Handout 2 Batch 3,5

2/15/2023
Non Performing Assets
Definition (NPA) is a loan for which the principal or interest payment

remained overdue for a period of 90 days.
Agriculture / Farm Loans; the NPA is defined as under:

 For short duration crop agriculture loans such as paddy,
Jowar, Bajra etc. if the loan (installment / interest) is not
paid for 2 crop seasons
 For Long Duration Crops, the above would be 1 Crop
season from the due date.
For Doubts, Queries: Telegram:@saileshbhupalam

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Some terms about loans

Standard Asset: If the borrower regularly pays his dues and on time;
secured loan: borrower pledges some asset (e.g. a car or property) as

collateral for the loan
Unsecured loan: without the use of property as collateral for the loan, and
it is also called a signature loan or a personal loan.
Provisioning: For every loan given out, the banks keep aside some extra
funds to cover up losses if something goes wrong with those loans.

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Provisioning requirements
Substandard
asset
Sub-standard – NPA but less than 12
provisioning months
o 15% of outstanding amount in case of
Secured loans
o 25% of outstanding amount in case of
Unsecured loans

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Provisioning requirements
Doubtful Sub-standard asset remains so for a period of 12 more months; it would
be termed as “Doubtful asset”. This remains so till end of 3rd year.
asset
provisioning
o Up to one year: 25% of outstanding amount in case of Secured loans;
100% of outstanding amount in case of Unsecured loans
o 1-3 years: 40% of outstanding amount in case of Secured loans; 100% of

outstanding amount in case of Unsecured loans
o more than 3 years: 100% of outstanding amount in case of Secured

loans;100% of outstanding amount in case of Unsecured loans.

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Loss assets
• If the loan is not repaid even after it remains sub-standard
asset for more than 3 years, it may be identified as
unrecoverable by internal / external audit and it would be
called loss asset.
• An NPA can declared loss only if it has been identified to be

so by internal or external auditors

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Gross and net NPAs
Gross NPA is just the sum

of all NPAs of the bank
Net NPA is Gross NPA
minus provisioning
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A loan becomes a Non-Performing Asset (NPA) when the interest or

principal becomes overdue for a period of:
• A. 5 years
• B. 90 days
• C. 180 days
• D. 365 days

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Why NPAs?
1> Due diligence not done by the bank – ex: Loan

disbursed for a road even before land acquisition
2> Poor monitoring by the bank post

disbursement
3> Diversion of funds by companies for purposes

other than for which loans were taken

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Why NPAs?
4> Earlier – used to do restructuring of NPAs to avoid
provisioning, now RBI made it strict – sudden rise in NPAs
seen.
5> Economic downturn since 2008
6> Export decline due to low global demand (double dip

recession, now trade wars)

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Why NPAs?
7> Policy paralysis, especially seen in UPA2

– delay in decision making
8> Crony capitalism – Banks are forced by

government to lend to certain corporates.
9> Poor bankruptcy provisions – exit

barriers led to piling up of bad loans

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Impact of NPAs
1>Provisioning norms – reduce profits

for the banks
2>Increase in interest rates to
compensate
3>Evergreening of NPAs

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Impact of NPAs
4> Twin balance sheet syndrome hurts

growth
5> banks become cautious in lending –
reduced loans
6> Monetary transmission issues arise

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• 1) Which of the following statements is/are correct regarding Monetary

Transmission?
1.It refers to the process by which a central bank’s monetary policy decisions
are passed on to the financial markets
2.Rising Non-Performing Assets (NPAs) and higher returns on small savings
schemes may hinder effective monetary transmission.
3.Lowering of CRR and SLR requirements may help ensure effective monetary
transmission
• Select the correct answer using the code given below
• (a) 1 only
• (b) 2 and 3 only
• (c) 1 and 2 only
• (d) 1, 2 and 3

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• 1) Which of the following statements is/are correct regarding Monetary Transmission?

1. It refers to the process by which a central bank’s monetary policy decisions are passed on to the financial markets
2. Rising Non-Performing Assets (NPAs) and higher returns on small savings schemes may hinder effective monetary transmission.
3. Lowering of CRR and SLR requirements may help ensure effective monetary transmission
• Select the correct answer using the code given below
• (a) 1 only
• (d) 1, 2 and 3
• Solution:d
• The monetary transmission mechanism is the process by which asset prices and general economic conditions are affected as a
result of monetary policy decisions. Such decisions are intended to influence the aggregate demand, interest rates, and amounts
of money and credit in order to affect overall economic performance. The traditional monetary transmission mechanism occurs
through interest rate channels, which affect interest rates, costs of borrowing, levels of physical investment, and aggregate
demand. Additionally, aggregate demand can be affected through friction in the credit markets, known as the credit view. In
short, the monetary transmission mechanism can be defined as the link between monetary policy and aggregate demand.
•

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Monetary transmission issues
Banks 1> Rising NPAs impact profits, so banks

not don’t reduce rates
passing 2> competition from small savings
on rate instruments
cut
Ex: National savings certificates, Kisan
vikas patra, Sukanya samriddhi yojna etc

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Benchmark prime lending rate(BPLR )
up Benchmark Prime Lending Rate (BPLR) was the

rate at which commercial banks charge their
to customers who are most credit worthy. Banks can

fix the BPLR with the approval of their Boards.
2010 Under BPLR, banks could lend even below BPLR.

