Introduction to Modern Age Banking

Goldsmiths to Moneylenders:
• The banking profession, in the strictest sense of the word, was first carried on by goldsmiths in
medieval Europe. Since, it was the business of the goldsmith to deal with valuable commodities
the goldsmith would build strong vaults to protect their inventory from theft. The residents of
the town wanted to rent the goldsmiths secure vault in order to keep their money safe. The
goldsmith therefore started taking deposits and this was in a way the birth of modern banking.

• Over a period of time, the goldsmiths realized that the deposits are usually far in excess of the
withdrawals. This meant that if 100 gold coins were deposited with the goldsmith, statistically
only 10 of them would be withdrawn at any given time. Therefore, the goldsmiths started
lending out the money that they had held on deposit even though it did not belong to them! This
was the birth of the second major function of modern banking i.e. lending money.

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 Introduction to Modern Age Banking
Unregulated Era:
• The modern era saw money lending transform into banking. Taking deposits and making loans
out of deposits was now the usual business of institutions now called banks. Also, the depositors
did not have to pay a fee to the banker to safeguard their gold in his secure vault. Instead they
received compensation in the form of interest to park their excess gold with the bankers.
• This was the era of unregulated banks. Banking during this era was entrepreneurial in nature.
Therefore, anyone who wanted to could set up a bank and enter the business. There were no
licenses required and there was no regulation. This era continued till the 1600’s. By then banking
had become big business
Issuance of Private Bank Notes:
• As banking evolved over time, people realized that carrying large amounts of gold over long
distances was unsafe as well as inconvenient. The radius of trade and commerce began to spread
far and wide and carrying money over long distances became necessary. This was the birth of
bank notes. Private Banks would issue private bank notes. The notes were nothing but a receipt
for gold that had been deposited at the bank and could be withdrawn if the receipt was
presented. Some of these notes were bearer notes i.e. the gold would be paid out to whoever
brought in the note to the bank.
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 Introduction to Modern Age Banking
Emergence of Central Banks:
• The era of unregulated banking can also be considered to be the era of unscrupulous banking.
Many fly-by-night banks came into existence during this period. Some of these banks were called
“wildcat banks” and they fleeced entire towns and cities of their savings. In order to bring an
order to this chaos and prevent the honest banks from losing business, central banks came into
existence.
• Central banks were banks created by special charter by the government. They would act as a
banker to the government. Also, they would be responsible for the proper functioning of the
other banks within their domain. This is when licenses became a requirement for banking
business. However, Central banks are largely a 20th Century phenomenon. Many countries did
not have a Central Bank till the late 1890’s.

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 Introduction to Modern Age Banking
Fractional Reserve Banking:
• Another important development in the modern banking system is the fractional reserve system.
This means that bankers only need to keep a fraction of the funds on deposit. Therefore, if a
bank receives $100 as deposit, it needs to maintain, let’s say $10 as deposit and the rest can be
used for lending. This $10 amount is set by the Central Bank and periodically varied to increase
and decrease the money supply as required.

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 Introduction to Fintech
Fintech is used to describe new tech that seeks to improve and automate the delivery and use of
financial services. ​At its core, fintech is utilized to help companies, business owners and consumers
better manage their financial operations, processes, and lives by utilizing specialized software and
algorithms that are used on computers and, increasingly, smartphones. Fintech, the word, is a
combination of “Financial Technology".
When Fintech emerged in the 21st Century, the term was initially applied to the technology
employed at the back-end systems of established financial institutions. ​Since then, however, there
has been a shift to more consumer-oriented services and therefore a more consumer-oriented
definition.
Broadly, the term “Financial Technology" can apply to any innovation in how people transact
business, from the invention of digital money to double-entry bookkeeping. Since the internet
revolution and the mobile internet/smartphone revolution, however, financial technology has
grown explosively, and fintech, which originally referred to computer technology applied to the back
office of banks or trading firms, now describes a broad variety of technological interventions into
personal and commercial finance.

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 Introduction to Digital Banking
Digital Banking is the automation of traditional banking services. Digital banking enables a bank’s
customers to access banking products and services via an electronic/online platform. Digital banking
means to digitize all of the banking operations and substitute the bank’s physical presence with an
everlasting online presence, eliminating a consumer’s need to visit a branch.

Digital Banking Services can include:

• Obtaining financial statements
• Transfer of funds
• Mobile Banking
• Bill Payments, etc.

