THE CONTEMPORARY ISSUES IN BANKING

CONTEMPORARY ISSUES
Revised Guidelines on Priority Sector LendingTargets and Classification Removal of fore-closure/pre-payment penalty on Home Loans Deployment of White Label ATMs Revised Guidelines on No Frills Account or Basic Saving Bank Accounts Basel III norms Deregulation of Savings Bank Deposit Interest Rate Rationale and Impact

REVISED GUIDELINES ON PRIORITY SECTOR LENDING

What are Priority sector Lendings? Typically these are small value loans to farmers for agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low income groups and weaker sections. The priority sectors are broadly taken as those sectors of the economy which, if not designated as priority sectors, may not get timely and adequate credit.

Revised Guidelines The revised guidelines aim at implementing the essence of recommendations of Nair Committee without dismantling the established and accepted structure of priority sector lending.

HIGHLIGHTS OF THE REVISED GUIDELINES

Overall target under priority sector is retained at 40 per cent as suggested by Nair Committee. The targets for both direct and indirect agricultural lending are kept unchanged at 13.5 per cent and 4.5 per cent of Adjusted Net Bank Credit, respectively.

The following important activities, among others, form part of priority sector lending as per the revised guidelines: Loans to Micro and Small Service enterprises up-to Rs.1 crore and all loans to Micro and Small manufacturing enterprises Loans upto Rs. 25 lakh for housing in metropolitan centres of population above 10 lakh and Rs.15 lakh at other centres.

Continued.. Loans to Food and Agro processing units. Loans to individuals for educational purposes including for vocational courses up to Rs.10 lakh in India and Rs.20 lakh abroad. Loans for housing projects exclusively for economically weaker sections and low income groups, provided the cost does not exceed Rs.5 lakh per dwelling unit. Loans to distressed farmers indebted to non institutional lenders. Overdrafts up to Rs.50000/- in No-Frills account. Loans to State Sponsored Organisations for scheduled castes and scheduled tribes. Loans to individuals for setting up of off-grid solar and other off-grid renewable energy solutions for households. Loans to individuals other than farmers up to Rs.50000/to prepay their debt to non- institutional lenders.

Continued. Foreign banks having 20 or more branches in the country will be brought on par with domestic banks for priority sector targets in a phased manner over a maximum period of 5 years starting April 1, 2013. They will be required to submit an action plan for achieving the targets over a specific time frame to be approved by RBI.

The foreign banks with less than 20 branches will have no sub targets within the overall priority sector lending target of 32 per cent. This is expected to allow them to lend as per their core competence to any priority sector category. Bank loans to Primary Agricultural Credit Societies (PACS), Farmers' Service Societies (FSS) & Large Adivasi MultiPurpose Co-operative Societies (LAMPS) ceded to or managed/controlled by such banks for on-lending to farmers for agricultural and allied activities are included under direct agriculture.

Continued.. Investments by banks in securitised assets, outright purchases of loans and assignments to be eligible for classification under priority sector provided the underlying assets qualify for priority sector treatment and the interest rate charged to the ultimate borrower by the originating entity does not exceed Base Rate of such bank plus 8 per cent per annum.

REMOVAL

OF FORE-CLOSURE/PRE-PAYMENT

PENALTY ON

HOME LOANS

What are foreclosure charges/ prepayment charges?

If the Loan installments are prepaid within a certain time period, a penalty is levied known as prepayment penalty or foreclosure charges.
Banks and lenders lend money in the form of only to make money out of services provided. And this require fairly longer duration to give profit. They cannot stop your legal right from making a payment. But at the same time pre payment would mean upsetting their profit calculation from interest. Hence the banks and lenders impose a prepayment penalty to compensate a portion of lost profit. Usually your loan agreement would have a clause defining your obligation and interest in case of pre payment in part or in full

Why do banks charge penalty for prepayment?

Removal of fore-closure/pre-payment penalty on Home Loans

On April 17, 2012 in the Monetary Policy Statement, RBI ordered all the banks to remove the foreclosure/prepayment charges. The Committee on Customer Service in Banks had observed that foreclosure charges levied by banks on prepayment of home loans are resented upon by home loan borrowers across the board especially since banks were found to be hesitant in passing on the benefits of lower interest rates to the existing borrowers in a falling interest rate scenario.

As such, foreclosure charges are seen as a restrictive practice deterring the borrowers from switching over to cheaper available source.

What is the objective of such decision? The removal of foreclosure charges/prepayment penalty on home loans will lead to reduction in the discrimination between existing and new borrowers and competition among banks will result in finer pricing of the floating rate home loans.

Though many banks have in the recent past voluntarily abolished pre-payment penalties on floating rate home loans, there is a need to ensure uniformity across the banking system. It has, therefore, been decided that banks will not be permitted to charge foreclosure charges/prepayment penalties on home loans on floating interest rate basis, with immediate effect.

DEPLOYMENT OF WHITE LABEL ATMS

In February 2012, RBI issued draft guidelines for deployment of WLAs Owned and operated by non-banking entities Customers from any bank will be able to withdraw money from such WLAs but will have to pay fee for the services. Such WLAs will not display logo of any particular bank Likely to be located in non traditional places

 What

is the purpose for introduction of White Label ATMs in India

In India only Banks are allowed to set up ATMs. Although between 2008 - 2011, there has been 30% growth in number of ATMs and by the beginning of 2012, we have about 87,000 ATMs in India. Yet the penetration of ATMs in Tier III and Tier IV cities has been low and downtime of such ATMs has been high. Thus, RBI is feeling that there is a need to expand ATM network, which can be done by only with the help of private operators.

