Milind S Limaye

A financial system means the structure that is available in an economy to mobilise the capital from various surplus sectors of the economy and allocate and distribute the same to the various needy sectors. Transformation of Savings to Investment and Consumption is facilitated by Financial system.
Milind S Limaye

The intermediaries who transforms Savings to Investment and Consumption are called as Financial Intermediaries.
Financial intermediaries are Banks, Financial Institutions, Mutual funds etc. The place where these activities take place are called as Financial markets.

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A) Money Market

B) Debt Market
C) Forex Market D) Capital Market

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A) Central Banking Authority

I.
II.

Monetary control
Supervision over Banks and financial institutions

III. Management of Government debt IV. Banker to Government V. Lender to last resort to banks

VI. Regulating monetory flow through monetary instruments such as CRR, SLR, Bank rate, Repo rate, Reverse Repo Rate etc.
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B) Capital Markets Regulatory authority

I. Equity and Debt market supervision and control

II. Supervision over Stock exchanges, Brokers, Equity and Debt raisers, Investment bankers, FIIs, Custodians, Depositories, Mutual Funds, Listed companies,

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C) Insurance and Pension Regulators

I. Regularatory framework for Insurance business and Pension funds

II. Supervision of all types of insurance business and pension funds

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According to section 5(b) of Banking Regulation Act 1949, the term Banking means - accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise.
Banking company" means any company which transacts the business of banking.
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Apart from the main functions as mentioned in the definition, banks are authorised to carry on other functions as mentioned in the section 6 of BRA 1949.
Other functions includes : collection and discounting of cheques and bills, safe custody of goods, offering safe deposit lockers, Issuance of Letters of Credit and Bank Guarantees, Remittances, conduction foreign exchange transactions etc.
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The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated. Though originally privately owned, since nationalisation in 1949, the Reserve Bank is fully owned by the Government of India.
Milind S Limaye

The Preamble of the Reserve Bank of India describes the basic functions of the Reserve Bank as:
"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage."

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Functions of RBI
Monetary control
Exchange control

Supervision of Banks and other financial institutions

Bankers Bank

Governments Bank
Issuance of notes
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Debtor Creditor
Creditor Debtor Trustee (Bailor Bailee)

Agent Principal
Lessor and Lessee

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National Credit council meeting held in 1968

Description of Priority sector formalised in 1972 Specific target for PSA advised to Banks in 1974 33 1/3 % of net advances Target revised to 40% by 1985.

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Categories of Priority Sector advances :

Agriculture (Direct or Indirect) Micro, Small and Medium enterprises Educational Loans Housing loans Advances to weaker sections Export Credit Government sponsored schemes

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A) Swarnajayanti Gram Swarozgar Yojana (SGSY) 1999 Replaced earlier schemes i.e.
1. 2. 3. 4. 5. 6. Integrated Rural Development Program (IRDP) Training of Rural Youth for self employment (TRYSEM) Development of Women and Children in Rural areas (DWCRA) Supply Of Improved Toolkits to Rural Artisans(SITRA) Ganga Kalyan Yojana (GKY) Million Wells Schemes (MWS)

Funded by centre and states in the ration of 75:25.

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B) Swarna Jayanti Sahakari Rozgr Yojana (SJSRY) C) Prime Ministers Rozgar Yojana (PMRY)
D) Scheme for Liberation and Rehabilitation of scvangers (SLRS)

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It is a voluntary association of poor, formed with common goal of social and economic empowerment. Unregistered group of less than 20 people from a homogeneous class who come together for addressing their common problem both economic and community. Does voluntary savings on regular basis. Banks lend in the ratio of savings to loans at 1:1 or 1:4 depending on the groups performance. Flexibility allowed to banks to determine the same.
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Reserve Bank of India (Regulator and Apex Bank)

Commercial Banks
1. 2. 3. 4. 1. 2. 3. 4. 5. Nationalized Private RRBs Foreign Banks State Co-op Banks Central Co-op Banks Primary Agricultural Credit Societies Land Development Banks State Land Development Banks
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Cooperative Banks

