the-reforms-in-banking-sectors

Reforms in the banking sectors were introduced on the basis of the recommendations of different committees:

(i) The first Narasimham Committee (1991),

(ii) The Verma Committee (1996),

(iii) The Khan Committee (1997), and

(iv) The Second Narasimham Committee (1998).

Narasimham Committee I-1991
  • ‘The Committee on Financial System’ was constituted by the Government of India, under the Chairmanship of Mr. M Narasimham, former Governor of RBI in 1991.

  • The aim of the committee was to recommend measures to restore the financial health of Commercial Banks and make them function efficiently and profitably.

The committee has given the following major recommendations: -

  1. Reduction in the SLR and CRR:

  • The committee recommended the reduction of the higher proportion of the Statutory Liquidity Ratio 'SLR' and the Cash Reserve Ratio 'CRR'.

  • Both of these ratios were very high at that time. The SLR then was 38.5% and CRR was 15%.

  • It was a hindrance in the productivity of the bank thus the committee recommended their gradual reduction. SLR was recommended to reduce from 38.5% to 25% and CRR from 15% to 3 to 5%.

2. Phasing out Directed Credit Program:

  • In India, since nationalization, directed credit programs (Priority sector lending) was adopted by the government. The committee recommended phasing out of this program.

  • This program compelled banks to earmark then financial resources for the needy and poor sectors at concessional rates of interest.

  • It was reducing the profitability of banks and thus the committee recommended the stopping of this program.

3. Interest Rate Determination:

  • The committee felt that the interest rates in India are regulated and controlled by the authorities.

  • The determination of the interest rate should be on the grounds of market forces such as the demand for and the supply of fund.

  • Hence the committee recommended eliminating government controls on the interest rate and phasing out the concessional interest rates for the priority sector.

4. Structural Reorganizations of the Banking sector:

  • The committee recommended that the actual numbers of public sector banks need to be reduced.

  • Three to four big banks including SBI should be developed as international banks.

  • Eight to Ten Banks having a nationwide presence should concentrate on national and universal banking services.

  • Local banks should concentrate on region-specific banking. Regarding the RRBs (Regional Rural Banks), it recommended that they should focus on agriculture and rural financing.

  • They recommended that the government should assure that henceforth there won't be any nationalization and private and foreign banks should be allowed liberal entry in India.

5. Banking Autonomy:

  • The committee recommended that the public sector banks should be free and autonomous.

  • In order to pursue competitiveness and efficiency, banks must enjoy autonomy so that they can reform the work culture and banking technology up-gradation will thus be easy.

6. Removal of Dual control:

  • Those days banks were under the dual control of the Reserve Bank of India (RBI) and the Banking Division of the Ministry of Finance (Government of India).

  • The committee recommended the stepping of this system.

  • It considered and recommended that the RBI should be the only main agency to regulate banking in India.

7. Establishment of the ARF Tribunal:

  • The proportion of bad debts and Non-performing asset (NPA) of the public sector Banks and Development Financial Institute was very alarming in those days.

  • The committee recommended the establishment of an Asset Reconstruction Fund (ARF).

  • This fund will take over the proportion of the bad and doubtful debts from the banks and financial institutes. It would help banks to get rid of bad debts.

8. Financial Institutions:

The committee made the following recommendations regarding financial institutions:

  • Transferring of the direct lending function of IDBI to a separated institution while retaining to IDBI apex and refinancing role.

  • The Reserve Bank should set up a new agency to supervise financial institutions such as merchant banks, mutual funds, leasing companies, venture capital companies, and factor companies.

  • Capital market is liberalized.

  • An appropriate legal structure is organized arid operate mutual funds on the basis of experience of other countries.

In short, the recommendation by the Narasimham committee has far-reaching implications on the working of banking and financial system.

Narasimham Committee II-1998

  • In 1998 the government-appointed yet another committee under the chairmanship of Mr. Narasimham.

  • It is better known as the Banking Sector Committee.