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 Fintech vs Digital Banking
Fintech is a much broader term than digital banking

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 Banking Regulation in India
The Indian banking sector is regulated by the Reserve Bank of India Act 1934 (RBI Act) and the
Banking Regulation Act 1949 (BR Act).
The Reserve Bank of India (RBI), India’s central bank, issues various guidelines, notifications and
policies from time to time to regulate the banking sector.
In addition, the Foreign Exchange Management Act 1999 (FEMA) regulates cross-border exchange
transactions by Indian entities, including banks.

Let’s look at the structure of Indian Banking System in the next slides:

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 Structure of Indian Banking System
Reserve Bank of India is the central bank of the country and regulates the banking system of India.
The structure of the banking system of India can be broadly divided into scheduled banks, non-
scheduled banks and development banks.
Scheduled Banks: Scheduled banks are banks that are listed in the 2nd schedule of the Reserve
Bank of India Act, 1934. The bank's paid-up capital and raised funds must be at least Rs5 lakh to
qualify as a scheduled bank. Scheduled banks are liable for low-interest loans from the Reserve
Bank of India and membership in clearing houses.
Scheduled banks are further divided into commercial and cooperative banks:
• Commercial Banks: The institutions that accept deposits from the general public and advance
loans with the purpose of earning profits are known as Commercial Banks. Commercial banks
can be broadly divided into following:
 In Public Sector Banks the majority stake is held by the government. An example of Public
Sector Bank is State Bank of India.
 Private Sector Banks are banks where the major stakes in the equity are owned by private
stakeholders or business houses. A few major private sector banks in India are HDFC Bank,
Kotak Mahindra Bank, etc.
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 Structure of Indian Banking System
 A foreign bank is a type of International Bank headquartered in a different country with
branches in India. A foreign bank is obligated to follow the regulations of both the home and
host countries. Example: Standard Chartered Bank
 Regional Rural Banks were established under the Regional Rural Banks Ordinance, 1975 with
the aim of ensuring sufficient institutional credit for agriculture and other rural sectors. The
area of operation of RRBs is limited to the area notified by the Government. Ownership of
Regional Rural Banks in India is as follows: Central Government (50%), State Government (15%)
and Sponsor Banks (35%). Example: Andhra Pradesh Grameena Vikas Bank whose sponsor bank
is State Bank of India
 Small Finance Bank: Objective of setting up of small finance banks is financial inclusion to the
unserved sections of the society. The functions include supply of credit to small and micro
business units, small and marginal farmers. Small Finance Banks were set up on the
recommendations of Nachiket Mor Committee, 2014. Ex: Ujjivan Small Finance Bank Limited
 Payment Bank: Payments banks is an Indian new model of banks conceptualised by the Reserve
Bank of India (RBI) without issuing credit. These banks can accept a restricted deposit, which is
currently limited to ₹200,000 per customer. Lending activity, credit card or advance is not
allowed for payment banks Ex: Paytm Payments Bank Limited
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 Structure of Indian Banking System
• Cooperative Banks: A Cooperative Bank is a financial entity that belongs to its members, who are
also the owners as well as the customers of their bank. They provide their members with
numerous banking and financial services. Cooperative banks are the primary supporters of
agricultural activities, some small-scale industries and self-employed workers.
An example of a Cooperative Bank in India is Mehsana Urban Co-operative Bank. At the ground
level, individuals come together to form a Credit Co-operative Society. The individuals in the
society include an association of borrowers and non-borrowers residing in a particular locality
and taking interest in the business affairs of one another. As membership is practically open to all
inhabitants of a locality, people of different status are brought together into the common
organization. All the societies in an area come together to form a Central Co-operative Banks.
Example: Saraswat Co-operative Bank Ltd
Cooperative banks are further divided into two categories - urban and rural.

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 Structure of Indian Banking System
Non Schedules Banks: All banks which are not included in the second section of the Reserve Bank of
India Act, 1934 are Non-scheduled Banks. Banks with a reserve capital of less than 5 lakh rupees
qualify as non-scheduled banks. They are not eligible to borrow from the RBI for normal banking
purposes except for emergencies. RBI is not able to protect the depositor’s interest in the case of
Non Scheduled Banks in India. These banks need to maintain the cash reserve ratio with themselves
but not with the RBI. Non scheduled banks can be of two types: commercial and cooperative
Examples: Local Area Banks are non scheduled banks; example can include Subhadra Local Area
Bank Ltd., Kolhapur (Maharashtra); Capital Local Area Bank Ltd - Phagwara (Punjab), etc. Other
examples can include The Andaman and Nicobar State Co-operative Bank Ltd; The Assam Co-
operative Apex Bank Ltd., etc.
Development Banks:
Financial institutions that provide long-term credit in order to support capital-intensive investments
spread over a long period and yielding low rates of return with considerable social benefits are
known as Development Banks. The major development banks in India are National Bank for
Agriculture and Rural Development (NABARD) 1982, Small Industries Development Bank Of India
(SIDBI) 1989

