ECONOMIC INDICATORS

Parameters 2010-11 2011-12Inflation as measured by variation in WPI (YOY basis) $@ Projected end March 2013 at 7%

8.98% 6.89%

M3 @Projected growth for 2012-13 at 15%

15.9% 13%

FX (USD bn) Reserve # 304.82bn 294.4bnGDP # (factor cost constant prices)@ Projected for 2012-13 at 6.5%

8.5% 6.5%

Manufacturing Growth # 8.3% 2.8%

Agriculture Growth # 6.6% 2.5- 3%Savings( as % of GDP) #Investments (as % of GDP)# Exports US $ terms #billion 245.56 303.7Imports US $ terms # billion 350.70 488.6Aggregate Deposit Growth of SCB@ projected to grow during 2012-13

15.8% 17.4%

Non-food Credit Growth of SCB@ projected non-food credit is to grow 17% in 2012-13

21.2% 19.3%

@ Source –Union Budget 2012 and monetary policy 12.$ As per revised estimates of CSO# Economic survey 2011-12

Chapter -1

Current Economic Scenario

“By 2030 India could become the 3rd largest economy after China and U.S. India also has the potential to record the fastest growth over the next 30 to 50 years. Of course, India’s growth could be higher than 5% over the next 30 years and close to 5% even in 2050 if development progresses successfully. In fact, India could be ahead of the U.S. in 2055 and be No. 1 in 2067.”

- Goldman Sachs BRIC report 2003

1. ECONOMIC SCENARIO - An overview - Since independence, India has made all

round progress in every sphere of economic activity. We take legitimate pride in the

fact that progress

has been sustained

in the framework of

a democratic policy

and an open society

deeply committed

to fundamental

human freedoms

and law of the land.

India’s economic

structure is

considerably

diversified - with

vast reservoir of

scientific,

technological and

managerial skills.

There has also been

significant

improvement in nation’s educational and health status as measured by school

environment, literacy rate and life expectancy at birth. Self-reliance has been basic

1

objective of economic planning in India since independence. However, 2011-12 has

been exceptionally challenging for the global economy in general and India in

particular as what started off as turmoil in the global market particularly Euro is now

snowballing in Indian economy which has been facing unprecedented inflation.

Economic fall out of this is (a) GDP slowdown, (b) Dollar appreciation, (c) Falling

forex reserve, (d) Widening gap in balance of payment, (e) Increasing fiscal deficit,

(f) Threat of rise in unemployment and job cut (g) pressure on stock market and (h)

Sinking business confidence index. It has fall out on banking system also namely (a)

Rise in delinquency of loan, (b) Falling NIM and profitability and (c) fear of stability

of financial system. In its recently released Financial Stability Report, RBI has hinted

that foreign institutional investment in stock may dip due to uncertainty in US and

Europe, Banks may have to grapple with more bad loans and current account deficit

may widen (ET 23.12.2011).

2. GDP

While global economy may have to settle for a slower growth of 3.25-3.50%,

India’s GDP had been growing at 8% plus for five years in a row - 8.4% in 2003-04,

8.3% in 2004-05, 9.2% in 2005-06, 9.7% in 2006-07 and 9% in 2007-08. However

due to unprecedented economic and financial crises globally, growth has slow down

to 6.7% in 2008-09, 7.4% in 2009-10, 8.4% in 2010-11 and 6.5% in 2011-12 and

expected to be 5.5% ( good in context of sluggish global economy) in 2012-13.

Slowdown in 2011-1 2 is attributed to poor growth in agriculture, forestry and fishing

(2.5%), manufacturing (3.9%) and construction (4.8%). Finance Minister recently

cited three reasons for this slow down: Global problems, high inflation and declining

investments.

Among BRICS countries, growth in China fell from 8.1% in Q1 of 2012 to 7.6%

in Q2. Growth in Brazil and South Africa also moderated significantly in Q1. World

Economic Outlook has revised global growth in 2012 marginally downward to 3.5%.

DR. C. Rangrajan, Chairman, Prime Minister’s Advisory Council outlined five

measures that can trigger investments: (a) if economy continues to grow at 8.5% that

it self may stimulate growth, (b) inflation should be tamed to a reasonable level as

quickly as possible, (c) fiscal deficit to be contained at budgeted level (d) target

2

for the infrastructure of this year should be fulfilled, (e) priority must be given for

completing these targets be it railway freight corridor or roadways projects. It is

now being debated that RBI should cut rates as keeping blind eye to growth and only

focussing on inflation is not in interest of the country.

3. Foreign Exchange Reserve

India’s forex reserves covered 7.1 months imports at the end of March, 12. Due

to many adverse factors such as falling growth, rising commodity prices, surging

trade deficit, spiraling inflation, rising interest rates and plunging value of Indian

rupees, Forex reserves have been on pressure. India is now fourth largest holder of

Forex reserve in Asia after China, Japan and Taiwan. A debate is going on if such a

huge Forex reserve is necessary. The traditional indicators of adequacy of reserves

are based on trade, debt and monetary indicators or even the “Guidotti Rule” or

“Liquidity at Risk” rule suggested by Alan Greenspan, they need to be supplemented

with what can be described as multiple indicators to assess the adequacy of the

reserves of any country at a given juncture. It should however be kept in mind that

there are many unquantifiable benefits of keeping high reserves like maintaining

confidence in monetary and exchange rate policies, enhancing the capacity to

intervene in foreign exchange markets, limiting external vulnerability so as to absorb

shocks during time of crises; providing confidence to the markets that external

obligations can always be met and reducing volatility in foreign exchange markets.

Thus comfort level of reserves is decided not only with current situation but also

with possible future eventualities. As is known, RBI is investing FX reserve into safe

treasury securities of developed countries at a significantly lower interest rate than

what India incurs on its liabilities. Economist Shri Bhaskar Datta, has opined that

accumulation of FX reserve is ‘embarrassment of riches’. It means that increase in

domestic money supply, which invariably results into increase of aggregate domestic

demand, thereby adding ‘demand-pull inflation’. There are suggestions that (a)

a part of these reserves can be placed with banks which in turn can lend it to

corporate, which are otherwise raising ECBs from external financial market. This

will earn higher returns to RBI, (b) GOI can utilize FX reserve to import large array

of non-food items to increase domestic availability and cool off inflation. (c)

3

RBI/GOI to move toward full capital account convertibility. The GOI and RBI has

recently decided to form a SPV with $ 5 billion as subsidiary of India Infrastructure

Finance Company based in London to lend fund to Indian Companies to finance its

infrastructure. GOI is also considering a proposal to for creating a price stabilization

fund for petroleum products by using a part of our reserves.

4. Foreign Direct Investment-

The foreign direct investment brings with it the crucial managerial skill,

technology, brand name and experience of the global player. FDI has three

components- fresh equity investment, reinvestment of profits or a part of it instead of

repatriating the same and investments brought in for paying workmen’s compensation

for relocation and other such purpose not related to equity investment. FDI inflow in

India was US$ 22.8 billion in 2006-07, US$34.8 billion in 2007-08, US$ 37.8 billion

in 2008-09, US$ 37.8 billion in 2009-10, US$ 34.8 billion in 2010-11 and US$ 46.8

billion in 2011-12. India has emerged as a preferred destination for foreign investors

and is ranked 3rd, next only to Brazil and China and US is ranked 4th as per

Bloomberg Survey (ET 22.09.10). Investment commission has recommended two

pronged strategy to increase foreign direct investment: (a) Increasing visibility in

countries like France, Spain, Canada and Taiwan which has little investment in India

and (b) focusing on US, UK, Netherlands and Japan. Investment commission further

identified as many as 93 potential foreign companies for investment across various

sectors. Expert panel under the chairmanship of UTI AMC Chairman Shri U. K.

Sinha has proposed to remove the distinction between various forms of foreign

investors such as foreign institutional investors, private equity or non-resident Indians

and suggested to replace it with qualified institutional investor model. The new model

will pave way to foreign individual investor to invest directly in stock market by

opening a dedicated trading account with registered depository participants.

5. Manufacturing & service sector

Manufacturing and service sector holds key to growth and job. IIP (Index of

Industrial production) of June, 12 indicated sharp decline in factory output to 1.8%

against 9.5% in the previous year. Output of capital goods and non durable goods

dipped sharply. Investment Commission in its report to the Government of India

4

has suggested that inflexible labour laws, poor infrastructure and ambiguity in

outlining the priority sectors has acted as impediments in building large firms,

attracting foreign direct investment and reaping the economies of scale. Economist

also feel that drastic fall in industrial output may prompt the Reserve Bank to

consider revisiting high interest rates in next review of monetary policy in September,

12.

6. Inflation

Headline inflation as measured by wholesale price index (WPI) eased to 7.2% as

on Dec. 12. RBI has revised its forecast for March 13 from 6.5% to 7%. Food

inflation was 10.6% in Nov. 12 and pulses, vegetables, milk, egg meat and fish prices

are still under pressure. Overall inflation scenario continues to be above RBI comfort

level with manufactured non-food product inflation inching up and food prices

remaining stubborn. It is generally believed that deficient monsoon rains and rising

global crude prices are expected to accelerate price pressure in the moths ahead. RBI

believes that current inflation pressure will persist due to disappointing monsoon,

adjustments in administered fuel prices, the depreciated exchange rate and

infrastructure bottlenecks. Current level of inflation is also considered ‘spiraling’ out

of control to hurt investments and economic growth due to tightening of monetary

policy. The higher inflation differential between India and major trading partners is a

source of pressure on competitiveness of Indian exports. Thus containing inflation is

essential to external balance of payment position as well as to growth in long run. It

is felt that revival of consumption demand, change in consumption pattern in favor of

protein rich items like egg, milk, fish, meat etc. where price increase has been high,

rising international commodities prices including crude oil, rise in excise and

custom duties due to roll back of fiscal stimulus and inflationary expectation are

putting pressure on inflation. World over central banks are concerned of inflation

and view is to ‘take care of inflation and growth will take care of itself’.

7. Interest Rate Instance

In quarterly policy of March 12, RBI said that despite deceleration in growth,

inflation risks remain, which will influence both the timing and magnitude of future

rate action. It is opined that (a) combination of weakened exchange rate and high oil

5

prices present upside risk to broader inflation, (b) dip in core inflation reflects

demand pressure in the economy and weak investment activities, (c) credible fiscal

consolidation will be an important factor shaping the inflation out look and (d)

current account deficit is likely to remain high and financing it may continue to be a

challenge. CRISIL Research opined that lending rates are unlikely to ease much

during 2012-13 in view of continued tightness in liquidity, increased government

borrowings and high cost of funds for banks.

9. Liquidity

Liquidity position in the current quarter (July- Oct, 12) is well within RBI comfort

levels with bank on average borrowings Rs. 42600 crores through the repo window.

Further CRR cut by 25 bps effective 22nd September, 2012 will add further liquidity

of Rs. 17000 crores in the system. With falling incremental credit deposit ratio from

93% in March, 12 to 83% in March, 13 and sluggish demand of credit, liquidity

position of banks is predicted to remain comfortable. It may be recalled that in order

to help the banks to overcome liquidity constraints in future, RBI has introduced

Marginal Standing Facility (MSF) at 2% of NDTL at 1% over repo rate and Liquidity

Adjustment Facility (LAF) through repurchase agreement (REPO) against collateral

of GOI bonds.

10. M3

M3 includes (a) currency with the public, (b) demand deposits with banks, (c)

time deposits with banks and (d) other deposits with Reserve Bank. M3 growth (net

of conversion) at 15.9% during 2010-11 was lower than the Reserve Bank’s indicative

trajectory of 17 per cent due to slow deposit growth and acceleration in currency growth. The

higher currency demand slowed the money multiplier. Consequently, M3 growth slowed

despite a significant increase in reserve money. This suggests that money supply growth was

not a contributing factor to inflation.

11. Trade deficit- Exports and Imports

Foreign Trade Policy 2004-09 has targeted growth of Export from $ 63.50 billion

as on March end 2004 to $ 200 billion by March end 2011 to achieve 1.5% of global

market share. CAGR envisaged is 21% for five years. Exports for 2011-12 have

crossed $ 303.7 billion with growth rate of 21%. Import during this period $ 488.6

billion with trade deficit of $185 billion which was quite high and is area of concern.

6

Exports in July 12, declined by 14.8% to $ 22.4 billion, sharpest contraction in three

year, in the wake of falling demand from US and Europe. Imports too declined by 8%

in July 12. Given the current global economic scenario and over whelming

protectionist sentiments in India’s traditional export market, high level of trade deficit

is going to adversely affect competitiveness of import dependent exports and will

continue to pose a great challenge to RBI in managing sliding rupee.

12. Current Account deficit

For most of its post-impendence economic history, India has seen a deficit in its

current account. However for brief period of 2001-02 to 2003-04, India witnessed a

current account surplus. The surplus during 2001-02 was US $ 11.76 billion, in

2000-01 it was US $ 5.86 billion US $ and in 2003-04, it was US $ 8.7 billion.

However again from 2004-05 current accounts turned deficit largely on back of rising

oil prices. Current account deficit could end 45% of GDP in 2012-13. The bloating

current account deficit has raised alarm bell for variety of reasons- (a) external debt

is now higher than forex reserve and (b) short term debts on residual maturity basis is

as high as 43% of total external debt as on June, 12, A rising current account deficit

would lead to depreciating currency, which may lead to higher interest rate and

consequent slow down in the economy. A slowdown could hurt both Indian Inc. as

also the government which could see lower tax growth and consequent higher deficit.

Looking to the healthy foreign exchange reserves crises is not in sight but continuous

increase in deficit is moving our economy into the zone of discomfort.

13. Fiscal & Revenue deficit

Fiscal deficit - excess of government expenditure over receipts less borrowing

– is measure of amount the government needs to borrow to meet its expenditure.

Fiscal deficit of 2011-12 rose to 5.9% of GDP ( budget 2012 propose to bring it

down to 5.3% in 2012-13) and considering off balance sheet items like oil and

fertilizer bonds and consolidated deficit of state government, the actual deficit turns

out to be almost 11% of GDP. Far more alarming is the more than four fold increase

in the revenue deficit, which is difference between revenue receipt and revenue

expenditure. Revenue deficit can only be financed by one of three sources: domestic

borrowing, borrowing overseas or printing money. Each of these comes with a

7

downside - raising interest rates, crowding out the private sector an adding the debt

burden in the case of the first two and adding to inflationary pressure in the case of

the third. Also revenue deficit does not result in the creation of any assets. It merely

adds to the interest and repayment burden without creating the wherewithal from

where the debt could be services. It may be noted that GOI invoked the emergency

provisions of the Fiscal Responsibility and Budget Management (FRBM) act to seek

relaxation from fiscal targets and to launch stimulus packages from December 2008.

FM P. Chidambaram presented (BL 30.10.12) fiscal consolidation plan under which

fiscal deficit will be brought down to 3% by 2016-17 in phased manner. Experts are

skeptical to this as they feel that unless government is able to control expenditure

particularly subsidies containing fiscal deficit will not be possible.

14. Deposits and Credit growth

For six long years, Indian Banks have no problem in mobilizing larger sum as

fresh deposits than the previous year but trend reversed since 2011-12 when deposit

growth was less than credit expansion. The problem has accelerated in 2012-13 as

YOY deposit growth in December, 12 was only 11.1% against credit growth of

15.1% .There are strong evidence of investors making use of other options which are

fetching higher returns to them such as bonds issues of NBFC raising approximately

Rs. 6400 crores by offering returns in the range of 10-13%. Further CD ratio at all

time high at 78.1% for year ending 2012 and incremental CD ration touching 201%

during 2011-12, suggests chocking of resources for corporate in ECB and public

issues mobilization markets and forcing them to borrow from banks at what ever rate

money is available. With this back ground, RBI has also raised repeated concern

about credit growth surpassing deposit growth and it has indicated the banks to

increase deposit and restrain credit growth and further advised them that deposit and

advances growth will be have to be aligned with each other.

15. Savings growth-

Driven by the surge in household savings in financial assets, the gross

domestic savings rate in the economy hit a historic high of 37.7% in 2007-08 but

plunged to 32% in 2008-09 due to world wide crises. It could recover marginally in

2010-11 but to expect to fall further in 2011-12 as economic conditions have been

8

far from conducive. Persistent inflation and slowing growth have eaten into the

incomes of households and corporate and economists apprehends that we may enter

into the phase of sub-30% savings rate. Further analysis provides that India financial

savings declined second year in row to 7.8% in 2011-12 meaning thereby households

save more in physical assets like gold, real estate etc., than in financial assets like

bank deposit, mutual funds, post office savings etc. The sharp fall in financial savings

further means that India has to depend more on overseas flows to funds its capital

needs. It may be noted that rise in savings/GDP ratio is not good enough to guarantee

growth unless household saves more in financial assets than to physical assets.

16. India’s current outlook

Citing corruption inadequate reforms, high inflation and slow growth, Global

Rating agency Fitch joined Standard & Poor in lowering India’s outlook to negative

from stable. New outlook reflect combination of deteriorating growth potential and

widening deficits even though global rating companies reaffirmed India’s long term

foreign and local currency rating at ‘BBB’ and short term foreign currency as ‘F3’.

17. Business Confidence Survey

Business confidence in India plunge to two year low as companies grapple with

problem such as high interest rates, frustration with governance, land acquisition

issues and eroding pricing power in inflationary environment. The survey conducted

by FICCI showed that companies are worried about performance of economy and

corporate sector in next six months. (ET 29.08.2011) The Reserve Bank’s IOS

conducted during March 2011 also indicated some moderation in business

expectations for the quarter ended June 2011. A weak business sentiment now could,

in other word, depress growth next year or the year after that if it persists but not in

the current year.

18. Current global economic scenario:-

We have very complex global economic environment at the moment. It is now

clear that global financial and economic outlook is unsettled and uncertain. The latest

assessment by major international agencies projecting sharp contraction in global

trade volumes in 2009 has exacerbated the uncertainty. The current assessments

project little chance of global economic recovery in 2009 but there are enough green

9

shoots indicating revival of Indian economy. It is expected that 2009-10 worst year

following global melt down will be behind us and economy will start growing.

19. U S Recession as threat:-

Decoupling, theory that the rest of the world does not have to catch a cold if the

US sneezes, which was all the rate last year could easily go down as on the of the

shortest live buzzword of economic theory. A new buzzword has started doing the

round is recoupling. According to this theory, the rest of the world is still umbilically

attached to the sate of the U S economy may be a lot more for Europe and somewhat

less of Asia. It is opined that last year problem of US were mostly domestic based on

housing but as signs of recession deepen, Europe, at least will not be able to escape

the ill effects and will take a but on domestic growth. The alternative growth engines,

China and India, despite their large domestic consumption, will not be able to fill the

gap created by US. While India may be reasonably shielded from the impact, China’s

export based economy may follow the American drummer.

20. European Banking Crisis

The banking sector in euro zone has come under extreme stress in recent months

due to its exposure to sovereign debt. The heavily exposed euro zone banking system

could suffer dramatically as a result of sovereign default as many of them hold large

amount of sovereign debut of countries such as Greece, Ireland, Italy, Portugal and

Spain. Worries over the health of Europe’s banks have led to downgrading of many

banks.

21. India among top five global brands:-

The Future Brand’s latest country brand index (CBI) has ranked India among the

top five countries for value for money, authenticity, history, best brand for art and

culture and business. The over all CBI index is toped by the United States, followed

by Canada and Australia.

22. Harnessing demographic dividend:-

Economists predicts that in 2020, the average age of an Indian will be 29 years,

compared to 37 for China and US, 45 for West Europe and 48 for Japan. Economists

tracking India’s demographic profile estimate that dependency ratio, defined as the

ration of dependent population (<15 & >64 years) to working age population (15 to

10

64 years), which is currently 0.6 will see a sharp decline and by 2030, India’s

dependency ration should be just over 0.4. It will continue to decline over the next 30

years or so and this constitutes the demographic dividend for India. Higher younger

population will lead to higher savings, higher investments and high per capita GDP.

Clearly, there is an unprecedented opportunity for India to become on of the world’s

most prosperous country and that too in just on generation.

POLICY CHANGES

From larger perspective, moot point is to revive confidence in the Indian economy

through growth enhancing measures. With GOI not able to put through economic

reforms (deferment of FDI is one such instance), it is RBI responsibility to fight the

battle alone through monetary and fiscal measures.

Given the structural characteristics, India is perhaps entering a new combination

of growth and inflation of 7 and 8 percent respectively. It is in this context obligatory

for RBI to move to rate easing path as early as possible so that confidence of market

is restored and growth comes automatically. Good point is that RBI governor has

started the process by 50 bps cut in repo rate vide monetary policy April 2012 with a

rider that he can not commit when and how fast further cuts would happen.

Chapter-2

11

Banking Sector Reforms and emerging issues

“We in India, have been adhering to a cautious and calibrated approach in our reforms so far and there is merit in adopting a ‘road map approach’ building on the strengths that we have already developed…The basic feature of Indian approach are gradualism; co-ordination with other economic policies, pragmatism rather than ideology; relevance to the context; consultative process; dynamism and good sequencing so as to be able to meet the emerging domestic and international trends. ”

-Dr. Y.V.Reddy- Governor, Reserve Bank of India.

Economist, former finance secretary and governor of RBI, Sri M. Narismhan was

the architect of financial sector reforms. His two reports of 1991 and 1998 form the

foundation of banking reform in India and are still regarded as the blue print of future

banking landscape. These reforms have provided necessary platform to the banking

sector to operate on the basis of operational flexibility and functional autonomy, thereby

enhancing efficiency, productivity and profitability. Further vulnerability of the banking

sector as revealed by the global financial crisis such as inadequate loss-absorbing

capital; insufficient liquidity buffers; excessive build-up of leverage; procyclicality of

financial markets; focus on firm-specific supervision and neglect of macro-prudential

supervision of system-wide risks; moral hazard from too-big-to-fail institutions; weak

governance practices; poor understanding of complex products; and shortcomings in risk

management etc. have to be addressed through reforms. India has been able to face all

these challenges in the reform process through gradualism; coordination with other

economic policies; pragmatism rather than ideology; relevance to the context;

consultative processes; dynamism and good sequencing, so as to be able to meet the

emerging domestic and international trends.

An attempt has been made in this paper to map reforms of the banking sector

since adoption of Narismhan Committee recommendations, their implications and also

lay down emerging agenda of reforms under consideration of the government of India

/Reserve bank of India.

REFORMS –

Enhanced competition and entry of private sector banks – In tune with the

Narsimhan Committee I recommendation, RBI has relaxed norms for issuing

12

license to new banks with objective to induce greater competition, reduce cost,

improve quality of service, promote financial inclusion that would ultimately

support inclusive growth. Many new private sector banks have been set up out

of which YES Bank is the latest offering. As competition mounted, Public Sector

Banks, which operated on the comfort of sovereign guarantee, were forced to

keep pace with private sector counter parts by upgrading their work process

through technology and also becoming customer focused. Banks are replicating

the story clearly seen in telecom and aviation sectors. While presenting Budget

of 2010-11, finance minister announced that more banking licenses will be issued

to private sector players and non banking finance companies to enhance

competition and help financial inclusion. As per policy paper released by RBI

(BL 30.8.2011) only entities/group in the private sector, owned and controlled by

residents, can promote banks but those having real estate and capital market

activities will not be eligible. New bank can only be set with wholly owned non

operative holding company with minimum capital of Rs. 500 crores and it will

have to hold minimum 40% capital for five years. Aggregate non-resident share

holding from FDI, FII and NRI will be restricted to 49% in first five years. At

present we have, 12 new generation private banks, 26 Public sector banks, 15

old private banks, 31 foreign banks, 85 regional rural banks, 31 foreign banks,

4 local area banks, 1721 urban cooperative banks, 31 state cooperative banks

and 371 district central cooperative banks.

Branch licensing- RBI has permitted opening of branches in tier 3 to tier 6

cities (population up to 50000 as per 2001 census) without prior authorization

under general permission. However banks will have to obtain prior authorization

for opening branches in tier 1 and tier 2 centers. Banks will have to plan their

branch expansion in tier 3 to tier 6 cities in such a manner that at least 1/3 rd of

newly opened branches are opened in under banked districts of under banked

states as notified by the RBI.

Road map for entry of foreign banks- RBI has notified ‘roadmap for presence

of foreign banks in India and guidelines on ownership and governance in private

banks.’ As per the roadmap, foreign banks wishing to establish a presence in

India for the first time could either choose to operate through branch presence, or

set up 100% wholly owned subsidiary (WOS) following the ‘one mode presence

criterion’. In phase-I, foreign banks already operating in India will be allowed to

13

convert their existing branches to WOS. In phase-II, WOS of foreign banks will

be accorded full national treatment, including opting for going public, subject to

26% of the capital being held by resident Indians at all times. RBI has also

allowed some flexibility in individual stake and subject to RBI approval this stake

can exceed 10%. However, if foreign banks’ assets in India (both on and off

balance sheets items) exceed 15% of the system, RBI may deny licenses to new

foreign banks. RBI vide Monetary Policy April 2009 decided to keep on hold

branch licensing of foreign banks in view of current global financial market turmoil

and uncertainties surrounding the financial strength of banks around the world. It

was indicated in the Monetary Policy Statement of April 2010 that drawing

lessons from the crisis, a discussion paper on the mode of presence of foreign

banks through branch or wholly owned subsidiary (WOS) would be prepared by

September 2010. RBI floated the discussion paper on presence of foreign

banks in India in January 2011 soliciting views/comments from all stakeholders,

including banks, non-banking financial institutions. RBI has stated in Monetary

Policy statement May 2011 that the comprehensive guidelines on the mode of

presence of foreign banks in India are being formulated, keeping in view the

suggestions/comments on the discussion paper, received from all concerned.

Capital and functional autonomy – Percy Mistry committee report

recommended that government give up its ownership by 2014 and Raghuram

Rajan Committee recommended that government to give up its ownership at

least in few banks. The Standing Committee on finance has cleared the proposal

to bring down the government stake in PSBs from 51% to 33% but GOI has

decided to keep the government equity to 51% minimum. The recommendation

of Dr. C. Rangrajan that holding of public sector undertaking like LIC, ONGC etc.

be included in 51% government ownership has also not found favour from the

government. In final stimulus package of 2008-09 and also in 2009-10 , GOI has

approved capital infusion by way of preferential capital in ten public sector banks

-mostly mid sized banks so as to help them in improving CRAR as most of these

banks have hit the threshold limit of 51% and more dilution would mean going

below the thresh hold level. RBI has also permitted banks to raise long term

funds through bond for infrastructure finance to overcome problem of assets

liability mismatch. Further a proposal for comprehensive amendment of the

Banking Regulation Act, 1949 and the Banking Companies (Acquisition &

14

Transfer of Undertakings) Act, 1970 & 1980 was introduced in the Parliament by

way of The Banking Law Amendment Bill 2011 which will include a new section

to override the provisions of the Competition Act, 2002 and to exempt the

applicability of such provisions to amalgamations /reconstitutions/ mergers/

acquisitions, etc. of different categories of banks meaning that such

mergers/acquisitions would not need permission from Competition Commission

of India; voting right to investors as per their share holding in private sector banks

which currently is capped to 10% and current cap of 1% maximum investment in

public sector bank is proposed to be raised to 10%, enabling banking companies

to issue preference shares subject to regulatory guidelines by the Reserve Bank;

formation of a depositor education and awareness fund; facilitating consolidated

supervision; and a provision for supersession of boards of directors by the

Reserve Bank; and increase in the quantum of penalties. The proposals relating

to the amendment of the Banking Companies (Acquisition & Transfer of

Undertakings) Act, 1970 & 1980 include raising the authorised capital of 

nationalized banks and enabling them to raise capital through “rights issue” or by

issue of bonus shares.

Setting up of Holding company: Budget 2012 proposes to set up an holding

company to hold government stake in banks, a move that will overcome the

trouble of periodic capital investment into publics sector banks that upsets fiscal

calculations. This initiative may also eliminate the embarrassment of knocking at

the doors of Life Insurance Corporation at it did last year to bail out the

government by investing policy holders’ fund , a move that also raised the issue

of corporate governance standard in India. The proposed structure may be by

way of corporate set up by an act of parliament so that it is away from the glare

of regulator.

Redefining NBFC structure: As per draft recommendation vide notification of

2010, any change in control or transfer of NBFC –ND ( non deposit taking NBFC)

or NBFC (D) ( deposit taking NBFC) beyond 25% of paid up capital will need RBI

approval, CRAR to move to 15% , assets classification norms at par with banks

would be applicable and benefits of SARFESAI would be available to NBFCs.

NBFCs with assets of Rs. 1000 crores and above would be subject to

comprehensive supervision including inspection at predetermined intervals.

15

Issue of preference shares/ other hybrid instruments- RBI has permitted

banks to raise capital through preference share route so that government holding

in banks is not diluted below 51%. Present legislation also caps the maximum

tenure for which preference shares can be issued. RBI has recently allowed

banks to issue hybrid instruments like perpetual bonds, as it will not require any

legislative change. RBI has also permitted banks to issue these bonds with “call”

and “step-up” option. Perpetual bonds are those in which investor does not have

the right to ask for the money back but the issuer has the right to pay back

investor. Typically insurance companies and pension funds subscribe to these

bonds. Banks are now scouting with the finance ministry for tax benefits on these

bonds, as these are long-term instruments.

Deregulation of lending interest rates – All lending rates (except for export

credit, loan to staff members and lending under interest subvention of

Government of India) have been de-regulated. Banks have introduced floating

and fixed interest rate products and are more aggressive in their offering.

Deregulation of deposit interest rates – Interest rates on deposits are

deregulated ( RBI deregulated savings deposits in October, 2011 and Non-

resident Indian deposits in December, 2011) and banks enjoy complete interest

rate freedom. Banks are also free to offer differential interest rate on high-ticket

deposit of Rs.15 lakh and above.

Base Rate: Under RBI directive, Base rate system was introduced w.e.f. 1st July,

2010. Banks have been advised to declare their base rate each quarter and they

can not lend below base rate. Further base rate will be applicable across the

board and bank will not be in a position to discriminate between old and new

borrowers. RBI has also made lending rate disclosure mandatory for banks to

bring greater transparency and has also advised banks to announce Base Rate

after taking into consideration (a) the cost of deposit , (b) adjustment for

negative carry of cash reserve ratio and statutory reserve ratio, (c) unallocatable

overhead cost for banks and (d) average return on net worth.

Phasing out of statutory preemption – The SLR requirement has been brought

down from 38.5% in 1991-92 to 23% in 2012 and CRR has been brought down

from 15% in 1991-92 to 4.25% in 2012. After passing of Reserve Bank

(amendment) bill 2006 legislative cap of 3% CRR and 25% SLR has been

16

removed. However RBI has decided that no interest will be paid to banks on

minimum CRR limit of 3%.

Capital Adequacy - CRAR of 9 % prescribed with effect from end March 2000

against 8% laid down in Basel II. .

Credit Delivery – Credit authorization scheme (CAS) has been withdrawn.

Selective Credit Control (SCC) has been relaxed excepting sugar. Norms for

assessment of Maximum Permissible Bank Finance (MPBF) as per 2nd method of

lending has been relaxed. Mandatory formation of consortium has been

dispensed with. Banks have been given freedom to decide norms of assessment

of MPBF and they enjoy complete freedom to decide their credit policy as per

approval of their board.

Exposure norms– RBI has advised banks to fix exposure norms for individual

as well as group so as to keep the exposure within prudential limits. It has also

advised the banks to fix exposure for industry specific risk for prudential credit

risk management as per international best practices. RBI vide monetary policy

April 2012 advised bank fix individual exposure to NBFC having more than 50%

gold loans.

Income Recognition and Prudential Norms – With a view to adopting the

international best practices in regard to Income recognition, asset classification

and provisioning, number of policy changes have been made viz. prescription of

provisioning requirement of 0.25% to 1% in respect of standard (or performing)

assets, reduction of the time period for classification of doubtful assets from 18

months to 12 months from March 31, 2005, introduction of 90 days norms for

classification of non performing assets w.e.f. March 31, 2004, stipulating 70%

minimum provision coverage ratio by 30th September 2010. The provisioning

norms are more prudent, objective, transparent, uniform and standardized as per

global norms to avoid subjectivity.

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act –Securitisation and Reconstruction of

Financial Assets and enforcement of Security Interest Act 2002 allows setting up

of Asset Reconstruction Companies (ARC) by banks with unprecedented powers

to take over the management of a defaulting company or take over and sale

distressed loans. The Act provides for 60 days notice to borrower to discharge

17

the liability in full failing which a bank can take possession of

mortgaged/hypothecated assets and sale them for liquidation of dues.

Assets Reconstruction Companies – ARCs set up under Securitization and

Reconstruction of Financial Assets and Enforcement of Security Interest Act

have been empowered to take over NPA from banks, engage in innovative

corporate finance such as merger, sale of brands or plants, inject new capital,

convert distressed companies into new companies and even take out an IPO.

ARC will have to work within RBI guidelines and subject to registration/license

from RBI. ARCs should have minimum owned funds of Rs. 100 crores and

maintain minimum capital adequacy of 15% at all times. ARCs are hardly a

successes story since they have been able to buy only a fraction of NPAs and

banks are complaining that they are not offering right price to them. This

problem is expected to be solved with setting up of few more ARCs because it

will increase competition.

Central Registry of Securitization Asset Reconstruction and Security Interest of India - A Central Electronic Registry, incorporated under section 25

of the Companies Act, 1956, as the Central Registry of Securitisation Asset

Reconstruction and Security Interest of India (CERSAI) to give effect to the

provisions of the Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interest (SARFAESI) Act, 2002 has been set up as not-

for-profit company in which Central Government is holding 51% share . The

objective of the central registry is to prevent frauds in loan cases involving

multiple lending from different banks on the same immovable property. The

registry became operational from March 2011 and its jurisdiction covers the

whole of India. As many as 166 lending institutions are placing their mortgage

related information with this registry.

Transparency in financial statements – RBI has advised banks to disclose

certain key parameters such as Capital to Risk Assets Ratio, percentage of

NPAs, movements of NPAs, movements of provisions towards NPAs, movement

of provisions held towards depreciation of investments, the total amount of

standard/sub-standard assets subjected to Corporate Debt Restructuring ,

maturity pattern of deposits, borrowings, investments and advances, foreign

currency assets and liabilities, lending to sensitive sectors, Net value of

investment, Return on Assets, Profit per employee and interest income as

18

percentage to working funds etc. Further the Joint Parliamentary Committee

2001 wanted the annual reports of banks to carry the RBI’s comments arising

from its inspection reports to ensure greater transparency and to make sure that

the shareholders get a fair idea of the operations of a bank. After failure of

Global Trust Bank, the demand has been made again which if placed up front

might help the ordinary depositor and shareholder of the danger ahead.

Accounting Standards – RBI has unveiled new accounting norms for banks,

which seek to move towards full compliance by banks with the accounting

standards issued by Institute of Chartered Accountants. The new norms seek to

bring intangible assets within the purview of the Banking Regulation Act. The

accounting standard 24 and 28 has been made effective from 1st April 2004.

Penal Action- The RBI has decided to publish penal actions against the bank.

The banks will have to publish such penalties in the note on account of their

balance sheets with effect from 1st November 2004.

Scheme of Banking Ombudsman- Banking Ombudsman has been introduced

since 1985 to look into and resolve customer grievances. RBI has further

widened the scope of the banking ombudsman scheme to cover all individual

cases/grievances relating to non-adherence to the fair practices code evolved by

IBA and adopted by individual banks and also the credit cards/ATM cards.

Complainants have been permitted to file eComplaint after down loading the

complaint form from RBI site.

Hiving off of regulatory and supervisory control – Board for Financial

Supervision (BFS) was set up under the RBI in 1994 after bifurcation of

regulatory and supervisory functions. An independent Department of Banking

Supervision (DBS) has been set up in RBI to assist the board.

Risk Management Systems – In view of the diverse financial and non-financial

risks confronted by banks in the wake of the financial sector deregulation, RBI

has put the risk management system in place. Banks have been asked to adopt

sophisticated techniques like VaR, Duration and Simulation model-based

approaches as also credit risk modeling techniques as part of risk management

measures.

Risk Based Supervision (RBS) – RBI has issued detailed guidelines for RBS

and have advised banks to develop risk assessment processes in accordance

with their risk profile and control environment which will subjected to review and

19

supervisory intervention by RBI as necessary. The emphasis will be on

evaluating the quality of risk management and the adequacy of risk containment.

The transaction based internal/external audit would be replaced by Risk Based

Internal Audit (RBIA) system.

Prompts Corrective Action – RBI has evolved a framework of Prompt

Corrective Action (PCA) with various trigger points. The framework is based on

three parameters viz. capital adequacy, asset quality and profitability. The

framework contemplates a set of mandatory and discretionary actions by

regulator (RBI) for dealing with banks that cross the trigger points.

Regulation Review Authority – The purpose of this Authority is to provide an

opportunity to the public at large to seek justification for and suggest deletion or

modification of any regulation, circular or return issued, or required by the

Reserve Bank. Anyone can apply to the Regulations Review Authority – a

citizen, a non-resident Indian, an institution (including banks), an association, an

academic or even an RBI employee. It is not necessary for the applicant to be

an affected party. The applicant may simply put down the details on a plain white

paper and give his suggestions stating justification, in as much detail as possible,

with an illustration to enable the Authority to take an expeditious view on the

application.

Appointments of business correspondents- Banks are now allowed to

outsource lending and deposit taking activities NGOs, micro-finance agencies,

post offices, NBFCs, Agents of small savings schemes/insurance companies,

individuals who owns petrol pumps, individual public call office (PCO) operators,

individual kirana/medical/fair price shops, cooperative societies, retired bank

employees, ex-servicemen and retired government employees, so as to reach

rural and remote areas. RBI has clarified that institutions for profit can also be

appointed business correspondents as earlier notion was that banks will appoint

only non-profit organizations. Under the scheme banks will have to prescribe

suitable limits for receipt and payment by business correspondent and

transaction done through agent will have to account for either on the same day or

next working day. Banks will be responsible to customer for any act of omission

or commission for their agent. BC model is considered as extremely vital for

achieving the goals of financial inclusion.

20

Inclusive growth drive- GOI and Reserve Bank are working in tandem to push

the agenda of inclusive growth and to bring villages of population of 2000 and

above within banking fold. GOI has announced setting up a fund of Rs. 800

crores to compensate banks for cost incurred in reaching credit to unbanked

areas. This will be in addition to existing Rs. 1000 crores financial inclusion fund

and financial inclusion technology funds set up with NABARD. RBI and GOI has

identified 72395 villages that will be covered in another two years. Public sector

banks have been asked to prepare the financial inclusion plan(FIP) to tap the

fortune of ‘bottom of pyramid’.

Bancassurance- Insurance business by Indian banks- GOI issued notification

that insurance is permissible business under Banking Regulation Act section 6

(1) (o) followed by RBI guidelines dated 8th August 2000 for entry into insurance

business with risk sharing model and with fee based business. While few banks

have started insurance business through subsidiary route, other banks have

entered in the business through agency route or under referral model.

Money Laundering and Financing of terrorism – India has been sharing the

increasing international concern on the use of the financial system for money

laundering and financing of terrorism. RBI has set out the policy, procedures and

controls to be introduced by banks. These include strict adherence to “Know Your Customer” (KYC) procedures for prevention of misuse of banking system

for money laundering and financing of terrorist activity, reporting of suspicious

transaction and developing in built system in the banks to monitor cash

transaction above thresh hold limit.

Guidelines on securitization of standard assets - RBI has issued guidelines

for securitization of standard assets with a view to have ‘fit and proper criteria’ on

continuous basis. RBI has also decided to prescribe a minimum lock in period

and minimum retention criteria for securitizing the loans originated and

purchased by banks so as to avoid sub prime like situation in India.

Code of conduct for credit cards- In view of growing complaints against

various malpractices for issuing of credit cards, RBI has decided that code of

conduct for issue and transparency in service charges evolved by IBA in

consultation with leading banks will be adopted by all credit card issuers. There

is also debate of introducing anti-tying regulations, which will prohibit banks to

force customers from buying unwanted products/services.

21

Setting up of Banking Codes and Standards Board of India- In annual policy

of April, 2005, RBI has proposed to set up a Banking Codes and Standards

Board of India on model of the mechanism in the UK in order to ensure that

comprehensive code of conduct for fair treatment of customers are evolved and

adhered to. The said board has been established in February 2006 under the

chairmanship of former RBI deputy governor Mrs. K J Udeshi. It is now

mandatory for every bank to adopt a compensation policy to make up for losses

incurred by customers due to mistakes committed by bank employees once it

signs the charter of the Banking Codes and Services Board (BCSB). The gamut

of retail banking services, including savings accounts, term and demand

deposits, credit cards, debit cards, foreign exchange remittances, and loan

accounts will have to be covered by the compensation policy.

Tax Sops for Fixed deposits- Union Budget 2006 has permitted fixed deposit of

five years above as eligible investment for tax exemption under 80 C (prescribed

ceiling is Rs. 100,000) bringing it at part with NSC/PPF etc. Government has

further relaxed the rules and allowed payment of money to second joint depositor

in event of death of first depositor before lock in period of five years. It is

expected tax sops on deposits will help the banks to garner larger share of

savings from households.

Bank’s investment in non-finance companies: RBI issued guidelines (BS

13.12.2011) for capping investments by banks in non-finance companies to 10%

of company’s paid up capital or 10% of bank’s paid up capital and reserves. The

investment already made by banks in ‘held for trading’ category would be

included in this cap.

Core investment companies to register with RBI- Investment companies with

assets size of Rs. 100 crores are considered systemically important and have

been asked to get them registered with RBI. As per notification such companies

will have to obtain RBI registration within six months. It is stipulated that leverage

ratio (ratio of outside liability to tangible net worth) should not exceed 2.5 and

these companies must maintain minimum capital ratio where by the adjusted net

worth shall not be less than 30% of risk weighted assets.

Corporate Governance – An adequate institutional and legal framework is in

place in India for effectively implementing a code of sound corporate governance

in banks. The statutes have built in legal provisions that prohibit or strongly limit

22

activities and relationships that diminish the quality of corporate governance in

banks. As a major step towards strengthening corporate governance in banks,

banks have been asked by RBI to place before their Board of Directors the

Report of the Consultative Group of Directors of banks and FIs (Dr. Ganguly

Group) set up to review the supervisory role of Boards of banks. The

recommendations include the responsibility of the Board of Directors, role and

responsibility of independent and non-executive directors, etc. With number of

banks now listed on stock exchange and accountable to shareholders, it is

necessary to focus on corporate governance in letter and spirit as quality of

decision making will be crucial in enhancing share-holders’ value.

Financial stability and development council- As a follow up of budget

proposal of 2010-11 to set up Financial Stability and Development Council

(FSDC), GOI through Securities and Insurance Law amendment ordinance

(2010) has set up a monitor macro prudential supervision authority including

supervision of large financial conglomerates and to deal with inter regulatory

coordination. Finance Minister has clarified that government will maintain

autonomy of all regulators and ordinance will play its role only when there is

conflict of interest among two regulators on hybrid products. FSDC has been

made functional to deal with financial stability, financial sector development,

inter-regulatory coordination, financial literacy, financial inclusion, macro

prudential supervision including functioning of large financial conglomerates.

Banking out of purview of Competition Commission of India - The GOI has

finally decided that banking sector including the mergers and acquisitions of

banks will be out of purview of the Competition Act 2002.

Prepayment penalty in home and other loans- The practice of banks imposing

pre payment charges in home, auto and other loans was under scrutiny by

competition commission of India as it is alleged that it restricts the choice of

borrowers to move to other bank and is against competitive opportunity for

borrowers. RBI vide monetary policy of April 2012 mandated that bank can not

charge prepayment charges in case of floating rate home loans.

EMERGING ISSUES-

Financial sector legislative reforms commission (FSLRC)- Finance Minister in

budget speech February 2010 has announced that government will rewrite financial

sector laws through FSLRC. The aim is to simplify and streamline the legal

23

framework to possibly suggest a completely new regulatory structure. GOI has now

floated a consultation paper citing response from various regulators. The commission

mandate will be to examine the kind of inconsistencies and overlap in financial sector

laws and workout standard principle based financial regulation.

Financial Sector Assessment Program (FSAP) - A comprehensive self

assessment of the financial sector in 2009 under a committee on Financial Sector

Assessment Chairman Dr Rakesh Mohan and Co-chairman Shri Ashok Chawla was

done based on the IMF-WB methodology. RBI has now decided to set up a task

force to take steps for implementation of the recommendation of G 20 working

groups viz. Enhancing Sound Regulations and Strengthening Transparency and

Reinforcing International Cooperation and Promoting Integrity in Financial Markets

and will also suggest an implementation schedule.

Basel III- Banks will have to adhere to internationally agreed phase-in period

(beginning January 1, 2013) for implementation of the Basel III framework. As per

proposal, banks will be required to keep 7% core capital i.e equity, reserves and

surplus and systemically important banks will have to keep additional 2.5% additional core capital. There are further suggestions for making provision for

additional capital as ‘counter cyclical provision’ to overcome situation like global

crisis of 2009-10. The Reserve Bank is studying the Basel III reform measures for

preparing appropriate guidelines for implementation. It is taking steps to disseminate

information on Basel III and help banks prepare for smooth implementation of the

framework.

FII cap in PSU banks- Presently a cap of 20% exists for subscription in banks equity

for foreign institutional investors. GOI is considering to raise this cap up to 24% as in

most of the banks FII cap has hit the upper ceiling. As per legal provision, FII cap

below 26% will be non-controversial as neither the FII will get a birth in board nor

does it have authority to block any move by calling extra-ordinary general meeting. It

may be recalled that Indian Bank Association has recommended to government to

hike the FII cap and also to keep ADR/GDR out of purview of FII cap.

Regulatory oversight over credit rating agencies- It is argued that all credit rating

agencies whose ratings are used for regulatory purposes should be subject to a

regulatory oversight regime that includes registration and that requires compliance

with substance of the IOSCO code of conduct Fundamentals. It is argued further

24

that RBI should look into cumulative default rate and transition matrix of the rating

agencies to continue accreditation.

Regulation over Micro finance institutions - Commercials banks who have lent

more than Rs. 18000 crores to MFIs are facing great stress due to regulatory

restrictions put forth by AP Act on interest rate restrictions, periodicity of repayment

not earlier than month and restructuring obligations. Central government is

contemplating legislation to ensure regulatory frame work and to overcome threat of

NPA which is already high in agriculture sector.

Size Matters- Urge to Merge - After merger of Global Trust bank with Oriental Bank

of Commerce and IDBI Bank with parent IDBI, the experts opine that more mergers

and amalgamations will take place in the next 4-5 years to create Mega-banks. The

banking sector is now moving from a regime of “large number of small banks” to

“small number of larger banks.” Hardening yields and consequent fall in value of

securities and lesser treasury income coupled with higher requirement of capital due

to Basel III are the main triggers of merger and consolidation. Otherwise also there

are sufficient reasons for consolidation in the banking sector like increased efficiency

resulting from economies of scale, reduced intermediation cost, greater capacity to

access the capital market and greater capacity to meet competition with international

players. It may be recalled that Narsimhan Committee - I recommended mergers

and acquisitions of banks so as to make 4-5 world-class banks that would compete

in global market. Indian Banks Association report on M & A in banking has

suggested corporatization that would make all bank coming under Companies Act

1956 and therefore under common legal framework. It has also recommend

amendment of section 72A of Income Tax Act to extend the benefit of set off of

accumulated losses and un-absorbed depreciation.

Depositors’ protection fund- This fund is to be set up by crediting deposits

remaining unclaimed for more than ten years and fund to be used for promotion and

protection of depositors’ interest. The unclaimed deposit kitty of banking sector was

Rs 2400 crores as on December 31, 2011 (BS 30.07.2012).

Transforming Deposit Insurance system- RBI is examining the transforming the

Deposit Insurance and Credit guarantee Corporation (DICGC) from a ‘pay box’

system to a one attending to all aspects of the bank failure resolution process. Non-

involvement of DICGC in the failure resolution process is considered a major area of

concern. ‘Pay box’ system in banking parlance means that deposit insurer serves

25

only as an agency to reimburse depositors. Central government budget proposal

2002-03 proposed to covert DICGC into BDIC (Bank deposit Insurance Corporation).

Separate Common Insolvency Code for banks- Committee on financial sector

assessment has suggested that a separate common and comprehensive insolvency

code for banks. Separate code is considered vital in view of financial global

uncertainty and legal complexities. So for PSBs are concerned there are no

solvency issues as sovereign is more than 50% shareholder but for private sector

banks this kind of legislation is considered necessary.

Bank’s entry into Merchant trading -The RBI has proposed an amendment in the

Banking Regulation Act, 49 to allow banks to become members of stock exchanges

and undertake merchant trading- to do trading on behalf of others. This will be

followed by an amendment in Securities Contract Regulation Act that will permit

banks to conduct this business. As per present rules, bank’s can take exposure up

to 5% in equity market. It may be recalled that RBI recently announced to consider

relaxation in 5% norms on case-to-case basis.

Removal of cap on 10 year fixed deposit- Banks are requesting RBI to remove

cap on more than 10-year deposits so that they have no asset-liability management

problem to finance long term loans like housing and infrastructure. Present

guidelines permits to accept deposits more than 10 years only from minors and that

too under certain conditions.

Changes in financial system- High level panel on financial sector reforms chaired

by Professor Raghuram G Rajan has recommended (ET 7.4.2008) that the

government should liberalize the interest rate regime of priority sector lending, sell

loss making small state run banks, encourage takeover of banks and reduce the

oversight that the government maintains on state banks in addition to the controlling

their boards. The committee has also made a strong case of removing the

restrictions on opening of bank branches and ATMs and for rewriting financial sector

regulations. It has also recommended that government should legislate to remove

the oversight of bodies such as CVC over public sector banks for better and speedy

decision making.