Who will benefit from White Label ATMs :

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 which will be convenient and located near to their home or place of work. Banks too support introduction of white label ATMs as such machines are likely to reduce pre-transaction cost for them and will be free from the problems relating to maintaining and running such a payment channel.

What Problems are Likely to be Faced by Bankers and Customers

The first and foremost concern for customers will be the inconvenience they may feel in case of failed transactions on WLAs. In such cases the dispute resolution mechanism will involve three entities the WLA operator, the sponsor bank of the operator, and the customer's bank. The WLA operators being non bank entities and running purely on profit basis may take longer time or avoid payments on account of failed transactions. The second concern for customers will be the high cost they are likely to pay for use of such ATMs.

REVISED GUIDELINES ON NO FRILLS ACCOUNT OR BASIC SAVING BANK ACCOUNT

Banks were advised in November 2005 to make available a basic banking 'no-frills' account either with 'nil' or very low minimum balance as well as charges that would make such accounts accessible to vast sections of population. With a view to doing away with the stigma associated with the nomenclature no-frills account and making the basic banking facilities available in a more uniform manner across banking system, it has been decided to modify the guidelines on opening of basic banking no-frills accounts.

According to these guidelines, banks are advised to offer a Basic Savings Bank Deposit Account which will offer following minimum common facilities to all their customers:

i. The Basic Savings Bank Deposit Account should be considered a normal banking service available to all. ii. This account shall not have the requirement of any minimum balance. iii. The services available in the account will include deposit and withdrawal of cash at bank branch as well as ATMs; receipt/credit of money through electronic payment channels or by means of deposit/collection of cheques drawn by Central/State Government agencies and departments; iv. While there will be no limit on the number of deposits that can be made in a month, account holders will be allowed a maximum of four withdrawals in a month, including ATM withdrawals; and v. Facility of ATM card or ATM-cum-Debit Card;

No charge on all the above facilities and No charge on nonoperation or activation of inactive account

Holders of Basic Savings Bank Deposit Account will not be eligible for opening any other savings bank deposit account in that bank. If a customer has any other existing savings bank deposit account in that bank, he/she will be required to close it within 30 days from the date of opening a Basic Savings Bank Deposit Account. The existing basic banking no-frills accounts should be converted to Basic Savings Bank Deposit Account

BASEL III NORMS

A comprehensive set of reform measures designed to improve the regulation, supervision and risk management within the banking sector. The Basel Committee on Banking Supervision published the first version of Basel III in late 2009, giving banks approximately three years to satisfy all requirements.

BASEL III GUIDELINES

The Reserve Bank of India had released draft guidelines on its website on December 2011 for comments and feedback from various stakeholders. According to the guidelines, which will be effective from January 1, 2013, banks will have to maintain their total capital ratio at 9%, higher than the minimum recommended requirement of 8% under the Basel III norms. The norms also require banks to maintain Tier I capital at 7% of risk weighted assets.

MAJOR CHANGES IN BASEL III

Better Capital Quality Capital Conservation Buffer Countercyclical Buffer Minimum Common Equity and Tier 1 Capital Requirements Leverage Ratio

DEREGULATION OF SAVINGS BANK DEPOSIT INTEREST RATE RATIONALE AND IMPACT

The only interest rate that continued to remain regulated was the savings deposit interest rate until October 25, 2011 The pros and cons of deregulation of savings bank deposit rate as under: Pros a) Deregulation of the interest rate on savings deposit will make the rate flexible along with other interest rates depending on the market conditions b) Regulation of savings deposit interest rate not only reduced its relative attractiveness, it also adversely affected the transmission of monetary policy c) Savings deposits constitute a large proportion of total deposits. However, owing to regulation of interest rate, there was hardly any competition in this segment with both banks and depositors acting passively. This inhibited product innovations

DEREGULATION OF SAVINGS BANK DEPOSIT INTEREST RATE RATIONALE AND IMPACT

Cons a) Savings deposits have been a source of cheap funds for banks and are core deposits, which are used to finance longterm assets. This, raised the concern that deregulation might lead to an unhealthy competition resulting in a large shift of deposits from some banks exposing them to a serious risk of asset liability mismatch b) Should unhealthy competition result in increase in interest rate and the overall cost of funds, banks might be discouraged from maintaining savings deposits with small amounts due to the associated high transaction costs c) In the event, if savings deposit interest rates decline markedly, income flow to small savers/pensioners may get affected adversely d) Following deregulation, some banks may introduce some complex products, which may not be so easily understood by savers. These strategies may result in increase in the misselling of savings bank products

DEREGULATION AND ITS IMPACT

Since the deregulation of savings deposit interest rate, five private sector banks, ten foreign banks and one co-operative bank have increased their savings deposit interest rate in the range of 100-500 basis points during the period so far So far, none of the public sector banks has increased its savings deposit interest rate Any unhealthy competition has not been seen amongst banks so far, as 15 SCBs, which have raised saving deposit rate, account for only 4.2 per cent of aggregate deposits However, these 15 banks witnessed above-average growth in their savings deposits The share of these banks to total savings bank deposits increased from 1.8 per cent to 2.1 per cent in the postderegulation period up to July 2012 and their contribution to the total growth of savings bank deposits stood at around 5 per cent during this period A survey of 11 banks comprising public sector, private sector and foreign banks reveals that banks that raised savings deposits interest rates have not changed their non-interest charges during post-deregulation period so far Since majority of banks are yet to change their savings deposits interest rates, the change in non-interest charges is yet to gather momentum

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