Month: May 2021

Reforms in the banking sector were introduced on the basis of the recommendations of different committees:

(i) The first Narasimhan Committee (1991),

(ii) The Verma Committee (1996),

(iii) The Khan Committee (1997), and

(iv) The Second Narasimhan Committee (1998).

The First Phase of Reforms:

The banking sector reforms are directed toward improving the policy framework, financial health and the institutional framework:

(a) Change in Policy Framework:

Improvement in policy framework has been undertaken by reducing the Cash Reserve Ratio (CRR) to the initial standard and phasing out Statutory Liquidity Ratio (SLR), deregulation of interest rates, widening the scope of lending to priority sectors and by linking the lending rates to the size of advances.

(b) Improving Financial Health:

Attempts to improve the financial soundness of the banking sector have been made by prescribing prudential norms. Moreover, steps have been taken to re-duct the proportion of Non-Performing Assets (NPAs).

(c) Improvements of Institutional Framework:

Such improvements have been achieved in three ways:

(i) Recapitalisation

(ii) Creating a competitive environment

(iii) Strengthening the supervisory system

Second Phase Reforms:

The first phase of the bank sector reforms is completed. The second generation reforms which are underway concentrate on strengthening the very foundation of the banking system in three ways: by reforming the structure of the bank industry, technological upgradation, and humaning resource development.

Prudential Regulation:

There are two types of banking regulations—economic and prudential. In the pre-reform era (before July 1991) the Reserve Bank of India (RBI) regulated banks by imposing constraints on interest rates, tightening entry norms and directed lending to ensure judicious end use of bank credit.

However, such economic regulation of banks hampered their productivity and efficiency. Hence, the RBI switched over to prudential regulation which calls for imposing minimum limit on the capital level(s) of banks.

The objective is to maintain the wealth of banks in particular and to ensure the soundness of the financial system in general. It allows much greater scope for the free play of market forces than what is permitted by economic regulations alone.

On the basis of recommendations of the Committee on Banking Sector Reforms, April 1998 (the second Narasimhan Committee) the RBI issued prudential norms. The major objective of setting such norms was to ensure financial safety, soundness and solvency of banks. These norms are directed toward ensuring that banks carry on their operations as prudent entities, are free from undue risk-taking, and do not violate banking regulations in pursuit of profit.

The main focus of reforms was in three areas:

(i) NPAs,

(ii) Capital adequacy, and

(iii) Diversification of operations,

(i) Non-Performing Assets (NPAs):

One serious problem faced by the public sector banks in the 1990s was a high proportion of NPAs. An NPA is an asset from which income is overdue for more than six months. According to the second Narasimhan Committee report (1998), “No other single indicator reflects the quality of assets and their impact on banks’ viability than the NPA figures in relation to advances.”

The gross NPAs of scheduled commercial banks (SCBs) increased over the period March 31, 1998 to March 31,2002 from Rs 50,815 crores to Rs 70,904 crores. Gross NPA of public sector banks (PSBs) were also correspondingly higher. However, the share of PSBs in total NPAs declined from 90% to 80% during the period (1998-2002).

Furthermore, there was a decline in the ratio of gross NPAs and net NPAs, measured as percentage of advances as well as assets. These ratios represent the quality of banks assets and are thus taken as measures of soundness of the banking system. Gross and net NPAs as a proportion of gross advances and total assets of SCBs declined substantially during this period.

However, the ratio of gross and net NPAs as a proportion of gross advances and of total assets increased substantially for new private sector banks from 2001-02 due to the merger of strong banks with weak banks.

But the root cause of increase in NPAs is the increasing proportion of bad debt. In case of some banks, net NPAs even exceeded their net worth. This means that such banks had negative net worth.

RBI Guidelines:

The RBI offered three options to banks to restructure bad debts:

(i) Debt Recovery Tribunals (DRTs)

(ii) Settlement Advisory Committees (SACs)

(iii) Recapitalisation from the Government

Guidelines on SACs were revised in July 2002 to provide a uniform, simplified, non-discriminatory and non-discretionary mechanism for the recovery of the stock of NPAs of all banks.

Altogether, seven DRTs have been set up for speedy recovery of loans. Finally with a view to enhancing the effectiveness of DRTs, the Central government amended the Recovery of Debts due to Banks and Financial Institutions Act in Jan, 2002.

