Prelims 2017

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Day 40

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TERMS RELATED TO BANKING SYSTEM

MONETARY POLICY
Planned Economic Development adopted by India required an active monetary policy. The two stated aims
of this policy were:
Boost economic development
Control inflationary pressures
The RBI is the main agency for implementing the monetary policy. RBI has defined its monetary policy in
terms of adequate financing of economic growth and at the same time ensuring reasonable price stability. The

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instruments which RBI employs to achieve a stable monetary policy include:

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BANK RATE
Rate at which the central bank lends to commercial banks. In other words, it is the rate at which RBI
rediscounts the bill of exchange.
It thus acts as a signal to the economy on the direction of the monetary policy. RBI uses changes in Bank
Rate to regulate fluctuations in exchange rate and domestic inflation.
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Each bank is free to decide the Base Rate below which it will not lend to borrowers. Banks should declare
the benchmark based on which such Base Rates are decided. One bank can have only one Base Rate.
At present it is 6.75%.
CASH RESERVE RATIO (CRR)
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Every Commercial Bank is required to keep a certain percentage of its demand and time liabilities
(deposits) with the RBI (either as cash or book balance).
The RBI varies this ratio as and when it perceives the need to increase or decrease money supply. RBI
is empowered to fix the CRR at a rate ranging between 3 per cent and 15 per cent.
RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks.
At present the CRR is 4%.
STATUTORY LIQUIDITY RATIO (SLR)
Commercial Banks are also required to keep (in addition to CRR) a certain percentage of their net demand
and time liabilities (NDTL) as liquid assets in the shape of cash, gold or approved securities.
As most of the SLR money is kept in treasury bills, government had, in the past, been using SLR as a means
to mobilize low cost resources. This abuse of SLR leads to distortion in the interest rate and credit supply.
In order to overcome this, Narasimhan Committee recommended that SLR should be brought down to
25 per cent, which is the current rate since 1993-94.
At present the SLR is 20.50%.
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OPEN MARKET OPERATION

This refers to the RBI buying and selling eligible securities to regulate money supply.
Traditionally, RBI was not resorting to this method. However, after the large inflow of foreign funds since
1991, RBI has had to step in to sterilize the flow to avoid excess liquidity.
LIQUIDITY ADJUSTMENT FACILITY(LAF)
Liquid Adjustment Facility is a monetary policy tool which allows banks to borrow money through
repurchase agreements. LAF is used to aid banks in adjustingthe day to day mismatches inliquidity. LAF
consists of repo and reverse repo operations.
REPO RATE
Repurchase Option (REPO) is the rate at which RBI lends to commercial banks. In other words, it is the
rate at which our banks borrow rupees from RBI.
Whenever, the banks have any shortage of funds they can borrow it from RBI. A reduction in the Repo
Rate will help banks to get money at a cheaper rate.

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When the Repo Rate increases, borrowing from RBI becomes more expensive.
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At present the Repo Rate is 6.25%.
REVERSE REPO RATE
The rate at which Reserve Bank of India (RBI) borrows money from banks and hence exact opposite of
Repo Rate.
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RBI uses this tool when it feels there too much money floating in the banking system. Banks are always
happy to lend money to RBI since their money is in safe hands with a good interest.
An increase in Reverse Repo Rate can cause the banks to transfer more funds to RBI due its attractive
interest.
RBI resorts to the Repo Route to fine tune the liquidity position, without resorting to major policy
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instruments such as changes in CRR and Bank Rate. However, markets are bound to react to frequent
changes in the Repo Rates and this will be reflected in corresponding changes in the deposit and lending
rates of commercial banks.
At present the Reverse Repo Rate is 5.75%
PRIME LENDING RATE
It is the interest rate charged by banks to their most creditworthy customers (usually the most prominent
and stable business customers).
Therate is almost always the same amongst major banks.
Some banks use the name Reference Rate or Base Lending Rate to refer to their Prime Lending Rate.
MARGINAL STANDING FACILITY (MSF)
Rates at which the Scheduled banks can borrow funds overnight from RBI against government securities.
It is a short term borrowing scheme for scheduled commercial banks in case the banks are in severe cash
shortage or acute shortage of liquidity.
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MSF has been introduced by RBI to reduce volatility in the overnight lending rates in the inter-bank
market and to enable smooth monetary transmission in the financial system.
At present the MSF rate is 6.75%.
SPECIAL DRAWING RIGHTS (SDR)
It is an artificial currency created by the IMF in 1969. SDRs are allocated to member countries and can
be fully converted into international currencies so they serve as a supplement to the official foreign
reserves of member countries.
Its value is based on a basket of key international currencies (U.S. dollar, euro, yen and pound sterling).
NON-BANKING FINANCIAL COMPANY (NBFC)
It is a company registered under the Companies Act, 1956 and is engaged in the business of loans and
advances; acquisition of shares/stock/bonds/debentures/securities issued by government, but does not
include any institution whose principal business is that of agriculture activity, industrial activity, sale/
purchase/construction of immovable property.

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NBFCs are doing functions akin to that of banks; however there are a few differences:

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A NBFC cannot accept demand deposits (demand deposits are funds deposited at a depository institution
that are payable on demand immediately or within a very short period like current or savings accounts).
It is not a part of the payment and settlement system and as such cannot issue cheques to its customers.
Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation(DICGC) is not
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available for NBFC depositors unlike in case of banks.
WHITE LABEL ATMS
Concepts of White label ATMs is adopted from Canada. Since 2006, some banks have been pressing with
RBI to introduce white label ATMs in India too.
White Label ATM or White Label Automated Teller Machines in India will be owned and operated by
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Non-Bank entities.
From such White Label ATM customer from any bank will be able to withdraw money, but will need to
pay a fee for the services. These white label automated teller machines (ATMs) will not display logo of
any particular bank and are likely to be located in non-traditional places.
The white label automated teller machines are likely to benefit customers as well as banks. With the
expansion of ATM network, customers will be able to withdraw funds at more locations, located near their
home or place of work.
SHADOW BANKS
After the subprime crisis of the US, the term Shadow Banks came into use in 2007.
Shadow Banks refer to those organizations that function like banks but are outside the banking regulation.
They help in providing quick source of credit to the public but have been criticized because they lead to
a creation of a bubble and on the defaulting on loans by the borrowers it leads to a crisis at one witnessed
in the US.
Economists express concern over the functioning of shadow banks for several reasons. Shadow banks
dont enjoy powers under SARFAESI Act and therefore it is difficult for them to recover money in case
of loan defaults. There are also concerns over their transparency and methods of functioning.
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BHARTIYA MAHILA BANK