Development Banks
1. 2. 3. 4. 5. Industrial Finance Co-operation of India (IFCI) Industrial Development of India (IDBI) Industrial Investment Bank of India (IIBI) Small Industries Development Bank of India (SIDBI) National Bank for Agriculture and Rural Development (NABARD) 6. Export-Import Bank of India

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Four phases of growth and development in banking in India

Phase I 1786 to 1969 Establishment of first bank till Nationalization of private banks Phase II 1969 to 1991 Expansion phase Phase III 1991 till 2010 Characterized by Globalization, Computerization and again Privatization Phase IV from 2010 Competition, Consolidation, Regulation
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Setting up of Reserve Bank of India (RBI Act 1934) Banking Regulation Act 1949 Nationalization of State Bank of India (1955) Social control over banks through Nationalization of banks(1969 and 1980) Setting up of DICGC, ECGC Setting up of RRBs (1975) Setting up of Development Banks / Financial Institutions Acceptance of Narasimhan Committee recommendations Milind S Limaye (1991)

Opening up banking business to new Private sector Banks and Foreign Banks Computerization and Technological development Change in organization structure of banks (Branch Banking to Functional Banking) More thrust on Service and Marketing due to increased competition

Increase in number of Products serviced

Deregulation of Interest
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Increased control by RBI (Exposure norms, NPA norms, Lending norms etc.) Implementation of Basel guidelines Thrust on recovery Establishments of Debt Recovery Tribulals (DRT), Corporate Debt Restructuring (CDR) for speedy recovery The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI act) Banking Ombudsman Scheme, 2006
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Core Banking Solution

Net banking and Phone Banking

Use of Credit and Debit cards for payment

Development in Payment and Settlement system ( Non MICR clearing to MICR clearing, Replacement of DD,TT, MT, Pay orders by RTGS, NEFT, ECS etc, Cheque Truncation)

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Regularatory Role of RBI and its Monitory Policy

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Financial system before RBI act

Dual control of currency by Govt. and credit by Imperial Bank Transfer of responsibility at the centre from British to Indian hands subject to RBI will be free from political influence be established Lack of confidence on Imperial Bank by other banking companies
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Hilton Young Commission Bill introduced in legislative assembly 1927 Central Banking Enquiry Committee 1931 White paper on Indian Constitutional Reforms Fresh bill in Assembly 1933 RBI Act 1934 Started operations from 01.04.1935.

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Preamble describing basic functions:

"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage."

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Established as Private Ltd. Company with share capital of Rs.5 crores (5 lac shares of Rs.100/- each face value)
Owned by private individuals except shares amounting to RS.2,30,000/- by Government Nationalization in accordance with Reserve Bank (Transfer to Public Ownership) Act 1948 w.e.f. 01.01.1949
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Functions of RBI
Monetary control Exchange control Supervision of Banks and other financial institutions Bankers Bank Governments Bank Issuance of notes
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Financial Supervision
The Reserve Bank of India performs this function under the guidance of the Board for Financial Supervision (BFS). The Board was constituted in November 1994 as a committee of the Central Board of Directors of the Reserve Bank of India.

Objective
Primary objective of BFS is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions and nonbanking finance companies.
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BFS meetings
The Board is required to meet normally once every month. It considers inspection reports and other supervisory issues placed before it by the supervisory departments. BFS through the Audit Sub-Committee also aims at upgrading the quality of the statutory audit and internal audit functions in banks and financial institutions. The audit sub-committee includes Deputy Governor as the chairman and two Directors of the Central Board as members.

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 The BFS oversees the functioning of Department of Banking Supervision (DBS), Department of NonBanking Supervision (DNBS) and Financial Institutions Division (FID) and gives directions on the regulatory and supervisory issues.

Some of the initiatives taken by BFS include:

restructuring of the system of bank inspections introduction of off-site surveillance, strengthening of the role of statutory auditors and strengthening of the internal defences of supervised institutions.

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Current Focus of BFS

supervision of financial institutions consolidated accounting legal issues in bank frauds divergence in assessments of non-performing assets and supervisory rating model for banks.

