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TYPES OF BANKS
UNIVERSAL BANK
It is financial supermarket where all financial products are sold under one roof.
It is a system of banking where bank undertake a blanket of financial services like investment banking,
commercial banking, development banking, insurance and other financial services including functions of
merchant banking, mutual funds, factoring, housing finance etc.
As per the World Bank, the definition of the Universal Bank is as follows:In Universal banking, the large
banks operate extensive network of branches, provide many different services, hold several claims on

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firms (including equity and debt) and participate directly in the Corporate Governance of firms that rely
on the banks for funding or as insurance underwriters.

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The second Narasimham committee of 1998 gave an introductory remark on the concept of the Universal
banking, as a different concept than the Narrow Banking. Narsimham Committee II suggested that
Development Financial Institutions (DFIs) should convert ultimately into either commercial banks or non-
bank finance companies.
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However, the concept of Universal Banking conceptualized in India after theRH Khan
Committeerecommended itas a different concept. The Khan Working Group held the view that DFIs
(Development Finance Institutions) should beallowed to become banks at the earliest.
Advantages of Universal Banking
Increased diversions and increased profitability.
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Better Resource Utilization.

Brand name leverage.
Existing clientele leverage.
Value added services.
One-stop shopping saves a lot of transaction costs.
Easy Marketing
Profit Diversification
DEVELOPMENT BANK
Development bank is essentially a multi-purpose financial institution with a broad development outlook.
A development bank may, thus, be defined as a financial institution concerned with providing all types
of financial assistance (medium as well as long term) to business units, in the form of loans, underwriting,
investment and guarantee operations, and promotional activities economic development in general, and
industrial development, in particular.
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Development banks in India are classified into following four groups:
Industrial Development Banks: It includes, for example, Industrial Finance Corporation of India (IFCI), Industrial
OR
Development Bank of India (IDBI), and Small Industries Development Bank of India (SIDBI).
Agricultural Development Banks: It includes, for example, National Bank for Agriculture & Rural Development
(NABARD).
Export-Import Development Banks: It includes, for example, Export-Import Bank of India (EXIM Bank).
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Housing Development Banks: It includes, for example, National Housing Bank (NHB).
NABARD
National Bank for Agriculture and Rural Development (NABARD) is an apex development bank with a
mandate for:
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Facilitating credit flow for promotion and development of agriculture, small-scale industries, cottage
and village industries, handicrafts and other rural crafts.
Supporting all other allied economic activities in rural areas, promote integrated and sustainable rural
development and secure prosperity of rural areas.
NABARD acts as a regulator for co-operative banks and Regional Rural Banks (RRBs).
NABARD also helps incapacity building of partner agencies and development institutions.
NABARD provide facilities for training, for dissemination of information and the promotion of research
including the undertaking of studies, researches, techno-economic and other surveys in the field of rural
banking, agriculture and rural development.
It provides technical, legal, financial, marketing and administrative assistance to any person engaged
in agriculture and rural development activities.
LEAD BANK
Introduced in 1969, based on the recommendations of the Gadgil Study Group on the organizational framework
for the implementation of social objectives.
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Objectives of Lead Bank Scheme:

Eradication of unemployment and under employment
Appreciable rise in the standard of living for the poorest of the poor
Provision of some of the basic needs of the people who belong to poor sections of the society.
Area Approach
The basic idea was to have an area approach for targeted and focused banking.
The bankers committee, headed by S. Nariman, concluded that districts would be the units for area
approach and each district could be allotted to a particular bank which will perform the role of a Lead
Bank.
The Lead bank Scheme was not fully able to achieve its targets due to shift in policies, complexities in
operations, lack of cooperation among various financial institutions and issues shifting to the Financial

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Inclusion.
There was a strong need felt to revitalize the scheme with clear guidelines on respecting the bankers

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commercial judgements even as they fulfill their sectoral targets.
The Government of India constituted a High-Power Committee headed byMrs. UshaThorat, Deputy
Governor of the RBI, to suggest reforms in the LBS. The task of this penal was to recommend how to
revitalize the LBS, given the challenges facing the banking sector, especially in an era of increasing
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privatization and autonomy.
The following were the recommendation of Usha Thorat Committee on Lead Banks
LBS should be continued to accelerate financial inclusion in the unbanked areas of the country.
Private sector banks should be given a greater role in LBS action plans, particularly in areas of their
presence.
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Enhance the business correspondent model, making banking services available in all villages having a
population of above 2,000 and relaxation in KYC (know your customer) norms for small value accounts.
There is a strong need to revamp and revitalise the Lead Bank Scheme so as to make it an effective
instrument for bringing about meaningful co-ordination among banks operating in various part of the
country.
PAYMENT BANK
A payments bank is like any other bank, but operating on a smaller scale without involving any credit risk.
In simple words, it can carry out most banking operations but cant advance loans or issue credit cards.
It can accept demand deposits (up to Rs 1 Lakh), offer remittance services, mobile payments/transfers/
purchases and other banking services like ATM/debit cards, net banking and third party fund transfers.
The NachiketMor committee appointed by RBI to propose measures for achieving financial inclusion and
increased access to financial services in 2013.The committee submitted its report suggesting creation of
specialized bank or Payment Bank to cater the lower income groups and small businesses so that by Jan
2016, each Indian resident can have a global bank account.
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Objectives of Payment Bank

