Subject - Banking Operations - II

Class - M.B.A Semester - IV

 Banking Sector Reforms
• Since 1991, the Indian financial system has undergone radical
transformation.
• Reforms have altered the organizational structure, ownership pattern
and domain of operations of banks,  financial institutions and Non-
banking Financial Companies (NBFCs).
• The main thrust of reforms  in the financial sector was the creation of
efficient and stable financial institutions and markets.  
 Narasimham Committee Report on
Banking Sector Reforms
• The United Front Government appointed Narasimham committee
to review the progress of  reforms in the banking sector.
• The committee submitted its report to the then Finance Minister
on  April 23, 1998.
• The main objective of the Banking Sector Reforms Committee was
to establish a  strong, efficient and profitable banking system of the
global standard
 NARASIMHAM COMMITTEE REPORT ON
BANKING SECTOR REFORMS

Strengthening Systems and Structura Technologic

The Banking Asset Methods in l Issues al
Sector Quality Banks Upgradation
1)Strengthening the Banking System :-

(i) Capital adequacy requirements should take into consideration

market risks in addition to credit risks.  

(ii) Risk weight of a government guaranteed advance should be

the same as other advances.  

(iii) Minimum capital to risk assets ratio (CRAR) be increased

from the existing 8 per cent to  10 per cent. There should be
penal provisions for bank that do not maintain CRAR.  
(2) Asset Quality :-

The following recommendations have been made to improve asset

quality:  
• The ratio of non-performing assets to the total assets should be
reduced.  
• For evaluating the quality of assets portfolio, advanced covered
by Government guarantees, which have turned stick , be treated
as Non- performing Assets.  
3) Systems and Methods in Banks:-  
The committee made the following recommendations to improve
the systems and methods in  banks:  
• There should be an independent loan review mechanism
especially for large borrowed accounts and systems to identify
potential Non-performing Assets (NPA).  
• Banks and financial institutions should have a system of
recruiting skilled manpower from the open market.  
• Public sector banks should be given flexibility to determine
managerial remuneration levels taking into account market
trends.  
4) Structural Issues:-  

The following recommendations have been made regarding structural issues

of the banks:

1. With the convergence of activities between banks and Developmental

Financial Institution  DFI they should be converted to banks later
2. Banking system should be reconstituted:  

(a) 2 or 3 banks with an international evaluation should be established.  

(b) 8 or IO large banks should be established. These banks should take care of
the needs of  the large and medium sectors

(c) There should be a large number of local banks.  

 
5) Technological Up gradation:-
There should be rapid computerization of the banking. There

should be modernization and technology up gradation of the

banking operations.
 Banking Sector Reform Measures
(i)Deregulation of Interest Rates: In order to provide
operational flexibility and competitive  environment to the
banks, interest rates on deposits and loan advances of all
commercial banks  including urban co-operative banks have
been deregulated, Le. , controls and regulations of the RBI  on
interest rate has been abolished. Interest rate is allowed to be
determined independently by the  banks.
(ii) Reduction in Reserve Requirements: As per the recommendations of the
Narasimham Committee, reserve requirements of the commercial bank
have been drastically reduced in order to ease the availability of liquidity
for credit and to enhance the role of the market forces. High reservation
implies high cost of credit and less availability of bonds for borrowing.

(iii) Measures to Improve Competitive Efficiency in Banking Sector: For

improving the  competitive efficiency of the banking sector, all
nationalized commercial banks are allowed to raise  capital from equity
market. Operational autonomy was given to the banks. Private sector,
foreign banks and insurance companies were also allowed to enter into
the banking sector.  
(iv) Prudential Norms: Narasimham committee recommended for
introduction of prudential norms to measure the performance of the
banking sector. Accordingly, income recognition, assets  classification,
provision for bad debts, norms on connected lending, risk concentration,
etc., were  introduced. As per the RBI directives, all the commercial banks
are adopted uniform and sound  

(v) Transparency Measures: For transparency in banking operation, banks are

required to disclose their balance sheet with detailed information as per
the norms specified by the International Accounts Standard Committee.
(vi) Capital Adequacy Measures: M. Narasimham Committee
recommended for setting up  some new and higher norms for
capital adequacy, i.e., capital to risk weighted assets ratio. It
was  recommended that capital adequacy ratio should at least
be 10 per cent. All the public sector banks  were required to
attain this norm by 1996.  

 
 Changing Role of Banks in India
• The role of banks in India has changed a lot since economic reforms of 1991. These
changes came due to LPG, i.e. liberalization, privatization and globalization policy
being followed by GOI.
• Since then most traditional and outdated concepts, practices, procedures and
methods of banking have changed significantly.
• Today, banks in India have become more customer-focused and service-oriented
than they were before 1991.
• They now also give a lot of importance to their rural customers. They are even
willing ready to help them and serve regularly the banking needs of country-side
India.
1. Better Customer Service
• Before 1991, the overall service of banks in India was very poor. There
were very long queues (lines) to receive payment for cheques and to
deposit money.
• In those days, some bank staffs were very rude to their customers.

• However, all this changed remarkably after Indian economic reforms of

1991.
• Banks in India have now become very customer and service focus. Their
service has become quick, efficient and customer-friendly.
• This positive change is mostly due to rising competition from new
private banks and initiation of Ombudsman Scheme by RBI.
2. Mobile Banking
• Under mobile banking service, customers can easily carry out major
banking transactions by simply using their cell phones or mobiles.

• Here, first a customer needs to activate this service by contacting his bank.
Generally, bank officer asks the customer to fill a simple form to register
(authorize) his mobile number.

• After registration, this service is activated, and the customer is provided

with a username and password.