Bharatiya Mahila Bank Ltd. is the first of its kind in the Banking Industry in India.
One of the key objectives of the bank is to focus on the banking needs of women and promote economic
empowerment.
It is being looked upon as the beginning of a unique new institution that will provide financial services
predominantly to women and women self-help groups to the small businesswomen and from the working
women to the high net worth individual.
It has been merged with SBI.
Some salient features of the bank are:
Bank will offer 4.5% interest on saving deposits.
It will not insist on collateral since most title deeds are in name of male family members.
It will lend to micro businesses like catering, crches & for upgrading kitchens in households.

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The bank aims to have Rs. 60,000 crore business and 775 branches by 2020.
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It will provide loans primarily to women, and will give low-cost education loans for girls.
Key positions, including treasury head and security head, held by women.
BANKING OMBUDSMAN
Banking Ombudsman is a quasi-judicial authority functioning under Indias Banking Ombudsman Scheme
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2006, and the authority was created pursuant to a decision by the Government of India to enable
resolution of complaints of customers of banks relating to certain services rendered by the banks.
The Reserve Bank of India in 2006 announced the revised Banking Ombudsman Scheme with enlarged
scope to include customer complaints on certain new areas, such as, credit card complaints, deficiencies
in providing the promised services even by banks sales agents, levying service charges without prior notice
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to the customer and non-adherence to the fair practices code as adopted by individual banks.
Applicable to all commercial banks, regional rural banks and scheduled primary cooperative banks having
business in India, the revised scheme came into effect from January 1, 2006.
PRIORITY SECTOR LENDING (PSL)
Introduced by Dr. K S KrishnaswamyCommitteein 1972, aimed to provide institutional credit to those
sectors and segments for whom it is difficult to get credit.
According to this, SCB have to give 40% of loans (measured in terms of Adjusted Net Bank Credit or
ANBC) to the identified priority sectors in accordance with the RBI Regulations.
Objective of Priority Sector Targets
The overall objective of priority sector lending programme is to ensure that adequate institutional credit
flows into some of the vulnerable sectors of the economy, which may not be attractive for the banks from
the point of view of profitability.
If these targets are not realized, banks have to finance the development programme implemented by the
government for the concerned sectors.
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New PSL Norms:

New PSL rules have been laid down by the RBI following the recommendations of internal working group in 2015.
Categories under PSL
Agriculture 18%: Within the 18 percent target for agriculture, a target of 8 percent of ANBC is prescribed
for Small and Marginal Farmers.
Micro, Small and Medium Enterprises 7.5 percent.
Export Credit: Incremental export credit up to 2 percent for domestic banks and foreign banks with 20
branches and above.
Education: Loans to individuals for educational purposes including vocational courses upto Rs 10 lakh.
Housing: Loans to individuals up to Rs 28 lakh in metropolitan centres (with population of ten lakh and
above) and loans up to Rs 20 lakh in other centres for purchase/construction of a dwelling unit per family.

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Social Infrastructure: Bank loans up to a limit of Rs 5 crore per borrower for building social infrastructure
for activities namely schools, health care facilities, drinking water facilities and sanitation facilities in Tier
II to Tier VI centres.

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Renewable Energy: Bank loans up to a limit of Rs 15 crore to borrowers (individual households- Rs 10
lakh) including for public utilities viz. street lighting systems, and remote village electrification.
Others: SHG, JLG etc.
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The new regulation also stipulates that banks should give 10% of their loans to the
Weaker sections which include Small Marginal Farmers, Artisans, village and cottage industries with a
credit limit uptoRs 1 lakh
Beneficiary of certain govt. sponsored schemes,
SCs/STs,
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SHGs,
Person with disabilities etc.
Foreign Banks with 20 branches and above already have priority sector targets of 40% and sub-targets for
Agriculture and Weaker Sections. These targets are to be achieved by March 31, 2018 as per the action plans
approved by RBI.
Foreign banks with less than 20 branches will move to total Priority Sector target of 40 percent by 2019-20.
The sub-target for MSME sector will be made in 2018.
NON-PERFORMING ASSETS (NPAs)
An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank
and is overdue for a period of 90 days.Banks are required to classify NPAs further into
Substandard, Doubtful and Loss Assets.
Substandard assets:Assets which has remained NPA for a period less than or equal to 12 months.
Doubtful assets:An asset would be classified as doubtful if it has remained in the substandard category
for a period of 12 months.
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Loss assets:As per RBI, Loss asset is considered uncollectible and of such little value that its continuance
as a bankable asset is not warranted, although there may be some salvage or recovery value.
Status of NPAs in India
Banks have been asked by the RBI to clean up their account statement and their asset book by March 2017
following the huge NPAs pending with these banks.
Resultantly this led to 29 public sector banks writing off Rs1.14 Lakh Crore of bad debts between 2013 -2015,
much more than what they had done in the preceding 9 years.
The gross bad loans of 39 listed Indian banks, in absolute term, rose 92% in fiscal year 2016 to Rs.5.79
trillion even as after provisioning, the net bad loans more than doubled to Rs.3.38 trillion.
In percentage terms, the average gross non-performing assets (NPAs) of this group of banks rose from
4.41% of loans in 2015 to 7.91% in 2016; net NPAs in the past one year rose from 2.45% to 4.63%.
Public sector banks, which have close to 70% market share of loans, are more affected than their private
sector peers. Two of them have over 15% gross NPAs and an additional eight close to 10% and more.

