BANKING

BANKING
A Financial Intermediary (FI) is an entity that acts as the middleman
between two parties in a financial transaction- between lenders vs.
borrowers, investors vs. entrepreneurs, households vs business firms.

Such FI can be subdivided into (1) Formal (2) Informal.

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Evolution of Banking in India

Under the British, the East India Co. established three presidency banks
viz. Bengal, Bombay and Madras. In 1921, these 3 were merged to form
Imperial Bank of India. After Independence, Nationalization of Imperial
bank was done to give birth to SBI in 1955.

The above banks were basically government banks. However, there

existed Indian banks as well. Eg: Allahabad Bank, PNB, BoB, Canara Bank.
The focus of Indian banks was mostly Foreign trade, hence located near
coastal trading centers.
Banking in Post Independent India
Many banks did start post-Independence. Their focus, however, was to a
great extent to cater Merchant & industrial houses. A nexus between
banks and industrial houses existed, whereby overdraft facilities were
provided for speculative investments as well and helped the industrial
houses make windfall gains. Reckless lending to directors was prevalent
and people from companies were very much a part of Board of Directors.
• These banks did expand with the opening of branches elsewhere but
only to meet the financial needs of industrial markets
• The rural areas were neglected by these banks which rendered
banking to be no tool for Financial inclusion. This also meant that the
goals of five year plans could not be achieved.
In order to correct these discrepancies, the Government began
nationalizing the banks

The advent of RBI

RESERVE BANK OF INDIA (RBI)
1913 Commercial banks were required to register under the
Companies Act, but monitoring was lax. No CRR, SLR,
BASEL Norms.
1926 Royal Commission on Indian Currency (Hilton Young
Commission Commission) recommends setting up a central
bank named 'Reserve Bank of India'.
1929 The stock market bubble finally burst(military industrial
complex), as investors began dumping shares en masse.
Banks collapsed all over the world economies. This day is

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infamously known as “Black Thursday.” Great Depression

in USA leads to collapse of 450+ banks in India. So British
Government becomes serious about setting up RBI.
1934 Reserve Bank of India Act was enacted.
1935 RBI becomes operational from 1st April, with 1st Governor
Sir Osborne Smith. Government ownership was ~4.4%
only.
1935 Commercial Banks fulfilling certain conditions were listed
in the 2nd Schedule of RBI Act, & such “Scheduled Banks”
were required to keep CRR with RBI.
1943-49 C. D. Deshmukh becomes the first INDIAN Governor of RBI.
He had also participated in the Bretton Woods Conference,
USA (1944).
1948-49 All private investors’ shares transferred to GoI under the
RBI transfer of ownership act 1948. Therefore, RBI
governor answerable to Parliament, has to pay dividend to
Government from its profits.
1949 Banking Regulation Act empowered the RBI to
• Give license to companies to open banks, give
permission banks to open new branches.
• Prescribe auditing and liquidity norms for Banks such as
SLR.
• Protect interest of depositors. Force elimination /
merger of weak banks.

Functions of RBI
1. Printing of all currency notes except coins and 1 rupee notes
2. Circulation of all coins and currency
3. Controller of Money Supply: Issues M0 under RBI Act, Makes
Monetary Policy.
4. Control of foreign exchange (FEMA)
5. Banker of the Govt and does public debt management
6. Banker’s Bank : Lender of Last resort, Advises in monetary matters.
7. Regulator of all “BANKS”: through BR Act’49, Payment Systems’07
8. Regulator of AIFIs and NBFC-D and others
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9. Promotional activitiesà consumer protection, Financial literacy and

financial inclusion
10. Data base management and international co-operation
11. The RBI plays an important part in the development strategy of the
Government of India.
12. Data Publication & International Coop. @BASEL, IMF, G20’s Financial
Stability Board etc.

Structure of RBI
RBI Central Board Composition
(Non-Official Directors) (Official Directors)
• 2 Government officials • RBI Governor
• 10 directors nominated by Government • 4 Dy. Governors
• 4 directors from RBI’s local boards @West,
East, North, South

RBI Governor & Dy Governor

25th Governor: Shaktikanta Das (Retd. IAS, Former finance secretary, G20
Sherpa, Member of 15th Finance Commission). He replaced Urjit Patel
(2018-Dec).

RBI Act (Section 8) provides for “NOT MORE than 4” Dy. Governors viz.
1. B.P. Kanungo: from RBI officer cadre.
2. N. S. Vishwanathan: from RBI officer cadre.
3. Mahesh Kumar Jain: Outsider
4.Michael Patra: Outsider

• Their tenure usually 3 years.

• Re-appointment Possible.
• They’re selected by Financial sector regulatory appointment search
committee (FSRASC) headed by the Cabinet Secretary (IAS) →
successful candidates’ names sent to Appointments Committee of the
Cabinet headed by the Prime Minister for final approval.

RBI Offices & Departments

• RBI 4 regions: Northern: Delhi, Eastern: Kolkata, Southern:
Chennai, Western: Mumbai

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• RBI has various departments looking after Banks, NBFCs, Payment

Systems, Foreign Exchange Management etc.
• Previously individual departments directly acted against violators.
WEF 1/4/2017: A New Enforcement Dept was setup in RBI for
centralized action against violators.
• This is different from FinMin’s Enforcement Directorate that looks
after Foreign Exchange Management Act, 1999 (FEMA) and
Prevention of Money Laundering Act, 2002 (PMLA)

Working

• The Governor has to call a Board meeting at least six times in a

year, and at least once each quarter.
• A meeting can be called if a minimum of four Directors ask the
Governor to call a meeting.
• The Governor or, if for any reason unable to attend, the Deputy
Governor authorised by the him to vote for him, presides the Board
meetings. In the event of split votes, the Governor has a second, or
deciding vote

Assets and Liabilities of RBI

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Liabilities
1. Capital
2. Reserve Fund
3. Other Reserves
a. National Industrial credit
Fund
b. National Housing credit
Fund
4. Deposits
a. Central and State Govts
b. Banks (all)
c. Indian and Intl. Financial
Institutions
5. Other Liabilities and Provisions
a. Contingency Fund (CF)
b. Asset Development Fund
(ADF)
c. Currency and Gold
Revaluation Account (CGRA)
d. Investment Revaluation
Account (IRA)
e. Miscellaneous Funds and
bills
f. Surplus Transferable to GoI
6. Notes Issued (Issue Dept)
a. Notes held in Banking Dept
b. Notes in Circulation
Assets
1. Notes, Rupee Coin (with RBI)
2. Gold coins, Bullion
3. Foreign Investments
4. Domestic Investments
5. Loans and Advances
a. Central and State Govts
b. Banks (all)
c. Indian and Intl. Financial
Institutions
6. Investments in Subsidiaries
a. DICGC
b. AIFIs
c. Bharatiya Reserve Bank
Note Mudran Pvt Ltd
d. Reserve Bank IT (P) Ltd
7. Other Assets
8. BoE and CPs

Income Expenditure
1. Interest 1. Printing of Notes
a. Domestic LAF, Securities, MSF, Loans 2. Agency charges
and Advances 3. Employee cost
b. Foreign Securities, Repo-Reverse 4. Interest
Repo, Deposits 5. Postage and telecom
2. Other Income charges
a. Sale of Securities 6. Rent, taxes etc
b. Exchange
c. Commissions
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d. Rents …. etc

From the balance above, every year contribution is made to various

Funds (Liabilities) and also surplus is transferred to GoI (a Liability)

RBI's Autonomy
Desirable: ‘monetary-fiscal coordination’

Functional autonomy and goal independence

Even at the time when the idea of central bank independence began to
germinate some two decades ago, this was understood to mean a
‘functional’ independence. That is, the bank would be unconstrained by
the government in its functioning, which includes both the instruments it
uses and how it uses them.