• Using secret credentials and registered phone, customer can now

comfortably and securely, find his bank balance, transfer money from his
account to another, ask for a cheque book, stop payment of a cheque, etc.
3. Bank on Wheels
• The 'Bank on Wheels' scheme was introduced in the North-East
Region of India.
• Under this scheme, banking services are made accessible to
people staying in the far-flung (remote) areas of India.
• This scheme is a generous attempt to serve banking needs of
rural India.
4. Portfolio Management
• In portfolio management, banks do all the investments work of
their clients.
• Banks invest their clients' money in shares, debentures, fixed
deposits, etc.
• They first enter a contract with their clients and charge them a
fee for this service.
• Then they have the full power to invest or disinvest their clients'
money. However, they have to give safety and profit to their
clients.
5. Issue of Electro-Magnetic Cards
• Banks in India have already started issuing Electro-Magnetic
Cards to their customers.
• These cards help to carry out cash-less transactions, make an
online purchase, avail ATM facility, book a railway ticket, etc.
• Banks issue many types of electro-magnetic cards, which are as
follows:
• Credit cards, Debit cards, Charge cards, Smart cards, Kisan credit
cards. 
6. Universal Banking
• In India, the concept of universal banking has gained recognition
after year 2000.
• The customers can get all banking and non-banking services
under one roof. Universal bank is like a super store.
• It offers a wide range of services, including banking and other
financial services like insurance, merchant banking, etc.
7. Automated Teller Machine (ATM)
• There are many advantages of ATM. As a
result, many banks have opened up ATM
centers to offer convenience to their
customers.
• Now banks are operating ATM centers
not only in their branches but also at
public places like airports, railway
stations, hotels, etc.
• Some banks have joined together and
agreed upon to set up common ATM
centers all over India.
8. Internet Banking
• Internet banking is also called as an E-banking or net banking.
Here, the customer can do banking transactions through the
medium of the internet or world wide web (WWW).
• The customer need not visit the bank's branch.

• Through this facility, the customer can easily inquiry about bank
balance, transfer funds, request for a cheque book, etc. Most
large banks offer this service to their tech-savvy customers.
9. Encouragement to Bank Amalgamation
• Failure of banks is well-protected with the facility of amalgamation. So
depositors need not worry about their deposits. When weaker banks are
absorbed by stronger banks, it is called amalgamation of banks.

10. Encouragement to Personal Loans

• Today, the purchasing power of Indian consumers has increased dramatically
because banks give them easy personal loans.
• Generally, interest charged by the banks on such loans is very high.

• Interest is calculated on reducing balance. Large banks offer loans up to a huge

amount like one crore.
• Some banks even organize Loan Mela (Fair) where a loan is sanctioned on the
spot to deserving candidates after they submit proper documents.
11. Marketing of Mutual Funds
• A mutual fund collects money from many investors and invests the money in
shares, bonds, short-term money market instruments, gold assets; etc.
• Mutual funds earn income by interest and dividend or both from its
investments. It pays a dividend to subscribers.
• The rate of dividend fluctuates with the income on mutual fund investments.
Now banks have started selling these funds in their own names.
• These funds are not insured like other bank deposits. There are different types
of funds such as open-ended funds, closed-ended funds, growth funds,
balanced funds, income funds, etc.
12. Social Banking
• The government uses the banking system to alleviate poverty and
unemployment. Many social development programmes are
initiated by the banks from time to time.
• The success of these programmes depends on financial support
provided by the banks.
• Banks supply a lot of finance to farmers, artisans, scheduled
castes (SC) and scheduled tribe (ST) families, unemployed youth
and people living below the poverty line (BPL).
 Contents
Banking Law & Practice

Banking Regulation Act

Banking Laws (Amendment) Act, 2012

Types of charges over securities ( Transfer of Property Act, Indian

Contract Act, SARFAESI)
Credit Information Companies (Regulation) Act, 2005

Negotiable Instruments Act

Anti Money Laundering & Know Your Customer

– Key Aspects and elements of AML KYC

 Banking Law and Practice
• Several enactments
–Banking Regulation Act, 1949
–Reserve Bank of India Act, 1934
–Banking Companies (Acquisition
and Transfer of Undertakings)
Act,1970 & 1980
–SBI Act, 1955 & SBI (Subsidiary
Banks) Act, 1959
–RRB Act, 1976
–Companies Act, 1956
• Regulations
• Widely accepted practices
–Negotiable Instruments Act, 1881
–Prevention of Money Laundering Act,
2002
–Securitisation and Reconstruction of
Financial Assets and Enforcement of
Security Interest Act, 2002
–Credit Information Companies Act
–Recovery of Debts due to Banks
–Transfer of Property Act
 Banking Regulation Act, 1949
Definition of banking & banking company

Licensing

Permitted business

Prohibited business

RBI’s powers

Control over management

 Definitions
Banking means

“ accepting, for the purpose of lending or investment, of deposits of money

from the public, repayable on demand or otherwise, and withdrawal by
cheque, draft, order or otherwise”

{Section 5(b)}
Banking company

“means any company which transacts the business of banking in India”

– Explanation excludes manufacturing and trading company

{Section 5 (c)}
 Permitted Business
 Can carry on business permitted u/s 6

– Borrowing, lending, bill discounting, etc.

