INDIA BANKING AND

FINANCE REPORT 2021

EDITED BY
PARTHA RAY
ARINDAM BANDYOPADHYAY
SANJAY BASU
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ADVANCE PRAISE

The current report reflects the research directions in which the NIBM faculty has been actively
engaged. While highlighting several achievements of the financial sector, it also covers a wide
spectrum of the challenges confronting the financial sector in general and the banking sector in
particular. Representing a healthy mix of theoretical models and policy recommendations, I am sure
it will hold considerable appeal for both the academic community and policy circles.

—Dilip Nachane, Distinguished Professor, Indian Institute of Technology Bombay, and

Honourable Professor and Former Director, Indira Gandhi Institute of
Development Research

I have enjoyed reading every page of Indian Banking and Finance Report 2021, which is very timely.
I congratulate NIBM, the director, and the faculty for bringing out such a well-researched, insightful
and comprehensive report. Busy banking and finance professionals will find many useful ideas and
perspectives in the report. I strongly recommend this book on the shelf of every banking executive
and finance professional, board member and CEO.

—Anil K. Khandelwal, Author and Former Chairman and Managing Director of

Bank of Baroda and Dena Bank

Indian Banking and Finance Report 2021 that touches upon almost all the areas relevant to the bank-
ing sector is indeed a good read. For a seasoned banker like me, reading a thoroughly researched
paper on any area of banking brings in a lot of joy and satisfaction. I am glad to note that all chapters
have several new ideas or new thoughts which practising banking professionals could adopt and
implement to make a difference in their approach to that functional area. It is pertinent to note that
authors of each chapter have delved into the subject very deeply to produce exemplary reading mate-
rials. I appreciate their hard work and knowledge to provide valuable observations through analysis
of data and facts and other materials on the subject.

—Sunil Mehta, Chief Executive Officer, Indian Banks’ Association

Indian Banking and Finance Report 2021 is a fine compendium of research papers on banking. The
report is rigorous, contemporary, relevant and fills in the much needed knowledge gap. It is so good
to see the team within NIBM working towards an insightful publication, possibly the first for an
academic institution. Everybody interested in the developments in the banking sector will find this
a ‘must-have’ on every practising banker’s bookshelf.

—M. S. Sriram, Professor, Centre for Public Policy,

Indian Institute of Management Bangalore
The report provides an excellent overview of the challenges and opportunities in banking and finance.
This compendium covers an array of relevant and contemporary issues. The 12 chapters, written
by experts, will be of great interest to policymakers, senior management in banks and researchers
tracking the changes on the turf of banking in India.

—Tamal Bandyopadhyay, Author and Columnist

 India Banking and
Finance Report 2021
 India Banking and
Finance Report 2021

Edited by

Partha Ray
Arindam Bandyopadhyay
Sanjay Basu
Copyright © National Institute of Bank Management, 2022

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First published in 2022 by

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CONTENTS

List of Figures vii

List of Tables ix
List of Abbreviations xiii
Preface xix

1. Macro-financial Perspectives on the Indian Economy 1

G. Nagaraju and Partha Ray
2. Bank Boards and Corporate Governance in India 21
Anjan Roy and Kaushik Mukerjee
3. Mergers and Acquisitions in the Indian Banking Industry 37
Dipali Krishnakumar and Richa Verma Bajaj
4. India’s Bad Bank: Opportunities and Challenges 57
Tasneem Chherawala
5. Macroeconomic Scenario Embedded Forward-looking Probability of
Default Models for IFRS 9 Purpose 75
Arindam Bandyopadhyay
6. Macbethian Apparitions: Early Warnings and Fraud Management 91
Richa Verma Bajaj, Dipali Krishnakumar and Smita Roy Trivedi
7. The Perils of Climate Change: A Risk Management Perspective for Banks and FIs  109
Arindam Bandyopadhyay and Sanjay Basu
8. FX Interbank Market of India: Liquidity and Stability 119
Gargi Sanati
9. New Trends in Infrastructure Financing 135
Debasish Mallick
10. Emerging Technological Innovations in Financing Micro, Small and
Medium Enterprises in India 151
Naveen Kumar K., M. Manickaraj and Sundeep Mohindru
 11. Digital Transformation of Banking Institutions 163
Deepankar Roy and Paritosh C. Basu
12. Leading through Disruptions: A Distributed Leadership Model for Banks in India 179
B. Ashok and Shomi Srivastava

About the Editors and Contributors 197

Index199

vi INDIA BANKING AND FINANCE REPORT 2021

LIST OF FIGURES

1.1 Global GDP Growth (%) 2

1.2 Quarterly Growth Rates of Indian GDP (Year-on-year) 3
1.3 Money Market Rates—Weighted Call Market and Weighted Triparty Repo Rate
and 364-day TB Primary Auction Cut-off 7
1.4 Condition of the Money Market
1.4a Daily Average Volume of Money Market (` Thousand Crore) 9
1.4b Average Daily Net Liquidity Absorption in LAF Operations (` Crore) 9
1.5 Trends in Government Securities Market
1.5a Primary Issues of Government Securities 10
1.5b Weighted Average Yields on Government Securities in Secondary Market 10
1.6 Trends in the Corporate Debt Market
1.6a Primary Issues of Corporate Bonds (` Lakh Crore) 11
1.6b Corporate Bond Spread (10-year Bond over 10-year G-Sec) 11
1.7 Trends in Equity Market
1.7a Trend in NIFTY and Price–Earnings Multiples 11
1.7b NSE Market Capitalization 11
1.8 Forex Market in Recent Times
1.8a Currency Appreciation(+)/Depreciation(–) (y-o-y) 13
1.8b Net FDI and Net FPI Flows 13
1.8c Forward Premium in USD/` Market 13
1.9 Trends in Select Banking Variables
1.9a Trend in PCR 15
1.9b Capital Adequacy (CRAR) 15
1.9c Net Interest Margin 15
1.9d Return on Assets 15

2.1 Framework for Enabling Board-level Governance 32

 3.1 Banking Mergers and Acquisitions in the World 37
3.2 Industry of Target in Banking M&A Deal Sample 40
3.3 Number of M&A Deals by Year of Announcement 41
3.4 Event Study Methodology 42
3.5 Cumulative Abnormal Returns to Distressed Deal Announcements 44
3.6 Cumulative Abnormal Returns to Consolidation Deal Announcements 45
3.7 Cumulative Abnormal Return for Voluntary Deals 46
3.8 Comparison of Performance Parameters for Consolidation, Distressed and
Voluntary Deals 51

4.1 Trend in NPLs, Provisions and Credit Growth of Scheduled Commercial Banks
in India (Excluding Payment Banks and Small Finance Banks) 62
4.2 Trend in NPL Amounts Involved and Recovery Rates from Alternative Channels
of Recovery in India 63
4.3 Trend in NPL Acquisition by ARCs and Issuance of Security Receipts 65
4.4 Trend in Outstanding Amounts of Security Receipts and Investor Profile 66
4.5 Banks’ Recovery Rates from Internal Workout and from Sale of NPLs to ARCs 66
4.6 Timelines of Establishment of NARCL 67
4.7 The Structure of India’s Bad Bank 68

5.1 Link between Z Index and Macroeconomic Factor 87

6.1 Total Fraud Losses in Banks in India 93

7.1 Nature and Drivers of Climate Change Risk 110

7.2 Risk Score Adjustments 112
7.3 Corporate Default Rate and CO2 Emissions in India 113
7.4 Scenario-based Loss Simulation Framework 114

8.1 Merchant and Interbank Transaction: Trends for India (Millions $) 121
8.2 Indian Interbank FX Turnover since 2018–2019 to 2020–2021 (Millions $) 121
8.3 Trend in FX Spot and FX Swap Market Turnover in India
(From 1996–1997 to 2020–2021) 123
8.4 Covid Impact on Liquidity of FX Spot and FX Swap Turnover in India 123
8.5 Comparison of FCY/INR and FCY/FCY Transactions for Spot and Swap 124
8.6 FCY/FCY—Comparison between FX Spot and FX Swap for FCY Leg 124

12.1 Commercial Bank Branches per 100,000 Adults from 2010 to 2020 181

viii INDIA BANKING AND FINANCE REPORT 2021

LIST OF TABLES

1.1 GDP Growth (%) 2

1.2 Consumer Price Inflation (Average) (%) 3
1.3 Quarterly Growth Performance of Sectoral GVA (at 2011–2012 Prices; %) 4
1.4 Quarterly Growth Performance of Sectoral GDP (2021–2022 Prices; %) 5
1.5 Trends in CPI (2012 = 100) Inflation (%) 6
1.6 Liquidity Measures by RBI during February 2020 through September 2021 (` Crore) 8
1.7 Bank Group-wise Gross NPAs and Net NPAs of Indian Banks 13
1.8 Distribution of Bank Credit Share (%) 14

2.1 Descriptive Statistics for Dependent and Independent Variables 28

2.2a Effect of Shareholding Pattern on Performance Variables 29
2.2b Effect of Shareholding Pattern on Strategy and Prudential Decisions 29
2.3a Effect of Board Composition on Performance Variables 29
2.3b Effect of Board Composition on Strategy and Prudential Decisions 30

3.1 Number of M&A Deals by Public Sector and Private Sector Banks from 2000 to 2020 40
3.2 Classification of M&A Deals by Type of Deal 41
3.3 Stock Market Reaction to Distressed Deal Announcements 44
3.4 Stock Market Reaction to Consolidation Deal Announcements 44
3.5 Stock Market Reaction to Voluntary Deal Announcements 45
3.6 Tests of Significance for 11-Day and 3-Day CARs 47
3.7 Performance of Acquiring Banks One Year Prior to Deal Completion with
One Year Post Deal Completion 47
3.8 Performance of Acquiring Banks Two Years Post Deal Completion 48
3.9 Comparison of Performance for Public and Private Banks Two Years Post
Deal Completion 49
3.10 Kruskal–Wallis 50
A.1 List of Deals Considered in Study 53
 4.1 Credit and NPL Profiles of Countries which Set Up Crisis-led Bad Banks 63

5.1 Regression Model 1 80

5.2 Creation of Macro-scenario ‘A’-based Z Shift to Estimate Macro-adjusted
Forward-looking PD 81
5.3 Regression Model 2 82
5.4 Creation of Macro-scenario ‘B’-based Z Shift to Estimate Macro-adjusted
Forward-looking PD 83
5.5 Applying the Z Shift Factor on X Bank’s Loan Portfolio Credit Risk 84
5.6 Z Shift Adjustment on X Bank’s Overseas Portfolio 84
5.7 Correlation Estimates of Selected Banks and FIs 85
5.8 Panel A: Extracting Macroeconomic Z Index Using Merton Model from
X Bank’s Aggregate Portfolio 86
5.9 Panel B 87

6.1 Top 10 EWS and Scores 93

6.2 Correlation Coefficients between top 10 EWS 97

7.1 Impact of Rating Change over Time Horizon 113

7.2 Climate Value at Risk 115
7.3 Regression Coefficients for Equity and Bond Markets, w.r.t. Lagged GDP 116
7.4 Bond and Equity Return Distributions 116
7.5 Climate MCS VaR for Bond and Equity Positions as on 31 March 2021 116

8.1 Worldwide Liquidity in FX Market 120

8.2 India in Global Frame—Descriptive Statistics (Billions $) 126
8.3 Correlation Analysis—FX Spot and FX Swap Segments 126
8.4 India’s FX Market Liquidity—Descriptive Statistics (Million Dollar) 127
8.5 Correlation Analysis—INR and FCY Legs 127
8.6 Stationarity Test—International Front 128
8.7 Cointegration and VECM Results—International Front (Liquidity in FX Spot and
FX Swap for the UK, the USA, Japan and India) 128
8.8 Granger-causality Test—International Front 129
8.9 Stationarity Test—Domestic Front 129
8.10 Cointegration Test and VECM—Domestic Front 129
8.11 Granger-causality—Domestic Front 130

9.1 Projected Aggregate Capex during FY 2020–2025 (` Crore) 139

9.2 Proposed Sources of Finance for Achieving the NIP Targets 140
9.3 Monetization in Brief—Potential Assets and Proposed for Monetization 144
9.4 Valuation Methodology Adopted—Sector/Asset Class-wise 146

x INDIA BANKING AND FINANCE REPORT 2021

10.1 Estimated Number of MSMEs (Activity-wise) 152
10.2 Commercial Bank Loans Outstanding (End of March) for the Last Six Years,
till 2021 153
10.3 Growth in Credit from Commercial Banks to Various Sectors during
Last Six Years Ending 2021 153
10.4 Basic Features and Benefits of DI and DTT in Financing MSMEs 155
10.5 Emerging Business Models and Advances in SCF Ecosystem 159
10.6 Some Selected Achievements of Digidhan Mission 161

11.1 Financial Performance in 2020 of Selected Banks (Financial Numbers Are in

USD Billion) 168
11.2 Directory of Standard and Differentiating Practices from Narratives and
Analyses Across the Themes 174

12.1 Commercial Bank Branches 181

12.2 Number of Active Bank Branches in the USA 181
12.3 Bank Group-wise Number of Functioning Offices of Scheduled Commercial Banks
(Excluding RRBs) 182
12.4 Snapshot of Number of Offices Opened by Banks in India (2010–2020) 182
12.5 Leadership Perception Survey: Mean and Median Values on Impact Zones on 1–5 186
12.6 Comparison of Different Types of DL 190

List of Tables xi
LIST OF ABBREVIATIONS

AAI Airports Authority of India

ABA Aatmanirbhar Bharat Abhiyan
AC Asset correlation
AD Authorized dealer
ADF Alternative digital finance
ADF Augmented Dickey–Fuller
AI/ML Artificial intelligence/machine learning
AMC Asset management company
AML Anti-money laundering
API Application programming interface
AQR Asset quality review
ARC Asset reconstruction company
AS Accounting Standard
B2C Business to consumer
BB Barclays Bank
BCBS Basel Committee on Banking Supervision
BDA Big data analytics
BES Banco Espirito Santo
BG Bank guarantee
BIS Bank for International Settlements
BOA Bank of America
BOOT Build-own-operate-transfer
BOT Build-operate-transfer
BSNL Bharat Sanchar Nigam Limited
Capex Capital expenditure
CAR Capital adequacy ratio
CAR Cumulative abnormal returns
 CBA Commonwealth Bank of Australia
CBES Climate biennial exploratory scenarios
CBI Central Bureau of Investigation
CBS Core banking solution
CC Cloud computing
CCIL Clearing Corporation of India Limited
CD Certificate of deposit
CMIE Centre for Monitoring Indian Economy
COP Conference of the Parties
CP Commercial paper
CPI Consumer price index
CRAR Capital-to-risk weighted assets ratio
CSO Central Statistical Organisation
CV Coefficient of variation
CWC Central Warehousing Corporation
DB Deutsche Bank
DBP Digital banking platform
DCA Direct contractual approach
DD Distance to default
DFI Development financial institution
DI Digital infrastructure
DL Distributed leadership
DLT Distributed ledger technology
DRT Debt recovery tribunal
DT Digital transformation
DTMF Digital transformation maturity framework
DTT Digital tools and technologies
ECL Expected credit loss
EDF Expected default frequency
EEPL Energo Engineering Projects Ltd
EPD Expected probability of default
EV Enterprise value
EVA Electronic virtual assistant
EWS Early warning signals
FATF Financial Action Task Force
FCI Food Corporation of India
FCY Foreign currency

xiv INDIA BANKING AND FINANCE REPORT 2021

FDI Foreign direct investment
FII Foreign institutional investor
FINTECH Financial technology
FIR First information report
FPI Foreign portfolio investment
FX market Foreign exchange market
FX spot Forex spot
FX swap Forex swap
GCC Gulf Cooperation Council
GCF Gross capital formation
GDP Gross domestic product
GNPA Gross non-performing asset
GOI Government of India
GPFCE Gross private final consumption expenditure
GSNB Grant Street National Bank
GSTN Goods and Services Tax Network
GVA Gross value added
HAM Hybrid annuity model
IAAS Infrastructure as a service
IBC Insolvency and Bankruptcy Code
IBRA Indonesian Bank Restructuring Agency
ICT Information and communication technology
IDBI Industrial Development Bank of India
IDRCL India Debt Resolution Company Limited
IFC International Finance Corporation
IFRS International Financial Reporting Standards
IIP Index of industrial production
IMF International Monetary Fund
INR Indian rupee
InvIT Infrastructure investment trust
IOC Indian Oil Corporation
iOS iPhone operating system
IOT Internet of things
IT Information technology
JJ Johansen–Juselius
KAMCO Korea Asset Management Corporation
KYC Know your customer

List of Abbreviations xv
 LC Letter of credit
LGD Loss given default
LMT Lakh metric tonne
LTRO Long-term repo operations
M&A Mergers and acquisitions
MCA Model concession agreement
MCS Monte Carlo simulation
MSME Micro, small and medium enterprises
MTNL Mahanagar Telephone Nigam Limited
MVA Market value of asset
MVE Market value of equity
NabFID National Bank for Financing Infrastructure and Development
NARCL National Asset Reconstruction Company Limited
NAV Net asset value
NBFC Non-banking financial company
NGFS Network for Greening the Financial System
NHAI National Highways Authority of India
NHPC National Hydroelectric Power Corporation
NIFTY National Stock Exchange Fifty
NIM Net interest margin
NIP National infrastructure pipeline
NMP National Monetization Pipeline
NMP National Monetization Plan
NPA Non-performing asset
NPL Non-performing loan
NTPC National Thermal Power Corporation
ODOP One District One Product
OHE Overhead equipment
OIL Oil India Limited
OMD Operate, maintain and develop
OMT Operate, maintain and transfer
P2P Peer-to-peer
PAAS Platform as a service
PCR Provision coverage ratio
PD Probability of default
PDS Public distribution system
P-E Price earnings

xvi INDIA BANKING AND FINANCE REPORT 2021

PFCE Private final consumption expenditure
PGCIL Power Grid Corporation of India Limited
PIT Point in time
PLI Production-linked incentives
PMGKP Pradhan Mantri Garib Kalyan Package
POS Point of sale
PPP Public–private partnership
PS Probability of solvency
PSB Public sector bank
QIB Qualified institutional buyers
QR Quick response
RCC Resolution and Collection Corporation
REIT Real estate investment trust
RFA Red flag account
RoA Return on asset
ROE Return on equity
ROI Return on investment
RPA Robotic process automation
SARFAESI Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest
SAS Statement on auditing standards
SASF Stressed Asset Stabilization Fund
SBI State Bank of India
SCB Scheduled commercial bank
SCF Supply chain finance
SEB State electricity board
SEBI Securities and Exchange Board of India
SEC Securities and Exchange Commission
SFIO Serious Fraud Investigation Office
SFM Structured financing models
SIDBI Small Industries Development Bank of India
SME Small-to-medium-sized enterprises
SR Security receipt
TAMC Thai Asset Management Company
TF Task force
TLTRO Targeted long-term repo operations
TOT Toll operate transfer

List of Abbreviations xvii

 TReDS Trade Receivables Electronic Discounting Scheme
TTC Through the cycle
VaR Value at risk
VECM Vector error correction model
VR Virtual reality
VUCA Volatility, uncertainty, complexity and ambiguity
WBC Westpac Banking Corporation
WFA Work from anywhere
YONO You Only Need One

xviii INDIA BANKING AND FINANCE REPORT 2021

PREFACE
The forces shaping the banking and the finan-
cial system in India have turned out to be fun-
damental, irreversible and challenging. These
have been aided by policy initiatives, regulatory
changes and market forces. The intense com-
petitive pressure in the financial market has re-
sulted in a tremendous variety of products and
services to meet the specialized needs of millions
of customers. Digitization is receiving large im-
petus and posing new challenges and increasing
contestability for financial services. There has
also been a rapid structural evolution due to the
merger of some of the public and private sector
banks, and the entry of new private sector banks,
small finance banks and payment banks. The on-
going pandemic also created disruptions in the
existing models of banking and finance.
It is in this context that the India Banking and
Finance Report 2021 seeks to address a selected
set of relevant issues pertaining to Indian bank-
ing. This report provides an analytical overview
of some of the key contemporary topics in the
BFSI sector. The contributors, primarily NIBM
faculty, have chosen some select subjects that
have bearing on Indian banking and finance.
The range, without any claim of exhaustiveness,
is fairly wide—from macro-financial perspec-
tives against the backdrop of the pandemic to
leadership concerns in banks, from a study of
bad banks to new initiatives in infrastructure fi-
nance, from digital transformation (DT) in banks
to innovations in micro, small and medium en-
terprises (MSME) and rural finance, from climate
risks in banking to forex market stability, from
mergers and acquisitions in the Indian banking
sector to the development of early warning sig-
nals (EWS) for fraud. There is also a chapter on
corporate governance in banks and financial
institutions. The emphasis has been given to in-
ternal strategies, regulatory reforms and policy
initiatives to be adopted by the banking sector in
India as well as policymakers.
The diverse themes are connected by a few
common threads: the challenges of globaliza-
tion, competition, financial crises and the cur-
rent pandemic. These factors often reduce the
margins and profitability of banks and financial
institutions and threaten their solvency and
stability. Survival and sustained growth require
new business models, effective risk manage-
ment practices and technological innovations. A
sharp improvement in internal corporate gover-
nance standards and leadership skills is neces-
sary to drive such changes. Regulatory reforms
in the domains of loan recovery and market
infrastructure are also essential to support insti-
tutional progress. New initiatives in the areas of
monetary and fiscal policies are crucial for the
success of unconventional strategies by banks
and regulators.
The recent pandemic and a number of finan-
cial crises that preceded it show that there are
limits to the effectiveness of standard solutions
proposed by banks, financial institutions, regula-
tors and national governments. In this context,
the compendium seeks to highlight the challeng-
es and opportunities in the emerging domains of
 banking and finance, learn some important les-
sons from the past and propose novel solutions,
wherever applicable, to these urgent problems.
Chapter 1, written by G. Nagaraju and Par-
tha Ray, covers many of the important issues
of real and financial sector connections in In-
dia. This chapter provides a broad overview
of the global and local issues facing the Indian
economy. The authors address the interconnec-
tion between the real sector and the financial
sector and elaborate on its implications. In this
context, the authors deeply analyse the severe
impact of the COVID-19 pandemic situation and
the prospect of economic recovery. The authors
have expressed concerns about an upward trend
in inflation in a number of advanced as well
as emerging economies due to supply shocks
caused by the pandemic. They also highlight the
proactive regulatory measures taken by the Re-
serve Bank of India to maintain adequate liquid-
ity in the financial market, thereby reducing the
cost of borrowing and thereby supporting bank
lending. This chapter sets a good background for
many key issues related to the Indian banking
sector, which are dealt with in more detail in the
subsequent chapters of the report.
In Chapter 2, Anjan Roy and Kaushik Muker-
jee discuss the evolution of corporate governance
norms, practices and literature in banking in In-
dia and abroad. The authors investigate impor-
tant research questions related to the influence
of shareholding pattern and ownership as well as
board composition and size on key performance
parameters of banks.
Chapter 3, written by Dipali Krishnakumar
and Richa Verma Bajaj, describes the nature of
M&A events in the Indian commercial sector
during 2000–2020. The authors have employed
several quantitative models to measure the im-
pact of merger announcements on stock market
returns. The authors find that the stock market’s
reaction is more often negative to announce-
ments of distressed deals and consolidation deals.
In addition, they analysed whether there was
any variation in the performance of banks in the
before and after merger period across the three
categories of deals, that is, distressed, voluntary
and consolidation deals. Finally, it compares the
xx INDIA BANKING AND FINANCE REPORT 2021
post-acquisition operating performances of pub-
lic and private sector banks.
Tasneem Chherawala, in Chapter 4, provides
a summary of the global experience in setting
up and operating bad banks and demonstrates
that the design of the bad bank is benchmarked
to global best practices. Backed by a sovereign
guarantee, the National Asset Reconstruction
Company Limited (NARCL) will pick up those as-
sets that are 100 per cent provided by the lend-
ers. Through the substantial, one-time transfer
of stressed assets, it will enable banks to clean up
their balance sheets and focus on fresh lending.
This is an important initiative of the government
to improve the appetite for lending by banks and
maintain financial stability. The transfer of bad
loans will free up capital in the banking sector,
which can then be allocated to fresh lending. The
author argues that this will boost credit growth
and there will not be an immediate fiscal impact
of the bad bank since it is not directly capitalized
by government funds. However, the author not-
ed that the performance of the NARCL in terms
of effective resolution of the acquired non-per-
forming assets will be a key factor in determin-
ing actual recovery values for the banks.
The new international financing reporting
standard (IFRS 9) has introduced a forward-look-
ing approach for the identification of credit im-
pairment and the estimation of expected credit
loss (ECL) that will provide a timely and adequate
accounting treatment of loan loss provisions.
Chapter 5, authored by Arindam Bandyopadhy-
ay, proposes two new forward-looking approach-
es for estimating the probability of default (PD)
through possible scenario analysis. There are two
alternate models: The first one uses regression
analysis and the second one is a structural ap-
proach employing Merton’s single-factor model.
Using the bank-specific annual NPA slippage rate
and corporate bond default rates in India, the au-
thor has identified two macro-variables, namely
non-food credit growth and export growth, that
influence PD. The chapter further observes sig-
nificant correlations between Merton’s Z-index
with macro-variables. The author provides sce-
nario analysis on the basis of the possible values
of covariates, which can be judiciously used by
senior management to predict future credit loss-
es. The developed methodologies will be useful
to Indian banks and financial institutions to de-
rive economic inputs into the ECL models.
Detection of EWS or red flag indicators is
crucial for the effective management of bank
fraud. Written by Richa Verma Bajaj, Dipali
Krishnakumar and Smita Roy Trivedi, Chapter
6 presents a case-based analysis of the most fre-
quent EWS as it appears in 648 publicly available
cases of fraud. The case-based analysis helps to
highlight the modus operandi of the most fre-
quently occurring EWS. On the basis of this, the
authors have developed a template designed to
help bankers assign objective scores to the EWS.
This will enable banks’ business and compliance
desks to better monitor such events.
In the recent past, climate change risk and its
severe impact on production pattern, including
banking operations, have received global atten-
tion. It is now established that the occurrence
and interaction of physical risks (due to erosion
in the value of financial assets and/or increase in
liabilities) and transition risks (which arise from
the process of adjustment to a low-carbon econo-
my) will also aggravate financial sector risks. The
regulatory pressures for change will grow over
time, as will stakeholder demands for greener
products. The Reserve Bank of India has also
expressed its commitment to integrate climate
change risks into financial stability monitoring.
The development of efficient assessment meth-
ods to understand the impact of climate change
scenarios on capital and business profiles is criti-
cal today. Chapter 7, authored by Arindam Ban-
dyopadhyay and Sanjay Basu, presents a concep-
tual framework to capture the multidimensional
impact of climate risks on bank solvency and sta-
bility. The authors have pointed out that risks
could be direct as well as indirect as industries
and firms reduce their carbon footprints in the
face of rising temperatures and high-variance
weather events. A Monte Carlo simulation
(MCS)-based approach has been used to capture
climate-related financial risks. Such a frame-
work will enable the banks and FIs to improve
their risk governance systems and processes,
stress testing practices and scenario analysis and
disclosure standards.
Chapter 8 by Gargi Sanati examines the inter-
connectedness of liquidity spillover in external
and internal dominion. The study finds that on
the domestic front, India is well integrated in its
forex spot (FX spot) and forex swap (FX swap)
transactions for both the INR and foreign cur-
rency leg. It also empirically observes that li-
quidity trend reveals that FX spot market is
predominant in India compared to the liquidity
in FX swap. This trend is exactly the opposite to
the existing global trend, which shows that the
most traded segment is FX swap, followed by FX
spot. Furthermore, it has been observed that the
liquidity crisis in the UK, US, and Japanese FX
spot and swap markets may have had an ampli-
fied impact on the liquidity or NOSTRO position
of Indian commercial banks. The study advocates
that international integration may lead to more
efficient and easy mode of operation in terms
of funding, hedging and speculation. However,
banks must ensure that the necessary measures,
including the skill of dealing room operations,
are in place to address the stability constraints
of the market. Due to well-integrated liquidity
in INR and FCY legs, there is a chance of an in-
tensification of the volatility in exchange rates in
FX spot and FX swap market segments, which
might also have possible negative implications
for the real sector.
The development of robust infrastructure is
often recognized as a primary factor of growth
for an emerging market like India. The National
Infrastructure Pipeline (NIP) and National Mon-
etization Pipeline (NMP) announced by the gov-
ernment are crucial components for taking the
next big steps towards a comprehensive infra-
structure development plan and funding of such
a plan. Chapter 9, authored by Debasish Mallick,
has a focused discussion on the new develop-
ments that have taken place to attract public and
private funds to the Indian infrastructure sector.
The author demonstrates how development of
financial institutions and a monetization plan
by the Government of India (GOI) are going to
solve the issues pertaining to the financing of
big infrastructure projects. While examining the
Preface xxi
 challenges of providing long-term finance on a
large scale, the author thoughtfully argues that
the success of infrastructure build-up depends
on the tuneful interplay of various factors such
as the economic, social and political environ-
ment as well as evolving rules and regulations in
the sector and subsectors.
In Chapter 10, Naveen Kumar K., M. Manickaraj
and Sundeep Mohindru write about emerging
technological innovations in financing MSMEs
in India. The MSME sector contributes signifi-
cantly to India’s gross domestic product and em-
ployment generation. However, the sector often
faces substantial constraints in accessing finan-
cial services from banks and other financial in-
stitutions. In recent years, rapid digitalization has
enabled the leverage of advanced technologies in
financing MSMEs along with seamless user ex-
periences. This chapter presents various emerg-
ing technological innovations in the financing of
MSMEs in India. The use of technology is facili-
tating various stages of the financial cycle for the
small business segment. The authors have ad-
dressed the existing credit gap for MSME finance
and touched upon some of the cases in India to
provide a deeper insight into the matter. The au-
thors argue that the faster evolution of Fintech
and the necessary regulation and supervision of
digital lending will facilitate an enabling envi-
ronment for MSMEs.
In the current age of information technol-
ogy, India is making rapid progress in the field of
payments. Banks are utilizing those avenues to
reach out to customers. Along with various poli-
cies, the COVID-19 pandemic situation has per-
haps further quickened the DT process in India.
As per the RBI data, there has been a significant
increase in the volume of digital payments over
the last three financial years. Chapter 11, writ-
ten by Deepankar Roy and Paritosh C. Basu, dis-
cusses the topic of DT of banking operations. The
authors have presented a qualitative study that
looks at the practices of eight large banks across
four continents on the basis of evidence col-
lected from their annual reports and other pub-
licly available information. The salient features
and impacts of these banks’ DT journeys so far
have been extensively covered in the study. The
xxii INDIA BANKING AND FINANCE REPORT 2021
study identifies that, with focus shifting from a
product-based approach to a customer-centric
approach, banks are now trying to find the best
methods to make a customer’s journey entirely
seamless. Lessons drawn from the study findings
would serve as guidelines for Indian banks for
benchmarking. The authors have stressed the
need for establishing a creative culture within
organizations for successful DT of business.
Business disruptions caused by economic, regu-
latory and technological changes prompted banks
in India to rewrite their business strategies and
people policies in the past. Chapter 12 has been
written by B. Ashok and Shomi Srivastava. In this
chapter, the authors have explored new models of
leadership that would lead the banks through dis-
ruptions. The models should be in harmony with
the organizational structure and system architec-
ture supporting them. The main argument of this
chapter is to choose distributed leadership (DL) as
the need of the hour to lead the banks through
disruptions. The authors delineate the necessity to
move away from the top-heavy leadership model
and effectively channel the leadership potential
available at all levels of management.
The Reserve Bank of India has continued to
maintain its accommodative policy stance to sup-
port and revive growth and fight against an un-
known enemy. The emergence of a new variant,
Omicron, has increased the risk of re-infection,
which may delay the process of economic reviv-
al. There is a need to increase the flow of credit to
the productive sectors of the economy to acceler-
ate the pace of economic revival. Going forward,
innovating new digital payment solutions, ease
of credit to the MSME segment, digital literacy,
financial inclusion, improvement in governance
pattern in banks and better management of bad
loans will play a key role in enhancing bank per-
formance and providing stability to growth.
The publication of the report has provided us
with the opportunity to showcase the research
done at the NIBM for the banking and finance
sector. Along with the NIBM faculty members,
some industry experts have also joined with
them as co-authors. It needs to be noted that the
views expressed in their contributions are those
of the individual authors and not of the NIBM or Onkar Swami, Parthapratim Pal, Pratik Mitra,
its Governing Board. Siddhartha Roy, Usha Janakiraman, Vikas Sriv-
astava and Rajiv Kumar for reviewing various
We are grateful to the esteemed external re-
chapters of the India Banking and Finance Report
viewers for their valuable comments and con-
2021. Thanks are also due to the NIBM publica-
structive suggestions. All the chapters were
tion team for their support. We thank Rajesh
revised on the basis of their comments. We are
Dey and the SAGE team for the editorial support
indebted to Ajay Kumar Choudhary, Anup Sinha,
and production of the report.
Arpita Ghosh, Ashish Srivastava, Debasish Saha,

Preface xxiii
Macro-financial Perspectives
on the Indian Economy
G. Nagaraju and Partha Ray
1.1. Introduction
The perceived relationship between the real sec-
tor and the financial sector in any economy is
one of the most vexed issues in macroeconom-
ics. Views tend to differ widely in this regard. On
the one hand, there is a strong view that finance
provides a strong edifice to growth; on the other
hand, there is an equally influential view that fi-
nance tends to follow enterprise. Be that it may,
as a prelude to a number of contemporary and
diverse issues on Indian banking and finance in
India Banking and Finance Report 2021, this chap-
ter gives a synoptic account of recent macro-
financial development in India as well as some of
the global macroeconomic trends. The purpose
is to set the backdrop without any endeavour to
ensure completeness of treatment.
Global economic trends in the last two years
have emerged as the story of the COVID-19 pan-
demic and the human struggle. What started
with some stray episodes of infection in the Wu-
han province of China at the end of 2019 soon
flared up into a global pandemic by the end of
March 2020, causing a large-scale loss of life and
an unprecedented increase in morbidity. This af-
fected various aspects of human life; economic
activity across the globe was and continued to be
severely impacted. Pandemic containment mea-
sures, such as lockdowns and other restrictive
measures, literally halted many industries and
services. While short- to medium-term impacts
are widely expected, there is concern about long-
term scarring on production capacity as a result
of impairments such as loss of human education
and learning, and permanent closure of certain
businesses (IMF, 2021a).
1
Chapter
Along with human innovations in effective
vaccination, such a deep downturn in growth
has been met by swift, progressive and sizeable
actions by authorities all over the world. Specifi-
cally, unprecedented economic stimulus pack-
ages (comprising monetary, fiscal and structural
measures) were adopted in a number of coun-
tries, and India was no exception. In most of
the countries, apart from the stimulus package
there was regulatory forbearance in the finan-
cial sector in general and banking sector in par-
ticular. There were also measures to infuse large
amounts of liquidity and credit. All these mea-
sures, along with the revival of activities, could
have led to a substantial degree of exuberance in
some parts of the financial markets.
Going forward, even if 2022 appears to be a
year of recovery, the withdrawal of stimulus
measures can have an unwarranted impact on fi-
nancial markets. However, the decline in growth
in 2020 was so severe that it could take years for
the economy to fully recover and return to the
trajectory of old normal.
How long will it take for the economy to re-
cover? Does the current situation reveal a dis-
connect between the real and the financial sec-
tor? Will the problems with non-performing
assets (NPAs) be back in the banking sector?
This introductory chapter gives a synoptic ac-
count of some such questions. Needless to say,
this would be a comment on the current reality
in an evolving situation. Thus, there may not be
any finality of analysis in our treatment. Still,
this could provide a sense of perspective and
the context of many of the issues covered in the
current report.
 Table 1.1 GDP Growth (%)
Country Group Name 2015 2016 2017 2018 2019 2020 2021 (P)
World 3.4 3.3 3.8 3.6 2.8 –3.1 5.9
Advanced economies 2.3 1.8 2.5 2.3 1.7 –4.5 5.2
Major advanced economies (G7) 2.1 1.5 2.2 2.1 1.6 –4.9 5.3
European Union 2.5 2.1 3.0 2.3 1.9 –5.9 5.1
Emerging market and 4.3 4.5 4.8 4.6 3.7 –2.1 6.4
developing economies
Emerging and developing Asia 6.8 6.8 6.6 6.4 5.4 –0.9 7.2
China 7.0 6.9 6.9 6.8 6.0 2.3 8.0
India* 8.0 8.3 6.8 6.5 4.0 –7.3 9.5
Source: IMF (2021a).
Note: P: Projections; *Refers to fiscal year.

1.2. Global Economic Scenario reflected not only in advanced economies but
also in emerging and developing economies. This
Just before the pandemic, global gross domestic is indicative of the widespread impact of the pan-
product (GDP) grew by 2.8 per cent in 2019 (the demic, leaving no geography unaffected.
slowest rate since 2015); it dropped to a con-
traction of (–) 3.1 per cent in 2020. Admittedly, While most national authorities and interna-
growth rates all over the world suffered in 2020. tional organizations have indicated a turnaround
The pandemic appeared to have pulled down in 2021, such projections are fraught with two
growth, especially in the G7 and EU countries, key issues. First, the high positive growth since
including India. China emerges as the only ma- 2021 is associated with a low base after 2020, and
jor country that has shown positive, albeit small, assuming no further adverse shocks, it may take
growth during 2020 (Table 1.1). at least three years for the global economy to re-
cover and follow the previous trend. Second, the
It is important to note that the growth of the immediate future is still characterized by signifi-
global economy during 2020 turned out to be cant uncertainties, including the development of
the lowest over the 40-year period of 1980– newer variants of the virus.
2020 (Figure 1.1). This sharp dip in growth was
What has been the impact on the size of the
economies? A look at the GDP in current US dol-
10 lars allows one to discern two major traits. First,
8 with contraction in most of the economies in
6 2020, the absolute size of different economies
4 does not appear to show significant growth in
2 2021 with respect to 2019 (pre-pandemic year).
0 Second, in relative terms, the gaps between dif-
–2 ferent nations may have increased. In fact, the
–4 recovery process seemed to create wedges be-
–6
tween different parts of the world. The Interna-
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020

tional Monetary Fund (IMF) in its October 2021

World Advanced Economies World Economic Outlook commented, ‘The dan-
Emerging Market and Developing Economies gerous divergence in economic prospects across
countries remains a major concern’ (p. xiii).
Figure 1.1 Global GDP Growth (%)
Another discomfort in global economic sce-
Source: IMF (2021a).
nario has been the emergence of inflationary

2 INDIA BANKING AND FINANCE REPORT 2021

 Table 1.2 Consumer Price Inflation (Average) (%)
Country Group Name 2015 2016 2017 2018 2019 2020 2021 (P)
World 2.7 2.7 3.2 3.6 3.5 3.2 4.3
Advanced economies 0.3 0.7 1.7 2.0 1.4 0.7 2.8
Major advanced economies (G7) 0.3 0.8 1.8 2.1 1.5 0.8 3.0
European Union 0.1 0.2 1.6 1.8 1.4 0.7 2.4
Emerging market and 4.7 4.3 4.4 4.9 5.1 5.1 5.5
developing economies
Emerging and developing Asia 2.7 2.8 2.4 2.7 3.3 3.1 2.3
China 1.4 2.0 1.6 2.1 2.9 2.4 1.1
India* 4.9 4.5 3.6 3.4 4.8 6.2 5.6
Source: IMF (2021a).
Note: P: Projections; *Refers to fiscal year.

concerns all over the world. Since the beginning
of 2021, consumer price inflation has increased
in both advanced and many of the emerging and
developing economies (Table 1.2). Such inflation-
ary pressures were driven by supply shortages,
an incipient firming of demand and increased
commodity prices. In the current situation, it is
not yet known how economies around the world
are dealing with the two problems of slowing
growth and rising inflation.
1.3. Recent Trends in Growth
and Inflation in India
Due to various factors, including the global re-
cession, India was already experiencing a down-
turn in economic growth before the COVID-19
crisis in India. The GDP growth rate, which had
reached a high of 8.9 per cent (year-on-year in
Q4 of 2017–2018), was on a downward trend
quarter after quarter and had reached a low of
3.0 per cent in Q4 of 2020–2021 at the time when
the COVID-19 pandemic hit India.
and disturbed the whole rhythm of economic
activity, which was feared to take a long time to
normalize.
As the unlocking process began in June 2020,
economic activity slowly resumed, and by De-
cember 2020, when most lockdown restrictions
were revoked, economic recovery was percep-
tibly in place. The recovery process was amply
supported by massive support measures initi-
ated by both the GOI and the Reserve Bank of In-
dia as part of policy action to fight the COVID-19
pandemic. As the recovery progressed, the sec-
ond quarter of 2020–2021 showed slightly better
growth of (–)7.4 per cent, and by the third and
fourth quarters of 2020–2021, the growth rate
had shifted into positive territory (Figure 1.2).
The fiscal year 2020–2021 ended up with a net
contraction of 7.3 per cent.
25
20.13
20
15 8.93
10
8.39
Percent

5
The nationwide lockdown that was imposed
0
on 24 March 2020 and the general fear of un-
Sep 08
Mar 09
Sep 09
Mar 10
Sep 10
Mar 11
Sep 11
Mar 12
Sep 12
Mar 13
Sep 13
Mar 14
Sep 14
Mar 15
Sep 15
Mar 16
Sep 16
Mar 17
Sep 17
Mar 18
Sep 18
Mar 19
Sep 19
Mar 20
Sep 20
Mar 21
Sep 21

–5
known fallout from the pandemic among the –10
–15
people virtually crippled the functioning of the
–20
economy. Except for the emergency and essen- –25 –24.43
tial services, the whole economic activity came –30
to a grinding halt for the period of the lockdown, Figure 1.2 Quarterly Growth Rates of Indian GDP (Year-on-year)
which lasted for about two months. This resulted Source: Economic Outlook, CMIE.
in a large-scale loss of output and employment,

Macro-financial Perspectives on the Indian Economy 3

 Just as the economy was returning to normal,
India was hit by a more virulent second wave of
coronavirus infections. In March 2021, double
mutant ‘Delta’ variant infections swept across the
nation, causing a serious health crisis and result-
ing in a large number of deaths. The daily average
infection rate in April and May reached a new
high of 4 lakh, with causalities nearing 5,000.
The second wave of COVID-19 in India raised
additional concerns about economic fallout as
several state governments imposed new restric-
tions and protocols. Fortunately, economic activ-
ity remained much more resilient during the sec-
ond wave. This was mainly due to the fact that
there was a better understanding of the virus
and people had learnt to continue working un-
der pandemic conditions. Many businesses had
adopted alternative modes of delivery. There was
a large-scale adoption of new information tech-
nology (IT)-enabled delivery modes, particularly
in service sectors like education. Where physical
presence was necessary, such as in manufactur-
ing and contact-intensive services, widespread
adoption of COVID-19 protocols enabled contin-
ued operations (Government of India, 2021b).
As the second wave of infections subsided, the
economic activity resumed its upward trend.
The first quarter of 2021–2022 achieved output
growth of 20.3 per cent (the high growth rate was
mainly due to a lower base), and as the recovery
continued, the second quarter saw growth of 8.5
per cent, which was higher than the RBI’s fore-
cast. The central bank anticipates that the recov-
ery will continue, with growth of 9.5 per cent in
fiscal year 2021–2022 (RBI, 2021f). The rate, how-
ever, was revised downward by NSO to 8.95 per
cent in the second advanced estimates released
on 28th February 2022.
How did the pandemic event reflect on the sec-
toral output? Table 1.3 shows that the majority of
the output losses during the pandemic were com-
ing from the industry sector, which accounts
for approximately 30 per cent of the total out-
put. Output losses were maximum in industries
such as construction and manufacturing, both
of which are known to be sensitive to economic
outlook sentiments. The services sector, which
has the largest contribution of about 57 per cent
of total gross value added (GVA), was relatively
less affected by the pandemic. Within the sec-
tor, the financial services sector was the least
affected and recovered quickly. Output from
agriculture was by and large unaffected by the
pandemic. Because of adequate rainfall and easy
labour supply, this sector was able to maintain an
output growth rate of 3–4.5 per cent throughout

Table 1.3 Quarterly Growth Performance of Sectoral GVA (at 2011–12 Prices) (Per cent)

Q1 Q2 Q3 Q4 Q1 Q2 Q3
2020– 2020– 2020– 2020– 2021– 2021– 2021–
21 21 21 21 22 22 22
1. Agriculture & allied 3.0 3.2 4.1 2.8 3.5 3.7 2.6
2. Industry –33.7 0.6 6.3 13.4 46.6 7.0 0.2
Mining and quarrying –17.8 –7.9 –5.3 –3.9 17.6 14.2 8.8
Manufacturing –31.5 5.2 8.4 15.2 49.0 5.6 0.2
Electricity, gas, water, etc. –14.8 –3.2 1.5 3.2 13.8 8.5 3.7
Construction –49.4 –6.6 6.6 18.3 71.4 8.2 –2.8
3. Services –20.8 –10.8 –0.9 2.1 10.5 10.2 8.2
Trade, hotels, etc. –49.9 –18.8 –10.1 –3.4 34.3 9.5 6.1
Financial, real estate, etc. –1.1 –5.2 10.3 8.8 2.3 6.2 4.6
Public administration –11.4 –10.2 –2.9 1.7 6.3 19.5 16.8
4. GVA at basic prices –21.4 –5.9 2.1 5.7 18.4 8.4 4.7
Source: Economic Outlook, CMIE.

4 INDIA BANKING AND FINANCE REPORT 2021

 Table 1.4 Quarterly Growth Performance of Sectoral GDP (2021–2022 Prices; %)
Q4 Q1 Q2 Q3 Q4 Q1 Q2
2019– 2020– 2020– 2020– 2020– 2021– 2021–
2020 2021 2021 2021 2021 2022 2022
GPFCE 2.0 –26.2 –11.2 –2.8 2.7 19.3 8.6
GFCE 12.1 12.7 –23.5 –1.0 28.3 –4.8 8.7
GCF –0.7 –47.7 –8.0 3.0 13.8 56.7 17.3
GFCF 2.5 –46.6 –8.6 2.6 10.9 55.3 11.0
Exports –8.8 –21.9 –2.0 –3.5 8.8 39.1 19.6
Imports –2.7 –40.9 –17.9 –5.0 12.3 60.2 40.6
GDP 3.0 –24.4 –7.4 0.5 1.6 20.1 8.4
Source: Economic Outlook, CMIE.

the period. Overall, GVA substantially recovered
from the pandemic effect, and it is expected to
close at marginally higher level in the fiscal year
2021–22 when compared with pre-pandemic
level of 2019–20.
How did the demand side of the economy
perform? From Table 1.4, it can be seen that the
pandemic severely impacted gross private final
consumption expenditure (GPFCE), the largest
and most stable component of total demand.
The GPFCE contracted by 26.2 per cent in Q1 of
2020–2021, which was possibly unprecedented
in India. Similarly, there was a large dip in the
level of gross capital formation (GCF). While job
losses and higher precautionary savings contrib-
uted to the reduction in GPFCE, the fear of un-
certainty and bleak economic outlook accounted
for the fall in GCF.
As the economy stabilized and the recov-
ery process started, demand variables regained
momentum. While GPFCE bounced back with
19.3 per cent and 8.6 per cent in Q1 and Q2 of
2021–2022, respectively, GCF improved by 56.7
per cent and 17.3 per cent, respectively, in the
same period. However, in terms of actual lev-
els, both the components have barely regained
their pre-pandemic levels and are expected to
exceed them in the coming quarters, provided
the growth conditions continue to be favourable.
During the pandemic period, India experi-
enced a severe contraction in international trade
as its exports and imports contracted signifi-
cantly. However, the recovery process reversed
the trend in international trade as both exports
and imports posted very high growth rates in the
post-pandemic period. As of Q2, 2021–2022, the
growth rates of India’s exports as well as imports
have been the highest in the history of India in
terms of volume. The continued performance of
the external sector, particularly the maintained
tempo of export growth rate, is very crucial for
India’s recovery process.
How was the performance of India on the in-
flation front during the pandemic? There were
a number of forces at work on the inflationary
front. First, because of the lockdown, there was
an adverse supply shock. Second, because of
the adverse job-related effects of the pandemic,
demand was also badly affected. Depending on
the relative strengths of the two effects, the net
impact on inflation could be either positive or
negative. Finally, because of the huge liquidity
injection and the flow of money into the asset
markets, there may be asset price inflation. On
the whole, inflation during the pandemic period
remained within moderate limits, though there
were some anxious moments at some point in
time. General consumer price index (CPI) infla-
tion, which is also the rate targeted by the RBI
for its monetary policy, rose above 6 per cent
(the upper band of the flexible inflation target-
ing regime of the RBI) in May and June 2021, but
then moderated subsequently to 5.3 per cent in
August and later to 4.48 per cent in October 2021
(Table 1.5). More recently, inflation has been grad-
ually on a rising path since then and it crossed 6
percent in January 2022.

Macro-financial Perspectives on the Indian Economy 5

 Table 1.5 Trends in CPI (2012 = 100) Inflation (%)
Pan, Fuel
Food and Tobacco, Clothing & & General
Beverages etc. Footwear Housing Light Miscellaneous Index
Weights 45.86 2.38 6.53 10.07 6.84 28.32 100
Feb 21 4.25 10.70 4.21 3.23 3.53 6.82 5.03
Mar 21 5.24 9.87 4.41 3.5 4.43 6.95 5.52
Apr 21 2.60 9.01 3.49 3.73 7.98 6.12 4.23
May 21 5.24 10.03 5.32 3.86 11.86 7.25 6.3
Jun 21 5.58 3.98 6.14 3.75 12.61 7.21 6.26
Jul 21 4.46 4.71 6.39 3.86 12.38 6.71 5.59
Aug 21 3.73 4.01 6.84 3.9 12.95 6.40 5.3
Sep 21 1.61 4.23 7.16 3.58 13.63 6.38 4.35
Oct 21 1.76 4.22 7.46 3.54 14.19 6.83 4.48
Source: Online Handbook of Statistics on Indian Economy, RBI.

1.4. Fiscal and Monetary 1.4.1. Fiscal Policy Measures in India

Policy Stimulus Measures
The COVID-19 crisis promoted large-scale sup-
port measures by governments all over the
world. Owing to the enormity of the human
crisis, governments responded with a spirit of
‘whatever it takes’1 and announced unprec-
edented policy actions in terms of both fiscal
policy and monetary policy.2
According to the IMF report, advanced coun-
tries in general spent much more than develop-
ing and less developed countries on COVID-19
measures. While advanced countries spent 17.3
per cent more of their GDP, emerging market
economies spent 4.1 per cent more of their GDP,
and low-income countries spent 2 per cent more
of their GDP (IMF, 2021d).
In line with the global response, India also
launched a massive policy action to fight the
COVID-19 crisis. While fiscal policy measures
generally target the alleviation of problems faced
by households and other vulnerable and weaker
sections of the population, monetary policy
measures target stress in the financial markets.
In the following sections, a few important
measures are highlighted.
The lockdown announcement was immediately
followed up by large-scale relief and welfare
measures in the form of the Pradhan Mantri
Garib Kalyan Package on 26 March 2021. The
scheme was intended to provide, inter alia,
food security to a large section of the poorer
households who might have lost their livelihood.
Under this scheme, free food grains were distrib-
uted to poor and vulnerable households under
the public distribution system. The scheme has
benefitted 80 crore people and is said to be the
world’s largest free food grain distribution pro-
gramme to date. Although originally intended
to last for three months, the scheme has been
extended four times and is currently being con-
tinued up to March 2022.3 The total cost was
originally estimated at `1.70 lakh crore but was
later revised upwards.4
As the nationwide complete lockdown ended
in May and the process of phase-wise unlocking
began, the government announced a series of
stimulus measures and other measures aimed at
reviving economic activity. These measures were
announced as part of a larger strategic campaign to
promote self-reliance called Atmanirbhar Bharat
Abhiyan (ABA), which was announced in three
different phases (Government of India, 2020).5

6 INDIA BANKING AND FINANCE REPORT 2021

 One of the important measures under the ABA
programme is the Emergency Credit Line Guar-
antee Scheme, which aims to provide a 100 per
cent collateral-free credit guarantee to COVID-19
crisis-affected MSMEs for their additional bor-
rowings. The ABA scheme also includes measures
to induce a faster recovery of economic activity.
In this direction, in order to provide incentives for
higher production and exports, the government
announced ‘production-linked incentive’ scheme.
Firms in 10 identified sectors are given incentives
to produce more than the production benchmark
under this scheme. This scheme has a large cash
outgo of `1.4 lakh crore for the government.
Similarly, under this larger ABA programme,
several other schemes have been announced with
different objectives, such as enabling employment
generation, boosting demand in real estate, pro-
viding housing in urban areas, capital infusion in
certain industries, equity to infra debt financing,
etc. The total financial burden for the government
on all the measures with cash outgo is estimated to
be `1,716,441 crore over a period of time. The fis-
cal outflow accounts for about 8.7 per cent of total
GDP in 2021–2022 (Government of India, 2020).
The unexpected COVID-19 crisis-related ex-
penditure put a heavy burden on the govern-
ment finances. The fiscal deficit, which was orig-
inally budgeted at `7.96 lakh crore (3.5% of GDP),
was eventually revised to `18.48 lakh crore, con-
stituting 9.5 per cent of GDP (PRS Legislative Re-
search, 2021).
by the RBI revealed the following objectives:
(a) minimizing the adverse macroeconomic im-
pact of the COVID-19 pandemic and associated
lockdowns; (b) enhancing effective transmission
of monetary policy, (c) preserving financial stabil-
ity, (d) easing financial strain on both households
and businesses, (e) facilitating trade through the
availability of credit and payment services and
(f) maintaining a smooth and regular flow of cur-
rency across the country (Mohan, 2021).
As a first step towards the COVID-19 policy
measures, the Monetary Policy Committee decid-
ed to cut the policy repo rate by 75 basis points,
from 5.15 per cent to 4.40 per cent, at an off-cycle
meeting on 27 March 2020. This was followed by
another 40 basis points cut in May 2020, for a to-
tal of 115 basis points cut in the repo rate while
keeping it at 4 per cent. At the same time, the RBI
cut the reverse repo rate to 3.35 per cent, which
made the policy rate corridor wider by an addi-
tional 40 basis points, over and above the usual
50 basis points and made the corridor asymmet-
ric on the lower side. The asymmetric corridor
was intended to disincentives the banks from
parking excess liquidity with RBI (Figure 1.3).
In the wake of the COVID-19 crisis, the RBI re-
sorted to using some unconventional measures,
which were hitherto never used, such as asset
purchase and forward guidance (RBI, 2021a).
These measures include long-term repo opera-
tion (LTRO), targeted long-term repo operations
(TLTRO), on-tap TLTRO, for the benefit of specific

1.4.2. Monetary Policy Measures 6

The Reserve Bank of India used almost all the av- 5.5
WACR Riparty Repo
enues of intervention that it had at its disposal 364 Day TB Cut Off Reverse Repo
5
MSF Rate
Per cent

as the central bank of India in order to maintain 4.5

stability in the financial markets and also support 4
economic activity during the pandemic times. The 3.5
policy measures include monetary policy mea- 3
sures (cutting interest rates), liquidity management 2.5
measures (bond purchases), regulatory measures 2
Jul 20

Jul 21
Jun 20

Jun 21
Dec 19

Dec 20
Oct 19

May 20
Jan 20

Oct 20

May 21
Apr 20

Aug 20

Jan 21

Oct 21
Apr 21

Aug 21
Sep 19

Feb 20
Mar 20

Sep 20

Feb 21
Mar 21

Sep 21
Nov 19

Nov 20

(regulatory forbearance) and other measures such

as fiscal cooperation, easing of collateral norms,
expanding the eligibility norms of borrowers, re-
Figure 1.3 Money Market Rates—Weighted Call Market and Weighted
laxing prudential norms like capital charges and Tri party Repo Rate and 364-day TB Primary Auction Cut-off
regulatory forbearance.6 A comprehensive analy-
Source: Economic Outlook, CMIE.
sis of the COVID-19 relief measures implemented

Macro-financial Perspectives on the Indian Economy 7

 sectors, including the 26 sectors identified by the
Kamath Committee as the most affected in the
COVID-19 crisis (RBI, 2020a).
The RBI announced several regulatory mea-
sures and relaxations to address the stress of the
COVID-19 crisis-hit borrowers, including individu-
als, MSMEs and corporates. Some of the borrowers,
who were otherwise standard account holders,
needed restructuring of payment servicing as their
cash flows were hit due to lockdown, including re-
strictions under the special resolution framework
announced by the RBI (RBI, 2020d, 2021b).
Given the diverse nature of the measures (li-
quidity-inducing, regulatory, forward guidance
and others), the task of putting up a consolidated
figure is fraught with difficulties. However, a
consolidated measure of liquidity injection on
various COVID-19 crisis-related measures over
the period of February 2020 to September 2021
was `17.22 lakh crore, which is about 8.7 per cent
of the GDP of 2020–2021 (Table 1.6).
Table 1.6 Liquidity Measures by RBI during February 2020 through
September 2021 (` Crore)
Facility Amount
LTRO 200,000
Variable rate repo 225,000
SLF for PDs 7,200
CRR cut 137,000
MSF (dip by additional 1% in SLR) 137,000
TLTRO 100,000
TLTRO (2.0) 50,000
Net OMO purchases including G-SAP 370,000
Special liquidity facility for mutual funds 50,000
Refinance to NABARD, Small Industries Development 141,000
Bank of India (SIDBI), NHB and EXIM Bank
Special liquidity scheme for NBFCs 30,000
56-day term repo 100,000
On Tap TLTRO 100,000
SLTRO for small finance banks 10,000
Term liquidity facility to emergency health services 50,000
On-tap liquidity window for contact-intensive sectors 15,000
Total 1,722,200
As per cent of nominal GDP for 2020–2021 8.7
Source: RBI (2021c).
8 INDIA BANKING AND FINANCE REPORT 2021
1.5. Trends in Financial
Markets
The timely and appropriate policy actions taken
by the GOI and the RBI were largely successful
in restoring order to financial market conditions
in India. The ample liquidity induced by the RBI
quickly resolved the distress conditions in the fi-
nancial markets and ensured smooth operation
of payments system in India. The rate cut, initi-
ated by the RBI, percolated to lending rates and
bond yields as India saw historically low inter-
est rates post the policy measures. Foreign capital
flows enabled by liberal global liquidity condi-
tions accentuated the recovery process in Indian
capital and financial markets. How did the pro-
cess play out? What are the broad patterns of this
recovery process? Some account of these devel-
opments in some of the important financial mar-
kets, namely the money market, bond market,
equity market and foreign exchange market (FX
market), is as follows.
1.5.1. Money Market
A number of initiatives by the RBI ensured ad-
equate liquidity in the money market, and all the
segments of the short-term markets remained in
orderly and stable conditions all through the pan-
demic period. Initially, some traces of strains were
noticed in the call money market as the average
rate reached 5.35 per cent on 26 March 2020, up
from 5.10 per cent the previous working day, but
this was quickly reversed and rates came down
in the subsequent trading days. Similarly, traces
of strain were noticed in the certificate of deposit
(CD) market when rates hit 8.8 per cent in March
2020 from 7.16 per cent in February 2020, but rates
came down to lower levels quickly in the subse-
quent months. Other markets such as the triparty
repo market and term markets like the commer-
cial paper (CP) market did not show much volatil-
ity in rates at the time of the pandemic onset. Over
time, however, due to surplus liquidity, rates in all
the markets in general went down.
The eased liquidity conditions were also vis-
ible in the improved trading volumes in all seg-
ments of the money market in general. The daily
average volumes, as reflected collectively in the
three overnight markets, namely call money,
 400
350
322
300
250
`1,000 Cr
239 222
200
189 163
150
120
100 89
60
50 50
18 17 11
0 –400,000
2018–19 2019–20 2020–21
Call Money Market Repo
Triparty Repo Total
Figure 1.4a Daily Average Volume of Money
Market (` Thousand Crore)
Source: Monthly Review of Economy, CCIL, October
2021.
Figure 1.4 Condition of the Money Market
market repo and triparty repo markets, have
shown a significant increase in the pandemic
years 2020–2021 and 2021–2022 (up to Septem-
ber; Figure 1.4a).
The surplus liquidity conditions were evident
in the reverse repo absorptions of the RBI under
LAF. Net absorptions were strikingly high dur-
ing the pandemic compared to previous years,
hovering around `3 to 4 lakh crore per day dur-
ing 2020–2021 and most of the 2021–2022 finan-
cial year (Figure 1.4b). At the same time, the total
durable liquidity, which includes reverse repo
absorption, excess reserves and government
deposits with the RBI, was maintained at about
`9–10 lakh crore (Patra, 2021).
1.5.2. Government Securities Market
At the onset of the COVID-19 pandemic in India,
the GOI stepped up its market borrowing pro-
grammes to meet the substantially higher relief
measures it had announced.7 As banker and debt
manager to the government, the RBI had the chal-
lenge of raising funds for the government without
impacting the rest of the financial markets and, at
the same time, keeping the cost of borrowing at
the minimum possible level. The challenge was
particularly stiff in light of the higher volume of
borrowing involved and at a pandemic time when
markets undergo liquidity strain as such.
50,000
364 8.712
0
–50,000 –9,633 –20,301
266 –58,606
–100,000
–92,935
Crores
–150,000
–200,000
–250,000
90
–300,000
8 –350,000 –325,666
–371,773
2021–22
2015–16
2016–17
2017–18
2018–19
2019–20
2020–21
2021–22 Oct
Figure 1.4b Average Daily Net Liquidity
Absorption in LAF Operations (` Crore)
Source: Compiled from RBI Source.
The RBI, however, managed to complete the
government’s historically high borrowing with-
out negatively impacting yields (Figures 1.5a and
1.5b). Further, the RBI, through various opera-
tions (some of which are described below), effec-
tively managed to bring down the yields signifi-
cantly during the pandemic period. Prior to the
pandemic, the one-year rate was around 5.5 per
cent, which traded at the lowest of 3.5 per cent
in December 2020 and is currently at about 4 per
cent. The longer-term bonds were also corrected
in a similar fashion.
As previously mentioned, the RBI relied on
large-scale secondary market purchases in open
market operations to lower the yields on both
short- and long-term bonds.8 During the pan-
demic year 2021–2022, the RBI purchased bonds
worth `3.13 lakh crore, including state govern-
ment bonds worth `30,000 crore. With such a
purchase, RBI’s ownership of government secu-
rities in total outstanding increased from 14.72
per cent in December 2019–2020 to 17.11 per
cent in June 2021, a historical high in the recent
past. The aggressive bond purchases by the RBI
have created an appetite for bonds in the market
and induced continued subscriptions for primary
auctions at lower yields.
Second, the RBI has actively performed ‘Op-
eration Twist’ wherein the RBI would purchase
Macro-financial Perspectives on the Indian Economy 9
 16.00
16.00 9.0
9.0
13.70
13.70 11.43
11.43
14.00
14.00
8.0
8.0
12.00
12.00

Crores
Lakh Crores
5.9
5.9
10.00
10.00 4.74
4.74 7.0
7.0
6.2
6.2
8.00
8.00 7.10
7.10
`` Lakh

6.0
6.0
6.00
6.00
5.0
5.0 5.2
5.2
4.00
4.00
11yyRM
RM 55yyRM
RM
2.00
2.00 4.0
4.0
10
10yyRM
RM 15
15yyRM
RM
0.00
0.00
3.5
3.5
2011–12
2011–12
2012–13
2012–13
2013–14
2013–14
2014–15
2014–15
2015–16
2015–16
2016–17
2016–17
2017–18
2017–18
2018–19
2018–19
2019–20
2019–20
2020–21
2020–21
3.0
3.0

Dec 14
14

Dec 15
15

Dec 16
16

Dec 17
17

Dec 18
18

Dec 19
19

Dec 20
20
Jun 15
15

Jun 16
16

17
Jun 17

Jun 18
18

Jun 19
19

20
Jun 20

Jun 21
21
Dec

Dec

Dec

Dec

Dec

Dec

Dec
Jun

Jun

Jun

Jun

Jun

Jun

Jun
Gross
GrossAmount
Amount Net
NetIssuance
Issuance

Figure 1.5a Primary Issues of Government Figure 1.5b Weighted Average Yields on
Securities Government Securities in Secondary Market
Source: RBI. Source: Economic Outlook, CMIE.

Figure 1.5 Trends in Government Securities Market

longer-term bonds and at the same time sell corporate debt, indicating an increasing ap-
shorter-term bonds in a liquidity-neutral man- petite for corporate debt in the market (Figure
ner so as to compress the longer term yields and 1.6b).
facilitate effective monetary policy transmis-
The appetite for debt seems to have stemmed
sion. Such moves appeared to have played a key
from the fact that corporates have improved
role in keeping the secondary market yields low,
their performance and strengthened their bal-
thereby assisting the lower cut-off in RBI auc-
ance sheets over the last two years. In July 2021,
tions for primary issues (RBI, 2021a).
The Financial Stability Report of the RBI mentions
that among the surveyed corporates, there is a
1.5.3. Corporate Bond Market general improvement in their sales, leverage and
The corporate bond market is playing an increas- cash positions to get them through the uncertain
ingly important role in the Indian financial sys- times of the pandemic (RBI, 2021d).
tem. With a total outstanding of `36.1 lakh crore
at the end of 2020–2021, this market constitutes 1.5.4. Equity Market
about 18 per cent of GDP and is nearly half the The equity market reacted sharply to the
size of government securities outstanding. The COVID-19 pandemic in the initial period. In
corporate bond market quickly recovered from March 2020, the board market index National
the COVID-19 impact and continued their fund- Stock Exchange Fifty (NIFTY) went down by
raising programme even during the pandemic 30 per cent from its previous high, made in
years, though a minor blip was observed during December 2019, reaching 8,500, the level that
the second wave of COVID-19 infections during prevailed in 2016. However, subsequent to the
March–July 2021. The corporate bond market announcement of relief measures by the GOI
saw issues worth `2–2.5 lakh crore throughout and the RBI, the index retraced all the losses
the pandemic year, which is above the 5-year quickly and proceeded to climb to historic highs.9
average (Figure 1.6a). The number of new issues The boom was reflected in the historically
was also kept in tandem with the volume. There high market capitalization. For the first time
was a moderation even in the risk premium of in history, NSE market capitalization exceeded

10 INDIA BANKING AND FINANCE REPORT 2021

 3.00
3.00 3.50
3.50 12.0
12.0 1.40
1.40
1.20
1.20
2.50
2.50 3.00
3.00 10.0
10.0
1.00
1.00

Number (Thousands)

Spread (Per cent)

Yields (Per cent)
2.50
2.50 8.0
8.0 0.80
0.80
Volume (` Lakh Cr)

2.00
2.00
0.60
0.60
2.00
2.00 6.0
6.0
1.50
1.50 0.40
0.40
1.50
1.50 4.0
4.0 0.20
0.20
1.00
1.00 0.00
0.00
1.00
1.00 2.0
2.0
–0.20
–0.20
0.50
0.50 0.50
0.50 0.0
0.0 –0.40
–0.40

Mar 14
Dec 14
Sep 15
Jun 16
Mar 17
Dec 17
Sep 18
Jun 19
Mar 20
Dec 20
Sep 21
0.00
0.00 0.00
0.00
Sep 16
Mar 17
Sep 17
Mar 18
Sep 18
Mar 19
Sep 19
Mar 20
Sep 20
Mar 21
Sep 21

10
10 yy Gsec
Gsec Yield
Yield 10
10 yy AAA
AAA Paper
Paper Yield
Yield

Volume
Volume Number
Number Risk
Risk Spread
Spread

Figure 1.6a Primary Issues of Corporate Bonds Figure 1.6b Corporate Bond Spread (10-year
(` Lakh Crore) Bond over 10-year G-Sec)
Source: Economic Outlook, CMIE. Source: Economic Outlook, CMIE.

Figure 1.6 Trends in the Corporate Debt Market

20,000
20,000 45
45 250
250 1.2
1.2
39.7
39.7 17,672
17,672
18,000
18,000 1.03
1.03
40
40 0.99
0.99
11
Market Cap (` Lakh Cr)

16,000
16,000 35
35 200
200
Nifty P/E Multiple

Market Cap/GDP
14,000
14,000 0.8
0.8
30
30
12,000
12,000 150
150
NIFTY

25
25
10,000
10,000 0.6
0.6
20
20 100
100
8,000
8,000
15
15 0.4
0.4
6,000
6,000
10
10 50
50
4,000
4,000 0.2
0.2
2,000
2,000 55
00 00
00 00
2005–06
2007–08
2009–10
2011–12
2013–14
2015–16

2017–18
2019–20
Mar 19

Mar 20
Jun 19

Jun 20
Dec 18

Dec 19

Dec 20
Sep 19

Sep 20

P/E
P/E ratio
ratio of
of Nifty
Nifty Nifty
Nifty Market
Market Cap/GDP
Cap/GDP Market
Market Cap
Cap

Figure 1.7a Trend in NIFTY and Price–Earnings Figure 1.7b NSE Market Capitalization
Multi ples Source: Economic Outlook, CMIE.
Source: Economic Outlook, CMIE.

Figure 1.7 Trends in Equity Market

nominal GDP as the ratio of market capitalization kind are natural to occur, particularly at a time
to GDP showed 1.03 in 2020–2021 (Figure 1.7b). when there was a continuing pandemic in the
backdrop of the performance.10 Although it is not
Has the equity market shown too much exu-
intended to take up these questions in greater
berance? Is there a risk of an asset market bub-
detail here, as a first-cut measure, we plotted the
ble busting in the near future? Questions of this

Macro-financial Perspectives on the Indian Economy 11

 price–earning (P–E) multiples of Nifty stocks
against the index itself. Figure 1.7a shows that
there is some moderation of P–E multiples, par-
ticularly in the later period, while the index has
continued to rise. Although this is not a decisive
finding against the overvaluation argument, it
does not provide evidence in its support. How-
ever, one cannot ignore the fact that equity
markets benefitted from global liquidity and re-
versing the COVID-19 policy measures poses an
immediate risk to the market.
1.5.5. Foreign Exchange Market
At the onset of the COVID-19 pandemic, the
rupee quickly depreciated by 2–6 per cent
against different major international curren-
cies. However, in subsequent quarters, on the
strength of favourable capital flows and eco-
nomic recovery, the rupee halted its depre-
ciation and even showed some appreciation
against the USD and JPY (Figure 1.8a). As capi-
tal inflows increased, the RBI purchased a sub-
stantial amount of foreign exchange to prevent
the rupee from appreciating.11
What prompted the capital inflows into India?
Enabled by easy monetary conditions across
the globe in the COVID-19 times, foreign capital
found India as a favourable avenue for invest-
ment. The outperformance of Indian corporates
and the latent recovery trends in the post-pan-
demic period drew significant foreign portfolio
investment (FPI) and foreign direct investment
(FDI) into India. India received the highest ever
capital flows in a quarter during Q3 of 2020–
2021, amounting to USD 38.6 billion, of which
net FPI constituted USD 21.2 billion (Figure 1.8b).
The forward segment of the FX market is
usually less volatile than the spot market in
India. However, during the pandemic time,
particularly during the first half of 2021–2022,
the forward market in India showed unusu-
ally high volatility. As capital flows increased,
many factors played out, pushing the premium
across the tenors to rise beyond interest rate dif-
ferentials. For instance, large-scale RBI’s inter-
vention in the spot and swapping the position
for future delivery seems to have stiffened the
12 INDIA BANKING AND FINANCE REPORT 2021
interbank forward premiums. Premiums were
also pushed up by forward cover demand by
FPIs who provided large amounts of capital for
high-volume IPOs during the same time period.12
Forward premiums did, however, fall to lower
levels in the subsequent period (Figure 1.8c), but
the whole episode raises broader questions re-
garding the vulnerability of the forward market
in India.
1.5.6. Banking Trends
Indian banking was facing rough weather much
before the onset of the COVID-19 pandemic in
India. Starting with the asset quality review
(AQR) conducted by the RBI in 2015–2016,
many banks in India, particularly public sector
banks (PSBs), were facing serious problems with
NPAs and the losses resulting therefrom. The
AQR was followed by a long period of bank-
ing book consolidation and business process
improvement, including customer service, risk
management, digitalization, etc. The process
was also supplemented by regulatory reforms
by the RBI in terms of prudential regulations re-
lated to asset classification, income recognition
norms, risk management practices and systems,
etc. As owner of PSBs, the GOI undertook sev-
eral reformatory measures to improve the func-
tioning of PSBs.13
The concerted efforts made in this direction by
all parties, including the government, regulatory
authorities and banks themselves, started yield-
ing favourable results in about three years’ time
when the COVID-19 pandemic occurred. Dur-
ing the pandemic period, there was widespread
concern that banks’ asset quality would deterio-
rate again. However, fortunately, banking asset
quality did not show any serious deterioration,
courtesy timely actions by the RBI and the GOI
(RBI, 2020e). Table 1.7 shows that between March
2018 and March 2021, the gross NPAs of Indian
banking reduced from `10.9 lakh crore to `8.31
lakh crore, a reduction of 24 per cent. The major-
ity of the reduction has come from PSBs, which
reduced their gross NPAs by 32 per cent during
the same period, from `8.9 crore to `6.1 crore.14
As of March 2021, PSBs still hold the lion’s share
of gross NPAs, accounting for 74 per cent of total
 4 4 50.0
50.0

2 2 40.0
40.0 38.6
38.6

0 0 30.0
30.0

USD Billion
USD Billion
Percent
Percent

20.0
20.0
–2 –2
10.0
10.0
–4 –4
0.00.0

Jun 19
Jun 19
Sep 19
Sep 19
Dec 19
Dec 19
Mar 20
Mar 20
Jun 20
Jun 20
Sep 20
Sep 20
Dec 20
Dec 20
Mar 21
Mar 21
Jun 21
Jun 21
Sep 21
Sep 21
–6 –6
–10.0
–10.0
USD
USD GBP
GBP EUR
EUR JPYJPY
–8 –8
–20.0
–20.0
Mar 20
Mar 20

Mar 21
Mar 21

Jun 21
Jun 20
Jun 20

Jun 21
Dec 19
Dec 19

Dec 20
Dec 20

Sep 21
Sep 19
Sep 19

Sep 20
Sep 20

Sep 21
Net
Net
FDIFDI Net
Net
FPIFPI Net
Net
Total
Total

Figure 1.8a Currency Appreciation(+)/ Figure 1.8b Net FDI and Net FPI Flows
Depreciation(–) (y-o-y) Source: CMIE.
Source: CMIE.

