Sip 2012 Presentation

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OBJECTIVES

Understand the workings, regulations andother concepts related to NBFCs andbanking in India.

Be abreast with the changing trends in thebanking sector and analyse the variouseconomic impacts of the same.

To understand various pros and cons ofinduction of NBFCs to the banking sector

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BACKGROUND

The project deals with the banking sectorat large with working and regulationsand further understand NBFCs with

respect to:- Classification

Regulatory Norms

Present Conditions

Future Discussion and probabledevelopments

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Economy Industry Analysis

Banks are the nodal points of the financial

sector and the backbone of any economy.

The Indian financial sector reported acompounded annual growth rate of over

19% for the last few years now where

Banks accounted for the major chunk of

the credit flow.

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KEY PLAYERS AND THEIR

PERFORMANCE

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Sector for the growth of

economy

Affects of RBI Monetary Policies ( CRR,

Repo Rate etc)

Financial Inclusion Importance and

Requirements

Exposure Norms

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EXPOSURE NORMS

The exposure ceiling is linked to the capital funds of the

lending bank. Capital funds is the sum total of the tier 1 and

tier 2 capital recognised for the computation of the capital

adequacy.

The exposure ceiling is 15% of capital funds in case of a

single borrower and 40% in case of a borrower group.

Credit exposure comprises of all types of funded and non-

funded credit limits and also the credit facilities

Priority Sector Advances

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PRIORITY SECTOR

ADVANCES

Priority sector constituted of only those sectors thatimpact large sections of the population, the weaker sectionsand the sectors which are employment intensive such as

agriculture and tiny and small enterprises. Loans to agriculture and allied activities, small scale

industries, poultry and core economic activities in rural areasincluding loans to micro-finance companies come under thepriority sector loans

40% of loan advances for local banks and 32% of net creditfacility of foreign banks.

32% inclusive of 10% of Adjusted Net Bank Credit towardssmall enterprises.

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PRIORITY SECTOR

ADVANCES total agricultural advances should be 18% of ANBC. This

includes indirect lending up to 4.5%. No specific target hasbeen earmarked for the foreign banks in this account.

40% of the total advances to small enterprises sector should goto micro (manufacturing) enterprises having investment in plantand machinery above Rs. 5Lac and up to Rs. 25lac and micro

service enterprises with investment in equipment above Rs 2lacand up to Rs 10lac.To sum it up 60% of small sector advancesshould go to micro enterprises.

Export credit is a part of the priority sector only in respect offoreign banks.

have to maintain a target towards achieving export credit asspecified by RBI from time to time. The level is at 12% of ANBC.

If the banks are not able to meet the above requirement thenthe deficit amount has to be forwarded as a loan to the RuralInfrastructure Development Fund and other similar funds setupby the National Bank of Agriculture and RuralDevelopment(NABARD) at substantially lower rates

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IMPORTANT PERFORMANCE


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INDICATORS OF THE

BANKING SECTOR ICICI remains the largest private sector lender private sector banks have a low stable NPA level at 2.26% which has

been rising marginally owing to the higher interest rates and tightmonetary policy

Capitalisation levels of public sector banks remained under controlowing to the strong capital infusion by the Government of India of overRs 150 billion

The levels remained much above the required levels of 6% and 9% fortier 1 capital and CRAR.

private banks maintain a better capitalization levels of around 16%whereas the public sector banks maintained it around 13%. Howeverdue to continuous government support via capital infusion enables thepublic sector banks to maintain a minuimum tier 1 capital of 8%

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INDICATORS OF THE BANKING

SECTOR A steady decline in the non interest incomes of the banks have been witnessed due to lower trading

profits on the portfolio maintained by the bank. The declining yields from the government securities hasan adverse effect on the incomes of the banks from non interest areas.

Private sector banks have showed a positive improvement in the CASA share at 40.92% public sectorbanks on the other hand faced a decline in the same at a 33.01%. Out of which SBI has managed toshow better performance than the peer public sector banks with CASA at 42.09%

Savings account have made up 22-23% of total bank deposits and thus such an increase in the interestrate could put a pressure on the net interest margin by 8- 15 basis points.

The gross NPAs of all the banks first increase from 2.16% in march 09 to 2.31 in march 10 andmarginally decreased in march 11 to 2.26%. Private sector banks have showed a strong improvement inNPAs from 2.83% to 2.34%.

For all the banks the solvency ratio maintains a comfortable situation of 10% as on march 11 marginallybetter than the previous 10.77% . PSU were at a better position due to the equity infusion from thegovernment in many PSU banks. The ratio declined for SBI to 17.65% from 15.47% due to a substantialincrease in the NPA levels.

Presently out of the 42 banks 4 banks have capital adequacy less than 12% and 7 have their capitaladequacy ratios above 15%.

The average Tier 1 capital adequacy ratio improved to 9.24% from 9.11%, whereas the same declinedfor private sector banks marginally from 11.40% to 11.30%.