•Buying, selling and •Underwriting and dealing in

dealing in bullion shares, debentures, etc.
•Buying and selling of
foreign exchange •Safe deposit
•Collecting and transmitting
•Traveller’s cheques of money and securities
Letters of credit •Undertaking/ executing
• trusts
– Activities that are incidental/ conducive to the promotion/ advancement of its business
– Central Govt. empowered to notify permitted business
 Act overrides memorandum, articles, etc.
 Prohibited Business
Trading prohibited vide Sec 6

Non-banking assets – Sec 9

– Immoveable property can only be held for own use
– Other – disposed within 7 years
• RBI can give additional 5 year extension

Restriction on nature of subsidiary companies – Sec 19

– Permitted business u/s 6
– Carrying on banking outside India
– Credit information business
– Other business with RBI and CG approval
 Licensing
 RBI empowered to issue & cancel licences

– Section 22 criteria
Grant of licence not prejudicial to operation and
Solvency
consolidation of banking system
Affairs/ management not detrimental to Foreign banks – home country does not discriminate
depositor and public interest against Indian banks
Adequate capital structure and capital
Other conditions specified by RBI
prospects
Public interest will be served
 Inspection
• Section 35
– Inspect books
• Also on direction of CG

• Copy of report to be given to bank

• Empowers RBI Inspecting officer to examine bank officials under

oath

– Also empowers RBI to carry out a scrutiny

 Powers of RBI
Sec 35A – Power to give directions
Sec 35B – Prior RBI approval required for appointment of
Chairman, MD, CEO or director
Sec 36 – Further powers and functions of RBI
– Caution/ give advice regarding certain transaction/ class of
transactions
– Call for meeting of directors, depute its officer to board meeting,
appoint observer, etc
– Report on Trend and Progress in Banking in the country
 Powers of RBI – Control over
management
• Sec 36AA – Power to remove managerial and other persons from
office
– Appeal lies with Central Government

• Sec 35B – Power to appoint additional directors

 Other important provisions
Sec 14 – Prohibition of charge on unpaid capital
Sec 15 – Prohibition on payment of dividend unless
intangible assets written off
Sec 17 – Creation of reserve fund
Sec 18 – Maintenance of cash reserve ratio
Sec 20 – Restrictions on loans and advances
Sec 24 – SLR
 Applicability of BR Act
 Nationalised Banks
– Banking Companies (Acquisition and Transfer of
Undertakings) Act,1970/1980;
– Section 51 of BR Act makes specific sections applicable

 Regional Rural Banks

– Regional Rural Banks Act, 1976

– Section 51 of the BR Act

 Cooperative Banks
– Cooperative Societies Act. 1912 or the respective Co-
operative Socieities Act of the state concerned
– Part V of the B R Act
 Some important RBI instructions in
context of BR Act
Master Circular
– Loans & Advances – Statutory and other restrictions
– Branch authorisation
– Cash Reserve Ratio and Statutory Reserve Ratio

Others
– Restriction on drawdown of reserves
– Guidelines on declaration of dividend
 Banking Laws (Amendment) Act
 Passed by Parliament in Dec 2012

 Some highlights
Depositor Education and Awareness
Voting rights
Fund
26% from existing 10% in private sector Primary cooperative societies to be
banks licenced by RBI
10% from existing 1% in public sector
Preference shares
banks
Prior approval for voting rights/ shareholding Naionalised banks can issue bonus
more than 5% shares
Joint inspections of associates with
Power to RBI to supersede entire board of banks
sectoral regulator
Power to call for information from associate and
group companies
LAWS RELATING TO SECURITIES
AND MODES OF CHARGING
 Overview of charges
Creation of a right in favour of the creditors
Nature of security Types of security Kind of Charge Defined in Act

Immoveable Land and building Mortgage Sec 58, Transfer of Property

property Act
Actionable claims Book debts, term deposit Assignment Sec 130, Transfer of Property
(i.e. unsecured receipts, etc. Act
debts)
Moveable property/ Plant & machinery, stocks, Pledge/ Pledge-Sec 172 Indian
goods vehicles, etc. hypothecation/ Contract Act
lien Hypothecation – Sec 2(n)
SARFAESI
Paper securities Shares, debentures, MF, Lien Sec 170 and 171Indian
bonds Contract Act
Personal guarantee Promoters & 3rd party Personal liability Sec 126 Indian Contract Act
guarantees
 Kinds of charges – Fixed v/s Floating
 Fixed charge
– created on properties such as land and buildings, plant and machinery

– Identity does not change

– Credit consent required for disposal

– Debtor retains ownership and possession

 Floating charge
– Created on assets that undergo change

– Security allowed to be used in ordinary course of business unless charge crystallises

 Kinds of charges
Pari Passu charge First charge
Several creditors- typically in consortium accounts First right over the proceeds
Equal priority

Exclusive charge Second charge

To one creditor Rights subject to those of first charge holder
No intervention of other creditors
 Mortgage
Dealt with in Transfer of Property Act, 1882
– “A mortgage is the transfer of interest in specific immoveable
property, for the purpose of securing the payment of money
advanced or to be advanced by way of loan, on existing or future
debt or the performance of an engagement which may give rise to
pecuniary liability”- Section 58

Types
Simple English mortgage
Conditional sale Equitable Mortgage
Unsufructuary mortgage Anomoalous morgage
 Simple Mortgage
“Without delivering possession of the mortgaged property, the mortgager binds
himself personally to pay the mortgage money and agrees, expressly or impliedly,
that in the event of his failing to pay according to his contract, the mortgagee shall
have a right to cause the mortgaged property to be sold by a decree of the court in
a suit and the proceeds of the sale to be applied so far as may be necessary in
payment of the mortgage money” [Sec 58(b)]

Intervention of court required

Mortgagee has no right to get any payments out of the rents

and produce of the mortgaged property

Mortgagee not put in possession of the property

Registration is mandatory
 Conditional Sale
“The mortgager ostensibly sells the mortgaged property on the condition that:
(a) on default of payment of the mortgage money on a certain date, the sale shall
become absolute, or
(b) on such payment being made the sale shall become void, or
(c) On such payment being made, the buyer shall transfer the property to the seller”
[Sec 58(c)]

