Module 2 Class Notes: Banking and Finance Law UpGrad Blended LLM Programme (2022) Faculty Instructor: Prof. Shuchi SinhaSession 1- Salient Aspects of Legal Framework for Banks Note on the regulatory and policy making authority of RBI: + The RBI is empowered to conduct its role and functions pursuant to various statutes, and under certain provisions of such statutes, it is empowered to issue regulations / guidelines / various notifications to implement the same. Thus, such notifications (e.g.: circulars, Master Circulars, Master Directions etc.) are not merely clarificatory or ‘advisory’ in nature but are part of the legal framework and are required to be complied with accordingly. E.g.: Under Section 21 of the Bankin, Regulation Act, 1949 (‘BR Act’), RBI is empowered to ‘determine the policy in relation to advances to be followed by banking companies generally or by any banking company in particular, and when the policy has been so determined, all banking companies or the Banking company concerned asthe case may be, shall be bound to follow the policy asso determined.” Thus, all notifications issued by RBI regarding rate of interest, margin, amounts, purposes and other terms and conditions for such loans and advances by banks must be complied with by banks (as they are issued pursuant to RBI’s powers under the statute, i.e., BR Act). Similarly, The Foreign Exchange Management Act, 1999 (‘FEMA’) provides RBI with the power to regulate borrowing or lending in foreign exchange. Thus, the Master Direction issued by RBI on external commercial borrowings (‘ECBs’) is issued pursuant to such power of RBI under FEMA and is accordingly the legal framework in respect of ECBs. Another example are the Master Circulars and other notifications relating to Cash Reserve Ratio and Statutory Liquidity Ratio to be maintained by Scheduled Banks, which are issued pursuant to RBI's powers under Section 42(1) of the Reserve Bank of India Act, 1934. Accordingly it may be noted that such notifications issued by RBI (whether in the form of circulars, Master Circulars, Master Directions or otherwise), which are issued pursuant to its power under statute, form part of the legal framework for such matters and require compliance in the same manner.Session 1- Salient Aspects of Legal Framework for Banks + Note on overview of legal framework: In these Class Notes, various provisions of the legal framework have been referred to / summarised / described — please note that these are set out to provide an indicative idea only for purposes of revision. Please refer to the bare act of the relevant statute / regulation / notification for the actual text and content of the laws, regulations, statutes and notifications referred to herein. NEXT SLIDE: ILLUSTRATION — Key Features: The Long Regulatory Arm of the RBI!OUTSIDE INDIA _, Formulates policy for lending and related activities of non-resident lenders INDIA RBI Apex Regulatory ‘Authority I i i i SCHEDULED NON-SCHEDULED ‘ALL INDIA FINANCIAL NBFCS BANKS BANKS INSTITUTIONS PUBLIC PRIVATE REGIONAL Scheduled NABARD SECTOR SECTOR RURAL Cooperative — Banks Banks Banks Banks ei BANK SIDBI Indian Banks Universal Banks | NHB Foreign Banks* Differentiated Banks having a license from RBISegment I: RBI Act * Section 3 and 4 : Provide for its incorporation and capital * Section 8: Provides for the administration of RBI through Central Board of Directors + Section 17: Provides for the business which RBI may transact, which includes inter alia: the accepting of money on deposit without interest from, and the collection of money for, the Central Government, the State Governments, local authorities, banks and any other persons the purchase from and sale to scheduled banks of foreign exchange the making to any scheduled bank or State co-operative bank of loans and advances repayable ‘on demand or on the expiry of fixed periods (provided under the relevant sub-sections of Section 17 and subject to the conditions provided therein) the making to the Central Government and State Governments of advances repayable within the prescribed time duration from the date of the making of the advance the acting as agent for the Central Government and certain other entities as specified (such as State Government, any local authority, etc.) for the purposes specified the promoting, establishing, supporting or aiding in the promotion, establishment and support of any financial institution, whether as its subsidiary or otherwise ......]Section 18: Provides for the role of RBI as the Lender of Last Resort: if the RBI is of the opinion that a special occasion has arisen making it necessary or expedient that action should be taken under Section 18 for the purpose of regulating credit in the interests of Indian trade, commerce, industry and agriculture, it can take certain actions such as make loans or advances, or purchase, sell or discount any bill of exchange or promissory note in accordance with the conditions specified. Section 19: Prohibits the kinds of businesses which RBI may not transact. Except as provided in Section 17, 18, 42 and 45 of the RBI Act, the Bank may not undertake certain specified activities, which include the following (and subject to conditions provided): oe ‘engage in trade or otherwise have a direct interest in any commercial, industrial, or other undertaking (except such interest as it may in any way acquire in the course of the satisfaction of any of its claims) purchase the shares of any banking company or of any other company, or grant loans upon the security of any such shares advance money on mortgage of, or otherwise on the security of, immovable property or documents of title relating thereto, or become the owner of immovable property make loans or advances draw or accept bills payable otherwise than on demand allow interest on deposits or current accounts.* Sections 2 rovides that RBI is obliged to transact Government business * Section 21: Provides that RBI has the right to transact Government business in India. Under this, management of the public debt of the Indian government is one of the important functions of the RBI*; Meaning of ‘public debt’ — this term refers to the government's raising funds through borrowings, for example: the loans obtained from creditors at concessional rates as well as from the public who buys debt securities from the government, such as the bonds released by the government through the RBI. * Section 21-A: Provides that, w.rt. State Governments, the said banking functions may be undertaken by way of an agreement between the RBI and the State Government. * Section 22: Provides that RBI has the sole right to issue bank notes in India. * Section 25 states that the design, form and material of bank notes shall be such as may be approved by the Central Government after consideration of the recommendations made by the Central Board of RBI. * Note: Coins and mints come under the authority of the Government of India under the Coinage Act, 2011, under which all coins and the Re 1 banknote is issued by the government (RBI issues bank notes in the denomination of Rs 2 and above). + As pr noes on RB's web, “The eset gl framework or management of the pul et proved by the Reserve Bk of nda At, 184, Spechialy, Sections 26,2, 218, 1112) 17(0) ofthe RB Act define the role ef the Sank in managing public debt cf the Cental and State Governments itt ri r.08 ineorimonmen/Upiaad/englsh/content/PDFs/RIA160509 pa]* Section 42 — SCHEDULED BANKS: This is the key Section setting out requirements to be met in order to be included in the II"? Schedule of RBI Act as a Scheduled Bank and further, prescribes the levels of cash reserves that scheduled banks are required to maintain. * Section 42(6) provides for inclusion into the II"¢ Schedule of RBI Act (pursuant to notification in the Gazette of India) of any bank which carries on the business of banking in India and satisfies certain criteria: (i) minimum paid-up capital and reserves, (ii) affairs are not being conducted in a manner detrimental to the interests of its depositors and (iii) fall within certain categories e.g.: State co-operative bank or a company / an institution notified by the Central Government in this behalf / corporation or a company incorporated under any law in force in