6.5 6.0
6.0
5.5
5.5
4.8
Percent

5.0

4.5

4.0

3.5
3.8
3.0
Mar 21
Mar 20

May 21
May 20

Aug 21
Aug 20

Apr 21
Apr 20

Jun 21
Jun 20

Jul 21
Jul 20

Jan 21

Nov 21
Nov 20

Oct 21
Oct 20

Sep 21
Feb 20

Sep 20

Feb 21
Dec 20

1 Month 3 Months 6 Months

Figure 1.8c Forward Premium in USD/` Market

Source: RBI.

Figure 1.8 Forex Market in Recent Times

Table 1.7 Bank Group-wise Gross NPAs and Net NPAs of Indian Banks
GNPA (` Crore) NNPA (` Crore) GNPA (%) NNPA (%)
March March March March Mach March March March
2018 2021 2018 2021 2018 2021 2018 2021
Public sector 895,601 616,615 454,473 196,452 14.6 9.1 8 3.2
Private sector 185,746 200,141 64,380 55,783 4.6 5.9 2.4 1.5
Foreign banks 13,849 15,049 1,548 3,238 3.8 2.3 0.4 0.5
Indian banking 1,095,196 831,804 520,401 255,473 11.2 7.5 6.2 2.5
Souce: Compiled by the authors using RBI souces.

Macro-financial Perspectives on the Indian Economy 13

 gross NPAs and accounting for 9.1 per cent of sector like the large corporate sector? Only time
their gross loans. Although gross NPAs are still will answer.
high, banks have, over time, made adequate pro-
The second important development is that,
visioning and reduced their net NPAs. Thus, the
post-NPA problems, there is a substantial reduc-
PSBs reduced their net NPA to 3.2 per cent in
tion in bank credit growth. The bank’s credit out-
2021 from 8 per cent in 2018. Thus, on the NPA
standing, which was growing at 13.4 per cent in
front, Indian banks have largely resolved their
Q2 of 2017–2018, moderated to 7.2 per cent in Q1
problems, either through recovery or by making
of 2019–2020.16 While credit growth was slowing
provisions, and are now looking good even dur-
across groups of banks, PSBs slowed more than
ing the ongoing pandemic.
others. During the period mentioned above, pub-
The NPA experience has changed many as- lic sector credit growth came down from 7.8 per
pects of Indian banking. Banks in India are now cent to 4.2 per cent.
being increasingly careful in their lending. This
On the back of credit slowing down, the RBI
has led to an improved risk assessment process
has undertaken major COVID-19 crisis-related
and creditor willingness. As a result, a few impor-
liquidity-inducing measures. What was the
tant changes have come into play. First, there is a
impact of these measures on bank credit? Did
perceptible shift in the lending portfolio of banks
these measures motivate banks to increase their
in India. Indian banks are increasingly shifting
lending? While one can observe a subtle increase in
their credit exposure away from large corpo-
growth in credit offtake during the post-liquidity-
rate exposure, where the incidence of NPAs was
inducing measures,17 banks in general seem to
observed to be high,15 towards retail portfolio
have preferred investment for their assets more
and with in that, more towards personal loans,
than credit. Between June 2020 and June 2021, the
where the NPA rate is relatively low. Table 1.8
share of credit in the total bank assets decreased
clearly bears out this shift, where bank credit
from 58.6 per cent to 54.2 per cent, whereas at the
to industry, which stood at 44.3 per cent of total
same time, the share of investments increased
credit in March 2015, came down to 31.5 per cent
from 26.1 per cent to 28.1 per cent. While the
in March 2020. The loss of market share of large
pattern is true across the bank groups, it is more
corporate credit is absorbed by personal loans
so with PSBs. The preference is largely driven by
and loans for services. The ongoing shift in bank
the motive of taking advantage of moderating
credit brings about important questions in Indi-
yields on government securities. This move by the
an banking. While being risk-sensitive in lend-
banks has substantially increased their market
ing is perfectly fine, can Indian banks continue
risk exposure. A rollback on any of the stimulus
to shy away from large-scale credit-absorbing
measures or a rate hike, could trigger upward
movement in the yields, which could cause serious
Table 1.8 Distribution of Bank Credit Share (%) losses to banks in their investment books.

March 2015 March 2020 How are Indian banks faring in terms of their
Non-food credit 100.0 100.0 performance parameters in light of the ongoing
resizing that has occurred in recent years in
Agriculture and 12.8 12.6
allied activities
Indian banking, particularly in terms of NPAs,
shifting credit patterns, tepid credit growth and
Industry 44.3 31.5
rising investment books? In the following text,
Micro & small 6.3 4.1 we will discuss trends in four important factors.
Medium 2.1 1.1
First, the provision coverage ratio (PCR) is an
Large 35.9 26.3 important indicator as it shows the loss-absorb-
Personal loans 19.4 27.7 ing capacity of the bank without affecting capi-
Services 23.5 28.2 tal. Figure 1.9a shows that the PCR for Indian
banking as a whole steadily increased from 2017
Source: RBI.
and reached a comfortable level of 75 per cent

14 INDIA BANKING AND FINANCE REPORT 2021

 90.0%
90.0% 25.00%
25.00%
18.6% 18.6%
18.6% 18.6%
80.0%
80.0% 20.00%
20.00%
16.4%
16.4%
70.0%
70.0%
15.00%
15.00%
14.3%
14.3%
60.0%
60.0%
10.00%
10.00%
50.0%
50.0%
5.00%
5.00%
40.0%
40.0%
Mar 17
Mar 17

May 21
May 21
Aug 17
Aug 17

Apr 19
Apr 19
Jun 18
Jun 18
Jan 18
Jan 18

Jul 20
Jul 20
0.00%
0.00%
Nov 18
Nov 18

Sep 19
Sep 19
Feb 20
Feb 20

Dec 20
Dec 20

Jun 20
Jun 20

Jun 21
Jun 21
Dec 19
Dec 19

Dec 20
Dec 20
Mar 20
Mar 20

Sep 20
Sep 20

Mar 21
Mar 21
Public
PublicSector
Sector Private
PrivateSector
Sector Public
PublicSector
Sector Private
PrivateSector
Sector
IndianBanking
Indian Banking Foreign
ForeignBanks
Banks Indian
IndianBanking
Banking

Figure 1.9a Trend in PCR Figure 1.9b Capital Adequacy (CRAR)

6.0%
6.0% 2.00%
2.00% 1.61%
1.61%
5.0%
5.0%
5.0%
5.0% 4.2%
4.2% 1.12%
1.12%
4.0%
4.0% 3.5%
3.5% 1.00%
1.00%
NIM %

3.0%
3.0% 0.64%
0.64%
RoA

2.9%
2.9%
2.0%
2.0%
0.00%
0.00% 0.28%
0.28%
1.0%
1.0%
0.0%
0.0%
–1.00%
–1.00%
2015–16

2016–17

2017–18

2018–19

2019–20

2020–21

2015–16

2016–17

2017–18

2018–19

2019–20

2020–21
Public
Public Sector
Sector Private
Private Sector
Sector
Public
Public Sector
Sector Banks
Banks Private
Private Sector
Sector Banks
Banks
Foreign Banks
Foreign Banks Total Banking
Total Banking Foreign
Foreign Banks
Banks Indian
Indian Banking
Banking

Figure 1.9c Net Interest Margin Figure 1.9d Return on Assets

Figure 1.9 Trends in Select Banking Variables

Source: RBI.

of impaired assets by December 2020. The sec-
ond indicator is the capital adequacy indicator
(Figure 1.9b). Banks built up a good amount of
capital in order to boost their capital adequacy
by mobilizing additional capital in the buoyant
capital markets (capital contributions made by
the government in the case of some PSBs) and
thus were comfortable with the capital adequa-
cy requirement. In June 2021, the capital-to-risk
weighted assets ratio (CRAR) for the banking in-
dustry as a whole was 16.4 per cent. While PSBs
had a CRAR of 14.3 per cent, private sector and
foreign banks each had CRAR of 18.6 per cent.
The third indicator is net interest margin (NIM),
which is the ratio of net interest income (inter-
est paid – interest earned) to interest-earning
assets (Figure 1.9c). NIB was around 3 per cent
for the whole industry for years before moving
to 3.5 per cent in 2020–2021, indicating increasing
margins. Among banking groups, PSBs have the
lowest NIM, despite doing better in recent times.
The fourth indicator we studied is return on asset
(RoA) (Figure 1.9d). For a long time, the RoA of PSBs
was negative before turning positive in 2020–
2021. The year 2020–2021 was a turnaround for
them as well, as they posted a 1.12 per cent RoA.
Foreign banks, despite having a small share in the
Indian banking sector, have performed well com-
pared to the other two groups of banks.
Thus, post Covid-19 pandemic, Indian banks are
in a comfortable position in terms of NPA ratios,
PCR, capital adequacy, NIM, as well as RoA. What

Macro-financial Perspectives on the Indian Economy 15

 accounted for such a wholesome turnaround in
Indian banking? Apart from the balance sheet
cleansing operations and other efficiency im-
provement programmes that bankers themselves
have been conducting, bankers are also benefit-
ted by healthier borrowers, particularly corporate
borrowers (Ram Mohan TT, 2021a). As the banks
were engaged in making their books robust, cor-
porates were also engaged in de-leveraging18 and
improving their operational efficiency by mini-
mizing costs. The ‘twin balance sheet’ problem,
which was famously blamed for NPA problems
in banks during 2015 (Government of India, 2015),
now seems to be working favourably for banks,
where banking health is derived from corporate
health. Going forward, corporate credit expan-
sion will provide a significant scope for bank’s
credit growth avenue (Ram Mohan, 2021b).
A discussion on Indian banking would not be
complete without talking about banking consoli-
dation and the likely structural changes that we
may see in the Indian banking panorama. Public
sector banks has been a dominant feature of In-
dian banking thus far; however, if current trends
continue, this may no longer be the case. Start-
ing with the large-scale asset quality problem in
2015, the GOI is looking at the bank merger route
as a way out for managing a large number of PSBs
and also to improve their operational efficiency.
A larger view is now making the rounds that PSBs
have outlived their intended objective of being
agents in the development of India. In this age of
competitiveness and technology, it is now time
to encourage efficiency and competition. This
thinking seems to have played out in reducing the
number of PSBs. There were 29 PSBs in 2008, and
the number was reduced to 12 in 2021 by way
of merging some of the banks.19 PSBs are also
steadily losing market share. In 2016, PSBs had
a 69.3 per cent share of total banking assets in
India, which was reduced to 60.1 per cent in
2021. The lost ground of PSBs is improved by ex-
panding the private sector banks in both number
and size. At the same time, a few new types of
banks have come into existence, namely small
finance banks and payment banks, which are
increasingly consolidating their position and ex-
panding the horizons of services in the banking
sector. On the whole, the emerging scenario of
16 INDIA BANKING AND FINANCE REPORT 2021
Indian banking is indicating panoramic changes as
the dominance of PSBs is disappearing and the role
of private sector banks, including small finance
banks and fintech companies, is rising.
1.6. Global Recovery
and COVID-19 Policy
Normalization
The unprecedented policy actions initiated to
fight the COVID-19 pandemic, and the induced
economic crisis across the globe seem to have
quickly achieved the intended objectives. Global
economies stabilized sooner than expected as
most of the financial markets achieved near nor-
malcy by the second half of 2020. Even as the
waves of infections in different countries con-
tinued, most of the economies showed recovery
and were firmly on a growth path by late 2021.
However, policy actions of this magnitude, as
seen across the globe, rarely occur without un-
intended consequences. The IMF had previously
warned about the ill effects of prolonged sup-
port measures if they were not phased out in a
systematic manner (IMF, 2021b). Importantly,
sustained surplus liquidity may lead to excessive
risk-taking, which may lead to financial vulner-
abilities and may eventually become structural
legacy problems if not addressed in time. While
unwinding is important, the process needs to be
undertaken in an orderly and phased manner
such that it does not hamper the ongoing recov-
ery and growth process (IMF, 2021c).
At a time when global recovery was sighted
and central banks across the world were contem-
plating policy reversals, a few major economies
met with certain unusual hindrances in the form
of supply and logistic disruptions arising out of
lockdown conditions across the world.20 Rising
demand pressures coming from the recovery
process combined with supply and logistic dis-
ruptions, along with globally stiffening energy
and commodity prices, gave rise to inflationary
pressures, particularly in advanced countries.21
Inflation is now an added concern among oth-
ers for central banks, which if left unattended
may become a serious issue, particularly when
financial markets are still supported by liberal
liquidity conditions. Given the liberal liquidity
conditions and hardening inflationary pressures,
the IMF recommends that central banks should
reign in inflationary expectations first, even if
it means loss of employment in the short term,
as inflation, if not transitory, can affect the very
purpose of growth (IMF, 2021a).
Keeping the evolving conditions in mind, many
of the global central banks have initiated a roll-
back of some of the liberal liquidity measures and,
in some cases, hiked policy rates. For instance, the
US Fed decided to reduce its monthly bond buy-
ing from USD 80 billion to USD 15 billion from No-
vember 2021 onwards. Similarly, at the October
2021 meeting, the Bank of Canada announced the
end of its bond-buying programme. The Europe-
an Central Bank maintained its accommodative
policy but reduced its bond purchases margin-
ally. The Bank of England, however, continued its
accommodative and easy money policies as ear-
lier. But a few other central banks increased their
policy rates. For instance, Brazil increased policy
rate from 6.27 per cent to 7.75 per cent in October
2021, while Russia raised rates from 6.57 per cent
to 7.5 per cent. Similarly, central banks belonging
to Chile, Hungary, Iceland, Peru, Sri Lanka, the
Czech Republic, South Korea, Norway and Poland
raised interest rates by different amounts in Oc-
tober–November 2021. In India, the RBI is consid-
ering actions such as sucking up excess liquidity
until February 2022 while maintaining surplus
liquidity conditions.
Financial markets around the world are gradu-
ally waking up to the impending policy normal-
ization measures by central banks across the
world. As the RBI report puts it, ‘Financial Mar-
kets remained on tenterhooks amidst heightened
uncertainty and accentuated risks’ (RBI, 2021g, p.
29). A few markets have already moved in the di-
rection of corrections, and some are following. For
instance, yields on US 10-year bonds rose from 1.2
per cent in August 2021 to 2 per cent in February
2022. In India, yields bottomed out in Q3 of 2020–
2021 and are now showing two-way movement
with an upward bias. During most of Q2 and Q3
of 2021–2022, the 10-year GSec yield was hover-
ing around 6.30 to 6.40 levels, and touched a high
of 6.9 percent in February 2022. The long bull
run in the equity market, which started in March
2020, also seems to have come to a halt in Octo-
ber–November 2021. The general exuberance
that was visible in global financial markets has
thus seemed to have waned in the wake of cen-
tral banks’ rolling back on the COVID-19 policies.
1.7. Concluding Observations
It is difficult to discern broad conclusions from
the living history of a pandemic year when the
economy is still in the process of a nascent yet
uncertain recovery, complicated by news of
newer variants of the virus. Notwithstanding
such limitations, the following broad conclusions
may perhaps be discernible.
First, the COVID-19 global pandemic affected
the world economy severely and across the
board, and the global economy experienced an
unprecedented contraction during 2020. Thanks
to the swift innovation of effective vaccination
as well as unprecedented stimulus measures, the
global economy recovered in 2021. However, it
would take a year or two for the global economy
to reach the pre-pandemic levels of GDP. Also,
the recovery process has been uneven across the
globe, with significant differences between de-
veloped and emerging market economies.
Second, a complication in the recent recovery
has been the upward trend in inflation in a num-
ber of advanced and emerging market econo-
mies. While higher commodity prices could have
been the result of prolonged supply shocks aris-
ing out of the pandemic-induced lockdown and
related restrictions on the restoration of normal
economic activity, they pose the risk of prema-
ture reversal of economic stimulus.
Third, India has been no exception to this glob-
al trend. While the economy registered a signifi-
cant contraction in 2020, it recovered in 2021.
An effective and widespread vaccination pro-
gramme, the adoption of a substantial economic
stimulus and a series of structural measures may
be behind this recovery. Nevertheless, India, too,
is facing some inflationary pressure.
Fourth, notwithstanding a contraction in 2020
and a nascent recovery in 2021, the equity mar-
ket has shown significant exuberance. This can
perhaps be traced to massive economic stimulus
Macro-financial Perspectives on the Indian Economy 17
 all around the globe, led by central banks in de-
veloped countries.
Fifth, the RBI announced a series of measures
with the objective of maintaining adequate li-
quidity in financial markets, reducing the cost of
borrowing and encouraging lending. Financial
markets in India have also shown reasonable
stability, primarily on account of the unconven-
tional monetary policy of the RBI. Globally, too,
financial markets stabilized with improved li-
quidity and reduced interest rates.
Finally, thanks to a series of regulatory mea-
sures, the banking sector has performed reason-
ably well in India since the pandemic. In the days
to come, despite some degree of regulatory for-
bearance, subdued credit offtake during the pan-
demic may not pose a significant concern on the
financial stability front. Ultimately, of course,
rekindling the growth and investment cycle has
to be accompanied by a revival of credit growth.
Postscri pt
This chapter was written by the end of 2021
covering information available at the point of
time. Now that we are at the end of the finan-
cial year 2021–22, how do more recent trends
look like? Instead of making any attempt to up-
date with more recent data, a few pointers are
flagged. First, the geopolitical tension of the
Russia–Ukraine military conflict has brought in
a fresh source of uncertainty in an otherwise
sobering global situation where passing away of
the Omicron-driven wave of the pandemic has
been accompanied by a considerable coverage
of vaccination, easing of travel restriction and
rekindled economic activity. Second, global in-
flationary situation (accompanied by high and
volatile crude oil prices) continued to be a mat-
ter of concern, with a number of leading central
banks have either started rate hike cycles or sig-
nalled their intention to do so. This could trigger
some reversal of foreign capital flows from the
emerging economies with attendant impact on
the various segments of the financial market.
Third, the piling up of substantial amount of pub-
lic debt all over the world could pose some threat
to economic and financial stability in the days to
18 INDIA BANKING AND FINANCE REPORT 2021
come. Fourth, in India the recent Union Budget
of 2022–23 with its emphasis on capital expendi-
ture is expected to generate substantial growth
impulses. Fifth, insofar as the stance of the mon-
etary policy is concerned, it is important to note
that RBI Governor has mentioned continuation
of ‘forward guidance of accommodative stance
as long as necessary to revive and sustain growth
on a durable basis and continue to mitigate the
impact of COVID-19 on the economy, while en-
suring that inflation remains within the target
going forward’ (Minutes of the Monetary Policy
Committee Meeting, 8–10 February 2022).
Notes
1. The phrase is attributed to Mario Draghi,
quoted in Mohan (2021).
2. A comprehensive account of policy actions
taken by world countries is compiled by
the IMF on its webpage ‘Policy Responses
to Covid-19’ (https://www.imf.org/en/
Topics/imf-and-covid19/Policy-Responses-
to-COVID-19#I).
3. h t t p s : //p i b . g o v. i n / P re s s Re l e a s e Pa g e .
aspx?PRID=1774586
4. https://www.india.gov.in/spotlight/pradhan-
mantri-garib-kalyan-package-pmgkp
5. The measures of the GOI are updated in the
repository of the GOI’s portal on a regular
basis with ‘Covid-19 Interministerial Notifica-
tions’ (https://covid19.india.gov.in/document-
category/ministry-of-finance/).
6. In his monetary policy statement, the Gov-
ernor of the RBI (8 October 2021) mentions
that, in total, more than 100 measures were
taken by the RBI. A repository of all updated
measures of the RBI is available at https://
www.rbi.org.in/scripts/bs_viewcontent.
aspx?Id=3894#FAQ
7. In the financial year 2020–2021, the GOI’s
net borrowings through dated securities
was `11.43 lakh crore, which was higher
than the previous year’s borrowing by 141.2
per cent.
8. The RBI’s acquisition of government securi-
ties is limited to only the secondary market
 route because, under the Fiscal Responsibil-
ity and Budget Management Act, 2003, the
RBI is prohibited from directly subscribing
to government securities.
9. The highest mark the Nifty index reached
was 18,477 on 19 October 2021. The BSE
Sensex touched a high of 61,675 on 18 October
2021.
10. RBI (2021d), Kumar (2021) and Ray and Pal
(2021) attempted a detailed analysis of cur-
rent equity market valuations.
11. Between February 2020 and February 2021,
forex reserves increased by 103.7 billion, a
rise of 21 per cent.
12. Venkatesh (2021); Bhat (2021).
13. To resolve the NPA problem in PSBs, the
GOI in 2016 adopted the ‘4R strategy’; the Rs
stand for recognition, resolution and recov-
ery, recapitalization and reform (Govern-
ment of India, 2016). To improve the perfor-
mance of PSBs, the GOI in 2018 developed
a special drive called ‘Enhanced Access and
Service Excellence’ for sustained develop-
ment of competitiveness and adoption of
industry best practices in PSBs.
14. Much of the NPA reduction in PSBs, how-
ever, was achieved more by way of writing
off bad loans than actual recovery. Writing
off of NPAs was of the order of `1.3, `1.8 and
`1.8 lakh crore, respectively, in 2018, 2019
and 2020, whereas recoveries were, respec-
tively, `0.82, `1.3 and `0.99 lakh crore during
the corresponding years (RBI, 2020e).
15. As of March 2021, the share of large corpo-
rate credit in total gross bank credit was 52.7
per cent, whereas their share of gross NPAs
was 77.9 per cent (RBI, 2021d, p. 47).
16. The period from 2017–2018 to 2020–2021
also corresponds with the ongoing economic
recession in India. While it is possible
that the recession also accounted for the
reduction in bank credit growth, risk
aversion in the wake of the NPA problem is
a substantial factor.
17. Non-food credit growth in September 2020
was 5.1 per cent (yoy), which increased to
6.7 per cent (yoy) in September 2021.
18. RBI (2021d) points out that debt-to-equity in
a sample of 1,360 listed non-finance compa-
nies went down from 0.22 in 2018–2019 H1
to 0.19 in 2020–2021 H1 (p. 21).
19. Further, the Finance Ministry announced
in the budget speech of 2021 that the gov-
ernment is in the process of merging two
more public-sector banks.
20. The lockdown had hampered the produc-
tion of certain critical components, such
as electronic chips. Similarly, massive dis-
location in the shipping container market,
shipping routes and air cargo came to the
surface, resulting in order backlogs and de-
livery delays (Friesen, 2021).
21. In the USA, the CPI inflation rate, which
was at 1.4 per cent in January 2021, went up
quickly and is at 6.2 per cent in October 2021,
which is a 31-year high. Inflation in Germany
has been rising since January 2021, and it is
now at 4.5 percent, a level last seen in the
1990s. Similarly, inflation was high in the UK,
Canada, New Zealand, etc. It has also reached
high levels in many emerging economies
such as Russia, Brazil and Turkey.
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Bank Boards and Corporate
Governance in India
Anjan Roy and Kaushik Mukerjee
2.1. Introduction
In recent times, several banks in India have
faced adverse publicity and material losses from
incidents of governance failures. Many of these
incidents have attracted penalties from the RBI
as they involved non-compliance with regula-
tory directions on matters such as norms for pro-
moter’s holdings, restructuring of loan accounts,
frauds classification and reporting, third-party
product sales to customers, remuneration to em-
ployees, etc. The Securities and Exchange Board
of India (SEBI) has also levied a penalty on banks
for lapses in making the required disclosures re-
lated to insider trading, mis-selling of bonds to
customers, not reducing stakes in other entities,
etc. Besides these, certain incidents of conflict of
interest involving key management personnel
have also gained wide attention.
Noting the increasing incidence of such prob-
lems, the RBI has pushed for massive governance
reforms in banks. According to a discussion pa-
per published on 11 June 2020:
In the context where management plays the
role of an agent of a board and the board in turn
plays the role of an agent of shareholders, gover-
nance failures have brought to fore the impact
of quality of governance on efficiency in alloca-
tion of resources, protection of depositors’ inter-
est as well as maintaining financial stability.
Incidents of governance failures in banking
and finance have occurred quite frequently
across the world and, at times, led to the collapse
of institutions. During the 1929 Wall Street mar-
ket crash, the head of the Chase National Bank
2
Chapter
made short calls on shares of his bank, even-
tually leading to its failure. In the 1980s, four
banks—the Continental Illinois National Bank
and Trust Company, the First City Bancorp, the
First Republic Bank and the mBank—met fail-
ure owing to insider trading (Jalbert et al., 2003).
Barings Bank failed in 1995 as a consequence of
losses made on unauthorized trades by one of its
securities operators. Close to the sub-prime crisis,
a certain board member at Goldman Sachs ille-
gally shared inside information to benefit cer-
tain hedge fund investors.
While the events of governance lapses have
not yet escalated to the size leading to collapse
of banks in India, the examples from abroad do
point out the potential risk of undermining a
bank’s reputation and the system-wide impacts.
Therefore, it is important to take a strong pre-
ventative approach to ensure that any incipient
failure of governance is recognized and arrested
timely. Given the variety of failures, issues of
governance implementation not only need a
systems perspective to understand their occur-
rence, there is also a need for determined action
at the board level of banks.
This chapter provides the findings of a mixed
method study on the subject by first describing
the challenge of corporate governance in banks,
and more particularly the history of evolution of
the practice in India. The following section then
discusses the likely reasons for governance fail-
ures in banks. Thereafter, the methodology for
the research is described along with the findings
relating to board-level factors as determinants of
bank financial and governance performances.
 2.2. Princi ples of Corporate
Governance in Banks
Banks are considered to be unique with regard to
their balance sheet structure and macroeconom-
ic function, and accordingly, their governance
may be different from non-bank organizations
(Nam, 2006). For example, being largely funded
by deposits and having loans as the largest com-
ponent of assets, banks usually have a very low
level of capitalization, for which reason they are
heavily regulated. Banks usually have a non-
transparent business model and are often prone
to becoming systemic entities that need constant
vigilance to prevent potential runs. Becht et al.
(2011) have argued that bank governance is dif-
ferent and requires radical departures from tra-
ditional governance for non-financial firms,
such as emphasizing the role of weak creditors.
More recently, Hopt (2021) also observed that
stakeholder governance, particularly creditor
and debtor governance, is more important than
shareholder governance for banks.
The terms and content of corporate gover-
nance in banks are enumerated in a BIS (2015)
document which defines the concept as follows:
A set of relationships between a company’s
management, its board, its shareholders
and other stakeholders which provides the
structure through which the objectives of
the company are set, and the means of
attaining those objectives and monitoring
performance. (BIS, 2015)
One key purpose of corporate governance is
to help define the way authority and responsi-
bility are allocated and how corporate decisions
are made.
The document provides a list of 13 principles,
namely related to the bank boards (Principle
Nos. 1, 2 and 3), senior management and group
structure (Principle Nos. 4 and 5), risk manage-
ment (Principle Nos. 6 to 8), compliance and in-
ternal audit (Principle Nos. 9 and 10), compen-
sation, disclosures and the role of supervisors
(Principle Nos. 11, 12 and 13). Implementation
of these principles is recommended to be com-
mensurate with the size, complexity, structure,
22 INDIA BANKING AND FINANCE REPORT 2021
economic significance, risk profile and busi-
ness model of the bank and the group (if any) to
which it belongs.
2.2.1. Corporate Governance in
Indian Banks
The introduction of corporate governance in
banks was made in 2001 when an advisory group
on ‘Corporate Governance for the RBI Standing
Committee on International Financial Standards
and Codes’ (R. H. Patil Committee) was set up. The
committee noted that the first important step to
improving governance in PSBs was to transfer
the actual governance functions from the con-
cerned administrative ministries to the boards of
the banks and to strengthen the latter by stream-
lining the appointment process of directors.
They recommended the appointment of a risk
management committee to the board, in addition
to three other board committees, namely the au-
dit, remuneration and appointment committees.
Later, the RBI formed a Consultative Group of
Directors of Banks and Financial Institutions in
2002 (A. S. Ganguly Committee) to review the su-
pervisory role of boards of banks and FIs, which
recommended that the nomination of directors
on the boards of PSBs should be guided by cer-
tain broad ‘fit and proper’ norms. In 2014, the RBI
constituted the P. J. Nayak Committee to review
the governance of boards of banks in India. The
committee reported several constraints for cor-
porate governance in banks stemming from the
board’s empowerment and capacity, for which
they recommended major shifts in ownership of
PSBs and other actions.
For following these, the RBI has addressed cor-
porate governance requirements in banks from
several viewpoints, such as the overall responsi-
bilities of the board of directors, the board’s struc-
ture and practices, qualification and the selection
of board members, senior management roles and
selection, risk management and others such as
compliance, audit, vigilance and compensation.
Recently, guidelines for the appointment of di-
rectors and constitution of various board-level
committees relating to audit, risk management,
nomination and remuneration and IT strategy
were recently prescribed. Some banks have insti-
tuted additional committees such as stakeholder
relationship committees, customer service com-
mittees, corporate social responsibility commit-
tees, review committees (to identify a borrower
as a wilful defaulter or non-cooperative) and a
special committee for monitoring large value
fraud. In the guidelines issued on 26 April 2021,
the RBI mandated that the chair of the board and
those of several committees, such as risk, audit
and vigilance, should be an independent director
instead of executive management. Also, a higher
threshold of independent and non-executive
directors in the board-level committees during
their meetings is now required.
A significant amount of attention has been
given to the role of the board. Their proactive
functioning is indeed vital to the governance
of banks. The board has overall responsibility,
including approving and overseeing manage-
ment’s implementation of the bank’s strategic
objectives, governance framework and corpo-
rate culture (BIS, 2015). The role and responsibil-
ity of the board, the qualification and expertise
of the members, the composition and diversity
of the board and the process of decision-making
strongly influence the governance of the banks.
According to the RBI’s notification in November
2016, 51 per cent of the total number of direc-
tors must have specialized knowledge and prac-
tical experience in as many as 15 areas related
to banking.
2.3. Governance Failures
and Likely Causes
A number of governance failures have been re-
ported in Indian banks in recent years. In 2018,
a large PSB suffered an enormous loss due to de-
fault by borrowers who were issued letters of
understanding in a fraudulent manner. Around
the same time, another consortium of bankers
faced a huge default and incurred the regulator’s
wrath for failing to classify a borrower account
as fraud. Several events were reported in private
banks as well. In one private bank, a senior ex-
ecutive was found involved in a loan made un-
der a certain quid pro quo deal linked to a family
member. In another bank, the regulator had to
supersede the board of directors after the bank
came close to being taken over by a non-banking
financial corporation. Besides these, many other
events involving governance or operational fail-
ures have been noticed by the regulator, and ac-
cordingly, banks have been penalized.
These events have caused concern because
while most banks follow the regulatory norms
prescribed for corporate governance, the actual
exercise of governance actions seems to be lack-
ing. Murthy and Deb (2011) have pointed out
how promoters of private banks in India may
circumvent regulatory guidelines related to vot-
ing rights to enable their dominance through
proxy voters. Besides, there are ample reports
that even though all norms related to constitu-
tion of board-level committees (e.g., risk, credit,
remuneration and nomination, etc.) are fulfilled,
they have not ensured good governance. While
the governance functions of the board are well
defined in a letter, it is observed that there is a
wide divergence in the effectiveness among
banks. Drawing from the various case studies of
governance failures, the incidence of such events
in Indian banks may be ascribed to the following.
2.3.1. Bank Shareholding Pattern and
Ownershi p Control
Ownership structure of banks, in terms of type
and concentration of shareholders such as gov-
ernment, promoter, institutional, public and for-
eign, can influence their standards of corporate
governance. Ownership control over decision-
making is exercised by obtaining majority votes
during shareholders’ meet. Lee (2002) observed
that shareholder-controlled banks have higher
risk-taking incentives in comparison to mana-
gerially controlled banks, particularly for those
with larger asset size and lower risk in their bal-
ance sheet. He also pointed out to the effect of
insider ownership in mitigating the agency prob-
lem in such banks. Bodenhorn (2013) found dif-
ferent effects of the presence of large individual
or institutional shareholder on governance of
banks. He observes that while the former group
were more concerned with access to loans, the
latter were with returns. Soana et al. (2021),
however, found that the number of large and
institutional shareholders has a positive impact
on profitability but no effect on risk. However,
Bank Boards and Corporate Governance in India 23
 long-term ownership by multiple large share- of the promoter. At the time of new entry, the
holders contributes to decreasing risk in banks. promoter’s contribution is required to be a maxi-
mum of 40 per cent of the paid-up capital. How-
Government shareholding has also been found
ever, their holdings must be reduced to less than
to have a discernable impact on bank behaviour
10 per cent within three years. Later in 2002, the
and the need for governance. Following the en-
RBI allowed FDIs from all sources to account for
hancement of government ownership in US
up to 49 per cent of paid-up capital, which was
banks after the global financial crisis, distrust
subsequently increased to 79 per cent. Accord-
and fear that their intervention would jeopar-
ingly, the domestic promoter shareholder was
dize private shareholders’ interests created sig-
also enhanced to provide a level playing field. In
nificant alarm in the industry. Yang (2019), how-
2003, responding to several private banks’ being
ever, pointed out that in a competitive financial
on the verge of being notified as foreign banks
market with a developed financial system and ad-
owing to their shareholding by foreign entities,
vanced political institutions, there are controls on
the RBI recommended that shareholding by way
the downside of government ownership. On the
of American Depository Receipts, Global De-
other hand, foreign ownership has been found
pository Receipts and Foreign Currency (FCY)
to have a positive impact on banks. Micco et al.
convertible bonds be excluded while calculating
(2004) observed that the entry of foreign banks
the FDI limit as such shareholders do not have
into developing countries makes domestic banks
any voting rights. Recently, an internal working
more efficient. In a study on the effect of owner-
group at the RBI has recommended an increase
ship structure in Gulf Cooperation Council (GCC)
in shareholding by promoters from the existing
countries, Arouri et al. (2011) found that the ef-
15 per cent to 26 per cent of the paid-up voting
fects of foreign and institutional ownership lev-
equity share capital of the bank.
els are positive and non-significant, respectively,
on bank performance. In contrast, Al-Amarneh Murthy and Deb (2011) have observed that
(2014) reported for Jordanian banks that owner- the policy of restrictions on voting rights has
ship concentration has a positive and significant not achieved its objectives. They identified new
effect on bank profitability, while foreign own- dimensions of corporate governance and under-
ership positively affects the bank’s operating lined the vulnerability of the depositor, particu-
efficiency. Fang et al. (2019) also asserted that larly in closely owned banks. In recent years,
foreign ownership leads to a better governance we have also witnessed significant conflicts
environment and reduces information opacity. between promoters of private banks and the
regulator regarding the dilution of the former’s
Arouri et al. (2011) as well as Hammami and
shareholding within a certain stipulated peri-
Boubaker (2015) found that concentration of
od of time. Haque and Shahid’s (2016) study of
ownership had a significant negative impact on
commercial banks in India suggested that while
the performance of banks in the GCC and Middle
the effect of ownership concentration on bank
East and North African countries. Similar find-
risk-taking and profitability was insignificant,
ings were also reported by Loh and Sok-Gee
both government and foreign ownership were
(2017) in the Malaysian banking industry. Pollak
positively associated with default risk and nega-
and Guan (2017) pointed out at the rising level
tively with bank profitability.
of institutional ownership of banks in the USA,
particularly the partially overlapping ownership
2.3.2. Board Composition, Diversity
assets, as leading to financial contagion. Interest-
and Decision Process
ingly, Zhou et al. (2018) have discussed ‘owner-
Bank boards are constituted of members desig-
ship balance’ as a factor behind improved perfor-
nated as whole-time, nominees or independent
mance of city commercial banks in China while
directors. Whole-time directors have executive
reducing their bankruptcy risk.
roles, while others hold non-executive posi-
In India, the RBI guidelines on new bank licens- tions. Whole-time directors also include the
es have stipulated limits for the shareholding managing director and chief executive officer,

24 INDIA BANKING AND FINANCE REPORT 2021

which in certain banks are held by the bank
promoter. Nominee directors are nominated
to the board by significant institutional share-
holders or large stakeholders, such as the gov-
ernment. Independent directors are individuals
appointed by the board owing to their personal
and professional qualities and can be on a full-
time or part-time basis.
The composition of the board, in terms of the
number and type of directors, has an influence
on the manner in which decision-making is done
by the board and the effectiveness of bank gov-
ernance. While the selection of board members
must meet the fit and proper criteria, a recent
document by BIS (2020) elaborates on the re-
quirement as following:
the ‘fitness’ criterion contains at least four ele-
ments: general expertise; practical banking
experience; time commitment; and conflicts of
interest. Differences arise in the detailed defi-
nition of these factors. Some authorities pre-
fer a principles based approach, while others
have issued more explicit guidance to shape
their supervisory decisions. As one aspect of
the fitness criterion, several jurisdictions are
prescriptive on time commitment, by limit-
ing the number of external directorships that
board members can hold. Some countries also
include an ‘independence of mind’ concept
within the ‘fitness’ criterion, which considers
the candidate’s ability to challenge directors
and senior management, mitigating the risk of
‘group think’.
The above points out the necessity of having a
board composition enabling independence and
diversity to improve decision quality. Indeed,
banking codes of corporate governance in several
developed nations include the following clause:
Complementarity, a collegial board,
independence and diversity are preconditions
for the supervisory board to perform its tasks
properly (De Haan & Vlahu, 2016).
Board diversity may include different mean-
ings such as a variety of expertise in different
areas of business and functions, or membership
from different nationalities or gender, etc. Stud-
ies have shown that greater diversity can also
help in controlling credit risk (Arango & Gaitan,
2021). Banks in India report as many as 18 areas
of expertise among the members of their board,
while expertise in new areas, such as digital
banking, cyber security and risk management, is
still needed. García-Meca et al. (2015) and Rafin-
da et al. (2018) provide evidence that gender di-
versity can lead to enhanced bank performance.
Many banks such as Lloyd Bank in the UK
have formally adopted board policies highlight-
ing the bank’s approach to inclusion and diver-
sity on their boards. Recently, in December
2020, Nasdaq asked the Securities and Exchange
Commission (SEC) in the USA for permission to
adopt new listing rules related to board diversity
and disclosure. Banks in India, such as IndusInd
Bank and Ujjivan Small Finance Bank, too, have
adopted the board diversity policy with the aim
of enhancing their ability to base their decisions
after evaluating multiple options and hence help
improve the performance of the bank.
The independence of board members has
been recognized to have an important effect
on the functioning of the board. Studies in dif-
ferent country contexts, such as by Pathan et
al. (2007) and Tulung and Ramdani (2018), have
reported that board independence has a posi-
tive influence on the performance of banks.
According to Vallascas et al. (2017), an increase
in board independence after 2009 led to more
prudent bank risk-taking, with boards favour-
ing increased capitalization and a reduction in
bank portfolio risk. However, they also observe
that such findings were limited and that in most
large international banks, board independence
does not contribute to safeguarding the interests
of bank creditors and taxpayers by constraining
bank risk-taking. Rashid and Hossain (2021) dis-
covered that independent directors, if empow-
ered, can act as whistle-blowers in their study of
banks in Bangladesh, which could mitigate the
negative role of politician directors.
Besides, the decision process followed by
board members must leverage members’ inde-
pendence and expertise. When a member raises
a concern pertaining to a particular issue, how
the discussion is structured and how consensus
is arrived at may determine the effectiveness of
Bank Boards and Corporate Governance in India 25
 governance. Dissent by board members must be
noted as a decision is made. The opinion of inde-
pendent directors has been reported as crucial
from the point of view of governance in Indian
banks (Sarkar & Sarkar, 2018). The governance
failure in one of India’s private banks was ex-
posed by one of their independent directors,
which points out that independent directors
need to be empowered.
2.3.3. Board’s Involvement in
Strategy Decisions
One of the key observations of the P. J. Nayak
Committee of 2014 was that boards of banks in
India may not have the required expertise in
business strategy and risk management. Accord-
ingly, they commented that
There is a need to upgrade the quality of board
deliberation in public sector banks to provide
greater strategic focus. There are seven themes
which appear critical to their medium-term
strengths comprising Business Strategy, Finan-
cial Reports and their Integrity, Risk, Compli-
ance, Customer Protection, Financial Inclusion
and Human Resources. All other items for
discussion should be brought to the Boards by
exception and should typically be discussed
in committees of boards. Among the seven
themes identified for detailed board scrutiny,
a predominant emphasis needs to be provided
to Business Strategy and Risk.
The role of the board members in determining
strategy can be very contentious given the sepa-
ration of roles between the board and executive
management. Accordingly, if the board involves
itself in strategy, the role of the executive may be
undermined. Kenny (2012) noted that the board
must provide the broad guidelines and con-
straints for the development of a strategic plan,
such as the planning horizon, return on capital,
capex limitations and policy of diversification,
to the executive management, which then takes
them forward to the strategic planning team.
Boards can add value by overcoming the blind
spots or decision myopia of the executive team
by referring to a wide variety of business en-
vironment scenarios. Thus, they can assist the
management in confronting strategic issues and
making difficult decision choices.
26 INDIA BANKING AND FINANCE REPORT 2021
Regulatory guidelines on corporate gover-
nance of banks, however, do not prescribe any
requirement for a strategy committee of the
board. In fact, none of the board committees is
actually meant to examine corporate invest-
ments or resource allocation. In an earlier paper,
Wommack (1979) recommended that boards
have a corporate objective or strategy commit-
tee, which should comprise outsiders or inde-
pendent directors. Certain global banks, such as
the Industrial and Commercial Bank of China
Limited, have established a strategy committee
of the board whose responsibilities include con-
ducting research on the strategy development
plans, business and organization development
plans, major financing and investment proposals
and other material issues that affect the develop-
ment of the bank. Strategy committees are also
found in the Piraeus Bank in Greece and the East
West United Bank in Luxembourg. The Asian
Infrastructure Investment Bank has a policy and
strategy committee of the board, while Bank Is-
lam Malaysia has a strategy review committee.
2.3.4. Oversight on Risk Management
and Prudential Actions
Following the introduction of the Basel guide-
lines, banks have adopted risk management
practices as per the three pillar approaches of
risk measurement, supervisory overview and
market disclosure. In 2008, the sub-prime cri-
sis revealed that risk processes in banks were
at best ‘work-in-process’ and needed to develop
in capability maturity. Stress testing and other
risk management tools have been identified as
vulnerable to failures due to disaster myopia,
network externalities and misaligned incentives
(Haldane, 2009). The Dodd–Frank Act of 2010,
therefore, mandated a separate risk committee of
the board, with at least one risk expert, for bank
holding companies with assets of $10 billion or
more. In the following, bank boards have insti-
tutionalized the risk management committee as
part of regulatory requirements for corporate
governance.
Banks’ risk management practices have tend-
ed to become increasingly analytical towards
the measurement of risk and the determination
of capital. In many banks, these may be pursued
mostly to meet requirements of regulatory com-
pliance, while other material risks may be left un-
attended. Choi (2013) observed that risk in banks
is usually handled better at the operational level,
but not at the managerial level. While risk events
such as product liability, loss of profits following
an incident, failure of computer-based systems
and reputational loss following bad press may
be managed, risks at the strategic level may not
be recognized at all. Banking scandals such as
the Libor rate-rigging and cross-selling to cus-
tomers are some of the evidence of such failures.
Gontarek and Belghitar (2018) observed that
ineffective oversight and a lack of effective risk
monitoring by bank boards contributed signifi-
cantly to the financial crisis then. However, Lip-
ton et al. (2018) have made a particular distinction
between risk oversight and risk management,
the former being a function of bank boards. They
argue that the board cannot and should not be
involved in actual day-to-day risk management.
They note that
Directors should instead, through their risk
oversight role, satisfy themselves that the
risk management policies and procedures
designed and implemented by the company’s
senior executives and risk managers are con-
sistent with the company’s strategy and risk
appetite; that these policies and procedures
are functioning as directed and that necessary
steps are taken to foster an enterprise-wide
culture that supports appropriate risk aware-
ness, behaviors and judgments about risk and
recognizes and appropriately escalates and
addresses risk-taking beyond the company’s
determined risk appetite.
In this regard, the three lines of defence have
been proposed as guidance for organization
structure in banks (COSO, 2015). These comprise
the management and internal controls as the
first line, the compliance functions along with
the financial controls and quality standards as
the second and the internal audit as the third. In
such a structure, the internal audit function is re-
quired to directly report to the board. However,
despite their adoption, recurring cases of fraud
and other misconduct have shown that these
lines of defence may not be enough for bank
governance. A BIS paper by Arndorfer and Minto
(2015) pointed out the limitations of the model
and proposed a fourth line of defence, which in-
cludes supervisors and external auditors.
In a world where market disruptions are more
frequent, banks must continually scan the busi-
ness environment for new sources of risk. Timely
recognition of unknown unknowns needs to be
made and appropriate risk mitigation measures
must be put in place. For example, board vetting
may be needed for credit decisions involving
large advances to corporate entities in industries
facing transition challenges.
2.4. Research Design,
Analysis and Findings
A mixed-method research design involving both
quantitative and qualitative methods was adopted
for this study. To be more precise, an explanatory
design (quantitative followed by a qualitative ap-
proach) was used, with purposeful sampling used
to gain deeper insights (Creswell & Clark, 2017).
The quantitative approach involved an empiri-
cal study that attempted to relate corporate gov-
ernance practices in terms of board features in
various banks and their likely impacts on their
performance. Performance here refers to sev-
eral parameters, such as profitability measured
as (a) RoA and (b) return on equity (ROE), (c) as-
set quality measured as gross non-performing
assets (GNPA) and (d) regulatory performance
measured as the number of penalties imposed
by the RBI. Strategy variables include decisions
regarding (a) risk appetite such as maintenance
of capital adequacy ratio (CAR), (b) setting growth
targets (growth), (c) composition of retail assets
(ret_ast) and (d) change in PCR (pcr_ch). The per-
formance parameters are hypothesized to be im-
pacted by several variables related to sharehold-
ing pattern and board composition in banks, as
listed in Table 2.1.
The shareholding pattern refers to the per-
centage of shares in the paid-up capital for differ-
ent categories of investors, such as the promoter,
foreign institutional investors (FIIs), foreign
investments via the depository receipt route
and domestic financial institutions. Features of
the bank board comprise their size in terms of
Bank Boards and Corporate Governance in India 27
 Table 2.1 Descri ptive Statistics for Dependent and Independent Variables
Variable Descri ption Average St. Dev.
Independent
sh_prom Shareholding by promoter and promoter group (%) 19.5 12.3
sh_fii Shareholding by FIIs (%) 38.9 8.8
sh_gdr Shareholding by foreigners via depository receipts (%) 10.8 9.0
sh_dfi Shareholding by domestic financial institutions (%) 16.8 13.0
ind_dir No. of independent directors (as % of total directors) 57.4 13.5
nom_dir No. of nominee directors (as % of total directors) 20.3 14.6
whl_dir No. of whole-time directors (as % of total directors) 22.3 9.5
fem_dir No. of women directors (as % of total directors) 13.0 6.6
tot_dir Number of directors (as % of assets size in ` Cr) 4.1 3.4
prm_dir Promoter as MD & CEO (1 = Yes; 0 = No) – –
ast_siz Size of assets (` lakh crore) 4.8 3.9
sub_assc Number of subsidiary and associate companies 9.7 9.3
Dependent
roe RoE (%) 12.7 13.9
roa RoA (%) 1.3 1.0
GNPA GNPAs (%) 2.9 3.2
penalty No. of penalties levied by RBI in a year 0.7 0.9
CAR Capital adequacy ratio (%) 16.5 2.0
growth Annual growth rate of asset (%) 18.9 13.1
ret_ast Composition of retail asset in total asset (%) 32.0 13.5
pcr_ch Change in PCR (%) 10.0 12.6

number of directors given the size of the balance
sheet of the bank and composition in terms of
various types of directors, such as whole-time
directors, independent directors and nominee
directors. Besides, whether the promoter as the
executive head of the board is also recognized
to be an important determinant of bank perfor-
mance is another question.
The set of six new generation private sector
banks has been included in the sample. Follow-
ing the banking reforms of the early 1990s, the
entry of new private sector banks has been al-
lowed in India. Many of these banks are now
well established with large sizes and advanced
management practices that have led to their
dominance as well as the enhancement of the
competitiveness of the banking industry. As the
other category of dominant banks, namely the
PSBs, is currently in the process of major orga-
nizational shifts following mergers, the study is
limited to the chosen set. Data on the variables
used have been obtained from the annual re-
ports of the banks for a 10-year period from
FY2011–2012 to FY2021–2022.
OLS regression models were determined for
the dependent variables as functions of the vari-
ous independent variables. For all the dependent
variables, separate models were created with a
number of independent and nominee directors
as alternative variables. As most of the model pa-
rameters emerged to be similar for both, the in-
dividual results for both variables are reported.
The models for the various outcome variables
regressed against the corporate governance
parameters are provided in Tables 2.2 (a and b)
and 2.3 (a and b). Two categories of tables have

28 INDIA BANKING AND FINANCE REPORT 2021

Table 2.2a Effect of Shareholding Pattern on Performance Variables
RoE RoA GNPA Penalty
B t B t B t B t
Constant 15.572 .754 .799 .584 4.563 .939 –.870 –.418
sh_prom –.171 –.590 .006 .328 –.050 –.728 .011 .371
sh_fii .295 1.237 .021 1.348 –.064 –1.148 .015 .623
sh_gdr .290 1.154 .046** 2.763 –.064 –1.081 .019 .747
sh_dfi –.839** –3.181 –.054** –3.066 .148* 2.388 .032 1.208
R 2
0.628 0.701 0.62 0.051
F 25.882 35.656 25.092 1.777
Sig. 0 0 0 0.147
N 60 60 60 60
Note: *, ** and *** indicate significance level at 10%, 5% and 1% respectively.

Table 2.2b Effect of Shareholding Pattern on Strategy and Prudential Decisions

Car Growth ret_ast pcr_ch
B t B t B t B t
Constant 3.546 .775 51.211 1.859 109.034*** 3.771 –11.951 –.338
sh_prom .150* 2.339 –.371 –.958 –.764* –1.882 .280 .565
sh_fii .161** 3.051 –.201 –.632 –.933** –2.797 –.129 –.317
sh_gdr .155** 2.781 –.299 –.890 –.484 –1.375 –.012 –.029
sh_dfi .124* 2.127 –.838* –2.382 –1.228** –3.326 .722* 1.600
R2 0.118 0.249 0.229 0.191
F 2.975 5.898 5.391 4.477
Sig. 0.027 0.001 0.001 0.003
N 60 60 60 60
Note: *, ** and *** indicate significance level at 10%, 5% and 1% respectively.

Table 2.3a Effect of Board Composition on Performance Variables

RoE RoA GNPA Penalty
B t B t B t B t
Constant –37.264*** –4.923 –2.611*** –4.688 12.639*** 7.270 1.071* 1.709
prm_dir .777 .245 .110 .474 –.650 –.894 .239 .909
tot_dir .506 1.157 .037 1.160 –.176* –1.750 –.092** –2.543
wt_dir .277* 1.877 .034** 3.118 .000 –.015 –.024* –1.926
ind_dir .724*** 7.144 .053** 7.053 –.154*** –6.609 .007 .878
nom_dir# –.737*** –7.327 –.054*** –7.473 .159*** 6.993 –.006 –.752
R 2
0.470 0.475 0.485 0.085
F 14.465 14.371 14.87 2.366
Sig. 0.000 0.000 0 0.064
N 60 60 60 60
Note: *, ** and *** indicate significance level at 10%, 5% and 1% respectively.

Bank Boards and Corporate Governance in India 29

 Table 2.3b Effect of Board Composition on Strategy and Prudential Decisions
Car Growth ret_ast pcr_ch
B t B t B t B t
Constant 11.998*** 10.473 .567 .065 21.384** 2.225 34.519*** 3.004
prm_dir 1.687*** 3.518 6.035* 1.660 –6.679* –1.660 –2.487 –.517
tot_dir –.155** –2.344 .443 .884 1.463** 2.637 –.494 –.744
wt_dir .104*** 4.652 –.164 –.971 .409** 2.185 –.371* –1.656
ind_dir .040** 2.631 .319** 2.748 –.043 –.336 –.401** –2.607
nom_dir# –.035** –2.242 –.337** –2.905 .002 .015 .399** 2.576
R 2
0.453 0.208 0.097 0.091
F 11.377 4.809 2.578 2.484
Sig. 0.000 0.002 0.047 0.054
N 60 60 60 60
Note: *, ** and *** indicate significance level at 10%, 5% and 1% respectively.

been created to report results for independent
variables representing the context of corporate
governance, namely shareholding pattern and
board composition. In regards to sharehold-
ing pattern, the models for RoE, RoA, GNPA,
growth, relative composition of retail segment
assets (ret_ast) and change in provision cover-
age (pcr_ch) are stronger with higher R2 values,
while those for the penalty imposed by the
RBI (penalty) have lower strength (penalty).
For most of these, the greatest impact emerges
from the shareholdings by domestic financial
institutions. A higher value of their sharehold-
ing positively influences the level of GNPA as
well as the level of CAR while having a negative
influence on growth, RoE and return on profit-
ability (RoP). The higher level of shareholding
of FIIs and by other foreign agencies through
routes such as depository receipt seems to posi-
tively impact CAR. Banks with higher foreign
shareholdings may also tend to have a lower re-
tail component in their asset portfolio. A higher
shareholding of the promoter similarly has a
positive impact on capitalization but a reduced
focus on retail assets.
In regards to the board composition, the mod-
els for RoE, RoA, CAR, GNPA and growth are
stronger with higher R2 values. Both measures of
profitability, that is, RoE and RoA, are positively
influenced by higher numbers of independent
directors on the boards of banks and negatively
by the number of nominee directors. In regards
to GNPA, the presence of independent and nomi-
nee directors has the opposite influence on the
reporting of such asset quality performances.
Higher composition of independent directors
has a significant impact on the lower reporting
of the same. However, the presence of a nomi-
nee director seems to have an influence towards
more prudential reporting. A similar observation
is noted in regards to change in PCR (pcr_ch).
A higher number of whole-time directors and
independent directors seem to have a signifi-
cant and negative impact on making provisions,
whereas the presence of nominee directors leads
banks to make higher provisions.
Regulatory performance of banks in terms of
a number of penalties (penalty) received is nega-
tively influenced by a higher number of board
of directors (tot_dir) as well as whole-time direc-
tors (whl_dir). The former may be impacted be-
cause of enhanced supervision, for example, in
the functioning of board committees. Besides,
the incidence of non-compliances could be in the
nature of operational lapses, which the executive
directors can address more effectively compared
to the non-executive ones.
Bank CAR bears a significant and positive
influence from higher numbers of whole-time
directors (whl_dir) and independent directors
(ind_dir), as well as the promoter being the head
of executive function of the bank (prm_dir). On

30 INDIA BANKING AND FINANCE REPORT 2021

the other hand, a higher number of directors
(tot_dir) and the presence of nominee directors
(nom_dir) impose a significant and negative
impact. The former observation indicates that
directors in executive roles may tend to build a
higher capital cushion in the bank, which may
be beneficial towards enhancing the lending ca-
pacity and future growth potential of the bank.
The latter observation points out to a more nor-
malizing impact of the bigger board size and the
presence of other institutional stakeholder direc-
tors, who may view growth plans more critically
and insist on higher capital efficiency.
With the promoter as the managing director
and chief executive officer (prm_dir), the impact
on growth (growth) is significant and positive,
indicating that banks may pursue higher growth
with the owner serving as head of management.
Interestingly, independent directors also bear a
similar influence, indicating their willingness to
allow higher growth. However, having a higher
number of nominee directors has a significant
but negative impact on growth, pointing to a
dampening effect of such board members on the
growth plans of banks.
The pursuance of the bank strategy in terms of
composition of the retail segment as part of total
assets is not found to be influenced by the num-
ber of independent directors. Instead, such strat-
egies are impacted more and negatively by the
promoter as the managing director. The number
of directors in the board, particularly the whole-
time directors, may influence the bank’s orienta-
tion towards retail banking business. Based on
the quantitative study’s findings, it can be con-
cluded that corporate governance practices, par-
ticularly the role of independent directors, have
a major influence on governance outcomes.
The quantitative study was followed up by a
qualitative one to get further insights into the nu-
ances related to corporate governance in banks.
This involved the classification of commercial
banks (by size) into two groups, segregating those
that are well governed and those that are not.
Banks that had suffered major governance fail-
ures (e.g., high value frauds, major reputational
risk events, etc.) were classified as those that
were not well governed. A case-based study was
adopted on the basis of the governance practices
reported in their annual reports and supplement-
ed by analyst reports. It was found that, when
compared on the basis of parameters such as size
of the board, the number of independent or nom-
inee directors, the number of meetings held in a
year and the number of members in committees
such as risk management, audit, nomination and
remuneration, there was not much difference
between the two types of banks. A t-test based
on these parameters revealed (t = 1.272; p = .232)
that there are no significant differences in their
compliance with statutory norms. These find-
ings were further corroborated through a set of
focus group discussions with senior bankers who
have served as board members of banks.
These findings suggest that well-governed
banks may have taken measures that exceeded
compliance with regulations. First, the manner
in which a board functions may be markedly dif-
ferent with regard to the processes and actions
taken for exercising the principles of corporate
governance. Second, the boards are involved in
crucial matters related to the implementation
of codes of conduct and are quick to intervene
whenever there are large divergences from
norms, such as with respect to high-value lend-
ing, asset quality and leadership behaviours.
2.5. Framework of
Governance Factors
On the basis of the findings of the study and
the practices observed in well-governed banks,
a framework is proposed (refer to Figure 2.1)
which encapsulates the board-level factors and
their impact on banks’ financial and governance
performance.
2.5.1. Bank Shareholding and
Stakeholder Influence
Shareholding patterns in banks influence risk-
taking and strategy decisions and hence perfor-
mance. Dominance in shareholding by certain
investors may unavoidably lead to boards pursu-
ing the particular shareholder’s agenda. Higher
shareholding by domestic financial institutions
seems to provide a conservative orientation to
Bank Boards and Corporate Governance in India 31

Bank shareholding and stakeholder
influence:
Representation of all stakeholders
including minority shareholders
Broader perspectives in decisions for
business continuity and organizational
sustainability
Directors are not related to each other
Board involvement in strategic
management:
Responsibility for setting strategic
direction, approving operating plans
and monitoring performance
Regular review of risk appetite and
growth strategies
Figure 2.1 Framework for Enabling Board-level Governance
banks by way of tempering growth and profit-
ability along with enhanced compliance with
prudential norms relating to the reporting of
GNPA. While FIIs do not seem to be exercis-
ing significant influence on bank performance,
shareholders through the depository receipt in-
vestment route seem to be more demanding of
profitability and returns from banks. The results,
however, do not present a clear picture regarding
the effect of a higher shareholding by promoters.
2.5.2. Board Composition and
Decision Processes
The composition of bank boards in terms of the
number and categories of directors can influence
the conduct of board meetings and the delib-
erations held therein. First, the larger size of the
board may lead to a broadening of perspective,
encompassing issues and concerns of a wide va-
riety of stakeholders. A larger board may enable
more far-sighted decision-making in regards to
compliance with regulatory norms. While the
dominating presence of whole-time directors
may lead to banks pursuing more short-term
32 INDIA BANKING AND FINANCE REPORT 2021
Board composition and decision
processes:
Diversity of expertise and indepen-
dence of directors
Structured framework for conduct of
board meetings with agenda index,
notes, resolutions, etc.
Assured functioning of whistleblower
policies and vigilance mechanism
Board oversight on risk management
and prudential practice:
Oversight on compliance with
prudential norms
Monitoring high value credit
decisions with early warning signals
on potential loan frauds
gains such as profitability, an inclusive board
membership can lead to decisions leading to long-
term sustainability. It is observed that the influ-
ence of independent directors on performance,
as well as decision-making variables, seems to be
aligned with whole-time directors. In contrast,
the presence of nominee directors from domes-
tic financial institutions, which are likely to be
more independent and objective, may enable dis-
senting views to be made more effectively to the
management.
2.5.3. Board’s Involvement in
Strategic Management
While strategy is the primary function of the
executive management of banks, the board can
play a significant role in the determination of
strategic direction. The results show that board
members can indeed influence the growth rates
pursued by banks. In this regard, the role of nomi-
nee directors, appointed by large shareholders or
stakeholder institutions, in regulating the growth
can be important when independent directors
may be willing to readily accept management’s
vision for growth. Nominee directors may also
be able to influence the bank’s view of its risk ap-
petite by fostering a more conservative approach
towards capital adequacy. As mentioned earlier,
independent directors usually belong to various
disciplines and may need to be informed with re-
gard to the peculiarities of banking business and
strategy making. The influence of non-executive
directors upon some deeper aspects of strategy,
such as business segment exposures, has not
been found to be significant.
2.5.4. Board’s Oversight on
Prudential Practices
The results also indicate the possible impact
bank boards can have on prudential practices by
recognizing and reporting NPAs and provision-
ing for the same. Here also, it seems that there is
a need for appropriately sizing the bank boards
to ensure that sufficient oversight is accorded to
executive decisions. In this regard, nominee di-
rectors may be able to have a greater influence in
eliciting compliance with prudential norms and
the pursuance of conservative policies, which
may be very important for managing the asset
quality of the bank. More importantly, the activ-
ism of board members may have a related impact
on the governance culture of banks.
2.6. Board Leadershi p
for Institutionalizing a
Culture of Governance
The effective functioning of the board, however,
would depend on its role as a leader in institu-
tionalizing a culture of good governance. This is
particularly important in banking, as Walter and
Narring (2020, p. 146) note:
Weakness in governance, risk culture and
behaviours can often be seen as leading indi-
cators of difficulties within banks, such as anti-
money laundering, rogue trade, corruption,
fraud, cyber risk incidents or financial losses.
Moreover, deterioration in traditional risks to
capital, such as credit, market and operational
risks, is often symptomatic of more fundamen-
tal deficiencies in the areas of governance and
risk culture. Therefore, good governance, risk
culture and ethical behaviours contribute to
promoting a more sustainable business model
over the full business cycle and during periods
of structural change.
Leaders shape the governance culture in banks
by influencing the cultural elements in terms of
the appropriate value systems, routines and ritu-
als, norms and behaviours, control systems and
the interplay of power structures and organiza-
tional politics. Board members can help in co-
creating policies and procedures that can be im-
bibed as cultural norms in order to ensure more
ethical conduct by employees at all levels. Appro-
priate expression of dissent and the functioning
of whistle-blower policies can help to provide
warning signals about breaches in governance. If
boards can promote the culture of ensuring regu-
latory compliance while catering to the needs of
business goals and profits, then good governance
can become the way of life in banks.
2.7. Conclusion
The findings of the study indeed point to the
significance of the board’s actions in banks to-
wards ensuring higher standards of corporate
governance. In particular, the board’s represen-
tation of wider stakeholder groups and the diver-
sity of membership provide the broad range of
perspective required towards making decisions
leading to institutional sustainability. Besides,
board independence and involvement in strate-
gic and prudential decisions are the most impor-
tant ways to exercise control over the executive
management of banks. In the light of such find-
ings, it can be said that the recent guidelines of
the RBI for enhancing corporate governance in
banks are most timely.
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Bank Boards and Corporate Governance in India 35
 3
Mergers and Acquisitions in
the Indian Banking Industry
Dipali Krishnakumar and Chapter
Richa Verma Bajaj

3.1. Introduction access to capital, disciplining ineffective manag-

During the period 1985–2020, the financial sec-
tor comprised the largest percentage of global
merger and acquisition (M&A) deals in value
terms, accounting for 16.3 per cent of total deal
value.1 Figure 3.1 shows the global trend relating
to M&A in the banking sector.
Indian M&A deals have been dominated by
deals in energy and natural resources, telecom
and manufacturing sector. Other sectors that
have witnessed deals include the infra sector,
transport, logistics and banking and financial
sectors.2 M&As in the banking sector have been
influenced by a move to strengthen and consoli-
date the Indian banking industry in recent years.
Worldwide M&As have been driven by motives
such as cost savings, scale efficiencies, opportuni-
ties for cross-selling, increasing market power,
ers, buying undervalued firms, adapting to envi-
ronmental, technological or regulatory changes.
However in the context of banks and financial
institutions, another factor that has motivated
acquisitions is the desire to maintain financial
stability or rescue banks and financial institu-
tions facing financial distress (Carapeto et al.,
2010; Koetter et al., 2007). Allowing one financial
institution to fail could potentially cause a conta-
gion effect and trigger a loss of confidence in the
entire banking system, with catastrophic effects
on markets and institutions.3 Regulators and
governments have often stepped in to save fail-
ing institutions, with an M&A deal being often
selected as the modus operandi. This phenome-
non is global and not restricted to any particular
country or set of countries. For example, in the
aftermath of the Global Financial Crisis, the US

1,400 600
1,200 500
1,000
400
800
300
600
200
400
200 100

0 0
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020

Number Value (in Billion USD)

Figure 3.1 Banking Mergers and Acquisitions in the World

Source: https://imaa-institute.org/mergers-and-acquisitions-statistics/
 market saw deals such as JP Morgan’s acquisition
of Bear Stearns; Bank of America’s (BOA) acqui-
sition of Merrill Lynch, and Wells Fargo’s acqui-
sition of Wachovia Bank, structured to prevent
the collapse of the acquired financial institution
and to contain the spread of a contagion effect in
the US and global financial markets.
Carapeto et al. (2010), Elsas (2007) and Koetter
et al. (2007) suggest that M&As have been ad-
opted across countries, including Poland, Italy,
China, Croatia, Indonesia, Germany, the Philip-
pines and Japan as distress resolution strategies,
often encouraged by the government. After the
Asian Financial Crisis in 1998, Korean financial
institutions went through an intense period of
restructuring, including the merger of unviable
banks with stronger banks, which was overseen
by the Financial Supervisory Commission.
A few deals in the Indian banking industry
involved the rescue of distressed entities, for
example, the Global Trust Bank acquisition by
Oriental Bank of Commerce (OBC) in 2004 pre-
vented the loss of hard-earned savings by more
than a million depositors. In 2013, the Industrial
Development Bank of India (IDBI) stepped in to
acquire the distressed United Western Bank. We
refer to these deals as ‘distressed deals’.
Some deals have taken place with the intent to
consolidate the banking entities in India, which
led to the number of PSBs failing to 12 in 2021
from 27 in 2017. For instance, the merger of five
associate banks with the SBI, announced in 2016,
was the biggest consolidation move in the his-
tory of Indian banks. The objective was to drive
possible synergy and position SBI at 50th place
in the list of global banks, in line with countries
such as China, Australia and Malaysia, where
banking is done by a few large entities. These
deals are referred to as ‘consolidation deals’.
Other deals are market-driven, such as the Ko-
tak Mahindra’s acquisition of ING Vysya, IDFC
FIRST Bank and Capital First deal, the reverse
merger of the erstwhile developmental financial
institution and Industrial Credit and Investment
Corporation of India Ltd with ICICI Bank, which
have changed the face of the financial sector in
India. We refer to these deals as ‘voluntary deals’.
38 INDIA BANKING AND FINANCE REPORT 2021
It is easy to merge the balance sheets of acquir-
ing banks with target institutions, but the big-
gest challenge that comes in this process is the
merger of culture, clients, technology and per-
sonal touch, which covers employees, customers,
product and technology issues and branch pres-
ence. In this context, it is interesting to note that
in the most recent acquisition announcement
among PSBs in 2019, all the merging entities use
the same core banking solution.4
It is a matter of interest to examine the out-
come of M&A strategies undertaken by Indian
banks over the last two decades. It is against this
background that the present study has addressed
the following issues with respect to acquisitions
announced by Indian commercial banks during
2000–2020: What is the reaction of the market to
the announcement of mergers in banks in India? Is
there any variation in the performance of banks
in the pre- and post-merger period across the three
categories of deals, namely distressed, voluntary
and consolidation deals? Do public and private sec-
tor banks vary in terms of acquisition performance?
The chapter is organized as follows: After a
brief history of M&A deals in India and abroad
in the first section, the second section presents a
review of existing literature on event studies and
the operating performance of banks. The scope
of study, database and methodology have been
presented in the third section. The results are
presented in the fourth section, and the conclu-
sion is presented in the fifth section.
3.2. Literature Review
The various studies that examine the pre- and
post-M&A performance are discussed as follows.
Kolaric and Schiereck (2014) and Krishnakumar
and Sethi (2012) observe that event studies, ef-
ficiency studies and performance studies are
the most frequently used methods for analys-
ing the performance of deals. Event studies
measure the impact on shareholder wealth by
examining the stock market reaction to deal an-
nouncements. Efficiency studies compare the
post-acquisition efficiency of the combined enti-
ty with an efficiency frontier. Accounting ratios
form the basis for performance studies.
3.2.1. Event Studies Focusing on
Stock Market Reaction to M&A
Deal Announcement
Target firms benefit from acquisitions, accord-
ing to event studies on banking M&A in the
US and Europe (Baradwaj et al., 1992; Beitel et
al., 2004; Campa & Hernando, 2006; Houston
& Ryngaert, 1994; Trifts & Scanlon, 1987). How-
ever, results for acquiring banks in the USA
vary. Baradwaj et al. (1992) observed statistical-
ly negative abnormal returns for acquiring US
bank bidders. Zhang (1995) reports a significant
positive wealth gain for acquirers and targets
combined. While Houston and Ryngaert (1994)
demonstrate that the overall gains to bidders and
targets combined are not statistically different
from zero. Trifts and Scanlon (1987) observe that
acquiring banks in interstate acquisitions do not
earn either positive or negative significant ab-
normal returns.
Campa and Hernando (2006) find that the av-
erage excess return to European acquiring firms
announced from 1998 to 2002 is close to zero.
Beitel et al. (2004) obtain similar results using
a sample of European deals between 1985 and
2000 and find that bidder CARs are either slight-
ly positive or negative depending on the event
window selected and do not differ significantly
from zero.
Examining market reaction to Indian deals,
Shobhana and Deepa (2012) study six deals an-
nounced between 1991 and 2005 and find that
the acquiring banks have lost shareholder value
in two of them, one deal did not result in any
significant change in value, and the remain-
ing three deals resulted in value gains. Anand
and Singh (2008) study the market reaction to a
sample of five mergers and find that both bid-
ders and targets earn significant positive re-
turns. Pandey and Kumari (2020) study market
reaction to eight acquisition announcements by
Indian banks and observe negative and signifi-
cant abnormal returns for acquiring banks dur-
ing the three-day event window. Jayadev and
Sensarma (2007) examine the market reaction to
five forced mergers and three voluntary mergers
and find that bidder banks do not gain in forced
mergers. However, bidder shareholders gained
in the case of voluntary mergers.
3.2.2. Studies Relating to the
Performance of Banks
Campa and Hernando (2006) examine the post-
acquisition performance of European acquisi-
tions in the financial industry from 1998 to 2002
using accounting performance-based measures
and do not observe a substantial change in the
performance of acquirers. They observe a slight
improvement in RoE but ascribe it to an overall
improvement in industry RoE. They identify a
decline in the efficiency ratio of bidding banks.
Cornett and Tehranian (1992) observe im-
proved employee productivity, the ability of the
banks to attract more loans and profitable asset
growth post acquisition. Akhavein et al. (1997)
also observe an increase in profit efficiency post
merger in the case of weak banks. Peng and
Wang (2004) and Selvam et al. (2005) find a posi-
tive impact of bank mergers on cost efficiency
and an improvement in the growth performance
of merged banks in terms of total assets, profits,
investment and deposits. Chadamiya and Me-
napara (2012) found that the merger of the weak
and non-viable banks has an impact on the prof-
itability of a sound bank and profit-making bank
after the merger. Patel (2018) studied the long-
term profitability of select Indian banks before
and after a merger for a period of 2003–2004 to
2013–2014 and found a negative impact of the
merger on RoE, RoA, net profit ratio, yield on
advance and yield on investment. However, the
earnings per share, profit per employee and busi-
ness per employee have shown positive trends
and growth after the merger.
The financial strength of banks post-acquisi-
tion has been examined using various param-
eters, such as asset quality, capital adequacy,
operating efficiency, management quality, earn-
ing capability and liquidity (e.g., Kalaichelvan,
2015; Kaur & Kaur, 2010; Makkar, 2013; Sahni &
Gambhir, 2018).
Our literature review suggests that many stud-
ies have been conducted to assess pre- and post-
M&A performance with few variables, a shorter
Mergers and Acquisitions in the Indian Banking Industry 39
 period and fewer banks. This study is an exten- Examining the business/industry of the tar-
sive one in terms of scope, time period consid- gets in Figure 3.2, we observe that the majority of
ered and number of deals used. We also compare the targets are banks, which comprise 30 deals.
performance across public and private sector Credit institutions/non-banking finance compa-
banks and across deal types. nies (NBFCs) constitute the next highest number
of deals in frequency terms. Credit institutions/
NBFCs include deals such as the acquisition of
3.3. Data and Methodology Gruh Finance by Bandhan Bank.
Our data comprise M&A by commercial banks
during the 2000–2020 period. We extract data
1 1 3
from Thomson Reuters Ikon on all completed
M&A deals by Indian banks with an announce- 8
ment date from January 2000 to December
2020. In addition, we also consider deals listed
in RBI speeches and newspaper reports. We
consider all deals which involve a majority
stake acquisition of above 51 per cent or deals
3
which involve acquisition of remaining interest
in a target. Our deal data set comprises 46 deals
listed in Table 3.1.
In Table 3.1, we observe that the largest num-
ber of acquisitions was by the State Bank of India 30
(SBI), followed by the Bank of Baroda in the
public sector. In the private sector, the largest Asset Management Banks Brokerage
number of deals were made by Kotak Mahindra Credit Institutions E-commerce/B2B Insurance
Bank, followed by ICICI Bank. For the purpose Figure 3.2 Industry of Target in Banking M&A
of this analysis, the IDBI is considered a PSB Deal Sample
since it was a PSB for a majority of the duration Source: Authors’ workings based on sample data.
of the study.

