Banking & Monetary Policy

• The Reserve Bank of India (RBI) has reported a sharp decline in gross non-performing assets (NPAs), or bad loans, in the banking system in the last two years, but wilful defaults have shot up with more legacy loan accounts now getting added to the wilful default category.
• There has been a rise of 38.50% or Rs 94,000 crore, in wilful defaults in the last two years, reflecting the gaps in loan appraisals and risk management in the banking sector.
• According to the RBI’s ‘Report on trends and progress of banking’, overall NPAs have fallen from 7.3% (of total advances) in 2021 to 5% by September 2022. In absolute numbers, gross NPAs (which also include wilful defaults) of banks reduced by 19.5% to Rs 6.1 lakh crore as of December 31, 2022 as against Rs 7.5 lakh crore over a year ago.

Basics Of Bad Assets:

• Non-Performing Assets (NPA): An asset that is not returning in the form of principal or interest during the last 90 reporting days is classified as NPA.
• Gross Non-Performing Assets (GNPA): GNPA is an absolute amount which reflects the total value of non-performing assets for the bank in a particular financial year.
• Net Non-Performing Assets (NNPA): NNPA subtracts the provisions made by the bank from the gross NPA. Hence, net NPA gives you the exact value of non-performing assets after the bank has made specific provisions for it.
• Provisioning is a mechanism to deal with bad assets. Under provisioning, banks have to set aside some funds to a prescribed percentage of their bad assets. The percentage of bad assets that has to be ‘provided for’ is called provisioning coverage ratio. The provisioning coverage ratio is the percentage of bad assets that the bank has to provide for from their own funds –most probably from profit.
• Wilful default: is deemed to have occurred if the borrower has defaulted in meeting their repayment obligations to the lender even when they have the capacity to honour the said obligations.

Impact of Non-Performing Assets:

Reasons For Declining NPAs:

• Drop in slippage ratio: The slippage ratio is the rate at which good loans are turning bad. It is the ratio of “Fresh accretion of NPAs during the year” to “Total standard assets at the beginning of the year”.
• The slippage ratio is around 2% in September 2022 for SCBs, which is the lowest since 2015. Low slippage shows how well the asset qualities are managed by the bank.
• Increasing write-offs: Banks voluntarily choose to write off NPAs to maintain healthy balance sheets. According to the data given by the Finance Ministry, banks had written-off bad loans worth ₹ 10,09,511 crore in the last 5 years. In the first half of FY 2022-23, the loan write-offs as a ratio of GNPAs increased to 22.6%.

These factors not only helped in reducing the share of bad assets but also increased the profitability of scheduled commercial banks in the last one year.

Failure of Silicon Valley Bank in the United States has brought about attention on Banking Regulations in India.

Banking Sector in India:

• The Reserve Bank of India (RBI), India’s central bank, issues various guidelines, notifications and policies from time to time to regulate the banking sector.
• The RBI supervises and is responsible for managing the operation of the Indian financial system. In addition to issuing regulations and guidelines for banking operations, it also administers the provisions of the RBI Act, the BR Act and FEMA. It has wide discretionary powers and is authorised to inspect and investigate the affairs of banks and to impose penalties in the event of non-compliance.
• India has both private sector banks (which include branches and subsidiaries of foreign banks) and public-sector banks (ie, banks in which the government directly or indirectly holds ownership interest). Banks in India can primarily be classified as:
  • Scheduled commercial banks (commercial banks performing all banking functions).
  • Cooperative banks (set up by cooperative societies for providing financing to small borrowers).
  • Regional rural banks (RRBs) (for providing credit to rural and agricultural areas).
  • Recently, the RBI has also introduced specialised banks such as payments banks and small finance banks that perform only some banking functions.

Key statutes and regulations that govern the banking industry in India:

• Reserve Bank of India Act 1934 (RBI Act): was enacted to establish and set out functions of the RBI. It grants the RBI powers to regulate the monetary policy of India and lays down the constitution, incorporation, capital, management, business and functions of the RBI.
• Banking Regulation Act 1949 (BR Act): provides a framework for supervision and regulation of all banks. It also gives the RBI the power to grant licences to banks and regulate their business operation.
• Foreign Exchange Management Act 1999 (FEMA): is the primary exchange control legislation in India. FEMA and the rules made thereunder regulate cross-border activities of banks. These are administered by the RBI
• Other key statutes:
  • The Negotiable Instruments Act 1881;
  • The Recovery of Debts Due to Banks and Financial Institutions Act 1993;
  • The Bankers Books Evidence Act 1891;
  • The Payment and Settlement Systems Act 2007;
  • The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002; and
  • The Banking Ombudsman Scheme 2006.
  • Public sector banks are regulated by the BR Act and the statute pursuant to which they have been nationalised and constituted. These include:
    • Banks constituted under the Banking Companies (Acquisition and Transfer of Undertakings) Act 1970 or the Banking Companies (Acquisition and Transfer of Undertaking Act) 1980; and
    • The State Bank of India and subsidiaries and affiliates of the State Bank of India constituted and regulated by the State Bank of India Act 1955 and the State Bank of India (Subsidiary Banks) Act, 1959 respectively.
    • While the GOI has not made any moves for further nationalisation of banks, the BR Act gives the GOI the power to acquire undertakings of an Indian bank in certain situations, such as breach of banking policy by the bank.
  • Government deposit insurance: The deposits placed with various banks are insured by the Deposits Insurance and Credit Guarantee Corporation (DICGC), which is a subsidiary of the RBI and is governed by the Deposits Insurance and Credit Guarantee Corporation Act 1961. The DICGC insures all deposits such as savings, fixed, current, recurring, etc, except the following:
• deposits of foreign governments;
• deposits of central and state governments;
• inter-bank deposits;
• deposits of the state land development banks with state cooperative banks;
• any amount due on account of any deposit received outside India; and
• any amount that is specifically exempted with prior RBI approval.