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 Banking Ombudsman Scheme
Banking Ombudsman Scheme enable the people to file complain to resolve the banking issues.
It is a scheme for resolving customer grievances in relation to services provided by entities regulated
by Reserve Bank of India in an expeditious and cost-effective manner under Section 35A of the
Banking Regulation Act, 1949 (10 of 1949), Section 45L of the Reserve Bank of India Act, 1934 (2 of
1934) and Section 18 of the Payment and Settlement Systems Act, 2007 (51 of 2007).
Integrated Ombudsman Scheme, 2021
The Reserve Bank of India to make the alternate dispute redress mechanism simpler and more
responsive to the customers of entities regulated by it, integrated the three Ombudsman schemes
into the Reserve Bank - Integrated Ombudsman Scheme, 2021.
• the Banking Ombudsman Scheme, 2006, as amended up to July 01, 2017;
• the Ombudsman Scheme for Non-Banking Financial Companies, 2018; and
• the Ombudsman Scheme for Digital Transactions, 2019
The Scheme come into force from November, 2021.
Continued on next slide…

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 Banking Ombudsman Scheme
Integrated Ombudsman Scheme, 2021 (cont.):
The Scheme, framed by the Reserve Bank in exercise of the powers conferred on it under Section
35A of the Banking Regulation Act, 1949 (10 of 1949), Section 45L of the Reserve Bank of India Act,
1934 (2 of 1934), and Section 18 of the Payment and Settlement Systems Act, 2007 (51 of 2007), will
provide cost-free redress of customer complaints involving deficiency in services rendered by
entities regulated by RBI, if not resolved to the satisfaction of the customers or not replied within a
period of 30 days by the regulated entity.

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 Retail vs Corporate Banking
Retail banking model is designed for the general public, with bank branches set up at different
locations in a city which handles retail customers daily.
In contrast, corporate banking is for businesses to help them in raising funds, providing credit, and
offering advice. It offers customized finance specifically designed and personalized for corporate
houses, as per their needs.

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Retail vs Corporate Banking

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 Types of Loan
Secured Loan: These loans require the borrower to pledge collateral for the money being borrowed.
In case the borrower is unable to repay the loan, the bank reserves the right to utilise the pledged
collateral to recover the pending payment. The interest rate for such loans is much lower as
compared to unsecured loans.
Examples of secured loans include loan against property , vehicle loans, etc.
Unsecured Loan: Unsecured loans are those that do not require any collateral for loan
disbursement. The bank analyses the past relationship with the borrower, the credit score, and
other factors to determine whether the loan should be given or not. The interest rate for such loans
can be higher as there is no way to recover the loan amount if the borrower defaults.
Credit Card are an example of unsecured loan.

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 Types of Loan
• Education Loan: Education loans are financing instruments that aid the borrower pursue
education.
• Personal Loan: Whenever there is a liquidity issue, you can go for a personal loan. The purpose
of taking a personal loan can be anything from repaying an old debt, going on vacation, etc.
• Vehicle Loan: Based on the on-road price of the vehicle, the loan amount will be determined by
the lender. You may have to get ready with a down payment to get the vehicle as the loan rarely
provides 100% financing. The vehicle will be owned by the lender until full repayment is made.
• Home Loan: Home loans are dedicated to receiving funds in order to purchase a house/flat,
construct a house, renovate/repair an existing house, or purchase a plot for the construction of a
house/flats. In this case, the property will be held by the lender and the ownership will be
transferred to the rightful owner upon completion of repayments.

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 Types of Loan
• Gold Loan: Many financiers and lenders offer cash when the borrower pledges physical gold, may
it be jewellery or gold bars/coins. The lender weighs the gold and calculates the amount offered
based on several checks of purity and other things. The money can be utilised for any purpose.
The loan must be repaid in monthly instalments so the loan can be cleared by the end of the
tenure and the gold can be taken back to custody by the borrower. If the borrower fails to make
the repayments on time, the lender reserves the right to take over the gold to recover the losses.
• Loan Against Assets: Similar to pledging gold, individuals and businesses pledge property,
insurance policies, FD certificates, mutual funds, shares, bonds, and other assets in order to
borrow money. Based on the value of the pledged assets, the lender will offer a loan with some
margin at hand. The borrower needs to make repayments on time so that he/she can get custody
of the pledged assets at the end of the tenure. Failing to do so, the lender can sell the assets to
recover the defaulted money.