(ii) Capital Adequacy Ratio:

Banking sector reforms were initiated by implementing prudential norms consisting of Capital Adequacy Ratio (CAR). The core of such reforms has been the broadening of prudential norms to the internationally accepted standards.

In 1988 the Basle Committee for international banking supervision made an attempt worldwide to reduce the number of bank failures by tying a bank’s CAR to the riskiness of the loans it makes. For instance, there is less chance of a loan to a government going bad than a loan to, say, an internet business. So, the bank will not have to hold as much capital in reserve against the first loan as against the second.

Throughout the world, commercial banks are under the legal obligation to maintain minimum capital funds for the sake of safety. The reason is that a bank’s capital base is vitally important for its long-term variability. It also acts as a shock absorber in the medium term since it gives the power to absorb shocks and thus avoid the risk of bankruptcy.

A bank’s capital funds must be equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures. CAR is a measure of the amount of a bank’s capital expressed as a percentage of its risk weighted credit exposures. It is related to risk weight assigned to asset acquired by banks in the normal process of conducting business. It is also related to the proportion of capital to be maintained on such aggregate risk weighted assets.

CAR is calculated on the basis of risk weightage on assets in the books of accounts of banks. Any type of business transaction carried out by a bank involves a certain specific type of risk. So, for the sake of safety, a portion of capital has to be set aside to make provision for this risk. This portion acts as a hedge against uncertainty, i.e., a ‘secret reserve’ to absorb any possible future loss.

Higher Capital Adequacy will improve the efficiency of banks in two ways:

(i) By forcing banks to reduce operating costs, and

(ii) By improving long-term viability through risk reduction.

Capital adequacy enables banks to mobilise more capital at reasonable cost.

The two important new parameters which are crucial for the growth of banks are asset quality and risk weightage.

On the basis of the Basle Committee proposals (1988), two tiers of capital have been prescribed for Indian SCBs:

Tier I: Capital which can absorb losses without forcing a bank to stop trading

Tier II: Capital which can absorb losses only in the event of a winding up.

Following the recommendations of the first Narasimhan Committee (1991) the RBI directed the banks to maintain a minimum capital of 8% as the risk-weighted assets; the second Narasimhan Committee (1998) suggested raising the ratio further. In March 2002, the capital to risk-weighted asset ratio (CRAR) was raised to 9%. It was subsequently raised to 10% with a view to tightening of the capital adequacy norm further.

At the end of March 2002, all SCBs (except five) had CRARs in excess of the stipulated 9%. The capital of PSBs has increased through government capital infusion, equity issues to public, and retained earnings.

(iii) Diversification in Bank Operations:

During the period of economic liberalisation PSBs have diversified their activities considerably. They have moved in new areas such as mutual funds, merchant banking, venture capital funding and other para-banking activities such as leasing (lease financing), hire-purchase, factoring and so on.

The main objective has been to make profits by deriving maximum economies of scale and scope, enlarging customer base and providing various types of banking services under one umbrella (both directly as also through subsidiaries). Many banks such as the SBI have become a one-stop financial services centre.

NBFC Insurance

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner, is also a non-banking financial company (Residuary non-banking company). The depositor must bear in mind that public deposits are unsecured and Deposit Insurance facility is not available to depositors of NBFCs.

Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks. The Deposit Insurance and Credit Guarantee Corporation pays insurance on deposits up to ₹ One lakh in case a bank failed.

Eligibility Criteria to set up Joint Venture (“JV”)

Fulfilling the criteria below will allow the NBFCs to set up a joint venture company for undertaking insurance business with risk participation.

• It should be registered with the RBI.
• It should have a net worth of Rs. 500 Crores.
• The ‘Capital Adequacy Ratio’ of the NBFC, engaged in loan and investment activities, should be more than 15% and for other NBFCs should be more than 12%.
• NPAs should not be more than 5% of the total outstanding leased/hire purchase assets and advances.
• NBFC should have a net profit for the last 3 consecutive years.