However, its autonomy was not to extend to ‘goal’ independence. What

the goals of the central bank should be were to be chosen by the
government without reference to the bank.

The main issue here was whether the bank should focus on inflation
alone or also on the level of employment. Within a decade, it had been
conceded that the focus would be exclusively on the former, and In 2015
the RBI was by law, in line with a “modern monetary policy”, expected to
target inflation.

Fed reserve: maximizing employment and stable prices

Issues of contention
• Corrective action to be taken for stressed banks
• Prudential norms to be adopted by financial institutions
• Easing of liquidity
• Sharing of the surplus generated by the RBI.

Of sharing surplus
Government of India legally is the owner of the surplus generated by the
country’s public institutions. Even under this architecture, though, all
care must be taken to ensure that the central bank’s reserves are of a
level commensurate with the extent of the financial sector and the
potential degree of systemic risk from its malfunctioning, which can vary.
So, we can’t go just by formulae here.
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On PCA
GoI plays vital role in selections of Governor and his deputies, it also has
representatives in the board. It would therefore only be prudent to leave
to this body to decide on the precise corrective action for banks with high
NPAs, the desirable state of liquidity and the prudential norms to be
observed by banks. The RBI is the banking regulator after all, and for the
government to attempt to direct it would constitute micro-management.

Stability of the economy

While acting as the lender of last resort can be stabilising, under no
circumstances would it be advisable to lower prudential norms in the
presence of stressed banks. The government’s concern for the health of
the medium and small enterprises is well-founded, after demonetisation.
The right course would be interest subvention, rather than tweaking
lending norms as proposed under online sanction within an hour.

The Central bank's independence and targeting of inflation has brought

no good either. Over 2013-2018 there has been a 5 percentage point

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swing in the real interest rate in India, moving from a negative to a

positive level, making it among the highest in the world, much higher
than that of China. It may well have contributed to slow industrial and
export growth, due to a real appreciation of the rupee, and a rise in NPAs
even after their existence had been recognised.

Enabling job creation

While it would be bad economics to tolerate high inflation, the absence of
inflation by itself only benefits those in employment, it does not assure
jobs to the unemployed. Thus a monetary policy that ignores the impact
of its actions on unemployment is not credible.

In conclusion
The populist message that inflation erodes the income of the poor
conceals the possibility that in the implementation such a policy could
hold back job creation by restricting investment.

The rising current account deficit, the slow growth of employment and
the disappointing performance of manufacturing, the sector most closely
affected by high interest rates, should prompt us to review how monetary
policy is conducted in India.

In the past, the RBI had a ‘multiple indicators approach’ which paid
attention to inflation, growth and the current account. This may not have
borne the precision conveyed by ‘inflation targeting’ but it did answer to
Keynes’s dictum, “It is better to be vaguely right than to be precisely
wrong.”

Using the reserves

Aim of keeping reserves
CGRA
• To cover a situation where the rupee appreciates against one or
more of the currencies in the basket
• If there is a decline in the rupee value of gold.
• The level of CGRA now covers about a quarter of the total currency
reserves of the RBI.

Contingency reserve
• To cover depreciation in the value of the RBI’s holdings of
government bonds-- domestic and foreign-- if yields rise and their
prices fall.

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• To cover expenses from extraordinary events such as

demonetisation
• Money market operations
• Currency printing expenses in a year of insufficient income.
• It guarantees the central bank’s role as the lender of the last resort.
• cover for the deposit insurance fund given that the Deposit
Insurance and the Credit Guarantee Corporation (DICGC) is a wholly-
owned subsidiary of the RBI.

The RBI’s position, therefore, is that it would be imprudent to consider

sharing any part of the reserve with the Centre. The Centre’s view is that
the technocrats in RBI are too conservative and the money belongs to it.

International Norms vis a vis RBI

• The Bank of Japan transfers its surplus at 5%, Greece at 8%, and
Turkey at 12%
• In the US, federal reserve is required by law to transfer net earnings
to the US Treasury, and maintaining a limited balance in a surplus
fund
• Though the RBI has a target of 12% (ratio of CF and ADF to total
assets), it has not been able to maintain this and currently the ratio
is about 7%

Committee on Economic Framework Capital

A committee is set to go into the issue of an “economic capital
framework” (ECF), or the reserves that the RBI must hold

The committee is required to design a framework for economic capital

rather than a fixed or rigid formula for surplus transfer. This framework
should recognise that the roots of the autonomy of the central bank lie in
it having the freedom to manage its balance sheet, not only in good times
when it transfers a surplus but equally in times when it may incur losses

Economic capital framework committee of RBI

Reserve Bank of India (RBI) has approved the transfer of record Rs 1.76
lakh crore dividend and surplus reserves to the government.
• The excess reserve transfer is in line with the recommendation of
former RBI governor Bimal Jalan-led panel constituted to decide
size of capital reserves that the central bank should hold.

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Background:
• RBI had constituted a panel on economic capital framework. It was
headed by Ex-RBI governor Bimal Jalan.

What’s the issue?

The government has been insisting that the central bank hand over its
surplus reserves amid a shortfall in revenue collections. Access to the
funds will allow the government to meet deficit targets, infuse capital into
weak banks to boost lending and fund welfare programmes.

What is economic capital framework?

Economic capital framework refers to the risk capital required by the
central bank while taking into account different risks. The economic
capital framework reflects the capital that an institution requires or
needs to hold as a counter against unforeseen risks or events or losses in
the future.

Why it needs a fix?

1. The government believes that RBI is sitting on much higher reserves
than it actually needs to tide over financial emergencies that India
may face.
2. Some central banks around the world (like US and UK) keep 13% to
14% of their assets as a reserve compared to RBI’s 27% and some
(like Russia) more than that.
3. Economists in the past have argued for RBI releasing ‘extra’ capital
that can be put to productive use by the government. The Malegam
Committee estimated the excess (in 2013) at Rs 1.49 lakh crore.

What is the nature of the arrangement between the government and

RBI on the transfer of surplus or profits?
Although RBI was promoted as a private shareholders’ bank in 1935 with
a paid up capital of Rs 5 crore, the government nationalised RBI in
January 1949, making the sovereign its “owner”. What the central bank
does, therefore, is transfer the “surplus” — that is, the excess of income
over expenditure — to the government, in accordance with Section
47 (Allocation of Surplus Profits) of the Reserve Bank of India Act, 1934.

Does the RBI pay tax on these earnings or profits?

No. Its statute provides exemption from paying income-tax or any other
tax, including wealth tax.

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Why RBI needs excess reserves?

1. The RBI needs adequate capital reserves for monetary policy
operations, currency fluctuations, possible fall in value of bonds,
sterilisation costs related to open-market operations, credit risks
arising from the lender of last resort function and other risks from
unexpected increase in its expenditure.
2. The RBI has maintained the view that it needs to have a stronger
balance sheet to deal with a possible crisis and external shocks.

Bimal Jalan committee Recommendations:

The surplus from the central bank comprised two components-Rs 1.23
lakh crore of surplus for the year 2018-19 and an additional Rs 52,637
crore of excess provisions that was made available as per the revised
economic capital framework recommended by the Bimal Jalan committee.