  • It was told to review the banking reform progress and design a program for further strengthening the financial system of India.

  • The committee focused on various areas such as capital adequacy, bank mergers, bank legislation, etc.

It submitted its report to the Government in April 1998 with the following recommendations;

1. Strengthening the Banking System:

  • Capital Adequacy Requirements should take into consideration market risks in addition to credit risks.

  • Risk weight on a Government guaranteed advance should be the same as other advances.

  • Minimum Capital to Risk Assets Ratio (CRAR) is increased from the existing 8 percent to 10 percent. There should be penal provisions for the bank that do not maintain CRAR.

  • Public sector bank in a position to access the capital market at home or abroad be encouraged.

2. Asset Quality:

  • The ratio of non-performing assets to the total assets should be reduced.

  • For evaluating the quality of assets portfolio, advanced covered by Government guarantees, which have turned sticky, be treated as Non-performing Assets.

  • For banks with a high NPA portfolio, the following two alternative approaches could be adopted.

  1. All loan assets in the doubtful and loss categories should be identified and their realizable value determined. The assets could be transferred to an Asset Reconstruction Company (ARC) which would issue NPA Scrap Bonds.

  2. The banks with a high ratio of Non-Performing Assets (NPA) should issue bonds backed by Government guarantee.

  • The interest subsidy element in credit for the private sector should be totally eliminated. The interest rate on loans under Rs. 2 lakhs should be deregulated.

3. System and Methods in Banks:

  • There should be an independent loan review mechanism, especially for large borrowed accounts and systems to identify potential Non-performing Assets. (NPA)

  • Banks and Financial institutions should have a system of recruiting skilled manpower from the open market.

  • Public sector banks should be given the flexibility to determine managerial remuneration levels taking into account market trends.

  • There may need to redefine the scope of external vigilance and investigation agencies with regard to banking business.

  • There is a need to develop information and control system in several areas concerning banking operations.

4. Structural Issues:

  • With the conversion of activities between banks and Developmental Financial Institution, the development financial institutions (DFI) should over a period of time convert themselves to the bank.

  • There should be a merger of large banks only with the large banks. The large bank should not be merged with weaker banks.

  • Weak banks should be either neutralised into healthy units or close down.

  • The banking system should be reconstituted:

  1. 2 or 3 banks with an international status should be established.

  2. 8 or 10 large banks should be established. These banks should take care of the needs of the large and medium corporate sectors and the larger of the small enterprises.

  3. There should be a merger of a large number of local banks.

  • The Reserve Bank of India should not be the owner of any other bank.

  • The minimum share of holding by Government Reserve Bank in the equity of the nationalized banks and the State Bank should be brought down to 33%.

  • There is a need for a reform of the deposit insurance scheme.

  • Reserve Bank of India should totally withdraw from the primary marked in 91 treasury bills.

  • Necessary changes should be made in banking and debt recovery legislation.

  • A high of professionalism needs to be introduced as much in the Board level as in Management.

  • The Board of Directors should include efficient and professional persons.

  • There should be rapid computerization of the banking There should be modernization and technology up-gradation of the banking operations.

In short according to the Narasimham Committee, ‘A strong and efficient banking system functionally diverse and geographically widespread, is critical to the attainment of the objectives of creating a market-driven, productive and competitive economy. The reforms in the banking sector have been receiving major emphasis.’

Therefore, the Committee made its recommendations in 1991 and 1998, evolving a market was driven and more efficient Banking System from a highly regulated environment and unprofitable.