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Impact of NPAs on Banks:
Rising of NPAs will lead to a crisis of confidence in the market.
OR
The price of loans, i.e. the interest rates will shoot up.
Shooting of interest rates will directly impact the investors who wish to take loans for setting up
infrastructural, industrial projects etc.
It will also impact the retail consumers like us, who will have to shell out a higher interest rate for a loan.
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This will hurt the overall demand in the Indian economy which will lead to lower growth rates and of
course higher inflation because of the higher cost of capital.
The trend may continue in a vicious circle and deepen the crisis.
Laws related to NPAs and Bankruptcy
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SARFAESI Act It empowers Banks/Financial Institutions to recover their NPAs without the intervention
of the court, through acquiring and disposing secured assets in case of outstanding amounts greater than
1 lakh. SARFAESI has been used only against the small borrowers primarily from MSME sectors.
Recovery of Debts Due to Banks and Financial Institutions (DRT) Act:The Act provides setting up
ofDebt Recovery Tribunals (DRTs)andDebt Recovery Appellate Tribunals(DRATs)for expeditious and
exclusive disposal of suits filed by banks / FIs for recovery of their dues in NPA accounts with outstanding
amount of Rs. 10 lac and above. DRTs are overburdened leading to slow disposal of cases.
Lok Adalats:Section 89 of the Civil Procedure Code provides resolution of disputes through ADR
methods such as Arbitration, Conciliation, Lok Adalats and Mediation. Lok Adalats mechanism offers
expeditious, in-expensive and mutually acceptable way of settlement of dispute.
Underbanking regulation act 1949, RBI is empowered to monitor the asset quality of banks by inspecting
record books.
BASEL NORMS: PRUDENTIAL NORMS AND CAPITAL ADEQUACY
Implementing the Narsimham Committee recommendations, RBI prescribed that banks should make 100
per cent provision for all loss assets or non-performing assets (NPAs) over a period of 2 years, as
prudential norms.
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Capital Adequacy Norms required the banks to achieve a capital to risk weighted asset ratio of 8 per cent.
A banks real capital is assessed after taking into account the riskiness of its assets. Providing a cushion
for the riskiness of the asset is necessary to guarantee against insolvency.
The international norm for Capital Adequacy Ratio was set by Basel Committee on Banking Supervision
under the aegis of the Bank of International Settlements (BIS) Basle, Switzerland, after the failure of the
German Bank Herstatt in 1974.
It is a committee of Bank Supervisors consisting of members from each of the G10 countries. The
committee is a forum for discussion of the handling of specific supervisory problems.
It came up with the first set of recommendations which are called Basel I. These included a minimum
capital adequacy of 8 per cent of the total risk weighted assets of a bank.
Many Indian Banks had to go in for public issues to satisfy capital adequacy norms. It was later realized
that Basel I norms addressed only financial risk.
Accordingly, a revised set of norms called Basel II was brought out in June 2004. These are more complex

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norms and are based on the three pillars of Capital Requirement, Supervisory Review and Market Discipline.
Despite Basel II norms, the financial market crisis of 2008 revealed the need for further stringency.

arising from financial and economic stress. OR
Basel III was proposed in Dec 2010 in order to improve the banking sectors ability to absorb shocks

RBI has issued instructions for the adoption of Basel III norms from Jan 2013 in a phased manner to be
completed by March 31, 2018.
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This will require fresh infusion of capital for which dilution of PSU bank capital has been decided without
diluting govt. control.
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BANKING SECTOR REFORMS

BANKING SECTOR DEVELOPMENT IN INDIA
In 1921, all presidency banks were amalgamated to form the Imperial Bank of India which was run by
European Shareholders.
After that the Reserve Bank of India was established in April 1935. At the time of first phase the growth
of banking sector was very slow.
Between 1913 and 1948 there were approximately 1100 small banks in India. To streamline the functioning
and activities of commercial banks, the Government of India came up with the Banking Companies Act,
1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No.23
of 1965).

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Reserve Bank of India was vested with extensive powers for the supervision of banking in India as a
Central Banking Authority.
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After Independence, in 1955, the Imperial Bank of India was nationalized (under State Bank of India Act
1955) and was given the name State Bank of India, to act as the principal agent of RBI and to handle
banking transactions all over the country.
Seven banks forming subsidiary of State Bank of India was nationalized in 1960.
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On 19th July, 1969, major process of nationalization was carried out. At the same time 14 major Indian
commercial banks of the country were nationalized.
In 1980, another six banks were nationalized, and thus raising the number of nationalized banks to 20.
Seven more banks were nationalized with deposits over 200 Crores. Till the year 1980 approximately 80%
of the banking segment in India was under governments ownership.
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On the suggestions of Narsimham Committee, the Banking Regulation Act was amended in 1993 and
thus the gates for the new private sector banks were opened.
The following are the major steps taken by the Government of India to Regulate Banking institutions in the
country:
1949: Enactment of Banking Regulation Act.
1955: Nationalisation of State Bank of India.
1959: Nationalisation of SBI subsidiaries.
1961: Insurance cover extended to deposits.
1969: Nationalisation of 14 major Banks.
1971: Creation of credit guarantee corporation.
1975: Creation of regional rural banks.
1980: Nationalisation of seven banks with deposits over 200 Crores.
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NATIONALIZATION OF BANKS IN INDIA

It was observed that certain sectors of the economy such as the agriculture, small-scale industries and
weaker sections of the society were relatively ignored by the banking system of the country. For example,
the agricultural sector only received 2.1% of the total credit as it stood in March 1967 compared to a
humungous 64% for the industry.
It was though by Government of India that it should impose some control over banks with a view to
preventing monopolistic trends, concentration of economic power and misuse of economic resources.
National Credit Control Council was set up on December 22, 1967 to assess periodically the available
resources of credit and to ensure its equitable and purposeful distribution among the several sectors.
Such a mechanism didnt work out and eventually nationalization was brought about through promulgation
of an ordinance in 1969, which nationalized 14 leading commercial bank of the country. Some of them
were the Punjab National Bank, IOB, Dena Bank, Syndicate Bank etc. In 1980 six more banks were
nationalized.