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COMPANY OVERVIEW

IDBI Bank is one of the largest public sector bank in India

As on 31st March 2012, IDBI had a network of 973 branchesand 1542 ATMs. The banks total business during financial year2011-12 reached Rs. 3,91,651 crore, the balance sheet reachedRs. 2,90,837 crore and it was able to earn a net profit of Rs.2032 crore which was up by 23.15%.

During the financial year 2010-11, the government of Indiainfused fresh equity capital to the extent of Rs.3119.4 crore thusincreasing the equity holding to 65.13%

Against the stipulated RBI norm of 9% CRAR and 6% for coreCRAR the bank maintained its levels way above at 13.64% ofCRAR and 8.03% of Tier 1 CRAR.

There was an addition of 107 branches during the financial year2011 thus adding to the already huge network and taking thenumber to 815. Out of these 238 are at metropolitan centres,307 at urban centres, 184 in semi urban and 86 in rural.

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COMPANY OVERVIEW

In the business of trade finance the non fund based business of LC andBG grew by 18% crossing Rs.60,000 crore . Fee income from Tradefinance activities rose by 30%.

The provision coverage ratio is the ratio of provisions held to gross non-performing assets of the bank works out to be 74.66% as on march2011 healthy against the regulatory guidelines of 70%.

The government of India holds 65.13% of shares in the bank but afterthe preferential allotment that could go upto 71%.

According to the latest details the bank has maintained a net interestmargin of 2% and is expecting to have it constant in the days to come.IDBI has a gross NPA less than 3% and net NPAs less than 2%.

The banks growth has been fuelled by a steady CASA and has nowbecome the fastest growing state owned bank today. Presently thebank has its operations of 2/3rd in corporate and 1/3rd in retail.

The banks exposure to stressed sectors such as power (15% of allexposure), Iron and steel(9.3%), Telecom (7.2%) and textile (4.3%)have led to high NPAs for the bank lately. The banks restructured bookstands at 6% which is higher than the peers where PSU banks have alevel of approximately 4.5%.

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FEW LATEST WORKING

RESULTS 2012

In FY 2012 net profit was up by 23.15% to Rs. 2,032 crore (previous year Rs. 1,650 crore)

Net Interest Income grew by 6.46% to Rs. 4,545 crore (previous year Rs. 4,269 crore)

Deposits increased by 16.63% to Rs. 2,10,493 crore ( previousyear Rs. 1,80,486 crore)

Total assets grew by 14.78% to Rs. 2,90,837 crore( previousyear Rs. 2,53,377 crore)

Advances were up by 15.32% to Rs. 1,81,158 crore( previousyear Rs. 1,57,098 crore)

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THE MID CORPORATE

GROUP vertical under corporate banking which

focuses attention towards the

companies having turnover between

Rs.100 crore and Rs.500 crore intends to cater to all kinds of financial

requirements of such corporate clients.

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THE MID CORPORATE

GROUPThe various asset products at offering at the MCG branch inKolkata are as follows:-

FUND BASED

Term Loans Working Capital Loan( WCDL, CashCredit, Export Credit)

Bill Discounting

Buyout Receivables

Bills Discounting

NON FUND BASED

Letter of Credit

Bank Guarantee

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What are NBFCs?

Broadly speaking all such entities that offer financial servicesother than banking can be said to be Non Banking FinancialCompanies (NBFC).

such entities are not banks but yet carry lending activities at parwith banks. They may also accept public deposits howeverthese deposits are term deposits for a specific duration and

cant be withdrawn on demand of the public. NBFCs have been a topic of intense discussion and speculation

since their inception in the Indian system

The role of NBFCs as effective financial intermediaries hasbeen well recognised as they have inherent ability to takequicker decisions, assume greater risks, and customise theirservices and charges more according to the needs of the clients

The distinction between banks and NBFC has been graduallygetting blurred since both the segments of the financial systemengage themselves in many similar types of activities.

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Growth of NBFCs

Simplified sanction procedures, flexibility and timelinessability to meet the credit needs and low cost operationalfunctions resulted in NBFCs getting an edge over thebanks in providing finance.

build up a clientele base among the depositors

mop up public savings command large resources as reflected in the growth of

their deposits from public, shareholders, directors and

other companies, and borrowings by issue of non-convertible debentures etc

Fitch report in 2010 the compounded annual growth rate

of NBFCs was 40% compared to a meagre 22% of banks Credit to retail underserved areas and to unbanked

customers of immense importance in the growth of theeconomy at large.

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Definition of NBFC as per

RBI a company defined in the Companies Act of 1956 and also registered

under the provisions of Section 45-IA of the Reserve Bank of India Act1934,which provides banking services without meeting the legaldefinition of a bank such as holding bank license.

basically engaged in the business of loans andadvances,acquisition,ofshares/stocks/bonds/debentures/securitiesissued by government or local authority or other securities of likemarketable nature, leasing, hire purchase, insurance business

does not include any institution whose principal business is that ofagricultural activity or any industrial activity or sale, purchase orconstruction of immovable property.

In terms of the RB1 Act, 1934, registration of NBFCs with the RBI ismandatory, irrespective of whether they hold public deposits or not. Theamended Act (1997) provides an entry point norm of Rs. 25 lakh as theminimum net owned fund (NOF), which has been revised upwards toRs.2 crore for new NBFCs seeking grant of CoR.