• It suggested that the framework may be periodically reviewed after

every five years.
• It recommended to align the central bank’s accounting year with the
financial year, which could reduce the need for paying interim
dividend.
• The panel recommended clear distinction between the two
components of economic capital, realised equity and revaluation
balances. This is because of the volatile nature of the revaluation
reserves.
• Only realised equity built from profits must be distributed. The panel
recommended that the Contingency Fund be maintained within a
range of 6.5% to 5.5% of RBI’s balance sheet.
• Hence, the excess from the pre-decided 5.5% level or Rs. 52,637 Cr
has been written back, that is transferred to the Centre.
• Revaluation gains from market fluctuations on foreign currency, gold
or other assets must be retained. Revaluation balances were not
distributable.
• Hence bulk of RBI’s legacy reserves are ring-fenced from transfer
demands.
• The Bimal Jalan committee should also be complimented for clearly
specifying that the revaluation reserve cannot be used to bridge
shortfalls in other reserves.

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Every year RBI transfer the surplus to government:

• RBI is not a commercial organisation like banks and other companies

owned or controlled by the government to pay a dividend to the
owner out of the profit generated.
• What the RBI does is transfer the surplus excess of income over
expenditure to the government.
• Under Section 47 of the RBI Act, “after making provision for bad and
doubtful debts, depreciation in assets, contributions to staff and
superannuation funds and for all other matters for which provision
is to be made by or under this Act or which are usually provided for
by bankers, the balance of the profits shall be paid to the Central
government”.

What is special about the pay out this time?

• The profit that is distributed has varied, averaging over Rs 50,000
crore over the last few years.
• Now, the RBI Board accepted the recommendations of a committee
headed by former Governor Bimal Jalan on transfer of excess
capital.
• This marks the first time the RBI will be paying out such a huge
amount, a one-off transfer. Earlier, the government had budgeted for
Rs 90,000 crore from the RBI as dividend for this fiscal year.

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Section 7 of RBI Act

Section 7 (1) of The RBI Act, 1934, became a contentious issue after the
tension between the central bank and government turned into a public
spat. No government has so far invoked this section in the central bank’s
83-year history.

Reaching a Flash Point :

Amid these tensions the govt. initiated steps towards invoking its powers
under Section 7 of the RBI Act of 1934. It is a provision under which the
government can give directions to the RBI to take certain actions “in the
public interest”.

This provision has been built into the law governing not just the RBI but
also regulatory bodies in other sectors. Until now, however, the
government has never exercised its powers under Section 7 of the RBI
Act.

Section 7 of the RBI Act, 1934 :

Under Section 7, “The Central Government may from time to time give
such directions to the Bank as it may, after consultation with the
Governor of the Bank, consider necessary in the public interest.
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Subject to any such directions, the general superintendence and direction

of the affairs and business of the Bank shall be entrusted to a Central
Board of Directors which may exercise all powers and do all acts and
things which may be exercised or done by the Bank.

Section 7 has 2 parts — consultation and then issuing a direction to the

RBI for taking some action in public interest.

Way Forward
Last year, Former Governor Y V Reddy had noted that the government
has powers to give directions. But, in giving directions also, unlike other
statutes, consultation with the Governor is necessary in regard to the RBI
before issuing the directions.

Independence to the central bank is granted by the government with a

specific purpose. Experience has also shown that trust and confidence
will improve if the spending authority, viz., the government is separate
from the money creating authority, that is, central bank or monetary
authority.

RBI regulatory sandbox

The Reserve Bank of India (RBI) has issued the final framework for
regulatory sandbox in order to enable innovations in the financial
technology space.

RBI will launch the sandbox for entities that meet the criteria of minimum
net worth of ₹25 lakh as per their latest audited balance sheet.
1. The entity should either be a company incorporated and registered
in the country or banks licensed to operate in India.
2. While money transfer services, digital know-your customer, financial
inclusion and cybersecurity products are included, crypto currency,
credit registry and credit information have been left out.

What is a regulatory sandbox?

A regulatory sandbox is a safe harbour, where businesses can test
innovative products under relaxed regulatory conditions. Typically,
participating companies release new products in a controlled
environment to a limited number of customers for a limited period of
time.

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Significance and benefits of a regulatory sandbox:

1. The “regulatory sandbox” will help fintech companies launch
innovative products at a lower cost and in less time.
2. The sandbox will enable fintech companies to conduct live or virtual
testing of their new products and services.
3. These companies will also be able to test the viability of the product
without a wider and expensive rollout.
4. It will help companies to experiment with fintech solutions, where
the consequences of failure can be contained and reasons for failure
analysed.

Commercial Banks
Before Independence

1707 Bank of Hindustan, Calcutta (Europeans owned)

1806-42 Three Presidency Banks at Bengal then Bombay then
Madras.
1861 all three were given the right to issue currency.
1921 They were combined into Imperial Bank of India -- SBI
(1955)
1865 Allahabad Bank (Europeans owned)
1894 PNB: Indian owned, Lala Lajpat Rai helped in foundation.
1908 Bank of Baroda by Maharaja Sayajirao Gaekwad III
1913-30s State Bank of Mysore, State Bank of Patiala, the rise and
collapse of Banking industry, then Birth of RBI (1935)
1940s State bank of Bikaner, Jaipur, Hyderabad, Travancore by
the respective princely states / Nawabs. Post-
Independence: became ‘Associated Banks of SBI’, and
ultimately, merged in SBI (2017)

The main function of these types of banks is to give financial services to

the entrepreneurs and businesses. Regulated by the RBI under the
Banking regulation Act.
FDI allowed in Indian banks → 49% automatic | 74% approval

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PVT. SECTOR BANKS (PVB)

While the nationalization of banks was done with the lofty objectives, but
politicization in Public Sector Banks (PSBs) created new set of problems:
• Government administered loan interest rates for populism= Low
profitability for PSBs.
• Low recovery from NPA due to political interference, and legal
loopholes.
• Employees unions hampering any innovation or customer
responsiveness.
• 1991: Balance of Payment (BoP) crisis finally forced Govt. to set up a
committee for Banking Sector Reforms under The former RBI
Governor Narasimhan. He said:
o Government should ↓ its shareholding in Public Sector Banks.
o RBI should ↓ CRR and SLR, Govt should not dictate interest rates
to Banks,
o Liberalize the branch expansion policy
o Allow entry of New Private Banks and New Foreign Banks.

Three rounds of private bank licensing in India

Round-1 (1993-95) Round-2 (2001-04) Round 3 (2013-16)
1. ICICI 1. Kotak Mahindra Rajan invited
2. HDFC 2. Yes Bank applications, Bimal Jalan
3. IndusInd (Founder Rana Committee made
4. DCB Kapoor) selections:
5. UTI-> later Axis 1. Bandhan Finance (A
bank Microfinance
6. IDBI->now company based in
owned by LIC W.Bengal)
7. Global Trust 2. IDFC (An infra
Bank-> Merged finance NBFC based
with Oriental in Maharashtra).
Bank
Later on, another NBFC
#8-9-10: Bank of “Capital First” merged so
Punjab, Centurion renamed into IDFC-First
Bank, Times Bank
were merged into
HDFC

Above banks are also known as "new-generation private banks" in India.

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On-Tap License to open Private Sector Banks

A private entity can open Bank only after getting license from RBI under
Banking Regulation Act, 1949. Previously, one had to wait till RBI invited
applications. But in the On-Tap system (WEF 2016), one can apply to RBI
whenever he wishes (like a driving license), provided that:
1. It’s a Resident Indian individual, NBFC, or private company with min.
10 years of experience in Banking-Finance Sector, and Min. 500
crore capital, and total assets not more than Rs. 5000 crores.
2. Proposed Bank will be controlled by Indians & willing to open 25%
branches in unbanked rural areas.