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Issuance of Notes
U/S 22 of RBI act, RBI has sole right to issue currency other than one rupee note and one rupee coin and subsidiary coins Currency management Printing, Distribution of notes, withdrawal of soiled notes, preventing counterfeiting of notes

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Monetary Control
Formulates, implements and monitors the monetary policy Objective
1. maintaining price stability 2. to promote sufficient credit for growth while ensuring that there is no emergency of inflationary pressure

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Monetary tools before 1990 (pre reform period)

Interest Rate regulations Selective credit control Reserve ratios Refinancing

Monetary tools after 1990 (post reform period)

Rationalization and Deregulation of interest rates Government securities open market operations Liquidity adjustment facility (LAF)

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6%, 7%, 8%, 9% and 24%

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Bank Rate Repo Rate Reverse Repo Rate Marginal standing facility rate (w.e.f. 09.04.2011)
Cash reserve Ratio Statutory Liquidity Ratio

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Cooperative Credit Societies Act 1904 New act in 1912 provided establishment of cooperative central banks by a union of primary credit societies and individuals
Main functions:
To attract deposits To use excess funds of some societies to make shortage of others (temporary) To supervise and guide the affiliated societies

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Maclagan Commiitte (1914)

Under B R Act 1949, only Urban Cooperative Banks, State Cooperative Banks and District Central Cooperative Banks are qualified to be called as banks in cooperative sector

Characteristics

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Complex structure:
Urban Urban Cooperative Banks with single tier structure Rural Two sets Short Term and long term Short Term - three tiers State Cooperative Banks, District Central Cooperative Banks, Primary Agricultural Credit Societies
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Long Term two tier State Cooperative Agricultural and Rural Development Banks (SCARDBs) and Primary Cooperative Agricultural and Rural Development Banks (PCARDBs)

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 Regional Rural Banks were established under the provisions of an Ordinance promulgated on the 26th September 1975 and the RRB Act, 1976 with an objective to ensure sufficient institutional credit for agriculture and other rural sectors.
RRBs are jointly owned by GOI, the concerned State Government and Sponsor Banks (27 scheduled commercial banks and one State Cooperative Bank); the issued capital of a RRB is shared by the owners in the proportion of 50%, 15% and 35% respectively.

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 Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by The Reserve Bank of India. Reserve Bank of India guidelines: Master circular on Prudential Norms on Income Recognition, Asset classification and Provisioning to Advances
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A) Interest and / or installment of principal remain overdue for a period of more than 90 days in respect of a term Loan.
Any amount due to the bank under any credit facility is overdue if it is not paid on the due date fixed by the bank. B) The account remains out of order for a period of more than 90 days, in respect of an Overdraft / Cash Credit.
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An account treated as 'out of order' if the outstanding balance remains continuously in excess of the sanctioned limit/ drawing power
In case where the outstanding balance in the principal operating account is less than the sanctioned limit/ drawing power, but there are no credits continuously for six months as on the date of balance sheet or credits are not enough to cover the interest debited during the same period, these account should be treated as 'out of order.

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C) The bill remains overdue for a period of more than 90 days in case of the bill purchase and discounted.
D) Interest and / or installment of principal remain overdue for two harvest season but for a period not exceeding two half years in the case of an advance granted for agricultural purpose. E) Any amount to be received remains over-due for a period of more than 90 days in respect of the other accounts.
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Asset Classification w.e.f. 31.03.2005

Substandard Assets - a substandard asset would be one, 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 - A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly.

Provisioning Gross NPAs Rs.117323 crores (2004) Rs. 64724 crores (2007) Rs. 81813 crores (2010)
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The Securitization And Reconstruction of Financial Assets And Enforcement of Security Interest Act, 2002 w.e.f. 21.06.2002
SARFAESI empowers Banks / Financial Institutions to recover their non-performing assets without the intervention of the Court. The Act provides three alternative methods for recovery of non-performing assets, namely: Securitization, Asset Reconstruction and Enforcement of security without intervention of court.
Milind S Limaye

Enforcement of security without intervention of court: The provisions of this Act are applicable only for NPA loans with outstanding above Rs. 1.00 lac NPA loan accounts where the amount is less than 20% of the principal and interest are not eligible to be dealt with under this Act. Non-performing assets should be backed by securities charged to the Bank by way of hypothecation or mortgage or assignment.
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Security Interest by way of Lien, pledge, hire purchase and lease not liable for attachment under sec.60 of CPC, are not covered under this act. Procedure:-

60 days Notice by secured creditor to borrower.