Exemption from Company Bill provisions- The Reserve Bank of India has sought

exemption from the provisions of the new company bill 2008 following the strong

conflict with the Banking Regulation Act 1947. For example new Company Bill has

not made any specific provisions for banks as was the case in erstwhile Companies

26

Act 1956. Among major items which will get affected without a suitable amendment

to the Companies Bill is the preparation of bank balance sheet. While public deposit

by companies as treated as borrowing for banks they are only deposits. Similar

problem is in case of off balance sheet items /contingent liabilities. While it is normal

for companies to have preference share, banks usually maintain preference shares

at exceptional cases and that too with RBI approval. Derivative items which are

hedging products are some time shown off balance sheet or on balance sheet if they

are marked to market for losses. Corporate debt restructuring which is unique to

banks and not to companies is other stumbling block. Another problem is exclusion

of government nominee director in company bill from the category of independent

director.

International financial reporting system (IFRS):- RBI has recently constituted a

task force to address implementation issues of IFRS convergence with banking

system by April, 1, 2013. It may be mentioned that banks will also have to adhere to

various risk reporting dead lines including transition to internal-rating based (IRB)

based approach for credit risk by March 31, 2014. Leading multinational bank

outside India are implementing Basel II initiatives that are IFRS compliant for loan

loss provisioning.

Priority sector lending: Committee headed by Mr. M.V.Nair, Chairman & Managing

Director, Union Bank of India has recommended to revise priority sector targets of

foreign bank to 40% ( present 32%), to do away with sub-target of direct and indirect

agriculture targets, introduce sub-target of 9% of ANBC for marginal and small

farmers and 7% of ANBC for micro and small enterprise and to increase the quantum

of education loan to Rs. 15 lakhs for study in India and Rs. 25 for study overseas and

one property per individual ( instead of Rs. 25 lakhs) as housing loan. RBI vide

monetary policy of April 2013 announced adoption of the recommendations .

Summing UpFinancial sector reform is a continuous process that needs to be in tune with the

emerging macroeconomic realities and the state of maturity of institutions and markets.

So far, India’s approach to financial-sector reforms has served the country well, in terms of aiding growth, avoiding crises, enhancing efficiency and imparting resilience to the system. It is expected that ongoing reform process will help us to build

globally competitive banking sector in India.

27

Chapter –3

RBI Monetary Policy

“Monetary policy space needs to be created through fiscal adjustment and structural measures to improve supply conditions and boost the investment climate so that revival is supported in a non inflationary manner.”

- RBI Quarterly review of monetary policy

Monetary Policy- an overview

The monetary policy statements of the RBI governor are window of policy

changes of the central bank in India. The broad objectives of the monetary policy in

India relate to maintenance of a reasonable degree of price stability and the need to

bring about adequate expansion of credit to foster faster growth. But the relative

emphasis on these objectives has differed in various phases of India’s development. In

the ultimate analysis, monetary policy has to be evaluated in an integrated framework in

terms of inter-relationship among money, credit, output and prices. It is seen that the

monetary policy statement has of late been more multidimensional than focusing merely

on monetary aggregates. It contains policy perspectives in respect of growth of

economy, inflationary expectations, fiscal position, trade and capital flows, exchange

rate scenario, interest rate instance and over all lending direction for banks. Till 1997-

98 monetary policy in India used to be conducted with broad money (M3) as an

intermediate target. The aim was to regulate money supply consistent with two

parameters namely (a) the expected growth in real income and (b) a projected level of

inflation. However questions were raised about the appropriateness of such a framework

vis-à-vis the changing interrelationship between money, output and prices in the wake of

the financial sector reforms and the opening up of the economy. In line with this thinking

RBI has switched over to a multiple indicator approach under which interest rates or rate

of return in different markets (money, capital and government securities markets) along

28

with data such as on currency, credit extended by banks and financial institutions, fiscal

position, trade, capital flows, inflation rate, exchange rate, refinancing and transactions

in foreign exchange available on high frequency basis are juxtaposed with output data to

draw policy perspectives. Since, April, 2005 RBI has started quarterly review in

accordance with international best practices.

Changes in operating procedure of Monetary Policy

In July 2010 RBI constituted a working group to review the operating procedure of

monetary policy under Chairmanship of Mr. Deepak Mohanty, Executive Director. Based

on the recommendations, following changes to the operating procedure of the monetary

policy has been made:

First, the weighted average overnight call money rate will be the oper-ating target of monetary policy of the Reserve Bank.

Second, there will henceforth be only one independently varying policy rate, and that will be the repo rate. This transition to a single indepen-dently varying policy rate is expected to more accurately signal the monetary policy stance.

Third, the reverse repo rate will continue to be operative, but it will be pegged at a fixed 100 basis points below the repo rate. Hence, the re-verse repo rate will no longer be an independent variable.

Fourth, a new Marginal Standing Facility (MSF) will be introduced. Banks can borrow overnight from the MSF up to one per cent (now ex-tended to two percent as per monetary policy 2012) of their respective net demand and time liabilities or NDTL. The rate of interest on amounts accessed from this facility will be 100 basis points above the repo rate.

As per the above scheme, the revised corridor will have a fixed width of 200 basis points. The repo rate will be in the middle. The reverse repo rate will be 100 basis points below it, and the MSF rate 100 basis points above it.

RBI ANNUAL POLICY 2012-131. Economic indicators- Projections for 2012-13

29

Assuming a normal monsoon and turnaround in IIP growth , GDP is projected to

grow at 7.3% ( Lowered forecast to 6.5% in July, 12 in 1st quarter review)

Inflation rate 6.5% (expected to remain range bound) – Raised to 7% in 1st quarterly review

Consistent with growth and inflation M3 projected at 15%

2. Monetary measures - Bank rate stand adjusted to 9% (at par with MSF)

CRR stays 4.75% Reduced to 4.50% w.e.f.22.09.2012. Further reduced to 4.25%

w.e.f.

Repo rate reduced by 50 bps to 8% with immediate effect

Reverse repo rate stand adjusted to 7% (100 bps below repo rate)

Marginal standing facility at 9% (100 bps above repo rate)

SLR reduced to 23% w. e. f. August 11, 2012 (vide First Quarter review of

monetary policy 2012)

3. Policy stance Adjust policy rates to levels consistent with the current growth moderation

Guard against risks of demand led inflationary pressures re-emerging

Provide a greater liquidity cushion to the financial system

4. Risk factors The outlook for global commodity prices, especially of crude oil is uncertain. This

will have implications for domestic growth, inflation and the fiscal and current

account deficits.

The fiscal deficit since 2008-09 has remained very high and there had been

significantly high slippage in 2011-12. Even though Union Budget envisages a

reduction in fiscal deficit in 2012-13, several upside risks to the budgeted fiscal

deficit remains having implication for inflation.

Fiscal deficit has led to large borrowing requirements of the government. The

budgeted net borrowing through dated securities for 2012-13 at Rs. 4.8 trillion

programme of government have the potential to crowd out credit to the private

sector.

Inflation in protein based items continues to be in double digit with little sign of

trend reversal. This has risk factor for food inflation.

6. Expected Outcome

30

Major outcomes are expected from policy action:-

Stabilize growth around its current post crisis level,

Contain risks of inflation and inflation expectations re-surging and

Enhance the liquidity cushion available to the system

7. Important announcement - Financial stability is on top of the agenda. RBI stress tests revealed that

banks’ capital adequacy remained above regulatory requirements but

deterioration in asset quality is major risks faced by banks.

Financial inclusion plans (FIP) will now focus on more in number and value of

transactions in no frill accounts and credit disbursed through information and

communication technology (ICT) based BC outlet. Banks have been directed

to disaggregate plans at controlling office and branch levels.

SLBC has been mandated to prepare roadmap covering all unbanked

villages of population less than 2000 and notionally allot these villages to

banks for providing banking services in a time bound manner.

Priority sector classification will be re examined in the light of Nair committee

recommendations and feed back received by RBI.

Based on recommendation of Rakesh Mohan committee on Financial sector

assessment, RBI in consultation with NABARD has conducted the exercise

and have identified cooperative banks not meeting licensing criteria. RBI will

be initiating action accordingly.

UCB to grant loan loans up to 15% of total assets to meet housing loan upto

Rs. 25 lakhs as per priority sector norms.

Banks have been directed not to levy foreclosure charges/penalties on

floating rate home loans.

Banks have been directed to have board approved transparent policy on

pricing of liabilities and they should also ensure that variation in interest rates

on single term deposit of Rs. 15 lakhs and above and other term deposit in

minimal.

Banks have been directed to initiate steps to allot Unique customer

identification code to all of its customers and complete the exercise by end

April 2013.

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Banks to offer a ‘basic savings bank deposit account’ with certain minimum

common facilities and without the requirement of minimum balance to all their

customers.

Banks have been directed to reduce their regulatory exposure ceiling in a

single NBFC having gold loan to the extent of 50% or more and also fix

internal sub limit on their exposure to NBFC having gold loan in excess of

50%.

Banks have been directed to complete the process of risk categorization and

compiling/updating profiles of all of their existing customers in a time bound

manner and in any case not later the end March 2013.

Banks have been mandated to put in place robust mechanism for early

detection of signs of distress and measures including prompt restructuring in

case of all viable accounts to protect economic value of assets and also to

maintained system generated data on segment wise NPA accounts, write

offs, compromise, recovery and restructured accounts.

Banks have been directed to have board approved policy on classification of

unclaimed deposits; grievances redressal mechanism for quick resolution of

complaints and period review of such accounts.

Raised provision for restructured standard loan by .75% to 2.75% (3rd

quarterly review). Mahapatra committee recommended to raise provisioning

of restricted loan to 5%.

Way Ahead The global financial turmoil has reinforced the importance of putting special

emphasis on preserving financial stability. At the same time, RBI has responsibility to

ensure price stability as persistent high inflation creates uncertainty for investors and

drive inflationary expectations. Hence, the central task for the conduct of monetary

policy has become increasing complex, very sophisticated and forward looking

warranting a continuous up gradation of monitoring scan and technical skills. The

current challenge is to strike an optimal balance between preserving financial stability,

anchoring inflation and sustaining the growth momentum. It also require complementary

measures by Government of India by initiating meaningful efforts in fiscal discipline,

controlling excessive borrowing by government, contain subsidy by raising administered

prices of diesel and urea and go ahead with pending legislation of economic reforms.

32

Chapter-4

Foreign Trade Policy 2009-2014“India has not been affected to the same extent as other economies of the world,

yet our exports have suffered a decline the last 10 months due to contraction in demand in the traditional markets. The protectionist measures being adopted by some of these countries have aggravated the problem.”

Shri Anand Sharma-Commerce Minister

33

Highlight Growth target of 15% for

next two year and 25% growth rate after two years and expect to double India’s exports of goods and services by 2014.

Export target of $ 200 billion set for 2010-11.

Extension of sops for export oriented units till march 2011.

Obligation under export promotion capital goods scheme relaxed.

Permission for tax refund scheme for jewellery sector.

No fee on grant of incentives to cut transaction costs.

Plan for diamond bourses in the country.

Single-window scheme for farm exports.

Twenty-six new markets added to focus market scheme. Sops under focus market scheme hiked from 2.5 percent to 3 %.

Number of duty-free samples for exporters raised to 50 pieces from 15.

Zero duty under technology upgrade scheme.

Introduction- The Foreign Trade Policy 2009-14

was announced on 27th August 2009 at a time when

the world was emerging from the shadow of

challenging economic period, worst we have seen

last seven decades. Economics and markets

throughout the world were in turmoil, causing sharp

contraction in international trade, adversely

impacting global investment flows and world

witnessed an unprecedented contraction of over

12%.

The objectives of the Foreign Trade Policy

2009-14 are:-

1) To double India’s percentage share of global

trade by 2014;

2) To arrest the declining exports and reverse the

trend;

3) To encourage exports through mix of measures

including fiscal incentives, institutional changes,

procedural rationalization and efforts for enhance

market access across the world and

diversification of export markets and

4) To provide a special thrust to the employment

oriented sectors which have witnessed job

losses in the wake of recession, especially in the

field of textile, leather and handicrafts.

Strategy -The key strategies are:

1) Unshackling of controls;

2) Creating an atmosphere of trust and transparency;

3) Simplifying procedures and bringing down transaction costs;

4) Adopting the fundamental principle that duties and levies should not be exported;

5) Identifying and nurturing different special focus areas to facilitate development of

India as a global hub for manufacturing, trading and services and

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6) Market diversification strategy to reach out non traditional destinations in Africa ,

Latin America and Asia since our traditional market witnessed a sharp contraction.

Special focus initiativesSectors with significant export prospects coupled with potential for employment

generation in semi-urban and rural areas have been identified as thrust sectors, and

specific sectional strategies have been prepared. Further initiative in other sectors will be

announced from time to time. For the present, Special Focus Initiatives have been

prepared for agriculture, handicrafts, handlooms, gems and jewelry and leather and

footwear sectors. Twenty six markets have been added to focus market scheme in

Foreign Trade Policy of 209-14 and sops under focus market scheme hiked from 2.5%

to 3%.

Package for AgricultureThe Special Focus Initiatives for agriculture include:

(a) A new scheme called Vishesh Krishi Upaj Yojana has been introduced to boost

exports of fruits, vegetables, flowers; minor forest produce and their value added

products.

(b) Duty free import of capital goods under EPCG scheme.

(c) Capital goods imported under EPCG for agriculture permitted to be installed

anywhere in the agri export zone.

(d) ASIDE funds to be utilized for development for agri-export zones also.

(e) Import of seeds, bulbs, tubers and planting materials has been liberalized.

(f) Export of plant portions, derivatives and extracts has been liberalized with a view

to promoting export of medicinal plants and herbal products.

Single window scheme for farm exports has been proposed in FTP of 2009-14.

Gems & Jewelry(a) Duty free import of consumables for metals other than gold and platinum allowed

upto 2% of FOB value of exports.

(b) Duty free re-import entitlement for rejected jewellery allowed upto 2% of FOB

value of exports.

(c) Duty free import of commercial samples of jewellery increased to Rs.1 lac.

(d) Import of gold of 18 carat and above shall be allowed under the replenishment

scheme.

FTP 2009-14 has proposed permission for tax refund scheme for jewellery sector

and to open diamond bourses in the country.

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Handlooms & handicrafts(a) Duty free import of trimmings and embellishments for handlooms and handicrafts

sectors increased to 5% of free on board (FOB) value of exports.

(b) Import of trimmings and embellishments and samples shall be exempt from CVD.

(c) Handicraft Export Promotion Council authorized to import trimmings,

embellishments and samples for small manufacturers.

(d) A new handicraft special economic zone shall be established.

Leather & footwearDuty free entitlements of import trimmings, embellishments and footwear

components for leather industry increased to 3% of free on board (FOB) value of

exports. Duty free import of specified items for leather sector increased to 5% of free on

board (FOB) value of exports. Machinery and equipment for effluent treatment plants for

leather industry shall be exempt from customs duty. FTP 2009-14 has proposed allow

re-export of unused leather subject to 50% duty.

Export promotion schemesTarget Plus:

A new scheme is accelerate growth of exports called ‘Target Plus’ has been

introduced. Exporters who have achieved a quantum growth in exports would be entitled

to duty free credit based on incremental exports substantially higher than the general

actual export target fixed. (Since the target fixed for 2004-05 is 16%, the lower limit of

performance for qualifying for rewards is pegged at 20% for the current year).Rewards

will be granted based on tiered approach. For incremental growth of over 20%, 25% and

100%, the duty free credits would be 5%, 10% and 15% of FOB value of incremental

exports.

Vishesh Krishi Upaj Yojana

Another new scheme called Vishesh Krishi Upaj Yojana (Special Agricultural

Produce Scheme) has been introduced to boost exports of fruits, vegetables, flowers,

minor forest product and their value added products. Vishesh Krishi Upaj Yojna (VKUJ)

has been further expanded to cover village and cottage industries to promote export of

soybean, coconut oil, fruits, vegetables, flowers, and forest produce, dairy, poultry and

other value added products. Export of these products shall qualify for duty free credit

entitlement equivalent to 5% of FOB value of exports. The entitlement is freely

transferable and can be used for import of a variety of inputs and goods.

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‘Served from India’ SchemeTo accelerate growth in export of services so as to create a powerful and unique

‘served from India’ brand instantly recognized and respected the world over, the earlier

DFEC scheme for services has been revamped and recast into the ‘Served from India’

scheme. Individual service providers who earn Rs.5 lac, and other service providers who

earn foreign exchange of at least Rs.10 lacs will be eligible for a duty credit entitlement

of 10% of total foreign exchange earned by them. In case of stand-alone restaurants, the

entitlement shall be 20%, whereas in the case of hotels, it shall be 5%. Hotels and

restaurants can use their duty credit entitlement for import of food items and alcoholic

beverages.

Export Promotion of Capital Goods (EPCG)(a) Additional flexibility for fulfillment of export obligation under EPCG scheme in

order to reduce difficulties of exporters of goods and services.

(b) Technological up-gradation under EPCG scheme has been facilitated and

incentivised.

(c) Transfer of capital goods to group companies and managed hotels now

permitted under EPCG.

(d) In case of movable capital goods in the service sector, the requirement of

installation certificate from Central Excise has been done away with.

(e) Export obligation for specified projects shall be calculated based on concessional

duty permitted to them. This would improve the viability of such projects.

(f) Import duty for capital goods under EPCG has been brought down to 3% from

5%. So exporters can import machinery which otherwise they could have

imported at 12.5% duty.

FTP 2009-14 proposes to relax obligation under export promotion of capital goods

scheme.

New status holder categorizationA new rationalized scheme of categorization of status holders as Star Export

Houses has been introduced as under:

Category – Total performance over three years

One Star Export House : Rs.15 crore

Two Star Export House : Rs.100 crore

Three Star Export House : Rs.500 crore

Four Star Export House : Rs.1500 crore

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Five Star Export House : Rs.5000 crore

Start Export Houses shall be eligible for a number of privileges including fast-

track clearance procedures, exemption from furnishing of bank guarantee.

Export oriented units (EOUs) (a) EOUs shall be exempted from service tax in proportion to their exported goods

and services.

(b) EOUs shall be permitted to retain 100% of export earnings in export earners

foreign currency accounts.

(c) Income tax benefits on plant and machinery shall be extended to DTA units,

which convert to EOUs

(d) Import of capital goods shall be on self-certification basis for EOUs.

(e) For EOUs engaged in textile and garment manufacture left over materials and

fabrics up to 2% of CIF value or quantity of import shall be allowed to be

disposed of on payment of duty on transaction value only.

(f) Minimum investment criteria shall not apply to brass hardware and handmade

jewelry EOUs (this facility already exists for handicrafts, agriculture, floriculture,

aquaculture, animal husbandry, IT and services).

Free trade and warehousing zone (FTWZ)(a) A new scheme to establish Free Trade and Warehousing Zone has been

introduced to create trade-related infrastructure to facilitate the import and export

of goods and services with freedom to carry out trade transactions in free

currency. This is aimed at making India into a global trading-hub.

(b) FDI would be permitted upto 100% in the development and establishment of the

zones and their infrastructure facilities.

(c) Each Zone would have minimum outlay of Rs.100 crores and five lac sq.mt. Built

up area.

(d) Units in the FTWZs would qualify for all other benefits as applicable for SEZ

units.

Import of second-hand capital goodsImport of second-hand capital goods shall be permitted without any age

restrictions. Minimum depreciated value for plant and machinery to be re-located into

India has been reduced from Rs.50 crore to Rs.25 crore.

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Services export promotion councilAn exclusive Services Export Promotion Council shall be set up in order to map

opportunities for key services in key markets, and develop strategic market access

programs, including brand building, in co-ordination with sectoral players and recognized

nodal bodies of the services industry.

Common facilities centerGovernment shall promote the establishment of common facility centers for use

by home-based service providers, particularly in areas like engineering & architectural

design, multi-media operations, software developers etc. in State and district level

towns, to draw in a vast multitude of home-based professionals into the services export

arena.

Procedural simplification and rationalization measures(a) All exporters with minimum turnover of Rs.5 crores and good track record shall

be exempt from furnishing bank guarantee in any of the schemes, so as to

reduce their transactional costs.

(b) All goods and services exported, including those from DTA units, shall be exempt

from service tax.

(c) Validity of all licenses/entitlements issued under various schemes has been

increased to a uniform 24 months.

(d) Number of returns and forms to be filed have been reduced. This process shall

be continued in consultation with Customs and Excise.

(e) Enhanced delegation of powers to Zonal and Regional Offices of DGFT for

speedy and less cumbersome disposal of matters.

(f) Time bound introduction of Electronic Data Interface (EDI) for export

transactions. 75% of all export transactions to be on EDI within six months.

FTP 2009-14 has proposed setting up of inter-ministerial group to address issues

raised by exporters.

Pragati MaidanIn order to showcase our industrial and trade powers to its best advantage and

leverage existing facilities, Pragati Maidan will be transformed into a world-class

complex. There shall be state-of-the-art, environmentally controlled, visitor friendly

exhibition areas and marts. A huge Convention Centre to accommodate 10000

delegates with flexible hall spaces, auditorium and meeting rooms with high-tech

39

equipment, as well as multi-level car parking for 9000 vehicles will be developed within

the envelop of Pragati Maidan.

Legal AidFinancial assistance would be provided to deserving exporters, on the

recommendation of Export Promotion Councils, for meeting the costs of legal expenses

connected with trade-related matters.

Grievance redressalA new mechanism for grievance redressal has been formulated and put into

place by a Government resolution to facilitate speedy redressal of grievances of trade

and industry.

Quality policy(a) Director General of Foreign Trade (DGFT) shall be a business driven,

transparent and corporate oriented organization.

(b) Exporters can file digitally signed applications and use Electronic Fund Transfer

Mechanism for paying application fees.

(c) All DGFT offices shall be connected via a central server making application

processing faster. DGFT HQ has obtained ISO 9000 certification by

standardizing and automating procedures.

Biotechnology parks

Biotechnology parks to be set up which would be granted all facilities of 100% EOUs.

Co-acceptance introduced as equivalent to irrevocable letter of credit to provide wider

flexibility in financial instrument for export transaction.

Special stimulus package 2010

In an effort to boost the country’s merchandise exports and sustain growth, the

government in January 2010 offered stimulus worth Rs. 500 crores to select export

sectors. The high light of the stimulus package are:

(a) The stimulus is for sectors like engineering products, electronic goods, rubber,

chemicals, plastics, machine tools, electrical and power equipments, steel tubes,

auto components and cotton woven fabrics etc.

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(b) 225 new products were included in the Focused product Scheme and special

focused products scheme.

(c) China and Japan have been added in the market linked focus programme under

which exportes are provided additional benefits.

(d) Benefits under mrket linked focus product scheme have been extended to export of

1837 new products.

(e) Some of the sectors included in MLFPS are steel tubes, earth moving equipment,

iron and steel structures, three wheelers, transmission towers, steel pipes and

compressors.

(f) Additional support would be given for export of handicrafts under Market Access

initiative scheme by Export Promotion Council for Handicrafts to set up warehouses

in Latin America.

Annual supplement of foreign trade policy 2010-11

(1) Higher support for market and product diversification

Additional benefit of 2% bonus, over and above the existing benefits of 5%/2% under

focus product scheme, allowed for about 135 existing products like handicrafts item, silk

carpet, Toys and Sports goods, leather product and leather footwear, Handloom

products etc. which have suffered due to recession in exports. Further 256 products

have been added under focus product scheme for 2% benefits.

(2) Support for technological up gradation

Zero duty EPCG scheme valid up to 31.3.11 has been extended for one more year up

to 31.3.2012 and in order to give boost to technological up gradation, the benefit has

been extended to cover paper and paper board, ceramic products, refractory, glass

and glassware, plywood and allied products, sport goods toy etc.

(3) Benefit and flexibility to status holders

1% status holder scheme has been extended by one more year up to 31st March 2012.

(4) Stability and continuity of foreign trade policy

Duty entitlement passbook (DEPB) scheme has been extended till 30.06.2011. It has

however, been indicate that scheme will not be extended further. Interest subvention of

41

2% pre-ship credit to export namely handloom, handicraft, carpet and SMEs have been

allowed till 31.3.11 as per budget proposals. The facility has now been extended for

Jute, textile, engineering and leather.

(5) Procedure simplification

Exporters have been given flexibility to get high value EPCG authorization, club

advance authorization with authorization of annual requirement, chartered engineer

certificate for advance authroisation has been waived.

(6) EDI initiative

In order to reduce the cost and time, the scope and domain of EDI has been

continuously broadened. An e-RCMC scheme has been commenced and many other

initiatives are proposed to make the EDI more cost effective and convenient.

(7) Sector specific measures

Sector specific measures for leather, handloom, textile, gems and jewellery, handicraft,

service sector and agriculture have been initiated to make the export of these sectors

competitive.

Export optimism

Our exports have faced contraction of 4.7% in 2009-10 due to global recession

and subsequent protectionist policies of developed countries but cheerful news is that

during 2011-12 export grew 21% and crossed $300 billion mark.

Looking Forward

At present, our exports to Europe, US and Japan amount to 36%, 18% and 16%

respectively of India’s total export of $168 billion in 2008-09. Export in 2011-12 grew

21% reaching $303.7 billion thus surpassing target of $300 billion. Asia, Latin America

and Africa are main contributor to this growth and signing of CECA and FTA with Asian

countries is set to raise Asia’s share in our exports to 55% by 2014.

Time has come to have a re-look to export basket in view of dramatic change in

world trading pattern. Slow recovery of US and recession in Euro zone has added further

dimension to this change. This shift has also taken place from export of traditional

items like textiles, clothing, food and chemical to high end products like I.T., automobiles

and intermediates. Other important pattern in export growth is that China has emerged

as third major destination of exports. Hence focus should shift to China specific strategy.

It is also known that FDI has played a dominant role in export growth of China. FDI

42

funded units have several advantages over domestic industries in promoting exports

particularly they act as catalyst of R & D and technology transfer.

Chapter-5

Changing complexion of Bank Credit Emerging opportunities, issues and challenges

“At the rate at which the economy is growing, a 10% growth looks inevitable for next 25 years. If the economy grows at this rate, the banking system’s assets have to grow 25-30%. If this happens, the banking system in the

43

next five years will be three times bigger than what it is today. Some banks may be four to five time bigger than what they are today.”

Shri O.P.Bhatt- Former Chairman, SBICREDIT GROWTH (% YOY)

2008-09 26th Feb. 2010Non food credit growth 19.6 15.9

1. Agriculture 21.2 24.42. Industry 28.1 20.13. Retail Loans 6.6 4.73.1 Housing 6.4 8.33.2 Advance against fixed deposit 6.8 1.63.3 Credit card outstanding 7.9 -28.33.4 Education 33.8 31.23.5 Consumer durables -22.6 -1.34 Services 18.7 15.04.1 Transport Operator 17.0 19.54.2 Professional Services 22.4 36.94.3 Trade 14.4 19.45 Real Estate Loans 58.8 0.96 Loans to NBFC 37.0 25.8

Introduction

The banking reforms and policy changes taking place in India during the last one

decade are gradually changing banking landscape and credit market. First visible

change is that banks are now more customers focused, who is not only more demanding

(better pricing of loan) but also for more convenience (hassle free documentation and

less paper work), more comforts (prompt sanction and flexibility in use of loan) and more

innovations (tailor made products). Second change is that deregulation has made the

banks free to formulate their own schemes and products as per their market segment

and this has forced them to redesign business process and lending policies and

procedures to meet changing expectations of the customers and the market. Thirdly,

introduction of risk management practices and target implementation of Basel III

recommendations have brought in more professional approach in credit delivery process

which is now more risk focused and has made pricing of loan-products dependent on

risk perception of the borrower and likely hood of default. Fourth visible change is that

banks are moving from so called lazy banking to busy banking by aggressively

expanding credit to retail, agriculture and MSME segments. Fifth visible change is that

banks are gradually becoming super market where they will not only lend but also offer

44

whole gamut of financial products including third party products so that customer gets

opportunity to select best product at competitive price. Sixth, autonomy given to public

sector banks by government in the area of HR and other operational matters has come

as a boom. The four year breather given by RBI for opening up banking sector for

foreign banks must be utilized by them to thoroughly restructure their credit policies to

put them on par with new private and foreign banks. Seventh, retail banking would

benefit immensely from the Indian demographic dividend and mortgages are likely to

cross Rs. 400,000 crores by March 2020, Eight, the bottom of the pyramid or ‘next

billion’ segment would emerge as largest numbers and will accentuate the demand of

low cost banking solutions, and Finally, banking sector is growing much faster than

GDP as loan-GDP ratio grew from 31% in 2004 to 54% in 2009 but concern is on assets

quality.

All these changes are on the one hand creating new business opportunities and on

the other hand also creating new challenges.

Credit Scenario- emerging opportunities Shift to farm sector- The liberalization in industrial goods and services has

bypassed agriculture, where growth rates have been far lower. As a result, share of

agriculture in national income has dropped from around 40% in early 80s to 20%

today. And due to this, economic gains of the country remained unequally distributed

among society as 2/3rd of our population continues to be dependent on sharply

declining national income. Liberalization of industry and service sector has made

them globally competitive. In agriculture, however, government has been chief

demand stimulus by offering assured off take of products at prices higher than

market driven. Having realized that credit is one of the constraining factor of growth

of agriculture and in many cases farmers have reported to have committed suicide

due to huge indebtedness to local money lenders, GOI directed public sector banks

in June 2004 to initiate steps to double the agriculture credit within three years with

the result agriculture lending by scheduled commercial banks (SCB) has tripled

during the last three years and touched Rs. 190,000 crores from Rs. 88,000 crore.

During 2009-10, banks agriculture credit growth has been substantially higher at

24.4% as on 26 Feb 10 against 21.2% as year ago. To achieve this target, banks

are adopting new business models like using infrastructure of post offices, NGOs,

rural kiosks and e-chaupal. Further many banks have started using low cost

45

technology like biometric ATM to reach out rural population. RBI has also initiated

other measures to encourage agriculture financing like easing of NPA norms for

agriculture (crop loan), relaxation in service area approach, granting 2% subvention

on 9% regulated interest rate of farmers’ credit card up to Rs. 3 lakhs, extending of

debt waiver and debt relief scheme up to 30th June 2010. The agricultural loan, which has been bane of banks, has overnight turned into a boon.

MSMEs: a new focus – MSMEs have been playing a critical role in developed and

developing economies. There are more than 13.4 million MSMEs in India at the end

of March 2009 contributing around 45% of manufactured output, 40% of exports

and provides employment to 60 million persons ( B S 30.3.10) . MSMEs also act as

the seedbed for the development of entrepreneurial skills and innovation. Thus role

of MSME in economic development of the country is well established. In order to

encourage banks to aggressively finance the MSME sector, Performance and credit

rating scheme of SME has been launched on 7th April, 2005 and six credit rating

agencies – Crisil, Icra, Dun & Bradstreet, Onicra, Care and Fitch – have agreed to do

their credit rating. A separate rating agency-SMERA- a joint venture of Sidbi and Dun

and Bradstreet has also been set up. SMERA has signed MOU with almost all the

banks. It has also been decided that 75% of the fee paid by SSI for rating will be

reimbursed by the government subject to maximum Rs. 25,000/-. RBI has also

decided to set up a debt structuring mechanism for SMEs on the line of CDR. RBI

further permitted the bank to do second time restructuring as a exceptional

regulatory measure to overcome the problem of global slowdown. Dr. K C.

Chakrabarty Deputy Governor of the Reserve Bank of India ( Business Line

12.10.2009) said ,” to day, there is no bank in this country which will refuse money.

Every bank is sitting on tones of money. Being from the Reserve bank, I can tell you

there is no dearth of credit. The problem is MSMEs don’t require credit, they require

money.” As per RBI data, MSME credit rose by 26.9% during 2008-09 reaching

outstanding of Rs. 2.59 lakh crores .Big corporate have multiple options for financing

and are very demanding in price and bank are therefore finding better opportunity in

MSME by way higher returns.

Retail lending - The retail loan growth was subdued to 4.7% in end of Feb 2010

from 6.6% in 2008-09. The decline is contributed by decline in advance against fixed

deposit, negative growth in credit card and consumer durables loans. Housing

46

loan market has grown 8.3% followed by car loan financé. With changed interest

rate scenario due to introduction of base rate and RBI continuous reservation on

teaser rates, retail loans growth during 2010-11 is expected to be sluggish. But

banks do not want to give up on retail lending considering that the business is

lucrative as risk is diversified; spread is better and cost of operation is less. It is

expected that banks will restructure innovative retail products to retain the growing

class of clients with high disposable incomes and to harness demographic dividend.

Bank credit through Micro finance institutions (MFI)- The term micro-finance is

defined ‘as provision of thrift, credit and other financial services and products of very

small amounts to the poor in rural, semi-urban and urban areas for enabling them to

raise their income levels and improve living standards.’ MFI also provide other non

credit services also such as capacity building, training, marketing the produce of

SHGs, micro-insurance etc. It is now huge industry in India with more than Rs. 1000

crores lending by commercial banks to MFIs. Many bankers are amazed at the

success of the micro-finance as much as even private sector is reporting substantial

disbursement under micro-finance. And, the success is not only about delivery of

credit but also almost 100% recovery, which is unheard in priority sector lending.

Since formal credit institutions like banks cannot directly reach to the poorer

sections, there was a need to search for alternative methods of financing to the rural

poor. Budget of 2005-06 has empowered micro-finance institutions (MFIs) as

intermediary between banks and beneficiaries and has proposed to enhance the

target of credit linkage to 2.5 lakh SHG during 2005-06. However recent events of

putting caps of interest rate, fixing periodicity of repayment not earlier than monthly

interval and restructuring obligations through A P Act, has raised concern over MFI

future prompting the Central government to speed up microfinance act.

Micro-mortgage- Micro-mortgage is evolving area. NHB study has found that there

are over 40 housing developers across India offering housing units/apartments at

cost between Rs. 3 lakhs to Rs. 10 lakhs which are affordable to house holds

earning as little as Rs. 7500 per month. But customer of this segment is not able to

buy house due to financial constraints giving opportunities to micro-mortgage

companies. It is understood that besides Dewan Housing and Finance co. and Gruh,

many other companies like MAS Financial Services, Micro Housing Finance

Corporation etc. are targeting micro-mortgage market. Given that micro-mortgage is

47

collaterised, affordable and commercially sustainable, market is poised for

significant growth.

Exports and imports business- Export growth during 2004-05 has been 24.41%

and exports have reached US $ 79.59 billion by March end 05. Exports are

targeted to reach US $ 195 billion by March end, 09. Imports have shown a growth of

35.62% and have reached US $ 106 billion. GOI has taken slew of measures to

improve exports by establishment of special economic zone (SEZ), agri-export zone,

export hardware technology park (EHTP) etc. Opening of economy has opened

huge avenues to banks for export and import business.

Financing infrastructure – As per RBI data, bank’s lending to infrastructure sector

rose by 52% to Rs. 56,709 crores as on March end 2005 from Rs. 37,224 crore a

year earlier. Roads, transport, communication, ports, energy, hospital, telecom,

healthcare, educational institution and storage facilities for farm sector including cold

storage form infrastructure. Tourism infrastructure financing is the next big thing.

Infrastructure is core strength of our economy. In the past government did

infrastructure financing but limited budget resources have opened option for private

sector and hence financing avenues have now opened for banks. Infrastructure is

capital intensive and high cost oriented. Funds requirement of this sector is huge.

Working capital requirement is relatively less. Repayment period is long including

gestation period, which creates problem in asset & liability mismatch. To overcome

ALM problem, RBI has permitted banks to raise long-term funds through bonds for

infrastructure financing. Securitization and take out financing has emerged as other

suitable option to banks for infrastructure financing. According to Centre for

Monitoring Indian Economy report, infrastructure spending is likely to grow more than

double to Rs. 8.34 lakh cores in 2006-07 from Rs. 3.95 lakh crores in 2003-04.

Banks are banking on the growth prospects of this emerging sector.

Corporate credit – Till now this segment was meeting its demand through external

commercial borrowings, foreign currency convertible bonds, local bonds placements

with financial institutions, mutual funds, insurance companies, commercial papers

etc. As per RBI data (BS dated 14.01.2010) , resource flow from domestic sources

(other than bank borrowing) to corporate up t0 October 09 was higher at Rs.230,000

crores from other sources and from banks was lower by Rs.107,801 crores. Since

advances to highly-rated corporate require less risk weight under Basel II norms,

they are quite attractive to banks for financing. Competition among banks is very

48

fierce but bulk financing and other benefits are very strong incentives for the banks to

look toward this sector aggressively even on sub-PLR pricing. It is estimated that

biggest intake could come from power, infrastructure, metal, telecom, auto and auto

ancillaries, coal and coal related industries, textile, port and shipping.

Capital Market product-Guarantee to stock and commodity dealers is becoming big

business. These guarantees are issued in favor of stock exchanges on behalf of

brokers to meet shortfall in margins, which broker has to deposit with exchanges for

trading in equities or commodities. As per industry practices besides guarantee

commission at 0.75% to 2.50% plus processing charges, banks get cash cover up to

50% of the guarantee. While direct lending in the capital market is considered as

high-risk activity, guarantees are comparatively considered safe by banks as

exchanges rarely invokes the bank guarantee.

Service sector- Service sector has emerged as most important segment of the

economy. It is contributing about 60% of GDP at current prices. Actually service

sector is key to India’s growth process. It is the sector that has huge opportunities to

lend. There are certain reasons, which have blocked seamless flow of credit to this

sector. One is lack of primary security like stock by which banks are traditionally

drawing comforts. There are also psychological blocks because projects like TV

serials, software etc. is such that their viability is difficult to judge. The rate of

obsolescence is high and salvage from sale of product is almost zero. Another

problem is of customization of financial products as each segment of service sector

is having its own uniqueness and old structural way of assessing working capital

finance and pricing of loan is not workable. In selected financing of amusement

parks, educational institutions, travel agency, hotels, IT sector etc. banks’ past

experience is not good. The perceived risk in financing service sector is high but

return (interest) is capped due to PLR plus pricing. Venture capital is one route.

Hybrid products like interest plus royalty is another way of pricing risky ventures. The

challenge before banks is to either innovate or lose market. This requires proper

lending policies that not only factor in methodology to assess credit and pricing the

products but also to launch customized products after assessing risks factors for

various segments of service sector.

Commodity finance business- A credit revolution is sweeping the countryside, as

commodity financing becomes the new buzzword among banks. As per data

49

available, the banks during 2004-05 have lent more than Rs. 10,000 crores to

farmers, traders and exporters against farm produces stored in warehouses. India’s

commodity trading is worth Rs. 400,000 crores annually and still a long way to get

the saturation. Collateral managers now assist banks in undertaking due diligence

(credit risk), guaranteeing quality and safety of the commodity (operational and

performance risk), proper documentation (legal risk) and insurance (default risk).

Banks are in process of establishing tie-up with commodity exchanges to lend to

farmers and traders. National Collateral Management Services Ltd. (NCMSL) has

been by National Commodities And Derivate Exchange Ltd. (NCDEL) , IFFICO and

Audit Control Expertise, Genava, with objective of creating a safe and liquid

warehouse receipt market in India. Looking to the size of the commodity market,

there is huge business opportunity waiting for the banks. The commodity financing

will be part of priority sector and agricultural lending.

Trade in commodity future- The contour of the commodities market are set to be

redrawn with GOI and RBI finalizing proposal to allow banks to trade in commodity

future and to make warehouse receipt eligible security. GOI has proposed to amend

Banking Regulation Act 1949 to enable bank to get into commodity futures and also

the Negotiable Instruments Act 1881 to make warehouse receipt a negotiable

instrument. It may be mentioned that Banking Regulation Act permits banks to trade

only in bullion. Warehouse Regulation Act is also in process that would create a

regulatory authority for accreditation of warehouse and setting standard to be made

applicable for scientific grading, packing, storage, preservation and certification of

commodities. It is also proposed to introduce demat warehouse receipts. Banks

have also taken up stake in commodity exchange and are ready to set up trading

desks.

Channel financing or Supply Chain Financing- SCF is emerging as one of the

fastest growing segments in the banking sector. SCF is an innovative finance

mechanism by which bank meet the various funds requirements of

suppliers/distributors, thus helping them seamless cash flow along the arteries of the

enterprise. Under channel financing, the suppliers/distributors can leverage on the

relationship with reputed companies in sourcing low cost credit with support from his

counterparts. It is a more advanced and sophisticated version of the age old working

capital financing. It covers the entire gamut of financing of both the suppliers and

vendors side. Under the SCF model, banks are looking at value chain around

50

manufacturing companies to finance the suppliers and distributors of their value

chain. This type of financing helps all the parties of the value chain as production and

material movement becomes smoother backed by ready and cheap financing.

Under SCF, the bank opens a line of credit for supplier in consultation/

recommendation of the manufacturing company. The line of credit is very specific to

the products, which vendor supplies to the manufacturing company. After supply, the

manufacturer routes the payment through an escrow account which gives comfort to

the banker. On distribution side, banks finance the distributors on the

recommendation of the manufacturer. Often there is arrangement of escrow account

kind of mechanism where the sale of the distributors is routed through the bank.

Under SCF following credit facilities are available-

1. Discounting of trade bills accepted by the dealer/distributor.

2. Limited overdraft facility to dealer/distributor for his business dealing with

large corporates.

Risk free income- Basel II implications are forcing banks to move to risk free

income like insurance and mutual funds. In the credit areas, banks are innovating by

leveraging on their credit dispensation strength to augment risk free income through

variety of ways like-

o Originator of loan- Banks will mobilize loan but will not carry in their books.

Earn income as originator. LIC has huge corpus of funds but cannot directly

lend. Here, the originator has an opportunity to lend.

o Monitoring fee- Transfer loan to SPV or other banks through securitization

process but continue to earn fee-based income for monitoring of loan. Even in

case of sale of distressed assets to ARC, bank has an opportunity to earn

monitoring fee, as they know the assets better than the buyer.

o Take out finance- In case of infrastructure projects; the loan is taken up by

other institution after a specified period to over-come the problem of assets

liability mismatch.

o Financial advisor- Banks are now offering discretionary portfolio management

services- investment in art, philanthropy, real estate, and funds within country

and in offshore funds - for its affluent customers, all under one roof.

o Information Service- Under SCF mechanism bank generate all data of

shipment from suppliers to the manufacturer and from manufacturer to

51

distributors and offers information service like data of product, brand, dealer

wise dispatch and payment to and from customers.

Issues & Challenges-

Credit Risk Management- Credit Risk is also known as default risk. The credit risk

depends on both external and internal factors. The external factors are the state of

the economy, wide swings in commodity/equity prices, foreign exchange rates and

interest rates, trade restrictions, economic sanctions, government policies etc. The

internal factors are deficiencies in loan policies/administration, absence of prudential

credit concentration limits, inadequately defined lending limits for loan officers/Credit

Committees, deficiencies in appraisal of borrowers’ financial position, excessive

dependence on collateral and inadequate risk pricing, absence of loan review

mechanism and post sanction surveillance etc. The effective credit risk

management necessitates that banks’ have to be prudent to keep on reading not

only Indian economy but also the entire globe that have bearing on the money

market, capital market, stock market, commodity market and forex market and

integrate its lending operations proactively in terms of market realities. They should

also put in place proper mechanism to address various risks arising out of deficiency

in lending policy, incorrect product structuring, inadequate loan screening, loop holes

in documentation, ineffective post sanction monitoring/follow-up and weakness in

collection/ recovery mechanism. In fact in segment like retail lending, channel

financing etc. banks are going through learning curve and there is strong need to put

in place effective policies of sanction and monitoring of loan and keep them updated.

CRISIL has recently stated (BS 04.05.06) that Indian companies have begun to

show a downward movement of creditworthiness. It may be recalled that modified

credit ration (MCR) being prepared by CRISIL has shown a decline for the first time

in three years. This may be a warning signal for the banks to keep track on asset

quality.

Pricing- Competition among banks to tap the low risk borrowers is driving down the

price. Loans to corporate and public sector undertakings are at sub-PLR. In certain

segments, such as home loan and car, the competition is so steep that banks are

offering loan at interest rates, which are almost 200-450 basis points below the PLR.

52

Even processing charges or documentation charges are waived. Till Basel II

becomes actually effective, there is incentive for banks to arbitrage interest income

by roping in high-risk borrowers. Even mid-segment borrowers have started

demanding sub-PLR loans. The competition among banks in this segment is hotting

up forcing the bank to put in place Sub-PLR interest rate policy so that bank may

not lose prime customers in mid-segment. All this has made loan pricing a very

complex process. As a rule pricing should be done scientifically on risk grading of the

borrower on plus (or minus) PLR basis but market compulsions are such that banks

are forced to lend at rates dictated by market leader, otherwise there are chances of

losing business.

Marketing - Walk in business is the thing of past. The customers are now demanding

on price (interest rates), on product (quality), place (home delivery, internet banking),

packaging (brand affinity), people (customer service), partnering (business alliances,

direct selling agents), and promotion (discount, freebies etc.) Due to this, old

business model of ‘capturing customer through aggressive selling’ has given way to

new business model of ‘captivating the customer through innovation’. In the area of

credit, banks are under pressure to devise new products, develop delivery channel

including e-channel, building brands, partnering alliance and appointing direct selling

agents, giving promotional offers, and reorienting man-power to make them customer

friendly. For public sector banks, it is a challenging task but there is not other option.

Capacity building- Developing skill level of credit officer, marketing and IT people

and designing training programme to develop these skill is a major HR challenge.

Introduction of Basel II, which requires risk rating of borrower through highly technical

tools, has made this task even more challenging. It is believed that banks will have to

invest lot of resources and money in building this capacity in new environment where

they will be required to be Basel II compliant not only from regulators perspective but

also from perspective of international investors.

NPA management- The growth in Non-performing assets of Indian Banks has largely

followed a cyclical pattern in relation to the growth in credit off take. A study of RBI

has indicated that NPA growth follows credit growth with a lag of two years. This is a

kind of warning to banks to watch out NPAs following good year of credit growth.

53

Approach to lending- There was the time when assessment of working capital

meant to be on 2nd method of lending suggested by the Tandon committee and

assessment of term loan used to be based on intricate calculation of IRR, DSCR,

discounted cash flow, NPV etc. Even for term loan to a farmer for bullock or a crop

loan to a farmer, the detailed cash flow statement coupled with cash surplus was

calculated to decide eligibility. The approach to lending has now changed with bank’s

having freedom to decide assessment methodologies on their own. For example,

banks are now having mix of 2nd method of lending, turnover method and cash flow

method depending upon cut off points and nature of activity for financing traders,

manufacturers and service sector. In case of crop loan or Kisan Credit Card (KCC)

the scale of finance approach is adopted which permits sanction of loan based on

land holding and cropping pattern multiplied by scale of finance fixed for that

particular crop. Even scale of finance approach is now being made discretionary to

allow finance as per quality of land, method of cultivation or status of labour (hired or

family). All retail products like housing loan, car loan, education loan, personal loan

etc. are customized and assessment of quantum of loan is simple as much as fixed

percentage of take home pay or income from business or profession. While the

simplification of the process has made the task of assessment of need based finance

easy, it has made product development a cumbersome process where not only

product features but also its feasibility has to be critically examined before it is

launched.

Credit rating of borrowers-CRISIL has recently launched bank loan rating. In

addition to commenting on the timely payment of principal and interest, the rating will

give an opinion on the extent of recoverability of the loan post default, by capturing

the impact of covenants, security and other repayment protection provided specifically

to lenders. These ratings can be on behest of borrower or lender. The rating will

strengthen the banks’ confidence in borrower. The rating would also support Indian

banks in implementation of Basel II by offering an opinion in loan specific risk and can

be used by the bank in pricing, capital allocation and portfolio management.

Business process re-engineering- The drive for greater customer convenience is

forcing banks to re-engineer their lending process such as setting up of Retail Assets

54

Central Processing Centre (RACPC), Small and Medium Credit Cell (SMECC),

entrusting job of due diligence to Credit Verification Agencies etc.

Assets securitization- With proposed amendment in Security Contract Regulations

Act, bank will be able to issue assets based securities (ABS) -both performing and

non-performing- which will be at par with any other securities like security or debt and

will be tradable in stock exchange. It will help the banks to overcome problem of

assets liability mismatch, enhance their liquidity and lower the cost of loan, as funding

cost will go down.

Product development- In a buyers market, the customer satisfaction is a key to

success of new products. Since customers’ needs are repetitive, multiplicative and

dynamic in nature, the product development aims at exploring and satisfying these

needs in a continuous manner. Weaning out existing non-profitable product is part of

this process. To meet this challenge, each and every bank is continuously launching

new products in the area of retail loan, corporate loan, agricultural loan, SME loan,

merchant credit etc. Some of the very popular products are home loan, car loan, loan

against rental, loan against mortgage of immovable properties, farmer’s credit-card,

artisan’s credit card, trade finance products for business-men, project loan for

corporate etc. With all pervasive use of technology certain e-product like e-home loan,

e-education loan and e-car loan are also emerging in the market.

Low cost delivery model- It is expected that ‘bottom of pyramid’ or ‘next billion’

segment would emerge as largest numbers of borrowers and will through a challenge

of low cost delivery model.

Business alliances- Joint venture/alliances with project developers, manufacturers,

marketers, outsourcing partners, builders, promoters, educational institutions,

hospital, insurance companies, mutual funds etc, who together embody the extended

enterprise has become the order of the day. The objective is to develop a mutually

supportive, value-creating mode; bringing together complimentary forces of alliance

partners to create more value together than one can deliver separately. Banks are

entering into business alliances with tractor, car and four wheeler manufacturers as

their preferred financiers. Banks are also outsourcing non-critical job pertaining to

marketing of financial products and recovery and follow up of loans through direct

55

selling agents and recovery agents. This is not only adding to operational efficiency

but also enabling the bank to focus on its core activity more efficiently and effectively.