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Requirements to be classified

as NBFC financial assets of a company are more than 50 per cent of its total

assets

and income from financial assets is more than 50 per cent of the grossincome

new credential was added in form of a requirement of an annualcertificate to be given by the auditor of the NBFC in support ofcommencement/continuance of business of NBFI and fulfilling thecriteria of principal business.

addition that such certificate shall also indicate the asset/incomepattern of the NBFC for making it eligible for classification as AssetFinance Company, Investment Company or Loan Company.

RBI granted Certificate of Registration (CoR) to new companies on thebasis of their intention to engage in the business of NBFI ( to minimizethe ambiguity of the COR auditors certificate is required to be filled at

every financial year ending) The asset-income criteria have become a tool in the hands of the RBI

to deprive the companies of their NBFC status on extraneous grounds.

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Classifications of NBFCs

On the basis of nature of business

Asset Finance Company

Core Investment Company

Loan Company

Infrastructure Finance Company

Infrastructure Debt Fund

Micro Finance Institution

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Classification of NBFCs

On the basis of deposits

NBFC-D

NBFC-ND

On the basis of asset size

NBFC-ND Systematically Important

NBFC- ND Non-Systematic

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Sources of funds

Debentures

Borrowings from banks

Commercial Papers

Inter Corporate Loans(in the descending order of share)

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Regulations of acceptance of

deposits

The NBFCs are allowed to accept/renew public deposits for aminimum period of 12 months and maximum period of 60months

NBFCs cannot offer interest rates higher than the ceiling rateprescribed by RBI from time to time. The present ceiling is 11per cent per annum.

The deposits with NBFCs are not insured

The repayment of deposits by NBFCs is not guaranteed by RBI.

NBFCs (except certain AFCs) should have minimum investmentgrade credit rating.

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NBFCs accepting public deposits

having mandatory disclosures

Audited balance sheet of each financial year and an audited profit and loss account in respect of

that year as passed in the general meeting together with a copy of the report of the Board ofDirectors and a copy of the report and the notes on accounts furnished by its Auditors

Statutory Annual Return on deposits

Certificate from the Auditors that the company is in a position to repay the deposits as and when theclaims arise

Quarterly Return on liquid assets

Half-yearly ALM Returns by companies having public deposits of Rs 20 crore and above or withassets of Rs 100 crore and above irrespective of the size of deposits

Monthly return on exposure to capital market by companies having public deposits of Rs 50 croreand above

A copy of the Credit Rating obtained once a year along with one of the Half-yearly Returns onprudential norms as above.

non-deposit taking NBFCs with assets size of Rs 100 crore and above have been advised tomaintain minimum CRAR of 10% and shall also be subject to single/group exposure norms.

An unrated NBFC, except certain Asset Finance companies (AFC), cannot accept public deposits.An exception is made in case of unrated AFC companies with CRAR of 15% which can accept

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Fundings and growth by

NBFCs NBFC account for 11.2% of assets of the total financial system according to the

economic surveys in 2010-11.

11.2 % asset finance companies held the largest share of assets of nearly 74.5% andalso the largest share of deposits amongst the NBFC-D segment by the end of march2010.

Typical fundings into :-

Construction Equipment

Commercial Vehicles

Gold Loans

Microfinance

Consumer Durables

Loan against shares etc.

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Instruments implemented

Loans

Hire Purchase

Financial Lease

Operational Lease

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NBFC ND-SI All NBFCs ND with an asset size of Rs. 100 crore and

more as per the last audited balance sheet will beconsidered as a systemically important NBFC-ND-SI.

once an NBFC reaches an asset size of Rs. 100 crore orabove, it shall come under the regulatory requirement forNBFCs-ND-SI despite not having such assets as on thedate of last balance sheet.

shall maintain a minimum Capital to Risk-weighted AssetsRatio (CRAR) of 10% which was changed to 12% as onMarch 31, 2010 and 15% as on March 31, 2011.

advised to have a policy in respect of exposures to asingle entity / group. NBFCs-ND-SI not accessing publicfunds both directly and indirectly can apply to the Reserve

Bank for an appropriate dispensation consistent with thespirit of the exposure limits.

may augment their capital funds by issue of PerpetualDebt Instruments (PDI) which shall be eligible for inclusionas Tier I Capital to the extent of 15% of total Tier I capitalas on March 31 of the previous accounting year.

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ALM System for NBFCs

decided to introduce an ALM System for the Non-Banking

Financial Companies (NBFCs), as part of their overallsystem for effective risk management in their variousportfolios

would be applicable to all the NBFCs irrespective ofwhether they are accepting / holding public deposits ornot.

to begin with NBFCs meeting the criteria of asset base ofRs.100 crore (whether accepting / holding public depositsor not) or holding public deposits of Rs. 20 crore or more(irrespective of their asset size) as per their auditedbalance sheet as of 31 March 2001 would be required toput in place the ALM System.