To widen the spread of payment and financial services to small businesses, low income households,
migrant labour workforce in secured technology driven environment.
With payments banks, RBI seeks to increase the penetration level of financial services to the remote areas
of the country.
SMALL FINANCE BANK
Small finance banks are a type of niche banks in India. The main purpose of the small banks will be to provide
a whole suite of basic banking products such as bank deposits and supply of credit, but in a limited area of
operation. The objective for these Small Banks is to increase financial inclusion by provision of savings vehicles
to under-served and unserved sections of the population, supply of credit to small farmers, micro and small
industries, and other unorganized sector entities through high technology-low cost operations.
RBI guidelines about small bank includes:
The firms must have a capital of Indian Rupees 100 crore. Existing Non-Banking Financial Companies
(NBFC), Micro-Finance Institutions (MFI) and Local Area Banks (LAB) are allowed to set up small

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finance banks.
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The Corporate Promoter should have 10 years experience in banking and finance.
The promoters stake in the paid-up equity capital will be 40% initially which must be brought down to
26% in 12 years. Joint ventures are not permitted.
Foreign share holding will be allowed in these banks as per the rules for Foreign Direct Investment in
private banks in India.
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The banks will not be restricted to any region. 75% of its net credits should be in priority sector lending
and 50% of the loans in its portfolio must in 25 lakh range.
The bank shall primarily undertake basic banking activities of accepting deposits and lending to small
farmers, small businesses, micro and small industries, and unorganized sector entities. It cannot set up
subsidiaries to undertake non-banking financial services activities. After the initial stabilization period of
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5 years, and after a review, the RBI may liberalize the scope of activities for Small Banks.
Small Banks have to meet RBIs norms and regulations regarding risk management. They have to meet
CRR, SLR, Repo rate and reverse repo rate requirements, like any other commercial bank.
The maximum loan size and investment limit exposure to single/group borrowers/issuers would be restricted
to 15% of capital funds.
For the first 3 years, 25% of branches should be in unbanked rural areas.
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CLASSIFICATION OF BANKS IN INDIA

BANKS
Banks are the financial institutions that are licensed to deal with money and its substitutes by accepting
time and demand deposits, making loans, and investing in securities. The bank generates profits from the
difference in the interest rates charged and paid.
Banks are connecting link between the people, who have surplus money and the people who are in need
of money. In addition to this, banks undertake the risk arising out of the possible default of the ultimate
borrower.

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In other words, bank is an institution which accepts deposits from the public and in turn advances loans
by creating credit. The following functions of the bank explain the need of the bank and its importance.
a.
b.
c.
To control the supply of money and credit. OR
To provide the security to the savings of customers.

To encourage public confidence in the working of the financial system, increase savings speedily and
efficiently.
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d. To avoid focus of financial powers in the hands of a few individuals andinstitutions.
e. To set equal norms and conditions (i.e. rate of interest, period of lending etc) to all types of
customers.
BANKING SYSTEM IN INDIA
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Banks are classified into Organized and Unorganized banking.

Un-organized Banking: The part of Indian Banking System which does not fall under the control of our
central bank (i.e. Reserve Bank of India) is called as un-organized banking. For example: Indigenous banks.
Organized Banking: The scheduled banks are those which are entered in the second schedule of RBI Act,
1939. Scheduled banks are those banks which have a paid up capital and reserves of aggregate value of
not less than Rs 5 lakhs and which satisfy RBI guidelines.
The Organized (Scheduled) Banking Sector can be categorized into three major categories:
a) Central Bank of the Country (RBI)
b) Commercial Banks
c) Cooperative Banks
CENTRAL BANK RBI
RBI is an apex institution in the banking and financial structure of the country which plays a crucial role in
organizing, running, supervising, regulating and developing the banking and financial structure of the economy.
Indias Central Bank is known as the Reserve Bank of India.
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Historical Background of RBI

In 1926, the Royal Commission on Indian Currency and Finance which is also known as the Hilton-Young
Commission recommended the creation of a central bank.
The idea was twofold
To separate the control of currency and credit from the government.
To augment banking facilities throughout the country.
The Reserve Bank of India Act of 1934 established the Reserve Bank as the banker to the central
government and set in motion a series of actions culminating in the start of operations on April 1, 1935.
RBI was nationalizedin 1949.
It has four Zonal offices at Delhi, Kolkata, Chennai and Mumbai for four regions: Northern, Eastern,
Southern and Western regions respectively. RBI has 19 offices, which are located in state capitals and a
few major cities in India. In addition, there are 9 sub-offices of RBI.