Other Commercial Banks

In Nehruvian Socialist Economy there was disdain & apprehensions about
Foreign Banks.

Only a handful of them were allowed to open branches. But, Post-

Narasimham-Reform: foreign banks approval policy was liberalized.

Foreign Bank • They’re Incorporated abroad (i.e. registered under

in India the Companies Act of a foreign nation) & opening
branch / subsidiary in India e.g. Citibank, Bank of
America, HSBC.
• While CRR, SLR & other norms applicable, but PSL
norms vary depending on number of branches.
Indian Public • Foreigners can invest max. 20% in its shareholding.
Sector Bank E.g. BoB (15%), SBI (14%), PNB (13%)
• Although Government thinking of raising it to 49% to
help capital mobilization for BASEL-III norms.
India Private • Foreigners can invest upto 49% (automatic) and upto
Sector Bank 74% by approval of Government. Eg. HDFC (73%),
ICICI (59%) Axis Bank (52%)
• Although Government thinking of raising it to 100%
to help capital mobilization for BASEL-III norms

Bank Nationalisation and Mergers

Nationalization of Banks After Independence: Reasons
NEXUS between Banks and Industrialists: From 1950s to 1960, only 188
elite people controlled the economy by being in board of top 20 banks,
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1452 companies, and numerous insurances, finance companies. This led

to reckless lending to directors and their firms. So, Banks failed
frequently, RBI had to close unviable banks.

Private Banks unwilling to open in rural areas- this did not help in
financial inclusion of poor, farmers, MSME or achievement of FYP targets
or reducing regional imbalance.

The nationalized or public sector banks (PSBs), accounting for nearly 70

percent of total banking in the country have been doing great service to
the nation.

Watershed moment in Indian Banking History: Class to mass

banking:
India’s banking policy after 1969 followed a multi-agency
approach towards expanding the geographical spread and functional
reach of the formal banking system.
• First, four new branches had to be opened in unbanked rural areas.
As a result, the number of rural bank branches increased
• Second, the concept of priority-sector lending was introduced. All
banks had to compulsorily set aside 40% of their net bank credit for
agriculture, micro and small enterprises, housing, education and
“weaker” sections.
• Third, a differential interest rate scheme was introduced in 1974.
Here, loans were provided at a low interest rate to the weakest
among the weakest sections of the society.
• Fourth, the Lead Bank scheme was introduced in 1969. Each district
was assigned to one bank, where they acted as “pace-setters” in
providing integrated banking facilities.
• Fifth, the Regional Rural Banks (RRB) were established in 1975 to
enlarge the supply of institutional credit to the rural areas.
• Sixth, the National Bank for Agriculture and Rural Development
(NABARD) was constituted in 1982 to regulate and supervise the
functions of cooperative banks and RRBs.

Nationalization after Independence

1948 RBI Transfer of Ownership Act.
1955 Imperial Bank nationalized and became SBI.
1955-56 LIC Act took over private life insurance cos.

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1963 State Bank of Jaipur and Bikaner merged together.

1969 'Banking Companies (Acquisition and Transfer of
Undertakings) Ordinance,
1969 14 Private banks with ₹ 50 cr/> deposits were nationalized
e.g. Bank of Baroda, PNB, Dena, Canara etc.
1972-73 GIC Act- took over private Non-Life (=General) insurance cos.
Later GIC was re-organized with 4 subsidiaries: National
Insurance, New India Assurance, Oriental Insurance and
United India Insurance.
1980 6 banks with ₹ 200 cr/> deposits were nationalized e.g.
Corporation Bank, Vijaya Bank, Oriental bank of Commerce
etc.
Reforms following Committees were made for reforms in banking
sector
M Narasimham-I (1991), M Narasimham-I (1997), Dr.
Raghuram Rajan Committee (2007) and P J Nayak Committee
(2014)

GOLDEN ANNIVERSARY OF NATIONALIZATION - ES20

First round of bank nationalisation was done in 1969 so, 2019-1969=50
years Golden anniversary of the bank nationalisation

Positives
• After nationalisation, the
number of Bank branches in
India, the amount of loan given
to farmers and villagers have
increased.
Negatives
• From 1960s to 80s: The
Government had launched
1. "green revolution"
2. Focused on poverty removal
through five year plans.

• This greatly contributed to the • RBI had initiated selective credit

agriculture production and control tools & moral suasion to
poverty removal in the rural channelize more loans to farmers.
areas.
• So, those actions were
• PSBs account for 70% of the responsible for boosting
banking business in India. agriculture & reducing poverty.

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• Bank nationalization itself has not

helped in it much

Private sector banks are better than PSBs

ES20 gave tonnes of depressing data about PSBs such as
• After 2013, PSBs’ credit growth has declined → GDP growth is
affected.
• 2019: PSBs’ total loss > 66,000 crore which is even double than
India’s budget allocation for education.

PSBs =losers PVBs= winners

Total NPA in Majority of NPA here Less
Indian Banks
Total Bank >90% occur in PSBs Hardly 7%
frauds in
India
Return on For every ₹1 that the They make 9.6 paise
Equity government profit
invests as share capital in against every ₹1 share
PSBs → capital.
they lose 23 paise.
Even in other technical indicators such as Return on assets, Market-to-
book ratio, growth of new loans, Capital adequacy norms for BASEL, etc:
(new) Private sector banks (PvB)s outperform PSBs. Thus, PSBs are
clearly not efficient today.

If they become efficient = ₹11 lakh+ crore profit for the Government
Reasons why PSBs are inefficient?
PSB staff’s salary does not depend on
the profitability of the bank. Employee
unions frequently engage in strikes
They’ve apathetic attitude towards the
use of artificial intelligence, computer
Solutions by ES20
• Allow campus recruitment,
lateral entry in higher
management positions
• Make employees ‘part
owners’ through employee
stock ownership plan (ESOP)
• Use Artificial Intelligence
(AI), Machine Learning (ML),

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technology, marketing, and customer Big Data Analytics,

satisfaction. geotagging of mortgaged
assets etc.
• Setup an organization PSBN
Network to implement above
ICT-solutions

Further, Since the government is the majority shareholder in PSBs,

1. Usually the persons favored by the present-day ruling party become
the Board of directors, irrespective of merit or qualification. Thus,
political considerations have significant control/influence over
bank’s business operations.

2. PSBs are subjected to Right to Information (RTI) act, Central

Vigilance Commission (CVC), Comptroller Auditor General (CAG),
Central Bureau of Investigation (CBI), Courts and media in a more
stringent manner.

Consequently, PSB officials fear harassment under the veil of

vigilance investigations & media-trials. They prefer safety and
conservatism over risk-taking and innovation.