In brief, main measures were aimed at in 1991;

  1. Ensuring a degree of operational flexibility.

  2. Internal autonomy for Public Sector Banks in their decision-making process.

  3. Greater degree of professionalism in Banking operations.

And in 1998, the committee has discussed the following three broad inter-related issues:

  1. Measures to strengthen the foundation of the Banking System.

  2. Streamlining procedures, upgrading technology, and human resource development.

  3. Structural changes in the system

Reforms made in the Banking Sector by Government as Recommended by Narasimham Committees:

As per the recommendations of two committees in 1991 and 1998 chaired by Mr. Narasimham, many major initiatives taken by the Government of India. These can be summarized as follows;

1. Deregulation of Entry of Private Sector Banks

2. Liberalized Branch Expansions

3. Deregulation of Interest Rates

4. Introduction of Capital Adequacy Norms

5. Introduction of Internationally Accepted Norms of Income Recognition

6. Permission to Public Sector Banks to sale their Shares

7. Reduction of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)

Liberalization Measures

a) Reduction of Pre-emption

  • While SLR has reduced to 25 percent in 1997 from 38.5percent, CRR was reduced to 4.5percent, much closer to the international standards of 3 percent.

  • The reduction in SLR and CRR have released substantial funds for deployment in the corporate and Business Sectors at the higher rate of interest.

b) Deregulation of Interest Rates

  • Scheduled Commercial Banks have now the freedom of setting the interest rates on their deposit and loans, subject to minimum floor rates and maximum ceiling rates.

Liberalization Measures

a) Reduction of Pre-emption

  • While SLR has reduced to 25 percent in 1997 from 38.5percent, CRR was reduced to 4.5percent, much closer to the international standards of 3 percent.

  • The reduction in SLR and CRR have released substantial funds for deployment in the corporate and Business Sectors at higher rate of interest.

b) Deregulation of Interest Rates

  • Schedule Commercial Banks have now the freedom of setting the interest rates on their deposit and loans, subject to minimum floor rates and maximum ceiling rates.

Prudential Regulation

  • There are two types of banking regulations—economic and prudential.

  • In the pre-reform era (before July 1991) the Reserve Bank of India (RBI) regulated banks by imposing constraints on interest rates, tightening entry norms and directed lending to ensure judicious end use of bank credit.

  • However, such economic regulation of banks hampered their productivity and efficiency.

  • Hence, the RBI switched over to prudential regulation which calls for imposing a minimum limit on the capital levels of banks.

  • On the basis of recommendations of the Committee on Banking Sector Reforms, April 1998 (the second Narasimham Committee) the RBI issued prudential norms.

  • The major objective of setting such norms was to ensure financial safety, soundness, and solvency of banks.

  • These norms are directed toward ensuring that banks carry on their operations as prudent entities, are free from undue risk-taking, and do not violate banking regulations in pursuit of profit.

  • It allows much greater scope for the free play of market forces than what is permitted by economic regulations alone.

Challenges facing the banking sectors

High leverage, weak returns

Less growth in the assets, steep losses, and erosion in the capital have led to the build-up of high leverage (ratio of assets to capital) in the banking system, particularly for public sector banks (PSBs).

The problem with high leverage is that it magnifies profits when the returns from assets are healthy, but it also blows up the losses in case of abysmal returns.

What is the leverage ratio?

The Basel Committee on Banking Supervision (BCBS) introduced a leverage ratio in the 2010 Basel III package of reforms.

The leverage ratio measures a bank's core capital to its total assets. The ratio uses tier 1 capital to judge how leveraged a bank is in relation to its consolidated assets.

It is basically a ratio to measure a bank's financial health.

The Formula for the Leverage Ratio is:

(Tier 1 Capital/ Total Consolidated Assets) ×100

Tier 1 capital represents a bank's common equity, retained earnings, reserves, and certain instruments with discretionary dividends and no maturity.

The higher the tier 1 leverage ratio, the higher the likelihood of the bank withstanding negative shocks to its balance sheet.

Basel III established a 3 percent minimum requirement for the leverage ratio while it left open the possibility of making the threshold even higher for certain systematically important financial institutions.

In the second bi-monthly policy review, the central bank has mandated leverage ratio of 3.5% for all the banks except for the domestic systemically important banks (D-SIBs), which will have a 4% ratio.