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Objectives of Bank Nationalisation
To mobilize savings of people to the maximum possible and to utilize them for productive purpose;

regulations; OR
To ensure that the banking operations are guided by a larger social purpose and are subject to close public

To ensure that the legitimate credit needs of private sector industry and trade, big and small, are met;
To ensure the needs of the productive sector and in particular, agriculture, small scale industry, self-
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employed professionals are met;
To actively foster the growth of the new and progressive class of entrepreneurs and create fresh opportunities
for hitherto neglected and backward areas in different parts of the country;
To curb the use of bank credit for speculative and for other unproductive purposes.
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Reforms
One of the sectors that has been subjected to reform as a part of the new economic policy since 1991
consistently is the banking sector.
Commercial Banks and their weaknesses by 1991: The major factors that contributed to deteriorating
bank performance upto the ends of eighties were:
High SLR and CRR locking up funds
Low interest rates charged on government bonds
Directed and concessional lending for populist reasons
Administered interest rates
Lack of competition
Thus, the reforms were needed to set the above problems right such as:
Floor and cap on SLR and CRR removed in 2006.
Interest rates were deregulated to make banks respond dynamically to the market conditions. Even
Scheduled Banks rates were deregulated in 2011.
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Near level playing field for public, private and foreign banks in entry
Adoption of prudential norms Reserve Bank of India issued guidelines for income recognition, asset
classification and provisioning to make banks safer
Basel Norms adopted for safe banking
VRS for better work culture and productivity
FDI up to 74% is permitted in private banks
The objectives of Banking Sector Reforms have been
To make them competitive and profitable
To strengthen the sector to face global challenges
To make banking Sound and safe
To help them technologically modernize for customer benefit

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To make available global expertise and capital by relaxing FDI norms
NARASIMHAM COMMITTEE
OR
Banking Sector reforms in India were conducted on the basis of Narasimham Committee reports I and II
(1991 and 1998 respectively). This committee was appointed against the backdrop of the Balance of Payment
Crisis. It was set up to analyze all factors related to financial system and give recommendation to improve its
efficiency and productivity.
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In 1991, the Narasimhan Committee recommended for:

Creating a level playing field between the public sector, private sector and foreign sector banks
Selection of few banks like SBI for global operations
Reducing Statutory Liquidity Ratio (SLR) as that will leave more resources with banks for lending
Reducing Cash Reserve Ratio (CRR) to increase lendable resource of banks
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Rationalizing and better targeting priority sector lending as a sizeable portion of it is wasted and also much
of it turning into non-performing asset
Introducing prudential norms for better risk management and transparency in operations
Deregulating interest rates
Set up Asset Reconstruction Company (ARC) that can take over some of the bad debts of the banks and
financial institutions and collect them for a commission.
Again in 1998, Finance Ministry of the GoI appointed a committee under the chairmanship of Mr. M
Narasimham to review the progress of the implementation of the banking reforms since 1992 and further
strengthening the financial institutions of India.
In 1998, the committee recommended for:
Need for stronger banking system by merging some banks which will have a multiplier effect on industry.
Stricter norms for NPAs and the concept of narrow banking which allows the banks to place their funds
only in short term and risk free assets.
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Greater autonomy for the PSBs in order to make them function in accordance with their international
counterparts.
Government of India equity in nationalized banks be reduced to 33% for increased autonomy
Review of functions of banks boards with a view to make them responsible for enhancing shareholder
value through formulation of corporate strategy and reduction of government equity.
Increasing Capital Adequacy norms to improve the risk absorption capacity of banks.
The committee targeted raising the capital adequacy ratio to 9% by 2000 and 10% by 2002. The Committee
recommended penal provisions for banks that fail to meet these requirements.
Implementations of Recommendations:
In order to implement these (Narsimham Committee II) recommendations, The RBI in Oct 1998, initiated
the second phase of Financial Sector Reforms raising capital adequacy ratio by 1% and tightened the
prudential norms for provisioning and asset classification in a phased manner.

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It also targeted to bring the capital adequacy ratio to 9% by March 2001.
In October 1999 criteria for autonomous status was identified by March 1999 and 17 banks were

considered eligible for autonomy.
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Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
(SARAFESI Act 2002) was introduced to curb NPAs like problems.
During the 2008 economic crisis, performance of Indian banking sector was far better than their international
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counterparts.
This was credited to the successful implementation of the recommendations of the Narasimham Committee-
II with particular reference to the capital adequacy norms and the recapitalization of the public sector
banks.
Impact of the two committees has been so significant that the financial-economic sector professionals
have been applauding there positive contribution.
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NEW BANK LICENCE CRITERIA