any place outside India. * Section 42(1) sets out requirements regarding minimum cash reserves. Pursuant to this Section, the RBI periodically issues circulars/directions to scheduled banks prescribing the required levels/ mode of cash reserve ratio (CRR) and statutory liquidity ratio (SLR)* NBFCs — Chapter IIIB of the RBI Act * Section 45-IA: Provides for the Power of RBI to register NBFCs * Schedules of the RBI Act * The First schedule : Provides for the areas served by various local boards (Western Area, Eastern Area, Northern Area, Southern Area ) * The Second Schedule : lists all the Scheduled Banks in India.Segment II: Banking Regulation Act, 1949 Need for enforcing Banking Regulation Act, 1949 (‘BR Act’) * Comprehensive Legislation: Prior to 1949, there was no such dedicated law relating to banking. Though the Indian Companies Act, 1913 contained certain provisions relating to banking companies, but they were not sufficient. + To Prevent Bank Failures: Bank failures were common, so prescribing appropriate safeguards including minimum capital/liquidity requirements was necessary. + Developing and Strengthening the Banking System: Balanced development of banking companies is promoted by requiring licensing and avoidance of indiscriminate profit driven activities (prescribes permitted activities of banks and gives RBI power to approve appointment/removal of bank’s Chairman/directors). + Safeguarding the Interests of Depositors: The Act protects the interest of depositors and the public at large by incorporating certain norms and procedures relating to depositors and provisions such as minimum cash reserves and liquidity ratios + Itwas originally titled as The Banking Companies Act, 1949 - It came into force wef. March 16, 1949 * It was renamed as the Banking Regulation Act 1949 (BR Act), w.e.f. March 1, 1966, to reflect the aims of the legislation.Key Provisions of BR Act * Section 5- Important definitions Section 5(b) defines "banking" as the the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or other wise. » Section 5(c) defines "banking company" as any company which transacts the business of banking in India (subject to the explanation). > Under Section 5(ca) "banking policy” as means any policy which is specified from time to time by the Reserve Bank in the interest of the banking system or in the interest of monetary stability or sound economic growth, having due regard to the interests of the depositors, the volume of deposits and other resources of the bank and the need for equitable allocation and the efficient use of these deposits and resources* Section 6- provides the list of permitted activities in which banking companies may engage, which include, inter alia: * * * * the lending money either upon or without security borrowing & raising of money drawing, making, accepting, discounting, buying, selling, collecting and dealing in bills of exchange, hundies, promissory notes, coupons, drafts, bills of lading, railway receipts, warrants, debentures, certificates, scrips and other instruments and securities whether transferable or negotiable or not ‘the granting and issuing of letters of credit, traveller's cheques and circular notes the buying, selling and dealing in bullion and specie; ‘the buying and selling of foreign exchange including foreign bank notes; the acquiring, holding, issuing on commission, underwriting and dealing in stock, funds, shares, debentures, debenture stock, bonds, obligations, securities and investments of all kinds; the purchasing and selling of bonds, scrips or other forms of securities on behalf of constituents or others, the negotiating of loans and advance; [...etc.] any other form of business which the Central Government may, by notification in the Official Gazette, specify as a form of business in which it is lawful for a banking company to engage * Section 6(2) provides that no banking company shall engage in any form of business other than those referred to in sub-section (1).* Section 8- provides for prohibition of certain trading activities (buying, selling and bartering of goods, subject to prescribed exceptions). Section 9- provides for disposal of non-banking assets (bank cannot hold any immovable property beyond 7 years except for its own use subject to exceptions provided). * Section 21- Prescribes for the power of Reserve Bank to control advances by banking companies when it is satisfied that it is necessary or expedient in the public interest or in the interests of depositors or the banking policy to do so, RBI has the power to determine the policy relating to advances and it may issue directions including inter alia in respect of purpose of advancement, margins to be maintained in respect of secured advances, maximum amount of advances or other financial accommodation, maximum amount to which guarantees will be given and the rate of interest and other related terms and condition etc. (as provided in Section 21). Section 21 further provides that every banking company shall be bound to comply with any directions given to it under this section.* Section 22: provides for RBI’s Licensing Authority: > RBI is empowered to grant license to commence banking business in India - and any such license may be issued subject to such conditions as RBI may think fit to impose - it is compulsory to obtain such license for conducting banking business in India. > RBI also has the power to cancel such banking license. » Prior to granting license, RBI may require to be satisfied by an inspection of the books of the company or otherwise on various aspects of the applicant including adequate capital structure and earning prospects, that the affairs of the company are not being, or are not likely to be, conducted in a manner detrimental to the interests of its present or future depositors, that the public interest will be served by the grant of a license to the company to carry on banking business in India, etc. ® Sajjan Bank (Private) Ltd v Reserve Bank Of India, Madras (AIR 1961 Mad 8) — Madras HC upheld the constitutional validity of Section 22.Corporate Governance: Key Provisions relating to Management of Banks through Board of Directors and Management + Note: Under various provisions of Sections 10-12, certain requirements are imposed to ensure a igh standard of corporate governance at the board / management of banks, including the qualifications of board members, impartiality of the board and so on. These provisions also include a number of strong powers to the RBI to remove / appoint board members and management and require the board to be reconstituted under certain prescribed conditions. * Section 10- Provides for restrictions on certain forms of employment for employees and managers of the bank * Section 10A(2)- Provides inter alia for special qualifications for at least 51% of the Board of Directors and time restrictions on holding office for board members and on having substantial interest in certain types of companies, firms, concerns etc. * Section 10A(5)- Provides RBI with the power to direct a bank to re-constitute its Board to ensure that the relevant requirements under Section 10A(2) are fulfilled * Section 10B- Provides for the appointment of Chairman and its qualifications * Section 10BB- Provides power to RBI to appoint Chairman of the Board of Directors or a Managing Director of a banking company under certain circumstances * Section 10D- Provides that sections 10A and 108 to override all other laws, contracts, in terms of appointment and removal of Director, Chairman of the board of Directors or a Managing Director * Section 12(A)(1) provides that RBI is empowered to pass an order requiring any banking company to call a general meeting of the shareholders of the company within a prescribed timeline and to elect in accordance with the permissible voting rights under the BR Act, fresh Directors.Key Provisions for preservation of the financial health of banks * Section 11- Requirement for minimum paid-up capital and reserves * Section 12- Provides for regulation of paid-up capital, subscribed capital and authorised capital and voting rights of shareholders. Section 17- Provides for incorporation of reserve fund for every banking company in India Section 18- Prescribes the requirement of