How is it different from capital adequacy ratio (CAR)?

capital adequacy ratio (CAR) is the ratio of a bank’s core tier 1 capital—that is, its equity capital and disclosed reserves—to its total risk-weighted assets. Whereas leverage ratio is a measure of the bank's core capital to its total assets.

CAR is a key measure of a bank's financial strength that has been adopted as part of the Basel III Accord on bank regulation.

How an increase or reduction in leverage ratio affect banks?

Reduction in leverage ratio will increase the capacity of banks to lend more i.e. if Leverage is reduced by .5% That means Banks will be able to lend that much more capital to the market.

On the other hand, an increase in leverage ratio reduces the Bank’s lending capacity.

RBI has recently reduced the leverage ratio from 4.5 percent to 4 percent for systemically important banks and 3.5 percent for other banks, which will help them increase exposure.

Asset Quality/NPA

  • Asset quality has seen sustained pressure due to the continued economic slowdown. The levels of gross non-performing advances (GNPAs) and net NPAs (NNPAs) for the system have been elevated.

  • Due to a high proportion of non-performing assets or outstanding due to banks from borrowers they are incurring huge losses. Most of them are also unable to maintain a capital adequacy ratio.

  • The asset quality deterioration continues with the farm loan waiver in certain states is creating a moral hazard issue.

Low growth in Bank Business

Growth in Deposits and Advances are considered as Banks’ Business. In the financial year 2017-18, the bank deposit growth was just 6.7 percent as against 11.3 percent of the previous year.

Low-interest rates offered by bank deposits have resulted in people shifting away from FDs to mutual funds which witnessed significant inflows in FY18.

Higher provisioning requirements

RBI’s Asset Quality Review (AQR) findings in Dec. 2015, classified large stressed assets as (Non-Performing Assets) NPA, which till then were being treated as non-NPA through flexibility in loan classification and restructuring.

Consequently, RBI increased provisioning requirements to meet expected losses from transparent recognition for clean balance sheets.

All these developments resulted in rising of Gross NPAs from 4.96% of advances in Mar. 2015 to 12.75% in Jun 2017 with provisioning for expected losses too growing substantially and also the implementation of Basel III capital norms.

RBI made special inspections of banks during August-November 2015 and prepared the AQR because it had a strong notion that some of the banks are underreporting their NPAs.

Many banks were postponing bad-loan classification while depicting accounts as performing.

What is provisioning?

Provisioning is preparing a contingency plan for the expected future losses. In case of banking, it involves setting aside a part of funds from the bank’s own funds as a percentage of bad assets.

For example, if Provisioning requirement has been set at 50% by the RBI for a particular category of Bad assets, then the bank has to maintain a fund equivalent to the value of 50% of that particular bad assets, out of its profit.

Assets of a bank mean loans they have given and investment they have made. If the loans are not coming, there should be provisioning for such bad debts.

The coverage ratio of provisioning differs on the basis of the quality of assets. For some assets categorized as loss assets, banks set aside 100% of such loss assets, out of their profits.

More conservative norms of RBI

The Basel Committee on Banking Supervision (BCBS) has observed that "several accepts of the Indian framework are more conservative than the Basel framework".

RBI has required banks to maintain the Capital Risk-Weighted Asset Ratio (CRAR) 1% higher than the global Basel norms both under the Basel II and Basel III framework.

Basel III

  • Originally set in 1974, the most recent set of norms, called Basel III.

  • These are a common set of global standards to be implemented by banks across countries.

  • After the 2008 financial crisis, need arose to strengthen the banking system further so that they could meet further risks. To meet these dangers, banks were asked to maintain a certain minimum level of capital and not lend all the money they receive from deposits.

  • This acts as a buffer during hard times. The Basel III norms also consider liquidity risks.

Pillars of the Basel Norms for Banking

Pillar 1: Minimum Regulatory Capital Requirements based on Risk-Weighted Assets (RWAs): Maintaining capital calculated through credit, market and operational risk areas.