Lenders liability and fair practices code- Transparency is buzz word in lending.

RBI is insisting on banks to put in place anti-tying measures not only to ensure that

lender does not resort to unfair trade practices but also to ensure that proper

grievance redressal mechanism is in place. It is, therefore, essential that interest rate,

method of compounding, penal interest, prepayment penalty, rebate for prompt

payment, right of borrowers like copy of loan documents, statement of account, right

of privacy i.e. not sharing his personal profile to business associate/other agencies

are in place to address reputation and legal risk arising out of banking business.

Due diligence of the loans-With fraud and forgeries on rise, due diligence assumes

greater importance in context of credit management. To safeguard from frauds and

forgeries, credit officials are required to meticulously follow lending policy, lenders’

liabilities and best practices code, basic principles of lending, KYC norms etc., for

customers acceptance and identification. They should also strictly monitor the end

use of loans and other internal control measures so as to ensure that post credit

sanction due diligence process is effective enough to check malpractices, if any.

Looking ahead-

During the last one decade or so, India has made rapid strides in economic

growth, foreign trade, services and more arguably, in industry. When economy is

growing at 8% or so, banking industry is expected to grow at 24% as normal multiplier of

GDP to credit is about three times. However impending inflation, increase in money

supply and increase in interest rates, credit growth slipped to 16.6% in 2009-10 from all

time high growth of 30% in 2004-05. So improving credit growth is biggest challenge

that banks are facing at present.

Chapter -6

56

Cash Flow AnalysisReading Borrower’s Health

Introduction A successful banker was once asked about secret of his decision-making. He

replied that before taking any lending decision he wanted the prospective borrower to

satisfy him on two basic points: firstly how he is going to pay back the money and

secondly what should he (banker) do to know that his plans on which repayment

depends are really materialising. Obviously there should be a system for the banker to

know about the health of his borrower’s business. Cash flow is one of the tools to have

this information and more precisely borrower’s ability to meet his obligations as and

when they mature. Unfortunately, the system has not been given due importance in

credit appraisal in Indian context.

Liquidity and SolvencyLiquidity refers to borrower’s ability to meet his current obligations i.e. how fast

the current assets are converted into cash to pay for current liability. Solvency on the

other refers to borrower’s ability to service the debt i.e. ability to meet interest cost and

repayment of term loan. A borrower may have enough assets but may not have enough

cash to meet his obligation (for the reasons which we shall analyse afterwards). Thus,

there is a need to look into liquidity in depth.

Liquidity and ProfitabilityGenerally speaking the health of a borrower is gauged by his ability to earn. But

sometime a borrower though showing profits may not be in a position to meet his

obligations because profits always does not mean liquidity. Profitable companies can be

cash broke and unprofitable companies may have rich cash loads. A borrower in

distress may resort to window dressing to hide his real state of affairs by resorting to

certain accounting conventions. The changes in valuation of inventory (last in first out

(LIFO) to first in first out (FIFO) or vice-versa), under provision of liability, revaluation of

assets etc. are usually adopted practices to inflate/manipulate profits. Hence there is a

need to know what cash is exactly generated by the borrower from operations to see his

ability to service the debt and to meet current obligations.

57

Cash Generation – What does it represent ?Refer cash generation most probable reply would be “profits add back

depreciation”. Let us analyse the statement with the help of a simple example:

Sales 100

Cost of sales* (80) *excluding depreciation

Depreciation (10)

Profit 10

So, profit plus depreciation means that cash generation is 20. Does it represent the

cash generated? In fact, it is not so because :-

(a) Sales include sales on credit, which very often are not realised in all.

(b) Cost includes expenses, which very often not paid in all.

(c) Profit includes tax and other items though provided but not paid.

Hence, there is a need to look beyond what we normally conceive as cash generated.

Cash Flow Statement –a source of vital information

Cash flow statement provides information regarding sources (where got) and

uses (where gone) of cash. In other words, it provides information of movement of cash

between two balance sheets dates. A reference to “Cash Flow – Flow Chart” will

provide information to the readers that how Profit & Loss and Balance Sheet can be

used to recast cash flow statement. The ability to understand Profit & Loss statement as

it relates to Balance Sheet which relates to cash flow can provide under noted valuable

information to the banker: -

(a) Whether operating cycle is generating enough cash to meet out cost of

operation (ability to meet current obligations)?

(b) Surplus available after operating cycle is enough to meet out interest and

dividend obligation. In other words whether company borrows money to meet

this obligation?

(c) What surplus is left to meet out term liability due (solvency)?

(d) Is there any surplus left for meeting cost of expansion? (Investment in fixed

assets for expansion, inventory built up etc.)?

(e) At what time, cash flow turns negative and how it is financed (short term loan

or long term loan)?

(f) Overall cash management shows management efficiency i.e. how cash is

managed? (excess, adequate, inadequate).

58

With study of 3-4 years of cash flow statement, a banker can find out cash

management position and can see whether cash position is improving or deteriorating.

Pertinent here is that cash flow cannot be manipulated by accounting conventions and

there is no way to hide significant flows from a banker. It should be taken for granted

that a company not generating cash will eventually fail because external sources (bank

loan, equity of long term loan) are like fair weather friends whose help is available only

when borrower is in a position to service them. No investor would like to risk his money

if he finds that the borrower will not be able to repay it. It should, however, be noted that

cash consuming operating cycle does not always mean ‘sickness’. It is true for growing

organisations also because, both need outside finance for their survival. The difference

is that, while former needs to make up money eaten up during operation later requires

it to meet growing wants i.e. increased inventory, receivables etc. Here, the banker’s

perception is crucial to differentiate between growing and weak organisations and to

decide whether he would like to put more money.

Cash Flow Statement – FormatCash flow statement can be prepared either directly from books of account or

indirectly from financial statements. In practice, cash flow is rarely drawn from cash-

book directly. It is usually derived from Profit & Loss statement and Balance Sheet.

There are number of ways to categorise sources and uses in cash flow statement. One

of the most useful and effective way is to categorise sources and uses of cash flow in

four major heads: (Refer Table – 3).

1. Operating Cash flow

a) Operating cycle

b) Quasi operating cycle

2. Financing Cash Flow

3. Investment flow

4. Financing (ST/LT) flow

Statement – How to prepare Indirect MethodPreparation of cash flow statement from Profit & Loss A/c and Balance Sheet is

done through derivation technique i.e. information for sources and uses of cash is

derived from these sources. Though the procedure is simple, it requires certain basic

knowledge. For better understanding to prepare the cash flow from P&L A/c and Balance

Sheet and to interpret the information effectively, it would be better to approach the

subject with the help of a case study.

59

Balance Sheet & P&L A/c of ABC Company Ltd. are reproduced below for

preparation of cash flow:-

TABLE 1 : ABC Co. Ltd. – Condensed Balance Sheet as on 31st March

LIABILITIES 1996 1997 ASSETS 1996 1997

Net Worth 11945 19994 Fixed Assets 8290 14680

Term Liabilities 2658 7655 Non Current Assets Nil Nil

Current liabilities Bank borrowing

Payable

Other current liability

16943

21106

21497

20957

20853

10974

Current Assets Cash

Inventory

Other current assets

Debtors

2470

35435

5318

22636

2442

28227

4988

30096

74149 80433 74149 80433

TABLE 2 INCOME STATEMENT for the year ended 31st March 1997

Sales 71700

Other Income 3000

Cost of sales - 51000

Depreciation - 4800

Selling expenses - 10300

Interest - 5900

Tax - 500

Dividend - 1800

Retailed earnings 400

Step – I: Prepare worksheet for change in balance sheet between the two dates. The

change in balance sheet items of ABC Co. Ltd. has been rearranged in work sheet I-

( Work sheet – I )ABC Co. Ltd. Statement of changes in balance sheet between 1996 to 1997

Fixed Assets (6390)

Inventory 7208

Debtors (7460)

Other current assets 330

Net Worth (1) 8049

Term Liability 4997

Bank Borrowing 4014

60

Payable (253)

Other current liabilities (10523)

Cash 28

(Figures in bracket indicate use; other source)Step – II Prepare worksheet II after rearranging figures from Profit and Loss Account

and merging it with Work Sheet – 1. :-

Work sheet – II (In Rs.)Sales 71700

Other Income 3000

Cost of sales (51000)

Depreciation (b) (4800)

Selling expenses (10300)

Interest (5900)

Tax (500)

Dividend (1800)

Fixed Assets (b) (6390)

Inventory 7208

Debtors (7460)

Other current assets 330

Equity (a) 7649

Term liability (c) 4997

Bank borrowing 4014

Payable (253)

Other current liability (c) (10523)

Cash (d) 28

Step – III Following adjustments have been made while preparing Work sheet No. II :-

(a) Change in net worth is effect of two things; retained profits and increase in

equity. In other words, increase in net worth more than profits retained

represents increase in its equity. In case of ABC Co. Ltd., increase in equity

is Rs.7649 (8049 – 400).

(b) Depreciation is not actually an outflow in itself; but is related with investment

in fixed assets. For calculating total outflow, depreciation is added back. In

61

case of ABC Co. Ltd., total outflow of cash in fixed assets was Rs.11190

(4800 + 6390).

(c) Current portion of term liability included in current liability needs

readjustment to know how much cash flow is associated with loan term and

how much with short term. In case of ABC Co. Ltd., figures balance sheet

have been shown after making readjustment.

(d) Increase in cash is use and decrease in cash is source.

Step – IV Incorporate the data in the format. Cash flow is now ready. (Refer Table 3).

TABLE 3 : CASH FLOW STATEMENT 1996-97 : ABC Co. Ltd.

OPERATING

CYCLE

SALES

DEBTORS

COST OF SALES

INVENTORIES

CREDITORS

71700

- 7460

- 51000

7208

- 253

64240

- 44045

QUASI

OPERATING

CYCLE

CASH FROM OPERATIONSELLING EXP.

OTHER INCOME

TAX

OCA

OCL

- 10300

3000

- 500

330

- 10523

20195

- 17993

FINANCING COST CASH FROM OPERATING CYCLEINTEREST

DIVIDEND

- 5900

- 1800

2202

- 7700

LONG TERM

FLOW

SOURCES + USES

CASH AFTER FINANCING COSTFIXED ASSETS

NON-CURRENT ASSETS

- 11190

0

- 5498

- 11190

FINANCING FLOW

SOURCES + USES

CASH AFTER LONG TERM FLOWLT LOAN

ST LOAN

EQUITY

4997

4014

7649

- 16688

16660

62

INCREASE ( + ) DECREASE ( - ) IN

CASH

- 28

Now, we can interpret the data available from cash flow statement. It is self-

revealing and need little efforts for interpretation.

Operating cycle has generated enough cash and after meeting operating

expenses, ABC Co. Ltd. is left with surplus of Rs.2202. This surplus is, however, not

enough to pay for interest and dividend, the same was paid by raising short-term bank

borrowing. The investment cost (purchase of fixed assets) has been met by raising

equity and long term loans. LT source (Equity and LT) was also used for financing

dividend. This is not a healthy proposition. The chargeable current assets (current

assets – OCA) of ABC Corporation has gone down by Rs.582 whereas the bank

borrowing has gone up by Rs.4014 indicating irregularity in the account. If data for 3-4

years is available and it looks like that ABC Co. Ltd. has such a state of affairs on

continuous basis, it is certain that the company is facing the liquidity crunch. To

conclude, all is not well with their cash management.

TWO MORE INDICATORS1. Cash generated to total debt ratio: - In place of PBT/Total outside liability ratio,

cash generated from operation to total outside liability ratio is more reliable to judge

debt servicing capacity of a borrower. ABC Co. Ltd., has cash generation to debt

ratio of 3.64%, whereas PBT/Debt ratio is 8.66%. Obviously debt servicing capacity

of ABC Co. Ltd., is only 3.64% which is not enough even to take care of financing

cost.

2. Common size cash flow:- To have comparative analysis percent-wise cash flow

is very often prepared to make the analysis easy.

TABLE 4 : COMMON SIZE CASH FLOW : ABC CO. LTD.

SOURCES Amount % USES Amount %

Cash from operating cycleBank borrowingCash------------------------------

Loan term loanEquity

2202

4014

28

--------------4997

7649

(11)

(22)

(00)

---------(27)

(40)

Financing cost (a) Interest

(b) Dividend

-----------------------------

Investment in Fixed Assets

5900

1800

-----------11190

(31)

(09)

-------(60)

63

18890 (100) 18890 (100)

It is clear that cash generated from operation (11%) was not enough to meet

financing the cost (40%). The ABC Co. Ltd. has raised bank loan (22% of total sources)

to meet the financing cost. A part of Financing cost was financed by long term sources

(Equity [40 – 11 – 22 = 7 ] ). Utilisation of this money for payment of dividend/interest is

not a healthy symptom. This speaks for inherent cash weakness of the company.

Investment in fixed assets (60%) was financed by Equity (40%) and Long term loan

(27%).

COMPARING WITH FUNDS FLOWIt is worthwhile to make a reference to funds flow analysis. The objective here is

to focus how the cash flow analysis is superior to fund flow analysis.

Fund flow statement of ABC Co. Ltd. can be drawn as under:

SOURCES USESNet fund generated Short term

Profit

Depreciation

400

4800 5200

Bills payables

OCL

Debtors

253

10523

7460 18236

Short term sources

Inventory

Bank borrowing

OCA

Cash

4014

7208

330

28 11580

Long Term 11190

Long term sources

Equity

Term loan

7649

4997 12646

_____

29426

_____

29426

Through this traditional analysis everything looks normal for the company. No

diversion is evident and long term sources are more than long term uses. In other

words, cash flow provided us more deeper insight in financial state of affairs of the

company rather than what is available from fund flow.

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SUMMING UPBy a systematic study of cash flow statement, a banker can easily identify

strength and weakness of a borrower. This is better indicator of borrower’s solvency and

liquidity. It highlights weakness of the borrower and can be used as instrument to identify

incipient sickness because liquidity crunch always precedes to losing profitability.

-000-

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Chapter-7Loan Syndication

OriginThe Narasimham Committee on the Financial System, appointed by the RBI in 1991,

examined, among the other things, the idea of starting loan syndication. The report of

the committee states, “While the structured consortium did indeed provide, some comfort

to the borrowing clientele in the sense that it saved them from the responsibility of

approaching several institutions for arranging their finance, it had two principal

drawbacks. When the consortium rejected an application, the borrower did not have any

further option. Secondly, even though the formal nature of the consortium has been

diluted and is now in theory voluntary in effect it is mandatory and militates against the

participating institutions developing a sense of accountability and responsibility for a

large portion of their portfolio. As a first step, we recommend that the system of

consortium lending be done away with. In its place, where the institutions and borrowers

agree a system of loan syndication or participation with other DFIs and commercial

banks could be considered”. But this idea of formation of Loan Syndication was not

well appreciated. Therefore, the Trade and Industry continued to voice their concerns

over the difficulties faced by them in complying with the RBI guidelines on lending

discipline for assessing the quantum of working capital to be provided to a borrower by

the banking system. Such difficulties arose mainly on account of the consortium

lending. Hence, the RBI decided to revise the system of lending under consortium

arrangement to overcome the difficulties of trade and industry. Accordingly, in 1993, it

appointed a committee under the chairmanship of Shri J V Shetty, Chairman and

Managing Director, Canara Bank to review the system of consortium lending. The

Committee examined various alternatives to the system of consortium lending, besides

suggesting liberal and flexible approach in the system of consortium lending. These

alternatives include inter bank participation certificates, commercial paper, debentures,

securitisation of debts and syndication of credit. The committee found the scope for

introducing these alternatives alongwith the consortium lending. Accordingly, the loan

syndication became part of lending system.

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Market sizeLoan Syndication market is presently estimated to Rs. 300000 lakh crores business.

Initially market was dominated by investment banks and state owned State Bank

sponsored SBI cap but gradually PSBs have also developed expertise and now three

PSBs namely Bank of India , Bank of Baroda and Punjab National Bank figures among

top ten loan syndicators. Even smaller banks like Uco Bank, Allahabad Bank,

Corporation Bank and Indian Overseas Bank are now venturing into this business

segment to leverage on customer relationship which they have built up over the years

and to earn fee income. However key to success is building capabilities to originating

the loans and selling down to other banks. Both need strong marketing abilities and

credit evaluation and assessment skills.

What is Loan Syndication?Banks may evolve appropriate mechanism for adoption of sole bank/multiple

bank/consortium or syndication opportunity framing necessary ground rules on

operational aspects. It shall be noted that the level of individual bank’s share shall

continue to be governed by the norm for single borrower / group exposure. Banks in

their own interest, should endeavor and ensure to have effective system for appraisal,

flow of information on borrower among participant banks, commonality in approach and

sharing of lendable resources, etc., under the single window concept. As syndication is

an internationally practiced model for financing credit requirements, banks are free to

adopt syndication route, irrespective of the quantum of credit involved, if the

arrangement suits to the borrower and the financing banks. With the withdrawal of

guidelines on consortium lending, the process of credit decisions will be further speeded

up; this will also afford greater mobility to the borrowers in accessing credit at

advantageous cost. Thus, the recent guidelines of the RBI have given a signal for the

Loan Syndication to be formed.

Process Involved in Loan Syndication?The process of loan syndication starts when a prospective borrower approaches a bank

of his choice and requests it to arrange for the required credit, on his behalf. The bank,

here, is referred as Lead Manager or Mandated Bank, which first prepares Information

Memorandum in consultation with the borrower. This information Memorandum

furnishes details of the project and credit requirements. It also discusses about the

terms of the offer made by the borrower such as interest, repayment period, security etc.

The Mandated bank takes out the required copies of the Information Memorandum and

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distributes among the prospective lenders requesting each one to participate in the

credit offer. Each prospective bank makes an independent evaluation of the borrower,

project and credit offer. If necessary, it may collect additional information from the other

sources as well. After sometime, the Mandated Bank convenes a meeting of

prospective banks to discuss the syndication strategy relating to co-ordination,

communication and control within the syndicated process and finalize the deal timing,

charges towards management expenses and cost of credit, share of each participating

bank in the credit, etc. In the meeting, banks agreeing to participate in the credit offer

form Loan Syndication and someone within the group is appointed as an Agent Bank

(referred as Agent). Agent and prospective credit institutions enter into an agreement,

which sets a limit for agency services. The Mandated bank or Agent communicates the

terms and conditions of the credit to the borrower who then offers his written consent to

the same. The borrower then gives a prior notice of his funds requirements and

accordingly, requests the Loan Syndication for disbursement. Before the disbursement,

the Agent has to get the documents executed on behalf of all banks for which there may

be a single set of documents or each bank may prescribe a separate set of documents.

Generally, a single window concept is followed in documentation. After documentation,

each bank deposits it’s share in credit with the Agent who then disburses the amount to

the borrower. Subsequently, the borrower makes the repayment of loan to the Agent ,

the participating banks are entitled to get their share in it on pro-rata basis. Once the

entire dues are paid, the loan syndication comes to an end. The process of re-

establishment of the loan syndication is followed when the borrower makes the fresh

request.

Functions of the Mandated Bank and Agent BankThe Mandated Bank has to obtain a letter (called the Mandate Letter) from the borrower

to arrange for the loan and also necessary details of the offer such as amount of loan,

interest rate, repayment period, security, etc. The Mandated Bank then prepares the

Information Memorandum in consultation with the borrower and sends the same to

prospective credit institutions, which may be interested in it. The Mandated Bank

obtains the written consent of credit institutions to join the loan syndication. It is also

expected to play a key role in forming the Loan Syndication and look after its work until

the Agent Bank is appointed. If the same bank is appointed as Agent, it has to offer

agency services.

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The Agent Bank, wherever appointed, is expected to perform only those duties, which

are prescribed in the Agreement entered with the syndicate members. This Agreement

in turn protects the interest of member banks and sets a boundary for the agent to

perform duties. The agent is expected to exercise the required skill, care and diligence

befitting its assignment. He has to disclose relevant facts of the credit to the Principal

(member banks). He is not to sub-delegate his authority and make secret profit out of

the agency services. As per the agreement, the participating banks are expected to

deposit their share with the Agent who, in turn, makes the entire amount available to the

borrower, when needed. Similarly, repayment amount of the borrower is deposited in

the Agent’s account and who then distributes among the members on pro-rata basis.

This account should be of the nature of a trust account so that the syndicate can protect

itself against insolvency or misappropriation by the agent. In order to have the right to

claim from the recipient (borrower) about any amount mistakenly paid; the Agent

incorporates a clause in the loan document. Further, the Agent may want to limit his

liability by incorporating a separate clause in this respect which grants immunity against

liability for any default or omission except in the case of its gross negligence and default

or willful misconduct of the agents, etc.

Relationship among Syndicate Members The group is generally small and, therefore, the members can consult one another.

They would like to resolve differences, if any, through mutual consultations. Since each

member has reasonably a large share, there is no need to insist on majority decision,

every time. Each member is capable for taking the matter with the borrower directly and

protects his interest. In case of default, the majority of the members can instruct the

Agent to initiate recovery. When enforcement of securities becomes necessary, each

member can pursue its own remedies as it pleases. As and when the borrower makes

the payments to the Agent, each member has to get its pro-rata share in it. In any case,

the relationship among the members has to be cordial and informal so that the

syndication of credit works effectively. But the relationship between agent and member

banks has to be formal and in line with the agreement entered between the two.

Methods of Loan SyndicationThere are two methods of syndication – direct lending and through participation. In

respect of ‘direct lending’, all the lenders sign the loan agreement independently with the

borrower and agree to lend upto their respective share. The obligations of the syndicate

members are several and they do not underwrite one another. As against this, in

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‘through participation’ method, the lead bank is the only lending bank, so far as the

borrower is concerned, that approaches the other lenders to participate in the loan. This

normally takes place without the knowledge of the borrower. The lead bank grants a

certain portion of the loan to each participant as agreed. It also agrees to pay to the

participants a pro-rata share of receipts from the borrower. There can be four types of

participation (a) Substitution – There is an agreement between the borrower and the

lead bank and other participants to permit the lead bank to disburse the loan on behalf of

the participants, (b) Undisclosed agency - Here, the lead bank is appointed as agent by

the syndicate before the loan is signed, but does not disclose this fact to the borrower. It

is, therefore, the principal as far as the borrower is concerned. (c) Sub-loan – Under

this method, each participant grants a loan directly to the lead bank on the condition that

the lead bank repays only to the extent of receipts from the borrower, (d) Assignment –

The lead bank assigns a proportion of the loan and of the benefit of the loan agreement

to the participants in consideration of the purchase price of pro-rata share of the loan to

be contributed by them.

Preparatory WorkIn terms of the RBI guidelines, each bank is expected to do necessary preparatory work

before the loan syndication is formed. To start with, there has to be a written policy of

loan syndication in which each bank has to indicate its loan policy and business

strategies. In particular, it has to spell out its policy in regard to loan amount ceiling for

formation of syndication, exposure limits for individual or group borrowings, charges for

agency services and for preparation of Information Memorandum etc. It should also

decide whether it wants to go in for common set of loan documents of syndication or

develop its own set of loan documents. It has also to work out its preference for ‘direct

method’ or ‘through participative’ method. Further, in case it has to perform certain

agency services under loan syndication, necessary details have to be provided to the

identified branches. If necessary, a specialized branch may be opened for offering

agency services as under the loan syndication. Finally, officers going to scrutinize credit

proposals under loan syndication and follow-up the credit matters need to be trained

besides creating the required infrastructure and technology base for handling of

syndicated loans.

Conclusion

Loan Syndication provides adequate flexibility and is more convenient to both borrowers

and banks. This may, in turn, result into timely and need based credit to corporate

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borrowers. In a competitive environment, it is essential to avoid delays in credit

sanctions for which there have to be certain pressures built within the system of loan

syndication. In other words, members of loan syndication should work with competitive

spirit. In regard to the need based credit, cash budget/cash flow system should be

followed in which the borrower has to spell out his cash requirement precisely. In any

case, benefits of the loan syndication should be mostly shared equally between

borrowers and banks. In the end, success of formation and conduct of loan syndication

very much depends upon seriousness, openness and collective action on the part of

both borrowers and banks.

-000-

Chapter- 8

Documentation and Charging of securities 1. Introduction- Documentation means execution of documents in proper manner and

according to provisions of law. Proper documentation comes to the rescue of the

banks in a court of law. Section 3 of the Indian Evidence Act defines a document as

"Any matter expressed or described upon any substance by means of letters, figures

or marks or by more than one of these means, intended to be used or which may be

used for the purpose of recording that matter". Execution of documents thus interalia

involves a process of taking the signature of the borrowers/guarantors etc. on the

necessary documents after proper stamping and completion of other formalities say

registration connected therewith. The documentation establishes a legal relationship

between the lending banker (creditor) and the borrower (debtor)/guarantor.

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2. Different types of borrowers – Borrowers can be classified into several categories

such as ( a) Individuals in single name and joint names, (b) Firm-sole

proprietorship firm and partnership firm, (c) Hindu Undivided Family, (d) Limited

liability companies/corporations etc. viz. (i) Private limited company, (ii) Public

Limited Company and (iii) local authorities, corporations or undertakings owned by

State/Union Government, (e) Clubs schools non-trading associations and literary

societies, (f) Co-operative societies and (g) Trusts.

3. Mode of creation of charges- Creation of charge on securities is done as per

nature of security through (a) hypothecation (for movable stocks such as goods,

book-debt, plant and machinery) (b) Pledge (for movable stocks) (c) Mortgage in

respect of immovable property, (d) assignment of debts like life policy and (e) lien on

deposit with the bank or post office.

4. Capacity to contract and free consent- Before getting the documents executed, it

is necessary to ensure that the parties executing documents are having capacity to

enter into contract. Similarly bank should ensure that borrower executing the

documents and charging the security or giving guarantee is doing so with his/ her

free will. To ensure this, the branch manager should see that documents are

executed by a major only (a person attain majority at the age of 18 years

excepting when the guardian is appointed by the court, age of majority is 21 years)

and, there is no occasion on which borrower may later claim that he has not signed

the documents with his free will on account of coercion, undue influence,

misrepresentation or mistake. As a matter of abundant precautions, safeguard by

way of witness/ letter of affirmation/public notice etc. are taken when illiterates

execute the documents or third party security is charged to the bank.

5. Checkpoints for effective documentation-- Execution of document is most crucial

part of lending. Any laxity/negligence on the part of branch manager/officer may lend

the bank in trouble when suit is filed and security is enforced. It is therefore essential

that under noted time tested precautions are observed while documents are

executed by the borrowers-

(a) Document should be executed in presence of the Manager/ other responsible

officer.

(b) Documents should be completed in one sitting in the same handwriting in the

same ink.

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(c) Document should be signed by the borrowers in full signature in the same

style throughout the documents. Generally borrowers put their signatures

using right hand. If however, borrower signs in left hand, a small note should

be annexed recording therein that the borrower has signed in left hand. In

case of illiterate borrower, a remark should be made if he/she has put his/her

right thumb or left thumb. In practice right thumb impression is obtained from

lady borrowers and left thumb impression from male borrowers.

(d) All types of correction, insertion, additions, alterations, cuttings, overwriting,

erasing, interlining, deletions etc. should be avoided. Otherwise, these

should be duly authenticated by the borrowers under his/her full signature

near each of such corrections, addition, interlining etc.

(e) Date and place of execution should be mentioned properly. Documents

should not be double dated such as 1/2, 9/10 etc.

(f) When the document runs into several pages, the borrowers should sign such

documents on each and every page. Signature should be obtained on the

documents particularly across the fold in such a manner that the signatures

run on the both pages.

(g) Unless there is a specific requirement, documents should not be got attested/

witnessed.

(h) Documents should be adequately and properly stamped as per state law,

(i) No column should be left blank. Keeping the documents blank or even one or

two column may invalidate the whole documents. Spelling of name and

address of the borrowers should be taken due care. Interest rate is very

crucial and it should be filled correctly stating over or below PLR with

quarter/half yearly/monthly compounding clearly. No credit facility should be

allowed until and unless all the borrowers including guarantors execute all the

documents.

(j) When the borrower happens to be a proprietorship firm/partnership firm, the

documents should be got executed once under the seal of the firm and

another individually. When the borrower happens to be a company, the

documents should be got executed once under the seal of the company with

the designation of the signatory in the company and another individually

under common seal of the company.

(k) Documents are to be preserved very carefully.

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5. Special convenants to meet RBI guidelines/regulatory requirements- Following special convenants should be added –

(a) The borrowing company will not induct a person who is director on the board

of the company which has been identified as a willful defaulter and that in

case, such person is found to be on the board of borrower company, it would

take expeditious and effective steps for removal of the person from its board.

(b) The borrower will not make any major change in the management involving

transfer of ownership without previous permission of the bank in writing.

(c) Certificate / declaration that directors/borrowers are not related to any senior

executive of the bank.

(d) Bank may withdraw sanction without assigning any reason.

(e) The borrower will not have any objection to the bank disclosing its name to

RBI/CIBIL in case of default or otherwise so required by the bank.

(f) Borrower will not to pay commission to guarantors.

6. Documentation -Stamping As per Section 2(11) of the Indian Stamp Act, 1899, a document is deemed to be

duly stamped if it bears an adhesive or impressed stamp of not less than the proper

amount and that such stamp has been affixed or used in accordance with the law for the

time being in force. It is legal requirement that documents must be stamped properly. If

a document is either not stamped or under-stamped, it is not valid. Document

should always be stamped before or at the time of execution of the documents. If the

documents are stamped later than the date of execution, it is not valid in a court of law.

Every adhesive stamp affixed on documents should be cancelled as per Section 12 of

the Indian Stamp Act. Writing name of the executant is considered as sufficient

cancellation. All documents contravening the provisions shall be deemed to be

unstamped and the effect can be remedied by payment of duty and the penalty. All

documents, which are not duly stamped, are inadmissible in evidence unless the duty

and penalty have been paid as provided in Sec. 35 of the Indian Stamp Act. Section 35

of the Indian Stamp Act, while providing for admitting certain not duly stamped

documents in evidence on payment of certain penalties and duties specially excludes

other documents (including promissory notes) from its operation. Thus an under-

stamped DP Note will be inadmissible in evidence for any purpose i.e. the writing therein

cannot be used as an acknowledgement of claim. The rule of strict Inadmissibility of a

75

pronote comes into play when a transaction merges into a pronote, which becomes its

only basis. Any evidence of such a transaction is barred under Sec.91 of the Evidence

Act and in such a case any deficiency in stamping the pronote will be fatal to the whole

suit. When any document is executed in more than one state in India then the

stamp duly payable on the document so executed will be higher of the stamp duty

payable.

7. Registration of documents with ROC Under section 125 of the Indian Companies Act, 1956, the following charges are to

be registered compulsorily-

(a) A charge for the purpose of securing any issue of debentures.

(b) A charge on uncalled share capital of the company.

(c) A charge on any immovable property wherever situated or any interest

therein.

(d) A charge on any book debts of the company.

(e) A charge not being a pledge on any movable property of the company.

(f) A floating charge on the undertaking or any property of the company.

(g) A charge on calls made but not paid.

(h) A charge on goodwill or patent or license under a patent on a trademark or on

a copyright or a license under a copyright.

8. Registration of Documents under Indian Registration Act, 1908- The documents,

as per detail below are compulsorily required by Section 17 of the Indian Registration

Act to be registered, at the office of the Registrar or Sub-Registrar within four months

from the date of its execution. A registered document shall operate from the time

from which it would have commenced to operate if no registration thereof had been

required or made and not from the time of its registration (Sec. 47). -

(a) Mortgage of immovable properties (except by deposit of Title Deeds).

(b) Instruments of gifts of immovable properties.

(c) Lease of immovable property from year to year or for any term exceeding one

year or reserving in yearly rent.

(d) Non-testamentary instruments which acknowledge the receipt or payment of

any consideration on account of the creation, declaration, assignments,

limitations, or extinction of any such right, title or interest.

(e) Non-testamentary instruments transferring on assigning any decree or order

of a court or any award when such decree or order or award purports or

76

operates to create, declare, assign, limit or extinguish whether in present or in

future, any right, title or interest whether vested or contingent of the value of

Rs.100/- and upwards to or in immovable property.

(f) Other non-testamentary instruments which purport or operate to create,

declare, assign, limit or extinguish whether in present or in future any right

title or interest whether vested or contingent of the value of Rs.100/- and

upwards to or in immovable property.

9. Extension\revival of period of documents According to Section 2(1) of the Limitation Act, 1963, period of limitation means

the period of limitation prescribed for any suit appeal or application by the schedule and

'prescribed period' means the period of limitation computed in accordance with the

provisions of the Limitation Act. There is a legal relation between documents and

limitations act. As long as the documents are within the period of limitation a banker can

institute a suit, prefer an appeal and apply for legal action for recovery. Once the

document has expired by period of limitation, and then the banker will have no legal

course of action to recover the dues from the defaulting borrowers. In other words if the

period of limitation expires then the party entitled to file a suit for enforcement of a right

is debarred from doing so. When the period of limitation as applicable in a particular

case has expired the documents become time-barred. A document can be revived or

its limitation period can be extended by -

(a) Part payment by the borrower himself or his duly authorised agent for this

purpose and also such payment is made before expiry of the documents

(Sec.19 of Limitation Act). Such payments should be in the handwriting or

under the signature of the borrower or his authorised agent.

(b) Obtaining acknowledgement of debt in writing across the requisite revenue

stamp from the borrower before expiration of the prescribed period of

limitation (Sec.18 of Limitation Act).

(c) When a fresh set of documents is taken before the expiry of the original

document, fresh period of limitation will start from the date of execution of the

fresh documents. A time-barred debt can be revived under Sec.25 (3) of

the Indian Contract Act only by a fresh promise in writing and signed by the

borrower or his authorised agent generally or specially authorised in that

behalf. A fresh promissory note/fresh documents executed for the old or a

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barred debt will give rise to fresh cause of action and a fresh limitation period

will be available from the date of execution of such documents.

(d) Section 4 of the Limitation Act states "Where the prescribed period of any

suit, appeal or application on a day when the court is closed, the suit appeal

or application may be instituted preferred or made on the day when the court

re-opens".

(e) As per Section 5 of the Limitation Act, 1963 any appeal or any application

other than an application under any of the provisions or Order XXI of the

Code of Civil Procedure, 1908 may be admitted after the prescribed period if

the applicant or the appellant satisfies the court that he had sufficient cause

for not preferring the appeal or making the application within such period.

SUMMING UPBanker should take utmost care and precaution while getting the documents

executed. They should take care to complete the formalities in connection with the

execution of documents, stamping, subsequent registration etc. according to the

prescribed procedure laid down in respective Acts so that there is no problem in getting

the documents admitted in a court of law later on, if need be, as evidence of claiming

right under such document and such document shall be enforceable against all the

executants. The due date of limitation period should be properly diarised and documents

should be revived well before they get time barred.

Chapter-9

Documentation of Limited Liability Companies1. Company defined-

According to Justice Lindlay by a company is meant an association of many persons

who contribute money or money’s worth to a common stock and employ it for a

common purpose. The common stock so contributed is denoted in money and is the

capital of the company. The persons who contribute it or to whom it belongs are

shareholders. The proportion of capital to which each member is entitled is his share.

Essential features of a company are -

(a) A Company is an artificial person created by law. It can act only through

agents- Board of directors, Managing Directors and Managers- who are

representatives of shareholders.

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(b) It has a perpetual succession. Death, insanity or bankruptcy of shareholders

does not affect its existence.

(c) Existence starts only after completion of formalities as per act.

(d) A Company can own property, own money, is creditor to other people and

can borrow also (subject to limitation).

(e) It has separate entity to its shareholders.

(f) The liability of shareholders is generally limited.

(g) The legal relationship of director and company is of principal and agent.

(h) A company must have it registered Office. It must have a common seal

(public limited only). It must comply various legal formalities and obligations.

2. Private and Public Limited company-As per Companies Act, 1956, there can be a private company or a public

company. Private company means a company which by its articles (a) restrict the

right to transfer its share, (b) limit the number of its members to 50 not including (i)

persons who are in the employment of the company and (ii) persons who, having

been formerly in the employment of the company, were members of the company

while in that employment and have continued to be members after the employment

ceased and (c) prohibits any invitation to the public to subscribe for any shares in or

debentures of the company. A public company is one, which is not a private

company. The difference between a private and public company is –

(a) The minimum number of members in a private company is two while that of a

public company is seven. In a private company, the maximum permissible

number is fifty; but in public company it is unlimited.

(b) In a private company, the articles of association restrict the transfer of share

where in a public company there is no restriction.

(c) A private company is prohibited by its articles of associations to invite

members of the public to subscribe for any shares in or debentures of the

company; but a public company may invite the general public to subscribe its

shares or debentures.

(d) The minimum number of directors in a public limited company is three

whereas in private limited company is two.

(e) A private company can issue its share and debentures without issue of

prospectus but a public company cannot.

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(f) A private company can commence business immediately after obtaining a

certificate of incorporation but a public company has to wait till a certificate to

commence business is granted to it.

(g) A private company must add the word ‘private limited’ with its name where as

public limited company is required to add ‘limited’ with its name.

3. Memorandum of Association-First step in formation of the company is preparation of its memorandum

of association. It is a charter of the company. It contains provisions relating to name

of the company (name clause), address of registered office of the company

(registered office clause), its object (object clause), detail of authorised capital (share

capital clause), liability of the share holders (liability clause) and signatures of

promoter directors (signature clause). While processing loan application of the

limited company, the bank is required to check that (a) the company is authorised to

do business for which advance is required, (b) the company has necessary

borrowing powers (applicable for non trading company) and (c) if the company is

guarantor, unconnected with its business there is specific power in the

memorandum.

4. Articles of Association-The articles of association are regulation of the internal management of the

company and are subordinate to the memorandum. The articles of association define

how the objects of the company will be carried out. A public company may not have

an article of association and in that event table A of the Companies Act shall apply.

While processing the loan application of the company, the banker should study

articles of association to ascertain (a) who is authorised to open account? (b) Who

will execute the documents? (c) Who is authorised to deposit title deeds to create

valid equitable mortgage? (d) How common seal will be affixed? The banker should

also check that (a) company has power to borrow and mortgage the property, (b)

company has affixed common seal wherever required, (c) sealing has been done in

accordance with the procedure as laid down in the article, (d) necessary resolution is

passed in the board naming officer (s) in whose presence, the seal is affixed and (e)

documents have been executed as specified in the article or in the resolution. In a

recent judgement Hon’ble Supreme Court has observed “ so far as the question of

putting up of the seal of the company is concerned, it is a relic of the days when

medieval barons, who could not read or write, used their rings to make a

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characteristic impress. Even in the absence of a seal, the company may still be held

to be liable having regard to the authority of those who executed it.”

5. Certificate of incorporation and certificate to commence business-On registration, a company gets a certificate from the registrar, which is

known as Certificate of Incorporation. From the date of incorporation, a company

becomes a legal person. It is a conclusive proof that all formalities for giving birth of

the company have been completed. A private company can commence business

immediately on receiving certificate of incorporation but a public limited company has

to obtain a certificate of commencing business also.

6. Borrowing powers of a company-Every trading company has an implied power to borrow money and give

security for a loan provided such borrowing is incidental to the conduct of its

business. But non-trading companies do not enjoy such a right unless there is an

express power to that effect in the memorandum of association. The power to

borrow, whether express or implied, may be further restricted by memorandum of

association or articles of association of the company. In case money borrowed plus

money proposed to be borrowed exceed the aggregate paid up capital and free

reserves of the public company approval of the company in general meeting is

necessary (Section 293 (I) (d). Further no public company can borrow unless it has

been granted certificate to commence business (Section 149). The board of directors

of the company can exercise the power to borrow only by means of a resolution

passed in meeting of the board and such resolution must specify the total amount

outstanding at any time up to which moneys may be borrowed by the delegate (Sec

292). The board can delegate powers to Managing Director, Manager or any

employee to execute documents and complete formalities relating thereto.

7. Registration of Mortgages and charges-The Company Act has specified that charge and mortgages on assets of

the company should be registered with the Registrar of the company under section

125. These charges are (a) to secure an issue of debentures, (b) on uncalled share

capital of the company, (c) On immovable property or any interest thereon, (d) on

book-debt of the company, (e) not being pledge on movable property, (f) floating

charge on any property of the company and (g) charge on goodwill/trade mark/patent

of the company. Further prescribed particulars of the charge, together with the

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instruments by which it is created or a certified copy thereof, are to be filed with ROC

within 30 days after creation of the charge with form no. 13 along with either of the

form No. 8 (for fresh or modification of charge), form no. 10 (for secured creditors) or

form no. 17 (for satisfaction of charge). Even when there is any alteration or

modification in terms of sanction like change in interest rate, modification of charge

has to be filed. It is the duty of the company to file charge/modification. Where a

charge is created out of India on property situated out of India, the period of 30 days

will commence after the date the instrument creating charge could have been

received in India in due course of post. Further the charge created out of India,

permission of RBI is required under Foreign Exchange Management Act (FEMA).

The company is required to keep a copy of document by which the charge is created

in its registered office. The copy of instrument creating charge filed by the company

with ROC should be verified to be true copy by a certificate under seal of the

company by a responsible officer or by a person interested in the charge. Non-

compliance/filing of charge is subject to penalties.

Any person (including the financing bank) who is interested in the charge

can also file charge for registration with ROC and recover the fee spent for

registration from the company. In case of delay, company/interested person can

approach ROC, which can allow for extension of 30 days in case company is able to

satisfy for genuineness of the delay. Though the ROC has no jurisdiction to extend

the period for filing for registration beyond the extended period of 30 days, still the

creditor holding the charge unregistered even in the extended time is not without a

remedy. Under section 141 of the Companies Act, company may approach Company

law board, which can condone delay in filing of charge if satisfied. If Company Law

Board also refuses; the company or its creditor to file application under section 637-

(b) to government to condone the delay. Needless to add that even though extension

of time can be sought under the law the branch manager must ensure that charge is

filed with ROC within initial period of 30 days. The object of registration is that

members of the public dealing with the company should have a notice of the

particular properties, which might have been subjected to mortgage or charges. A

charge by way of subsequent mortgage, duly registered under section 125 will have

priority over a charge unregistered there under. Upon registration of charge, the

registrar of companies (ROC) is required to issue a certificate for registration of

charge and this is conclusive proof that charge has been registered and cannot be

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challenged on any ground. ROC is required to maintain the register in which all

charges are to be recorded (section 130). This register should remain open for

inspection by any person on payment of prescribed fee. In case the charge is not

filed as stipulated, the charge is void against the liquidator / any creditor of the

company in the event company goes into liquidation. However where the company is

a going concern the security created by the charge for which charge has not been

filed can be enforced through court as the defaulting company itself cannot deny the

lender the cover of security. This position of company law is in accordance with the

common law that no man can take advantage of his own default. In case charge has

been filed but not registered by the ROC, then charge holder is not responsible, as

there is no fault on his part. (State Bank of India Vs Depro Food Ltd & others 1988

Comp case 375,384 (P & H). However a prudent banker should always ensure that

charge is got registered, necessary certificate of registration of charge has been

obtained or post registration inspection of ROC record has been done to confirm

registration of the charge in bank’s favour. Just as it is obligatory on the part of the

company to file particulars of a charge or modification thereof, the company is also

duty bound to file satisfaction of charge. To protect the interest of charge holder in

the event of a fraudulent attempt by the company to file satisfaction of the creditor’s

charge section 138 (2) stipulates that ROC shall on receipt of satisfaction of charge,

shall send a notice to the charge holder calling upon him to show cause within a time

not exceeding fourteen days specified in the notice why payment or satisfaction not

be recorded as intimated to him. In case no objection is made, ROC will file

satisfaction.

As a part of government’s commitment to governance reforms, GOI under MCA

21 programme has introduced electronic filing of charge with ROC. For usage of e-

Forms for filing of charges bank will have to download it from MCA portal

www.mca.gov.in and the same will have to be digitally signed by both bank

manager as well as Managing Director/Secretary of the company. The relevant

document creating charge in favour of the bank will have to annex with the form after

scanning. The project is expected to go on live from 30th June 2006 by which time

bank officers are expected to understand the system as well as put in place system

of e-filing of the charge form.

8. Documents to be obtained from company-

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(a) Copy of memorandum of association and articles of association certified to be

true and up to date.

(b) A copy of Certificate of Incorporation and Certificate of Commencement of

business (in case of public limited company only).

(c) Certified true copies of the board resolution (i) to open and operate account,

(ii) to borrow money, (iii) to execute documents, (iv) to charge securities, (v)

to pledge shares/deposit title deeds for equitable mortgage and (vi) to put

common seal of the company on executed documents.

(d) Certified true copies of general body resolution (i) under section 293 (I) (d) of

the Act, where the borrowing exceeds the paid up capital and free reserves (in

case of public limited companies only), or (ii) An undertaking on prescribed

format that director will ensure to comply with the provision of the act under

section 293 (I) (d) and (iii) under section 292 (a) for creation of mortgage

over fixed assets of the company.

(e) List of present directors duly certified by secretary along with general body

resolution for their election.

(f) A copy of power of attorney if documents are executed by authorized

signatory under power of attorney.

(g) Confirmation under section 292 (5) that powers of the directors in respect of

the borrowings have not been restricted or withdrawn in general body

meeting.

(h) Certificate / Undertaking that directors of the company are not related with any

senior executive of the bank.

(i) Undertaking that the company will not make any major change in the

management involving transfer of ownership without previous permission of

the bank in writing.

(j) Undertaking that company will not have any objection to the bank disclosing

its name to CIBIL in case of default or otherwise so required by the bank.

(k) Undertaking not to pay commission to guarantors.

(l) Letter of negative lien stating that assets are free and un-encumbered and the

said assets shall not be sold, mortgaged, pledged or hypothecated or any way

encumbered without the previous consent of the bank in writing

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(m) A search report that movable and immovable property offered as security is

not subject to prior charge either registered with ROC or pending for

registration.

9. Execution of documents-(a) All documents to be executed in presence of branch manager or designated

officer.

(b) The documents should be got executed once under the seal of the company

with the designation of the signatory in the company and another individually

under common seal of the company.

(c) The documents to be executed by the person as authorized in the article of

association or as per resolution. They may be managing director, director or

officer.

(d) If Power of attorney holder executes documents, he should sign as

authorized signatory or as attorney.

(e) Demand promissory note (DPN)- as applicable either linked to PLR on

floating interest basis or fixed interest basis has to be executed. Common

seal must be affixed on DPN.

(f) The general letter of hypothecation (GLH) should be stamped as an

agreement. GLH should bear common seal.

(g) Equitable Mortgage- Title deeds will be deposited by the director/ officer of

the company specifically authorized for this purpose in presence of witness

(who will witness deposit of title deed) in pursuance of resolution passed by

the board of directors.

(h) Guarantee-Check that specific power to enter into contract of guarantee has

been provided in memorandum (incase company is doing business

unconnected with the beneficiary) and also check if such powers are vested

to directors. Also obtain a certified true copy of the resolution of board

regarding execution of guarantee and also approved text of guarantee.

Guarantee should bear common seal.

(i) 2nd Charge –The borrower, institution enjoying 1st charge and the bank, will

execute tripartite agreement. Charge deed must bear common seal. A copy

of the 2nd charge agreement to be held by the branch along with confirmation

that the charge has been filed/registered with ROC.

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10. Consortium advances under single window system-To overcome the delay in disbursement of sanctioned limit due to

cumbersome procedure of documentation involving various consortium banks, RBI

suggested introduction of single window concept of lending under which consortium

leader is authorized by the member banks to complete documentation formalities on

their behalf which includes charging of security in favour of consortium banks and

filing/ registration of charge with registrar of companies for all the banks. Draft of

model documents devised by IBA which were later were approved by RBI have been

adopted by all the banks. Sharing of security and rights and responsibilities of all

consortium banks is documented through inter-se agreement.

Following documents have been prescribed under the single window

system-

(a) Letter of authority given by all other member banks individually to a lead

bank.

(b) Letter of authority given by other member banks to second largest bank.

(c) Working capital consortium agreement.

(d) Joint deed of hypothecation.

(e) Inter-se agreement among banks.

(f) Revival letter for the purpose of limitation.

(g) Letter regarding release of working capital pending creation of second

charge.

-000-

Chapter- 10

Monitoring of Potential NPAsIntroduction

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The follow-up of advances which is in vogue in banks aims at assessing the working of

the units financed by them and ensuring the proper end-use of funds. This includes

stock verification, study of ledger data, factory inspection, study of quarterly information

system (QIS), discussion with the borrower, study of market report, etc. From the follow-

up exercise, it is expected to obtain signals of incipient sickness in the units/irregularities

in bank accounts and to take appropriate preventive action. (An exhaustive list of such

signals is given in Appendix I). Unfortunately, the present system follow-up is not

adequate and efficient enough to meet the above expectation. To elaborate, there are

too many signals; one does not know which one to be attended to. Further, although

sickness/irregularity is identified, timely preventive action is not taken. Further, in the list

of priorities of a branch manager, follow-up of advances is generally the last item.

Consequently, preventive action is not taken up, or action is taken with a considerable

delay. Finally, restructured standard assets which is on rise and reflect serious concern

about assets slippage, a proactive approach is necessary. As per estimate (ET

31.07.2010) standard restructured assets of 28 banks rose to Rs. 111,057 crores as on

March 2010 from Rs.65,956 crores as on March 2010 and are triple the size of NPA of

these banks and as high as 49% of net worth of these banks. Thus to overcome these

limitations of the existing system of follow-up of advances, “Credit Monitoring” is

suggested as a tool to supplement the present follow-up system and not supplant the

same.