Table 3.1 Number of M&A Deals by Public Sector and Private Sector Banks from 2000 to 2020

Number Number
Public Sector Banks of Deals Private Sector Banks of Deals
State Bank of India 6 Kotak Mahindra Bank 5
Bank of Baroda 5 ICICI Bank 4
Union Bank of India 4 Centurion Bank of Punjab 2
Punjab National Bank 3 IndusInd Bank 2
IDBI 2 Axis Bank 1
Indian Overseas Bank 2 Bandhan Bank 1
Corporation Bank 1 Federal Bank 1
Canara Bank 1 HDFC Bank 1
Indian Bank 1 IDFC Bank 1
Oriental Bank of Commerce 1 RBL BANK 1
Vijaya Bank 1
Total Deals 27 Total Deals 19
Source: Thomson Reuters, RBI speeches, newspaper articles.

40 INDIA BANKING AND FINANCE REPORT 2021

 8
7
6
5
4
3
2
1
0
2000 2001 2002 2003 2004 2005 2006 2008 2009 2010 2014 2015 2016 2017 2018 2019
Figure 3.3 Number of M&A Deals by Year of Announcement
Source: Authors’ compilation.
Examining the number of deals announced
by year in Figure 3.3, we observe that the larg-
est number of deals were announced in 2006,
followed by 2019, when mega-mergers were an-
nounced among some of the PSBs on 30 August
2019. These deals were effective in April 2020.
On the basis of the nature of the deal, we cat-
egorize them as distressed deals, where a dis-
tressed bank is merged into a stronger bank.
In case where the deal involves consolidation
among PSBs, these deals have been classified as
consolidation deals, and the remaining deals are
classified as voluntary deals. Table 3.2 provides
the number of deals in each category for public
and private sector banks. The full deal list with
categorization, dates of announcement, etc., is
provided in Appendix A (Table A.1).
Except for the acquisition of distressed Ganesh
Bank of Kurundwad Ltd. by a private sector
bank, the Federal Bank, all other distressed ac-
quisitions involve public sector entities stepping
in to acquire distressed banks. Consolidation
deals are deals in the public sector, whereas vol-
untary deals are mainly in the private sector.
Table 3.2 Classification of M&A Deals by Type of Deal
Sector of Acquiring Bank Consolidation
Private
Public 15
Grand Total 15
Source: Authors’ compilation.
3.3.1. Stock Market Reaction/
Event Study Methodology
The event study methodology has been used
to determine the cumulative abnormal returns
(CAR) for 3 days and 11 days around the event an-
nouncement date. We use the event study meth-
odology as described by Mackinlay (1997). This
method involves three steps. The event study
methodology is described in Figure 3.4. The first
step is to compute the expected returns during
an estimation window before the announce-
ment date.
An estimation window of –50 to –250 days is
used to determine the expected return of the ac-
quiring bank stock in relation to the market index.
We use the market model for the estimation.
Rit = ∝i + bi Rmt + eit(3.1)
where
Rit is the expected return on the firm
Rmt is the return on the market portfolio
∝i is the intercept term
bit is the sensitivity of the return on the firm to
S&P BSE 100 returns
eit is the zero mean disturbance term
Deal Type
Distressed Voluntary Grand Total
1 18 19
6 6 26
7 24 46
Mergers and Acquisitions in the Indian Banking Industry 41
 –5
Estimation window = –50 to –250
days before announcement date
Figure 3.4 Event Study Methodology
Source: Authors’ compilation based on Mackinlay (1997).
The next step is to arrive at the abnormal re-
turns around the event date. We compute the ex-
pected return for the acquiring bank stock given
the S&P market index return for each of the days
–5 to +5 days surrounding the announcement
date, using the results from the estimation win-
dow in Step 1. The event announcement date is
considered Day 0.
Abnormal stock return = A
 ctual return –
Expected return
Finally, we compute the CAR for the acquiring
company stock for 3 days and 11 days around the
event announcement date as follows:
3-day CAR = ∑ Abnormal Returns Day –1 to
Day +1
11-day CAR = ∑ Abnormal Returns Day –5 to
Day + 5
Further, we only consider one deal by an ac-
quiring bank when multiple target acquisitions
are announced on the same day. Our final set of
deals for event studies comprises 34 deals.
3.3.2. Methodology Relating to
Performance of Banks and Variable
Definition
This study further makes an attempt to look at
the impact of M&A on the performance of banks
in India. The post-acquisition performance has
been analysed by comparing the performance
of the acquiring bank one year before the deal
announcement with the performance of the
merged entity two years post-acquisition an-
nouncement. Data have been obtained from the
statistical tables relating to banks in India, RBI,
42 INDIA BANKING AND FINANCE REPORT 2021
–4 –3 –2 –1 0 1 2 3 4 5
Event window
Announcement day = Day 0
3-day window = –1 to + 1
11-day window = –5 to + 5
Announcement date = Day 0
CMIE PROWESS database and annual reports
of banks in the study. The performance of the
banks is measured using the following variables
(Exhibit 3.1) available in the literature. The vari-
able selection is broadly based upon the impact
of the acquisition on the capital adequacy, asset
quality, operating efficiency, liquidity position
and profitability. These parameters are further
divided into sub-parameters to look at the over-
all performance.
3.4. Results and
Interpretation
The results of this chapter are presented as
follows: (a) an analysis of market reactions to
deal announcements and (b) an analysis of
banks’ operational performance following deal
announcement.
3.4.1. Event Study Results
We present the CAR for deal announcements
during the 3-day and 11-day event windows.5
The first set of results is presented for distressed
deals in Table 3.3 and Figure 3.5. We are able to
compute the 3-day and 11-day CAR for 5 out of 7
deal announcements during the period.
We observe that except in the case of 11-day
CARs for the acquisition of Nedungadi Bank, all
other CARs are either negative or zero, indicat-
ing that the market does not seem to perceive
these deals to have a positive impact on acquirer
banks. These findings are in line with Jayadev
and Sensarma (2007), though they use the term
‘forced’ instead of ‘distressed deals’.
Exhibit 3.1 Various Definitions
Variable Name Formula
Assessment of capital adequacy
Capital adequacy Tier I and tier II CRAR
ratio
Debt equity ratio Total outside liability to net
worth
Advances to assets Total advances to total
ratio assets
Assessment of assets quality
GNPA ratio Gross NPAs to gross
advances
Net NPA ratio Net NPA to net advances
Assessment of operating efficiency
Cost to income (Operating expenses –
ratio Other income)/interest
income
Total advances to Total credit to total deposits
total deposits
Business per Total business (deposits plus
employee advances) by total number
of employees
Profit per employee Profit after tax with total
number of employees
Assessment of liquidity position
Liquid assets to Liquid assets (cash in hand,
total assets cash at bank, balance with
RBI, balance with other
banks) to total assets
Liquid assets to Liquid assets to total
demand deposits demand deposits
Assessment of profitability
RoA Net income to total assets
RoE Net profit to shareholder
funds, i.e., capital + reserves
and surplus
Net interest Spread (Interest earned –
revenue to total Interest expenses) to total
assets assets
Impact of
Higher Ratio
on Performance Explanation
+ Indicates safety of the banks
against bankruptcy.
– Higher ratio indicates less
protection for the stakeholders
in the bank.
+ This ratio reflects on the bank’s
aggressiveness in lending which
ultimately results in better
profitability for the lending
institutions.
– Measure of the assets quality of
a lending institution.
– Measure of the quality of the loan
book after considering provisions.
– A key financial parameter to
determine efficiency of the
bank with respect to controlling
operating costs.
+ Assess the management ability
to convert the deposits available
with the bank into high earning
advances.
+ It shows employees’ efficiency to
generate business for the bank.
+ An indicator of efficiency of
employees.
+ Indicates the overall liquidity
position of a bank and its ability
to pay off its liability.
+ Measures the ability of a bank
to meet the demand from
depositors from liquid assets.
+ Indicates bank’s performance in
generating profits.
+ It provides the investor the
insight about the bank’s
profitability.
+ It is an indicator of bank’s profit
margin. Higher spread is an
indicator of better earning given
the total assets of the bank.
Mergers and Acquisitions in the Indian Banking Industry 43
 Table 3.3 Stock Market Reaction to Distressed Deal Announcements
Acquirer Target 3–day CAR (%) 11–day CAR (%)
Punjab National Bank Nedungadi Bank –0.24 4.65
Oriental Bank of Commerce Global Trust Bank (India) –5.99 –13.13
IDBI United Western Bank 0.73 –5.44
Federal Bank Ganesh Bank of Kurundwad Ltd –5.92 –5.42
Indian Overseas Bank Shree Suvarna Sahakari Bank Ltd 0.38 –4.53
Source: Authors’ compilation.

10.00%

5.00%

0.00%
Nedungadi Bank Global Trust South Gujarat United Western Ganesh Bank of Shree Suvarna
–5.00% Ltd Bank Local Area Bank Bank Ltd Kurundwad Ltd Sahakari Bank
Ltd Ltd
–10.00%

–15.00%
3-Day CAR% 11-Day CAR%

Figure 3.5 Cumulative Abnormal Returns to Distressed Deal Announcements

Authors’ compilation.

Next, we present the results for consolidation
deals in Table 3.4 and Figure 3.6.
The market has reacted positively in the
case of both 3-day CARs and 11-day CARs in
the case of the SBI acquisition of State Bank of
Travancore, State Bank of Mysore, State Bank
of Bikaner and Bharatiya Mahila Bank. It is
said that the acquisition by the SBI enabled it
to boost its asset base and market share, posi-
tioning itself to compete with global banks.6
Following the announcement of Allahabad
Bank’s acquisition, PNB received a positive
market reaction. All other consolidation deals
announced in 2019 received a negative market
reaction. The combined CRAR and net NPA
position for Allahabad Bank and Indian Bank
combined were stronger than the other banks
involved in the PSU consolidations announced
in 2019 (RBI, 2020).
Next, we present the results for the other
deals, which are classified as voluntary deals in
Table 3.5 and Figure 3.7.

Table 3.4 Stock Market Reaction to Consolidation Deal Announcements

Acquirer Target 3-day CAR (%) 11-day CAR (%)
SBI State Bank of Indore 0.90 –2.66
SBI SBI Capital Markets Ltd –1.18 –2.04
SBI State Bank of Mysore, Travancore, 4.28 5.44
Bikaner, Bharatiya Mahila Bank
Bank of Baroda Vijaya Bank and Dena Bank –10.95 –17.64
Union Bank of India Corporation Bank –2.19 –9.25
Punjab National Bank Oriental Bank of Commerce –0.95 –5.29
Indian Bank Allahabad Bank 2.35 2.15
Union Bank of India Andhra Bank –2.19 –9.25
Punjab National Bank United Bank of India –0.95 –5.29
Canara Bank Syndicate Bank –9.80 –9.61
Source: Authors’ compilation.

44 INDIA BANKING AND FINANCE REPORT 2021

 10.00%

5.00%

0.00%
State Bank SBI Capital State Bank Vijaya Bank Corporation Oriental Allahabad Andhra United Bank Syndicate
of Indore Markets of Mysore, & Bank Ltd Bank of Bank Ltd Bank Ltd of India Bank
–5.00% Ltd Travancore, Dena Bank Commerce
Bikaner,
Bharitiya
–10.00% Mahila
Bank

–15.00%

–20.00%
3-Day Cumulative Abnormal Returns 11-Day Cumulative Abnormal Returns

Figure 3.6 Cumulative Abnormal Returns to Consolidation Deal Announcements

Source: Authors’ compilation.

Table 3.5 Stock Market Reaction to Voluntary Deal Announcements

Acquirer Target 3-day CAR (%) 11-day CAR (%)
ICICI Bank Bank of Madura 12.53 11.60
ICICI Bank ICICI 17.05 23.76
IndusInd Bank Ashok Leyland Finance Ltd 3.08 –2.74
IDBI IDBI –2.41 –2.64
Vijaya Bank Vijaya Bank –1.86 –0.99
Corporation Bank Corp Bank Homes Ltd 1.59 –0.66
Kotak Mahindra Bank Kotak Mahindra Bank 10.03 9.28
Centurion Bank of Punjab Bank of Punjab 6.30 –5.34
Kotak Mahindra Bank Kotak Mahindra Bank 7.83 9.35
Centurion Bank of Punjab Lord Krishna Bank –0.12 –2.13
ICICI Bank Sangli Bank Ltd 0.63 0.79
HDFC Bank Centurion Bank of Punjab –4.24 –4.85
ICICI Bank Bank of Rajasthan –4.98 –2.92
Kotak Mahindra Bank ING Vysya Bank 9.79 5.61
Union Bank of India Union Bank of India 2.10 –5.77
Kotak Mahindra Bank Kotak Mahindra Bank 0.38 2.18
Axis Bank Jasper Infotech Pvt Ltd –5.79 –6.15
IndusInd Bank Bharat Financial Inclusion Ltd 0.89 –1.24
Bank of Baroda Rue La Boetie SAS –0.13 –3.70
IDFC Capital First Ltd –1.35 0.79
RBL Bank RBL Bank –0.42 3.34
Bandhan Financial Services Housing Development –10.79 –18.99
Pvt Ltd Finance Corp Ltd
Source: Authors’ compilation.

Mergers and Acquisitions in the Indian Banking Industry 45

 30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
–5.00%
–10.00%
–15.00%
–20.00%
–25.00%
Bank of Madura Ltd
Industrial Credit & Investment Corp of
India Ltd {ICICI Ltd}
Ashok Leyland Finance Ltd

IDBI

Vijayabank Housing Finance Ltd

Corp Bank Homes Ltd

Kotak Mahindra Primus Ltd

Bank of Punjab Ltd

Kotak Securities and Kotak Capital

Lord Krishna Bank Ltd

Sangli Bank Ltd

Centurion Bank of Punjab Ltd

Bank of Rajasthan Ltd

ING Vysya Bank Ltd

Union KBC Trustee, Union KBC Asset
Management
Kotak Mahindra Old Mutual Life
Insurance Ltd
Accelyst Solutions Pvt Ltd

Bharat Financial Inclusion Ltd

Baroda Pioneer Asset Management Co Ltd

Capital First Ltd

Swadhaar FinServe Pvt Ltd

Gruh Finance Ltd

3-Day Cumulative Abnormal Returns 11-Day Cumulative Abnormal Returns

Figure 3.7 Cumulative Abnormal Return for Voluntary Deals

Source: Authors’ compilation.

The largest gains among this set of deals were test of normality does not hold.8 Since the number
observed in the case of ICICI Ltd’s merger with of deals in our event study is small and the as-
ICICI Bank. The move of ICICI, the erstwhile de- sumption of normality does not hold, we also ran
velopmental financial institution into a univer- non-parametric tests along with a parametric t-
sal bank, has been perceived as a positive move test for significance of 3-day and 11-day CARs.
for the institution by the equity markets. This
Table 3.6 indicates that both 11-day and 3-day
finding is in line with Anand and Singh (2008).
CARs are not significantly different from a mean
The other deals that received a positive response value of zero for all deals in our full sample. How-
of more than that, or close to 5 per cent, are the ever, when we examine the sub-sample of deals
acquisition of the Bank of Madura by ICICI, Kotak by PSBs, we observe that the mean value of 11-
Mahindra Primus and Kotak Securities by Kotak day CARs is negative and significant at the 5 per
Mahindra Bank. In contrast, the move by Band- cent level of significance based on the t-test. The
han Bank to acquire Gruh Finance has received Wilcoxon signed rank test also finds that PSB re-
the largest negative response of this set of deals. turns during the 11-day event window are lower
The negative reaction may be because of a per- at the 10 per cent level of significance (Note 7).
ception that Bandhan Bank overpaid for the ac- It seems that the market reacts negatively more
quisition when they acquired Gruh Finance from often to deal announcements by PSBs, while the
HDFC Bank. The loss of the HDFC brand backing market does not react significantly in a positive or
to Gruh Finance was also considered a negative.7 negative direction to deal announcements by pri-
Next, we examine whether the CARs are sig- vate sector banks.
nificantly different than a mean value of zero and
whether they differ significantly between public 3.4.2. Operating Performance Results
and private sector banks. We run a test of normal- We collected data on the specified indica-
ity for the 3-day and 11-day CARs and find that the tors in Exhibit 3.1 for one year before the deal

46 India Banking and Finance Report 2021

 completed, one year after, and two years after
Table 3.6 Tests of Significance for 11-Day and
3-Day CARs the deal was completed for all M&A deals com-
pleted from 2006 to 2020. For example, if the
No of Mean
deal is completed in 2008 (irrespective of the an-
Obs. CARs t
nouncement date), we collect the indicators for
11-day CAR
2007, 2009 and 2010. The indictors are matched
All deals 35 –.015 –1.14 from the year before completion, that is, 2007, to
Deals by PSBs 17 –.042 –2.903** one year after completion, that is, 2009 and 2010,
Deals by private to determine whether there was any impact on
sector banks 18 0.009 0.438 any of the indicators measured. In case of deals
3-day CAR completed in 2020, we are only able to compare
All deals 35 .003 0.318 the performance for one year post deal comple-
Deals by PSBs 17 –.0137 –1.384 tion instead of two years.
Deals by private The results of the t-tests are presented for all
sector banks 18 0.019 1.120 deals, pre- and post 1 year, and pre- and post
Source: Authors’ compilation. 2 years, in Table 3.7. The table presents the mean
Note: *, ** and *** indicate 10%, 5% and 1% level value for the indicator one year before deal
of significance, respectively.
completion and mean value one year post deal

Table 3.7 Performance of Acquiring Banks One Year Prior to Deal Completion with One Year Post
Deal Completion
Mean 1 Year Mean 1 Year Impact on
Obs Pre-acquisition Post-acquisition p-value Performance
Assessment of Capital Adequacy
Capital adequacy 27 14.654 14.383 0.654 –
Debt/Equity 27 11.793 11.859 0.878 –
Advances to assets ratio 27 0.583 0.599 0.177 +
Assessment of Assets Quality
GNPA ratio 26 5.224 5.497 0.596 –
Net NPA ratio 27 2.341 2.361 0.945 –
Assessment of Operating Efficiency
Cost-to-income ratio 27 9.763 10.264 0.719 –
Total advances to total
27 0.831 0.833 0.968
deposits ~
Business per employee 27 1,063 1,149 0.06* +
Profit per employee 27 4.717 4.436 0.867 –
Assessment of Liquidity Position
Liquid assets to total assets 27 0.092 0.084 0.178 –
Liquid assets to demand
27 1.308 1.231 0.436
deposits –
Assessment of Profitability
RoAs 27 0.890 0.705 0.238 –
RoE 27 9.161 8.770 0.835 –
Net interest revenue to total
27 3.035 3.029 0.966
assets –
Source: Authors’ compilation.
Note: *, ** and *** indicate 10 per cent, 5 per cent and 1 per cent levels of significance.

Mergers and Acquisitions in the Indian Banking Industry 47

 completion. The p-values and the direction of
change of the parameter on performance are
also listed.
We observe that business per employee has
increased from an average of `1,063 lakh to
`1,149 lakh, one year post acquisition, which
is significant at the 10 per cent level of signifi-
cance. All other parameters, except for total ad-
vances to total deposits, which have remained
constant, exhibit a negative impact one year
post acquisition.
We next examine the performance of the ac-
quiring banks from one year pre-acquisition to
two years post-acquisition. It is hypothesized that
a bank would take a few years to integrate the
target company and subsequently start achieving
synergies from the acquisition.
Since there are a number of deals that were
completed in 2020 for which two years of post-
acquisition data are not available, we are able to
compare the performance of a lesser number of
banks. In Table 3.8, performance one year prior to
acquisition completion is compared to two years
post deal completion. Business per employee at
the 1 per cent level of significance continues to
show an improvement. This is in line with Cornett
and Tehranian (1992) and Patel (2018). Some of the
other parameters that were negatively impacted
in the first year after the acquisition show an im-
provement. These include all the ratios reflecting
capital adequacy, namely capital adequacy, debt/
equity and advances to assets. The GNPA ratio is
still higher than in the pre-acquisition period. The
banks seem to have been able to contain costs,
though not significantly as the cost-to-income

Table 3.8 Performance of Acquiring Banks Two Years Post Deal Completion
Mean 1-year Mean 2 Years Impact on
Obs Pre-Acquisition Post-Acquisition p-Value Performance
Assessment of Capital Adequacy
Capital adequacy 19 14.421 15.012 0.549 +
Debt/Equity 19 11.863 11.402 0.612 +
Advances to assets ratio 19 0.577 0.605 0.037 +
Assessment of Assets Quality
GNPA ratio 21 4.160 4.362 0.779 –
Net NPA ratio 19 1.921 1.868 0.895 +
Assessment of Operating Efficiency
Cost-to-income ratio 19 8.808 8.681 0.945 +
Total advances to total 19 0.840 0.833 0.909 –
deposits
Business per employee 19 909 1,137 0*** +
Profit per employee 19 5.758 5.333 0.732 –
Assessment of Liquidity Position
Liquid assets to total assets 19 0.097 0.088 0.331 –
Liquid assets to demand 19 1.171 1.160 0.931 –
deposits
Assessment of Profitability
RoAs 19 0.979 0.848 0.266 –
RoE 19 12.166 9.146 0.122 –
Net interest revenue to total 19 2.965 3.038 0.641 +
assets
Source: Authors’ compilation.
Note: *, ** and *** indicate 10 per cent, 5 per cent and 1 per cent levels of significance.

48 INDIA BANKING AND FINANCE REPORT 2021

ratio has declined. Profit per employee is still
lower than in the pre-acquisition period. The li-
quidity position remains stressed and returns are
also lower. However, net interest revenue to total
assets exhibited a marginal improvement.
Next, we examine whether there is a differ-
ence in the post-acquisition performance of pub-
lic and private sector banks. In Table 3.9, since an
organization would take at least two years to in-
tegrate, we present the results of the acquisition
two years post acquisition for public and private
sector banks. We observe an improvement in
business per employee for both public and pri-
vate sector banks at the 1 per cent level of signifi-
cance. Private sector banks exhibit an improve-
ment in advances to deposit ratio at the 5 per cent
level of significance. In case of PSBs, we observe a
deterioration in cost efficiency with an increase
in cost-to-income ratio at the 5 per cent level of
significance. We do observe a decline, albeit sta-
tistically insignificant, in capital adequacy, debt/
equity, asset quality, liquidity and profitability in
PSBs. Data for PSU consolidations announced in
2019 are awaited.

Table 3.9 Comparison of Performance for Public and Private Banks Two Years Post Deal Completion
No of Mean 1-year Mean 2 Years Impact on
Obs. Pre-Acquisition Post-Acquisition p-Value Performance
Assessment of Capital Adequacy
Public sector 9 12.920 12.859 0.923 –
Private sector 10 15.771 16.949 0.525 +
Debt/Equity
Public sector 9 15.380 15.747 0.599 –
Private sector 10 8.697 7.491 0.469 +
Advances to Assets Ratio
Public sector 9 0.587 0.615 0.181 +
Private sector 10 0.567 0.596 0.138 +
Assessment of Assets Quality
GNPA ratio
Public sector 9 5.474 6.221 0.617 –
Private sector 12 3.174 2.969 0.765 +
Net NPA Ratio
Public sector 9 2.569 2.698 0.871 –
Private sector 10 1.338 1.121 0.549 –
Assessment of Operating Efficiency
Cost-to-income Ratio
Public sector 9 5.555 8.692 0.036** –
Private sector 10 11.735 8.672 0.328 +
Total Advances to Total Deposits
Public sector 9 0.874 0.781 0.500 –
Private sector 10 0.810 0.879 0.016** +
Business per Employee
Public sector 9 1,126 1,421 0.000*** +
Private sector 10 714 882 0.005*** +
Profit per Employee
Public sector 9 4.204 1.919 0.352 –

(Table 3.9 Continued)

Mergers and Acquisitions in the Indian Banking Industry 49

 (Table 3.9 Continued)
No of Mean 1-year Mean 2 Years Impact on
Obs. Pre-Acquisition Post-Acquisition p-Value Performance
Private sector 10 7.157 8.405 0.183 +
Assessment of Liquidity Position
Liquid Assets to Total Assets
Public sector 9 0.104 0.084 0.187 –
Private sector 10 0.090 0.092 0.839 ~
Liquid Assets to Demand Deposits
Public sector 9 1.405 1.296 0.650 –
Private sector 10 0.960 1.038 0.453 +
Assessment of Profitability
RoAs
Public sector 9 0.665 0.396 0.189 –
Private sector 10 1.261 1.255 0.965 ~
RoE
Public sector 9 12.261 6.875 0.187 –
Private sector 10 12.080 11.191 0.387 –
Net Interest Revenue to Total Assets
Public sector 9 2.310 2.491 0.425 +
Private sector 10 3.554 3.529 0.913 –
Source: Authors’ compilation.
Note: *, ** and *** indicate 10%, 5% and 1% level of significance, respectively.

We next compare the pre- and post-acquisition
performance of deals based on their type, such
as distressed, voluntary or consolidation deals.
Since the number of deals in each category is
very small, a t-test is not considered appropriate
and we conduct a non-parametric Kruskal–Wallis
Test to compare the performance parameters one
year prior to acquisition to two years post acqui-
sition in Table 3.10 to evaluate whether there is a
significant difference in the performance of ac-
quiring firms by deal type.
As observed in Table 3.10, we do not observe
any significant difference across the three deal
types.
We present the mean data for some important
performance parameters by deal type and per-
formance parameter in Figure 3.8.

Table 3.10 Kruskal–Wallis

Variable Degree of Freedom p-Value χ2
Capital adequacy 2 0.518 1.316
Debt to equity 2 0.842 0.345
GNPA 2 0.341 2.150
Cost to income 2 0.401 1.829
Business per employee 2 0.240 2.853
Liquid assets to total assets 2 0.485 1.445
RoAs 2 0.878 0.261
RoE 2 0.974 0.053
Source: Authors’ compilation.

50 INDIA BANKING AND FINANCE REPORT 2021

 Capital Adequacy Debt/Equity Ratio
20.0 16.2 16.1 20.0 17.1
15.4 15.6 15.3
12.5 13.0 12.7 13.7
15.0 15.0
15.1 15.4 9.5
14.7 8.9
10.0 13.4 13.4 10.0
9.6
5.0 5.0
– –
Consolidation Distressed Voluntary Consolidation Distressed Voluntary

One Year Pre One Year Post Two Years Post One Year Pre One Year Post Two Years Post

GNPA Ratio Cost to Income Ratio

10.0 9.2 9.1 14.0
11.7 11.6
12.0 10.5 10.8
8.0
10.0 8.9 9.2
5.6
6.0 8.0
4.1 4.5
4.0 3.3 2.9 3.5 6.0 4.3
3.6
2.0 4.0 2.2
2.0
2.0
– –
Consolidation Distressed Voluntary Consolidation Distressed Voluntary

One Year Pre One Year Post Two Years Post One Year Pre One Year Post Two Years Post

Business Per Employee Liquid Assets to Total Assets

0.12
1,064 0.10
Voluntary 963 0.10 0.10 0.09 0.09
913 0.08 0.08
0.08 0.08
0.08 0.07
1,230
Distressed 1,022 0.06
889
0.04
1,287
Consolidation 1,570 0.02
1,430
–
– 500 1,000 1,500 2,000 Consolidation Distressed Voluntary

Two Years Post One Year Post One Year Pre One Year Pre One Year Post Two Years Post

Return on Assets Return on Equity

1.5 1.3 20.0 16.5
0.9 15.0 13.1
1.0 0.9 0.9 0.9 0.8 11.2 11.9 11.4
0.6 10.0 8.2 8.2
7.8
0.5 0.4
0.1 5.0 1.9
– –
Consolidation Distressed Voluntary Consolidation Distressed Voluntary

One Year Pre One Year Post Two Years Post One Year Pre One Year Post Two Years Post

Figure 3.8 Comparison of Performance Parameters for Consolidation, Distressed and

Voluntary Deals
Source: Authors’ compilation.

Mergers and Acquisitions in the Indian Banking Industry 51

 Capital adequacy: On the basis of mean values,
we observe that firms that undertake voluntary
deals seem to be better capitalized and have a
lower debt-to-equity ratio than firms that under-
take distressed or consolidation deals. However,
we observe that consolidation and distressed
deals do not seem to lead to a deterioration in the
capital adequacy of acquiring firms.
Asset quality: Firms that undertake voluntary
deals have a lower GNPA position than firms
that undertake consolidation or distressed deals.
However, it is interesting to note that the firms
that undertake these non-voluntary deals seem
to improve their GNPA position, as the mean
GNPA of distressed firm acquirers in consolida-
tion deals has come down. Data for PSU bank ac-
quisitions completed in 2020 were awaited at the
time of this study.
Operating efficiency: The cost-to-income ratio
has increased, showing an increase in burden
impacting the operating efficiency for both dis-
tressed and consolidation deals; however, the cost
to income has improved for voluntary deals. Busi-
ness per employee has declined in consolidation
deals but improved in both distressed and volun-
tary deals, indicating some improvement in em-
ployee efficiency post acquisition in these deals.
Liquidity: We observe that the liquidity posi-
tion of acquiring banks in voluntary deals has
improved in the two years post-acquisition pe-
riod; however, there is a marginal decline in the
case of distressed and consolidation deals.
Profitability: RoAs have improved marginally
in both consolidation and voluntary deals and
have remained the same in distressed deals. Net
interest revenue to total assets has improved
marginally for consolidation and distressed deals
and declined in case of voluntary deals.
3.5. Conclusion
Indian commercial banks, in both the public and
private sectors, have actively engaged in M&A
deals during 2000–2020. We examine the stock
market reaction and post-acquisition operating
performance of these M&A deals.
The market typically perceives distressed
and consolidation deals negatively. Within
52 INDIA BANKING AND FINANCE REPORT 2021
consolidation deals, the market reacted positive-
ly to the consolidation within the SBI and also
to the acquisition of Allahabad Bank by Indian
Bank. The market may have perceived a stronger
market position in the case of SBI and a strength-
ened post-acquisition balance sheet in the Alla-
habad Bank deal.
Voluntary deals have received a mixed re-
sponse, with ICICI Bank’s acquisition of ICICI
Limited receiving the highest cumulative gains
during the study period and Bandhan Bank’s
acquisition of Gruh Finance earning the highest
negative CAR. The mean 11-day cumulative mar-
ket returns to deals announced by PSBs are nega-
tive and significant, indicating a negative market
perception about deals of PSBs.
Operating performance results indicate that
the mean business per employee improved sig-
nificantly post acquisition. By comparing the
performance of public and private sector banks,
we find that banks from both sectors exhibit an
improvement in business per employee. How-
ever, PSBs also face deteriorating efficiency with
an increase in the cost-to-income ratio. Accord-
ing to private sector data, these banks undertake
more aggressive growth after acquisition, which
is reflected in an increase in the advances to de-
posit ratio.
Consolidation and distressed deals exhibit an
improvement in capital adequacy, business per
employee, reduction in debt/equity and GNPA
ratio. However, an increase in cost-to-income ra-
tio and a decline in liquid assets to total assets is
an area of concern. There is an improvement in
RoA and RoE in consolidation deals. On the con-
trary, voluntary deals face a reduction in capital
adequacy, an increase in debt/equity, a deteriorat-
ing GNPA position and a decline in RoA and RoE.
However, voluntary deals have managed cost to
income better, have exhibited an improvement in
business per employee and do not face as much
stress on liquidity. Acquirers involved in consoli-
dation deals could maintain a closer watch on op-
erating costs and management of liquidity.
This study provides useful insights into the
market perception of M&A deal announcements
and the impact of acquisitions on the operating
performance of acquiring banks.
Appendix A

TABLE A.1 List of Deals Considered in Study

Year Target Name Acquirer Name Classification

2000 Bank of Madura Ltd ICICI Bank Voluntary
2001 ICICI ICICI Bank Voluntary
2002 Nedungadi Bank Punjab National Bank Distressed
2002 Benaras State Bank Bank of Baroda Distressed
2003 Ashok Leyland Finance IndusInd Bank Voluntary
2004 IDBI IDBI Voluntary
2004 Vijaya Bank Housing Finance Ltd Vijaya Bank Voluntary
2004 Global Trust Bank Oriental Bank of Commerce Distressed
2004 Corpbank Homes Ltd Corporation Bank Voluntary
2004 South Gujarat Local Area Bank Ltd Bank of Baroda Distressed
2005 Kotak Mahindra Primus Ltd Kotak Mahindra Bank Voluntary
2005 Bank of Punjab Ltd Centurion Bank of Punjab Voluntary
2006 United Western Bank Ltd IDBI Distressed
2006 Ganesh Bank of Kurundwad Ltd Federal Bank Distressed
2006 Kotak Securities Ltd Kotak Mahindra Bank Voluntary
2006 Kotak Mahindra Capital Co. Kotak Mahindra Bank Voluntary
2006 Lord Krishna Bank Ltd Centurion Bank of Punjab Voluntary
2006 Sangli Bank Ltd ICICI Bank Voluntary
2006 Bharat Overseas Bank Indian Overseas Bank Consolidation
2008 Centurion Bank of Punjab Ltd HDFC Bank Voluntary
2008 Shree Suvarna Sahakari Bank Ltd Indian Overseas Bank Distressed
2009 State Bank of Indore SBI Consolidation
2010 Bank of Rajasthan ICICI Bank Voluntary
2010 SBI Capital Markets Ltd SBI Consolidation
2014 ING Vysya Bank Kotak Mahindra Bank Voluntary
2015 Union KBC Trustee Co Pvt Ltd Union Bank of India Voluntary
2015 Union KBC Asset Management Union Bank of India Voluntary
Co Pvt Ltd
2016 State Bank of Mysore SBI Consolidation
2016 State Bank of Travancore SBI Consolidation
2016 Bharatiya Mahila Bank Ltd SBI Consolidation
2016 State Bank of Bikaner & Jaipur SBI Consolidation
2017 Kotak Mahindra Old Mutual Life Kotak Mahindra Bank Voluntary
Insurance Ltd
2017 Accelyst Solutions Pvt Ltd Axis Bank Voluntary
2017 Bharat Financial Inclusion Ltd IndusInd Bank Voluntary

(Table A.1 Continued)

Mergers and Acquisitions in the Indian Banking Industry 53

 (Table A.1 Continued)

Year Target Name Acquirer Name Classification

2017 Baroda Pioneer Asset Management Bank of Baroda Voluntary
Co Ltd
2018 Capital First Ltd IDFC Bank Voluntary
2018 Swadhaar FinServe Pvt. Ltd RBL Bank Voluntary
2018 Vijaya Bank Bank of Baroda Consolidation
2018 Dena Bank Bank of Baroda Consolidation
2019 Gruh Finance Ltd Bandhan Bank Voluntary
2019 Corporation Bank Union Bank of India Consolidation
2019 Oriental Bank of Commerce Punjab National Bank Consolidation
2019 Allahabad Bank Indian Bank Consolidation
2019 Andhra Bank Union Bank of India Consolidation
2019 United Bank of India Punjab National Bank Consolidation
2019 Syndicate Bank Canara Bank Consolidation

Appendix B. Regulatory Housing Finance Ltd did not receive regulatory

Framework for Mergers and
Acquisitions of Banks in India
M&A in the Indian banking industry are governed
by the Banking Regulation Act, 1949. Section 44A
regulates voluntary mergers, and Section 45 for
compulsory amalgamations/M&A. Voluntary
amalgamation of private sector banks is addition-
ally governed by RBI Master Directions.9
In amalgamation of private banks, the draft
scheme is to be approved by two-thirds major-
ity of the total board members (not just of those
present and voting). Subsequently, the scheme
must be approved by two-thirds majority in
value of the shareholders present in person or
by proxy at the shareholder meeting. Next, the
scheme is to be submitted to the RBI for sanction.
In case of an amalgamation between a private
sector bank and NBFC, the procedure is slightly
modified. In this case, after the approval by the
Board of Directors, the scheme is submitted to the
RBI for approval. NCLT approval and sharehold-
er approval is sought after the scheme has been
approved by the RBI. There have been instances
where the RBI has not permitted amalgamations
in the private sector. For example, the amalgama-
tion between Lakshmi Vilas Bank and Indiabulls
approval. Subsequently, LVB has been amalgam-
ated compulsorily with a subsidiary of DBS bank
under Section 45.
PSB mergers/amalgamations are guided by the
Banking Companies (Acquisition and Transfer
of Undertakings) Acts of 1970 and 1980 which
specify that the central government, in consulta-
tion with the RBI, may make a scheme, for the
amalgamation of any nationalized bank with
any other nationalized bank or any other bank-
ing institution.
Several measures have been taken to smoothen
the process of mergers of PSBs. As per notification
in 2017, amalgamations of nationalized banks
are exempt from the scrutiny of the Competi-
tion Commission for 10 years thus speeding the
mergers. A committee under the chairmanship
of the Union Finance Minister has been set up to
consider the schemes of amalgamations of nation-
alized banks under the ‘alternative mechanism’.
The mechanism considers proposals received
from boards of banks or may also direct banks to
consider proposals for amalgamation; these pro-
posals seek inputs from the RBI before granting
in-principle approval. Recommended schemes
are put up to both houses of the Parliament for
approval. Recent mergers of PSBs announced in
2019 followed the alternative mechanism.

54 INDIA BANKING AND FINANCE REPORT 2021

Notes
1. https://imaa-institute.org/m-and-a-by-in-
dustries/
2. h t t p s : / / w w w . g r a n t t h o r n t o n . i n /
globalassets/1.-member-firms/india/assets/
pdfs/annual-dealtracker-2021.pdf
3. h t t p s : // w w w. f i n a n c i a l e x p r e s s . c o m /
market/10-years-of-lehman-brothers-bank-
ruptcy-a-timeline-of-decade-old-crisis-at-
defunct-wall-street-giant/1313066/
4. RBI (2020).
5. Details of regression estimates for a, b, R2 and
adjusted R2 available on request.
6. https://www.firstpost.com/business/sbis-
merger-with-associates-all-you-need-to-
know-about-the-deal-2965730.html
7. https://mnacritique.mergersindia.com/band-
han-bank-gruh-finance-hdfc-merger/
8. Results available on request.
9. https://m.rbi.org.in/Scripts/BS_ViewMasDi-
rections.aspx?id=10364
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India’s Bad Bank
Opportunities and Challenges
Tasneem Chherawala
4.1. Introduction
The Foreword by the RBI governor to the Finan-
cial Stability Report (RBI, 2021) highlights the
role of banks and financial intermediaries in
bolstering India’s post-pandemic economic re-
vival. It unequivocally emphasizes the need to
maintain the health of the banking sector and
preserve financial stability as a precondition to
this support. The Indian banking sector, how-
ever, stands on a precipice today. While credit
and market risks already on the balance sheet
are prudently provisioned and adequately capi-
talized, banks continue to show risk aversion in
funding credit offtake. One of the key factors
weighing down the lending capacity of banks
in India today is the burden of non-performing
loans (NPLs), to which provisions and capital re-
main inexorably tied.
Over the last one and a half decades, NPL
additions on the books of Indian banks have
continued to outpace reductions, implying a
burgeoning bad debt portfolio. Recoveries from
bad debts were subject to the banks’ internal
workout processes and available legal remedies.
Since 2004, banks have also been able to sell
their NPLs to asset reconstruction companies
(ARCs) for cash and security receipts (SRs). De-
spite these alternative channels, the NPL recov-
ery rates continued to decelerate until 2016. The
enactment of the Insolvency and Bankruptcy
Code (IBC) in 2016 boosted the legal framework
for creditor rights through quicker resolutions
of defaulters and helped to improve recov-
ery rates and reduce the NPL ratios of banks.
4
Chapter
However, the occurrence of the COVID-19 pan-
demic in 2019 triggered an economic recession,
with dire predictions of a further increase in de-
faults and also slowed down corporate resolu-
tion processes under the IBC.
It was at this critical juncture that the gov-
ernment proposed the establishment of a cen-
tralized bad bank—NARCL—and a private asset
management company (AMC)—India Debt Reso-
lution Company Ltd (IDRCL)—with the objective
of acquiring the bad debts of Indian public and
private sector banks. With a large portfolio of
NPLs offloaded to the NARCL, banks could then
focus their financial and manpower resources on
the core activity of lending to support the post-
pandemic economic recovery.
While the move to set up a bad bank has been
extolled in many quarters, at this nascent stage,
there are multiple questions pertaining to the
rationale behind its establishment, the appro-
priateness of its design, the nature of the NPL
portfolio it will acquire and prospects of its fu-
ture operations and performance that need to
be addressed. In this chapter, we first describe
the historical experiences of bad banks estab-
lished in other countries and in India to address
toxic assets in the banking sector. We then anal-
yse the recent NPL crisis in the Indian banking
sector, which has motivated the formation of
NARCL as India’s Bad Bank. Finally, we evaluate
the opportunities and challenges thrown up by
the establishment of NARCL and conclude with
its implications for the various stakeholders in
the Indian economy.
 4.2. What Is a Bad Bank and
Why Was It Established?
Economic growth depends on the health of the
financial markets in general and the banking
sector in particular. Financial crises can lead to
systemic losses across banks, which can jeopar-
dize financial stability. Alternatively, the idio-
syncratic large losses of an individual but sys-
temically important financial institution can
also spill over to other financial market players.
In such cases, governments need to step in with
strategies to restore the banking system, one of
which involves the segregation of toxic assets
from the underperforming bank(s) into a sepa-
rate ‘bad bank’ so that the originating bank(s) can
be made viable (Gandrud & Hallerberg, 2013).
A ‘bad bank’ is a special-purpose financial entity
established with the narrow objective of acquir-
ing impaired financial assets from other financial
institutions and taking them through to resolu-
tion. A bad bank is thus equivalent to an impaired
AMC, the equivalent of an ARC in India. The bad
bank manages and disposes of the impaired assets,
independent of the originating bank. The finan-
cial institutions that sell these bad loans receive
cash and non-cash considerations. The resulting
balance sheet clean-up and freed-up capital may
potentially enhance their capacity and willing-
ness to lend, improve their earnings and allow
them to focus on core business activities (Landier
& Ueda, 2009). This benefit becomes more critical
during stressed macroeconomic conditions, when
financial stability and a credit boost to the econo-
my are considered essential to put it back on track.
The bad bank concept is neither new in global
financial markets nor a first for India. Bad banks
have been created in many countries to address
impairment-driven banking crises at both sys-
temic and idiosyncratic levels. These AMCs have
been established either with the general objec-
tive of bank resolution or to specifically purchase
NPLs and other loss assets of stressed banks (Cer-
ruti & Neyens, 2016).
4.2.1. Structure and Ownershi p of
Bad Banks
Bad banks can have a centralized or decentral-
ized structure (Gandrud & Hallerberg, 2013;
58 INDIA BANKING AND FINANCE REPORT 2021
Klingebiel, 2001). Centralized bad banks collect
and acquire large volumes of bad debts from
multiple financial institutions and manage them
within a common resolution framework. They
are often crisis-led, established through govern-
ment initiative and benefit from a high level of
consensus and political will (Cerruti & Neyens,
2016). Decentralized bad banks, on the other
hand, are bank-specific AMCs established to
handle the toxic assets of a single stressed finan-
cial institution.
The ownership structure of bad banks can
also vary. They can either be entirely owned
by the government (public AMCs) or be pri-
vately promoted by a single stressed bank or
be collectively sponsored by multiple stressed
banks and other private investors or then have
a mixed public–private ownership. The owner-
ship choice can have a significant impact on the
operations and efficiency of the bad bank (Gan-
drud & Hallerberg, 2014). Other than equity, bad
banks can also raise funds through the issuance
of debt and securitization of NPLs to finance
their bad debt purchases. Crisis-led centralized
bad banks have often required state guarantees
for such security issuances to ensure greater in-
vestor confidence. Public funding of bad banks
and government guarantee support entail a fis-
cal cost, the quantum of which often depends
upon the bad bank’s ultimate performance in
terms of recoveries.
4.2.2. Asset Acquisition by the
Bad Bank
The assets acquired by the bad bank are typical-
ly impaired and subject to losses. The effective-
ness of their resolution hinges on factors such
as sector, age and size of the NPLs, availability
of security, clear titles and clean documenta-
tion. Thus, as suggested by Woo (2000), the bad
bank may exercise discretion in the selection of
assets. Specifically, for a centralized AMC ac-
quiring assets from multiple banks, portfolio di-
versification, minimum size limits and common
linkages like loans to the same debtors or loans
with shared collateral become important crite-
ria for asset identification in order to achieve
economies of scale and maximize recovery val-
ue. Furthermore, in order to avoid a potential
moral hazard for the originating bank(s), the
asset transfer should preferably be a one-time
event rather than an open-ended process (Cas &
Peresa, 2016).
An important aspect of the asset acquisition is
the determination of the optimum transfer price
of NPLs. Ideally, this should be based on market
values established through a transparent, mar-
ket-based due diligence process conducted with
the assistance of an independent third-party
valuer (Cerruti & Neyens, 2016). Impaired assets
have a market value that is significantly lower
than their book value. When assets are trans-
ferred at high discounts to book value, it leads to
the upfront recognition of losses by the originat-
ing banks. The high haircuts preclude the moral
hazard associated with book value-based trans-
fers of bad loans and also ensure that the AMC
is incentivized to make profitable recoveries in-
stead of becoming a ‘zombie bad bank’ (Gandrud
& Hallerberg, 2014).
4.2.3. Operations and Performance
of the Bad Bank
The key function of the bad bank is to be able to
efficiently manage, resolve and dispose of the
acquired assets. This requires sufficient indepen-
dence, efficiency and accountability in its opera-
tional structure, which has to be ensured through
insulation from political influence, an expert
management team and regular reporting and
audits, especially for a centralized public AMC or
one that has received direct or indirect state sup-
port (Cas & Peresa, 2016). Furthermore, the asset
management and disposal strategies adopted by
the bad bank will also underpin its performance.
In most cases of global bad banks, strategies that
focus on rapid asset disposal have shown better
economic recovery, whereas in a few, higher re-
turns have been derived from a more orderly and
paced-out resolution approach. The resolution
strategies and recovery values are also dependent
upon the macroeconomic conditions and the legal
environment. This being said, bad banks that have
an explicit ‘sunset clause’ that specifies a period
at the end of which they are wound down have
a lower risk of mission creep (Cerruti & Neyens,
2016) since they try to maximize their recoveries
within the defined time boundaries.
4.3. Bad Banks in the
Global Context
4.3.1. The Early Bad Banks
One of the earliest private bad bank structures
was implemented in 1988 by US-based Mellon
Bank Corporation (Pinedo, 2009), which created
a new private institution called Grant Street Na-
tional Bank (GSNB) to hold and resolve its toxic
assets. With an initial capital of USD 123 million,
sponsored by Mellon Bank, GSNB made a one-
time acquisition of USD 1 billion worth of bad
loans from Mellon Bank at a 53 per cent discount.
By 1995, having successfully recovered the over-
dues, and having in turn paid off all its obliga-
tions, GSNB was dissolved.
Klingebiel (2001) provides a detailed cross-
country study of the structures, outcomes and
key favourable and unfavourable factors associ-
ated with a number of bad bank-like entities that
were established between 1987 and 1993 in coun-
tries such as Finland (Arsenal), Sweden (Securum
and Retriva), the USA (Resolution Trust Corpora-
tion), Ghana (NPART), Mexico (FOBAPROA) and
the Philippines (Asset Privatisation Trust). These
were all, without exception, entirely govern-
ment-owned and created to address bank-spe-
cific or systemic NPL-related stress. The study
concludes that the AMCs were effective for nar-
rowly defined purposes of resolving unviable fi-
nancial institutions and disposing of their assets,
subject to professional and skilled management,
political independence, appropriate funding,
adequate bankruptcy and foreclosure laws and
transparency in operations and processes.
The public-AMC Securum, established in 1992
by the Swedish State, is also upheld as a model
bad bank (Bergstrom et al., 2003). Capitalized
with SEK 24 billion equity, it was a bank-specific
AMC mandated to resolve SEK 67 billion book
value of insolvent loans from state-owned Nor-
denbanken and Gota Bank. The government
recapitalized Nordenbanken on the basis of an
estimated transfer price of SEK 50 billion. Secu-
rum’s independent board and management team
adopted multiple resolution strategies for suc-
cessfully disposing of 98 per cent of the acquired
portfolio within five years of its launch (Cerruti
& Neyens, 2016). At the time of closure, it had
India’s Bad Bank 59
 recovered close to 86 per cent of the book value
of insolvent loans acquired and paid back SEK 14
billion in capital to the state.
4.3.2. The Bad Banks of the
East Asian Crisis Era
The aftermath of the East Asian crisis led to a
spurt of bad banks across Korea (Korea Asset
Management Corporation [KAMCO]), Indonesia
(Indonesian Bank Restructuring Agency [IBRA]),
Malaysia (Danaharta), China (Great Wall Asset
Management, Orient Asset Management, Cinda
Asset Management and Huarong Asset Manage-
ment), Japan (Resolution and Collection Corpo-
ration [RCC]) and Thailand (Thai Asset Manage-
ment Company [TAMC]). Academic literature
is flush with individual case studies and collec-
tive analysis of the performance of these AMCs
(Cerruti & Neyens, 2016; Dreyer, 2020a, 2020b;
Fung et al., 2004a, 2004b; Inoguchi, 2012; Terada-
Hagiwara & Pasadilla, 2004). On the basis of this
literature, a cross-country comparison of the bad
banks established post the East Asian crisis has
been provided in Appendix A.
The common features of these AMCs were
that they were all state-owned and centralized
(with the exception of the bank-specific public
AMCs of China), and their key mandate was the
acquisition and resolution of bad loans that had
crippled their domestic banking systems during
the crisis. There were, however, cross-country
variations for all other operational aspects (Fung
et al., 2004a). While many of the AMCs were
established with sunset clauses, the actual lifes-
pans varied from five years (KAMCO, Korea) to
indefinite (RCC, Japan). The size and nature of the
NPL portfolios transferred to the bad banks de-
pended upon the country-specific bad debt lev-
els and profiles. The average transfer prices had
haircuts ranging from 0 per cent (Chinese AMCs)
to 78 per cent (IBRA). A varied mix of resolution
mechanisms were used, including the sale of as-
sets, medium-term workout and loan restructur-
ing, reorganization of businesses, foreclosures
and collateral sales. The pace of recovery and the
final recovery amounts against the face value of
loans acquired were also widely different across
countries. Danaharta and TAMC were the only
two AMCs that had surplus recoveries vis-à-vis
60 INDIA BANKING AND FINANCE REPORT 2021
acquisition prices at the time of closure, which
were shared with the originating banks (Dana-
harta) or transferred to the government (TAMC).
Inoguchi (2012) empirically analysed the influ-
ence of factors such as bank-specific character-
istics, macroeconomic conditions and the sale
of NPLs to public AMCs in reducing the NPL
overhang in Malaysia and Thailand following
the 1997 Asian Financial Crisis. They show that
economic growth, supported by bad loan sales
to AMCs, was effective in the case of Thailand,
whereas bank-specific factors and post-crisis
financial reforms were more successful in Ma-
laysia. Terada-Hagiwara and Pasadilla (2004),
on the other hand, indicate that for Korea and
Indonesia, the benefits of AMC set-ups in terms
of improving bank and corporate profitability
lagged by two years. Using chronological data
of decentralized private AMCs for private banks
and state-led AMCs for individual state-owned
banks set up in Thailand between 1999 and 2002,
and the centralized public Bad Bank TAMC in
2001, the authors establish that the removal of
NPLs from banks’ books through the decentral-
ized route, especially if done at little cost to the
bank, can induce moral hazard in the form of
reckless lending.
4.3.3. Bad Banks of the
Global Financial Crisis Era
The period during and immediately after the
Global Financial Crisis (2007–2008) led to anoth-
er generation of AMCs being established in the
USA and in many European nations to manage
the impaired assets of banks and FIs adversely
impacted by the crisis. In the USA, Citi Holdings,
established as a private, bank-specific AMC by
Citigroup in 2009, acquired approximately USD
900 billion of bad and non-core assets of the par-
ent bank. Citi Holdings became profitable for the
first time in 2015, and by 2017, it was reabsorbed
into Citigroup. A special-purpose vehicle was
also created through USD 6 billion in share sales
to the Swiss government in order to buy out 10
times the value of the troubled assets of UBS AG
in 2008 (Pinedo, 2009). The Troubled Asset Relief
Program, a joint initiative of the US Treasury, the
Federal Reserve and FDIC, while not exactly a
bad bank structure, aimed to guarantee specific
stressed assets of two major banks, Citigroup and Other than the descriptive studies listed
BOA, but ultimately failed to get implemented. above, a number of interesting issues pertaining
to bad banks are empirically analysed by vari-
Bad banks were a widely used part of the re-
ous authors. Gandrud and Hallerberg (2013) use
sponse to support crisis-affected banks in Europe.
a global data set of AMCs set up between 1980
A total of 15 AMCs were created by 12 EU coun-
and 2012 to show that the hazard of a coun-
tries between 2008 and 2014 to assist at least
try creating a bad bank in a particular year is
37 failing banks (Gandrud & Hallerberg, 2014).
strongly crisis-led, is significantly impacted by
Country-specific bad bank studies have been
IMF pre-conditions and is inversely related to
conducted for Germany (Schäfer & Zimmermann,
the countries’ reserves relative to GDP. Some po-
2009; Ulrich & Ilgmann, 2013), Ireland (Honohan,
litical factors, such as election years, democracy
2009), Spain (FROB, 2012), United Kingdom (Law-
index and veto players in the legislative set-up,
son, 2021) and Italy (Gandrud & Hallerberg, 2017).
show mixed evidence in influencing the hazard
The European AMCs demonstrated a mixed track
of bad bank creation.
record in terms of size and portfolio of toxic as-
sets acquired, transfer pricing and mechanism, Brei et al. (2013) examine the effect of direct
lifespans, resolution processes, and disposal and and indirect public capital support as part of
recovery performance. Appendix B provides a the broader rescue packages that were adopted
comparative summary of these bad banks. during the Global Financial Crisis on sustaining
bank lending. On the basis of robust empirical
Gandrud and Hallerberg (2014) discuss the im-
analysis of 108 large international banks from
plications of alternative ownership structures of
1995 to 2010, they demonstrate that accumulated
the AMCs created to acquire bad loans from Eu-
losses over the crisis period outpaced recapital-
ropean banks and, in this context, highlight the
ization and eroded the potential of excess capital
role of the Eurostat rules for the establishment
being available for credit growth. Thus, as banks
of AMCs in Europe, which require them to have
emerge from a crisis, their lending capacity im-
51 per cent private ownership to be temporary
proves only after threshold levels of capital are
institutions and to have business plans that focus
earmarked for balance sheet repair. A follow-on
on minimizing losses to public exchequers. Appli-
paper (Brei et al., 2020) delves into the efficacy of
cation of steep haircuts to determine the transfer
bad banks and recapitalizations in inducing lend-
price of impaired assets was perceived to be an
ing and reducing NPLs of the originating banks
important mechanism to encourage the early
on the basis of an empirical study of 135 banks
recognition of losses by the originating banks,
from 15 European nations over 2000–2016. It
incentivize profitable recoveries for the bad
finds that combined measures of bad loan seg-
banks and prevent them from becoming ‘zom-
regation and capital infusion are required to be
bies’. Such an approach would also avoid giving
effective in cleaning up bank balance sheets and
crisis-affected banks costly public bailouts. How-
promoting bank lending. It also demonstrates
ever, the haircuts were not uniformly adopted
that bad bank efficacy increases if asset pur-
in all countries. Cas and Peresa (2016) compare
chases are privately funded, smaller shares of
the Irish, Spanish and German experiences of
originating bank assets are transferred and if the
AMCs to identify success factors and analyse the
legal systems are strong.
impact of the changing bank resolution rules in
the European Union on the AMCs’ design. They
find that the type and valuation of assets trans- 4.4. The NPL Crisis in the
ferred, clean asset documentation, a conducive
macroeconomic environment and a strong legal
Indian Banking Sector
framework with skilled and efficient asset man- Over the last decade, the Indian banking indus-
agement capabilities are all crucial for successful try saw a rapid build-up in gross NPLs (Figure 4.1),
asset disposals by AMCs. It highlights that while with the gross NPL ratio peaking at 11.92 per
the AMCs did contribute to banking sector stabi- cent in 2018 and creating a substantial overhang
lization, their fiscal costs were unavoidable. in subsequent years. With rising NPLs, greater

India’s Bad Bank 61

 12.0
31.80%
10.0
Amount in ` Trillion
8.0
6.0
4.0
2.0
0.0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Gross NPLs (lhs) NPL Provisions (lhs)
Figure 4.1 Trend in NPLs, Provisions and Credit Growth of Scheduled Commercial Banks in India
(Excluding Payment Banks and Small Finance Banks)
Source: Statistical Tables Related to Banks in India (RBI).
proportions of banks’ capital were diverted to
holding larger amounts of bad debt provisions
as opposed to fresh lending. Over the same pe-
riod, the credit growth rate declined and fell to
a negligible 2.69 per cent in 2017 (Figure 4.1).
Credit growth had started picking up from 2018
onwards, synchronous with NPL deceleration,
when the COVID-19 pandemic induced an eco-
nomic recession and incremental bank credit
plunged to 6.18 per cent. Furthermore, the mac-
ro-stress tests conducted by the RBI indicated
that the GNPA ratio of all SCBs could increase
from 7.5 per cent in September 2020 to 13.5 per
cent by September 2021 under the baseline sce-
nario and worsen to 14.8 per cent under severe
macroeconomic stress, after controlling for the
impact of regulatory forbearances allowed in the
context of the pandemic (RBI, 2021).
Historically, banks in India used various inter-
nal workout processes, such as one-time settle-
ments with defaulting borrowers, restructuring
of stressed loans and legal mechanisms like debt
recovery tribunals (DRT) and lok adalats, to re-
cover their outstanding dues. The legislation of
the Securitisation and Reconstruction of Finan-
cial Assets and Enforcement of Security Inter-
est (SARFAESI) Act, 2002, gave banks another
internal tool to attach and sell security for the
62 INDIA BANKING AND FINANCE REPORT 2021
35.00%
10.4
30.00%
9.0
25.00%
6.09 20.00%
15.00%
11.92%
8.80% 10.00%
6.18% 5.00%
2.69%
0.00%
Gross NPL to Advances (rhs) Credit Growth (rhs)
recovery of their loan dues without court inter-
vention. The SARFAESI Act also paved the way
for the establishment of private ARCs through
which banks and FIs could sell their bad loans.
As can be seen in Figure 4.2, over the same pe-
riod of upsurge in NPLs, there was a sharp in-
crease in the amount of banks’ bad debts that
were put through legal recovery processes as
well as an increasing amount of NPL sales to
ARCs. However, recoveries from legal channels
have gradually fallen to as low as 10.3 per cent
in 2016 from a high of 50.1 per cent in 2008. The
promulgation of the IBC in 2016 provided a bet-
ter legal framework for banks to benefit from
healthier and quicker resolution values. It was
one of the factors that led to improvement in
the recovery rates from various legal channels
(DRT, SARFAESI, IBC), albeit with a lag, till it
reached 23.2 per cent in 2020.
The year 2020 represented a critical junc-
tion for the Indian economy and the banking
sector. First, the bank NPL-to-GDP ratio stood
at 6.18 per cent, with Indian banks struggling
with a legacy burden of large NPLs with low
salvage prospects. India’s NPL ratio was not as
alarmingly high as compared to countries in
East Asia and Europe, which ultimately created
crisis-led bad banks (Table 4.1). However, the
 8,000 60.0%
7,424.31

7,000
50.1% 50.0%

6,000

40.0%
5,000
4,313.39
` Billion

4,000 30.0%

23.2%
3,000
20.0%

2,000

10.3% 10.0%
1,000

0 0.0%
2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020
Legal Channels ARCs Legal Channels

Figure 4.2 Trend in NPL Amounts Involved and Recovery Rates from Alternative Channels of
Recovery in India
Source: RBI Reports on Trends and Progress of Banking in India.

Table 4.1 Credit and NPL Profiles of Countries which Set Up Crisis-led Bad Banks
Countries Affected by the East Asian Crisis (Fung et al., 2004a, 2004b)
Banking Assets as % NPL as % of GDP NPL as % of
of GDP (2002) (Peak) Total Loans (Peak)
China 210 35.00 42.00
Indonesia 74 26.80 48.60
Japan 149 8.40 9.70
Korea 154 10.00 15.00
Malaysia 158 25.50 30.10
Thailand 136 54.10 51.60
Countries Affected by the Global Financial Crisis (Cas & Peresa, 2016)
Domestic Banking
Assets as % of GDP1 NPL as % of GDP1 NPLs as % of Loans1
Ireland 472.80 46.33 9.80
Spain 344.70 25.85 7.50
Germany 291.30 9.32 3.20
Bank Credit to GDP2 NPL as % of GDP2 NPLs as % of Loans2
India 563 6.184 8.84
Note: 1 in the year of setting up of the Bad Bank; 2 India’s data as of 2020; 3 as published by BIS and 4 derived
from RBI data on scheduled commercial banks (SCB; excluding small finance banks).

India’s Bad Bank 63

 fears of pandemic-driven worsening asset qual-
ity subdued the lending appetites of Indian banks.
The credit-to-GDP ratio remained at 56 per cent in
2020 (much lower than that of Asian peers and the
G20 average) and was clearly inadequate for re-
viving economic growth in the post-pandemic era.
The time was ripe, therefore, for the GOI to ini-
tiate the set-up of a centralized bad bank which
would acquire legacy NPLs from public and pri-
vate sector banks and bring the Indian banking
sector out of the quagmire of accumulated bad
debt to focus on lending. The government’s deci-
sion was heralded by Acharya and Rajan (2020),
who had already made a case for the establish-
ment of a Bad Bank, albeit with appropriate
checks and balances, to deal with the NPL over-
hang of the Indian banking sector.
4.5. Decentralized Bad
Banks and ARCs in India:
Historical Perspective
4.5.1. Bank-specific Public AMC
In 2004, a bank-specific, government-sponsored,
special-purpose trust—Stressed Assets Stabili-
zation Fund (SASF)—had been established for
a one-time acquisition of `90 billion net book
value of stressed assets of state-owned IDBI. The
bad debts were purchased at book value through
government investment in 20-year, non-interest-
bearing securities issued by SASF. The objective
was to help IDBI clean up its balance sheet prior
to becoming a full-fledged commercial bank. The
audit of the trust by the Public Accounts Com-
mittee showed that till March 2018, only 53 per
cent of the book value of assets transferred had
been recovered through settlement and resolu-
tion, with the bulk of the recovery coming in
the first four years. Recoveries were higher for
smaller and lower vintage accounts compared
to older and larger stressed accounts. The report
also identified multiple lapses in the function-
ing of SASF in terms of delay in audit, inadmis-
sible exchange of healthy recovery assets for
weak ones by IDBI, improper valuations, non-
neutral organizational set-up of the Trust with
low manpower and weak monitoring of SASF
performance. It also highlighted that despite the
64 INDIA BANKING AND FINANCE REPORT 2021
massive balance sheet clean-up at the cost of tax-
payer money, IDBI had reverted to an NPL trap,
which finally led to its takeover by a public sec-
tor insurance firm.
4.5.2. Asset Reconstruction
Companies
The SARFAESI Act (2002) allowed private ARCs
to be set up in India as business entities to pur-
chase defaulted loans from banks and financial
institutions on an ongoing basis and manage the
stressed assets for disposition, resolution and re-
covery. Asset Reconstruction Company of India
Limited was incorporated in 2003 as the first
private bad bank through the joint sponsorship
of three state-owned banks and one private
bank. Since then, the number of ARCs in India
has grown to 28. These ARCs are private enti-
ties, with equity contributed by state-owned
banks, private banks and other domestic and
foreign investors. They are registered with the
RBI and subject to its regulations and supervi-
sion. The transfer prices for the stressed assets
are either bilaterally negotiated with the selling
banks or based on auctions. The purchase price
is paid through a mix of cash and the issuance of
SR, with a minimum five-year maturity, extend-
ible to eight years. Investors in the SRs also pay
a periodic asset management fee to the ARCs.
Domestic credit rating agencies assign recovery
ratings to the SRs, which are indicative of their
net asset value (NAV).
Bhagwati et al. (2017) provide a detailed de-
scription of the business models, operations and
performance of Indian ARCs against a backdrop
of evolving regulations. They suggest that ARCs
can play an important role in the price discovery
for bad assets and lead to appropriate restruc-
turing solutions for the NPL overhang in Indian
banks if the conditions under which ARCs have
previously operated are tweaked.
CRISIL (2017) describes the performance of
Indian ARCs since their inception. The report
indicates that in the early years till 2014, the
number of players was small. They had lower
capital requirements and were able to acquire
NPLs at steep discounts by issuing SRs primar-
ily to originating banks. Subsequently, as more
ARCs were established, a number of regulatory
and structural changes were effected. First, the
minimum net owned funds requirement for
ARCs was increased from `20 million to `1 bil-
lion, limits for foreign investments in SRs and
sponsor holdings in ARCs were relaxed and SRs
could be listed for secondary market trading.
These measures are aimed at enhancing capital
positions and diversifying the funding sources of
ARCs. Second, the RBI increased the minimum
investment of ARCs in SRs to 15 per cent and pre-
scribed management fees based on NAV rather
than acquisition value to encourage more skin in
the game for ARCs. Third, ARCs were allowed to
be members of the joint lenders’ forum for quick-
er debt aggregation and resolution, putting them
on an equal footing with banks. Fourth, provi-
sioning and valuation norms were made more
stringent for banks which invested in SR issued
by ARCs to discourage back-door re-entry of sold
NPLs. From 2016 onwards, ARCs were also able
to take advantage of the resolution mechanisms
under the IBC and improve the recovery values
of bad debts acquired.
From Figure 4.3, we see that ARCs’ incremen-
tal year-on-year NPL acquisitions, by volume
and as a percentage of banking sector NPLs, re-
mained low till 2013. From 2014 onwards, while
the size of NPLs acquired by ARCs increased
800
700
600
Amount in ` Billion
500
400
300
26.05%
200
21.36%
100
0 0.00%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Incremental NPLs Acquired (lhs)
Security Receipts Issued as % of BV of NPLs (rhs)
Figure 4.3 Trend in NPL Acquisition by ARCs and Issuance of Security Recei pts
Source: RBI Reports on Trends and Progress of Banking in India.
substantially, driven primarily by more and bet-
ter capitalized ARCs being established, the same
had a negligible impact due to the sharp rise in
NPLs outstanding. The average NPL acquisition
price of ARCs, as reflected by the SRs issued as a
percentage of the book value of NPLs acquired,
remained range-bound between 21 per cent and
26 per cent till 2013. The subsequent uptrend
was likely to be a combined outcome of competi-
tive bidding by a larger number of better capital-
ized ARCs expecting higher recoveries through
IBC as well as banks selling less aged NPLs to de-
rive better values.
The cumulative outstanding amounts of SRs
issued by ARCs in lieu of NPL purchases, bur-
geoned over the years (Figure 4.4), primarily
because of the underperformance of ARCs in
recoveries and associated redemptions. Until
2017–2018, NPL-selling banks remained the ma-
jority investors (80% or more) in SRs. From 2018
onwards, with increased investments in SRs by
foreign-stressed asset funds, banks’ share came
down below 70 per cent.
The RBI’s Financial Stability Report (RBI, 2019)
published an analysis of net discounted recov-
ery rates measured as a percentage of the face
value of SRs issued by the top 6 ARCs between
100.00%
713
90.00%
80.00%
70.00%
60.00%
50.00%
36.74% 40.00%
30.00%
32.54%
20.00%
10.00%
NPLs Acquired as % of Bank NPLs Outstanding (rhs)
India’s Bad Bank 65
 1,600
1,400

Amount in ` Billion
1,200
1,000
800
600
953 998.4 1,009
400 777
651
200 429 441
69 83 96 103 112 116 126
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

SR Subscribed by Banks SR Subscribed by ARCs SR Subscribed by Others

Figure 4.4 Trend in Outstanding Amounts of Security Recei pts and Investor Profile
Source: RBI Reports on Trends and Progress of Banking in India.

2004 and 2018. The analysis demonstrated a
precipitous decline in recovery rates for SRs
that originated from 2014 onwards. The long-
run average recovery rate was 47.1 per cent,
whereas the average recovery rate from 2014 to
2018 was a meagre 7.8 per cent. From 2014 on-
wards, ARCs’ recovery and redemption of SRs as
a percentage of NPLs acquired and banks’ own
recovery rates broadly followed a synchronous
trend (Figure 4.5), but ARC recoveries remained
significantly lower than those of banks’ internal
workout processes. The combined recoveries
that banks made from the upfront cash payment
and redemption of SRs by ARCs fell short of the
recoveries that banks could derive from their
own efforts.

0.6

0.5

0.4

0.3
23.24%
0.2
11.71%
0.1
4.16%

0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Banks’ Upfront Net Cash Recovery from NPL sales to ARCs as % of BV of SR Issued
Redemption of SRs as % of NPLs Acquired
Recovery Rate from Banks' Internal Work Out Processes as % of NPL Amounts Involved

Figure 4.5 Banks’ Recovery Rates from Internal Workout and from Sale of NPLs to ARCs
Source: RBI Reports on Trends and Progress of Banking in India.