Pillar 2: Supervisory Review Process: Regulating tools and frameworks for dealing with peripheral risks that banks face.

Pillar 3: Market Discipline: Increasing the disclosures that banks must provide to increase the transparency of banks.

Capital requirements under Basel 3 norms:

  • The capital norms recommend Capital Adequacy ratio (CAR) be increased to 8 percent internationally, while in India it is 9 percent.

  • Out of the 9 percent of CAR, 7 percent of Risk-Weighted Assets (RWA) has to be met by Tier 1 capital while the remaining 2 percent by Tier 2 capital.

  • So, if the bank has risky assets worth Rs 100, it needs to have Tier 1 capital worth Rs 7. This capital can be easily used to raise funds in times of troubles.

  • In addition, banks also have to hold an additional buffer of 2.5 percent of risky assets, called Capital Conservation Buffer (CCB).

  • Banks maintain 5.5 percent Common Equity Tier 1 (CET 1) as against 4.5 percent required under the Basel III framework.

  • The banking regulator introduced Basel III norms in India in 2003 and aims to bring in all commercial banks by March 2019.

 

Human Resource Issues

Presently the Banking sector is suffering from the shortage of experienced staff. While fresh recruitments are happening at the junior levels, a slowdown in recruitment in the past coupled with the attrition of office staff has led to a shortage at the middle and senior levels.

Bridging human resource gaps and managing employee turnover are major challenges that banks need to be prepared to address.

In short, the Human resource problems faced by Banks are:

  • Huge retirements (losing experienced employees)

  • Compensation policy is not enough to attract talent to match today’s business complexities. No performance-based incentives at present.

  • Skill Upgradation required in a quicker way.

Technology and its impact

  • With the increasing use of technology in the banking system such as net banking, mobile banking, etc. cybersecurity has become a major challenge.

  • Fragmentation in the core banking system and the SWIFT system becomes the loophole in data management as witnessed in Nirav Modi case.

Bank Frauds

The quantum of funds involved in frauds in banks and other financial institutions during the year 2017-18 increased to Rs 32,048 crore as against Rs 23,930 crore in the previous year mainly due to banks such as HDFC, ICICI, and PNB.

For public sector banks, it had gone up significantly from Rs 19,529 crore to Rs 29,246 crore mainly due to PNB reported fraud. The number of frauds detected in banks was 2883 in 2017-18 as against 2709 in the financial year 2016-17.

Powers of the RBI in case of PSBs

The Committee noted that the RBI had stated that some powers available to the RBI under the Banking Regulation Act, 1949 are not available in the case of PSBs. These include:

  1. removing and appointing Chairman and Managing Directors of banks,

  2. superseding the Board of Directors, and

  3. granting licenses.

The Committee also noted that the RBI can, however,

  1. inspect the bank,

  2. consult with the government on appointing senior bank officials, and

  3. have a nominee on a PSB’s management committee.

In this regard, the Committee recommended that the government should constitute a high-powered committee to evaluate the powers of the RBI with respect to PSBs as provided under various statutes.

Measures were taken

Enhanced recapitalisation

In respect of public sector banks, the government has prepared a four-year plan known as Indradhanush for recapitalization needed to support higher credit growth as per Basel III norms.

Government has committed itself to Rs 70,000 crore out of the total expected requirement of Rs 1,80,000 crore till FY19. The remaining amount is likely to be raised by banks through the sale of non-core assets and dilution of government equity to 52%.

Government has initiated a new performance framework for banks through Indradhanush based on efficiency and capital optimization.

The government further announced a decision to further recapitalize PSBs to the tune of Rs. 2,11,000 crore, through recapitalisation bonds of Rs. 1,35,000 crore and budgetary provision of Rs. 18,139 crore (the residual amount under Indradhanush plan) over two financial years, and the balance through capital raising by banks from the market.