A system of half yearly reporting was put in place in thisregard and the first Asset Liability Management to besubmitted to RBI by only those NBFCs which are holdingpublic deposits within a month of close of the relevant halfyear.

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Cover for Public Deposits

In order to ensure protection of depositors interest,NBFCs should ensure that at all times there is fullcover available for public deposits accepted by them.

While calculating this cover the value of alldebentures (secured and unsecured) and outside

liabilities other than the aggregate liabilities todepositors may be deducted from the total assets.

the assets should be evaluated at their book value orrealizable/market value whichever is lower for thispurpose.

incumbent upon the NBFC concerned to inform theRegional Office of the Reserve Bank in case theasset cover calculated as above falls short of theliability on account of public deposits.

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Required NOF To ensure a measured movement towards strengthening the

financials of all deposit taking NBFCs by increasing their NOF

to a minimum of Rs.200 lakh in a gradual, non-disruptive andnon-discriminatory manner

NBFCs having minimum NOF of less than Rs. 200 lakh mayfreeze their deposits at the level currently held by them.

Asset Finance Companies (AFC) having minimum investmentgrade credit rating and CRAR of 12% may bring down publicdeposits to a level that is 1.5 times their NOF while all othercompanies may bring down their public deposits to a level equalto their NOF

Companies on attaining the NOF of Rs.200 lakh may submitstatutory auditor's certificate certifying its NOF.

The NBFCs failing to achieve the prescribed ceiling within thestipulated time period, may apply to the Reserve Bank forappropriate dispensation in this regard which may beconsidered on case to case basis.

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NBFC-MFI

An NBFC-MFI is defined as a non-deposit takingNBFC that fulfils the following conditions

Minimum Net Owned Funds of Rs.5 crore. (ForNBFC-MFIs registered in the North Eastern Region

of the country, the minimum NOF requirement shallstand at Rs. 2 crore).

Not less than 85% of its net assets are in the natureof qualifying assets.

An NBFC which does not qualify as an NBFC-MFI

shall not extend loans to micro finance sector, whichin aggregate exceed 10% of its total assets.

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QUALIFYING ASSETS

loan disbursed by an NBFC-MFI to a borrower with a ruralhousehold annual income not exceeding Rs. 60,000 or urbanand semi-urban household income not exceeding Rs. 1,20,000

loan amount does not exceed Rs. 35,000 in the first cycle andRs. 50,000 in subsequent cycles

total indebtedness of the borrower does not exceed Rs. 50,000

tenure of the loan not to be less than 24 months for loanamount in excess of Rs. 15,000 with prepayment withoutpenalty

loan to be extended without collateral

aggregate amount of loans, given for income generation, is notless than 75 per cent of the total loans given by the MFIs

loan is repayable on weekly, fortnightly or monthly instalmentsat the choice of the borrower

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Regulatory Framework

(After Andhra Pradesh incident)

As stated above, all new NBFC-MFIs except those in the

North Eastern Region of the country should have a minimum

Net Owned Funds(NoF) of Rs 5 crore; those located in the

North eastern region should have a minimum NoF of Rs. 2crore for purposes of registration.

maintain a capital adequacy ratio consisting of Tier I and Tier

II Capital which shall not be less than 15 percent of its

aggregate risk weighted assets.

The total of Tier II Capital at any point of time, shall notexceed 100 percent of Tier I Capital.

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Provisioning Norms

The aggregate loan provision to be maintained byNBFC-MFIs at any point of time shall not be lessthan the higher of :-

1% of the outstanding loan portfolio or

50% of the aggregate loan instalments which are

overdue for more than 90 days and less than 180days and 100% of the aggregate loan instalmentswhich are overdue for 180 days or more.

All other provisions of the Non-Banking Financial (Non-

Deposit accepting or holding) Companies PrudentialNorms (Reserve Bank) Directions, 2007 will beapplicable to NBFC-MFIs

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Pricing Norms

All NBFC-MFIs shall maintain an aggregatemargin cap of not more than 12%. The interestcost will be calculated on average fortnightlybalances of outstanding borrowings andinterest income is to be calculated on averagefortnightly balances of outstanding loanportfolio of qualifying assets

Interest on individual loans will not exceed26% per annum and calculated on a reducing

balance basis. Processing charges shall not be more than 1% of gross loan amount

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FAIR PRACTICES IN


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FAIR PRACTICES IN

LENDING

only three components in the pricing of theloan viz., the interest charge, the processingcharge and the insurance premium.

no penalty charged on delayed payment.

shall not collect any Security Deposit/ Margin

from the borrower

Non Coercive Methods of recovery

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COMPANIESNBFC carrying on the business of acquisition of shares and securities which

satisfied the following conditions:-

at least 90% of its Total Assets are in the form of investment in equity

shares, preference shares, debt or loans in group companies CICs is that 90% of its assets must have been invested in group

companies.