66 INDIA BANKING AND FINANCE REPORT 2021


Govt.
IDRCL
announces
established as
set-up of
a private AMC
NARCL
Feb 2021 Jul 2021 3 Sep 2021
NARCL
registered
with paid-up
capital of
`764 million
Figure 4.6 Timelines of Establishment of NARCL
Source: Author’s own construction from public announcements.
4.6. NARCL—The New
Centralized Bad Bank in India
In the budget speech for FY 2021–2022, Finance
Minister Nirmala Sitharaman announced the
setting up of a bad bank along the lines of an
ARC for aggregating, acquiring and managing
the legacy NPLs of the Indian banks. Within
eight months of this announcement, National
Asset Reconstruction Company Ltd (NARCL)
was registered as a public entity and had raised
the requisite capital for RBI approval to operate
as a licensed ARC. The IDRCL was also incor-
porated as a private AMC. The government ap-
proved a guarantee of `306 billion on securities
issued by NARCL. Figure 4.6 summarizes the
timelines of the key actions pertaining to final-
izing the bad bank in India. The short time span
over which NARCL was set up is indicative of
the political will and commitment to reforms in
the banking sector.
4.6.1. The NARCL—IDRCL Structure
and Business Model
The NARCL has a centralized bad bank struc-
ture, and its current capital base of `1.5 billion is
entirely contributed by PSBs. The expectation,
however, is that it will ultimately operate with
a capital base of `60 billion, with 51 per cent
ownership by PSBs and public FIs and the re-
maining 49 per cent owned by the private sec-
tor. On the other hand, IDRCL, an operational
Govt. approves
` 306 billion
guarantee for
NARCL
securities
14 Sep 2021 16 Sep 2021 4 Oct 2021
Additional NARCL
capital infused granted
by PSBs to meet license to
RBI’s eligibility operate as
norms ARC by RBI
service entity, which will be employed by
NARCL for the management, resolution, liqui-
dation and recovery of bad debts acquired by
NARCL, will be a private entity with a maxi-
mum 49 per cent equity share of the public sec-
tor. The figurematic representation of the bad
bank structure is as shown in Figure 4.7.
The centralized structure of NARCL is impor-
tant given the systemic nature of the NPL prob-
lem in the Indian banking sector. It enables the
aggregation of bad loans across multiple banks
where there are common borrower and collat-
eral linkages. Consolidation of loans will enable
faster decision-making and enhance the effi-
ciency of recoveries through the application of
a common resolution process. Majority public
ownership of NARCL is also an appropriate and
unavoidable requirement, given that the share
of PSBs in the NPL transfer is expected to be
higher than that of the private banks. The pub-
lic nature of the bad bank will merit the appli-
cation of the government guarantee to support
the funding of the NPL acquisition. While it can
be hoped that as a public entity subject to RBI
oversight, NARCL will operate transparently
and with greater accountability, there is a risk of
potential political influence and reduced opera-
tional independence.
On the other hand, keeping IDRCL’s owner-
ship private is appropriate, since it will allow the
recruitment of the best talent at market-based
India’s Bad Bank 67
 Guarantee SRs
Sell NPAs
NARCL
The Government
Banks (The Centralized
of India
Public Bad Banks)
Pay Acquisition
Price (15% Pay Guarantee
Cash, 85% SRs) Fee
Asset Management,
Resolution and Recovery

IDRCL
(The Private
AMC)

Figure 4.7 The Structure of India’s Bad Bank

compensation and incentive-based pay struc-
tures. As a private entity, it will be better able
to pursue the most effective resolution strate-
gies without public sector constraints. The key
challenges will be to ensure that IDRCL’s per-
formance is monitored to ensure that economic
objectives are not compromised for private gains
and its operations are not unduly biased.
4.6.2. Asset Acquisition by NARCL
The actual NPL selection and acquisition process
by NARCL is yet to commence. However, the
broad criteria for asset selection have already
been announced. NARCL is expected to acquire
stressed loan assets valued at more than `5 bil-
lion each from various banks in India, adding
up to about `2 trillion in a phased manner. As of
March 2020, this amounted to more than 22 per
cent of the total gross NPLs outstanding for SCBs.
In Phase I, fully provisioned assets of about `900
billion are expected to be transferred to NARCL,
while the remaining assets with lower provi-
sions would be transferred in Phase II. While the
actual NPL portfolio to be acquired in either of
the phases is not finalized, the indicative list for
Phase I transfer is expected to include at least 22
large stressed accounts. This portfolio includes
chronic defaults from core and infrastructure
sectors, many of which have already been placed
under the corporate insolvency resolution pro-
cess by the originating banks. The absence of
tangible collateral security for infrastructure
loan exposures, particularly in the road sector,
may reduce transfer values. Also, substantial due
diligence may be required for the vintage loans
in order to avoid documentation problems that
can delay asset transfers and disposal. Thus, it
will be imperative for NARCL to adopt stringent
asset selection criteria.
An important aspect of the asset acquisition
by NARCL is that it will primarily be a one-off
transfer as opposed to continuous transfers of
bad debts by banks. This is therefore less likely
to create the moral hazard problem of weaken-
ing credit discipline, which is usually associated
with banks that are given frequent and low-cost
bailouts via public funds (Terada-Hagiwara &
Pasadilla, 2004).
The price at which NARCL acquires the NPLs
will play an essential but conflicting role in this
bad bank structure. The higher the transfer
price, the greater the benefits to banks in terms
of larger upfront cash recovery along with pro-
spective redemptions of larger amounts of the
SRs issued. However, if NARCL fails to derive
adequate value from the resolution of the NPLs
vis-à-vis the transfer price, this will reflect poor-
ly on the Bad Bank’s own future performance.
To avoid mis-valuation of the NPLs, the struc-
ture specifies that NARCL will quote an initial
acquisition price for the bad debt to the lead

68 INDIA BANKING AND FINANCE REPORT 2021

bank, which will then use a ‘Swiss Challenge’
methodology to invite other ARCs in the market
to optimize price discovery. This methodology
ensures that transfer prices closely approximate
market valuations and leads to fair haircuts that
originating banks will have to accept for selling
their NPLs. It will, however, be important that
NARCL’s preliminary quotes are based on inde-
pendent valuation.
The NPL acquisition will be funded at a 15:85
ratio, which means that NARCL will pay the
selling banks 15 per cent of the final acquisition
price in cash up front. The remaining 85 per cent
will be issued in the form of SRs to investors in
the market (including banks, FIIs and QIBs). This
is as per RBI’s extant norms for asset acquisition
by ARCs in India. The difference vis-à-vis ARC
acquisitions is that the face value of the SRs is-
sued by NARCL will be backed by a 5-year GOI
guarantee to be invoked to cover shortfalls be-
tween amounts realized from the underlying as-
sets and the face value of the SRs issued for those
assets, subject to an overall ceiling of `306 billion.
With a 15:85 cash-to-SRs ratio paid by NARCL
to acquire `2,000 billion in book value of NPLs,
the government guarantee on SRs translates
into `360 billion in marked-down value of NPLs,
that is, a steep haircut of 82 per cent. Thus, there
will be a floor recovery rate of 18 per cent for
the banks’ sale of NPLs, of which only 2.7 per
cent will be upfront cash recovery, with the bal-
ance becoming available on redemption of SRs.
While this floor recovery rate is better than
what the other ARCs in India have delivered in
the past, it is lower than the 23.24 per cent of
banks that were able to recover in 2020 through
their own efforts, supported by the IBC. The
numbers also imply that NARCL will need to
increase its equity capital base from the current
`1.5 billion to at least `54 billion to make the 15
per cent cash payment of the floor price of the
total NPL portfolio.
4.6.3. Investors in Security Recei pts
Issued by NARCL
The recent profile of investors in the SRs issued
by ARCs in India has shown improved diversifi-
cation, with qualified institutional buyers (QIBs)
and FIIs’ share of such investments increasing
relative to the originating banks (Figure 4.4).
This trend augurs well for the potential mar-
ket for stressed assets acquired by NARCL. The
availability of the government guarantee can be
expected to further enhance the attractiveness
and liquidity of issued SRs and give banks the
scope to sell down their holdings for improved
recoveries.
4.6.3.1. NARCL’s Expected Performance
in Resolution of Acquired NPLs
The basic ingredients for ensuring the strong
performance of NARCL in the resolution and
recovery of acquired NPLs are all in place. An
independent and experienced board of NAR-
CL, supported by the turnaround expertise
of the private AMC, will provide the requisite
management skills. Adhering to strict asset
selection criteria and applying unbiased, mar-
ket-based prices to NPLs will ensure a fair ac-
quisition value over which returns will have to
be shown. As an ARC, the bad bank will have a
wide variety of legal arsenals available to finan-
cial creditors in India today to pursue the most
effective resolution of the bad debts. However,
since NARCL will operate within the same legal
environment as banks and ARCs, the challenge
will be to demonstrate a recovery performance
that is superior.
While the NARCL does not have an explicit
‘sunset clause’ for its winding up, the five-year
tenor of the government guarantee will indi-
rectly act like one since the conditions for its
invocation are linked to the resolution or liq-
uidation of the acquired bad loans. This will
incentivize a time-bound completion of the
resolution process and curtail the warehousing
of the bad debts for a longer period. The guaran-
tee fee required to be paid by NARCL to the gov-
ernment, which will step up for longer holding
periods, will also deter resolution delays. How-
ever, the current pandemic-induced economic
slowdown and the recent experiences pertain-
ing to significant under-pricing of insolvent
company acquisitions suggest that quick turn-
arounds of bad debts and profitable recovery
values may pose a bigger challenge to NARCL’s
ultimate performance.
India’s Bad Bank 69
 4.7. Conclusion
The announcement of the establishment of
India’s first bad bank to resolve the bad loan
problems of the banking sector is a timely step.
NARCL is the outcome of the government’s
commitment to improve the health of the bank-
ing sector of the country. Drawing from the les-
sons of bad banks established in other countries
and ARCs set up in India, we can see that the
structure of NARCL–IDRCL has been designed
with careful consideration of global experience
with respect to ownership, asset aggregation,
transfer pricing, operations and debt resolution
mandate. If the bad bank performs as expected,
it will ensure significant benefits to the multi-
ple stakeholders.
For the commercial banks, and especially the
PSBs, the bulk transfer of stressed assets will re-
lease provisions, and whatever upfront consid-
eration they receive against fully provisioned
assets will improve their bottom line. While in-
vestment in SRs against NPL sales will postpone
full recovery, the availability of the central gov-
ernment guarantee will provide the requisite
capital relief to the banks during the holding
period. Furthermore, banks will be assured of a
floor recovery rate of 18 per cent based on the
guarantee commitment and will be able to par-
ticipate in the upside of higher recoveries based
on NARCL’s performance and the availability of
a liquid market for selling the SRs at higher mar-
ket values.
70 INDIA BANKING AND FINANCE REPORT 2021
The transfer of bad loans will free up capital in
the banking sector, which can then be allocated
to fresh lending. This will be a much-needed cred-
it stimulus that the government desires to boost
post-pandemic economic growth. Furthermore,
there will not be an immediate fiscal impact from
the bad bank since it is not directly capitalized by
government funds. However, if recovery values
are lower than the guarantee amount, which
in turn depends on the performance of NARCL,
then there may be a prospective burden on the
public exchequer on invocation of the guaran-
tee. The balance sheet clean-up of the PSBs will
lead to their value enhancement, which will be
a positive for the government’s objective of bank
privatization. The stressed assets market in
India will also increase in volumes and efficiency
with the better price discovery mechanisms that
NARCL is expected to adopt.
However, it is important to recognize that
the bad bank structure may not provide a long-
term solution to stressed assets created in the
banking sector due to risky lending practices
and can only be treated as a one-time respite
measure. That respite too is meaningful only
if it comes with improved collecting ability by
the bad bank (Acharya & Rajan, 2020). Thus,
with respect to NARCL’s mandate and perfor-
mance, only time will tell whether its establish-
ment as part of the government’s 4R strategy
of ‘recognition, resolution, recapitalization and
reforms’ for the Indian banking sector was a
success or not.
APPENDIX A. Cross-country Comparison of East Asian Crisis-led Bad Banks

Country and Ownershi p Establishment Asset Profile and

Bad Bank and Design and Sunset Period Transfer Price Recovery Performance
Korea • Centralized • Established in • NPLs face value of • By 2002, KAMCO
KAMCO • 95% state- 1997 KRW 110 trillion had recovered KRW
owned • Discontinued acquired 30.27 trillion (29.5%
in 2002 • Average transfer recovery rate)
price of KRW 39.79
trillion (64% haircut)
Indonesia • Centralized • Established in • Corporate and • Out of a total IDR 135
IBRA • 100% state- 1998 commercial loan bad trillion of corporate
owned • Wound up in debts of face value loans, IBRA recovered
Apr 2004 of IDR 392 trillion IDR 41.4 trillion
acquired (30.6% recovery rate)
• The expected fair till 2002
value of these loans • For IDR 25.8 trillion
was IDR 88.3 trillion of SME and retail
(78% haircut) portfolio, recovery
was 75% of principal
Malaysia • Centralized Set up in 1998 • Acquired bad loans • Recovered RM
Danaharta AMC and dissolved in of book value RM 30.35 billion, by the
• 100% state- Dec 2005 47.76 billion time of dissolution,
owned • Threshold loan size representing 58% of
was RM 5 million face value of debt
primarily corporate acquired.
and property loans • Surplus recovery
• Average purchase was shared with
price was RM 9.03 participating FIs
billion (54.6%
haircut)
Thailand • Centralized • Set up in 2001 • As of June 2003, • As of June 2003,
TAMC AMC • Expected to acquired book value TAMC had achieved
• 100% state- operate till of NPLs Baht 784.38 a disposal rate of
owned 2013 majority loans from 73.46% of the assets
manufacturing and and it launched a
real estate special ‘last price’
• Average acquisition campaign to dispose
price of Baht 265 remaining assets
billion (66% haircut) • At liquidation in
June 2013, TAMC
transferred Baht 10
billion profit to MOF
Japan • Centralized Set up in 1999 • As of 2002, RCC had RCC had made
RCC AMC acquired a total cumulative recoveries
• 100% state- book value of JPY of JPY 5.99 trillion
owned 34.9 trillion (17% of total book
• Average acquisition value of debt acquired
price JPY 9.7 trillion and 61% of acquisition
(72% haircut) price) as of 31 Dec 2002

China • Decentralized • Set up in 1999 4 AMCs acquired a total The AMCs could
(Great Wall, • 100% state- • Expected of RMB 1.4 trillion book dispose only RMB 301
Orient, owned lifespan of 10 value of NPLs, primarily billion, against which
Cinda, years manufacturing and RMB 101.3 was cash
Huarong) commercial loans at 0% and non-cash recovery
haircut (7.3%) as of Dec 2002

India’s Bad Bank 71

 APPENDIX B. Cross-country Comparison of Global Financial Crisis (2008)-led Bad Banks

Country and Ownershi p and Establishment Asset Profile and

Bad Bank Design and Sunset Period Transfer Price Recovery Performance
USA (Citi • Bank specific • Set up in 2009 Total assets amounting • Became profitable
Holdings) • Privately • Reabsorbed to $ 900 billion were from 2015 onwards
sponsored by into Citigroup acquired • By January 2017,
Citigroup in Jan 2017 only $ 54 billion
assets remained
unresolved
Portugal The Bad Bank • Established in Held troubled assets About a year after the
Banco Es- was owned August 2014 of BES original transfer, gov-
pirito Santo by the BES • Expected to ernment re-transferred
(BES) shareholders be liquidated some senior bonds
Bad Bank and junior bond within a few from Novo Banco to
holders years BES Bad Bank to make
up for an over-evalua-
tion of the assets and
cover for additional
losses of Euro 2 billion
Germany • Bank specific • Set up in Face value of EUR At the end of 2015,
FMS • 100% public October 2010 175.6 billion of bad the size of FMS’s
Wertman- ownership • Expected life loans of HRE group portfolio was EUR 94.7
agement of 10 years was transferred at 0% billion, a decrease of
haircut. over 46% from the
initial portfolio size.
Ireland • Centralized • Established in • Book value of assets • Became profitable
NAMA • 51% private 2009 transferred was since 2011. Had sold
and 49% • Expected to Euro 74.2 billion. 75.3% of its assets
public close in 2020 • Asset transfer price by end 2015
ownership was at 57.4% hair- • Recovery (from face
cut. value) was 54% as
of Dec 2017
• By June 2016, NAMA
had repaid 85% of
its senior bonds
Spain • Centralized • Established in • The acquired bad • By the end of 2015,
Sareb • 55% private 2012 debts had book it had sold only
and 45% • Expected to value of Euro 107.4 15.4% of its portfo-
public close in 2027 billion. lio.
ownership • Assets were trans- • Recovery from face
ferred at 52.7% value = 20% as of
haircut. Dec 2017.
United • Bank specific Set up in GBP 115.8 billion of • UKAR became
Kingdom • 100% public October 2010 bad assets of Brad- profitable after
(UKAR) ownership ford & Bingley and 2010 and had made
Northern Rock were approximately £8.1
acquired at book billion profits as of
value. June 2019.
• In February 2021,
UKAR had sold off
all of its assets and
wound up.

72 INDIA BANKING AND FINANCE REPORT 2021

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Macroeconomic Scenario
Embedded Forward-looking
Probability of Default Models
for IFRS 9 Purpose
Arindam Bandyopadhyay
5.1. Introduction
The International Financial Reporting Standards
9 (IFRS 9) have introduced fundamental changes
in credit impairment standards and the assess-
ment of loss allowances that are expected to
have a significant impact on the financial state-
ments of banks and financial institutions. The
new accounting norms set by the International
Accounting Standard Board (IASB, 2014) have
introduced a new ECL-based impairment mod-
el that will require more timely recognition of
ECLs. India has adopted Indian Accounting Stan-
dards (Ind AS) that are based on and substantially
converge with IFRS. The IFRS 9 standards for In-
dia (Ind AS 109) were published by the Ministry
of Corporate Affairs, GOI, in February 2015. The
new Indian Accounting Standard (Ind AS 109)
replaced the ‘incurred loss’ model with an ECL
model. Due to the Global Financial Crisis, the
merits of having forward-looking provisioning
practices have been recognized. The availability
of adequate loan loss provisioning enables the
banks to withstand the dent the mounting losses
may cause on the banks’ earnings and capital.
The new accounting norm requires banks and
FIs to internally model the key elements of their
credit risk-related losses, namely PD, loss given
default (LGD) and exposure at default, and there-
by derive more risk-sensitive measures for ECL.
In line with IFRS 9, Ind AS 109 has introduced a
forward-looking approach for the identification
of credit impairment and estimation of ECL that
will provide a timely and adequate accounting
treatment of loss provisions. The transition to Ind
AS 109 will entail a major change in the approach
5
Chapter
and amount of provisions that banks and FIs
must hold for their portfolios. The forward-look-
ing ECL-based provisions (allowance) have been
applied at origination and for all subsequent re-
porting periods to financial assets till de-recog-
nition. The requirement to consider ‘time value
of money’ arises because these credit losses are
future projections associated with future events
of default and need to be discounted using an ap-
propriate discount rate (the effective interest rate
as per Ind AS 109) to reflect the provisions which
will be made on the current reporting date.
An important consideration in the IFRS 9 ECL
model is the use of forward-looking informa-
tion in the models. An expected loss is the loss
anticipated on a credit exposure or credit port-
folio due to defaults expected to occur during
the normal course of business. It is the current
internal estimate of probable future credit loss.
Forward-looking estimates can be obtained from
historically derived numbers as a good starting
point. However, for advanced approaches, for-
ward-looking PD adjustments need to be made
by incorporating macroeconomic factors into PD
estimation. In this chapter, we have addressed
these considerations for the overall portfolio of
the bank. We demonstrate how forward-looking
information can be incorporated through regres-
sion models. An econometric modelling frame-
work has been suggested to establish the link.
Once this relationship is established, forecast-
ing the losses or determining the lifetime PD re-
quires using forward-macro-adjusted PDs.
The popular methods used in estimating PDs
are the transition matrix approach, roll rate
 and vintage method (Mukherjee & Maji, 2017).
However, there is a need to link the PD estimates
with common macroeconomic factors to derive
more accurate forward-looking scenarios. By as-
suming a scaling approach, banks and financial
institutions can establish a link between point
in time (PIT) and PD estimate to run their day-to-
day business within the range of a through-the-
cycle (TTC)-based capital constraint (Ingolfsson &
Elvarsson, 2010).
Provisioning for loan losses refers to the mech-
anism used to recognize credit impairments. It
is a critical component of effective financial re-
porting and prudential supervision (RBI, 2012).
There is a growing interest among bankers and
policymakers in how to derive forward-looking
scenario-based PDs for loss provision purposes
under the new financial accounting norms. In
a recent speech at the India Economic Conclave,
Shri Shaktikanta Das (2021), Governor of RBI,
emphasized the importance of improving tech-
niques for identifying risks early, measuring
them, mitigating them proactively and building
adequate provisioning buffers to absorb poten-
tial losses.
There is empirical evidence that can be bench-
marked where the Z index extracted from tem-
poral PD movements actually depicts past credit
conditions. For example, the Z index value re-
mains negative or even zero during bad time, and
because of this, there is a decline in credit ratings.
Similarly, during better times, Z stays positive
(Belkin et al., 1998; Gross et al., 2020; Perederiy,
2015). Filusch (2021) has recently highlighted
the modelling challenges for lining the business
cycle in deriving PIT PD term structure for devel-
oping ECL models of financial accounting. Using
a 15-year sample data from credit rating agency
S&P, the author has adopted Markov chain sto-
chastic model to derive forward-looking PDs
over time. The study emphasized the need to
connect the borrower-level PD with macroeco-
nomic factors to derive forward-looking ECL
estimates. In India, few empirical attempts have
been made to address the issue of the estima-
tion of forward-looking loan loss provisioning.
A recent RBI (2020) study finds procyclicality in
the behaviour of loan loss provisions by Indian
76 INDIA BANKING AND FINANCE REPORT 2021
banks due to their backward-looking nature.
In a panel data analysis, the study highlights the
merits of having forward-looking provisioning
practices, especially for PSBs in India. An effi-
cient loan loss provision management strategy
entails that banks should build loan loss reserves
in good time to provide a cushion to retain their
appetite to lend when the economy is experienc-
ing a cyclical downturn. Similarly, in a downturn
situation, a forward-looking view will enable the
bank to not overestimate its risks and lose its
lending appetite due to a very conservative esti-
mation of loss provisioning.
Few empirical attempts have been made with
Indian cases to demonstrate how an inherent
macroeconomic index (i.e., the Z index) can be
derived from a loan pool that can be judiciously
utilized for generating futuristic PD scenarios.
In this work, two empirical approaches are de-
vised to incorporate macroeconomic scenarios
into the derivation of forward-looking PDs. In
the first approach, we have developed regres-
sion models to examine how macroeconomic
factors contribute to the bank’s yearly default
rate. Two important macroeconomic drivers:
(a) non-food credit growth and (b) export growth
are found to have significant influence on an
export credit-oriented bank’s annual default
rates. This has been captured when we study
the bank’s yearly movements of NPAs and fresh
slippage rates.
The second approach is termed the structural
approach and is based on the Merton model
(1974) and its extensions. The dynamics of bor-
rower default within a pool is assumed to fol-
low idiosyncratic as well as systematic factors.
The borrower’s default status is determined by
its movement of market value of assets (MVA)
and its distance to default (DD) point (i.e., its ob-
ligations). Merton’s single factor model has been
used to derive the ‘Z’ index to link the bank’s
long-run PD with PIT PD. The estimated Z index
can be further linked with macroeconomic vari-
ables (such as GDP, index of industrial production
[IIP] growth rates, export growth, unemploy-
ment rate and interest rate). In this manner, mac-
roeconomic variables can also be factored into a
structural model (Ray, 2018).
 The macro-index (called the Z index) derived
from the PD trends using regression methods
and the Merton single factor model will enable
the banks to derive forward-looking 12-month
PDs for Stage 1 and lifetime PDs for Stage 2 ac-
counts. Both the PDs are useful for estimating
expected loss provisions in banks and financial
institutions.
5.2. Data,Variables and
Methodology
We have devised two alternative frameworks
for linking the bank’s PD of a loan with the
macroeconomic scenarios. In the first method,
we follow a time series regression framework
to establish an empirical relationship between
the annual default rates and key macroeco-
nomic factors. In the first approach, we utilized
historical NPA movements data of an export
credit-oriented bank. This enables us to derive
the marginal default rates of the bank and to
extract the Z index. The movement of NPAs and
gross advances data of a few comparable banks
were obtained from their audited annual re-
ports. This covers the time period from 2009 to
2020. The annual macroeconomic factors have
been collected from the Centre for Monitoring
Indian Economy (CMIE) database. The detailed
summary has been presented subsequently in
Table 5.8. In the first method, we also utilized
the X bank’s corporate rating history to derive a
rating transition matrix and applied the derived
Z index to capture the shift in the rating tran-
sition and derived PD. In the second approach,
we utilize the specific X bank’s NPA movements’
data to obtain annual marginal default rates (ex-
posure weighted), long-run PD and extract the
Z index. The derived Z index has been again
linked to key macroeconomic indicators follow-
ing the Merton single factor method. Finally, we
tested the robustness of the second approach by
extending our analysis to include CRISIL data on
corporate bond default rates. The time period
covered in the robustness check study is be-
tween the years 1994–1995 and 2019–2020. The
macro-variables (e.g., GDP growth rate and non-
food credit growth rate) were obtained from the
Macroeconomic Scenario Embedded Forward-looking Probability of Default Models for IFRS 9 Purpose
CMIE and the Central Statistical Organisation
(CSO) database.
5.2.1. Method I: Regression
Methodology to Derive Z index
We have first used a regression-based model to
project a futuristic scenario for making forward-
looking adjustments. Our macro-model uses two
important drivers: non-food credit growth and
export growth rate, which have an influence on
yearly loan default rates (MPDs). The marginal
default rates are obtained using the movement
of NPAs data of a leading financial institution ac-
tively engaged in export finance.
The following empirical steps have been taken
to derive pool-level PD.
Bank-level pooled PDs have been analysed
by using the aggregate NPA movements of the
bank’s data obtained from audited annual re-
ports. This gives a quick estimate of the overall
portfolio risk position–marginal PDs as well as a
long-run one-year average PD. The computation
formula at a bank level has been summarized in
Equations 5.1 and 5.2:
∆GNPA t
MPD t = (5.1)
( ∑ t=−2 Standard Assets) / 3
n

∑
T
MPD t
PD 1 year = t=1
(5.2)
T 
The marginal PDs derived from the above-
mentioned approach (Equation 5.1) have been
linked with macroeconomic indicators like non-
food credit growth (NFCRED_GR) and export
growth (EXPORT_GR) to develop regression
models. This has been later used to generate for-
ward-looking macroeconomic scenarios. Neces-
sary lag adjustments have been made to derive
their time series empirical relationship.
This method is quite intuitive and a macroeco-
nomic scenario can be easily linked with an odd
ratio (derived from the predicted default rate) to
generate a change in PD. The bank can apply this
method to derive forward-looking macroeco-
nomic scenario-based PDs for ECL calculation.
The detailed analysis has been demonstrated in
the results section.
77
 Thus, the first model is based on statistical re-
gression-based analysis linking the PD shift fac-
tor to changing macro-variables—non-food credit
growth and export growth (lagged value). The
regression-based model for generating forward-
looking scenarios has a judgemental component
involved that may come from the top manage-
ment (or economic research unit). The bank can
customize the scenarios and weights as per its
business forecast and management insights.
5.2.2. Method II: Merton’s
Methodology for Deriving
the Z Index
The second model is based on Merton’s (1974) one-
factor model that derives the Z index to link long-
run PD with short-run PIT PDs and uses a single
asset correlation (AC) measure to link the loan
pool with systematic factor. This is an established
method followed by global best-practised banks.
This method also has a judgemental component
which can be derived from senior management’s
insights. However, this is an advanced approach,
which may be taken up in a phased manner.
5.2.2.1. Step 1: Estimation of
Asset Correlation
Bluhm and Overbeck (2003, 2007) have deduced
a methodology for the estimation of ACs on the
basis of the volatility of default rate time series.
Using Moody’s bond default data from 1970 to
2001, they derive the grade-wise implicit AC of
US corporates. Using the framework, we calcu-
lated an implicit AC that captures the common
macroeconomic condition.
The basic set-up of a one-factor model of cred-
it risk is based on the assumption that a firm is
driven by its implicit asset return distribution. It
is assumed that each firm earns some random re-
turn on its assets A at the horizon T. If the return
is sufficiently negative, the value of the firm’s as-
sets falls beneath the value of its fixed liabilities
(or debt, D) and the firm defaults. The asset re-
turn A at a chosen horizon T is a sum of system-
atic factor C and an idiosyncratic factor ϵ.
Variance of conditional default rates g(y) is ex-
pressed by:
V [ g ( y )] = JDP ( PD, ) − PD × PD (5.3)

78 INDIA BANKING AND FINANCE REPORT 2021
⇒ V [ g ( y )] − JDP ( PD, ) + PD 2 = 0 (5.3a)

Here, PD can be obtained from the mean value
of historical time series default rates.
V[g(y)] can be obtained from the sample vari-
ance of a time series of observations of historical
default rates or it is = UL2p which is the variance of
MPDs.
 = default rate volatility implied AC which
we are going to estimate. JDP is the joint default
probability of two obligors in a uniform portfolio
with parameters PD and implicit AC . Solving
for  gives us volatility-implied AC . This can be
done using optimization method.
The JDP function and variance expression
(Equations 5.3 and 5.3a) have been used to derive
the AC.
Similarly, default correlation is estimated us-
UL% 2P
ing: DC = (5.4)
UL% i2
These correlation coefficients capture the
common macroeconomic systematic effect on
loan portfolios.
5.2.2.2. Step 2: Estimation of
the Z Index
In the second approach, we derive the Z index
that represents the systematic factor using the
AC approach.
The systematic factor (or Z index) that repre-
sents the overall macroeconomic condition can
be extracted using the following formula.
As per the Vasicek (1984) model, a firm’s asset
return follows the path described in the follow-
ing equation:
V ( t , r ) = Z ( t , r ) + 1 − e( t ) (5.5)

Here, t is the observation point and Z (t, r) rep-
resents the aggregated macroeconomic effect of
all factors;  is the common AC. This function
was also mentioned by Merton (1974). Moody’s
KMV market-based model for predicting EDF
has used this academic concept.
Taking a loan (D) is like buying a call option due
to a limited liability of the equity investors who
are the owners as well as the residual claimants
to the value of the firm (V). Giving a loan is like
writing a put option. If a borrower’s invest-
ment project fails and it cannot repay the bond
holder or the bank (i.e., V<D), it has the option
of defaulting on its debt repayment and turning
any remaining assets over to the debt holders.
Because of limited liability for equity holders,
the firm’s loss is limited on the downside by the
amount of equity invested in the firm (i.e., its
stake S). On the other hand, if things go well (&
V>D), the equity investors can keep most of the
upside returns on asset investments after prin-
cipal and interest on the debt have been paid.
The shareholders can keep the difference V – D.
Given that the shareholders face only a limited
downside risk of loss of their equity investment
but a large potential upside return if things
turn out well, equity is analogous to buying a
call option on the assets of the firm (Saunders &
Cornett, 2010).
This way, Black and Scholes’ option (1973)
model, subsequently adopted by Moody’s KMV
functions, was used to estimate the pay-off
functions to solve for MVA and asset volatil-
ity (A). These are the two important inputs for
estimating DD and expected default frequency
(EDF) in MKMV.
This is the conceptual framework to bring two
option equations to solve for MVA and A. These
two nonlinear equations are as follows:
MVE = f (MVA, A t, rf , D) & (5.6)
E = g(A)(5.7)
where MVE = annual market capitalization;
A is asset volatility; t is the time horizon (here,
1 year); rf is the risk-free rate (e.g., 364 T-bills rate);
D is the book value of debt or total liabilities, and
E is the yearly equity volatility.
DD provides us with an estimate of how far
the firm’s market value is away from the default
point (i.e., the firm’s total debt obligations). This
is measured in terms of standard deviation in
a normally distributed return series. Once we
obtain the MVA and asset volatility (A), we can
derive the DD. The greater the DD, the lower the
Macroeconomic Scenario Embedded Forward-looking Probability of Default Models for IFRS 9 Purpose
default risk (EDF). Once DD is estimated, one can
derive EDF.
Thus, EDF estimates PD(t, r)=Prob(Vt<D) which
is capturing the tail portion of the asset return
distribution.
If assets follow the path shown in Equation 5.5,
which is driven by systematic factors and firm-
specific idiosyncratic factors, it can be shown
that the firm will default if asset value falls be-
low a threshold. This probability of asset value
falling below a threshold is termed as PD at a
PIT. From this concept, it can be mathematically
shown that
 Φ −1 ( PD( r ) TTC − Z ( t , r ) 
PD( t , r ) = Φ   (5.8)
 1−  

This PD is the point in the PD.
From Equation 5.8, we can extract the unob-
servable Z index using the inverse equation:
Φ −1 ( PD( r ) TTC − 1 − Φ −1 ( PD( r , t ))
Z (t, r ) = (5.9)


Using marginal PDs as PIT PDs and the bank’s
long-run stable PD as pure TTC PD, the AC is de-
rived through the Bluhm and Overbeck (2003,
2007) method.
Next, we have taken a view of key macro-
factors such as export growth, IIP growth, GVA
growth and non-food credit growth to derive a
good time average Z index (positive) and a bad
time average Z index (negative). Hence, during
an upturn in the economic cycle, Z values will
be higher and positive. During the trough of the
business cycle, Z values will be lower and nega-
tive, thereby increasing the bank’s PD.
Finally, we derive a weighted average Z index
to represent the future Z index. The weights can
be chosen on a judgemental basis as well as based
on future macroeconomic projections. Such
weights can be assigned by the bank’s senior
management. At the moment, we have given 10
per cent for good and 90 per cent for bad scenar-
io weights.
79
 5.2.2.3. Step 3: PIT PD Forecast
After obtaining the projected Z index, we com-
pare it with macroeconomic factors to deter-
mine the average Z index for good times (positive
when macro-factors are better) and for bad times
(negative when macro-factors are at their low-
est). Next, using a weighted scenario, we project
the average Z index for 2019–2020 by consider-
ing both good and bad conditions. Using the pro-
jected Z index, we predict a forward-looking PIT
PD. The forward-looking PD can be estimated us-
ing the following expression.
In a more lucid form, this expression can be
written as follows:
 Φ −1 ( PDTTC ) −  × Z ( t ) 
PDPIT ( t ) = Φ   (5.8a)
 1−   macro-factors to the yearly default rates of the

where PDPIT (t) is the PIT forward-looking PD for
time horizon t.
 is the cumulative standard normal distribu-
tion.
–1 is the normsinv function, which is the in-
verse of the standard normal z series.
 is capturing the systematic factor, where  is
the estimated AC.
Z(t) is the macroeconomic adjusted index (e.g.,
Z > 0 if economic conditions are good and z < 0 if
they are bad).
Note that the AC  captures the common cor-
relation between different assets in the bank’s
total loan pool.
We have taken one scenario, for example, to il-
lustrate the PIT PD projection method.
5.3. An Empirical Framework
and Key Results
5.3.1. Empirical Method 1
In our first approach, we have run two regres-
sion models where we apply two important
bank. Next, we have followed the variable sca-
lar approach (log-odd adjustment) to PDs due
to the forecasted changes in macroeconomic
factors.
In Table 5.1, the regression result confirms
that contemporaneous non-food credit growth
(NFCRED_GR) has a significantly negative influ-
ence on the yearly default rate. The regression
coefficient value is –0.399903 and is statistically
significant (t = –3.381745 with p-value < 0.01).

Table 5.1 Regression Model 1

Variables Coefficient t-statistic Prob.
NFCRED_GR(–1) –0.359901 –2.883094** 0.0204
Intercept 0.076478 4.194933*** 0.0030
No. of observations 10
R-squared 0.509570
Adjusted R-squared 0.448267
F-statistic 8.312230
Prob (F-statistic) 0.020414
Akaike info criterion –5.302474
Schwarz criterion –5.241957
Durbin-Watson stat 2.1024433
Source: Author’s own estimates.
Note: ** denotes significance at 5 per cent or better.
*** denotes significance at 1 per cent or better.
Dependent variable is marginal PD: MPD, sample period is 2009 to 2019.

80 INDIA BANKING AND FINANCE REPORT 2021

 Thus, an increase in non-food credit growth
in the current year by 10 per cent leads to a de-
cline in PD of the same year by around 3.6 per
cent. Note that the overall adjusted R-square
(depicting the model fitness) is 45 per cent.
Thus, 45 per cent of the variability of the yearly
MPD is explained by changes in non-food credit
growth. The F-value is also statistically signifi-
cant (F = 8.31 & p = 0.02), indicating model fitness
is good. The lower Akaike information criterion
and Schwarz criterion indicate good model fit.
The intercept (C) coefficient is statistically sig-
nificant (t = 4.1949 & p = 0.0030). It indicates that
other factors not captured in this regression have
also influenced X Bank’s overall PD. The above
regression model links X Bank’s MPDs obtained
through slippage rates with macroeconomic fac-
tors. The residual test confirms the absence of
serial correlation and heteroskedasticity in the
error term. Note that each time series variable
is stationary, which has been confirmed by the
Augmented Dickey–Fuller (ADF) unit root test
(results will be produced on request).
The overall regression fit is good.
The fitted regression equation can be written
as follows:
MPD = 0.076478 – 0.359901 × NFCRED_GR(–1)
(5.10)
(4.1949) (–2.883)
The figures in the parenthesis are the t-values.
The above equation has been used to project
future MPDs in the next step.
5.3.2. Macroeconomic
Adjustment of PD
Macroeconomic adjustment to PD can be carried
out using the estimated Equation 5.10. This has
been done using probabilistic scenarios as given
in Table 5.2.
We have applied a 23 per cent decline in credit
growth as a bad scenario and 5 per cent increase
in non-food credit growth as a good scenario.
The weightage scheme used is 90 per cent and
10 per cent.

Table 5.2 Creation of Macro-scenario ‘A’-based Z Shift to Estimate Macro-adjusted Forward-looking PD

Scenario A
Z Shift
Odd: Good/Bad (23% Decline
= (1–PIT PD) × 100)/ Ln (Good/ in Credit Weightage
PD Values (PIT PD × 100) Bad) Growth) (Bad Time)
Historical PIT PD 3.45% 28.01 3.332524 90%
Forward-looking
shifted PD 3.73% 25.79 3.250035 –0.0825
Z Shift
(5% Increase
Ln (Good/ in Credit Weightage
PD Values Odd: Good/Bad Bad) Growth) (Good Time)
Historical PIT PD 3.45% 28.01 3.332524 10%
Forward-looking
shifted PIT-PD 3.39% 28.54 3.351325 0.018801

Weighted
Z shift
Forward-looking
PIT PD 3.720% –0.07236
Source: Author’s own computations.

Macroeconomic Scenario Embedded Forward-looking Probability of Default Models for IFRS 9 Purpose 81
 Historical PIT PD is obtained from recent years
annual NPA movements (additions in NPA to
three year average standard assets). The cor-
responding odd ratio: good/bad and log odd has
been estimated to derive the Z index (like the Z
score in Altman).
Note that default rates are converted to odd and
log odd ‘ln(Good/Bad)’ to derive a Z score corre-
sponding to the historically derived PIT PD. Next,
we examine the Z shift due to a change in the
macroeconomic factor of non-food credit growth.
As a next step, we use the regression results
given in Table 5.1 and Equation 5.10 to establish a
linkage with Z and PD with macroeconomic fac-
tors. For this, we have done scenario analysis us-
ing the regression equation, and the results are
demonstrated in Table 5.2. We have taken a 23 per
cent decline in non-food credit growth in the next
year and examined the shift in the Z values and
expected PD. This scenario is considered ‘bad’. We
have also considered a good situation which may
also come, and in that case, non-food credit growth
may go up by 5 per cent, further examining its im-
pact on Z and expected PD. One year ahead, we
have assigned a weightage of 90 per cent to bad
situations and 10 per cent to good situations. This
weightage can also be decided by senior manage-
ment on the basis of a macro-forecast of the Indian
economy for the next year. The non-food credit
growth projection can also be done accordingly
and a percentage change can be worked out.
One can notice that due to a negative shock
(23% fall in non-food credit growth), PIT PD goes
up from 3.45 per cent to 3.73 per cent, and in re-
sponse to a positive shock (5% increase in non-
food credit growth), PIT PD declines from 3.45
per cent to 3.39 per cent.
Using a weighted average of good and bad
times, the weighted Z shift value becomes
–0.07236. When we again adjust this Z shift
with PD using an exponential function, EPD =
1/(1 + exp [–Z]), we obtain the projected forward-
looking PIT PD. Popularly, the inverse of natural
log odd is the exponential function used in the
logit model to predict default risk. This way, we
derive the shifted PIT PD, which is macro-factor
adjusted. Thus, the value of X Bank’s overall
macro-factor adjusted forward-looking PIT PD is
worked out as 3.70 per cent.
5.3.3. Scenario B
We have developed another macro-factor-based
regression model to generate a second set of sce-
narios. In this regression model, we have taken
MPD as the dependent variable and one period
(one year) lag of export growth as the indepen-
dent variable ‘XPORT_GR(–1)’.
The regression output is reported in Table 5.3.

Table 5.3 Regression Model 2

Variables Coefficient t-statistic Prob.
XPORT_GR(–1) –0.080251 –2.176565** 0.0515
Intercept 0.031808 4.998091*** 0.0011
No. of observations 10
R-squared 0.350234
Adjusted R-squared 0.269013
F-statistic 4.312122
Prob (F-statistic) 0.071496
Akaike info criterion –5.021143
Schwarz criterion –4.969626
Durbin–Watson stat 1.227123
Source: Author’s own estimates.
Notes: ** denotes significance at 5 per cent or better.
*** denotes significance at 1 per cent or better.
Dependent variable is marginal PD: MPD, sample period, 2010 to 2019.

82 INDIA BANKING AND FINANCE REPORT 2021

 The coefficient of regression factor XPORT_
GR(–1) is negative (–0.08025) and is statistically
significant (t = –2.176 & p <= 0.05). This implies
that there is an inverse relationship between
lagged export growth and the current marginal
PD. Thus, if export growth in the current year
falls by 100 per cent, the PD would increase in
the next year by around 8 per cent. A residual
test confirms that the error term is normally dis-
tributed in the absence of any serial correlation.
The fitted regression result can be written in
equation form as follows:
MPD = 0.031808 – 0.080251 × XPORT_GR(–1)
(4.998) (–2.176) (5.11)
Using the regressed lagged relationship es-
tablished in Equation 5.11, we have devised a
forward-looking scenario and assessed its im-
pact on future PD of the bank using Scenario B.
It has been explained in Table 5.4. It is important
to note that this empirical result is specific to a
bank. In order to generalize such a relationship,
this approach can be further extended to other
banks in a panel framework as well.
historically derived PIT PD of the bank. For this,
we have considered lagging export growth as a
macroeconomic indicator. We have used the re-
gression results reported in Table 5.3 (Regression
Model 2) and regression Equation 5.11.
One can notice from Table 5.4 that due to the
fall in export growth (representing bad time with
weightage of 90%), Z shift changes downwards
and PIT PD shifts positive from 3.45 per cent to
3.64 per cent. This can be captured by converting
the Z shift to an expected PD by using an expo-
nential function: EPD = 1/[1 + exp(Z)]. In the same
manner, when we consider a good time when ex-
port growth increases by 40 per cent, Z shifts up-
wards to 0.03372 and PIT PD reduces from 3.45
per cent to 3.34 per cent.
Finally, considering both bad and good time
possibilities with greater weightage to bad, we
obtain a weighted average Z shift of –0.04762.
Using the Z shift, we derive a forward PIT PD
estimate of 3.61 per cent. This has been done by
utilizing the exponential function: EPD = 1/(1 +
exp[Z]).

We have repeated the previously explained Ultimately, by combining both the scenarios,
odd ratio and Z shift adjustments on the we have forecasted that the forward-looking

Table 5.4 Creation of Macro-scenario ‘B’-based Z Shift to Estimate Macro-adjusted Forward-looking PD

Scenario B
Odd: Good/
Bad = (1 – PIT Z Shift
PD PD) × 100)/ Ln(Good/ (70% Decline in Weightage
Values (PIT PD × 100) Bad) Export Growth) (Bad Time)
Historical PIT PD 3.45% 28.01 3.332524 90%
Forward-looking
shifted PD 3.64% 26.47 3.275862 –0.0567
Z Shift
(40% Increase
PD Odd: Good/ Ln(Good/ in Export Weightage
Values Bad Bad) Growth) (Good Time)
Historical PIT PD 3.45% 28.01 3.332524 10%
Forward-looking
shifted PIT-PD 3.34% 28.97 3.366296 0.033772
Weighted
Z shift
Forward-looking
PIT PD 3.61% –0.04762
Source: Author’s own illustration on X Bank portfolio.

Macroeconomic Scenario Embedded Forward-looking Probability of Default Models for IFRS 9 Purpose 83
 one-year PD would be 3.65 per cent, assuming
that both macro-situations can happen together.
The predicted PD is 3.65 per cent, which equals
the weighted average of Scenario A and Scenario
B PIT PDs.
The prescribed methodology may be adopted
by the bank to adjust macroeconomic factors to
their PIT PD estimates associated with other in-
dividual portfolios also. However, the bank can
customize the scenarios and weights as per their
business and management insights.
For example, we can use Method 1 Scenario A
(associated with a probabilistic forecast of non-
food credit growth) to derive macro-factor-based
forward-looking PDs associated with the domes-
tic, internally rated credit portfolio of X Bank, as
shown in the last column of Table 5.5.
Roll rate analysis or migration analysis is per-
formed over the last five years (2015–2019) on
X Bank’s corporate loan portfolio to generate
the above matrix. Once the account is moved to
default (i.e., 90 days past due), the probability of
such a migration across rating buckets provides
us with the estimate of PD. This is based on the
corporate rating migration history of 3,000 bor-
rowers that were rated internally by the bank.
Similarly, we can use Method 1 Scenario B (as-
sociated with a probabilistic forecast of lagged
export credit growth) to derive macro-factor-
based forward-looking PDs associated with the
pooled PD of the overseas loan portfolio of the X
Bank as shown in Table 5.6.
The predicted PD has been further validated and
calibrated, and the forecast accuracy is 99 per cent.

Table 5.5 Applying the Z Shift Factor on X Bank’s Loan Portfolio Credit Risk

Non-food
Credit
Forecast
Rating Group-wise PIT PDs for Domestic Loan
based Forward-
Portfolio of X Bank
Odd: Weighted looking
SG MG RG WG Default Good/ Ln(Good/ Average Z PIT PD
(%) (%) (%) (%) (%) Bad Bad) Shift (%)
SG 95.21 4.74 0.00 0.00 0.05 1999.00 7.60 –0.08006 0.05
MG 0.25 91.82 6.67 0.50 0.75 132.33 4.89 –0.08006 0.81
RG 0.00 19.72 58.13 7.61 14.53 5.88 1.77 –0.08006 15.55
WG 0.00 1.25 10.00 37.50 51.25 0.95 –0.05 –0.08006 53.25
Default 0.00 0.00 0.00 0.00 100.00
Source: Author’s own illustration on X Bank portfolio
Note: SG: Super grades with lowest risk; MG: Middle grades; RG: Risky grades and WG: Worst grades.

Table 5.6 Z Shift Adjustment on X Bank’s Overseas Portfolio

1-year PIT Pooled PD of Overseas Credit Portfolio 5.35%

Odds 17.67794
Ln(Odds) 2.872318
Exports forecast based weighted average Z shift$ –0.04762
Forward-looking PIT 1-year PD for overseas loan portfolio (using exponential
function) 5.60%
Source: Author’s own illustration on X bank portfolio.
Note: $ = We have used weighted average Scenario B in this case.

84 INDIA BANKING AND FINANCE REPORT 2021

5.3.4. Taking the Estimated Forward-
looking PD to the Future Default Path
The bank can use the above illustrated meth-
odologies for forward-looking macroeconomic
adjustments of PD (1-year horizon) for Stage 1
exposures. Similarly, the bank can examine the
impact of macroeconomic adjustments on the
PD term structure for Stage 2 exposures as well.
In this context, forecasting macroeconomic vari-
ables for longer horizon is important. The bank
can use agency-provided projections or build its
own time series forecasting models to forecast
the macro-variables.
For Stage 2 accounts, after making forward
adjustments, the PD term structure can be estab-
lished through survival analysis as given below:
CPD5 = pd(1) + pd(2) × (1 – pd(1)) + pd(3)
× (1 – pd(1)) × (1 – pd(2)) + pd(4) × (1 – pd(1))
× (1 – pd(2)) × (1– pd(3)) + pd(5) × (1 – pd(1))
× (1 – pd(2)) × (1 – pd(3)) × (1–pd(4)) (5.12)
This way, lifetime PDs can be estimated us-
ing equation 5.12. Where pd(1), pd(2), pd(3), …,
pd(5) are the forecast forward-looking PDs af-
ter adjusting the macroeconomic factor. The
above cumulative PD (CPD) estimation is fol-
lowed by established rating agencies (Bandyo-
padhyay, 2019; Hamilton, 2002; Hamilton &
Cantor, 2006).
Banks can use such a methodology as an ad-
vanced approach. Otherwise, historical averages
based on internal data trends can also be used for
future projections.
5.3.5. Method II: Embedding
Forward-looking Conditions Using
Asset Correlation Approach
In the second method, we extract the Z index
that represents macroeconomic conditions em-
bedded in the aggregate portfolio of asset risks
by using the Merton (1974) model and by using
AC. We first estimate the common AC of the
bank that captures the presence of a systematic
effect on the bank’s loan portfolio. This has been
done using the AC approach as deduced in the
methodology section.
For comparison purposes, the overall portfolio
credit risk factors of X bank have been summa-
rized in Table 5.7 along with some other commer-
cial banks for comparison purpose.
AC is capturing the single common risk fac-
tor. If AC is high, it indicates that there will be a
greater increase in fresh slippage to NPA due to
macroeconomic fluctuations. This correlation is
a measure of the sensitivity of the bank’s incre-
mental risk of default on loans to the systematic
factors that represent the state of the economy
(Bandyopadhyay, 2017; Bandyopadhyay et al.,
2007; Bandyopadhyay & Ganguly, 2013). This
variability in fresh slippage occurs due to either
large loans defaulting or many loans defaulting
at the same time. The PD in the first column is

Table 5.7 Correlation Estimates of Selected Banks and FIs

Bank Name PD% UL% or SD (PD) DC (%) AC (%)
Axis Bank 2.36 2.34 2.38 13.65
BOB 2.57 1.95 1.51 8.97
BOI 3.94 3.42 3.09 13.27
Canara Bank 3.48 2.02 1.21 6.23
Central Bank 4.35 3.46 2.88 11.92
Exim Bank 2.37 2.12 1.94 11.52
HDFC Bank 1.90 1.00 0.54 4.27
ICICI 2.80 2.07 1.58 8.88
PNB 4.20 3.45 2.97 12.41
SBI 3.67 2.07 1.21 6.05
Source: Based on annual audited data on NPA movements of banks and FIs for the last 10 years.

Macroeconomic Scenario Embedded Forward-looking Probability of Default Models for IFRS 9 Purpose 85
 the long-run average PD estimated at the bank
level. The UL percentage is the standard devia-
tion of yearly marginal PDs.
As a next step to incorporating macro-adjust-
ment, we study the yearly movement of PIT
marginal PDs and compare them with the stable
long-run TTC PD of the bank to compute the
Z index. We obtain the long-run PD from the
bank’s fresh slippage rate. For this, the formu-
las specified in Equations 5.1 and 5.2 have been
used. The bank’s long-run TTC (PDTTC) of 2.3736
per cent has been estimated using annual histor-
ical NPA movements data and fresh slippage sta-
tistics. The single factor AC has been estimated
from the variance Equation 5.3a. The estimated
AC of X bank is compared with the other peer
banks presented in Table 5.7. One can notice that
the AC value is 11.52 per cent (given in Table 5.7
for X Bank).
Average PD estimates are long-run PDs.
Table 5.8 presents year-wise marginal PDs, TTC
long-run PD and an extracted yearly Z index. Us-
ing the AC of the Bank X and PD and volatility
inputs, we have obtained the yearly Z indices
which are presented in Table 5.8. Equation 5.9 has
been used for deriving the Z indices. As a next step,
we have compared the value of Z indices under
different economic conditions (good versus bad).
For this, we have taken reference from key mac-
roeconomic variables, which are export growth,
IIP growth rate, GVA growth rate and non-food
credit growth rate. The derived value of the Z in-
dex measures the ‘credit cycle’. Notice that in good
years, Z value will be positive, implying for each
initial credit rating a lower-than-average default
rate and a higher-than-average ratio of upgrades
to downgrades. In bad years, the reverse will be
true (i.e., Z is negative) and default rates will be
relatively higher. We have then estimated the av-
erage Z index for relatively good time when these
growth rates were comparatively higher (aver-
age Z for the time periods 2009–2010, 2010–2011
and 2011–2012). Similarly, an average Z index
has been estimated for the period when these
growth indicators were relatively depressed (av-
erage Z values during 2015–2016, 2016–2017 and
2018–2019). Next, we predict the projected Z in-
dex, which is estimated as Z = –0.76578 for one
year forward (i.e., 2019–2020).

Table 5.8 Panel A: Extracting Macroeconomic Z Index Using Merton Model from X Bank’s Aggregate
Portfolio
X Bank’s ExportGr IIP_Gr GVAGr CreditGr
FY MPD TTC-LRPD Z-Merton AC (%) (%) (%) (%) (%)
2008–2009 0.00225 0.023736 2.033021 13.74 2.50 4.31 17.51
2009–2010 0.00182 0.023736 2.218692 –3.53 5.29 6.86 16.91
2010–2011 0.00602 0.023736 1.119065 40.49 8.23 8.03 21.49
2011–2012 0.008786 0.023736 0.7409 21.83 2.89 5.22 16.99
2012–2013 0.016765 0.023736 0.051362 –1.82 3.33 5.42 14.06
2013–2014 0.030677 0.023736 –0.65463 4.67 3.28 6.05 13.95
2014–2015 0.019458 0.023736 –0.1166 –1.29 4.02 7.15 9.05
2015–2016 0.024862 0.023736 –0.40134 –15.49 3.33 8.03 10.91
2016–2017 0.072733 0.023736 –1.80528 5.17 4.58 7.88 8.16
2017–2018 0.043254 0.023736 –1.08923 10.03 4.44 6.94 10.00
2018–2019 0.034472 0.023736 –0.79916 11.52 8.75 3.84 6.63 13.29
2019–2020 3.39% 2.40% –0.76578
Source: Derived by the authors from X Bank’s aggregate portfolio. The macro factors are obtained from CMIE
database.
Note: MPD = marginal PD, TTC-LRPD: TTC long-run PD; Z-Merton: Z index derived using Merton Model as specified
in Equations 5.8, 5.8a and 5.9. ExportGr: Annual export growth (obtained from EPWRF data); IIPGr: Annual IIP
growth rate; GVAGr: Gross value-added annual growth rate; CreditGr: Banks’ credit growth rate (annual).

86 INDIA BANKING AND FINANCE REPORT 2021


Table 5.9 Panel B
Z good Z bad Weight
1.359553 –1.00193 Good
10%
Source: Author’s own computations.
The predicted Z index represents the one-
period-ahead projected macroeconomic condi-
tion for 2019–2020. This has been presented in
Table 5.9. We have used a weightage scenario of
10 per cent for good times and 90 per cent for bad
times. This weightage scheme can be decided by
the senior management of banks in consultation
with their economic research or planning unit.
The forecasted Z index, along with TTC PD and
AC, finally gives us a forecasted PIT forward-look-
ing PD, which is given in the last row of Table 5.8.
This forward-looking PIT-PD estimate of 3.39 per
cent has been derived using the expression given
in Equation 8a in the methodology section.
The estimated 12-month forward-looking PIT
PD for the first year would be 3.39 per cent. This
way, other years can also be projected using
Equation 5.12. The entire analysis is presented in
Tables 5.8 and 5.9 along with the estimates.
Z-projected
This projected Z indicator is bank specific. The
Bad
above-specified approach is advanced and the
90% –0.7657798 bank can adopt it in business in a phased manner.
A robustness check of the above method has
been carried out on a longer data set. For this, we
have studied the rating migration history of cor-
porate instruments rated by a credit rating agency,
CRISIL, in India. Using their annual default rates
(migration from beginning year rating to default
category) for the period 1994–1995 to 2019–2020,
we extract the Z index using the Merton single-
risk factor framework described in methodology
2. The common AC using the variance equation
and long-run TTC PD of 3.09 per cent is estimated
at 8.82 per cent. This represents the overall corpo-
rate risk profile situation in India.
The extracted Z index, along with leading mac-
roeconomic indicators such as the annual GDP
growth rate and the bank’s credit growth rate, has
been plotted in Figure 5.1. The derived Z index val-
ues (presented in the bar plot) are plotted on the
right axis and the macro-indicators on the left axis.

Z Index & Macro Factors

0.4 3

0.35
2
0.3
1
0.25

0.2 0

0.15
–1
0.1
–2
0.05

0 –3
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020

GDPGR CREDITGR Z

Figure 5.1 Link between Z Index and Macroeconomic Factor

Source: Author’s computation based on agency rating data of various instruments and their annual default
rates and macroeconomic variables obtained from CMIE and CSO.

Macroeconomic Scenario Embedded Forward-looking Probability of Default Models for IFRS 9 Purpose 87
 The correlation between the Z index and GDP
growth is estimated at 45 per cent, which is sta-
tistically significant. Similarly, the estimated cor-
relation coefficient between the Z index and the
credit growth rate is 75.66 per cent and is statisti-
cally significant. It is quite evident in Figure 5.1
that during good times when system banks’ cred-
it growth and economic growth rate are high,
the Z index is also positive and high. However,
during an economic downturn, when the GDP
growth rate is lower and the credit growth rate
decelerates, the Z value becomes negative. We
also discovered a statistically significant nega-
tive correlation between Z value and gross fis-
cal deficit to GDP ratio, with a coefficient value
of –0.574.
We have run two regressions to capture the
relationship between the Z values and macro-
economic factors. The estimated regression coef-
ficients will enable us to predict future Z values
and finally obtain one-, two- and three-period-
ahead forecasts for PD. We have applied lag val-
ues to eliminate any endogeneity issues:
Z = –2.125 + 29.755 × GDPGR(–1)
(–1.90) (2.100) (5.13)
Time period: 1996–2020; overall
R-square = 0.153; adjusted R-square = 0.130
Z = –2.287 + 14.112 × CREDITGR(–1)
(–4.91) (5.550) (5.14)
Time period: 1996–2020; overall
R-square = 0.575; adjusted R-square = 0.555
In both regressions depicted in Equations 5.13
and 5.14, residual error tests confirm that error
has no serial correlation and also passes the nor-
mality test (results can be reported on request).
Both the regression coefficients are statistically
significant with p < 0.05.
Statistically, projected macro-variables will
enable us to predict future Z values and for-
ward PIT PDs. It is important to note that all
these three time series variables are stationary
at a level that has been confirmed through ADF
unit root tests. Even in this statistical forecast-
ing, the management overlay can come through
the choice of forecasted values given by various
agencies (e.g., the IMF, World Bank and RBI).
88 INDIA BANKING AND FINANCE REPORT 2021
Depending upon the projected scenarios and Z
values, we can predict forward-looking PIT PDs
for different time horizons. For example, if the
projected credit growth rate in 2020–2021 is
around 8 per cent, the estimated Z value using
regression Equation 5.14 would be –1.17685, and
the projected one-period-ahead PIT PD would
be 5.59 per cent. Similarly, if the normal GDP
growth rate projection during 2020–2021 is esti-
mated at 6 per cent, the forecasted PIT PD can be
derived from Equation 5.13. We have also kept
a rolling window to validate the scenario-based
forecasted PDs. The senior management of
banks can suitably adjust these PDs by applying
their judgemental insights about future move-
ments of economic parameters.
5.4. Concluding Discussions
The new international financing reporting
standard has introduced a forward-looking ap-
proach for the identification of credit impair-
ment and estimation of ECL that will provide
a timely and adequate accounting treatment of
loan loss provisions.
Banks and financial institutions can use long-
term macro-data to derive futuristic probability
scenarios to more precisely estimate their loan
loss provisions. There is a flexibility inherent in
IFRS9 to give due weight to economic trends. Be-
sides statistical analysis, considerable judgement
will be needed to measure ECLs at this time. IFRS
9 is a principal-based accounting standard (AS)
and it requires the use of experienced judgement
as well.
The chapter proposes two new forward-look-
ing approaches for estimating PD through pos-
sible scenario analysis. Here, we have made an
attempt to mix statistical indicators and judge-
mental factors in creating futuristic scenarios
which can be suitably adjusted to derive for-
ward-looking PDs.
The regression-based model for generating
forward-looking scenarios has a judgemental
component involved that may come from the
top management (or economic research unit). A
bank can customize the scenarios and weights
as per their business forecast and management
insights. This method is quite intuitive, and the
macro-scenario can be straightforwardly linked
with a variable odd ratio (good/bad) to generate a
change in PD. Management overlays play a vari-
ety of roles In expected loss forecasting, includ-
ing macroeconomic changes, sector- and region-
specific issues.
The second model is based on Merton’s one-
factor model that derives the ‘Z’ index to link
long-run PD with PIT PD and uses a single AC
measure to link the loan pool with systematic fac-
tor. Once Z is extracted, one can track its historical
movement over the economic cycle, which has
been demonstrated in this chapter with numeri-
cal illustrations. It can also be linked to the GDP
growth rate using a regression model to gener-
ate grade-wise PD forecasts. The Z is found to be
negative during the trough of the economic cycle
and positive during good times. This method also
has a judgemental component which can be de-
rived from senior management’s insights. The
developed empirical framework will be useful to
banks and FIs to adjust macroeconomic factors
to their PIT PD estimates associated with other
individual portfolios. However, banks need to
customize the scenarios and weights as per their
business and management insights.
Acknowledgement: The author would like
to thank Dr Tasneem Chherawala, Shri Vidy-
adhar Kulkarni, Shri Sandipan Ray and various
management development programme par-
ticipants for helpful discussions, comments
and suggestions on this topic. Many construc-
tive comments and suggestions provided by an
anonymous reviewer were immensely helpful
in further improving the chapter substantially.
A special thanks to Dr Partha Ray for his com-
ments and suggestions. All remaining errors, if
any, are, of course, the authors’ own.
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Macbethian Apparitions
Early Warnings and
Fraud Management
Richa Verma Bajaj, Dipali Krishnakumar
and Smita Roy Trivedi
6.1. Introduction
Loan fraud comes with apparitions. In a gloomy
similarity to Macbeth’s ominous apparitions,
warning signals appear over time in credit ac-
counts as the money gets siphoned off from the
banking system. In cases spreading across indus-
tries from stationery to diamonds in India, more
than one Early Warning Signals (EWS) in loan
accounts have appeared, suggesting problems.
While there have been cases of mala fide over-
looking of warning signals by bank officials and
even allegations of connivance (Geetanjali group
fraud is a case in point), mostly the early warning
becomes a needle in a haystack or is overlooked
based on the uncertainty of whether the EWS is
serious enough to pursue.
The need to monitor EWS cannot be overem-
phasized. The use of red flags or EWS is crucial
for effective fraud management (Albrecht et al.,
2012; Coenen, 2008; Stamler et al., 2014). That be-
ing said, the mere presence of an EWS list may not
be enough. Interestingly, Pincus (1989) conducted
a field experiment to understand the efficacy
of the red flag questionnaire and found that the
questionnaire had no significant impact on fraud
risk management. We contend that in addition to
having an EWS list, it is essential to assign weight-
ages or scores to the EWS. For example, Smith et
al. (2005) pointed out that the US Statement on
Auditing Standards (SAS), which does not assign
weightages, may suggest to auditors that all risk
factors are equally important, which is unlikely.
Fraud risk assessment is thus made effective by as-
signing scores or weightages (Shelton et al., 2001).
6
Chapter
In the Indian scenario, the stepping stone for
fraud management was laid in 2015, with the
introduction of ‘framework for loan fraud’ for
fraud control.1 The framework introduced the
concept of Red Flag Account (RFA).2 RBI initial-
ly introduced 45 EWSs as a trigger to initiate a
detailed investigation in a RFA. The RBI (2017a)3
provided a list of 42 EWS for fraud monitoring
and reporting. However, while the RBI provided
the EWS list necessary for fraud detection, it may
not be sufficient. Bankers are often caught in the
dilemma of whether to heed to the EWS or allow
business growth. In this case, the scoring of EWS
becomes essential. Scoring of the EWS can give
vital clues to how likely a fraud is in a particular
case. In a previous study (Roy Trivedi et al., 2021,
henceforth RKV), we worked in this direction to
provide a score/ranking of 61 EWS (including the
42 EWS given by the RBI). Using a unique natu-
ral language processing (NLP) methodology, RKV
identified occurrences of 61 EWS in 648 cases of
known fraud (based on first information reports
[FIR] filed with the CBI by the PSBs) and ranked
these EWS. Categorical logistic regression is used
to further analyse the relation between the pres-
ence of certain EWS and the magnitude of fraud.
However, RKV is limited to the extent that
while it scores/ranks the EWS, it does not go on
to look at EWS in the context of particular cases
or explore the linkages between the EWS. While
ranking and scoring of EWS is a required step
towards effective fraud monitoring, it cannot
ensure that signals are detected on time. For ex-
ample, a banker overseeing a credit relation may
know that ‘substantial related party transaction’
 is an EWS but would still not know exactly when
the transactions can be taken to be ‘substantial’,
what sort of transactions between the parties to
monitor and so on. Add to this the fact that most
big-ticket accounts have many related parties,
and we can understand that early fraud detec-
tion may not be easy at all.
It is therefore necessary to understand the
modus operandi and bring more clarity to each
EWS. In this chapter, we address this gap in lit-
erature. This chapter looks at EWS in the con-
text of particular cases, exploring the ways in
which such EWS appear and the modus ope-
randi for perpetuating fraud. Based on this, a
granular template is developed with specific
questions on each EWS and scores are given to
the answers. The banker has a template with
questions to be answered in ‘yes’ or ‘no’, and
each ‘yes’ has a score in the template. The scores
used are from RKV, our earlier study. The tem-
plate therefore provides a score between 0 and 1
for a credit account, and a higher score suggests
a greater chance of fraud. This template, we be-
lieve, can be an essential tool for effective fraud
monitoring.
The present study finds some interesting link-
ages between EWS and features of EWS. While
siphoning of funds, an important EWS, usually
appears at the penultimate stage, it has some
crucial early signs. Siphoning of funds is closely
linked to dubious transactions between sisters
or group concerns. While the presence of sister
concerns is common, bankers should look out
for signals of ‘substantial interest’ and ‘signifi-
cant influence’ between related parties (ICAI,
2000). The ‘non-routing of proceed through lead
bank’ method is frequently used for diversion.
Further, there is a link between the use of false
documents, financial manipulation and fund
siphoning. Moreover, use of false documents in
domestic and international trade transactions is
a common EWS, which has also been highlight-
ed by the Financial Action Task Force (FATF)
as an important red flag indicator (FATF, 2006).
As international trade transactions depend on
documentary evidence (ICC, 2007), the possibil-
ity of the misuse of fraudulent documents to
fund trade transactions amplifies the risk for
the banking sector. It is therefore important to
92 INDIA BANKING AND FINANCE REPORT 2021
have a comprehensive approach to fraud-risk
management.
The rest of the chapter is organized as follows.
The second section gives broad trends in fraud
in India, the literature on EWS and presents
the objectives of the study in the context of the
literature. The third section explores linkages
between the EWS and presents the analysis of
EWS in the context of the cases. The fourth sec-
tion discusses the broad takeaways, use of the
template and recommendations.
6.2. Frauds: Trends
and Literature
A bank fraud can be defined as a
deliberate attempt/act of omission or com-
mission by any person carried out in the
course of a banking transaction or in the
books of accounts maintained manually or
under computerised environment in banks,
resulting into a gain to any person for a tem-
porary period or otherwise, with or without
any monetary gain or loss to the bank. (Please
see Chakrabarty, 2013,4 for a discussion on the
definition of fraud)
The Financial Stability Report of RBI (2017b)5
highlighted how fraud in banks and financial
institutions is a major emerging risk to the fi-
nancial sector. It is reported that serious gaps in
credit underwriting standards, lack of continu-
ous monitoring of cash flows and cash profits,
diversion of funds, double financing and general
credit governance issues in banks are evident in
a number of large value frauds. These irregulari-
ties involve both internal (bank employee) and
external (customer or vendor) factors in perpe-
trating fraud losses to banks. Figure 6.1 shows the
number and magnitude of frauds in banks in In-
dia from 2009–2010. Although the decline is ob-
served in fraud cases in 2020–2021, on account
of the decline in fraud cases in PSBs in India, the
fraud severity is still as high as 1,384 billion Indi-
an rupees (INR), enough to dent the profitability
of banks in India.
While the RBI and the Government of India
(GOI) initiated a series of steps For fraud manage-
ment,6 the most important for bankers remains
 10,000 2,000

8,000
1,500
6,000
1,000
4,000
500
2,000

0 0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Number of Frauds Value of Frauds (` Billion)

Figure 6.1 Total Fraud Losses in Banks in India

Source: RBI (2020).

the RBI Master Direction on Frauds7 (1 July 2016),

Table 6.1 Top 10 EWS and Scores
revised and updated in July 2017, for commercial
banks and select financial institutions in India. EWS Score
The guidelines include an illustrative list of 42 Siphoning of funds 0.329
EWS for alerting bank officials to wrongdoings in Fake/fabricated documents 0.189
loan accounts before they become fraudulent.8
Bribe/collusion/theft 0.182
While the use of red flags or EWS is important False information/hiding facts 0.066
for effective fraud management (Coenen, 2008;
Frequent change in scope 0.053
Stamler et al., 2014), the literature clearly indi-
Substantial related party transactions 0.037
cates that not all signals are equally important
(Smith et al., 2005) and that fraud risk assessment Delay in outstanding due 0.022
becomes effective when relative likelihoods are Fictitious counterparties or 0.021
assigned to red flag indicators (Shelton et al., transactions
2001). In this direction, in our earlier study, RKV Frequent invocation of BGs and 0.015
using NLP tools provided a score/ranking of 61 devolvement of LCs
EWS (including the 42 EWS given by the RBI) in Not routing of proceeds through 0.012
653 cases of known fraud. The paper ranks the lead bank/lenders
EWS and assigns frequency-based scores to each Source: Roy Trivedi et al. (2021).
EWS, where the score assigned to each EWS is
the ratio of the number of occurrences of that
particular EWS to the total number of EWS in should understand how exactly this siphoning
the 648 publicly available cases of fraud from the occurs, what sort of transaction should he/she be
CBI. Categorical logistic regression is used to fur- careful about, which documents should be check
ther analyse the relation between the presence and how and so on. Clearly, knowing the modus
of these EWS and the magnitude of fraud. The operandi is needed if the EWS is to be detected
top 10 of the EWS, in terms of frequency-based early enough to stop a fraud.
scores, are presented in Table 6.1.
This chapter addresses this gap in the litera-
However, this step of scoring and ranking of ture. We look at the most important EWS in the
EWS, though essential, may fall short as an effec- context of cases that have a higher proportion of
tive tool for early fraud detection. For example, such EWS and analyse the modus operandi for
Table 6.1 above suggests siphoning of funds and these EWS. Based on this, a template has been
fake/fabricated documents are important EWS. developed which can be used by bankers direct-
However, for operational purposes, the banker ly for any loan account. A score between 0 and

Macbethian Apparitions 93
 1 can be provided to each account based on this
template and a higher score suggests a greater
chance of fraud.
6.3. Objectives, Data and
Methodology
This chapter therefore has three objectives:
1. Case-based analysis of the EWS that
commonly appear in a select sample of
frauds
2. Identification of interlinkages between
these EWS
3. Design of a template with questions for
effective fraud identification
The data set used in this chapter is the same
as in RKV: the cases filed by the PSBs with the
Central Bureau of Investigation (CBI). As per the
RBI directives, all fraud cases detected in PSBs
above the value of `3 crore are to be reported to
various offices of the CBI in the form of an FIR.
These CBI FIRs from 2016 to 2019 form part of
our database.9 For the case-based analysis, we
look at this sample data set of CBI files available
in the public domain.
We focus on understanding the EWS in the
context of the cases in which they have appeared
and note the interconnectedness between the
EWS. Specific case-based examples are used to
highlight the modus operandi for each EWS.
Based on the relevant EWS, a template is formed
to help bankers identify fraud at the earliest by
focusing on the most relevant EWS and also
looking at the interconnectedness between
EWS. The questions in the template and the scor-
ing will help bankers assign an objective number
to the chance of a fraud happening.
6.4. The Most Frequent EWS
and Their Modus Operandi
6.4.1. Si phoning of Funds
Siphoning of funds remains a key area charac-
terized by fraud and money laundering. The si-
phoning of funds sanctioned for credit can take
various forms. The company may use the funds
sanctioned under term loans for working capital
94 INDIA BANKING AND FINANCE REPORT 2021
in variance with sanction terms. A common mo-
dus operandi is the siphoning or diversion of
funds through transactions with sister or group
concerns. This time and again shows up as sub-
stantial related-party transfers. Another way in
which funds are siphoned involves the routing
of proceeds through other banks, without the
knowledge of the lead bank, and ‘non-routing of
proceeds through the lead bank’. Moreover, funds
may be used for investment in financial assets
(equity/debt) in departure from sanction terms
and without the knowledge of the lead bank.
While the diversion of fund is a major EWS
in the appearance of frauds, it is important to
note that diversion or siphoning of funds would
appear in the penultimate stage of the fraud,
especially when the forensic audit is being con-
ducted. Then how do bankers identify signals of
a siphon early enough to stop it? The cases cov-
ered under this study suggest that the earliest
signals appear in the form of dubious linkages
that appear between a company and its sister
concerns.
The following early signals have appeared
in cases where there is a significant proportion
of ‘siphoning of funds’: first, the presence of as-
sociates with common shareholder pattern and
‘considerable influence’. To give a typical exam-
ple, let us consider Ramsarup Utpadak (Unit-ll)
of M/s Ramsarup Industries Limited,10 Kolkata,
which has a high frequency score for siphon-
ing of funds. M/s. RAV Dravya Private Limited,
a trading house and a sister concern of Ramsa-
rup Industries, owned 34.48 per cent of shares of
N. R. Mercantile Private Limited, the company
managing the stocks of Ramsarup Industries
Limited and subsidiaries. The remaining share
of N. R. Mercantile Private Limited was held by
Mr Ashish Jhunjhunwala and his wife, both of
whom are the directors of M/s. Ramsarup In-
dustries Private Limited. The addresses of the
company and M/s. RAV Dravya Private Limited
were the same. There was a clear pattern of com-
mon shareholders among the three companies,
which suggests that there would be substantial
influence by the key shareholders of Ramsarup
Industries Limited in both RAV Dravya and
N. R. Mercantile. Energo Engineering Projects
Ltd11 (EEPL) showed a similar pattern of close
collusion with sister concerns, sharing common
addresses and having common people in man-
agement and board positions.
Second, substantial transactions to and from
accounts of sister concerns are common: like
huge unexplained outward payments to a trad-
ing house and sister concern of the company
(Ramsarup Industries Limited); 50 per cent or
more of purchases/sales from/to a particular
group of companies or persons resident in one
common place (M/s Surya Boards Ltd and EEPL).
The examples above suggest that the pattern
of movement of funds/goods/credit between
sister or associates causes concerns. However,
practically, a significant proportion of companies
would have sister/associate concerns, making it
difficult to identify the early signals. In this case,
the related party concept as identified in AS 18
Related Party Disclosures is helpful. In accor-
dance with the AS 18 guidelines, there is a clear
definition of the terms ‘substantial interest’ and
‘significant influence’,12 which can help to ascer-
tain the degree of collusion between entities and
help bankers to be vigilant.
6.4.2. Fake/Fabricated Documents
Fake and fabricated documents are the second
most important part of the EWS and appear in
several of the cases with a wide variety of modus
operandi, often linked to the related party activi-
ties. In a large number of cases, the authenticity
of documents is not established, such as signa-
tures appearing bogus, or of related parties, re-
cords are not maintained and forged documents
are submitted. The cases of EEPL13 highlight most
of these: missing information (invoices submit-
ted did not have vehicle number and weight of
goods), wrong information (vehicle numbers in
the invoices were not registered with state au-
thorities at the website of the Ministry of Road
Transport & Highways [Gol]), conflicting infor-
mation (mismatches of vehicles used as per other
documents with lorry receipts), bogus authenti-
cation (signature of the transporter is the same as
that on the purchase order), etc. Needless to say,
most of the above-mentioned instances occurred
early enough to warn the financial institutions
involved of fraud but were overlooked. The use
of fraudulent export orders and documents for
letter of credit (LC) appears commonly. The Su-
preme Tex Mart case14 establishes a clear link
between the use of false documents, financial
manipulation and fund siphoning. Fabricated
documents were used by the company to avail
export credit facilities and also to show false im-
ports for LC, which led to jacked-up financials and
higher credit. Importantly, LC and bank guaran-
tee (BG) devolvement feature in the top 10 EWS.
However, while a faked or fabricated docu-
ment is an important tell-tale sign, it is very
difficult to identify in operations. In the case
of international trade transactions, the entire
process of LC, for example, rests on documents
and authentication in accordance with the ICC
(2007)15 and ISBP16 guidelines. Detection of forged
documents, including transport documents, may
often require a specialist that might be outside of
the expertise of the banker. For example, a forged
bill of lading may not be ascertained as such by
a banker even through information on a ship-
ping company’s website and may require a check
with the International Maritime Bureau.17
6.4.3. Frequent Changes in Scope
According to the RBI Asset Quality Review
2015, poor project evaluation, extensive project
delays, poor monitoring and cost overruns are
resulting in frequent changes in scope in many
projects in India. In a similar direction, we see
that frequent changes in scope are perpetrated
by companies such as Sowbhagya Ispat India
(P) Limited,18 ERA Infra Engineering, Kwality,19
Kanishka, SPS Steel Rolling,20 Best Crompton
Engineering Projects Ltd, Zylog (Systems) India
Ltd,21 Surana Power Ltd,22 etc., through the fre-
quent enhancement of consortium limits, fre-
quent enhancement of working capital or term
loan-related limits, over-run financing, modi-
fication in package and change in scope of the
projects.
6.4.4. False Information and
Hiding Facts
Important documents missing or not submit-
ted, along with false information, can be a vital
EWS. In the case of M/s Ramsarup Industries
Limited, Kolkata, GR/Bills of transport evidenc-
ing the movement or trading of fabrics were not
Macbethian Apparitions 95
 submitted, and later on, it was found that the
trading turnover was merely book entries. In
case of Supreme Tex, repeated probing by lend-
er banks failed to retrieve information. Crucial
information such as inventory write-downs,
land purchases, and extending credit to associ-
ates that is not shared with lenders is a pattern
observed in many of the fraudulent companies.
In fact, the pattern of incorrect information be-
ing given along with documents being falsified
is often inseparably linked together.
6.4.5. Bribe/Collusion/Internal
Control
Bribe/collusion or internal control weaknesses
have been identified as the third most impor-
tant signal, though not listed as an EWS in the
RBI Master Direction on Frauds (2017a). The
presence of internal control weaknesses has
been observed in a number of cases. A typical
modus operandi is given in the case of Jagad-
amba Automotives Private Limited.23 A special
investigation was carried out after the bank
management observed a sudden surge in the
advance portfolio along with reports of fraud-
ulent loan accounts at a branch. All these is-
sues could have come to light earlier through
routine audit checks on pre- and post-sanction
monitoring. In the case of Ms Mobi Tech,24 it is
alleged that the branch manager colluded with
the borrower by sanctioning a working capital
facility disproportionate to the revenue of the
company, by accepting valuation reports mul-
tiple times the actual property value, by not
verifying the sources of funds for the infusion
of capital by the borrower, etc. A maker checker
process failure is observed in the case.
These instances of fraud may be controlled in
the future through centralized loan processing
centres and security features/exception reports
in Core Banking System/Loan processing sys-
tems, which would not enable tampering with
loan schedules or would throw up alerts if del-
egated authority limits are breached.
6.4.6. Other Signals
Signals about the key production areas suffer-
ing, along with negative regulator action, can
96 INDIA BANKING AND FINANCE REPORT 2021
signal that something is wrong with the enter-
prise. For example, in the case of M/s Ramsarup
Industries Limited, the Security and Exchange
Board of India in 2019 served a notice to them
for violating Insider Trading Regulations. Apos-
tolou et al. (2001) found ‘known history of secu-
rities law violations’, ‘significant compensation
tied to aggressive accounting practices’ and
‘management’s failure to display an appropri-
ate attitude about internal control’ as the three
most important red flags rated. Heiman-Hoff-
man et al. (1996) found that auditors perceived
‘attitude factors’ such as dishonest, hostile, ag-
gressive and unreasonable management at-
titudes to be more important warning signs
than ‘situational factors’. In contrast, Majid et al.
(2001) revealed situational factors such as ‘diffi-
cult-to-audit transaction’ and ‘indication of go-
ing concern’ to be more important than ‘attitude
factors’. This indicates that banks should build a
system where early adverse information about
the companies’ financials and management pro-
cesses is obtained through news reports and/or
social media.
One of the important observations made in
this study is the interlinkage noted between the
different EWS. A Pearson’s correlation was run
to assess the relationship between the various
EWS. The results are presented in Table 6.2. We
observe a statistically significant positive corre-
lation among many of the top 10 EWS appearing
in the fraud cases, indicating that many of these
signals are likely to appear together in cus-
tomer accounts, thus indicating a higher prob-
ability of fraud occurring. In line with the case
analysis, we see a positive correlation between
siphoning of funds, frequent changes in scope
and substantial related party transactions. This
suggests that these early warnings are more
likely to happen together, suggesting that bank-
ers can be cautious if signals relating to any of
these appear in a loan account. The negative
correlation between bribes/collusion/theft and
other signals is not surprising because, while in
other cases, the early warnings were noted by
the bankers, in cases involving collusion, such
early warnings were more likely suppressed or
deliberately ignored.
 Table 6.2 Correlation Coefficients between top 10 EWS
1 2 3 4 5 6 7 8 9 10
1 Siphoning of funds 1.00
2 Fake/fabricated 0.02 1.00
documents
3 Bribe/collusion/theft –0.09** 0.05 1.00
4 False information/ 0.21* 0.10** 0.05 1.00
hiding facts
5 Frequent change in 0.16* 0.05 –0.00 0.24* 1.00
scope
6 Substantial related 0.34* –0.03 –0.1** 0.16* 0.16* 1.00
party transactions
7 Delay In outstand- 0.08** 0.04 0.03 0.14* 0.15* 0.01 1.00
ing due
8 Fictitious counter- 0.13* 0.10* –0.09** 0.04 –0.01 0.12* 0.10* 1.00
parties or transac-
tions
9 Frequent invocation 0.18* 0.12* 0.00 0.1** 0.12* 0.13* 0.12* 0.19* 1
of BGs and devolve-
ment of LCs
10 Not routing of pro- 0.19* 0.03 –0.03 0.10* 0.11* 0.08** 0.11* 0.02 0.2* 1
ceeds through lead
bank/lenders
Source: Authors’ own.
Note: Here, *, ** and *** denote statistical significance at 1 per cent, 5 per cent and 10 per cent levels, respectively.

