Syllabus-Reforms in Banking sector; Regulation of credit by RBI.
Number of questions- Mains: 02, Prelims – 10
Mains Questions of the day-
1.Recently RBI gave Asset Reconstruction Company (ARC) license to NARCL set up with the aim of cleaning up the bad loans from bank books. What is Asset Reconstruction Company? Mention the potential advantage and challenges of ARC’s?
Introduction:
Mention the Asset Reconstruction Company and its importance
Body:
- Mention the potential benefits of ARC’s.
- Mention the challenges with ARC’s.
Conclusion:
Mention the way forward.
Content:
Asset Reconstruction Companies (ARCs)
- It is a specialized financial institution that buys the Non-Performing Assets (NPAs) from banks and financial institutions. So that, banks and Financial institutions can clean up their balance sheets.
- A NPA is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
- Typically, ARCs buy banks’ bad loans by paying:
- A portion as cash upfront (15% as mandated by the RBI) and
- Issue security receipts for the balance (85%).
- This helps banks to concentrate on normal banking activities.
- Banks, rather than going after the defaulters by wasting their time and effort, can sell the bad assets to the ARCs at a mutually agreed value.
- The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 provides the legal basis for the setting up of ARCs in India.
- The Act helps reconstruction of bad assets without the intervention of courts.
- Since then, a large number of ARCs were formed and were registered with the RBI.
- RBI has got the power to regulate the ARCs.
- In India, ARCs are incorporated under the Companies Act and registered with RBI under section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI), Act 2002.
- ARCs need to maintain a minimum NOF (Net Owned Fund) of Rs 100 crore and a capital adequacy ratio of 15% of its risk weighted assets.
- Risk-weighted assets are used to determine the minimum amount of capital that must be held by banks and other financial institutions in order to reduce the risk of insolvency.
- Asset Reconstruction Company (India) Ltd or ARCIL, was first ARC of India set up in 2002 by four banks SBI, ICICI Bank, PNB and IDBI Bank.
- Recently RBI gave Asset Reconstruction Company (ARC) license to NARCL (government backed group of Public Sector Banks) set up with the aim of cleaning up the bad loans.
Potential benefits of ARC: –
- Get Rid of Stressed Loans:
- The suggestions are aimed at enabling banks to get rid of stressed loans in the early stage of default.
- The norms also seek to appoint valuers for large-value loans that are sold.
- Help ARCs Raise Resources:
- ARCs will raise resources by tapping different categories of market participants eligible for investment in Security Receipts.
- Banks have also been incentivized (availability of funds in bank increase) for sale of NPA (Non-Performing Asset) early stage.
- With existing ARCs not adequately capitalised to deal with huge NPA problem of banks, NARCL can help banks in reducing NPAs, yielding other benefits as well such as:
- Allowing banks to focus on normal banking functions
- Improved lending’s to productive sectors (increase the funds available to banks and Financial institutions by selling of NPA’s to ARC) for faster economic recovery
- Help government in banks privatisation with improved Public Sector Banks valuations.
- Opportunities for other ARCs at MSME’s level:
- NARCL will reconstruct assets of NPA’s only more than ₹500 crore of the banking sector.
- By limiting the ARC’s, so that they can focus at huge business opportunities in retail and MSMEs with stressed assets aggregating (total NPA’s) about ₹1 lakh crore.
- Unrealized Potential:
- Despite different ways to solve problems or flexibilities in working, the potential of ARCs is not fully realized in India due to lack of funding, limited number of qualified professionals or other limitations.
- With government-backed guarantees (for 5 years), NARCL entry can bring new culture and values in sector.
- Promote Competition:
- Assets allocated to NARCL will go through ‘Swiss challenge’, i.e., giving other ARCs an opportunity for highest evaluation.
- It will promote competition and help banks in overcoming valuation concerns through maximum recovery
Challenges with ARC’s: –
- Risk of reckless lending:
Shifting of NPAs without accountability rises the risk of reckless lending which can further amplify the problem of NPA’s.
- Lack of Urgency:
- For restructuring and turning around of bad loans, NARCL need separate Asset Management Company (proposed as India Debt Management Agency or IDMA).
- But no steps are taken for its establishment yet.
- Qualified Professionals: India lacks adequately trained manpower.
- Mere Shift of Bad Asset:
With PSBs as stakeholders and at top positions, NARCL risks the mere shift of bad loans from government owned banks book to government backed NARCL.