Consolidation: Mergers and Privatisation

Consists of two types of reforms: 1) Merger 2) Privatization

MERGERS
2008-10 State Bank of Saurashtra and State Bank of Indore merged
into SBI.
2013 BMB was setup as PSB, HQ Delhi, 100% ownership by
Union Government.
2017 BMB & 5 Associated Banks of SBI viz. State Bank of Bikaner
and Jaipur (SBBJ), State Bank of Hyderabad (SBH), State
Bank of Mysore (SBM), State Bank of Patiala (SBP) and State
Bank of Travancore (SBT), merged with SBI from 1st April
by swapping of shares.
2017, Nov Alternative Mechanism Panel setup under the FM Jaitley’s
chairmanship

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• They examine the proposals for merger/consolidation

of the Public Sector Banks (PSBs) and forward to
Cabinet for approval.
• Department of Financial Services coordinates the
filework.
2019, 1st Vijaya Bank and Dena Bank merged into Bank of Baroda, by
April swapping of shares. Among these three oldest: BoB (1908) >
Vijaya (1931)> Dena (1938)

Amalgamating Banks Anchor Bank (Remaining PSBs)

• Oriental Bank of Commerce
• United Bank of India
• Syndicate Bank
• Andhra Bank
• Corporation Bank
• Allahabad Bank
• BMB & 5 Associate banks
(Amalgamated earlier)
• Vijaya bank
• Dena Bank
(Amalgamated Earlier)
1) PNB: It’ll become the 2nd largest
bank after SBI, in terms of business
size and branch network)
2) Canara Bank
3) Union Bank of India
4) Indian Bank
5. SBI
6)Bank of Baroda
7. Bank of India
8. Central Bank of India
9. Overseas Bank of India
10. UCO Bank
11. Bank of Maharashtra
12. Punjab and Sind Bank

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Benefit? Geographical & technological synergies (in ATM, Branches,

Servers etc.) resulting into reduced cost of business → better lending &
deposit rates.

PRIVATIZATION

UTI Bank → ‘Privatization’ into Axis Bank (2007)

• Setup in 60s as a Sarkaari Mutual Fund Company through Unit Trust
of India Act 1963
• 1993: Obtained License to open UTI Bank.
• 2001: Ketan Parekh Sharemarket Scam, Govt has to bailout UTI →
further restructuring 2007 → Became Axis Bank: 77% private
shareholding + 23% by Public sector bodies like LIC, New India
Assurance, SUUTI etc. (as of 2019, Jan).

IDBI Bank → Purchased by LIC (2018)

Setup in 60s as a Development Financial Institution (DFI) through the
Industrial Development Bank of India Act, (1964).

2004: Transformed into a Public Sector Bank, after Narasimham-II

suggested DFI abolition.
• IDBI Bank shareholding: 81% Government + ~11% LIC + remaining
by other investors
• 2014: RBI’s P.J. Nayak Committee that suggest Govt should exit
shareholding in smaller PSBs, to enhance their efficiency.
• Budget 2016: Govt agreed to reduce shareholding to <50% in IDBI
Bank.
• 2018: IDBI has the highest NPA (28%) among PSB, so no mentally-fit
investor willing to buy Govt’s shares. Govt. (forces) LIC to buy its
40% for ~9k crores. Thus, LIC will own 51% in IDBI. Deal was
approved by the respective financial regulators (RBI and IRDAI) by
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2018-July. Though LIC itself is public sector entity but RBI has
declared IDBI as ‘private sector’ bank.
• Positive: Govt. no longer worry about BASEL-recapitalization of IDBI.
LIC can market its insurance policies to IDBI consumers
(bancassurance).
• Negative: LIC policy holders’ money is going into a loss-making Bank.
They’ll be deprived of better insurance-investment products
(opposite to had LIC invested in a profitable company) = this
amounts to “Financial Repression of Households”

Benefit? Govt. need not waste tax-payers’ money in running such loss
banks. Govt. need not recapitalize them for BASEL-III norms.

Anti-Arguments: Employees worried seniority, promotion, increments;

financial burden of Voluntary Retirement Scheme (VRS). Banks may lose
regional identities & customer intelligence with transfer of employees.
Big customers may shift to other banks for faster service and
personalized privileges.

ES20: 50 years of bank nationalization:

• 2019: Global top-100 banks: China (18 banks), USA (12 Banks),
Japan > France > …..India (only 1 bank: SBI at Rank#55).
• Even Sweden and Singapore have more global banks than India,
even though these countries’ size of economy (GDP) is much
smaller than India.
• So, given India’s size of economy (in terms of GDP), India should
have 6-8 banks in the global top 100. → These large banks provide
large loans → India can reach $5 trillion GDP by 31/3/2025.
• Therefore, merger of public sector banks is necessary. It’ll increase
the manpower, financial strength of the merged entities, then they
can compete at global level

Narasimhan committees

Narasimhan Committee I – 1991

Narasimhan Committee I was constituted to overhaul banking sector of
India & to resolve the problems of Banking sector which included
• Rising NPA
• Lack of Rural Expansion
• Lack of Financial inclusion
• High Interest Rates

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All the recommendations of this committee have been implemented by

successive governments over the years.
1. The govt/RBI do not decide the banks’ loan interest rates anymore.
The banks use Base Rate system
2. To recover debts, Debt Recovery Tribunal was set up in 1993
3. Branch expansion policy is more liberal with only one condition
that 25% of the branches must be rural areas
4. Reserve ratios have been reduced over the years(CRR-15%, SLR-
40%)
5. NBFC regulatory framework has been put in place
6. Govt has reduced its share and parted some control in PSBs, thus
facilitating entry of professionals into the Board of Directors
7. Private banks and Foreign banks can set up shop, when the RBI
issues licenses

Narsimhan Committee II – 1998

• Introduced Voluntary retirement scheme (VRS) in public sector
banks.
• Legal reforms for loan recovery → SARFAESI act 2002
• Computerization, electronic fund transfer, legal framework
• Permit for new private / foreign banks

Scheduled and Non-Scheduled

When RBI is satisfied that a bank has (Paid Up Capital + Reserves) = Min
25 Lakhs & it is not conducting business in a manner harmful to its
depositors, then such bank is listed in the 2nd Schedule of RBI Act, and
known as a Scheduled Bank.

Scheduled Bank Non-Scheduled Bank

• Required to deposit CRR money
to RBI
• Eligible to borrow / deposit funds
in RBI’s window operations.
• Are required to protect the
interests of depositors and abide
to RBI norms.
• Can be subdivided into two parts
• Can maintain the CRR money
with themselves.
• Depends on RBI’s discretion.
• Of course, they also have to do
it, else RBI can shut them down
under BR Act.
• Hundreds of cooperative banks
are non-Scheduled.

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▪ Scheduled Commercial
Banks (SCB)
▪ Schedule Cooperative Banks
like Haryana Rajya Sahakari
Bank, Tamil Nadu State Apex
Cooperative Bank

Differential Banks
Universal Bank Differential Bank
Open Anywhere: example SBI, Geographical Restrictions on
Branches ICICI branch opening for Local
[*After opening 25% of Area Bank (LAB), Regional
branches in unbanked rural Rural Banks (RRB)
areas]
Accept Both Time & Demand Payment Bank – Accept Max.
Deposits 1 Lac only.
of any amount.
Give Anyone [After 40% PSL] - SFB, RRB: 75% to PSL
Loans to - Payment Bank can’t give
loans;

Chronology of differential banks: RRB(1976) → Local Area Bank

(1996) → Small Finance Bank & Payments bank(2015) → Wholesale
banks (proposed)

RRB and LAB

Regional Rural Banks
• Based on M.Narasimhan’s
Committee on Financial
Inclusion in 1970s
• Setup under the provisions of
RRB act 1976 & its amendment
in 2015.
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Local Area Bank
• Based on Budget-1996 by
Finance Minister Manmohan
Singh
• Unlike RRBs, they're not setup
by Union or State govts or by
any special act or parliament.
But by pvt entities simply
 BANKING

• Voting power: Union = 50%, applying to RBI under Banking

State =15% , Sponsor bank = 35
% •
• Subjected to CRR, SLR norms
but RBI could prescribe
separate norms.
• PSL: 75%.
• Their loan interest rates can’t
be more than prevailing lending
rates of Cooperative Banks in
the area.
• Restricted to few districts. E.g.
Baroda Gramin Bank branches
confined to Gujarat’s southern
districts.
• Ultimate regulator: RBI but
immediate regulator NABARD.
Regulation Act.
Present in Max. 3 geographically
contiguous districts. only 1
urban centre per district.
• They’re Non-Sch. Banks so while
CRR, SLR, PSL etc may apply but
every norm with caveats.
• Initially 4:
a. Coastal Bank Andhra
Pradesh
b. Subhadhra Local Area Bank,
Kolhapur;
c. Krishna Bhima Samruddhi
(Andhra & Karnataka) and
d. Capital Local Area Bank:
Punjab (Largest).