Eligibility Criteria to act as Insurance Agent

• Not all NBFCs are required to get registered with the RBI as per Section 45 of the RBI Act, 1934. However, if an NBFC wants to enter the market of the insurance business, then it has to get itself registered with the RBI.
• It should have a net worth of Rs. 5 Crores as per the latest audited balance sheet. Fulfilling these two criteria allows the NBFC to undertake insurance business, on a fee basis, as an agent of the insurance companies without any risk participation.

Pan shops and Payday lending

A pawnbroker offers loans on items that are not accepted as collateral by traditional banks or lenders. Items that typically show up in pawn shops include jewelry, electronics and collectible items.

The second complaint, more specific to the pawn industry, is that unscrupulous pawn shops sometimes don’t ask enough questions about where the goods they are buying or offering loans on actually came from. Regulations require that pawnbrokers request proof of ownership before making a deal with a potential customer but the less reputable players in the industry have a nasty habit of forgetting to ask. It is far from the entire industry, or even close to a majority of it, but the image is there and tends to make pawn lending unique among short-term loans in its connection to seediness.

Which is why it might be surprising to note that 2018 and 2019 have in many ways been strong growth years for the pawn industry in the U.S. and around the world. Consumers are leveraging pawn shops more frequently and investors are taking the industry more seriously as a vehicle for growth.

A payday loan (also called a payday advance, salary loan, payroll loan, small dollar loan, short term, or cash advance loan) is a short-term unsecured loan, often characterized by high interest rates.

The term “payday” in payday loan refers to when a borrower writes a postdated check to the lender for the payday salary, but receives part of that payday sum in immediate cash from the lender. However, in common parlance, the concept also applies regardless of whether repayment of loans is linked to a borrower’s payday. The loans are also sometimes referred to as “cash advances,” though that term can also refer to cash provided against a prearranged line of credit such as a credit card. Legislation regarding payday loans varies widely between different countries, and in federal systems, between different states or provinces.

To prevent usury (unreasonable and excessive rates of interest), some jurisdictions limit the annual percentage rate (APR) that any lender, including payday lenders, can charge. Some jurisdictions outlaw payday lending entirely, and some have very few restrictions on payday lenders. Payday loans have been linked to higher default rates.

The basic loan process involves a lender providing a short-term unsecured loan to be repaid at the borrower’s next payday. Typically, some verification of employment or income is involved (via pay stubs and bank statements), although according to one source, some payday lenders do not verify income or run credit checks. Individual companies and franchises have their own underwriting criteria.

In the traditional retail model, borrowers visit a payday lending store and secure a small cash loan, with payment due in full at the borrower’s next paycheck. The borrower writes a postdated check to the lender in the full amount of the loan plus fees. On the maturity date, the borrower is expected to return to the store to repay the loan in person. If the borrower does not repay the loan in person, the lender may redeem the check. If the account is short on funds to cover the check, the borrower may now face a bounced check fee from their bank in addition to the costs of the loan, and the loan may incur additional fees or an increased interest rate (or both) as a result of the failure to pay.

In the more recent innovation of online payday loans, consumers complete the loan application online (or in some instances via fax, especially where documentation is required). The funds are then transferred by direct deposit to the borrower’s account, and the loan repayment and/or the finance charge is electronically withdrawn on the borrower’s next payday.

Nidhi Company

A nidhi company is a type of company in the Indian non-banking finance sector, recognized under section 406 of the Companies Act, 2013. Their core business is borrowing and lending money between their members. They are also known as Permanent Fund, Benefit Funds, Mutual Benefit Funds and Mutual Benefit Company. They are regulated by Ministry of Corporate Affairs, which is also empowered to issue directions to them in matters relating to their deposit acceptance activities. However, in recognition of the fact that these companies deal with their shareholder-members only. Nidhi means a company which has been incorporated with the object of developing the habit of thrift and reserve funds amongst its members and also receiving deposits and lending to its members only for their mutual benefit.

Nidhi companies existed even prior to the existence of companies Act 2013. The basic concept of nidhi is “Principle of Mutuality” These companies are more popular in South India, and 80% of Nidhi companies are located in Tamil Nadu.