maintaining cash reserve for every banking company, except a scheduled bank (separately provided for) Section 19- Banking companies are restricted from forming any subsidiary company (subject to some exceptions) and from holding any shares in any company, whether as pledgee, mortgagee or absolute owner of an amount >30% of the paid-up share capital of that company (or thirty per cent of its own paid-up share capital and reserves, whichever is less) * Section 24- Prescribes the requirement of maintaining a certain percentage of liquid assets by banksProvisions to address merger, reconstruction, winding up or solvency of banks ince these events in relation to a bank can have an impact beyond the shareholders of the depositors / general public who are customers of such bank, the BR Act includes special for such events — and gives the RBI detailed powers to oversee, approve and take various relation to merger, reconstruction, winding up or insolvency of banks. Some of the relevant provisions in this regard include, inter alia: * Section 35A- Prescribes power of the Reserve Bank to give directions in the public interest, in the interest of banking policy, to secure the proper management of any banking company and to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors. * Section 35AA- Prescribes Power to Central Government to authorize Reserve Bank for issuing directions to banking companies to initiate insolvency resolution process * Section 35AB — Prescribes power to Reserve Bank to issue directions in respect of stressed assets.Merger, reconstruction, winding up or insolvency of banks contd.(2) * Section 36: Further powers of RBI regarding directing affairs of banking company: if the RBI at any time is satisfied that in the public interest or interest of banking policy or for preventing the affairs of the banking company being conducted in a manner detrimental to the interests of the banking company ots depositors it isnecessary so to do, then it may pass an order on such terms and conditions as it deems fit to require the board of directors of the bank to take various steps as prescribed. * Section 44A (read with Section 36(1)(b): provides the detailed procedure for amalgamation of banking companies and states that no banking company shall be amalgamated with another banking company, unless a scheme containing the terms of such amalgamation has been placed in draft before the shareholders of each of the banking companies concerned separately, and approved by a resolution passed by a majority in number representing two-thirds in value ofthe shareholders of each of the said companies, present either in person or by proxy at a meeting called for the purpose... + If the scheme of amalgamation is approved by the requisite majority of shareholders in accordance with the provisions of this section, it shall be submitted to RBI for sanction and shall, if sanctioned by the Reserve Bank by an order in wi assed in this behalf, be binding on the banking companies concerned and also on all the shareholders thereat * Sections 38-45: Detailed provisions relating, to suspension of business and winding up ofa bank and including powers of Government of India and the REI, e.g: no banking company may be. Voluntarily wound up unless RBI certifies in writing that the company is able to pay in full al its debts to its creditors as they accrue under Section 44. Further, under Section 45, RBI has been provided powers to apply to the Central Government for suspension of business by a banking company and to prepare scheme of reconstruction of amalgamation. + Anumber of detailed procedural and substantive requirements are provided with respect to merger, reconstruction, winding up or insolvency of banks under the relevant provisions of the ct.2020 Amendment to Banking Regulation Act- * In 2020, certain amendments were made to Banking Regulation Act, 1949, to provide for better management and proper regulation of co-operative banks under RBI's supervision. * The following sections have been amended -Section 3, Section 45 and Section 56. + Amendment to Section 45, will now enable the central bank to proceed with reconstruction or amalgamation of co-operative banks in public interest, without first imposing a moratorium to avoid disruption of its operations. + The amendment was made in the wake of several co-operative bank crisis, like the The failure of Punjab & Maharashtra Co-operative Bank (PMC) of 2019, where’ it was found that PMC had been allegedly running fraudulent transactions for several years to facilitate lending to HDIL through fictitious accounts and violating single-party lending rules, HDIL promoters allegedly colluded with the bank management to draw loans from one of bank's branch. The bank officials did not classify these loans as non-performing advances, despite non-payment. This finally led to the collapse of PMC Bank. * Arecent report by RBI titled- “Report of the Expert Committee on Urban Co-operative Banks”, has been published on August 23, 2021.- https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1185#Intr oductionDifferentiated Banks What are differentiated banks ?- * In 2013, RBI in its discussion paper ‘Banking Structure in India - The Way Forward’, analyzed whether India needed differentiated banking license regime. * Since, with the broadening and deepening of financial sector, some banks may choose to operate in niche areas, where banks find their specific realm and mainly provide services in their chosen areas. * RBI approved setting up of Small Finance Banks and Payment Banks as differentiated banks in India. * Custodian Banks and Wholesale and Long-Term Finance banks (WLTF) are newly proposed differentiated banks.Payment Banks * The payments bank are set up as a differentiated bank and shall confine its activities to further the objectives for which it is set up. (Guidelines for Licensing of Payments Banks, 2014- https://rbi.org.in/scripts/bs_viewcontent.aspx%3FId%3D2900 ) * The primary objective of setting up of payments banks will be to further financial inclusion by providing * (i) small savings accounts and * (ii) payments / remittance services to migrant labour workforce, low income households, small businesses, other unorganised sector entities and other users, by enabling high volume-low value transactions in deposits and payments / remittance services in a secured technology- driven environment. + Examples- Airtel Payment Bank, Indian Post Payment Bank, Fino Payment Bank, Paytm Payment Bank, Jio Payments Bank, NSDL Payments Bank1. pe Noe Therefore, the payments bank would be permitted to to undertake only certain restricted activities permitted to banks under the Banking Regulation Act, 1949, as given below: Acceptance of demand deposits, i.e,, current deposits, and savings bank deposits from individuals, small businesses and other entities, as permitted. Issuance of ATM / Debit Cards. Payments banks, however, cannot issue credit cards. Payments and remittance services through various channels including branches, Automated Teller Machines (ATMs), Business Correspondents (BCs) and mobile anking. Issuance of PPIs as per instructions issued from time to time under the PSS Act. Internet banking Functioning as Business Correspondent (BC) of another bank The payments bank may undertake utility bill payments etc. on behalf of its customers and general public. Eligible promoters Existing PPI license holders could opt for conversion into payments banks. (Not mandatory)Small Finance Banks in the Private Sector- * In November 2014, RBI released Guidelines for Licensing of Small Finance Banks in the Private Sector. (https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?ld=2901 ) + As per the guidelines, the objectives of setting up of small finance banks will be to further financial inclusion by * (a) provision of savings vehicles, and * (ii) supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganized sector entities, through high technology-low cost operations.