6.5. Discussions and in place to check for document authenticity, es-

Recommendations
The discussions in the last section and the cases
highlighted underline the web-like connections
between the EWS. The most important aspect
of EWS is the systematic siphoning of funds by
the companies, and this, as we saw, is the pen-
ultimate stage. The early signals are the dubi-
ous transactions between sister concerns and
the presence of unexplained economic linkages
between concerns. This necessitates an under-
standing of signals of ‘substantial interest’ and
‘significant influence’ between related parties.
There are linkages between false documents,
financial manipulation and fund siphoning. The
possibility of using fraudulent documents in in-
ternational trade transactions is also highlighted
by FATF and remains an important concern. It is
therefore crucial to have adequate mechanisms
pecially since bankers only check documents in
the context of discrepancies for LC transactions
in the accordance with UCP 600 guidelines. We
find that all these EWS do appear early in the
cases, indicating the need to have mechanisms
for their timely identification.
Much like the Shakespearian tragedy Mac-
beth, the EWS apparitions are ominous and
significant. They suggest something is amiss
in the accounts much before the fraud is actu-
ally perpetuated. Many of the companies that
feature in CBI FIRs were well-performing and
profitable accounts when the first set of EWS
appeared. But time and again, such companies
soon start showing stress and then the tell-tale
signs of fraudulent activities appear. In most
cases, the bank is already looted of enormous
amounts before action is initiated against the
company. This highlights how important the

Macbethian Apparitions 97
 EWS given by the RBI were and yet how time multiplying weights and marks. The summation
and again they were overlooked. of scores gives the final score relating to a single
loan account. The template can thus be used to
One of the reasons why EWS may be over-
score borrower relationships on a scale of 0 to 1.
looked or ignored is the classic trade-off between
A higher score indicates a higher probability of
business growth and compliance that banks face.
fraud. Such templates or scoring systems can go
Bankers dealing with such accounts are aware of
a long way towards nipping fraud in the bud and
the EWS but find it very difficult to take actions
preventing losses for the banks. The development
against a supposedly ‘well-performing’ or ‘impor-
of such scoring systems by banks using their in-
tant’ client on the basis of the EWS. It is therefore
ternal data can be a useful step in this direction.
important to have an objective score of EWS as
they appear, and such scores can be concurrently
Disclaimer and declarations: The authors
tracked by business and compliance units. To aid
have no conflict of interest to report. The views
in the early detection of frauds, we developed a
and suggestions presented here are solely those
simple template (Appendix C) which can be used
of the authors and do not reflect the viewpoint
to score and mark EWS on the basis of the RBI
of the RBI or of the National Institute of Bank
master circular as they appear. The template is
Management.
easy to use: if the answer to any question in a sec-
tion is ‘yes’, 1 mark is assigned in the next column, The analysis is based on information in the
and 0 otherwise. The weights for each section CBI FIRs (https://cbi.gov.in/Links/View-FIR) and
(on the basis of our earlier study, RKV) are given does not include information from further legal
next. The score for each section is obtained by proceedings, if any.

APPENDIX A List of Early Warning Signals

The EWS List as per the RBI Master Circular

Bouncing of high-value cheques
Foreign bills remaining outstanding for a long time and the tendency for bills to remain overdue
Delay observed in payment of outstanding dues
Frequent invocation of BGs and devolvement of LCs
Underinsured or overinsured inventory
Invoices devoid of TAN and other details
Funding of the interest by sanctioning additional facilities
Frequent requests for general-purpose loans
Frequent ad hoc sanctions
Heavy cash withdrawal in loan accounts
Significant increase in working capital borrowing as a percentage of turnover
In merchanting trade, import leg not revealed to the bank
Concealment of certain vital documents, such as master agreements and insurance coverage
Frequent changes in accounting period and/or accounting policies
Claims not acknowledged as debt high
Substantial increase in unbilled revenue year after year
Material discrepancies in the annual report
Significant inconsistencies within the annual report (between various sections)
Poor disclosure of materially adverse information and no qualification by the statutory auditors
Frequent changes in the scope of the project to be undertaken by the borrowers
Not routing of sales proceeds through a consortium/member bank/lenders to the company

(Appendix A Continued)

98 INDIA BANKING AND FINANCE REPORT 2021

(Appendix A Continued)
The EWS List as per the RBI Master Circular
High-value RTGS payments to unrelated parties
Increase in borrowings, despite huge cash and cash equivalents on the borrower’s balance sheet
Dispute on title of collateral securities
Request received from the borrower to postpone the inspection of the godown for flimsy reasons
Exclusive collateral charged to a number of lenders without NOC of existing charge holders
Critical issues highlighted in the stock audit report
Liabilities appearing in the ROC search report that are not reported by the borrower in its annual
report
Non-production of original bills for verification upon request
Significant movements in inventory, disproportionately differing vis-a-vis changes in turnover
Significant movements in receivables, disproportionately differing vis-à-vis changes in turnover
and/or increase in ageing of the receivables
Increase in fixed assets without corresponding increase in long-term sources (when the project is
implemented)
Costing of the project which is at wide variance with the standard cost of installation of the project
Funds coming from other banks to liquidate the outstanding loan amount unless in normal course
Floating front/associate companies by investing borrowed money
LCs issued for local trade/related party transactions without underlying trade transaction
Large number of transactions with interconnected companies and large outstanding from such
companies
Substantial related party transactions
Default in undisputed payment to the statutory bodies as declared in the annual report
Raid by income tax/sales tax/central excise duty officials
Disproportionate change in other current assets
Resignation of the key personnel and frequent changes in the management
Significant reduction in the stake of the promoter/director or increase in the encumbered shares
of the promoter/director
EWS added by RKV
Management failure*
Business failure*
Bank norms flouted*
Bribe/collusion/theft*
Insider trading*
Fake/fabricated documents*
Fictitious counterparties or transactions*
Third-party transaction/remittance*
Non-cooperation/Non-compliance*
Does not make economic sense*
Unauthorized removal of stock or less stock*
Manipulated stock statements*
Security valuation*
Non-submission of stock statement*
Assets not created from loan*
Annual returns not filed*
Siphoning of funds*
Note: *The EWS added by the authors.

Macbethian Apparitions 99
 APPENDIX B EWS Ranking Based on Frequencies

EWS Score
1 Siphoning of funds 0.3293
2 Fake/fabricated documents 0.1894
3 Bribe/collusion/theft 0.1816
4 False information/hiding facts 0.0656
5 Frequent change in scope 0.0530
6 Substantial related party transactions 0.0365
7 Delay in outstanding due 0.0220
8 Fictitious counterparties or transactions 0.0208
9 Frequent invocation of BGs and devolvement of LCs 0.0155
10 Not routing of proceeds through lead bank/lenders 0.0124
11 Annual report discrepant 0.0078
12 Bank norms flouted 0.0078
13 RTGS to unrelated parties 0.0068
14 Exclusive collateral charged to a number of lenders 0.0067
15 Resignation of the key personnel frequent changes in the management 0.0064
16 Security valuation 0.0059
17 Unauthorized removal of stock or less stock 0.0054
18 Manipulated stock statements 0.0053
19 Dispute on title collateral securities 0.0036
20 Non-cooperation/non-compliance 0.0028
21 Heavy cash withdrawal loan a/c 0.0026
22 Bounced cheque 0.0022
23 Significant movements in receivables disproportionately to turnover/receivables 0.0017
24 Assets not created from loan 0.0014
25 Funding interest payment 0.0010
26 Business failure 0.0008
27 Poor disclosures or no qualification of statutory auditors 0.0008
28 Important doc not given 0.0006
29 In merchanting trade import leg not revealed to the bank 0.0006
30 Non-submission of stock statement 0.0006
31 Raid by income tax/sales tax/central excise duty officials 0.0006
32 Annual report inconsistency 0.0004
33 Increase in unbilled revenue 0.0004
34 Annual returns not filed 0.0004
35 Insider trading 0.0003
36 Default in undisputed payment to the statutory bodies 0.0003
37 Third-party transaction/remittance 0.0001
38 Large number of transactions with interconnected companies and large 0.0001
outstanding from such companies
39 LCs issued for local trade/related party transactions without underlying trade 0.0001
transaction
40 Frequent ad hoc sanctions 0.0001
41 Significant increase in WC borrowing 0.0001
42 Management failure 0.0001

100 INDIA BANKING AND FINANCE REPORT 2021

 APPENDIX C

Total
Score
If the answer to any of the questions in a section is ‘yes’, (Weights
Section mark 1 in the next column or 0 otherwise Marks Weights × Marks)
Does the customer have related parties that can have 0.32929
‘substantial influence’ on its business?
1
Are there substantial intergroup transactions?
Are there regular remittances to offshore entities?
Did a third-party check of property documents reveal any 0.18938
discrepancies?
2 Did one or more documents submitted for L/C repeatedly
show discrepancies?
Are LC discrepancies frequently waived off?
3 Has there been any suspicion of bribery or collusion? 0.18158
Has the LC been modified many times or cancelled? 0.06564
Are there frequent last-moment changes in payment
instructions?
Has any information on collateral been falsely given?
4 Has any know your customer (KYC) information been falsely
given?
Has any balance sheet information been falsely given?
In general, has customers hidden any crucial facts in the last
three months?
Did you notice the change in the project post-initial appraisal? 0.05295
Did you notice the poor quality of the contractors who
5 conducted the TEV study?
Did you notice an increase in unbudgeted expenditure?
Is your client not adhering to project milestones?
Is there one or more sister concerns that can have ‘substantial 0.03651
influence’ on their business?
Does the sister concern have less than two years’ relationship
with the bank?
Has the sister concern recently (in less than a year) changed
6
lines of business?
Has the sister concern moved to an entirely different line of
business?
Does the reason for changing business activity not make
economic sense?
Has the customer delayed servicing either principal or 0.02202
interest frequently?
Has the customer made deposits in cash credit accounts
either late or very close to the date before the account
would turn NPA?
Has the customer requested to reschedule repayment dates?
7 Has the customer delayed the renewal of facilities frequently?
Has the customer failed to meet any financial commitment,
either to the bank or others, as per information available to
the bank?
Does the customer have an insufficient balance in the
account compared to the level of activity claimed in the
financial statements?
(Appendix C Continued)

Macbethian Apparitions 101

 (Appendix C Continued)

Total
Score
If the answer to any of the questions in a section is ‘yes’, (Weights
Section mark 1 in the next column or 0 otherwise Marks Weights × Marks)
Does the customer have less than a two-year relationship 0.02076
with the bank?
Has the customer recently (in less than a year) changed his/
her line of business?
8 Has the customer moved to an entirely different line of
business in the last year?
Does his/her reason for changing business activity not make
economic sense?
Is KYC deficient with regard to international banking?
Have any guarantees been invoked in the last three months? 0.01547
Have any LCs been devolved in the last three months?
Are there advance discrepancy waivers on L/C?
Is the discrepancy waiver not making economic sense?
9 Have there been discrepancies in the description of goods in
any of the last three L/C transactions?
Have there been discrepancies in transport documents in any
of the last three L/C transactions?
Have transport documents not been given in any of the last
three L/C transactions??
Have there been any incidence of bills being discounted 0.01240
10
through other banks?
Do financial statements of the company seem to be fabricated 0.00780
or false?
Have the auditors failed to give qualified audit opinion?
Have any adjustments to accounts such as payables, stock
and debtors been observed by stock auditors or auditors of
the company?
Did the company revise financials after submitting them to
11 the bank (this can be checked in the MCA portal)?
Were there instances of financial statements submitted by
the company that were false or incorrect?
Are receipts in customer accounts not in line with the level of
turnover claimed in financial statements?
Are payments to suppliers and other operational creditors
not in line with the level of purchases and expenses claimed
in the financial statements?
Have audit or compliance teams observed that funds have 0.00780
12 been disbursed to the customer without verification of bills/
other documents/pre-sanction inspection?
Have audit or compliance teams found that the customer has
been permitted facilities above drawing power/temporary
overdraft which is beyond bank norms/credit guidelines?
Have audit or compliance teams found that any bank official
has acted outside his/her delegated authority with respect to
the dealings with the customer account?
Have audit or compliance teams found lapses in monitoring
of the account such as ensuring end-use, site visit and stock
audits?

102 INDIA BANKING AND FINANCE REPORT 2021

 Total
Score
If the answer to any of the questions in a section is ‘yes’, (Weights
Section mark 1 in the next column or 0 otherwise Marks Weights × Marks)
Have audit or compliance teams found instances of tampering
with loan repayment schedules, drawing power, unauthorized
entry, etc., observed in the CBS with respect to the customer?
Have any bank procedures/norms/rules been flouted with
respect to the customer’s account?
13 Are there RTGS from unrelated parties? 0.00683
Do the details about the collateral under CERSAI (Central 0.00669
Registry of Securitisation Asset Reconstruction and Security
14 Interest of India) appear unsatisfactory?
Is there any delay in the mortgage registration procedure?
Has there been a resignation of senior management personnel? 0.00641
Has a member of the board/audit committee resigned during
15
the year apart from regular appointments during AGMs?
Has any auditor resigned during the financial year?
Is there a discrepancy in collateral valuation? 0.00585
16 Did you observe an erosion of collateral value?
Does the written-down inventory seem not plausible?
Is there a depletion in the quantity of the hypothecated stock? 0.00543
17 Is there a discrepancy between the stock statement and the
physical stock count?
Did you notice manipulation of amount in stock statement? 0.00530
18
Did your customer submit a fake stock statement?
Did you maintain accurate control over the title of securities? 0.00362
19 Did you obtain a title clearance report from the client?
Do you have the valuation report for the security?
Are there instances of the customer failing or delaying 0.00279
providing the information requested by the bank?
Has the customer delayed the date of stock audit/plant visit/
inspection?
Has the customer not complied with any terms of sanction/
loan covenants?
20
Has the customer not cooperated during a stock audit/plant
visit/inspection?
Has the customer not allowed the bank valuer/representative
to enter the premises?
Has the customer not provided any assets for inspection?
Has the customer not responded to requests from the bank?
Have you noticed large-value cash withdrawals from the loan 0.00265
accounts in the cash transaction report?
21
Have you noticed any large-value cash payments from the
loan accounts?
Have one or more cheques issued by the customer bounced? 0.00223
Are there instances of the customer not having honoured a
financial commitment to a third party?
22 Has customer been requested credit against uncleared bal-
ances regularly?
Has credit been given to customer against uncleared cheque de-
posits and eventually those cheques have bounced (kite flying)?

(Appendix C Continued)

Macbethian Apparitions 103

 (Appendix C Continued)

Total
Score
If the answer to any of the questions in a section is ‘yes’, (Weights
Section mark 1 in the next column or 0 otherwise Marks Weights × Marks)
Is there a large delay in the collection of receivables/increase 0.00167
in receivables?
Are there problems of default by buyers as reported by the
23 customer?
Are the receivables days not in line with turnover?
Is a large percentage of sales still outstanding?
Is the proof of assets acquired from a loan sanctioned inad- 0.00139
equate?
Is there a delay in the installation of assets against loans taken?
24 Are assets created/construction progress not in line with loan
disbursement?
Have assets purchased been subsequently removed?
Are assets not produced for inspection?
Has the customer approached the bank to secure loans for 0.00098
25
funding interest payments?
Has there been any newspaper/trade forum reports of 0.00084
26
business failure?
Does the financial statement seem to have less/poor quality 0.00084
disclosures?
Is there suspected collusion with the statutory auditor?
Have any newspaper/reports/information come to the notice
of the bank to indicate that the company is facing material
27 adverse issues, but no mention of the same is available in the
financial statements or audit reports?
Has audited reports been revised without a proper reason
being given?
Is there any instance of the auditor’s failure to carry out the
audit diligently?
Is there transhipment through various locations without 0.00056
economic reason?
28
Is there an attempt to circumvent certain countries?
Is import leg not clear in the merchant trade transaction?
Did you notice any delays in the submission of stock state- 0.00056
29
ments by your client?
Has there been any raid by income tax/sales tax/central excise 0.00056
30
duty officials?
Has the company consistently reported profits but the cash 0.00042
flows from operations are very low or negative?
Is the debtor turnover ratio or debtor/receivable days very low/
high as compared with the past financials of the company?
Is debtor turnover ratio or debtor/receivable days very high
as compared with industry peers?
31 Is the inventory turnover or inventory holding days are very
low/high as compared with the past financials of the com-
pany or industry?
Is the creditor turnover ratio or creditor days very high/low as
compared with the past financials of the company or industry?
Are profits and growth for the company not in line with the
industry?

104 INDIA BANKING AND FINANCE REPORT 2021

 Total
Score
If the answer to any of the questions in a section is ‘yes’, (Weights
Section mark 1 in the next column or 0 otherwise Marks Weights × Marks)
Delay or failure to file annual returns 0.00042
32
Are delays in filing returns mentioned on the MCA portal?
Check the ratio of unbilled revenue (invoices yet to be raised 0.00042
and shown as part of current assets) to total revenue for
33 the current year as compared with the previous year for the
company. Has this percentage increased significantly (e.g.,
20% or more)?
Delay or default in payment of GST/PF/TDS 0.00028
Tax outstanding listed in company’s annual reports
34
Tax notice affixed to customer premises observed
Tax outstanding mentioned in audit report
Has there been any newspaper/market reports of insider 0.00028
35
trading/SEBI actions for insider trading?
Is there an increase in cost in comparison to the budget?
36 0.00014
Is there a need for more working capital to meet ends?
Is there a high volume of transactions with interconnected 0.00014
37 companies, as well as a high amount of money owed to such
companies?
Are LCs issued for local trade/related party transactions 0.00014
38
without an underlying trade transaction?
Has there been any newspaper/trade forum reports of 0.00014
39
management failure?
Is your client diverting excess liquidity? 0.00014
Did you notice a decline in the number of transactions in the
40 account?
Did you notice a substantial increase in debtors or stock
levels in the customer account
41 Do funds come from third-party accounts frequently? 0.00014

Notes the advice of the RBI and security aspects re-

lating to e-transfer of funds by banks.
1. RBI (2015).
7. The Master Direction on Frauds lists out
2. RFA is the one where a suspicion of fraudu- the classification of frauds, the formation
lent activity is raised by the presence of one of a central fraud registry, the reporting of
or more EWS. frauds and the framework of loan frauds.
3. RBI (2017a). 8. RBI (2015) also introduced the concept of
4. Chakrabarty (2013). RFAs through a master circular on loan
fraud. An RFA is one where there is suspi-
5. https://rbi.org.in/Scripts/PublicationReport- cion of fraudulent activity by the presence
Details.aspx?UrlPage=&ID=876 of one or more EWS.
6. These include Master Direction on KYC 9. Private sector banks have to report high-
Norms, Prevention of Anti Money Launder- value frauds above `1 crore to the state police
ing Act, 2002, circulation of a list of terrorist as well as the Serious Fraud Investigation
organizations, circulation of wilful defaulters Office (SFIO) of the Ministry of Corporate
by Credit Information Bureau India Ltd., freez- Affairs. However, the original filings by
ing of assets of suspicious parties by banks on private sector banks with SFIO could not be

Macbethian Apparitions 105

 accessed, hence we have not included them
in this study.
10. CBI FIR No. RC2152017E0002, dated
12/06/2017.
11. CBI FIR No. RCBD1/2019/E/0008 dated
04.11.2019.
12. An enterprise is considered to have a sub-
stantial interest in another enterprise if it
owns 20 per cent or more of the voting pow-
er of the other enterprise, either directly or
indirectly. Similarly, an individual is consid-
ered to have a substantial interest in an en-
terprise if that individual owns, directly or
indirectly, 20 per cent or more of the voting
power of the enterprise. Significant influ-
ence may be exercised in several ways, for
example, by representation on the Board of
Directors, participation in the policymaking
process, material inter-company transac-
tions, interchange of managerial personnel
or dependence on technical information. Sig-
nificant influence may be gained by share
ownership, statute or agreement. The EWS
questionnaire has questions that closely look
at the presence of sister/associate concerns
and whether there are transactions that do
not look proper.
13. CBI FIR No. RCBD1/2019/E/0008 dated
04.11.2019.
14. CBI FIR No. RCBD1/2020/E/0004.
15. ICC (2007).
16. International Standard Banking Practice
ISBP, ICC. 978-92-842-0199-0.
17. AML/CFT Industry Partnership (2018).
18. CBI FIR No. BS&FC/2017/09/30.05.2017.
19. CBI FIR No: RC2232020A0005/10/09/2020.
20. CBI FIR BI/BS&FC/2017 RCBSK2017E0003
05/5/07/2017.
21. CBI FIR No. BS&FC/2018/14/16.07.2018.
22. CBI/BSFB/BLR 2019 11 01.11.2019.
23. CBI FIR No. RC0742017E0003.
24. CBI FIR No. RC0292018A0005.
106 INDIA BANKING AND FINANCE REPORT 2021
References
AML/CFT Industry Partnership. (2018). Best
practices for countering trade based money
laundering. https://www.abs.org.sg/docs/li-
brary/best-practices-for-countering-trade-
based-money-laundering.pdf
Apostolou, B. A., Hassell, J. M., Webber, S. A., &
Sumners, G. E. (2001). The relative impor-
tance of management fraud risk factors. Be-
havioral Research in Accounting, 13(1), 1–24.
Chakrabarty, K. C. (2013). Frauds in the banking
sector: Causes, concerns and cures (Inaugu-
ral address by Dr K. C. Chakrabarty, Deputy
Governor, Reserve Bank of India on 26 July
2013 during the National Conference on Fi-
nancial Fraud organized by ASSOCHAM at
New Delhi).
Coenen, T. L. (2008). Essentials of corporate fraud
(Vol. 37). John Wiley & Sons.
Financial Action Task Force (FATF) (2006). Trade
based money laundering. https://www.fatf-
gafi.org/media/fatf/documents/reports/
Trade%20Based%20Money%20Laundering.
pdf
Heiman-Hoffman, V. B., Morgan, K. P., & Patton,
J. M. (1996). The warning signs of fraudulent
financial reporting. Journal of Accountan-
cy, 182(4), 75.
ICAI. (2000). AS-18 related party disclosures.
h t t p s : // k b . i c a i . o r g /p d f s / P D F F i l e 5 b -
3b3e6ef07360.27604018.pdf
ICC. (2007). Global rules. https://iccwbo.org/
global-issues-trends/banking-finance/
global-rules/#1488883561633-a6f3f3ac-
5b0b.978-92-842-0280-5
Majid, A., Gul, F. A., & Tsui, J. S. L. (2001). An anal-
ysis of Hong Kong auditors’ perceptions of
the importance of selected red flag factors
in risk assessment. Journal of Business Eth-
ics, 32(3), 263–274.
Pincus, K. V. (1989). The efficacy of a red flags
questionnaire for assessing the possibility
of fraud. Accounting, Organizations and So-
ciety, 14(1–2), 153–163.
RBI. (2015). Framework for dealing with loan
frauds. https://www.rbi.org.in/Scripts/No-
tificationUser.aspx?Id=9713
RBI. (2017a). Master directions on frauds—
Classification and reporting by commercial
banks and select FIs. https://www.rbi.
org.in/Scripts/BS_ViewMasDirections.
aspx?id=10477
RBI. (2017b). Financial stability report. https://
rbi.org.in/Scripts/PublicationReportDetails.
aspx?UrlPage=&ID=876
RBI. (2020). Annual report (2019–2020). https://
www.rbi.org.in/Scripts/AnnualReportPub-
lications.aspx?year=2020
Roy Trivedi, S., Krishnakumar, D., & Verma
Bajaj, R. (2021). Loan frauds and bad boy
billionaires: A new approach of loan fraud
prevention using NLP. NIBM.
Shelton, S. W., Whittington, O. R., & Landsittel, D.
(2001). Auditing firms’ fraud risk assessment
practices. Accounting Horizons, 15(1), 19–33.
Smith, M., Omar, N. H., Idris, S. I. Z. S., & Baharud-
din, I. (2005). Auditors’ perception of fraud
risk indicators: Malaysian evidence. Mana-
gerial Auditing Journal.
Stamler, R. T., Marschdorf, H. J., & Possamai, M.
(2014). Fraud prevention and detection: Warn-
ing signs and the red flag system. CRC Press.
Macbethian Apparitions 107
The Perils of Climate Change
A Risk Management Perspective
for Banks and FIs
Arindam Bandyopadhyay and
Sanjay Basu
7.1. Introduction
No man is an island entire of itself; every man
is a piece of the continent, a part of the main;
…And therefore never send to know for
whom the bell tolls; it tolls for thee.
(John Donne, No Man Is an Island)
The old testament narrates how God guided
Noah to build and populate an ark when he de-
cided to flood the earth for 40 days (Genesis, Ch.
6–8). Likewise, the Mahabharata describes how
Lord Brahma asked Vaivasvata Manu to build
a ship and protect the planet from an impend-
ing deluge (Vana Parva, Ch. 12). From the flood
myths across cultures to the extinction of dino-
saurs and the demise of the Indus Valley civili-
zation, almost every epoch has been associated
with a climate catastrophe. The trend continues
to this day—climate risk threatens our health,
livelihood and very existence in the foreseeable
future. It is ubiquitous. From the Paris agreement
in 2015 to COP26 in October–November 2021,
global leaders have been engaged in constant at-
tempts to mitigate the risk of climate change.
Against such a backdrop, it is strange that the
relationship between financial risk management
and climate change has been tenuous at best. The
North Sea storm tide of February 1953, which led
to the collapse of many dykes and killed more
than 1,800 people in Holland, provided an impe-
tus for Extreme Value Theory, which is a popular
statistical tool in risk management (Jorion, 2002).
The inclusion of geographic concentration under
Pillar II of Basel II (within ‘Credit Concentration
Risk’) is another example of the linkage between
climate events (e.g., the December 2004 tsunami)
7
Chapter
and risk management. However, such instances
are rare and the literature on the assessment and
management of climate risks for banks and fi-
nancial institutions is nascent worldwide.
In particular, there is a strong case for climate-
related financial risk management by Indian
banks and FIs. A recent report of the Ministry of
Earth Sciences (Krishnan et al., 2020) has high-
lighted that since the middle of the 20th centu-
ry, India has witnessed a significant increase in
average and extreme temperatures, sea levels,
droughts and the frequency of severe cyclones.
It has been ranked as the seventh most affected
country among 180 countries in the Global Cli-
mate Risk Index 2021 (CRI 2021) by German-
watch (Eckstein et al., 2021). The CRI score is
based on a country’s exposure and vulnerability
to climate events. India was ranked 46th in 2012.
The Intergovernmental Panel on Climate Change
Report, released in August 2021, is also categori-
cal that the Indian Ocean is the fastest warming
ocean, and the number and intensity of cyclones
in the Arabian Sea are on the rise.
This chapter presents an analytical frame-
work for the measurement and management
of climate risk. It demonstrates how scenario
analysis can be combined with MCS to generate
loss estimates for the loan and trading portfolios.
The credit and market value-at-risk (VaR) fore-
casts may be used by banks to create economic
capital buffers, identify key risk indicators and
alter portfolio composition to mitigate climate
risk. Regulators and policymakers may follow
the same approach to incentivize those sectors
(e.g., through lower risk weights or capital relief)
that reduce climate risk. The structure may also
 be adopted by all stakeholders to develop regula- A climate risk episode is defined as a green
tory and internal climate risk stress tests, which swan that is outside the normal range of expect-
are relevant to Indian markets. Disclosure and ed events (BCBS, 2021). The Global Financial Cri-
governance standards for climate risk may be sis of 2007–2009 was a black swan event because
improved in light of the exercise. of its low frequency and high severity. Green
swans are different from black swans since there
The chapter is organized as follows: The sec-
is some certainty that climate change risks will
ond section discusses the features and drivers of
materialize someday (higher likelihood but un-
climate risk. In the third section, we focus on the
certain timing of occurrence). The term green
recent literature on climate risk management by
might also have emerged due to the implications
banks and FIs. The fourth section discusses cred-
of climate risk for nature.
it VaR models. In the fifth section, we develop
market VaR estimates from expert judgement on Climate risk has two important elements:
the impact of climate change on GDP. The sixth physical risk and transition risk. Physical risks
section highlights the implications of the study arise when climate-related events erode the
and concludes. value of financial assets and/or increase liabili-
ties. Transition risks can rise when various in-
dustries move towards a low-carbon economy
7.2. Nature of Climate Risk (Financial Stability Board, 2020). Changes in the
Climate risk is described as uncertainty caused by physical environment, caused by climate shocks,
severe weather events such as floods, droughts will have a direct and indirect impact on invest-
and typhoons, which cause disasters that carry ment strategies and the choice of liabilities. Such
physical risks that can have a negative impact on transitions could mean that some sectors of the
businesses and the overall economy. The cost of economy face big shifts in asset values or higher
catastrophic weather events is rising in terms of costs of doing business. Moreover, the transition
monetary loss, loss of lives and livelihoods, sav- towards a low-carbon economy may eventually
ings, capital assets, jobs and income. This may convert high-valued assets into stranded assets.1
lead to transition risks (in terms of change in the
As a response to these changes, some firms are
mode of operations, systems and processes, relo-
now choosing to reduce investments in sectors
cation, etc.), which may further add to new oper-
like coal to help manage transition risks. Similar-
ating costs.
ly, the move towards a greener economy could
also impact companies that produce cars, ships
and planes, or use a lot of energy to make raw
Climate Risk materials such as steel and cement. In the same
manner, the iron and steel sectors that use coal
and the cement sector are going to be taxed or
Physical risk: Transition risk:
influenced by government policy that will have
Risk related to the Risk related to the
transition to a lower an impact on profitability (carbon tax or shift in
physical impact of
climate change carbon economy production) and thereby influence repayment
behaviour. Similarly, consumer cars can move
Change in on batteries. As companies disclose more infor-
Specific events policy Replacing
Long-term shifts:
(emission) existing policy mation relating to climate change, financial firms
(Acute risk):
Rising sea level, will be able to make more informed decisions.
Floods, temperature
droughts, SEBI’s (2021) business responsibility and sustain-
Shift in
cyclones consumer & ability reporting (BRSR) norms, which are sched-
investor uled for compulsory roll-out from FY 2023 on-
sentiment
wards, will further enable financial institutions
Figure 7.1 Nature and Drivers of Climate Change Risk to identify firms’ potential business sustainabil-
Source: Authors’ own.
ity risk. The key drivers of climate change risk
have been summarized in Figure 7.1.

110 INDIA BANKING AND FINANCE REPORT 2021

7.3. Assessment of
Climate Risk
Banks need to assess the impact of climate
change risk and integrate it into the areas of
governance, risk management, scenario analysis
and disclosures, and examine their readiness for
recent and upcoming climate-related supervi-
sory expectations. Development of efficient as-
sessment methods to internalize climate change
scenarios and understand their impact on capital
and business is critical to effectively reducing
their risks. Global best practice banks have start-
ed conducting portfolio stress tests to assess the
effect of increasing climate risk events on their
loan portfolios (agriculture, housing, commercial,
project finance, etc.).
This is the reason why the Bank of England
carried out climate stress tests for British finan-
cial service firms in June 2021. The aim is to test
different combinations of physical and transition
risks over a 30-year period and examine the abil-
ity of the 19 largest banks to cope with climate
change at a systemic level. A Climate Biennial Ex-
ploratory Scenario analysis has been conducted to
generate future outcomes. The probable scenarios
are based on a subset of the Network for Green-
ing the Financial System NGFS (2020) climate sce-
narios.2 The purpose is to scrutinize the resilience
of the country’s 19 biggest banks and insurers,
including HSBC, Barclays Bank (BB), Aviva, AXA,
etc., to stresses arising from the shift to a net zero-
carbon economy as well as the impact of extreme
weather conditions over the coming decades. In
order to help investors know what is green and
what is not, the United Kingdom has introduced a
‘green taxonomy’ to label the assets.
BCBS (2021) contains some important obser-
vations on the measurement of climate-related
financial risks. First, the unique nature of the
problem requires granular and forward-looking
methods to capture both physical and transition
risks in greater detail, since historical data may be
irrelevant. Second, much of the emphasis so far
has been on transition risk, while physical risk
assessment is less tangible. Third, much more at-
tention has been paid to credit and counterparty
risk than market, liquidity and operational risk.
Fourth, banks and FIs may have to depend on
non-standard data and assessment methods in
the future.
Baudino and Svoronos (2021) offer some vital
principles for climate change-related stress tests
for banks. Such an analysis may be conducted
as follows: First, a large number of futuristic
climate risk scenarios need to be developed to
capture the significant uncertainty in outcomes.
Second, these scenarios should portray climate
change over long (30–50 year) horizons. Third,
climate change scenarios have to be connected to
aggregate and sectoral macroeconomic variables
such as GDP, unemployment or inflation. Fourth,
the impact of such macroeconomic shocks must
be assessed on financial sector indicators such as
bond and equity indices, PD and LGD.
Dietz et al. (2016) are among the few papers
to estimate market VaR due to climate change.
The authors use a popular integrated assessment
model (DICE by William Nordhaus) to project
a number of GDP and interest rate scenarios
and compute the decline in the market value of
bonds and equities. They show that if the Paris
agreement is followed, 99 per cent VaR could be
halved by 2100.
Rao (2021) summarizes the efforts by the RBI
to assess climate-related financial risks and in-
centivize sustainable finance in India so far. He
points out the difficulties in measurement and
quantification of climate risk because of its un-
certainty and extended time horizons. He also
states that the RBI has set up a Sustainable Fi-
nance Group within the Department of Regu-
lation to build in-house capacity and integrate
climate risk into the financial stability moni-
toring exercise. In order to further these objec-
tives, the RBI published its ‘Statement of Com-
mitment to Support Greening India’s Financial
System—NGFS’ on 3 November 2021 (RBI, 2021).
Through this statement, the RBI commits to (a)
exploring weaknesses in the business models,
balance sheets and internal capacity of banks
and FIs to measure and mitigate climate-related
financial risk, (b) integrating climate-related risks
into financial stability monitoring exercise, and
(c) creating awareness and spreading knowledge
among regulated entities on climate-related risk
measurement and management.
The Perils of Climate Change 111
 7.4. Credit Risk
There is a broad range of scenarios that capture
the cost of climate change risks: debtors receiv-
ing huge environmental fines from authorities for
waste pollution, plastic and car producers losing
significant amounts of business due to new legis-
lation, loans not being repaid due to crop failure
and business closures due to pandemic situations.
Banks need to factor these types of causal re-
lationships into their credit rating models and
recalibrate them. We have demonstrated such
adjustments in the following illustrations by
taking the examples of corporate and housing
loan portfolios.
Figure 7.2 demonstrates how adverse climate
scenarios, such as floods, along with macroeco-
nomic scenarios may impact borrower distress
as well as erosion in property value and thereby
create credit losses. Such a scenario’s impact can
be assessed on their loss rate through the MCS
technique.
In corporate rating, banks and FIs consider ob-
ligor-specific risks, which are assessed through
financial risks (balance sheet ratios), industry
risk and management risk. Transition risks
may arise due to the adjustment of asset prices
towards a low-carbon economy. It manifests
where greater disclosure of carbon footprint is
required and regulatory changes impose obliga-
tions on firms to transition to a low-carbon econ-
omy (Capasso et al., 2020). Further, an abrupt and
unexpected implied escalation of climate regula-
tion (such as the Paris Agreement)3 can act as a
strong exogenous shock that can influence bor-
rower creditworthiness. Accordingly, the effects
of changes in cost and quantity of emissions on
financial risk, the impact of changes in energy
sources (business risk) and the impact of govern-
ment policies to curb emissions on industry risk
must all be considered. Similarly, entity’s expo-
sure to physical risk (e.g., high carbon and emis-
sion intensity) will also be checked.
These scores can be adjusted downwards or
upwards due to their vulnerability to physical
risk in different industries or geographic seg-
ments. Levels of physical and transition risks can
vary from firm to firm depending upon its in-
dustry affiliation and geographic location. Firms
in industrial sectors such as coal, oil, gas and
electricity generation are highly exposed to the
carbon transition. Similarly, firms with plants
located in areas with high exposures to climate-
related adverse events will have relatively high-
er physical risks. Investor pressure and stronger
disclosure norms will drive Indian companies to
address climate concerns.
It is quite evident from Figure 7.3 that there is
a steep increase in CO2 emissions per capita for
India over time. Between 1998 and 2018, CO2
emissions grew substantially from 0.82 to 1.80
tonnes per capita. At the same time, the corpo-
rate default rate has also increased from 2.2 per
cent to 6 per cent. We have observed a statisti-
cally significant positive correlation between the
two series and the estimated coefficient is 0.782.
This association may vary in different industries
depending upon its exposure to transition risk.

Obligor Score Physical Risk Adjustments Transition Risk Adjustments

• Borrower-specific • Physical risk score • Carbon usage
adjustment (+) adjustments • Dependence on fossil
• Mitigation & adaptation • Business model fuels
strategy(–) protection towards • Transition risk score
• Residual score climate change adjustment
• Residual physical risk • Business model change
score & future action plan
• Residual transition risk
score

Figure 7.2 Risk Score Adjustments

Source: Authors’ own (conceptually derived from the empirical literature).

112 INDIA BANKING AND FINANCE REPORT 2021

 2 0.09
1.8 0.08
1.6 0.07
1.4
0.06
1.2
0.05
1
0.04
0.8
0.03
0.6
0.4 0.02

0.2 0.01

0 0
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
CO2 Emissions Default Rate

Figure 7.3 Corporate Default Rate and CO2 Emissions in India

Source: Data compiled from World Bank and CMIE.

A recent study by Capasso et al. (2020) has shown score, which is obtained from their key financial
that there is a significant negative relationship ratios. This means that these companies’ finan-
between the DD of companies and CO2 emissions cial solvency and credit ratings will be grimly af-
and carbon intensity. Companies with high car- fected if emission costs go up or their production
bon emissions and intensity are perceived by the level is curtailed in the future due to transition
market as more likely to default. risk. The impact on credit ratings due to physical
risk and transition risk can be further assessed
Firms also take mitigation and adoption strate-
through the rating transition matrix. The shift in
gies as part of management responses to physical
credit rating will give us an idea about the chang-
risk as well as transition risk due to current and
ing credit risk profile of borrowers, which can be
future climate change. This strategic aspect can
further assessed through an increase in credit
be suitably adjusted to derive residual scores. Ac-
risk-weighted assets due to a rise in unexpected
cordingly, a shift in scores as well as ratings (e.g.,
losses. The shift in rating profile has been illus-
down-gradation by one or two notches, includ-
trated in Table 7.1.
ing movement towards default) can be plotted
over different time trajectories to understand the
impact of climate risk. Table 7.1 Im pact of Rating Change over Time
Horizon
This way, we can establish a linkage between
% Share of Borrowers
exposure to climate change and firm credit risk.
Once the emerging climate risks are identified Grades T T+5 T + 10 T + 15
and factored properly, they need to be reflected AAA 10.87 6.57 0.98 1.36
in the risk rating of the borrowers. In a separate AA 29.88 13.69 2.04 4.91
panel regression, we have observed that the prob-
A 33.70 16.94 4.07 8.24
ability of solvency (PS) of firms in the cement in-
BBB 14.73 33.20 16.30 21.82
dustry is positively and significantly influenced
by the proportion of carbon emissions to total as- BB 7.97 17.29 32.60 37.10
sets. The balance sheet information was extract- B 0.80 6.50 34.64 21.28
ed from the company’s annual reports and the CCC/D 2.04 5.81 9.37 5.29
carbon emission data were obtained from India’s
Source: Authors’ own.
CDP reports. The PS is obtained through the Z

The Perils of Climate Change 113

 As a next step, the change in percentage share
of borrowers due to the impact of changing cli-
mate risk can be assessed in terms of an increase
in risk-weighted assets and an imminent effect
on the capital adequacy ratio. The incremental
risk-weighted assets (under Basel 3), including
default impact, will give an idea of additional
capital requirements against climate change risk.
Climate change risks can cause potentially
large negative shocks in a bank’s trading port-
folio as well. Banks need to include asset price
stress scenarios into their statistical VaR and ex-
pected shortfall models to examine their impact
in terms of additional capital and profit. This will
enable them to proactively deal with climate
change threats.
7.4.1. Loss Simulation Approach—
Climate VaR
VaR is a risk measure which is generically de-
fined as the maximum possible loss for a given
position or portfolio within a known confidence
interval over a specific time horizon due to a cer-
tain kind of risk. Economic capital is the tail per-
centile (maximum loss amount) that represents
Severity
Prob
Prob
Losses sizes
Prob
Figure 7.4 Scenario-based Loss Simulation Framework
Source: Authors’ own.
114 INDIA BANKING AND FINANCE REPORT 2021
the total amount of risk (VaR) less the expected
loss (average loss) covered by the loan loss reserve.
Figure 7.4 demonstrates the loss convolution
method that combines the frequency of events
with loss severity exposures over a time horizon
of 30 years. The MCS approach is a method by
which one can obtain the aggregate loss distribu-
tion by means of open-form solutions in which
an algorithm is ingeniously implemented in a
computer algorithm, and it iterates the scenari-
os and generates 10,000 probable loss numbers.
Using simulation, we can generate different sce-
narios for the frequency and severity of losses
by generating random numbers using the corre-
sponding types of distributions (identified using
actual loss data). For the different scenarios, each
potential loss is generated through a simulation
that uses the random numbers from the identi-
fied frequency distribution. Recently, leading
SCBs in India have disclosed billions of rupees
exposed to climate change risk. This will give us
an idea of the potential loss implications for the
banking industry in India. This in turn is used
to generate the corresponding severity of losses
from the identified severity of loss distribution.
Frequency
Number of Losses
Aggregated Loss Distribution
pn FX*n(x)
Aggregated losses:
n 0
 Table 7.2 Climate Value at Risk
Confidence ClimVaR Normal
Solvency Target Interval (%) Scenario (%)
BB 95 3.41
BB+ 99 4.09
BBB 99.50 4.21
Source: Authors’ own.
The losses so generated are then aggregated to
generate the aggregate loss distribution. Climate
value-at-risk (ClimVaR) is calculated as the 99.9
percentile of the loss distribution. The simulat-
ed loss values derived from the scenarios men-
tioned in Figure 7.2 and Table 7.1 have been sum-
marized in Table 7.2.
The climate VaR provides us an idea of the
probable loss percentage and its implications on
bank solvency. It may go side by side with the
regulatory prescribed scenario analysis provid-
ed in recent Basel Committee on Banking Super-
vision (BCBS) guidelines. Analysing the poten-
tial impact of both physical risk and transition
risk on loan write-off is critical for future plan-
ning. It is essentially a what-if analysis, which is
a very useful method to quantify all the poten-
tial exposures.
7.5. Market Risk
In this section, we assess the impact of adverse
climate change on Indian bond and equity mar-
kets. Our approach is based on Dietz et al. (2016)
and Baudino and Svoronos (2021). We predict cli-
mate-related bond and equity portfolio losses in
four steps. First, we present 30 hypothetical GDP
shocks for India, till mid-century (i.e., 2020–2050)
caused by climate risk. We modify these 30-year
scenarios into annual forecasts. Second, we re-
gress current equity and bond indices (in year t)
on lagged GDP values (in year [t – 1]). Third, we
translate the adverse GDP scenarios into bond
and equity market events. Fourth, we fit the dis-
tributions of these shocks and simulate 50,000
scenarios to compute bond and equity market
VaR. Hence, MCS allows us to capture the range,
uncertainty and complexity of future shocks to
the financial sector caused by climate change.
ClimVaR Non ClimVaR
Normal Scenario (%) Abnormal Scenario (%)
3.80 3.59
5.23 5.46
5.52 5.89
At this stage, some elaboration is in order. Our
scenarios are borrowed from Mani et al. (2018),
Kahn et al. (2019), Auffhammer (2019), Woetzel
et al. (2020) and the Swiss Re Institute (2021). The
application of mild, moderate and severe sce-
narios based on expert judgement to augment
historical data is common in the risk manage-
ment literature. These authors employ different
models to capture the impact of climate change
on GDP. The specific question that all of these
address is as follows: Cet.par., what is the impact
of climate risk on GDP levels by 2050? In other
words, if climate change (e.g., a sharp rise in tem-
perature and precipitation) was the only factor,
what would be the degree of change in GDP over
the next 30 years? Most of these articles portray
GDP scenarios for many countries, from which
we extract only the Indian ones.
The next point is that we annualize the GDP
shocks for a couple of reasons. First, data on bond
and equity indices are not enough to capture a
30-year relationship with GDP. Even when we
estimate an annual relationship, we obtain only
18 observations for the Clearing Corporation of
India Limited (CCIL) bond index (2004–2021).
Therefore, we convert 30-year GDP shocks into
annual scenarios through the popular square
root rule. Second, though the macroeconomic
impact is indeed protracted, we should depict the
effect of climate change on financial markets in
the near future. Such a perspective will enable
banks, regulators and policymakers to initiate
prompt remedial action. Unless the projected
losses are close enough, stakeholders may not be
serious about possible solutions. As Lord Keynes
observed many years ago, in the long run, we are
all dead. In fact, the need for urgent responses
is acute for India, which is ranked as one of the
worst affected countries.
The Perils of Climate Change 115
 Table 7.3 Regression Coefficients for Equity and Bond Markets, w.r.t. Lagged GDP
Coefficients Standard Error t Stat p-Value
bE 1.574480 0.137849 11.42173 0.000
bB 1.171241 0.041616 28.14431 0.000
Source: Authors’ own calculation.

In order to estimate losses in bond and equity

Table 7.4 Bond and Equity Return Distributions
markets, we consider the March-end values of the
BSE Sensex and the CCIL G-Sec index (Broad To- Best-fit Location_ Scale_
Distribution para para
tal Return Index) for 18 years between 2004 and
2021. We are constrained by the fact that the CCIL Extreme value
Bond minimum –0.00741 0.011108
index data are available only from the end of De-
cember 2003. The lag values of GDP at constant Extreme value
prices between 2003 and 2020 are obtained from Equity minimum –0.00996 0.014932
the RBI database. We develop a log-linear relation- Source: Authors’ own calculation.
ship between each index and lag GDP as follows:
ln(Et) = aE + bE ln(GDPt−1)  (7.1) Table 7.5 Climate MCS VaR for Bond and Equity
ln(Bt) = aB + bB ln(GDPt−1)  (7.2) Positions as on 31 March 2021
Bond (%) Equity (%) Portfolio (%)
The regression coefficients capture the elastic-
95% 4.04 5.43 4.74
ity of each (bond or equity) index, w.r.t lagged
GDP. They denote the percentage change in an 97.50% 4.82 6.49 5.65
index for year t, with a 1 per cent change in the 99% 5.85 7.86 6.86
level of GDP in year (t – 1). The results are sum- Source: Authors’ own calculation.
marized in Table 7.3.
Both the coefficients are statistically signifi- Table 7.5 results need to be interpreted careful-
cant. They can be used as scalars to transform ly. Over a one-year horizon, for instance, the 99%
adverse GDP shocks into equity and bond mar- worst portfolio loss is 6.86 per cent. In other words,
ket scenarios. For instance, a 2 per cent decline in there is a 1 per cent chance that actual losses from
GDP due to climate risk is followed by a 3.16 per climate risk will exceed 6.86 per cent of the bal-
cent reduction in equities (i.e., 2 bE) and 2.34 per anced portfolio over the next one year. The other
cent fall in bond (i.e., 2 bB) indices. Hence, we con- values may be understood in a similar manner.
vert all the 30 GDP shocks into equity and bond
market returns. Then, we fit the distributions for
these two sets of ‘what-if’ scenarios. The results 7.6. Concluding Discussions
are presented in Table 7.4.
Banks need to realize how climate risk can im-
On the basis of the distribution parameters, pact their business models and examine whether
we simulate 50,000 shocks for bond and equity additional capital needs to be held against such
indices. Since there is a single risk factor (i.e., risks. This will sensitize the senior management.
GDP fluctuations due to climate change), the It can be part of their internal capital adequacy
correlation between these two sets of returns is assessment process. Banks need to embed cli-
perfectly positive (i.e., +1). For simplicity, if we as- mate change risk into their enterprise risk man-
sume equal weights on bonds and stocks (i.e., a agement framework. It is also essential for risk-
balanced fund), the annual VaR estimates for the focused management to formulate strategies and
individual securities and the portfolio, at various build their capabilities to cope with climate risks.
confidence levels, are as follows. Many investors are responding to their clients’

116 INDIA BANKING AND FINANCE REPORT 2021

shifting preferences and considering environ-
mental, social and governance factors in their
investment decisions. Banks must assess the im-
pact of climate risk and integrate it into the areas
of governance, risk management, scenario anal-
ysis and disclosures, and examine their readiness
for recent and upcoming climate-related super-
visory expectations.
The methodology and framework explained in
this chapter will be helpful to the Indian bank-
ing sector. The climate VaR models we elaborate
on, on the basis of scenario analysis and MCS,
will recognize amplifiers, non-linearities and tail
risks that pertain to climate change. The con-
ceptual structure, discussed in this chapter, will
enable the BFSI sector to improve its risk gover-
nance systems and processes, stress-testing prac-
tices, scenario analysis and disclosure standards.
At a broader level, our chapter also explains
why we need to invest in nature. Dasgupta
(2021) argues that we need a financial system
that channels financial investments—public and
private—towards economic activities that en-
hance our stock of natural assets and encourage
sustainable consumption and production, like
green bonds and renewable energy projects.
These initiatives may reverse the sharp bor-
rower downgrades, GDP decline and collapse of
equity and bond markets over time due to cli-
mate risk. In other words, the focus of the finan-
cial sector should be on produced capital (roads,
buildings, ports, machines), human capital (skills,
knowledge) and natural capital. Dasgupta (2021)
calls that measure inclusive wealth.
It is quite evident in our analysis that climate
risk is no longer being considered as a stand-
alone risk. It appears to create other risks as
temperatures change—the loss of biodiversity,
environmental refugees, pandemics and so on.
This new complexity is now being increasingly
recognized. The COVID-19 pandemic and a de-
structive weather event like the AMPHAN cy-
clone occurring at the same time is an example
of the double whammy that can come about. In-
dian banks have a choice to make in determining
the role they play in providing green finance and
creating resilience to bounce back from direct
hits on their portfolios. Second, banks have their
own internal models for fixing their risk appe-
tites and then assigning risk to each activity and
each portfolio. Would it now require a two-part
risk strategy? Initially, some plausible scenarios
of environmental risk could be simulated given
scientific information and observable trends as
outlined in our analysis. For two or three of these
possible scenarios, the bank fixes its risk appetite
and does the usual risk profiling. The new di-
mension here would be processes and policies
that allow a quick switch to a new risk profile if
the environmental scenario changes. This may
have to be done at the earliest for better strategic
planning for the future.
The Rabindra Sangeet Aakash aamay bhorlo
aaloy/aakash aami bhorbo gaane.… (The sky has
filled me with radiance, I’ll fill it with melodies)
portrays a beautiful symbiotic relationship be-
tween mankind and nature. The restoration of
that pristine association requires imagination, in-
novation and sustained commitment from indi-
viduals and institutions at all levels. As Dasgupta
(2021) observes, we and our descendants deserve
nothing less.
Acknowledgement: The authors gratefully
acknowledge the invaluable comments and sug-
gestions given by the anonymous reviewer that
helped us to further improve the chapter.
Notes
1. Stranded assets are those assets that have
suffered from unanticipated write-downs,
devaluation or conversion to liabilities.
2. The NGFS is a group of 91 central banks and
supervisors. The climate scenarios are de-
veloped to provide a common starting point
for assessing climate risk effects on the
economy and financial system.
3. The Paris Agreement is an international
treaty signed at the 21st Conference of the
Parties (COP21) to strengthen countries’
ability to deal with the adverse impacts of
climate change. It sets out a global frame-
work to avoid risky temperature change by
limiting global warming to well below 2 de-
grees centigrade (or 3.6 degrees F). There is
The Perils of Climate Change 117
 growing concern that if current greenhouse
gas emission trends continue, the amount of
emissions permitted to keep targeted warm-
ing below 2 degree Celsius will be depleted
by the mid-century.
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FX Interbank Market of India
Liquidity and Stability
Gargi Sanati
8.1. Introduction
The FX market is well known for its highest li-
quidity, which is approximately 6.5 trillion dollar
a day as per the triennial report of the Bank for
International Settlement (BIS, 2019). The world-
wide interconnectivity of the FX market is one
of the reasons for its gigantic amount of liquidity.
However, the intricacies of its functionality still
remain captive in the treasury dealing rooms of
commercial banks. The FX market has two in-
terlinked segments: the merchant desk or retail
segment and the interbank desk or wholesale
desk. Out of all the instruments in the FX inter-
bank market, the most liquid instrument is the
FX swap, followed by the FX spot. An FX swap is
purely an interbank product and is used for ob-
taining FX funding. Also, it is extensively used
for the cover operation of NOSTRO liquidity
for different value dates, for example, cash, tom
and forward. So we can say that, except spot, all
interbank cover operations require the engage-
ment of FX swaps. The rising popularity of in-
terbank segments of the FX market, especially
the FX swap segment, which consists of more
than 50 per cent of the total trading volume, is
incontestable. It may be noted that FX swap is
purely an interbank product and should not be
confused with currency swap. While currency
swaps are an instrument that has been discussed
in academia quite widely, FX swap remains an
unexplored instrument despite its unparalleled
dominance in the FX market (refer to Table 8.1
for liquidity comparison). As described by Bark-
bu and Ong (2010), FX swaps came to notice dur-
ing the financial turmoil in the second half of
2007. The high spillover impact of the liquidity
8
Chapter
crunch was observed across FX swap markets,
which had intensified in the later part of 2008
following the collapse of Lehman Brothers. The
market started to be increasingly one-sided with
high demand for USD among the non-USD finan-
cial institutions as they were desperate to secure
their funding and interbank operations. Even in-
stitutions that were previously supplier of USD
began hoarding the currency. Despite its exten-
sive liquidity, the proliferation of cross-border
transactions in FX swaps over time has left this
market exposed to the fallout from the interna-
tional liquidity crunch (Barkbu & Ong, 2010).
Given the importance of the FX interbank
market in terms of liquidity and expansion, we
examine the recent development of the liquidity
scenario of India’s FX market, especially cover-
ing FX spot and FX swap. Our objective is to un-
derstand if India also follows the same trend as
the global market in terms of liquidity and inte-
gration of the market. Our study endeavours to
understand the interlinkage of India’s FX market
turnover with the other countries, for example,
the USA, the UK and Japan. Besides, it examines
the integration of FX spot and FX swap, covering
both INR (FCY/INR) and FCY transactions.
We start by investigating the recent expansion
of merchant and interbank desks in India’s FX
dealing room. The schematization of the study
is given as follows. In the second section, we
present the basic operations of the FX interbank
market and explain the reasons behind the high
liquidity in the FX market. Through scenario
analysis, we explain the interbank cover opera-
tion for both spot and swap segments in this pro-
cess. In the third section, we explain the database
 and empirical methodology in brief. The fourth
section describes the results of preliminary
analysis both for the domestic and international
fronts of the interbank FX market. Empirical
estimation of spillover impact across different
market segments in domestic and international
front is illustrated in the fifth section. The sixth
section concludes the study.
8.2. Structure, Liquidity
and Functioning of Indian
FX Market
The bank’s front office treasury operation desk
may be divided into two segments: (a) FX mer-
chant desk, in which the deal is contracted be-
tween banks and the merchants such as ex-
porters and importers, (b) FX interbank desk, in
which the deal is agreed between the banks and
the interbank, popularly known in treasury par-
lance as ‘the market’. However, these two market
segments are interlinked by their operations.
On request, the merchant desks dealers provide
hedging possibilities to the exporters, importers
and the clients who want to make inward and
outward remittances for any of the four differ-
ent value dates, namely cash, tom, spot and for-
ward. To avoid the exchange rate risk or the price
fluctuation of the FX market, the merchant deals
are booked for any of the above-mentioned set-
tlement dates. Once a customer gets a confirmed
rate from a merchant desk for a particular value
date, the exchange rate risk shifts from the cus-
tomer to the banks. Afterwards, any volatility or
exchange rate movement no longer affects the
customer for its payables and/or receivables but
may hit the bank if it keeps its position open and
does not do any cover operation subsequently in
the interbank. On the other hand, proprietary
trading in FX dealing rooms may be considered
a significant contributor to the liquidity in the
interbank market. For proprietary trading, the
dealers make views about the market, and posi-
tions can be taken on the basis of these views.
Subsequent to the realization of expectation,
interbank dealers can cover the open position
and book the profit/loss. Mainly, this interbank
cover operation, on account of merchant deals or
proprietary trading, may lead to high liquidity in
120 INDIA BANKING AND FINANCE REPORT 2021
Table 8.1 Worldwide Liquidity in FX Market
Trillion USD
Total 6.5
Spot 1.98
Forward 0.99
FX swap 3.2
Currency SWAP 0.1
Fx Options 0.2
Source: BIS Triennial Report 2019.
the spot and swap segments. As per the Bank for
International Settlements (BIS) triennial report of
2019, FX swaps have recorded 3.2 trillion dollars
of trading a day, followed by FX spot, which is
1.98 trillion dollars a day (Table 8.1).
Indian banks, as authorized dealer (AD), may
keep exchange positions in USD, euro, GBP, yen,
AUD, Swiss franc, Canadian dollar, Singapore
dollar, Danish krone, Swedish krone and Hong
Kong dollar. It may be noted that for each of the
transactions in the FX market, there is a debit
or credit of respective currencies through the
NOSTRO account, which is linked with high
exchange rate risk if left open. Moreover, ADs
are given a daylight limit and an overnight limit
(which is one-sixth to one-tenth of the daylight
limit, varying across banks) to manage the overall
exposure of FX risk through interbank cover op-
erations. For proliferation in understanding the
interbank cover operation, we provide a brief
description of interbank market parlance as ac-
cepted by the Global Code of Conduct in the FX
market in Appendix A (refer to Box A.1).
One important factor of foreign exchange risk
exposure for any bank relates to its position in
merchant operations and proprietary trading.
Figure 8.1 reveals the widening gap in recent
years, which might be indicative that Indian
dealing rooms have become vibrant with great-
er participation in proprietary trading and inter-
bank cover operations. Yet India does not come
among the top 10 liquid markets in terms of FX
turnover. Nonetheless, we observe a significant
enhancement in liquidity with an increasing gap
between merchant and interbank segments, es-
pecially after 2007–2008 (Figure 8.2). This is an
 16,000,000

14,000,000

12,000,000

10,000,000

8,000,000

6,000,000

4,000,000

2,000,000

0
1996–97
1997–98
1998–99
1999–00
2000–01
2001–02
2002–03
2003–04
2004–05
2005–06
2006–07
2007–08
2008–09
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2016–17
2017–18
2018–19
2019–20
2020–21
–2,000,000

TMT TIT Linear (TIT)

Figure 8.1 Merchant and Interbank Transaction: Trends for India (Millions $)
Source: Author’s own compilation from RBI database on FX turnover.

1,600,000

1,400,000

1,200,000

1,000,000

800,000

600,000

400,000

200,000

0
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

2018–19 2019–20 2020–21

2 per. Mov. Avg. (2019–20) 2 per. Mov. Avg. (2020–21)

Figure 8.2 Indian Interbank FX Turnover since 2018–2019 to 2020–2021 (Millions $)

Source: Author’s own compilation from RBI database on FX turnover.

important signal of overall improvements in the lack of partaking in interbank dealing ex-
participation, which may be on account of more cept for the one required for merchant cover
transactions in proprietary trading and related operation. On the contrary, interbank liquidity
cover operations. The shallow liquidity in the has experienced a sharp increasing trend since
interbank market was primarily predominant 2007–2008, with a brief halt in 2009–2010. This
for almost a decade, from 1996–1997 to 2006– trend shows a significant improvement in li-
2007, and it is almost in line with the liquidity in quidity and performance of FX dealing room
the merchant segments. Prominently, it reveals operations with a bear run during 2019–2020

FX Interbank Market of India 121

 and 2020–2021, which is a phenomenon of the
post-COVID-19 scenario for overall FX market
turnover.
Furthermore, Figure 8.2 reveals that India has
faced a sharp decline in its liquidity situation in
the first quarter of 2020–2021. However, with
cyclicality in the second and third quarters, we
observe a noteworthy recovery in the liquidity
situation in the last quarter of this financial year.
8.2.1. The Rationale behind the
Capacious Liquidity in FX Spot
and FX Swap
In this subsection, we explain the rationale be-
hind the voluminous liquidity in the FX market.
The sophistication of interbank cover operations
for spot transactions elucidates such liquidity
conditions in connection to merchant deals in
USD/INR.1 We have already explained that any
type of merchant deal provides a hedging oppor-
tunity to the exporter or importer and transfers
the FX risks to the banks. This exchange risk is
categorized into exchange and fund positions of
the bank. The fund position or NOSTRO position
of a bank is also known as the liquidity position.
If a bank has an export customer who wants to
convert 10 million (Mio) dollars into INR at the
value spot, then the NOSTRO account of the bank
would be overbought with the 10 Mio dollar
amount on behalf of the export customer. Alter-
natively, it is said that the bank has long position
in the dollar. In return, banks have to credit the
equivalent INR to the account of the customer. So
to earn the equivalent amount of INR, the bank
has to sell 10 Mio dollars to the interbank market
to square off the long or overbought position for
the value spot. In this process, the bank exposes
itself to the risk of exchange rate fluctuations. On
the contrary, the exporter receives the amount
in INR value spot at an agreed rate as contracted
by the merchant dealer. Consequently, the rate at
which interbank cover operations happen may
incur a profit or loss for the bank depending on
the prevailing exchange rate during the time of
the interbank cover operation. Similarly, if an
importer has to convert its payables into dollar
value spot, then the bank’s NOSTRO account
would get debited on the settlement date, that
is, the on-spot date. So on the spot date, the bank
122 India Banking and Finance Report 2021
has oversold position on its NOSTRO account, for
which the bank must buy dollars from the inter-
bank and thereby book a cover operation on the
value spot.
The bank, let us assume bank X, has to cover
its exchange and NOSTRO positions, which are
open due to merchant or customer deals, also
known as market taker. The interbank cover
operation by bank X opens up the exchange and
NOSTRO positions for another bank, let’s say
bank Y, which plays the role of a market maker.
Subsequently, the market maker, that is, bank Y,
has to cover its open position with, say, bank Z.
So it explains the mechanism through which
the liquidity of the market grows manifolds.
This one merchant transaction generates
multiple interbank cover operations and makes
the volume exceptionally large for FX spot
(technical details on the transaction are given in
Appendix A [Box A.2]).
However, it should be noted that banks do
not have direct access to cover the NOSTRO or
fund position for cash, tom and forward settle-
ment. For any such cover operation, banks need
to involve an ‘interbank’ product called an FX
swap. It is interesting to note that FX swap is
exclusively available to interbank dealers2 to fill
fund position gaps caused by merchant transac-
tions and proprietary trading. FX swap refers to
simultaneous buy/sell or sell/buy a currency,
say, USD 1 MIO against INR at two different
value dates, say, spot over 1 month forward or
cash over spot at two different rates. It may be
noted that for booking a buy/sell or sell/buy in
an FX swap transaction, the counterparty and
the amount in terms of product or base currency
remain the same. In market parlance, generally,
a swap is always mentioned along with the two
legs involved. For instance, ‘buy/sell, spot over
3 months’ means the first leg is spot and the sec-
ond is 3 months forward. For pre-spot dates, it is
either cash over spot (C/S, near leg cash and far
leg spot) or tom over spot (T/S). Like the chain in
the spot segment, the FX swap market also has a
similar flow between market taker and market
maker, which may run infinitely, thereby gen-
erating the most liquid market segment in the
financial markets.
 Let us assume that there exists an importer
800,000
who has payables today of USD 1 MIO (value
cash). So the bank’s NOSTRO account would 700,000
be debited by 1 MIO USD value today. To meet 600,000
the liquidity requirement, the bank has to buy 500,000
1 MIO USD value in cash which is possible only 400,000
by involving an FX swap. It may also be noted
300,000
that the cover operation of this merchant deal
200,000
requires an interbank spot transaction on its
first leg, followed by a buy–sell swap transac- 100,000
tion for settlement cash over spot. So the over- 0

100
111
122
133
144
155
166
177
188
199
210
221
232
243
254
265
276
287
12
23
34
45
56
67
78
89
1
sold exchange position (due to a sell contract to
the importer) would be first covered by the pur- TotIntSpot TotIntFxSwap
chase of 1 MIO dollar spot in the first leg of the
Figure 8.3 Trend in FX Spot and FX Swap Market Turnover in India
transaction in the NOSTRO account. Then, to (From 1996–1997 to 2020–2021)
fill the maturity mismatch between cash, which
Source: Author’s own compilation from the database of RBI, FX turnover
is oversold on today’s date, and spot, which is data.
overbought for settlement after two days, the
interbank dealer has to engage in a buy–sell
swap for cash over spot. This transaction, as
TotIntSpot TotIntFxSwap
done by the market taker (say, bank X), covers 800,000
the exchange rate risk for the bank. However, it 700,000
makes the market maker (say, bank Y) exposed 600,000
to exchange rate risk in the spot desk and inter- 500,000
est rate risk (linked to the movement of forward 400,000
premiums or swap points) or liquidity risk in 300,000
FX swap desk. So, as a taker, bank Y now covers 200,000
its position, say, with bank Z (market maker) in 100,000
spot and with bank C (market maker) in the FX 0
May

May
Aug

Aug

Mar
Nov

Mar

Nov
Apr

Dec

Dec

Feb
Jun

Sep

Feb

Apr
Oct

Jan

Jun

Sep
Oct

Jan
Jul

swap. The chain may continue an infinite num-
ber of times and that leads to a gigantic amount
of liquidity in the FX spot and FX swap markets
(Appendix A [Box A.3]).
After knowing the operational structure and
rationale behind the enormous liquidity in FX
interbank market, let us now examine the li-
quidity condition in FX spot and FX swap mar-
kets in India. Interestingly, it may be observed
that since 2007–2008, for a significant period,
the FX spot market remained more liquid com-
pared to the FX swap, except for 2019–2020 and
2020–2021 (Figure 8.3). In April 2020, there was
an acute drop in both FX spot and FX swap liquid-
ity (Figure 8.4). It was immediately after the gov-
ernment’s announcement of a complete lockdown
in India, effective from the last week of March
2020. However, liquidity in FX swaps reversed
more sharply and steadily, returning to the level
at the end of the financial year 2020–2021. On
Jul
2019–20 2020–21
Figure 8.4 Covid Impact on Liquidity of FX Spot and FX Swap
Turnover in India
Source: Author’s own compilation from the database of RBI, FX turnover
data.
the other hand, though the liquidity in FX spot
was reinstated at the same level, it does not show
the same forte in the recovery.
However, it may be undoubtedly said that li-
quidity in FX turnover in both spot and swap is
driven by FCY/INR (Figure 8.5). We observe a sig-
nificant difference in liquidity between the FCY/
INR leg and FCY/FCY, which is more prominent
for FX swap. This liquidity gap reveals the need
of the hour to improve the dealing capacity of
front-office treasury, more specifically in the FX
swap segments. From Figure 8.5, it may also be

FX Interbank Market of India 123

 600,000 700,000

500,000 600,000

500,000
400,000
400,000
300,000
300,000
200,000
200,000
100,000 100,000

0 0
1
21
41
61
81
101
121
141
161
181
201
221
241
261
281

1
23
45
67
89
111
133
155
177
199
221
243
265
287
FCY/INR (Spot) FCY/FCY (Spot) FCY/INR (FX Swap) FCY/FCY (FX Swap)

Figure 8.5 Comparison of FCY/INR and FCY/FCY Transactions for Spot and Swap
Source: Author’s own compilation from the database of RBI, FX turnover data.

