Banking Sector - Origin & Development

BANKING SECTOR –
ORIGIN & DEVELOPMENT
P.K.Mishra
Executiv Director (Retd.)
Reserve Bank of India
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Banking - Origins
 The word Bank is of German origin cognate with
“Banque” (French) and “Banca” (Italian)
meaning bench
 Drawn from the practice of Jewish money-
changers of Lombardy, Italy, doing business
sitting on a bench in the market place
 Banking is in vogue since time immemorial.
Earliest evidences are from around 2000 BC in
the famous temples of ancient Greece
 Banking attained full development in Greece and
Rome
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Banking – Origins ….
 Earliest example of a private commercial bank in the
modern age is “Banco della Plazza di Rialto” set up in
1587 in Venice.
 Growth of such private banks which became part of
fabric of commercial life led to development of National
Banks – earliest example is Bank of Sweden, 1668
 Bank of England, originally a joint stock company, began
its existence in 1694. It became a Central Bank in 18th
Century by acting as Banker to the Government, Banker
to other London Banks and Lender to banking and other
institutions
 Bank of Scotland was founded in 1695
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Banking – Origins ….
 Paper Currency was first issued by
Stockholm Banco in 1661
 Lloyds Bank started in 1765, it became
Lloyds Bank Ltd. In 1889
 Britain followed the Branch Banking
System in 1828
 US follows the Unit Banking System
 First Bank set-up in US was Bank of North
America, Philadelphia in 1781.
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Indian Banking Sector - Origins
 Very old – references can be seen in Manu
Smriti
 In 1770 first bank named “Industan” was
started by M/s. Alexandura & Co.
 1773: General Bank of Bihar & Bengal was
established
 1806:First Presidency Bank – Bank of
Bengal was established
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 1840: Second Presidency Bank – Bank of
Bombay was established
 1843: Third Presidency Bank – Bank of
Madras was established
 Presidency Banks were acting as Central
Banks : Government business, issuing
notes
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 1921: All the 3 Presidency Banks were
amalgamated to form Imperial Bank of India
 Imperial Bank was the sole Banker to the
Government of India, Banker to banks,
Managing Public Debt, conduct clearing
 1926: Royal Commission on Indian Currency &
Finance (Hilton-Young Commission) suggested
the creation of Reserve Bank of India
 1934: RBI Act was passed
 1935:1st April, RBI was inaugurated
 1949: RBI was Nationalised
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 1955: SBI Act was passed
 Purpose of converting Imperial Bank to
State Bank of India was “The extension of
Banking facilities on a large scale, more
particularly in the rural and semi-urban
areas and for diverse other public
purposes”
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Indian Banking Sector –
Development - Nationalisation
 1967: Government considered far-reaching
changes to the banking Industry
 1968: Banking Laws (Amendment) Act was
passed to bring about Social Control
 Not less than 51% of Board of Directors of a
bank had to be persons with special
knowledge/experience in matters such as
Accounting, Agriculture, Rural Economy,
Banking, Co-operation, Economics, Finance, Law
and Small Scale Industry
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 19th July 1969: By an ordinance nationalised
14 major Indian Commercial Banks having
deposits of Rs. 50 crore and more.
Subsequently 5 more banks were nationalised.
 Objective: To sub serve national priorities like
ensuring rapid growth in Agriculture, Small
Scale Industry, Exports, Raising of
employment levels, encouraging new
entrepreneurs, development of backward areas
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 Concept of Social Banking started with a
view to establish socialist pattern of
society by reducing inequalities of income
and wealth in the country
 Requirements of economically weaker
sections were considered by relaxing
criteria for margin/security/profitability to
achieve social and national objectives
 Branch Expansion
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Development
 1969 – HISTORICAL DECISION
 RESULTED IN BANKS BECOMING SICK
 Reasons
• Monopoly- No competition
• Excessive recruitment
• Employees considering as Govt. employees
• Decline in work culture and Customer service
• Trade Unionism
• Misuse of PSBs by Govt. for political gains – Loan Melas,
various urban & rurla schemes for vote catching
 Resulted in huge NPAs in banks
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Development
 1990 – BALANCE OF PAYMENT CRISIS
 1991- New Industrial Policy announced
 1992 – OPENING UP OF INDIAN
ECONOMY- CLOSED ECONOMY
 ENTRY OF FIIs- FDI IN VARIOUS
SECTORS-INTEGRATION OF FINANCIAL
MARKETS
 MORE PLAYERS- PRIVATE & FOREIGN
BANKS-MUTUAL FUNDS
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Challenges
 TWO TYPES OF CHALLENGES
EXTERNAL
INTERNAL
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Challenges
 EXTERNAL CHALLENGES -
 TWO TYPES
 MARKET DRIVEN CHALLENGE
 CHALLENGE THROWN BY
REGULATOR
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Challenges – Market Driven
 INCREASED COMPETITION
 NEW BANKS –PRIVATE & FOREIGN
 MUTUAL FUNDS
 FIIs
 NEW PLAYERS AFECTING MARKET SHARE
 SPREADS & PROFITABILTY
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Challenges
FUNDS MANAGEMENT
 EFFICIENCY IN FUNDS
MANAGEMENT
 COST OF FUNDS-MINIMISE
 TRANSACTION COST
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Challenges
 ESTABLISHMENT COST
 STAFF COST –INCREASE
PRODUCTIVITY
 RECYCLINGOF FUNDS-
CONTINOUS
 MECHANISATION
 REDUCTION IN NPAs
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Challenges
MEETING DEMANDS OF
CUSTOMERS
 DOOR-STEP BANKING
 INTERNET BANKING
 RETAIL BANKING
 GOOD SERVICE
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Challenges
ECONOMY
 SECTORAL FUNDING
 AGRICULTURE/PRIORITY
SECTOR
 GOVT.SPONSORED SCHEMES
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Challenges
SOCIETY
 CORPORATE GOVERNANCE
 TRANSPARENT POLICY
 GOOD ETHICAL STANDARDS
 OPEN BALANCE SHEET
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Challenges
SYSTEMIC RISK
 MADHAVPURA BREAKDOWN
 RISKS-CREDIT,LIQUIDITY &
OPERATIONAL
 BETTER RISK MANAGEMENT
 SYSTEMS TO BE PUT IN PLACE
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Challenges-Regulator
 PRUDENTIAL NORMS
 INCOME RECOGNITION
 CAMELS
 BASEL II – 3500 CRORES
NEEDED BY BANKs