Out of 90%, at least 60% must be in form of equities. That leaves a scopefor only 30% for non-equity investments.

the remaining 10% investments also cannot be directed towards any activityother than deposits in banks, investments In government securities, etc

its investments in the equity shares (including instruments compulsorilyconvertible into equity shares within a period not exceeding 10 years fromthe date of issue) in group companies constitutes not less than 60% of itsTotal Assets

it does not trade in its investments in shares, debt or loans in groupcompanies except through block sale for the purpose of dilution ordisinvestment

it does not carry on any other financial activity except investment in bankdeposits, money market instruments, government securities, loans to andinvestments in debt issuances of group companies or guarantees issued on

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Revised Regulatory Framework

CICs, having an asset size of less than Rs 100 crores will bedeclared as exempted from all the requirements of NBFCsincluding registration.

for this purpose all CICs belonging to a group will beaggregated.

CICs which have assets of Rs 100 crores or above will beconsidered as systematically important. Registrationrequirements will continue to apply to such companies. Inaddition, there are new requirements, including maintenance of30% capital adequacy ratio and leverage restraints.

The rest of the prudential requirements currently applicable toNBFCs will be exempted in case of systematically importantCICs adhering to the above requirements

CIC cannot sell its holdings except by way of block deals.

asset size of Rs 100 crores or more will be considered asSystemically Important Core Investment Companies (CICs-ND-

SI). These companies will continue to require Certificate ofRegistration 40

USHA THORAT COMMITTEE


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USHA THORAT COMMITTEE

RECOMMENDATIONS India is one of the few countries which are regulating

investment companies and financial companies under the sameregulatory regime, whereas the nature and business ofinvestment companies may be totally different.

de-registration of all non-depository companies with asset sizeof Rs 50 crores or below.

regulate NBFCs with asset size of less than Rs 1000 crores

only if they have public funds, including funds from bankingchannels.

Change definition of principle business increase the thresholdof 50% of income and assets to 75%.

WG brings in a new concept of liquidity ratio which is a part ofBasel III recommendations. Basel III, ratio based on 30 dayscashflows and helps to maintain better asset liability

management. tax deduction for provisions made by NBFCs

The WG suggests parity between banks and NBFCs in terms oftax deductibility

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INFRASTRUCTURE DEBT

FUNDS non-deposit taking NBFC that has Net Owned Fund of Rs 300 crores

or more and which invests only in Public Private Partnerships (PPP)and post commencement operations date (COD) infrastructure projectswhich have completed at least one year of satisfactory commercialoperation and becomes a party to a Tripartite Agreement.

IDF- NBFC would raise resources through issue of either Rupee orDollar denominated bonds of minimum 5 year maturity. The investors

would be primarily domestic and off-shore institutional investors,especially insurance and pension funds which would have long termresources.

shall have at the minimum, a credit rating grade of 'A' of CRISIL orequivalent rating issued by other accredited rating agencies such asFITCH, CARE and ICRA

shall have at the minimum CRAR of 15 percent and Tier II Capital of

IDFNBFC shall not exceed Tier I. IDF-NBFCs shall invest only in PPP and post COD infrastructure

projects which have completed at least one year of satisfactorycommercial operation and are a party to a Tripartite Agreement with theConcessionaire and the Project Authority for ensuring a compulsorybuyout with termination payment.

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CREDIT CONCENTRATION

NORMS

The maximum exposure that an IDF-NBFC can take onindividual projects will be at 50 percent of its total CapitalFunds (Tier I plus Tier II for the Non-Banking Financial(Non-Deposit Accepting or Holding) Companies PrudentialNorms (Reserve Bank) Directions, 2007).

An additional exposure up to 10 percent could be taken atthe discretion of the Board of the IDF-NBFC.

RBI may, upon receipt of an application from an IDF-

NBFC and on being satisfied that the financial position ofthe IDF-NBFC is satisfactory, permit additional exposureup to 15 percent (over 60 percent) subject to suchconditions as it may deem fit to impose regardingadditional prudential safeguards.

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ENTRY OF NEW BANKS

to ensure that the banking system grows in size andsophistication to meet the needs of a moderneconomy.

there is a need to extend the geographic coverage ofbanks and improve access to banking services.

greater financial system depth, stability andsoundness contribute to economic growth.

vast segments of the population, especially theunderprivileged sections of the society, have still noaccess to formal banking services.

larger number of banks would foster greatercompetition, and thereby reduce costs, and improvethe quality of service.

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PAST APPROACH TO NEW


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BANKS Large industrial houses were not permitted to promote new

banks,however, individual companies, directly or indirectlyconnected with large industrial houses were permitted to own10 percent of the equity of a bank, but without any controllinginterest.

NBFC with good track records was considered eligible to

convert into a bank, provided it was not promoted by a largeindustrial house and satisfied the prescribed minimum capitalrequirements, a triple A (AAA) or its equivalent, credit rating inthe previous year, capital adequacy of not less than 12 percentand net Non Performing Assets (NPA) ratio of not more than 5percent.

The initial minimum paid up capital was prescribed at Rs. 200

crore to be raised to Rs.300 crore within three years ofcommencement of business.

Promoters were required to contribute a minimum of 40 percentof the paid up capital of the bank at any point of time, with alock-in period of five years.