Ultimately one borrower getting cheaper loan
than the other was a major problem. Hence base
rate was introduced

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Base Rate
Base Rate is the interest rate below which Scheduled
2010 Commercial Banks (SCBs) will lend no loans to its customers
to 1) Cost for the funds (interest rate given for deposits+ loans
taken),
2016 2) Operating expenses,
3) Minimum rate of return (profit or margin), and
4) Cost for the CRR (for the four percent CRR, the RBI is not
giving any interest to the banks)

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Marginal cost of funds based lending rate

(MCLR)
2016 Marginal – new funds that are coming in
onwards (deposits, loans)
Changed formula to calculate interest rates of
banks
Ex: Housing = MCLR +1%;

Auto = MCLR +2%

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MCLR
1>Marginal cost of funds: (interest for new deposits
MCLR and interest on new loans)
2>cost of holding CRR
3> Operating cost: rents, salaries etc
4> Tenor premium: Higher interest can be charged for

long term loans

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Impact of MCLR
Better monetary transmission
Lower interest rates for borrowers
Less discretion for banks in deciding

interest rates

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External benchmark lending rate (EBLR)
All the three – BPLR, base rate, MCLR can be

considered as internal benchmark lending rates
There is still a chance the banks will not cut

lending rates as long as they have the freedom
So, RBI came up with EBLR

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Unlike MCLR which was internal system for each bank, RBI has offered
banks the options to choose from 4 external benchmarking mechanisms:
1> The RBI repo rate
2> 91-day T-bill yield
3> 182-day T-bill yield
4> Any other benchmark market interest rate as developed by

the Financial Benchmarks India Pvt. Ltd.

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Bank interest rates will be decided

based on EBLR – ex: repo rate + 3%
will make the interest rates transparent.
borrower will also know the spread or

profit margin for each bank

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• Q.1) Consider the following statements about Marginal Cost of

funds based Lending Rate (MCLR):
1. MCLR refers to the minimum interest rate of a bank below which
bank can never lend.
2. MCLR is determined on the basis of marginal cost or incremental
cost of arranging one more rupee to the prospective borrower
• Choose the correct statements from the option given below:
• a) 1 only
b) 2 only
c) Both 1 and 2
d) Neither 1 nor 2

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• Q.1) Consider the following statements about Marginal Cost of funds based Lending
Rate (MCLR):
1. MCLR refers to the minimum interest rate of a bank below which bank can never
lend.
2. MCLR is determined on the basis of marginal cost or incremental cost of arranging
one more rupee to the prospective borrower
• Choose the correct statements from the option given below:
• a) 1 only
b) 2 only
c) Both 1 and 2
d) Neither 1 nor 2
• Ans. B
• Explanation:
• MCLR refers to the minimum interest rate of a bank below which it cannot lend, except in
some cases allowed by the RBI.

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Measures taken to resolve NPAs
1>Debt Courts took 6-8 years

recovery
tribunals
Separate tribunals established to reduce
time taken
But huge lag developed in tribunals also
– they were insufficienct

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2>SARFAESI The Securitization and Reconstruction of Financial
Act – 2002 Assets and Enforcement of Security Interest
If more than 25% of bank loans are NPA’s, no

need to go to court or tribunal
They can send a notice and auction the collateral.

Can buy loans to reach 25% mark.

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3> Asset
reconstruction Loans sold to these companies and then
companies converted to equity
(ARCs)
Banks cannot hold equity beyond a point
– it creates more risk in the economy
So, ARCs were created.

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2015 – mission Indradhanush

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Mission Indradhanush
Appointments -- separate post of Chairman

and Managing Director and the CEO
Bank Board Bureau – will focus on

appointments without political interference
Capitalization – 1.8 lakh cr required for banks

upto 2019, 70kcr will be provided by govt

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Destressing – strengthening risk control measures
Employment – government will not interfere in

hiring and firing decisions
Framework for accountability – Key performance

indicators linked to performance incentives

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Governance Reforms – PJ nayak committee

recommended governance reforms
PJ nayak – setup Bank Investment Company as a

holding company, BBB (done), repeal acts which
require 50%+ stockholding of government in PSBs

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Functions of BBB
Recommendations to the government on top-level appointments like full-time Directors, non-
Executive Chairman, tenure, extension, termination, ethics, training of managers in PSBs.
providing assistance to Public Sector Banks to restructure their business strategies
Assisting banks with the strategies to deal with issues of bad loans or stressed assets
Strategies for raising capitals through innovative financial instruments and methods
suggest plans for consolidation and merger with other banks while they are trapped in the
problem of high collective gross NPAs.