 RISK BASED INTERNAL AUDIT
 RISK BASED SUPERVISION
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Challenges
 Management Information System
• Importance of factual and correct
reporting
• Criticality: As money is involved
• Enabler to take future decisions
• Tool to take corrective steps
• To fulfill the compliance and regulatory
needs
• For the purpose of accountability
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Challenges
 Audit & Internal Control Management
 Risk Based Supervision – Risk Based Intrnal Audit
 Concurrent Audit, Revenue Audit, Internal Inspections
 Regulatory Audit: RBI’s Annual Finacial Inspection, Offsite
Monitoring And Surveillance Systems (OSMOS)
 Statutory Audit : for the purposes of Balance sheet audit
 Vigilance Mechanism
 Setting up an Independent Vigilance mechanism under the guidance
of CVC- to safeguard public money/wealth
 Preventive vigilance
 Spirit fostered : No man is above the law
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Challenges
 INTERNAL CHALLENGES
 STRENGTHEN THE BANKS
 QUALITY OF HUMAN RESOURCE
 MANAGEMENT OF KNOWLEDGE & SKILL
 NEED FOR CONTINUOUS TRAINING
 CHANGE IN MENTAL ATTITUDE-TEAM
WORK
 TO LEAD RATHER THAN BE LED
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Challenges
 Motivational steps to keep the employees
oriented/focused towards corporate objectives
 Corporate vision/mission
 Well laid out training infrastructure/ practices
 Rewards in the form of promotions, recognition/
incentives/deputation overseas/external training/
sight-seeing etc.
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Banking Sector - Reforms
 The Narasimham Committee
 The banking sector reforms in 1990 were
based on the report of the committee
headed by Shri M.Narasimham, ex-
Governor of Rserve Bank of India in 1991
 Major recommendations of the committee
were as follows:
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 ( 1) There should be no bar to new banks being
set up in the private sector, provided they have
the start up capital and other requirements
prescribed by the RBI
 ( 2) The government should indicate that there
would be no further nationalisation of banks and
there should not be difference in treatment
between public sector banks and private sector
banks
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 (3)The banking system should evolve towards a
broad pattern consisting of three or four large
banks including the State Bank of India which
could become international in character,
• (4)Eight to ten national banks with a network of
branches throughout the country engaged in
universal banking;
• (5)Local banks whose operations would be
generally confined to a specified region; and
lastly rural banks to cater to rural areas
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Local Area Banks
 Only four LABs are functioning at present. These are,
 Coastal Local Area Bank Ltd. established on 27th December 1999 with an
area of operation comprising three contiguous districts viz. Krishna, Guntur
and West Godavari with its head office at Vijayawada (Andhra Pradesh),
 Capital Local Area Bank Ltd. established on 14th January 2000 with its area
of operation comprising three districts viz. Jalandhar, Kapurthala and
Hoshiarpur with its head office at Phagwara (Punjab),
 South Gujarat Local Area Bank Ltd., established on 3rd October 2000 with
an area of operation comprising three contiguous districts viz. Navsari,
Surat and Bharuch with its head office at Navsari (Gujarat),
 Krishna Bhima Samruddhi Local Area Bank Ltd.established on 28th February
2001 with an area of operation comprising three contiguous districts of
Mahbubnagar in Andhra Pradesh and Raichur and Gulbarga in the state of
Karnataka with its head office at Mahbubnagar(Andhra Pradesh).
 The licence of Vinayak Local Area Bank Ltd., Sikar (Rajastan) established on
21st October 2000 was cancelled by Reserve Bank on 16th January 2002 as
major irregularities were noted in its functioning.
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 (6) There should be an Assets Reconstruction Fund
(ARF) which could take over from the banks and
financial institutions a portion of their bad and doubtful
debts at a discount, the level of discount being
determined by independent auditors on the basis of
clearly defined guidelines
• The ARF should be provided with special powers for
recovery, somewhat broader than those contained in
sections 29 to 32 of the State Financial Corporations Act,
1951
• The capital of ARF should be subscribed to by the public
sector banks and financial institutions
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 (7) The banks and financial institutions should
be authorised to recover bad debts through the
special tribunals and based on the valuation
given in respect of each asset by a panel of at
least two independent auditors
 (8) The public sector banks with profitable
operations should be allowed to tap the capital
market for enhancement of their share capital
• Subscribers to such issues could be mutual
funds, profitable public sector undertakings
(PSUs) and the employees of the institutions
besides the general public
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 (9) Branch licensing should be abolished and the
option of opening branches or closing branches
other than rural branches should be left to the
commercial judgment of the individual banks
 (10) There should be phased reduction of CRR
and SLR
 (11) Banks should adhere to prescribed Capital
Adequacy Ratio (CAR) and should attain a CAR of
8% by 1998
 SLR – Section 24 of B.R.Act
 CRR – Section 42 of RBI Act
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 (12) A board for financial supervision should
be set up to oversee the operations of the
banks
 (13) Banks should conform to prudential
income recognition norms of provisioning
against bad and doubtful debts and ensure
transparency in maintaining balance sheets
 (14) There should be speedy
computerisation of the banking industry
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 (15) Foreign banks should be subjected to the
same requirements as applicable to Indian banks
and RBI policies should be more liberal in
respect of allowing the foreign banks to open
branches or subsidiaries
 (16) Joint ventures between foreign banks and
Indian banks should also be permitted
particularly in regard to merchant banking,
investment banking, leasing, insurance and
other newer forms of financial services
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 (17) Priority sector lending by banks should be
reduced from 40% to 10% of their total credit.