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 Committees on Bank Finance
Dehejia Committee:
A study group under the chairmanship of V.T. Dehejia was constituted in 1968 in order to determine
“the extent to which credit needs of industry and trade were inflated and to suggest ways and
means of curbing this phenomenon”. The committee submitted its reports in September 1969.
The important findings of the committee are given below:
• Higher growth rate of bank credit to industry than the rise in industrial output.
• Banks in general sanctioned working capital loans to the industry without properly assessing
their needs based on projected financial statements.
• There was also a tendency on the part of industry to divert short-term bank credit to some
extent for acquiring fixed assets and for other purposes
• The present lending system facilitated industrial units to rely on short-term bank credit to finance
for fixed assets.

Cont. on next slide

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 Committees on Bank Finance
Dehejia Committee:
On the basis of the above findings the following recommendations were made by Dehejia
Committee to bring about improvements in the lending system:
Credit application should be appraised by the bankers with reference to present and projected total
financial position as shown by cash flow analysis and forecast submitted by borrowers
In order to avoid the possibility of multiple financing, a customer should deal with only one bank.
However if the credit requirement is more the committee recommended the adoption of
“Consortium arrangement”.
*In the financial world, a consortium refers to several lending institutions that group together to
jointly finance a single borrower.

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 Committees on Bank Finance
Tandon Committee:
In 1974, a study group under the chairmanship of Mr. P. L. Tandon was constituted for framing
guidelines for commercial banks for follow-up & supervision of bank credit for ensuring proper end-
use of funds. The group submitted its report in August 1975, which came to be popularly known as
Tandon Committee Report on Working Capital. Entailed a shift from ‘security based’ to ‘need based’
approach to bank credit.
Some of the findings include:
• The banks do not have any credit appraisal or planning. It is the borrower who decides how much
he would borrow
• Bank credit is treated as the first source of finance rather than being taken as a supplementary to
other sources of finance
• The working capital finance should be made available only for a short period, as it has otherwise,
led to accumulation of inventories with the industry

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 Committees on Bank Finance
Tandon Committee:
Major recommendations of the Tandon committee include:
• Assessment of need based credit of the borrower on a rational basis on the basis of their business
plans.
• Bank credit would only be supplementary to the borrower’s resources and not replace them, i.e.
banks would not finance one hundred percent of borrower’s working capital requirement.
• Bank should ensure proper end use of bank credit by keeping a closer watch on the borrower’s
business, and impose financial discipline on them.
• Working capital finance would be available to the borrowers on the basis of industry wise norms
(prescribe first by the Tandon Committee and then by Reserve Bank of India) for holding different
current assets, viz. Raw materials including stores and others items used in manufacturing process;
Stock in Process; Finished goods; Accounts receivables.

(cont. on next slide)

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 Committees on Bank Finance
Tandon Committee:
Major recommendations of the Tandon committee include:
• Credit would be made available to the borrowers in different components like cash credit, bills
purchased, etc.
• In order to facilitate a close watch under operation of borrowers, bank would require them to
submit at regular intervals, data regarding their business and financial operations, for both the
past and the future periods.

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 Committees on Bank Finance
Chore Committee:
The Reserve Bank of India in March, 1979 appointed another committee under the chairmanship of
Shri K.B. Chore to review the working of cash credit system in recent years with particular reference
to the gap between sanctioned limits and the extent of their utilisation and also to suggest
alternative type of credit facilities which should ensure greater credit discipline.
Some of the important recommendations of the Committee include:
• The banks should obtain quarterly statements in the prescribed format from all borrowers having
working capital credit limits of Rs. 50 lacs and above.
• The banks should undertake a periodical review of limits of Rs. 10 lacs and above.
• The banks should not bifurcate cash credit accounts into demand loan and cash credit
components.
• If a borrower does not submit the quarterly returns in time the banks may charge penal interest
of one per cent on the total amount outstanding for the period of default.

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 Committees on Bank Finance
Chore Committee:
• Banks should discourage sanction of temporary limits by charging additional one per cent
interest over the normal rate on these limits.
• The banks should fix separate credit limits for peak level and non-peak level, wherever possible.