Requirements for Nidhi Company

• A Nidhi company to be incorporated under this Act shall be a Public Company;
• It shall have a minimum paid up equity share capital of 5,00,000/-.
• No preference shares shall be issued.
• If preference shares had already been issued by a Nidhi Company before commencement of this Act, such preference shares are to be redeemed in accordance with the terms of issue of such shares.
• The object of the company shall be cultivating the habit of thrift and savings amongst its members, receiving deposits from and lending to its members only for their mutual benefits.
• It shall have the words ‘Nidhi Limited’ as part of its name

Functions of Nidhi company

• The rules of funding in a Nidhi company is done through the contribution of its forming members.
• Later that money is used to offer loans to its own members according to their needs at very reasonable rates.
• The funds or deposits of a Nidhi company are limited when compared with other banks because they are only able to operate their as they will be working with specific fund base in a limited area.

The Central Government made ‘Nidhi Rules, 2014’ for the purpose of carrying out the objectives of ‘Nidhi’ companies. These rules shall be applicable to-

• Every company which had been declared as a Nidhi or Mutual Benefits under Section 620A(1)of Companies Act, 1956;
• Every company functioning on the lines of a Nidhi company or Mutual benefit society but has either not applied for or has applied for and is awaiting notification to be a Nidhi or Mutual Benefit Society under Section 620A(1)of Companies Act, 1956;
• Every company incorporated as a Nidhi pursuant to the provisions of Section 406 of the Companies Act, 2013.

Chit funds

Chit fund is defined as per the Section 2(b) of the Chit Fund Act, 1982. According to this act; A chit fund is a type of rotating savings and agreement among different persons i.e. friends, relatives, neighbours and family members to subscribe a certain sum of money for a specified period of time. Chit funds are often microfinance organizations. Chit Funds are also known as the Chitty, Kuree, chit.

A chit fund is a type of rotating savings and credit association system practiced in Pakistan, India, Bangladesh, Sri Lanka and other Asian countries. Chit fund schemes may be organized by financial institutions, or informally among friends, relatives, or neighbours. In some variations of chit funds, the savings are for a specific purpose. Chit funds are often microfinance organizations.

Risk

Both organizers and subscribers in chit funds are exposed to credit risk because subscribers might default on their periodic payments. One analysis of data from two chit fund companies found that 35% of subscribers have defaulted at least once during their tenure at one of the companies and 24% of them have defaulted after winning an auction for the pot. Chit fund companies can sue defaulters in court but the procedure is time-consuming and is unlikely to produce a timely settlement. It’s up to the chit fund organizers to vet the credit-worthiness of subscribers. To reduce the risk of default, some organizers also require subscribers who win auctions to submit sureties for their future liabilities.

Since chit fund payments are not insured by the government, the system is a riskier method of saving than using a bank savings account.

Popular Chit Funds in India

Chit funds limit only to India. Normally we do not find chit funds in any other part of the world. Some of the most famous and successful chit fund houses are:

• Mysore Sales International: Government of Karnataka
• Kerala State Financial Enterprise (KSFE): Government of Kerala
• Shriram Chits: Shriram Group
• Margadarsi Chits: Ramoji Rao Group

RNBC

Residuary Non-Banking Company is a class of NBFC which is a company and has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner and not being investment, asset financing, loan company.

These companies are required to maintain investments as per directions of RBI, in addition to liquid assets. The functioning of these companies is different from those of NBFCs in terms of method of mobilisation of deposits and requirement of deployment of depositors’ funds. However, Prudential Norms Directions are applicable to these companies also.

• They offer a rate of interest of not less than 5% per annum on term deposits and 3.5% on daily deposits both compounded annually.
• They can’t accept deposits for a period less than 12 months and not more than 84 months.
• They can’t offer any gifts or incentives to solicit deposits from public.
• They can’t accept deposits repayable on demand, i.e., they cant open saving or current accounts.

Industrial Investment Bank of India Ltd. (IIBI): The Industrial Investment Bank of India Ltd. (IIBI) was formed by transforming the Industrial Reconstruction Bank of India (IRBI). It was set up by IDBI at the instance of the Government of India in April 1971 for rehabilitation of sick industrial companies. IRBI was incorporated under the Companies Act, 1956 and renamed as the Industrial Investment Bank of India Ltd. in March 1997. 

IIBI offered a wide range of products and services, including term loan assistance for project finance, short duration non-project asset-backed financing, working capital/other short-term.

It is a full-fledged all-purpose development bank with adequate operational flexibility and autonomy. After the reconstruction its focus has changed from rehabilitation finance to development banking.