* The small finance bank shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganized sector entities. * It can also undertake other non-risk sharing simple financial services activities, not requiring any commitment of own fund, such as distribution of mutual fund units, insurance products, pension products, etc. with the prior approval of the RBI and after complying with the requirements of the sectoral regulator for such products. * There will not be any restriction in the area of operations of small finance banks * The small finance bank should primarily be responsive to local needs. After.Guidelines for ‘on tap’ Licensing of Small Finance Banks in the Private Sector” * After the guidelines for licensing of Small Finance Banks in the private sector were released on November 27, 2014, the Reserve Bank issued in-principle approval to ten applicants and they have since established the banks. * It was mentioned in the guidelines that after gaining experience in dealing with these banks, RBI would consider receiving the applications on a continuous basis. * Thus, the Guidelines for ‘on tap’ Licensing of Small Finance Banks in the Private Sector, were released in December 2019.* The key points in the guidelines are- (i) The licensing window will be open on-tap; (ii) minimum paid-up voting equity capital / net worth requirement shall be Rs 200 crore; (iii) for Primary (Urban) Co-operative Banks (UCBs), desirous of voluntarily transiting into Small Finance Banks (SFBs) initial requirement of net worth shall be at Rs 100 crore, which will have to be increased to Rs 200 crore within five years from the date of commencement of business. Incidentally, the net-worth of all SFBs currently in operation is in excess of Rs 200 crore; (iv) SFBs will be given scheduled bank status immediately upon commencement of operations; (v) SFBs will have general permission to open banking outlets from the date of commencement of operations; (vi) Payments Banks can apply for conversion into SFB after five years of operations, if they are otherwise eligible as per these guidelines.Session 2: Legal Framework for Non-banking Financial Companies (NBFCs) * Segment I — Legal Framework of The Reserve Bank of India Act, 1934 [Chapter III-B] * Segment II —Other routes of regulation for NBFC- RBI Master Directions & CircularsIntroduction and Historical Background of NBFCs + These non-bank entities were envisioned by RBI and the policy makers as a means to cover those gaps and address the financing needs of the economy that the traditional banking sector was not able to. + These financial intermediaries require lesser capital and are subject to fewer qualifications in comparison to banks, for the purpose of making it simpler for promoters to set up such entities. + Though initially NBFCs had a relatively low-key beginning in India in the 1960s, they have grown exponentially in recent times, particularly in the last 10-15 years. + Arecent report on the NBFC sector by the Federation of Indian Chambers of Commerce and Industry estimated that in 2019, close to almost 25% of total credit outstanding in our country was being provided by NBFCs * As per a recent RBI report, NBFC sector has exhibited tremendous growth as evidenced by the expansion in their balance sheet size from Rs. 10.6 lakh crore in March 2012 to Rs.Rs. 35.9 lakh crore in September 2020 + NBFCs play a complimentary role to the banking sector and assume importance in meeting the financial gaps in the businesses, products, customers as well 25 the geographies not covered by the banks and other financial institutions, including by way Of last mile intermediationSegment | — RBI Act [Chapter III-B] Important definitions Section 45-I(c) — Provides a detailed definition of financial institution Section 45-I(e)- Provides definition of non-banking institution as “a company, corporation or cooperative society”. * Section 45-I(f)- Provides for definition of non-banking financial company, as i. financial institution which is a company; ii, anon-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; such other non-banking institution or class of such institutions, as the Bank may, with the previous approval of the Central Government and by notification in the Offical Gazette, specify.Other Important provisions for NBFCs * Section 45-IA- Provides for the requirements of registration and of a minimum net owned fund in order to commence operations as an NBFC. This section empowers the RBI to grant registration, refuse registration or cancel the registration of NBFCs * Section 45-IB- Provides for the Maintenance of certain percentage of assets by NBFCs (they are required to invest and continue to invest in India in unencumbered approved securities, in an amount above a prescribed threshold, subject to prescribed conditions). * Section 45-IC- Requires the establishment of reserve fund by each NBFCOther Important provisions for NBFCs * Section 45- ID- Provides for power of RBI to remove directors from NBFC office. * Section 45-IE- Provides for power of RBI to supersede Board of directors of NBFC (other than Government Company). *The above two section were inserted by the Finance (no. 2) Act, 2019 in wake of scams like the Infrastructure Leasing and Financial Services Ltd (IL&FS) crisis. In September 2018, IL&FS, a group company, had defaulted on its debt obligations. The defaults jeopardised hundreds of investors, banks and mutual funds associated with IL&FS triggering a liquidity crisis in the financial services market. The government had to replace the IL&FS board with chosen nominees in October. Similarly, in March 2021, CBI registered a case against two of the promoters of crisis-hit Dewan Housing Finance Limited (DHFL), for creating "fake and fictitious" home loan accounts amounting to over Rs 14,000 crore and availed Rs 1,880 crore in interest subsidy from the Government of India. That scam took place between April and June in 2018 when Yes Bank invested Rs.3,700 crore of public money in short-term debentures of DHFL.Regulatory And Supervisory Role Over NBFCs * Section 45JA- Provides power to RBI to determine policy and issue directions in respect of NBFCs >It is done in the public interest or to regulate the financial system of the country to its advantage or to prevent the affairs of any non- banking financial company being conducted in manner detrimental to the interest of the depositors or in a manner prejudicial to the interest of the non-banking financial company. * Section 45L — Provides Power to RBI to call for information from financial institutions and to give directions. > It is for the purpose of enabling RBI to regulate the credit system of the country to its advantageSegment II- Other routes of regulation for NBFC : RBI Master Directions & Circulars RBI periodically issues consolidated regulations for various types of NBFCs or to cover specific aspects of their operations by way of Master Circulars. Some examples of such Master Circulars include, inter alia: * Master Direction — NBFC- Housing Finance Company (Reserve Bank Directions) 2021, updated on December 28, 2021 * Master Direction- Mortgage Guarantee Companies (Reserve Bank Directions), 2016; Updated on October 5, 2021 * Master Direction- Residuary Non-banking Companies Reserve Bank Directions), 2016; Updated on February 22, 2019 * Master Direction- NBFC- Peer to Peer Lending Platform (Reserve Bank Directions), 2017; Updated on October 5, 2021 * Master Direction- Information Technology Framework for NBFC (June 8, 2017) . Master Circular- NBFC — Micro Finance Institutions, Direction 2015, updated on April 20,Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs, October 22, 2021 * To be effective from 1 October 2022 * Over the years, the NBFC sector has evolved in terms of size, complexity, and interconnectedness within the financial sector. * Many entities have become systemically significant and hence there is a need to align the regulatory framework for NBFCs keeping in view their changing risk profile. . ihe new regulatory structure for NBFCs will comprise of four layers based on their- 1) size, 2) activity, 3) and perceived riskiness.* The four layers will be as follows- a) NBFCs in the lowest layer shall be known as NBFC - Base Layer (NBFC-BL). b) NBFCs in middle layer shall be known as NBFC - Middle Layer (NBFC-ML). c) NBFCs in upper layer shall be known as NBFC - Upper Layer (NBFC- UL) respectively. d) The Top Layer is ideally expected to be empty and will be known as NBFC - Top Layer (NBFC-TL).