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 Functions of RBI
Reserve Bank of India (RBI) is the Central Bank of India. RBI was established on 1 April 1935 by the
RBI Act 1934. Key functions of RBI are as follows:
• Issue of notes: The Reserve Bank has a monopoly for printing the currency notes in the country.
It has the sole right to issue currency notes of various denominations except one rupee note
(which is issued by the Ministry of Finance). The coins are issued for circulation only through the
Reserve Bank in terms of the RBI Act.
• Banker to the Government: Acts as the Banker, Agent and Adviser to the Government of India
and states. It performs all the banking functions of the State and Central Government and it also
tenders useful advice to the government on matters related to economic and monetary policy.
• Banker’s Bank: The Reserve Bank performs the same functions for the other commercial banks as
the other banks ordinarily perform for their customers. RBI lends money to all the commercial
banks of the country.
• Controller of the Credit: The RBI undertakes the responsibility of controlling credit created by
commercial banks. When RBI observes that the economy has sufficient money supply and it may
cause an inflationary situation in the country then it squeezes the money supply through its tight
monetary policy and vice versa
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 Functions of RBI
• Custodian of Foreign Reserves: For the purpose of keeping the foreign exchange rates stable, the
Reserve Bank buys and sells foreign currencies and also protects the country's foreign exchange
funds.
• Other Functions: The Reserve Bank performs a number of other developmental works. These
works include collecting and publishing the economic data, buying and selling of Government
securities, etc.

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 Some Key Concepts
One of the primary functions of RBI is to control the supply of money in the economy and also ‘the
cost of credit.’ Meaning, how much money is available for the industry or the economy and what is
the price that the economy has to pay to borrow that money.
‘Availability of money’ is nothing but liquidity and ‘cost of borrowing’ is interest rates.
These two things (Supply of money and cost of credit) are closely monitored and controlled by RBI.
The inflation and growth in the economy are primarily impacted by these two factors.
To control inflation and the growth, RBI uses certain tools like:
Cash Reserve Ratio (CRR): It is the ratio of Deposits which banks have to keep with RBI. Under CRR a
certain percentage of the total bank deposits has to be kept in the current account with RBI. Banks
will not have access to this amount. They cannot use this money for any of their economic or
commercial activities. Banks can’t lend this portion of money to corporate or individual borrowers.
If RBI cuts CRR then it means banks will be left with more money to lend or to invest. So, more
money can be released into the economy which may spur economic growth.

(Cont. on next slide)

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 Some Key Concepts
Cash Reserve Ratio (CRR):

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 Some Key Concepts
Statutory Liquidity Ratio (SLR): Besides CRR, Banks have to invest certain percentage of their
deposits in specified financial securities like Central Government or State Government securities.
This percentage is known as SLR. This money is predominantly invested in government securities
which mean the banks can earn some amount as ‘interest’ on these investments as against CRR
where they do not earn anything.

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 Some Key Concepts
Repo Rate: When we need money, we take loans from banks. And banks charge certain interest rate
on these loans. This is called as cost of credit (the rate at which we borrow the money). Similarly,
when banks need money they approach RBI. The rate at which banks borrow money from the RBI by
selling their surplus government securities to the central bank (RBI) is known as “Repo Rate.” Repo
rate is short form of Repurchase Rate.
Put simply, the repo rate is simply the annualised interest rate at which banks borrow money from
the Reserve Bank of India (RBI) over a short term
It simply means the rate at which RBI lends money to commercial banks against the pledge of
government securities whenever the banks are in need of funds to meet their day-to-day
obligations. Banks enter into an agreement with the RBI to repurchase the same pledged
government securities at a future date at a pre-determined price. RBI manages this repo rate which
is the cost of credit for the bank. Example: If repo rate is 5% , and bank takes loan of Rs 1000 from
RBI , they will pay interest of Rs 50 to RBI. So, higher the repo rate higher the cost of short-term
money and vice verse. Higher repo rate may slowdown the growth of the economy. If the repo rate
is low then banks can charge lower interest rates on the loans taken by us

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 Some Key Concepts
Bank Rate: The rate of interest charged by
the central bank on the loans they have
extended to commercial banks and other
financial institutions is called “Bank Rate”. In
this case, there is no repurchasing
agreement signed, no securities sold or
collateral involved. Banks borrow funds from
the central bank and lends the money to
their customers at a higher interest rate,
thus, making profits. When Bank Rate is
increased by RBI, bank’s borrowing costs
increases which in return, reduces the supply
of money in the market. Hence, it is also
called Discount Rate.