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BANKS if the promoter's contribution to the initial capital was more

than the minimum 40 percent, they were required to dilutetheir excess stake after one year of the bank's operations.

Banks were required to maintain an arms lengthrelationship with business entities in the promoter groupand individual company/ies investing upto 10 percent ofthe equity.

could not extend any credit facilities to the promoters andcompany / ies investing up to 10 percent of the equity.

Capital adequacy ratio of the bank had to be 10 percenton a continuous basis from the commencement of

operations. Banks were obliged to maintain upto 40 percent of theirnet bank credit as loans to the priority sector.

Banks were obliged to open at least 25 percent of theirtotal number of branches in rural and semi urban centres.

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EXPERIENCE

been that banks promoted by individuals, thoughbanking professionals, either failed or merged withother banks or had muted growth.

Only those banks that had adequate experience inbroad financial sector, financial resources,

trustworthy people, strong and competentmanagerial support could withstand the rigorousdemands of promoting and managing a bank.

Local Area Bank model has inherent weakness suchas unviable and uncompetitive cost structures whichare a result of its small size and concentration risk.

the size of operations and also the locationaldisadvantage of these banks act as a constraint toattracting and retaining professional staff as well ascompetent management.

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EXPERT


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EXPERT

RECOMMENDATIONS recommended permitting ownership in Indian banks

of up to 15 percent by Indian corporates, and also toincrease limits of holdings by any one foreign bankup to 15 percent in private banks.

encourage non-banking finance companies to

convert into banks. foreign banks may be allowed to enhance their

presence in the banking system.

allowing more entry to private well-governed deposit-taking small finance banks with stipulation of higher

capital adequacy norms, a strict prohibition onrelated party transactions, and lower allowableconcentration norms

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ISSUES FOR


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ISSUES FOR

CONVERSION Minimum capital requirements for new

banks and promoters contribution

Minimum and maximum caps on promotershareholding and other shareholders

Foreign shareholding in the new banks Eligible Promoters

Whether industrial and business housescould be allowed to promote banks

Should Non-Banking FinancialCompanies be allowed conversion

into banks or to promote a bank

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MINIMUM CAPITAL


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MINIMUM CAPITAL

REQUIREMENTS The guidelines issued in 1993 for licensing

of new banks in the private sector hadprescribed Rs. 100 crore as minimumcapital and the 2001 guidelines raised this

to Rs. 200 crore to be increased to Rs.300crore over three years fromcommencement of business.

Taking into account the lapse of time sincethe last guidelines issued in January 2001

and inflation since then, there is a case tohave the minimum capital requirement atmore than Rs. 300 crore.

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POSSIBLE OPTIONS AND


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SOLUTIONSHaving a low minimum capital requirement (but more thanRs.300 crore)

Pros

attract those who are serious about participating in financialinclusion to set up banks.

may result in optimum utilization of capital from the beginning.

Cons may result in many non-serious entities with inadequate

financial backing seeking banking licenses.

Small banks suffer from disadvantages in scale and scope andalso face concentration risk making them more vulnerable.

could lead banks to run out of capital early, leading to increased

risk taking for showing higher profit to attract more capital. Large number of small banks lead to weakening of supervision

in the sector

by putting pressure on supervisory resources.

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Having a high (say Rs.1000 crore) minimumcapital requirement for new Banks

Pros

since licenses are given to only full-fledged bank,adequate minimum capital requirement may benecessary to ensure that the banks operate on astrong capital base.

would evince interest from serious parties withsufficient financial backing.

banks would be able to play a more meaningful rolein financial inclusion, as they are able to investresources in technology and partnerships forfinancial inclusion.

Cons

Promoters may not be seriously committed tofinancial inclusion as they are

likely to be focused on more profitable large ticketsize commercial banking.

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Initial minimum capital may be prescribed


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at say Rs.500 crore with a condition toraise the amount to say Rs.1000 crorewithin a period of say 5 years.

Pros enable applicants from a wider spectrum, i.e.

those willing to focus on financial inclusion aswell as those interested in more sophisticated

commercial banking, to seek a bankinglicence.

It would be easier to dilute the promoters'stake to a lower percentage of the total capitalof the new bank as the bank grows.

Cons

Some of the newly licenced banks may not beable to fulfill this condition of scaling up thecapital and level of operations

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PROMOTER SHAREHOLDING guidelines on entry of new private sector banks sought to reduce the

control of functions of banks by the promoters,to avoid problems arising

out of possible conflict of interests, such as connected lending the promoters have been allowed to bring in higher stake (minimum of

40 percent of the paid-up capital of the bank) at the time of licensing ofbanks with a lock-in period of 5 years.

intention was to have a stable capital base, and strong professionalmanagement, but without any interference or control of management bythe promoters.

require promoters and other shareholders of the banks to divest/dilutetheir shareholding to a level of 10 percent or below of the banks sharecapital within a specified time frame.

exceptional circumstances and where the ownership is that of afinancial entity, that is well established, well regulated, widely held,publicly listed and enjoying good standing in the financial community,higher shareholding is permitted to a level of more than 10 percent upto 30 percent.