In 2018-19, the government had pumped in the highest-ever infusion of Rs 1.6 lakh crore into PSBs to meet regulatory and growth capital requirements, helping five lenders come out of the Reserve Bank of India's (RBI) Prompt Corrective Action (PCA) framework.

The enhanced provision is aimed at:

  1. Meeting regulatory capital norms

  2. Providing capital to better-performing PCA Banks to achieve 9% Capital to Risk-weighted Asset Ratio (CRAR); 1.875% Capital Conservation Buffer and the 6% Net NPA threshold, facilitating them to come out of PCA

  3. Facilitating non-PCA banks that are in breach of some PCA thresholds to not be in breach

  4. Strengthen amalgamating banks by providing regulatory and growth capital

Bimal Jalan Committee in New Bank License, 2013

Bimal Jalan committee was set up to screen the applications for grant of bank license to New Banks in the Private Sector and to recommend licenses to only those applicants who comply with the RBI guidelines. Bimal Jalan Committee has submitted its report to RBI in Feb 2014.

On the recommendation of this committee, RBI issued a license to two banks: Bandhan Microfinance and IDFC (Infrastructure Development and Financial Corporation)

Gopalakrishna Committee on “Capacity building”, 2014

RBI set up this Committee for ‘Capacity building in banks and non-banks’.

Its major recommendations were:

  • Recruitment: Common Bank aptitude test (BAT) should be conducted online. BAT score should be used for entry-level recruitments in banks.

  • Training: Both internal and external trainings must be mandatory for promotions. For grooming frontline staff or best customer service, standardizing internal training programs with soft skills modules (on the lines of some best practices in private banks) were suggested.

  • Repository of banking personnel: It was suggested to have a repository of existing personnel in senior positions in banks by auditing existing staff.

  • Matching strategic training with employee life cycle: It was suggested that linking HR policies to business strategy synchronous with employee life cycle is essential. Family needs in employee life cycle like stability in middle age for children’s education etc. could be matched with proper job rotation and specialised long term postings.

Committee on bank frauds: The RBI has, in February 2018, constituted a panel under the chairmanship of Y.H. Malegam to look into the factors that contributed to the increase in the number of frauds and come up with measures to prevent frauds.

Government’s 4R’s approach

Government has adopted 4R’s approach of Recognition, Resolution, Recapitalisation, and Reforms for comprehensive clean-up of the banking system:

Recognition of restructured standard assets as NPAs was initiated with Asset Quality Review in 2015 and with discontinuation of restructuring schemes this year, the recognition exercise is nearly over with such assets declining from the peak of 7.0% in March 2015 to 0.59% as of September 2018.

The resolution process has been strengthened by changing the creditor-debtor relationship through the Insolvency and Bankruptcy Code and debarment of wilful defaulters and connected persons, which has resulted in record recovery this year.

Recapitalisation, under which, with today’s decision, total mobilisation of capital in PSBs since the commencement of clean-up in 2015-16 is slated to be over Rs. 3,00,000 crore.

Reforms have accompanied recapitalisation in the form of a comprehensive PSB Reforms Agenda that addresses the root causes of poor asset quality and commits banks to clean lending and rolling out of next-generation banking services by leveraging benefits of technology and formalisation of the economy.

Through 4R’s, the banking system has registered a sharp reduction in stress and loan defaults, record recovery and steady increase in provision coverage.

Insolvency and Bankruptcy Code

As per the reports of CRISIL (A global rating agency), Insolvency and Bankruptcy Code (IBC) has proved to be a key reform in identification and resolution of insolvencies in India in an expedited manner, however, some of the challenges still remain to be resolved.

About IBC

Introduction

  • It applies to both Individual and companies.

  • It provides for a 180- days period to resolve insolvency.

  • It provides immunity to the debtors from claims of resolution by creditors during this period of resolution.

  • It provides for a common platform of debtors and creditors of all classes to resolve insolvency.