* The SBR regulations were issued further to a discussion paper by RBI released a publication on Jan 22, 2021 called: Discussion Paper on Revised Regulatory Framework for NBFCs - A Scale-Based Approach (https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=20316#AN) That discussion paper had some diagrams, which are discussed in next slides-Empty Top Layer ~ supervisory discretion ‘About 25-30 Upper layer NBFCs through filtering process Equivalent to NBFC-ND-SI & NBFC-D. Equivalertto NBFC-NO but with theethold at #1000 crore Scale Based Approach ~ Introducing Scale Based Framework A ”Scale Based Approach — The Filtering Process e ‘Se SCALE of Significance ACTIVITY Upper Layer Middle Layer (NBFC-UL) (NBFC-ML) > Sample (top 50 NBFCS in terms of asset + Mousing Finance size) to undergo following filters ‘Company _ + standalone Primary Size — 35% Oaders > inter-connectedness— 25% © Infrastructure Finance f Company > Complexity — 10% ‘Always NBFC-MIL. > Supervisory inputs — 30% ‘+ Infrastructure Debt Fund [segment penetration, liability mix, * Core Investment ‘group structure) Company > Top 10 to be included in any caseSession 3: Legal Framework for Loans from International Financial Institutions & Foreign Banks Segment | — External Commercial Borrowings (ECB) PolicyWhat are External Commercial Borrowings? * when an Indian corporate borrower seeks to borrow money or raise certain forms of debt finance for its business-related purposes from a lender that is not a resident Indian (i. e., an “external” lender), it is a case of potential External Commercial Borrowings or “ECB” — such proposed debt finance would need to satisfy the requirements of ECB Policy (i.e., RBI's Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations — see below) What is ECB Policy? * The first step in the legal framework for external commercial borrowings (ECB) les in the Foreign Exchange Management Act, 1999 (FEMA), and the various regulations issued pursuant to FEMA, further to which the specific regulations relating to ECB are issued. * FEMA and the regulations thereunder provide a number of general and specific powers to the + RBI accordingly issued the: Master Direction - External Commercial Borrowings, Trade Credits and Structured Obli ns (March 26, 2019, and last updated on 10th December 2021, ).- https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11510#4 This Master Direction is generally referred to hereinafter as the ECB Policy.Some key matters regulated under the ECB policy include, inter who would qualify as an “eligible borrower”, who would qualify as a “recognised lender” > restrictions on the “end use” for such loans > requirements w.r.t. minimum average maturity period > cap on all-in-cost for such borrowings > hedging requirements Liberalisation of the ECB policy- >The Government of India with the RBI has been liberalising the ECB policy from time to time, by reducing the layers of approval that were previously required, to enable Indian firms/companies to have greater access to international capital market* External Commercial Borrowings (ECB) and Trade Credits (TC) Policy —Changes due to LIBOR transition- RBI Notification on December 8, 2021 * The notification provides that in view of the imminent discontinuance of LIBOR as a benchmark rate, “benchmark rate in case of FCY ECB/TC shall refer to any widely accepted interbank rate or alternative reference rate (ARR) of 6-month tenor, applicable to the currency of borrowing.” *LIBOR- London Interbank Offer Rate, is referred to as the global reference rate and a benchmark for unsecured short-term borrowing in the interbank market and short-term interest rates. It is used for pricing of interest rate swaps, currency rate swaps as well as mortgages.Libor Scandals and the 2008 Financial is * Avery wide range of interrelated financial companies insured risky mortgages and other questionable financial products using credit default swaps (CDS). Rates for CDS were set using Libor. American International Group (AIG) issued vast quantities of CDS on subprime mortgages and countless other financial products. After the the financial crisis of 2007-2008, AIG was forced into bankruptcy. Once AIG went bankrupt, it became clear that failing subprime mortgages and the securities built on top of them weren't properly insured, many banks became reluctant to lend to each other. Libor transmitted the crisis far and wide since everyday Libor rate-setting banks estimated higher and higher interest rates. Libor rose, making loans more expensive. According to Forbes- “In 2012, extensive investigations into the way Libor was set uncovered a widespread, long-lasting scheme among multiple banks— including Barclays, Deutsche Bank, Rabobank, UBS and the Royal Bank of Scotland—to manipulate Libor rates for profit.”Forms of ECB- * ECB can take a number of forms, including i. loans; ii. securitized instruments; iii. trade credit of a duration over 3 years; iv. financial lease; v. foreign currency convertible bonds; and vi. foreign currency exchangeable bonds. * ECBs can be availed of in foreign currency or in Indian Rupees.Key aspects of ECB Policy- > Eligible Borrowers: As part of such liberalization, all entities that are eligible to receive foreign direct investment can now be considered Eligible Borrowers. > Recognised Lender: The essential requirement is that such lender should be a resident of a FATF(The Financial Action Task Force) or IOSCO (International Organisation of Securities Commissions) compliant country. There are few exceptions to this rule as well > End Use- Prior to the current ECB Policy (as set out in 2019), ECB proceeds could not be utilized for working capital purposes, general corporate purposes and repayment of Rupee loans except under specific circumstances. However, these end-use restrictions have now been largely relaxed. > All-in-cost ceiling- It refers to that total amount the borrower can pay the lender as a total of interest, fees and other charges (excluding commitment fees, a certain permitted amount of penalty and withholding tax paid by the borrower in India). >The minimum average maturity- The average maturity (i.e the minimum tenure that loans availed under the ECB route can have} of such loans cannot be shorter than the minimum average maturity as prescribed under the ECB Policy. > Hedging obligation- The ECB Policy also contains provisions for the parties to ECB to. ensure proper hedging of foreign currency risks related with fluctuations in exchange rate for the same.Session 4: Legal Framework for Common Financial Instruments * Segment I- Negotiable Instruments Act, 1881Negotiable Instruments Act, 1881 (‘NI Act’) What are Negotiable Instruments? * This law covers certain types of financial instruments (‘Negotiable Instruments’) which impart a right to be paid a certain sum of money — these negotiable instruments are transferable, in written form and have certain common features * Section 13 (1) of NI Act, defines Negotiable Instruments as- A “negotiable instrument” means a promissory note, bill of exchange or cheque payable either to order or to bearer.Important provisions of NI Act * From the perspective of the commonly prosecuted and litigated aspect under this Act, the provisions under the NI Act relating to dishonour of cheques are of high current relevance and importance. Since cheques are a commonly used payment means in business and trade circles, the issues around them are prominent. Accordingly, let’s examine some basic concepts relating to cheques: Section 6 defines cheque as a bill of exchange drawn ona specified banker, and not expressed to be payable otherwise than on demand. * So, a cheque can be seen as a specific type of bill of exchange. All cheques are bills of exchange, but all bills are not cheques. Cheque includes an electronic image of a cheque and such image of a truncated cheque as well. Section 7 provides the definition of ‘drawer’ and ‘drawee’. The maker of the bill of exchange or cheque is called “drawer” and the person thereby directed to pay is called the a “drawee”.Important provisions of NI Act — contd. Section 4 defines promissory note as an instrument in writing (not being a bank-note or a currency note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money to (or to the order of) a certain person, or