 (18) The committee recommended phasing out
of concessional interest rates
 (19) It was of the view that the present
structure of administered interest rates was
highly complex and rigid and proposed that
interest rates be further deregulated so as to
reflect emerging market conditions
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 Most of the recommendations of the
committee have since been implemented
 Meanwhile, keeping in view the changing
global scenario after the setting up of the
WTO, rising NPAs and the need for more
efficient, competitive and broad based
banking sector, the government set up
another committee, once again headed by
Shri Narasimham in 1998
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 The Narasimham Committee II
 The Narasimham Committee in its second report
on banking sector reforms, submitted in April
1998, made a series of sweeping
recommendations which are being used as a
launching pad to take Indian banking into future
 The report covers an entire gamut of issues
ranging from bank mergers and the creation of
globalised banks to bank closures, recasting
bank boards and revamping banking legislations
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 The major recommendations of the
committee are:
 (1) Concept of ‘narrow banking’ should be
tried out to rehabilitate weak banks.
• Narrow banking, according to the committee,
implies that weak banks should not be
permitted to invest their funds anywhere
except in government securities as these
were absolutely safe and risk-free.
• If this was not successful, the issue of
closure should be examined
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 (2) Two or three large Indian banks should be
given an international character.
 (3) Small local banks should be confined to
states or a cluster of districts in order to serve
local trade, small industry and agriculture.
 (4) The committee has also commented on the
government’s role in public sector banks by
observing that government ownership has
become an instrument of management. Such
micro-management of banks is not conducive to
the enhancement of autonomy and flexibility.
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 (5) Functions of boards and management need
to be reviewed so that the boards remain
responsible for enhancing shareholder value
through formulation of corporate strategy
 (6) There is a need to review minimum
prescriptions for capital adequacy. In this regard
the committee recommended that minimum CAR
be raised to 10% by 2002. Most of the banks
have a CAR of 11% or higher
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 (7) The committee also felt a need to lay
down prudential and disclosure norms and
sound procedures for the purpose of
supervision and regulation.
 (8) There should be an integration of
NBFC’s lending activities into the financial
system.
 (9) There is a need for public sector banks
to speed up computerisation and focus on
relationship banking.
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 (10) A review of recruitment procedures,
training and remuneration policies in public
sector banks should be carried out.
 (11) Threat of action by vigilance and other
investigative authorities, even in the case of
commercial decisions creates low morale. The
committee recommended that this issue be
addressed in right earnest.
 (12) Need for professionalising and depoliticising
of bank boards.
 (13) The Banking Service Recruitment Boards
should be abolished
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 The RBI has taken steps to implement many of
the recommendations of the Narasimham
Committee II.
 It has raised the CRAR from 8% to 9% effective
from the year end 31 March, 2000.
 With a view to further improve the quality of the
assets portfolio and enhancing the financial
soundness of banks, income recognition and
provisioning norms on government guaranteed
advances have been brought at par with those
on other advances.
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 In a measure aimed at further strengthening
the inherent strength of banks balance sheets,
provisioning requirements have been
introduced for standard assets.
 Regarding government securities, RBI has laid
down that government-approved securities will
have to provide a risk-weight of 2.5%
 Government is planning to reduce its
shareholding in nationalised banks from 51%
to 33%
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 Banks now have to classify a minimum 75% of
their investments in approved securities as
current investments.
 This has been done with a view to adopt
prudent accounting standards
 It has also been decided that a bank’s or a
financial institution’s investment in tier II bonds
issued by other banks will be subjected to a
ceiling of 10% of the bank’s or financial
institution’s total capital
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 This was decided after it was observed that there
was a high level of cross holding of debt
instruments relating to tier II capital of banks and
financial institutions themselves without there
being any real accretion of capital to the financial
system.
 According to RBI guidelines, many banks have set
up Asset Liability Management (ALM) systems
 The purpose of ALM guidelines is mainly to
strengthen the management information system
(MIS) within the banks to sensitise them to the
market risk assumed by them.
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Banking Sector – Trends &
Progress
 The Narasimham Committee II defined a “weak
bank” as one whose accumulated losses and
NPAs exceed its net worth or whose adjusted
operating profits (operating profit less income
on recapitalisation bonds) was negative for three
consecutive years.
 Based on these, the Verma Committee on
Restructuring of Weak Banks set up by the RBI
in February 1999 identified three banks as weak
banks.
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Progress
 The Verma Committee which submitted its
report in October 1999 had itself identified
seven parameters covering three areas for
classifying a bank as weak:
1. Solvency (Capital Adequacy Ratio and Coverage
Ratio)
2. Earning Capacity (return on assets and net
interest margin)
3. Profitability (ratio of operating profit to average
working funds, ratio of cost to income and ratio of
staff cost to net interest income plus all other
incomes)
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Progress
 The process of reforms in the banking sector has
been continuing so as to enhance the efficiency
and competitiveness of the sector
 As a result of these reforms, two of the three
identified weak public sector banks viz. UCO
bank and UBI have turned around and started
making profits. The third bank viz. Indian Bank
also turned around.
 However, a major problem that still haunts the
banking sector is the growing proportion of
NPAs of banks.