Suggested Credit Monitoring System (CMS) Credit monitoring is a continuous process and, therefore, an officer in the branch

will have to be identified exclusively for this job, which may be designated as

Credit Monitoring Officer (CMO). He will not be involved in credit sanctions for

which there will be a separate officer who will be responsible mainly for

processing of credit proposals.

CMS should be applicable to all accounts. But initially, it is better to cover bigger

advances say, Rs 10 lacs or more. Similarly, this refers to those accounts, which

are potentially sick SSI units wherein loan default is for less than 12 months.

The CMO will be responsible for studying data/information gathered from various

sources for obtaining signals of incipient sickness of the potential NPA as well as

potential sick SSI units and taking up preventive/remedial action with the help of

Branch Manager and other field staff.

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He will also maintain a profile of the borrowers for which a 'Borrower Profile Card’

is suggested in Appendix II.

Credit monitoring ensures special attention to the high value borrowal accounts

enjoying credit limit in excess of Rs 10 lakhs so that it would be possible to take

early preventive action.

Sources of InformationTo obtain the signals of incipient sickness or an account becoming an NPA, the CMO

has to refer to various sources of information. These includes:

Conduct of cash credit, term loan, bills, Bank guarantee, letter of credit, DPG,

etc. reflecting outstanding exceeding the limit/drawing power, defaults in loan

installments, return of bills, encashment of bank guarantee, devolvement of

letter of credit, diversion of bank fund, etc.

Operations in the ledger account i.e. the borrower deposits entire sale proceeds

in the cash-credit account.

Stock inspection report- irregularity if any.

Factory visit report-observations of adverse nature.

Receivables management to focus age of receivables.

Renewal proposal and process note- observation of appraising officer.

Minutes of the meetings held with the borrower and also with co-banks in the

consortium meetings.

Market reports- adverse report if any.

Compliance of terms and conditions of the last credit sanction

Report of the last statutory audit, RBI inspection report, concurrent audit and

stock audit.

Published annual report of the unit.

Identification of Potential NPA / Sick Units in SSI SectorFrom the above-mentioned sources of information, the CMO has to collect data to

identify signals. Here, he should concentrate on few but useful signals which should

cover operational performance, conduct of borrowal accounts, movement in sock

position, Ageing of book-debt, market reputation, prompt submission of various

statements, non-compliance of terms of the last sanction, diversion of funds, collection of

dues from customers, etc. An attempt has been made to develop a format for

identification of signals as furnished in Appendix III. Signals have to be identified on

monthly basis. For each month , the CMO has to study the accounts allotted to

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him and has to bring such signals, if any, to the notice of the branch manager. In the

same format, it is attempted to put () mark or () mark against each signal. Presence

of a signal is marked by the sign () and the absence of a signal is marked by the sign

(). If there is a repeat occurrence of a signal, preventive action has to be taken up

immediately; otherwise the account may become sick/non-performing soon.

In the format, it is shown that the ABC Industrial Unit does not experience any

signal of sickness in the first four months. But in the fifth month, sales declined.

Consequently, cash credit account was overdrawn, bills account was out order and

there was a default of term loan. In the next month i.e. Month-6, sales once again

picked up but the party did not deposit the entire sale-proceeds in the account. As a

result of this, loan default and irregularly in cash credit and bills account continued. In

addition, funds were also diverted. Now, this is a potential NPA (account is out of order

below 90 days and installments are overdue below 90 days) and, there is still on month

left to prevent slippage and retain as standard asset. For this purpose, preventive action

has to be taken up.

Preventive ActionEach signal calls for certain preventive action. Sometimes, it may be advisable to watch

the signal for some time and thereafter take action. In any case, CMO will not only bring

the presence of signals to the notice of the branch manager and also suggest the type of

action to be taken up. He will instruct the staff at the counter to keep an eye on

transactions recorded in the ledger book. Such action would depend on the nature of

sickness/ irregularity. But certain actions are common which include writing of a letter to

the borrower, discussion with the borrower, visit to the factory-site, keeping a close

watch on the transactions recorded in the ledger book, writing a letter to the higher

authorities to indicate the developments in the account, etc. In Appendix IV, it is

attempted to discuss various actions to be considered to prevent sickness.

ConclusionIt is attempted to show how to obtain signals of sickness or an account likely to become

an NPA. In addition, action points are also suggested. Initially, credit monitoring may

be done for few accounts on pilot basis. Thereafter, other accounts may be covered. It

also calls for creating awareness on credit monitoring among the staff-members for

which, the branch managers have to take initiative.

Appendix I

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Checklist of follow-up measures to obtain signal of incipient sickness

A. Stock Inspection-irregularities.

B. Ledger Book- irregularities or adverse features.

C. Adverse market reports.

D. Adverse features obtained from financial statements.

E. Discussion with the Borrower in problem areas.

( Measure specific signals are given in Chapter 19-Due diligence in credit management)

Appendix IIBorrower’s Profile Card

Name ------------------------------------- Branch --------------------- RO/ZO :------------------

Constitution ---------------------------- Type of A/c : SS I/Corporate /Trading /ServiceIndustry (Code/Sub-code): ------------------------------- Products ---------------------------

Contact Person : Name------------------------ Guarantor : Name ---------------------------

Address -------------------- Address-----------------------

--------------------

------------------------ Tel.No. -------------------- Tel.No

------------------------

Fax No. -------------------- Fax No.-----------------------

e-mail -------------------- e-mail -----------------------

Associated Firm (if any): -------------------- Position of A/c : Sick/CDR/Recalled/ BIFR/DRT/Decreed/Others

Introducer : --------------------------- Bank Rating : -------------------------------------------

Single/Multiple (Lead Bank -------------------) Since when dealing with our

Bank------------------Year ------------

Date of Last Sanction: CC ----------------------- Renewal Date----------------------------

TL --------------------- Sanctioning Authority :Branch/ZO/CO

Others ---------------------

Securities : Primary -------------------- Expiry Date of Insurance Policy -----------

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Collateral ------------------ Expiry Date of Documents:------------------

M-1 M-2 M-3 M-4 M-5 M-6 Limit/BP OB OB OB OB OB

OBS.No. Credit Facility Limit/DP ------ ------ ------ ------ ------ --------

1. Cash Credit (Hyp)--------- ------ ------ ------ ------ ------ ---------

2. Cash Credit (Pled)--------- ------ ------ ------ ------ ------ ---------

3. Bills ----------------- ------ ------ ------ ------ ------ ---------

4. Other s (Short term)-------- ------ ------ ------ ------ ------ ---------

5. Term Loan ----------------- ------ ------ ------ ------ ------ ---------

6. Non Fund Based ---------- ------ ------ ------ ------ ------ ---------

Limits

Appendix IIIIdentification of Potential NPA

( for presence of a signal for absence of a signal)

S.No.

SignalMonthM-1 M-2 M-3 M-4 M-5 M-6

1 Fall in sales/cash losses/erosion in networth x x x x x

2 Overdrawals in cash credit account x x x x

3 Bills A/c out of order x x x x

4 Other short-term loan – default x x x x

5 Term loan-default : Int/Prin. x x x x

6 Development of DPG/LC/BG x x x x

7 Delay/Non submission of stock statement x x x x

8 Incomplete documentation in terms of

creation/ registration of charge, mortgage, etc.

x x x x x x

9 Non fulfillment of terms of last sanction x x x x X x

10 Diversion of funds x x x x

11 Payment from customers held up x x x x

12 Adverse market report x x x x X x

13 Unfavourable factors affecting the unit x x X x x x

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14 Others (specify) - - - - - -

Appendix IVCredit Monitoring Steps

(1) Identify the potential NPAs where loan default is for two months.

(2) Study the causes – whether default is due to inherent weaknesses or due to

temporary liquidity or cash flow problem.

(3) Offer contingency help immediately in the form of ad-hoc limits if cash flow mis-

matches are genuine.

(4) If limits are found to be inadequate leading to loan default during the year, ask

the borrower to submit the renewal proposal and enhance the limit suitably.

(5) If cheques are drawn on parties not related to business or heavy cash drawal

and no corresponding increase in stock, pass cheques for payment after a

detailed scrutiny. Borrowers should be advised to state the purpose of the

cheque for which it is drawn.

(6) Visit the factory immediately, if the stock statement is not submitted and verify

the securities.

(7) Collect the interest on monthly basis. Frequent visits are called for wherever

there is a default of interest payment.

(8) Keep the documents live, obtain balance confirmation, do rectification of

audit/inspection irregularities .

(9) Rectify /attend to the observation of concurrent auditor, statutory auditor, branch

inspector, credit audit, regional manager’s report, etc.

(10) Read the local news-paper daily, ascertain the position of accounts with other

banks, exchange information about the borrower in the consortium meeting, etc.

(11) Initiate any other steps to prevent slippage in standard asset.

-000-

Chapter- 11

Recovery Measures

1. INTRODUCTION

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NPA of the banking system is moving up. Gross NPA of PSB stood at Rs. 123 lakh

crores at the end of Jun, 12 and have seen an addition of Rs. 11000 crores in last 15

months (ET 23.08.12). In this chapter, it is attempted to discuss about various recovery

measures adopted by banks and financial institutions (FIs) to recover dues including

NPA. Over the years, many initiatives have been taken by the Reserve Bank of India

and the Government of India in introducing new measures in the light of the problems

experienced by banks and FIs In addition, these banks and FIs have also tried to

come-out with innovative ideas for NPA reduction. Data in respect of all these measures

is not available and hence, it is difficult to point-out which of the measure is most

effective. But experience suggests that each measure is unique in terms of its

effectiveness. Hence, it is worth to review such recovery measures. For our

convenience, these can be classified into non-legal and legal measures.

NON-LEGAL MEASURES1. Reminder system

2. Visit to Borrower’s Business Premise/Residence

3. Recovery camps

4. Road shows

5. Appointment of Professional Recovery Agents

6. Holding on operations

7. Rehabilitation of sick units

8. Corporates Debt Restructuring

9. Loan compromise

10. Lokadalat or Loknayalaya

11. Circulation of List of Defaulters

12. Appropriation of subsidy or exercising the right to set-off

13. Recalling of Advances

14. Write-off

15. Recovery through Specialized Branches (Recovery branches)

LEGAL MEASURES15. Recovery through Judicial Process (Filing of suit)

16. Debt Recovery Tribunals

17. National Company Law Tribunal

18. Merger and Amalgamation

19. Financial Reconstitution

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20. Recovery under Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interest Act, 2002.

21. Other Legal measures.

NON-LEGAL MEASURES1. Reminder SystemThis is the cheapest mode of recovery by sending reminders to the borrowers before the

loan instalment falls due. Generally, response to this arrangement particularly from

honest borrowers is encouraging. But efforts need to be strengthened in banks in

sending reminders on timely basis. Enough care should be taken to prepare a draft-

letter in informal language (preferably regional language) If possible; better quality

stationery may be used to motivate borrowers to open the letter. With the

computerisation of branches, this measure can be heavily relied upon.

2. Visit to Borrower’s Business Premise/ResidenceThis is a more dependable measure of recovery. Visits need to be properly planned.

Involvement of staff at all levels in the bank branch is called for. Costs involved in

recovery need to be kept to the minimum. Frequent visits are called for in case of

hardcore borrowers. Over the years, it is observed that the number of visits is going

down due to cut in workforce in banks. Consequently, the recovery process is affected.

Branches should maintain a record of visits made and recovery amount collected. It is

essential to conduct visits in a planned manner when limited time is available in this

regard.

3. Recovery CampsIn respect of agricultural advances, recovery camps should be organized during the

harvest season. To take maximum advantage, recovery camps need to be properly

planned. It is also essential to take the help of outsiders, particularly, revenue officers in

the state government, local panchayat officials, regional manager in the bank, etc. It

also calls for a professional approach to give a wide publicity of the recovery camp to be

organized in the local area, mobilize as many farmers as possible and motivate the staff

to get involved in the recovery drive. On the spot compromise/settlement should be

encouraged which gives positive signals to the borrowers.

4. Road showsIn case of recalcitrant borrowers, it is a very effective way of creating pressure on the

borrower. During road show, a group of employees calls on the borrower and persuades

him to repay bank’s dues. The timing of road show is strategically fixed during peak

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business hours of the borrowers so that there is moral pressure on him not only from his

neighboring businessmen but also from the customers. Many banks have very

effectively used this tool of recovery, particularly from businessmen and salaried class.

There are certain do and don’t for the road show. The road show must be organized in

peaceful and non-violent manner. It should be within normal business hours and should

not be organized either in the late evening or early morning. Manager should watch over

the activity of his other officers and see that no body takes law and order in his hand.

Confrontation or show down with the borrower should be avoided.

5. Appointment of Professional Agencies for RecoveryRecently, IBA has framed model policy for banks on matters concerning the

appointment of outside professional agencies whose services can be utilized to

ascertain the whereabouts of the borrowers, enforcement of securities and recovery of

money lent. It is observed that there is some hesitancy on the part of public sector

banks in engaging them for recovery purposes due to unpleasant experiences in certain

cases. But looking to rising magnitude of NPA, banks have little option but to engage

professional agencies for recovery and enforcement of securities. This should, however,

be done after examining the credentials of the agencies and following guidelines. It is

also essential for the bank to keep a constant vigil on their practices so that there is no

occasion of alleged harassment or intimidation of any kind, either verbal or physical,

against any person in their debt collection efforts, including acts intended to humiliate

publicly or intrude the privacy of the borrowers/guarantors/ or their family members . In a

land mark judgment given by Supreme Court Hon’ble Justice A.R. Lakshmananan and

Altamas Kabir has observed that “‘we are governed by a rule of law. The recovery

could be done only through legal means. The banks cannot employ goondas to take

possession.” As per draft guidelines of RBI circulated on 30 th November 2007, RBI has

suggested that Indian Institute of Banking and Finance will introduce test for recovery

agents which will have training period of minimum 100 hours and appoints of recovery

agents after one year will be subject to their passing such tests.

6. Holding on operationsHolding on operations gives respite to the borrowers and help them to run the

business till finalization of rehabilitation or restricting package. The facility can be

permitted in NPA or potential NPA accounts which show warning signals.

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7. Rehabilitation of Sick Units At present, there are two types of sick units financed by the banks and the financial

institutions. These include:

a) Industrial units in the small scale sector.

b) Industrial units in the Non-small scale sector.

As per the Government of India definition, a small scale industrial unit is the one in which

case, the investment in the plant and machinery (original costs) does not exceeds

Rs.100 lakhs ( enhanced to Rs. 500 lakhs for certain specified items) and in the case of

ancillary units the same should not exceed Rs.25 lakhs. All those accounts, which fulfill

this definition, are treated as the units in small sector. All other industrial accounts are

treated as units in the non-small scale industrial sector. Reserve Bank of India has

defined a 'weak’ unit in the non-SSI sector. Sick Industrial Companies (special

provisions) Act (SICA) also defines a 'sick’ unit in the non-SSI sector.

Definition of a Sick Unit in the SSI SectorSSI and Tiny/Decentralized unit – Any borrowal account which becomes sub-standard

when interest or principal is overdue for more than 6 months or, its accumulated losses

exceed 50% of net worth and the unit has been in commercial production for atleast 2

years, is considered as sick unit.

Definition of a Sick Unit in Non-SSI Sector i.e., Weak CompanyAccording to the RBI definition “an industrial unit will be classified as 'weak' at the end of

any accounting year if it has accumulated losses equal to or exceeding 50 per cent of its

peak net worth immediately preceding 5 years”. This definition is applicable to all those

units in the non-SSI sector and not falling under the purview of the Sick Industrial

Companies (Special Provisions) Act, 1985.

The section 3 of the Sick Industrial Companies (Special Provisions) Act 1985 defines a

sick company as under:

“A Sick Industrial Company means an industrial company registered as a company for not less than 5 years and has accumulated losses equal to or exceeding its net worth”. Causes of SicknessCauses of industrial sickness have to be viewed from the general background of

industrial economy. At a point of time, the problems of industries are not uniform.

However, factors generally responsible for the problems can be divided into external and

internal. External factors are those over which the unit has no direct control and, internal

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factors are those which are within the control of the management of the concern.

Sickness can originate right from the stage of conception to the stages of crystallization

of the concept and/or implementation of the project.

(A) Rehabilitation of Sick Units not falling under the purview of the SICAIn general, a sick unit is defined by considering its capacity to generate internal funds. A

sick unit fails to generate internal surplus on a continuing basis and depends on its

survival on frequent infusion of external funds. Thus the nursing programme is for

raising the unit’s capacity to generate adequate internal surplus. A certain portion of

internal surplus could then be used for reducing the irregularity in the account. A

suggested approach to nursing of sick SSI unit is given in chapter-13.

(B) Rehabilitation of Sick Companies as under Sick Industrial Companies Act (SICA) -Where an industrial company (defined under Sec 3 of Industrial Development and

Regulation Act of 1951) has become sick, the Act provides for a reference to the Board

within 60 days of finalization of audited financial statements for determination of

measures that may be adopted. Such measures may include merger, financial

reconstruction sale or lease of a part or whole of activity, change of management, take

over of ownership etc. It is obligatory for the sick companies to refer their cases to the

Board. Financial institutions, RBI and the Government may refer the companies to the

Board for Industrial and Financial Reconstruction, referred to as the Board hereafter.

The Board determines whether the company has become sick and then registers the

case. After registration the Board decides the strategies to be adopted for revival. The

scheme is then prepared. The written suggestions and consent from all concerned

parties are obtained. Thereafter, the legal formalities as stated under the relevant Acts

(such as Companies Act 1956, Foreign Exchange and Regulation Act etc.) are

completed. After the formalities are completed, the scheme is sanctioned which then will

be binding on all the concerned parties. Where the sanctioned scheme is implemented,

the Board may call for any information from the company for assessing the progress in

implementation of the scheme and effects of the scheme on overall performance of the

company. If necessary, the Board may appoint a Special Director on the Company’s

Board to safeguard the interest of financial institutions. For any misuse of funds, the

Board can take legal action. Thus, it is hoped that the Board consists of members who

have special knowledge and professional experience of not less than 15 years. There is

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a provision to appoint 14 members on the Board. With the above arrangements it is

hoped that the Board would be able to deal with the matters of rehabilitation more

effectively. The Industrial Reconstruction Bank of India (IRBI) performs a similar job but

it does not possess as much statutory powers as that of the Board. Under the Act of

1985, the Board and Appellate Authority are deemed to be the civil courts and all

matters of rehabilitation are dealt with legally to safeguard interest of sick companies

and public. Nursing or rehabilitation programme varies from unit to unit. But it is

essential that important aspects of nursing or rehabilitation have to be highlighted in the

programme. In this context, a broad outline on nursing or rehabilitation is already

discussed earlier.

To conclude on rehabilitation, though enough arrangements are made in terms of

formulation of policy guidelines, rehabilitation schemes, creation of sufficient number of

institutions to look after revival of sick units, the success rate is very low. Hardly, 5 per

cent of total sick units are fully revived. This is mainly due to lack of seriousness on the

part of entrepreneurs, lack of co-ordination between banks and financial institutions,

substantial delay in release of subsidies/relief from the government, etc. But our efforts

in rehabilitation of sick units need to be strengthened. It is cheaper to revive a sick unit

than starting a fresh one on its closure. Further, chances of recovery of bank dues are

high if sick units are revived successfully.

8. Corporate Debt Restructuring (CDR) BodyA need was felt to create a special agency to facilitate debt restructuring because there

has been some hesitancy on the part of banks and financial institutions to implement

RBI guidelines on debt restructuring. Recently, a three-tier body, viz., CDR has been set

up to co-ordinate the corporate debt-restructuring programme. CDR consists of forum,

Group and Cell. While the Forum evolves broad policy-guidelines, the Group takes

decisions on the proposals recommended by the Cell. Initially, the borrower approaches

his Lead Bank/FI with a request to restructure debt, which in-turn puts up the proposal to

the Cell. The CDR covers only multiple banking accounts enjoying credit facilities

exceeding Rs 20 crore. Cases of DRT, BIFR and doubtful and loss accounts and suit-

filed cases are outside the purview of the CDR. Even cases of willful default can be

considered excepting cases of willful default or diversion of funds with malafide intention.

Thus, standard and sub-standard accounts are only eligible to seek CDR shelter.

Decisions of the group are based on the `super majority’ principle. If 75 per cent of the

secured creditors by value and 60% by number agree to the rehabilitation plan, it is

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binding on the other banks/FIs. The CDR is a voluntary system based on debtor-creditor

agreement and inter-creditors’ agreement. No banker/borrower can take recourse to

any legal action during the `stand-still’ period of 90-180 days. While the arrangements

under CDR seem to be feasible from the debt restructuring perspective, its success

depends upon the cooperation extended by borrowers and bankers, on the one hand,

and understanding among banks and FIs, on the other. Doubts are raised about the

implementation of these agreements taking into the present working of the loan

consortium arrangements. RBI has constituted a committee under chairmanship of Mr

Vepa Kamesha, Deputy Governor, RBI to look into operational difficulties of the scheme

and to suggest measures to make the scheme effective. Total debt restructuring is

expected to reach Rs.1.5 lakh crores at the end of March, 12 from Rs. 1.1.lakh crores at

the end of March, 11.

9. Loan compromiseIn general, it is experienced that filing of suits and recovery of dues of banks through the

process of courts is a cumbersome, expensive and time consuming task without any

fruitful results in many cases. One of the main reasons attributed for non-recovery of

dues through the process of law/court is lack of proper follow-up and timely and proper

action. Hence, it would be worthwhile to think of other ways to tackle the situation. The

tradition of amicable settlement through panchyat and arbitration, leads to think as to

why bank loan disputes cannot be settled without having a recourse to the court.

A compromise in bank loan means agreeing to a borrower’s request of accepting a part

of outstanding of dues in the books of the bank as full and final payment or allowing for

the non-compliance of the terms of the loan, after analyzing the alternative courses of

action, genuineness and capacity to repay. It is also called as voluntary debt reduction

or scaling data of dues. In the situation, where the borrower’s ability/capacity is repaying

the bank’s dues and the bank’s ability to recover the same by other means are limited; a

compromise proposal can work well.

Compromise proposals can be entertained at different stages, which include (a) pre-

litigation stage, and (b) post litigation/decree stage. At the pre-litigation stage,

concessional measures such as reschedulement, rephasement, rehabilitation, etc. can

be used which would allow some breathing time and build/strengthen the repayment

capacity of the borrower. However, when such measures initiated in the account do not

yield any fruitful result and the borrower incurs heavy cash losses, it is better to go in for

a compromise or scaling down the dues. Similarly in other cases, where business loss

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has crept in due to one or other genuine reasons and the borrower is not a willful

defaulter and requests for minor concessions such as waiver of penal interest,

concession in interest rate, etc, the borrower’s offer can be accepted for compromise. In

these cases, reschedulement of unpaid loan installments can also be considered.

Compromise at post-litigation/decree stage can also be entertained so that the

borrower’s business or activity is uninterrupted. In order to avoid cost, labour and time

involved in litigation matters and to have better image in market, borrowers offer a lump-

sum amount and request the bank to withdraw the suits against them. At times, it

becomes necessary, in some cases, to settle outside the court through an amicable

agreement and, the antecedents of the defendant are such that courts take a

sympathetic view and award a lenient decree against the defendants. Sometimes, after

obtaining decree, if a third party comes forward to purchase the assets, the bank may

consider the case for compromise. It is also possible for the bank that it may go in for

compromise if the decreed asset would not fetch more than the claim the amount. In all

cases, where suits have been already field, whatever compromise is to be made, must

be sorted out through court in the form of a consent decree, so that it will be binding on

all defendants. If parties do not fulfill the promise, remedy through court or Debt

Recovery Tribunal will always open to the banks.

There can be two types of compromise. The Reserve Bank of India and the

Government of India worked out One Time Settlement Schemes covering loan

outstanding upto Rs. 5 crores (subsequently raised to Rs. 10 crores) and Rs. 25000

respectively. In addition, each bank is given an autonomy to evolve One Time

Settlement (OTS) Scheme. It is necessary to create awareness on OTS and mobilize as

many compromise proposals as possible. There should not be any delays in arriving at

compromise. Such proposals should be prepared carefully keeping in mind the bank

guidelines. Otherwise, this may become a vigilance case. It is better to involve all staff

members in mobilizing compromise proposal. Care should be taken that the recovery

through compromise does not give a wrong signal to a good borrower. Over the years,

banks have succeeded to recover through compromise substantially. But there is

enough scope step up the recovery drive through this measure.

If decided to go in compromise, all issues must be sorted out through the court in the

form of a consent decree, so that it will be binding on all defendants. In case of more

than one judgement debtor, the consent of one and all is required for compromise. In

any case, the compromise has to be decided on the basis of merit of each case.

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In view of the fact that huge amount is being blocked in non-performing assets for quite

a long period with all kinds of risks and uncertainties, compromise for settlement of debt,

viz., by allowing certain concessions to borrowers, has to be encouraged and for that

purpose, a cost-benefit analysis can be done which on one hand takes into account the

loss which may arise in case compromise is accepted and the benefit which may accrue

if the compromise is not made, on the other. In general, it is experienced that the banks

will be advantageous position in opting for an amicable settlement rather than for legal

approach. Besides, such compromise would avoid all legal complications, time lapses

and other inherent risks of individual loans.

Every branch manager has to formulate a compromise proposal in the light of broad

guidelines issued by the bank. The proposal should contain major items which include

means or capacity of the party, determination of amount covering outstanding amount,

other charges, etc. efforts already made for recovery, staff accountability, etc. The

proposal recommended should be referred to the sanctioning authority which examines

several factors including fulfillment of terms and conditions of sanctioning of loan

compromise, any laxity in conduct and post-disbursement supervision of the account,

any act of commission or omission on the part of staff leading to the debt proving

irrecoverable, enough recovery efforts put in, valuation of securities, interest to be

charged in respect of settlement though installment, etc.

Loan compromise should be considered as a last resort of recovery. It should be a

voluntary exercise. It calls for a professional approach in preparing the compromise

proposal for which each bank is given autonomy by the Reserve Bank of India. In

addition, compromise schemes introduced by the Government of India (upto Rs

25,000/-), the Reserve Bank of India (in the first instance upto Rs 5 crores and then for

Rs 10 crores), should be implemented as per the guidelines covering the eligibility

criterions, the cut-off date, and nature and extent of concessions. Decisions on

compromise proposals should be taken by adopting a committee approach. In this

regard, banks have been advised to set up a Settlement Advisory Committee. Though

there are many schemes of compromise, success in recovery is limited due to lack of

awareness of such schemes by small farmers, small traders etc; due to stricter vigilance

norms the staff is hesitant to entertain compromise cases; difficulties in fixing staff

accountability before recommending a proposal; etc. Efforts should also be made not to

encourage good borrowers to seek compromise. In any case, due to high NPAs, banks

have to depend on loan compromise as an effective measure of recovery.

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10. Lokadalat or LoknyayalayaThe concept of Lok Adalat was introduced in 1982 as part of strategy of legal aid. By

now, it is known for effecting mediation and counselling between the parties and to

reduce burden on the court, especially for small loans. Large number of Lok Adalats is

being organized in different parts of the country from time to time and it has got

recognition and patronage, particularly, every segment of the society. Based on

experience of several states, a Central Act known as Legal Services Authorities Act,

1987 was passed providing legal basis for the Lok Adalats and Legal Authorities to the

compromise arrived at between the parties through such Lok Adalats. Several people of

particular localities / various social organizations are approaching Lok Adalats which are

generally presided over by two or three senior persons including retired senior civil

servants, defence personnel and judicial officers. They take up cases which are suitable

for settlement of debt for certain consideration. Parties are heard and they explain their

legal position. They are advised to reach to some settlement due to social pressure of

senior bureaucrats or judicial officers or social workers. If the compromise is arrived at,

the parties to the litigation sign a statement in presence of Lokadalats which is expected

to be filed in court to obtain a consent decree. Normally, if such settlement contains a

clause that if the compromise is not adhered to by the parties, the suits pending in the

court will proceed in accordance with the law and parties will have a right to get the

decree from the court.

To arrive at compromise with the party, banks may provide remission of interest, etc. In

this context, certain guidelines have been formulated by banks in consultation with the

Indian Banks Association (IBA). Accordingly, the bank-suits involving claims upto Rs 5

lakhs (now raised to Rs 20 lakhs) may be brought before the Lokadalat. There should

be decree for the interest claimed before suit. Now a days, even non-suit filed cases in

the doubtful and loss categories can be considered for settlement. Debt Recovery

Tribunals can also organize Lokadalats. Lokadalats have to finalize settlements in terms

of broad guidelines of the concerned bank.

In general, it is observed that banks do not get the full advantage of the Lokadalats. It is

difficult to collect the concerned borrowers willing to go in for compromise on the day

when the Lokadalat meets. In any case, we should continue our efforts to seek the help

of the Lokadalat.

11. List of Defaulters of RBI and of CIBIL

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Currently, the RBI circulates the list of defaulters among Financial Institutions (FIs) and

Banks which is found useful in avoiding wilful defaulters. The RBI has defined a wilful

defaulter for the first time. It has provided the broad parameters for identification of wilful

defaulters whose list will be circulated among banks and FIs. Auditors of companies

have to report in their certificate about diversion of funds, if any. In addition, on January

30, 2001, Credit Information Bureau of India Limited (CIBIL) was set up to provide

critical data required by any credit institution before arriving at credit decision. CIBIL

was set up jointly by State Bank of India, HDFC, Dun and Bradstreet and Trans Union.

Credit Information Bureaus, like credit rating agencies, are critical for the operation of the

financial system and, in many ways, have a privileged relationship with the regulator.

Banks/FIs to obtain the consent of all their borrowers for dissemination of credit

information to enable CIBIL to compile and disseminate credit information. CIBIL now

has a database of 8 million records of credit history of individual consumers taken from

various banks, financial institution, micro-finance companies and non-banking finance

companies. CIBIL also plans to broaden its scope to store information on buyers of

insurance and services like telecom and other utilities. FI/Banks/NBFC who are

members of CIBIL can determine on line whether a prospective borrower is a disciplined

borrower or a serial defaulter on payment of fee of Rs 10 per borrower.

11. Appropriation of Subsidy or Exercise of Right of Set-offIn some of the sponsored schemes, namely, SEEUY or SUME, the amount of subsidy is

kept in deposit accounts to be appropriated after a specified lock-in-period. In such

cases where subsidy is available and the account is likely to become NPA, the subsidy

amount should be appropriated (keeping in view the requirements of lock-in-period) in

the loan account and necessary action should be initiated for recovery/write off of the

balance amount. Where readily encashable securities such as Fixed Deposits, LIC

policies, Govt. Securities etc. are available and borrowers are not responding to request

for regularization of accounts, such securities should be encashed after giving due

notice to the borrowers, guarantors etc.

12. Recalling of AdvancesWhen rigorous follow up efforts do not yield any fruitful result and circumstances so

warrant that the their loan amount to be realized at once and/or facility to be terminated

in the interest of the bank, a final recall notice has to be served asking the party to adjust

the irregularity in the account immediately. Wherever necessary, the party is also

informed about the bank’s intention to terminate the facility after the specified time limit.

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As far as possible, issuing of legal notice should be restricted to once only and in case of

small advances, recall notice through an advocate may be avoided unless the

circumstances require such a course of action. Recall notice should be sent if the

borrower is a willful defaulter, bank liability is significantly uncovered, death of the

borrower, dissolution of partnership firm, siphoning of funds, borrower refusing to renew

the credit limit, etc. All normal recovery efforts should have been made to pursue the

borrower and guarantor to repay the dues which include personal contacts, persuasion,

serving demand notice, bringing local influence, proposal for transfer to recalled

advance, etc. The proposal should be submitted to the appropriate sanctioning authority

at least six months before expiry of Limitation period. As per the Credit Guarantee Fund

Trust, requirement of a recall notice to borrower/guarantor should be issued providing

therein a 30 days’ time for adjustment of the account. The notice should be served

properly. On serving a recall notice and getting the approval of the higher authorities, the

accounts should be transferred to recalled-category to exercise utmost care for effecting

recovery, and to have special control over accounts. Branch managers should initiate

appropriate course of action for recovery depending upon the case. In respect of

genuine borrowers, the action points include persuasion, personal contracts,

reschedulement, remission of penal interest, one-time settlement and write off wherein

the amount is small and chances of recovery are almost nil. But in respect of willful

defaulters, it is better to file a suit. While sending a proposal to recall the advance to the

higher authorities, necessary information should be provided in the prescribed formats.

Such information includes statement of account, Confidential Report (CR) of borrowers

and guarantors, latest stock position, valuation of securities, present activities, reasons

for stopping operations, efforts made for recovery, etc. Interest application in the

account should be stopped as per prudential norms but must be calculated each month

but for the purposes of filing suit, Credit Guarantee Fund Trust, etc interest and other

charges may be debited to a separate account i.e. sundries or suspense account. Any

recovery made from the recalled advances, the amount to be shared with the Credit

Guarantee Fund Trust on pro-rata basis. Corresponding entries have to be made in the

party’s recalled advance account. Thus, the exercise of recalling of advances is one of

the recovery strategies, which are found effective in respect of genuine borrowers who

avoid facing legal action through the courts.

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13. Write off If it is going to be unremunerative either to file suit and/or continuing the account in the

bank's books, it is advisable for the bank to go in for waivement of legal action and/or

writing off dues. By waiver of legal action, banks may take a decision not to pursue

recovery through a Court of Law. But for write off, the banks can decide to close the

account by transfer of funds from their profits to the loan account. Waivement of legal

action is suggested when (i) the means of the borrower are negligible, (ii) borrowers are

below the poverty line, (iii) cost of recovery is higher, (iv ) beneficiaries are absconding,

(v) it is difficult to obtain periodic balance confirmation of debt cum-acknowledgement of

debt, and (vi) securities are already sold by the borrower. Write off is proposed under

certain circumstances such as (i) borrowers are adjudicated as insolvents and the bank

has already realized part of the dues as a secured creditor, (ii) Revenue authorities

under the State Public Recovery Act have recovered some amount and there no further

chances of any recovery (iii) both borrower and guarantor are untraceable after selling

their assets, and (iv) decrees remain unexecuted several times due to reasons beyond

the control of the bank. Decisions to waive legal action or write off are taken at

controlling office on recommendation of the Branch Manager. If permission of the

Credit Guarantee Fund Trust is required, the same may be obtained. For write off,

various factors are considered which include (i) means or capacity of the borrower and

guarantor (ii) the amount to be written off (iii) efforts of recovery already put in and, (iv)

staff accountability. The write off exercise is internal and the branch staff should keep

the matter confidential. Even after write off, recovery efforts should continue and if any

amount recovered in this regard, the same may be shared with the Guarantee Fund

Trust on pro-rata basis. Finally, the branch managers should comply with the entire

bank guidelines in respect of write off.

14. Recovery Through Specialized (Recovery) branchesTo deal with the matters related to tribunals, certain expertise is required. Such

expertise is also needed to effect recovery from core NPAs. In this regard, a few public

sector banks have set up Recovery Branches, which are exclusively concerned, with

the NPAs with a total liability of Rs. 10 lakhs and above. These branches undertake

certain activities which include creation of data base of NPAs, monitoring of the NPAs,

recovery from NPAs through compromise, follow-up of the decreed accounts etc. and

additional attention to the matters related to special tribunals. These branches are set

up without creating any burden to the bank by using the unutilized premises. A senior

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executive heads these branches. Officers working earlier in rehabilitation cell in the

controlling office are generally posted to these branches. Each branch is provided with a

computer to create the database. These handle suit filed accounts, recalled advances

and the cases in which legal proceedings are yet to be initiated. The number of

accounts in these branches is in the range of 60 to 90. These branches should keep a

close contact with the advocates and court authorities. Execution of decree or DRC

certificate is their prime task. These branches experience a few problems. To

elaborate, response to compromise proposals from borrower is not encouraging.

Consequently, these branches have to go through the lengthy procedures for court

settlements. In decreed accounts, details of assets of the judgement debtor are not

available in most of the cases since the time lag between the date of filing and the award

of a decree is more than 10 years. As a result of this, execution is found to be difficult.

Finally, it is essential to create the required expertise by providing at least one law officer

in the recovery branch. Even after the transfer of accounts to the recovery branches, the

original branches should continue to put in their efforts for recovery and assist the

recovery branches in finalizing the compromise deals. While transferring the accounts,

the original branches should ensure necessary details of net worth, securities,

whereabouts of the key partners/directors and guaranteers, etc. In this regard, they may

also prepare a fresh inspection report on the accounts to be transferred to the recovery

branches. Taking into account the increasing number of NPAs and complexities of

recovery, these branches may engage professional recovery agencies on fee basis. But

it should be ensured that these agencies should not follow unlawful measures. Similarly,

to know about the details of the properties of the borrowers/ guaranteers, services of a

professional detective agency may also be hired provided their fees are reasonable.

Lastly, wherever good clients are available in the local area, they may also be

persuaded to take over the recalled/decreed accounts to effect recovery.

15. Help of informers: With defaulters employing new means to siphon off funds and

conceal assets, banks are also reinventing ways and means to identify assets own by

defaulters to take recourse to attachment and auction. Madras high court vide its 2007

judgment has considered legality in engaging informers while ruling that if borrows can

find newer methods of evading repayment of bank loan, banks are justified in devising

newer methods of recovery.

16. Other Measures

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It is suggested to review the existing system of staff incentives for recovery from

hardcore NPAs/de-recognized interest. Incentives may also be offered to lawyers who

can manage to get a decree in a record time. Close monitoring of suit-filed cases with

dealing advocate is also called for. Certain banks are having system of periodical review

with the advocates, which has been very effective. Finally, in respect of small advances,

loan write-off may be considered, if the chances of recovery are not fair and cost of

litigation is disproportionately high to possible recovery

LEGAL MEASURES17. Recovery through Judicial ProcessWhen bank’s are convinced that all other non-legal recovery measures would not bring

any positive result and the documents may become time barred or have fear that the

securities charged might be alienated to the determent of the bank, bank has to resort

to legal action. Before taking a decision to file a suit, the bank shall ensure that there

are sufficient securities available in the account and the borrowers and guarantors are

having adequate attachable assets to satisfy the decree against them. The purpose of

obtaining decree serves the purpose only when it is capable of being executed.

Enough care has to be taken at early stage of recovery through courts. These stages in

chronological order include summon servicing, submission of a written statement,

recording the evidences, arguments, framing of issues, decision and order. Firstly, the

permission to file suit has to be obtained from the competent authority in the bank.

Thereafter, the branch manager to file suit should contact the approved advocate.

Before filing the suits, branch manager should ensure that documents are live, securities

are properly charged to the bank, fresh financial report on borrower / guarantor is

obtained, and a complete list of witnesses is prepared. The banker should exercise the

right of set off / appropriations, if any liquid security/balance in other account is

available. The plaint prepared by the advocate is checked up thoroughly as to the

correctness of facts and figures. All parties and guarantors are to be sued. Names and

addresses and securities should be stated properly and, suit should filed in the court of

the specified jurisdiction. A notice of demand to the borrower and the guarantor should

be issued before commencing any legal action. In respect of a suit against the

government, statutory notice should be sent in accordance with the provisions of Section

80 of CPC.

In particular, to serve the summons, address and other details of the defendant should

be collected by the branch manager. Bank's advocate should be contacted time and

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again to impress upon him to complete court formalities relating to hearing, submission

of statement, etc. The branch manager should brief the advocate on banking aspects.

After the decree is awarded, the details of the same should be read carefully.

There can be different kinds of decree such as a) simple mortgage decree which is for

the realization of money charged on immovable property by sale, b) for recovery of

possession of land; c) for recovery of any property other than land or money; d) for

ordering to do some act other than payment of money or to stop from doing some i.e.

under this may be classified decrees for specific performance of contracts, execution of

documents, injunction, etc.

If it is a conditional decree, condition must be fulfilled before execution. A decree which

is on the face of it a nullify cannot be executed. It must not be barred by limitation.

Execution of decree shall be in different forms such as delivery of property, appointing a

receiver or in such other manner as the nature of relief granted, attachment and sale and

by arresting of Judgment Debtor (JD). Execution by arrest is not available as a matter of

right and arrest or detention cannot be ordered unless it is proved to the satisfaction of

the court that the borrower is unwilling to pay inspite of adequate means to pay. The

burden of proving this is on the decree holder. Court may refuse simultaneous

execution against the person and property of the debtor.

According to Article 136 of Limitation Act, 1963 the period of limitation is 12 years for the

execution of any decree other than those granted and mandatory injunctions or order of

any civil court. But an execution application made within 12 years, may carry the

execution proceedings beyond 12 years for the purpose of final completion. Money

payable under a decree shall be by depositing into court, payable outside court directly

to the decree holder or his/her banker, or as the court directs.

Further, the execution may also be applied against the Judgment Debtor. If the

Judgment Debtor dies before satisfaction of the decree / order, the decree holder may

apply for execution against his legal representatives. The legal representative shall be

liable only to the extent of the property if the deceased debtor, which has come to his

hand and has not been fully disposed off. The court may compel such legal

representatives to provide such account as it thinks fit. Similarly, the application for

execution is to be paid by the decree holder. If he is dead, the legal representatives may

apply for execution.

As soon as the accounts are decreed, it should be ensured whether the decree is in

conformity with the claims made by banks in the plaint. In case of any major

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discrepancy from bank’s normal claim, steps should be taken for revision / appeal within

a reasonable time, say one month from the date of decree. As soon as decrees are

awarded , execution petition should be filed within three months of the date on which

certified copies are made available to the bank branch. In decreed accounts where

certain agricultural land is to be attached, bank may participate in the auction for which

necessary permission from the competent authorities within the bank is needed. In case

securities are attached before judgment and / or after execution of decree and kept in

bank’s custody, due care should be taken as to keep them in tact. When a case is

decided partly or wholly against the bank, desirability of filling of an appeal or otherwise

should be considered. If there is a default clause, which states “whenever borrower

fails to pay three consecutive installment, decree becomes absolute or otherwise” steps

for execution of decree for whole amount should be initiated on occurrence of the

default. The judgment debtor which does not pay in terms of the decree, alternative

steps for execution, by attachment and sale of the properties and/or by arrest of the

judgment debtor etc. as may be deemed for, should be taken promptly. Insolvency law

enables a creditor, who has obtained a decree to realize his debt by serving insolvency

notice of not less than a month. A debtor who fails to comply the notice within the

specified period, Bank can proceed against him for adjudicating him as an insolvent. If

the property to be attached which is situated outside the jurisdiction of the court, which

has passed the decree, it should be got transferred to the other concerned court in

whose jurisdiction the property is located.

Quite often, banks have to proceed against their borrowers in a court of law where no

security is available. It takes a long time to obtain a decree like in other cases, and then

proceed for execution of the decree so obtained. In such case, the Code of Civil

Procedures 1908, order 37 offers a quick remedy known as summary procedure suit,

which banker can use. The procedure of summary suit can be availed in applicable

cases (such as bills of exchange, promissory notes, etc.) and in case of secured

advance, the procedure is not advisable as security held by the bank is not enforceable

under the order 37. But under the Limitation Act 1963, there is no difference in the

period of limitation between summary suits or other suits. As part of procedures the

summons of the suit is issued first and when the defendant appears, the plaintiff is to

serve on defendant summons for judgment. When the summons of the judgment is

served, the defendant has to obtain the leave court to defend the case. If the defendant

does not turn up for hearing, the claim of the bank is presume to be admitted.

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There are certain difficulties in respect of recovery through the courts. The time

consumed in the entire process is very long. The long pending civil suits hamper the

settlement of the new cases. Even after a long waiting period in majority of the cases,

courts go on circumstantial evidences and technicalities of the case. Even where the

securities can be enforced, the process takes a considerable time. When banks finally

realize their dues, the amount recovered is much less than the amount lent, if inflation is

taken into account. Further, suits filed by banks do not get any priority in the courts and

they have to wait for their turn for the same to come up for hearing when securities

deteriorate in value and recovery, if at all, is negligible. When it is decided to execute

the decree awarded, there may not be a purchaser or he may offer such a low price,

which may not cover the amount of default resulting in a loss to the bank. Lastly, three

is a feeling amongst defaulters that they can hold up recovery as much as possible or

extract as much monetary concessions as possible.

18. Debt Recovery Tribunals (DRTs)The proposal for setting up of special Tribunals for recovery of debts due to banks and

financial institutions (FIs) was the important legal development in the country. This

proposal was very much in line with the recommendations of the Tiwari Committee and

the Narasimham Committee. The need was felt for creation of such Tribunals due to

considerable delays in disposal of cases by the courts. As on September end 1990,

more than 15 lac cases of public sector banks were pending in various courts. These

Tribunals are set up under the Recovery of Debts due to Banks and Financial Institutions

Act, 1993.

Under the Act, two types of Tribunals are set up i.e. Debt Recovery Tribunal (DRT) and

Debt Recovery Appellate Tribunal (DRAT). The DRTs are vested with competence to

entertain cases referred to them, by the banks and FIs for recovery of debts due to the

same. Each DRT consists of a Presiding Officer who is appointed by the Central

Government who is or has been or is qualified to be a District Judge. But DRAT

constitutes of only one person who is / has been / or is qualified to be, a High Court

Judge or, he must have, for at least three years, held a post in the Indian Service Grade

I or, he must have worked as the Presenting Officer of DRT for at least three years. The

order passed by a DRT shall be appealable to the Appellate Tribunal but no appeal shall

be entertained by the DRAT unless the applicant deposits 75% of the amount due from

him as determined by it. However, the Affiliate Tribunal may, for reasons to be received

in writing, waive or reduce the amount of such deposit.

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Under the 'debt’ means “any liability (includes of interest) which is alleged as due from

any person to a bank or a FI during the course of any business activity undertaken by

the bank or the FIs or the consortium under any Law for time being in force, in cash, or

otherwise further secured or unsecured, or whether payable under a decree or order of

any civil court, otherwise substituting on and legally recoverable on the date of

applications”.

Any case involving debt exceeding Rs 10 lakhs can be referred to Tribunal. However,

the Central Government may reduce this ceiling, if need arises. Every suit or other

proceeding pending before any court immediately before the date of establishment of a

Tribunal under this Act being a suit or a preceding, the course of action whereon it is

based is such that it would have been, if it had arisen after such establishment, within

the jurisdiction of such Tribunal shall stand transferred on that date to such Tribunal.

Under the Act, banks, All Indian Financial Institutions and RRBs are eligible to approach

the Tribunal.

There may be three propositions relating to procedures. First, the Tribunal and the Appellate Tribunal shall not be bound by the procedures laid down under CPC, 1908. Second, they will be guided by the principles of 'natural justice'. Third, subject to other provisions of this statute and of any rules, they shall have made to regulate own procedure, including the places at which they shall have their sittings.An important power conferred on the Tribunal is that of making an interim order (whether

by way of injunction or stay) against the defendant to debar him from transferring,

alienating or otherwise dealing with or disposing of any property and the assets

belonging to him without prior permission of the Tribunal. This order can be passed

even while the claim is pending.

After the claim is upheld by the Tribunal, it issues a certificate to the Recovery Officer

and the latter has various powers in execution include attachment, sale, arrest,

appropriation as Receiver and power to require the defendant (debtor) to remit the

money to the Recovery Officer. Under the Act, the Recovery Officer possesses the

powers as that of an Income Tax Officer for recovery debts due to the banks and FIs.

The Act provides the Tribunal and Appellate Tribunal the powers of a Civil Court in

several maters. These include summoning of witnesses, discovery and production of

documents, receiving evidence on affidavits and issuing commissions. The Act also

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requires both tribunals to dispose of the applications or appeals within a period of 6

months.

The special machinery in the form of debt recovery tribunals and recovery officer will

help in expediting the hearing, determinations and recovery of bank claims which

generally wait in the queue for years even for reaching a stage of hearing. The

requirement of depositing of 75% of the claim amount for appeal will prevent endless

tribunal appeals.

Procedures to be followed under the Act are simple. To start with, the concerned bank

or FI is expected to make an application to the Tribunal within the specified geographical

limits. The application should be accompanied by such statements or evidence and by

the prescribed fees. On receipt of the application, the Tribunal shall issue summons

requiring the defendants should cause within 30 days of the service of the summons or

to stay the relief prayed for should not be granted. The Tribunal after giving the

applicant an opportunity of being heard, passes such orders on application as it thinks fit

to meet ends of justice. The Tribunal may make an interim order whether by injunction

or stay and debarring the defendant from the sale or transfer of assets. Thereafter, the

Tribunal issues a recovery certificate and passes on to the Recovery Officer for recovery

of the amount of debts as specified therein. The Recovery Officer should send a notice

in writing and requiring the defendant or his related parties to pay the amount within the

specified period. On receipt of money, the receipt will be issued. If the defendant fails to

make the payment, the Recovery Officer will then seize the property and arrange for

sale. He can even arrest the defendant if the circumstances so warrant. The aggrieved

party may make an appeal within 45 days from the date of the order to the Appellate

Tribunal, which will then pass an order, confirming, modifying or canceling the order,

appealed against. There is a requirement of deposit of 75% of the claim amount though

this can be waived or reduced at the discretion of the Appellate Tribunal.

At present, there are 29 DRTS and 5 Appellate Tribunals in the country. In order to

provide the required infrastructure to DRTs, the RBI has asked banks and FI within the

jurisdiction of the DRT should set up a Local Advisory Committee to interact with the

Presiding Officer periodically and provide the required infrastructure.

In January 2000, the Act was amended. The major amendments include: the

Government has powers to appoint more than one Recovery Officer in the DRT. The

Recovery Officer requires the debtor to declare in affidavit the particulars of his assets.

DRT can pass an order for recovery of the amount and issue certificates in case of the

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decrees which have been passed but has not executed. A party aggrieved by order of

Recovery Officer can file an appeal before the DRT within 30 days from the date, the

order is issued to him. As on June 2004, 35,700 cases involving Rs. 66,568 crores were

pending with DRT. The amount recovered was just Rs. 7,845 crores.