Any acquisition or transfer of shares of private sector banks, taking theaggregate shareholding of an individual or group, either directly orindirectly to 5 percent or more of share capital, requiresacknowledgement from the Reserve Bank of India

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SOLUTIONSRetaining current option

Pros

Large shareholding by promoters in the initial stage would ensure thatthe bank has promoters stake in the development of the bank in theinitial stages while the dilution requirement would lead to diversifiedholding without significant control on the functions of bank.

Requiring dilution of shareholding upfront at the time of licensing wouldensure that only promoters having no interest in exercising control overthe banks would seek bank license.

bank would be run professionally in the long run in the absence of anysignificant influence.

Cons

Serious promoters may find the dilution requirement to a very low levelunattractive and could deter them from setting up a bank.

In the absence of any serious promoter, the bank may lack the visionand direction a new bank may require.

there would be difficulty in fixing accountability and responsibility for theaffairs of the bank.

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Retain the general threshold for the shareholders at 5percent of the capital but raise the threshold for


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percent of the capital but raise the threshold forpromoters and other significant shareholders to say20 percent in the long run.

Pros

could invite serious promoters as well as serve thepurpose of diversified shareholding.

promoters would be interested in formulating long termvision and goals, provide direction, take keen interest inimproving business and profitability in order to protecttheir reputation.

promoters would be interested in infusing capital into thebank in times of distress to protect their reputation.

fixing responsibility and accountability becomes easier

Cons

change would also have to be implemented for otherexisting banks.

promoters and other shareholders may not consider thelevel of shareholding significant enough for committingresources and energies.

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Allow promoters to hold their initialshareholding of 40 percent


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shareholding of 40 percentPros

ensure continuing stake of promoters in the

bank with all the attendant benefits ofproviding direction, commitment andresources.

Cons

lead to concentrated shareholding inbanks, which in the Indian context is foundto be detrimental to depositors interests inthe long run.

promoters would gain control on thefunctioning of banks, which may lead todiversion of depositors' funds, lendingwithin the group on non-commercial terms,connected lending, etc.

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no restriction on ownership up to 5 / 10 percent with


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no restriction on ownership up to 5 / 10 percent withpermission to hold up to 40 percent of capital in banks withshareholders' equity up to say Rs. 1000 crore, 30 percent ofcapital in banks with shareholders' equity more than sayRs. 1000 crore and up to say Rs. 2000 crore, and permitted

maximum holding (10 percent or 20 percent) in banks withshareholders' equity of more than say Rs. 2000 crore.Pros The promoters support and direction would be available to the

bank in the formative years, with the advantage of ensuring longterm vision, goals and direction for the bank.

Once the bank grows to a substantial size and has the potentialof creating an impact in the financial system, this model ensuresthat the bank is run professionally and that there is nocontrolling shareholder influencing the functions of the bank.

Cons

could induce the promoters to expand their business very slowlyso as to have control for a longer period and thus underperform

from the economys perspective. there may be some resistance to giving up their control and

shareholding, leading to possible non transparent shareholding.

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NBFCs conversion to Banks

The 2001 guidelines on entry of new banksin the private sector permitted NBFCs witha good track record for conversion into abank

it satisfied the specific criteria relating tominimum net worth, not promoted by alarge industrial house, AAA (or itsequivalent) credit rating in the previousyear

capital adequacy of not less than 12percent

net NPA ratio of not more than 5 percent

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POSSIBLE OPTIONS


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POSSIBLE OPTIONSPermitting conversion of NBFCs into banks

Pros

NBFCs are already regulated by RBI and have a track record

NBFC model particularly those in lending activities has been successful in expandingthe reach of financial system and thus by converting to banks, this model could be

scaled up to better leverage the benefits and achieve the objective of financialinclusion.

sectoral credit issues, such as infrastructure and microfinance, could be betteraddressed if NBFCs specializing in the specified sectors can better leverage theircompetence by converting to banks and having access to low-cost funds.

Cons

NBFCs are not, as yet, subject to regular onsite inspections.

a light-touch regulatory framework for non-deposit taking NBFCs

ability of the NBFC to run a bank under a heavier regulation cannot be extrapolatedfrom this experience.

NBFCs may not fulfill the well established and well regulated criteria and hence thetrack record of an NBFC cannot be taken as an automatic eligibility criterion forconversion into banks.

Conversion of NBFCs into bank would require folding up of large number of branchesand withdrawal from many segments of businesses as well as disinv

estment from subsidiaries/affiliates not engaged in businesses permitted to banks.Migration of stronger NBFCs will not strengthen the banking space while the NBFCs

space will be weakened. The maturity mix of the asset portfolio is also skewed towards long term and the asset

mix may not be compatible to the banking liabilities. If NBFCs are converted into banksthey may take a long time to align themselves to banking.

continued dependence on wholesale deposits and short term borrowings to sustaineven their existing business operations would raise financial stability issues.