Sale is ostensible – not real

If money not paid ostensible sale shall become absolute – Court decree
required
No personal liability for repayment of the loan
 Unsufructuary mortgage
“mortgage transaction in which
(a)the mortgager delivers possession expressly, or by implication binds himself to
deliver possession of the mortgaged property to the mortgagee, and
(b)Authorises the mortgagee to retain such possession until payment of the
mortgage money and to receive the rents and profits accruing from the property or
any part of such rents and profits and to appropriate the same in lieu of interest, or
in payment of the mortgage money, or partly in lieu of interest and partly in
payment of the mortgage money” [Sec 58(d)]

Mortgagee in actual legal possession of the property, till dues are repaid

Mortgage has the right to receive rents and profits accruing from the
property
No personal liability of the mortgager

No time limit specified

 English mortgage
“mortgagee binds himself to repay the mortgaged property absolutely to the
mortgagee, but subject to the provision that he will retransfer it to the mortgagee
upon payment of the mortgage money as agreed” [Sec 58(e)]

Personal covenant to pay on a specified date notwithstanding the

absolute transfer of property to the mortgagee
Absolute transfer

– Subject to reconveyance in event of repayment

Court decree for sale
 Equitable mortgage
“where a person delivers to a creditor or his agent documents of title to immoveable
property, with the intent to create a security thereon, the transaction is called a
mortgage by deposit of title deeds” [Sec 58(f)]

Deposit of title deed with intention to secure

debt
– Original deed not required but recommended
– Saves on stamp duty
Deposit at notified places only
– Independent of location of the property
 Anomalous mortgage
“a mortgage which is not a simple mortgage, a mortgage by conditional sale and
Unsufructuary mortgage and English mortgage or a mortgage by deposit of title deeds
within the meaning of this section” [Sec 58(g)]

Should satisfy the basic definition of

mortgage
Should not fall in the earlier categories
Usually a combination of two mortgages
 Mortgages- Other key aspects
Registration requirements
– Registration required for mortgages other than equitable
mortgage – Sec 59
– Indian Registration Act- Sec 23 - required within 4 months
of execution
– Companies Act, 1956-Sec 125- within 30 days of execution

Priority of mortgages
– First in point of time has better title – Sec 48
– Amongst registered instruments- date of execution
– Registered has priority over unregistered
• Exception is deposit of title deeds
 Mortgages-Other key aspects
Enforcement
– Code of Civil procedure
– Jurisdiction based on location of property
– Preliminary decree
– Final decree
– Sale
 Which Mortgage would you
prefer?
Mortgage Personal Liability Possession
Simple Mortgage  
Conditional Sale  
Unsufructuary Mortgage  
English Mortgage  
Equitable Mortgage  
(Court decisions) (Deposit of title deeds)
 Assignment
Transfer of actionable claim
– Claim to debt other than debt
• secured by mortgage of immoveable property
• Hypothecation/ pledge of moveable property not in possession

Key features
– Should be in writing
– Due notice to be given to the debtor
– Assignor cannot give better title
– Eg LIC policies used as security
 Pledge
“Pledge is the bailment (delivery) of goods as security for payment of
a debt or performance of a promise” (u/s 172 of Indian Contracts Act)
Key aspects
– Delivery of goods
• Need not be physical delivery

• May be constructive delivery – eg handing over keys of godown

• Can only be on existing goods- not on future goods

– Pawnor – borrower who gives the goods as security

– Pawnee- lender who takes the goods as security

– Ownership retained with pawnor

– Possession with pawnee

• Possession may be parted with against Trust Receipt

• Right to retain or sell goods where pawnor makes default in payment

• Notice to sell required to be given

• Right of pledge prevails over any other dues including Government dues except workers wages
 Hypothecation
Defined in SARFAESI, 2002 (Sec  Precautions

2(n)) – Periodic stock statements

– Charge upon moveable property
– Registration of charge
– Existing/ future
– Notice of charge
– Without delivery – possession
– Insurance of property
with borrower

Drawbacks
– Risk of fraud- multiple charges
on same property
– Erosion of security value
 Lien
General Lien
– Creditor’s right to retain property of debtor
– Possession in ordinary course of business
– Limited to possession of property – not to sell

Banker’s lien
– General lien+ right to sell
– Applicable to negotiable instruments and credit
balances
– Not applicable to safe deposit, for sale
 Stamping of documents
Stamp duty – tax levied on  Consequences
documents • Admissibility as evidence
– Originated in Netherlands – 1624
• Adjudication
– France (1654), Denmark (1657),
Prussia (1682)
Key aspects
– Amount of duty
– Type of stamp used
– Cancellation of stamp
– Time of stamping and execution
– Place of stamping and execution
 Law of limitation
 Period within which suit can be filed

– Bars to remedies
– Original right may continue to be exercisable

 Right of action revived by

– Fresh set of documents

– Acknowledgement of debt
• Writing, signed, stamped and addressed to lender
– Part payment authorised by the borrower
 Power of Attorney
• Types

– General v/s special

• Registration of power of attorney

• Precautions

– Scope of powers

– Agent acting within the scope of powers

– Confirmation of validity
 SARFAESI Act, 2002
Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002
– Coverage
– Securitisation and reconstruction of financial assets
– Enforcement of security interest without court intervention
– Central Registry
 SARFAESI - Coverage
Effective since June 21, 2002

Retrospective coverage

Applicable to whole of India including J&K

Also covers notified Housing Finance Companies

Sec 31

 Lien and pledge

 Aircrafts, shipping vessels

 Conditional sale, hire purchase, contract where no security interest created

 Financial asset<=Rs.1 lakh

 Agricultural land

 Amount due<20% of the Principal +Interest

 SARFAESI – Securitisation/
Reconstruction Companies
Registration with RBI
– Guidelines issued by DNBS
– Minimum owned fund of Rs100 crore/ 15% of financial assets to be
acquired – whichever is lower