DRTs are criticized in respect of recovery made considering the size of NPAs in the

country. In general, it is observed that the defendants approach the High Court

challenging the verdict of the Appellate Tribunal which leads to further delays in

recovery. Validity of the Act is often challenged in the court which hinders the progress

of the DRTs. Lastly, much needs to be done for making the DRTs stronger in terms of

infrastructure.

19. National Company Law Tribunal As per the announcement made in the Budget 2001-02, Sick Industrial Companies Act

(SICA) will be repealed and Board for Industrial Finance and Reconstruction (BIFR) will

be wound-up. As an alternative arrangement, it is proposed to set up National company

Law Tribunal (NCLT) by amending the Companies Act, 1956. In August 2001, the Bill

was introduced in the Parliament. Accordingly, NCLT is expected to consolidate the

powers of BIFR, High Court and Company Law Board to avoid multiplicity of forums. In

matters of rehabilitation of sick units, all concerned parties are supposed to abide by the

orders of NCLT. There shall be 10 benches, which will deal with rehabilitation,

reconstruction and winding-up of companies. It is estimated to complete the entire

process during a period of 2-3 years as against 20-25 years presently taken. The

Tribunal will have, in addition, powers of contempt of court.

A rehabilitation and revival fund will be constituted to make an interim payment of dues

to workers of a company declared sick or is under liquidation, protection of assets of sick

company and rehabilitate sick companies. While NCLT will be acting on the lines of

BIFR in the matters of rehabilitation, viability of the projects will be assessed on `cash

test’ and not in the present practice of 'net-worth’. Another important change will be in

respect of time limit for completing each formality relating to rehabilitation and winding-

up. Though the Bill is well drafted to ensure NCLT to become more effective than BIFR

in respect of rehabilitation and winding-up, doubts are raised about the implementation

of the Bill taking into account the present political set up.

20. Merger and AmalgamationMerger and Amalgamation are the two distant terms. A merger is a combination of two

companies whereby only one survives. But an amalgamation involves combination of

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two or more companies whereby an entirely new company is formed. When two

companies of the same size combine, usual mode is amalgamation. When two

companies of different size combine merger is preferred.

Combination of the companies takes place for a number of reasons. Some of the

important reasons are given below.

Operating Economics :Duplication of facilities is eliminated and all operations can be consolidated to

achieve economies on overhead cost. Particularly in case of horizontal merger,

operating economies can be best utilized. In cases of vertical merger, economies in

distribution and purchasing are achieved. There are few operating economies in

conglomerate merger.

Management AcquisitionIf a firm lacks aggressive and competent management, it has two alternatives, either

to gradually stagnate or to combine with another company having efficient and

effective management.

GrowthSometimes, it is easier and cheaper to have a growth by merger rather than internal

growth. The numerous costs and risks involved in development of new products can

be avoided by acquisition of another unit.

Debt CapacityIn a country like ours where tax rate is high the debt funds are cheaper than the

equity funds. If a company borrows more, the expected future earnings and dividend

per share will increase when all other things remaining the same. The debt capacity

of the combined entity is greater than the sum of the individual debt capacities of the

two companies involved in combination.

DiversificationA merger is also done with diversification in view. A Company may be able to

reduce the instability of earnings by increasing the product line. But increasing

product line is an expensive affair for a small firm with low equity base. A large firm

also may not like to undertake risk of a new product line and may prefer acquisition

rather than developing the product itself.

Taxation

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In an economy like ours, where rate of corporate taxation is very high at higher slabs

of profit generation, avoidance of tax is another cause of merger. A financially sound

company in a very high corporate tax bracket has an incentive in saving tax by taking

over sick units and, a sick unit can be made viable through merger. Merger helps in

minimizing competition, pooling of resources, effecting general economies in

production, distribution and overheads. Given below are legal provisions of merger,

tax concessions available, mechanism for merger, provisions for approval clearance

of merger, etc.

Provisions of Merger Under Companies Act 1956Provisions are laid down u/s 390-396 where transfer/purchase of shares are

approved by not less than 9/10th of value of shares of transfer company,

merger/amalgamation can be done without recourse to the court.

In case a merger/amalgamation is effected through the court, the court shall direct a

meeting where 3/4th majority approves the arrangement, it shall be binding on all on

approval by the court. The court will make an order only where the transaction

appears just and fair and where the court is satisfied that sanction of the majority has

not been obtained by fraud and improper means.

The scheme is also subjected to careful scrutiny as per standards laid down

justifying judicial interference. The court sees to it that the scheme is reasonable

and fair to all parties.

Concessions under Income Tax ActUnder Sec. 72-A of the Act, voluntary amalgamation of a sick company with a sound

company allows the latter to carry forward and set off accumulated losses and

unabsorbed depreciation of the former. The Act grants deductions to the sound

company in respect of depreciation allowance, capital expenditure etc., in addition to

exemption from liability to capital gains tax for both the sick unit and its share

holders. There is also no liability to tax any deemed profits representing the amount

of balancing charge or any claim for terminal depreciation in case of the sound

company (i.e. amalgamating company). All benefits are subject to amalgamation

falling within definition of amalgamation contained in this Act.

Conditions for Availing of BenefitsThe amalgamating company should be an industrial company and the amalgamated

company may/may not be and industrial company. The benefits to set off losses and

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depreciation allowance to amalgamated company is subject to satisfaction of the

following conditions:

Accumulated loss of amalgamating company in the immediately preceding

year in which amalgamation is effected must exceed 5 per cent of aggregate

amount of paid up share capital and reserves of that company as on that

date.

Amalgamating company was not financially viable before amalgamation.

Financial viability should be determined by financial experts.

Amalgamation should facilitate rehabilitation/revival of business of

amalgamating company.

In case amalgamating or amalgamated company owns an industrial

undertaking registered under MRTP Act 1969, the amalgamation must be

approved by the Government under MRTP Act unless it is exempted from

such approval.

For merger with its foreign majority company, the amalgamated company

must conform to provisions of Foreign Exchange Management Act.

Assessee should fulfil such other conditions as Central Government may

specify.

Procedures for Clearance of Merger ProposalsAn application for the purpose of Income Tax Act should be made in prescribed form

to Secretary, Department of Industrial Development. Company should supply

information regarding steps taken for rehabilitation and revival of the unit which

should be accompanied by a certificate.

21. Financial ReconstructionThe essence of a rehabilitation programme for a sick unit involves rescheduling its

maturing obligations and matching them with the liquidity expected to be generated in

future and maintenance of the resultant capital structure through the period of

reconstruction. The steps involved in the reconstruction programme have been

discussed in the following paragraphs.

The assets and the liabilities, after reconstruction, should properly match and the post

reconstruction equity and debt should be capable of being adequately serviced in future

by internal generation of the unit. This may call for reduction of the existing preference

capital, rescheduling of existing loans, conversion into equity, reduction, write off or

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combination of such measures, consistent with the continued operation of the unit on a

viable basis.

In considering such measures, liabilities have to be scaled down if they are not

represented by adequate tangible assets. Assets for the purpose of reconstruction

should be valued at a reasonable price considering the unit as a going concern.

Industrial reconstruction includes change of management. Banks, financial institutions

and the Government will have to play a vital role in this regard. The existing

management may have to be reconstituted and they may take over the management of

the company under the Industrial (Development and Regulation) Act.

The plan of reconstruction consists of projected balance sheet, projected income

statement, statement of sources and uses of funds, capital expenditure programme and

management inputs and other proposed corrective measures in non-financial areas.

Statement of sources and uses of funds should suggest the changes in funds generated

from operations at different intervals during reconstruction period.

Capital Expenditure Programme involves :

Revised capital expenditure to achieve projected production and sales.

Matching payment of its dues with expected liquidity at future dates.

Postponement of specific liabilities.

The extent of capital restructuring necessary for the unit is determined by its need for

funds during the period of reconstruction arising out of :

Payment of dues to pressing creditors.

Acquisition of additional current assets.

Capital expenditure programme.

Future losses.

Past liabilities such as workers' dues; arrears of taxes, excise, electricity bills etc.

other creditors - secured and unsecured.

Even after reconstruction many sick units will continue to incur cash losses and creditors

will have to finance the losses, and past liabilities are never reduced. Consequently,

financial institutions will withdraw their support.

The sick unit has an imbalanced capital structure, high debt equity ratio and adverse

total external liability to net worth. Therefore, it is desirable to consider the financial

reconstruction to off load burden of external liabilities not matched by existing productive

assets. Banks and financial institutions must scale down the liabilities by write off. For

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the purpose of capital reconstruction, assets should be valued on current price

considering the unit as a going concern.

The involvement of the Government comes in the form of take-over of the management

under I (D&R) Act 1951. In this case, the Government appoints authorized persons to

carry on the business of the company. Following major changes take place after the

Government take over:

Existing management vacates the office.

Shareholders become dormant.

Government appoints new management.

Newly appointed management is accountable to the Government.

On the other hand in case of reconstruction involving the bank and financial institutions,

responsibility is equally with them and the entrepreneurs. Financial institutions are

responsible for appointing suitable management of yield desired result. Normally

reconstruction under both the above styles commences with the infusion of fresh funds

with an altered management set up.

Difficulties faced at the time of framing acceptance capital structure are due to the lack

of support from different agencies involved in such reconstruction. In the absence of

this, it becomes difficult to initiate reconstruction programme. The major handicap that a

sick unit poses before a reconstruction agency is huge over burden of accumulated

liabilities and past losses.

22.Recovery under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002The Act covers the following three areas viz.

(i) Registration and regulation of Securitisation Company (SCO) and Asset

Reconstruction Company (ARC)

(ii) Enforcement of Security Interest by banks and financial institutions without court

intervention, and

(iii) Establishment of Central Registry of securitisation and reconstruction of financial

assets and creation of security interest under the act.

The Act provides for setting up of Securitisation Company (SCO) and Asset

Reconstruction Company (ARC). Such company before commencement of business

should obtain a certificate of registration from RBI. The networth of the company should

not be less than Rs. 100 crores or an amount exceeding 15% of the total financial assets

acquired or to be acquired. The SCO or ARC can acquire financial assets of any bank

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or FI by issuing a bond or any other security on mutually accepted terms between the

SCO/ARC and the bank/FI. On acquisition of financial asset by SCO/ARC from bank/FI,

the SCO/ARC shall become the deemed lender and all rights of such bank/FI shall vest

in the SCO/ARC in relation to the financial assets. Any suit, appeal or other proceedings

pending at the time of acquisition of assets shall be continued by SCO/ARC. The

SCO/ARC can issue security receipt of institutional buyers for subscription. The

SCO/ARC can provide for proper management of the business of the borrower, sale or

lease of a part of whole of the business of the borrower, reschedulement of payment of

debts by the borrower and settlement of dues payable by the borrower.

The Act also provides for enforcement of security by Banks/FIs in their favour without the

intervention of court/tribunal. For this, the borrowal accounts should have been

classified as NPA and the Banks/FIs issue a notice to the borrower requesting to repay

the liabilities in full within 60 days from the date of notice. The banks/FIs are entitled to

exercise all the rights of enforcement of securities subject to the above compliance.

Such enforcement of security can be in the form of taking over possession/management

of the secured assets and appointing any person including SCO/ARC to manage the

secured assets. If the banks feel that there could be resistance in taking possession of

the charged assets, bank can submit an application in writing to the District

Magistrate/Chief Metropolitan Magistrate in whose jurisdiction; the secured assets

situate, to take possession of the assets and documents and forward to the secured

creditor (bank). In the case of joint financing of financial assets, the secured creditor can

exercise the rights only if agreed upon by creditors whose share in the account is

minimum 75% by value. In case borrowers raise any objection or make a representation,

the bank will have to consider such objections on merit and will have to communicate

within one week of receipt of such representation. No cause of action will be available to

the borrower merely on the ground that his objection has not been accepted by the bank.

The bank is, therefore, free to take the possession of the movable or immovable secured

assets after complying with the procedure after expiration 60 days of notice and after

reply of the objections, if any. However after taking possession by the secured creditors,

the borrowers may make an application to DRT which shall be dealt by DRT as

expeditiously as possible and to be disposed of within 60 days. If the application is not

disposed within period of 4 months, any party may make an application to the DRAT for

directing the DRT for expeditious disposal of the application. Aggrieved by the decision

of DRT, borrower can appeal to DRAT only after depositing with it 50% of the amount

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due as claimed by the bank or determined by the DRT, which ever is less, however,

DRAT may reduce the amount up to 25%of the debt if satisfied.

For the purpose of registration or transactions of securitisation and reconstruction of

financial assets and creation of security interest under the act, the Government of India

may set up a Central Registry and its branches opened in different places duly defining

the territorial limits of such branches. Any transaction relating to securitisation,

reconstruction of financial assets, and creation of security interest is to be recorded in

the Central Register kept at the Head Office of the Central Registry. The filing of such

transaction with Central Registry is to be made on payment of a fee prescribed within 30

days. The failure to register security interest with Central Registry attracts penalty in the

form of fine of Rs. 5000 per day.

The Act arms the lenders with powers to directly initiate recovery procedures by taking

possession of the secured assets of the borrowers which would include the transfer of all

underlying assets. The lender could, in effect, attach, sell or auction any of the assets

taken over by them. They can also decide to take over the management of the assets,

appoint any person to manage the assets taken over and also order settlement of dues

from any person who has acquired the secured assets from the borrower.

The new law would not only help in recovering the existing NPAs of the Banks/FIs, but

also curb the instincts toward willful defaults in future. The legislation protects banks/FIs

from unnecessary legal hassles from defaulting companies and also from cross

legislation among the FIs since many companies had secured loans from multiple

financial institutions.

The Act empowers lending institutions with enhancement rights in the recovery of NPAs.

Under the Act, lenders have recourse to several options in dealing with non-performing

advances without judicial intervention.

The provisions of the Act shall not apply in case of loans upto Rs. 1.00 lacs and in

respect of any security interest created in agriculture land. Likewise the cases where the

amount due is less than 20 per cent of the principal amount and interest thereon, the

same is outside the purview of the Act. The new law is viewed as an important step

forward towards addressing the need for a viable legal framework to undertake

securitisation and/or asset reconstruction in India. The legislation could be used by

competitors to buy out assets of ailing rivals though it would also open up secondary

market and put pressure both on borrowers and lenders to settle their disputes. The Act

will provide greater flexibility to the Indian financial system in managing its non

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performing assets more effectively and efficiently. The Act is expected to correct the

imbalance between borrowers and lenders in this country, a consequence of which has

been the accumulation of non-performing assets on a massive scale. By allowing banks

to sell off assets charged to them without having to seek the permission of a court of law,

the Act empowers banks to realize their dues expeditiously, avoiding the endless delays

in the legal system.

23. Other Legal MeasuresOther Legal measures mainly include the recovery under State Finance Corporation Act,

1951, Co-operative Societies Act, 1950 and recovery under state act of sponsored

scheme cases.

Section 29 of the State Finance Corporation Act, 1951 empowers State Finance

Corporations (STCs) to take-over the management or property or both of the industrial

concern which has defaulted loan installments covering interest and principal. This right

applies to the property mortgaged, pledged, hypothecated or assigned to the Financial

Corporation. On take-over of the property, the corporation gets all the rights of the

owner. This also refers to goods manufactured or produced wholly or partly from goods

forming part of the security held by it. On receipt of sale proceeds of the property, the

corporation is entitled to reimburse first all costs/expenses incurred in holding the

property and arranging for subsequent sale and recovery of dues. If any surpluse left

over, the same shall be paid to the person entitled thereto. Where Financial Corporation

has taken any action against and industrial concern under provisions of sub-section (I),

the Financial Corporation has shall be deemed by the owner of such limited company for

the purpose of suits by or against the concern, and shall then and be sued.

Despite the above wide ranging powers, the Financial Corporations has not been able to

recover much effectively because of non-cooperation from the management of the

industries concern. Workers also agitate and prevent any take-over of the property.

Thus, what is important is to create a conducive recovery environment and not just

vesting the additional powers to the Financial Corporation as discussed above.

Recovery under the Maharashtra Co-operative Societies Act, 1960 is also possible.

Credit institutions in co-operative sector have to apply to the Registrar to seek his

assistance in recovery of dues from the members. The Registrar, after receiving

necessary particulars, will make such inquiries, as he deems fit, and then grant a

certificate for the recovery amount due as arrears. The certificate granted by the

Registrar shall be final and a conclusive proof and the same shall be enforceable

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according to the law like land revenue. Credit institutions in co-operative sector are

taking full advantage of the facility provided under the Act. As discussed above, the

recovery process is also slow in this context, because of recovery climate which is not

conducive besides lack of co-operation from defaulting members.

In certain states there is separate law to deal with small loan and agricultural loans.

Banks may take advantage of these legal recourses and file recovery certificates with

the designated officers. A regular follow-up of the certificate file cases is essential.

CONCLUSIONThe list of recovery measures may go on when we refer to additional innovative

strategies adopted by banks and FIs, in this regard. Thus, there is no dearth of schemes

for recovery. Adequate numbers of institutions are set up to assist in recovery matters.

Both the RBI and the GOI are busy in announcing new policy guidelines relating to

recovery from NPAs. Banks are feeling pressure on asset quality due to (a) massive

credit expansion in past fours years (b) Rising delinquency in retail loans, (c) Slow down

in the economy and consequential problem with sectors like real estate, MSME etc. (d)

slow down in exports and (e) massive restructuring done during 2008-09 which may add

fresh NPA in coming years. Fitch has forecasted that 15 to 25% of banks’ restructured

loan (whopping Rs. 1.23 lakh crores were restructured during 2008-09) may turn NPA

during 2010-11 (ET 13.01.2009). To arrest this trend, enough care has to be taken to

prevent slippage in standard assets more particularly in restructured loans and upgrade

the NPA loan under sub-standard category. More importantly, recovery drive should be

taken up on a war-footing. For this purpose, banks will have to take advantage of all the

possible recovery measures by involving their staff and other outside agencies. In

addition, there should be coordinated efforts by banks and FIs in recovery in those cases

where both of them are involved. Recovery function in banks and FIs needs to be

strengthened by inducting a professional approach. There should be adequate staff in

the field to contact defaulters time and again. Staff involvement in recovery drive has to

be ensured by offering sufficient incentives to them. Active lawyers may also be

rewarded properly. Assistance from the professional agencies should liberally be sought

for. Above all, judicial machinery has to become more efficient to dispose off cases

pending before them for years together. Similarly, DRTs have to gear-up to assist

banks and FIs in their recovery effort. Lastly, the Government of India has to facilitate

the process of seizure of assets of the defaulters and their subsequent sale for which the

Central Registry should be set up immediately. Lastly, in view of the proposed stricter

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NPA identification norm of 90 days introduced since March 2004, it is high time for banks

and FIs to look quality of credit rather than quantity and take effective and timely steps to

check delinquency as soon as symptoms of NPA are visible.

Chapter-12

Loan Compromise – An effective recovery measure

IntroductionIn general, it is experienced that filing of suits and recovery of dues of banks through the

process of courts/DRTs is a cumbersome, expensive and time consuming, and task

without any fruitful results in many cases. One of the main reason attributed for non-

recovery of dues through the court/DRT is lack of proper follow-up and timely and proper

action. Hence, it would be worthwhile to think of other ways to tackle the situation. The

tradition of amicable settlement through panchayat and arbitration, leads to think as to

why bank loan disputes cannot be settled without having a recourse to the court/DRT.

Of late, loan compromise as a recovery measure is becoming popular. Hence, it would

be appropriate to know all about loan compromise.

Salient Features of Loan CompromiseLoan compromise in a bank means agreeing to a borrower’s request of accepting a part

of outstanding of dues in the books of the bank as full and final payment or allowing for

the non-compliance of the terms of the loan, after analyzing the alternative courses of

action, genuineness and capacity to repay. It is also called as voluntary debt reduction

or scaling down of dues. In the situation, where the borrower’s ability/capacity in

repaying the bank’s dues and the bank’s ability to recover the same by other means are

limited, a compromise proposal can work well.

Compromise proposals can be entertained at both stages of loan, which include (a) pre-

litigation stage, and (b) post litigation/decree stage. At the pre-litigation stage,

concessional measures such as reschedulement, rephasement, rehabilitation, etc. can

be used which would allow some breathing time and build/strengthen the repayment

capacity of the borrower. However, when such measures initiated in the account do not

yield any fruitful result and the borrower incurs heavy cash losses, it is better to go in for

a compromise or scaling down the dues. Similarly in other cases, where business loss

has crept in due to one or the other genuine reasons and the borrower is not a willful

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defaulter and requests for minor concessions such as waiver of penal interest,

concession in interest rate, etc. his offer can be accepted for compromise.

Compromise at post-litigation/decree stage can also be entertained so that the

borrower’s business or activity is uninterrupted. In order to avoid cost, labour and time

involved in litigation maters and to have better image in the market, borrowers offer a

lump-sum amount and request the bank to withdraw the suits against them, which may

be entertained. At times, it becomes necessary, in some cases, to settle outside the

court through an amicable agreement and, the antecedents of the defendant are such

that courts/DRTs take a sympathetic view and award a lenient decree against the

defendants. Sometimes, after obtaining decree, if a third party comes forward to

purchase the assets, the bank may consider the case for compromise. It is also possible

for the bank may go in for compromise if the decreed asset would not fetch more than

the claim the amount. In all cases, where suits have been already field, whatever

compromise is to be made, must be sorted out through court in the form of a consent

decree, so that it will be binding on all dependents. If parties do not fulfil the promise,

remedy through court or DRT will always open to the banks.

Types of CompromiseThere can be two types of compromise. The Reserve Bank of India and the

Government of India independently introduced One Time Settlement Schemes covering

loan outstanding upto Rs. 5 crores (subsequently raised to Rs. 10 crores) and Rs. 25000

respectively. Now, both these schemes are not in operation since they were purely

temporary measures. Hence, each bank is given autonomy to evolve its own One

Time Settlement (OTS) Scheme, well suited to profit position. What is important? It is

necessary to create awareness on OTS and mobilize as many compromise proposals as

possible. There should not be any delays in arriving at compromise. Such proposals

should be prepared carefully keeping in mind the bank guidelines. It is better to involve

all staff members in mobilizing compromise proposal. Care should be taken that the

recovery through compromise does not give a wrong signal to good borrowers. Over the

years, banks have succeeded to recover through compromise substantially. But there is

enough scope to step up the recovery drive through this measure.

How to Formulate Compromise ProposalTo start with, a borrower should express his interest in loan compromise in writing. He

may also indicate the terms of compromise, well suited to his expectations. But branch

manager may not agree. Hence, he has to formulate a compromise proposal in the light

of broad guidelines issued by the bank. The proposal should contain major items which

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include means or capacity of the party, determination of amount covering outstanding

amount, other charges, etc. efforts already made for recovery, staff accountability, etc.

More importantly, the securities offered to the bank need to be valued by an approved

valuer. The branch manager has to carry out a cost: benefit analysis which on one hand

takes into account the loss that may arise in case compromise is accepted and the

benefit which may accrue if the compromise is not made, on the other. The proposal

recommended should be referred to the sanctioning authority which examines several

factors including fulfillment of terms and conditions of sanctioning of loan compromise,

any laxity in conduct and post-disbursement supervision of the account, any act of

commission or omission on the part of staff leading to the debt proving irrecoverable,

enough recovery efforts put in, valuation of securities, interest to be charged in respect

of settlement though installment, etc. Decisions in respect of loan compromise should be

taken by a committee consisting senior executives excepting small loans where powers

are delegated to branch heads. After receiving the necessary sanction of the proposal,

the branch manager is expected to ask the borrower to fulfil the terms including the

down payment. In general, one time settlement is preferred to settlement in

installments. In case of suit filed accounts, the settlement is put through the court and a

consent decree is drawn. In non suit filed cases, it is better if the terms of settlement is

drawn through a memorandum of understanding and if the amount is payable in

instalment, post dated cheques are obtained from the borrowers so that there is

adequate pressure on him to keep his promise and in case of dishnour of cheques bank

may have option to proceeds legally under section 138 of Negotiable Instruments Act,

1885. In case of small borrowers, bank are also offering fresh loan so that the borrowers

can start their activity afresh.

ConclusionLoan compromise should be considered as a last resort of recovery. It should be

a voluntary exercise. It calls for a professional approach in preparing the compromise

proposal. In terms of amount involved in NPAs, success of banks in recovery through

loan compromise is limited due to lack of awareness of such schemes by small farmers,

small traders etc; stricter vigilance norms because of which the staff is hesitant to

entertain compromise cases; difficulties in fixing staff accountability before

recommending a proposal; etc. The Compromise proposals from willful defaulters should

not be entertained. These need to be addressed. Thus, appreciating the growing

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importance of loan compromise, DRTs have rightly started organising the Lokadalats

which dispose off small cases through compromise. It is desired to keep up this tempo.

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Chapter-13

REHABILITATION OF SICK SSI UNITS I. Identification of a Sick SSI UnitAs per the Government of India definition, a small-scale industrial unit is the one in which

case, the investment in the plant and machinery does not exceed Rs.100 lakhs

(enhanced to Rs. 500 lakhs for certain specified items) and in the case of ancillary unit

the same should not exceed Rs.25 lakhs. Identification of a sick SSI unit has to be

done keeping in mind the official definition as provided by the Reserve Bank of India.

Accordingly, any borrowal account, which becomes sub-standard when interest or

principal is overdue for more than 3 months or, its accumulated losses exceed 50% of

net worth and the unit has been in commercial production for at least 2 years, is

considered as sick SSI unit.

II. Causes of SicknessCauses of industrial sickness have to be viewed from the general background of an

industrial economy. At any point of time, the problems of industries are not uniform.

However, factors generally responsible for sickness can be divided into external and

internal. External factors are those over which the unit has no direct control. But,

internal factors are those which are within the control of the management of the unit.

Sickness can originate right from the stage of conception of an idea to set up the unit till

the stage of crystallization of the concept and/or implementation of the project.

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Normally, no account falls sick all of a sudden. Before the account falls sick, we do get signals from various sources which include:a) Ledger Book

b) Stock Inspection

c) Discussion with Borrowers

d) Market Reports

e) Financial Statements

A systematic study of the balance sheet and profit & loss account gives the following signals:

(a) Unsatisfactory trend in profits.(b) Rise in debts.(c) Shortage of working funds.(d) Unsatisfactory position of equity.(e) Diversion of short term funds for long term uses.(f) Building up of unproductive assets(g) Unhealthy accounting practices

Given below are the important points form a balance sheet of a potential sick unit which can give some indication of sickness;

Balance Sheet of a Potential Sick SSI UnitSr.No. Liabilities Assets

1. Current Liabilities Current Assets

a) Short term borrowings would be

high and indiscriminate -

irregularity in the cash credit for

the last two months

Current assets would stand

depleted and, whatever exist would

consist of:

b) There would be some unpaid

statutory liabilities such as

wages, bonus etc.

a) Dead stock and non-moving

inventory

c) Supplies would remain unpaid

for a long period

b) Over due debts mostly

irrecoverable

d) Considerable amount of

contingent liabilities would exist

mostly due to law suits

c) Negligible cash and bank balance

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2. Term Liabilities Fixed Assets

Last two monthly loan

installments would remain

unpaid and would continue

These would appear inflated and

non-realizable

3. Equity Intangible Assets

It is gradually reducing Those including losses and

capitalized expenses would be

prominent

III. Rehabilitation of Sick SSI Units In general, a sick SSI unit is defined in terms of its capacity to generate internal funds. A

sick unit fails to generate internal surplus on a continuing basis and depends on its

survival on frequent infusion of external funds. Hence, need for rehabilitation or nursing

is very much felt. Details of rehabilitation or nursing are discussed as under:

1. Objectives of Nursing Programme: To enable the unit to operate at a profitable level.

To adjust the irregularity in the account, if any, according to a phased programme.

Thus, the nursing programme involves two aspects i.e., (i) preparation of feasibility

report before implementing the nursing programme and (ii) careful monitoring of the

performance of the unit during the nursing period.

2. Features of Nursing Programme: The programme should be carefully drawn and all doubts must be clarified before

chalking out the same. It must be supported by the bank and the borrowers.

As the unit is already heavily debt burdened, the programme should be based on

well-calculated break even point. Under nursing, the unit should operate at a much

higher level than before and in this regard, the following questions must be

answered:

Is it possible to operate at a higher level under present market

conditions?

Will present plant and machinery allow manufacturing output at

higher level of activity?

Can present organization cope with increased level of activity?

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To be able to operate at higher level, additional finance will be necessary and

especially in cases where the net worth of the unit has become almost negative.

In such cases, the end use of funds must be carefully monitored.

The repayment programme must be carefully worked out, enough funds must be

available to the unit to operate at the desired level with a view to ensuring

continued internal generation of surplus.

The nursing programme should be decided by the concerned authorities within a

reasonable time. The longer the decision-making period, the greater would be

magnitude of the problem.

3. Decision on NursingKeeping in view all the possible outcomes, risk involved and the irregularity in the

account, bank decision should aim at promoting the business activity and not the

borrower as an individual. The decision should be based on likelihood of possible

recovery. Finally, bank can support the borrower provided he has equal interest in

coming out of the sickness. In other words, banks decision to nurse a unit could be

justified if it can:

Generate adequate activity and employment

Control the business activity effectively

Commit additional funds, if necessary

Elicit co-operation from workers, suppliers of materials, etc.

4. Preparation of Nursing Programme(A) Assessment of Feasibility of the Project :The programme should be finalized after a detailed study of the sick unit and

understanding the problems of the unit. In this context, the following points should be

kept in mind;

(i) `Is the project feasible i.e. to operate above the break-even point?

(ii) Are the prevailing market prices remunerative? Is it necessary to change

the pricing policy?

(iii) Are raw materials available to produce goods at the desired level of

activity?

(iv) Are there any constraints such as power, transport bottlenecks, paucity of

space, skilled workers etc?

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(v) Are of the existing machineries able to cope with the increased level of

activity?

(vi) Is the borrower prepared to accept the financial discipline being imposed

by the bank?

If all the above questions are positively answered, the project is feasible and should be

considered for nursing programme.

(B) Assessment of Additional Funds: Additional funds are required for the following:

(i) Statutory liabilities payments to creditors to be paid,

(ii) Payments to other creditors

(iii) Minimum funds required to purchase machineries to raise the

productive capacity to the desired level

(iv) Minimum working capital requirements till cash cycle gets into

motion.

(v) Operating deficits in the short run arising as per cash flow

estimates and any other shortage therein to be provided for.

Sources of Funds include:(i) Additional capital contribution from the borrower and deposits from the friends

and relatives

(ii) Disposal of excess stock or fixed assets not required,

(iii) Speedy recovery of outstanding bills/ book-debts ,

(iv) Internal generation of funds

(v) Additional working capital limits

(vi) Additional term loan for acquisition of fixed assets

(C) Preparation of Cash Flow Estimates; Bank will have to prepare a cash flow

statement showing cash flow estimates during the rehabilitation period. The

estimates should be prepared on the basis of the realistic considerations. The

nursing programme must also have a provision to sanction ad-hoc limit in case the

process of credit sanction takes a long time and in the meanwhile, the unit may need

a small amount for certain immediate payments.

(D) Arrangements made with other creditors: Before finalizing the nursing

programme, bank may seek co-operation from the creditors for supply of raw

materials. It must be ensured that supply of raw materials will continue on regular

basis and at economical price. Bank must ensure that the creditors will continue to

grant normal credit to the borrowers.

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(E) Marketing Arrangements : While finalizing the nursing programme, bank have to

study the marketing problems and offer suggestions. Such suggestions would

include;

A product that has lost its name in the market with the trader but not with the

ultimate users is easy to re-establish by restoring confidence of the former.

If existing sales-agents are not interested in continuing or not needed because of

high cost, there could be two options; either to appoint other suitable selling

agents or to create a wide network of selling agents who could be used to realize

the overdue debts under gradual collection arrangements through steady

supplies of the product to such parties.

(F) Arrangement for Recovery of Overdue Debts and Disposal of unwanted Assets: In some cases, it is possible that certain assets which are unwanted, should

be disposed off. We have to identify such assets in consultation with the borrower.

We must ensure that the borrower will make all efforts to recover overdues from

customers. Before deciding on whether to nurse the unit or not, we should know

what could be the realizable amount from the disposal of unwanted assets.

(G) Freezing of Existing Bank Borrowings: This system is suggested for smooth

banking operations. Cash credit balance against dead stock, including non-moving

inventory and over due debts, should be separated and frozen. Interest thereon

should also be kept separate and frozen. For the purpose of deciding on the new

financial arrangements, the current assets, which are in use, should only be

considered. The distinction between frozen and operating accounts gives

operational control through security of transactions at the lender’s end.

(H) Arrangements made with Other Financial Institutions and Equity Holders for additional funds; In case of the borrowers having facilities with more than one

credit institution, the nursing programme could be finalized with the consent of the

consortium bankers. The possibility of issuing additional equity shares should also

be examined. Under the nursing programme, the stake of other lenders should be

finalized.

(I) Arrangements for Management Performance : It is often thought of replacing

the old management with new management to overcome the failure of the former.

For ensuring the performance, the action can be as drastic as removing the entire

top management. This is suggested in case of mis-management, mis-use of funds,

wrong inheritance and other similar situation. Lenders have a right to participate in

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management and decision making. The critical positions are finance, purchases,

sales and production. Success of these executives should be measured on the

basis of growth of the borrowers’ business and safeguarding of lenders’ interest.

5. Guidelines on MonitoringHaving decided to nurse that unit, the bank has to undertake the follow-up activities

mentioned in the succeeding paragraphs.

1. Developing Information System : For the purpose of nursing, it is necessary that

information is collected periodically. Such information to be collected depends on the

individual case. Statements and returns normally collected from borrowers would

include:

Stock Statements

Weekly/Monthly/Quarterly budgets and actual figures for

production, sales, purchases, overhead expenditure etc.

Monthly cash flow statements

Operating Statement

Balance Sheet

The follow up action starts with the collection of necessary information from the

borrower. Before nursing the unit, we must indicate information required so that the

borrower can develop his own information system.

2. Review of Performance: We have to review the performance of the borrower

regularly, say monthly. Such review performance should aim at examining whether

there has been improvement in the working of the unit. We have to ensure that;

There is not much variance between the projected and actual figures of

production and sales

The funds are used as agreed upon. If the cash budget system is

introduced, we should see that the cash is managed as expected.

3. Monitoring Areas of Weakness: Review of the account reveals the areas of

weakness. A detailed study of such areas would suggest the line of action. For

instance, if marketing was observed as a major area of weakness, the steps should be

taken to improve, such as arrangements with salesmen/dealers, product design, pricing

strategy etc.

In several cases, weakness may be in the organization itself. The organization can

be strengthened by an appointment of the professional personnel. The bank may also

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nominate one of its executives as a director to observe policy decisions that are being

taken.

In regard to financial weakness, following alternatives are available:

To provide additional credit facilities

To convert excess short term credit into term loan

To modify short term credit facilities

To reduce interest rate and other charges

To rephase the term loan instalment so that a longer repayment period is

granted

To adjust a certain portion of the sale proceeds towards the irregularity in

the account

To grant repayment holiday for a definite period

There could be some small units, which have become sick on account of external factors

like lack of power supply, water, raw materials, etc. Such units may be referred to the

State level Co-ordination Committee, which has been set up at the state level with

representatives of banks, term lending institutions, state government etc.

REBHABILITATION OF SICK SSI UNITS - Dos and Don'tsBanks are expected to handle the sick SSI units as per the guidelines of the RBI. Their

work starts from the day when a sick unit is identified and concludes when the account is

either found potentially not viable or is nursed to bring back to health. It is attempted to

offer certain tips in the form of Dos and Don’ts :

1. Early identification of the sick unit is necessary for the effective cure of sickness.

But it is observed that branches commit a lot of delay in identifying sick unit and

also in reporting to the regional office, the reason being a fear-element in their mind

i.e reporting of more and more sick units to the controlling office which might

undermine their performance. In this regard, to ensure the early identification of the

sick unit by bank branches, suitable arrangements need to be made. One of such

arrangement may be to educate and motivate field staff for timely identification of

sick units. For this purpose, each bank may have to prepare a booklet containing a

few success stories narrating how early identification helps in rehabilitating a sick

unit .

2. For identification of a sick unit, audited balance sheet is a must to ascertain the level

of accumulated losses and networth. If audited balance sheet is not available due to

certain genuine difficulties, the branch manager may accept a provisional balance

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sheet duly signed by the entrepreneur. Even this is not possible, the manager may

visit the SSI unit and prepare a report. On the basis of conduct of accounts and the

factory inspection report, the manager may form an opinion that the unit had

become sick and proceed to assess causes of sickness and viability.

3. After identification of the sick unit , a viability report has to be prepared by the

borrower himself or with the help of some outside consultant. In most of the cases,

outside consultant's help is sought for. But in the context of consultant's report,

bank's experience is not satisfactory. Quite often, it is experienced that the reports

of the consultants may not reveal major weaknesses of the project, and

assumptions made in their report for estimating sales, bank finance, etc., are found

to be unrealistic. Hence banks have to make many changes in the project report

which almost leads to preparing the same afresh. So, it is necessary to make

arrangements for ensuring a consultation with outside consultants in the matters of

formulation and implementation of the project report at various stages.

4. For the preparation of rehabilitation scheme and implementation of the same,

coordinated efforts of banks and financial institutions are called for. Despite several

guidelines from the RBI on consortium advances, much is desired to put these

guidelines into practice. Consequently, the process of rehabilitation of sickness

suffers. To strengthen the consortium arrangements, it is suggested that there

should be a fair understanding among the members of consortium to ensure that :

(i) Appraisal should be at one stage instead of carrying out the same at each

institutional level.

(ii) Documentation should be completed at one stage.

(iii) There should be free exchange of information regarding outstanding

balances, position of securities etc.

(iv) There should be regular review meetings with the borrowers.

(v) There should be common terms and conditions.

Besides strengthening consortium arrangements, it is also necessary to adopt a time

bound programme for preparation and implementation of the rehabilitation package for a

sick unit. Efforts should be made to complete these tasks in a period of six months to

safeguard the interest of sick units.

5. For effective preparation and implementation of the rehabilitation package,

attitudinal changes are desired both in banks and sick companies, so that full trust is

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established. Consequently, the companies are enabled to disclose their problems

with the branch managers more openly and quickly.

6. For effective co-ordination, 'Sick Units Cell' set up at the head office and zonal

offices of the bank, need to be strengthened to offer the required support and

guidance to the branches.

7. For monitoring, the information from sick units is necessary. Despite good efforts

on the part of the bank, the required information is not coming forth. In this context,

it is suggested that reliefs and concessions offered to them under rehabilitation

package may be withdrawn, when information is not submitted. But the same may

be restored once the information is made available to the banks.

8. It is reported in several studies that SSI units fall sick mostly on account of

managerial deficiencies. Mismanagement or misuse of funds is common. Banks

may take a stern action in cases when there is a deliberate attempt to make the unit

sick by siphoning of funds. To deal with such cases, the existing loan agreements

of banks may be reexamined. It is suggested to insert a separate clause for penal

action against those responsible for siphoning banks funds. One more suggestion

may be made here. In case of total failure of units , promoters of such companies

should be black listed from obtaining fresh industrial licences as well as bank

finance treating them as willful defaulters.

9. It is not necessary to nurse every sick unit. Branch managers should be choosy in

this regard. Willful defaulters and cases where unit is not considered potentially

viable due to demand recession and no scope for diversification, need not be

considered for nursing. There should be proper compliance of the RBI/bank

guidelines as regards reliefs and concessions. Bank managers should not

recommend beyond the stipulated norms.

10. It should not lead to a situation that a sick unit remains under nursing for a long time.

The unit can be nursed for a maximum period of seven years and concessions in

interest rate, etc., should be given upto five years. In rare cases, a second dose of

nursing can also be considered which should be for a short period of one year. It

should be the policy of the bank to withdraw concessions and recall advances even

during the period of rehabilitation if funds are siphoned off. In any case close

monitoring of performance of sick units is a must.

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Chapter-14

SUCCESS STORIES ON REHABILITATION OF SICK SSI UNITS – LESSONS

INTRODUCTION

Industrial sickness can be defined as a phenomenon whereby a large number of units

are unable to meet their dues to banks and financial institutions or service their debts

due to deteriorating financial position for a variety of internal and external causes.

Today, industrial sickness is not peculiar to any country or any industry. In advanced

countries, treatment given to cure industrial sickness is different from that of developing

countries. In advanced countries, with better security systems and abundant capital, the

approach to sickness is to restore a unit to normalcy through restructuring devices within

a short time or else, close it down. Such easy and straight forward options are not

available for large labour abundant economies like India which can ill afford large scale

unemployment either of labour or of valuable productive assets caused by sickness.

Further, substantial funds of banks and financial institutions are blocked. Since,

industrial sickness is increasing at a faster rate, everyone is concerned. In India, around

10 per cent of bank credit is blocked in sick units. Sickness in the small scale industries

is much severe. There has been an incremental rise of around 30 per cent in the

number of sick units in this sector. So, banks, financial institutions, Government and

entrepreneurs are deeply worried of unprecedented growth in sick units and look for

remedial measures.

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To combat industrial sickness, a number of measures have been undertaken in India.

These measures include uniform definition of a sick company, common criterions for

assessing viability of the sick company, concessions to be granted in interest rate,

promoters’ contribution etc. by banks under rehabilitation package, concessions from

government to a sick company (in respect of electricity, sales tax, excise duties,

transportation rates, etc.), coordinated efforts by forming consortium of banks and

financial institutions, creation of a separate Board for Industrial Finance and

Reconstruction etc. This list of measures can go on.

NEED FOR THE STUDY

Despite the above mentioned measures, sickness in industries is on the rise. To

elaborate, the rate of success in rehabilitation of sick units is less than 10 per cent of

total sick units under rehabilitation scheme. This low rate of success has become a

source for demotivation. No one would like to take initiative in rehabilitation activities.

So, to motivate both financial institutions and entrepreneurs in rehabilitation exercise, it

is worthwhile to bring to their notice of those units which were sick at one time and, due

to hard work and the right approach of banks and financial institutions, the same were

successfully rehabilitated. By studying such units, the banks and financial institutions

would not only get motivated but also gain confidence in the task assigned to them. But

such success stories or live cases are not readily available. Further, lessons from such

success stories are yet to be drawn for the benefit of entrepreneurs, banks, financial

institutions and the Government. Keeping these felt needs in mind, the author attempted

to collect such rare cases from banks and financial institutions in India. In all, 15 cases

were gathered. The analysis of these cases was done to draw lessons on rehabilitation.

III. ABOUT SUCCESS CASES

It was decided to collect as many success stories as possible. It was also decided to get

the cases prepared by banks and financial institutions. Therefore, banks and financial

institutions were contacted. Initially, Small Scale Industry Department in each of these

institutions was requested to identify at least one successfully rehabilitated unit and

provide details of the concerned branch manager / officer responsible for handling the

same. Fifteen institutions (14 banks plus 1 financial institution) provided the details.

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Thereafter, the concerned branch managers/officers in each of these 15 institutions were

approached to write a success story of the identified unit incorporating the following:

1. Identification data i.e. location, year of establishment, constitution, products,

industry, credit facilities enjoyed, etc.

2. Factors responsible for motivating the entrepreneur to start the unit.

3. When did the unit start experiencing problems ?

4. When was it declared as a sick unit ?

5. Causes of sickness

6. Details of the rehabilitation package.

7. Implementation of the package

8. Strategies adopted by the entrepreneur to revive the unit

9. Progress shown during the post implementation period

10. Involvement of the entrepreneur, banks and others in the successful

rehabilitation

11. Latest position of credit facilities

12. Any other useful information to discuss about the progress of the unit after

rehabilitation

The units included in the sample are as under :

1. A tiny unit in the SSI sector (1)

2. Ancillary unit (1)

3. Unit financed under Technocrat scheme (1)

4. Export oriented unit (1)

5. Unit financed under IDBI Rehabilitation Scheme (1)

6. Units in which death of a key director and takeover of management by his

relative (2)

7. Units taken over by professionals (3)

8. Units experiencing project over run and falling sick at the infant stage (2)

9. Unit experiencing strained labour relations (1)

10. Units affected by recession in industry (2)

11. Unit was first considered for recovery through the court but subsequently it was

decided to rehabilitate (1)

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Other characteristics of the units in the sample are discussed below :

A. Eight out of 15 units came into being during 1970’s. All of the units are relatively

old being in operations for the last 8 years or so.

B. Units in the sample are located in different parts of the country. Four of them are

in Maharashtra. Others are from Tamil Nadu (3), Karnataka (2), Gujarat (2),

West Bengal (2), Kerala (1) and Uttar Pradesh (1).

C. All units are engaged in manufacturing activities. Most of them i.e. 7 out of 15

are in engineering industry. Other industries in which units are engaged include

electronics, textile, garment and hosiery, paper, flour mill etc.

D. Most of them i.e. 11 out of 15 units are private limited companies. Four are

proprietorship concerns.

E. All the units have sought finance from banks, state financial institutions, and

other government sponsored financial institutions except 3 units which raised

term finance from term lending institutions.

FINDINGS OF THE STUDY

1. Estimated period required for declaration as a sick unit from the date of occurrence of cash losses:

It was attempted to work out estimated period taken by the bank to declare each

one as a sick unit from the date of occurrence of cash losses for the first time. It

was found that the period varied from one case to another. Most of the cases i.e.

9 out of the total, were declared `sick’ within a period of just a year or two from

the data of occurrence of cash losses in the books, for the first time. In other

cases, the period was around 3-4 years. It was also found in these cases that

occurrence of cash losses was continuous and therefore, their equity was eroded

by more than 50 per cent in a short period of 2-3 years.

2. Causes of Sickness

Major causes of sickness of units include project over-run, demand recession,

labour problems, unfavourable government policy, death of a key director, non-

availability of raw materials and other inputs, managerial deficiencies etc. In two

cases, sickness occurred mainly on account of external forces on which they had

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no control. Such external forces include death of a key director and liberal import

policy of the government. In other four units, sickness was due to partly internal

causes (lack of understanding among directors, strained labour relations, non-

availability of raw materials on timely basis due to improper planning, slow

recovery of dues from customers etc.) and partly external causes (market

recession, unfavourable government policy, stiff competition etc.). In remaining

cases, i.e. 9 units, sickness was on account of internal causes and project over-

run was quite common. The project over-run was due to improper planning and

ineffective co-ordination and control. In 2 out of 9 units, sickness arose when

workers went on a strike due to unhealthy attitude of the entrepreneur. On the

whole, it was found that 12 units fell sick due to internal causes and managerial

deficiencies in key functional areas was predominantly found.

3. Nature of Rehabilitation Assistance

Banks / State Financial Corporations prepared the rehabilitation scheme keeping

in mind norms set for concessions, reliefs etc. by the RBI. The nature of

assistance was not common. Concessions and reliefs are in the form of waiving

of penal interest rate, funding of unpaid interest on cash credit and term loan and

of uncovered portion of irregularity in the cash credit account, rephasement of

overdue installments of term loan, meeting of cash losses till the unit breaks

even, relaxing terms and conditions such as low or nil margin longer moratorium,

lower interest rate, assessing working capital on need basis and low contribution

from promoters. In most of the cases, certain concessions were common which

included funding of overdue interest, rephasement of overdue installments,

creation of Working Capital Term Loan (WCTL) and irregularity in the cash credit

to meet cash losses. In one case, interest charged until the commencement of

business was refunded because the unit became sick mainly due to application

of interest. In this case, there was a project over run by two years. In two cases,

promoters’ contribution was as low as 5% of the total working capital limits. In

other two cases, the penal interest was waived. Additional sanction of working

capital on ‘need basis’ was commonly observed. Similarly, in many cases, fresh

sanction of term loan was accorded by financial institutions for the purpose of

modernisation of machineries. In two cases, change of management was

considered as a part of rehabilitation.

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All units were found to be happy with the rehabilitation package which was well

suited to meet their requirements. To work out the right kind of package, it is

necessary for a banker to have a thorough understanding of the sick units. This

understanding should not only relate to working of the units but also of their

financial structure and projected cash flows. Thus for revival of sickness, it is

desired to work out the most appropriate package of rehabilitation.

4. Strategies adopted by the units for revival

Units in the sample adopted different strategies for revival keeping in mind the

main causes of sickness. These strategies are discussed as under :

(a) Diversification : Seven out of 15 units went in for diversification in

different forms. Three units changed the product line since demand for the

existing product/s was inadequate. For this kind of diversification, existing

resources (machineries, materials and workforce) were utilized. The other type

of diversification was of shifting from manufacturing activities to job-work. This

need was felt necessary because, the manufacturing as an activity, was found

uneconomical. This observation was made in two units. One unit diversified its

concentration from exports market to local market in view of the fact that the

demand for exports was declining sharply. In other unit, there was a shift in

concentration from local market to exports market.

(b) Change of Management: Change of management as well as ownership was

inevitable on the death of an entrepreneur. In one unit, upon the death of the

entrepreneur his wife stepped in. She was found to be equally competent

and highly committed. Naturally, she was able to revive the unit. In another

case, a son of an entrepreneur was inducted on the death of the latter. In this

case also, incoming entrepreneur was highly competent and adopted modern

methods of management. Therefore, the unit was fully revived. In three

cases, professionals were introduced to revive the units. In the context of

change of management it is worth referring to one unit in which case, a newly

inducted management decided not to accept any remuneration from it until

bank loans were fully repaid. One more unit is interesting to refer here. Bank

filed the court case for the recovery since the management was not

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competent. But, when the management was changed, bank withdrew the

case from the court and rehabilitated the same. There was a positive

response to the efforts put in by the new management. Thus, the unit was

revived.