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Functions of Central Bank (RBI)
Bank of Issue: It has a sole authority to issue currency notes and coins through the issue department,
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which is solely responsible for the issue of notes and coins.
Banker to Banks and Government: As the Bankers bank, RBI acts as the custodian of cash reserves of
commercial and other Banks.
Commercial banks are under statutory obligation to keep a part of their deposits as reserves with the
central bank.
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The central bank provides credit, mainly short-term credit, to the commercial banks. It provides them
guidance and direction and regulates their activities.
Commercial banks are required to shape their policy in accordance with these directions and guidance of
the central bank.
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As the banker and financial adviser to the government the central bank receives the deposits of cash,
cheques, drafts etc. from the government.
It provides cash to the government for paying salaries and wages and other cash disbursements. It makes
payments on behalf of the government.
It gives short-period loans to the government. It buys and sells foreign currencies on behalf of the government.
Lender to Last Resort: RBI helps commercial banks when they have exhausted their resources and are
in financial need. In its capacity as the lender of the last resort, the central bank provides, directly or
indirectly all reasonable financial assistance to commercial banks.
Controller of Credit: RBI controls the credit creation by the commercial banks which are regarded as the
most important function of Central Bank.
At present, Credit Money or Bank Money is the dominant form of money and essentially requires the
supply of credit to be regulated so as to ensure the smooth functioning of the economy.
For this, the central bank adopts quantitative and qualitative methods of credit control. Quantitative
methods aim at controlling the cost and availability of credit, while the qualitative method influences the
use and direction of credit.
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How is Central Bank different from Commercial Banks?

On the basis of Profit: A central bank does not aim at making profits like a commercial bank and hence
is not a profit making institution. It acts in the public interest so as to control and regulate the banking
and financial system of the country.
On the basis of functions performed: A central bank does not perform ordinary commercial banking
functions such as accepting deposits from the general public of the country.
Ownership: A central bank is an organ of the government and, therefore, is owned by the government
and managed by the government officials. But a commercial bank is generally maybe owned by both,
private individuals as shareholders and by the government.
Issuer of Currency: A central bank has sole monopoly of note issue, but commercial banks cannot issue
notes.
COMMERCIAL BANKS

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Commercial Banks are created for profit motive.
Scheduled Commercial Banks (SCBs) are grouped under following categories:



Nationalized Banks
Foreign Banks
Regional Rural Banks
OR
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Nationalized Banks
State Bank of India and its associates along with the nationalized banks such as the IDBI Banks,
Indian Bank, Dena Bank etc. are all public sector banks.
Other scheduled commercial banks include private banks such as ICICI, Axis, HDFC bank etc.
operating in the country.
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Foreign Banks
Operating in the country include Deustche Bank, Bank of America, Citibank, HSBC, and Royal Bank
of Scotland etc.
Regional Rural Banks
Regional rural banks came into being in the 1970s with the objective of providing deposit and credit
facilities to the people in rural areas especially the small and marginal farmers, agricultural labourers,
and small entrepreneurs.
Even though these banks count as the scheduled commercial banks but their focus and reach is
generally limited to a district or two.
Some of the examples of Regional Rural Banks are Assam GraminVikash Bank, Allahabad UP
Gramin Bank, Baroda Gujarat Gramin Bank etc.
At present there are 91 RRBs functioning in India.
CO-OPERATIVE BANKS
It is an institution established on the basis of cooperative principles and dealing in ordinary banking
business with No Profit No Loss Basis.
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These banks are controlled, owned, managed and operated by cooperative societies and came into existence
under the Cooperative Societies Act in 1912.
These banks are located in the urban as well in the rural areas. Although these banks have the same
functions as the commercial banks, but their rate of interest is low in comparison to other banks.
At present, there are 170 scheduled commercial banks in the country, which includes 91 Regional Rural
Banks (RRBs),19 Nationalized Banks,8 Banks in State Bank of India Groupand theIndustrial Development
Bank of India Limited (IDBI Ltd).
There are three types of cooperative banks in India, namely
Primary Credit Societies: These are formed in small locality like a small town or a village. The members
using this bank usually know each other and the chances of committing fraud are minimal.
Central Cooperative Banks: These banks have their members who belong to the same district. They
function as other commercial banks and provide loans to their members. They act as a link between the
state cooperative banks and the primary credit societies.
State Cooperative Banks: these banks have a presence in all the states of the country and have their

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presence throughout the state.
NON-SCHEDULED BANKS
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Banks not under 2nd Schedule of theReserve Bank of IndiaAct, 1934. These are also known as Local
Area Bank.
Non-scheduled banks are also subject to the statutory cash reserve requirement. But they are not required
to keep them with the RBI; they may keep these balances with themselves.
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They are not entitled to borrow from the RBI for normal banking purposes, though they may approach
the RBI for accommodation under abnormal circumstances.
There are 5 Non-Scheduled Urban Cooperative Banks in India
AkhandAnand Co-Operative Bank Ltd.
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Alavi Co-Op Bank Ltd.

Amarnath Co-operative Bank Ltd.
AmodNagrikSahakari Bank Ltd.
AmreliNagrikSahakari Bank Ltd.
Along with this 4 local area banks in India which, forms under non-scheduled list of Banking as per RBI
Coastal Local Area Bank Ltd.
Capital Local Area Bank Ltd.
Krishna BhimaSamruddhi Local Area Bank Ltd.
Subhadra Local Area Bank Ltd.
FUNCTIONS OF SCHEDULED COMMERCIAL BANKS
The primary business of any commercial bank is to accept deposits and give short term loans. Apart from this,
a scheduled commercial bank performs a number of other useful functions to the society such as:
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a. Collection of Deposits
b. Advancing Loans
c. Utility Services
d. Agency Services
Collection of Deposits: Most important function of commercial bank. These deposits can be of various
forms:
Fixed Deposits: These are the deposits for a fixed period to earn interest by the customers of a bank. Such
deposits have high interest rate than the other types of deposits. In case the customer withdraws money
before the end of stipulated term of deposit, s/he has to pay penalty.
Saving Bank Deposit: These are deposits made by persons out of their expenditure. These banks function
with the intention to culminate saving habits among people, especially those who belong to low income
groups or those who are salaried.