The Reserve Bank of India (RBI) granted two preliminary licences to set up new banks in a country where
only one household in two has access to formal banking services.
The approval of licences for IDFC Ltd (IDFC.NS) and Bandhan Financial Services marks the start of a
cautious experiment for a sector dominated by lethargic state lenders, many of which are reluctant to expand
into rural areas or towns where banking penetration is low. No new Indian bank has been formed since Yes
Bank (YESB.NS) in 2004.
RBI has come up with guidelines for issuing new bank license.
Key features of the guidelines are:
(i) Eligible Promoters:Entities / groups in the private sector, entities in public sector and Non-Banking
Financial Companies (NBFCs) shall be eligible to set up a bank through a wholly-owned Non-Operative
Financial Holding Company (NOFHC).
(ii) Fit and Proper criteria:Entities / groups should have a past record of sound credentials and integrity,
be financially sound with a successful track record of 10 years. For this purpose, RBI may seek feedback
from other regulators and enforcement and investigative agencies.
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(iii) Corporate structure of the NOFHC:The NOFHC shall be wholly owned by the Promoter / Promoter
Group. The NOFHC shall hold the bank as well as all the other financial services entities of the group.
(iv) Minimum voting equity capital requirements for banks and shareholding by NOFHC:The initial minimum
paid-up voting equity capital for a bank shall be5 billion. The NOFHC shall initially hold a minimum of
40 per cent of the paid-up voting equity capital of the bank which shall be locked in for a period of five
years and which shall be brought down to 15 per cent within 12 years. The bank shall get its shares listed on
the stock exchanges within three years of the commencement of business by the bank.
(v) Regulatory framework:The bank will be governed by the provisions of the relevant Acts, relevant
Statutes and the Directives, Prudential regulations and other Guidelines/Instructions issued by RBI and
other regulators. The NOFHC shall be registered as a non-banking finance company (NBFC) with the
RBI and will be governed by a separate set of directions issued by RBI.
(vi) Foreign shareholding in the bank:The aggregate non-resident shareholding in the new bank shall not
exceed 49% for the first 5 years after which it will be as per the extant policy.
(vii) Corporate governance of NOFHC:At least 50% of the Directors of the NOFHC should be independent
directors. The corporate structure should not impede effective supervision of the bank and the NOFHC

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on a consolidated basis by RBI.
(viii) Prudential norms for the NOFHC:The prudential norms will be applied to NOFHC both on stand-
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alone as well as on a consolidated basis and the norms would be on similar lines as that of the bank.
(ix) Exposure norms:The NOFHC and the bank shall not have any exposure to the Promoter Group. The bank
shall not invest in the equity / debt capital instruments of any financial entities held by the NOFHC.
(x) Business Plan for the bank:The business plan should be realistic and viable and should address how the
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bank proposes to achieve financial inclusion.

(xi) Other conditions for the bank:
The Board of the bank should have a majority of independent Directors.
The bank shall open at least 25 per cent of its branches in unbanked rural centres (population upto
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9,999 as per the latest census)

The bank shall comply with the priority sector lending targets and sub-targets as applicable to the
existing domestic banks.
Banks promoted by groups having 40 per cent or more assets/income from non-financial business
will require RBIs prior approval for raising paid-up voting equity capital beyond10 billion for every
block of5 billion.
Any non-compliance of terms and conditions will attract penal measures including cancellation of
licence of the bank.
(xii) Additional conditions for NBFCs promoting / converting into a bank:Existing NBFCs, if considered
eligible, may be permitted to promote a new bank or convert themselves into banks.
OTHER RECENT COMMITTEES
A. Nachiket Mor Committee
The Committee on Comprehensive Financial Services for Small Businesses and Low Income Households
was set up by the RBI under the chairmanship of Nachiket Mor.
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In its final report, the Committee has outlined six vision statements for full financial inclusion and financial
deepening in India:
1. Universal Electronic Bank Account (UEBA): Each Indian resident, above the age of eighteen years, would
have an individual, full-service, safe, and secure electronic bank account.
2. Ubiquitous Access to Payment Services and Deposit Products at Reasonable Charges: The Committee
envisions that every resident in India would be within a fifteen minute walking distance of a payment
access point.
3. Sufficient Access to Affordable Formal Credit: Each low-income household and small-business would have
access to a formally regulated lender that is capable of assessing and meeting their credit needs. Such a
lender must also be able to offer them a full-range of suitable credit products at an affordable price.
4. Universal Access to a Range of Deposit and Investment Products at Reasonable Charges: Each low-
income household and small-business would have access to providers that can offer them suitable investment
and deposit products. Such services must be available to them at reasonable charges.

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5. Universal Access to a Range of Insurance and Risk Management Products at Reasonable Charges: Each
low-income household and small business would have access to providers that have the ability to offer

OR
them suitable insurance and risk management products. These products must at minimum allow them to
manage risks related to: (a) commodity price movements; (b) longevity, disability, and death of human
beings; (c) death of livestock; (d) rainfall; and (e) damage to property.
6. Right to Suitability: Each low-income household and small-business would have a legally protected right
to be offered only suitable financial services. She will have the right to seek legal redress if she feels that
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due process to establish Suitability was not followed or that there was gross negligence.
The key recommendations are:
Providing a universal bank account to all Indians above the age of 18 years by January 1, 2016. To achieve
this, a vertically differentiated banking system with payments banks for deposits and payments and
wholesale banks for credit outreach. These banks need to have Rs.50 crore by way of capital, which is
a tenth of what is applicable for new banks that are to be licensed.
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Aadhaar will be the prime driver towards rapid expansion in the number of bank accounts.
Monitoring at the district level such as deposits and advances as a percentage of gross domestic product
(GDP).
Adjusted 50 per cent priority sector lending target with adjustments for sectors and regions based on
difficulty in lending.
B. P. J. Nayak Committee
It was constituted by the RBI for making recommendations regarding corporate governance in PSU banks.
Recommendations of the Nayak Committee are:
Scrapping and removal of Bank Nationalisation Acts, SBI Act and SBI(Subsidiary Banks) Act.
Conversion of PSBs into Companies as per the Companies Act.
Formation of a Bank Investment Company/BIC under the Companies Act; transfer of shares by the
central government in PSBs to the BIC.
BIC in turn would have over the controlling power to boards of PSBs.
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Government will only control earning return on investment.

Fair return on investment to the Central government would be the responsibility of BIC.
Appointments of CEOs, Inside Directors and top Executives of PSBs would be the responsibility of the
Bank Boards Bureau constituting three serving or retired bank chairmans and the government would not
be involved in this decision in any way.
Nayak committee also recommends proportionate voting rights to all shareholders and reduction of
governmental shareholding to 40%.
Mission Indradhanush for revamping Public Sector Banks
The mission includes the seven key reforms of appointments, board of bureau, capitalisation, de-stressing,
empowerment, framework of accountability and governance reforms.
The mission includes:
1. Appointments : Executives from the private sector have been hired to run state-owned banks with the
government.