(c) Finance : There are two units which became sick due to shortage of

funds. Having realized the need for funds, the concerned entrepreneurs

managed to bring in additional funds from friends and relatives. These funds

were not withdrawn until the units were fully revived.

(d) Technical Aspects : In one unit, rejection of finished goods was on

the higher side. It was rightly decided by the entrepreneur to modernise

machineries and, when the same was done, it was revived. In another unit, there

was project over-run since the required machinery was not made available in

time. The machinery was imported one. Consequently, the unit became sick but

the entrepreneur decided to go in for a second hand machinery which was locally

available. With some minor repairs, the machinery started functioning. With this

arrangement, the unit was revived. In one unit, cost of production was on the

higher side. With the introduction of improved technology, the cost reduced.

Subsequently, the unit was revived.

(e) Labour : In one case, workers went on strike for a long time due to

unsatisfactory attitude of the entrepreneur. On the death of the

entrepreneur, his son was inducted to the unit who adopted

altogether a different approach towards workers. He was able to

pursue the workers to come for the work. He also counselled them

adequately. Consequently, the unit was revived. In another case,

productivity of the workers was very low. The entrepreneur rightly

decided to offer incentives on the basis of output. This was proved to be

a major source of inspiration. Consequently, the productivity of workers

improved significantly. Thus, the revival of the health of the unit could

take place. It is worth to know that in the same case, the concerned court

authorities granted retrenchment of workers which also proved to be a

useful remedy for revival. Entrepreneur of the unit presented his case so

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well before the court authorities that his request was considered here, a

lot of home work relating to economics of retrenchment was done.

(f) Others : There are some more strategies adopted for revival. One unit

decided to purchase a generator to overcome the power shortage. This was a

right decision leading to the revival of the unit. In another case, shortage of raw

material (raw steel) was the main cause of sickness. The unit rightly decided to

become a subsidiary of a mini steel plant. This led to revival of the unit. To

improve the quality of the product, one entrepreneur hired the services of a

consultant who suggested various ways for improving the quality. When the

consultant’s report was implemented, the quality of the product improved. Thus,

the unit was revived.

The above mentioned strategies are few in number. There can be some more

strategies depending upon the nature of sickness. For selection of the right

strategy, it is necessary to diagnose causes of sickness correctly.

5. Time factor- In the context of revivals of sick units, time factor is the most

important one. The revival can take place if decisions are taken at the right point

of time. It is necessary to have a time bound programme for different aspects

of rehabilitation which include detection of sickness, conducting a viability study,

preparation of proposal for rehabilitation, implementation of the proposal and

monitoring of the project. It was found in the units , under the study, that

entrepreneurs paid sufficient importance to the time factor. They were found to

be eager to get their units revived soon. Therefore, the proposals were

submitted on timely basis. Banks and financial institutions also adopted a time

bound programme which is broadly indicated for various items of work as under :

- Conducting of viability study : 1 month

- Preparation of rehabilitation scheme : 1 month

- Disbursement : 1 month

The above mentioned time schedule was followed in most of the cases. Thus, it can

be concluded that for revival of sickness both entrepreneurs and bankers have to

adopt a time bound programme to carry out different aspects of rehabilitation.

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6. Profile of Entrepreneurs-It is interesting to study the background of

entrepreneurs. They were found to be hard working which was evident right from

the stage of detection of sickness till its cure. They were found to be highly

committed and therefore, they were prepared to sacrifice even their gains. They

didn’t expect any return from the unit until it was revived. Their integrity was

undoubtedly of higher order. This was considered as a basis for providing

financial assistance to the units. It was also found that there was a fair

understanding among the directors of the units and, therefore, decisions were

taken promptly. Further, the group of directors was well balanced in terms of

expertise. Entrepreneurs were found to be open to banks and financial

institutions. This helped in establishing a better rapport between the two. They

were found to be cooperative to the financial institutions in supplying the required

information and complying with necessary formalities. They were found to be

risk takers and, therefore, decisions were taken promptly. They were also found

to be aware of modern methods of management and practiced the same.

Finally, the entrepreneurs had pleasing manners and therefore, they were given

better treatment by all the outside parties.

7. Role of Banks and Financial Institutions-It is worthwhile to talk about the role

of banks and financial institutions. In all cases, it was observed that there was a

good understanding between the entrepreneurs and the banks. Bankers’ attitude

towards entrepreneurs was quite satisfactory. Banks were found to be more liberal

and helpful while chalking out the rehabilitation package. They were found to be

very quick in decision making. In one case, the required sanction was given within a

period of just one week. Further, at the time of preparation of the scheme, they had

total perspective of the units. Therefore, they suggested to modernise management

besides replacing old machinery. They took up risk on many occasions. Upon the

death of an entrepreneur, his immediate successor (wife) was considered to take

over the unit. Banks gave the required assistance even under those circumstances.

In one unit when the court granted the decree, the bank rightly considered it for

rehabilitation taking into account the benefits of rehabilitation. With the change of

management, the unit started operating nearly at full capacity. It also became a

profit making company.They were consistent in their approach to rehabilitation all

through the period of revival. They were not only a financier but also a counselor to

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the unit. Their advice on money matters was very much rewarding to the units.

There was a good team of banks and financial institutions which shared the related

work. Coordination between banks and financial institutions was of high order and

therefore, credit decisions were taken timely. Finally, bankers were found to be alert

during the period of post sanction. They maintained a close supervision of the

factory and operations in the bank account. Consequently, the end-use of bank

funds was fully ensured.

V. LESSONS FROM SUCCESS STORIES

1) Rehabilitation of a sick unit should be considered as a rare occasion and

therefore, every one concerned with it should be serious in dealing with the

related matters. Their seriousness should also be seen right from the stage of

identification of a sick unit till the same is successfully rehabilitated.

2) On occurrence of a sickness, everyone gets affected. May be, some are badly

affected while others may suffer marginally. Therefore, all those involved in

rehabilitation exercise have to necessarily make sacrifice. This applies even to

the promoters, government and workers.

3) In addition to the required sacrifice expected from all the concerned parties, it is

equally important to adopt a right strategy for revival of sickness. Selection of the

strategy primarily should depend upon the nature of sickness. It is also

necessary to consider cost implications, competence of management, moods of

workers etc. so that the strategy so selected for revival is widely welcomed.

4) For early revival, all work related to rehabilitation has to be time bound. For

which, the role and responsibility of banks, financial institutions, entrepreneurs

and the government should be properly spelt out so that it is possible to avoid

delays in preparation and implementation of the scheme.

5) Rehabilitation is basically a team work and therefore, members of the team

including entrepreneurs, consultants and the government have to put in co-

ordinated efforts to implement the project. In particular, co-ordination between

banks and financial institutions on one hand and banks and government, on the

other, has to be ensured.

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6) Banks and financial institutions are expected not only to supply timely and

adequate finance under rehabilitation but also to offer counselling services to the

entrepreneurs at various stages of rehabilitation. This need is very much felt in

the case of small sized firms.

7) To complete the process of rehabilitation, it normally takes 5 to 7 years. It may

happen that the unit under rehabilitation may suffer due to natural calamities

including death of a key partner/director. In that case, all other parties have to

adopt a sympathetic approach to the firm and extend necessary co-operation.

8) Wherever, default in repayment of loan is deliberate one, stern action is expected

by banks and financial institutions including filing a suit immediately. There

should not be any delay in this regard.

CONCLUSION

Mere introduction of rehabilitation scheme or a package of concessions will not

assure successful revival of a sick unit unless attitude of banks, financial

institutions, government, healthy companies etc. is positive. Similarly, sick

companies should look at rehabilitation as `one time opportunity’ given to them

during their life-span and, therefore, they should endeavour to regain their lost

strength with a high degree of commitment and professional approach. When

these expectations are fulfilled, the present rate of success in rehabilitation can

be enhanced effectively. There are already many success stories in this regard.

So, let everyone march on for reviving each eligible sick unit as early as possible

to make our industrial economy more healthy.

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Chapter-15

DRTs and Lok Adalats

IntroductionBanks and financial institutions are increasingly finding that Debt Recovery Tribunals

(DRTs) do really help in dealing with non-performing assets. For instance, DRT at

Bangalore is ranked number One by the Ministry of Finance which has disposed off

nearly 3500 cases valued at over Rs. 1900 crores since its inception in 1994. As of

March 31, 2004 DRTs in the country have admitted 56988 cases wherein the amount

involved is Rs. 108655 crores. The cases disposed off and the amount involved in them

stood at 23393 and Rs. 18656 crores respectively. Though the overall recovery through

DRTs is yet to be stepped, there is a considerable progress in their performance. This is

mainly due to several initiatives taken by the DRTs. One such initiative is that DRTs

have started holding ‘Lok Adalats’ or ‘Lok Nyayalayas’ to dispose off small value cases.

For instance, the first Lok Adalat in Maharashtra for compromise settlement of bad loans

of banks and financial institutions under the aegis of the DRT was held in Mumbai on

September 29, 2004. To facilitate both banks and borrowers to gain the full advantage

of the Lok Adalats organised by DRTs, it is necessary for them to know more about this

initiative.

The Origin of Lok AdalatsThe concept of Lok Adalat was introduced by the then Chief Justice of India, Shri P N

Bhagwati in the year 1982 as a part of legal aid. By now, it has become a usual feature

of the legal system for effecting mediation and conciliation between the parties and to

reduce burden on the Courts/DRTs specially for small loans. Large number of Lok

Adalats are being organised in different parts of the country from time to time and it

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has got recognition and the patronage of practically every segment of the society.

Based on the experience of several States, a Central Act known as Legal Services

Authorities Act 1987, has been passed providing legal basis for the Lok Adalats and

Legal Authorities to the compromise arrived at between the parties through such Lok

Adalats. Since these Adalats are yet to take a legal shape, they are based on the social

movement only. Several organisations including DRTs, banks and financial institutions

are holding Lok Adalats, which are generally presided over by two or three senior

persons of status and experience including retired Senior Civil Servants, Defence

Personnel and Judicial Officers.

Procedures at Lok AdalatsThey take up the cases which are brought to them by any organisation for consideration.

Parties are heard and they are explained their legal position. They are also advised

about the merits of their cases in accordance with law. They are further counselled to

reach some settlement. Wherever social pressure of senior bureaucrats, judicial officers

or social workers can work, the same is also tried. If the compromise is arrived at, it is

reduced to writing and the parties to the litigation are expected to sign. The Lok Adalats

not being a legal entity do not normally sign the deed of settlement. After the

compromise is arrived at and signed in presence of Lok Adalats, it is to be filed in courts

and a consent decree is to be obtained. Normally, such settlements do contain a clause

that, if the compromise is not adhered to by the parties, the suit pending in the court will

proceed in accordance with the law and the parties will have a right to get decree from

the court. At the time of the session of Lok Adalats, in case some of the parties to the

dispute are not present, they are directed to be present in court for executing the

compromise as arrived at before in the Lok Adalat.

Banks and Lok Adalats – General GuidelinesTo arrive at compromise banks may have to reduce the rate of interest as per their

compromise scheme. To maintain some uniformity in this regard, banks in consultation

with Indian Banks’ Association originally formulated certain guidelines. These guidelines

are :-

1. The bank suits involving claims upto Rs. 20 lakhs may be brought before the Lok

Adalats.

2. Both suit filed and non-suit filed cases can be referred to, Lok Adalats.

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3. Settlement with regards to waivement of interest or sacrifice of principal may be

decided as per delegated authority of the bank official attending the Lok Adalat and

as per recovery management policy of the bank.

4. The defendant should pay half the court fees as cost to the bank and party should

bear rest of the cost as would be proposed by Lok Adalats.

5. The future interest may be agreed to as would be proposed by the Lok Adalats

having regard to Section 34 of CPC.

6. As per merits of each case, considering the total amount and financial condition of

the debtor, six monthly or yearly instalments may be agreed as would be proposed

by the Lok Adalats with a default clause providing for whole amount becoming due

in case of any two defaults.

7. The sick units declared may be given concession in interest as per the existing bank

rules and regulations.

Strength of the Lok AdalatsLok Adalats have had notable success with more than 10 million cases settled through

mechanism. The reasons for these successes need to be identified. First, Lok Adalats

have an element of conciliation and mediation which is lacking in the courts. Second,

Lok Adalats have the counterpart of pre-trial hearings, and have thus settled 50000

disputes at a prelitigative stage itself. Third, Lok Adalats rules are binding on everyone

and no appeals are possible. Fourth, lawyers are not required in Lok Adalats and

consequently, delays have come down fairly. Fifth, Lok Adalats can dispense with

cumbersome court procedures since they autonomous bodies. In this way, there are

many more benefits of the Lok Adalats.

Recent ChangesRecognising the growing importance of Lok Adalats in compromise settlement especially

in respect of small loans, the Central Government in August 2004 has enhanced the

monetary ceiling for referring case for compromise settlement of dues of banks and

financial institutions using the forum of Lok Adalats to Rs. 20 lakhs as against Rs. 5

lakhs earlier. The scope of the Adalat is now expanded to cover both suit filed and non-

suit filed cases in the ‘doubtful’ and ‘loss’ categories with an outstanding balance upto

Rs. 20 lakhs.

Looking AheadThere are twenty nine DRT and 5 DRAT across the country. With the unique advantages

of the Lok Adalats, DRTs have to change their mind-set to dispose off cases of small

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borrowers by organising the same more frequently and also at district and block levels.

This in turn helps DRTs to concentrate more on high value and complicated cases.

DRTs can be merely a facilitator to impress upon both borrowers and banks to settle

disputes on the spot. Further, Lok Adalats are more customers friendly in terms of

procedures for loan settlement besides there is no cost involved in having access to

them. Hence, both borrowers and banks have to take the fullest advantage of the forum

created by the government. But this should be the collective effort of DRTs, banks and

small borrowers to strengthen this forum. More importantly, officers representing the

banks should have sufficient powers to accept the compromise proposal worked out at

the Lok Adalat within the broad compromise policy guidelines of each individual bank

and abide the suggestions of the presiding officer. Borrowers in-turn will have to

appreciate the bank formalities and policy guidelines and agree to the directions of the

Lok Adalats. Towards this end, a need for training and education to DRTs, banks and

borrowers is clearly felt.

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Chapter - 16

Recovery procedure under Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest

Act, 2002(SARFAESI)

“The act does not provide a magic wand to remove the sickness in the industry, it can,

at the best, be looked upon as a transient phase in the culture of financing.”

-Justice B P Banerjee

INTRODUCTIONDuring the recent past, many legal reforms have been introduced by the Government

and the Reserve Bank of India for facilitating banks and financial institutions (FIs) to

recover their Non Performing Assets (NPAs). These reforms include setting up of

Board for Industrial and Financial Reconstruction (BIFR), Debt Recovery Tribunals

(DRTs) etc., besides enacting a new act entitled, "Securitization and Reconstruction of

Financial Assets and Enforcement of Security Interest Act, 2002 (conveniently called as

Securitization Act.

The Act empower the banks and FIs to recover their dues in NPA accounts without

intervention of the court by issuing notice to the defaulting borrowers and guarantors

calling upon them to discharge the dues in full within 60 days. The act further provides

that in case the borrower fails to comply with the 60 days demand notice given by the

bank to repay the dues, the bank can-

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(a) Take possession or the management of secured assets of the borrower, and can

transfer the same by way of lease, assignment or sale for realizing the secured

assets without intervention of court/DRT,

(b) Appoint any person to manage the secured assets which has been taken over the

secured creditor (bank), and

(c) Instruct at any time by notice in writing to any person who has acquired any of the

secured assets from the borrower and from whom any money is due or become due

to borrower to pay it to the secured creditor.

After receipt of 60 days notice by the bank, the borrower shall not deal with the assets,

which are charged, to the bank. However, dealing with the said assets in the ordinary

course of business of the borrower is permitted.

The Security Interest (enforcement) Rules 2002 notified by the government provides the

manner in which the secured creditor shall take possession of the securities and

procedure for disposal of such securities.

Section 17 (2) of the original act provided that the borrower can file an appeal with the

DRTs against any of the aforementioned actions of FIs/Banks taken under the act

provided 75% of the demanded money is deposited by the borrower with the DRT. The

said stipulation regarding deposit of 75% demand money was struck down by the

Hon’ble Supreme Court in Mardia Chemical case, and thereafter it was felt necessary

that law be amended to bring it in conformity with the orders of the Hon’ble Supreme

Court. So the President of India promulgated an ordinance named ‘Enforcement of

Security Interest and recovery of Debts Laws (amendment) Ordinance 2004’ which was

later converted into amendment bill and has since became an act.

Through this amendment sub-section (2) of section 17 that was declared invalid by the

Supreme Court has been deleted and reference to appeal contained in section 17 is

changed to an application. The amendments of 2004 now

(a) Empower banks to take over the management of the business of the borrower,

including the right of transfer by way of lease, assignment or sale or realizing the

secured assets,

(b) Banks are under obligation to consider representation of the borrower and reply

within seven days of such representation and if on examining the representation

made by borrower/guarantor, the banks is satisfied that there is a need to make any

changes or modification in the demand notice, the bank shall modify the notice

accordingly and serve a revised notice or pass such other suitable orders as deemed

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necessary, within seven days from the date of receipt of the representation or

objection.

(c) But mere issuance of 60 days notice or reply of the queries or rejection of objection

of the borrower by the bank will not be a cause of action for filing an application in

the DRT,

(d) However a right has been provided to the borrower for making an application/petition

in DRT for challenging the action of the bank for enforcing the security interest once

bank take over management control or take possession of the assets but before they

are sold,

(e) DRTs have been mandated to decide the case within 60 days. If the case is not

decided by DRT even within four months, the borrower or bank can approach the

appellate tribunal (ADRT ),

(f) The appellate tribunal shall entertain no appeal unless the borrower deposit 50% of

the amount of debt due to him as claimed by the secured creditor or determined by

DRAT. DRAT may reduce the amount to 25% of the debt also.

Since Sarfaesi Act has given wide powers to seize, maintain and sell secured assets of

NPA borrowers to banks, there is urgent need for understanding procedures by

authorized officers (who are empowered to seize and sell the assets) so that provision of

the act are effectively used for benefit of the banks.

RECOVERY PROCEDURES It is attempted here to discuss procedures to be adopted by banks and FIs for

enforcement of security interest by referring to (1) Relevant provisions of the Act 2002

and subsequent amendment of 2004, (2) Central Government Rules and (3) RBI

guidelines issued as on 12th December, 2002. It is also kept in mind the possible

queries that may be put forth by branch managers or authorized officials on their actions

as indicated under the Act. The prescribed system is as under-:

1. Each bank/FI has to set up a separate cell to co-ordinate the work relating to

recovery under the Act.

2. Each bank/FI should appoint an authorized officer (AO) who should not be less than

a Chief Manager. Different banks have authorized different level of officers say

Regional manger or Zonal manager. The authorized officers (A0) are vested with the

following powers-

(a) To issue demand notice to borrower(s)/guarantor(s) u/s 13 (2) of the act.

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(b) To takes steps for substituted service of notice by affixing the same on the

conspicuous part of the secured assets or / and paper publication (rule3).

(c) To take possession of assets (both movable and immovable) and execute

panchanama for having taken possession of movable assets.

(d) To take inventory of movable assets and keep all movables in safe custody by

him or through agents.

(e) To approach the Chief Metropolitan Magistrate or the District Magistrate in writing

to take possession of any secured assets and forward such assets to him,

wherever needed in case AO faces any problem in discharge of his

responsibility. Bombay high court in a land mark judgment has ruled that no

notice or hearing needs to be given to a borrower or a third party when assistant

is taken from the Chief Metropolitan Magistrate to take possession of secured

assets under securitization act. High court has further ruled that the magistrate

has simply to look into two aspects first whether the secured asset falls within his

territorial jurisdiction and second whether the bank had given notice to the

borrower under section 13 (2) of the act to repay the amount due.

(f) To take steps for protection, preservation and insurance of the secured assets

taken into custody.

(g) To take possession or recover dues from 3rd parties, other than borrower after

issuing due notices containing direction, prohibitions, or taking possession of title

deeds.

(h) To affix possession notice on the property taken into possession and issue public

notice in news paper for having taken over possession of the secured assets.

(i) To fix reserve price after obtaining estimated value of secured assets by bank’s

approved valuer.

(j) To issue 30 days sale notice to the borrower/guarantor.

(k) To issue newspaper advertisement setting out the terms of sale through public

tender or public auction.

(l) To sell the secured assets in one or more lots by obtaining quotations, inviting

tenders, holding public auctions or by private treaty to recover maximum price.

(m) To receive sale money and issue certificate of sale.

(n) To publish photographs of borrowers along with demand notice or notice of

taking possession or notice of sale.

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3. Authorized officer will have to first identify NPA accounts to whom the notice has to be

sent. NPA accounts of Rs. 1 lakh and above and loan overdue being more than 20% of

principal amount, are only covered under the act. In case of consortium / multiple

finance, consent of creditors representing at least 75% of value of amount outstanding is

required before issuance of notice. Secured assets must not be agricultural land. AO

should also confirm/check that documents are not time-barred and remain within

limitation till sale process is completed.

4. Thereafter a notice under section 13 (2) of 60 days should be served to

borrowers/guarantors by a registered post with A.D./ Speed post/ Courier/ Fax/ email/

etc. and in case borrower/guarantor is found avoiding service of notice, then notice can

be served by affixing on the door, or publishing in two local newspapers (one must be

vernacular).

5. If the full payment is made by the borrower during the notice period, no further action

is called for. If he makes part payment, the bank/FI can retain the right to seize the

asset to claim the balance amount. During the notice period, Bank/FI can entertain a

request for compromise from the borrower. If the borrower makes part payment in such

a way that loan installments remain due for a period of less than 3 months or irregularity

is less than three months as on the end of the notice period, the bank/FI cannot take

further action since it is a performing loan asset as on expiry of the notice period.

6. In case borrower makes a representation/objection/reply for consideration of the bank,

the AO should consider objection/representation with due application of mind. AO is

duty bound to respond to the borrower if he does not accepts his objections with reasons

within one week of receipt of such objections. Such communication rejecting the

objection will not give any cause of action to borrower/guarantor to file application with

DRT.

7. In case borrowers/guarantors fail to make payment in terms of notice within 60 days,

AO may decide to take possession of secured assets (both movable and immovable).

8. Procedure of taking possession and disposal of movable assets by the AO is as

under-

(a) AO should take possession in presence of two witnesses.

(b) He should prepare a panchnama under his signature and signed by two

independent witnesses for taking possession of movable assets.

(c) He should prepare an inventory of all movable assets taken into possession

and should deliver a copy to borrower or guarantor as applicable.

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(d) He should keep the movables immediately to a nearby godown for storage

and protection and Inform insurance company and arrange for insurance if

not already available.

(e) He should take adequate steps for preservation, protection and safety of the

seized assets.

(f) He should get the assets valued by the bank’s approved valuer and fix

reserve price.

(g) If the borrower agrees to bring in a potential buyer who is ready to pay

minimum fixed price, assets can be sold through private treaty with the

consent of borrower.

(h) He should issue 30 days notice for sale mentioning outstanding dues,

description of assets, reserve price, mode of sale and proposed date and

time of sale through (i) public tender, (ii) public auction or (iii) private treaty.

If the proposed sale is by inviting tender from public, then AO has to publish a

notice in two leading newspapers –one in vernacular language- giving all

details and also mention earnest money to be deposited. He may also

mention that the sale is subject to confirmation by bank.

(i) AO should do actual sale on date, time and venue given in notice/paper

advertisement. Excepting sale by public auction or public tender, terms of

sale should be first settled with the borrower/guarantor and the prospective

purchaser. AO may accept sale price from the person offering maximum price

and deliver the goods and issue certificate of sale.

(j) If the assets are of perishable nature, AO should sale the assets immediately

after taking possession.

(k) If the secured asset is a debt or a share in a corporate body, the Authorized

Officer can directly send a notice to the debtors to make payment to the

bank/FI or transfer shares in bank’s name, as the case may be. AO can

recover dues from 3rd parties other than borrower after issuing due notices

containing direction or prohibitions. For example, if the secured assets are

leased or rented, AO may direct the lessee / tenant to pay the lease rent/

monthly rental to bank. In case of advance against book-debts, AO may

prohibit the debtors to pay to the borrower and direct them to pay to the bank.

(l) Assistance of empanelled advocates may be taken where AO may feel any

difficulty.

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9. Procedure for taking possession and disposal of immovable secured assets by AO is

as under-

(a) AO shall take possession of secured assets (either constructive or actual) by

delivering a possession notice to borrower/guarantor or by affixing the

possession notice on the outer door of the property.

(b) Possession notice should be published in two leading news papers one of

which should be in vernacular language.

(c) If actual possession and custody of the secured asset is taken, then AO will have

to take prudent care of the property by taking steps for preservation, protection,

security, safety and insurance.

(d) AO should get the property valued by an approved valuer and thereafter fix the

reserve price.

(e) Assistance of empanelled advocates may be taken where AO feels any difficulty.

(f) If the borrower agrees to bring in a potential buyer who is ready to pay minimum

reserve price, assets can be sold through private treaty with the consent of

mortgagor (Borrower/guarantor).

(g) AO should send 30 days sale notice to the borrower/guarantor advising them

interalia amount of debt, description of secured assets, mode of sale, reserve

price, terms of depositing earnest money (25%), encumbrances if any on the

secured assets, date, time and place of public auction or tender. Notice of sale

should also be affixed on the property and published in two leading news paper-

one vernacular- having wide circulation in the area where property is situated.

AO must also mention that the sale is subject to confirmation by bank. It should

be clearly mentioned in sale notice that the proposed sale is on ‘as is where is ‘

basis and the bank will not be liable for any charges, dues, levies, taxes,

encumbrances or adverse possession what so ever, neither the bank shall be

liable for the clear and marketable title of the borrower on the charged securities

as the secured assets.

(h) AO should do wide publicity of notice of sale. He/branch officials should contact

potential buyers so that they receive sufficient offers in terms of sale notice.

(i) AO should accept the bid of highest bidder only if it is above reserve price and

accompanied by the earnest money. Balance amount has to be paid by the

bidder within 15 days. The secured asset should only be sold above the reserve

price fixed by the AO.

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(j) When full bid amount is paid, the sale will be confirmed and a sale certificate will

be issued.

(k) In case of default in payment of balance amount by the bidder, the property will

be put to sale again and same procedure of sale will apply. The earnest money

deposited will be forfeited and credited to borrower’s account.

(l) If there is no bidder due to reserve price being high, the AO may reduce the

reserve price by 10 %to 15% and put the secured assets for sale 2nd time after

complying with the procedure noted above.

(m) If excess money is received over and above the banker’s claim, the same should

be credited to the borrower’s account or refunded to him. If there are preferred

creditors (workers’ dues, statutory dues, etc.), the payments should be paid to

them first before the settlement of bank/FI dues.

(n) In case the company is in liquidation, the amount realized from the sale of the

secured assets shall be distributed in accordance with the provision of section

529 A of the Companies Act (workmen’s dues paripassu charge).

(o) Where the property is subject to any encumbrances, the purchaser is expected to

deposit extra amount to discharge encumbrances or meet contingencies.

(p) The Authorized Officer may prefer the sale of movable assets to immovable

assets for early recovery of NPAs.

10. Suit for recovery of balance amount should be filed with Debt Recovery Tribunals

(DRTs)/ appropriate court as per jurisdiction for recovery of shortfall, if any, on sale

of the secured assets.

11. After initiating action under Sarfaesi Act and before actual sale of secured interest, if

is found that documents are getting time barred, bank/ FI must file suit in DRT/civil

court explaining the circumstances.

12. AO may take over the management of the business of borrower under section 13 (4)

of the act. When the business is taken over, the AO may appoint as many as director

or administrator as required. A notice of taking over management and appointment of

directors/administrators should be published in two leading daily newspapers- one in

vernacular- having wide circulation in the area. The directors/persons in control will

vacate the office immediately on publication of the notice and hand over the office to

directors/administrators appointed by the A.O. and they will take into their custody all

property, effects and actionable claim of the business of borrower. The management

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shall be restored as soon as debts are realized in full. No proceedings for winding up

or appointment of receiver shall lie without consent of the A.O.

13. Wrongful seizure of assets may cause penalties. AO should take care.

14. AO is under obligation to make disclosure of all vital facts to the buyer of the

property. In a land mark judgment of Haryana Financial corporation vs Rajesh Gupta

Supreme Court has held that ‘mere perusal of the provisions of the Transfer of

Property act will show that it was incumbent upon the corporation to disclose the

buyer about the non existence of an independent passage to the unit, It was also the

duty of the corporation to inform the buyer that the passage mentioned in the

revenue record was not fit for movement of vehicles. The corporation also failed to

show the buyer the entire documentation as required by law.’

Interference by High Court

In land mark judgement (ET 3.8.2010) Supreme Court has asked High Courts

not to interfere with the debt recovery proceedings initiated by banks against the

defaulters as it will have serious adverse impact on the right of lenders to recover

their dues. It further directed that alternative remedies available to the borrowers

must be exercised under DRT act and SARFEASI Act before the High Court

exercise its discretion to interfere with the proceedings.

Advocates can not sign securitization notice on behalf of bank

In an important judgment Andhra Pradesh High court ( Sampoorna Battu

v. ICICI Bank) has held that only authorized person ( Chief Manager or above)

can sign the notice and noted that issuance of notice by the bank’s advocate

has no locus standi and even subsequent countersigning will not be a remedy to

rectify the defect. (BS 11.01.13)

SICA Act

Section 35 of Sarfaesi act gives its provisions an overriding effect over

anything to the contrary contained in any other law that obviously includes the

Sick Industrial Companies ( special provisions) Act 1985 (SICA). But in Noble

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Aqua case Odisha High court ruled otherwise against which State Bank of India

appealed to Supreme Court. What perhaps has queered the pitch for the

secured creditors is Section 37 of the Sarfaesi Act that goes on to say that the

act is in addition to and not in derogation of any other law in force. This forces

banks to stop Sarfaesi proceedings against Sick companies. With more and

more corporate moving to CDR, it is time to policy makers to lay down rules to

make the Sarfaesi override SICA so that instead of yielding to mirage of CDR

banks actually take advantage of Sarfeasi and enforce recovery.

Change in or Take Over of the Management of the Business of the Borrower

The Reserve Bank of India notified these guidelines effective April 21, 2010,

framed under Section 9(a) of the Securitisation and Reconstruction of Financial

Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) to enable

the Securitisation Company or Reconstruction Company (SC/RC) to realise their

dues from the borrowers, by effecting change in or takeover of the management of

the business of the borrower and related matters.

Object of the Guidelines

The objective of these guidelines is to ensure fairness, transparency, non-

discrimination and non arbitrariness in the action of Securitisation Companies or

Reconstruction Companies and to build in a system of checks and balances while

effecting change in or takeover of the management of the business of the borrower

by the SC/RCs under Section 9(a) of the SARFAESI Act. The SC/RCs shall follow

these guidelines while exercising the powers conferred on them under Section 9(a)

of the SARFAESI Act, 2002.

Powers of SC/RC and Scope

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A SC/RC may resort to change in or takeover of the management of the business of

the borrower for the purpose of realization of its dues from the borrower subject to

the provisions of these guidelines. The SC/RCs resorting to take over of

management of the business of the borrower shall do so after complying with the

manner of takeover of the management in accordance with the provisions of Section

15 of the SARFAESI Act. On realization of its dues in full, the SC/RC shall restore

the management of the business to the borrower as provided in Section 15(4) of the

SARFAESI Act

Eligibility conditions to exercise power for change in or takeover of management

a) A SC/RC may effect change in or take over the management of the business of

the borrower, where the amount due to it from the borrower is not less than 25%

of the total assets owned by the borrower; and

b) Where the borrower is financed by more than one secured creditor (including

SC/RC), secured creditors (including SC/RC) holding not less than 75% of the

outstanding security receipts agree to such action.

Grounds for effecting change in or takeover of management

SC/RC shall be entitled to effect change in management or take over the

management of business of the borrower on any of the following grounds:

a) the borrower makes a willful default in repayment of the amount due under the

relevant loan agreement/s;

b) the SC/RC is satisfied that the management of the business of the borrower is

acting in a manner adversely affecting the interest of the creditors (including

SC/RC) or is failing to take necessary action to avoid any events which would

adversely affect the interest of the creditors;

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c) SC/RC is satisfied that the management of the business of the borrower is

not competent to run the business resulting in losses/ non repayment of dues

to SC/RC or there is a lack of professional management of the business of

the borrower or the key managerial personnel of the business of the borrower

have not been appointed for more than one year from the date of such

vacancy which would adversely affect the financial health of the business of

the borrower or the interests of the SC/RC as a secured creditor;

d) the borrower has without the prior approval of the secured creditors (including

SC/RC), sold, disposed of, charged, encumbered or alienated 10% or more

(in aggregate) of its assets secured to the SC/RC’4

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(e) there are reasonable grounds to believe that the borrower would be

unable to pay its debts as per terms of repayment accepted by the borrower ;

(f) the borrower has entered into any arrangement or compromise with

creditors without the consent of the SC/RC which adversely affects the

interest of the SC/RC or the borrower has committed any act of insolvency;

(g) the borrower discontinues or threatens to discontinue any of its

businesses constituting 10% or more of its turnover;

(h) all or a significant part of the assets of the borrower required for or

essential for its business or operations are damaged due to the actions of the

borrower,

(i) the general nature or scope of the business, operations, management,

control or ownership of the business of the borrower are altered to an extent,

which in the opinion of the SC/RC, materially affects the ability of the

borrower to repay the loan;

(j) the SC/RC is satisfied that serious dispute/s have arisen among the

promoters or directors or partners of the business of the borrower, which

could materially affect the ability of the borrower to repay the loan,

(k) Failure of the borrower to acquire the assets for which the loan has been

availed and utilization of the funds borrowed for other than stated purposes or

disposal of the financed assets and misuse or misappropriation of the

proceeds;

(l) Fraudulent transactions by the borrower in respect of the assets secured to

the creditor/s.

Policy regarding change in or takeover of management

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Every SC / RC shall frame policy guidelines regarding change in or takeover of the

management of the business of the borrower, with the approval of its Board of

Directors and the borrowers shall be made aware of such policy of the SC/RC. Such

policy shall generally provide for the following:

(i) The change in or takeover of the management of the business of the

borrower should be done only after the proposal is examined by an

Independent Advisory Committee to be appointed by the SC/RC consisting of

professionals having technical / finance / legal background who after

assessment of the financial position of the borrower, time frame available for

recovery of the debt from the borrower, future prospects of the business of

the borrower and other relevant aspects shall recommend to the SC/RC that

it may resort to change in or takeover of the management of the business of

the borrower and that such action would be necessary for effective running of

the business leading to recovery of its dues;

(ii) The Board of Directors including at least two independent directors of the

SC/RC should deliberate on the recommendations of the Independent

Advisory Committee and consider the various options available for the

recovery of dues before deciding whether under the existing circumstances

the change in or takeover of the management of the business of the borrower

is necessary and the decision shall be specifically included in the minutes.

(iii) The SC/RC shall carry out due diligence exercise and record the details of

the exercise, including the findings on the circumstances which had led to

default in repayment of the dues by the borrower and why the decision to

change in or takeover of the management of the business of the borrower has

become necessary.

(iv)The SC/RC shall identify suitable personnel / agencies, who can take over

the management of the business of the borrower by formulating a plan for

operating and managing the business of the borrower effectively, so that the

dues of the SC/RC may be realized from the borrower within the time frame.

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(v) Such plan will also include procedure to be adopted by the SC/RC at the

time of restoration of the management of the business to the borrower,

borrower’s rights and liabilities at the time of change in or takeover of

management by the SC/RC and at the time of restoration of management

back to the borrower, rights and liabilities of the new management taking over

management of the business of the borrower at the behest of SC/RC. It

should be clarified to the new management by the SC/RC that the scope of

their role is limited to recovery of dues of the SC/RC by managing the affairs

of the business of the borrower in a prudent manner.

Procedure for change in or takeover of management

(a) The SC/RC shall give a notice of 60 days to the borrower indicating its

intention to effect change in or take over the management of the business of

the borrower and calling for objections, if any.

(b) The objections, if any, submitted by the borrower shall be initially

considered by the IAC and thereafter the objections along with the

recommendations of the IAC shall be submitted to the Board of Directors of

the SC/RC. The Board of Directors of SC/RC shall pass a reasoned order

within a period of 30 days from the date of expiry of the notice period,

indicating the decision of the SC/RC regarding the change in or takeover of

the management of the business of the borrower, which shall be

communicated to the borrower.

LOOKING AHEAD

As per RBI data, out of 61,263 notices issued by PSBs involving an outstanding of Rs. 19,744

crores, PSBs have recovered only Rs.1784 cores from 24,092 borrowers. It is a good

beginning, but we have a long way to go. Now banks will have to capitalize on the benefits of

the act. Hence, what is important is to identify eligible accounts immediately. Notice should

be served to them immediately. Banks/FIs should give priority for seizure of secured assets in

those accounts where secured assets are likely to fetch potential buyers easily or borrowers

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are found cooperating. There should be utmost care in preserving the assets, which are

seized. In particular, authorized officers should take reasonable care to comply with the

provision of the act and RBI guidelines. It calls for a professional approach from authorized

officers in seizure and sale of secured assets. Such measures will definitely send strong

signals to willful defaulters. Thus, one can hope that banks/FIs will succeed in bringing down

the level of NPAs by enforcing security interest. It will also create a congenial repayment

climate in the country by dissuading willful default.

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166

Chapter-17

SARFAESI Act 2002 - FAQIntroduction

With the recent judgment delivered by the Supreme Court in respect of ICICI

Bank and Mardia Chemicals, banks are now busy in seizure of secured assets and sale

under the Securitization and Reconstruction of Financial Assets and Enforcement of

Security Interest (SARFAESI) Act, 2002. While waiving the condition under 17 (2)

under the SARFAESI Act to deposit 75% of the bank-claim by the aggrieved borrower

with the Debt Recovery Tribunal (DRT), the Apex Court took a note of the Lenders’

Liability – Best Practices Code of the Reserve Bank of India besides making it obligatory

on the part of banks to provide clarification to a borrower to whom notice is served

under 6 of the Act. Though banks are now allowed to proceed with their arrangements

to sell the assets seized under the Act, most of the borrowers are rushing to the DRT to

seek justice for which no deposit of the banker’s claim is called for. Consequently,

banks are prevented to sell the assets until the DRT decides on the petition filed by the

aggrieved borrower. Hence, these banks made a request to the Government to amend

the SARFAESI Act and the Recovery of Dues to Banks and Financial Institutions Act,

1993. While performing the tasks, banks would like to seek clarification on various

matters concerning the seizure and sale of assets. In this chapter , it is attempted to

provide clarification on various bank procedures through frequently asked questions.

Questions and AnswersQ1. Can any officer in banks seize assets?

Ans. No, only the authorized officers appointed under section 13 (12) can seize

secured assets. Each bank/FI has appointed authorized officers under provision of

this section. In public sector banks, officer in SMG IV and above and not below the rank

of Chief Manager can be appointed as the authorized officer.

Q.2. How do we serve notice?

Ans. As under section 6 of the Act, notice of 60 days (from the date of receipt of

notice) should be served properly, i.e., by a registered post with A.D., affixing the notice

on the door, or publishing in the local newspapers. Notice to all the parties is necessary

if the number is more than one. Simultaneous action may also be taken against the

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guarantor. The notice has to be delivered at the place where the borrower/ guarantor,

actually and voluntarily resides or carries on business or personally works for gain and

where the borrower is corporate, the demand notice has to be served at registered office

address.

Q.3. Is it necessary to seek permission from the Court/DRT for serving the notice in

respect of suit filed/DRT cases?

Ans. In terms of the proviso to amended section 19 of the DRT Act, the bank, may if

so chooses move an application for permission of DRT for withdrawal of the recovery

suit pending before DRT for enabling the bank for taking action under securitisation act .

It should be noted that withdrawal of DRT suit may have implication from limitation point

of view and before taking such a decision a banker must carefully examine all inns and

out. However if the notice under section 13 (2) of the Securitisation Act was issued

before 11th November 2004 in a borrowal account in respect of which the recovery

proceedings are already pending before DRT, there is no need for withdrawal of the

recovery suit.

Q.4. Is it necessary that documents to be valid on the date of serving notice?

Ans. Yes, not only the date of serving notice but also on the date of sale of seized

assets.

Q.5. What is expected to be done by the authorized officer during the notice period?

Ans. If the full payment is made by the borrower during the notice period, no further

action is called for. If he makes part payment, the bank can retain the right to seize the

asset to claim the balance amount. If the borrower makes part payment in such a way

that loan installments remain due for a period of less than 3 months as on the end of the

notice period, the bank cannot take further action since it is now a performing loan asset.

During the notice period, bank may entertain a request for compromise from the

borrower.

Q.6. What are the procedures to be followed for seizure of the assets?

Ans. On expiry of 60 days notice period, Authorised Officer (AO) may take following

actions for seizure and sale of movable and immovable assets-

(a) AO should take possession of movable secured assets in presence of two

witnesses. He should prepare a panchnama under his signature and signed

by two independent witnesses for taking possession of movable assets. He

should prepare an inventory of all movable assets taken into possession

and should deliver a copy to borrower or guarantor as applicable. He should

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keep the movables immediately to a nearby godown for storage and

protection and inform insurance company and arrange for insurance if not

already available.

(b) AO shall take possession of immovable secured assets (either constructive

or actual) by delivering a possession notice to borrower/guarantor or by

affixing the possession notice on the outer door of the property. Possession

notice should simultaneously be published in two leading newspapers one

of which should be in vernacular language.

(c) AO should take adequate steps for preservation, protection and safety of the

seized assets. AO should take sufficient care of the assets seized including

insurance cover, posting a security guard, etc. and should get the assets

valued by the bank’s approved valuer and fix reserve price.

(d) If the borrower agrees to bring in a potential buyer who is ready to pay

minimum fixed price, assets can be sold through private treaty with the

consent of borrower.

(e) AO should issue 30 days notice for sale mentioning outstanding dues,

description of assets, reserve price, mode of sale and proposed date and

time of sale through (i) public tender, (ii) public auction or (iii) private treaty. If

the proposed sale is by inviting tender from public, then AO has to publish a

notice in two leading newspapers –one in vernacular language- giving all

details and also mention earnest money to be deposited. He may also

mention that the sale is subject to confirmation by bank.

(f) AO should do actual sale on date, time and venue given in notice/paper

advertisement. Excepting sale by public auction or public tender, terms of

sale should be first settled with the borrower/guarantor and the prospective

purchaser. AO may accept sale price from the person offering maximum price

and deliver the goods and issue certificate of sale.

(g) If the assets are of perishable nature, AO should sale the assets immediately

after taking possession.

(h) Assistance of empanelled advocates may be taken where AO may feel any

difficulty.

Q.7. What are the types of possession of assets?

Ans. There can be of two types of possession – physical and token. For example -

receiving a key of a flat is a token possession. If the secured asset is a debt or a share

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in a corporate body, the Authorized Officer should send a notice to the borrower asking

him to direct the debtors to make payment to the bank or transfer shares in its name, as

the case may be. AO can recover dues from 3rd parties other than borrower after issuing

due notices containing direction or prohibitions. For example, if the secured assets are

leased or rented, AO may direct the lessee / tenant to pay the lease rent/ monthly rental

to bank. In case of advance against book-debts, AO may prohibit the debtors to pay to

the borrower and direct them to pay to the bank.

Q.8. Whether it is mandatory under the Act to take physical possession of the property

before sale is affected?

Ans. NO. In respect of immoveable property it is NOT mandatory under the act to take

physical possession of the concerned immoveable property before sale is affected.

Q.9. Whether judgment of the Supreme court in the Transcore prohibits taking symbolic

possession of immovable property and speaks of actual physical possession u/s 13 (4)

of the act.

Ans. NO, the judgment of the Supreme court in Transcore did not prohibit taking

symbolic possession of immoveable property and did not speak only of physical

possession under section 13($) of the act.

Q.10- Who should value the assets under possession of the bank?

Ans. Get valuation of the assets in possession through an approved valuer of the

bank.

Q.11. Can we allow the borrower to use assets after possession?

Ans. Yes, on possession of assets, the bank may appoint a manager to manage such

assets. In that case, this matter should be published in the local newspaper. A copy of

the Panchanama should be affixed on the asset.

Q.12 Can the asset be sold immediately?

Ans. No, sell the asset only after serving a notice period of 30 days to the borrower, so

that he gets one more opportunity.

Q.13. What are the types of sale?

Ans. AO may adopt any of the following methods to sale the secured assets-

(a) Obtaining quotations from parties dealing in secured assets or otherwise

interested in buying such assets.

(b) Inviting tender from public, or

(c) Holding public auction, or

(d) By private treaty.

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Q.14. If excess money is received through sale of the assets, to whom this belongs?

Ans. If excess money is received over and above the bank’s claim, the same should

be passed on to the borrower. If there are preferred creditors in respect of workers’

dues, statutory dues, etc. the sale proceeds should be utilized to pay to them first

before the settlement of bank dues.

Q15. Whether claim of statutory dues such as state sales tax, electricity, royalty

payment etc. have priority over dues of secured creditors?.

Ans. In Centre Bank of India Vs. State of Kerala , Hon’ble Supreme Court has ruled

that claim of secured creditors over borrower’s assets have priority over statutory dues

such as sales tax, lease rent, power dues etc.

Q.16. What should be done after receiving the amount on sale of the asset?

Ans. Issue a Certificate of Sale to the purchaser on receipt of full payment as per

terms of sale.

Q.17. What are the procedures to be followed for the sale of immovable assets?

Ans. The purchaser has to pay a deposit of 25% of the amount of the sale price on the

date of auction - sale and the balance should be paid within the next 15 days. Once

entire sale amount is received, the sale should be confirmed and sale certificate should

be issued. On default of payment within the specified period, the earlier deposit of 25%

should be forfeited and the same should be credited to the borrower’s loan account and

the property may be considered for re-sale.

Q.18. To whom the banks should approach for shortfall in recovery though the sale of

the secured assets?

Ans. Debt Recovery Tribunals (DRTs) or competent court ( as per jurisdiction) should

be approached for recovery of shortfall, if any, on sale of the secured assets.

Q.19. If found difficult to take actual possession of secured the asset, whose help may

be sought for by A.O.?

Ans. To approach the Chief Metropolitan Magistrate or the District Magistrate in writing

to take possession of any secured assets and forward such assets to him, wherever

needed in case AO faces any problem in discharge of his responsibility. Bombay high

court in a land mark judgment has ruled that no notice or hearing needs to be given to a

borrower or a third party when assistant is taken from the Chief Metropolitan Magistrate

to take possession of secured assets under securitization act. High court has further

ruled that the magistrate has simply to look into two aspects first whether the secured

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asset falls within his territorial jurisdiction and second whether the bank had given notice

to the borrower under section 13 (2) of the act to repay the amount due.

Q.20. What is the cut-off limit of loans to be considered under the SARFAESI Act?

Ans. Debts of Rs. 1 lakh and above and overdues being more than 20% of principal

amount are only to be considered under the Act.

Q.21. Which assets should not be considered for seizure?

Ans. The following are not eligible under the Act:

* Agricultural land and tools of farmers

* Pledged assets

* Unsecured assets/ clean loans/undrawn limits

* Unpaid stock

Q.22 Is it possible to seize the assets in the absence of borrower?

Ans. Yes, it is possible.

Q.23. Can we consider collateral securities?

Ans. The Act refers to all the assets, which are secured – both primary and collateral.

Q.24Is it necessary to seize the assets of the borrower first and then a guarantor?

Ans. It is not necessary. Simultaneous action is also possible.

Q.25. In consortium advances, who can serve a notice?

Ans. It is desired if joint action is initiated when members of the consortium join the

lead institution and serve a notice.

Q.26. If there are no bidders despite organizing public auction repeatedly, what should

be done?

Ans. If there is no option, It is advisable to file suit with DRT to save limitation.

Q.27. Can the bank seize the assets when the borrower approaches Corporate Debt

Restructuring Body for debt recast?

Ans. No. The bank can do so only after the restructuring period.

Q.28. Whether in a case where second charge holder resorts to enforcement of security

interest, should he satisfy the dues of first charge holder from the sale proceeds of the

secured assets?

Ans. Yes the dues of the first charge holder have to satisfied. The 1st charge holder

should also be consulted before taking steps for sale.

Q.29. While taking possession of stock, how a part of them under lien to unpaid seller is

to be identified?

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Ans. The AO is expected to know from verification of purchase register of the borrower,

which is paid up, and which is not paid stock. Unpaid stock cannot be taken over.

Q.30. What are the prospects of recovery under the Act in future?

Ans. Chances of recovery are expected to be bright if the SARFAESI Act and DRT

Act are amended to prevent the aggrieved defaulter in approaching DRT to fight on

trivial issues and thus bargaining more time to settle bank dues.

Q.31- Can the bank publish photographs of borrowers/guarantors along with possession

or sale notice?

Ans. In case of Ku. Archana Chauhan v. State Bank of India, Jabalpur w.p. no. 3319/

2006 dated 7.3.2006, it has been held that publication of photographs of the borrowers

can not be said to be impermissible mode. Action cannot be said to be arbitrary or lillegal

in any matter. It can not be said to be defamatory publication made.

Q.32- Whether High Court can direct one time settlement?.

Ans-It is held by Ho’nble High Court of Chennai in a land-mark judgment dated

07.07.05 that court under article 226 of constitution can not reschedule the loan. It held

that court must exercise restraint in passing such an order.

Q33. – Whether tenancy created by the borrower after creation of mortgage in favour of

the banks would be valid?

Answer-Madras High court vide judgment dated 23rd February 2007 in the matter of

Shree Lakshmi Products Vs. SBI, Coimbatore has held that tenancy created after

mortgage in contravention of section 65 A of Transfer of property act would not be

binding upon the bank and provision of SARFEASI Act 2002 will prevail over the local

law in case of conflict and such tenancy right shall stand determined once action u/s

13(4) has been taken by the bank.