- Capital Requirements:
With 15% upfront payment needs, NARCL will require capital somewhere between Rs. 6,500-7000 crore to resolve RS. 89,000 crore NPAs
- Other issues with ARCs
- Lack of flexibility in controlling structure of an ARC, as they are either owned by the private parties or the bank (i.e. not by the government).
- Regulatory ambiguity in functioning of ARCs.
For ex: Insolvency and Bankruptcy Code, 2016 (IBC) has provisions for submission of ‘resolution plans’ by financial entities (including an ARC), the SARFAESI Act does not explicitly permit ARCs to ‘invest’ in or acquire equity in firms.
Way forward-
Based on past failures and the existing issues, Indian ARCs need to have more support to deal with the huge bad loan issue through major reforms like:
- Amending SARFAESI Act to close regulatory gap between SARFAESI and IBC.
- Setting up of a Distressed Loan Sales Trading Platform for receiving bids for NPAs for better price discovery.
- Governance reforms in the banks:
There is a need for reforms in critical governance pillars such as the conduct and operations of risk management departments in financial institutions, auditors, boards, rating agencies, independent analysts and regulatory supervisors.
- Preparing a panel of sector specific management firms/individuals having expertise in running firms/companies which could be considered for managing the (acquired distressed) companies.
- Relaxation in controlling structure norm to encourage more private entities in this sector, bringing more specialists and depth into the asset reconstruction for greater competition and transparency.
2.The Reserve Bank of India (RBI) revised priority sector lending (PSL) guidelines in line with emerging National Priorities. What is priority sector lending (PSL) and mention the salient features of revised PSL?
Introduction:
Mention the Priority Sector Lending (PSL) and its importance
Body:
Mention the salient features of revised guidelines of PSL
Conclusion:
potential benefits from the revised PSL: –
- Provide support to farmers:
- Provisions like support for installation of solar power plants and support to small and marginal farmers provide the requisite financial support farmers.
- Thus encouraging the agricultural sector.
- Also, higher credit limit to FPOs/FPCs would encourage development of such institutions.
- Address regional disparities:
New guidelines have the potential to address the regional disparities in the flow of priority sector credit via the new ‘identified districts’ methodology.
- Create environmentally friendly lending policies:
Encouragement to sectors like renewable energy and development of Biogas Plants also aim to encourage and support environment friendly lending policies to help achieve Sustainable Development Goals (SDGs).
- Health Infrastructure:
- The revision in PSL guidelines will incentivise credit flow towards health infrastructure.
- Thus providing increased financial support for developing of agencies in health sector in COVID and post-COVID financial scenario.
Content:
Priority sector lending: –
- Priority Sector are those sectors that the Government and Reserve Bank of India consider as important for the development of the country as a whole and are to be given priority over other sectors.
- So, under priority sector lending, the banks are mandated to provide an adequate and timely credit to encourage the growth of those sectors.
- The origins of priority sector lending can be traced back to 1966 when Morarji Desai saw a need for increasing credit to agriculture and small industries.
- However, the definition for priority sector was formalised based on a Reserve Bank of India (RBI) report in 1972.
- In 1974, the commercial banks were given a target of 33.33% of their Adjusted Net Bank Credit (ANBC), which was increased to 40% of ANBC on the recommendations of Dr. K.S. Krishnaswamy committee.
- The priority sector definition grew over time, extended to cover important neglected sectors of the economy.
- Priority sector lending categories:
Priority sector lending by banks in India constitutes the lending to following sectors:
- Agriculture
- Micro, Small and Medium Enterprises
- Export Credit
- Education
- Housing
- Social Infrastructure
- Renewable Energy
- Others
Some of the salient features of revised PSL guidelines are:
The Reserve Bank of India (RBI) revised priority sector lending (PSL) guidelines to include entrepreneurship and renewable resources, in line with emerging national priorities
- Fresh categories included in the PSL category:
- Bank finance of up to ₹50crore to start-ups.
- Loans to farmers both for installation of solar power plants for solarisation of grid-connected agriculture pumps.
- For setting up compressed biogas (CBG) plants.
- Higher weightage has been assigned to incremental priority sector credit in ‘identified districts’ where priority sector credit flow is comparatively low.
- Accordingly, from FY 2021-22, a higher weight (125%) would be assigned to the incremental priority sector credit in the identified districts where the credit flow is comparatively lower and a lower weight (90%) would be assigned for incremental priority sector credit in the identified districts where the credit flow is comparatively higher.