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Progress
 Based on the recommendations of both the
Narasimham Committee I & II and the Verma
Committee, the following measures have been
taken to address the problems of the banking
sector:
1. More and mere DRTs and appellate tribunals
(ATs) have been set up to facilitate expeditious
adjudication and recovery of banks and financial
institutions. Accordingly, comprehensive
amendments have been carried out in the
recovery of debts due to the Banks and Financial
Institutions Act, 1993, by issue of an ordinance
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Progress
2. A Credit Information Bureau has been set
up to curb the growth of fresh NPAs.
3. Changes in the legislative provisions have
been made to accord necessary flexibility
and autonomy to the boards of banks to
enable them to take decisions on corporate
strategy and be responsible to the
shareholders, customers, employees and
the public at large
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Progress
4. More powers have been provided to DRTs for
recovery of bad debts. Also in an all out effort
to clean up the balance sheet of banks, the
RBI formulated guidelines to facilitate recovery
of loans of Rs.10 crore or less. In case of big
borrowers of over Rs. 10 crore, the
government has empowered bank chiefs to
crack the whip
5. In order to reduce the staff cost of public
sector banks, the government also introduced
the VRS for the banking sector
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Progress
6. Transparent guidelines have been
formulated for bank’s investment in
shares and financing of equities.
7. The banking service recruitment boards
have been abolished. Accordingly, banks
have been advised to frame their own
recruitment strategies, with the approval
of the respective boards to meet future
requirements.
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Progress
8. As many as 38 DRTs and 5 ATs have
been set up so far
9. Banks have set up separate recovery
departments
10. Legal cells of banks have been
strengthened
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RBI Guidelines for New Banks
 Background
 Based FM’s budget speech & RBI’s Annual Policy
Statement for 2010-11,
a discussion paper on “Entry of New Banks in the
Private Sector” was placed on RBI website on
August 11, 2010 “Entry of New Banks in the Private
Sector” was placed on RBI website on August 11,
2010
 After seeking comments from various agencies the
final guidelines were issued on December 23, 2010
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 On August 1 2016 the Reserve Bank of India (RBI)
issued revised guidelines for the at-will licensing of
universal banks in the private sector (the licensing
guidelines) which, for the first time, will allow applicants
to apply for a banking licence from the RBI at will.
 Previously, the RBI invited applications only during
specified windows. Under the block licensing regime, the
RBI issued 10 bank licences in 1993, two bank licences
in 2001 and, most recently, two bank licences in 2013
under the 2013 licensing guidelines (2013 licensing
guidelines).
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 Key features
 The licensing guidelines prescribe detailed
guidelines for new banks in respect of, among
other things:
 eligible promoters;
 corporate structures;
 shareholding (including foreign investment
limits); and
 decision-making procedures.
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 Below are the key features of the guidelines.
 Eligible promoters
 Both individuals (with 10 years of experience in banking
and finance at a senior level) and corporate entities are
eligible to promote banks under the licensing guidelines.
Private entities and groups (which are "owned and
controlled by residents") and non-banking financial
companies (NBFC) (which are "controlled by residents")
with a successful 10-year track record are also eligible to
promote banks. Further, NBFCs can convert into banks.
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 NBFCs cannot apply for a banking licence if:
 they are part of a business group that has total
assets of Rs 50 billion or more; and
 the non-financial business of the group is more
than 40% of its total assets (in terms of gross
income).
 Large industrial groups therefore cannot apply
for a banking licence.
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 Corporate structure
 Promoters that have other group entities must set up and
hold the bank through a non-operative financial holding
company (NOFHC). The NOFHC will be a RBI-registered NBFC
and hold the promoter's banking and non-banking businesses
separately to ring-fence the bank and other financial service
entities of the group from other group entities.
 Unlike the 2013 licensing guidelines – under which banks had
to be set up by individuals or standalone promoting or
converting entities with no other group entities – banks need
not be set up through an NOFHC.
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 Promoter equity
 At least 51% of the equity share capital of the NOFHC must
be held by the promoter or promoter group.
 At least 51% of the equity share capital of the NOFHC must
be held by the promoter or promoter group.
 The licensing guidelines provide that apart from the bank, the
Non-operating Finance Holding Company (NOFHC) is
not permitted to set up a new financial services entity for at
least three years from the date on which the NOFCH's
business was commenced (aside from the existing financial
services companies held by the NOFHC).
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 Bank capital
 Banks must have a minimum paid-up
share capital of Rs 5 billion and thereafter
maintain a net worth of at least Rs 5
billion at all times.
 Banks must also list their shares within six
years of commencing business.
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 Shareholding pattern
 The promoters or NOFHC must hold a minimum of 40%
of the paid-up voting equity capital of the bank for five
years from the date on which the bank's business was
commenced. Shareholding by promoters or an NOFHC in
the bank must be reduced over time.
 Only the promoters can hold more than 10% of the
paid-up voting equity capital of the bank for the first five
years. The licensing guidelines expressly require banks
to be controlled by Indian residents at all times.
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 Foreign direct investment
 Foreign direct investment is permitted in a
new bank as per the existing foreign
investment rules (ie, up to 49% under the
automatic route and up to 74% with
government approval).
 However, this is subject to the restrictions on
promoter shareholding prescribed under the
licensing guidelines.
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 Corporate governance, prudential
and exposure norms
 Banks must comply with the RBI's corporate
governance norms (ie, with respect to the
composition of the board of directors and
committees).
 Banks must also comply with the RBI's
directions on prudential norms, exposure
norms and asset classification.
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 Application process
 Applications will be considered by a standing expert
advisory committee (consisting of external experts in
banking or finance) which will then be referred to an
internal screening committee (consisting of the governor
and deputy governors of the RBI) before being
recommended to the committee of the RBI central board
for an 'in-principle' approval.
 The in-principle approval is valid for 18 months, within
which time the promoter must apply for final approval.
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 Comment
 In its discussion paper issued in August 2013, the RBI recognised
the need for "reviewing the current 'Stop and Go' licensing policy"
and "adopting a 'continuous authorisation' policy", which the RBI
noted keeps competitive pressure on existing banks.