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2022 prelims Qn
• With reference to the 'Banks Board Bureau (BBB)', which of the following
statements are correct?
• 1. The Governor of RBI is the Chairman of BBB.
• 2. BBB recommends for the selection of heads for Public Sector Banks.
• 3. BBB helps the Public Sector Banks in developing strategies and capital
raising plans.
• Select the correct answer using the code given below:
• (a) 1 and 2 only
• (d) 1, 2 and 3

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2022 prelims Qn
• With reference to the 'Banks Board Bureau (BBB)', which of the following
statements are correct?
• 1. The Governor of RBI is the Chairman of BBB.
• 2. BBB recommends for the selection of heads for Public Sector Banks.
• 3. BBB helps the Public Sector Banks in developing strategies and capital
raising plans.
• Select the correct answer using the code given below:
• (a) 1 and 2 only
• (d) 1, 2 and 3

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2018 – RBI abolished a lot of measures
Called SDR, CDR, S4A, JLF

them as
alphabet
Said they give too much lenience, perpetuating the
soup problem of NPAs
Increased reporting requirements for NPAs –

Special mention accounts (to prevent evergreening)

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Insolvency and Bankruptcy Code and it’s amendment

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Insolvency and bankruptcy meaning
Insolvency -- when an individual or

company can no longer meet their financial
obligations to lenders
Bankruptcy – is a legal proceeding involving
a person or business that is unable to repay
their outstanding debts

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2015 – Chakravyuha challenge addressed
Exit problem was severe in India
Insolvency and bankruptcy code created

to solve this
Easy exit  improved ease of doing
business

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Insolvency and bankruptcy code introduced

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Performance of IBC
By 50%+ cases lacked sufficient grounds, outside

settlement
2018 -- Out of remaining, only 540 admitted
4700
cases Out of admitted, only 1.9% resolved, 5.9% went for
liquidation
taken
Corporate debtors initiated in 20% of admitted cases
up
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2019 amendment
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IBC amendment ordinance 2020 (during

lockdown)
no application for corporate insolvency resolution

process (CIRP) initiation under could be filed, for
any default arising on or after 25th March 2020.
This will be applicable for a period of 6 months or

such further period, not exceeding one year from
this period, as may be notified.

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lockdown)
Issues Doesn’t allow voluntary insolvency

with proceedings also
ordinance
Treats all defaults to be covid-19 induced in
the given period
It could have left the decision to NCLT

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lockdown)
Ordinance has now lapsed
But during the time it was present,

whatever defaults happened are still
protected

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IBC amendment Act 2020
seeks to remove bottlenecks and streamline

the corporate insolvency resolution process.
aims to provide protection to new owners of a

loan defaulter company against prosecution
for misdeeds of previous owners.

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Provisions related to real estate
Requires of a minimum of 10 per cent of allottees or 100

individual allottees in a real estate project to initiate insolvency
proceedings
homebuyers are recognized as financial creditors under the IBC
So, individual homebuyers coming together could initiate

insolvency against a real estate company for delays in possession

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Liabilities for wrongful trading
A director or a partner of the corporate debtor may be

held liable to make personal contributions to the assets
of the company in certain situations.
This liability can occur if despite knowing that the

insolvency proceedings cannot be avoided, the person
did not exercise due diligence in minimizing the potential
loss to the creditors.

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FDRI bill, 2017
Was proposed for resolution of

bankruptcy in financial institutions
But became controversial due to bail in
provision

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FDRI bill
Scrapped DICGC – deposit insurance and credit guarantee
corporation (upto 1 lakh deposit insurance)
Classification of Financial institutions based on risk of

failure (will precipitate bank runs)
Creates IRC – Independent resolution corporation

(insurance amount will be decided on case by case basis
by IRC)

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FDRI bill
Post 2008 crisis in US – financial stability board(FSB)
Bail established
in? It recommended bail-in clause to prevent moral

hazard, contagion risk and repeat of 2008 type crisis
Already implemented in UK, EU, Canada, Australia
In India we adopted the same clause in FDRI bill

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FDRI bill
2018 – uproar over bail in clause and

removal of deposit insurance
Bill was dropped
2019 – bill being proposed again, may

have some changes.

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Bad bank
the concept of a “bad bank” was applied in previous
banking crises in Sweden, France, and Germany.
based on the principles of an asset restructuring company

(ARC), which buys bad loans from the commercial banks
at a discount.
tries to recover the money from the defaulter by
providing a systematic solution over a period of time

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Bad bank
Since a bad bank specialises in loan recovery, it

is expected to perform better than commercial
banks, whose expertise lies in lending.
Government may create this bank and

guarantee the loans it buys.

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Advantages
Solves twin balance sheet syndrome as bad loans move
into a single entity
Can develop capacity and unique methods
Can invite investment as government guarantee

reduces risks
Can maintain professional management and build
expertise

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Issues
It is costly – new organization, IT

structure, employees etc
Taxpayers have to bear burden of bad
loans
Creates moral hazard – banks feel they
can just sell the bad loans

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In India
Public sector Asset Rehabilitation Agency (PARA)

proposed by economic survey 2016-17
ARCs so far have not been allowed to raise capital

from the market to prevent contagion effect
But PARA would need around 30,000 cr + and has

to tap into the market

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Another solution,
To reduce Viral acharya – recommended 2 bodies instead of one.

risk
associated
with bad Private asset management company – for those assets
bank that have value in the short run, can easily be recovered
ex: telecom, textile sector
National Asset management company – for the long term
projects – cannot expect short term recovery ex: Power
sector, infrastructure

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Has the bad bank been setup?