- The targets prescribed for ‘small and marginal farmers’ and ‘weaker sections’ are being increased in a phased manner.
- Higher credit limit has been specified for Farmer Producer Organisations (FPOs)/Farmers Producers Companies (FPCs) undertaking farming with assured marketing of their produce at a pre-determined price.
- Loan limits for renewable energy have been doubled.
- For improvement of health infrastructure, credit limit for health infrastructure (including those under ‘Ayushman Bharat’) has been doubled.
Prelims Questions of the day:
1.Which of the following agency responsible for keeping inflation target below a certain threshold by using various instruments of Monetary Policy?
- Central Government
- State Government
- Monetary Policy Committee.
- RBI
Answer: C
Explanation:
The RBI has a government-constituted Monetary Policy Committee (MPC) which is tasked with framing monetary policy using tools like the repo rate, reverse repo rate, bank rate, cash reserve ratio (CRR).
It has been instituted by the Central Government of India under Section 45ZB of the RBI Act that was amended in 1934.
Functions:
The MPC is entrusted with the responsibility of deciding the different policy rates including MSF, Repo Rate, Reverse Repo Rate, and Liquidity Adjustment Facility.
2.By which of the following Act, the institutionalisation of Monetary Policy Committee has happened in India?
- SARFAESI Act 2002
- Insolvency and Bankruptcy Code 2016
- FRBM act 2003
- RBI Amendment Act 2016.
Answer: D
Explanation:
The Inflation Targeting framework in India was initiated through the Inflation targeting agreement of 2015 which further culminated into the amendment of the RBI Act in 2016.
The Act provided for the following framework:
- It tasked the monetary policy with the goal of achieving price stability while keeping in mind the objective of growth.
- To fulfill this objective, a Monetary Policy Committee (MPC) was created by amendment of the Reserve Bank of India Act, 1934.
- The MPC has been entrusted with the task of fixing the policy rate required to achieve the inflation target.
- The Act adopted year-on-year changes in the headline Consumer Price Index (CPI) as the measure of inflation target.
- The target was fixed at 4% with an upper and lower tolerance band of 2%. This target is to be reviewed every five years.
3.Which of the following index is taken as base for calculation inflation in India by monetary policy committee?
- Whole Sale Price Index
- Consumer Price Index
- Index Of Industrial Production
- Purchasing Power Index
Answer: B
Explanation:
The Inflation Targeting framework in India was initiated through the Inflation targeting agreement of 2015 which further culminated into the amendment of the RBI Act in 2016.
The Act provided for the following framework:
- It tasked the monetary policy with the goal of achieving price stability while keeping in mind the objective of growth.
- To fulfill this objective, a Monetary Policy Committee (MPC) was created by amendment of the Reserve Bank of India Act, 1934.
- The MPC has been entrusted with the task of fixing the policy rate required to achieve the inflation target.
- The Act adopted year-on-year changes in the headline Consumer Price Index (CPI) as the measure of inflation target.
- The target was fixed at 4% with an upper and lower tolerance band of 2%. This target is to be reviewed every five years.
- CPI measures the inflation levels at the level of the consumer expenditure.
- CPI represents consumer baskets better than the other measures like WPI.
- CPI provides information on price movements in services sector also.
- CPI includes Food Inflation which is a critical part of price stability objective in emerging markets like India.
4. Under which of the following Act, Forex Reserves in India are managed by Central Bank of India?
- Foreign Exchange Management Act 1999
- RBI Act 1934
- FRBM Act 2003
- Both A and B
Answer: D
Explanation:
Central bank of India, the Reserve Bank of India is responsible for management of Forex reserves under:
- Reserve Bank of India Act, 1934 and
- Foreign Exchange Management Act,1999
5.How much percentage of Adjusted Net Bank Credit (ANBC) of scheduled commercial banks allocated for priority sector lending?
- 40%
- 75%
- 30%
- 60%
Answer: A
Explanation:
Priority Sector Lending
- The RBI mandates banks to lend a certain portion of their funds to specified sectors, like agriculture, Micro, Small and Medium Enterprises (MSMEs), export credit, education, housing, social infrastructure, renewable energy among others.
- All scheduled commercial banks and foreign banks (with a sizable presence in India) are mandated to set aside 40% of their Adjusted Net Bank Credit (ANDC) for lending to these sectors.
- Regional rural banks, co-operative banks and small finance banks have to allocate 75% of ANDC to PSL.