350,000
8.3. The Database and
300,000 Econometric Methods
250,000
We extensively use the time series database on
200,000 turnover in the FX market available with the RBI.
150,000 From August 1996–1997 to July 2021–2022, these
100,000 data are available on a monthly basis. However,
50,000 we have considered the data till March 2020–2021
0 to remain consistent with the analysis of the com-
1
12
23
34
45
56
67
78
89
100
111
122
133
144
155
166
177
188
199
210
221
232
243
254
265
276
287

plete financial year. In this database, the RBI pro-

FCY/FCY (Spot) FCY/FCY (FX Swap)
Figure 8.6 FCY/FCY—Comparison between FX Spot and FX Swap
for FCY Leg
Source: Author’s own compilation from the database of RBI, FX turnover
data.
observed that the FX spot market, for its both
INR leg and FCY leg, experienced a sharp fall in
liquidity immediately after the lockdown impact
of COVID-19 in India. On the contrary, the FCY
leg reveals an impartiality between the sharp fall
in the FX spot and FX swap during March and
April 2020 (Figure 8.6).
Although the liquidity in the FCY/INR leg for
both FX spot and FX swap is almost the same,
Figure 8.6 exceptionally reveals that liquidity in
FCY/FCY for FX spot segment is weaker than in
the FX swap. However, for India, overall, it may
be claimed that interbank market liquidity and
stability is driven by FX spot.
vides entire details of merchant and interbank
turnover under two major segments: purchase and
sale. As the objective of our study is to measure the
overall liquidity of the interbank market, we have
considered the total of purchase and sale amounts
and not the net of the two. We have considered
two major products of interbank for our analysis:
FX spot and FX swap. As already discussed, the
liquidity of these products is significantly higher
compared to the rest of the segments.
We face a major constraint on the availability
of similar data for cross-country analysis. Even
Reuter’s database has limitations in providing the
same type of data consistently over time across
countries. Till today, the only source of country-
specific data for FX turnover was BIS. However,
country-specific data available in the BIS database
are triennial. So, for retrieving the time series
data, we had to rely on the respective countries’
central banks’ databases. It may be noted that for
cross-country analysis, we have considered only

124 INDIA BANKING AND FINANCE REPORT 2021

the biggest three exchanges in the UK, the USA
and Japan. We compare the spillover impact and
liquidity condition of India’s FX market in view
of FX liquidity in these three countries.
In the context of our objective to measure the
liquidity and stability of the Indian FX market,
we conduct econometric analyses on the interna-
tional and domestic fronts. We examine if India’s
interbank market is facing any impact from li-
quidity spillover from the USA, the UK and Japan
by applying the Johansen–Juselius or JJ cointe-
gration test (Johansen, 1988; Johansen & Juselius,
1990), followed by the vector error correction
mechanism or vector error correction model
(VECM) (Engle & Granger, 1987) and the Granger-
causality test. We have employed the JJ cointe-
gration test over the Engel–Granger cointegration
test as the JJ cointegration test allows a system
test considering all the variables as dependent
variables. On the contrary, for the Engel–Grang-
er cointegration test, the selection of dependent
variable is mandatory, which is considered a
major limitation in its use. This is because the
financial markets are integrated. Considering
endogeneity in the system, it is unlikely to select
one market as a dependent variable and the rest
as the independent variables. If all our variables
are integrated in the same order, we can prove
that there exists at least one combination of esti-
mated parameters that leads to a long-run equi-
librium. In other words, the presence of at least
one cointegrating vector confirms that though
the variables, individually, are mean-diverting, in
the long run, they follow an equilibrium path and
do not drift away from each other. This long-run
equilibrium is possible through the existence of a
short-run adjustment factor, which is established
through VECM. Also, the JJ cointegration test
is applied to analyse four segments of the inter-
bank FX market in India; FCY/INR spot, FCY/INR
swap, FCY/FCY spot and FCY/FCY swap.
The ADF test (Dickey & Fuller, 1979, 1981) for
unit root concludes that all our variables are
stationary at first difference, which means that
they are all I (1). In the ADF test (Equation 8.1), the
null hypothesis is the presence of a unit root, or
that the level variables are non-stationary. The
null and alternative hypotheses may be written
as H0:  = 0 or the presence of a unit root:
∆y t = a0 + y t −1 + ∑ i=2 bi ∆y t −i+1 + et
p
(8.1)

where  = (1 − ∑ i=1 ai ) and b i = − ∑ j =1 aj
p p
All the variables are considered as endogenous
under JJ test which is a system method in the
VAR framework. As a consequence, arbitrary
choice of the endogenous variable in the model
specification can be avoided. With constant and
deterministic trend, the VECM representation
(Equation 8.2) can be expressed in the following
form (Enders, 2008):
∆Xt =  + 1∆Xt−1 + 2∆Xt−2 + 
+ p∆Xt−p+1 + Xt−1 + Dtt(8.2)
The JJ test is focused on estimating the long-
run matrix () and the equilibrium is defined by
Xt−1 = 0. For multiple cointegrating vectors, we
have 1<rank()<n. For international integration
Xt represents the FX market turnover of the UK, the
USA, Japan and India) and for domestic market
integration Xt represents liquidity in FCYINR spot,
FCYINR swap, FCY spot and FCY swap).
Two test statistics, namely trace test and the
maximum eigenvalue test, are conducted under
the JJ cointegration. With T number of observa-
∧
tions and i – the estimated values of character-
istic roots, the representation of trance statistics
(Equation 8.3) and eigenvalue statistics (Equation
8.4) are as follows:
trace ( r ) = − T ∑ i=r +1 ln(1 − λˆ i )
n
(8.3)

Here, in this case, the null hypothesis tests the
existence of less than or equal to r cointegrating
vectors against a general alternative that there
exists more than r cointegrating vectors:
max ( r, r + 1) = − T ln(1 − λˆ r+1 ) (8.4)

For the eigenvalue test, the null hypothesis is the
existence of utmost r cointegrating vectors against
the alternative of r + 1 cointegrating vectors.
We also employ the pair-wise Granger-
causality test to see how much of the current y
can be explained by past values of y and then
to see whether adding lagged values of x can
improve the explanation. y is said to be Granger-
caused by x if x helps in the prediction of y
(Equations 8.5 and 8.6).
FX Interbank Market of India 125
 The bivariate regression form is as follows:
y t = a0 + a1y t−1 +  + aky t−k
+ b1x t−1 +  + bkx t−k + t(8.5)
x t = a0 + a1x t−1 +  + aky t−k
+ b1y t−1 +  + bky t−k + ut(8.6)
The null hypothesis is that x does not Granger-
cause y in the first regression and that y does not
Granger-cause x in the second equation.
8.4. Preliminary Analysis
Before we present the result of the econometric
analysis, this section describes the primary anal-
ysis with respect to India’s FX spot and FX swap
liquidity in the global context. Besides, we also il-
lustrate the analysis in the context of Indian inter-
bank segments, both for the INR leg and crosses.
Table 8.2 represents the liquidity scenario of
FX spot and FX swap transactions in India with
respect to its three counterparties. It may be
thought-provoking to note that India has to go
a long way in terms of enhancing the overall li-
quidity condition of the market for both FX spot
and FX swap. On the contrary, the risk per unit
of return represented by the coefficient of varia-
tion (CV) in FX swap transactions in India is much
higher compared to its most liquid counterparties.
In the spot segment, India’s risk per unit of return
is similar to the UK’s. On the other hand, the neg-
ative skewness shows that, except for the USA,
there is a high probability that the UK, Japan and
India will experience a high-value transaction for
the FX spot. Also, the high probability of high-
value transactions holds true for Japan and India
for the FX swap market. Also, leptokurtosis is ob-
served in the USA, the UK and India for FX spot
transactions. Beyond the normal distribution, any
positive value of kurtosis represents an unexpect-
ed high value loss or a thicker tail. Notably, India is
the only country in our sample set experiencing a
thick fat tail for FX swap transactions.
Interestingly, it may be noted that 87 per cent
(out of 200) of the total trade involves USD, as
per the triennial report of BIS (2019). It is the UK
that has the most vibrant and gigantic market for
both FX spot and FX swap.
Table 8.3 reveals that India has a strong linear
and statistically significant relationship with the

Table 8.2 India in Global Frame—Descri ptive Statistics (Billions $)

FX Spot Transaction FX Swap Transaction
UK USA Japan India UK US Japan India
Geomean 661.7 386.9 108.7 24.6 996.4 232.4 169.2 15.8
SD 179.6 74.1 21.9 6.5 257.5 51.3 36.3 4.4
CV (%) 27.1 19.2 20.2 26.4 25.8 22.1 21.4 27.7
Skew –0.2 0.4 –0.1 –0.6 0.2 0.1 –0.2 –0.6
Kurt 0.6 0.7 –0.5 0.4 –0.5 –0.2 –1.1 0.7
Source: Author’s own calculation. Data are compiled from the respective central bank’s website.

Table 8.3 Correlation Analysis—FX Spot and FX Swap Segments

FX Spot FX SWAP
UK USA Japan India UK USA Japan India
UK 1.00 1.00
USA 0.75*** 1.00 0.85*** 1.00
Japan 0.80*** 0.45*** 1.00 0.86*** 0.73*** 1.00
India 0.72*** 0.38** 0.76*** 1.00 0.86*** 0.75*** 0.85*** 1.00
Source: Author’s own calculation. Data are compiled from the respective central bank’s website.
Note: `***', `**' represent that the coefficients are significant at 1 per cent and 5 per cent levels of significance.

126 INDIA BANKING AND FINANCE REPORT 2021

 Table 8.4 India’s FX Market Liquidity—Descri ptive Statistics (Million Dollar)
FCY/` (Spot) FCY/` (FX Swap) FCY/FCY (Spot) FCY/FCY (FX Swap)
Geomean 113,763.1556 136,769.2001 69,026.57666 28,639.91332
SD 151,990.3985 145,472.2272 64,856.12465 29,801.49909
CV (%) 133.60 106.36 93.96 104.06
Skewness 0.27 0.24 –0.03 0.02
Kurtosis –1.29 –1.14 –1.38 –1.16
Source: Author’s own calculation. Data are compiled from the RBI.

Table 8.5 Correlation Analysis—INR and FCY Legs

FCY/` FCY/` FCY/FCY FCY/FCY
(Spot) (FX Swap) (Spot) (FX Swap)
FCY/INR (Spot) 1
FCY/INR (FX Swap) 0.94*** 1
FCY/FCY (Spot) 0.84*** 0.84*** 1
FCY/FCY (FX Swap) 0.80*** 0.84*** 0.90*** 1
Source: Author’s own calculation. Data are compiled from the RBI.
Note: ‘***’ represents the coefficients significant at 1 per cent level of significance.

UK and Japan in FX spot transactions. However,
for the USA, the FX spot market has a low and
significant correlation with India. On the other
hand, India shows a stronger linear association
with all three countries: the USA, the UK and Ja-
pan. So we may conclude that India is more con-
nected on the international front through the FX
swap compared to FX spot market.
Similarly, Table 8.4 shows the liquidity con-
dition of all the four segments of the Indian FX
market. It can undoubtedly be claimed that the
INR leg for both spot and swap settlements is
more liquid. Moreover, the spot settlement in-
volving the INR leg experiences the maximum
risk per unit of return. On the other hand, kurto-
sis value represents an even distribution, and no
tail risk in the form of thicker tails exists in any
of the four segments of the market.
Table 8.5 reveals that the linear relationships
across all four segments of the markets, irre-
spective of their settlement dates, are extremely
strong and positive. They are also statistically
significant at the 1 per cent level. It reveals that
within India, positive or negative linear shocks
either in the INR leg or FCY leg lead to high spill-
over of liquidity from one to other segments of
the market.
8.5. Econometric Analysis
This section summarizes the spillover impact
of liquidity on the international front and the
domestic front. We begin by estimating the
ADF test for the overall liquidity in FX spot and
FX swap for the UK, the USA, Japan and India.
Table 8.6 shows that all the variables are non-
stationary at level and stationary at first differ-
ence. So we conclude that overall, the FX spot
and FX swap markets for all the countries (the
UK, the USA, Japan and India) are integrated at
order 1, or they are I(1).
As all the respective variables are I (1), we em-
ploy JJ cointegration tests to examine the long-
run equilibrium in the Indian FX market with
its three biggest counterparties. It may be noted
that JJ cointegration allows the test to be con-
ducted on the non-stationary variables itself. So,
as we do not have to depend on the first differ-
ence variables, the loss of information is ruled out.

FX Interbank Market of India 127

 Table 8.6 Stationarity Test—International Front
Level (H0: Presence of Unit Root)
UK Non-stationary (p = 0.3559)
USA Non-stationary (p = 0.8654)
Japan Non-stationary (p = 0.4790)
India Non-stationary (p = 0.1936)
Source: Author’s own.
Note: We have found a significant linear trend and a constant in the level variable. So we allow trend and
intercept at level and intercept at first difference as the best fitted model for the non-stationarity test.3
Table 8.7 Cointegration and VECM Results—International Front (Liquidity in FX Spot and FX Swap for
the UK, the USA, Japan and India)
Hypothesized No. of CE(s)
None
At most 1
At most 2
At most 3
VECM
Source: Author’s own.
Note: ‘***’, ‘**’ and ‘*’ represent that the coefficients are significant at 1 per cent, 5 per cent and 10 per cent
levels of significance.
Table 8.7 concludes that Indian FX market liquid-
ity, considering both spot and swap settlements,
does not drift away from its counterparties,
the UK, the USA and Japan, in the long run. At
a 1 per cent level of significance, trace statistics
shows that there is only one cointegrating vector.
If we allow a 5 per cent level of significance, then
there exist at least two cointegrating vectors.
However, no significant long-run equilibrium
is concluded by the maximum eigenvalue test.4
Our result confirms that India’s interbank mar-
ket liquidity is largely integrated with the UK,
the USA and Japan. So positive or negative spill-
over impact from any of these largest FX markets
in the world may lead to abundance or scarcity of
liquidity in the Indian FX interbank market, es-
pecially in the presence of significant market tur-
moil. The liquidity position on the international
front might increase the cost of hedging and
funding for India. Even outside the treasury deal-
ing room, India may face the consequences of the
volatility in the overall liquidity position on the
international front. Moreover, any shortage of
128 INDIA BANKING AND FINANCE REPORT 2021
1st Difference (H0: Presence of Unit Root)
Stationary (p = 0.000)
Stationary (p = 0.000)
Stationary (p = 0.000)
Stationary (p = 0.000)
Trace Statistics Maximum Eigenvalue Test
58.47*** 27.44*
31.04** 21.13
15.26 14.26
1.23 3.84
–0.89***
liquidity position may have serious implications
on economic activity. The integration of these
market segments is validated by the result of
VECM, which shows that the short-term adjust-
ment factor is negative and significant (–0.89) at
a 1 per cent level of significance.
The Granger-causality test, as shown in
Table 8.8, reveals that interbank FX market
liquidity in the UK and Japan is more influential
for India. The findings indicate the existence
of one-way causal relationship, and they are
significant at 1 per cent level. It means that Indian
interbank liquidity does not Granger-cause the
liquidity in the UK and Japan. Moreover, it also
reveals that FX interbank liquidity in Japan
has a causal impact on the liquidity in the UK;
however, the same is not true vice versa.
On the domestic front, we observe that the
Indian interbank FX market is non-stationary
at level and stationary at first difference for all
its market segments, for example, FCY/INR spot,
FCY/INR swap, FCY/FCY spot and FCY/FCY
 Table 8.8 Granger-causality Test—International Front
Null Hypothesis (Lag 1; observation 30) F-statistic
Japan does not Granger-cause India 7.96***
India does not Granger-cause Japan 0.02
The UK does not Granger-cause India 11.19***
India does not Granger-cause the UK 1.78
The USA does not Granger-cause India 1.65
India does not Granger-cause the USA 3.52*
The UK does not Granger-cause Japan 1.14
Japan does not Granger-cause the UK 5.36**
The USA does not Granger-cause Japan 0.13355
Japan does not Granger-cause the USA 2.40139
Source: Author’s own.
Note: ‘***’, ‘**’ and ‘*’ represent that the coefficients are significant at 1 per cent, 5 per cent and 10 per cent
levels of significance.

Table 8.9 Stationarity Test—Domestic Front

Level (H0: Presence of Unit Root) 1st Difference (H0: Presence of Unit Root)
INRSpot Non-stationary (p = 0.4453) Stationary (p = 0.000)
INRSwap Non-stationary (p = 0.5723) Stationary (p = 0.000)
FCYSpot Non-stationary (p = 0.1638) Stationary (p = 0.000)
FCYSwap Non-stationary (p = 0.1866) Stationary (p = 0.000)
Source: Author’s own.
Note: We have found a significant linear trend and a constant in the level variable. So we allow trend and
intercept at level and intercept at first difference as the best fitted model for the non-stationarity test.

Table 8.10 Cointegration Test and VECM—Domestic Front

Hypothesized No. of CE(s) Trace Statistics Maximum Eigenvalue Test
None 80.76*** 0.14***
At most 1 35.11** 0.08***
At most 2 8.98 0.02
At most 3 2.72 0.01
VECM –0.41***
Source: Author’s own.
Note: `***', `**' represent that the coefficients are significant at 1 per cent and 5 per cent levels of significance.

swap. So we conclude that all of them are I (1) or
integrated at level 1 (Table 8.9).
Table 8.10 illustrates the result of JJ coin-
tegration. Trace statistics conclude that long-
run equilibrium exists with two cointegrating
vectors across FCY/INR and FCY/FCY segments,
both for the spot and swap settlements. The
maximum eigenvalue statistics also validate the
existence of two cointegrating vectors at a 1 per
cent level of significance. The result evidences

FX Interbank Market of India 129

 the liquidity spillover across the two important
value dates, spot and FX swap, in NOSTRO ac-
count of the commercial banks in India. The
interlinkage of these two imperative instru-
ments of the FX interbank market might have
a widespread and amplified impact on the over-
all stability of the NOSTRO account liquidity
of banks in India. Furthermore, the short-run
speed of adjustment is established through the
negative and significant coefficient value (–0.41)
of VECM.
Moreover, the result of the Granger-causality
test (Table 8.11) reveals that the spot settlement
of FCY/INR and FCY/FCY Granger-causes FCY/
INR swap, which is statistically significant at
1 per cent and 5 per cent levels, respectively.
Table 8.11 Granger-causality—Domestic Front
Null Hypothesis (Obs. 300; Lag 1) F-stat
FCYSPOT does not Granger-cause 5.71**
INRSWAP
INRSWAP does not Granger-cause 1.62
FCYSPOT
FCYSWAP does not Granger-cause 2.56
INRSWAP
INRSWAP does not Granger-cause 3.16*
FCYSWAP
INRSPOT does not Granger-cause 15.32***
INRSWAP
INRSWAP does not Granger-cause 0.02
INRSPOT
FCYSWAP does not Granger-cause 11.43***
FCYSPOT
FCYSPOT does not Granger-cause 7.66***
FCYSWAP
INRSPOT does not Granger-cause 2.24
FCYSPOT
FCYSPOT does not Granger-cause 0.23
INRSPOT
INRSPOT does not Granger-cause 2.92*
FCYSWAP
FCYSWAP does not Granger-cause 0.88
INRSPOT
Note: ‘***’, ‘**’ and ‘*’ represent that the coeffi-
cients are significant at 1 per cent, 5 per cent and
10 per cent levels of significance.
130 INDIA BANKING AND FINANCE REPORT 2021
Also, there exists a two-way Granger-causality
for FCY/FCY swap and FCY/FCY spot with a
statistical significance of more than 1 per cent.
On the contrary, FCY/INR spot and FCY/INR
swap show weak causality to move FCY/FCY
swap.
8.6. Conclusion
With inordinate liquidity and a proliferation of
cross-border funding, the FX interbank market
has proved its distinctiveness among all seg-
ments of the financial markets. In this context,
our study examines the liquidity and stability
of the Indian FX interbank market and thereby
analyses the interconnectedness of liquidity
spillover in external and internal dominions.
On the domestic front, it analyses two major
segments of FX interbank segments, (a) spot
and (b) swap, considering both the INR leg and
FCY leg. Also, we study the FX interbank mar-
ket integration of India with the three biggest
market segments, for example, the USA, the UK
and Japan, covering both FX swap and FX spot
settlement.
Our preliminary analysis reveals a widening
gap between the liquidity in merchant desks and
the interbank desks. This reveals more involve-
ment of FX dealers in interbank activity, which
goes beyond the requirement of interbank cover
operations for merchant deals. A sharp positive
trend has been seen since 2006–2007 for both
FX spot and FX swap in the Indian FX market.
However, this liquidity trend reveals that the FX
spot market is predominant in India compared to
the liquidity in FX swap. This trend is exactly op-
posite to the existing global trend, which shows
that the most traded segment is FX swap, fol-
lowed by FX spot. It is also observed that the in-
terbank FX liquidity experienced a sharp decline
immediately after the lockdown announcement
in March 2020.
Overall, the liquidity in the INR leg is found to
be stronger than the FCY leg for both spot and
swap settlements. However, if we compare the li-
quidity for spot and swap settlements in the FCY
leg itself, the FX swap segments are more liquid
compared to FX spot.
 Our preliminary analysis on the internation-
al front shows that the risk-taking capacity of
the Indian interbank market is no less than its
counterparties such as the UK, the USA and Ja-
pan. Also, India shares a very high positive cor-
relation in FX spot liquidity with the UK and
Japan. Moreover, the FX swap market in India
is strongly and positively correlated with all its
counterparties, including the USA. Similarly, on
the domestic front, India has a strong positive
correlation across INR and FCY legs for FX spot
and FX swap markets.
Our econometric analysis on the international
front shows that a long-run integration of India
is prevailing with its three largest counterpar-
ties: the UK, the USA and Japan. This result is
supported by the short-run speed of adjustment.
Moreover, the result of the Granger-causality
test reveals that liquidity in the UK and Japan
for FX spot and FX swap has a significant impact
on the overall interbank liquidity of India. Also,
the liquidity in FX interbank segment of Japan
shows a one-way causal impact on the FX liquid-
ity of the UK.
Similarly, India’s FX interbank segments re-
veal strong interconnectedness between its
INR and FCY legs for both FX spot and FX swap
settlements. So we conclude that liquidity spill-
over is highly likely across all the FX interbank
segments in India. This result is supported by a
significant and negative short-run adjustment
factor. Besides, from the result of the Granger-
causality test, we find that liquidity in both the
spot legs, INR and FCY, is more influential in
driving liquidity in the INR swap leg. Moreover,
bidirectional strong Granger-causality exists
between the FCY spot and FCY swap legs.
Overall, we conclude that the Indian FX inter-
bank market is well integrated on the interna-
tional and domestic fronts. One important infer-
ence of this integration for the Indian treasury
dealing room is a more efficient and easy mode
of operation in terms of funding, hedging and
speculation. However, banks must ensure that
the necessary measures, including proficiency in
dealing room operations, are in place to address
the stability problems that may arise as a result
of the high liquidity and its related usage. Profi-
ciency in dealing, in particular, may prove to be
extremely fruitful if the interbank FX market
experiences any turbulence and is under stress.
Liquidity crunch in the FX interbank spot and
FX swap markets of the UK, the USA and Japan
may have an amplified and significant impact
on the liquidity or NOSTRO position of Indian
commercial banks. Also, due to well-integrated
liquidity in INR and FCY legs, there is a chance of
intensification of the volatility in exchange rates
in FX spot and FX swap market segments, which
might also have possible negative implications
for the real sector.
Acknowledgement: I express my sincere
gratitude to the anonymous reviewers for their
very insightful comments and suggestions. The
usual disclaimer applies.
FX Interbank Market of India 131
 APPENDIX A
Box A.1 Interbank Market Parlance
Base currency: The currency which is priced. In USD/
INR, USD is the base currency. In GBP/USD, the base
currency is GBP.
Quoting currency or price currency: The currency that
is used in pricing the base currency. In USD/INR, the
quoting currency is INR, and in GBP/USD, the quoting
currency is USD.
Bid rate: The rate at which a market maker buys the
base currency. If USD/INR is quoted as 66.70/72, then
the bid rate is 66.70. It means the market maker is will-
ing to buy USD at the rate of 66.70 INR.
Offer rate: The rate at which market maker sells the
base currency. If USD/INR is quoted as 66.70/72, then
offer rate is 66.72. It means market maker is willing to
sell USD at the rate of 66.72 INR.
Market maker: The bank that quotes the rate to the taker.
Some of the major market makers presently are Deutsche
Bank (DB), J. P. Morgan, Citi Bank, Barclays and UBS.
Market taker: The bank that asks for the quote and ap-
proaches the interbank market for the quote.
NOSTRO account: An account maintained in a foreign
currency with a bank usually located in that coun-
try. For example, an Indian bank maintains a USD
account with Citi Bank, New York, and maintains
a euro account with DB, Frankfurt. These accounts
Source: Author’s own.
Box A.2 Spot Settlement (Import Customer)
Import customer having 1 MIO USD to convert into IN
Interbank spot rate USD/INR 74.75/76; deal date is
14 December 2020
Credit Debit
Spot (16 December 2020) Oversold Position
So by booking a spot deal on 14 December 2020 (deal
date), the import merchant transfers the risk of foreign
exchange fluctuations to the bank book. The bank’s
NOSTRO position would be debited with one MIO
USD on 16 December 2020.
Source: Author’s own.
132 INDIA BANKING AND FINANCE REPORT 2021
would be referred to as the Indian bank’s USD NOS-
TRO account and GBP NOSTRO account, respectively.
VOSTRO account: An INR account maintained with a
bank in India by a bank located abroad is referred to
as a VOSTRO account. For example, Citi Bank, New
York, maintains a rupee account with the Bank of
Maharashtra, Mumbai. This account will be referred
to as Citi Bank’s VOSTRO account.
Cash value date: Settlement is at T = 0. The deal date
and settlement date are both the same.
Tom value date: Settlement is at T + 1. It means the date
of settlement falls due on the next working day for the
non-USD centre (between USD/INR non-USD centre is
INR centre). On the settlement date, both the USD and
non-USD centres should remain open.
Spot date: Settlement is at T + 2. ‘Value spot’ means
that the date of settlement falls due on the second
working day for the non-USD centre after the date of
deal. On the settlement date, both the USD and non-
USD centre should remain open.
Forward value date: Any settlement date beyond spot
would be categorized as ‘forward’. The rate of forward
cover is arrived at after taking into consideration the
current spot rate and the current forward points for
the date of delivery.
Cover operation in interbank
Credit Debit
Spot (16 December 2020) + Oversold Position
Subsequently, bank has to cover its oversold position
by buying the same in interbank unless there is an ex-
port customer having equivalent transaction booked
on the same day. If the bank goes to the interbank to
buy USD 1 MIO, the interbank sells the dollar at INR
74.76. So bank offers the rate of INR 74.78 to the im-
port customer, keeping a 2 paise exchange margin.
 Box A.3 Interbank Transaction and FX Swap in USD/INR

1. USD/INR 74.50/52 and C/S: 0.03/0.04

Explain the cover operation for USD importer who wants a conversion on value cash.
Exchange arithmetic:
Interbank rate: 74.52 – 0.03 = 74.49
Interbank cover operation:
a. Bank buys USD value spot in interbank at 74.52. With this transaction, the exchange position and fund
position in USD become as follows:

Exchange Position in USD Fund Position in USD

Purchase Sale Credit Debit

Customer –1 Cash Maturity gap –1

Interbank +1 Spot +1 Maturity gap

b. To cover the position, bank has to do a swap.

i. Buy USD/sell INR cash
ii. Sell USD/buy INR spot
USD is in premium in the spot market, receive low 0.03

Exchange Position in USD Fund Position in USD

Purchase Sale Credit Debit

Customer –1 Cash Buy –1

Interbank +1 Spot +1 Sell

c. Cover rate 74.52 – 0.03 = 74.49

Source: Author’s own.

Notes
1. It may be noted that the mechanism of in-
terbank cover operation for currency pairs
such as EUR/INR, GBP/INR, JPY/INR and
EUR/GBP has not been described in detail.
However, they add to the liquidity in FCYs.
For details, please refer to Sanati (2017).
2. The currency swap and FX swap are two dif-
ferent products.
References
Bank for International Settlements. (2019). Trien-
nial Central Bank Survey: Foreign Exchange
Turnover in April 2019. Monetary and Eco-
nomic Department.
Barkbu, B. B., & Ong, L. L. (2010). FX swaps: Im-
plications for financial and economic stability
(Working Paper No. WP/10/55). Internation-
al Monetary Fund.

3. For details, refer to Enders (2008). Dickey, D. A., & Fuller, W. A. (1979). Distribution of
the estimators for autoregressive time series
4. We are not considering statistical signifi- with a unit root. Journal of the American
cance at a 10 per cent level. Statistical Association, 74, 427–431.

FX Interbank Market of India 133

 Dickey, D. A., & Fuller, W. A. (1981). Likelihood
ratio statistics for autoregressive time se-
ries with a unit root. Econometrica, 49,
1057–1072.
Enders, W. (2008). Applied econometric time se-
ries. John Wiley & Sons.
Engle, R. F., & Granger, C. W. J. (1987). Cointegra-
tion and error correction: Representation,
estimation and testing. Econometrica, 55(2),
251–276.
134 INDIA BANKING AND FINANCE REPORT 2021
Johansen, S. (1988). Statistical analysis of coin-
tegrating vectors. Journal of Economic Dy-
namics and Control, 12, 231–254.
Johansen, S., & Juselius, K. (1990). Maximum like-
lihood estimation and inference on cointe-
gration with application to the demand for
money. Oxford Bulletin of Economics and
Statistics, 52, 169–210.
Sanati, G. (2017). Financing international trade:
Banking theories and applications. SAGE.
New Trends in
Infrastructure Financing
Debasish Mallick
9.1. Introduction
The infrastructure scenario in India has under-
gone a significant change over the years. From a
state-owned, state-controlled and state-operated
infrastructure, the sector has witnessed increasing
private participation through the public–private
partnership (PPP) model. Private participation
in infrastructure projects is designed on the ba-
sis of conceding the right to the private sector to
build, operate, maintain and transfer infrastruc-
ture projects in India. Apart from private capital
flow to meet physical investment needs, capital
also flows into infrastructure sector projects in
India from portfolio investors, who participate
in structured financial transactions designed on
the basis of the underlying cash flow of brown-
field infrastructure projects. The portfolio flows
are from both domestic and international fund
houses, pension funds, insurance companies, etc.,
which participate in the expectation of returns
by way of long-term predictable cash flow from
their investments. Such portfolio inflows and
the underlying investment offerings are recent
but have gained traction and mobilized a good
amount of resources, as witnessed by the spate
of recent Infrastructure Investment Trust (InvIT)
issues launched and their record of satisfactory
mobilization. Notwithstanding the increasing
trend, however, the projected inflow may not be
adequate to meet the infrastructure aspirations
of India as discussed below. Accordingly, to meet
the emerging financing needs for the sector, GOI
has proposed two new fund-raising avenues,
namely the setting up of a new DFI (National
Bank for Financing Infrastructure and Devel-
opment [NabFID]) and adopting a monetization
9
Chapter
programme under the National Monetization
Plan (NMP).
This chapter attempts to review the transition
in Indian infrastructure financing, including the
proposed NabFID and the NMP. It focuses on the
new developments in attracting public and pri-
vate funds to the infrastructure sector and high-
lights the setting up of a new DFI and asset mon-
etization plan. The next section introduces the
National Infrastructure Pipeline (NIP). The third
section speaks of the financing gap, while the
fourth and fifth sections introduce the NabFID
and the NMP, respectively. Concluding remarks
are given at the end.
9.2. Backdrop
India has been a perennially infrastructure-def-
icit economy. The setting up of new infrastruc-
ture projects in India has been slow and delayed
due to various factors: administrative, regulatory
and financial, among others. There has been a se-
vere shortfall in proper maintenance of existing
facilities. All this has continuously added to the
infrastructure backlog. The high and diversified
economic growth achieved in recent years has
accelerated the incremental needs and also added
to the quality needs of the infrastructure sector.
Further, current thinking is focused on the cre-
ation of infrastructural facilities with an empha-
sis on ‘ease of living’ and not only on meeting the
needs of industry, trade and commerce. All this
has been well focused in the NIP drawn up by the
government and discussed in subsequent pages.
The provision of required infrastructure facilities
today needs an emphasis on both quantity and
 quality. The two attributes have been achieved
in projects implemented under the PPP model.
Indeed, India’s experiment with the PPP model of
infrastructure investment and development has
witnessed both capacity augmentation and qual-
ity improvement in the sector.
The next phase of infrastructure planning and
development as envisaged in government policy
is now more integrated. While the PPP model
and the role of the private sector have come to
stay, growth and development in the infrastruc-
ture sector are now being planned in an integrat-
ed manner. Project-level planning and develop-
ment is now making a transition to planning for
an integrated development of infrastructure as
propounded in the NIP. The focus under the NIP
is to plan and prioritize projects, keeping in mind
the development imperatives and the vision of a
USD 5 trillion economy. The NIP is designed to
meet diversified development needs across vari-
ous infrastructure subsectors so as to achieve the
high growth objectives without compromising
on environmental considerations, better living
standards, health and education facilities.
The NIP is to be implemented over a 5-year pe-
riod ending in FY 2024, and it has an estimated
aggregate investment requirement of `111 lakh
crore (USD 1.5 trillion). As the traditional financ-
ing sources are estimated to be inadequate to
meet the investment needs of NIP, there is a felt
need for additional financing sources, which is
now proposed to be met through NMP and the
setting up of the new DFI.
The challenges of providing long-term finance
on a large scale for setting up infrastructure facili-
ties have received focused attention in policy dis-
cussion since around the early 2000s, when the
sector was opened up for private sector participa-
tion. Prior to that, the provision of infrastructure
facilities in India and its financing have largely
been in the domain of the state, defined severally
as the central government, state government, mu-
nicipalities and other district/local-level authori-
ties. A notable exception then was the electricity
companies’ having exclusive right/licence over
the generation, transmission and distribution of
electricity over a ‘licensed’ area. Such companies
have been in operation for a long time in India
136 INDIA BANKING AND FINANCE REPORT 2021
and continue in a few urban areas, namely Mum-
bai and its suburbs, Kolkata, Chandernagore (since
discontinued), Surat and Ahmedabad, to name a
few. A few other private enterprises that oper-
ated in the infrastructure space, albeit at the lo-
cal level, at the turn of Independence were either
taken over or nationalized by the state directly
or through mergers with the public sector. The
state dominated overwhelmingly in providing
roads, ports, airports, telecom, power—the hard
infrastructure facilities that were opened up for
private sector participation under the PPP model.
The private sector was initially inducted and
permitted to build new greenfield facilities or par-
ticipate in brownfield expansion/diversification
as was then decided by public authorities, under
the PPP programme. The said rights to the private
sector were conceded in a structured manner,
for a limited period of time, as per the approved
framework of the respective concession agree-
ment. The ownership of the projects continues to
be with the state. The private sector has to com-
pulsorily return the project to the state at the end
of the concession period. The transition to this
model of private sector management started in a
limited manner around the turn of the century
when the first set of road projects were entrusted
to the private sector under the build-operate-
transfer (BOT) model by the National Highways
Authority of India (NHAI) and a few minor ports
were awarded to the private sector initially by
the state governments of Gujarat and Orissa. The
exercise, however, remained confined to conced-
ing rights to the private sector to build, manage
and operate approved greenfield infrastructure
projects. The exercise has since been expanded
and diversified. The various subsectors of infra-
structure today have a sizeable presence of the
private sector, not only in greenfield but also in
brownfield projects. The private sector partici-
pants have now become the dominant partner
in the crucial sectors of airports and telecom. The
delivery standards and quality experience with
private sector participation have generally been
satisfactory. The concept of the PPP model in
infrastructure projects in India has found accep-
tance in popular minds in the country.
Around the turn of this century, when PPP
projects first marked the entry of the Indian
private sector into the infrastructure space, the
exercise was essentially about investment for
setting up new/greenfield projects in the road,
port, power and telecom sectors under the BOT
and build-own-operate-transfer (BOOT) models.
Under the said models, the private sector was
vested with the rights and responsibilities of set-
ting up the infrastructure project as per specified
standards and maintaining and upkeeping it for a
pre-specified period of years, at the end of which
the project was to be returned to the state au-
thorities. The concessionaire was given the right
to collect an approved toll to defray the project’s
cost and expense. The project risk, including toll
collection risk, under the BOT and BOOT ar-
rangements, continued predominantly with the
concessionaire. The FIs and banks that financed
the project also bore a large share of the risk.
Model concession agreements (MCAs), annuity-
based tolling, hybrid annuity model (HAM), toll
operate transfer (TOT) models, etc., adopted sub-
sequently, in stages, significantly altered risk al-
location among various project counterparties
and reduced the risk borne by the concession-
aire. TOT was perhaps the first attempt at the
monetization of infrastructure assets. Standard-
ization of risk allocation across projects under
the MCA and adoption of the annuity and HAM
models improved the risk matrix of the project as
perceived by the concessionaire and also signifi-
cantly enhanced the confidence of the financier.
Some of the other policy-level changes include
increasing entry of the private sector into rail-
ways, open market access/merchant power and
power trading in the electricity sector, market-
based pricing across wide-ranging infrastructure
facilities as against controlled pricing earlier and
continuing private sector dominance in the air-
ports and telecom sectors.
In the initial days post-Independence, the set-
ting up of infrastructure facilities was financed
predominantly out of budgetary allocation of
the government. Institutional finance from the
Indian DFIs—IDBI, ICICI and IFCI—was not avail-
able, nor was bank finance taken for setting
up infrastructure assets. The State Electricity
Boards (SEBs) and the state road transport opera-
tors were exceptions, as they received long-term
financing from DFIs.
Around the turn of the century, infrastructure
projects in India have been financed through a
combination of sovereign resources and private
capital. Budgetary grants have been used to fi-
nance infrastructure projects in the state sector.
On the other hand, PPP projects set up with ma-
jor participation by the private sector have been
financed through private capital, institutional/
bank borrowings and market resources.
9.2.1. Transition in Financing Pattern
Financing of infrastructure projects from other
than sovereign/public sources started receiving
attention only after the private sector was per-
mitted entry into infrastructure development
under the PPP route. Infrastructure projects had a
longer gestation in terms of implementation and
break even. Most of the infrastructure projects in
India have been characterized by a high debt-to-
equity ratio, as the large equity inflow required
is still tardy. The high debt required in the sector
has been met by a large long-term upfront credit
flow from domestic banks and institutions. The
relatively higher cost of funds of Indian banks
has translated into a relatively higher user cost of
Indian infrastructure sector services.
Assistance for the initial set of infrastructure
projects extended under the PPP model was pro-
vided by a handful of the then existing DFIs, name-
ly IDBI and ICICI. Initially small, but in a steadily
growing manner, assistance was also extended
by the larger of the commercial banks. Lending
by banks to infrastructure projects is significant
today in view of their participation in the project
implementation stage itself. Assistance is also ex-
tended by select NBFCs, including dedicated infra-
structure NBFCs in the public sector. Though the
domestic bond market participation in infrastruc-
ture project is growing, the same has been made
mostly in refinancing of outstanding loans in com-
pleted projects. The bond market has been slow in
participation in view of the availability of a limited
number of investors with long-term investible re-
sources and the regulatory restrictions on invest-
ing in debt instruments with a lower credit rating,
which most of the under-implementation infra-
structure projects suffered from.
As discussed earlier, the traditional financing
routes are unlikely to be able to meet the large
New Trends in Infrastructure Financing 137
 investment and financing needs for implement-
ing the NIP. The NITI Aayog has suggested set-
ting up NabFID and adopting the NMP to meet
the investment needs of NIP. Both the initiatives
are new and are conceived to provide resources to
meet the estimated resource gap to meet the in-
vestment requirements of projects under the NIP.
9.3. National Infrastructure
Pi peline
The NIP is a first-of-its-kind, whole government
exercise to provide world-class infrastructure,
which would be an enabler to achieve the me-
dium- and long-term growth objectives of the
economy and also provide citizens with an im-
proved quality of life. NIP provides an overall
perspective and identifies/lists out projects in
the various subsectors of the infrastructure sec-
tor, implementation of which is considered nec-
essary to achieve the said objective. The exercise
aims to improve project preparation and attract
investments into infrastructure.
A task force (TF) to draw up the NIP for each of
the years from FY 2019–2020 to FY 2024–2025
was set up under the chairmanship of the Sec-
retary, Department of Economic Affairs, GOI.
The TF included, among others, the CEO of NITI
Aayog and the Secretary of the Department of
Expenditure, as members. The terms of reference
of the TF were to (a) identify technically feasible
and financially/economically viable infrastruc-
ture projects that could be launched in fiscal
years 2020–2025, (b) estimate annual infrastruc-
ture investment/capital cost, (c) guide ministries
in identifying appropriate sources of financing
and (d) suggest measures for project monitoring
and implementation. The NIP for FY 2020–2025,
covering the above issues, was released by the
FM on 29 April 2020.1
9.3.1. Approach of the NIP
NIP is conceived as a supply-side reform to aug-
ment infrastructure growth to realize the vision
of a USD 5 trillion Indian economy by 2025. The
pipeline is drawn up on the basis of an assess-
ment of the new and augmented infrastructure
facilities required to achieve the target of reach-
ing a USD 5 trillion economy and also to upgrade
138 INDIA BANKING AND FINANCE REPORT 2021
the quality of infrastructure at par with global
standards. The exercise of drawing up the pipe-
line has followed a ‘top-down’ approach, drawn
up on the basis of the whole—the entire economy
and its people. Apart from the macroeconomic
targets, the emerging social or economic trends,
namely (a) expanded population and workforce,
(b) increasing pace of urbanization, (b) more pro-
nounced shift to a service-based economy and
(c) environmental risk, along with the need to
set up disaster-resilient infrastructure facilities,
have also been considered while prioritizing the
NIP. The pipeline not only includes projects in the
core infrastructure sectors of roads, ports, air-
ports, power and telecom but also housing, water
and sanitation, digital and transportation needs,
health facilities, education, etc., which promote
the ease of living. The exercise is expected to
provide a positive and enabling environment
for significant private investment in infrastruc-
ture. The report also calls for creating a fast-track
institutional, regulatory and implementation
framework for infrastructure projects.
The NIP has been drawn up on a best-effort
basis by aggregating information provided by
various stakeholders, including line ministries,
departments, state governments and the private
sector across infrastructure subsectors. All the
projects, greenfield as well as brownfield, un-
der conceptualization, under-implementation
or underdevelopment, with project cost of more
than `100 crore are captured under NIP. The
projected total infrastructure investment in the
final report is assessed at `111 lakh crore over
7,400 projects which are to be implemented dur-
ing FY 2020–2025. The full pipeline comprises a
detailed list and is in consonance with achieving
the growth imperatives while also remaining
in tune with the emerging social and economic
trends.
The total capital expenditure (capex) in infra-
structure sectors in India during FY 2020–2025
is projected at `111 lakh crore as per the NIP. En-
ergy, roads, and railways are the sectors with
the highest projected aggregate capex during FY
2020–2025 (Table 9.1).
The envisaged aggregate capex of `111 lakh
crore under NIP comprises projects under
 Table 9.1 Projected Aggregate Capex during FY 2020–2025 (` Crore)
No. Sector Projected Capex % to Total
1. Energy 2,690,003 24.17
2. Roads 2,033,823 18.27
3. Railways 1,367,563 12.29
4. Ports 121,194 1.09
5. Airports 143,448 1.29
6. Urban (including smart cities, MRTS, affordable housing, Jal 1,919,267 17.24
Jeevan mission)
7. Digital communication 309,672 2.78
8. Irrigation 894,473 8.04
9. Rural infrastructure 773,915 6.95
10. Agriculture & food processing 168,727 1.52
11. Social infrastructure (including education, health, sports and 393,386 3.53
tourism)
12. Industrial infrastructure (including industries and internal 314,957 2.83
trade, and steel)
Aggregate projected capex 11,130,428 100.00
Source: National Infrastructure Pipeline, official data, 2020.

implementation of `44 lakh crore (about 40%),
projects under development of `22 lakh crore
(about 20%) and projects at the conceptual stage
of `34 lakh crore (about 30%). Project stage infor-
mation is not available for about 10 per cent of
project capex. The centre (39%) and states (40%)
are expected to have an equal share in imple-
menting the NIP. The private sector will cover
the remaining 21 per cent share of the projected
expenditure.
Core infrastructure activities, namely energy
(24%), roads (18%), railways (12%) and urban
(17%) account for 71 per cent of the projected ca-
pex during FY 2020–2025. Rural infrastructure
(6.95%) and irrigation (8.04%) comprise about half
of the remaining 30 per cent of the budgeted ex-
penditure. The residual amount of about 15 per
cent would meet the capex requirements of the
other infrastructure subsectors.
At the policy and official levels, NIP has now
emerged as the focal point of all official discus-
sions and concentrations on infrastructure
growth and development and the required in-
vestment for the next 5-year period ending in FY
2025. As mentioned in the Union Budget (GOI,
2021), a new DFI would provide supplemental fi-
nance for implementing this plan, along with the
existing financing source. The NITI Aayog has
drafted an NMP to provide additional resource
support for pursuing NIP targets. The next sec-
tion discusses the financing gap, which is to be
met by internal resources generated through the
monetization programme and resources to be de-
ployed by the new DFI.
9.3.2. Financing Gap in
NIP Implementation
NIP envisages investment of `111 lakh crore
during the 5-year period FY 2020–2025, that is,
an annual average investment level of `22 lakh
crore. As against this, infrastructure investment
in India aggregated `36 lakh crore, averaging
5.8 per cent of the GDP, during the 12th plan
period (2012–2017). Infrastructure investment
in FY 2018–2019 is estimated at `10 lakh crore.
The annual estimates now projected for achiev-
ing the NIP targets are a significant step up (2.5
times) from the level of infrastructure spending
achieved earlier. The required/recommended in-
vestment level to achieve the NIP target is about
7–8 per cent of GDP, an annual incremental

New Trends in Infrastructure Financing 139

 investment of about 2 per cent of GDP from the
current levels DEA (2020).
The DEA (2020) document, published by the
NITI Aayog (2021), has presented the potential
sources of finance that can be pursued to meet
the challenge posed by the high level of required
incremental investment. As mentioned in the
document, the traditional sources are expected
to finance 83–85 per cent of the envisaged ca-
pex, including budgetary allocation of 42–46 per
cent, out of which 18–20 per cent is through the
central government and 24–26 per cent from
the states. About 40 per cent of the resources are
expected to be raised through extra budgetary
resources, including investment from develop-
ers in the form of debt and equity. The document
has proposed the raising of debt resources from
both domestic and international bond/debt capi-
tal markets. Equity is expected to be raised from
private developers, internal accruals of PSUs
and from funds/institutions—both domestic and
international. The remaining financing gap of
about 15–17 per cent of the target investment is
expected to be met through asset monetization
programme and disbursement from the new DFI.
A tabular representation of the same has been
provided in Table 9.2.
The feasibility of meeting the above targets
would hinge crucially on certain factors. First
and foremost, the ability of the central/state gov-
ernment to make adequate resources available,
especially when social sector/relief spending is
Table 9.2 Proposed Sources of Finance for Achieving the NIP Targets
Source
Budgetary Sources Private or extra budgetary sources
(Expected: around (Expected: around 40%)
42%)
Central budget Debt: Financing by banks (8–10%);
(18–20%) NBFCs (15–17%)
State budget Debt: Bond markets (6–8%)
(24–26%)
Equity: PSU accruals from sponsors/
developers, institutions/funds/
insurance companies (8–15%)
Source: NITI Aayog (2021).
Note: *Monetization plan and new DFI.
140 INDIA BANKING AND FINANCE REPORT 2021
expected to take precedence on account of the
ongoing pandemic and the post-pandemic years.
Second, maintaining liquidity in the long-dated
bond/debt markets to make available sizeable
resources for infrastructure investment. The
third driving force would be the appetite of pri-
vate sponsors/developers (investors) to invest in
capital-intensive infrastructure projects with
protracted break even in the current circum-
stances of uncertainty. Fourth factor is drawing
up well-designed, structured projects or invest-
ment opportunities for institutions or fund hous-
es to consider equity investment. The resources
mobilized from these traditional sources are not
expected to be adequate to meet the growth am-
bitions propounded in the NIP. NITI Aayog has
proposed the mobilization of additional resourc-
es by setting up a new DFI with an exclusive fo-
cus on financing infrastructure sector projects.
Proposed sources are documented in Table 9.2.
Finally, rolling out an appropriate asset moneti-
zation programme is also very essential.
The next two sections discuss each of the two
plans separately.
9.4. New DFID—NABFID
The GOI has proposed the setting up of a new
DFI to facilitate the mobilization and deploy-
ment of long-term resources exclusively for
financing infrastructure growth and develop-
ment. A bill for setting up a NaBFID has been
Innovative and alternative financing
sources (new DFI and monetization)*
(Targeted: around 15%)
Innovative and alternative financing
(15–17%)
passed by Parliament in April 2021 and has sub-
sequently received the assent of the President
of India. In the words of the honourable finance
minister, ‘Infrastructure needs long term debt
financing. A professionally managed develop-
ment financial institution (DFI) is necessary
to act as provider, enabler and catalyst for in-
frastructure financing.’ As mentioned by the
finance minister in her budget speech (2021),
the institution is to be set up as a body corpo-
rate with an initial GOI holding of 100 per cent,
which can be diluted in the future but not be-
low 26 per cent of the capital. NaBFID will have
an initial capital base of `20,000 crore. A lend-
ing target of `5 lakh crore in three years has
been set for the institution.
With the legislative enablers in place, steps
have been initiated to set up the new DFI as
an institution for extending and arranging fi-
nance exclusively for the infrastructure sec-
tor. A much-respected institution builder has
recently been appointed as the chairman of
NaBFID. It may be of interest to note that insti-
tutions with such an exclusive mandate for in-
frastructure financing have been set up in the
recent past as well. None of these institutions
has been able to take up the lead responsibility
and/or extend/channelize large funds to make
an impact on sectoral growth. The new DFI has
a challenge to succeed where its predecessors
have failed.
The institutions earlier set up for exclusively
financing infrastructure projects have suffered
from constraints similar to those the three ma-
jor DFIs (IDBI, IFCI and ICICI) have faced in the
past while pursuing term financing for industri-
al growth and development. With an inflexible
asset base (only infrastructure) and a higher cost
of funds, compared to commercial banks, these
institutions have not been able to make much
impact and, in most cases, have been non-lead
participants in the lending consortium for the
respective infrastructure project. The new DFI
has been assigned a wider and more diversified
role in that, in addition to being a financier, it
has also been entrusted with the responsibility
of coordinating the activities of other institu-
tions engaged in financing infrastructure proj-
ects. The Act also provides for the new DFI to
facilitate and promote the long-term bond and
debenture markets in India, which are expect-
ed to garner large resources for infrastructure
growth. In addition, the institution will provide
arbitration facilities exclusively for the infra-
structure sector, which have remained a much
sought-after regulatory enabler for fast disposal
of sectoral disputes. In the process of envisag-
ing a larger and more vibrant role for the new
DFI, the bill provides for some strong enablers
to make the institution unique in performing its
multifaceted role as well as continue in a mean-
ingful role as a financier.
To enable the institution to carry out the afore-
said objectives and business, resource-raising
avenues have been proposed in a manner that is
expected to make it possible to raise large-scale,
long-term low-cost resources as under:
• Borrow or raise money by way of loan
or secure the payment of money raised
through debenture issuance and charge
or secure the same by trust deed or oth-
erwise on the undertaking of the insti-
tution, including its capital or upon any
specific property or rights.
• Borrow money from the central govern-
ment, SCBs, financial institutions, mutu-
al funds or any other class of person as
the central government may notify.
Short-term money can be accepted only
for managing asset and liability mis-
matches and not for any other business
purpose.
• Buy or sell, or enter into dealings in FCY.
• The central government may, on a request
being made by the institution, guarantee
the bonds, debentures and loans issued by
the institution for the repayment of prin-
cipal and payment of interest.
• The central government may support the
institution through grants or contribu-
tions in the form of cash or marketable
G-Secs.
• The government shall prescribe a conces-
sional rate of fee, not to exceed 0.1 per cent
per annum, at which a government guar-
antee may be extended to the institution
New Trends in Infrastructure Financing 141
 for borrowing from multilateral institu-
tions, sovereign wealth funds and other
foreign institutions as prescribed.
• To insulate the institution from any fluc-
tuations in exchange rates, hedging costs
in connection with borrowing of FCY by
the institution for the purpose of grant-
ing loans and advances, or its repayment,
may be reimbursed by the central gov-
ernment in part or in full.
NaBFID has an important mandate in pursu-
ing implementation of the NIP. The institution
is also visualized as an answer to India’s quest
for long-term, low-cost finance for funding in-
frastructure investment. The Act confirms the
extension of significant support to the institu-
tion by GOI by way of a low-cost guarantee
and, more importantly, by providing ‘hedging’
facilities on its FCY liability. The twin support
would enable the DFI to raise low-cost resourc-
es from both domestic and international finan-
cial markets, which could usher in a lower cost
of funds for the institution and translate into
lower user charges.
NaBFID has been given an all-encompassing
role in infrastructure matters, including intra-
sectoral dispute resolution, the development of
a non-bank long-term financing market, and
coordinating the functioning of all institutions
engaged in infrastructure financing. The institu-
tion also has an important role in providing non-
recourse financing to the sector. The financial/
guarantee/hedging support from the GOI will
provide it with the financial strength and abil-
ity to mobilize low-cost resources to build and
sustain a viable business in a market beset with
competition from commercial banks and other
intermediaries, while having the advantage of
a low-cost fund base. On the other hand, its role
as a financial market builder and arbitrator of in-
tra-sectoral disputes will provide it with a large
sway over infrastructure development matters.
9.4.1. Observations
It is also important to note that the institution,
as per the provisions of the Act, would provide
only ‘non-recourse’ financing to the infrastruc-
ture sector, while most other lending institutions
142 INDIA BANKING AND FINANCE REPORT 2021
provide financing ‘with recourse’ to the spon-
sors, etc., other than a few project/sponsor-wise
exceptions. This puts an onerous responsibility
on the new institution to develop a robust model
for setting up appraisal standards and monitor-
ing processes in infrastructure financing cases,
which is outside the scope of this discussion.
However, it could well lead to cannibalization of
the infrastructure financing market, whereby
sponsors could show an increasing tendency
to avail finance from NaBFID, in preference to
other banks/FIs. This could, overtime, increase
the business growth of NaBFID substantially vis-
à-vis other institutions/banks. This eventuality
could spur systemic risk as well as risk to the
institution, both of which have to be adequately
taken care of.
Considering that the institution is yet to set up
its organizational network, formalize its systems
and processes, including its appraisal and moni-
toring standards, and also make a foray into the
resource market, meeting its immediate objec-
tive of channelizing large resources to the sector
could be a formidable challenge.
9.5. National Monetization
Plan
The NMP envisages the generation of capital in-
ternally through the monetization and recycling
of existing infrastructure assets. The practice
involves ceding, for a limited period, rights over
the cash flow of the project in lieu of upfront pay-
ments. The rights are ceded by the public project
authorities in favour of the interested private
investor, who makes the upfront payment. The
upfront payment so received is to be redeployed
to create new infrastructure facilities. NMP is an
asset or capital recycling programme with the
strategic objective of unlocking the value of in-
vestments in public sector assets by tapping pri-
vate sector capital. The proceeds of monetization
are proposed to be leveraged for augmentation/
greenfield investment. The programme is dis-
tinct from disinvestment in that ownership of
the asset under NMP would continue with the
government/respective public authorities. Com-
pleted infrastructure projects as well as projects
at an advanced stage of implementation are in-
cluded under NMP. The NITI Aayog has worked
out an elaborate plan under the NMP, which is
now a published document. As per the estimate
included therein, the said plan indicates a poten-
tial to monetize assets up to `6 lakh crore (about
11% of the required resources of `111 lakh crore)
in the country in the four-year period ending FY
2025, so as to be co-terminus with the NIP. Cross-
country case studies cited by the NITI Aayog in
the NMP document report very satisfactory suc-
cess in the mobilization of resources through the
monetization route.
The key objectives of the NMP, as stated in the
NMP document, are to
• Serve as a medium-term road map for the
line ministries and agencies
• Provide medium-term visibility to inves-
tors on infrastructure asset pipeline
• Provide a platform for ministries to track
asset performance
• Bring in greater efficiency and transpar-
ency in public asset management
9.5.1. Monetization Process
Asset monetization can be accomplished in one
of two ways: (a) through direct contractual ap-
proach (DCA) or (b) through structured financ-
ing models (SFM). DCA involves entering into a
concession/contract between the public entity
and private sector partner developer. Projects
being offered under DCA are likely to be taken
up by developers for greenfield implementation
or brownfield upgradation/expansion and sub-
sequent maintenance/operations/trolling till
a expiry of the concession contract/period. On
the other hand, SFM involves the setting up of
structured financial instruments based on the
underlying cash flow of the project for long-
term fund generation via the capital market or
through a pool of investors. Portfolio investors,
such as funds, insurance companies and pension
funds, who seek long-term steady returns are
likely SFM subscribers. InvITs, REITs and other
market instruments wherein the right over
the cash flow is only transferred to the inves-
tor for a specified period, while the day-to-day
management/operation of the asset is not ceded
to the investor, are examples of SFM. InvIT has
become popular in the Indian monetization
scenario as a capital market instrument. InvITs
have been floated by sponsors of PPP road proj-
ects in the past. The Power Grid Corporation of
India Ltd (PGCIL) and NHAI, as a part of the of-
ferings under the NMP, have issued or are in the
process of issuing InvITs against operating pow-
er transmission and road projects, respectively,
in their portfolio. These offerings have received
or are expected to receive a good response from
investors.
The NMP finalized by NITI Aayog proposes
both the DCA and SFM process for the monetiza-
tion exercise. The actual processes to be adopted
would be determined on a project-specific basis.
The monetization of completed infrastructure
projects can be done by either the DCA or SFM
process. Projects at an advanced stage of imple-
mentation (including projects where expansion
and/or upgradation are proposed) are usually
amenable to the DCA process.
9.5.2. Assets Considered for
Monetization
A top-down approach has been adopted where-
in the said (NMP) document identifies projects
proposed for monetization by preparing a se-
lect list from a macro-list of core sector projects
owned and operated by central government or
public authorities. The exercise is presented in
Table 9.3.
9.5.3. Indicative Valuation of
Monetization
The NMP document has used a mixed approach
for estimation of the indicative value of the assets,
namely the market approach (based on compara-
ble market transactions wherever available), the
capex approach (based on capex which has to be
funded by the private sector partner, in line with
the contract), the book value approach (based on
investment made in the project and adjusted for
age/residual life of the project) and the enterprise
value (EV) approach (based on net present value of
discounted cash flow expected from the project in
the future). The NITI Aayog has adopted a sector/
New Trends in Infrastructure Financing 143
 Table 9.3 Monetization in Brief—Potential Assets and Proposed for Monetization
Proposed % of Ag-
Monetiza- Indicative gregate
tion/% of Valuation Mon-
S. Ministry/ Key Asset Potential Amount etization
No. Asset Class Entity Variable Value Assets (` Crore) Amount
1. Roads Ministry of Length of 132,499 km 26,700 160,200 27
Roads (NHAI) national kms/
highway 20%
2. Power Ministry Trans- 171,950 km 28,608 ckt 45,200 8
transmis- of Power mission transmission km: 17%
sion (PGCIL) network & line; 262 sub-
substations stations with
444,738 MVA
transforma-
tion capacity
3. Power National Thermal 60,224 MW – – –
generation Thermal generation
Power Corpo-
ration (NTPC)
and its JVs/
subsidiaries
4. Power National Hydro- 7,071 MW 6 GW (3.5 39,832 7
generation Hydroelectric power (hydro) GW hydro,
Power Corpo- renew- 4,912 MW 2.5 GW re-
ration ables (solar) newable) =
NTPC (solar) 6%
5. Airports Airports Number 137 airports 25 no. 20,872 4
Authority of of AAI of AAI
India (AAI) airports airports =
18%
6. Ports Major ports 12 major 1,535 31 projects 12,828 2
ports = MMTPA in 9 major
handling ports
capacity
7. Telecom Bharat Telecom 69,047 14,917 nos. 35,100** 6
towers Sanchar Ni- towers towers (no.) of BSNL
gam Limited and MTNL
(BSNL) towers/
Mahanagar 21% of
Telephone towers
Nigam Lim-
ited (MTNL)
8. Optical Bharat Optical 525,076 km 2.86 lakh
fibre cable Broadband fibres km of
fibre/57%
9. Railway Indian Railway 7,325 400 no.
stations Railways stations stations (5.5% of
(Nos) stations)
10. Railway Indian Track 126,366 track 1,400 km 152,496*
track Railways network km (67,956 (2% of
route length) network)
(Table 9.3 Continued)

144 INDIA BANKING AND FINANCE REPORT 2021

 (Table 9.3 Continued)
Proposed % of Ag-
Monetiza- Indicative gregate
tion/% of Valuation Mon-
S. Ministry/ Key Asset Potential Amount etization
No. Asset Class Entity Variable Value Assets (` Crore) Amount
11. Natural Gas Authority Length of 19,998 km 8,154 km 24,462 4
gas pipe- of India Lim- operation-
line ited, Indian al pipeline
Oil Corpora-
tion (IOC)
and others
12. Petroleum IOC, Hindu- Pipeline 14,623 km 3,930 km 22,504 4
& products stan Petro- network = 23%
pipeline leum Corpora- (length)
tion Limited,
Bharat Petro-
leum Corpora-
tion Limited,
Oil India Lim-
ited (OIL)
13. Ware- Food Corpo- Warehous- 818 lakh MT 210 lakh 28,900 5
houses ration of India ing capac- metric
(FCI), Central ity tonnes
Warehousing (lmt)
Corporation {175 lmt -
(CWC) and FCI, and 35
others lmt – CWC}
14. Sports Ministry of Sports 5 National 2 national 11,450 2
stadium Youth Affairs stadium & stadia and stadia & 2
& Sports regional various regional
= Sports centres regional centres
Authority of centres
India
15. Mining Coal = 160 28,747 5
assets projects &
Minerals =
761 blocks
Source: NITI Aayog (2021).
Notes: The monetization proceeds mentioned above comprise (a) actual cash proceeds expected to be re-
ceived from the transaction and (b) savings in estimated balance capital investment when the project is hand-
ed over to the investor (who takes over the project); * Indicative monetization value over the NMP period. It
includes railway station development, passenger train operations, track, good sheds, Konkan Railway, hill rail-
ways, dedicated freight corridor and railway colonies redevelopment.** figures against telecom towers include
expected monetization proceeds of optical fibre cable.

asset class-wise approach to arrive at the indica-
tive valuation, as given in Table 9.4.
It may be noted that ‘market approach’ has
been adopted in the case of projects in the road,
power transmission and telecom tower subsec-
tors, in which a large number of transactions have
been concluded. The large number of completed
transactions suggests the existence of good mar-
ket liquidity and good investor appetite for trans-
actions. Multiple transactions also set benchmark
valuations and market clearing prices for the sub-
sectors. A capex approach has been adopted in
case the development needs of the sector suggest
a necessity for large capex, as in railways, ports,
airports, mining, warehousing, sports stadiums

New Trends in Infrastructure Financing 145

 Table 9.4 Valuation Methodology Adopted—Sector/Asset Class-wise
S.
No. Sector/Asset Approach to Monetization
1. Roads Market approach
2. Ports Capex approach
3. Airports Capex approach
4. Railways Railway stations—Capex approach
Passenger trains—Capex approach
Private freight terminals—Capex approach
Railway colonies redevelopment—Capex approach
Track infrastructure under Dedicated Freight Corridor Corporation of
India Limited—Book value approach
Track, overhead equipment (OHE)—EV approach
5. Power generation Book value approach
6. Power transmission Market approach
7. Natural gas pipeline EV approach
8. Product pipeline EV approach
9. Sports stadium Capex approach
10. Warehousing Capex approach
11. Telecom Fibre assets—Capex approach
Tower assets—Market approach
12. Mining Capex approach
13. Urban housing Capex approach
redevelopment
Source: Compiled by the author.

and housing redevelopment. Power transmis-
sion, natural gas/product pipeline and railway
OHE track, which have a stable business model
and a projected steady business/cash flow expec-
tation, are best monetized using the EV approach.
A book value approach has been adopted for sec-
tors in which heavy capital investment has been
made in the past and the assets continue to gener-
ate steady business/cash flow.
9.5.4. Monetization Process Proposed
The NMP document has proposed the adoption of
both the DCA and SFM methods for the proposed
monetization exercise. The exact process to be
adopted will depend on the status of the respec-
tive project. The document has not drawn up any
elaborate methodology in this regard. However,
it looks prudent when the document appears
to suggest that the project, which is complete
in its implementation and is performing well
operationally, may be considered for monetiza-
tion via the SFM process. InvITs have gained in-
creasing popularity for successfully creating such
structures and have gained increasing popularity
with investors—both retail and wholesale—do-
mestic and overseas. InvITs have been issued in
the past for certain operating projects, mainly in
the road sector. The performance of InvITs has
been successful. The instrument has good liquid-
ity and has generated a good return for investors.
NHAI and PGCIL have launched or are launching
InvITs for monetization of their road and power
transmission assets as part of the NMP exercise.
The DCA method may be adopted in sector/proj-
ects where large capex work is necessary or ex-
pected for completion of the projects or for their
expansion or upgrade.
The aforesaid approach to monetization with an
apparent emphasis on SFM is realistic and is likely