• The government has set up the
India Debt Resolution Company Ltd (IDRCL),
an asset management company (AMC)
that will work in tandem with the
National Asset Reconstruction Company Ltd (NARCL)
to clean up bad loans

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In all these solutions,
Problem IBC – compromises some debtors and

of shareholders
equity
Bad bank – needs taxpayer money
Bail in – needs Depositor’s money

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In Economy,
Rich give loans to govt, earn interest. Govt

has to collect taxes to pay this interest
Tax collection – around 50% from indirect

taxes which everyone pays.
So redistribution of wealth happening

from poor to rich

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Project Sashakt
Proposed 1> Bad loans of up to ₹ 50 crore will be managed at the

bank level, with a deadline of 90 days
by Sunil
Mehta
2> 50-500 crore, banks will enter an inter-creditor
panel agreement, authorizing the lead bank to implement a
resolution plan in 180 days, or refer the asset to NCLT
3> For loans above ₹ 500 crore, the panel recommended
an independent AMC, supported by institutional funding
through the AIF.

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AMC – asset management company
An asset management company (AMC) is a company

that invests its clients' pooled funds into securities.
Asset management companies provide investors with

more diversification and investing options such as
mutual funds, hedge funds and pension plans, and
these companies earn income by charging service
fees or commissions to their clients.

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What are AIFs?
SEBI AIFs refer to any privately pooled investment fund, (whether from Indian
or foreign sources), in the form of a trust or a company or a body
definition corporate or a Limited Liability Partnership (LLP).
AIF does not include funds covered under the SEBI (Mutual Funds)
Regulations, 1996, SEBI (Collective Investment Schemes) Regulations,
1999 or any other regulations of the Board to regulate fund
management activities.
Hence, in India, AIFs are private funds which are otherwise not coming
under the jurisdiction of any regulatory agency in India.

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Basel requirements

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Basel is a place in Switzerland
1974 – Herstatt, a German bank failed
G10 countries + Spain and Luxemburg

wanted to prevent such incidents

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Some regulations must be developed
Basel committee for banking supervision

formed (BCBS)
Banks do a lot of innovations every year
– so rules need to change too
So, we have 3 sets of Basel norms

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For all multinational banks in the world
Basel 1 -- 1988
Basel 2 -- 2004
Basel 3 -- 2008
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In India,
They are automatically applicable on

multinational banks
Domestic banks were not following for a
while,
But later implemented. Currently under
basel 2, going to implement basel 3

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Basel norms focus on
1> Minimum capital requirement
2> supervisory review (supervision to

meet norms)
3> Market discipline (disclosure norms)

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Minimum capital requirement
Measured by capital adequacy ratio
Must be at least 8%
But RBI says 9% for India

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Capital adequacy ratio
Measure of bank’s financial strength to ensure

that banks have enough cushions to absorb losses
before becoming insolvent and losing depositors’
funds.
CAR is required to be 9% by RBI (based on BASEL

III norms), where 7% has to be met by Tier 1
capital while the remaining 2% by Tier 2 capital.

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Tiers of capital of a bank
Tier 1 capital consists of shareholders'

equity and retained earnings. (permanent)
Tier 2 capital includes revaluation reserves,

hybrid capital instruments and subordinated
term debt, general loan-loss reserves, and
Undisclosed reserves.(Temporary)

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Risk weighted assets
Assets of a bank -- loans
Given weight according to their risk

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Capital adequacy ratio (CAR)
(Tier I + Tier II
Capital)/ X 100
Risk Weighted
Assets

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Capital conservation buffer
The capital conservation buffer is

a capital buffer of 2.5% of a bank's
total exposures that needs to be
met with an additional amount of
Common Equity Tier 1 capital.

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Domestic systematically important banks (D-

SIBS)
Very big banks need to be more cautious
If they fail, economy fails
So need to take extra measures

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Basel 3 says (for D-sibs)
4 factors 1> Size(40%)

based
on 2> Interconnectedness
which
we 3> Complexity in operations
choose
D-sibs 4> substitutability(20% each)
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RBI
If 2% GDP, then sufficient size
RBI declared  SBI, ICICI, HDFC
Too big to fail banks

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50 years of bank nationalization

'Banking Companies (Acquisition and Transfer of
1969 Undertakings) Ordinance, 1969'
nationalized 14 banks with deposits of over Rs 50 crores.
brought more than 75% banking sector under state control

along with its assets, liabilities, entire paid-up-capital.
Negotiated compensation to be paid in the form of G-secs

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But banks went to court
No clear principles in determining compensation
SC struck down nationalization act as it violated

right to property under art 31(2)
Parliament enacted it again with specific

provisions of compensation of each of the banks

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Also,
25th
Amendment
To enable socialistic legislation
act was
passed
Right to property not a fundamental
right.
compensation will be decided by
parliament.

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Why nationalization of banks?