Borrower may represent or raise objection If such representation / objection not acceptable, secured creditor to reply within one week of receipt of objection / representation
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Appeal can be preferred by the borrower to DRT by depositing 50% of the claim amount.
If appeal is not preferred and the claimed amount under notice is not paid by borrower within the period specified, secured creditor can proceed to take possession / management of the asset / appoint any person to manage secured asset and sell the property. Help of Chief Metropolitan Magistrate or District Magistrate can be taken
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In case borrower pays full dues before sell of the asset, no action need to be taken

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RBI declares draft guidelines for new bank licences.

RBI is clear about the priorities: it wants the right kind of promoter, the right kind of business model, adequacy of resources financial, management and human and finally right kind of governance structure.

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Eligibility Sound credentials and a successful track record of the promoters for last 10 years. Entities or groups having significant (10% or more ) income or assets or both from real estate, construction and / or broking activities in the past three years will not be eligible.
Structure A wholly owned non operative holding company will hold the bank and other financial companies in the group
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Minimum capital Initial capital, Rs.500 crs. NOHC will hold min 40% of paid up capital of the bank for five years, which will be brought down to 20% within 10 years and 15% within 12 years from the licencing date.
Foreign Shareholding Aggregate non resident shareholding shall not exceed 49% for the first five years.

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Corporate Governance At least 50% of the board of NOHC should be independent directors. The RBI will supervise the bank and the NOHC on a consolidate basis.
Business model Should be realistic and viable and should clearly address how the bank will achieve financial inclusion.

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Branch openings At least 25% of the branches must be located in rural india, with a population of not above 9000 people.
Priority sector applicable. advances norms will be

Listing of shares to be listed within 2 years from the licence date.

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Minimum capital adequacy 12% for a minimum period of three years. Exposures In case of industrial groups, all exposures to vendors, suppliers, customers and group entities will have to be approved by the board and all advances to these entities will need a security cover of 150% houses

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Convergence of NBFCs into bank NBFC can promote new bank or can convert itself into a bank. However, promoters will have to set up a NOHC first . New bank could be allowed to take over and convert existing NBFC branches only in tier 3 to 6 centers. Existing branches of the NBFC in Tier 1 and 2 centers will be allowed to convert into branches only with prior approval.

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Interested parties 1. Tata Group 2. Birla Group 3. Reliance Group 4. Edleweiss 5. Bajaj Financial Services 6. L&T Finance 7. LIC Housing Finance 8. Religare Enterprises 9. SREI Infrastructure Finance

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Update: Bank loans grown by Rs.1,02,779 crs bet April and end August this year against Rs.1,09,189 crs in the same period year ago.

Total bank credit Rs.40,44,862 crs as on 26.08.2011. Demand from Mining, infrastructure and Home loan sectors.

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BASEL Accord refers to banking supervision Accords (recommendations on banking laws and regulations) BCBS Basel Superivision Committee on Banking