Recent Measures to Improve Regulation of Financial Institutions:

• With a view to providing a greater measure of protection to depositors in banks, DICGC raised the limit of insurance cover for depositors in insured banks from the earlier level of ₹1 lakh to ₹5 lakh per depositor.
  • Accordingly, the number of fully protected accounts at end-March 2022 constituted 97.9% of the total number of accounts. In terms of amount, the total insured deposits as at end- March 2022 stood at ₹81,10,431 crore and constituted 49.0% of assessable deposits (₹1,65,49,630 crore).
  • This is higher than the guidance of the International Association for Deposit Insurance (IADI) which recommends coverage of the number of accounts up to 80% and 20-30% in value terms.
• Banking Regulations Act - Amendment (2020) for Cooperative Banking:
• Issuance of shares and securities by cooperative banks - increase capital base
• Supersession of Board of Directors - to address management issues
• Allowed RBI to initiate a scheme for reconstruction or amalgamation of a bank without placing it under moratorium - boost public confidence
• Changes introduced to the PCA Framework:
• PCA applicability and criteria:
  • PCA Framework would apply to all banks operating in India including foreign banks operating through branches or subsidiaries based on breach of risk thresholds of identified indicators
  • However, payments banks & SFBs have been removed from the list of lenders where PCA can be initiated
• Parameters for PCA:
  • Capital, Asset Quality and Leverage are 3 parameters which will be the key areas for monitoring in the revised framework and there are three risk threshold, from 1 to 3, in the increasing order of severity
  • The revised framework has removed return on assets as an indicator
• A bank will be placed under PCA Framework based on the Audited Annual Financial Results and the ongoing Supervisory Assessment made by RBI
• RBI may impose PCA on any bank during the course of a year (including migration from one threshold to another) in case the circumstances so warrant
• Exit from PCA and Withdrawal of Restrictions under PCA:
  • If no breaches in risk thresholds in any of the parameters are observed as per 4 continuous quarterly financial statements, one of which should be Audited Annual Financial Statement (subject to assessment by RBI);
    • Based on Supervisory comfort of the RBI, including an assessment on sustainability of profitability of the ban
• Corrective actions prescribed after a bank is placed under PCA:
  • Risk Threshold 1:
    • Restriction on dividend distribution/remittance of profits
    • Promoters/Owners/Parent (in the case of foreign banks) to bring in capital
    • Risk Threshold 2:
    • In addition to mandatory actions of Threshold 1
    • Restriction on branch expansion; domestic and/or overseas
    • Risk Threshold 3:
    • In addition to mandatory actions of Threshold 1 & 2
    • Appropriate restrictions on capital expenditure, other than for technological upgradation within Board approved limits
    • Discretionary Actions:
    • Special Supervisory Actions
    • Strategy related
    • Governance related
    • Capital related
    • Credit risk related
    • Market risk related
    • HR related
    • Profitability related
    • Operations/Business related
    • Any other
• Consumer Protection Measures:
  • Banks in India are subject to consumer protection laws that act as an alternative and speedy remedy to approaching courts, a process that can be expensive and time-consuming.
  • The Consumer Protection Act 1986 (the Consumer Protection Act) is the primary legislation governing disputes between consumers and service providers. The relationship between a bank and its customer is regarded as that of a consumer and service provider, therefore bringing them under the ambit of the Consumer Protection Act. A three-tier mechanism has been established to deal with complaints:
    • District forum: this operates at the district level and deals with consumer complaints of a value not exceeding 2 million rupees.
    • State commission: this operates at the state level and deals with consumer complaints of a value between 2 million rupees and 10 million rupees. It also hears appeals against the orders passed by the district forum and
    • National commission: this operates at the national level and deals with consumer complaints of a value exceeding 10 million rupees. It also hears appeals against the orders passed by the state commission. An appeal from the order of the national commission can be directed to the Supreme Court of India.
  • Banking Ombudsman Scheme: for the purpose of adjudication of disputes between a bank and its customers.
    • The scheme provides for a grievance redressal mechanism enabling speedy resolution of customer complaints in relation to services rendered by banks.
    • The banking ombudsman is a quasi-judicial authority appointed by the RBI to deal with banking customer complaints relating to deficiency of services by a bank and facilitate resolution through mediation or passing an award.
    • A complaint under the scheme has to be filed within one year of the cause of action having arisen.

Measures taken for sound health of NBFCs:

• RBI has proposed to move from a general approach of light touch regulation to one that monitors larger players almost as closely as it does banks. To enable this idea, it has proposed following changes:
  • Creation of a 4-layer regulatory framework which includes a Base layer, a Middle layer, Upper layer and a Top layer. The degree of regulation in each sector is proportional to the perception of risk in that sector.
  • Classification change for NPAs of base layer NBFCs from 180 to 90 days overdue.