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2. Bank Board Bureau : The Bank Board Bureau will start functioning from the next financial year and
is the first step toward a full-fledged bank holding company, an entity that will house the governments
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stake in state run banks struggling with mounting non-performing loans that have touched 6 per cent
of gross advances.
3. Capitalization : The government will inject a total of Rs 25,000 crore of capital into debt-laden state
banks in this fiscal; Rs 20,000 crore would be injected in a month. Over the next four years, the
government plans to inject Rs 70,000 crore.
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4. De-stressing : The government will concentrate on distressing the banks bad loans.
5. Empowerment : The government will strive to make it easier for PSBs to hire. The government is
looking at introducing Employee Stock Ownership Plan (ESOPs) for the PSU bank managements.
6. Framework of Accountability : The government also announced a new framework of key performance
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indicators for state-run lenders to boost efficiency in functioning while assuring them of independence
in decision making on purely commercial considerations.
7. Governance Reforms: The process of governance reforms started with Gyan Sangam - a conclave
of PSBs and FIs organized at the beginning of 2015 in Pune which was attended by all stake-holders
including Prime Minister, Finance Minister, MoS (Finance), Governor, RBI and CMDs of all PSBs and
FIs. There was focus group discussion on six different topics which resulted in specific decisions on
optimizing capital, digitizing processes, strengthening risk management, improving managerial
performance and financial inclusion.
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FISCAL FRAMEWORK: THE WORLD IS

5
CHANGING, SHOULD INDIA CHANGE TOO?

Context
Advanced countries have embraced fiscal activism, giving a greater role to
counter-cyclical policies during crisis. But India's experience has taught the
opposite lessons increase spending and deficit during accelerating growth
lead to financial crisis during 1990's and vulnerability during 2013.On primary
deficit front India has been a outlier with high primary deficit vis--vis other

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countries. This means government is dependent on growth and favourable
interest rates to contain debt to GDP ratio. Events have reaffirmed the need
for rules to contain activism, so as to rein in excessive spending during booms
and inordinate deficits during downturns.
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Technical Terms
A. Procyclical and Counter Cyclical fiscal Policies - A procyclical fiscal policy can be summarised
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simply as governments choosing to increase public spending and reduce taxes during an economic
boom, but reduce spending and increase taxes during a recession. A countercyclical fiscal policy
refers to the opposite approach: reducing spending and raising taxes during a boom period, and
increasing spending/cutting taxes during a recession.
B. Fiscal activism: fiscal policies of a government
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which believes in active participation in the national

economy to affect its economic agenda and
objectives.
C. Quantitative easing - One of the main tools they
have to control growth is raising or lowering interest
rates. Lower interest rates encourage people or
companies to spend money, rather than save. But
when interest rates are at almost zero, central banks
need to adopt different tactics - such as pumping
money directly into the financial system. Central
Bank prints money and then uses this money to
buy bonds from investors such as banks or pension
funds. This increases the overall amount of useable
funds in the financial system. Making more money
available is supposed to encourage financial
institutions to lend more to businesses and
individuals. It can also push interest rates lower across the economy, even when the central banks
own rates are just about as low as they can go. This in turn should allow businesses to invest and
consumers to spend more, giving a knock-on boost to the economy.
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Gist of Economic Survey Chapter

The Chapter compare Indian response on fiscal policies of flow (deficit) and stock (debt) compared to
other world economies over the period and during time of crisis especially during global financial crisis
and what should be Indias future fiscal policy framework toward these ends.
In this time of pessimism the advance countries followed fiscal expansionary policies, however even after
cyclic conditions are changing, advance economies may favour activist fiscal policies especially in case
of USA. In current times, the new view of fiscal policy shifts the emphasis from stocks to flows, arguing
for greater activism in flows (deficits) and minimizing concerns about the sustainability of the stocks
(debt). Should India follow the same path? This is imperative at a time when India is reviewing the fiscal
policy framework enshrined in the FRBM Act of 2003.

India and the World: Flows

As Advanced Economies (AEs) are taking path of activist fiscal policies considering challenges of weak
economic activity and the inability to address this problem through monetary policy, India may have the
need for counter-cyclic policy due to twine deficit problem and debt overhang.

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However Indias situation differs from that of the AEs in some important ways which run counter to
taking path of activist counter-cyclical policy. This include High growth rate along with substantially high
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inflation rate,As a result, monetary policy is nowhere close to the zero lower bound.
Apart from it India, Indias fiscal stance has an in-built bias toward higher deficits, because spending rises
pro-cyclically during growth surges, while revenue and spending are deployed counter-cyclically during
slowdowns. The inability to rein in these deficits played a key role in undermining Indias external
situation which resulted in full blown crisis of 1991 and later crisis of 2013. This pattern creates fiscal
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fragility. Fiscal rules, insofar as they can be effective and binding, must therefore aim to prevent spending
surge during booms and constrain counter-cyclicality during downturns.
India and the World: Stocks
India has stock problem which include high debt-to-GDP ratio compared to many other emerging markets.
However its fiscal strength can be accessed by taking fiscal commitment and debt dynamics into
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consideration.
Regarding fiscal commitment,if fiscal and debt sustainability is about confidence and trust as revealed in
the ability and willingness of governments to limit their debt levels and pay them off without disruption
than India has a very good record of keeping its debt commitment both internally and externally.
On debt dynamics, the implications for the growth interest rate differential are stark. India would have
a favourable growth interest rate differential compared to AEs because of its high growth rate for next
15 years. This is favourable for debt sustainability, however challenge lies in quite high primary deficit that
is the shortfall between its receipts and its non-interest expenditures, compared to its peers. As a result
of running a primary deficit, the government is dependent on growth and favourable interest rates to
contain the debt ratio. This could result in upward spiral of debt ratio if growth rate and interest rates
are faltered.