Acquisition of financial assets

– Scheme wise
– Funded by investors – QIBs
– Issuance of Security Receipts
– Managed by trust
 SARFAESI – Enforcement of security
interest
No need for court intervention
– Overriding effect over provisions of Transfer of property Act
– Notice mandatory
• 60 days notice
• Details of amount payable and secured asset intended to be enforced
• Borrower prohibited from transferring assets

– Can appeal to DRT – deposit of 50% of the amount due

Can seek help of District Magistrate/ Chief Metropolitan

Magistrate
 SARFAESI – Enforcement of security
interest
Recourse available to lender
– Possession of secured asset
– Management of secured asset
– Appoint person as manager of secured assets
– Require from any person who has acquired the secured asset
from the borrower to pay the amount due to the extent of the
secured asset
Appropriation of proceeds
– Expenses->Dues->Balance to debtor
– If winding up – dues of workman have pari passu charge
Consortium accounts – multiple secured creditors
– Creditors representing ¾ of outstanding dues have to agree
Recent amendment- bank may purchase at auction [13(5A)]
 SARFAESI – Enforcement of security
interest
Safeguards
– Inventory of property taken into possession
– Take care of property as owner of ordinary prudence – insure if
necessary
– Expedite sale if subject to speedy decay
– Possession notice
• affixation at outer door/ conspicuous place
• Publication in 2 leading newspapers including one vernacular
– Auction
• 30 days notice – publication in 2 leading newspapers incl. vernacular
• Valuation to fix reserve price
– Appeal to DRT - Compensation
• Within 45 days of measures being initiated
• 50% to be deposited- DRT may reduce to 25%
 SARFAESI - CERSAI
Sec 25 Company promoted by Government &
PSU banks
Maintains registry of
– Securitisation of financial assets
– Reconstruction of financial assets
– Creation of security interests
Registration additional – not substitute for
existing requirements
Records available for search
Minimisation of frauds due to multiple borrowing
on same security
 Recovery of Debts due to Banks and
Financial Institutions Act, 1993
Coverage
– Applicable to whole of India except J&K
– Debt > Rs. 10.00 lakhs

Constituted Debt Recovery Tribunals for speedy

recovery
– Established by Central Government
– Single member – Presiding Officer
– Appeal against DRT order lies with DRAT
• Chairperson
– Jurisdiction of civil courts (other than HC/SC) barred
CREDIT INFORMATION COMPANIES
(REGULATION) ACT, 2005
 Credit Information
Companies(Regulation) Act, 2005
Objective- regulation of credit information companies

Registration
– Compulsory registration with RBI
• Existing companies to apply within 6 months
– Conditions
• Minimum capital – Rs. 30 crore (authorised), Rs.20 crore(issued)
• Management not prejudicial to interests of users, clients or borrowers, credit
information companies
• Additional conditions at discretion of RBI
– RBI may determine cap on maximum number of credit information
companies
– RBI may cancel registration
– Appeal lies with Central Government
 RBI Powers
Registration and cancellation
Frame policy and regulations
Give directions
Inspection
Appoint observers
Supersede board – appoint administrator
Specify maximum fee
Recommend exemption and rules
 Management of Credit Information
Companies
• Management
– Chairman (whole time)/ Managing Director
– 50% of board with specialised knowledge
• Public administration, law, banking, management,
finance, accountancy and information technology
– RBI empowered to supersede board – appoint
Administrator
 Functions
Permitted businesses
– Collect information on trade, credit and standing of borrowers of
member credit institutions
– Provide
• Information to specific users, credit institutions
• Credit scoring
– Research projects
– Other business specified by RBI

Membership
– Credit institutions to become members
– Compulsory to be member of at least one
– Bound to give information

Disclosure of credit information restricted

 Information Privacy Principles
Accuracy and secrecy of credit information

Alteration of credit information

– Credit information to be supplied by credit
institutions
– Borrower may request updation

Fine for unauthorised access

 Credit Information Companies
Regulations, 2006
 Specified users
– Member credit institutions (specified in Act itself)
• Banks, Financial Institutions, NBFCs, credit card companies, housing finance company, state financial
corporation
– Insurance companies
– Cellular phone service providers
– Rating agency
– Broker
– Trading member of recognised commodity exchange
– SEBI
– IRDA
 Forms of business
 Privacy principles
 Maximum fee and charges
– Membership - Rs.15.00 lakh
– Providing credit information report- Rs.500 for individuals, Rs. 5,000 for other borrowers/
specified users
 Principles
1. Care in collection of credit information
2. Data security and secrecy
3. Access and modification
4. Data collection limitation
5. Data use limitation
6. Data accuracy
7. Archiving and length of preservation
 Credit Information Companies
• Credit Information Bureau (India) Ltd,
• Equifax Credit Information Services Pvt. Ltd
• Experian Credit Information Co. of India Pvt.
Ltd,
• Highmark Credit Information Services Pvt. Ltd.
 Reporting of wilful defaulters
Wilful default
– Default in meeting obligations
• Despite capacity to repay
• Diversion of funds
• Siphoning of funds
• Sale of assets
Diversion
– Short term loans used for long term purposes
– Purchasing assets other than those for which the loan was
sanctioned
– Transferring to subsidiaries group companies
– Investments of funds in equity/ debti without lender’s
permission
– Shortfall in deployment vis-à-vis disbursal
 Reporting of wilful defaulters
Penalties
– No additional facilities
– Legal process
– Proactive towards change of management
– Covenant- prohibiting directors from wilful defaulters