Q34. Whether bank can take steps u/d 14 of the act after completion of sale of

immovable property?

Ans. Yes, bank can take steps under section 14 of the act after completion of sale of

immoveable property.

Q35. Whether pre deposit condition of 25% for hearing the matter before DRAT can be

relaxed for sick company?

Answer: The Delhi High Court dismissed the petition filed by Swadeshi Cement Ltd

against the order of DAT to deposit 25% in advance to hear the appeal filed by the

company and declared that sick company are not entitled to such benefits when Asset

Care Enterprise invoked the SARFEASI act the company.

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Looking AheadThis chapter on frequently asked questions makes a modest attempt to offer

clarifications on bank procedure prescribed under SARFESAI Act 2002 for seizure and

sell of secured assets so that authorized officers can exercise their powers in fair,

reasonable and fearless manner. In case of doubt, authorized officer must take legal

advice to avoid complications.

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Chapter- 18

Asset Reconstruction Companies

Introduction

The downturn in the economy in 2008-09 has caused large scale loan defaults that

resulted in huge non performing assets which added more than Rs. 11000 crores as

fresh NPA during 2008-09. The NPAs of commercial banks increased from Rs.55,800

crores as on March 2008 to Rs. 66,900 crores as on March 31, 2009 . (TOI 15.07.2009)

This NPA level is despite massive debt waiver of Rs. 65000 croes in agriculture during

2008-09. Hence, it is necessary to reduce the level of NPA on a war-footing through

various measures. In this regard, certain innovative measures were thought of.

Creation of Asset Reconstruction Company (ARC), also known as Assets Management

Companies (AMC) is one such measure. ARCs set up under Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest (SARFESAI)

Act have been empowered to take over NPA from banks, engage in innovative corporate

finance such as merger, sale of brands or plants, inject new capital, convert distressed

companies into new companies and even take out an IPO. ARC will have to work within

RBI guidelines and subject to registration/license from RBI. Accordingly all ARCs

should have minimum owned funds of Rs. 100 crores and to maintain minimum capital

adequacy of 15% at all times. GOI is also considering allowing the ARCs to have 49%

foreign direct investment.

Many more developments are likely to take place in the matters of recovery of NPAs

through ARCs. Hence, an attempt is made, in this chapter , to discuss both conceptual

and operational aspects of ARCs, besides examining the relevant issues. Let us start

with the recommendations of the Narasimham Committee Report.

The Second Narasimham Committee on ARC

In India, the Committee on Banking Sector Reform (1998) appointed by the Reserve

Bank of India, suggested for the first time to set-up an ARC for take-over of NPAs of

weak banks. According to the Committee, for reducing the NPAs of weak banks, there

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can be two approaches. In the first approach, all hard-core NPAs (doubtful and loss)

should be identified by each bank. Securities backing these NPAs should be assessed

to arrive at realizable/ marketable value. Such NPAs should then be transferred to the

ARC which would issue NPA Swap Bonds, as consideration for the assets (NPAs)

taken-over. The amount of bonds should be equal to the sum of realizable value of the

assets transferred. If the volume of NPAs is very large, each weak bank may set-up it’s

own ARC as a subsidiary. Or, a group of weak banks with moderate size of NPAs, may

promote an ARC jointly. Such ARC may be set-up either in the public sector or in the

private sector. In case, banks decide to set-up an ARC, it is essential that they spare

their staff required for take-over of assets and their subsequent sale. This arrangement

ensures that the institutional memory on NPAs is made available to the ARC. In

addition, there is some rationalization of staff in the banks, whose assets are sought to

be transferred to the ARC. For speedy and effective recovery, the ARCs should be

permitted to file suits in Debt Recovery Tribunals (DRTs). In case it is attempted to

create an ARC in the private sector, the Committee envisages certain problems. For

instance, there may not be many takers for the assets representing NPAs in the banks

because, most of them may not be backed by fixed assets like land and building or,

their market value may be negligible.

In the second approach, the reduction of NPAs is suggested without creating an ARC.

Here, NPAs will be reduced by making provisions/write-offs. This can be done if the Tier

I capital is very large. Otherwise, Tier II capital can be raised by issuing bonds so as to

meet the shortfall in the Capital Adequacy Ratio arising out of huge provisions and write-

offs to be made. If banks are likely to experience difficulties in getting subscription to

these bonds, the government may guarantee the same. Further, these bonds may be

considered as ‘approved securities’ by GIC, LIC or Provident Funds and ‘SLR

investment’ by banks. An alternative measure to widen the capital base is to seek

budgetary support by banks, which seems to be difficult at this stage. Thus, with the

increased capital it is possible to reduce net NPA amount and it’s percentage to the total

advances. The Committee, in the end, advises that banks and FIs should sit together to

work out the approaches as outlined above.

Process of Asset Reconstruction

To get a fair understanding of the processes of the asset reconstruction, let us take

an example. Forward Bank has hard-core NPAs of Rs. 2000 crores as on 31-03-02.

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This bank would like to sell these NPAs to the ARC. Accordingly, it makes an

assessment of the realizable or market value through an independent valuer, which is

arrived at a certain amount, say, Rs. 1400 crores. The bank approaches the ARC for

the sale of NPAs. The ARC purchases these NPAs at Rs. 1600 crores, i.e. realizable

value. It issues NPA Swap Bonds worth Rs. 1600 crores to the Forward Bank. The

bond would carry a fixed interest rate of say, 7.5 per cent equal to the rate on

recapitalization bonds. The Forward Bank will then provide for the entire loss of Rs. 400

crores (Rs. 2000 – 1600 crores) in the profit and loss account. Or, this can be

amortized if the profits are not adequate. Further, it’s networth will decline by Rs. 400

crores since loans and advances will be reduced by Rs. 2000 due to write-off (Rs. 400

crores) with addition to investment portfolio (Rs. 1600 crores). The bank will continue to

receive interest on bonds each year until the date of maturity. Then, these bonds will be

redeemed on maturity by the ARC. Alternatively, there can be periodical redemption of

bonds. After the purchase of NPAs, the ARC will recover the maximum amount from

NPAs over a period of time. If the amount so received is more than the purchase-value,

the business turns out to be profitable one. This is quite possible since the ARCs are

supposed to be professional experts in recovery from the NPAs. Thus, the above

arrangement is found to be beneficial to both banks and ARC.

Lessons from International Experiences

In the international scenario, a bank resolution or bank rehabilitation agency takes

control of problems of banks, and therefore, operates under a much broader mandate

than an asset management company. Generally, a bank resolution agency focuses on

winding up insolvent banks, including asset management. The approach was introduced

in the US, with the Resolution Trust Corporation (RTC) which was formed in 1989 to

liquidate insolvent savings banks as well as with the Federal Deposit Insurance

Corporation (FDIC). In the resolution made, these agencies were also incharge of

disposing of all assets, including non-performing assets. In Japan, the Deposit

Insurance Corporation (DIC) offers adequate support for troubled banks and bank

liquidation. Loan work-outs are carried out by the resolution and collection bank (a DIC

subsidiary). In Ghana, a Non-Performing Assets Recovery Trust (NPART) was set-up

in 1989 to deal with the recovery and disposal of bad debts and other collaterals.

NPART was authorized to sue for recovery and collect proceeds from debts. On the

Ghana model, Tanzania and Uganda also set-up NPART in 1988 and 1995 respectively.

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In Mexico, the Deposit Insurance Company, through its loan work-out subsidiary, was

put incharge of assets management. China, in view of high NPAs, has set-up ARCs –

even selling of assets to foreigners at steep discounts. In Malaysia, ‘Dahantra’, a

restructuring agency, has done well in disposing of three-fourths of assets which it

acquired. Thus, encouraged by the experiences of these countries, India should go

ahead in setting up many more ARCs. But there are several issues relating to the

organizational aspects.

Organizational Aspects of ARCs

Sometime in 2000, the Finance Minister for the first time proposed to set-up an ARC

mainly for the weak banks. Subsequently, it was thought that the scope of the ARCs

should be enlarged to cover all public sector banks. In the long run, even banks in the

cooperative sector and NBFCs may also be targeted. In any case, the country requires

several ARCs and not just one, to represent each of the major geographical areas.

These shall be set-up in the private sector so that more flexibility in their organizations

can be ensured. Alternatively, banks can jointly set-up a subsidiary to act as an ARC.

Whatever may be the form of organization, adequate capital has to be provided to the

ARC. But such support is not likely to come from the Government. The other issue

refers to the stamp duties to be paid on purchase of loan assets by ARCs. This would

be a major burden. But, if proposed to set-up an ARC as a cooperative unit or a trust,

there is a way out. Alternatively, ARCs may be exempted from the payment of stamp

duties recognizing the dire need to reduce NPAs of banks. Regarding the staff, we

should not go in for merely deputationists from banks and financial institutions since they

have already demonstrated their inability to recover the NPAs. Hence, it is essential that

ARCs should induct a pool of professionals on full time basis. It can also be debated

whether the investment made in ARCs could be given the SLR status. It is also

important that ARCs have a definite period of tenure, after which they should be

liquidated. Usually, one may insist a life period of say 5-7 years. Further, to achieve the

basic objectives, cost control occupies an important place. Lastly, the prices at which

assets are transferred should be based on market prices. The ARCs should not be

compelled to take-over assets at prices other than what it’s management feels. In

particular, they should have more autonomy and wide powers to manage NPAs. In this

regard, the recent enactment on Securitization and Reconstruction of Financial Assets

has spelt out the role and functions of ARCs.

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Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

This Act empowers banks and financial institutions to take-over the assets from

defaulters by serving a notice of sixty days, without any intervention from the court. On

take-over, these assets shall be managed, leased out, or sold to liquidate loans. But this

is not an easy job. Hence, services of ARCs have to be hired. The important provisions

of Sarfaesi Act in reference to ARC are as under-

1. Unfettered right to the lenders acting in majority (>75% by value) to enforce security

rights without intervention of court.

2. No single investor to have majority control over ARCs.

3. Additional right of ARC which is not available to lender i.e. sale or lease of

businesses by superceding board powers.

4. Enables foreign investor participation.

5. Measures for reconstruction-

(a) Change in or takeover of management of business of the borrower

(b) Sale or lease of part or whole business of the borrower

(c) Rescheduling of payment of debt

(d) Enforcement of security interest

(e) Settlement of dues payable by the borrower

(f) Taking possession of the secured assets

6. Enforcement of security interest

(a) Can be enforced without intervention of court.

(b) Borrower to discharge liability within 60 days notice.

(c) Secured creditors have right to take possession, take management control of

secured assets including right to transfer.

(d) In consortium right can be exercised if more than 75% borrowers agree to

proceeds under the act.

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It will be observed that under Sarfaesi, ARCs are vested with the rights of a

‘deemed lender’ in respect of take-over of assets and subsequent sale or management

of assets. Though the ARCs are given wide powers, still doubts are raised about their

effectiveness. Since Central Registry is not set-up, it is difficult to sell assets though

taken over from loan defaulters. But one thing is certain that the need for promotion of

ARCs in India is very much felt. Though their role and responsibility have been spelt,

what is required is to create a conducive environment and work-out arrangements for

setting up more such ARCs.

Setting up of ARCs

Several players have applied to RBI for registration in order to commence

business. First ARC known as ARCIL has been registered as private sector entity with

51% equity in the hands of private sector banks. It is registered with RBI under section 3

of the SARFESAI act 2002 as Securitisation and Reconstruction Company, which

commenced business from August 29, 2003. The company is an associate member of

IBA. In two and half year operation, ARCIL has acquired bad loans from 32 banks of

over Rs.22,000 crores at an average acquisition cost of 23% of total dues (Business

Standard 12th May 2006) . ICICI bank is the biggest seller of 134 bad loan of Rs. 8450

crores followed by SBI, which sold 181 bad loans of Rs. 2,468 crores. So far only 6 out

of total 19 nationalized banks have sold their bad loans to ARC (Economic Times

14.04.2005). ARCIL has also ventured in acquiring retail housing loans of Rs. 1000

crores of National Housing Bank and ICICI bank. (FE 25.8.2008) Theoretically ARCIL

has reduced the NPA of banking industry by 13%. UTI has promoted the second ARC

known as ASREC. The company received RBI license in October 2004. It has acquired

NPAs from 11 banks/FIs having gross value of Rs.1109.50 crores consisting of 164

accounts. Out of this ASREC recovered Rs.70.67 crores through resolution. Other

ARCs are (a) India SME asset Reconstruction Company Limited (ISARC) promoted by

SIDBI, (b) Assets Care Enterprise (ACE) Ltd. Promoted by IFCI, and (c) Reliance Asset

Reconstruction Company promoted by Reliance ADA group. ARCs are hardly a

successes story since it has been able to buy only a fraction of NPAs and banks are

complaining that they are not offering right price to them. This problem is expected to

be solved with setting up of few more ARCs because it will increase competition.

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Conclusion

Recent Inspection of RBI of ARCIL has suggested serious deficiencies in asset

reconstruction business in general and ARCIL in particular. First there is issue of poor

corporate governance that enabled the major shareholders to collude in off loading their

bad loans to ARC. Second issue is of technical nature about business model of ARCs

about acquiring bad loans and then realizing them. Typically NPLs are acquired by

ARCs under a trust structure and security receipts representing interest in underlying

securities issued to qualified Institutional buyers with ARCs acting as trustees. The

proceeds thus realized is used to pay sellers of NPLs. Since sellers are also bank or

financial institutions, the model is akin to a cozy deal between bank and ARCs,

reminiscent of incestuous relationship between financial players that was hall mark of

2008 financial crisis. In other words bank get NPL off the book by selling to a trust

which in turn is funded by them. So instead of impaired loans they now hold securities

representing the same impaired assets. Third is that ARCs are no better equipped to

handle the NPLs than the banks them selves. The securitization Act 2002 was expected

to make drastic changes in recovery landscape but it has not happened. Hence

the success of the ARCs will depend upon the seriousness of the government in

implementing the Act. Further, Debt Recovery Tribunals (DRTs) will have to be made

strong to offer necessary help to ARCs in recovery of dues. Lastly, banks and financial

institutions have to realize that, for recovery from hard-core NPAs, the need for the

services of ARCs clearly exists. All the more important is to create awareness on the

role and responsibility of bank officers under the Act, the functioning of ARCs, etc. for

which the need for strengthening our efforts in training and education is clearly felt.

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Chapter- 19

Due Diligence in Credit Management

IntroductionOf late, due diligence in credit management is reemphasized in banks due to increasing

irregularities and frauds. This is evident from the RBI circular of August 24, 2004

wherein deficiencies commonly observed in credit management, are explained. In this

backdrop, there is a felt need to strengthen the system of due diligence in credit

management in banks. Towards this end, it is attempted to develop a checklist for the

benefit of credit officers in banks. The checklist is based on the study of RBI guidelines,

Loan Policy prepared in banks, Lenders Liabilities – Best Practices Code in banks and

Basic Principles of Bank Lending. Though this seems to be comprehensive checklist,

there is scope to expand the same based on experiences of banks.

Check-listI. Pre-sanction Formalities

Fulfill the KYC norms for opening a savings / current account by a potential

borrower. Obtain photograph, IT PAN, sales tax/excise registration number, shop

and establishment registration number, etc. of the person authorized to operate

the account.

Give a loan application forms only if found eligible under the concerned bank

scheme. Help the borrower to complete the loan application form.

Receive the loan application form duly filled-in which should be submitted along

with: -

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o Project proposal, past and projected financial statements (audited

balance sheet, and profit & loss account) and cash flow statement; xerox

copies of the relevant certificates; bio-data of the promoter, etc. The

project proposal should contain the required details.

o Issue a receipt for the loan application form being received and enter in

the Loan Applications Received Register.

As part of credit appraisal, scrutinize documents including partnership deed,

certificate of incorporation, articles of association, resolution of the board to raise

borrowings, trust deed, certificate of registration, etc. (as the case may be) and

verify the registered office/business office address.

Obtain the market report of the borrower and reference letter from referees.

Collect the details of existing borrowing arrangements with the other banks, if

any.

Check list of willful defaulters from RBI/CIBIL web site.

Do compliance of guidelines relating to take-over of the loan account from the

other bank/s. Obtain credit report and no lien/no charge letter.

Borrower should be asked to give a certificate stating details of current account

opened with other bank(s). Otherwise obtain undertaking that they are not

keeping current account with any other bank.

Assess the financial status of associated companies, if any, and call for their

audited financial statements.

Scrutinise details of the guarantors which include their relationship with the

borrower, net worth, business activities, securities to be offered, etc.

Prepare a process note for loan sanction which should include:

Background of the promoters

Position of the present business activities

Proposed business activities

Project cost and sources of funds – details

Interview the applicant and record the conversation in brief.

Check that proposal is within the exposure norms as applicable to the

individual/group/industry.

If the proposal is under sensitive sector examine exposure norms and guidelines

under bank’s credit policy and RBI restrictions if any.

Do rating of the borrower under bank’s risk grading system.

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Approve the projected figures as stated in the proposal, which should be based

on convincing assumptions, and verify certificates of auditors and architects.

Examine the market conditions to approve business estimates.

Assessment of feasibility of the project – technical, commercial, financial and

managerial aspects. Interpretation of the financial statements and cash flow

statements through key ratios – D:E, CR, DSCR, BEP, IRR, etc. Examine the

financial standing of the project and profitability of the borrower.

Do social cost: benefit analysis.

Conduct pre-sanction inspection to verify information as furnished in the loan

application form and assess the antecedents of the promoters/guarantors. Also

verify the details of the securities to be offered; proof of the residence, lease

deed, sales deed, rent agreement, etc.

Sanction credit facilities keeping in mind the lending powers delegated. If

proposed limit fall under authority of higher office, recommend the proposal to

them. Issue a letter of sanction to the borrower stating the terms and conditions

and obtain his written consent.

If decided not to sanction, state reasons thereof. Observe the time limit set for

loan sanction.

Prepare a set of documents for execution.

Disburse the loan amount only after fulfillment of all terms and conditions. In

particular, promoters’ contribution should be deposited first before disbursement

of the amount. The term loan amount should be disbursed as per the progress of

the project. End use of firms should be satisfied.

Conduct inspection of the factory/business premises within a month from the loan

disbursement to ensure the end use of borrowed funds.

II. Post-sanction FormalitiesAs part of post sanction formalities, (A) Conduct of Stock Inspection, (B) Follow-up the

transactions in Loan Ledger, (C) Discuss with the Borrower, (D) Study the Market

Reports, (E) Analyze the Financial Statements and cash flow statement, (F) Review and

Renew the Working Capital Limits, (G) Rehabilitate Sick Units, (H) Recover from Non-

performing Advances. Due diligence in respect of these post-sanction formalities is

suggested as under :

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F. Stock InspectionBy comparing the stock statement of a borrower with his stock register to confirm that

the stock position as declared by him is in accordance with the books of accounts. If

there is a major variation, it is a bad signal.

In case of large borrowers verification of stock includes:

(a) stock kept at the factory premises;

(b) finished stock at the sales depots of the company;

(c) raw materials sent to outsiders for conversion or processing; and

(d) stock in transit

Besides physical verification of stock, it is essential to see :

(a) purchase price of raw materials as indicated in the invoices;

(b) position of stock in process and finished stock as on the given date duly

certified by the production manager; and

(c) pricing policy of the company and methods of valuation of stock adopted.

Following tips may be of great use-

Conduct inspection periodically. Banks are having policy of inspection on

monthly/ quarterly intervals depending upon health (risk grading) of the

borrowing units.

Do sufficient homework before inspection. After inspection, calculate the

drawing power and note down in the loan ledger. Note down adverse

observations in Inspection Register.

Do ABC analysis. Do 100% verification of high value less number of stocks and

30% verification of low value high number of stocks.

The physical verification of stock ensures the end use of loans. If the stocks are

not adequate, it indicates that the funds are not fully utilized for the agreed

purpose.

Any major variation in stock value as per the stock statement on one hand and

books of accounts on the other gives an indication of misappropriation of stock or

diversion of funds.

If the stock not belonging to the company is stored in the factory godown, it

indicates that the company is indulging in malpractices.

If the stock statements are deliberately not submitted for a long time, it shows

that a major portion of the stock does not exist.

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If the company has maintained excess stock, it also indicates that the company is

indulging in trading also.

If the company has taken a dual finance from two different banks on the same

stock, it indicates dishonesty of the borrowers.

It is difficult to ensure the quality of stock. But, if there is no movement of certain

finished goods, it shows that the stock is outdated, slow moving, obsolete or

unsaleable.

It is advisable to get the stocks checked/ valued by stock auditors or internal

technical officers of Valuation Cell. Gradually, dependence on external valuers

should be reduced.

During inspection, the presence of bank board, book-keeping and maintenance

of registers, insurance cover, etc. should be looked into.

Look into the level of operations, orders in hand, turnover of staff, labour

situation, payment of rent and statutory dues, break-down/shutdown, pollution

control, etc.

Carry out age wise classification of receivables. Obtain the list of major

customers and examine the credit offered to them which should be in line with

market practices. Inquire the reasons for bills returned unpaid.

G. Stock Audit Bank very often entrust stock & book debt audit to firm of Chartered accountants. Following areas are generally entrusted to audit firms to be looked into:-

o Physical verification of inventory.

o Study on inventory control practices, proper up keep and requisite

record/books.

o Basis of valuation- whether in line with standard practices and stipulations of

the bank.

o System study to segregate non-moving or obsolete inventory.

o Age wise analysis of book debits.

o Examine genuineness of the trade transaction passing through book

debts/receivable.

o Comments on maintenance of plant and machinery.

o Status of registration of ROC charge.

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o Insurance status of stock/plant and machinery.

o Any other information found relevant.

B. Follow-up of Transactions in Ledger Book Poor turnover in an account indicates that, either the sales are being routed

through other banks or have, in fact, been dropped. In either case, the bank

should make an enquiry. Poor turnover indicates poor health.

Cheques for large and round amount, post-dated cheques and cheques

frequently issued in favour of those parties not related to business, may need to

be examined carefully. A dialogue with the borrower should be initiated to find

out the reasons for the same and take remedial steps.

Frequency of returning of cheques should be examined. If it is high, it indicates

liquidity problem of the borrower or otherwise he is engaged in overtrading.

The Bills Account reveals major transactions of the business. Frequent return of

bills may mean that the borrowers’ goods are being rejected by purchasers or the

purchasers are sending payments directly to the borrower. When the bills are

received back, the borrower is promptly advised that they have been returned by

the collecting branch for the reason, `payment not forthcoming’ and that he

should regularize his account.

If there has been irregularity in the account for a longer period, it indicates that

outflows are in excess of inflows of cash.

If there are no operations in the account during a part of the year, it indicates that

the unit has stopped working during that period. This is a signal for analysing the

reasons for the inactive operations in the account.

The behaviour of the account during the year would help bank in getting the

signal. The actual drawings should be related to the business requirements. It is

expected that the unit normally requires more funds during the busy season. It is

also expected that the unit has to maintain a minimum level of stock during the

off-season and, therefore, it requires minimum funds. Any variation in these

expectations would throw a signal.

If there is a heavy withdrawal of cash without convincing reasons, this is a signal

of misuse of funds.

C. Discussion with the Borrower on adverse featuresThe following are the signals of incipient sickness of the unit :

Major breakdown in plant and machinery

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Labour strike

Frequent changes in management

Sudden death/illness of a partner/director

Disputes among the partners/directors

Repeated reconstitution of the firm/board

Frequent requests from the borrower for enhancement of credit limits or granting

excess drawing

D. Study the Market Reports The following are the adverse developments relating to a borrowal account as

market reports or news in the newspaper:

Recession in the industry

Unfavourable position of the inputs

Unsatisfactory report about the party

Sharp fall in prices (output)

Unfavourable changes in government policy as regards excise, imports and

exports, price fixation by the government, etc.

Routing transactions through other bank/s or legal action by other bank in sister

concern or group account .

E. Analyse the Financial Statements Several weaknesses in financial health of the unit can be understood from

analysis of financial statement like :-

Unsatisfactory trend in profits

Sales below projected level

Rise in book debts

Shortage of working funds

Unsatisfactory position of equity or withdrawl of funds by partners or proprietor

Diversion of short term funds for long term use

Building up of unproductive assets

Unhealthy accounting practices

F. Review and Renew the Working Capital Limits Ask the borrower to submit the renewal proposal before the credit limits expire.

Review the performance during the current year in terms of SWOT analysis.

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Scrutinise the proposal to enhance the credit limits in terms of assumptions in the

estimating projected sales, inventory levels, credit requirement, conduct of the

accounts, stock inspection and industry prospects.

Comply with the guidelines of the Bank in respect of exposure limits, sensitive

sectors

Review or renew the facility in terms of lending powers or otherwise refer to the

sanctioning authority.

Decide on the credit proposal timely, particularly before the expiry of the limits.

Non review of accounts for more than 90 days will make the account NPA as per

prudential norms.

Consider to sanction ad-hoc limit if enhancement is going to take time to meet

pressing payments of wages, bonus, purchase of raw material, electricity, taxes,

etc.

G. Rehabilitation a Sick Unit It is essential to take-up the following steps to rehabilitate a sick unit :

Identify a sick unit as per the official definition.

Ask the borrower to submit the proposal to rehabilitate the unit.

Study the causes of sickness, internal and external

Prepare the rehabilitation scheme keeping in mind the guidelines of the

RBI/Bank.

Sanction the scheme by funding irregularity, uncharged interest and sanction of

need based limit.

Implement the rehabilitation scheme- necessary contribution from borrower to be

ensure.

Monitor the progress during the post implementation of the scheme.

Review the progress in rehabilitation of the unit in terms of the loan repayment

with interest.

Initiate legal action if the rehabilitation efforts fail.

(For detailed procedure of rehabilitation of sick unit refer to Chapter-13)

H. Recovery from Non-Performing Advances (NPAs) Several steps relating to recovery from NPAs shall include the following :

Bank should formulate a Recovery Policy.

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Bank should set the targets for recovery from NPAs and also for prevention of

potential NPAs. A separate Recovery Department / Cell should be set up in the

bank to co-ordinate recovery efforts.

Send a reminder to the defaulters on timely basis, pay a visit to their business

premise/residence.

Entertain a compromise proposal as per the broad policy guidelines of the bank.

Recall the advance.

File suit against the borrowers in the Civil- court/DRT/Certificate case .

Serve a notice of 60 days under the SARFAESI Act and take action of sale and

seizure of assets or take over of management.

Initiate action under Transfer of Property Act by entrusting the work to the private

auctioneers.

Organise ‘recovery camp’ and reward those recovering the highest amount.

Initiate any other steps to strengthen recovery efforts and upgrade the quality of

potential NPAs.

(For detailed recovery measure refer to chapter -11)

ConclusionIn this chapter , it is attempted to put in one place various items of due diligence in credit

management. But this may not be considered as an exhaustive list. Hence, credit

officers may take into account additional item of due diligence based on their experience

and common sense. This exercise of developing the check-list is felt necessary to

counter operational risk in large scale credit expansion particularly in Agriculture, SSI

and Retail loans. Due diligence will also help the bankers in checking slippage of NPA or

controlling potential NPA. Towards this end, it is appropriate to reiterate that non-

compliance of principles of lending and bank guidelines would deteriorate the quality of

loan portfolio and allowing the credit risk to go up. Hence, due diligence in credit

management must receive due care.

-000-

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Chapter-20

Negotiation Skills and Strategies for Banking Business

Getting a best deal

In a negotiation situation two parties negotiate for a best possible out come say

price. The process starts with the negotiation preparation, common negotiation mistakes,

whether to make a first offer or not, respond to offers from the other party, structuring

your initial offers, finding out how far you can push the other party, strategies for

haggling effectively and to how to maximize not only your outcome but also the value of

outcome of other parties. It is well known that negotiators who focus only on claiming

value reach worse outcomes than do those who cooperate with the other side to improve

deal for both parties. There are also occasion when negations are not the answer to the

problem. A banker should learn to distinguish between the times when he should be

playing the negotiation game and times when he should be changing the game.

Customer driven marketCredit is now market driven. Borrowers are not only negotiating interest rates,

service charges, free- remittance facility but also terms and conditions of loan

aggressively. They are demanding flexible repayment terms, floating interest options,

collateral free loans, sub-PLR interest rates, top up or ad-hoc finance, less paper work

and formalities, fast sanction and disbursement. In deposit front, there is demand of new

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products and services, which not only brings convenience but also better returns and

cost. Banks are now selling third party products like insurance and mutual funds, which

not only requires proactive selling but also good negotiation skill and marketing

strategies. Even in finalizing the terms of loan sanction, rehabilitation and compromise

negotiation skills are essentials, which provide competitive edge to branch managers. In

HR and IR matters, negotiation skills play an important role. It is, therefore, essential for

every bank officer to acquire and develop negotiating skills, which would help him or her

to do banking business efficiently and effectively.

Negotiation tips- Negotiation is about achieving a mutually acceptable outcome to a situation in which

the parties involved initially have differing aims. Do not negotiate unless this is either

necessary, or some advantage may be obtained by doing so. Three stages are

involved in negotiation: preparation, the negotiation itself, and implementation.

Before embarking on negotiation, there is a need to assess the parties’ relative

strengths/weakness and possible outcome, improvement in bottom line etc.

Establish what the other party’s case is and what they are seeking to achieve. If

possible, one objective should be to help the other party to feel satisfied with the

outcome.

Value time, schedules and deadlines. A good negotiator will not beat around the

bush or adopt delay tactics or waste time talking about mundane matters. It is

professional to get down to business and address key issues.

Exchange factual data in advance of negotiations. This may influence the outcome

or prevent delay and confusion during negotiation.

Consider the possible existence of a hidden agenda – underlying issues, which may

influence the conduct and outcome of the negotiations.

Negotiations are influenced by their style and pace, by the composition of the

negotiating team, and by the arrangements for seating and refreshments.

The subject, scope and purpose of the meeting should be made clear before

negotiations commence.

Be focused on the problem or issue. Logical arguments are the key to smooth

negotiations.

The first speaker influences the progress of negotiation significantly.

It is important to be firm yet polite when making a stand or presenting a point.

Be patient and let the process of negotiations takes its course.

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When considering concessions, introduce the condition first and do not give details

of the concessions until the other party shows some willingness to negotiate on the

condition. Clearly specify advantages and disadvantages.

Put ego aside and concentrate on the matter at hand. It is finding an amiable solution

that’s important not self worth or position.

Avoid the psychological traps and have the magnanimity to admit when you are

wrong. Be open minded during negotiations.

Never threaten or manipulate the opposite party- it is completely unethical and unfair.

Normally, avoid emotional commitment, but display of emotion may occasionally be

beneficial provided that they are sincere and used consciously.

A continuous session should rarely exceed two hours, a formal presentation for 15 to

20 minutes, and an informal introduction for two to three minutes.

Effective negotiators are good listeners; they ask questions more than they make

statements.

Aim for solutions that are interest based and not what individual desires or aims are.

It is best to consider any situation as a whole rather than from a personal view point.

Do not accept weak solutions or temporary solution. Try to negotiate a plausible

settlement.

There is a positive advantage in making it easy for the other side to move, rather

than challenging them on a win/lose basis.

Compromise should be seen as constructive, not weakness. It is a win-win game.

The closer a negotiation is to reaching agreement, the more sensitively the

discussion needs to be handled.

Some record of the outcome of negotiations, however informal, is desirable in order

to ensure a common understanding of what has been agreed.

Before finalizing an agreement, check that all aspects have been agreed particularly

dates for implementation, review or completion; and definitions of terms.

An agreement is not successful until it has been effectively implemented.

Periodic and jointly agreed summaries of progress can secure a phased agreement

and prevent reversion to earlier argument.

Humor, can be used to reduce tension and help create a bond between the parties.

The main options of handling breakdown are to take unilateral action to enforce an

outcome, or to seek third party intervention. The most powerful and risky form a third

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party resolution is arbitration – where both parties bind themselves in advance to

accept the arbitrator’s solution – or legal action through the courts or tribunals.

Face-to-face discussions are not the only form of negotiation: effective use can also

be made of correspondence and the telephone. Video conferencing is now an

effective way of negotiation in cost effective manner.

Telephone discussions may be used to settle minor or simple negotiating points

extremely quickly.

Although some people are better natural negotiators than others, negotiating skills

can be acquired or improved by practice, coaching and training.

Chapter-21

Loan Default and Profitability of BanksIntroduction

Verma Committee on Restructuring of Weak Public Sector Banks, appointed by

the Reserve Bank of India, as part of assignment, identified weak banks, strong banks

and potential weak banks based on the study of seven efficiency parameters. These

parameters include capital adequacy ratio, coverage ratio, return on assets, net-interest

margin, operating profits to average working funds, cost to income, and staff cost to net

interest income plus other income. Accordingly, three banks were identified as weak

banks when none of the seven efficiency parameters were met. As against this, two

banks were considered as strong banks when all parameters were complied. But in

respect of six banks most of the parameters i.e. five or six of the total parameters i.e.,

seven, were not fulfilled. Hence, they were considered as potential weak banks. This

paper attempts to extend the study conducted by the Verma Committee more

specifically to ascertain whether enough signals of weakness were indicated much

before the event.

Study Plan

The present study considers 1998-99 as the year of event when the Verma

Committee identified weak banks, strong banks and potential weak banks. Since the

data relating to banks are not available on uniform basis for the earlier years, there is a

slight change in the set of parameters as considered by the Verma Committee.

Accordingly, this study considers nine efficiency parameters, which are computed, based

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on the data collected from the Reserve Bank of India publication i.e., Report on Trend

and Progress of Banking in India. The parameters includes :

Capital Adequacy Ratio

Net Non Performing Assets/Net Advances

Net Profit / Total Assets

Gross Profit / Working Funds

Net Interest Income (Spread)/Total Assets

Interest Income / Total Assets

Interest Expended / Total Assets

Intermediation Cost / Total Assets

Provisions and Contingencies / Total Assets

The above parameters focus on two major concerns of banks i.e. loan default and

profitability where as the Verma Committee covered all aspects of financial health. The

study aims at pointing out signals of loan default and deterioration in profitability prior to

the year of event.

Initially, it was attempted to find out whether the above parameters were interdependent

for which regression analysis was carried out. As seen from Table 1, the correlation

coefficient is positive in respect of four pairs i.e. Net profit/Total assets and Capital

Adequacy Ratio; Net profit/Total assets and Gross profit/Total assets; Net profit/Total

assets and Interest spread/Total assets; and Net profit/Total assets and Interest

income/Total assets. And in regard to other four pairs i.e. Non-performing assets/Total

advances and Capital Adequacy Ratio; Non-performing assets/Total assets and Net

profit/Total assets; Net profit/Total assets and Intermediation Cost/Total assets; Net

profit/Total assets and Provisions and Contingencies/Total assets, it is negative

marginally. The remaining pair i.e., Net profit/Total assets and Interest Expanded/Total

assets is the least correlated one due to the fact that interest obligations directly depend

on deposits and borrowings and not on profit. Barring this pair, all pairs are fairly

correlated. Hence, it would be an interesting exercise to study the behaviour of the

above-mentioned ratios for three groups of banks (weak, strong and potential weak)

before the year of event i.e. 1999. For this purpose, a mean value of each ratio (Table

1) was computed. The following observations are made from the study of these mean

values.

Observations:

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The level of non-performing assets discriminated between two groups. For instance,

the average ratio of non-performing assets/total advances of weak banks, strong

and potential weak banks for the year 1998-99 was 15.73, 6.36 and 9.25 percent

respectively. Though weak banks and potential weak banks attempted to reduce

the ratio over the years, the level of NPAs was considerably high. As against this,

strong banks kept NPAs at low level.

Return on total assets is also a discriminator between the two groups. For weak

banks, the average ratio of net profit/total assets was negative for the entire period,

though it was attempted to reduce it from 3.73% (negative) in 1995-96 to 1.24%

(negative) in 1998-99. As against this, strong banks maintained an average annual

return of 1.19 percent on total assets. Potential weak banks witnessed a positive

ratio though it was very low. In 1998-99, banks in all the three groups have not

performed well and, therefore, the ratio behaved typically.

Any change in the return on total assets depends upon corresponding change in net

profit on one hand and size of total assets on the other. And, net profit is the sum

of gross profit less provisions and contingencies. Since the return on total asset

discriminates one group from another, interest spread and provisions and

contingencies should also be related to total assets. The average gross profit/total

assets ratio varied from one group to another very widely. In 1989-99, the average

ratio was 0.10 (negative), 2.20 and 0.95 percent respectively for weak banks, strong

banks and potential weak banks. Over the years, weak banks attempted to reduce

gross loss substantially. As against this, strong banks experienced slight reduction

in the gross profit ratio but it’s level still remained as high as 2.20 percent in 1998-

99. The potential weak banks also succeeded in improving the position but their

ratio was very low as compared to industry average figures. But in 1998-99, the

average ratio of potential weak banks exceeded the sample average ratio. Thus, all

groups tried to show a higher gross return on total assets. But, what really matters

is the level of the ratio.

The size of interest spread also decides net profit. Weak banks in the sample

maintained just half the spread of strong banks as seen from the average ratio of

interest spread/total assets which was 1.69 per cent in 1998-99 for weak banks as

against 3.31 per cent for strong banks. For potential weak banks, it was moderate

being at 2.56 per cent which was lower than industry average i.e. 2.81 per cent. In

1998-99, all banks witnessed a decline in interest spread as compared to 1997-98

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figures. It is interesting to note that weak banks improved the position of spread

over the years whereas strong banks and potential weak banks, witnessed some

deterioration in it. But for weak banks, low interest spread is a matter of concern.

Interest spread is the net of interest income less interest expended so, weak banks

tried to attack both items i.e. interest income and interest expended. But in respect

of strong banks and potential weak banks, while there was some success in

augmenting interest income, it was found difficult to check interest expended.

Relatively speaking, all groups experienced high interest expended as compared to

industry average figures throughout the period i.e. 1995-99. Here again, what

matters is the level of interest income of weak banks.

All the three groups were able to check intermediation cost i.e., operating expenses.

There was a marginal difference in the average ratio of intermediation cost/ total

assets in 1998-99 which was 2.79 per cent and 2.73 percent for weak banks and

strong banks respectively. It was 2.19 per cent for strong banks. Both weak banks

and potential weak banks have to learn from strong banks in restricting the

intermediation cost. For the year 1998-99, the average ratio of strong banks was

much lower than both sample average and industry average.

Non-performing assets have to be provided for. Though the data on provisions

made for NPAs are not available, some idea may be obtained from provisions and

contingencies as stated in the income statement. Accordingly, the average ratio of

provisions and contingencies/total assets witnessed a declining trend in respect of all

three groups during the period i.e. 1995-99. This is because of reduction in the

gross NPA percentage which was 12.77 for all three groups in 1995-96 and then

declined to 10.69 in 1998-99. There was a steep fall in the ratio of weak banks and

potential weak banks in 1998-99 over 1995-96 figures. This suggests that these

banks were able to make a good recovery from NPAs during the period.

The average Capital Adequacy Ratio in 1998-99 also discriminates weak banks from

strong banks very distinctly when the same was 3.43 per cent and 12.28 percent

respectively. For potential weak banks, this was 10.57 per cent as against industry

average ratio of 10.82 percent. Weak banks were far behind the minimum

prescribed norms of 8 percent. Over the years, while weak banks continued to

observe a low ratio, strong banks not only maintained high capital adequacy ratio but

also improved its level.

Conclusion

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From the above observations, a few issues arise. Weak, strong and potential weak

banks were adequately discriminated by loan default on one hand and profitability on the

other. Though banks in all three categories reduced the NPA percentage and improved

the position of profitability, what matters is their levels. In other words, weak and

potential weak banks were saddled with high NPAs and low profitability. Even today, the

problem persists. Hence, corrective strategies have to be thought of.

Table- 1 :Correlation Coefficient (r) of Parameters

Sr. No. Parameter r

1. Non-performing assets/Total assets and Net

profit/Total assets

- 0.84

2. Non-performing assets/Total assets and Capital

Adequacy Ratio

- 0.86

3. Net profit/Total asset and Capital Adequacy Ratio 0.98

4. Net profit/Total assets and Gross profit/Total assets 0.83

5. Net profit/Total assets and Interest Spread/Total

Assets

0.85

6. Net profit/Total Assets Interest Income/Total Assets 0.86

7. Net profit/Total Assets & Interest Expended/Total

Assets

- 0.09

8. Net profit/Total Assets Intermediation Cost/Total

Assets

- 0.61

9. Net profit/Total Assets and Provisions and

Contingencies/Total Assets

- 0.77

-000-

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Chapter-22

Retail Banking – New Paradigm“The purpose of business is to attract and retain a customer”.

-Peter Drucker

1. Post reform development – Marketing StrategyLiberalization and de-regulation process started in 1991-92 has made a sea change

in the Indian banking system. From totally regulated environment, banks moved into

a market driven competitive environment. The traditional banking approach to

depend upon walk in customer has given way to

super market where all financial need of the

customers are satisfied under one roof. If we look to

the evolution of marketing, we find that different

strategies have evolved over a period of time for

production, distribution and promotion of products. It

started with mass marketing model - where mass production of goods was done with

the hope that low cost and price would automatically create a big market. Later on,

producers shifted to product variety model that was based on assumption that much

variety across the shelf will eventually win a customer. And last one is target

marketing where the producer/financial service provider identifies variety of market

segments, selects one or more of them and than resorts to relationship marketing by

strategically positioning its products to the target customers. The same pattern is

evolving in bank marketing in India.

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2. Retail Banking- Customer focus2.1. Berry recommended five strategies for practicing marketing- (a) Developing a

core service around which to build a customer relationship, (b) Customizing the

relationship to the individual customer, (c) Augmenting the core service with

extra benefits, (d) Pricing services to encourage customer loyalty and (e)

Marketing to employees so that they will perform well for customers.

2.2. The traditional marketing mindset is ‘command and control’ mindset that relies

on selling to passive customers who demand and perceptions can influence and

manipulated. However in the information age, marketing people has to evolve

strategy of ‘connect and collaborate’ with customers to create, deliver and share

value by establishing long term relationship.

2.3. First law of good customer relationship is ‘take good care of your customers’.

Good office ambience and interiors not only make customer relax and upbeat

but also have them feel welcome, taken care and important.

2.4. Since all banks offer more or less the similar products and replication of the

product is very easy, it is the customer service that makes the difference. The

customers these days are becoming more and more demanding on price,

product and convenience. They are well informed and seek financial advice

before they buy a product. They have no loyalty with any institution and ready to

switch over to any bank as and when they get a better deal. Banks’ are gearing

themselves to become customer centric where all focus is on building

sustainable long-term customer relationship.

2.5. With little to distinguish between different players, banks are searching for newer

ways to reach out to the customers. A few banks have now launched home

delivery service that provide home delivery of cash and demand drafts and

home pick up of cash and cheques etc. These are measures to retain customers

and enhance their loyalty.

2.6. Relationship Banking plays a crucial role in strategy building. The emphasis

here is on viewing the customer-relationship as long term mutually beneficial

rather than confining to a particular loan or deposit transaction. Bank now tries

to meet total financial requirements of the customer to get repeat business. In

order to promote lifetime relationship, bank does offer relationship concession

(reduction in interest), relationship discount (concession in service charges), free

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counseling and investment advice which customer can value in terms of their

loyalty.

2.7. In competitive environment, customer can choose what they consider best. In

choosing their banks customers are influenced by the image of the bank and the

perceived quality of service. The bank that provides better service or perceived

to be better than others gets customers. Good customer service in itself works

like a ‘brand’ for the bank. It speaks of the service standard.

2.8. A perception of good service relates to courtesy, promptness, employee

attitudes, physical facilities, customers’ recognition, speed, clarity and

communicative skills and host of such features. It gets manifested in the care,

concern, commitment and sensitivity shown by the bank staff. A delighted

customer helps the bank in acquiring new customers. Such a customer is an

unpaid salesperson of the bank.

2.9. Relationship banking requires sales force with complete knowledge of product

with pleasing attitudes and genuine concern of customer’s problem. However to

offer correct product to the customers, bank staff need to have complete

knowledge of the products and skill in marketing the products. He must

understand customer’s need so that the he can offer to him best product

available and not the one, which he is having. He should know how to greet

customers, meet their needs and handle their doubts and complaints. As

knowledge and skill development requires lot of orientation and attitudinal

changes, banks are training/retraining their human resources to build up these

competencies and capabilities.

2.10. The research has shown that cost of acquiring a new customer is six

times more than that the cost of retaining a customer (Gruen, 1997) and hardly

14% customers leave an organization for competitive reasons whereas 68%

leave for indifferent approach. Therefore all attention is now on retaining

customers by pampering them through better price (better interest rate,

concession in service charges etc.), more convenience (instant sanction, easy

documentation, focused service, customer friendly staff etc.) better quality

(product variety) and extras like freebies or add on (zero processing charge,

free car insurance, free home insurance etc.) In fact for retaining customers, a

bank has to constantly reinvent itself. Captivating (instead of capturing)

customer is new mantra of retail banking.

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2.11. Customers are also becoming less tolerant of mistakes. The retention

strategy involves encouraging and entertaining complaints proactively to create

customer friendly image. Banks are providing call center or toll-free help line to

enable the customer to make queries and register grievances.

2.12. A new dimension in customer service is ethical practices. Responsible

ethical behavior is now seen as an essential part of customer relationship.

Banks are publishing best practices code in support of their commitment to

ethical business practices.

2.13. De-selection of customer is also an important issue, which is often

ignored in context of social banking. According to Market Line Associates, the

top 20% of typical bank customers produce as much as 150% of over all profit,

while the bottom 20% of customers drain about 50% from bank’s bottom line

and the revenues from the rest just enough for meeting their expenses. De-

selection involves deliberately losing few customers, which are considered

unimportant/loss making. For example banks are changing focus from number

of savings bank accounts to value of accounts and in the process weeding out

those accounts where customer persistently fail to maintain minimum balance.

2.14. De-selection should be differentiated from ‘Customer on trial’ – customer

doing trial of a product or service or a bank. Strategic marketing involves

converting such customers into a higher spending, more frequent referring

advocate. See FIVE rupee magic – HLL sells number of products at Rs. 5 like

Pepsodent, Pond’s talk, Pond’s cold cream, Rin, Taaza, Fair & Lovely, Clinic

Plus and Lux. The strategy is to induce first user customer by offering a product

as cheap as Rs 5 to penetrate the market and then converting these buyers into

permanent customers by offering value for their money. A bank has recently

introduced Rs. 5 Saving Bank ‘no-frill’ account to capture customers by an

entry-level product.

2.15. Income that a customer generates to the bank directly or through referral and

recommendation model refers to “Life time value of a customer”. Such

customers are specifically targeted for business development. CRM plays a

crucial role in fully harnessing the value of existing as well as potential

customers. CRM is a new face of marketing.

2.16. The basic concept of CRM is that it aids businesses by use of technology and

human resources to gain insight into the behavior of customer. Many CRM

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software solutions are now available to create Customer Information System

(CIS), Data warehousing, Data mining and Sales Force Automation (SFA). CRM

can help the bank in (a) acquiring newer more profitable customers, (b) selling

more products to the exiting more profitable customers and (c) reducing

customer churn by retaining more profitable customers.

2.17. Speed and time are critical factors in customer service. Internet banking,

mobile banking, ATM, tele-banking etc. are all offered to take care of speed and

time. Technology today is a key facilitator to any time, anywhere and anyhow

banking. IT is building competitive advantage for banks.

2.18. Demographic and psycho-graphic changes of people are causing demand shift

in a very big way and these are key drivers of demand side of retail products.

Mapping customer needs is important for product development so that actual

requirement of the customer is known and can be satisfied. The process starts

with the mapping the customer’s behavior by analyzing various activities that he

performs while selecting, purchasing, using and disposing a product and then to

locate gaps from where he derives value. In a classic case of car loan, a

customer asked the bank why the bank wanted him to retain a car for seven

year by offering him seven-year product. In fact, a short-term loan say, one to

two year would have served his purpose.

3. Retail Banking –Product focus3.1. The term product in bank means a set of services designed to varied needs,

motives, styles, values etc., of bank customers. It is wants-satisfying commodity

created and delivered for customer’s satisfaction. Like any other physical

product, the structure of the bank products consists of different components like

core component, augmented component, ancillary service component etc. It

may be deposit-based product or a credit based product. For example, no frill

home loan is a core product, other facility like personal insurance, life insurance,

house hold insurance, flexi-repayment plan etc., is augmented component and

pre credit/ post credit counseling, tax planning and advise in selection of

property etc. is ancillary service component. The product development is key to

successfully face competition.

3.2. The marketing of financial products is totally different to marketing of physical

products (You can not sell a home loan, they way you sell soaps) due to nature

of financial products i.e. intangibility of product and its inseparability from

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provider. Intangibility means buyers can not compare service the way they can

compare the goods by looking to its appearance, feel, weight, smell, size,

shape, price, packaging and brand. They can observe the difference only by

measuring expected vis a vis the perceived benefits. To enable customers to

measure benefits, bank has to create product visibility through aggressive

advertising, mouth publicity and by creating professional ambience. To

overcome problem of inseparability, the bank has to project it self as robust,

reliable and user-friendly service system.

3.3. To create a distinction in the market, the bank has to design services strategies

to build credibility and professional relationship among customers. For example

many banks have started offering home delivery and home pick up service of

cash, drafts/cheques and other banking products like utility bill payment which

for past many years was the exclusive domain of retail shops like provision

stores. This is helping the banks to increase penetration, cut retailing cost and

improve customer base. A bank with tie-up of a telecom company has

leveraged technology by offering eSettlement product so that customer can

settle the bills minus cash from comfort of his home. However banks has to take

care of credibility of third party by ensuring that outsourcing agent maintain

service standard.