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The money these people deposit in the banks are invested in securities, bonds etc. These days, many
commercial banks perform the dual functions of savings bank. The postal department is also in a way a

saving bank.

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Current Account Deposits: Also known as demand deposit. The bank opens this account on an initial
deposit of Rs. 100 but certain conditions have to be met to prove credit worthiness of the customer. There
are no limitations on the amount of deposit and number of withdrawals. Generally, no interest is paid on
current deposits.
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Advancing loans: Commercial banks also play an important role in the economy by providing loans to
industries, individuals, businesses, agriculture etc. They also provide loans for export and import trade.
Utility services: Commercial banks perform various services useful to the customer. Some of them have been
listed below:
Locker facility: Banks provide locker facility to customers to keep their valuables, such as securities,
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jewellery, documents etc.

Draft facilities: Banks issue drafts to customers and enable them to transfer funds from place to place.
Letters of credit: Banks issue letters of credit to their customers. These are useful to traders to buy goods
from foreign countries on credit.
Agency Services: Commercial banks also perform several activities on behalf of their customers.
Collections: Commercial banks take up collection of promissory notes, cheques, bills, dividends,
subscriptions, rents, etc., on behalf of their customers as agents. The bank charges service charges for
rendering these services to its customers.
Payments: Banks also accept the responsibility to pay insurance premium, rents, taxes, electricity bills, etc.
periodically on behalf of its customers for whom they charge commission.
Sale and purchase of securities: Customers sometimes approach the bankers for sale and purchase of
their securities. For these services the banks charge commission.
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THE FESTERING TWIN BALANCE

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SHEET PROBLEM

Context
For some time, India has been trying to solve its Twin Balance Sheet problem-
overleveraged companies and bad-loan-encumbered banks. NPAs continued
to climb, reaching 9 percent of total advances by September (80% in PSB's).
At the same time corporate profitability has reduced, their cash ?ows are
deteriorating even as their interest obligations are mounting. The reason is

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corporations over-expand during a boom, but combination of financial crisis,
delayed clearances and increasing interests left them with obligations that
they can't repay. So, they default on their debts, leaving bank balance sheets
impaired, as well.
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This combination then proves devastating for growth, since the hobbled
corporations are reluctant to invest, while those that remain sound can't invest
much either, since fragile banks are not really in a position to lend to them.
This has spill over effect in terms of higher cost of loans to performing borrowers
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and shrinking growth of loans to MSME sector. One possible strategy would
be to create a 'Public Sector Asset Rehabilitation Agency' (PARA), charged with
working out the largest and most complex cases. However, its success depends
on staffing professionals of impeccable integrity and delinking its actions from
political consequences.
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Technical Terms
A. Over-leveraged firms - If a company is overleveraged, it has borrowed too much money and cannot
make payments on the debt.
B. Stressed assets = NPAs + Restructured loans + Written off assets
NPA - A loan whose interest and/or instalment of principal have remained overdue (not paid) for
a period of 90 days is considered as NPA.
Restructured asset or loan - They are that assets which got an extended repayment period, reduced
interest rate, converting a part of the loan into equity, providing additional financing, or some
combination of these measures.
Written off assets - They are those loans/assets bank or lender doesnt count the money borrower
owes to it. The financial statement of the bank will indicate that the written off loans are compensated
through some other way. There is no meaning that the borrower is pardoned or got exempted from
payment.
C. Asset Quality Review - Typically, Reserve Bank of India (RBI) inspectors check bank books every
year as part of its annual financial inspection (AFI) process. However, a special inspection was
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conducted in 2015-16 in the August-November period. This was named as Asset Quality Review
(AQR). In a routine AFI, a small sample of loans is inspected to check if asset classification was
in line with the loan repayment and if banks have made provisions adequately. However, in the AQR,
the sample size was much bigger and in fact, most of the large borrower accounts were inspected
to check if classification was in line with prudential norms. The RBI believed that asset classification
was not being done properly and that banks were resorting to ever-greening of accounts. Banks were
postponing bad-loan classification and deferring the inevitable.
D. Ever-greening of Loan Ever-greening refers to the practice of companies taking a fresh loan to pay
up an old loan.