But later Capital LAB converted

into Small Finance Bank (2016),
so now only 3 left.

• Only RBI regulates them.

SFB & PB
On Nachiket Mor Committee’s recommendations (2013-14), Governor
Raghuram Rajan approved these new types of banks for
1. Financial inclusion
2. Competition & innovation among players.

Parameters Small Finance Banks Payment banks

Examples Capital Small Finance Bank
(Punjab), Ujjivan
(Karnataka), Utkarsh (UP)
Eligibility • Min.100cr. capital
• Resident Indian, Local
Area Bank, NBFC, Micro-
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7 at present: Airtel, India
Post,
FINO, Paytm, Aditya Birla
Idea,
Jio, NSDL. (Total 11 were
selected)
• Min.100cr. Capital
• Resident Indians,
NBFCs, PPI-wallets
 BANKING

finance, with 10 years (pre-paid payment

exp. in banking / finance instrument), mobile
telephone companies,
super-market chains,
cooperatives &
companies controlled
by
resident Indians
Area RBI Committee gave Anywhere
selection
preference North East &
Central India clusters
where Universal Banks’
penetration is poor
Selected by? Usha Throat (Former RBI Nachiket Mor(Ex-RBI
Dy.Gov) Board Member)
CRR, SLR, Same as Indian private Same as Indian Private
Repo, FDI? banks Banks, but caveats in SLR.
Rural Must have 25% branches in No need but 25% access
Penetration unbanked rural areas points must be in rural
areas like Business
correspondence (BC),
Kiraana Stores
Target Unserved, Underserved Promoting Small savings
Consumers Farmers, Micro, Small Remittance of migrant
industries labors, low income
households, unorganized
sector, small business.
Accept Yes, without any • No NRI deposits, Fixed
Deposits restrictions deposit, Recurring
Deposit.**
• Can accept only
Demand Deposits and
max. balance Rs. 1lac
per year per customer.
Debit cards YES (but EMV-Chip) YES (EMV-Chip)
Credit cards YES (but EMV-Chip) No (because can’t “loan”)

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Loans • Yes, but 75% in PSL, • Can’t loan, So no PSL.

• 50% of loan portfolio of
Rs. 25 lakhs/< loans.
Evolve? Yes, after 5 years can
become
Universal Commercial
Bank.
• They’re required to
invest all deposits in G-
sec, T-Bill and in other
SCBs.
Not mentioned.

** While Paytm Payment Bank accepts fixed deposit but it’s acting simply
as an ‘Agent’ to open your fixed deposit IndusInd Bank, a private sector
Commercial Bank.

• BASEL-III norms applicable on both of SFB & PB, and they are tighter
than a (universal) commercial scheduled bank.
• Both can sell Mutual Fund (MF), Pension, Insurance policies with
approvals of respective regulators.

On-Tap Licenses for SFB

8 out of 10 Small Finance Banks (SFB) became Scheduled Banks. RBI
reviewed & found they have achieved their priority sector targets and
helped in financial inclusion. More competition and new players will help
so 2019-June, RBI announced it’ll allow ‘On Tap’ license for SFB soon. (i.e.
no need to wait for notification, apply whenever you wish like a driving
license)

Eligibility conditions to get SFB license ‘On Tap’:

• Minimum 200 crore capital.
• Resident individuals/professionals with ten years of experience in
banking and finance;
• 5 year/> old companies owned by Indian residents
• Existing NBFCs, MFIs, local area banks and payments banks.
• Urban cooperative banks (UCB) allowed to convert into SFB but
capital norms slightly different.
• 2019-Dec: Even Payment banks can convert into SFB, after 5 years
of operation

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India Post Payment Bank (IPPB)

• Registered as a Public Limited Company under Companies Act,
100% owned by Department of Posts (Ministry of Communication
and Information Technology.) → Obtained RBI’s License under
Banking Regulation Act to start working as a Payment Bank.
• Airtel Payments Bank was first to launch operations in 2017- Jan.
Later, IPPB launched pilot branches at Raipur (Chhattisgarh) and
Ranchi (Jharkhand). Then IPPB launched full-fledged operations in
2018.
• In between, Paytm, Fino, Birla Idea and Jio launched their Ops.
• Motto: “No customer is too small, no transaction too insignificant,
and no deposit too little”
• Largest customer reach with 1.55 lakh Post offices across India.
Doorstep banking through Postmen (but fees applicable).
• Intra-Bank transfer: no fees. IMPS: fees applicable.
• Bank Account Types: Safal, Sugam, Saral (internal differences
about ATM withdrawal limits etc.).
• Account can be opened with zero balance, no minimum balance
requirement. Max. Balance 1 Lac per person per year. Minimum
Customer Age: 10 years / >
• Also partnered with Bajaj Alliance Life Insurance (BALIC) to sell
insurance policies.
• 2019-July: IPPB announced it desires to convert itself from
Payment Bank into a Small Finance Bank, so it can offer loans to
customers

(Proposed) Wholesale & Long Term Finance Banks (WLTF)

2017: RBI proposed. Entry capital 1000 crores, can’t accept deposits less
than 10 crores, can give loans only to large corporates & infrastructure
projects. Other banks may use it for PSLC-certificate trading.

Cooperative Banks
Type Commercial Banks Cooperative Banks
Banking Reg. Act Applicable since 1949 Applicable since 1966.
Regulator RBI RBI , State Registrar of
Cooperative Societies

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CRR, SLR, Yes Yes, but, RBI could keep

BASEL-III different slabs/ norms.
Repo, MSF Eligible Yes, but only selected
borrow category of Cooperative
Banks
PSL Lending Yes 40-75% Only for UCBs… presently
40%, will have to increase
to 75% by March 2023
Who can Anyone First preference to
borrow members
Vote power Based on Shareholding, According to Cooperative
like a Commercial Society norms, members
Company will have vote power
Profit Motive Yes, purely profit Desire to help community.
motive, so lending rates So, lending rates little
may be higher than lower than
Coop.
Presence All India & overseas Mainly in
Guj,MH,Andhra,TN

Urban Cooperative Banks Rural Cooperative Banks

Further subcategories depending
on
• Scheduled / Non-Scheduled;
• Single State / Multi State.
From 2018, RBI allowed them to
voluntarily upgrade to Small
Finance Banks, with certain
conditions.
• Long term: Land Banks,
Cooperative Agriculture &
Rural Development Banks
• Short term: State Cooperative
Bank → District Central
Cooperative Bank (DCCBs) →
Primary Agricultural Credit
Societies (PACS)

Challenges: Politicization, casteism, poor recovery of loans, scams,

money laundering. They were prevented from exchanging banned 500-
1000 notes due to malpractices.