Conclusion
Back in 2003 there was common agreement that fiscal rules were better than discretion, that fiscal policy
should be aimed at medium-term objectives such as reducing the stock of debt rather than shorter-term
cyclical considerations. Now, advanced countries have moved away from these principles toward greater
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fiscal activism, giving counter-cyclical policies much more of a role and giving correspondingly less
weight toward curbing the debt stock. But Indias experience has taught the opposite lessons. It has
reaffirmed the need for rules to contain fiscal deficits, because of the proclivity to spend during booms
and undertake stimulus during downturns. It has also highlighted the danger of relying on rapid growth
rather than steady and gradual fiscal and primary balance adjustment to do the heavy lifting on debt
reduction.
In short, it has underscored the fundamental validity of the fiscal policy principles set out in the FRBM.
Even as these basic tenets of the FRBM remain valid, the operational framework designed in 2003 will
need to be modifiedto reflect the India of today, and even more importantly the India of tomorrow. This,
then, will be the task of the FRBM Review Committee: to set out a new vision, an FRBM for the 21st
century.

Supplementary Readings

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A. Fiscal Responsibility and Budget Management (FRBM) Act
Indian economy faced with the problem of large fiscal deficit and its monetization spilled over to external

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sector in the late 1980s and early 1990s. The large borrowings of the government led to such a precarious
situation that government was unable to pay even for two weeks of imports resulting in economic crisis
of 1991. Consequently, Economic reforms were introduced in 1991 and fiscal consolidation emerged as
one of the key areas of reforms. After a good start in the early nineties, the fiscal consolidation faltered
after 1997-98. The fiscal deficit started rising after 1997-98. The Government introduced FRBM Act,2003
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to check the deteriorating fiscal situation.
FRBM Act provides a legal institutional framework for fiscal consolidation. Fiscal Responsibility and
Budget Management (FRBM) became an Act in 2003. The objective of the Act is
To ensure inter-generational equity in fiscal management
Long run macroeconomic stability
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Better coordination between fiscal and monetary policy, and

Transparency in fiscal operation of the Government
The Government notified FRBM rules in July 2004 to specify the annual reduction targets for fiscal
indicators. The FRBM rule specifies reduction of fiscal deficit to 3% of the GDP by 2008-09. Similarly,
revenue deficit has to be reduced with complete elimination to be achieved by 2008-09. The Government
can move away from the path of fiscal consolidation only in case of natural calamity, national security
and other exceptional grounds which Central Government may specify. The Finance Minister has to
explain the reasons and suggest corrective actions to be taken, in case of breach.
The Act bans the purchase of primary issues of the Central Government securities by the RBI after 2006,
preventing monetization of government deficit. The Act also requires the government to lay before the
parliament three policy statements in each financial year namely
Medium Term Fiscal Policy Statement
Fiscal Policy Strategy Statement and
Macroeconomic Framework Policy Statement.
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To impart fiscal discipline at the state level, the Twelfth Finance Commission gave incentives to states
through conditional debt restructuring and interest rate relief for introducing Fiscal Responsibility Legislations
(FRLs). All the states have implemented their own FRLs.
Implementation
The implementation of FRBM Act/FRLs improved the fiscal performance of both centre and states. The
States have achieved the targets much ahead the prescribed timeline. Government of India was on the path
of achieving this objective right in time. However, due to the global financial crisis, this was suspended
and the fiscal consolidation as mandated in the FRBM Act was put on hold in 2007-08.The crisis period
called for increase in expenditure by the government to boost demand in the economy. As a result of fiscal
stimulus, the government has moved away from the path of fiscal consolidation. However, it should be
noted that strict adherence to the path of fiscal consolidation during pre crisis period created enough fiscal
space for pursuing counter cyclical fiscal policy.

Amendments to FRBM Act

Through Finance Act 2012, amendments were made to the Fiscal Responsibility and Budget Management

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Act, 2003 through which it was decided that in addition to the existing three documents, Central Government
shall lay another document - the Medium Term Expenditure Framework Statement (MTEF) - before both
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Houses of Parliament in the Session immediately following the Session of Parliament in which Medium-
Term Fiscal Policy Statement, Fiscal Policy Strategy Statement and Macroeconomic Framework Statement
are laid.
Concept of Effective Revenue Deficit and Medium Term Expenditure Framework statement are the
two important features of amendment to FRBM Act in the direction of expenditure reforms. Effective
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Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets. This
will help in reducing consumptive component of revenue deficit and create space for increased capital
spending. Effective revenue deficit has now become a new fiscal parameter. Medium-term Expenditure
Framework statement will set forth a three-year rolling target for expenditure indicators.
As per the amendments in 2012, the Central Government has to take appropriate measures to reduce the
fiscal deficit, revenue deficit and effective revenue deficit to eliminate the effective revenue deficit by the
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31st March, 2015 and thereafter build up adequate effective revenue surplus and also to reach revenue
deficit of not more than 2 % of Gross Domestic Product by the 31st March, 2015.
Vide the Finance Act 2015, the target dates for achieving the prescribed rates of effective deficit and fiscal
deficit were further extended. The effective revenue deficit which had to be eliminated by March 2015
will now need to be eliminated only after 3 years i.e., by March 2018. The 3% target of fiscal deficit to
be achieved by 2016-17 has now been shifted by one more year to March 2018.
Committee to Review the Implementation of the FRBM Act
In the Union Budget 2016-17 it was proposed to constitute a Committee to review the implementation
of the FRBM Act and give its recommendations on the way forward. This was in view of the new school
of thought which believes that instead of fixed numbers as fiscal deficit targets, it may be better to have
a fiscal deficit range as the target, which would give necessary policy space to the Government to deal
with dynamic situations. A time has come to review the working of the FRBM Act, especially in the
context of the uncertainty and volatility which have become the new norms of global economy.
The FRBM Review Committee has given its report recently. The Committee has done an elaborate
exercise and has recommended that a sustainable debt path must be the principal macro-economic anchor
of our fiscal policy. The Committee has favoured Debt to GDP of 60% for the General Government by
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2023, consisting of 40% for Central Government and 20% for State Governments. Within this framework,
the Committee has derived and recommended 3% fiscal deficit for the next three years.
The Committee has also provided for Escape Clauses, for deviations upto 0.5% of GDP, from the
stipulated fiscal deficit target. Among the triggers for taking recourse to these Escape Clauses, the
Committee has included far-reaching structural reforms in the economy with unanticipated fiscal
implications as one of the factors. Considering all these aspects, budget 2017-18 has pegged the fiscal
deficit for 2017-18 at 3.2% of GDP and 3% in the following year.