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Permitting standalone (i e those not promoted by


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Permitting standalone (i.e. those not promoted byIndustrial / Business Houses) NBFCs to promotebanks

In addition to the PROS and CONS before, the followingare also relevant

Pros

The expertise of the NBFC in the financial sectorcould flow into the bank if NBFCs are allowed to

promote banks . could retain their niche space and yet contribute to

the financial sector through the bank

NBFCs already being regulated would have averifiable track record The operations of the NBFCs

may not be liquidity constrained and hencepossibilities of diversion of funds may be less.Possibility of improved governance in banks due toownership by entities experienced in the financialsector.

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Cons


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Due to the maturity differences of the assets and liabilitiesof the NBFCs and banks, there may be possibilities of thebank funds being utilized to meet the NBFC liabilities andalso of indulgence in regulatory arbitrage.

NBFC Groups engaged in activities that are not permittedto banks would be a source of concern and contagion.

Their experience in the financial sector would not beadequate enough to be a source of strength in promotingbanks.

NBFCs may not have the financial strength or parentageto support banks capital needs particularly in periods ofstress

(NBFCs or its subsidiaries / Associates should not beengaged directly or indirectly in real estate activities for

being considered eligible to promote banks. )

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Business Model

Status- quo could be maintained where new bankscould be licensed under the usual conditions.

Pros

This would enable the new banks to compete in a

level playing field. This could avoid having differential supervision and

regulation for the new banks.

Uniform norms could be applied to all banks, oldand new, for their compliance.

Cons This approach would not further the objective of

licensing new banks for achieving acceleratedfinancial inclusion.

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Considering the thrust on financial inclusion, a business modeloriented towards this objective could be preferred. The business

d l ld b i d t l l ti l t th t t d


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model could be required to clearly articulate the strategy andthe targets for achieving significant outreach to clientele in Tier3 to 6 centers (i.e. in populations

less than 50000) especially in the underbanked regions of thecountry either through branches or branchless models.

Pros

This would induce the new banks to participate in financialinclusion in a big way.

This would also encourage banks to adopt latest andinnovative methods and leverage information technology.

As the micro finance companies have already proved that thefinancial inclusion business model is viable, banks may not faceproblems relating to viability of the models.

Cons

The business model heavily oriented towards financial inclusionmay not be able to provide commensurate returns to banks toenable them to compete with other private sector banks in the

country. It will create uneven playing field vis--vis the existing banks

with its attendant negative consequences for such banks.

In case the bank deviates substantially from its proposedbusiness model particularly if its earnings are low threatening itsviability, there may not be any regulatory remedy. The thrust on

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CONCLUSIONS

NBFC is not part of the payments system; nor does it have access tothe Reserve Bank of India's (RBI) lender-of-last-resort facility, at leastnot directly. Partly as a consequence of this, the RBI's oversight overNBFCs has also been marked by a lighter touch.

the line between banks and NBFCs is blurred thus there can be nocase for a lighter touch when it comes to regulating NBFCs. Especiallywhen the steady increase in bank credit to NBFCs in recent years

raises the very real possibility of risks being transferred from the morelightly-regulated NBFC sector to the banking sector.

thrust of the recommendations is to bridge the bank-NBFC regulatorygap- non-deposit taking NBFCs have no cash reserve ratio (CRR)requirement, nor are they required to maintain a statutory liquidity ratio(SLR). There are no restrictions on branch expansion or on financingactivities.

deposit-taking NBFCs are subject to some restrictions on branchexpansion, exposure to capital market and real estate, they benefitfrom regulatory forbearance in the form of a lower SLR: 15% against24% for banks.

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CONCLUSIONS

Though the capital adequacy ratio for NBFCs is higher at 15%compared to 9% for banks, the period for classifying loans asnonperforming assets (NPAs) in case of NBFCs is higher at 180/360days against 90 days for banks.

differences in the provisioning framework as well

regulatory framework for ownership and governance is also verydifferent

consequence of the lighter regulatory regime for NBFCs was regulatoryarbitrage with NBFCs, including bank-sponsored NBFCs, engaging inactivities that were out of bounds for banks. The danger inherent in thiswas dramatically brought home during the subprime crisis in the Westwhen non-banks no less than banks held the system to ransom andhad to be bailed out with taxpayer money.

their dependence on bank borrowing poses an ever-present risk.

bringing NBFCs under the purview of the Sarfaesi Act so that they areable to recover bad debts faster and extending beneficial tax treatmentfor regulatory provisions of NBFCs.

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CONCLUSIONS

The finance ministry has sought strict norms for non-bankingfinance companies, or NBFCs, that want to convert into banksor promote banks. The move threatens to upset plans of severalfinance companies that are keen to enter the banking space.

The ministry is currently examining the draft guidelines on thenew banking licenses submitted by RBI.

The RBI's discussion paper on conditions for entry of newbanks had invited arguments for and against allowing NBFCs toconvert into banks.

In the guidelines sent to the government, the RBI has favouredboth the options. It has even proposed that if an NBFCsconverts itself into a bank, its existing branches in Tier III to TierVI cities should get a branch status automatically.

One of the major initiatives for new banking licenses is financialinclusion. NBFCs which have already set up their base insmaller cities are more competent to take the cause of financialinclusion.

Documents

Sip 2012 Presentation