWS show or indicate some signs of credit
deterioration in the loan account.
EWS of NPA
• Financial Warning Signals-Default in repayment, continuous Irregularity
in the account, deterioration in working capital or in liquidity, declining
sales compared to precious period., etc.
• Operational Warning Signals-Underutilisation of plant capacity, frequent
labour problems, loss of important customers., etc.
• Managerial Warning Signals-Diversion of funds and poor financial
controls, lack of cooperation from key personnel, undertaking of undue
risks., etc.
• Banking Warning Signals-Frequent request for further loans, delays in
servicing of interest, opening of accounts with other banks., etc.
• External Warning Signals-Economic recession, natural calamities,
introduction of new technology., etc.
Tools for NPA Recovery / Management of NPA
• Lok Adalat
• Usually Lok Adalat is used for settlement of disputes involving account in
‘doubtful’ and ‘loss’ category. This method is proved to be quite effective for
speedy justice and recovery of small loans.
• Debt Recovery Tribunal (DRT)
• This method is used to recover the NPA amounting ₹ 10.00 lacs and above. It
is the special court establishing by central government for the purpose of
bank or any financial institutions recovery. The retired judges of High Court
are appointed as the judges of this court.
Tools for NPA Recovery
• SARFAESI Act
• Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 (also known as the SARFAESI Act) helps for
recovery of NPA without intervention of any court.
• Asset Reconstruction Company (India) Ltd. (ARCIL)
• ARCIL is the first asset reconstruction company (ARC) of India. It is a company
which was set up with the objective of taking over Non Performing Assets
(NPA) from banks or financial institutions and to reconstruct or repack these
assets to make these assets saleable.
Management of NPA
• Robust risk scoring technique to ensure better quality of loans.
• Improving the quality of credit monitoring by designating a separate
credit manager or relationship manager.
• Monitoring EWS and taking immediate appropriate remedial action.
• Knowing a client’s profile thoroughly and preparing a credit report by
paying frequent visits to the client and his business unit.
• Compromise or use various settlement schemes.
 Banking Sector
Reforms

As per recent update in

January 2022, banking
sector reforms in India
have been ongoing for
years, aiming to
enhance efficiency,
transparency, and
resilience. Some key
initiatives includes
• Recapitalization
• The government infused capital into public sector banks to strengthen their
balance sheets and improve lending capacity.
• Asset Quality Review (AQR)
• The RBI conducted AQRs to identify and address non-performing assets
(NPAs) in banks, leading to improved asset quality. NPA’s are improved
through Asset Reconstruction Companies.
• Consolidation
• Merger of several public sector banks was undertaken to create larger
entities with stronger financials and better operational efficiencies.
• Digitalization
• Banks have been encouraged to adopt digital technologies to enhance
customer experience, improve operational efficiency, and facilitate financial
inclusion.
• Governance reforms
• Measures have been taken to improve corporate governance practices in
banks, including appointing professional management and enhancing
transparency.
• Regulatory changes
• The RBI has introduced various regulatory measures to strengthen the
banking sector's stability and resilience, such as revised capital adequacy
norms and guidelines on risk management.
Banking Ombudsman
The Banking Ombudsman is a
quasi-judicial authority that the
Government of India created in 2006 to
resolve customer complaints about bank
services. The Reserve Bank of India (RBI)
appoints a senior official to serve as the
Banking Ombudsman for three years,
with the possibility of a two-year
extension up to the age of 65. The
Banking Ombudsman is responsible for
addressing customer complaints about
shortcomings in banking services.
Banking Ombudsman
As of January 2024, there are 22 Banking
Ombudsmen, with offices located
primarily in state capitals. The RBI has
established a centralized receipt and
processing center in Chandigarh for
receiving and initially processing
physical and email complaints in any
language.
You can lodge a complaint with the
Banking Ombudsman online. The
scheme defines "deficiency in service"
as the basis for filing a complaint.

https://rbi.org.in/Scripts/Complaints.asp
x
Banking Ombudsman – Role and Functions
• Resolving Customer Complaints
• The primary function of a banking ombudsman is to resolve disputes between
customers and their banks or financial institutions. This includes investigating
complaints thoroughly and impartially to determine whether the bank has acted
unfairly or negligently.
• Mediation and Conciliation
• Ombudsmen facilitate communication between the customer and the bank,
attempting to find a mutually acceptable solution through mediation or conciliation.
They provide a neutral third-party perspective to help both parties reach a
resolution.
• Investigation
• Ombudsmen have the authority to investigate complaints independently, gathering
evidence and information from both the customer and the bank. This may involve
reviewing documents, conducting interviews, and analyzing relevant data to assess
the merits of the complaint.
Banking Ombudsman – Role and Functions
• Issuing Recommendations or Decisions
• Depending on the jurisdiction, banking ombudsmen may have the power to
issue recommendations or binding decisions to resolve disputes. These
decisions may include ordering the bank to compensate the customer for
financial losses, rectify errors, or change their policies or practices.
• Providing Guidance and Advice
• Ombudsmen often offer guidance and advice to customers on their rights and
responsibilities regarding banking services. This may include educating
customers about their contractual obligations, how to avoid common banking
pitfalls, and the avenues available for resolving disputes.
Banking Ombudsman – Role and Functions
• Monitoring and Reporting
• Ombudsmen may also monitor trends in customer complaints to identify
systemic issues within the banking industry. They may publish reports and
recommendations to regulators and policymakers to improve banking
practices and consumer protection measures.
• Promoting Consumer Awareness
• Ombudsmen play a role in promoting consumer awareness about their rights
and avenues for seeking redress. They may conduct outreach activities, such
as public awareness campaigns, to inform consumers about the services they
provide and how to access them.