Related Questions
1. Rule based fiscal policy is necessary to rationalize fiscal activism both during boom and downturn.
Comment
2. What are the merits of using fiscal policy during Crisis? What has been Indias experience in this
regard?

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UNIFIED PAYMENT INTERFACE

Unified Payments Interface (UPI) is a system that powers multiple bank accounts into a single mobile
application (of any participating bank), merging several banking features, seamless fund routing & merchant
payments into one hood. It also caters to the "Peer to Peer" collect request which can be scheduled and paid
as per requirement and convenience.
The key objective of a unified system is to offer an architecture to facilitate next generation online immediate
payments leveraging trends such as increasing smartphone adoption, Indian language interfaces, and universal
access to Internet and data.
UPI is expected to further propel easy instant payments via mobile, web, and other applications. The payments

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can be both sender (payer) and receiver (payee) initiated and will be carried out in a secure, convenient, and
integrated fashion. Virtual payment addresses, 1-click 2-factor authentication, Aadhaar integration, use of

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payer's smartphone for secure credential capture, etc. are some of the core features. It supports the growth
of e-commerce, while simultaneously meeting the target of financial inclusion.
UPI is important for implementation of the JAM (Jhan Dhan Yojana, Aadhar and Mobile) trinity.
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NATIONAL COMPANY LAW TRIBUNAL

The Central Government has constituted National Company Law Tribunal (NCLT) under section 408 of the
Companies Act, 2013.
The National Company Law Tribunal NCLT is a quasi-judicial body, exercising equitable jurisdiction, which
was earlier being exercised by the High Court or the Central Government. The Tribunal has powers to regulate
its own procedures.
The establishment of the National Company Law Tribunal (NCLT) consolidates the corporate jurisdiction of
the following authorities:

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1. Company Law Board
2. Board for Industrial and Financial Reconstruction.
3.
4.
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The Appellate Authority for Industrial and Financial Reconstruction.
Jurisdiction and powers relating to winding up restructuring and other such provisions, vested in the High
Courts.
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In the first phase the Ministry of Corporate Affairs have set up eleven Benches, one Principal Bench at New
Delhi. These Benches will be headed by the President and 16 Judicial Members and 09 Technical Members
at different locations.
Powers of NCLT
The NCLT has been empowered to exercise the following powers:
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1. Most of the powers of the Company Law Board under the Companies Act, 1956.
2. All the powers of BIFR for revival and rehabilitation of sick industrial companies;
3. Power of High Court in the matters of mergers, demergers, amalgamations, winding up, etc.;
4. Power to order repayment of deposits accepted by Non-Banking Financial Companies as provided in
section 45QA of the Reserve Bank of India Act, 1934;
5. Power to wind up companies;
6. Power to Review its own orders.
The NCLT shall have powers and jurisdiction of the Board for Industrial and Financial Reconstruction (BIFR),
the Appellate Authority for Industrial and Financial Reconstruction (AAIFR), Company Law Board, High
Courts relating to compromises, arrangements, mergers, amalgamations and reconstruction of companies,
winding up etc. Thus, multiplicity of litigation before various courts or quasi-judicial bodies or forums have
been sought to be avoided. The powers of the NCLT shall be exercised by the Benches constituted by its
President.
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INVESTOR-STATE DISPUTE SETTLEMENT (ISDS)

ISDS or investment court system (ICS) is a system through which individual companies can sue countries
for alleged discriminatory practices.
If an investor from one country (the "home state") invests in another country (the "host state"), both of
which have agreed to ISDS, and the host state violates the rights granted to the investor under public
international law, then that investor may bring the matter before an arbitral tribunal.
Foreign investors alone (including their subsidiaries and shareholders) are able to initiate claims against the
government; the government cannot initiate an ISDS proceeding.
The decision-makers in these ISDS proceedings are private arbitrators appointed on a case by-case basis

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to decide the investors' claims against the host government.
When deciding the case, the substantive law the arbitrators apply is not the domestic law of the "host"
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state that normally governs the investment. Rather, it is the law of the treaty, as interpreted by the
arbitrators.
If the arbitrators find that the government violated the treaty, they can order the government to pay the
investor substantial damages. If a tribunal issues an award against the government, courts of most
countries are required to enforce it.
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ISDS is an instrument of international public law and provisions are contained in a number of bilateral
investment treaties, in certain international trade treaties, such as NAFTA
Why it has been established?
Firstly, the investor may not want to bring an action against the host country in that country's courts
because it might think they are biased or lack independence.
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Secondly, investors might not be able to access the local courts in the host country. There are examples
of cases where countries have expropriated foreign investors, not paid compensation and denied them
access to local courts. In such situations, investors have nowhere to bring a claim, unless there is an ISDS
provision in the investment agreement.
Thirdly, countries do not always incorporate the rules they sign up to in an investment agreement into
their national laws. When this happens, even if investors have access to local courts, they may not be able
to rely on the obligations the government has committed itself to in the agreement.
Criticisms of ISDS
ISDS provides an additional channel for investors to sue governments, including a belief that all disputes
(even international law disputes) should be resolved in domestic courts.
ISDS could put strains on national treasuries or that ISDS cases are frivolous.
It decreases the potential impact of ISDS rulings on the ability of governments to regulate.
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