to the bearer of the instruments. Section 5 defines bill of exchange as an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, (or to the order of) a certain person or to the bearer of the instrument.Important characteristics of Negotiable Instruments 1. Itis in written form 2. It is transferable — this means that the title to such instruments — that is, the right to their ownership — can be transferred from one person to another and this can be done in the two ways under the Act: > by endorsement > by delivery What does Negotiation mean? * A instrument may be said to be negotiated when such instrument (Bill of Exchange, Promissory Note or Cheque) is transferred to another person such that the transferee now becomes entitled to the payment. * This concept is contained in Section 14 of the NI Act + Section 14 provides that: When a promissory note, bill of exchange or cheque is, transferred to any person, so as to constitute that person the holder thereof, the instrument is said to be negotiated.Important characteristics of Negotiable Instruments — contd. a 4. A Negotiable Instrument (“NI”) is transferable under the NI Act for an unlimited number of times up to its maturity (during its period of validity) The independent title of Transferor and Transferee: even if the transferor had a flawed title, the transferee can get a good title, if he did not know of the defect and accepted the transfer in good faith and for a consideration. Certainty of amount - sum should be clearly stated Certainty of date (clear period of validity/maturity) An NI imparts the right to sue in respect of the instrument, which lies with the holder as well as “holder in due course”. ® Section 8 defines "Holder“: “holder” of a promissory note, bill of exchange or cheque means ® Section 9 defines "| any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto. Where the note, bill or cheque is lost or destroyed, its holder is the person so entitled at the time of such loss or destruction jolder in due course" as any person who for consideration became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or the payee or indorsee thereof, if payable to order, before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his titleNegotiable Instruments Laws (Amendment) Act, 1988- Insertion of Section 138 > Insertion of a new chapter, Chapter XVII, in the Negotiable Instruments Act, 1881. * This new chapter added added the Sections from 138 to 142 to the NI Act. * Prior to such change in 1989, there were only civil and alternative dispute resolution (ADR) remedies for dishonoured cheques * Under Section 138 there is no need to prove mens rea or the intent of the payer to not pay the promised amount. > Why was the amendment needed?- Because of the widespread problem of fraudulent behaviour and non-payment of dues as evidenced by dishonoured cheques. This mistrust of cheques encouraged a move towards cash transactions which brought a host of their own problems, such as counterfeit notes, corruption, and large amounts of untraceable and untaxable money.Section 138: Dishonour of cheque for insufficiency etc., of funds in the account * This section provides for punishment, in case a cheque is dishonoured due to insufficiency of funds and returned by the bank as unpaid. * The key ingredients of this section are- 1. The cheque should have been issued for the discharge, in whole or part, of any debt or other liability. 2. The cheque should have been presented within a period of six months from the date on which it is drawn or within the period of its validity, whichever is earlier. 3. The payee or holder in due course should have issued a notice in writing to the drawer within 30 days of the receipt of information by him from the Bank regarding the return of the cheque as unpaid. 4. After receipt of the said notice from the holder in due course, the drawer should have failed to pay the cheque within 15 days of receipt of the said notice.Other important provisions of Chapter XVII » Section 139: It provides a presumption in favour of holder that such holder of a cheque received the cheque of the nature referred to in section 138 for the discharge, in whole or in part, of any debt or other liability Section 140: It prohibits the defence that the drawer had no reason to believe when he issued the cheque that the cheque may be dishonoured on presentment for the reasons stated in section 138. » Section 141: It addresses a scenario where the offence under S 138 is committed by a company. Section 142: It address the cognizability of offences under Section 138, also provides the time period(one month), within which such complaint must be made.Important amendments to NI Act The Negotiable Instruments (Amendment and Miscellaneous Provisions) Act, 2002 Inserted new sections 143 to 147 in the said Act aimed at speedy disposal of cases relating to dishonour of cheque, as well as making them compoundable. » Punishment provided under section 138 too was enhanced from one year to two years. 2. The Negotiable Instruments (Amendment) Act, 2015 >Dashrath Rupsingh Rathod v State of Maharashtra (AIR 2014 SC 3519) > Section 142A was inserted (Text in next slide)- It provides the jurisdiction for offence under section 138 3. The Negotiable Instruments (Amendment) Act, 2018 } Inserted Section 143 A and Section 148- aimed to reduce the number of cheque bounce cases pending in the courtsSection: 142A. (2) Notwithstanding anything contained in the Code of Criminal Procedure, 1973 or any judgment, decree, order or direction of any court, all cases transferred to the court having jurisdiction under sub-section (2) of section 142, as amended by the Negotiable instruments (Amendment) Ordinance, 2015, shall be deemed to have been transferred under this Act, as if that sub-section had been in force at all material times. (2) Notwithstanding anything contained in sub-section (2) of section 142 or sub-section (2), where the payee or the holder in due course, as the case may be, has filed a complaint against the drawer of a cheque in the court having jurisdiction under sub-section (2) of section 142 or the case has been transferred to that court under sub-section (1) and such complaint is pending in that court, all subsequent complaints arising out of section 138 against the same drawer shall be filed before the same court irrespective of whether those cheques were delivered for collection or presented for payment within the territorial jurisdiction of that court. (3) If on the date of the commencement of the Negotiable Instruments (Amendment) Act, 2015, more than one prosecution filed by the same payee or holder in due course, as the case may be, against the same drawer of cheques is pending before different courts, upon the said fact having been brought to the notice of the court, such court shall transfer the case to the court having jurisdiction under sub-section (2) of section 142, as amended by the Negotiable Instruments (Amendment) Ordinance, 2015, before which the first case was filed and is pending, as if that sub-section had been in force at all material times.Important case laws under Section 138- 1. Kaushalya Devi Massand vs Roopkishore Khore (AIR 2011 SC 2566)- * The dispute in this case arose, when the respondent issued cheques for Rs. 3 lakh, to the complainant, in lieu of the payment of consideration against the sale of property, in 1997. The cheques were dishonoured on the round of insufficient funds. Hence the complaint was made. Eventually the Respondent had deposited a sum of Rs.3,50,000/-, as against the cheque amounting to Rs.2 lakhs. The Magistrate First Class, Indore (M.P.), observed that since Respondent had deposited a sum of Rs.3,50,000/-, as against the cheque amounting to Rs.2 lakhs, sentence of fine only would suffice without awarding any jai sentence. The learned Magistrate, accordingly, sentenced the Respondent to pay a fine of Rs.4 lakhs which was to be paid to the Appellant as compensation. (out of which Rs 3, 50,000/- was already paid, Rs.50,000/- was left to be paid), Also the magistrate observed that failure to deposit the said amount of Rs.50,000/-, the Respondent would have to undergo two months’ Rigorous Imprisonment.Kaushalya Devi Massand vs Roopkishore Khore — contd. * An appeal was filed