E. Principal agent problem - The problem of motivating one party (the agent) to act on behalf of
another (the principal) is known as the principal-agent problem, or agency problem for short. The
principle agent problem arises when one party (agent) agrees to work in favor of another party
(principal) in return for some incentives. Such an agreement may incur huge costs for the agent,
thereby leading to the problems of moral hazard and conflict of interest. Owing to the costs incurred,

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the agent might begin to pursue his own agenda and ignore the best interest of the principal, thereby
causing the principal agent problem to occur.
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Gist of Economic Survey Chapter
The chapter look into the Twin Balance Sheet (TBS) problem of India. After Asset Quality Review
(AQR) by RBI, in early 2016 it became clear that India was suffering from a twin balance sheet
problem, where both the banking and corporate sectors were under stress.
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NPA Issue in Indian Banks

NPAs climbed to 9 percent of total advances by Sep 2016double their year-ago level. In which more than
four-fifths of the non-performing assets were in the public sector banks, where the NPA ratio had reached
almost 12 percent. On the corporate side, Credit Suisse reported that around 40 percent of the corporate debt
it monitored was owed by companies which had an interest coverage ratio less than 1, meaning they did not
earn enough to pay the interest obligations on their loans.
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Why TBS problem did not create bank runs during crisis?
Typically, countries with a twin balance sheet (TBS) problem follow a standard path. Their corporations
over-expand during a boom, leaving them with obligations that they cant repay. So, they default on their
debts, leaving bank balance sheets impaired, as well. This combination then proves devastating for growth,
since the hobbled corporations are reluctant to invest, while those that remain sound cant invest much
either, since fragile banks are not really in a position to lend to them. 4.8 This model, however, doesnt
seem to fit Indias case.
Indias TBS problem is unique, because it did not come to surface during Global Financial Crisis (2008)
and even economy continued to grow at good pace. This was mainly because most of NPAs were
concentrated in the public sector banks, which not only hold their own capital, but are ultimately backed
by the government, whose resources are more than sufficient to deal with the NPA problem. As a result,
creditors have retained complete confidence in the banking system.
In this scenario to understand Indias TBS problem four set of Questions need to be answered.
What went wrong and when did it go wrong?
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How has India managed to achieve rapid growth, despite its TBS problem?
Is this model sustainable?
What now needs to be done?
What went wrong and when did it go wrong?
During the mid-2000s i.e. at time of boom firms abandoned their conservative debt/equity ratios and
leveraged themselves up to take advantage of the perceived opportunities, setting off the biggest investment
boom financed by an astonishing credit boom in the countrys history, mainly from banks and large inflow
of funds from overseas. But just as companies were taking on more risk, things started to go wrong.
Costs soared far above budgeted levels, as securing land and environmental clearances proved much
more difficult and time consuming than expected.
At the same time, forecast revenues collapsed after the GFC; projects that had been built around the
assumption that growth would continue at double-digit levels were suddenly confronted with growth

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rates half that level.
Financing cost increased due to RBI increased interest rates to quell double digit inflation.
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For overseas financing rupee depreciated, forcing firms to repay debt at much high exchange rate.
Higher costs, lower revenues, greater financing costs all squeezed corporate cash flow, quickly leading
to debt servicing problems. By 2013, nearly one-third of corporate debt was owed by companies with an
interest coverage ratio less than 1 (IC1 companies), many of them in the infrastructure (especially
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power generation) and metals sectors. By 2015, the share of IC1 companies reached nearly 40 percent.
How has India managed to achieve rapid growth, despite its TBS problem? (Twin Balance Sheet
Syndrome with Indian Characteristics)
India followed the standard path to the TBS problem: a surge of borrowing, leading to over leverage and
debt servicing problems. What distinguished India from other countries was the consequence of TBS.
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TBS did not lead to economic stagnation in India, as occurred in the U.S. and Europe after the Global
Financial Crisis. To the contrary, it co-existed with strong levels of aggregate domestic demand, as
reflected in high levels of growth despite very weak exports and moderate, at times high, levels of
inflation. This is called as Balance sheet Syndrome with Indian Characteristics. This can be explained by
following reasons:
The unusual structure of its banking system (government backed public sector banks), which ensured
there would be no financial crisis.
As supply side constraints were loosened considerably during the boom, investment in infrastructure
keep the pace of growth up even after GFC. In comparison, the US boom was based on housing
construction, which proved far less useful after the crisis.
Apart from it Indian financial system adopted the strategy of give time to time, meaning to allow
time for the corporate wounds to heal. Thus banks decided to give stressed enterprises more time
by postponing loan repayments, restructuring by 2014-15 no less than 6.4 percent of their loans
outstanding. They also extended fresh funding to the stressed firms to tide them over until demand
recovered
As a result, total stressed assets have far exceeded the headline figure of NPAs. Restructured loans along
with unrecognised debt (loans owed by IC1 companies that have not even been recognised as problem
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debts the ones that have been ever greened, where banks lend firms the money needed to pay their
interest obligations) which are estimated at around 4 percent of gross loans, and perhaps 5 percent at
public sector banks. In that case, total stressed assets would amount to about 16.6 per cent of banking
system loans and nearly 20 percent of loans at the state banks. Now the question raised is:
Is this Strategy sustainable?
For some years the financing strategy has worked, in the sense that it has allowed India to grow rapidly,
despite a significant twin balance sheet problem. But this strategy may now be reaching its limits. After
eight years of buying time, there is still no sign that the affected companies are regaining their health, or
even that the bad debt problem is being contained.
To the contrary, the stress on corporates and banks is continuing to intensify, and this in turn is taking a
measurable toll on investment and credit. Moreover, efforts to offset these trends by providing
macroeconomic stimulus are not proving sufficient: the increase in public investment has been more than
offset by the fall in private investment, while until demonetisation monetary easing had not been transmitted
to bank borrowers because banks had been widening their margins instead. In these circumstances, it has
become increasingly clear that the underlying debt problem will finally need to be addressed, lest it derails
Indias growth trajectory.
What needs to be done? E
OR
In these circumstances, it has become increasingly clear that the underlying debt problem will finally need
to be addressed, lest it derails Indias growth trajectory.
Steps Taken by RBI to deal with the stressed asset problem which include the 5/25 Refinancing of
Infrastructure Scheme, Initially, the schemes focused on rescheduling amortisations to give firms more
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time to repay But as it became apparent that the financial position of the stressed firms was deteriorating,
the RBI deployed mechanisms to deal with solvency issues, as well.
RBI has been encouraging the establishment of private Asset Reconstruction Companies (ARCs), in
the hope that they would buy up the bad loans of the commercial banks. The problem is that ARCs
have found it difficult to recover much from the debtors. Thus they have only been able to offer low
prices to banks, prices which banks have found it difficult to accept.
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So the RBI has focussed more recently on two other, bank-based workout mechanisms. In June 2015,
the Strategic Debt Restructuring (SDR) scheme was introduced, under which creditors could take
over firms that were unable to pay and sell them to new owners. The following year, the Sustainable
Structuring of Stressed Assets (S4A) was announced, under which creditors could provide firms with
debt reductions up to 50 percent in order to restore their financial viability. The success of these
limited by only few number of cases settled under these schemes.
Reasons Why Schemes has Limited Success
In part, the problem is simply that the schemes are new, and financial restructuring negotiations inevitably
take some time. But the bigger problem is that the key elements needed for resolution are still not firmly
in place:
Ever greening of loans increased the unrecognised stress assets.
Failure of Joint Lenders Forums to arrive on single decision.
Proper incentives were missing for public sector bankers to grant write down under S4A scheme to
restore viability. To the contrary, there is an inherent threat of punishment, since major write-downs
can attract the attention of investigative agencies.
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Recapitalisation by government under Indradhanush scheme was limited.