Institution created under code

Insolvency and Bankruptcy Board: Board will comprise of members from RBI and the Ministries of Finance, Corporate Affairs and Law. It will regulate the activities of insolvency professionals, insolvency professional agencies and information utilities.

Insolvency professionals: It will be a cadre of licensed professionals. They will be tasked with the administration of the resolution process, management of debtor’s assets, as a source of information to creditors, to help them in decision making.

Information Utilities: The utility would specialise in procuring, maintaining and providing/supplying financial information to businesses, financial institutions, adjudicating authority, insolvency professionals and other relevant stakeholders. In 2017, National e-Governance Services Ltd (NeSL) became India’s first information utility (IU).

Insolvency Professional Agencies: It registers insolvency professionals. The agencies conduct examinations to certify insolvency professionals and enforce a code of conduct for their performance.

Adjudicating authorities: Act created National Company Law Tribunal (NCLT) for corporates and Debt Recovery Tribunal (DRT), for individuals as well as partnership firms for the adjudication of the resolution process. The responsibilities of the authority include:

  • approval to initiate the resolution process

  • appoint the insolvency professional,

  • approve the final decision of creditors

Process for resolution of insolvency

  1. Initiation:

  1. A financial creditor or corporate debtor can give an insolvency plea to adjudicating authority (NCLT or DRT) to admit in corporate insolvency resolution process (CIRP). Authority will either accept or reject the plea within 14 days.

  2. If accepted by the authority, it will appoint the insolvency professionals for drafting a plan of resolution within a period of 180 days (can be extended unto 270).

  3. The professional provides financial information of the debtor from the information utilities to the creditor and manage the debtor’s assets.

  1. The decision to resolve insolvency:

  1. Insolvency professional will create a committee consisting of financial creditors. This committee will make a decision either to revive the debt owed to them by changing the repayment schedule or sell (liquidate) the assets of the debtor to repay the debts owed to them. If the Committee fails to reach a decision in 180 days, the assets of debtor will go into liquidation.

  1. Liquidation

  1. If the debtor goes into liquidation, an insolvency professional administers the liquidation process.

  2. Following the order of precedence, in which Proceeds from the sale of the debtor’s assets are distributed:

      1. Insolvency resolution costs, including the remuneration to the insolvency professional,

      2. Secured creditors, whose loans are backed by collateral, dues to workers, other employees,

      3. Unsecured creditors,

      4. Dues to government,

      5. Priority shareholders and

      6. Equity shareholders.

Insolvency and Bankruptcy Code (Second amendment) bill, 2017

The bill was passed to prevent certain parties from bidding for companies as resolution applicant and uphold the credibility of the resolution process.

Salient features

  • It defines a resolution applicant as the one, who submits a resolution plan after receiving an invite by the insolvency professional to do so.

  • An applicant to submit a resolution plan needs to fulfill certain criteria laid down.

  • The Bill inserts a provision prohibiting certain persons from submitting a resolution plan.

  • The bill has made the provision that the committee will approve a resolution plan by a 75% majority, subject to any conditions specified by the Insolvency and Bankruptcy Board.

  • The bill prohibits the insolvency professional to sell the movable or immovable property of the debtor in case of liquidation.

  • Bill inserts a provision of penalties for contravening the provisions of the code.

Insolvency and Bankruptcy Code (Second amendment) bill, 2018

  • It amends to IBC, 2016.

  • It identifies allottees under a real estate project as Financial creditors.

  • The voting threshold for routine decisions taken by the committee of creditors has been reduced from 75% to 51%.

  • It provides for the withdrawal of a resolution application submitted to the NCLT under the Code. This decision can be taken with the approval of 90% of the committee of creditors.

What were the needs for IBC?

  • India’s rank in ease of doing business report was 130 in 2017, that has improved to 77 in 2019.

  • As per the World Bank report of 2015, in India insolvency resolution (IR) took 4.3 years on an average.

  • While IR takes 1 year for the United Kingdom and 1.5 years in America.

  • Reasons behind delays in India were a delay in courts and lack of clarity about the current resolution framework.