1>Private Banks were unreliable – in the previous
decade 40 banks a year failed on an average
2> To achieve the larger goals of socialism
3> To ensure flow of credit to critical sectors
4> To ensure funds for planned development of the

economy

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Impact
1> Rural branches increased 4 fold in a decade
2> PSL ensured credit to critical sectors
3> Increased loans to government under SLR
4> Large employment generation due to rapid branch

expansion

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Issues
1> Profits reduced
2> Poor efficiency due to bureaucratic attitude
3> CAG audits, PoCA, CVC etc made their functioning

risk averse
4> recently, RTI and other extra obligations have
increased burden

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In hindsight,
It had an overall positive impact on the

economy
Building on it’s success, various banking
reforms implemented in 90s
Now merger of banks also a structural
measure in the right direction

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Banking reforms
Narasimhan 1> Establishment of 4 tier hierarchy for banking
1 (1991) structure with 3 to 4 large banks (including SBI) at the
top and at bottom rural banks engaged in agricultural
activities.
2>A phased reduction in statutory liquidity ratio.
3>Phased achievement of 8% capital adequacy ratio.

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Banking reforms
Narasimhan 4> Abolition of branch licensing policy.
1 (1991)
5> Proper classification of assets and full disclosure

of accounts of banks and financial institutions.
6> Deregulation of Interest rates.

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Banking reforms
Narasimhan 1. Need for a stronger banking system for which
2 (1998) mergers of the PSBs and the financial institutions
Close weak ones, merge strong with strong
(Recent mergers between weak and strong banks

also)

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Banking reforms
Narasimhan 2. A 3-tier banking structure was suggested after
2 (1998) mergers:
(a) Tier-1 to have 2 to 3 banks of international
orientation;
(b) Tier-2 to have 8 to 10 banks of national orientation;
and
(c) Tier-3 to have large number of local banks.

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Banking reforms
Narasimhan Higher norms of Capital-to-Risk— Weighted Adequacy
2 (1998) Ratio (CRAR) suggested—increased to 10 per cent.
Budgetary recapitalisation of the PSBs is not viable and

should be abandoned.
Legal framework of loan recovery should be strengthened

(the government passed the SARFAESI (Act, 2002).

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Banking reforms
Narasimhan Net NPAs for all banks suggested to be cut down to
2 (1998) below 5 per cent by 2000 and 3 per cent by 2002.
Rationalisation of branches and staffs of the PSBs
suggested.
Licencing to new private banks (domestic as well as
foreign) was suggested to continue with.
Banks’ boards should be depoliticised under RBI
supervision.

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Nachiket mor committee (2014) – setup by

RBI
On 1> universal bank account to all Indians
financial (Jan dhan)
inclusion
2> Use Adhaar as a tool for financial
inclusion (JAM trinity)
3> Create differentiated banks (being
done)

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Nachiket mor committee (2014) – setup by

RBI
4> 50% PSL with regional differences –
not done
5> Stop loan waivers, interest
subvention – not done

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Banking reforms
Nationalization
Narasimhan 1 and 2
PJ nayak
Merger of banks
NPA crisis and measures being taken
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Banking reforms
Nachiket mor – financial inclusion
Basel norms

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Prompt corrective action
set of guidelines for banks that are weak

in terms of identified indicators including
– poor asset quality, insufficient capital
and insufficient profit or losses.
It is an early intervention package or
resolution guideline

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Banks under PCA
Jan 2018 – there were 12 banks under PCA
Govt recapitalized and took several measures
By March 2018 only 6 banks
2019 Aug – 5 banks under PCA

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Leverage?
Leverage ratio -- ratio of tier 1 capital to

total assets
Was suggested in basel 3
Now RBI using in PCA

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Financing of infrastructure
Take out financing
NIIF, FDI , Invits
VGF, VCF, asset monetization

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National Infrastructure Investment Fund

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Invit – infrastructure investment trusts

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NBFCs
A Non-Banking Financial Company (NBFC) is a

company registered under the Companies Act,
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

361
Who can be an NBFC?
50:50 Financial activity as principal business is

when a company’s financial assets constitute
test more than 50 per cent of the total assets
and income from financial assets constitute

more than 50 per cent of the gross income.

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Regulation of NBFCs
Multiple regulators
Based on their operation

363

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2/15/2023
Systematically important NBFCs
NBFCs whose asset size is of ₹ 500 cr or more

as per last audited balance sheet are
considered as systemically important NBFCs.
The rationale for such classification is that the

activities of such NBFCs will have a bearing on
the financial stability of the overall economy.