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Some Key Concepts

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 Some Key Concepts
Reverse Repo Rate: It is the rate at which RBI borrows money from banks. Reverse Repo Rate is a
mechanism to absorb the liquidity in the market, thus restricting the borrowing power of investors.
Reverse Repo Rate is when the RBI borrows money from banks when there is excess liquidity in the
market.
In other words, the banks park their excess funds with the central bank at this rate, often, for one
day.
The banks benefit out of it by receiving interest for their holdings with the central bank. During high
levels of inflation in the economy, the increase in reverse repo encourages the banks to park more
funds with the RBI to earn higher returns on excess funds. Banks are left with lesser funds to extend
loans and borrowings to consumers. It is lower than the repo rate.

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 Basel Norms
Basel norms or Basel accords are the international banking regulations issued by the Basel
Committee on Banking Supervision
The Basel norms is an effort to coordinate banking regulations across the globe, with the goal of
strengthening the international banking system. It is the set of the agreement by the Basel
committee of Banking Supervision which focuses on the risks to banks and the financial system.
What is the Basel committee on Banking Supervision?
The Basel Committee on Banking Supervision (BCBS) is the primary global standard setter for the
prudential regulation of banks and provides a forum for regular cooperation on banking supervisory
matters for the central banks of different countries.
It was established by the Central Bank governors of the Group of Ten countries in 1974.
The committee expanded its membership in 2009 and then again in 2014. The BCBS now has 45
members from 28 Jurisdictions consisting of Central Banks and authorities with responsibility of
banking regulation.

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 Basel III
Basel III was rolled out by the Basel Committee on Banking Supervision—a consortium of central
banks from 28 countries, based in Basel, Switzerland—shortly after the financial crisis of 2007–
2008.
Basel III is an international regulatory accord that introduced a set of reforms designed to mitigate
risk within the international banking sector by requiring banks to maintain certain leverage ratios
and keep certain levels of reserve capital on hand. In 2010, Basel III guidelines were released.
Measures introduced include:
• Minimum Capital Requirements Under Basel III: Under Basel III, the minimum capital adequacy
ratio that banks must maintain is 8%. The capital adequacy ratio measures a bank's capital in
relation to its risk-weighted assets.
Under Basel III, the minimum total capital ratio that a bank must maintain is 8% of its risk-
weighted assets (RWAs), with a minimum Tier 1 capital ratio of 6%. The rest can be Tier 2. A
bank’s total capital is calculated by adding both tiers together.
Typically, Tier 1 capital includes common stock, disclosed reserves, retained earnings and certain
types of preferred stock. Tier 2 capital refers to a bank’s supplementary capital; it can consist of
undisclosed reserves, revaluation reserve, subordinated term debt, etc
 Basel III
• Capital Buffers for Tough Times:
Basel III introduced new rules requiring that banks maintain additional reserves known as
countercyclical capital buffers—essentially a rainy day fund for banks. These buffers, which may
range from 0% to 2.5% of a bank’s RWAs, can be imposed on banks during periods of economic
expansion. That way, they should have more capital at the ready during times of economic
contraction, such as a recession, when they face greater potential losses.
So, considering both the minimum capital and buffer requirements, a bank could be required to
maintain reserves of up to 10.5%.

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 Capital Adequacy Ratio:
Capital Adequacy Ratio is known as Capital to Risk (Weighted) Assets Ratio (CRAR).
The Capital Adequacy Ratio set standards for banks by looking at a bank’s ability to pay liabilities,
and respond to credit risks and operational risks. A bank that has a good CAR has enough capital
to absorb potential losses. Thus, it has less risk of becoming insolvent and losing depositors’
money.

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 Capital Adequacy Ratio:
Capital Adequacy Ratio:
Example:

Bank A has three types of assets: Debenture, Mortgage, and Loan to the Government.

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 Capital Adequacy Ratio:
Capital Adequacy Ratio:

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 Capital Adequacy Ratio:
Capital Adequacy Ratio:

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 Non Performing Asset
A loan asset becomes a Non- performing Asset (NPA) when it ceases to generate income for the
bank for more than 90 days.
A loan is classified as a non-performing asset when it is not being repaid by the borrower. It results
in the asset no longer generating income for the lender or bank because the interest is not being
paid by the borrower. In such a case, the loan is considered “in arrears.”
Classification of Non Performing Assets:
Banks are required to identify the quality of assets of the bank for the evaluation of bank
performance. As per the recommendations of Narasimham Committee, the Reserve Bank of India
has redefined the non-performing assets and advised all commercial banks to classify their
advances into four broad categories i.e. standard, sub-standard, doubtful and loss assets.
The standard assets are treated as performing assets and the remaining three categories are
treated as non-performing assets.
Standard Assets: Standard asset is one which does not disclose any problems and which does not
carry more than normal risk attached to the business. Such an asset should not be an NPA.
(Cont. on next slide).