Stressed assets are concentrated in a remarkably few borrowers, with a mere 50 companies accounting
for 71 percent of the debt owed by IC1 debtors. Thus for the big firms the road is not littered with
obstacles. It seems to be positively blocked.
All of this suggests that it might not be possible to solve the stressed asset problem using the current
mechanism, or indeed any other decentralised approach that might materialise in the near future. Instead
a centralised approach might be needed.
One possible strategy would be to create a Public Sector Asset Rehabilitation Agency (PARA),
charged with working out the largest and most complex cases. Such an approach could eliminate most
of the obstacles currently plaguing loan resolution. It could solve the coordination problem, since debts
would be centralised in one agency; it could be set up with proper incentives by giving it an explicit
mandate to maximize recoveries within a defined time period; and it would separate the loan resolution
process from concerns about bank capital.

E
How would a PARA Actually Work?
It would purchase specified loans (for example, those belonging to large, over-indebted infrastructure and
OR
steel firms) from banks and then work them out, either by converting debt to equity and selling the stakes
in auctions or by granting debt reduction, depending on professional assessments of the value-maximizing
strategy.
Once the loans are off the books of the public sector banks, the government would recapitalise them,
SC
thereby restoring them to financial health and allowing them to shift their resources financial and
human back toward the critical task of making new loans. For this the capital requirements would
nonetheless be large.
Part would need to come from government issues of securities.
A second source of funding could be the capital markets, if the PARA were to be structured in a
way that would encourage the private sector to take up an equity share.
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A third source of capital could be the RBI. The RBI would (in effect) transfer some of the government
securities it is currently holding to public sector banks and PARA. As a result, the RBIs capital
would decrease, while that of the banks and PARA would increase

Issues Need to Resolve for Proper Functioning of PARA

First, there needs to be a readiness to confront the losses that have already occurred in the banking
system, and accept the political consequences of dealing with the problem.
Second, the PARA needs to follow commercial rather than political principles.
The third issue is pricing. To transfer loan to PARA market prices could be used, but establishing
the market price of distressed loans is difficult and would prove time consuming.
Conclusion
Addressing the stressed assets problem would require 4 Rs: Reform, Recognition, Recapitalization, and
Resolution. This is the second time in a decade that such a large share of their portfolios has turned
nonperforming - unless there are fundamental reforms, the problem will recur again and again. Following
the RBIs Asset Quality Review, banks have recognised a growing number of loans as non-performing.
With higher NPAs has come higher provisioning, which has eaten into banks capital base. As a result,
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Economic Survey (2016-17) 33

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banks will need to be recapitalised the third R much of which will need to be funded by the
government, at least for the public sector banks. The key issue is the fourth R: Resolution. For even if
the public sector banks are recapitalised, they are unlikely to increase their lending until they truly know
the losses they will suffer on their bad loans. Nor will the large stressed borrowers be able to increase their
investment until their financial positions have been rectified. Until this happens, economic growth will
remain under theat.
Why is a Public Sector Asset Rehabilition Agency (PARA) Needed?