 The block licensing regime lead to an artificial shift in the value of
banking licences, and did not always give applicants adequate time
to think through the commercial aspects of banking licences.
 The at-will regime will lead to increased transparency, better
innovation and more realistic valuations, and is a significant step
towards a healthier licensing regime for new private banks in India.
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 Endnotes
 (1) While the banks licensed in 2001 and 2013 have
continued to operate, of the 10 banks licensed in 1993,
only six continue to operate (either incorporated,
merged with a parent or rebranded).
 (2) Similar to past practices in limiting the ability of large
industrial houses to promote banks, where the entity,
group or the group of which the NBFC is part has total
assets of Rs50 billion or more, the entity will not be
eligible to promote or convert to a bank if the non-
financial business of the group accounts for more than
40% of the total assets or income.
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Small Finance Banks & Payments Banks
 Background
 It may be recalled that in the Union Budget 2014-2015 presented on
July 10, 2014, the Hon’ble Finance Minister announced that:
 “After making suitable changes to current framework, a structure
will be put in place for continuous authorization of universal banks
in the private sector in the current financial year. RBI will create a
framework for licensing small banks and other differentiated banks.
Differentiated banks serving niche interests, local area banks,
payment banks etc. are contemplated to meet credit and remittance
needs of small businesses, unorganized sector, low income
households, farmers and migrant work force”.
1/30/2020 71
Contd…..
 i) Objectives:
 The objectives of setting up of small finance banks will be to
further financial inclusion by (a) provision of savings vehicles,
and (ii) supply of credit to small business units; small and
marginal farmers; micro and small industries; and other
unorganised sector entities, through high technology-low cost
operations.
 The objectives of setting up of payments banks will be to
further financial inclusion by providing (i) small savings
accounts and (ii) payments/remittance services to migrant
labour workforce, low income households, small businesses,
other unorganised sector entities and other users.
1/30/2020 72
Contd….
 ii) Eligible promoters: Resident individuals/professionals
with 10 years of experience in banking and finance; and
companies and societies owned and controlled by residents
will be eligible to set up small finance banks. Existing Non-
Banking Finance Companies (NBFCs), Micro Finance
Institutions (MFIs), and Local Area Banks (LABs) that are
owned and controlled by residents can also opt for conversion
into small finance banks. Promoter/promoter groups should
be ‘fit and proper’ with a sound track record of professional
experience or of running their businesses for at least a period
of five years in order to be eligible to promote small finance
banks.
1/30/2020 73
Contd….
 Existing non-bank Pre-paid Payment Instrument (PPI) issuers; and other
entities such as individuals / professionals; Non-Banking Finance Companies
(NBFCs), corporate Business Correspondents(BCs), mobile telephone
companies, super-market chains, companies, real sector cooperatives; that
are owned and controlled by residents; and public sector entities may apply
to set up payments banks.
 A promoter/promoter group can have a joint venture with an existing
scheduled commercial bank to set up a payments bank. However,
scheduled commercial bank can take equity stake in a payments bank to
the extent permitted under Section 19 (2) of the Banking Regulation Act,
1949.
 Promoter/promoter groups should be ‘fit and proper’ with a sound track
record of professional experience or running their businesses for at least a
period of five years in order to be eligible to promote payments banks.
1/30/2020 74
Contd…
 iii) Scope of activities :
 The small finance bank shall primarily undertake basic banking activities of
acceptance of deposits and lending to unserved and underserved sections
including small business units, small and marginal farmers, micro and small
industries and unorganised sector entities.
 There will not be any restriction in the area of operations of small finance
banks.
 Payment Banks
 Acceptance of demand deposits. Payments bank will initially be restricted to
holding a maximum balance of Rs. 100,000 per individual customer.
 Issuance of ATM/debit cards. Payments banks, however, cannot issue credit
cards.
 Payments and remittance services through various channels.
 BC of another bank, subject to the Reserve Bank guidelines on BCs.
 Distribution of non-risk sharing simple financial products like mutual fund units
and insurance products, etc.
1/30/2020 75
Contd…..
 iv) Capital requirement: The minimum paid-up equity capital for
small finance banks and payments banks shall be Rs. 100 crore. The
payments bank should have a leverage ratio of not less than 3 per
cent, i.e., its outside liabilities should not exceed 33.33 times its net
worth (paid-up capital and reserves).
 v) Promoter's contribution: The promoter's minimum initial
contribution to the paid-up equity capital of such small finance bank
shall at least be 40 per cent and gradually brought down to 26 per
cent within 12 years from the date of commencement of business of
the bank.
 The promoter's minimum initial contribution to the paid-up equity
capital of such payments bank shall at least be 40 per cent for the
first five years from the commencement of its business.
1/30/2020 76
Contd….
 vi) Foreign shareholding: The foreign shareholding in the small finance
bank would be as per the Foreign Direct Investment (FDI) policy for private
sector banks as amended from time to time.
 The foreign shareholding in the payments bank would be as per the Foreign
Direct Investment (FDI) policy for private sector banks as amended from
time to time.
 vii) Prudential norms :
 The small finance bank will be subject to all prudential norms and
regulations of RBI as applicable to existing commercial banks including
requirement of maintenance of Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR). No forbearance would be provided for complying with
the statutory provisions.
 The small finance banks will be required to extend 75 per cent of its
Adjusted Net Bank Credit (ANBC) to the sectors eligible for classification as
priority sector lending (PSL) by the Reserve Bank.
 At least 50 per cent of its loan portfolio should constitute loans and
advances of upto Rs. 25 lakh.
1/30/2020 77
Contd…..
 The payments bank cannot undertake lending activities.