before SC, where the appellant challenged the decision of the Magistrate, stating that while not sentencing the Respondent to a jail sentence despite the enormity of the offence committed by the Respondent, ironically the Magistrate sentenced the Respondent to two months' Rigorous Imprisonment in default of payment of Rs.50,000/- towards the fine/compensation of Rs.4 lakhs. The counsel for appellant also urged, that since the appellant is a widow, and this dispute has been going on since 14 years, it was only proper that a jail sentence be awarded to the Respondent to serve as a deterrent to others involved in similar activities However, the Supreme Court held that that “the gravity of a complaint under the Negotiable Instrument Act cannot be equated with an offence under the provisions. of the Indian Penal Code or other criminal offences. An offence under Section 138 of the Negotiable Instruments Act, 1881, is almost in the nature of a civil wrong which has been given criminal overtones”2. Meters and Instruments (P) Ltd. v. Kanchan Mehta (AIR 2017 SC 4594) > In this case, the accused was willing to pay the amount on the cheque default, to the complainant, but owing to earlier Supreme Court judgements which had made mutual consent necessary for compounding of offence under Section 138, the High Court could not grant any relief to the accused. >The SC noted that ~"Offence under Section 138 of the Act is primarily a civil wrong. Burden of proof is on accused in view presumption under Section 139 but the standard of such proof is preponderance of probabilities . The same has to be normally tried summarily as per provisions of summary trial under the Cr.P.C, but with such variation as may be appropriate to proceedings under Chapter XVii of the Act. Thus read, principle of Section 258 Cr.P.C. will apply and the Court can close the proceedings and discharge the accused on satisfaction that the cheque amount with assessed costs and interest is paid and if there is no reason to proceed with the punitive aspect. > In view of the above, we hold that where the cheque amount with interest and cost as assessed by the Court is paid by a specified date, the Court is entitled to close the proceedings in exercise of its powers under Section 143 of the Act read with Section 258 Cr.P.C.3. P. Mohanraj vs M/S. Shah Brothers Ispat Pvt. Ltd (AIR 2021 SC 1308) * In this case, the respondent issued two statutory demand notices u/s Section 138 read with Section 141 of the Negotiable Instruments Act, 1881 to the company Diamond Engineering Pvt. Ltd. and its three directors. The dispute was regarding dishonouring of cheques, that was given by the company to the respondent for supplying steel products to the company. Since no payment was made pursuant to the two statutory demand notices, two criminal complaints were filed by the respondent against the company and the appellants under Section 138 read with Section 141 of the Negotiable Instruments Act before the Additional Chief Metropolitan Magistrate (ACMM) in jumbai. Meanwhile, the respondent also issued a, a statutory notice under Section 8 of the Insolvency and Bankruptcy Code, to the company. The procedure of corporate insolvency commenced, pursuant to the directions of the Adjudicating Authority. Here a moratorium in terms of Section 14 of the IBC was ordered. Also, the Adjudicating Authority stayed further proceedings in the two criminal complaints pending before the ACMM in Mumbai. An appeal was filed to the. National Company Law Appellate Tribunal (“NCLAT”), the NCLAT set aside this order, holding that Section 138, being a criminal law provision, cannot be held to be a “proceeding” within the meaning of Section 14 of the IBC.4, Dashrath Rupsingh Rathod versus State of Maharashtra (Criminal Appeal No. 2287 of 2009), AIR 2014 SC 3519 * In this case a set of Appeals were presented before the Supreme Court. These appeals raised a legal nodus of substantial public importance pertaining to Court's territorial jurisdiction concerning criminal complaints tiled under Chapter XVII of the Negotiable Instruments Act, 188: In this particular appeal (Criminal Appeal No. 2287 of 2009) , a cheque was drawn and dishonoured at Bank of India, at Bhandara district of Maharashtra. However, the complaint was filled at Judicial Magistrate First Class, Yavatmal district of Maharashtra. The High Court of Judicature at Bombay, Nagpur Benchheld that in such case, the Judicial Magistrate First Class, Yavatmal district of Maharashtra had no jurisdiction to entertain the Complaint. He ordered that the complaint should be returned to the complainant for filing in the appropriate Court. The Supreme Court upheld the decision of High Court and held that the territorial jurisdiction for dishonour of cheques is restricted to the court within whose local jurisdiction the offence was committed, which in the present context is where the cheque is dishonoured by the bank on which itis drawn. * The Supreme Court directed that only those cases where, post the summoning and appearance of the alleged accused, the recording of evidence has commenced as envisaged in section 145(2) of the Negotiable Instruments Act, 1881, will proceeding continue at that place.* All other complaints (including those where the accused/respondent has not been properly served) shall be returned to the complainant for filing in the proper court, in consonance with exposition of the law, as determined by the Supreme Court. * Hence, this appeal was filled before SC, where the question arose, whether the institution or continuation of a proceeding under Section 138/141of the Negotiable Instruments Act can be said to be covered by the moratorium provision, namely, Section 14 of the IBi Decision- * Supreme Court held that a Section 138/141 proceeding against a corporate debtor is covered by Section 14(1)(a) of the IBC. * Itis clear that a Section 138 proceeding can be said to be a “civil sheep” in a “criminal wolf’s” clothing, as it is the interest of the victim that is sought to be protected, the larger interest of the State being subsumed in the victim alone moving a court in cheque bouncing cases. The proceedings are quasi-criminal in nature.Guidelines by the SC- In Re: EXPEDITIOUS TRIAL OF CASES UNDER SECTION 138 OF N.1. ACT 1881 (SUO MOTU WRIT PETITION (CRL.) NO.2 OF 2020) * The High Courts are requested to issue practice directions to the Magistrates to record reasons before converting trial of complaints under Section 138 of the Act from summary trial to summons trial. + The High Courts are requested to issue practice directions to the Trial Courts to treat service of summons in one complaint under Section 138 forming part of a transaction, as deemed service in respect of all the complaints filed before the same court relating to dishonour of cheques issued as part of the said transaction. For the conduct of inquiry under Section 202 of the Criminal Code, evidence of witnesses on behalf of the complainant shall be permitted to be taken on affidavit. In suitable cases, the Magistrate can restrict the inquiry to examination of documents without insisting for examination of witnesses.A proposal to decriminalize the offence of dishonour of cheques under section 138 of the Negotiable Instruments Act, 1881. >On 8 June, 2020, the Department of Financial Services, Ministry of Finance of the Government of India released a Statement of Reason, for ‘Decriminalisation of Minor Offences For Improving Business Sentiment And Unclogging Court Processes’ (https://dea.gov.in/sites/default/files/consultation%20paper%20decri minalisation_O.pdf ) >It includes to decriminalize the offence of dishonour of cheques under section 138 of the Negotiable Instruments Act, 1881 >The government is considering such decriminalisation in light of the huge numbers of such criminal cases pending in court.Session 5: Challenges relating to National & International Financial Systems Affecting the Legal Framework & Resulting Laws/Rules + Segment |- 1. The Global Financial Crisis (GFC) of 2007-09 (the effects of this GFC continued and some are still being felt to the present day) 2. Basel Norms + Their adoption in India + Segment Il- 1. _Non- Performing Assets (NPAs) 2. _ Laws and Regulations arising out of NPA crisis and poor