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OR
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Supplementary Readings

A. Steps taken by RBI to handle NPA

The 5/25 Refinancing of Infrastructure Scheme: This scheme offered a larger window for revival
of stressed assets in the infrastructure sectors and eight core industry sectors. Under this scheme
lenders were allowed to extend amortisation periods to 25 years with interest rates adjusted every
5 years, so as to match the funding period with the long gestation and productive life of these
projects.
Strategic Debt Restructuring (SDR): The RBI came up with the SDR scheme in June 2015 to
provide an opportunity to banks to convert debt of companies (whose stressed assets were restructured
but which could not finally fulfil the conditions attached to such restructuring) to 51 percent equity
and sell them to the highest bidders, subject to authorization by existing shareholders. An 18-month
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period was envisaged for these transactions, during which the loans could be classified as performing.
But as of end-December 2016, only two sales had materialized, in part because many firms remained
financially unviable, since only a small portion of their debt had been converted to equity.
Asset Quality Review (AQR): Resolution of the problem of bad assets requires sound recognition
of such assets. Therefore, the RBI emphasized AQR, to verify that banks were assessing loans in
line with RBI loan classification rules. Any deviations from such rules were to be rectified by March
2016.
Sustainable Structuring of Stressed Assets (S4A): Under this arrangement, introduced in June
2016, an independent agency hired by the banks will decide on how much of the stressed debt of
a company is sustainable. The rest (unsustainable) will be converted into equity and preference
shares. Unlike the SDR arrangement, this involves no change in the ownership of the company.

B. Mission Indradhanush - public sector banks revamp plan

The seven shades of Indradhanush mission include:

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Appointments: The Government decided to separate the post of Chairman and Managing Director
by prescribing that in the subsequent vacancies to be filled up the CEO will get the designation of
OR
MD & CEO and there would be another person who would be appointed as non-Executive Chairman
of PSBs. This approach is based on global best practices and as per the guidelines in the Companies
Act to ensure appropriate checks and balances. The selection process for both these positions has
been transparent and meritocratic. The entire process of selection for MD & CEO was revamped.
Private sector candidates were also allowed to apply for the position of MD & CEO.
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Bank Board Bureau: The BBB is a body of eminent professionals and officials, which will replace
the Appointments Board for appointment of Whole-time Directors as well as non-Executive Chairman
of PSBs. They will also constantly engage with the Board of Directors of all the PSBs to formulate
appropriate strategies for their growth and development.
Capitalization: As of now, the PSBs are adequately capitalized and meeting all the Basel III and RBI
GS

norms. However, the Government of India wants to adequately capitalize all the banks to keep a
safe buffer over and above the minimum norms of Basel III. The capital requirement of extra capital
for years up to FY 2019 is likely to be about Rs.1,80,000 crores. Out of the total requirement, the
Government of India proposes to make available Rs.70,000 crores.
De-stressing PSBs - The infrastructure sector and core sector have been the major recipient of PSBs
funding during the past decades. But due to several factors, projects are increasingly stalled/stressed
thus leading to NPA burden on banks. Government is addressing problems causing stress in the
power, steel and road sectors which would improve operations in these sectors and consequently De-
stress PSBs
Strengthening Risk Control measures and NPA Disclosures : Besides the recovery efforts under the
DRT & SARFASI mechanism the following additional steps have been taken to address the issue
of NPAs:
a) Creation of a Central Repository of Information on Large Credits (CRILC) by RBI
b) Formation of Joint Lenders Forum (JLF), Corrective Action Plan (CAP), and sale of assets.
- The Framework outlines formation of JLF and corrective action plan that will incentivise
early identification of problem cases, timely restructuring of accounts which are considered to
be viable, and taking prompt steps by banks for recovery or sale of unviable accounts.
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c) Establishment of six New DRTs

d) Flexible Structuring of Loan Term Project Loans to Infrastructure and Core Industries
Empowerment: The Government has issued a circular that there will be no interference from
Government and Banks are encouraged to take their decision independently keeping the commercial
interest of the organisation in mind.
Framework of Accountability: A new framework of Key Performance Indicators (KPIs) to be
measured for performance of PSBs is being announced. It is divided into four sections relating to
efficiency of capital use, diversification of business/processes, NPA management and financial
inclusion.
Governance Reforms: Banks have been assured of no interference policy, but at the same time
asking them to have robust grievance redressal mechanism for borrowers, depositors as well as staff.

Related Questions
1. Discuss how the Twin Balance Sheet syndrome has made it necessary for government to look

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forward to create crowding-in effect on economy? Also analyze, how this would affect the fiscal
consolidation targets?
OR
2. Discuss implications of increase in debt/equity ratio for firms? Analyze the performance of Indian
corporates on this parameter and identify the underlying reasons?
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DTAA
It stands for Double Taxation Avoidance Agreement. A DTAA is a tax treaty signed between two or more
countries. Its key objective is that tax-payers in these countries can avoid being taxed twice for the same
income. A DTAA applies in cases where a tax-payer resides in one country and earns income in another.
DTAAs can either be comprehensive to cover all sources of income or be limited to certain areas such as
taxing of income from shipping, air transport, inheritance, etc.

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OR
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India has DTAAs with which nations?