 Apart from amounts maintained as Cash Reserve Ratio (CRR) with
the Reserve Bank on its outside demand and time liabilities, it will
be required to invest minimum 75 per cent of its "demand deposit
balances" in Statutory Liquidity Ratio(SLR) eligible Government
securities/treasury bills with maturity up to one year and hold
maximum 25 per cent in current and time/fixed deposits with other
scheduled commercial banks for operational purposes and liquidity
management.
1/30/2020 78
Contd…..
 ix) Procedure for application: In terms of Rule 11 of the Banking
Regulation (Companies) Rules, 1949, applications shall be submitted
in the prescribed form (Form III) to the Chief General Manager,
Department of Banking Regulation, Reserve Bank of India, 13th
Floor, Central Office Building, Mumbai – 400 001. In addition, the
applicants should furnish the business plan and other requisite
information as indicated. Applications will be accepted till the close
of business as on January 16, 2015. After experience gained in
dealing with small finance banks, applications will be received on a
continuous basis. However, these guidelines are subject to periodic
review and revision.
 This is applicable for both Small Finance banks and Payments
Banks.
1/30/2020 79
Contd…….
 x) Procedure for RBI decisions :
 An External Advisory Committee (EAC) comprising eminent
professionals like bankers, chartered accountants, finance
professionals, etc., will evaluate the applications.
 The decision to issue an in-principle approval for setting up of a
bank will be taken by the Reserve Bank. The Reserve Bank’s
decision in this regard will be final.
 The validity of the in-principle approval issued by the Reserve Bank
will be eighteen months.
 The names of applicants for bank licences will be placed on the
Reserve Bank’s website.
 Applicable to both types of banks
1/30/2020 80
Contd….
 72 applications for Small Finance Banks

and 41 for Payments Banks received so far
by RBI. A panel consisting of the Deputy
Governors and the Governor to scurtinise
the applications. First set of licenses likely
to be issued by end of December 2015
1/30/2020 81
Indian Banking – The Road Ahead
 The future challenges facing the Indian
Banking System can be categorised into three
broad categories viz.
A. Challenges in coping up with the emerging
regulatory and supervisory framework
B. Challenges in meeting the specific needs of the
economy and
C. Challenges in fixing the fault lines in the
system
1/30/2020 82
A. Challenges in coping up with the Emerging
Regulatory and Supervisory Framework
i. Implementation of advanced approaches under
Basel II
 The implementation of the advanced approaches
under Basel II poses several challenges for banks
and the Reserve Bank of India alike.
 The standardized approaches have already been
implemented in India and all the commercial
banks have migrated to the standardized
approach under Basel II framework as of March
2009.
1/30/2020 83
 Migration to the Advanced Approaches is important for
larger banks because it involves adoption of more
sophisticated risk management systems.
 Moreover, there are reputational issues too if large banks
continue with standardized approaches.
 However, the implementation of the advanced approaches
raises several issues relating to development of human
resource skills, technology upgradation, branch
interconnectivity, availability and management of historical
data, robustness of risk management systems, etc.
 Though RBI has set an indicative time schedule for
implementation of the Advanced Approaches, banks’
response has not been encouraging so far. It is high time
for larger banks to seriously upgrade their systems and
skill sets and migrate to the Advanced Approaches.
1/30/2020 84
ii. Migration to Basel III
a) Capital
 Basel II was designed because its predecessor i.e.
Basel I was considered risk insensitive and too
preliminary to cope up with the rapid
developments in the financial sector resulting in
substantial regulatory arbitrage.
 The basic purpose of Basel II was to leverage on
the risk management systems of internationally
active banks and use that for enhanced risk
management architecture and, in the process,
have better measurement of capital
requirements.
1/30/2020 85
 It is ironical that when the crisis took place, Basel II was
either not implemented or just implemented in the
jurisdictions. And yet we have had to leapfrog and go in
for enhancements under Basel II. and Basel III.
 Under Basel III, an assessment of Indian banks in terms
of capital requirements has revealed that,
notwithstanding some issues with a few individual
banks, the system, as a whole, is very well capitalized
and the transition to the revised capital norms of overall
capital adequacy, Tier I component or equity component
would be smooth.
 The stress point, however, would be that banks will be
required to adjust the unamortized portion of Pension
and Gratuity liabilities in the opening balance sheet on
April 1, 2013 on transition to IFRS.
1/30/2020 86
b) Liquidity Management
 The Financial Stability Report (FSR) of the Reserve Bank of
India for the half year ended June 2011 has expressed
concerns over growing reliance of banks on wholesale
funding/ market borrowing to fund assets.
 One reason for such reliance could be the low growth of
deposits not commensurate with the credit growth.
 Such reliance, however, could prove disastrous as evidenced
during the crisis as the wholesale funding sources can dry up
quickly.
 Banks, therefore, have to factor this in their liquidity
management. There, however, remains an issue under Basel
III about the extent to which SLR holdings can be taken into
consideration for the purpose of calculating the liquidity
ratios.
1/30/2020 87
 As the SLR holdings are required to be maintained on an
ongoing basis, these would technically not be reckoned for
liquidity purposes.
 However, it may be reasonable to reckon, under stress
conditions, at least a part of the SLR holdings in calculating
the liquidity ratio, as the SLR holdings are primarily
government bonds against which the Reserve Bank provides
liquidity.
 Further, the major challenge for Indian banks in
implementing the liquidity standards is to develop the
capability to collect the relevant data accurately and
granularly and also to formulate and predict the liquidity
stress scenarios with reasonable accuracy and consistency.
 Given that Indian markets have not experienced the levels of
stress that global markets were subjected to, predicting stress
scenarios is going to require a qualitative judgemental call.
1/30/2020 88
iii) Shadow Banking System – Greater consistency in
regulation
 Another important regulatory challenge is ensuring
“greater consistency in regulation of similar
instruments and institutions performing similar
activity" to prevent or contain regulatory arbitrage.