Functions:

• Short duration non-project asset backed financing working capital/ other short-term loans to companies.
• Term-loan assistance for project finance.
• Investments in Capital Market and Money market instruments.
• Equity Subscription Asset Credit.
• Equipment finance.

UTI Mutual Fund was carved out of the erstwhile Unit Trust of India (UTI) as a Securities and Exchange Board of India (SEBI) registered mutual fund from 1 February 2003. The Unit Trust of India Act 1963 was repealed, paving way for the bifurcation of UTI into: Specified Undertaking of Unit Trust of India (SUUTI) and UTI Mutual Fund (UTIMF).

UTI Mutual Fund has been the pioneer for launching various schemes viz. UTI Unit Linked Insurance Plan (ULIP) with life and accident cover (Launched in 1971), UTI Mastershare (Launched in 1986), India’s first Offshore Fund, India fund (Launched in 1986), UTI Wealth Builder Fund, the first of its kind in the Indian mutual fund industry combining different asset classes i.e. equity and gold which are lowly correlated.

Functions of UTI:

• To grant loans and advances.
• To accept discount, purchase or sell bills of exchange, promissory note, bill of lading, warehouse receipt, documents of title to goods etc.,
• To provide merchant banking and investment advisory service.
• To extend portfolio management service to persons residing outside India.
• To provide leasing and hire purchase business.
• To buy or sell or deal in foreign exchange dealings.
• To invest in any security floated by the Central Government, RBI or foreign bank.
• To formulate unit scheme or insurance plan in association with or as agent of GIC.

Objectives:

(i) To enable them to share the benefits and prosperity of the industrial development in the country.

(ii) To encourage and pool the savings of the middle and low-income groups.

Advantages of Unit Trust:

• There is a high degree of liquidity of investment as the units can be sold back to the trust at any time at prices fixed by trust.
• The Unit-holders will be getting regular and good income, as 90 percent of its income will be distributed.
• The investment is safe and the risk is spread over a wide range of securities.
• Dividends up to Rs. 1,000 received by the individual are exempt from income-tax.

‘Small Industries Development Corporations (‘SIDCO‘) are state-owned companies or agencies in the states of India which were established at various times under the policy of Government of India for the promotion of small scale industries.

Objectives of SIDCO

• To provide infrastructure facilities like roads, drainage, electricity, water supply, etc. is one of the primary objectives of SIDCO.
• The main objective of SIDCO is to stimulate the growth of industries in the small-scale sector.
• To Promote industrial estates which will provide industrial sheds of different sizes with all basic infrastructure facilities.
• To Promote skilled labor through the setting up of industrial training institutes.
• To Provide technical assistance through training facilities to the entrepreneurs.

Functions of SIDCO

SIDCO promotes women entrepreneurs:

In addition to the above, in order to promote women entrepreneurs, a separate industrial estate for women has been set up at Tirumullaivoyal, near Chennai, where women entrepreneurs are trained in various fields of small scale industries.

SIDCO promotes skill development centres:

In an effort to supply skilled laborers to various small scale industries, skill development centres are being set up in various industrial estates which will be training workers in varied industrial activities and they will be trained in modern skill.

SIDCO set up Captive power plants:

In order to provide uninterrupted and good quality power supply, SIDCO has taken up a plan to set up captive power plants in major industrial estates. It is now planning to set up these plants in 10 industrial estates.

SIDCO provides Export marketing assistance:

To promote export marketing among the small scale industries, SIDCO has developed websites because of which it is able to display the products of the small scale industries in foreign markets and obtain export orders. Once an export order is obtained, the Common export manager of SIDCO will make arrangements for extending various services for export of the product.

SIDCO assists in Bills discounting:

When small scale units supply goods to government departments, there is a delay in receiving payments. In such a situation, the bills drawn on government departments will be discounted by SIDCO and upto 80% of the bill value is given to the supplier. This helps the SSI units in solving their working capital crisis.

SIDCO provides marketing assistance:

In order to provide an efficient marketing support to small scale industries, the corporation has taken up various schemes. In fact, the corporation participates in the tenders floated by the state government departments and also with the DGS & D (Director General of Supplies and Disposal). SIDCO makes advance payments for obtaining orders and distribute them among the various small scale units.