365
Are they same as banks?

Majorly NBFCs cannot accept demand deposits
yes, but
some NBFCs are not a part of the payment and settlement system
exceptions
NBFCs cannot issue cheques drawn on itself
NBFC depositors do not have deposit insurance facility of the

Deposit Insurance and Credit Guarantee Corporation, unlike banks

366
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367
Banking in India
Bank of Hindustan – 1st bank -- 1770
General bank of India – 2nd bank- 1786
Oudh commercial bank – 1881 – 1st commercial bank
1st bank that was started by Indians and still in

operation – PNB - 1894

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2/15/2023
Banking in India
1st foreign bank still operating in India –

Chartered bank(1858), now standard chartered
Recently – on the tap licenses allowed
Bandhan microfinance and IDFC bank were

given license in 2015

369
RBIs Internal working group suggestions
Nov 1> large corporates should be allowed as promoters of

banks – cap on promoters stake can be increased from
2020 current 15% to 26%
Revise 2> Initital paid up capital required to setup a bank to be
licensing increased to 1000 cr for full fledged banks
norms
3> Big NBFCs (50kcr+ assets, 10+ years of operation) to be
for considered for conversion to banks
banks
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2/15/2023
Positives 1> Bring more capital to banking sector,

of reduce pressure on govt
corporates
as bank 2> better competition in the banking
promoters
sector
3> More choices available for people –
to deposit, take loans

371

Negatives Connected banking – Corporates as promoters
of of banks give loans to their own companies
corporates
as bank Circular banking – Quid pro quo to bypass
promoters regulations and go for connected banking
Destabilization of banking sector is possible –

due to increased risk transfer

372
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2/15/2023
Inflation

373
Meaning
Increase in the general price level of an

economy is called inflation
If general price levels fall over a period
of time it is called deflation
Disinflation is the reduction of rate of
inflation

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2/15/2023

375
Causes of Inflation
Demand pull – Either the demand increases over

the same level of supply, or the supply decreases
with the same level of demand and thus the
demand-pull inflation arises.
Cost push -- The price rise which is the result of

increase in the production cost is cost-push
inflation.

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2/15/2023

377
Demand Rise in population.

Pull
Factors Black money.
Rise in income.
Excessive government expenditure.
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2/15/2023
Examples
Infrastructure bottlenecks which lead rise in production and
Cost distribution costs.
Push Rise in Minimum Support Price (MSP).
Factors Rise in international prices.
Hoarding and black marketing.
Rise in indirect taxes.

379
Terms related to inflation

Reflation is when inflation returns after a spell of
deflation and recession
Stagflation is inflation along with rising unemployment

due to recession
Skewflation --phenomenon in which there is a price rise

of one or a small group of commodities over a sustained
period of time

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2/15/2023

381
Types of inflation
Low/creeping – gradual, predictable, small level of inflation
Galloping/runaway –double to triple digit inflation ex: latin

American countries in 80s
Hyperinflation – extremely high inflation

Ex: Bolivia 1985 24000% inflation, Germany after 1st world war,
etc

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2/15/2023
Types of inflation
Bottleneck inflation – supply falls drastically due

to natural disasters, wars, etc
Core inflation – Shows price rise in all goods and

services excluding energy and food articles.
Headline inflation – Shows price rise in all goods

and services including energy and food articles

383
Types of inflation
Structural inflation – A type of persistent inflation

caused by deficiencies in certain conditions in the
economy such as backward agricultural sector,
inefficient distribution and storage etc
Imported Inflation – Exchange rate depreciation

leads to increased cost of imports and hence the
goods in domestic market

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2/15/2023
Types of inflation
Open inflation – The inflation that results when

government does not suppress it with subsidies
and monetary policy is called open inflation
Suppressed inflation – Inflation is managed

through monetary and fiscal policy actions, but
not resolved. It may re-emerge if policies change.
Hence it is called suppressed inflation.

385
Measurement of inflation
Rate of Inflation is measured using price indices.

A price index is a weighted average of prices of
number of goods and services.
In the index the total weight is taken as 100 at a

particular year of the past (the base year), and is
compared to the current year -- shows a rise or
fall in the prices of current year

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2/15/2023
Measures to check inflation
Importing goods which are in short supply
Cutting down taxes on production to bring down prices
Tighter monetary and fiscal policy to reduce the

liquidity in the economy
Ban on exports of some items – ex: Onion

387
Philips curve
It is a graphic curve which shows

relationship between inflation and
unemployment in an economy.
It shows an inverse relationship
between the two.

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2/15/2023

389
Effects of inflation
redistributes wealth from creditors to

debtors
indicates rising aggregate demand and indicates

comparatively lower supply and higher purchasing
capacity among the consumers.
Investment in the economy is boosted by the inflation (in
the short-run) because of two reasons:

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2/15/2023
Increases
investment
1>Higher inflation indicates higher
because demand and suggests entrepreneurs
to expand their production level, and
2> Higher the inflation, lower the cost
of loan

391
Incomes of salaried employees reduce

in real terms.
Incomes of firms may increase

nominally, but in real terms, they
remain same.

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Savings are likely to increase in the short

run, as cash value erodes and money in
the bank atleast gets some interest.
But in the long run savings rate reduces

if inflation remains high, as savings may
result in negative real interest rates

393
Consumption falls as goods and services

get costlier
Direct taxes increase as they are
imposed on the value, which is inflated
Currency depreciates with inflation in
case of flexible exchange rate.