Quarterly reporting
– Suit filed
– Rs. 25 lakh and above

Monitoring end use

NEGOTIABLE INSTRUMENTS ACT,
1881
 Negotiable Instruments Act, 1881
Brought in to
– Encourage use of negotiable instruments
– Improve credibility of negotiable instruments

Important aspects
– Definitions
– Negotiation v/s transfer by assignment
– Presumption of consideration
– Endorsement
– Payment in due course
– Holder in due course
Definitions – Negotiable Instrument
 Definitions - Holder
Holder (Sec 8)
– Person entitled in his own name to possession
– Entitled to receive/ recover amount due

Holder in due course (Sec 9)

– On consideration becomes
• Possessor – bearer instruments
• Endorsee/Payee – order instruments
– No cause to believe that title defective
 Cheques
• Cheques
– Crossing – Special vs general
– Order v/s Bearer
– Protection to
• Paying banker for payment in due course – Sec 128
• Collecting banker for receiving payment for customer in
good faith & without negligence – Sec 131
• Cheques payable to order subsequently endorsed - Sec
85
So what is the difference?

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 Crossing of Cheques
General Crossing (Sec 123)
– Two parallel transverse lines
– Payment only through banker (Sec 126)

Special Crossing (Sec 124)

– Name of the banker also mentioned
– Payment only through banker whose name is
mentioned (Sec 126)

Liability to true owner continues if not paid

through a bank (Sec 129)
 Protection to paying and collecting
bankers
Protection to paying banker
– Sec 128 – protection for payment in due course
• Same rights and same position if the cheque had been
paid to and received by the true owner thereof

Protection to collecting banker

• Sec 131
• Good faith and without negligence
• No liability if title proves defective
 Payment in due course
• Payment in accordance with
– Apparent tenor of the instrument
– Good faith
– Without negligence
– No reasonable ground for believing that possessor
of NI not entitled for to receive payment
 Order and Bearer Cheques
Order
– Drawn payable to order
– If endorsed by/behalf of payee, drawee discharged by payment in due
course

Bearer
– Expressed payable to bearer
– Discharge by payment to bearer
• Irrespective of subsequent endorsements
– Endorsement in blank –
• payable to bearer even if originally payable to order
 Account Payee
• Not provided in the NI Act
• Developed as practice
• RBI instructions
– January 23, 2006
– Limited exemptions to cooperative societies
– Demand drafts over Rs.20,000 (AML aspect)
ANTI MONEY LAUNDERING
KNOW YOUR CUSTOMER
 AML & KYC
Background
– June 1998 – UN call on member states to adopt
national money laundering legislation
– Prevention of Money Laundering Act, 2002

Objective
• Prevent banks from being used by criminals for money
laundering and terrorist activities
 Key aspects
 Customer
– Account holder/ business relationship
– Beneficial owner
– Any person connected to the transaction which can cause significant
reputational/ other risks to the bank/FI

 General guidelines
– Confidentiality of customer information
– Remittances over Rs.50,000 – only by debit to customer’s account/ cheque
– Tenor of instrument reduced to 3 months
– Adherence to provisions of Foreign Contribution (Regulation) Act, 2010
 Elements of KYC Policy
Customer Acceptance Policy

Customer Identification Procedures

Monitoring of Transactions

Risk Management
 Customer Acceptance Policy
No accounts in fictitious/ benami names
Parameters for categorising customers based on risk
perception
Documentation to be collected
Not to open/ close accounts where due diligence not
possible
Circumstances where agency/ fiduciary capacity allowed
Background checks
Product wise/ geography wise controls
Profile of each customer
 Examples of customers requiring
higher due diligence
Non Resident customers
High Net Worth individuals
Politically exposed persons & their relatives
Companies having close family
shareholding/firms with sleeping partners
Non face to face customers
Trusts, charities, NGOs, etc receiving donations
– Exemption for NGOs promoted by UN
 Customer Identification Procedure
 Policy should be specified for various stages
– Initiating the relationship
– Carrying out a financial transaction
– Doubts about veracity of data
 Natural persons
– Identity of customer
– Address
– Photograph
 Legal persons/ entities
– Legal status
– Authorised persons
– Ownership and control structure
 Unique Customer Identification Code (UCIC)
 Avoid undue hardship to customers
Customer identification requirements
– Indicative Guidelines
Walk in customers
Salaried employees
Trustee accounts
Companies and firms
Accounts managed by professional
intermediaries
Politically exposed persons
Non face-to-face customers
Proprietary concerns
 Simplified KYC
Targeted at low income groups - urban and rural poor

Limits
– Balance not to exceed Rs.50,000
– Total credits not to exceed Rs.1,00,000

Simplified KYC procedure

– Introduction from another account holder with full KYC
– Other documents that satisfy the bank about the identity
 Money Mules
Third parties act on behalf of criminals

Recruited through
– Spam emails
– Advertisements on genuine websites/ newspapers
– Social networking sites

Banks advised to strictly adhere to guidelines

on KYC/AML
 Monitoring of transactions
Understanding of normal and reasonable
pattern of activity
Monitoring dependent upon the risk
classification of the account
Special attention to large and complex
transactions
Threshold limits
Cash transactions
 Risk Management
Board to ensure effective KYC,AML system in
place
Role of audit and compliance mechanisms
Quarterly review before Board
Cash Transaction Report
Suspicious Transaction Report
Screening & training of employees
 Bank Lending
• Banks extend credit to different categories of borrowers for a wide variety of purposes. Bank credit is

provided to households, retail traders, small and medium enterprises (SMEs), corporates, the

Government undertakings etc. in the economy.

• Retail banking loans are accessed by consumers of goods and services for financing the purchase of

consumer durables, housing or even for day-to-day consumption. In contrast, the need for capital

investment, and day-to-day operations of private corporates and the Government undertakings are

met through wholesale lending.