India has DTAAs with more than eighty countries, of which comprehensive agreements include those with
Australia, Canada, Germany, Mauritius, Singapore, UAE, UK and USA.
What are the benefits of DTAA?
DTAAs are intended to make a country an attractive investment destination by providing relief on dual
taxation. Such relief is provided by exempting income earned abroad from tax in the resident country or
providing credit to the extent taxes have already been paid abroad.
For example, if a person is sent on deputation abroad and receive emoluments during stint away from home,
income may sometimes be subject to tax in both the countries. The person can claim relief when filing tax
return for that financial year, if there is an applicable DTAA. Similarly, if the person is an NRI having
investments in India, DTAA provisions may also be applicable to income from these investments or from their
sale.
DTAAs also provide for concessional rates of tax in some cases. For instance, interest on NRI bank deposits
attract 30 per cent TDS (tax deduction at source) here. But under the DTAAs that India has signed with
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several countries, tax is deducted at only 10 to 15 per cent. Many of India's DTAAs also have lower tax rates
for royalty, fee for technical services, etc.
Example citing the working of DTAA:
An NRI individual living in X country maintains an NRO account with a bank based in India. The interest
income on the balance amount in the NRO account is deemed as income that originates in India and hence
is taxable in India.
In case, India and X nation are contracted under the DTAA, this income will have tax implications in accordance
with the rate specified in the agreement. Otherwise, the interest income will attract tax @ 30.90 % i.e. the
current withholding tax. Also, NRI is entitled to avail the benefits under the provisions of DTAA between India
and his country of residence with respect to interest income on government securities, company fixed deposits,
dividend and loans.

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OR
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MULTILATERAL COMPETENT
AUTHORITY AGREEMENT
The MCAA is a multilateral framework agreement that provides a standardised and efficient mechanism
to facilitate the Automatic Exchange of Information (AEOI) in accordance with the Standard for
Automatic Exchange of Financial Information in Tax Matters ("the Standard").
It avoids the need for several bilateral agreements to be concluded.
AEOI based on CRS (Common Reporting Standards)
It always ensures each signatory has ultimate control over exactly which exchange relationships it enters
into and that each signatory's standards on confidentiality and data protection always apply.

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India joined MCAA on 3rd June, 2015, in Paris. India to receive information from almost every country
in the world including offshore financial centres.

entities in which Indians are beneficial owners OR
It would be instrumental in getting information about assets of Indians held abroad including through

For implementation, necessary legislative changes have been made by amending Income-tax Act, 1961.
SC
It is a key to prevent international tax evasion and avoidance.
The new global standard on Automatic Exchange of Information (AEOI) reduces the possibility for tax
evasion. It provides for the exchange of non-resident financial account information with the tax authorities
in the account holders' country of residence. Participating jurisdictions that implement AEOI send and
receive pre-agreed information each year, without having to send a specific request.
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AEOI will enable the discovery of formerly undetected tax evasion. It will enable governments to recover
tax revenue lost to non-compliant taxpayers, and will further strengthen international efforts to increase
transparency, cooperation, and accountability among financial institutions and tax administrations. Additionally,
AEOI will generate secondary benefits by increasing voluntary disclosures of concealed assets and by
encouraging taxpayers to report all relevant information.
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FINANCIAL STABILITY AND

DEVELOPMENT COUNCIL (FSDC)
It is an apex-level body constituted by the government of India.
Recommendations for such a super regulatory body were first mooted by the Raghuram Rajan Committee in
2008. Finally in 2010, the then Finance Minister of India, Pranab Mukherjee, decided to set up such an
autonomous body dealing with macro prudential and financial regularities in the entire financial sector of
India.
FSDC has replaced the High Level Coordination Committee on Financial Markets (HLCCFM), which was
facilitating regulatory coordination, though informally, prior to the setting up of FSDC. It is not a statutory
body.

E
Chairperson: The Union Finance Minister of India
Members: Heads of the financial sector regulatory authorities (i.e., RBI, SEBI, IRDA, and PFRDA), Finance
OR
Secretary and/or Secretary, Department of Economic Affairs (Union Finance Ministry), Secretary, Department
of Financial Services, and Chief Economic Adviser. FSDC can invite experts to its meeting if required.
The objectives of FSDC would be to deal with issues relating to:
Financial stability
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Financial sector development

Inter-regulatory coordination
Financial literacy
Financial inclusion
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Macro prudential supervision of the economy including the functioning of large financial conglomerates.
Coordinating India's international interface with financial sector bodies such as the Financial Action Task
Force (FATF) and Financial Stability Board (FSB).
Functions: To strengthen and institutionalise the mechanism of maintaining financial stability, Financial Literacy,
Financial Inclusion, financial sector development, inter-regulatory coordination along with monitoring macro-
prudential regulation of economy. FSDC was formed to bring greater coordination among financial market
regulators.
The FSDC Sub Committee Chaired by the Governor of the RBI. All the members of the FSDC are also the
members of the Sub-committee. Additionally, all four Deputy Governors of the RBI and Additional Secretary,
DEA, in charge of FSDC, are also members of the Sub Committee. The Council/Sub-committee deliberates
on these issues and suggests taking appropriate steps, as required.
FSDC was formed to bring greater coordination among financial market regulators. The council is headed by
the finance minister and has the Reserve Bank of India (RBI) governor and chairpersons of the Securities and
Exchange Board of India, Insurance Regulatory and Development Authority and Pension Fund Regulatory
and Development Authority as other members along with finance ministry officials.
Notes