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2/15/2023
exportable items of an economy gain competitive prices

in the world market. Due to this, the volume of export
increases
Inflation will lead to lower imports as foreign goods
become costlier

395
Prelims 2021 qn
• With reference to Indian economy, demand-pull inflation can be
caused/increased by which of the following?
1.Expansionary policies
2.Fiscal stimulus
3.Inflation-indexing wages
4.Higher purchasing power
5.Rising interest rates
• Select the correct answer using the code given below.
• (a) 1, 2 and 4 only
• (b) 3, 4 and 5 only
• (c) 1, 2, 3 and 5 only
• (d) 1, 2, 3, 4 and 5

396
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2/15/2023
Prelims 2021 qn
• With reference to Indian economy, demand-pull inflation can be
caused/increased by which of the following?
1.Expansionary policies
2.Fiscal stimulus
3.Inflation-indexing wages
4.Higher purchasing power
5.Rising interest rates
• Select the correct answer using the code given below.
• (a) 1, 2 and 4 only
• (b) 3, 4 and 5 only
• (c) 1, 2, 3 and 5 only
• (d) 1, 2, 3, 4 and 5

397
Measurement of inflation
Base effect -- It refers to the impact of the rise in

price level (i.e., last year’s inflation) in the
previous year over the corresponding rise in price
levels in the current year (i.e., current inflation).
GDP deflator -- This is the ratio between GDP at

Current Prices and GDP at Constant Prices

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Base effect in action

399

400
87
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401
Inflation Indices
Wholesale Price Index (WPI) It is the most widely used inflation
WPI indicator in India.
Published by the Office of Economic Adviser, Ministry of
Commerce and Industry.
All transactions at the first point of bulk sale in the domestic
market are included.
Major criticism for this index is that the general public does not buy
products at wholesale price.
The base year of All-India WPI has been revised from 2004-05 to
2011-12 in 2017.

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2/15/2023
Inflation Indices
Wholesale Price Index -- WPI continues to constitute three major

WPI groups—Primary Articles, Fuel and Power, and Manufactured
Products. The number of items is 697
New series was adopted for WPI based on Saumitra Chaudhury
working group (setup in 2012) Some major changes done
items have been increased from 676 to 697
Item level aggregates for new WPI have been compiled using
Geometric Mean (GM) following international best practice

403

404
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2/15/2023
Inflation Indices
It measures price changes from the perspective of a

CPI retail buyer.
It measures changes over time in the level of retail prices

of selected goods and services on which consumers of a
defined group spend their incomes.

405

406
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2/15/2023
Consumer Price Index
CPI Depending upon the socio-

economic differentiations among
consumers, India has three
differing sets of CPI with some
differentials in the basket of
commodities

407
Inflation Indices
(CPI) 1> CPI for Industrial Workers (IW)

released
at
national 2>CPI for Agricultural Labourers/Rural
level Labourers (AL/RL)
are: 3> CPI (Rural/Urban-Combined)

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2/15/2023
Inflation Indices
The first two are compiled by the Labour

Bureau in the Ministry of Labour and
Employment.
third is compiled by the Central Statistical

Organisation (CSO) in the Ministry of
Statistics and Programme Implementation

409

410
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411

412
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2/15/2023
WPI, tracks inflation at the producer level and CPI captures changes
CPI in prices levels at the consumer level.
vs. differ in which weightages assigned to food, fuel and manufactured

items.(food in CPI is far higher (46%) than in WPI (24%).)
WPI WPI does not capture changes in the prices of services, which CPI
does.
In April 2014, the RBI had adopted the CPI as its key measure of
inflation. (before this, WPI)

413
Issues with WPI
1> Not according to global standards – most

countries use PPI or CPI
2> Rates captured from mandis, wholesalers

does not necessarily reflect how much people
actually pay for household consumption

414
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Issues with CPI
Started in 2011, doesn’t have sufficient

data for analysis
Consumer prices affected by subsidies,
taxes, distribution costs

415
Producer price index (PPI)

Abhijit The PPI measures price changes from the perspective of the producer
sen(2003) while the consumer price index (CPI)
committee measures it from the consumers’ perspective
had
taxes, trade margins and transport costs are excluded
recommended
B.N. Goldar committee (2014)setup to advise on methodology for PPI, has
given it’s report
Another committee setup under Ramesh chand for the same (June 2019)
– revise WPI and suggest PPI methodology

416
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2/15/2023
Producer price index (PPI)

1> Easier for international comparison
2> Includes services, whereas WPI doesn’t
3> Removes multiple counting bias inherent in WPI
4> Comparison between CPI and PPI shows where

actual inflation is happening

417
Inflationary gap
The excess of total government spending above

the national income (i.e., fiscal deficit) is known
as inflationary gap.
Brings some extra money into the economy
Creates inflationary pressure

418
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2/15/2023
Deflationary gap
The shortfall in total spending of the

government(i.e., fiscal surplus) over the
national income
Reduces overall money supply
Creates deflationary pressure

419
What is healthy level of inflation?
Multiple committees – between 4 to 6%

(Chakravarthy, Tarapore etc)
Current inflation targeting is also at 2 to
6%
But why?