• Loans for capital expenditure are usually extended with medium and long-term maturities, while

day-to-day finance requirements are provided through short-term credit (working capital loans).

Meeting the financing needs of the agriculture sector is also an important role that Indian banks play.
 Principles of lending
• Safety: Banks need to ensure that advances are safe and money lent out by them will come back. Since the

repayment of loans depends on the borrowers' capacity to pay, the banker must be satisfied before lending

that the business for which money is sought is a sound one. In addition, bankers many times insist on

security against the loan.

• Liquidity: To maintain liquidity, banks have to ensure that money lent out by them is not locked up for long

time by designing the loan maturity period appropriately. Further, money must come back as per the

repayment schedule.

• Profitability: To remain viable, a bank must earn adequate profit on its investment. This calls for adequate

margin between deposit rates and lending rates. banks may lose customers to their competitors and

become unprofitable.

• Risk diversification: To mitigate risk, banks should lend to a diversified customer base. Diversification

should be in terms of geographic location, nature of business etc.

 Loan Policy
• Based on the general principles of lending stated above, the Credit Policy Committee (CPC) of

individual banks prepares the basic credit policy of the Bank, which has to be approved by the

Bank's Board of Directors.

• The loan policy outlines lending guidelines and establishes operating procedures in all aspects

of credit management including standards for presentation of credit proposals, rating

standards and benchmarks, delegation of credit approving powers, prudential limits on large

credit exposures, asset concentrations, portfolio management, loan review mechanism, risk

monitoring and evaluation, pricing of loans, provisioning for bad debts, regulatory/ legal

compliance etc

• The loan policy typically lays down lending guidelines in areas like Level of credit-deposit

ratio, Targeted portfolio mix, Ratings, Loan pricing, Collateral security

 Types of Advances(Lending)
Universal Banking Services
• Fund based lending: This is a direct form of lending in which a loan with an actual cash

outflow is given to the borrower by the Bank. In most cases, such a loan is backed by

primary and/or collateral security. The loan can be to provide for financing capital goods

and/or working capital requirements etc.

• Non-fund based lending: These are services, where there is no outlay of funds by the

bank when the commitment is made. At a later stage however, the bank may have to

make funds available. Since there is no fund outflow initially, it is not reflected in the

balance sheet. However, the bank may have to pay. Therefore, it is reflected as a

contingent liability in the Notes to the Balance Sheet.

 Fund-based Services (Lending)
• Working Capital Finance: Working capital finance is utilized for operating purposes, resulting in creation

of current assets (such as inventories and receivables). Banks carry out a detailed analysis of borrowers'

working capital requirements. Credit limits are established in accordance with the process approved by the

board of directors. The limits on Working capital facilities are primarily secured by inventories and

receivables (chargeable current assets). Working capital finance consists mainly of cash credit facilities, short

term loan and bill discounting.

• Project Finance: Project finance business consists mainly of extending medium-term and long-term rupee

and foreign currency loans to the manufacturing and infrastructure sectors. Banks also provide financing by

way of investment in marketable instruments such as fixed rate and floating rate debentures. Lending banks

usually insist on having a first charge on the fixed assets of the borrower. The project finance approval

process entails a detailed evaluation of technical, commercial, financial and management factors and the

project sponsor's financial strength and experience.

• Loans to Small and Medium Enterprises: A substantial quantum of loans is granted by

banks to small and medium enterprises (SMEs). While granting credit facilities to smaller

units, banks often use a cluster-based approach, which encourages financing of small

enterprises that have a homogeneous profile such as leather manufacturing units,

chemical units, or even export oriented units

• Bank Overdraft : A facility where the account holder is permitted to draw more funds that

the amount in his current account.

• Bill Purchase / Discount – When Party A supplies goods to Party B, the payment terms

may provide for a Bill of Exchange (traditionally called hundi).

• Credit Card : The customer swipes the credit card to make his purchase. His seller will

then submit the details to the card issuing bank to collect the payment. The bank will

deduct its margin and pay the seller. The bank will recover the full amount from the

customer (buyer). The margin deducted from the seller’s payment thus becomes a

profit for the card issuer.

• Personal Loans: These are often unsecured loans provided to customers who use these

funds for various purposes such as higher education, medical expenses, social events

and holidays. Sometimes collateral security in the form of physical and financial assets

may be available for securing the personal loan

• Vehicle Finance : This is finance which is made available for the specific purpose of buying a

car or a two-wheeler or other automobile. The interest rate for used cards can go close to

the personal loan rates. However, often automobile manufacturers work out special

arrangements with the financiers to promote the sale of the automobile. This makes it

possible for vehicle-buyers to get attractive financing terms for buying new vehicles.

• Home Finance: Banks extend home finance loans, either directly or through home finance

subsidiaries. Such long term housing loans are provided to individuals and corporations and

also given as construction finance to builders. The loans are secured by a mortgage of the

property financed. These loans are extended for maturities generally ranging from five to

fifteen years and a large proportion of these loans are at floating rates of interest
 Non-Fund-based Services
• A letter of credit is a document, typically from a bank (Issuing Bank), assuring that a

seller (Beneficiary) will receive payment up to the amount of the letter of credit, as

long as certain documentary delivery conditions have been met.

• Guarantee: In business, parties make commitments. The beneficiary of the

commitment wants to be sure that the party making the commitment (obliger) will

live up to the commitment. This comfort is given by a guarantor, whom the

beneficiary trusts.

• Loan Syndication: This investment banking role is performed by a number of

universal banks
• Sale of Financial Products such as mutual funds and insurance is another major service

offered by universal banks.

• Financial Planning and Wealth Management are offered by universal banks.