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 Non Performing Asset
Banks are required to classify non-performing assets further into the following three categories
based on the period for which the asset has remained nonperforming and the realisability of the
dues:
• Sub-standard Assets: With effect from March 31, 2005 an asset would be classified as sub-
standard if it remained NPA for a period less than or equal to 12 months
• Doubtful Assets: With effect from March 31, 2005, an asset is required to be classified as
doubtful, if it has remained NPA for more than 12 months
• Loss Assets: A loss asset is one where loss has been identified by the bank or internal or external
auditors or by the Co-operation Department or by the Reserve Bank of India’s inspection but the
amount has not been written off, wholly or partly. In other words, such an asset is considered un-
collectible and of such little value that its continuance as a bankable asset is not warranted
although there may be some salvage or recovery value.

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 Provisions
Provisions for Standard Assets:
• Direct advances to the agricultural enterprise – 0.25 %
• Advances to Customer Real Estate Sector – 1.00 %
• All others – 0.40 %

Provision for Sub Standard Asset:

• Secured Exposures – 15 %
• Unsecured Exposures – 25 %
• Unsecured Exposures in case of Infrastructure loan accounts – 20 %

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 Provisions
Provisions for Doubtful Assets:
• Secured Exposures:
Doubtful upto 1 year – 25 %
Doubtful from 1 year to 3 years – 40 %
Doubtful for more than 3 years – 100 %
• Unsecured Exposures – 100 %

Provisions for Loss Assets:

• 100% provision is required for this kind of asset

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 Measures to Reduce Non Performing Asset
Some of the preventive measures to reduce Non Performing Asset include:
• Evaluate borrower’s Credit Information Bureau (India) Limited (CIBIL) score.
• Compromise or use various settlement schemes.
• Use Asset Reconstruction Company.
• Actively circulate information of defaulters.
• Take strict action against large NPAs.
• Legal Reforms such as implementation of the Insolvency and Bankruptcy Code have already
taken place.
Let’s understand some key terms related to the measures mentioned above
• Credit Information Bureau (India) Limited (CIBIL): Credit Information Bureau (India) Limited
(CIBIL) is a credit bureau or credit information company, engaged in maintaining the records of all
the credit-related activities of companies as well as individuals, including credit cards and loans.
The registered member banks and several other financial institutions periodically submit their
information to CIBIL. Based on the information and records provided by these institutions, CIBIL
issues Credit Information Report (CIR) and credit score to applicants and financial institutions.
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 Measures to Reduce Non Performing Asset
Let’s understand some key terms related to the measures mentioned above
• Credit Information Bureau (India) Limited (CIBIL) (cont.): CIBIL is a credit information database.
It provides data to the banks and other lenders to quickly and efficiently filter the loan
applications which they receive in the course of their business.
The Credit Information Bureau (India) Ltd. (CIBIL) was incorporated in 2000 and launched its
operations in April 2004. In 2016, Transunion acquired 92.1% stake in CIBIL to become
Transunion CIBIL. The company is now called TransUnion CIBIL Ltd. Other Credit Bureaus in the
country include: Equifax, Experian, CRIF Highmark. All the credit bureaus in the country are
licensed by the RBI.

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 Measures to Reduce Non Performing Asset
Let’s understand some key terms related to the measures mentioned above
• One Time Settlement for Recovering NPAs in Banks: One-time settlement or OTS is a type of
compromise settlement executed by the banks in order to recover non-performing assets (NPAs).
OTS is a scheme where the borrower (the one who has defaulted) proposes to settle all the dues
at once, and banks agree to accept an amount lesser than what was originally due. The banks
settle the loan and waiver/write it off against a one-time instalment, thereby compromising on a
portion of their profits.
The Reserve Bank of India (RBI) mandate states that banks must have a loan recovery policy that
is responsible for negotiations and settlement of non-performing assets. One-time Settlement
(OTS) schemes are available in all banks as an effort to deal with NPA levels. However, not every
borrower is given this provision and whether to settle a bad loan account through OTS is on a
sole discretion of the concerned bank based on some criteria and is not applicable in case of
wilful defaults.