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2/15/2023
Some inflation good for the economy

1> Producers feel there is demand – produce more
Why?
2> Consumers feel prices rise steadily and predictably,
don’t put off buying decisions
3> Investment is forthcoming as there is indication of
healthy demand in the economy
4> Borrowers benefit and this creates more borrowing
– more consumption and investment

421
Control of inflation through interest rates
Deposit
interest
rates
Loan
interest
rates

422
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2/15/2023

423

424
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2/15/2023
Prelims 2021 qn
• Which of the following is likely to be the most inflationary in its
effects?
• (a) Repayment of public debt
• (b) Borrowing from the public to finance a budget deficit
• (c) Borrowing from the banks to finance a budget deficit
• (d) Creation of new money to finance a budget deficit

425
Liquidity trap
Liquidity trap is a situation when expansionary monetary

policy (increase in money supply) does not increase the
loan off-take(number of loans taken), investment and
hence does not stimulate demand and economic growth.
When does it occur: A liquidity trap usually happens

around a severe recession. Families and businesses are
afraid to spend, no matter how much credit is available.

426
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Double financial repression(Economic survey)
Savings getting lower returns is called as financial

repression
On asset side – SLR + PSL restrict banks, so they

give less interest rates to depositors
On liabilities side – High inflation reduces the real

interest rates that people get for their savings

427
Index of Industrial production
IIP
Index of Industrial Production (IIP) measures the quantum
of changes in the industrial production in an economy and
captures the general level of industrial activity in the
country.
The base year is always given a value of 100. The current

base year for the IIP series in India is 2011-12.
So, if the current IIP reads as 116 it means that there has
been 16% growth compared to the base year.

428
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Index of Industrial production

IIP is a short term indicator of industrial growth till the results from
IIP Annual Survey of Industries and National Accounts Statistics are
available
compiled and published every month by Central Statistics Office (CSO)

of the Ministry of Statistics and Programme
Implementation with a time lag of six weeks from the reference month.

429

430
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431
National Statistical Office (NSO)
CSO – central statistical office and NSSO – National

May sample survey organization merged to form NSO
2019 Will be headed by MOSPI secretary

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Base year
A base year is the first of a series of years in an economic
or financial index. It is typically set to an arbitrary level of
100.
Change in base year means, the new base year is taken as
100
How is it chosen?

433
Base year
How 1> Should be recent(usage of goods change with time)
do we 2> shouldn’t be a recession or a boom year

choose
3> normal monsoon
4> Normal year without major reforms affecting

indicators

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Challenges with rebasing
1> Continuity – last time rebasing did

not release back series, making trend
analysis difficult
2> Metrics were revised recently –
frequent revisions can create
confusion

435
Problem with 2017-18 as base year
1> Impact of demonetization

and GST present in the year
2> data for this year hasn’t

even been finalized yet
436
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Purchasing managers index

Purchasing Managers’ Index (PMI) is an indicator of
business activity — both in the manufacturing and
services sectors.
It is a survey-based measure that asks the respondents
about changes in their perception of some key business
variables from the month before.
It is calculated separately for the manufacturing and
services sectors and then a composite index is
constructed.

437
Purchasing managers index

A figure above 50 denotes expansion in business activity.
PMI Anything below 50 denotes contraction.
Higher the difference from this mid-point greater the

expansion or contraction.
If the figure is higher than the previous month’s then the

economy is expanding at a faster rate. If it is lower than
the previous month then it is growing at a lower rate.

438
106

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2/15/2023

Non Performing Assets

Definition (NPA) is a loan for which the principal or interest payment

Agriculture / Farm Loans; the NPA is defined as under:

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Some terms about loans

secured loan: borrower pledges some asset (e.g. a car or property) as

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o 1-3 years: 40% of outstanding amount in case of Secured loans; 100% of

o more than 3 years: 100% of outstanding amount in case of Secured

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• An NPA can declared loss only if it has been identified to be

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Gross and net NPAs

Gross NPA is just the sum

A loan becomes a Non-Performing Asset (NPA) when the interest or

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1> Due diligence not done by the bank – ex: Loan

2> Poor monitoring by the bank post

3> Diversion of funds by companies for purposes

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6> Export decline due to low global demand (double dip

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7> Policy paralysis, especially seen in UPA2

8> Crony capitalism – Banks are forced by

9> Poor bankruptcy provisions – exit

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1>Provisioning norms – reduce profits

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4> Twin balance sheet syndrome hurts

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• 1) Which of the following statements is/are correct regarding Monetary

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• 1) Which of the following statements is/are correct regarding Monetary Transmission?

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Monetary transmission issues

Banks 1> Rising NPAs impact profits, so banks

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Benchmark prime lending rate(BPLR )

up Benchmark Prime Lending Rate (BPLR) was the

to customers who are most credit worthy. Banks can

2010 Under BPLR, banks could lend even below BPLR.

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2016 2) Operating expenses,

3) Minimum rate of return (profit or margin), and

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Marginal cost of funds based lending rate

Ex: Housing = MCLR +1%;

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3> Operating cost: rents, salaries etc

4> Tenor premium: Higher interest can be charged for

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Better monetary transmission

Lower interest rates for borrowers

Less discretion for banks in deciding

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External benchmark lending rate (EBLR)

All the three – BPLR, base rate, MCLR can be

There is still a chance the banks will not cut