• Executors and Trustees: a department within banks – help customers in managing

succession of assets to the survivors or the next generation.

• Lockers: a facility that most Indian households seek to store ornaments and other

• valuables
 Money Remittance Services
• Demand Draft / Banker’s Cheque / Pay Order

• National Electronic Funds Transfer (NEFT):National Electronic Funds Transfer (NEFT) is a nation-wide

system that facilitates individuals, firms and corporates to electronically transfer funds from any bank branch

to any individual, firm or corporate having an account with any other bank branch in the country.

• Real Time Gross Settlement (RTGS): RTGS transfers are instantaneous unlike National Electronic Funds

Transfer (NEFT) where the transfers are batched together and effected at hourly intervals.

• Society for Worldwide Interbank Financial Telecommunications (SWIFT): SWIFT is solely a carrier of

messages. It does not hold funds nor does it manage accounts on behalf of customers, nor does it store

financial information on an on-going basis. As a data carrier, SWIFT transports messages between two

financial institutions. This activity involves the secure exchange of proprietary data while ensuring its

confidentiality and integrity.SWIFT, which has its headquarters in Belgium, has developed an 8-alphabet

Bank Identifier Code (BIC). The BIC helps identify the bank
 BASEL Framework
• Bank for International Settlements (BIS)

• Established on 17 May 1930, the BIS is the world's oldest international financial

organization. It has its head office in Basel, Switzerland.

• BIS fosters co-operation among central banks and other agencies in pursuit of monetary and

financial stability. It fulfills this mandate by acting as:

• A forum to promote discussion and policy analysis among central banks and within the

international financial community

• A centre for economic and monetary research

• A prime counterparty for central banks in their financial transactions

• Agent or trustee in connection with international financial operations

• Every two months, the BIS hosts in Basel, meetings of Governors and senior officials

of member central banks. The meetings provide an opportunity for participants to

discuss the world economy and financial markets, and to exchange views on topical

issues of central bank interest or concern.

• BIS also organizes frequent meetings of experts on monetary and financial stability

issues, as well as on more technical issues such as legal matters, reserve

management, IT systems, internal audit and technical cooperation.

• BIS is a hub for sharing statistical information among central banks. It publishes

statistics on global banking, securities, foreign exchange and derivatives markets.

• Through seminars and workshops organized by its Financial Stability Institute (FSI),

the BIS disseminates knowledge among its various stake-holders

 What is Currency Swaps
A currency swap (or a cross currency swap) is a foreign exchange derivative between two

institutions to exchange the principal and/or interest payments of a loan in one currency for

equivalent amounts, in net present value terms, in another currency.

 What is Multinational Company ??
A multinational corporation (or transnational corporation) (MNC/TNC) is a corporation or

enterprise that manages production establishments or delivers services in at least two

countries

• Multinational banks (MNBs), by definition, are those that physically operate in more than one

country. For instance, Citibank operates offices in more than 90 countries around the world

• International banks engage in cross-border operations and do not set up operations in other

countries. A Bank of America loan to a bank in Poland is considered international banking.

Reasons For growth of Multinational Banking
• Regulatory environment

• Technological Changes

• Financial Innovation

• Growing diversity

• Economies of scale
 Various Organizational Structure for
Multinational banking

• Correspondent Banking

• Resident Representatives

• Bank Agencies

• Foreign Branches

• Foreign Subsidiaries And Affiliates

• Consortium Banks
 Risks in foreign exchange dealings
• RBI and FEDAI issue guidelines to all banks to identify, measure and manage risks

• Risks can be classified under:

– Market risk: Loss arising out of change in the market price of an asset

– Liquidity risk: risk that you will not be able to easily sell your assets

– Operational risk: Failure of internal processes, people, systems or external events

– Legal risk: Contracts are not legally enforceable or documented incorrectly

– Credit risk: Counterparty defaulting in payment

• Pre-settlement: Credit risk before the maturity of a transaction

• Settlement risk: Timing differences in cash flows,

– Country risk: Movement of funds across borders may be obstructed by sudden government controls

– Interest rate risk: Interest rate risk or gap risk arises out of adverse movement of interest rates a bank faces on its currency swaps/forward

contracts or other interest rate derivatives

 What is Asset Liability Management??
• The process by which an institution manages its balance sheet in order to allow for

alternative interest rate and liquidity scenarios

• Banks and other financial institutions provide services which expose them to various

kinds of risks like credit risk, interest risk, and liquidity risk

• Asset-liability management models enable institutions to measure and monitor risk, and

provide suitable strategies for their management.

• Offshore banking is a term used to describe banking activity in currencies other
than the currency of the country in which the bankaccounts are held. Countries / territories

conducting such business are called offshore financial centres.

 INTERNATIONAL FINANCIAL
INSTITUTIONS:
International financial institutions (IFIs) are financial institutions that have been

established by more than one country, and hence are subjects of international laws.

Their owners or shareholders are generally national governments, although other

international institutions and other organizations occasionally figure as shareholders. The

most prominent IFIs are creations of multiple nations, although some bilateral financial

institutions exist and are technically IFIs. Many of these are multilateral development

banks (MDB).
 WHAT ARE INTERNATIONAL
FINANCIAL INSTITUTIONS (IFI’S)?
World Bank Group (WBG):

 International Bank for Reconstruction and Development (IBRD)

 International Development Association (IDA)

 International Finance Corporation (IFC)

 Multilateral Investment Guarantee Agency (MIGA)

 International Centre for Settlement of Investment Disputes (ICSID)

International Monetary Fund (IMF)

Regional development banks, such as:

 African Development Bank (AFDB)

 Asian Development Bank (ADB)

Manav Agarwal
manavs87@gmail.com
9823962733