Some of the achievements of IBC

  • As of March 31, 2019, under the Corporate Insolvency Resolution Process (CIRP), a resolution plan for 94 stressed assets was approved by the NCLT. These accounts valued at Rs 1,75,000 crore, of this amount 43% has been recovered.

  • As per the estimates, the banking sector’s gross NPA (aggregate) dropped to ~10% in March 2019 from 11.5% at the end of fiscal 2018.

  • Although there has been a time lag in a resolution of cases, still it was way faster than the recovery time of 3.5-4 years taken by asset reconstruction companies.

  • IBC has resulted in improvement in rights of creditors and also in the identification of bankruptcies and initiation of resolution proceedings. It has empowered creditor to initiate a resolution proceeding against a defaulting corporate borrower.

  • Its implementation has resulted in better financial discipline among borrowers.

Challenges facing IBC process

  • In comparison to the maximum stipulated timeline of 270 days, as mentioned in IBC code, resolution of cases took 324 days.

  • While many big tickets cases could not be finalised even after 400 days.

  • The current strength of National Company Law Tribunals (NCLT) benches is insufficient to deal with the larger number of pending cases.

  • There has been a loophole in the functioning of Committee of Creditors. Nominated members of Financial creditors does not have any authority to make decisions upfront. It leads to a conflict of interest in reaching a revival plan.

  • There is no proper infrastructure of the Information Utilities (IU) that provide access to credible and transparent evidence of default.

  • There is a multiplicity of regulators to Insolvency Professionals i.e. presence of numbers of insolvency professional agencies (IPAs) to regulate professionals.

What should be done?

  • An immediate improvement of NCLT and NCLAT infrastructure is required.

  • Digitisation of the NCLT/NCLAT platform would improve their performance.

  • Proactive training/on-boarding of judges, lawyers, and other intermediaries will be necessary for effective implementation of the code.

  • Technological infrastructure needs to be strengthened to avoid any kind of data loss and to maintain confidentiality. There is a requirement of enhanced IU infrastructure.

PCA framework

The Reserve Bank of India (RBI) has recently removed three banks, Dhanlaxmi Bank, Allahabad Bank and Corporation Bank from the PCA framework by moving them out of its weak-bank watchlist.

Prompt Corrective Action or PCA is a framework under which banks with weak financial metrics are put under watch by the RBI.

The PCA framework deems banks as risky if they slip below certain norms on three parameters —

  1. Capital ratios,

  2. Asset quality and

  3. Profitability

The framework has 3 threshold levels based on the ratios of the above-given indicators.

Indicator

Risk Threshold 1

Risk Threshold 2

Risk Threshold 3

CRAR

<10.25% but >=7.75%

<7.75% but >=6.25%

<6.25%

common equity Tier 1- < 3.625 per cent

Net Non-performing advances (NNPA) ratio

>=6.0% but <9.0%

>=9.0% but < 12.0%

>=12.0%

 

Profitability or Return on assets (ROA)

Negative ROA for two consecutive years

Negative ROA for three consecutive years

Negative ROA for four consecutive years

Actions on breach of threshold

Purpose of PCA framework

PCA is intended to help alert the regulator as well as investors and depositors if a bank is heading for trouble.

The idea is to head off problems before they attain crisis proportions. Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to restore the financial health of a bank.

Challenges due to PCA framework

Since the PCA framework restricts the amount of loans banks can extend, this will definitely put pressure on credit being made available to companies especially the MSMEs.

The committee appointed by RBI is of the opinion that banks put under the PCA framework are barred from doing their normal operations.

RBI should provide a coherent and positive road map for each of these eleven banks to come out of the stringent PCA framework within a stipulated timeframe so that they can resume their normal banking operations.

The Committee are apprehensive that the PCA framework may end up bringing more and more PSBs under its ambit, which may aggravate matters and culminate in a vicious cycle in the banking sector and the economy at large.

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