recovery rate for lenders in India a. RDDBFI Act b. SARFAESI Act = lee d. Amendments to Banking Regulation Act e. Other laws and regulations aimed at recovery / enforcement of debtSegment I- The Global Financial Crisis of 2007-09 How the crisis unfolded: * Real estate was long considered one ofthe safest investments and mortgage: backed housing loans (“mortgages”) were deemed a solid asset for the lenders operating in that sector. Further, the big lenders had always held the view that the property markets in different American cities would rise and fall independently of one another, So any drop in one area would not affect others. * However, following years of responsible lending to homeowners with poor credit histories (‘sub- prime mortgages’}, the US housing market began to collapse around the end of 2006, resulting in evictions, foreclosures and prolonged unemployment. Many other cracks in the US crédit and financial system began emerging in 2007. + In 2008, many big names in banking industry started filling for bankruptcy. + Lehman Brothers bank, filed for bankruptcy on September 15, 2008. * Tis resulted in a domino effec where the American public could not predict which big name banking and finance firm would topple next, and Wall Street became a carnage zone. * Bank of America agreed to purchase Merrill Lynch, and American International Group (“AIG”) was saved by an $85 billion capital injection by the US government * On September 25th, 2008, J P Morgan Chase agreed to purchase the assets of Washington Mutual + These failures caused a crisis of confidence that made American banks reluctant to lend money and this was the genesis and epicenter of the GFC, which went on to wipe out trillions of dollars’ worth of assets, hitting hardest the ordinary citizens of USA and in many other parts of the world,Key Players Lenders (including banks and mortgage companies) who gave mortgage-backed home loans to prospective home buyers — and who eventually began giving such loans to borrowers with poor credit histories / low credit scores Investment bankers who advised clients (including mutual funds, pension funds, hedge funds etc) on investments The clients of investment bankers Credit ratings agencies Insurance companiesHow the Global Financial Crisis (GFC) Evolved (part1): + The housing market in USA had for decades been seen as fail-safe and guaranteed to rise in value. Lenders such as banks and mortgage companies gave loans to prospective homeowners and the property being purchased was mortgaged as security in favour of the lender (such loans are generally referred to as “mortgages” in market jargon in USA). * The years before the GFC saw a rise in risky mortgage lending (“sub-prime mortgages”) in USA. Lenders wished to generate large quantities of mortgages (this is linked to lucrative demand for such mortgages from investment bankers, as set out below). Thus, they eventually loosened the standard practices of diligence, income verification and assessment of credit-worthiness in order to grant vast quantities of mortgages to borrowers who were unfit for such mortgages. + These mortgages were then sold to investment bankers in bulk, who divided and sub-categorised them in order to create risky derivatives/ mortgage-backed securities ("MBS") such as collateralized debt obligations (“CDOs”). These investment bankers were making huge profits by buying up large quantities of mortgages and using creative financial engineering to create various types of MBS. * The investment banks creating CDOs worked with credit rating agencies to obtain high ratings for many such CDOs. It was later discovered that there were various irregularities with such credit rating including some common investors/owners between the banks/ shadow banks and credit rating agencies.How the Global Financial Crisis (GFC) Evolved (part 2): * Insurance companies (such as the insurance behemoth AIG) added to the risky situation by selling huge quantities of an insurance product along with CDOs that was supposed to protect the buyer from risk of default — these were called Credit Default Swaps (“CDS”). However, the insurance companies did not set aside adequate cash amounts as would be required to honour the CDSs sold by them. * The CDOs were sold by investment bankers to their clients — these holders of CDOs would often sell them forward to other purchasers. + Eventually, these sub-prime mortgages began to see the inevitable deluge of defaults by the home loan borrowers who had been given such mortgages without the usual requirements of credit-worthiness, which led to a collapse in the US housing market and the CDOs becoming worthless. This subsequently led to the crisis of credit and larger impact on the global financial system by way of the GFC.Important Contributing Factors w.rt. GFC + Deregulation: An important underlying issue that directly aided the lenders, investment banks and others in these risky (though initially highly profitable) actions was DEREGULATION. Given the relative prosperity and economic growth of the 1990s and early 2000s, the financial industry and its lobbyists were able to convince political leaders to repeal some important regulations and pass new regulations that gave it unprecedented freedom from regulatory oversight e.g. (i) partial repeal of Glass Steagall Act (1933) (i) passing of The Financial Services Modernization Act of 1999 (Gramm-Leach- Bliley Act), which inter alia allowed banks to use deposits to invest in derivatives (iii) passing of Commodity Futures Modernization Act, which exempted derivatives from regulatory oversight, (iv) in 2004, the Securities and Exchange Commission (SEC) weakened the net-capital requirement (the ratio of capital, or assets, to debt, or liabilities, that banks are required to maintain as a safeguard against insolvency), which encouraged banks to invest even more money into MBSs. + Shadow Banks: This deregulation came about at a time of explosive growth of the “shadow banking” industry in the US. + A shadow banking system is the group of financial intermediaries facilitating the creation of credit across the global financial system but whose members are not subject to the same level of regulatory oversight as banks because unlike traditional banks and credit unions, these institutions do not accept traditional deposits. So they did not face the normal regulatory oversight and rules regarding capital reserves and liquidity that are required of traditional lenders in order to help prevent bank failures and financial crises. Examples of shadow banks include investment banks, mortgage companies, hedge funds, etc. + The unprecedented rise of shadow banking along with deregulation of the financial services sector directly contributed to the GFC.ener pas turned them into oe eee Pema oid cae eee) Secon eee oer nFallout of the Global Cri > Threat of total collapse of a number of large financial institution, crashing of stock markets around the globe > Credit freeze brought the global financial system to the brink of collapse >The response was to inject liquidity into the credit market- central banks (such as US Federal Reserve, the European Central Bank) purchased US$2.5 trillion of government debt and troubled private assets from banks. The crisis caused loss of wealth and even impoverishment to a vast and unprecedented number of individuals, financial institutions and industries » Failure of key businesses, decline in consumer wealth ® It led to a global recession and contributed to the European sovereign-debt crisis.Segment | contd. - Basel Norms + Their adoption in India * The indispensable need for regulation of banking and financial markets was felt after the Global crisis. The Basel Accords * Bank for International Settlements (“BIS”) is the world's oldest international financial organisation, headquartered at Basel in Switzerland. BIS is owned by 63 member central banks from all over the world, representing countries accounting for approximately 95% of the world GDP. Reserve Bank of India is one of the members, + The Basel Committee On Banking Supervision (“BCBS”) of BIS has put together a set of agreed parameters, which aim to address risks to banks and the financial system- 1. Basel | (1988) 2. Basel II (2004) 3. Basel III (2010)