The Basel Committee, established by the central-bank Governors of the Group of Ten countries at the end of 1974, meets regularly four times a year. It has four main working groups which also meet regularly.
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The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. Countries are represented by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank.
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The present chairman of the Committee is Mr Stefan Ingves, Governor of Sveriges Riksbank, Switzerland, w.e.f. 01.07.2011 The Committee does not possess any formal supranational supervisory authority, and its conclusions do not, and were never intended to, have legal force. Rather, it formulates broad supervisory standards and guidelines and recommends statements of best practice in the expectation that individual authorities will take steps to implement them through detailed arrangements - statutory or otherwise - which are best suited to their own national systems.
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The first Basel Accord, known as Basel I, was issued in 1988 and focuses on the capital adequacy of financial institutions. The capital adequacy risk, (the risk that a financial institution will be hurt by an unexpected loss), categorizes the assets of financial institution into five risk categories (0%, 10%, 20%, 50%, 100%). Banks that operate internationally are required to have a risk weight of 8% or less.
Concentrated only on Credit Risk
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Aim 1. Ensuring that capital allocation is more risk sensitive; 2. Enhance disclosure requirements which will allow market participants to assess the capital adequacy of an institution; 3. Ensuring that credit risk, operational risk and market risk are quantified based on data and formal techniques;

4. Attempting to align economic and regulatory capital more closely to reduce the scope for regularatory arbitrage.
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Basel II uses a "three pillars" concept

(1) Minimum Capital Requirements (addressing risk),

(2) Supervisory Review and (3) Market Discipline

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First Pillar The first pillar deals with maintenance of regulatory capital calculated for three major components of risk that a bank faces: Credit Risk, Operational Risk and Market Risk. Other risks are not quantifiable at this stage. considered fully

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The Credit Risk component can be calculated in three different ways of varying degree of sophistication, namely Standardized Approach, Foundation IRB and Advanced IRB. IRB stands for "Internal Rating-Based Approach".

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The standardized approach sets out specific Risk Weights for certain types of credit risk. The standard risk weight categories used under Basel 1 were 0% for government bonds, 20% for exposures to OECD Banks, 50% for first line residential mortgages and 100% weighting on consumer loans and unsecured commercial loans. Basel II introduced a new 150% weighting for borrowers with lower credit ratings. The minimum capital required remained at 8% of risk weighted assets, with Tier 1 capital making up not less than half of this amount.
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Banks that decide to adopt the standardized ratings approach must rely on the ratings generated by external agencies. Certain banks used the IRB approach as a result.

Operational Risk
There are three different approaches
1. Basic Indicator Approach (BIA) 2. Standardized Approach 3. The Internal Measurement Approach
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Market Risk
For Market Risk, the preferred approach is Value at Risk Value at Risk (VaR) is a widely used risk measure of the risk of loss on a specific portfolio of financial assets.

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The second pillar deals with the regulatory response to the first pillar, giving regulators much improved 'tools' over those available to them under Basel I. It also provides a framework for dealing with all the other risks a bank may face, such as systemic risk, pension risk, concentration risk, strategic risk, reputational risk, liquidity risk and legal risk, which the accord combines under the title of residual risk. It gives banks a power to review their risk management system. Internal Capital Adequacy Assessment Process (ICAAP) is the result of Pillar II of Basel II accords
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Market Discipline
This pillar aims to complement the minimum capital requirements and supervisory review process by developing a set of disclosure requirements which will allow the market participants to gauge the capital adequacy of an institution.
It supplements regulation as sharing of information facilitates assessment of the bank by others including investors, analysts, customers, other banks and rating agencies which leads to good corporate governance
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The aim of pillar 3 is to allow market discipline to operate by requiring institutions to disclose details on the scope of application, capital, risk exposures, risk assessment processes and the capital adequacy of the institution. These disclosures are required to be made at least twice a year, except qualitative disclosures providing a summary of the general risk management objectives and policies which can be made annually
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Institutions are also required to create a formal policy on what will be disclosed, controls around them along with the validation and frequency of these disclosures. In general, the disclosures under Pillar 3 apply to the top consolidated level of the banking group to which the Basel II framework applies.

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"Basel III" is a comprehensive set of reform measures, developed by the BCBS, to strengthen the regulation, supervision and risk management of the banking sector.

Aims: 1. improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source 2. improve risk management and governance 3. strengthen banks' transparency and disclosures.
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Proposed changes
The quality, consistency, and transparency of the capital base will be raised. (tier 3 capital to be removed) The risk coverage of the capital framework will be strengthened. The Committee will introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework. The Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress
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Promoting stronger provisioning practices (forward looking provisioning)

The Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement

The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions.
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