6.Under which of the following Act, RBI issues Licenses to Banks and Financial Institutions?
- RBI Act 1934
- RBI Act 2016
- Finance Act 2016
- Banking Regulation Act 1949
Answer: D
Explanation:
The Banking Regulation Act, 1949:
It is a law. It regulates the functioning of banks and provides details on several aspects including licensing, management, and operations of banks in India. It had been passed as the Banking Companies Act, 1949 and came into force from March 16, 1949. Further the Banking Companies Act 1949 had been changed to the Banking Regulation Act 1949 and being implemented as the same from March 1, 1966.
Provisions of the Banking Regulation Act, 1949:
Several powers are provided by the Act to the Reserve Bank of India:
- to license banks, have regulation over shareholding and voting rights of shareholders;
- to supervise the appointment of the boards and management;
- to regulate the operations of banks;
- to lay down instructions for audits; control moratorium, mergers and liquidation;
- to issue directives in the interests of public good and on banking policy, and impose penalties
7.Under which of the following Act, Non-Banking Financial Company are formed?
- FRBM Act 2003
- Companies Act 1956
- RBI Act 1934
- FEMA Act 1999
Answer: B
Explanation:
- A NBFC is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business etc.
- NBFCs play a crucial role in the banking sector by increasing the penetration of financial products to unbanked areas, providing innovative products for both rural and urban customers, catering to the need of infrastructure lending and to other areas where long term financing is needed.
8.Which of the following committee was appointed by RBI for suggesting the framework for bank loans which were stressed on the account of the COVID-19 Pandemic?
- H.M.malegam committee
- Bimla jalan committee
- Narasimha committee
- K V Kamath committee
Answer: D
Explanation:
Reserve Bank of India (RBI) appointed K V Kamath committee submitted its report on resolution framework for bank loans which were stressed on account of the COVID-19 pandemic.
About Loan restructuring:
- It is a process used by companies and individuals facing financial distress or on the brink of insolvency to lower and renegotiate their debts and restore liquidity so that companies can continue their business.
- Basically, loans are restructured to avoid the risk of default on existing debt. The restructuring enables borrowers to reschedule their loan payment, get a limited loan repayment holiday, or lower interest rates on their existing loans.
9.Which of the following terms related to the Insolvency and Bankruptcy Code 2016?
- Insolvency Resolution professional
- Committee of creditors
- Unsecured creditors
- All the above
Answer: D
Explanation:
Insolvency and Bankruptcy Code, 2016:
It provides a time-bound process for resolving insolvency in companies and among individuals.
- Insolvency is a situation where individuals or companies are unable to repay their outstanding debt.
- Bankruptcy, on the other hand, is a situation whereby a court of competent jurisdiction has declared a person or other entity insolvent, having passed appropriate orders to resolve it and protect the rights of the creditors. It is a legal declaration of one’s inability to pay off debts.
- The waterfall mechanism under Insolvency and Bankruptcy Code gives priority to secured financial creditors over unsecured financial creditors.
Insolvency Resolution Process: –
- Insolvency resolution process can be initiated by any of the stakeholders of the firm: firm/debtors/creditors/employees.
- If the adjudicating authority accepts, an Insolvency resolution professional (IP) is appointed.
- The power of the management and the board of the firm is transferred to the committee of creditors (CoC). They act through the IP.
- The IP has to decide whether to revive the company (insolvency resolution) or liquidate it (liquidation).
- If they decide to revive, they have to find someone willing to buy the firm.
- The creditors also have to accept a significant reduction in debt. The reduction is known as a haircut.
- They invite open bids from the interested parties to buy the firm.
- They choose the party with the best resolution plan, that is acceptable to the majority of the creditors (66 % in CoC), to take over the management of the firm.
10.Which of the following Act, is responsible for formation of Asset Reconstruction Company (ARC)?
- Insolvency and Bankruptcy Code 2016
- FRBM Act 2003
- FEMA 1999
- SARFAESI Act 2002
Answer: D
Explanation:
- In India, ARCs are incorporated under the Companies Act and registered with RBI under section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI), Act 2002.
- ARCs need to maintain a minimum NOF (Net Owned Fund) of Rs 100 crore and a capital adequacy ratio of 15% of its risk weighted assets.
- Asset Reconstruction Company (India) Ltd or Arcil, was first ARC of India set up in 2002 by four banks SBI, ICICI Bank, PNB and IDBI Bank.