 In the case of systemically important non-deposit taking
NBFCs (NBFCs-ND-SI), a gradually calibrated regulatory
framework in the form of capital requirements, exposure
norms, liquidity management, asset liability management
and reporting requirements has been extended, which
has limited the space for regulatory arbitrage as
also their capacity to leverage.
1/30/2020 89
 Given the increasing significance of the sector, the
supervisory regime for the systemically important
NBFCs will need to be strengthened further for a
more robust assessment of the underlying risks.
 A Working Group under the former Deputy
Governor, Ms. Usha Thorat on NBFCs has, inter alia,
examined the issues related to the regulatory gaps
and arbitrage opportunities that exist in the system,
and has given recommendations for addressing
these issues as well as for enhanced disclosure
requirements and improved supervisory practices,
etc.
1/30/2020 90
(iv) Other Issues
 The Indian banking system has a modest leverage which provides
comfort.
 The RBI has also been enhancing and fine-tuning its supervisory
processes on an ongoing basis and based on the evolving financial
scenario.
 A revised framework for monitoring of financial conglomerates has
been rolled out since 2009.
 The Financial Stability and Development Council (FSDC) has also
been activated under the aegis of the Government of India for
system level monitoring of build-up of risks and
instability, specifically, risks emanating from the Systemically
Important Financial Institutions (SIFIs) including the financial
conglomerates. This is also expected to enhance coordination
among the financial regulators. However, enterprise wise risk
management processes need to be implemented / strengthened in
the financial conglomerates and SIFIs.
1/30/2020 91
B. Challenges in meeting the specific needs of
the economy
 Indian economy is one of the fastest growing
economies of the world.
 The economy with its varied geography and
demography has specific requirements in order to
traverse to the next orbit and attain its full potential.
 Banks have to gear up to meet such requirements by
redesigning their business strategies. A few of the
most important requirements of the economy are (i)
Financial Inclusion (FI), (ii) Infrastructure Financing
and (iii) Financing of housing and real estate.
1/30/2020 92
C. Challenges in correcting the Fault Lines
(i) Asset Quality
 Non-performing Assets (NPA) have caused some concerns.
 While the rise in NPAs could partially be attributed to the
adverse impact of the global financial crisis, the aggressive
lending stance of banks during the preceding boom period
as also inadequate due diligence and laxity in monitoring of
the loan accounts are also responsible for deterioration in
the asset quality.
 This has been so, especially in case of retail loans. While
the gross NPA ratio declined from 3.30 % at end March
2006 to 2.25% at end March 2011 , mainly due to a
commensurate increase in gross advances; the absolute
amount of gross NPAs increased by Rs.46,669 crore (an
increase of 91%) during FY 2005-06 to FY 2010-11.
1/30/2020 93
 It may be comforting to take refuge under net
NPA figures but the comfort is misplaced.
 Banks need to, not only utilize effectively, the
various measures such as CDR mechanism, One
Time Settlement schemes, Debt Recovery
Tribunals, provisions of the SARFAESI ACT etc.
put in place by RBI and the Government of India
for resolution and recovery of bad loans but also
have to strengthen their due diligence, credit
appraisal and post sanction loan monitoring
systems to minimize and mitigate the problem of
increasing NPAs.
.
1/30/2020 94
(ii) Consolidation
 Mergers and acquisitions (M&A) as a means of
inorganic growth are increasingly being used the
world over to undertake restructuring of leading
business enterprises.
 It is followed as a part of the strategy to achieve
a larger size and faster growth in market share
and reach, and to become more competitive
through economies of scale and scope.
 India does not have larger banks to finance its
huge infrastructural needs and large industrial
projects.
1/30/2020 95
 The structure of the banking system as
recommended by the Narasimham Committee II
consisting, along with medium sized and smaller
banks, of a few large international banks, would
not only meet the financing needs of
infrastructure and large projects and provide the
economies of scale and scope but also leverage
the country’s image as a financial
destination and enable Indian banks to
compete globally in terms of fund mobilisation,
credit disbursal, investment and rendering of
financial services.
1/30/2020 96
 This could be attained through
consolidation. However, while encouraging /
promoting the consolidation route, the need for
competition within the domestic banking sector
should not be overlooked nor the risks and
challenges that emanate from the presence and
operations of large systemically important financial
institutions be ignored.
 While nobody knows what the optimum size in
terms of largeness is, one thing which is very clear
is that banks should refrain from, and regulatory
dispensation should not permit, building complex
structures.
1/30/2020 97
(iii) Corporate Governance Deficit
 Several studies have highlighted the direct relationship
between good governance standards and the
performance and efficiency of an entity.
 This is all the more true in respect of banks, which, in
their fiduciary capacity deal with public money on one
hand and on the other, enjoy government /central bank
support due to their centrality in the overall financial
system.
 The recent crisis has also amply demonstrated how weak
governance framework contributed to the build up to the
crisis through excessive risk taking.
 Transactions in risky and complex products which were
barely understood, neither by the financial entities nor
the customers, was another contributing factor. 98
1/30/2020
 While over the last one decade, the governance
requirements have been considerably enhanced in India,
good governance has to be a continuous and ongoing
process.
 In India we had the “derivatives” episode recently which
was a case of inadequate application of “suitability and
appropriateness” requirements and, consequently, was a
case of governance deficit.
 As such the Board of Directors and the senior
management have a great oversight responsibility in
ensuring that the respective banks lay down robust
compliance culture and corporate governance framework
which is reviewed periodically for its efficacy and
efficiency.
1/30/2020 99
(iv) Information Asymmetry
 Information asymmetry in a multiple banking scenario is a
serious issue.
 A framework for pooling and sharing of credit information
amongst banks had been put in place so as to enable banks
to streamline their credit appraisal framework and also to
instill discipline among the defaulting borrowers.