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Budget-2017: provided funds to NABARD for implementing Core

Banking Solution (CBS) within PACS & DCCB- this will help in targeted
delivery of farm loans and subsidies & prevent malpractices and
siphoning of funds.

What was the purpose?

Initially set up to supplant indigenous sources of rural credit, particularly
money lenders. Today, they mostly serve the needs of agriculture and
allied activities, rural-based industries and to a lesser extent, trade and
industry in urban centers.
Registered under state registrar of co-operatives of the Cooperative
Societies Act, 1912 → Under the state government
Regulation
Managerial aspects of these banks — registration, management,
administration, recruitment, amalgamation, liquidation, etc are all
controlled by the state governments. Matters related to banking are
governed by RBI directives under the Banking Regulation Act, 1949 and
Banking Laws (Application to Co-operative Societies) Act, 1965
Ownership
Cooperative banks are owned by their customers and follow the
cooperative principle of one person, one vote. Work on the principle of
“No Profit, No Loss". Voting is based on one person one vote

Why unsatisfactory performance of land development banks?

1. Uneven Growth
2. Problem of Overdues
3. Lack of Trained Staff
4. These banks charge very high interest rates on the loans provided by
them.
5. There is much delay and red-tapism in the granting of loans
6. Second loan is not advanced unless the first is repaid.
7. Installments and the period of loans are not fixed on the basis of the
repaying capacity of the borrowers.
8. The procedure of receiving a loan from these banks is so complicated
that the agriculturist is forced to seek help from the money lender,
9. Weaker sections of the rural society such as landless labourers,
village artisans and marginal farmers, are generally unable to secure
loans from these banks for their productive activities simply because
they do not have land or adequate security to offer against loans.
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10. Mostly loans are given for the repayment of old loans and for
development purposes.

Various advantages of cooperative credit institutions are given

below:
• Alternative Credit Source
• Cheap Rural Credit
• Productive Borrowing
• Encouragement to Saving and Investment
• Improvement in Farming Methods: Credit facilities
• Role of Cooperative Banks before 1969:
o Till the nationalisation of major commercial banks in 1969,
cooperative societies were practically the only institutional
sources of rural credit. Commercial banks and other financial
institutions hardly provided any credit for agricultural and
other rural activities.
• Role of Cooperative Banks after 1969:
o After the nationalisation of commercial banks in 1969, the
government has adopted a multi-agency approach. Under this
approach, both cooperative banks and commercial banks
(including regional rural banks) are being developed to finance
the rural sector.
o But, this new approach also recognised the prime role to be
played by the cooperative credit institutions in financing rural
areas because of the following reasons:
▪ Co-operative credit societies are best suited to the socio-
economic conditions of the Indian villages.
▪ A vast network of the cooperative credit societies has been
built over the years throughout the length and breadth of
the country. This network can neither be duplicated nor be
surpassed easily.
▪ The cooperative institutions have developed intimate
knowledge of the local conditions and problems of rural
areas.

Weaknesses of Cooperative Banking:

1. General Weaknesses of Primary Credit Societies: Organisational
and financial limitations of the primary credit societies considerably
reduce their ability to provide adequate credit to the rural
population.
a. Cooperative credit still constitutes a small proportion of the
total borrowings of the farmers,

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b. Needs of tenants and small farmers are not fully met.

c. More primary credit societies are financially weak and are
unable to meet the production-oriented credit needs,
d. Overdues are increasing alarmingly at all levels,
e. Primary credit societies have not been able to provide adequate
and timely credit to the borrowing farmers.

2. Inadequate Coverage: Despite the fact that the cooperatives have

now covered almost all the rural areas of the country, its rural
household membership is only about 45 per cent. Thus, 55 per cent
of rural households are still not covered under the cooperative credit
system.

In fact, the borrowing membership of the primary credit societies is

significantly low and is restricted to a few states like Maharashtra,
Gujrat, Punjab, Haryana, Tamil Nadu and to relatively rich land
owners.

3. Inefficient Societies: In spite of the fact that the primary agricultural

credit societies in most of the states have been re-organised into
viable units, their loaning business has not improved.

4. Problem of Overdues: A serious problem of the cooperative credit is

the overdue loans of the cooperative institutions which have been
continuously increasing over the years. Large amounts of overdues
restrict the recycling of the funds and adversely affect the lending
and borrowing capacity of the cooperative societies.
a. Indifferent management or mismanagement of primary
societies;
b. Unsound lending policies resulting in over-lending or lending
unrelated to actual needs, diversions of loans for other
purposes;
c. Vested interests and group politics in societies and willful
defaulters;
d. Inadequate supervision over the use of loans and poor recovery
efforts;
e. Lack of adequate control of central cooperative banks over
primary societies;
f. Lack of proper links between credit and marketing institutions;
g. Failure to take quick action against willful defaulters; and
h. Uncertain agricultural prices.

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5. Benefits to Big Land Owners: Most of the benefits from the

cooperatives have been covered by the big land owners because of
their strong socio-economic position. The share of the poorest rural
population (i.e. tenants, share croppers and landless labours) was
only 6.2 per cent.

6. Lack of Other Facilities: Besides the provision of adequate and

timely credit, the small and marginal farmers also need other
facilities in the form of supply of inputs (i.e., better seeds, fertilisers,
pesticides, etc), extension and marketing services.

These facilities will enable them to utilise the borrowed credit in a

proper way. Therefore, the credit societies should be reorganised
into multi-purposes cooperatives.

7. Multiple masters: The biggest problem facing co-operative banks is

that they have more than one master —
a. UCBs à RBI and the Registrar of Co-operative Societies (RCS) of
the respective state
b. District and state co-operative banksà Nabard, the RBI and the
RCS.

Shutting down PACS and Large sized Multipurpose Societies can be

started.

8. Competition: The cooperatives in northeast states and in states like

West Bengal, Bihar, Odisha are not as well developed as the ones in
Maharashtra and Gujarat. There is a lot of friction due to competition
between different states, this friction affects the working of
cooperatives.

PMC Bank
The Punjab and Maharashtra Cooperative (PMC, HQ-Mumbai, setup
1984) is a Multi-State Scheduled Urban Co-operative Bank. It functions in
Maharashtra, Delhi, Karnataka ,Goa, Gujarat, Andhra Pradesh and Madhya
Pradesh.
• PMC bank loaned large amount to a weak company HDIL(Housing
Dev and Infra Ltd), because of its cozy relations with bank directors.
Company who couldn’t repay it. NPA became so large, bank might
collapse.

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• RBI imposed withdrawal limits on the depositors using the powers

of Banking Regulation Act. Because ‘bank run’ would have been so
high even CRR-SLR can’t fulfill it, if there was no withdrawal limit.
• Merger / closing / liquidation of a cooperative bank requires
approval by Government’s registrar of cooperatives. So, RBI alone
can’t do much action.
• RBI’s Y.H. Malegam Committee (2011) had suggested many reforms
on UCBs, but they’re not yet implemented until Government amends
the laws.

Therefore, RBI offered Urban Cooperative Banks to convert their license

into Small Finance Bank (SFB), then RBI alone will have supervision
powers without interference from Government. But UCB banks not
interested, they enjoy the present loopholes.

Budget-2020: Promised to amend the Banking Regulation Act to increase

RBI's powers over cooperative banks.

Cooperative banks under RBI

Union Cabinet has approved to bring regulation of cooperative banks
under Reserve Bank of India. In order to achieve this, the Cabinet
approved amendments to Banking regulation act.