146 INDIA BANKING AND FINANCE REPORT 2021

to meet with greater success. In essence, SFM is a
financial product with an ‘underlying’ established
cash flow of completed projects. As a result, it car-
ries a lower risk for investors. Further, the set of
financial investors for investment in the SFM pro-
cess is large and brings in higher market liquid-
ity. The success of INVITs, which have gained in-
creasing popularity among investors (both retail
and wholesale) domestically and overseas, is the
most used monetization programme. InvITs have
been used in the past for certain operating proj-
ects, mainly in the road sector. The performance
of InvITs has been successful. The instrument is
easy and quick to launch, has good liquidity, good
investor appetite and has generated a good return
for investors. NHAI and PGCIL have launched
or are launching InvITs for monetization of their
road and power transmission assets as part of the
NMP exercise. The DCA method, on the other
hand, is attractive to the public authorities as it
can save resources allotted to a project/sector,
which can then be utilized in other projects. The
investor, however, has to engage himself/herself
actively in the project implementation and carry
exclusively all the unallocated project risk. Appe-
tite for taking over such projects would depend on
the presence of an enabling investment/business
environment. The takeover would also be sub-
ject to the successful completion of rigorous due
diligence. Monetization for projects offered under
the DCA process is, therefore, likely to be slow
on offtake and may be difficult to pursue when
limited time is available to mobilize resources to
implement the ambitious NIP.
9.5.5. Observations
NMP is a new resource-raising process proposed
for investment in the infrastructure sector. Con-
sidering the large stock of good-quality infra-
structure assets available in the country, the
implementation of the NMP is likely to generate
a good amount of resources, which can then be
reinvested for new asset creation, resulting in a
virtuous system of development of infrastructure
assets, as has happened in countries cited in the
NITI Aayog (2021) document. The asset monetiza-
tion programme would generate resources that
would get reinvested as equity in the project,
thereby improving the overall debt-to-equity ra-
tio in the sector with all its attendant benefits.
The recent relaxations in the foreign investment
regulations, along with the favourable liquidity
conditions, positive perception and high appetite
for Indian debt papers, are likely to make SFM in-
struments launched under NMP, by reliable Indi-
an public authorities, attractive to foreign financial
investors looking for a steady long-term return.
The monetization of physical assets following
the DCA process is likely to have its own chal-
lenge considering the multiple infrastructure
subsectors in which the exercise is to be launched
and overcoming the diverse challenges that are
likely to be encountered in the respective sectors.
The DCA exercise, however, is necessary for car-
rying out new builds as well as expansion/upgra-
dation of assets, which could make a significant
difference in the provision of quantity and qual-
ity of infrastructure. The NMP is the first step
towards a systematic approach for improving
infrastructure delivery. The success of the plan
depends crucially on the appropriateness of the
strategy adopted at the individual project level
and the pace of its adoption and implementation.
Success would also depend on the existence of a
favourable business environment, which would
determine the investors’ appetite and confidence
in taking over such projects.
9.6. Concluding Remarks
NIP presents a comprehensive growth plan for
Indian infrastructure. The NIP is a guide for the
transition from project-level planning to compre-
hensive national-level implementation planning,
which is to be implemented over a period of five
years ending in FY 2025. The estimated volume
of expenditure of `111 lakh crore (USD 4.5 tril-
lion) is challenging. The proposed monetization
programme under the NMP and the setting up of
the new DFI are important steps in that direction.
The NIP and NMP are two complimentary steps
towards a comprehensive infrastructure devel-
opment plan and how to fund such a plan. The
NIP and NMP documents estimate a potential
fund infusion of about 15–17 per cent from these
two new avenues to take care of the projected
shortfall in resource mobilization from conven-
tional sources. Numerically, the estimate suggests
a long-term aggregate capital inflow of between
New Trends in Infrastructure Financing 147
 `17 lakh crore and `19 lakh crore from NMP and
the new DFI. The targeted amount is no doubt
extremely large. The mobilization of such large
resources in a relatively short time span presents
a paramount challenge for the system. The suc-
cess of the same would depend primarily on the
continuation of global liquidity and investors’ ap-
petite towards Indian infrastructure assets. The
realization would also depend on our ability to
deliver the expected results from these proposed
measures in a timely and well-structured man-
ner. Some critical issues highlighted below re-
quire a closer look by policymakers.
The NabFID Act suggests the setting up of an
exclusive institution. This has been done in the
past also but has not been able to deliver the ex-
pected success—a primary reason being its rela-
tively high cost of funds, vis-à-vis commercial
banks. GOI has accordingly proposed measures
to ensure the continuous inflow of low-cost
funds to NabFID, which had not been provided
earlier. An important measure proposed is to
provide currency hedging facilities, which could
be a strain on the fiscal bear in the case of wide-
ranging currency fluctuations and movements. It
is important to note that NabFID is not conceived
only as a lender to the infrastructure sector but
also as a coordinator of all institutions/banks/
NBFCs that lend/propose to lend to the sector. In
that, it metaphorically takes over a mantle that
IDBI was entrusted with during the early days
of Indian DFIs, with very successful results in
building a diversified industrial edifice.
Monetization as proposed in the NMP is a sig-
nificant addition to infrastructure financing in
India. When reinvested, the estimated resources
to be received out of this exercise will qualify
as equity (internal accruals) and would be most
suitable for infrastructure investment. India has
initiated a journey on this route through a few
SFM cases—the launch of InvIT for road and
power transmission sector projects—over the last
five years. As mentioned in the NMP document,
the total assets under management (AUM) under
the eight active InvITs is around `1.4 lakh crore.
The NMP document mentions several notable
international monetization transactions, includ-
ing the monetization of the Indiana toll road in
148 INDIA BANKING AND FINANCE REPORT 2021
2005–2006 through a 75-year operate maintain
and transfer (OMT) concession at an upfront
payment consideration of USD 3.8 billion, which
aided in financing the entire Indiana States Road
asset management plan for a period of 10 years.
The document also mentions the monetization
transaction of Transgrid, the electricity distribu-
tion company of New South Wales, Australia,
which was monetized through a 99-year lease
transaction for AUD 10.3 billion, despite being a
regulated asset (the network price is set by the
regulator). The transaction was concluded by a
consortium of pension and infrastructure funds
and indicates that the market and fund houses
do have an appetite for well-structured deals
from credible jurisdictions even if the underly-
ing cash flow is subject to regulation.
Monetization through the DCA route has also
been initiated under OMT concessions, TOT
concession and operate, maintain and develop
(OMD) concessions. Between 2009–2010 and
2014–2015, NHAI has awarded a total of 2,395
km and mobilized a total of `17,000 crore under
the TOT concessions. Some state governments
have also adopted the TOT model for monetiza-
tion of assets. A landmark auction by a state apex
agency under TOT concession is the awarding of
tolling rights on the Mumbai Pune Expressway
and the old Mumbai Pune Expressway for a total
consideration of `8,262 crore. The OMD conces-
sions have been particularly successful in the
monetization and transfer of airports through
the PPP route, through which large amounts
of funds have been mobilized. In a recent exer-
cise in February 2019, AAI mobilized `900 crore
for the monetization of six existing airports at
Ahmedabad, Jaipur, Lucknow, Guwahati, Thiru-
vananthapuram and Mangalore. Keeping in
view these recently concluded transactions, it
appears that a large number of publicly owned
Indian assets from the subsectors/projects short-
listed may well have the potential to mobilize
the apparently ambitious target of `6 lakh crore
for investment in projects included in the NIP.
Implementation of the monetization plan, with
its need for identification, structuring and run-
ning of the full process of monetization within
the small time span of about four years, could,
however, pose its own challenge.
 In short, are we rushing through? It is impor-
tant to note that infrastructure build-up is more
than just financial issue; it necessitates a harmo-
nious interplay of various factors, such as the eco-
nomic, social and political environment, as well as
evolving rules and regulations in the sector/sub-
sectors and other dependent areas of operation.
Compressing the challenging exercise into all of
four years is steep and deserves a closer look. The
issue assumes its criticality as implementation of
the NIP and meeting the aspirations of ‘delivering
infrastructure assets’ at par with international
standards depends crucially on achieving the tar-
gets set for NabFID and also under the NMP.
Note
1. The NIP has spelt out its vision and mission
statement as follows:
• Vision: Infrastructure services that
raise the quality of life and ease of liv-
ing in India to global standards.
• Mission: (a) Develop a 5-year plan of
infrastructure development in key sec-
tors, (b) facilitate design, delivery and
maintenance of public infrastructure
as per global standards, (c) facilitate
generic and sectoral reforms in regu-
lation and administration of public in-
frastructure as per global best practices
and (d) push India up in global rankings
in public infrastructure.
References
DEA (2020). Report of the Task Force National In-
frastructure Pipeline (NIP). Vols. I & II.
GOI. (2021). Budget 2021–22, speech of Nirmala
Sitharaman, honourable Minister of Finance.
Ministry of Finance.
NITI Aayog. (2021). National monetisation pipe-
line: Vol. I (Monetisation Outlook)..
New Trends in Infrastructure Financing 149
Emerging Technological
Innovations in Financing
Micro, Small and Medium
Enterprises in India
Naveen Kumar K., M. Manickaraj
and Sundeep Mohindru
10.1. Introduction
MSMEs in India play a pivotal role in employ-
ment generation, promotion of entrepreneurship
and innovation, exports, and inclusive and bal-
anced economic development. The Micro, Small
and Medium Enterprises Development (MSMED)
Act, 2006, defines MSMEs on the basis of a
composite criterion of investment in plant and
machinery and turnover. Accordingly, the def-
initions are as follows:
• Micro enterprise, where the investment
in plant and machinery or equipment
does not exceed 1 crore rupees and turn-
over does not exceed 5 crore rupees.
• Small enterprise, where the investment
in plant and machinery or equipment
does not exceed 10 crore rupees and turn-
over does not exceed 50 crore rupees.
• Medium enterprise, where the invest-
ment in plant and machinery or equip-
ment does not exceed 50 crore rupees
and turnover does not exceed `250 crore.
The above definition covers all the sectors, in-
cluding manufacturing, services and trade, and it
came into effect on 1 July 2020.
Channelling finance from formal financial in-
stitutions to the MSME sector has always been a
big challenge. In fact, one of the major objectives
behind nationalizing banks in the country in
1969 was to increase the funding support to the
sector by the banks. Post nationalization, many
steps were taken by both the government and
the RBI to increase the amount of credit from
10
Chapter
banks to the sector. However, the achievement
in this regard is far below the goals. Digitizing
the economic and other activities in the country
is taking place at a fast pace, particularly during
the last few years. The increase in focus of banks
and financial institutions on digitalizing their
financial services and the shift from traditional
lending to digital lending drives the growth of
the digital lending market. Digital lending is the
process covering loan application, credit analysis,
loan sanction, disbursement of loans and manag-
ing the loan portfolio through digital platforms.
Digital lending platforms enable borrowers and
lenders to lend money through paperless elec-
tronic means. It offers ease of use, an enhanced
consumer experience and reduced overhead
through savings in customer verification time.
The digital lending process begins with an
online application with user registration, online
document submission, customer authentication
and verification, loan approval, loan disburse-
ment and loan recovery. This platform is increas-
ingly being adopted among banks as it offers
seamless monitoring and enhanced profitability
benefits. In addition, it allows borrowers to eas-
ily apply for loans and offers them transparency,
which, in turn, leads to significant time savings.
This automated nature of the online lending
platform offers lenders and borrowers a more
precise approach to delivering funding solutions,
thus reducing stress and increasing the chances
of successful loan approval.
Many new players have introduced innova-
tions in lending to the underserved and unserved
sectors, particularly to MSMEs. Digital lending is
 the last hope to increase the flow of formal credit
to MSMEs in the country. This chapter presents
a review of various technology innovations that
are being used for financing MSMEs.
10.2. MSME Sector in India:
Stylized Facts
India has around 64 million MSMEs and the
break-up of the same is given in Table 10.1. Over
99 per cent of the total MSMEs are micro-en-
terprises, which are largely informal in nature.
Small enterprises are 3.31 lakh and medium en-
terprises are 0.05 lakh, accounting for 0.52 per
cent and 0.01 per cent of total estimated MSMEs,
respectively. An activity-wise classification of
MSMEs in India is presented in Table 10.1.
Since 1969, when banks in the country were
nationalized, India has taken many steps to chan-
nel finance from banks and financial institutions
to the MSME sector. The steps taken include: di-
rected lending under the priority sector lending
scheme, appointment of various committees for
finding means and methods for financing the
MSMEs, establishment of dedicated institutions
for promotion, development and financing of
small businesses, including National Small In-
dustries Corporation, National Institute for Mi-
cro, Small and Medium Enterprises, SIDBI, Micro
Units Development & Refinance Agency Ltd,1
Credit Guarantee Fund Trust for Micro and Small
Enterprises, etc. The GOI and the RBI have recent-
ly initiated technology-based steps to increase
MSMEs financing. The schemes include PSB59
minutes loan, Udyog Aadhaar Memorandum,
Goods and Services Tax Network (GSTN), demon-
etization, Digital India Movement, Government
Table 10.1 Estimated Number of MSMEs (Activity-wise)
Category Rural
Manufacturing 114.14
Electricity* 0.03
Trade 108.71
Other services 102.00
Total 324.88
Source: Government of India (2021).
Note: *Non-captive electricity generation and transmission.
152 INDIA BANKING AND FINANCE REPORT 2021
e-Market platform, Trade Receivables Electronic
Discounting Scheme (TReDS), Digidhan Mission,
recognition and regulation of fintech companies
and so on. Despite all these steps and schemes for
increasing the flow of finance, the actual flow of
credit from banks and financial institutions re-
mains very low.
It is evident that the flow of credit from com-
mercial banks to the sector is far below expecta-
tions, as can be seen in Tables 10.2 and 10.3.
Tables 10.2 and 10.3 show that the amount of
credit given by commercial banks in the country
to micro and small manufacturing enterprises is
very low and has grown at the lowest rate com-
pared to the growth in credit to all other sectors.
However, credit to micro and small service en-
terprises has grown at a higher rate.
A study by the International Finance Cor-
poration (IFC) has found that the total funding
requirement of MSMEs in India is `87.87 lakh
crore, of which debt is `69.3 lakh crore and eq-
uity is `18.4 lakh crore. Around 58.4 lakh crore
of debt (81%) was raised from informal sources.
The report further goes on to state that the ad-
dressable credit gap is `25.8 lakh crore (IFC, 2018).
Another study by Microsave Consulting has esti-
mated the current demand for credit by MSMEs
in 2020 at `105.5 lakh crore (USD 1,431 billion;
Microsave Consulting, 2020). The study reports
that the major requirement of MSMEs is work-
ing capital.
As MSMEs struggle to get traditional funding
sources, technological innovations in lending
are expected to fill the financing gaps. In the last
few years, many digital lending platforms have
intervened to finance the MSMEs. Fintech loans,
Urban Total Share (%)
82.50 196.65 31
0.01 0.03 0
121.64 230.35 36
104.85 206.85 33
309.00 633.88 100
 Table 10.2 Commercial Bank Loans Outstanding (End of March) for the Last Six Years, till 2021
Loan Outstanding as at the end of March (` Lakh Crores)
2015– 2016– 2017– 2018– 2019– 2020–
Sector 2016 2017 2018 2019 2020 2021
Non-food credit 65.47 70.94 76.88 86.33 92.12 96.62
Agriculture and allied activities 8.83 9.92 10.30 11.11 11.58 13.00
Industry (micro and small, medium
27.31 26.80 26.99 28.86 29.05 29.18
and large)
Services 15.41 18.02 20.50 24.16 25.95 26.31
Personal loans 13.92 16.20 19.08 22.21 25.54 28.14
Of the total non-food credit loan given to micro and small enterprises,medium and large enterprises:
Micro and small enterprises 8.48 9.02 9.96 10.48 10.80 11.07
• Micro and small (manufacturing
3.71 3.70 3.73 3.76 3.82 3.84
enterprises)
• Micro and small (service enterprises) 4.76 5.32 6.23 6.72 6.99 7.23
Medium 1.15 1.05 1.04 1.06 1.06 1.36
Large 22.44 22.05 22.23 24.04 24.18 23.98
Source: RBI (2021b).

Table 10.3 Growth in Credit from Commercial Banks to Various Sectors during Last Six Years Ending
2021
2016– 2017– 2018– 2019– 2020–
2017 2018 2019 2020 2021
Sector (%) (%) (%) (%) (%)
Non-food credit 8.36 8.37 12.29 6.70 4.89
Agriculture and allied activities 12.40 3.81 7.87 4.18 12.27
Industry (micro and small, medium and large) –1.86 0.73 6.91 0.67 0.44
Services 16.95 13.77 17.81 7.42 1.37
Personal loans 16.36 17.80 16.36 14.99 10.18
Micro and small enterprises 6.42 10.47 5.15 3.13 2.48
• Micro and small (manufacturing enterprises) –0.47 0.88 0.67 1.68 0.53
• Micro and small (service enterprises) 11.79 17.12 7.83 3.93 3.54
Medium –8.72 –1.07 2.62 –0.75 28.84
Large –1.74 0.78 8.16 0.58 –0.81
Source: RBI (2021b).

in particular, are expanding rapidly. As per the 10.3. Digital Innovations

studies of the Cambridge Centre for Alternative
Finance, ‘global debt-based alternative finance
(fintech loans) increased 26 per cent from $ 287
billion in 2016 to $ 373 billion in 2017.’ The next
section of the chapter elaborates on various in-
novations in financing MSMEs across countries,
with a special reference to India.
in Financing MSMEs:
Global and India
Digital innovations are admittedly disrupt-
ing the banking and financial services sectors
across the world. The digital lending players are

Emerging Technological Innovations in Financing Micro, Small and Medium Enterprises in India 153
 increasingly adopting innovative technology
solutions to acquire large amounts of data on
customers, analytical models for fast-tracking
lending decisions and credit risk management
and advanced and cost-effective tech-built chan-
nels with the capacity to deliver services re-
motely. Admittedly, the digital lending market
is witnessing a paradigm shift from advanced
countries to emerging market economies, more
specifically towards underserved and excluded
segments of society. The new markets are getting
connected with improved financial and digital
literacy, mobile connectivity and the develop-
ment of innovative digital infrastructure (DI).
Globally, MSME lending with innovative mod-
els has reached several markets with diversi-
fied products. Alternative digital finance to the
MSME sector has witnessed high growth dur-
ing 2020. The global alternative digital finance
for businesses accounted for $35 billion in 2019,
with a year-on-year growth of 13 per cent, and
has grown to $53 billion market size in 2020, with
a substantial year-on-year growth of 51 per cent
(GPFI, 2021; World Bank, 2020). According to the
Digital Lending Platform Market Outlook—2027,
the market size of the global digital lending space
is expected to grow at a CAGR of around 17 per
cent during 2020–2027. The growth trajectory
of digital lending is endorsed by perpetual im-
provement and innovation among financial
sector players (including fintech’s) along with
augmented government policy initiatives for a
sustainable digital ecosystem.
10.3.1. Innovative Technologies in
Digital Lending: The Ecosystem
Technological disruptions in MSME financing
are transforming the business models and im-
proving the efficiency of lending platforms. The
technology solutions in MSME financing are
broadly classified into (a) DI and (b) digital tools
and technologies (DTT). DI refers to the techno-
logical foundation upon which the MSME finan-
cial products and business models are launched.
The ‘distributed ledger technology’ (DLT), ‘block-
chain’, ‘cloud computing’ (CC), ‘Internet of Things’
(IOT), etc., are the most prominent innovations in
DI. DTT refers to the delivery channels that are
facilitated by technology devices and tools such
154 INDIA BANKING AND FINANCE REPORT 2021
as mobile phones, big data analytics (BDA), artifi-
cial intelligence (AI)/machine learning (ML), ap-
plication programming interface (API) and quick
response (QR) code. The details of the technol-
ogy and its benefits to MSMEs are discussed in
Table 10.4.
The ecosystem witnessed a large number of
innovative digital products for MSMEs, such
as collateral-free unsecured loans, serving the
underserved and excluded, innovative ways
for lending to high-risk business/customer seg-
ments, accurate and quality credit assessment
tools with the help of data analytics, simplified
and lean processes throughout lending opera-
tions, non-complicated regulatory and compli-
ance obligations for customers and so on.
Ever since digital advances have disrupted the
lending business, the focus has shifted to a bet-
ter and improved customer experience, faster
turnaround time and adoption of technology.
Today, the end-to-end digital journey is becom-
ing a reality with the emergence of the digital
ecosystem, which includes Aadhar-based e-KYC,
e-mandate, e-sign and e-stamping. AI, ML and
cloud technology are being adopted on a very
large scale. With a surge in smartphone usage
and internet penetration, customers now have
the access to more digital avenues for 40–60 per
cent of loan purchase transaction across all loan
types influenced by digital channels.
There are various other products such as sup-
ply chain finance (SCF), equipment financing,
franchise financing, merchant cash advance
and purchase finance offered for the MSMEs
during the pandemic. With innovation brought
by fintech, banks are also realizing the impor-
tance of customizing the risk policies and credit
evaluation methods in order to meet the credit
needs of this segment. Bank offerings are evolv-
ing through the leveraging of technology and
analytics. Assistance is provided to MSMEs to
adjust to ‘one nation, one tax’ regime by invest-
ing in capacity building with various trade asso-
ciations. For example, Yes Bank has launched a
new credit product to help small businesses avail
secured loans on the basis of their GST returns
without any additional assessment of their bal-
ance sheets or bank statements.2
 Table 10.4 Basic Features and Benefits of DI and DTT in Financing MSMEs
Category Technology Basic Features
DI CC There are three types of CC infrastruc-
tures used in business places, namely
platform as a service (PaaS), software as
a service and infrastructure as a service
(IaaS).
MSME business model defines the type/
nature of cloud services and its cost.
Blockchain/ Blockchain facilitates secured transac-
DLT tion records in distributed and decen-
tralized manner. It uses cryptographic
technologies across the nodes to vali-
date the transactions and their security.
IOT IOT enables business to generate, col-
lect and share the information over the
large networks.
DTT Mobile Mobile phones with and without internet
phone/ allows the people to transact remotely
internet and anytime. Smartphones enabled with
connectivity digital banking features facilitate access
to wide range of banking and financial
services including the mobile money.
BDA Digital devices generate a huge amount
of structured and unstructured data every
day. The analysis of these data is finding
an important place in MSME financing.
AI/ML AI models learn from the large set of
data using various algorithms and these
models can be intelligently used in
various decision-making. ML is a subset
of AI, which uses various algorithms
with the help of mathematical
techniques. ML algorithms are classified
as (a) supervised (labelled data) and
(b) unsupervised (un-labelled data).
API API allows one application to
communicate with other applications.
As an interface, it helps the technology
developers to design an application by
using free defined process across the
systems for faster information transfer.
It assists people to access and use wide
range of products and services.
QR QR codes maintain a large amount of
data and allow decoding at a higher
speed. Due to their two-dimensional
features, they are faster and can be se-
curely used for given purpose and users.
Biometric Biometric technologies provide a wide
technologies range of features for secured and swift
transactions.
Source: GPFI (2021).
Emerging Technological Innovations in Financing Micro, Small and Medium Enterprises in India
Benefits
MSME lending platforms can save cost of creating
their own IT infrastructure and also operating cost by
using IaaS as a CC stack.
Flexibility in increasing or decreasing scale of business.
Protection from cyber threats and higher data safety.
Facilitates for swift development of software applica-
tions and programmes for MSME financing.
Provides various benefits in the value chain of MSME
finance, such as identification, risk distribution and
management, documentation, payment system man-
agement and authentication of digital transactions.
IOT helps in value creation for lenders and MSMEs
through improved operational effectiveness, customer
services and prudent decision-making.
Efficient and cost-effective delivery of financial services.
Enables ‘DT of MSMEs’.
Access to low cost information and improved enter-
prise efficiency.
Provides clarity on business operations, customer de-
mand and market dynamics.
Simplifies many complex decision-making through
robust data analysis.
Enable integration of data in the digital ecosystem
across various stakeholders.
Advanced AI/ML algorithms help predict the risk
associated in enterprise finance and develop suitable
risk management tools.
It further helps in detecting frauds, compliance
management on AML and other possible regulatory
risks in MSME finance.
Enables open banking ecosystem for fintech finance.
API has several other facilitating roles in MSME
development, such as enterprise identity, value chain
management, customer management and payments.
Provides huge data storage capacity, fast scanning,
omnidirectional readability and many other
advantages, including error correction.
Facilitate ease in management of KYC compliance of
MSMEs.
Enterprises use biometric identification and transaction
for banking and financial services.
155
 10.3.2. MSME Digital Lending:
Three Core Elements
The DI and DTT offer innovations in the digital
lending ecosystem by way of three core ele-
ments, namely (a) innovative delivery channels,
(b) advanced data analytics and (c) enhanced cus-
tomer engagement and experience. These three
core constituents in DL enable improvement in
the process of lending with the use of alterna-
tive digital channels such as smartphone-based
apps and quick codes in which alternative data
sources and advanced analytics are used for ef-
fective credit decisioning with enhanced cus-
tomer experience.
Given the nature of the MSME customer base
across rural and urban economies, formal and
informal sectors providing multiple digital de-
livery channels for convenient and swift credit
delivery and repayment are very essential for
building sustainable digital lending models. Due
to the informal nature of the sector, digitizing the
lending process is one of the critical drivers for
MSME finance and development. There is a wide
range of data available, including data regard-
ing payments of bills, bank transactions, phone
calls and so on, that is taken into consideration
for building data analytics with the help of algo-
rithms. Transparency in digital lending is essen-
tial for customer engagement and experience,
building convenient digital channels, personal-
ized products and affordable pricing. Tailor-made
and customer-centric digital communications
are the major advantages of the digital ecosystem
in improving customer experience and continu-
ous engagement.
10.3.3. Collaboration between
Fintech Companies and Banks
Fintech companies are eager to cooperate, part-
ner or collaborate with banks for the following
reasons: (a) banks generally have a more well-
defined and stable client base, (b) a partnership,
cooperation or collaboration with a bank is a
stamp of trust that confirms the credibility of
these fintech services to the customer, (c) banks
tend to have bigger investment budgets that can
provide a flow of capital to further develop fin-
tech services and (d) banks have a lot of internal
know-how and knowledge in areas that fintech
156 INDIA BANKING AND FINANCE REPORT 2021
firms can benefit from, such as legal and regula-
tory (e.g., client due diligence) compliance and
risk management.
On the other hand, banks are eager to col-
laborate with fintech players due to (a) the high
technology adoption rate by customers and the
emergence of one-stop shops and (b) the visible
shift to platform-based business models. The col-
laboration can soon result in the development of
a banking-as-a-service market.
10.4. Digital Lending
Business Models: Use Cases
from India
India is one of the fastest-growing emerging
market economies with innovative digital lend-
ing models. The IndiaStack3 is an innovative
and unique public DI that enables market play-
ers to innovate in new digital lending without
monopolistic market dominance. The evolving
government policy and public infrastructure
mechanisms are supporting the decline of asym-
metries across the ecosystem and authorizing
consent-based democratic data access and use.
Five unique digital lending models have emerged
in MSME lending in India:
• Marketplace lenders
• Balance sheet lending
• Invoice financing
• SCF
• Hybrid marketplace lending
The basic characteristics of the models and use
cases from India are discussed hereunder.
10.4.1. Marketplace Lenders
The marketplace lenders are the ‘digital platform
intermediaries’ that facilitate the customers and
financiers in handling the lending ecosystem
through customer acquisition, credit appraisal,
loan disbursement and recovery management.
India witnessed the first marketplace lending
in 2008, though it started in other parts of the
world in 2005 (IFC, 2018). However, the ma-
turity in this space in India is seen after 2014,
with public infrastructure in place. The greatest
merits of the digital platform are that it delivers
the financial services across geographies and
time zones. Marketplace platforms help lenders
map the risk profiles of their customers with the
help of advanced data analytics with precision,
faster credit decisioning and differentiated risk-
based pricing. The marketplace lending plat-
forms use a variety of technology and market
players. Well-known types are ‘guaranteed re-
turn’,4 ‘traditional peer-to-peer’ (P2P),5 ‘notary’,6
‘invoice trading’,7 etc.
In recent years, India has been known for
many popular marketplace lenders in the MSME
sector, such as Lendingkart, InCred, Faircent,
KreditBee and Innoviti. Innoviti is one of the
oldest marketplace lenders, founded in 2008 in
Bangalore and with a geographical reach of more
than 20 Indian cities. The business model of In-
noviti connects banks and financial institutions
with over 10,000 MSMEs with a loan outstand-
ing of `3.8 billion.
Lendingkart is another popular digital lend-
ing platform for MSMEs in India. It was started
in 2014 in Ahmedabad. Its business model allows
its partner banks to lend via mobile apps. During
2020–2021, it extended more than 17,000 busi-
ness loans amounting to `11 billion. The loan size
ranges from `50,000 to 20 million, with a ten-
ure of up to 36 months and flexible repayment
schedules. Lendingkart uses analytics and big
data scoring to evaluate their customers’ busi-
nesses and the risk associated with lending.
Faircent is the first NBFC-P2P lending market-
place based in Gurgaon and started its business
in 2013. The platform facilitates digital interac-
tion between the financier and the borrower.
Faircent provides risk-based credit scoring
models with a win-win approach for both lend-
ers and borrowers; borrowers benefit from a re-
duced cost of credit, and lenders gain business
with minimized credit risk. The business model
of Faircent is totally digital and paperless, from
customer onboarding to final settlement. Thus,
the model ensured greater penetration and a
lower cost of borrowing for the customers. Fair-
cent receives more than 3 million loan requests
every month and processes over `1 million loans
every month.
Emerging Technological Innovations in Financing Micro, Small and Medium Enterprises in India
10.4.2. Balance Sheet Lending Models
The balance sheet digital lenders are regis-
tered as NBFCs under the Indian Companies
Act, 2013. In this model, the lender takes the
credit risk and lends to the MSMEs from their
own capital. This model of lending is also called
‘portfolio lending’, where the loan portfolio
is shown on the platform’s balance sheet. The
business model of ‘balance sheet’ digital lenders
depends on funds raised from multiple sources,
such as family and friends, institutional lend-
ers and private equity investors, to lend from
their ‘own balance sheet’. All risks and returns
are directly associated with the model, and the
platform is responsible for any loss or gain from
the business.
The leading players in balance sheet lending
are InstaKash, Capital Float, IntelleGrow, U GRO
and so on. InstaKash is a Bangalore-based digital
lending company that was started in 2014 to of-
fer MSME working capital loans. The platform
appraises the customers on the basis of alterna-
tive data to generate the credit scores along with
Aadhar biometric information verification. The
lending platform uses advanced AI and ML algo-
rithms along with physical verification during
loan disbursement. The platform disburses the
loan within 72 hours and charges monthly inter-
est of 2 per cent.
Capital Float was founded in 2013 in Banga-
lore and is one of the prominent online platforms
that provides working capital finance to MSMEs.
Capital Float works on a unique business model
that enables the customer to complete the online
registration within 1 minute along with flexible
repayment schedules. The platform generally
disburses loans within a week to its registered
borrowers. The platform offers loans ranging
from 0.1 million to 1 million with an interest rate
of 13–19 per cent and a processing fee of 2.5 per
cent per loan. There are various types of loans
offered by Capital Float to its customers, such
as short-term business loans, working capital
finance, point-of-sale (POS) finance and loans
based on (a) cash flows, (b) receivables and (c)
bank statements.
U GRO is an NBFC and listed on the BSE. It is a
digital lending platform with a focus on MSME
157
 lending. U GRO’s business model is to serve
MSMEs in select industrial sectors, including
chemicals, food processing, healthcare, hospital-
ity, education, FMCG, auto components and elec-
trical equipment. The firm raised around `9.5
billion in capital from institutional investors,
private equity funders and other sources. U GRO
has built a robust enterprise financing digital
system with advanced analytical tools supported
by a deeper understanding of the intersectoral
and subsector features.
10.4.3. Invoice Financing
Delayed payment from the buyers is one of the
most perennial problems faced by MSMEs. To ad-
dress this challenge, many digital platforms are
actively delivering receivable or invoice finance
services to MSMEs. For MSMEs, invoice financ-
ing provides instant working capital with no col-
lateral security, as well as end-to-end digitalized
processing, which builds transparency and trust
among all stakeholders. To understand the busi-
ness model of an ‘invoice financing platform’, for
example, a small firm sells its goods and services
to a buyer who will generate the invoice pay-
able within 30–90 days. During this period, the
supplier can avail working capital against the
invoice from a financier for a particular fee or
discount. The final settlement will take place
between the financier and the buyer-business
enterprise through a digital platform.
The GOI and the RBI have taken several poli-
cy measures to address the challenges faced by
MSMEs in accessing financial services. TReDS
is one such digital initiative to facilitate the SCF
with a faster interchange of information across
MSMEs, corporate buyers and financiers.
In 2014, the RBI allowed the NBFC digital plat-
forms to operate TReDS, which is an institutional
mechanism to finance against the receivables of
buyers: large corporates, public sector undertak-
ings, government departments, etc. (RBI, 2018).
Three digital platforms, namely the Receivables
Exchange of India Ltd, M1xchange (Mynd Solu-
tions) and A.TReDS, are operating on the TReDS
platform, and they provide finance to MSMES
against their receivables under both factoring
and reverse factoring. Banks, NBFC factors and
158 INDIA BANKING AND FINANCE REPORT 2021
NBFCs are permitted to operate as financiers un-
der this model. During the financial year 2017–
2018, 22,704 invoices were uploaded to TReDS,
out of which 19,890 invoices were financed for
`8.15 billion. In the last three to four years, the
number of invoices and loans granted to MSMEs
through TReDS platform has increased manifold.
During the financial year 2019–2020, 530,077
invoices were uploaded on the platform, out
of which 477,969 invoices were financed with
`111.66 billion (RBI, 2020).
Along with the TReDS, there are many other
digital lending platforms that provide finance
against the invoice receivables. Two such promi-
nent platforms are KredX and Loanzen. KredX
was founded in 2015 in Bangalore as an ‘invoice
discounting platform’ to fulfil the working capi-
tal demands of small enterprises so that delayed
payments from buyers would not affect their
cash flows. The business model of KredX is dis-
tinctive from many other digital platforms due
to its ‘simple and easy online process’, ‘collateral-
free loan’, ‘seamless cash flow’, ‘swift digital dis-
bursement’, ‘customized solutions’, etc. KredX
has financed more than 800,000 invoices and
transactions totaling of USD 3 billion have been
processed. KredX has served more than 23,000
enterprises and 100 plus corporates are associ-
ated with it.
Loanzen was founded in 2015 in Bangalore as
MSME receivable financing platform. It helps en-
terprises get unsecured financing against their
pending invoices from buyers. The business
model of Loanzen targets enterprises with less
than three years of operations and those that are
finding difficulty in cash flow management due
to delayed payments from their customers. The
firm provides working capital loans for up to 120
days against the receivables.
10.4.4. Supply Chain Finance Models
In the SCF model, the participation of buyers like
large corporates and aggregators makes it dis-
tinct and more specialized in financing MSMEs.
The SCF model facilitates working capital fi-
nance to MSMEs through invoices or receivables
as sporadic securities. There are two well-known
SCF business models: ‘factoring’ and ‘reverse
factoring’. In the former business model, the
MSMEs sell their account receivables for a dis-
counted price to the financier or third party like
banks/financial institutions or to a digital plat-
form aggregator. In the latter business model, the
buyers of MSMEs’ products and services origi-
nate the transactions by floating the invoices on
the digital platforms.
The SCF model helps both MSMEs and corpo-
rates manage their working capital effectively
by leveraging the prevailing business relation-
ship between the two. As many of the Indian
MSMEs sell their final products and services to
multinational companies or international com-
panies, global SCF has also emerged in the recent
past. Some of the global platforms are actively in-
volved in providing SCF to MSMEs.
Digital business models have transformed the
SCF market by leveraging the advanced techno-
logical interface that provides an efficient and
transparent business process. The fintech and
SCF models are unique (Table 10.5) due to their
differentiated business models that are emerging
from advanced technology, offering innovative
digital products and services and use of remote
process and customer experience (PwC, 2020).
10.4.5. Hybrid Marketplace Lenders
The technology has multiple advantages for de-
signing unique and innovative models in the lend-
ing space. One such example is ‘marketplace hy-
brid model’ which is a blend of marketplace and
balance sheet lending models. In a hybrid model,
the majority of loan portfolios are created with
a lender’s own money, and the remaining port-
folios are made using marketplace lending. The
platforms adopt strong AI/ML models to decide
the creditworthiness of the customers and match
them with a suitable financier for the desired
loan. The majority of platforms are experimenting
with either a balance sheet or marketplace lend-
ing model. As the model matures and they gain
experience, they develop a stronger hybrid model
with an effective combination of both.
Capital Float is a noteworthy use case to refer
to in the space of hybrid marketplace lending

Table 10.5 Emerging Business Models and Advances in SCF Ecosystem

Disruptive Technologies
APIs: Digital platforms
leveraging the advance-
ment of APIs in developing
tech-stack’s that are asset-
light models and easy to
customize across the SCF.
Data analytics: Advanced
data analytics through AI/
ML-based algorithms helps
the fintechs to identify
various business opportuni-
ties in the value chain with
robust risk management
and value creation.
DLT/blockchain technology:
The SCF platforms adopt
DLT or blockchain technol-
ogy to facilitate transpar-
ent transaction across the
players in the ecosystem.
Source: PwC (2020).
Innovative Products
Electronic-warehouse
receipt finance (E-WRF):
MSMEs/corporates shall be
able to get the working
capital against their collat-
eral in warehouse through
all in digital process.
Invoice discounting: Digital
lenders offer receivable
finance against the unpaid
invoices with transpar-
ent discounting or price
discovery.
Capex discounting: Equip-
ment purchase finance is
getting digital and has
flexible option for the en-
terprises to purchase and
make payments.
Differentiated Business Model
Dynamic discounting model: Digital
platforms offer dynamic discounting
to motivate a timely payment from
buyers in exchange for cash discounts.
Early cycle discounting: Fintech’s have
evolved an innovative business model
with the help of predictive analytics.
The firms use alternative data along
with the information on purchase,
shipment and payment to develop the
model that are able to capture and
extend finance before invoices are
approved by any financier.
Securitization of SCF: Fintechs and
debt platforms are partnering to
finance against invoice-backed securi-
ties through reinvestment on cash
flows from invoices.

Emerging Technological Innovations in Financing Micro, Small and Medium Enterprises in India 159
 in India. Its model blends across both balance
sheets, as well as an aggregator and partnership,
and marketplace lending models. As a partner-
ship digital marketplace lender, it collaborates
with banks and NBFCs in India for lending to
MSMEs. Another prominent use case is ‘Kinara
Capital’. It is an NBFC providing loans to small
enterprises with flexible loan size from `0.1 mil-
lion to 3 million with entire digital process in
local languages. The firm offers various type of
loans ranging from term loans to working capital
finance. The firm has disbursed more than `20
billion to over 35,000 MSMEs in India.
10.5. Digital Lending during
the COVID-19 Pandemic
Since the onset of the pandemic in 2020, the adop-
tion of digital technologies has accelerated among
many MSMEs. This has facilitated them to avail in-
stant credit from technology-based lenders. Other-
wise, they would have relied mostly on informal
moneylenders as earlier. The lockdown due to CO-
VID-19 led to a huge surge in digital payments, and
many lenders have been trying to capitalize on
this opportunity. For example, NeoGrowth Credit,
which has been in business for about 9 years now,
disbursed a loan amount of around `14.5 billion
during the financial year 2020–2021 and is now
aiming to increase the same to `25 billion during
2021–2022. Other top MSME lenders include Lend-
ingKart, FlexiLoans, U GRO, etc., which too have
increased their market share during the pandemic.
During the COVID-19 pandemic, many other
lenders also leveraged technologies and AI/ML
to automate their lending process, thereby facili-
tating rapid processing of applications and quick
loan disbursals. They are focusing on data sci-
ence and analytics in order to mitigate the risk
of fraud. For instance, in April 2020, ‘IndiaLends’,
an online platform, launched Digital Lending 2.0,
a series of touchless and contactless products,
including loans, lines of credit and insurance for
MSME customers.
Some of the prominent models used by digital
platforms to finance MSMEs during COVID-19
are P2P lending, POS financing, invoice-based
lending, crowd financing, pay-later loans, SCF
160 INDIA BANKING AND FINANCE REPORT 2021
and digital mortgage. During 2018–2020, the
share of digital lending platforms in the total
MSME lending segment was around 13 per cent,
which is expected to rise to 50 per cent by 2023.
10.6. Regulatory Concerns
in Digital Lending
With the advent of technology and fast-paced
growth in digital lending, it has created various
concerns for the regulator. These are discussed
as follows:
1. Lack of regulation: Many digital lending
platforms take advantage of blind spots in
the law. They target vulnerable customers
by compromising regulatory compliance
and offering easy access to credit. To curb
the menace, the RBI formed a working
group on digital lending, including lend-
ing through online platforms and mobile
apps. The working group has submitted
its report on 18 November 2021, which
contains various measures and sugges-
tions for regulation of regulated entities
such as banks, NBFCs and unregulated
players like digital lending platforms.
2. Although digital lending platforms have
rightfully received backlash, demoniz-
ing the entire industry is overkill. Digital
lenders play a significant role in financial
inclusion. They provide services to cus-
tomers that banks are unable to provide.
They bring relief to people who need easy
access to credit. So the focus must be on
quelling predatory practices, not throt-
tling the entire digital lending industry.
For instance, borrowers should have the
freedom to use their data to avail loans
digitally and regulations must not strip
users of this right.
3. Light-touch regulations: Light regulations
are the prerequisite for the promotion of
digital banking in general and lending in
particular. In most cases, digital platforms
are unable to lend money on their own. So
they partner with regulated entities like
banks or NBFCs. These regulated entities
lend money to the borrowers with the help
 of digital platforms and are tasked with
keeping the platforms in check as per regu-
latory compliance. In many cases, they
failed to do so, which led to the regulatory
concern. In June 2020, the RBI reminded
banks and NBFCs that they must abide by
the Fair Practices Code when they offer
loans through digital lending platforms.
Also, they must ensure that their digital
lending partners follow the Fair Practices
Code while interacting with borrowers.
4. Data protection: Another factor empow-
ering digital platforms is the lack of a
dedicated data protection law in India.
The Personal Data Protection Bill, 2019,
is still in the works. In its absence, apps
can take sweeping consent from users to
access their personal data from various
sources and then use their data without
their consent.
Regulators and policymakers have to be more
cautious than ever before as the digital lending
market is expanding rapidly and the funding
needs of MSMEs are being catered to more through
NBFCs or fintechs. Well-equipped regulators with
smart tools and using smart monitoring are need-
ed to ensure a healthy digital lending space.
10.7. Future of Digital
Lending and Conclusion
In order to make India a less cash economy, the
GOI has launched a Digidhan Mission to pro-
mote digital financial transactions in 2017–2018.
During 2019–2020, India achieved the following
milestones (Table 10.6).
Table 10.6 Some Selected Achievements of
Digidhan Mission
Particulars Milestone Achieved
Aadhar seeding 1125.10 million
Mobile seeding 1,081.70 million accounts
Number of digital 45,720 million
transactions
Number of physical 5,787,878
and mobile POS
Source: Government of India (2020).8
Emerging Technological Innovations in Financing Micro, Small and Medium Enterprises in India
As explained earlier, the current COVID-19 pan-
demic has forced the adoption of digital technolo-
gies by small businesses and households alike.
Many micro-enterprises have started accepting
and making payments digitally. Many have tied
up with ecommerce firms, and a large number
of small businesses have started accepting orders
through Facebook and WhatsApp. All these au-
gur well for enabling digital lending.
With the successful digital business models
of fintech as well as banks and financial insti-
tutions and the introduction of new products/
segments, this year will see the highest number
of acquisitions in the market. Banks and NBFCs
will acquire primarily lending fintechs for their
technology and customer access. Wealth firms,
which have shunned technology till now, will
acquire wealthtechs for their tech prowess. Pay-
ment fintechs will acquire smaller payment play-
ers, wealthtechs, insurtech players, etc. Lending
fintech will acquire wealthtech and insurtech to
bring width to their business. Wealthtech play-
ers would acquire smaller wealthtech players for
access to their customer base.
According to MEDICI Global,9 India has ex-
perienced a fintech revolution as a result of a
four-point framework: (a) formalizing identity
through the use of the Aadhar number, (b) ob-
taining a bank account or equivalents (Pradhan
Mantri Jan-Dhan Yojana) for everyone to store
money, (c) creating scalable money transfer plat-
forms (IMPS,10 UPI,11 BBPS,12 etc.) and (d) enabling
banks, fintechs and wealth/insurance/lend-
ing firms to innovate via platforms such as UPI,
GSTN, and DigiLocker. At the core of the rapid
growth of fintech are new technologies that
have revolutionized the ways in which finan-
cial products and services are created, provided
and managed. However, digital lending involves
credit analysis and credit decision-making us-
ing sophisticated technology with minimal or no
human intervention. This is a risky proposition
and needs to be handled with adequate testing,
back testing and so on. Nevertheless, the faster
evolution of fintech and necessary regulation
and supervision of digital lending will create an
enabling environment for digital lending to pick
up at a faster pace in India, and one can hope that
the funding gap of MSMEs will largely be filled
161
 adequately and efficiently in a matter of a few
years down the line.
Acknowledgement: Authors are grateful to the
anonymous referee for their valuable feedback.
Notes
1. Micro Units Development & Refinance
Agency Ltd.
2. https://www.yesbank.in/business-banking/
loans/yes-gst
3. It is a set of APIs that let governments, business
enterprises and start-ups take advantage of
the public infrastructure to deliver paperless,
cashless and presence-less financial services.
4. The platform offers loan guarantees to the
creditors to cover the loan amounts and
their interest.
5. A prospective borrower registers with many
details for a future loan, and the platform
verifies all of the details. The creditors can
select the borrowers on the basis of their
risk appetite, and accordingly, the digital
contracts take place between the lenders
and borrowers.
6. The model acts as an ‘agent’ between credi-
tors and borrowers, whereby financial insti-
tutions originate all digital loans.
7. The model finances the receivables or
invoices. The invoices are traded on the
platform for getting working capital or for
emergency liquidity for the business unit,
say, for MSMEs.
8. https://digipay.gov.in/dashboard/About.aspx
9. MEDICI Global is a leading platform provid-
ing insights and advisory for the fintech in-
dustry (https://gomedici.com/).
10. Immediate payment service.
11. Unified Payments Interface.
12. Bharat Bill Payment System.
162 INDIA BANKING AND FINANCE REPORT 2021
References
Government of India. (2016). 6th economic census.
Government of India. (2020). Digidhan mission.
Ministry of Electronics and Information
Technology. https://digipay.gov.in/dash-
board/About.aspx
Government of India. (2021). Annual report 2021.
Ministry of MSMEs.
GPFI. (2021). The 2nd global alternative finance
market benchmarking report. https://
rbi.org.in/Scripts/AnnualPublications.
aspx?head=Trend%20and%20Progress%20
of%20Banking%20in%20India
IFC. (2018). Financing India’s MSMEs: Estimation
of debt requirements of MSMEs in India.
Microsave Consulting. (2020). Bridging the credit
gap for MSMEs: Gaps in access and solutions.
https://www.microsave.net/wp-content/
uploads/2021/01/201207_Bridging-the-
Credit-gap-for-MSMEs.pdf
PwC. (2020). Unlocking credit for MSMEs: Innova-
tions in supply chain finance. https://www.
pwc.in/consulting/financial-services/fin-
tech/fintech-insights/unlocking-credit-
for-msmes-innovations-in-supply-chain-
finance.html
RBI. (2018). Guidelines for the trade receivables dis-
counting system (TReDS).
RBI. (2019). Report of the Expert Committee on Mi-
cro, Small and Medium Enterprises.
RBI. (2020). Report on trend and progress of bank-
ing in India.
RBI. (2021a). Annual reports (digital payments/
transactions).
RBI. (2021b). Handbook of statistics on Indian
economy, 2020–2021.
World Bank. (2020). Promoting digital and inno-
vative SME financing. https://www.gpfi.org/
sites/gpfi/files/saudi_digitalSME.pdf
Digital Transformation of
Banking Institutions
Deepankar Roy and Paritosh C. Basu
11.1. Introduction
Consumer expectations and behaviour are con-
tinuously changing due to the DT of business
operations across industry sectors with applica-
tions of advanced technologies. This has created
pressure on conventional firms and disrupted
various sectors. Lemon and Verhoef (2016) ob-
serve that consumers have access to dozens of
media channels and apps. Their customer jour-
ney includes an ever-increasing number of digi-
tal touchpoints. Wlömert and Papies (2016) find
that many brick-and-mortar businesses have
been threateningly overtaken by creative, fast-
growing digital newcomers. A case in point are
the giant e-commerce players such as Alibaba
and Amazon. They utilize digital capabilities to
infiltrate markets hitherto not accessible by tra-
ditional players. Banks such as ING see Amazon
as a major prospective rival, while the giant ship-
per Maersk may face competition from Alibaba.
DT is the process of integrating digital tech-
nologies into the core of an entity’s functions,
from hierarchy to tools and operations to cus-
tomer services. It optimizes the combined power
of digital tools, innovative processes and peo-
ple. Given that DT is an interdisciplinary func-
tion encompassing changes in vision, mission,
strategy, culture, ICT (information and commu-
nication technology) and operating activities,
multidisciplinary collaboration is a must. Thus,
business managers are increasingly being chal-
lenged to adapt and perform in the emerging
digital ecosystem.
Digital technologies, namely AI, blockchain,
IOT, robots, robotic process automation (RPA),
11
Chapter
augmented reality and virtual reality (VR) are
being applied to DT at an overwhelming speed.
Scholars such as Brynjolfsson and Mcafee (2014)
believe that the world is approaching the dawn
of a machine era in a networked environment.
According to an Accenture report, start-ups are
not only increasing in number but also rapidly
innovating for faster value creation. The promi-
nence of financial technology (fintech) start-ups
and customers’ preference for digital experi-
ences make it critical for traditional financial
institutions to consider DT. Fintech competition
is unbundling the value chain via specialized ser-
vices, which large banks cannot ignore this (CB
Insights Research, 2015).
Large organizations adopting DT aim at a va-
riety of goals, including meeting stakeholders’
expectations, simplifying procedures, anticipat-
ing risks, implementing risk-enabled systems,
enhancing the power of business and revenue
models, etc. This qualitative study looks at the
major objectives and practices of eight large
banks across four continents on the basis of evi-
dence collected from their annual reports and
other publicly available information. It attempts
to explain the nature of stakeholders’ demands,
attributes, adoptions and applications of tools
for DT.
This research illustrates the core of changes
implemented by those selected eight large banks
through DT. The findings on five major themes
reveal the nature of transformations and dis-
tinguish institutional behaviours in practice.
Further analysis of information on new initia-
tives provides directional indications of further
advancements. The conclusion drawn therefrom
 would serve as a set of guidelines for institutions’
comparative standards for benchmarking.
This chapter is divided into six sections. Theo-
retical foundations have been enumerated in the
second section. Research methodology has been
provided in the third section. Observations and
findings from research have been presented in
the fourth section. The fifth section contains
narratives describing the significance of the find-
ings and how they may be further categorized to
better understand DT maturity. The sixth section
depicts salient features of the DT journey of the
Indian banking industry.
11.2. Theoretical Foundation
11.2.1. Technology Adoption
by Organizations
Hsu et al. (2006) draw attention to how the dif-
fusion of innovation theory shows the variables
such as individual leaders’ traits and an organi-
zation’s internal structural and external charac-
teristics influence technology adoption and in-
novativeness. Scott (2001) identifies that the TOE
framework dwells on three factors of an institu-
tion’s context, namely technology, organization
and environment, that influence technology
adoption and implementation. The decision to
adopt technology may not be purely based on in-
ternal motives; Dimaggio and Powell (1983) sug-
gest that institutions may be prompted to adopt
and use technology by some external isomor-
phic pressures. Soares-Aguiar and Palma-dos-
Reis (2008) explained how generic trends and
institutional pressures that are mimetic, coercive
and normative may influence temperaments to-
wards technology.
11.2.2. Digital Business Strategy—
Surpassing Technology Adoption
According to Bharadwaj et al. (2013), the emerg-
ing theme of digital business strategies may be
categorized under four major groups, namely
scope, scale, agility and source of value creation.
Institutional ecosystems, intending to leverage
digital opportunities for value creation by inte-
gration of processes and functions, would be an
influencing force for scoping digital strategies. To
innovate, the scale and speed of digital strategy
164 INDIA BANKING AND FINANCE REPORT 2021
will require leveraging networks and ecosys-
tems. Performance metrics are used as an in-
dicative measure of business value creation from
digital technology initiatives.
Many traditional players cling to profitability
as a financial metric, whereas many digital firms
give importance to growth in the number of users,
customers and sales rather than being profitable.
High growth cannot substitute for profitability
concerns, despite that being important. There-
fore, large traditional players face challenges
when competing with digitally transformed com-
petitors. They need to simultaneously achieve
two goals, namely reduce costs through DT and
increase revenues through improved customer
experience. Some researchers, including Chris-
tensen et al. (2016), have recommended that they
set up a new arm with full focus on DT.
11.2.3. Transformation through
Digital Technology Usage
The achievement of success in DT projects de-
pends largely on the level of maturity in the
adoption of technology. Westerman et al. (2011)
attempted to define DT as ‘the use of technology
to radically improve the performance or reach of
enterprises’. Their research has shown that DT
has an impact on institutions in three key areas,
namely customer experience, operational pro-
cesses and business model.
The nature of transformation is not only in
applying new technologies but also in the in-
stitution’s ability to rethink opportunities that
include expansion, collaboration, interactions,
modularization and integration of current busi-
ness processes with digital technology. The inter-
est of leadership in cultural change, openness to
facing risks and resilience in the development of
a digital business strategy are very relevant. Key
digital assets and capabilities required for a DT
include digital assets, digital agility, capabilities
for digital networking and BDA capability.
11.2.4. Transformation through
Changes in Organizational Structure
Besides the digital resources required for a trans-
formation, it is also important to modify the
organizational structure and remain flexible to
progress with DT. Earlier studies revealed that
DT helps implement a more flexible organiza-
tional structure with agile forms and digitally
operating areas.
11.2.5. Digital Transformation
of Banks
Financial institutions are among the most highly
regulated sectors in the world and are expected
to keep pace with regulatory changes and com-
petition. However, contemporary developments
are towards promoting open banking architec-
ture with the least possible intervention by tra-
ditional control systems. The drivers for such
changes are the proliferation of digital technolo-
gies, including AI and BDA, smart mobile devices
with speedier connectivity, the emergence of
fintech start-ups and changes in customers’ at-
titudes and behaviours. With financial institu-
tions continuing to evolve, discussions about the
future of work and how banks will engage con-
sumers are becoming more significant.
11.3. Methodology
11.3.1. Identification of Samples,
Data Sources and Data Collection
This research-based work studies ideas of digital
technology-led transformation as demonstrated
by large banks from four continents, namely In-
dia, the USA, Australia and Europe. Eight large
banks have been identified, namely SBI, HDFC
Bank, the Bank of New York Mellon Corporation
(BNY), BOA, the Commonwealth Bank of Austra-
lia (CBA), Westpac Banking Corporation (WBC),
DB and BB, all holding greater than USD 100 bil-
lion in assets. Table 11.1 contains a summary of fi-
nancial performance of these eight banks in 2020
under certain major parameters, including for
turnover, profit, ROI, total advances, and budget
for technology and digital transformation. Read-
ers after perusing through the table would be able
to appreciate their financial state of affairs and op-
erating results before acquiring more knowledge
about their DT activities. These eight banks have
demonstrated a significant focus on harnessing
digital technology. The annual reports of these
eight banks for the financial years 2019–2021
provide detailed and focused narratives on their
dedicated and innovative action steps for DT and
the results achieved so far. The research design
includes studies of gradual and consistent emer-
gence in technologies, as well as continued insti-
tutional focus and commentaries on the subject.
Published news reports, articles, interviews, com-
mentaries of senior executives, etc., as available
in cyberspace and on the websites of the selected
banks have also been examined. The relevant nar-
ratives derived from the literature review have
also been corroborated. All of this contributed to
a better understanding of the narratives on DT’s
associations, overlaps, and stand-alone ideas.
11.3.2. Data Analyses
This is achieved by qualitative, theme-based nar-
rative analysis.1 The narratives have been coded
applying Vivien Beattie et al.’s (2004) theme-
based narrative analysis techniques for qualita-
tive research and further analysed to present the
findings and insights. Analyses have also been
performed for qualitative information, including
visuals, graphs, tables and other sections, with a
focus on DT.
11.3.2.1. Data Coding Process
The research bases its coding process on the cat-
egorization of the said disclosures in those banks’
annual reports into five broad themes of relevance
and related sub-themes. These themes were iden-
tified through two considerations. The first being
views on technology adoption from an extant lit-
erature review and expert opinion. The second is
from the exploratory study, which factored in the
identification of any new themes or particularly
sub-themes emerging from the narratives. Within
each of the themes, appropriate narratives have
been identified as indicative expressions. Some of
them have been included in this chapter for read-
ers to better interpret the findings.
11.4. Findings and
Observations
11.4.1. Theme-based Qualitative
Analysis of Narratives
The primary objective of such data analysis is
to bring out the expressions of those banks’ re-
sponses towards digital technologies by scan-
ning and coding all data and information into
themes and sub-themes.
Digital Transformation of Banking Institutions 165
 The narratives and evidence obtained are coded
into the themes manually by adopting inter-rater
assessment techniques (Kayapinar, 2015). The
findings are indicative of institutional practices,
disclosures and focus on digital technology and
helped identify new themes. This study could
ascertain five key theme areas across the eight
banks, namely (a) digital growth strategies, (b)
digital technology, (c) application of digital tech-
nologies in banking operations, (d) change in orga-
nizational structure and (e) digital ecosystem. The
coding process entailed theme-based classification
of the narratives (in sentences and paragraphs).
11.4.2. Theme 1: Digital Growth
Strategies
Growth is one of any business manager’s most im-
portant responsibilities, whether that comes from
the branch, through M&A or digital channels. Dig-
ital growth can be a scalable and predictable way
for a bank to grow if executives can effectively
and accurately measure and execute their efforts.
Banks need a well-thought-out digital growth
strategy because of the changing role of branches
and competition from peer banks and fintechs.
11.4.2.1. Digital Vision
A digital vision answers the question, ‘How does
a bank want to define itself as an organization
with respect to emerging technologies?’ A digital
vision should paint a convincing picture of the
transformation, and it should nurture under-
standing at all levels of the organization.
HDFC: ‘Our vision is to make HDFC Bank a
digital-first bank where every customer journey
across touch-points is seamless, contextual, pre-
dictive and frictionless.’
BOA: ‘…We are combining our industry-lead-
ing expertise with cutting-edge technology to
build smart, forward-thinking solutions that en-
able us to continue leading the way in helping
people live better financial lives, as well as com-
panies and institutional investors improve their
financial performance.’
BB: ‘Digital eagles—to get the most out of digi-
tal. Our vision for the future combines technol-
ogy with humanity, leveraging the very best
digital solutions to deliver care that’s proactive,
responsive and personalised.’
166 INDIA BANKING AND FINANCE REPORT 2021
11.4.2.2. Digital Mission
A bank declares an action plan to undertake DT
through the integration of digital technologies,
processes and competencies across various levels
and functions in a strategic way.
HDFC: ‘Adopting technology to power DT in
banking, focusing on semi-urban and rural areas
to drive high growth, and creating sustainability
in far-flung areas across India.’
BNY: ‘BNY Mellon has made an unwavering
commitment to systemic resiliency and contin-
ued digitization. Our open and objective stance
on technology and innovation means that we
work to develop solutions that can help reduce
friction and increase transparency throughout
the investment lifecycle.’
CBA: ‘Our mission was to bring new solutions to
market that empower customers as never before.’
11.4.2.3. Digital Strategy
It focuses on leveraging technology to improve
corporate performance, and that means develop-
ment of new products and/or the redesigning of
existing processes. It lays down an organization’s
strategies for leveraging digital technologies to
gain new competitive advantages and the strate-
gies it will employ to make these changes.
HDFC:
Digital 2.0 essentially is about re-imagining our
digital platforms providing the customer with
a frictionless financial experience. The objec-
tive is to move the customers from a single
transaction to a complete financial solutions
journey and thereby, meet all their financial
needs…. Be it Pay, Save, Invest, Borrow, Shop,
Trade, Insure and Advice….
The next phase of the bank’s transformation
is based on five important pillars and is altering
how clients transact and connect with the bank.
They are as follows: reimagined customer in-
terface, digital analytics, digital acquisition and
digital marketing, innovation, API banking and
VRM (virtual relationship manager).
CBA:
Prioritises customer experience to deliver
intuitive and user-friendly digital banking
services. Invests in Customer Engagement
 Engine, which uses AI, ML (Machine Learn-
ing), and insights from customers’ activities
for a relevant and personalized experience.
Invests in innovation and strategic partners to
enhance back-end processes and customer fac-
ing applications. We are advancing our digital
strategy to deliver one of the greatest digital
experiences in the world to our consumers.
11.4.2.4. Partnership with Fintechs
and Neobanks
With the relevance of the platform economy gain-
ing momentum, banks need to respond to benefit
from such ecosystems and marketplaces as they
create space for banks to fulfil customers’ needs
by getting partners onboard and enabling end-to-
end delivery of offerings. Digital strategies need
not always be organic. Partnerships with fintechs
and neobanks can prove useful to evolve with DT.
SBI: The Fintech Innovation Incubation Program
of this bank aims to support innovative start-ups
in their quest to grow into scalable and long-term
fintech entities. The SBI is developing world-class
incubation facilities with sectoral experts for
mentoring. The objectives are to encourage start-
ups and foster an entrepreneurial culture in India.
CBA: This bank has teamed up with Square Peg
and Zetta Venture Partners to offer its 15 million
customers new digital banking options. It has
pledged $ 10 million to support sourcing, scaling
and financing local fintechs and develop upcom-
ing AI businesses in Australia.
11.4.2.5. Use of Digital Platforms
and Online Marketplaces
The most prominent growth strategy for digi-
tal banks involves the use of digital platforms.
Platforms can scale up quickly and handle the
expanded number of customers, suppliers, com-
plementary service providers, etc., because the
costs for serving additional users are low.
SBI: YONO (You Only Need One) is an inte-
grated digital banking platform (DBP) offered
by this bank to enable users to access a variety
of financial and other services such as flight
and train bookings and online shopping. It is
offered as a smartphone app for both Android
and iPhone Operating System (iOS). Over 80
merchant partners are live on the YONO business
to consumer (B2C) marketplace platform across
21 categories, witnessing about `320 crore of
gross merchandise value.
11.4.2.6. Metrics for Measuring DT
Money and resources spent on DT may not yield
an immediate return on investment (ROI). There-
fore, it is important to use metrics such as score-
cards to measure successes and to identify how
much time and money should be spent on spe-
cific areas. Once such group-wise scorecards are
ready, compared and critiqued, a clear mission
begins to emerge. Organizations should measure
ROI from DT in terms of both financial returns
and a set of appropriately designed quantitative
and qualitative returns, such as hackathons, agile
project management and collaborations, to usher
in a cultural shift.
BOA: The digital customer base has increased
from 36 million in 2018 to 38 million in 2019. In
2019, digital channels generated 29 per cent of
overall revenue. A total of 34 per cent of mort-
gages and 56 per cent of auto loans are presently
originated through mobile apps or online bank-
ing sites. Members are more than 85 per cent sat-
isfied with their banking relationship and have a
retention rate of nearly 99 per cent. In addition, 8
out of 10 members say that they are ‘highly like-
ly’ to recommend the bank to friends and family.
BB: The digital customer base is 11.5 million
and counting. Customers banking securely
on the app have increased to over 7.4 million,
with 1.7 billion interactions in 2017 compared
to 83 million five years ago. Over 120 customer
journeys have been transformed for customers
with industry firsts such as Siri payments, video
banking and mobile cheque deposit. A total of 70
per cent of operations were transferred to digital
channels, while 67 per cent of products are pro-
vided through digital channels.
11.4.3. Theme 2: Digital Technology
This section covers various types of products and
services that selected banks offer using cutting-
edge technologies such as blockchain, AI, ML,
RPA, analytics and CC.
11.4.3.1. Blockchain
The banking industry has faced multifari-
ous problems for a long time. The features of
Digital Transformation of Banking Institutions 167
 Table 11.1 Financial Performance in 2020 of Selected Banks (Financial Numbers Are in USD Billion)
Financials SBI HDFC BNY BOA CBA WBC DB BB
Net income 2.86 12.71 3.63 17.89 7.36 1.67 0.73 3.36
Revenue 52.30 21.16 15.81 85.53 18.62 22.18 35.56 29.75
Total equity 37.40 28.48 45.94 272.92 49.41 49.42 72.97 91.41
ROE 8% 16.49% 8.7% 6.14% 10.3% 6.5% 0.25% 3.68%
Technology/DT budget 0.54 NA 3 10 4.36 1.45 15.25 5.67
Net interest income 16.57 9.41 2.98 43.36 11.97 12.13 13.52 11.10
Cost–income ratio 43.34% 40.37% 76.77% 74.17% 43.50% 61.60% 80% 64%
NIM 3.26% 4.10% 0.84% 1.90% 2.03% 2.03% 1.25% 2.94%
Net NPA 5.04 0.62 0.10 6.37 1.11 6.64 26.87 2.43
Total deposits 504.31 181.22 341.55 1795.48 459.68 429.44 666.39 657.45
Total advances 339.42 153.77 56.47 909.06 493.08 503.49 500.93 468.29
Source: Annual reports of 2020.
Note: Exchange rates as on 21 September 2021.
1 AUD = 0.7265 USD 1 EUR = 1.1737 USD.
1 INR = 0.01359 USD 1 GBP = 1.3665 USD.

blockchain technology, namely safe, P2P net-
work, immutability, encryption, embedded
smart contracts, security, privacy, transparency,
decentralized database, cost-effectiveness and
minimum centralized control, offer solutions
to tackle these issues. Blockchain has many use
cases for banking operations, such as inter-bank
clearance and settlement, lending and borrow-
ing, trade finance and digital currencies.
SBI: This bank has partnered with JP Morgan
to use the latter’s blockchain-based solutions to
speed up international transactions. The objec-
tives are to lower transaction costs, shorten pay-
ment processing time and achieve customers’
delight, besides benefits from all other features
of blockchain.
BOA: This bank uses blockchain to settle nu-
merous stock deals. It has joined the USA’s block-
chain network for the settlement of equities.
This service allows two parties to settle equity
deals in a matter of minutes rather than days.
The Securities and Exchange Commission, USA,
has authorized this service in October 2019.
BB: BB and Wave, an innovative start-up,
have become the first companies to use block-
chain to complete a global trade transaction. The
new system has the potential to speed up trade
transactions, save expenses, improve internal
procedures and minimize the danger of docu-
mentation fraud.
11.4.3.2. AI/ML
Banks are increasingly employing AI and ML
in a variety of applications across channels to
draw inferences from large volumes of data. This
helps to appreciate emerging trends in custom-
ers’ needs, behaviour and type of service deliv-
ery that would be beneficial. It also helps predict
the types of fraudulent activities that may attack
customers’ devices.
BOA: This bank has started using AI to forecast
the likelihood of a company defaulting on loan
repayment. Increasingly, AI is helping the bank
understand clients’ evolving expectations and
improve risk-enabled service delivery with effi-
ciency and reliability.
CBA: In real time, the Customer Engagement
Engine runs 400 ML models and ingests 157
billion data points. The engine delivers around
35 million decisions per day on a real-time basis
in less than 300 milliseconds for each.
BB: Because of banks’ large data sets and im-
provements in CC, they are increasingly employ-
ing AI in fraud detection and prevention.