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 Measures to Reduce Non Performing Asset
Let’s understand some key terms related to the measures mentioned above
• Asset Reconstruction Company: The bank always has the option of taking legal action on the
defaulting borrowers, it is not always economically feasible to do so. The bank sometimes
decides to just cut its losses, clean up its balance sheet and keep the business moving towards
better avenues. This is where an Asset Reconstruction Company (ABC) comes in.
An asset reconstruction company is a special type of financial institution that buys the debtors of
the bank at a mutually agreed value and attempts to recover the debts or associated securities
by itself.
Asset reconstruction companies are in the business of buying bad loans from banks. For
instance, if a bank lends money to a person or company, they expect to receive periodic
payments of principal and interest. However, when they do not receive those periodic payments
for an extended period of time, these loans are classified as nonperforming assets. If these NPA’s
are allowed to stay on the bank’s balance sheet, they erode investor confidence in the bank.
Hence, banks sell these bad loans to specialists called asset reconstruction companies. The
business of these companies is to buy bad loans from banks at a steep discount. These
companies then take special measures to recover the money owed. If they are able to recover
the money, they make a profit, if not they lose the money.
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 Measures to Reduce Non Performing Asset
Let’s understand some key terms related to the measures mentioned above
• Asset Reconstruction Company:
The asset reconstruction companies or ARCs are registered under the RBI and regulated under
the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest
Act, 2002 (SARFAESI Act, 2002).
For legal purposes, these entities are considered to be banking entities. Therefore the laws that
apply to banking companies also apply to Asset Reconstruction Companies.
Each and every aspect of their operation including asset acquisition is closely monitored by the
banking regulator.
ARC’s are allowed to raise funds from Qualified Institutional Buyers (QIB) in order to raise cash to
make an upfront payment required to buy discounted debts. ARC’s could issue securities to raise
this cash. However, it is the responsibility of the ARC to ensure that retail investors are not
investing their money in these instruments. ARC’s are high risk business and therefore only
restricted to QIB’s that have the capacity to take such a loss.

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 Measures to Reduce Non Performing Asset
Let’s understand some key terms related to the measures mentioned above
• Insolvency and Bankruptcy Code, 2016:
The Insolvency and Bankruptcy Code, 2016 (IBC) enacted on May 28, 2016, against the backdrop
of mounting non-performing loans, with a view to establishing a consolidated framework for
insolvency resolution of corporations, partnership firms and individuals in a time-bound manner,
seeks to tackle the non-performing asset (NPA) problem in two ways. Firstly, behavioural change
on part of the debtors to ensure sound business decision-making and prevent business failures is
encouraged. Secondly, it envisages a process through which financially ailing corporate entities
are put through a rehabilitation process and brought back up on their feet.
When a corporate debtor (CD), or a company which has taken loans to run its business, defaults
on its loan repayment, either the creditor (a bank or an entity that has lent money for
operational purposes) or the debtor can apply for the initiation of a Corporate Insolvency
Resolution Process (CIRP) under Section 6 of the IBC.

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 NCLT & NCLAT
The National Company Law Tribunal (NCLT) was setup by the Central Government in 2016 under
Section 408 of the Companies Act, 2013. The National Company Law Tribunal has been setup as a
quasi-judicial body to govern the companies registered in India and is a successor to the Company
Law Board.
It was based on the recommendation of the Justice Eradi Committee on law relating to insolvency
and winding up of companies. All proceedings under the Companies Act, including proceedings
relating to arbitration, compromise, arrangements and reconstruction and winding up of
companies, shall be disposed of by the NCLT. The NCLT is the adjudicating authority for insolvency
resolution process of companies and limited liability partnerships under the Insolvency and
Bankruptcy Code, 2016. NCLT, besides a principal bench at New Delhi, has fourteen other benches
— Ahmedabad, Allahabad, Bengaluru, Chandigarh, Chennai, Cuttack, Guwahati, Hyderabad, Kolkata,
Mumbai, Jaipur, Kochi, Amravati, and Indore.
Decisions of the NCLT may be appealed at the National Company Law Appellate Tribunal (NCLAT).
The National Company Law Appellate Tribunal (NCLAT) was constituted under Section 410 of the
Companies Act, 2013, for hearing appeals against the orders of NCLT. It was established on June 1,
2016. It has two benches — one principal bench at New Delhi and the other in Chennai.

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