The amendments will apply to all urban co-operative banks and multi-
state cooperative banks.

As per the changes:

1. Cooperative banks will be audited according to RBI’s norms.
2. RBI can supersede the board, in consultation with the state
government, if any cooperative bank is under stress.
3. Appointments of chief executives will also require permission from
the banking regulator, as is the case for commercial banks.

Why this was necessary?

This was felt necessary in the wake of the recent Punjab & Maharashtra
Cooperative (PMC) Bank crisis.
• Cooperative banks have 8.6 lakh account holders, with a total
deposit of about ₹5 lakh crore.
• Besides, Urban cooperative banks reported nearly 1,000 cases of
fraud worth more than ₹220 crore in past five fiscal years.

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How cooperative banks are regulated?

Cooperative banks are currently under the dual control of the Registrar of
Cooperative Societies and RBI. While the role of registrar of cooperative
societies includes incorporation, registration, management, audit,
supersession of board and liquidation, RBI is responsible for regulatory
functions such maintaining cash reserve and capital adequacy, among
others.

OMBUDSMAN SCHEME
The Reserve Bank of India has tightened the banking ombudsman
scheme with the objective to strengthen the grievance redressal
mechanism for customers.

Who is a Banking Ombudsman?

Banking ombudsman is a quasi judicial authority, created to resolve
customer complaints against banks relating to certain services provided
by them.
• A senior official, who has been appointed by the Reserve Bank
• It covers all kinds of banks including public sector banks, Private
banks, Rural banks as well as co-operative banks.

Background
Banking ombudsman scheme
It is run by the RBI directly to ensure customer protection in the banking
industry.
• The scheme was introduced under Section 35 A of the Banking
Regulation Act, 1949 by RBI with effect from 1995. The present
Ombudsman scheme was introduced in 2006.
• All Scheduled Commercial Banks, Regional Rural Banks and
Scheduled Primary Co-operative Banks are covered under the
Scheme.

Internal Ombudsman Scheme 2018:

The Internal Ombudsman Scheme of 2018 mandates banks to grant a
fixed term of three to five years, which cannot be renewed, to the IO.
• The IO can be removed only with prior approval from RBI. The
remuneration would have to be decided by the customer sub-
committee of the board and not by any individual.
• The Ombudsman Scheme of 2018 covers appointment/tenure,
roles and responsibilities, procedural guidelines and oversight
mechanism for the IO, among others.
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• The implementation of IO Scheme 2018 will be monitored by the

bank’s internal audit mechanism apart from regulatory oversight
by RBI.

New guidelines:
All commercial banks having 10 or more banking outlets to have an
independent internal ombudsman (IO) to review customer complaints
that are either partly or fully rejected by the banks.

As banks should internally escalate complaints that are not fully

redressed to their respective IOs before conveying the final decision to
the complainant, customers need not approach the IO directly.

Microcredit model
Microcredit has gained much traction as a tool for ensuring the welfare of
the most impoverished in the society but there are certain flaws in the
model.

What is microcredit?
Microcredit refers to the granting of very small loans to impoverished
borrowers, with the aim of enabling the borrowers to use that capital to
become self-employed and strengthen their businesses. Loans given as
microcredit are often given to people who may lack collateral, credit
history, or a steady source of income.

Need for and significance of microcredit:

1. The core idea of microcredit is that a small loan will provide access
to the larger economy to people who typically live outside the scope
of the institutions on which the mainstream economy rests.
2. Such a loan is meant to enable them to commence with productive
activities, and will give them the initial boost required to gain entry
into an industry
3. Microfinance activities usually target low-income individuals, with
the goal of helping them to become self-sufficient. In this
way, microfinance activities have an aim of poverty alleviation as
well.

Why are microcredit institutions failing to deliver long-term benefits?

1. Lack of evidence of transformative effects of microfinance on the
average borrower.

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2. stringent repayment schedule offered by most microcredit

institutions.
3. institutions offering microcredit are unable to judge the risk
associated with lending to certain borrowers.
4. To lower the risk of defaulting, microcredit lenders therefore resort
to repayment schedules that demand an initial repayment that is
almost immediate, after which borrowers must adhere to
an inflexible weekly schedule for repayments.
5. The effect of this is that borrowers are unable to use the loans on
investments that will take some time to be fully realised, and instead
are forced to use the loans they receive on short term investments
that only boost production to an extent, and the overall growth of
their incomes remains meagre.

How can the microcredit system be reformed to have greater benefits

for borrowers?
1. Revise repayment schedule with some grace period to begin
repayment.
2. Switch from weekly repayment schedule to a monthly one.
3. As for the barriers to assessing credit risk, these can be mitigated by
using community information.

What are the other applications of microcredit?

1. For entrepreneurs to begin production and attain self-sufficiency.
2. allow rural labourers to migrate to urban areas to find work during
the lean season
3. situations where seasonal factors cause drops in income
4. used to dampen the effects of shocks like floods by providing people
with a form of insurance

Way ahead:
Microcredit has a vast range of applications for poverty alleviation and
general development, but existing systems require reform in multiple
areas to allow for unfettered benefits that last. Furthermore, in areas
were the application of microcredit is relatively new, microcredit systems
must be carefully evaluated before they are put into place, so as to enable
the greatest benefit from such institutions.

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Punjab to create land banks in rural areas

With an aim to create land banks in rural areas to boost industrial
development, the Punjab Cabinet has given in-principle approval to
amend the law for transfer of common village land in rural areas to the
state’s industry department.

Implications:
The amendment will facilitate gram panchayats to promote development
of villages by unlocking the value of ‘Shamlat’ or village common land.

The new rule would pave the way for transfer of ‘Shamlat’ land for
industrial projects to the industry department and state-owned Punjab
Small Industries & Export Corporation (PSIEC).

Role of panchayats:
The amendments ensure that the Panchayats get their dues, with all
decisions to be taken on a case to case basis keeping their interests in
view.

With this amendment, a gram panchayat could, with the prior approval of
the state government, transfer the ‘Shamlat land’ vested in it by way of
sale on deferred payment terms to industries department or PSIEC for
their industrial infrastructure projects.

What is Shamlat land?

It is one that does not come under habitation and cultivation and is
considered as consolidated land holdings for common use.

Time Bank

Madhya Pradesh government’s Happiness Department plans to set up a

Time Bank.

Objective: It would lend currency to an hour, which could be exchanged

to learn a new skill without the need for any paper money.

What is a time bank? It is a reciprocity-based work trading system in

which hours are the currency. With time banking, a person with one skill

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set can bank and trade hours of work for equal hours of work in another
skill set instead of paying or being paid for services.

How it operates? Whenever a bank member needs a service or wants to

acquire a skill, say gardening or playing a guitar, she could exchange a
credit, worth an hour, with another member knowing the skill.

History: First Time Bank was set up in Japan in 1973. Today, there are
more than 500 such communities across 32 countries

D-SIB: Domestic Systematic Important Banks

In 2010, G-20’s brainchild Financial Stability board (HQ: BASEL)
asked countries to identify Systematically Important Financial
institutions and put framework to reduce risk in them

Each year in August, RBI identifies banks that ‘too big to fail’ (=if they fail,
it’ll severely hurt the economy)’ and labels them as Domestic Systematic
Important Banks (D-SIB), & orders them keep additional equity capital
against their Risk Weight Assets (RWA) & imposes other technical norms
on them.

Presently, 3 D-SIBs in India: ICICI, SBI, HDFC

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