 The utility of such data, however, hinges inexorably, on its
integrity and timeliness.
 Lapses in sharing of information defeats the very purpose of
such arrangements. Unfortunately this arrangement has not
worked. Banks should strive to make this work. Hopefully
with licenses granted for additional Credit Information
Companies, we expect the system to evolve a robust
information sharing arrangement and further the development
of the banking system.
1/30/2020 100
(v) Product Pricing
 Costing of banking products is an issue which has largely been
escaping serious debate.
 Proper and fair pricing of risks and of banking products is essential
from risk management and customer service perspectives. It can
also enhance competition resulting in passing of the benefits of such
increased competition in terms of lower costs to the ultimate
customer.
 The challenge before banks is to make the best use of technology
and innovation to bring down the intermediation costs while
protecting their bottom lines. The issue of fairness to all classes of
customers is also a very important issue. Today, there are a lot of
complaints from customers about lack of fairness in floating rate
products. Banks need to be sensitive to that. To deal with this
issue, RBI would be setting up a Working Group as announced in
the recent Monetary Policy to look into the appropriate methodology
for pricing of credit.
1/30/2020 101
(vi) Customer Service
 Banking is predominantly a customer oriented business
and good customer service is the key to banks’ growth
and stability. With enhanced competition amongst
banks, customer service becomes the sole differentiating
factor to be leveraged to stay relevant and to forge
ahead in the business.
 However, in pursuit of returns and profits, customer
service is often ignored if not totally forgotten. As the
customer awareness grows, banks would be required to
gear up for providing more efficient and at the same
time, cost effective services leveraging the technological
capabilities. Customer retention is going to be the key
factor for banks, going ahead.
1/30/2020 102
 Recognising the need for revisiting the issue of customer
service in banks, a Committee (Chairman: Shri M.
Damodaran) was constituted by the Reserve Bank in May
2010.
 The Committee looked into the banking services rendered
to retail and small customers and pensioners, structure and
efficacy of the existing grievance redressal mechanism, the
functioning of Banking Ombudsman Scheme, and
possibility of leveraging technology for better customer
service and has recommended steps for improvement.
 The recommendations and the public comments received
thereon are being examined by RBI for implementation.
 Meanwhile, in the recently concluded Ombudsman
Conference, 10 action points were identified, which are
essential to protect the rights of the customers.
1/30/2020 103
(vii) Know Your Customer (KYC)
 Money laundering is a growing menace and it not only poses
serious threat to the stability and integrity of the financial system
but also to the sovereignty and safety of nations worldwide.
 In the coming days, challenges before banks would primarily lie
in saving themselves from the growing threat of money
laundering.
 In India, PMLA was passed in 2002 and it has been aligned with
the FATF recommendations in 2009.
 Further, India has become a member of FATF in 2010. Banks
are being extensively sensitized about money laundering and
KYC norms. KYC discipline assumes critical importance especially
in the light of RBI’s concerted efforts to widen the reach of
banking as part of financial inclusion initiatives. Banks have to
ensure a very high degree of KYC compliance and a very robust
AML regime. Once these standards are achieved, a unified KYC
for banking system could be thought of.
1/30/2020 104
(viii) Risk Management, Technology and HR
Development
 In view of the current dynamic business scenario of
increasing financial sophistication and innovative
financial tools, banks are faced with complex risks.
 Thus, robust enterprise wide risk managements
systems are the fundamental requirement for banks to
be able to survive in the long run.
 Banks with proper risk management systems would
not only gain competitive advantage but would also
add value to the shareholders and other stakeholders.
Banks, therefore, have to endeavor for integrated risk
management systems, both within the bank and also
across the group.
1/30/2020 105
 Such an integrated risk management architecture would
be currently difficult due to the disconnect between
businesses, risk managers and IT systems across the
organizations in their existing set-up.
 Indian banks have achieved most of the computerization
under the Core Banking Solution (CBS). This may not,
however, prepare them adequately for the necessary
MIS and analytical tools for risk management.
 In order to upgrade the risk management systems,
banks need to upgrade their technology proportionately
so that the MIS and the analytical tools for risk
management are available. This will entail large
investments in technology particularly for those banks
who have to migrate to the advanced approaches under
Basel II.
1/30/2020 106
 The Reserve Bank of India, on its part, has taken several
initiatives in this direction which include formulation of
the IT Vision document 2011-17 which sets the priorities
for commercial banks for moving forward from the core
banking solutions to enhanced use of IT in areas like
MIS, regulatory reporting, overall risk management,
financial inclusion, customer relationship management
and enhancing automated data flow within banks and to
RBI without any manual intervention, etc.
 Measures are afoot to setup Next Generation RTGS (NG-
RTGS) system taking into account the latest
developments in the areas of technology, messaging and
networking, etc.
1/30/2020 107
 On the part of banks, there is an imperative need for a three-
pronged action agenda, viz.,
I. Technology upgradation coupled with its integration with the
overall business strategy to achieve an edge in respect of
services provided to their constituents, better housekeeping,
optimizing the use of funds and building up of MIS for decision
making, better management of assets & liabilities and the risks
assumed which in turn have a direct impact on the balance
sheets.
II. A more dynamic and challenging work culture to meet the
demands of customer relationships, product differentiation,
brand values, reputation, corporate governance and regulatory
prescriptions.
III. Focus on internal controls, risk mitigation systems and
business continuity plans to effectively mitigate possible
operational risks arising out of adoption of technology which
could have a potential bearing on the overall financial stability.
1/30/2020 108
ANY QESTIONS
???????
1/30/2020 109

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BANKING SECTOR –

ORIGIN & DEVELOPMENT

 MARKET DRIVEN CHALLENGE

 NEW PLAYERS AFECTING MARKET SHARE

 SPREADS & PROFITABILTY

 72 applications for Small Finance Banks

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