168 India Banking and Finance Report 2021

11.4.3.3. RPA
RPA, powered by AI for cognitive abilities, helps
to replicate human actions, judgement and intel-
ligence to complete repetitive tasks in the back
office such as data extraction, form filling, data
conversion and periodic reporting. RPA can dis-
rupt the functioning of back, middle and front
offices and help save cost with increased speed,
accuracy and compliance.
HDFC: It has automated data collection pro-
cesses using RPA. Loan processing for all loca-
tions has been moved to a centralized platform
where all credit administrators may observe
real-time loan processing in progress. It also al-
lows the bank to assign cases to credit managers
depending on the nature of the loans, location
and eligibility. This has led to a reduction in time
by 50 per cent and improved services for more
clients. Productivity of staff for data entry and
decision-making has improved by 40 per cent
and 12 per cent, respectively.
WBC: In the aftermath of the COVID-19 pan-
demic, this bank has increased its usage of both
attended and unattended software ‘robots’ to
automate the management of process-intensive
jobs. These perform large-scale processing ac-
tivities, including qualification and approval of
financial assistance packages.
11.4.3.4. Chatbots
A chatbot is an ICT device powered by AI for
NLP. It can conduct online chat/discussions, imi-
tate the way a person would act as a conversa-
tional partner. Chatbots are used for a variety of
tasks, such as customer support, request routing
and collecting information. Virtual assistants or
website pop-ups are the most common ways to
interact with chatbots.
HDFC: Electronic virtual assistant (EVA), India’s
first and largest AI-powered banking chatbot,
was introduced by this bank in 2017 to better
serve consumers. EVA has answered 5 million
enquiries from over a million customers with
an accuracy rate of over 85 per cent. Instead of
searching, browsing or waiting for a call, custom-
ers instantly obtain desired information by chat-
ting with EVA. EVA has successfully been linked
with Amazon’s Alexa, making it the first bank to
provide voice banking through Alexa.
BB: Customers of this bank may now make
payments by saying to Siri (Apple’s voice assis-
tant), ‘Hey Siri, pay [Sarah] £15 ($19) using Bar-
clays.’ To use the functionality, customers will
need an iOS device with touch ID and an Apple
operating system from iOS 10 onwards.
11.4.3.5. Big Data Analytics
Customers’ data are gathered by banks through
social media platforms, websites, previous
purchases and browsing history. When users
browse through websites, mobile apps and/or
digital displays, the on-screen data, including
graphics/pictures, are analysed and utilized to
produce suggestions using tools for BDA.
BOA: This bank can progressively process and
analyse data from its entire client base thanks to
BDA. If a client starts an application online but
doesn’t finish it, he/she may receive a follow-up
offer through a message or an e-mail to schedule
an appointment at a physical branch. They have
geared up their financial forecasts by using BDA.
Forecasting, which used to take months, can
now be done in less than a day.
CBA: This bank has introduced a new business
analytics platform, namely Daily IQ 2.0, aimed at
providing access to big data to small-to-medium-
sized enterprises (SMEs). The main objective is to
allow SMEs to use the repository of bank’s trans-
action information, along with critical data feeds
and scenario modelling, to generate a clearer
daily picture of the possibilities and dangers that
exist inside their organization.
11.4.3.6. Cloud Infrastructure
Banks are increasingly turning to CC solutions to
store data and enable applied analytics to meet
capacity and speed requirements. This helps im-
prove customer insights, functional efficiency,
innovation and agility. Risks related to security
and business continuity breaches can also be
minimized.
SBI: The private cloud of this bank, christened
‘Meghdoot’, was launched in 2014. It has success-
fully delivered IAAS to over 1,000 apps. It has the
capacity to host 15,000 virtual servers and a scal-
able architecture to offer computing infrastruc-
ture on demand, and it is on its way to becoming
a PAAS provider.
Digital Transformation of Banking Institutions 169
 BNY: It has announced a partnership with
Google Cloud to assist market participants in
better forecasting daily settlement failures of
billions of dollars, saving substantial capital and
liquidity, and increasing operational efficiency.
This initiative uses data analytics, AI and ML
technologies to build new collateral manage-
ment and liquidity solutions.
11.4.3.7. API
It is a software interface that connects two com-
puter programs and provides integration servic-
es. APIs are increasingly gaining traction as tools
that help developers build innovative digital eco-
systems. APIs can be used to drive a company
ahead by allowing integration with external and
internal ICT and digital ecosystems.
SBI: API connections with the ICT systems of
other service providers such as National Securi-
ties Depository Limited, Unique Identification
Authority of India, credit bureaus and Insurance
Information Bureau of India have been made for
ease of transaction processing. So if a customer’s
data are already accessible on these platforms,
the bank doesn’t ask for KYC.
BOA: This bank is collaborating with a variety
of ERP and treasury management system pro-
viders to integrate their solutions using API as
well as with clients interested in piloting the API
through direct connections. It is also in discus-
sions with third-party solution providers, such
as fintechs, about leveraging its APIs to assist
their clients with financing solutions.
WBC: WBC’s Open Banking Product API al-
lows third parties to have access to information
about Westpac’s current products. It was made
and recorded in accordance with the Australian
Consumer Data Standards. Bank’s Product API
offers items for transaction accounts, term de-
posits, credit cards, mortgage products, personal
loans, etc.
11.4.4. Theme 3: Applications of
Digital Technologies in Banking
Operations
Digital technologies allow a bank’s customers to
access banking products and services through
an online or e-platform. It involves digitizing
any bank’s operations and replacing its physical
170 INDIA BANKING AND FINANCE REPORT 2021
presence with a 24/7 online presence, minimiz-
ing a consumer’s need to visit a branch.
11.4.4.1. Lending
Digitization of the lending process has several
benefits for banks, including better decisions,
better customer experience and cost savings.
HDFC: Paperless auto loans with biometric
technology within 30 minutes, personal loans in
10 seconds through NetBanking, PayZapp, Chillr,
LITE App and instant loans at ATMs are just a
few of the services offered by this bank. Snap &
Search on the Vahan Gyan App allows users to
rapidly determine the cost of a loan for a given
make or model, as well as the EMI alternatives
available for each variant and model.
CBA: Stream Working Capital, a new digital
loan service from CBA, allows faster businesses
and provides more flexible access to cash flow by
utilizing pending invoices. It is integrated with
accounting software Xero to offer real-time data
on a company’s capital requirements.
11.4.4.2. Payments
New technologies are opening new avenues
for innovation in payments. To make full use of
these opportunities, banks need to evolve and
modernize their legacy technology.
HDFC: Its OnChat app allows customers to chat
on Facebook Messenger to avail services such as
bill payments, travel bookings and event book-
ings.
CBA: A customer of this bank can pay or choose
from a range of digital wallets such as Apple Pay,
Google Pay or Samsung Pay by linking an eligible
debit or credit card to the app to get started.
WBC: Customers of this bank can use Apple’s
intelligent assistant, Siri, to make payments
without having to open the bank’s mobile app.
11.4.4.3. Customer Onboarding
Integrated DBPs, introduced by banks all over
the world, can onboard customers while comply-
ing with all regulatory formalities, including up-
loading of KYC documents, without any physical
contact with prospective new customers.
SBI: The bank saw a considerable increase in
new customer onboarding, with about 21,000
digital accounts opened every day through its DBP
named YONO. These are more than 65 per cent of
all eligible accounts opened. During the fiscal year
2020, approximately 43.5 lakh digital accounts
were opened, including 71.43 lakh since launch.
HDFC: The DBP of this bank is empowered to
engage with customers and conduct personal-
ized conversations with the virtual relationship
manager for instant account opening after video
KYC is completed.
WBC: Westpac is using a digital platform in its
banking-as-a-service offering to handle customer
onboarding, including identity and fraud checks.
11.4.5. Theme 4: Change in
Organizational Structure
Becoming a digital organization is an overarch-
ing process that involves employee activities
and behaviour. This includes the way employ-
ees interact with other employees, both inter-
nally and with external stakeholders. In many
instances, the roles, responsibilities and organi-
zational structure must change to accommodate
DT. There is also a need to instil a culture that
supports the new digital organization while en-
abling the company’s strategy.
11.4.5.1. Separate Business Unit
The entire set of business models and functions
of many organizations is being transformed by
digital technologies. To carry out the transition
efficiently and effectively, a distinct responsi-
bility centre or unit is set in place to work for
adoption and transformation with technologies.
In most cases, executives of such a unit report di-
rectly to the company’s CEO.
BNY: A new enterprise digital assets unit was
launched by BNY that helps stakeholders handle
rising and evolving needs connected with digital
assets, such as cryptocurrencies, by accelerating
the development of solutions and capabilities.
DB: It has launched an Innovation Division to
achieve its primary goal of DT, which is to digi-
tize all activities of the bank.
11.4.5.2. Digital Leadership
DT is one of the critical competitive conditions
for most businesses in current Industry 4.0 era.
Processes for broad spectrum service delivery
are converted digitally to improve speed, qual-
ity and profitability. Such a shift necessitates the
presence of a digital leader who can champion it.
BOA: According to the CEO of this bank,
‘We’re a technology company, wrapped around
a great bank, and that’s going to be the future of
what we do.’ He is a firm believer in the abilities
of AI to transform banking.
DB: All responsibilities of DB’s chief digital of-
ficer are divided between DT of the core busi-
ness and development of new businesses, with a
total focus on cost reductions and internal digi-
talization.
11.4.5.3. Managing Change during
Digital Transformation
While implementing digital technologies, an or-
ganization must address the multidimensional
aspects of organization-wide changes. The intro-
duction of new technologies provides opportu-
nities to reengineer corporate policies and pro-
cesses to enhance efficiencies and effectiveness
to improve business volume and ROI. DT implies
big-scale change that necessitates strong execu-
tive support, a focused communications strategy
and a trained and experienced team of commit-
ted personnel.
SBI: This bank is in the process of converting its
work from home policy to work from anywhere
(WFA). WFA has already been implemented in 19
overseas offices, and domestic operations will be
covered soon. Digitization is viewed as a means
of ensuring that a transaction is convenient for
both customers and employees.
BOA: BOA’s long-standing culture of inno-
vation is also propelling DT. During the crisis
of the COVID-19 pandemic, the bank has over-
emphasized the importance of connectivity,
bandwidth and power of digital technologies
for improving customers’ access and banking
experiences.
BB: The huge change management effort en-
tailed in persuading about 80,000 employees
that they are part of a new digital company with
a digital client base and DT is inevitable and
each must comprehend the shift. This helped to
achieve a mindset shift and employees’ commit-
ment to DT.
Digital Transformation of Banking Institutions 171
 11.4.5.4. Training of Existing Workforce
on Emerging Technologies
The goal of a DT is not to replace existing person-
nel with new ones but to instil application-ori-
ented capabilities. Training helps with learning
and honing of skill sets, as well as reinvigorate
the attitude and approach of employees with an
innovative mindset.
BOA: This bank is using Strivr’s solution to
train employees for a variety of functions, rang-
ing from simulators that help them train on the
bank’s account opening and servicing systems to
AI-powered tools. VR is also being used to assist
bank staff with upskilling and shifting to other
roles more rapidly.
DB: HR function of this bank plays an impor-
tant role not only in redefining profiles and guar-
anteeing innovative upskilling methods but also
in helping employees through this transforma-
tion and accompanying them on the trip.
11.4.6. Theme 5: Digital Ecosystem
A digital ecosystem is a seamlessly integrated
network of ICT resources, digital platforms, IOT
and APIs that can work together as a virtual
single entity. Suppliers, customers, trade part-
ners, apps, third-party technology, data service
providers, etc., constitute the digital ecosystem.
Its success depends on interoperability and ben-
efits the organization through faster adoption of
technologies, the crafting of new business and
revenue models and ensuring deliverables to all
stakeholders with improved speed, quality and
cost effectiveness.
11.4.6.1. Cyber Security
It is the technique of insulating, securing and
defending against harmful assaults on comput-
ing systems and data storage. It entails a set of
technologies and procedures that safeguard net-
works, ICT devices and other systems from at-
tack and damage caused by unauthorized access
and spawned malwares.
HDFC: Every threat to cybersecurity and data
privacy is assessed using a framework compris-
ing steps to identify, detect, prevent, protect, re-
spond and recover. Controls such as firewalls,
anti-malware, anti-advanced persistent threats,
172 INDIA BANKING AND FINANCE REPORT 2021
data loss prevention, red teaming, intrusion pre-
vention/detection, digital rights management,
24×7 security operation centre and forensics so-
lutions have been implemented.
BNY: The Enterprise Resiliency Office of this
bank is at the heart of its enterprise resiliency
strategy, with Resiliency Risk Management serv-
ing as a second line of defence. Building versatile
capabilities within its business services frame-
work, IT asset management, application trans-
formations and mainframe modernization, disas-
ter recovery, testing and business continuity are
all part of its resiliency approach.
11.4.6.2. Data Privacy
It has become a significant topic of discussion in
banking due to failures in security and concerns
about how banks are using the personal data
they collect about their customers. As banks in-
creasingly depend on the cloud to store informa-
tion and conduct financial transactions online,
data privacy concerns continue to grow. Com-
mitments to protecting consumer information
have led some countries to enact new laws that
require companies to implement tighter security
while guaranteeing consumers certain rights re-
lated to their personal data.
SBI: Data governance councils at different
functional levels, supported by data governance
officers, have already been established at this
bank. Its strong data governance policy and pro-
cesses help assure compliance with changing
data protection regulations.
BNY: BNY has implemented measures for
stricter compliance with provisions under the
General Data Protection Regulation, the Gramm–
Leach–Bliley Act and Fair Credit Reporting Act
to ensure privacy and safety of all stakeholders’
information.
BOA: This bank is dedicated to safeguarding
the personal data with stringent procedures and
compliance supervision in place to guarantee
that data are stored and used responsibly in com-
pliance with relevant statutes and regulations.
The bank uses organizational, technological and
administrative safeguards, and a worldwide net-
work of compliance officers.
11.4.6.3. Open and Neobanking
API-based banking operations enable fintechs
and other entities to build and offer simple solu-
tions to customers. Open banking enables banks
to share data with other entities. And neobank-
ing is essentially banking without branches.
Both open and neobanking are impossible with-
out banking APIs; hence, these APIs form the
backbone of most new jargon and concepts in
the banking ecosystem.
CBA: Customers have more control over their
banking data with open banking. It was intro-
duced following the passage of legislation related
to Consumer Data Rights by the Australian gov-
ernment. This implies that customers may share
their data with CBA and their CBA data with ap-
proved organizations. This bank recently dipped
its toe into the neobanking area with a service
dubbed CommBank Neo.
WBC: Customers of this bank can use open
banking to share information online with other
trusted parties, including other banks. Westpac
has named Afterpay as its first digital ‘bank-as-
a-service’ partner. In Q2 of 2021, Afterpay will
offer Westpac transaction and savings accounts,
and other cashflow management solutions, to its
3.3 million clients.
11.4.6.4. Hackathons
It is defined as an event that brings together am-
bitious young entrepreneurs and software engi-
neers for a day or two and enthuses them to pro-
duce a great killer app with hitherto unheard-of
digital solutions. Business entities are also apply-
ing the same techniques of crowdsourcing inno-
vative ideas to overcome organizational stagna-
tion and foster more innovative cultures.
SBI: One of this bank’s goals in DT is to foster an
outcome-based technology culture among start-
ups and in-house ‘innovation cell’ using hack-
athons, with an emphasis on building cutting-edge
solutions for the bank in a time-bound manner.
BNY: ‘BNY invited all to participate in the
CONNECT20 Challenge to exhibit creative solu-
tions that solve selected problem statements in
pursuit of the best and brightest. Participants
would have the opportunity to be highlighted
and accepted into BNY’s Accelerator Program.’
11.5. Adoption,
Implementation and
Implications
In this section, the adoption and implementa-
tion of different digital technologies and busi-
ness process transformation strategies have been
segmented on the basis of common, abundantly
occurring and differential applications. For this,
frequencies of instances in narratives have been
analysed from the perspective of innovative ap-
plications of digital technologies. The identified
differentiated/advanced practices demonstrate
progressions in DT of the concerned bank, which
can be achieved only after excelling in standard
practices. The findings provide perspectives and
guidance on practices followed by banking insti-
tutions, which can further be extended through
research.
While this may set normative behaviour
among similar institutions, it will also help un-
derstand standard and differentiate advanced
exhibitions in adopting and applying digital
technologies. This establishes that institutions
have varied levels of DT even though their ob-
jectives may be almost identical. This results in
variations in benefit realizations. A framework
developed from comparative practices with het-
erogeneous technologies has been provided in
Table 11.2.
Table 11.2 outlines the emergent practices
across the newly defined themes and how they
become more mature over time. A similar study
across banks in different continents, sizes and
service focus will render a more generalized un-
derstanding. A Digital Transformation Maturity
Framework (DTMF) would be beneficial to insti-
tutions in determining the course of their trans-
formation trajectories and provide a ready refer-
ence of use cases and benchmarks.
While standard practices are followed by
most banks, the authors observed beneficial
differentiating practices in only a few banks.
This can emerge when standard practices are
satisfied. Table 11.2 is a guiding index of all such
practices across the theme areas. A particular
bank may be demonstrating a blend of standard
Digital Transformation of Banking Institutions 173
 Table 11.2 Directory of Standard and Differentiating Practices from Narratives and Analyses Across
the Themes
1. Digital Growth Strategies
Standard Practices
Digital Vision
• Build leadership position in digital banking
through investments in physical and human
capital.
Digital Mission
• Committed towards transforming the bank
into a digitalized organization.
Digital Strategy
• Seamless delivery of more cost-efficient
digitalized banking services with enhanced
speed and quality at anytime anywhere.
Partnershi p with Fintechs and Neobanks
• Collaborate with fintechs to provide custom-
ers new digital banking experience.
Use of Digital Platforms and Online Marketplaces
• Have a simple mobile app for delivering
online banking services.
Metrics for Measuring DT
• Measuring ROI from DT in quantitative and
financial returns.
2. Digital Technology
Standard Practices
Blockchain
• Banks are forming consortiums to simplify
BG process, making it more transparent and
secure.
AI/ML
• Branch staff use AI-powered recommenda-
tions to offer pre-approved deals in one
click on real time that customers can take
advantage of.
RPA
• Banks have implemented RPA for perform-
ing repetitive tasks and eliminate risks from
manual interventions.
Chatbots
• AI-based chatbots answer customers’ queries
on various types of retail loans, term depos- • Banks are developing chatbots which can
its, FAQs like ATM locations, etc.
174 INDIA BANKING AND FINANCE REPORT 2021
Differentiating Practices
• To be the leader in digitalization for un-
derstanding customers better, make more
informed decisions and strengthen control
functions.
• Financial and digital empowerment for mil-
lions of individuals and business entities.
• Leveraging digital technologies to streamline
and automate operations and expand data
capabilities to help risk-enabled performance
management for customers’ delight.
• Supporting innovative start-up entities in
their quest to become a large fintech entity.
• Developing super apps to deliver banking
and non-banking services, third-party finan-
cial products and offering B2C marketplace
platform to promote commercial activities.
• Measuring ROI from DT in qualitative returns
such as hackathons, agile project manage-
ment and collaborations to bring about a
cultural shift in the organization.
Differentiating Practices
• Banks are launching new entities for handling
ever-increasing volume of digital assets to
meet evolving needs for DT with solutions for
strategic capability building.
• Banks have started using AI-driven solutions
to forecast the probability of a company/indi-
vidual defaulting loan repayment.
• RPA-driven solutions follow governance
requirements to achieve pre-planned goals.
Those have flexibility for minor adjustments
to befit operational requirements.
• Banks have defined business and technologi-
cal parameters that prioritize and select use
cases based on best practices.
• Customers can make payments by just speak-
ing to virtual personal assistants.
interact with clients chatbot for them to get
connected with markets, exchanges and plat-
forms for security/investment transactions.
(Table 11.2 Continued)
BDA
• Help improve client acquisition and reten-
tion. These technologies render digital mar-
keting more intelligent and cost-efficient.
Cloud Infrastructure
• Banks are investing in private clouds on a
pay-per-use basis to save money with flex-
ibility to scale up or down if needed.
API
• Banks open product APIs to allow third-party
access to information about its current products
for retail, wholesale and mortgage businesses.
3. Applications of Digital Technology in Banking Operations
Standard Practices
Lending
• Banks are offering instant paperless retail
loans through mobile banking apps, net
banking, etc. This near real-time decisioning
is possible due to BDA capabilities.
Payments
• Banks are introducing ‘Tap and Pay’ func-
tion on their cards which allows a near field
communication-enabled POS terminal to in-
terface directly with a virtual card on mobile
devices for payments.
Customer Onboarding
• Digital accounts are being opened on bank’s
mobile banking/super apps. KYC checks are
done through new methods such as video
KYC and biometric KYC.
4. Change in Organizational Structure
Standard Practices
Separate Business Unit
• Banks are launching an innovation division
as part of their aim to digitize all their
activities.
Digital Leadershi p
• Most of the digital leaders emphasized that
the focus should be on cost reductions and
internal digitalization.
Managing Change during DT
• Banks are inculcating the culture of innova-
tion to propel DT.
• Banks are introducing business analytics plat-
form to provide access to big data to their SME
customers. Transaction analyses and scenario
modelling help generate daily picture of risks
that exist in their respective organizations.
• Banks are signing strategic collaborations
with public cloud service providers to respond
more precisely to customers’ emerging de-
mands through quicker applications develop-
ment and utilization of powerful AI and data
analytics tools.
• To service a new developing community of
digital first enterprises, banks are creating
world-class API exchanges that provide secure
access to innovative service products.
Differentiating Practices
• Banks have redesigned end-to-end retail
lending experience, allowing customers to ap-
ply for a mortgage online, watch its progress
and accept offers online while also receiving
expert financial advice.
• Customers are using virtual personal
assistants, e.g., Amazon Alexa to make
payments without having to open a bank
mobile banking app.
• Banks are using services of fintech companies
via banking-as-a-service for customer on-
boarding, including identity and fraud checks.
Differentiating Practices
• Some banks are launching new Enterprise
Digital Assets unit that would help handle
evolving needs from emerging digital assets
by accelerating development of solutions and
attainment of capabilities.
• New age digital leaders believe that they
are a technology company wrapped around
a great bank, which they feel would be the
bank’s future.
• Leadership team of a bank, that has em-
barked on DT, reorient managerial policies,
procedures efforts to persuade its staff that
they are part of a new digital company with a
digital client base.
(Table 11.2 Continued)
Digital Transformation of Banking Institutions 175
 (Table 11.2 Continued)
Training of Existing Workforce on Emerging
Technologies
• Banks provide a variety of self-paced learn-
ing opportunities including virtual coaching
support to help employees conduct custom-
er conversations and build relationships.
5. Digital Ecosystem
Standard Practices
Cyber Security
• Banks protect customers’ personal and fi-
nancial information very seriously and rigor-
ous security measures are in place to ensure
privacy and safety.
Data Privacy
• Banks are safeguarding personal data of cus-
tomers with stringent rules, procedures and
compliance supervision.
Neobanking
• Neobanks, mainly fintechs, though lacking
bank licenses, are providing comprehensive
digital and mobile banking options by part-
nering with mainstream banks.
Hackathons
• The objective is to foster an outcome-based
technology-driven culture among start-ups
and in-house developers with an emphasis
on building cutting-edge solutions for the
bank in a timely manner.
Source: This table has been created by authors based on their research findings.
• Banks are providing AI powered tools that
allow employees to conduct effective con-
versations with clients. VR is also being used
to assist bank staff upskill and shift to other
roles more rapidly.
Differentiating Practices
• Banks are placing a high focus on risk-
enabled operational efficiency. They have
formed enterprise resiliency units as a part of
their core enterprise resiliency strategy.
• To guarantee long-term compliance with
privacy rules, certain banks use organizational,
technological and administrative safeguards
and worldwide network of compliance officers.
• Banks are announcing neobanks as their
‘Bank-as-a-Service’ partner. Neobanks are
architecting cash flow management solutions
for traditional banks.
• Banks are creating platforms to support
entrepreneurial community. Through national
networks of digital technology labs, banks
incubate highly potential start-ups with
co-working spaces, mentoring and access to
cutting-edge technologies to rapidly proto-
type new product ideas.

and differentiated practices. The DTMF would
become more robust by the study of practices
across more banks in varied contexts. The gen-
eralized directory of practices will be useful in
assessing maturity of transformation and identi-
fying focus.
11.6. Implications for
Indian Banks
In this section, salient features of the DT journey
of Indian banking industry have been briefly de-
picted, keeping in view the evident narratives of
eight major banks in previous sections. The ob-
jective is to ideate and suggest the next few steps
Indian banks will have to take to reorient their
DT practices. India’s banking institutions are ex-
periencing major disruptions and are investing
heavily in digital technologies to catch up with
leading domestic and global competitors. GOI has
also fired all cylinders for accelerated digitiza-
tion of Indian citizens, delivery of services, direct
transfers of remunerations/benefits under vari-
ous schemes, inclusive banking, etc. ‘IndiaStack’,
a major API platform-based initiative, through
which every Indian citizen is being tagged with
unique digital identifiers, for example, Aadhaar,
is creating a rapidly growing digital community.
The Indian economy is now a hotbed of finan-
cial services innovation. Prominent fintech start-
ups have established themselves as near-infinite,
indispensable aids for daily life. Cases in point
are UPI, Paytm, PhonePe, BankBazaar, Lending-
kart, etc. In addition, mobile-only banks are rap-
idly maturing, for example, DBS Bank’s Digibank
and SBI Digi Bank. In this context, initiatives by

176 INDIA BANKING AND FINANCE REPORT 2021

the GOI and the RBI to strengthen the lending
ecosystem and create an open banking environ-
ment, such as Public Credit Registry, Account
Aggregator Framework and Open Credit Enable-
ment Network are worth mentioning.
India’s banking sector has also witnessed in-
dustry convergence, with entities from other
industries pursuing new banking opportunities,
for example, Airtel Payments Bank and Airtel
Money from the telecommunications industry
and Ola Money from transportation. Several In-
dian banks are aiming to derive benefits from ap-
plications of cognitive technology. For example,
Yes Bank is one of the first institutions to an-
nounce innovation in payments. The bank is em-
bracing cognitive and blockchain technologies to
enhance the digital experiences of stakeholders.
Fifteen Indian banks have formed a consortium
to develop a blockchain platform for trade fi-
nance transactions.
For numerous banks, past technology invest-
ments tended to be somewhat reactive and ad-
hoc. Accommodating digital mobility became
essential once it was clear that an increasing pro-
portion of customers was relying exclusively on
portable devices. The bar of expectations from
banks is getting raised day by day due to intense
competition from born-digital entrants, and ho-
listic and disciplined approach towards DT by
certain large incumbents.
The time has come for Indian banks to take
cues from giants and craft out strategic plans and
intensify actions for pervasive DT across spec-
trums of all functions and stakeholders while
remaining vigilant about new technological
developments. For banks to transform digitally
with success, their respective technology archi-
tectures must befit the business and revenue
models. While competing with non-traditional
players, the banks must achieve customers’ de-
light while banking through handheld devices,
going beyond the traditional mindset of provid-
ing a nice front-office experience.
DT processes for banking have evolved over
the past decade in India. With focus shifting from
a product-based approach to a customer-centric
approach, banks are now trying to find the best
methods to make a customer’s journey entirely
seamless. This has led to the development of
business models such as banking-as-a-service,
embedded finance, neobanks and digital banks.
The COVID-19 pandemic has pushed banks
back to the drawing board to reframe digital
strategies and be ready for the future transfor-
mation landscape. Banking is at the tipping point
towards the orbital change from partly digital to
fully digital in conformity with global standards
and in compliance with legal and regulatory pro-
nouncements. And for sustainable success, banks
must culturally revolutionize minds and skill sets
of employees. A transparent system for two-way
communication across the organizational hierar-
chy is also a must for grand orchestration.
The DT journey of any organization requires a
creative culture, the absence of which can lead
to failure. The human capital management team
has a key role in ensuring the success of DT. They
must ensure a perfect blend of newly recruited
and internally trained staff members with busi-
ness insights. The quality of such manpower
must include design thinking, agility and a data-
driven DigiTech mentality. A culture like this is
essential to seizing opportunities that arise be-
cause of technological advancements.
Note
1. Narrative research is a term that subsumes
a group of approaches that in turn rely on
written or spoken words or visual represen-
tations. Narrative research can be consid-
ered both a research method in itself and
the phenomenon under study. Data collect-
ed as narratives can be coded to define the
core constructs and themes emerging from
the data. While some of the themes derived
through the analysis may be inductive as
they would be grounded in theory, others
may be deductive—we can discover some
newly emerging themes.
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ijresmar.2015.11.002

Leading through Disruptions
A Distributed Leadership Model
for Banks in India
B. Ashok and Shomi Srivastava
12.1. Introduction
Business disruptions caused by economic, regu-
latory and technological changes have prompt-
ed banks in India to rewrite their business and
people strategies in the past. Banks, like most
of the business organizations, were, however,
unprepared when the pandemic disruption
caused by the SARS-CoV-2, the virus that causes
COVID-19, struck the whole world. It is now al-
most certain that the post-pandemic world may
not be the same again. There could even be mul-
tiple disruptions as the threat of new viruses
spreading in the globalized world is also being
predicted by scientists.
In this chapter, we try to explore possible new
approaches to changing the leadership DNA of
banks so that the twin objectives of resilience
and growth are achieved. While doing so, our
thoughts are informed by the organizational
realities of banks, which have been redrawn by
technological disruptions and the emergence
of the digital culture. This has taken us to some
of the conceptual frameworks such as system
thinking (Clemson, 2012), organizational cy-
bernetics (Ericson, 1970) and digital leadership
(Raskino et al., 2015) and enthused us to draw
from the analogy of distributed systems and
concurrency (à la Leslie Lamport) and use the
terms in a purely literal sense to expand our ar-
gument on leadership. The conceptual journey
we undertook thus takes us to the relatively
new concept of Distributed Leadership (DL)
(Gronn, 2000; Spillane, 2006) and emboldens us
to suggest it as an alternate model.
12
Chapter
12.2. Performance and
Leadershi p
While discussing ‘what drives performance?’,
Harker and Zenios (2000) identify three drivers of
performance: (a) strategy, (b) execution of strategy
and (c) environment. The rationale behind posit-
ing ‘environment’ as a driver of performance has
been explained thus: ‘Environmental factors are
indirectly controlled by the banks through lob-
bying activities, marketing efforts, research and
development, and hence, they can also be viewed
as major factors in understanding performance.’
Certain keywords emerge as relevant pointers to
our discussion, which are as follows:
1. Strategy: Product mix, client mix, geo-
graphical location, distribution channels
and organizational form
2. Strategy execution: X-efficiency (a la
Leibenstein: aligning technology, human
resources and other resources), human
resource management, use of technology
and process design
3. Environment: Technological changes/IT,
consumer tastes, research and develop-
ment, and influencing regulatory policies
The keywords clearly lead to the realm of or-
ganizational leadership and prompt a reflection
on the leadership imperative. A review of Rob-
ert J. Shiller’s wonderfully illuminating book,
Narrative Economics, begins thus: ‘Economics
is the study of people at work, but where are
the people?’ (Grant, 2019). Another perceptive
 observation in the context of Narrative Econom-
ics goes thus:
The 20th century mind set, built on the goal of
maximizing shareholder value, is still preva-
lent in many large corporations, along with all
the attendant principles and processes that fol-
low from it—bureaucracy, vertical hierarchy,
autocratic leadership, backward looking strat-
egy, sales and marketing focused on short-term
profit, and control oriented HR. Corporations
run in this fashion cannot adapt fast enough
to cope with the turbulent digital marketplace.
(Denning, 2021).
12.3. Organizational
Structure of Banks
Banks have established internal reporting struc-
tures starting from the branches to the head/
corporate office. Such a structure plays a major
role in translating the corporate business strat-
egy and implementing administrative policies
across the organization. Typical four-tier and
three-tier organizational structures, based on
the geographic spread of branches, more or less
look like the following:
Four-tier: Head/corporate office  Circle/zonal
offices  Regional offices  Branches
Three-tier: Head/Corporate office  Zonal/
regional offices  Branches
However, some banks have moved away from
the geographical/generic classification and in-
stead classified their branches based on busi-
ness profiles such as housing loan branches and
retail asset branches. The reporting structure,
however, remains hierarchical across banks in
India. The branches/delivery points and other
offices would be headed by managerial person-
nel belonging to different levels of the organiza-
tional hierarchy.
12.3.1. Branch-driven Business
Models of Banks
Banks in India have a physical presence in all
parts of the country through their network of
branches. The distribution strategy of banks and
the cost implications thereon notwithstanding,
180 INDIA BANKING AND FINANCE REPORT 2021
the opening or closing of bank branches in India
is governed by Section 23 of the Banking Regu-
lation Act, 1949. The relevant regulations, how-
ever, cannot be static given the changes in the
business ecosystem and the changing expecta-
tions of banks in a market like India. The revised
guidelines on Branch Authorisation Policy, an-
nounced by the RBI (2017), make an attempt to
address these changes. The revised guidelines,
inter alia, introduce a new term ‘banking outlet’,
which replaces the good old concept of bank
branches. Although the term ‘branch’ has, over
the years, evolved to include ‘all branches, i.e.,
full-fledged branches, specialized branches, sat-
ellite offices, mobile branches extension coun-
ters, off-site ATMs (Automated Teller Machines),
administrative offices, controlling offices, service
branches (back office or processing centre), etc.’,
the new term ‘banking outlet’
is a fixed point service delivery unit, manned
by either bank’s staff or its Business Correspon-
dent where services of acceptance of deposits,
encashment of cheques/cash withdrawal or
lending of money are provided for a minimum
of 4 hours per day for at least five days a week.
Further, the RBI expects banks ‘…to enlighten
people about banking outlets as adequate substi-
tutes for physical “brick and mortar” branches
in low population density or low population lo-
cations’. There is no getting around the fact that
branches in low population locations are gener-
ally unviable. Nevertheless, we think that, in the
context of business strategy and leadership, the
quest for substitutes for physical ‘brick and mor-
tar’ branches should have been a business deci-
sion by the banks rather than a matter of regula-
tory compliance.
12.3.2. Technology,Networking and
the Continuing Relevance of Brick-
and-mortar Branches in India
Starting with the introduction of Advanced
Ledger Posting Machines in 1980, banks in In-
dia could bring 90 per cent of their branches
under the Core Banking System (CBS) by 2010
March. The network of bank branches resulting
in a back-end system that processes the transac-
tions across the various branches of a bank was
the hallmark of CBS. It facilitated anywhere and
anytime banking. It was expected that technol-
16
ogy and networking would eventually wean the
14
banks from ‘brick-and-mortar’ branches. Bank- 12
ers’ perspectives and empirical analysis, how- 10
ever, do not appear to be in agreement with this. 8
6
The Branch is dead, long live the Branch! 4
The death of the physical branch has been a 2
foregone conclusion for many. Brett King argues 0
2008 2010 2012 2014 2016 2018 2020 2022
that ‘The current economics of branch banking
Figure 12.1 Commercial Bank Branches per
are simply defenceless and investing in expen-
100,000 Adults from 2010 to 2020
sive real estate is simply not going to bring in
Source: World Bank (https://data.worldbank.org/
new customers or revenue significantly enough indicator/FB.CBK.BRCH.P5?end=2020&start=2004&
to pay’ (King, 2012). Macro-numbers, however, view=Figure).
paint a different picture. The World Bank data on
commercial bank branches (per 100,000 adults)
Notwithstanding the slight reduction in num-
from 2004 to 2020 (all countries and all econo-
bers in between, the number of branches per
mies) throws an interesting picture (Table 12.1).
100,000 adults has grown from 10.98 in 2010 to
The data from 2010 to 2020 are plotted in 14.15 in 2020, an increase of about 29 per cent.
Figure 12.1.
The FDIC data pertaining to the number of
banks and the number of active branches in the
USA during the same period (2010–2020) give us
Table 12.1 Commercial Bank Branches
a trend which is quite different from the dominant
Number of Branches per narrative about the closure of branches (Table 12.2).
Year 100,000 Adults
The decrease in the number of active bank
2004 9.79
branches needs to be understood in the backdrop
2005 10.59 of the number of banks functioning in the USA. As
2006 10.94
2007 11.66 Table 12.2 Number of Active Bank Branches in the USA
2008 11.70 Number of Number of Average Number of
Year Banks Branches Branches per Bank*
2009 11.08
2010 6,532 84,876 12.99
2010 10.98
2011 6,279 85,309 13.59
2011 11.58
2012 6,087 84,898 13.95
2012 11.82
2013 5,851 83,859 14.33
2013 12.03 2014 5,609 82,818 14.77
2014 12.39 2015 5,348 81,941 15.32
2015 11.67 2016 5,115 80,407 15.72
2016 12.35 2017 4,918 79,067 16.08
2017 11.86 2018 4,717 77,715 16.48
2018 11.53 2019 4,523 77,015 17.03

2019 11.51 2020 4,377 74,924 17.12

Source: FDIC (https://banks.data.fdic.gov/explore/historical/?displayField
2020 14.15
s=STNAME%2CTOTAL%2CBRANCHES%2CNew_Char&selectedEndDate=
Source: World Bank (https://data.worldbank.org/ 2020&selectedReport=CBS&selectedStartDate=2000&selectedStates=&s
indicator/FB.CBK.BRCH.P5?end=2020&start=2004& ortField=YEAR&sortOrder=desc) and authors’ calculations.
view=Figure). Note: * Added by the authors.

Leading through Disruptions 181

 Table 12.3 Bank Group-wise Number of Functioning Offices of Scheduled Commercial Banks (Excluding RRBs)
Year Private Regional Local Small
Ended SBI and Nationalized Other Sector Foreign Rural Area Finance Payment
(Mar) Associates Banks PSBs Banks Banks Banks Banks Banks Banks Total
2020 23,562 69,234 35,682 336 22,262 94 4,486 820 156,476
2019 23,474 69,031 33,181 326 22,009 93 3,413 833 152,360
2018 23,881 69,206 2,117 29,441 311 21,875 93 1,734 171 148,829
2017 25,734 68,635 2,204 27,815 312 21,529 82 415 5 146,731
2016 25,291 66,599 2,144 25,515 343 21,044 120 141,056
2015 24,565 64,328 1,863 20,657 339 20,199 108 132,059
2014 23,638 59,863 1,489 18,716 332 19,136 92 123,266
2013 21,942 53,907 1,156 16,209 349 17,985 80 111,628
2012 20,795 50,096 1,047 14,117 337 17,038 71 103,501
2011 19,756 45,840 882 12,190 332 16,167 58 95,225
2010 18,699 43,067 766 10,611 322 15,638 52 89,155
Source: RBI.

per the FDIC data, the change in the number of in-
stitutions could be due to certain parameters such
as new figures, conversions, unassisted mergers,
failures-assisted merger and failures-paid off. The
average number of branches per bank has been
increasing amid the noise of predictions about
moving away from brick-and-mortar branches.
Although not exactly comparable with that
of the USA, the data on ‘functioning offices’ of
commercial banks in India also underlines the
continuing importance of the branch-driven
business model (Table 12.3).
Functioning offices include branches as well
as administrative offices of banks. For our analy-
sis, the number of administrative offices might
not be materially significant. As regards private
sector banks, we included the figure under the
category ‘other PSBs’ as it obviously pertains to
IDBI Bank which was reclassified by the RBI as a
private sector bank from 2019. Accordingly, our
analysis has been highlighted in Table 12.4.
The numbers pertaining to the SBI need to be
seen in perspective. Although the cumulative av-
erage of the number of offices opened from 2010

Table 12.4 Snapshot of Number of Offices Opened by Banks in India (2010–2020)

Number of Offices Cumulative Average % Increase in the
Added from of Number of Offices Number of Branches
2010 to 2020 Opened per Year in 2020 over 2010
SBI + Associates 4,863 486.3 26
Nationalized banks 26,167 2,616.7 61
Private sector banks 24,305 2,430.5 214
Foreign banks 14 1.4 4
RRBs 6,624 662.4 42
Local area banks 42 4.2 81
Small finance banks (from 2017) 4,071 1,357 Not relevant
Payment banks (From 2017) 815 271.7 Not relevant
All commercial banks 67,321 6,732.1 76

182 INDIA BANKING AND FINANCE REPORT 2021

to 2020 is 486.3, the cumulative average dips to
–432.25 between 2017 and 2020, presumably due
to rationalization of offices after the merger of
associate banks with the SBI.
It is interesting to note the exponential growth
in the number of offices recorded by the private
sector banks. Is it a reflection of the increased de-
mand from the government on banks to deepen
financial inclusion in the country? Is it a matter
of compliance or a strategic decision that the pri-
vately owned banks have embarked on such an
expansion drive? The inference we draw from
all this is that it is too early to sing an elegy for
branch banking. It would be safe to assume that
branch-driven service delivery would continue
to be relevant, albeit with re-engineered process-
es and systems.
12.3.4. Multichannel Banking
Rather than cutting the branch network trim,
which obviously is an easy solution, making
it part of a multichannel distribution strategy
makes sense. A section from the insightful dis-
cussion on ‘Bring the Brick-and-Mortar Back
to Life’ which highlights the challenge for the
bankers as ‘…getting the most production pos-
sible from the branches and people’ is given in
Box 12.1.
Box 12.1
While discussing that topic with a retail
bank executive friend recently, he said that
he agreed that the banking industry will
look starkly different in 10 years, but he has
a business to run today.
If he were working from a blank sheet,
the bank he would build today wouldn’t look
the same. But he doesn’t have a blank sheet.
He has an existing network, existing sys-
tems, a large employee base and gratefully, a
customer base to service. His challenge is get-
ting the most production possible from the
branches and people he has in the present.
Source: American Banker (8/4/2011, Vol. 176, Issue
120, p10-10. 1/2p).
© American Banker
While discussing technology, especially in-
ternet and strategy, Michael Porter observes
thus: ‘(the) winners will be those that view the
Internet as a complement to, not a cannibal of,
traditional ways of competing’ (Porter, 2001).
The keyword here is ‘complement’. It would be
appropriate to paraphrase this observation by
adding the term ‘mobile’ too in this context. This,
we think, is exactly the underpinning strategy
behind the branch expansion by banks in India,
notwithstanding the regulatory expectations.
12.4. Organizational Issues
and Talent Constraints
Affecting the Model
The organizational structure demands plac-
ing managers at various levels. The PSBs have
a structured scale system with well-defined
norms for elevation from lower to higher scales.
The structure starts from the junior manage-
ment (Scale I) to middle management (Scales II
and III), senior management (Scales IV and V)
and top executive grades (Scale VI, VII and the
recent addition of Scale VIII in banks) with a
stipulated minimum level of total business. Al-
though the structure of private sector banks is
not analogous with that of PSBs, the hierarchy
and the organizational expectations are, for the
most part, comparable. We restrict our discus-
sion to the levels of managerial personnel, from
junior management to top executive grade, as
the personnel in positions such as deputy man-
aging directors (in the case of SBI), executive
directors (full-time directors of PSBs) and the
managing directors are expected to have gov-
ernance accountabilities as well, in addition to
their executive responsibilities. The challenges
of corporate governance in PSBs have been
well recognized (Reddy, 2002) and continue to
be highlighted (e.g., Acharya & Rajan, 2020). It
doesn’t mean that governance issues are ger-
mane to PSBs only. The governance issue of
private sector banks has also been discussed,
though as ‘relatively idiosyncratic’ in nature
(Acharya & Rajan, 2020, p. 3). We, nevertheless,
focus on the organizational issues and explore
possible solutions to address them.
Leading through Disruptions 183
 12.4.1. The Case of the Missing Middle
The majority of bank managers are expected to
be command takers, their performance measured
in terms of their budget achievements. Nonethe-
less, it is evident from the reporting structure, ir-
respective of ownership of the banks, that each
of these positions does have a leadership role to
play as well. It is, however, our experience that
rather than recognizing them as nodes in the
leadership value chain, organizations look for
their technical/operational, supervisory and ad-
ministrative competencies only.
The leadership issue is more pronounced in
PSBs, especially from the middle to senior levels.
As a result of the fast-track elevation opportuni-
ties offered internally, comparatively younger
officers are placed in middle and senior positions.
Nevertheless, when it comes to leadership and
strategic competencies, the demographic advan-
tage appears to peter out, pointing to a missing
middle in leadership talent.
12.4.2. Leadershi p Challenges in
Public Sector Banks
PSBs are saddled also with legacy issues in respect
of the leadership pipeline. The introduction of
technology and the compulsions of cost-cutting
and profitability prompted the banks to ‘cut ex-
cess fat’ by offering severance package to both
officers and employees, followed by a counter-
productive, in retrospect, hiring freeze. Acharya
and Rajan (2020, pp. 9–10) summarize the issue,
saying: ‘Past hiring freezes have decimated their
middle-management ranks, and private banks
and multinationals have also poached talented
personnel from PSBs.’
The Banks Board Bureau, established by the
Government of India in 2016, ‘tasked to Search
and Select apposite personages for Board of PSBs,
Public Sector Financial Institutions and Public-
Sector Insurance Companies and recommend
measures to improve Corporate Governance in
these Institutions’ introduced a forward-looking
Leadership Development Programme for a pool
of officers in the cadres of general managers and
deputy general managers from PSBs. The officers
in these cadres form the ‘top executive’ scale of
the officers. It is evident that, unless the lead-
ership pipeline is strengthened in banks, such
184 INDIA BANKING AND FINANCE REPORT 2021
laudable interventions would not lead to the de-
sired results. It is therefore important that posi-
tions at comparatively junior levels on the scale
are identified as leadership roles and a struc-
tured talent development strategy is introduced.
12.4.3. Networking of Branches—
Organizational Analogy—Distributed
Systems
Banks, being distributed organizations, adopted
technology for networking the delivery points/
branches. The adage, Conway’s Law, states that
‘any organization that designs a system (defined
broadly) will produce a design whose structure
is a copy of the organization’s communication
structure’ (Conway, 1968). This couldn’t be more
true in comparing the network topology and
the organizational structure of most banks. The
analogy could as well be discerned in the distrib-
uted systems adopted by banks.
12.5. Banks in India:
Need for an Innovative
Leadershi p Model
The antecedent variables behind the leadership
challenges in banks identified by us are enumer-
ated below:
• Past hiring freezes and the resultant
missing middle
• Short-term vision
• Command takers
• Transaction only communications
Rather than looking for an army of command
takers, banks should recognize the importance
of developing leaders at all levels. As already dis-
cussed, unless a leadership pipeline is developed,
the top would also face a void in terms of strate-
gic and leadership skills.
12.5.1. VUCA and the Leadershi p
Imperative
The forces of volatility, uncertainty, complexity
and ambiguity (VUCA) are more pronounced in
our pandemic-stricken world. Economic, regula-
tory and technological disruptions have already
had a profound impact on banks in India. The
COVID-19 pandemic, however, has proved to be
‘the most unkindest’ of all such disruptions. No
amount of rhetoric would armour the banks to
face it. Byron Loflin (2021), Global Head of Board
Engagement, Nasdaq, discusses why banking
leadership still matters and highlights the exis-
tential threats posed by the 2008 financial crisis
and the 2020 pandemic, concluding that ‘VUCA is
a reminder of our need for leadership excellence.’
It is therefore imperative for banks in India to re-
define the contours of leadership and strategical-
ly develop leaders at different levels to overcome
the existential threats posed by the VUCA world.
12.5.2. Disruptions and Banks—
The Impact Zones
The impact of disruptions would be quite pro-
nounced, primarily in the network of branches,
and the cumulative effect of those would affect
the bank as a whole. For the purpose of this chap-
ter, the following impact zones within banks in
India where the disruptions would have pro-
found impact are heuristically assumed for the
purpose of this chapter:
1. Marketing and market share
2. Social and rural banking
3. Technology
4. Risk management
5. People
The market share of individual banks in various
business segments would be impacted by the dis-
ruptions. The impact would also be severe on so-
cial and rural banking, which is being recognized
as a potential market segment. The pandemic re-
emphasizes the importance of technology in de-
livery of banking services. Similarly, the paradigm
of risk needs to be revisited to mitigate the losses
that the forces of disruption would unleash. Ulti-
mately, everything boils down to people.
12.6. Leadershi p Perception
Survey: Some Princi pal
Results
A survey on leadership perception was con-
ducted among senior-level executives working
in these verticals in various banks. The survey
was designed to elicit the responses of executives
at senior levels as to what they think about lead-
ership in each of the impact zones. A question-
naire on the four-point Likert scale (Appendix A)
was sent to the executives associated with the
five impact zones. The analysis of the responses
(Table 12.6) underlines our hypothesis that to
achieve resilience and growth, the banks need to
expand the arc of managerial leadership.
Impact Zone 12.5.1: Range of mean values is 3.3
to 3.8. Table 12.5 also shows the median value of
4 for all the parameters. The executives strongly
agree that though technology-enabled market-
ing will hold the key, marketing will continue
to work under human leadership and the exist-
ing learning and development system of banks
should be totally aligned to business strategy
and customer centricity so that people at all lev-
els will think like leaders.
Impact Zone 12.5.2: Range of mean values for
various parameters of the impact zone is 3.2 to
3.6. The survey indicates that the executives
strongly agree that social and rural banking will
continue to be important to banks. Despite the
growing number of urban-centric customers,
social and rural banking should be considered
as potential market segments. Achieving sus-
tainable business growth amid the disruptions
would be possible only if the banks developed
leaders at all levels and built strategic thinking
capabilities.
Impact Zone 12.5.3: Mean values of all the items
range from 3.5 to 3.6, except the one on technol-
ogy like AI eventually overtaking human func-
tions, where the mean value is 2.4 (disagree). Re-
spondents strongly agree on other issues in the
zone, highlighting the importance of converging
technological and leadership skills.
Impact Zone 12.5.4: Mean values range from
3.2 to 3.7. It suggests that respondents strongly
agree on all the issues flagged. The median val-
ues are also in the range of 3 (agree) to 4 (strong-
ly disagree).
Finally, Table 12.5 shows the results of Impact
Zone 12.5.5 on people. The results indicate that
mean values on the parameters of people’s im-
pact range from 3.2 to 3.7. The median value also
ranges from 3 to 4.
Leading through Disruptions 185
 Table 12.5 Leadershi p Perception Survey: Mean and Median Values on Impact Zones on 1–5
Impact Zone 12.5.1. Marketing and Market Share Mean
(Includes corporate, institutional as well as retail business segments) (N = 118) Median
Market share can be increased by technology-driven marketing 3.3 4
using analytics, AI, ML, etc., where the human involvement would
only be secondary and supportive in nature.
The market demand for app-based, contactless banking will be 3.3 4
huge, and it would reduce the bank’s dependence on physical
delivery points. Marketing through technology will hold the key.
This would require sustained investment in technology rather
than in human skills.
Notwithstanding the emphasis on technology, marketing will 3.6 4
continue to work under human leadership, and banks should
continue to invest in human resources to respond to the
ever-changing needs of the market.
Leadership will play an important role in marketing, and it will 3.8 4
be important to develop strategic thinking at all levels of the
marketing spectrum in all business verticals.
The existing learning and development system of banks should be 3.7 4
totally aligned with business strategy and customer centricity so
that people at all levels think like leaders. Such an approach will
enable the banks to face the market disruptions effectively.
Impact Zone 12.5.2. Social and Rural Banking
Social and rural banking will continue to be important to banks 3.6 4
despite the increasing number of urban-centric customers.
Social and rural banking should be considered as a market 3.6 4
segment with tremendous potential, rather than a mandated
activity. Such a shift in paradigm would be possible through
leadership and strategic responses.
The policy interventions of the government, like the recently 3.2 3
launched ‘One District One Product (ODOP)’ approach, for
instance, can be looked at by the banks as an avenue for business
growth. This would entail strategic thinking at all levels.
Achieving business goals in the segment will continue to be of 3.5 4
paramount importance for the banks. Nevertheless, an approach
that looks beyond the business budgets should be developed so
that the banks can develop processes and products to meet the
specific needs of the segment.
The market disruptions would have cascading effects on the 3.6 4
segment and achieving sustainable business growth amid the
disruptions would be possible only if the banks developed leaders
at all levels of the vertical and built strategic thinking capabilities.
Impact Zone 12.5.3. Technology
Technology like AI, for example, would eventually overtake 2.4 2
human functions, and banks should therefore develop
technological capabilities rather than strategic and leadership
capabilities.
Technology should be used to augment human capabilities rather 3.6 4
than to replace human talent in banks.

(Table 12.5 Continued)

186 INDIA BANKING AND FINANCE REPORT 2021

(Table 12.5 Continued)
Mean
(N = 118) Median
The technological ecosystem of banks should be market-oriented 3.6 4
and customer-centric, and to achieve this, the technical talent
should be exposed to strategic and leadership skills.
Business functions should draw strategic lessons from efficiency 3.5 4
improvement systems like the agile methodology, etc., and
the capabilities of both technical and leadership talent in such
methodologies should be developed by the banks.
Aligning technological and leadership skills at all levels of 3.5 4
the organization would enable the banks to face disruptions,
technological or otherwise.
Impact Zone 12.5.4. Risk Management
Banks continue to invest in technology and people to meet the 3.7 4
regulatory and policy requirements on risk management. Strict
compliance with these requirements would lead to a ‘risk culture’
in the organization.
Analytics and technology facilitate the bank’s understanding of 3.4 3
the risks better and allow them to plan for mitigation strategies.
However, when it comes to developing a ‘risk culture’, the focus
should shift to people in the organization.
By recruiting qualified risk management professionals, banks can 3.3 3
improve the risk culture to a great extent.
It is the individual leadership behaviour that impacts the culture 3.5 4
of the organization, so it is important that the leadership skills of
risk management professionals are developed.
Leaders’ behaviour at all levels within the bank should be aligned 3.6 4
to the philosophy of risk management. This would ultimately
change the organizational culture.
Impact Zone 12.5.5. People
HR in banks should be realigned with the business strategy, 3.7 4
technology and risk management by developing people as
change agents.
Rather than traditional and transactional roles, HR in PSBs 3.7 4
should focus on transformational HR whereby leadership
and strategic thinking capabilities are developed across the
organization.
Learning and development function within the bank should 3.6 4
reorient itself towards leadership development and strategic
thinking.
Talent management in banks should focus on technology and 3.2 3
risk management. The rest of the functions would benefit from
this approach.
Talent management in banks should be centred around business 3.6 4
strategy, market orientation, technology and risk management.
HR should strategize to develop leaders at all levels in each of
these strategic segments.

Leading through Disruptions 187

 Responses to the survey suggest that senior
3.8
bank executives perceive the idea of leadership
at all levels as relevant and important. 3.7

3.6

3.5

MEAN
3.9
3.8 3.4
3.7 3.3
3.6
3.2
MEAN

3.5
3.4 3.1
i ii iii iv v
3.3
SUB POINT
3.2
3.1 Impact Zone 12.5.4 Risk Management
3
i ii iii iv v
SUB POINT
3.8
Impact Zone 12.5.1 Marketing and Market Share 3.7
3.6
3.5

MEAN
3.4
3.7
3.3
3.6 3.2
3.5 3.1
3
MEAN

3.4
2.9
3.3 i ii iii iv v
3.2 SUB POINT

3.1 Impact Zone 12.5.5 People

3
i ii iii iv v

SUB POINT
12.7. Distributed Leadershi p:
Impact Zone 12.5.2 Social and Rural Banking The Way Ahead
12.7.1. Leadershi p
Leadership is one of the most researched con-
4 cepts in the academic world. Despite so much
epistemological and ontological work in the area,
3.5
there is no agreement on the definition of leader-
3
ship. By and large, the most accepted definition
2.5
of leadership is that ‘it is an ability to influence
MEAN

2
others to achieve organizational goals.’ The ex-
1.5 tant literature on leadership identifies some of
1 the most prominent models, such as charismat-
0.5 ic leadership, transformational leadership and
0 Fiedler’s contingency leadership. These theories
i ii iii iv v of leadership have identified various leadership
SUB POINT styles that are context specific in their applica-
tion. Meanwhile, the external and internal en-
Impact Zone 12.5.3 Technology
vironments of an organization jointly interact

188 India Banking and Finance Report 2021

with each other and determine the leadership
style of a leader in an organization. To elaborate,
if the environment is stable, research indicates
that the bureaucratic style is more effective in
comparison to other styles of leadership. Leader-
ship can be individualistic at times and dispersed
or shared at others.
12.7.2. Distributed Leadershi p
Recent years have seen growing recognition of
the relational and collective nature of leadership,
portraying it as a shared and group process (Uhl-
Bien, 2006). According to Uhl-Bien (2006, p. 655),
a social influence process through which
emergent coordination (i.e., evolving social
order) and change (e.g., new values, attitudes,
approaches, behaviors and ideologies) are con-
structed and produced…. This perspective does
not restrict leadership to hierarchical positions
or role. Instead it views leadership as occurring
in relational dynamics through the organiza-
tion... [and] the importance of context in the
study of these relational dynamics.
DL diverges from the idea of single individual
(individualistic) leadership, epitomizing the role
of a group of individuals (Burke, 2010). Senge
(2002) argues that the prevailing individualistic
culture decidedly restricts our view of organiza-
tional leadership. Woods et al. (2004) opined that
DL is a conjoint action of a group of people. The
action is in either a formal structure in the form
of teams or committees or ad hoc arrangement.
They identified DL as providing the opportunity
to engage a diversity of expertise ‘distributed
across many’. The concept of DL advocates for
multiple leaders (Spillane et al., 2004). According
to Spillane (2006), co-performance and recipro-
cal interdependencies are critical ingredients of
the DL. Harris and Spillane (2008) talked about
how leadership activities are shared within and
between organizations through DL.
DL is not only held by those with designated,
formal leadership roles but is enacted by mul-
tiple individuals in the organization. For Spill-
ane (2006), the distribution is based on ‘enacted’
nature of leadership, emphasizing processual
elements of interactions among contributors op-
erating from various vantage points within an
organization. Woods et al. (2004) have elaborated
on DL as an emergent property of a group or net-
work of interacting individuals.
Gronn (2002) distinguished between two differ-
ent kinds of DL. The first is a numeric or additive
view in which DL is the sum of its parts: the aggre-
gate of attributed influence in a group of individu-
als in which any member can exercise leadership.
The second of Gronn’s definitions describes DL
as concertive action and provides three forms of
concertive DL: (a) spontaneous collaboration—the
DL arises in response to particular problems and
requirements as a solution; (b) intuitive collabo-
ration—based on close understanding of people
which emerges through interdependence and re-
liance on each other to create shared role and (c)
institutionalized collaboration—where learning
from (a) and (b) is formalized to some degree.
MacBeath (2005) identified six models of DL: (a)
formal DL—where leadership is intentionally del-
egated or devolved, (b) pragmatic DL—where lead-
ership role and responsibilities are negotiated and
divided between different actors, (c) strategic DL—
where new people, with particular skills, knowl-
edge and/or access to resources, are brought in to
meet a particular leadership need, (d) incremental
DL—where people acquire leadership responsibili-
ties progressively as they gain experience, (e) op-
portunistic DL—where people willingly take on
additional responsibilities over and above those
typically required for their job in a relatively ad
hoc manner, (f) cultural DL—where leadership is
naturally assumed by members of an organization/
group and shared organically between individuals.
Spillane (2006) elaborated on three conceptual
forms of distribution: (a) collaborative (the lead-
ership practice stretches over the work of two or
more individuals working in the same space and
time), (b) collective (it is similar to collaborative ex-
cept that individuals are working separately but
interdependently) and (c) coordinated (the DL re-
fers to leadership practice that has to be performed
in sequence). Most of the scholarly discussions on
DL revolve around the practice of leadership in the
educational sector. Our effort is to adapt the con-
cept to suit the leadership requirements of banks.
The comparison of different models/types of
DL and the initiatives required at individual and
organizational levels is given in Table 12.6.
Leading through Disruptions 189
 Table 12.6 Comparison of Different Types of DL
Extent of Initiatives Required* at:
Individual Organizational
Type of DL Characteristics Level Level
Gronn (2002)
1. Numeric/Additive DL is the sum of its parts; the aggregate High Low
of its attributed influence in a group of
individuals in which any member can
exercise leadership.
2. Concertive Concertive action suggests a more holistic High Medium
view in which leadership is demonstrated
through synergies achieved by joint action.
2.1. Spontaneous DL arises in response to particular problems High Medium
collaboration and requirements. Interactions between
different participants, with different skills
and backgrounds, bring about a solution or
a way of moving on, adjourning when the
problem is solved.
2.2. Intuitive DL is based on a close understanding High Medium
collaboration of people, which emerges through
interdependence and reliance on each
other to create a shared role.
2.3 Institutionalized Where learning from 1 and 2 is formalized Medium High
collaboration to some degree.
MacBeath (2005)
1. Formal DL Leadership is intentionally delegated or Low High
devolved.
2. Pragmatic DL Leadership role and responsibilities are High High
negotiated and divided between different
actors.
3. Strategic DL New people, with particular skills, knowledge Low High
and/or access to resources, are brought in to
meet a particular leadership need.
4. Incremental DL People acquire leadership responsibilities High Medium
progressively as they gain experience.
5. Opportunistic DL People willingly take on additional High Low
responsibilities over and above those
typically required for their job in a
relatively ad hoc manner.
6. Cultural DL Leadership is naturally assumed by members High Low
of an organization/group and is shared
organically among individuals.
Spillane (2006)
1. Collaborative Leadership practice stretches over the work High Medium
of two or more individuals working in the
same space and time.
2. Collective Similar to collaborative except that High High
individuals are working separately but
interdependently.
3. Coordinated Leadership practice that has to be Medium High
performed in sequence.
Note: *Inference is ours.

190 INDIA BANKING AND FINANCE REPORT 2021

12.7.3. Leadershi p Development
Strategies of Banks in India
There is scanty academic literature related to
leadership development strategies in the context
of banks in India. Studies in the broader realm
of leadership, such as leadership style and orga-
nizational effectiveness (Budhiraja & Malhotra,
2013), intellectual capital and competitive advan-
tage (Chahal & Bakshi, 2015) and organizational
justice (Tamta & Rao, 2017), do not engage in dis-
cussing the strategic angle of leadership develop-
ment in Indian banks. Gautam and Malla (2013),
incidentally, acknowledge the leadership role of
branch managers in banks.
ICICI Bank (2020) mentions the ‘comprehen-
sive leadership development programmes and
leadership engagement sessions conducted on a
regular basis for all critical roles in the Bank’. As
regards succession planning, the bank ‘measures
the depth of leadership bench at the Senior Lead-
ership levels’ and they confidently explain that
they ‘have a strong bench for all key positions
and continuously measure the depth of succes-
sion for all critical leadership roles’. Going by the
logic of ‘leadership bench’, the critical leadership
roles appear to be at the senior and top levels of
the management. Banks in public sector, howev-
er, do not enjoy the freedom to aim at the depth
of their leadership bench through talent acquisi-
tion and lateral hiring. State Bank of India (2020)
speaks about ‘a policy on Succession Planning
for the Senior Leadership positions to ensure a
smooth transition at all the critical executive
level positions’ (such as DMDs, CGMs and GMs).
The bank has established an in-house training
college named the State Bank Institute of Leader-
ship ‘to impart knowledge and expertise in areas
of strategic management and organizational be-
haviour to senior managers and top executives’.
Bank of Baroda (2020) launched a ‘comprehen-
sive leadership development programme’ called
‘We Lead’. The programme is in its second phase,
starting in 2020. The programme covers ‘espe-
cially identified people’ at three levels, such as
follows:
1. Baroda Senior Leadership Programme—
general managers and deputy general
managers
2. Baroda Emerging Leaders Programme—
assistant general managers
3. Baroda Rising Stars Programme—chief
managers
The programme has the objective of building
leadership capabilities in managerial personnel
from senior to top levels in the hierarchy. Essen-
tially, it is a training-driven initiative and more
or less similar to the initiatives in banks such as
ICICI Bank and SBI.
12.7.4. Moving towards a Structural
Model of Leadershi p
As already discussed, the banks in India need to
adopt a leadership model that would enable them
to sail through the choppy waters of disruption
and create stakeholder value in a sustained man-
ner. The model should also be in harmony with
the organizational structure and system archi-
tecture supporting it. To put in place such a sys-
tem, the banks need to look beyond the existing
paradigm of training-driven leadership develop-
ment and be ready to redraw the organizational
structure and process from the perspective of
leadership at all levels. It is against this backdrop
that we proffer DL as an alternative model to
lead the banks through disruptions.
12.8. Way Forward
12.8.1. Type of DL
Choosing the type of DL that would be suitable
for banks is not an easy task. We tried to analyse
the extent of an individual’s involvement in each
of the types suggested by some of the major au-
thors on the topic. In the context of banks, with
well-defined control and communication sys-
tems, individual initiatives may not be adequate
to bring about major changes. Organizational
initiatives by way of a structured roll-out of the
chosen model would be required for success-
ful transformation. We, therefore, suggest that
the ‘formal DL’ put forward by MacBeath (2005)
would be ideal for banks in India. The model en-
tails intentionally distributed or devolved lead-
ership within the organization. The focus here
would be on various leadership activities that
are devolved in a structured way with definite
behavioural expectations. It is not envisaged as
Leading through Disruptions 191
 a substitute for strategic/policy-level leadership
decisions, which it cannot be.
Target group of the intervention: Target of the
intervention should be identified based on the
leadership expectations of different levels of
managers. Considering the perceived skill gaps
and the missing middle, it would be appropriate if
the intervention started with officers in Scale IV
or corresponding positions in private banks.
Structuring the intervention: It would be be-
yond the scope of this chapter to explain how
such an intervention could be structured. None-
theless, a broad-indication list of activities is sug-
gested to trigger further thoughts on structuring
the DL initiative.
A. Pre-roll-out phase
a. Get the top management to buy-in.
b. Prepare a ‘leadership organogram’.
c. Identify and enumerate leadership re-
sponsibilities and leadership activities.
d. Communicate the responsibilities and
activities to the identified target group.
e. Establish a system-driven mechanism for
continuous feedback.
f. Revisit the competency mapping of each
of the identified positions futuristically.
B. Roll-out phase
a. Develop personal development plans for
the identified candidates through assess-
ment-cum-development centre approach.
b. Introduce a mentee-driven mentorship
programme.
c. Facilitate ‘action learning’ and critical
thinking.
d. Expose the target group to thoughts, ideas
and experiences of leaders from other in-
dustries/academia.
e. Provide continuous feedback.
f. Senior and top-level leaders to engage
in periodic non-business conversations
with the target group individually.
C. Periodic evaluation
192 INDIA BANKING AND FINANCE REPORT 2021
12.9. Conclusion
DL in organizations calls for a well-designed,
structured approach that must be executed by se-
nior leaders. It cannot be left to the learning and
development/training system, not even the HR
team, to roll out the change. Establishing DL in
banks should be designed as a transformational
strategy for which top management buy-in is ab-
solutely necessary. Although DL is not envisaged
as a training initiative, which it can never be, the
training system within the banks can be instru-
mental in translating the strategy to action.
Appendix A. Leadershi p
Perception Survey
Impact Zone 12.5.1. Marketing and
Market Share
(Includes corporate, institutional as well as retail
business segments)
1. Market share can be increased by technology-
driven marketing using analytics, AI, ML,
etc., where human involvement would only
be secondary and supportive in nature.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
2. The market demand for app-based, contact-
less banking will be huge, and it would reduce
the bank’s dependence on physical delivery
points. Marketing through technology will
hold the key. This would require sustained
investment in technology rather than in hu-
man skills.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
3. Notwithstanding the emphasis on technol-
ogy, marketing will continue to work under
human leadership and banks should contin-
ue to invest in human resources to respond
to the ever-changing needs of the market.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
4. Leadership will play an important role in
marketing, and it would be important to
 develop strategic thinking at all levels of the
marketing spectrum in all business verticals.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
5. The existing learning and development sys-
tems of banks should be totally aligned with
business strategy and customer centricity
so that people at all levels think like leaders.
Such an approach will enable the banks to
face the market disruptions effectively.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
Impact Zone 12.5.2. Social and
Rural Banking
1. Social and rural banking will continue to be
important to banks despite the increasing
number of urban-centric customers.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
2. Social and rural banking should be consid-
ered as a market segment with tremendous
potential, rather than a mandated activity.
Such a shift in paradigm would be possible
through leadership and strategic responses.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
3. The policy interventions of the government,
like the recently launched ODOP approach,
for instance, can be looked at by the banks as
an avenue for business growth. This would
entail strategic thinking at all levels.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
4. Achieving business goals in the segment will
continue to be of paramount importance for
the banks. Nevertheless, an approach that
looks beyond the business budgets should
be developed so that the banks can develop
processes and products to meet the specific
needs of the segment.
5. Market disruptions would have cascading ef-
fects on the segment and achieving sustain-
able business growth amid the disruptions
would be possible only if the banks develop
leaders at all levels of the vertical and build
strategic thinking capabilities.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
Impact Zone 12.5.3. Technology
1. Technology like AI, for example, would
eventually overtake human functions, and
banks should therefore develop techno-
logical capabilities rather than strategic and
leadership capabilities.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
2. Technology should be used to augment hu-
man capabilities rather than to replace hu-
man talent in banks.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
3. The technological ecosystem of banks
should be market-oriented and customer-
centric, and to achieve this, the technical tal-
ent should be exposed to strategic and lead-
ership skills.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
4. Business functions should draw strategic les-
sons from efficiency improvement systems
like the agile methodology, etc., and the ca-
pabilities of both technical and leadership
talent in such methodologies should be de-
veloped by the banks.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
5. Aligning technological and leadership skills
at all levels of the organization would enable
the banks to face the disruptions, technologi-
cal or otherwise.

a. Strongly disagree c. Agree a. Strongly disagree c. Agree

b. Disagree d. Strongly agree b. Disagree d. Strongly agree

Leading through Disruptions 193

 Impact Zone 12.5.4. Risk Management
1. Banks continue to invest in technology and
people to meet the regulatory and policy
requirements on risk management. Strict
compliance with these requirements would
lead to a ‘risk culture’ in the organization.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
2. Analytics and technology facilitate the
bank’s understanding of the risks better and
allow them to plan for mitigation strategies.
However, when it comes to developing the
‘risk culture’, the focus should shift to the
people in the organization.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
3. By recruiting qualified risk management
professionals, banks can improve the risk
culture to a great extent.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
4. It is the individual leadership behaviour that
impacts the culture of the organization, so
it is important that leadership skills of risk
management professionals are developed.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
5. Leaders’ behaviour at all levels within the
bank should be aligned with the philosophy
of risk management. This would ultimately
change the organizational culture.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
Impact Zone 12.5.5. People
1. HR in banks should be realigned with busi-
ness strategy, technology and risk man-
agement by developing people as change
agents.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
2. Rather than traditional and transactional
roles, HR in PSBs should focus on trans-
formational HR whereby leadership and
194 INDIA BANKING AND FINANCE REPORT 2021
strategic thinking capabilities are developed
across the organization.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
3. Learning and development functions within
the bank should reorient themselves to-
wards leadership development and strategic
thinking.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
4. Talent management in banks should focus
on technology and risk management. The
rest of the functions would benefit from this
approach.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
5. Talent management in banks should be cen-
tred around business strategy, market orien-
tation, technology and risk management. HR
should strategize to develop leaders at all lev-
els in each of these strategic segments.
a. Strongly disagree c. Agree
b. Disagree d. Strongly agree
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ABOUT THE EDITORS AND
CONTRIBUTORS
Editors
Partha Ray is the Director of NIBM. His research
interests include global macroeconomic issues,
monetary and financial sector policies and insti-
tutions.
Arindam Bandyopadhyay is an Associate Pro-
fessor and Associate Dean (Consultancy) at
NIBM. He is the editor of NIBM journal Prajnan.
His areas of interest are risk management, Basel
regulations, applied corporate finance and quan-
titative techniques.
Sanjay Basu is an Associate Professor in the
Finance Area and the Associate Dean (Research)
at NIBM. His areas of interest are bond portfolio
management, market risk management, asset–
liability management, financial crises, applied
game theory and contract theory.
Contributors
B. Ashok is an adjunct faculty at NIBM. He is an
experienced banker who, before joining the in-
stitute, worked with the Central Bank of India
as General Manager, HR, and has held various
board-level positions in banks and financial in-
stitutions. His interests include human resources
management and leadership.
Richa Verma Bajaj is an Assistant Professor of
finance at NIBM. She has teaching, research and
consulting experience of 15 years in the area of
risk management.
Paritosh C. Basu is an academician with 34 years
of corporate experience. He is currently a full-
time Senior Professor and Chairperson of MBA
(Law) programme of the NMIMS University
School of Business Management.
Tasneem Chherawala is an Assistant Profes-
sor at NIBM. Her domain expertise includes risk
modelling and management, Basel, IFRS, finan-
cial derivatives, project finance and structured
finance, in which she conducts executive train-
ings and PGDM courses.
Dipali Krishnakumar is an Assistant Profes-
sor of finance at NIBM. She has over 22 years’
experience in investment banking, corporate
finance, auditing, accounting, business analysis
and education. Her teaching and research in-
terests include earnings manipulation, Ind AS/
IFRS, and mergers and acquisitions.
Naveen Kumar K. is an Assistant Professor at
NIBM. His research interests include development
economics, applied finance, agricultural econom-
ics, new technologies in banking and finance.
Debasish Mallick is the former Deputy Manag-
ing Director of Exim Bank of India, and he has
a distinguished career in development banking,
investment banking and commercial banking
spanning over 35 years.
M. Manickaraj is an Associate Professor and As-
sociate Dean Education at NIBM. He specializes
in equity markets, financing MSMEs and carbon
finance.
 Sundeep Mohindru, a charted accountant, has
more than 23 years of experience in technology,
finance and consulting. He is the Founder Director
of M1xchange (TReDS) and the Mynd group (offers
SaaS-based finance and HR solutions).
Kaushik Mukerjee is an Associate Professor and
Associate Dean-Training at NIBM. His research
interests include corporate governance, strategic
leadership, corporate and strategic marketing.
G. Nagaraju is an Associate Professor at NIBM.
He is actively involved in the teaching, training
and research of foreign exchange markets, tech-
nical analysis for financial markets, monetary
policy analysis, fixed income instruments and
central bank functions.
Anjan Roy is an Associate Professor at NIBM
and Associate Dean (E-certification). His areas of
interest are strategic planning and management,
and banking operations.
198 INDIA BANKING AND FINANCE REPORT 2021
Deepankar Roy is an Assistant Professor at
NIBM. His research interests include digital
transformation, digital financial services, fintech
and ICT management.
Gargi Sanati is an Assistant Professor at NIBM.
Her research interest includes international fi-
nance, credit risk and market risk analysis, finan-
cial forecasting and interbank dealing.
Shomi Srivastava is an Assistant Professor at
NIBM. His areas of specialization are leadership,
human resource management, discipline man-
agement, preventive vigilance, change manage-
ment and organizational development.
Smita Roy Trivedi is an Assistant Professor at
NIBM. Her research interests include interna-
tional economics, central banking, foreign ex-
change market, macro-prudential measures and
technical analysis for markets.
INDEX

asset acquisition, 58–59 Centre for Monitoring Indian Economy (CMIE)

asset quality review (AQR), 12 database, 77
asset management companies (AMCs), 57–61 certificate of deposit (CD) market, 8
asset reconstruction companies (ARCs), 57–58, 62–70 Clearing Corporation of India Limited (CCIL) bond
Atmanirbhar Bharat Abhiyan (ABA), 6–7 index, 115
climate risk
bad banks assessment, 111
asset acquisition, 58–59 elements, 110
defined, 58 physical, 110
early, 59–60 commercial bank branches, 181
East Asian Crisis Era, 60 commercial paper (CP) market, 8
Global Financial Crisis Era, 60–61 consumer price index (CPI), 5
NPL crisis, 61–62 trends, 6
operations and performance, 59 consumer price inflation, 3
purpose, 58 core banking system (CBS), 180
structure and ownership, 58, 68 corporate bond
bank corporate governance market, 10
board leadership, 33 primary issues, 11
business strategy and risk management, 26 spread, 11
factors, framework, 31–33 COVID–19 crisis in India, 3
failures and likely causes, 23–27 banking trends, 12
framework, 32 crisis–related liquidity–inducing measures, 14
ownership structure, 23–24 global recovery, policy normalization, 16–17
principles, 22–23 Indian banks, position, 15–16
research design, analysis and findings, 27–28, liquidity measures by RBI, 8
30–31 policy measures, 7
shareholding pattern, 23–24 protocols, 4
bank credit share, distribution, 14 regulatory measures and relaxations by RBI, 8
bond and equity relief measures, 7
regression coefficients, 116 second wave, 4
return distributions, 116 credit risk, 112–15
branch–driven business models of banks, 180 cyber security, 172
bribe/collusion or internal control, 96
business models, 156–60 debt recovery tribunal (DRT), 62
business responsibility and sustainability reporting decentralized bad banks, 58
(BRSR) norms, 110 dependent and independent variables, descriptive
statistics, 28
capital adequacy indicator, 15 digital lending
capital adequacy ratio (CAR), 27 business models, 156–60
capital–to–risk weighted assets ratio (CRAR), 15 COVID–19 pandemic, 160
Central Statistical Organisation (CSO) database, 77 future, 161–62
centralized bad banks. see bad banks regulatory concerns, 160–61
 digital transformation, of banking institutions
adoption, implementation and implications, 173,
176
defined, 163
digital business strategy, surpassing technology
adoption, 164
findings and observations, 165–73
implications, 176–77
organizational structure, changes, 164–65
samples, data sources and data collection, 165
technology adoption by organizations, 164
usage, 164
distributed leadership model
concept, 179
future, 188–89, 191–92
innovative leadership model, 184–85
leadership perception survey, 185, 188
organizational issues and talent constraints,
183–84
organizational structure of banks, 180–83
performance and leadership, 179–80
type, 191–92
early warning signals (EWS), 91
correlation coefficients, 97
frequent, modus operandi, 94–96
list, 98–99
ranking based on frequencies, 100
scores, 93
understanding, 94
East Asian crisis–led bad banks, cross–country
comparison, 71
Emergency Credit Line Guarantee Scheme, 7
equity market, 10
Expected Credit Loss (ECL), 75–76, 88
Extreme Value Theory, 109
fake and fabricated documents, 95
fiscal policy
measures in India, 6–7
foreign direct investment (FDI), 12
foreign exchange market, 12
foreign institutional investors (FIIs), 27
foreign portfolio investment (FPI), 12
frauds, 92–94
fraud losses in banks in India, 93
funds
siphoning, 94–95
FX interbank market
database and econometric methods, 124–26
econometric analysis, 127–30
FX spot and FX swap, 122–24
importance, 119
interconnectivity, 119
preliminary analysis, 126–27
structure, liquidity and functioning, 120–24
transaction, 121
turnover, 121
worldwide liquidity, 120
200 INDIA BANKING AND FINANCE REPORT 2021
Global Climate Risk Index, 109
Global Financial Crisis–led bad banks, cross–coun-
try comparison, 72
government securities market, 9
trends, 10
Granger–causality test, 128–30
Grant Street National Bank (GSNB), 59
gross capital formation (GCF), 5
gross domestic product (GDP)
global, 2
quarterly growth rates, 3
sharp dip, 2
gross non–performing assets (GNPA), 27
gross private final consumption expenditure
(GPFCE), 5
gross value added (GVA), 4
sectoral, quarterly growth performance, 4–5
inflation in, India
CPI, 5
recent trends in growth, 3–5
infrastructure financing
new DFID–NABFID, 140–42
pipeline, 138–40
setting, 135–37
transition, 137–38
interbank market parlance, 132
interbank transaction and FX swap, 133
Intergovernmental Panel on Climate Change
Report, 109
International Financial Reporting Standards 9
(IFRS 9) model, 75
international monetary fund (IMF), 2
Insolvency and Bankruptcy Code (IBC), 57, 62, 65
leadership, 179
perception survey, 192–94
Lok Adalat, 62.
long–term repo operation (LTRO), 7
macro–index (Z index), 76–77
macroeconomic factor, and link between, 87
Merton’s methodology for deriving, 78–80
regression methodology to derive, 77–78
market risk, 115–16
merger and acquisition(M&A)
banking, in, world, 37–38
banks, performance of, study, 39–40
CMIE PROWESS database and annual reports,
42
data, 40
deals, 37, 41, 53–54
event study methodology, stock market reaction,
41–42
event study results, 42, 44, 46
market reaction, study, 39
operating performance results, 46–50, 52
performance of banks and variable definition,
methodology, 42
 public sector and private sector banks, deals, 40 Indian banks, 13
regulatory framework, 54 rate, 14
stock market reaction to, deal announcement, 39 trends, 62
strategies, 38
Merton model, 76 open and neo banking, 173
Micro, Small and Medium Enterprises Develop-
ment (MSMED) performance variables
commercial bank loans outstanding, 153 board composition, effect, 29
definitions, 151 shareholding pattern effect, 29
digital innovations in financing, global and India, probability of default (PD)
153–54, 156 adjustments, 75
digital lending (see digital lending) empirical framework and key results, 80–88
estimated number, 152 estimating, methods, 75–76
growth in credit, 153 forward–looking scenario–based, 76
India, 152–53 macroeconomic drivers, 76
MSMED Act, 151 variables and methodology, 77–80
monetary policy provision coverage ratio (PCR), 14
measures in India, 7–8 trends, 15
money market, 8 public sector banks (PSB), leadership challenges,
condition, 9 184
surplus liquidity, 9
Monte Carlo Simulation (MCS), 109, 114–16 red flag account (RFA), 91
multichannel banking, 183 return on asset (RoA), 15
risk score adjustments, 112
National Asset Reconstruction Company Ltd roll rate and vintage method, 75–76
(NARCL)
asset acquisition, 68–69 scheduled commercial banks, bank group–wise
expected performance in resolution, of acquired number of functioning offices, 182
NPLs, 69 Securitisation and Reconstruction of Financial
IDRCL structure and business model, 67–68 Assets and Enforcement of Security Interest
investors in security receipts, issued, 69 (SARFAESI) Act, 62–64
national infrastructure pipeline (NIP), 138–40 select banking variables, trends, 15
national monetization plan (NMP), 142 spot settlement, 132
assets considered, 143 stakeholder influence, bank shareholding, 31–32
indicative valuation, 143, 145–46 stationarity test, 129
objectives, 143 strategy and prudential decisions
observations, 147–49 board composition, effect, 30
potential assets and proposed, 144–45 shareholding pattern effect, 29
process, 143 Stressed Assets Stabilization Fund (SASF), 64
proposed, 146–47 ‘Swiss Challenge’ methodology, 68–69
valuation methodology adopted–sector/asset
class–wise, 146 targeted long–term repo operations (TLTRO), 7
National Stock Exchange Fifty (NIFTY) through–the cycle (TTC)–based capital constraint, 76
board market index, 10 transition matrix approach, 75–76
NSE market capitalization, 11 transition risks, 110
price–earning (P–E) multiples, 12 Troubled Asset Relief Program, 60–61
trend, 11
net interest margin (NIM), 15 volatility, uncertainty, complexity and ambiguity
Network for Greening the Financial System NGFS, (VUCA), 184–85
111 Value–at–Risk (VaR), 109–110, 114–17
non–performing asset (NPA), 12
crisis in, Indian banking sector, 61–64 work from anywhere (WFA), 171
experience, 14 World Bank data, 181

Index 201