3.4. Since banks operate in buyers market, customer satisfaction is key to success

of new products. Basically the customer’s needs are repetitive, multiplicative and

dynamic in nature. The product development strategy aims at exploring and

satisfying these needs in a continuous manner. Alfred P. Sloan once said ‘ we

must design not just cars we would like to build but, more important, the car that

our customers would want to buy.’

3.5. Each product has its life cycle. Product innovation is a necessity so that before

life cycle of the product is over, there is new product to take its place. The bank

should, therefore, aim at creating new products or modify existing products

after mapping customer’s need. Creation/ modification of products can be done

either through value creation (innovate or die) or value addition (new features) or

value affordability (cheap or no frill products). Opening of Savings Bank account

with only RS.5/- is a classic example of value affordability.

3.6. While development of new product is important, it is equally important to wean

out obsolete/low demand/loss making or low profit products. Like any thing else,

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each product has its life cycle. Typical life cycle is- introduction, growth,

maturity and decline. But very often most banks do not examine their products

to check if they are selling too many products, identify weak ones and kill

unprofitable ones. Merge, milk, sell, or kill are four options for product

management.

3.7. Merging products than dropping them is an option, which is exercised when a

bank finds that a product targeted for deletion is having customers that might

grow in future. So products are merged and new features are promoted to

initiate migration of customers to new brand.

3.8. Milking strategy is adopted for those products where it is found that the product

is popular with a small segment. So a bank drops all sales promotion

expenses and allows the product to die its natural death and meantime available

sales potential is exploited by providing bare minimum support.

3.9. Unprofitable brands/products are either sold or killed to save money for

marketing profitable products. Large banks often dispose off products that no

longer meet their financial targets although these may be profitable to smaller

banks. The legal safe guards in respect of sale of products are taken to ensure

that the brands/products do not return as rivals.

3.10. Failed products are also dropped or killed. Failed product is one that does not

meet the expected need and wants of the customers. In Indian context, Gold

Deposit scheme is a classic case, which failed due to Indian psychic that people

do not want to dismantle their ornaments. Stock invest scheme is other product

which lost its utility due to reduction in allotment time of primary issue and has

therefore been withdrawn by RBI.

3.11. The race for becoming a ‘one-stop financial supermarket’ is hotting up like

never before and even smaller banks are now talking about becoming the

destination for all kinds of financial products. While developing own products is

an expensive proposition and is a time consuming process, third party product is

sold aggressively by taking benefit of established and recognized brand in

segments where the bank itself possesses no experience. It is also important

that while selling third party products, bankers must convey unconditionally to

the customers that they are only selling some thing for which responsibility to

service and performance lies with the third party. Selling of third party products

also help the bank to cross sell its own products.

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3.12. The bank has to deal with diverse nature of customers- rural and urban, rich

and poor, high net worth to middle class, retail and institutional. In order to

assess the need properly, customer segmentation is done so that instead of

one-product fits all approach, individual solution by way of tailor made products

are offered. Identification of market segment is also crucial from product pricing,

promotion and distribution point of view.

3.13. With all pervasive use of technology various e-products are now in the market

that leverage innovations and convenience for customers. Internet is a key

driver of technological change and has brought major transformation in delivery

process. But, at the same time, it has opened serious security concern. Product

development needs to address all these related issues in a holistic and

integrated manner so that customer accepts the product with out any hesitation.

3.14. In order to promote the product in a highly competitive market, it is most

appropriate to use creative marketing tool to simulate impulsive buying by

potential customers. Opening of savings bank account with zero balance is one

such innovation made by banks to garner accounts of salaried people in bulk.

Other ways of product promotion are offering freebies, add on etc. Cross selling,

UP selling, Ask-selling, Soft-selling, freebies, adds on, and piggy-ride are other

strategies to push sales. While implementing sales promotion plans marketers

should decide amount and nature of incentive/concession, which is eligible, how

to advertise, when it should start and how long it should last.

3.15. Direct marketing (selling 1:1) is a very powerful tool and can be very

successfully utilized for selling products like credit cards, mutual funds, life

insurance etc. There are number of stories of successful insurance agents

giving their presentation before family members and telling about families which

are able to face crisis due to insurance. TV and other media advertising, which

increases product visibility, further supplement direct selling. However,

customer privacy these days is getting utmost important and even RBI has

cautioned banks not to use personal information for soliciting customer either

directly or through alliance partners/ direct selling agents without express

condition or disclosure to the customers. So bank, while resorting to direct

marketing, must design their strategy in such a way that no irritation is caused to

customer by their unsolicited telephone call or SMS or email.

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3.16. In order to create product affinity among customers brand building is done as a

strategy so that customer can identify the product by way of log or punch lines or

product name. For brand marketers the need to develop able, stable and

durable brands is extremely critical for creating product affinity. In India name of

most of the financial products is linked to the name of the bank. This technique

is advantageous for product identification as well as product differentiation.

3.17. Product pricing is another important element of marketing strategy. Based on

trade off between price and quality, KOTLER predicted nine marketing mix

strategies on pricing - premium strategy, overcharging strategy, rip-off strategy,

penetration strategy, average strategy, borax strategy, super-value strategy,

good value strategy and cheap value strategy. The bank may adopt any one or

more strategies as considered appropriate depending upon bank’s policy of

profit maximization, market-share leadership, product quality leadership or

survival strategy.

3.18. Transparency is new buzzword of marketing strategy. Banks that charge

hidden cost by fine print may lose competitive advantage as such a strategy

may create customer confusion.

4.Retail Banking-Multiple delivery channels4..1 One customer multiple channel is now order of the day. From traditional physical

branches/extension counters to ATM/internet/Tele-banking/mobile banking

/smart cards/ touch screen/kiosk/call centers various delivery channels are now

available for the customers to choose from. These channels now offer

24X7X365 banking on any time anywhere and anyhow basis and have added a

new chapter in convenience banking. The determination of proper channel for

selling a product is very crucial from product management angle. The decision

depends upon marketing strength of the bank vis a vis the availability of

channel.

4..2 While offering a range of delivery channels, it is necessary that banks integrate

physical channel with electronic channel effectively and offer a seamless

service. The customer must be able to deal with a coordinated informed

organization, whether he access it through a branch, a call center, the internet or

any other channel.

4..3 There is now a deliberate paradigm shift to wean away customers from branch

to other channels not only to substantially lower cost but also to become high

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revenue generating profit centers that, apart from increasing visibility, can now

cross-sell and up-sell products.

4..4 Banking with these new channels is a unique shopping experience to the

customers, which shifts focus from eye contact to e-contact. These channels

provide time and place advantage to the customers. Further bank has to build

integrated delivery channels with both vertical and horizontal integration. In

order to do so bank has to install an enabling and compatible multi-channel

platform which would support and seamlessly integrate both the existing and

future delivery channels.

4..5 ATM is most successful delivery channel followed by telephone banking and

Internet banking. As ATM is becoming more and more user friendly, banks have

started dispensing third party products like railway ticket, movie tickets, refilling

mobile etc. As per conducted by AC Nielson ORG-MARG for NCR nearly 90%

ATM users prefer to receive information on new product and services through

ATM.

4..6 Internet Banking provides numerous facilities to retail customers like utility bill

payment, online shopping, ticketing, share trading, down loading statement of

account, knowing balance, knowing status of cheque issued, electronic fund

transfer, transfer to PPF account, request for draft/cheque book etc. For trade

and commerce Internet banking provide facilities such as on-line opening of

letter of credit, on-line bill loading, account sweeping, account pooling, fund

management etc. It also enables the bank to provide multi-branch banking with

multi-city cheque-book facility. Internet is now USP of retail loan.

5. Retail Banking- Joint Ventures/Business Alliances5..1 An U.S. market study of Anderson Consulting found that 58% of the financial

sector’s most dynamic companies – the ‘value captures’ that generates both

high growth and high share-holders return- are built around business alliances.

5..2 To captivate customers joint ventures/alliances with product developers,

manufacturers, marketers, outsourcing partners, builders, promoters,

educational institutions, hospitals, insurance companies etc. who together

embody the extended enterprise has become the order of the day. The

objective is to develop a mutually supportive, value-creating chain; bringing

together complementary competencies of alliance partners to create more value

together than one can deliver separately.

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5..3 NABARD/Commercial banks have entered into collaboration agreement with

corporate like TATAS, ITC, and Hindustan Lever etc., for contract farming thus

opening new vistas for rural credit financing.

5..4 Bancaassurance model is totally based on business alliance between bank and

insurance companies, as Banking Regulation Act does not permit the bank to

enter into insurance business directly. To boost fee based income, banks are

entering into business alliances with insurance companies- both life and general

and are exploiting business opportunities by selling insurance products to their

existing customers. SBI Life has reported that total premium collection of Rs. 27

crores from bancaassurance business out of total premium collection of Rs. 51

crores in Q1 of 2004-05.

5..5 Mutual fund is other area where synergies of bank and mutual fund companies

are exploited through business alliance. HDFC mutual funds has reported that

they have tie up with ICICI Bank, HDFC Bank, Canara Bank, Citibank and

Standard Chartered Bank to sell its mutual funds product and as much as 27%

of the mobilization is now coming through this channel.

5..6 Manufacturers, dealers and financiers are stitching their wits together in

marketing through collaboration and alliances. Collaboration agreements with

tractor/car manufacturers and automobile dealers are churned daily which

creates mutually supportive business mode. While for manufactures/dealers it

provides opportunity to boost sales, for the bank it is an opportunity to finance.

Even in second hand car market, dealers are collaborating with banks to finance

buyers.

6. Retail Banking- A New ParadigmRetail banking is for ‘fittest, fasted and smartest’. It has become totally customer

centric. The man who cares his customers will eventually win. Size, location or

past history does not matter any more. What matters- how quickly a bank can

adapt itself to the changing world at Internet speed that itself is fast changing.

The emerging retail banking paradigm is -

There is visible shift of focus from product to customer. Best marketing secret

is to love your customers, to cherish them, to appreciate them, to listen them

and be honest with them.

Banks need to be passionate about nurturing customer relationship. Long-

term success comes from deeper and more honest customer relationships.

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Banks need to constantly anticipate and adapt as per customer’s changing

need and demand. Product innovation and renovation is key to success.

Banks need to take speedy actions and decisions as new generation

customer value time.

Banks need to integrate physical channel with electronic channel effectively

so that new generation customers feel comfortable.

Bank need to forge strategic partnership with dealers /manufacturers/

builders/promoters etc to harness synergies of alliance partners.

Bank need to do regular strategic marketing audit of their business to make

sure that they continue to be customer oriented.

-0-0-0-

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Retail Loan-StatisticsType March

1996March 2004

Housing 6303 51981Consumer 1476 8274Shares bonds etc.

1933 2020

Real estate 1173 5577Fixed deposits 12000 26346Personal loan 12559 35165Total 35454 129363

Amount in Rs. crores.RBI report on trend and progress of banking

Chapter-23

Retail Loan – Opportunities and Challenges

“The market is bigger than we have ever dreamt.” Jack Welch

1. Retail Banking- post reform developmentAfter introduction of financial sector reforms in 1992, banks are facing numerous

challenges like increasing competition from private and foreign banks, low productivity,

high operational costs, pressure on spreads and focus on NPA management due to

tightening of prudential norms. But they are awash with liquidity. Corporate clients are

now demanding loan at Sub-PLR due to new avenues available to raise borrowing

overseas at much cheaper rates. This has forced the banks to look for new avenues for

growth and survival by repositioning themselves in new business segments of economy

where opportunities are more and risk is less. Retail customers who represent huge

untapped market for credit has suddenly become a new business mantra for banks.

2. Retail loan- new business opportunities Welcome to new India, where living off debt is

well-accepted norm of life. If recent statistics (see box) on consumer finance are any indication, last few

years have been trend setting. The conservative,

cautious, thrifty and debt-averse middle class of past

seems to have given way to a new middle class

(population about 32 million) that is free from all

inhibitions regarding conspicuous consumption. It has

no stigma of borrowing for consumer spending. Indian

Corporate has been dreaming for a long time to tap this huge market of middle class

that is hungry for consumer durables but short of cash. The cheap retail loan has made

their dream come true.

3. Retail loan- market size

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RURAL GAME“49% (or 32,538) of all scheduled commercial bank branches are rural, 31 per cent (or 13 crores) of the total deposit accounts and 43 per cent (2.2 crores) of total credit accounts are in rural branches. Over 6.42 crore Kisan credit cards have been issued by banks."

The retail assets crossed Rs. 149,000 crores in 2004 from Rs. 42,000 crores in

1999 according to industry estimates. Home loan market constituted 47% (Rs.60,

000.00) in 2004-05 followed by car loan 22.3% and personal loan 8.1% ( Economic

times 07.05.2005). Present penetration level of retail loans is only 6.5% of our GDP,

compared with 10.2% in Thailand, 49.3% in Malaysia and 68.4% in South Korea. (The

Asian Banker) Thus untapped potential of retail loan in our country is very high. The

over all demand for car loans and two wheelers has seen a 25-30% growth since

January 04. Consumer durable loans have grown consistently more than 20-25% since

2000 while two wheeler loans have grown 30%. Car finance too has grown 30%. Seeing

big opportunity banks have become very aggressive in retail loan with the result market

volume is building up by leaps and bounds. The feisty private sector banks like HDFC

bank and ICCI bank have already occupied much of the retail space. Public Sector

banks are carving out space for themselves through (a) Wider reach (branch network),

(b) Large customer base, (c) Strong brand presence, (d) Large product portfolio, (e)

Multiple delivery channels and (f) Leveraging technology (to handle large volumes).

4. Retail loan- Going Rural India’s smaller cities and towns are beginning to assert themselves in the credit

market place as among the top 100 cities, the

share of non-metros in total bank credit increased

to 28% in 2003-04 from 15% in 2001-02 (See box).

Further per capita income in rural India is Rs. 9481

where as in urban India it is Rs.19, 407 but in rural

place no body pays for drinking water, primary

health care or home rent. So disposable income in

rural India is really high. As per NCEAR survey

over a third of our middle class (annual household income of Rs. 2 lakhs to Rs. 10 lakhs)

live in rural areas and another sixth reside in small towns of population less than 5 lakh.

Further as per survey the number of middle and high-income household in rural India is

expected to grow from 80 million to 111 million by 2007. In urban India the number of

middle and high-income households is expected to grow from 46 million to 59 million.

Consumer growth is taking place at fast pace in 17113 villages with population of more

than 5000. Of these 9989 villages are in 7 states, namely Andhra Pradesh, Bihar,

Kerala, Maharashtra, Tamilnadu, Uttar Pradesh and West Bengal. All this data indicates

the amount of buying power of great rural India. It also indicates existence of enormous

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business opportunities particularly for retail loans. With more than 40000 rural and semi

urban branches having powerful bonding with the customers and their implicit faith,

banks are uniquely positioned to exploit this opportunity. Some of the major challenges

of the rural marketing are –(a) scattered nature of population, (b) diversity, (numerous

languages and dialects, caste, culture and religion) (c) poor connectivity leading to high

distribution cost and (d) communication problem (low literacy and limited reach of mass

media). Going rural is new market mantra for public sector banks.

5. Retail loan - as driver of economic growthThe spurt of retail credit in sectors like consumer finance, automobiles, two-

wheelers, financial services, home loans, education and credit card indirectly helps the

economy by pushing up the sales of the products and services involved. Government

has increasingly pushing lending to this segment because it has multiplier effect on the

growth of the economy.

6. Retail loan- New Marketing ParadigmThe basic nature of financial products of intangibility and inseparability from the

bank creates many a hurdle for the bank service marketers. Intangibility makes it difficult

for the provider to communicate to customers in very precise terms. It also poses

problems for the customers as they find it difficult to differentiate and evaluate the

services of various providers. In order to create a distinction in the market, the players

have to:-

(a) Designing services strategies – It is aimed to build credibility and professional

relationship among customers. Credibility is built over a period of time by ways of

fulfilling the promises through competitive performance.

(b) Tangibilisation of services- the customer do no see or touch anything to decide

before buying financial products. In order to create trust of customers, the bank

has to tangibilise its service product by providing proof of performance through

advocacy (mouth publicity) or advertisement and through pleasant and

professional ambience at the service counters.

(c) Developing delivery system- it has to establish a robust, efficient, reliable and

user-friendly delivery channels.

(d) Information technology is changing the way the services are designed,

managed and delivered. Advances in IT have enabled banks to offer variety of

new services. In doing so, many traditional services are becoming obsolete. For

example, electronic fund transfer is making demand draft obsolete and ATM card

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has made traveler’s cheques out of date. It also adds to competitive advantage

to banks.

The customer is the focus of this new marketing paradigm, which works on

premises of -

a) Loyalty-It is less expensive to keep an existing customer than to acquire a new

one.

b) Scope –It is easier and more profitable for a company to sell to a satisfied

customer.

c) Efficiency- Business should bear in mind that some customers are more

profitable than others.

7. Retail loans – Shifting focus The focus of retail banking has constantly been evolving; in early 90s it was

product focus, in late 90s it was sales focus, in 2000 it was price focused and today it is

customer focused. To have competitive advantage, a banks are -

(a) Shifting focus from product to customer,

(b) Keeping developing products as per need and demand of the customers,

(c) Developing efficient appraisal and risk assessment skill among managers for

speedy decision and sanction,

(d) Exploiting customer base and available delivery channels by aggressively

pushing the products,

(e) Forging strategic partnership/alliance with business partners such as builders,

auto dealers etc. to extract maximum competitive advantage and

(f) Continuously working for innovation and creativity for product development.

8. Retail Loan – New Business Process Walk in business is the thing of the past. The new business process of retail

loans is to captivate customers by offering best of breed products through multiple

delivery channel and joint venture/business alliances. The New Business Process

comprises of: -

(a) Best of breed products- The product development is key to successfully face

competition. It is a continuous process. The objective should be to remain one

step ahead of competitors. With all pervasive use of technology various eProduct

are now in the market that leverage technology for convenience of customers.

(b) Multiple delivery channels- One customer multiple channel is now order of the

day. From traditional physical branches/extension counters to ATM/internet/tele-

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banking/mobile banking /smart cards/ touch screen/kiosk/call centers various

delivery channels are now available for the customers to choose from. These

channels now offer 24X7X365 banking on any time anywhere and anyhow basis.

There is now a deliberate paradigm shift to wean away customers from branch to

other channels not only to substantially lower cost but also to become high

revenue generating profit centers that, apart from increasing visibility, can now

cross-sell and up-sell products.

(c) Joint Venture/Alliances- To captivate customers joint venture/alliances with

product developers, manufacturers, marketers, outsourcing partners, builders,

promoters, educational institutions, hospitals, insurance companies etc. who

together embody the extended enterprise has become the order of the day. The

objective is to develop a mutually supportive, value-creating mode; bringing

together complementary competencies of alliance partners to create more value

together than one can deliver separately.

9. Retail Loan- Designing StrategiesDesigning strategies is most important part of retail marketing. A strategy is a

road map to sell products. Strategies differentiate a bank with its competitors. It helps to

build competitive advantage. The strategies can be classified into various categories like

operational strategies that includes both structural and infrastructure decision, marketing

strategies includes pricing, placement and delivery decisions, human resource strategy

includes the skill levels of the sales people hired and the type of training they require, IT

strategy includes IT infrastructure to deliver the service as per expected standards and

service strategies like six sigma, quality circle, zero defect program etc.

10. Planning for the future - Emerging issues, strategies and challenges1. “Generation Next” segment (350 million young Indian between age group of 15-34

years see life and life-style very differently)- This is going to be the target in

immediate future. It is currently urban phenomenon but it would not be too long when

it will emerge in rural India also. They are tech-savvy and prefer electronic channel.

They seek financial information from variety of sources and are very fickle shoppers.

Banks will have to leverage technology and develop ebased products to tap this

segment.

2. “Rural segment” is one from where fresh demand of retail loan is being generated.

PSBs are in real advantage as they have good network of rural and semi-branches

where competition is less and opportunities are more.

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3. “Never use” category”-customer who has never availed/bought financial products

are being targeted through various promotional offers. This category holds huge

untapped potential. Loan mela/bazaar/road shows are creative product promotional

tools to create impulsive buying in new customers. Property melas and exhibitions

cut short the process of customer acquisition on two counts; the properties are pre-

vetted hence need no scrutiny and the customer just walks in. Such melas attracts

tremendous foot -fall – potential customers- drums up huge business volume at low

cost. Banks should learn art to organize loan bazaar/mela/road shows so as to

exploit local potential and establish a better product visibility.

4. “Brand building” for wider reach and product affinity is a strategic tool. Brand in

broad term includes all means of identifying a product by way of log, or punch lines

or product name. Brands communicate a value proposition to the customer and

consequently strategy should be to strengthen the brand with appropriate investment

Retail manager should be trained to project brand value (competitive advantage in

pricing, less paper work, speedy sanction etc.) to the customers. They should avail of

each and every opportunity to explain products features to develop customer brand

affinity. Remember that one satisfied customer brings eleven new customers.

5. Product innovation and renovation- Replication of product is very easy. Retail

loan managers will have to be market sensitive and they will have to seize each and

every opportunity to redesign a product as per market need or to introduce new one

with minimum of time. For this regular interaction of marketing team and corporate

planner is essential so that based on feed back innovation and renovation is done

on regular basis. Remember that first mover will always have advantage over

followers. Freebies and add-ons like zero processing fees, free insurance with car or

housing loan, no prepayment penalty,

concession in interest and charges to loyal

customers etc. are other innovative ways to

captivate customers.

6. Cross selling and up selling is a very

successful way of improving volumes. As a

strategy existing customers should be offered

products where profit margins are more e.g.

offering car loan, furnishing loan etc. to existing

housing loan customers. Further based on contribution of the customers to bank,

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SCB CreditOutstanding

March1997 @

March2002@

TotalCredit

284.4 656.0

Personal loan 19.20 46.50

% Of total 6.75% 7.00%@ Amount in thousand crores of rupees- CMIE data

TOP FIVE GOLD LENDERS ( In crores)

1. Muthoot Finance Rs. 7342 2. Indian Overseas Bank Rs. 5,220 3. Indian Bank Rs.39204. Manappuram Rs.2,5605. South Indian Bank Rs. 2360

(IMaCS industry report -2010 update)

differential-pricing strategies such as discount in interest, as relation ship waiver has

to be evolved.

7. Personal loan segment of retail loan has seen maximum growth. Total personal

loan outstanding of SCBs increased from Rs. 19200 crores in 1997 to Rs.46500

crores in 2002 (see box). The market is gradually saturating and fresh

disbursements are largely by way of roll over or on repayment of previous loan.

Banks will have to target business from other segments of retail loan.

8. Car finance industry record sales of 2.5 lmillion units in FY 2011:- Discounts

finance schemes, low interest rate, festive season offer and new launches like teaser

rates offer have worked wonders to Indian auto industry during 2010-11 which

clocked car sales to clock record high of 25 million units. However during 2011-12

the car sales is likely to stabilize at 12-15% growth due to higher borrowing cost and

surging prices. From banker perspective, a car loan customer is much better risk

than an unsecured personal loan or a credit card. However lack of clarity in

repossession of vehicle from defaulters due to Supreme Court judgment and

consequential delinquency of loan has caused many banks to go slow in financing

this segment.

9. Gold Loan: A gradual shift from pawn-brokers to organized lenders by people who

raise money against gold or

ornaments is expected to double

the holding of three specialized

companies in the business to 200

tonnes or over a third held by

Reserve Bank of India by the end

March, 2011. Indian households

estimated to have 18000 tons of

gold and out of this hardly 1000 tons is pledged. Hence gold loan potential is huge.

There are NBFC like Muthoot and Manappuram Gold in gold loan business in

addition to banks. LTV ratio (excluding making charges) is around 75% . Normally

NBFC sells/auction gold after 15 months and recognize a loan as NPA after 12

months. Looking great opportunity, banks are targeting the market very

aggressively. One nationalized bank, recently decided to set up exclusive outlet for

gold loans so as to compete with the NBFCs head on. Bank is also planning to put

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of assaying machine so that dependence on jewellers is reduced and loan is

sanctioned without delay.

10. Two wheeler financing: - Over the last decade the two-wheeler industry was the

highest value creators recording annual share holder return of over 40%. One of the

drivers of the growth was strong sales growth at over 15% for last five years which

provided immense business opportunity of financing. From bank’s perspective

serving this customer segment is an operationally intensive exercise covering

locations much beyond city limits and being dependent on correspondents banking

relationship. The customers typically belong to lower and middle class which tend to

borrow irrespective of repaying capacity and very often overleveraged by borrowing

and spending. As per reports (BS 18.02.2008), two wheeler lending has declined

more than 15% during 2007-08 over previous year. Recent norms on appointment of

recovery agents, lack of clarity in repossession of vehicles and growing delinquency

in two wheeler loans have forced banks to go slow in this segment.

11. Housing loan has large potential- House today is better affordable through loan.

Tax breaks have spurred credit demand. As per feedback of Assocham (BL

5.11.2007) the age group for property registration for personal use has been 30-38

years in most cases from 50-58 earlier. GOI move to give 1% interest subvention

on home loan up to Rs. 25 lakhs and cover them under priority sector has made

the banks to push harder this segment. The SARFAESI Act has increased level of

comfort as bank can now go for foreclosure of loan without intervention of court.

Given the fact that the total shortage of dwelling units at the beginning of the

Eleventh Plan period 2007- is estimated to be nearly 2.5 crore, the opportunity of

housing finance sector is huge. Rural and Semi-Urban sector is almost untapped.

Housing loan growth slowed to 12.1% during 2011-12 from 16% in 2010-11 due to

high property prices and high interest rates. With expectations of fall in interest rates,

banks are now bullish in home loan market. To meet competition focus will have to

shift on customer’s convenience and tailor made products to garner larger share of

housing loan pie. One innovation of Citibank’s Home Credit, Standard Chartered’s

Home Saver and HSBC Smart Home in which home loan is linked with a over-draft

account with the result interest obligation get reduced to the extent of credit balance

in OD adjusted against principal loan outstanding in the home loan. Second home

loan seeker is other segment where demand is emerging. Credit assessment in this

will be entirely different process, as bank will have to factor in possible rental income

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while considering repayment capacity. Third segment is up gradation to bigger

house, which is emerging market due to rise in income of professionals.

12. Teaser rates home loans: Teaser rates or terraced loan scheme launched by SBI

and later followed by many banks helped them to capture at a bigger size of the

market and also expand the market size. It may be noted that as per scheme interest

is fixed slightly lower to market rate initially for two/three years on fixed basis and

subsequently linked to market determined rates.

13. Switching of loan particularly in housing sector has significant inertia. RBI

directives to banks not to charge pre-payment charges has given opportunity to

home loan borrowers to switch to other lenders if they find that they are able to get

loan at a better prices. PSBs should get ready to tap this opportunity.

14. Women segment- Loan schemes like loan for purchase of gold ornaments have

been specially targeted for women segment. India consumes gold worth 800 tonnes

annually and gold jewelry market is estimated to be about Rs.45,000 Crores

(Business standard 29th September 04). A few south based banks have already

leveraged the potential of this segment. Other PSBs should develop and position this

product to target segment to exploit business opportunity.

15. Educational Loan- Loan to students for pursuing higher education is fast emerging

retail loan segment. Education loan portfolio stood Rs. 2976 crores as on June, 30,

2010 covering 1.71 lakhs students. (B S September 13,2010) As per a study

(Business Line 7.3.2011) hardly 5% students pursuing higher education in India

takes education loan against about 60% in US taking recourse to such loans.

However gradually education loan segments have started increasing many fold

mainly due to easy availability, collateral free, tax break on loan repayment and

inclination to self-finance the study. For banks loan provide the opportunity to catch

customer when they are young and that too for the lifetime. Some banks have

started offering loan for financing fee of coaching classes as considerable cost is

incurred by students in preparing for entrance examinations.

16. Travel Loan or Holiday loan - Banks have now cashing on people’s urge spurge on

foreign holidays by offering ‘travel loan’. Till now, it was prerogative of few foreign

banks, but lately public sector banks have also started granting such loan. Banks are

tying up with travel companies to tap potential travellers. Banks charge lower

interest on travel loan as these loans are typically sanctioned to high net worth

people with lesser probability of defaults.

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17. IPO Loan- with capital market at its peak and number of IPOs on line, banks have

started aggressively selling IPO loan to retail customers. It is upcoming segment and

has immense potential.

18. Bancassurance offer opportunities of cross selling of retail loan products by

bundling with insurance products. Banc assurance has started taking strong roots in

our country and there are expectations that average collection through banking

channel will rise to 50% in next five years. This product offers vast cross selling

opportunity to banks by bundling with their own financial products besides building

fee-based income.

19. Joint venture/business alliances have become order of the day. They provide

mutually supportive, value creating mode by bringing together complementary

competencies of alliance partners to create more value together. While private sector

banks have successfully embraced this model, PSBs are also gradually looking to

this business mode not only for business development but also for due diligence and

recovery.

20. Due diligence of retail loans: - Instances of resorting to multiple financing by

unscrupulous borrowers are very common. Instances of housing loan on the basis of

fake documents and impersonation have also been reported. To safe guards from

frauds, sanctioning/disbursing officials are required to meticulously follow KYC

policies of customer acceptance and identification and other systems of internal

control. It is interesting to learn that a PSB has recently unveiled its plan to use credit

verification agencies to improve due diligence of retail loans.

21. ‘People with right soft skill’ is the requirement of retail banking. They should have

not only complete knowledge of the products but must have pleasing attitude and

genuine concern of customers’ problem. Regular training of retail people is essential

to make them successful sales person.

22. Consumer lending blues- After aggressive growth in the past few years’ banks

have now started feeling the pinch as NPA in retail loan is on rise. Banks have also

started receiving reprimand from Reserve Bank and court for use of strong arm

tactics of recovery agents. The problem is symptomatic of a deeper systemic rot that

afflicts retail lending in India. Poor institutional mechanism for recovery of dues as it

takes a long time to recover debts through judicial process. It is in this context to

emphasize that field staff should be educated to exercise high degree of diligence

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by not only rigidly following KYC polices in identification of borrowers and screening

loan applications but also monitoring recovery.

23. PDC management-Banks to take recourse of Section 138 of Negotiable Instrument

Act are taking PDC in all retail loans. From timely presentation of cheques to timely

and prompt legal action, it is necessary that awareness in legal aspects be created

among mangers so that provisions of the act are fully harnessed for benefit of the

bank. Physical handling of huge volume of cheques is compelling banks to consider

alternate like ECS (electronic clearing system) or credit to receive monthly

installments as this arrangement is cost and time effective.

24. Fair practices code- With RBI insisting on banks to put in place anti-tying

measures, there is growing demand that lender do not resort to unfair trade

practices. It is, therefore, essential that interest rate, method of compounding, penal

interest, prepayment penalty, rebate for prompt payment, right of borrowers like copy

of loan documents, statement of account, right of privacy i.e. not sharing his personal

profile to business associate/other agencies should be explained to prospective

customer and bank should put in place a grievance redressal mechanism to sort out

problem.

25. Credit counseling- In retail credit cases of multiple credits is very common. Other

problem is revolving credit of credit cards from multiple issuers. Once a borrower is

in distress, it is very difficult for him to come out unless proper guidance is given to

him. Credit counseling centers educate such people on financial education, credit

counseling and debt management. Borrowers in distress may call to these centers

to take guidance to reschedule debts, work out repayment plan or scaling down of

debt or one time settlement.

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Taking a Loan: RememberMany people take loans when they don’t need them. Avoid that.Apply for loans, don’t take loans that banks call up and offer. Clarify the loan amount because you might land up being charged interest on a higher amount. Clarify how the bank will go about recovery. Know your rights. In difficulty, call the bank to renegotiate the repayment terms.

26. Sale of impaired assets - ARCs deal only with purchase of high value assets. The

retail loan portfolio, which consists of housing and car loan, necessitates setting up

of ARCs to deal with impaired assets of retail loans.

SUMMING UP-In the years to come, customers will be more demanding, competition will be more

intense and dealings need to be more transparent. While the delivery is not going to be a

major challenge, surely the quality maintenance will be. It is a great challenge for the

banks. Managing service quality warrants a perfect understanding of customer need,

designing products which customer appreciates, developing and monitoring the process

that delivers the service or product, training sales people and measuring customer

satisfaction. This is possible only when day-to-day experiences are critically analyzed

and products and policies are aligned to market demand.

Chapter –24Retail Banking - S T P Marketing

“Banks have to move from the old fashioned, one size fits all products to customer

segmentation and customization.”

1. Retail Marketing –Captivating the customer through innovationsWalk in business is the thing of the past. The customers are now more demanding on

price (better interest rates), product (quality), place (home delivery, internet banking

etc.), packaging (brand affinity), people (customer service), partnering (business

222

alliance/joint venture) and promotion (discount, freebies etc.). They are well informed,

seek financial advice and collect product information from variety of sources like financial

planners, TV, press, ready to bear risk, sensitive to price as well as quality of product

and explores/negotiate best possible deals. They have no loyalty with any institution

and as and when they get better offer (price or quality), they are ready to switch over to

any bank. Intense competition among banks has complicated the matter further as each

one tries to have larger share of the pie by one or the other means. Due to intense

competition, the old retail business model of ‘capturing customer through aggressing

selling’ has changed to new business model of ‘captivating the customer through

innovation’. The key element to achieve this strategy is customer segmentation as one-

product fits all approach is no longer feasible.

2. Service Marketing- DifferenceThe marketing of financial products is totally different to marketing of physical

products (You can not sell the financial products they way you sell soaps) due to nature

of financial products i.e. intangibility of product, perishable nature of service and its

inseparability from its provider. Intangibility means buyers can not compare service the

way they can compare the goods by looking to its appearance, feel, weight, smell, size,

shape, price, packaging and brand. This also means that they cannot evaluate it

objectively. But they can observe the difference by measuring expected vis a vis the

perceived service. In order to enable customers to measure benefits, bank has to create

product-value visibility through aggressive advertising, mouth publicity and by creating

professional ambience. Services are also perishable and consequently can not be

produced in advance and kept as inventory like manufactured goods. Services are

difficult to patent and subject to copy by the competitors easily. To overcome the

problem of inseparability and to deliver service effectively, banks have to project it self

as robust, reliable and user-friendly service delivery system.

3. Marketing Strategy- EvolutionIf we look to the evolution of marketing, we find that different strategies have evolved

over a period of time for production, distribution and promotion of products. It started

with mass marketing model - where mass production of goods is done with the hope that

low cost and price would automatically create a big market. Henry Ford used to joke,

‘you can have any colour car as long as it was black’. Later on producers shifted to

product variety model which was based on assumption that many variety across the

shelf will eventually win a customer. And last one is target marketing where the

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producer/service provider identifies variety of market segments, selects one or more of

them and than resorts to relationship marketing by strategically positioning its products

to target customers.

4.1 Market Segmentation

Market segmentation is the division of the market into distinct groups of buyers who

might require different products or market mixes due to their different need and wants.

Once segmentation is done, bank can focus on particular segment of customers with

common needs and wants. The basis of market segmentation can be -

a) Geographical segmentation such as states, region, countries etc. where

producer can pay attention to geographical differences. For example there may

be greater need of woolen garments for northern India rather than west or east.

b) Demographic segmentation is dividing the market based on demographic

variable such as age, sex, occupation, family size, life cycle etc. For example

ready-made garment market can be divided into kids, ladies and adult.

c) Psychographic segmentation is dividing the market by life-style or socio-

economic status or personality characteristic. For example, banks customer can

be divided into HNWI (high net worth individuals), Senior Citizens (Customers of

60 years and above) etc.

d) Behaviour segmentation is dividing the market based on customer’s

knowledge of product, usage, attitudes and responses. For example, soap

market is segmented on perceived value of beauty, hygiene and health.

a) Transactional segmentation is process of relating a customer to a service,

which he is most likely to use. For example, young customers (age 20 to 40

years) may use more ATM, Customer in age group 35- 45 years may avail

more housing loan and so on. In credit card business, it is possible to reduce

cost and improve payment by segmenting customer based on transactional

segmentation. A good risk might receive a polite reminder, a habitual but

dependable late payer might have his reminder delayed and poor risk might

get a strongly worded reminder with a threat of canceling card.

4.2 Indian Banking & segmentation-The bank has to serve both rural and urban customers, small and large

entrepreneur, high earning and low earning customers, retail and institutional etc.

Hence segmentation is possible in many ways. However based on behavior and

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“Women bank account holder constitutes only 17.3% of total accounts. Rural women have a better share in comparison to semi urban and urban women. Regional rural banks have mobilized more accounts from women than other banks. “

- Economic Times 20.07.2005

attitude of customer to product and delivery channel preference, customer

segmentation can be done in under-noted five categories: -

(a) Time pressed life-style customers- Catch them young! Is business practice. These customers suffer from time but willing to buy products to

meet life-style need, ready to spend more but not willing to visit bank to know

products. Bank need to have well trained staff to market products to this

segment.

(b) Middle-class customers- They adore traditional banking with personal

touch, can spare time to visit the bank, conscious of interest cost and has no

stigma of borrowing for consumer spending. Estimated market size is 30

million.

(c) Senior citizens/retired – Catch them old! Is new buzz word. 30% of bank

fixed deposit is held by Senior Citizen. They are drawing pension from banks

and keeping their deposits both in savings and fixed deposit. Availing loans

like pension loans and against deposits in exigencies. Banks are offering ½%

to 1% higher interest to senior citizens.

(d) Young generation IT Savvy Customers- Comfortable with new technology,

like plush interior and good ambience in branches, show least loyalty to

relationship and switch banks very often, cost as well as product conscious.

4.3 Women segmentWomen controls or influence 65% of world’s annual consumer spending of

$18.4 trillion. And in the next five years,

women’s incomes will grow from $13 trillion to $

18 trillion, outstripping China and India’s

combined economies. (TOI 06.03.2010)

Therefore “the customer is queen” is new

buzzword in marketing. Study reveals that the

key decision-makers in home are young women

of 18-35 years. With increasing education and

more and more women taking up jobs, she is

one who either takes decision on all-important

buying matters or has major say in decision process. She is price sensitive and

quality conscious as well. She is innovator and early adopter of new products.

The marketers are responding to the queen customer with respect. There is

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upward trend of women-oriented financial products. Take for example Mahila

credit card, which is specially targeted to lady customers as women are

considered high spenders, default rate among them is low and among defaulters

list women defaulters are very few. The card offers free all-women health

check-up facility at select hospitals and health clinics. It is believed that women

spend more on credit card than men. There is a famous anecdote about a man

who did not report the loss of credit card of his wife because he thought that ‘thief

was spending much less than his wife’. As per market estimates, women who are

independent career women or women of high strata of society own 14% of credit

cards. Loan for purchase of jewelry is another women centric product. Banks

have also started customizing savings account for them with added services like

minor’s account under their guardianship; add on debit card for their children etc.

Banks are also adding colours to their Locker room by providing array of beauty

products at the dressing table in the locker room to serve women customers.

Other privileges offered to women customers are invitation to events like

cookery events, fashion show etc. Recently one bank has offered free ‘all risk’

insurance cover to women account holders for risk of loss of jewelry either by

snatching or theft or burglary while at home or during travel, hotel stay etc.

Micro financing through self-help group is also preferred to women due to their

better repayment culture.

4.4 Student segment Student is also an important segment. “Catch them young” is watchword

of the bankers. Opening of account with Rs. 11 in the name of minor student is

one product, which was recently launched by a bank. Some banks are offering

credit card to student pursuing higher education and offering spends now and

pay later facilities. Education loan is very popular product for student pursing

management and technical courses.

4.5 Islamic Banking: Considering that India has the second highest muslim population in the

world, Islamic banking has huge potential. The key difference between

Conventional banking and Islamic banking is that while conventional banking

offers interest on deposit, Islamic banking work on principle of sharing of profit.

Islamic banking is offered by leading banking in west. In India, Islamic banking

has not taken off due to lack of clarity of legal and regulatory issues. But recent

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judgment of Kerala High court is likely to pave the way for establishment of first

Islamic bank in Kerla.

4.6 Segmentation by valueBusiness has varying level of customer profitability. Normal customer

profit analysis shows that only 40 per cent customers generation 100 per cent

profits. Another 30 per cent produced modest profit while the bottom 30 percents

generates negative returns and so nullified the profit produced by the middle 30

percent. Segmentation by value lies at the heart of an effective customer strategy

for banks where customers contributing maximum profits are segmented into a

high priority segments and are rewarded by better service or value added

products technology backed products or by both.

4.7 Pre-requisites of effective segmentationUseful market segments must have following characteristics-

a) Measurability- the size and purchasing power or impact on credit quality

of the segment can be measurable.

b) Accessibility- the segment can be effectively reached and served.

c) Substantiality- the segment is large or profitable enough.

d) Actionability –Effective programme can be designed for attracting and

serving the segment.

e) Responsiveness-The target customers are likely to respond.

f) Acceptability-The management can be held acceptable for result.

g) Testability-Requires constant testing of strategies and practices.

5. TargetingOnce segmentation is complete, the producer/service provider has to select the

segment, which it wishes to target. The process starts with evaluation of market

segment by collecting data of potential sales, growth and profit for all the

segments and also to find out which segments is attractive enough keeping in

view its own product profile vis a vis the potential competition. Lastly, the

targeted segment must be within his objectives and resources i.e. if the segment

is as per objective, if it has enough resources in comparison with its competitors.

Once evaluation exercise is done, the producer/service provider has to choose

one or more segments to decide it target market. A target market is a set of

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buyers with common characteristics, which a producer/service provider wants to

serve. The following strategies are implementing for market targeting-

a) Undifferentiated marketing i.e. differences between market segments are

ignored and the market is approached as a whole with a single product.

This strategy focuses on common needs of customers and product is

designed to appeal to the largest possible number of buyers. Such a

strategy provides cost economies but fail to satisfy all buyers.

b) Differentiated marketing i.e. several market segments are targeted with

separate marketing mixes for each segment. It is extremely popular

model as it tries to satisfy need of all buyers. Since it increases cost, the

segment should be large enough to provide economies of scale.

c) Concentrated marketing i.e. to concentrate on one or more segment

where one finds more opportunities as per its SWOT analysis.

6. Positioning- Once a company decides a segment to enter, it has to decide how to enter into

it. If it is an established segment and competitors have already taken position in that

segment, it has to study competitors position vis a vis its own position before

entering into that market. Market positioning is a process through which a company

occupies a clear, distinctive and desirable place in the market. Positioning is unique

in the sense that it is not the actual attributes of the product that is important but

perceived quality that attract a customer. The positioning strategies are based on

product attributes, usage occasions, users, product categories etc. For example,

NIRMA used price as its weapon and due to this mighty Hindustan Lever had to

crumble. Body shop did not highlight any product attribute like beauty or cleanliness

but made different positioning statement that they do not test their shampoos or

soaps on animals. Amul ice creams with use of real milk and Anchor toothpaste with

100% vegetarians positioned themselves in the market. The key elements of

positioning consists of Pricing, Branding, Promotional policy, Product advertising

policy and Customer Service standards.

7. Bonding with the customers through branding While products are created in the factory, brands are created in the mind.

Branding is a process of building a brand. Positioning is about putting the brand in

the mind of the customer. In fact branding and positioning is two sides of the same

coin; one without the other does not serve its purpose. One cannot do branding

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without positioning. And for success of a brand, passionate customer relationship is

more important as brands die not because of look but for lack of customer-

relationship.

8. Challenge Ahead-“One size fits all approach” is no longer feasible and has to give way to innovation

through customer segmentation and product customization. Towards going closer to

the customer in identified market segments, banks are establishing SBUs (strategic

business units) such as Corporate Account Group, International Banking division,

Retail banking boutique, Agricultural Finance branches etc. Each SBUs aim to target

the customers with products suitable for them. The challenge before the banks is to

design cost effective quality products that attract customers of various segments and

then position them in the market through brand building.

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Chapter-25

Retail Loan A Risk Management Perspective

“Good shoppers know that you should not do grocery shopping when you are hungry, because you end up buying more than you need. Similarly, contractors will usually wait till it stops raining to fix that roof leak. Financial crisis cycles, like business cycle, are endemic to banking. Lesson is that there is dire need of timely and effective action to avoid turmoil.”

-Anonymous

1. Retail Loan- Risk Management Perspectives - The retail loan portfolio of the banks

in past few years has grown up very fast (CAGR over 30%) and it now constitutes

about 21% of total loan portfolio. The credit expansion has been shifting from metro to

tier 2/3 cities also. However, high growth in retail loan has started inviting concern of

various stake holders such as investors, regulators, bankers etc. over different matters

and certain important issues raised are-

Are Indian borrowings beyond their means?

Is the average customer leveraged too much beyond his capacity?

Whether the growth is too high to cause concentration risk?

Whether assets quality is compromised in volume led retail lending?

Whether the portfolio may deteriorate with aging?

And whether it is likely to crowd out industrial credit?

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RETAIL LOAN NPAAS % OF

OUTSTANDING LOANS

Category %Consumer durable

6.6%

Credit cards 6.3%Other personal loans

2.6%

Home loans 1.9%Total 2.5%

2. Exponential Growth in Retail Credit necessitates sound policies of Risk Management- Despite exponential growth in past four

years, the retail loan as percentage of GDP is quite low at

6.5% in India in comparison to other countries say 10.2% in

Thailand, 68.4% in South Korea, 75% in USA and 49.3% in

Malaysia. Low penetration level suggests significant

untapped potential of retail loan in India. In fact, low interest

rates, fiscal incentives/tax concession and easier product

availability had been key driver of retail loan boom in the

recent past and significantly contributed in credit

expansion and profitability of the banks. The retail loans

are considered safe as risk is diversified among large number of individual borrowers

located across the geographical dimensions as wide as the network of bank branches.

The default rate (NPA) (see box) in retail loan is only 2.5% as against 7.4% of

average NPA of the total credit portfolio. However CRISIL in its report (ET 5.1.2009)

stated that gross NPA of retail loan may rise to 4% as March 2009 from 2.7% in March

2007 and has thus cautioned for careful in expansion of retail loans . Following issues

from risk management perspective need to be addressed objectively. Firstly, too much

focus on retail loan may disturb the portfolio balance and consequently create

concentration risk. Secondly, fast expansion of retail loans has brought in its fold a set

of borrowers who have no regular employment, no collateral to offer and many of them

resorted to multiple borrowings thus falling under high credit risk category. Thirdly,

information about credit history of borrower is crucial to safeguard against

fraud/forgery which is very often not available. Fourthly, rising inflation may create

problem in servicing of loan by the salaried class who are considered highly leveraged.

Fifthly There is excessive increase in prices of gold and real estate outrunning

inflation rate say for example housing prices climbed at 16-25% and gold prices has

risen even faster rate at 14-40%. (RBI annual report 2011-12) Any adverse

(downward) movement in assets price will increase credit risk. In this back drop RBI

had observes that though lending to housing and commercial real estate had slowed

down but close vigil is still necessary as housing prices inflation has not moderated.

Moody’s Investors Services in report on Asia Banking Outlook 2006 has noted surge in

retail loan but has shown apprehension as ‘these loans are, as yet, untested in a

negative credit cycle.’ All this necessitates that bank should not only put in place a

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system to recognize such risks on continuous basis but also initiate measures to put

risk management practices in more effective and integrated manner.

3. Retail Loan- Systemic Risk out of macro - economic shock- Basel Committee II

has cautioned that over exposure to housing and other retail sectors could create

bubbles in the market as a consequence of over spending by the salaried class

followed by defaults and cautioned the banks against limit less financing. In this

context, It is argued that large number of Indian house hold are over-leveraged and

while their salaries are not inflation linked, the home and other loan which are on

floating basis are. It is also argued that while corporates are protected by limited

liability clause, house-holds have no such protection. A high inflation situation, as

existing in India at present, may increase loan default. When this happened in UK and

US in the 1980s; the negative effect was exacerbated by a sharp fall in the real estate

prices. The demand for housing dropped as interest rates rose and default in previous

loan also shot up. CRISIL has conducted a study of variable home loan market

(Economic times 24.11.04) and has observed that close to 90% loans are under

variable rate and 150-200 bps rise in interest rate will adversely impact the repayment

capacity of the borrowers who opted for tenure of 15 years and above. It has made a

forecast that NPA may rise if interest rises by 200 bps or more as about one-fourth of

the borrowers are already using more than 50% of their salary to repay loans.

4. Retail Loan and Credit Risk management -Retail loans are basically consumption

loans and are largely unsecured (excepting housing loans). They run the risk of

becoming bad as repayment depends upon discretion of the customer (Moral hazard)

with no security in the hand of the bank to fall back and time consuming and

prohibitive legal process. In case of housing loan, the risk is fall in real estate prices

which has seen huge increase in past few years. While economists and bankers differ

on impact of rising inflation on future growth of retail loan, they are all are concerned

that rising interest rate in consequence of increasing inflation may impair asset quality.

The effective credit risk management necessitates that various risks arising out of

deficiency in lending policy, incorrect product structuring, inadequate loan screening

and documentation, ineffective post sanction monitoring/follow-up and weak

collection/recovery mechanism are adequately and timely addressed. And like

traditional lending, the bankers while taking lending decision of retail loans, should

strictly adhere to the five ‘Cs’ of credit i.e. character, capacity, and credit, convenants

and collateral. As risk mitigating measure, the Reserve Bank of India vide mid term

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review of monetary policy of November, 10 (2010-11) advised banks (i) that the

home loan borrowers will have to pay at least 20% margin ( ceiling on loan to value

ratio raised to 80%) (ii) To increase standard provisioning of home loan under teaser

rates from 0.4% to 2% and (iii) to increase risk weight on home loan of Rs. 75 lakhs

and above from 75% to 125%. Further NHB, is promoting a separate company as

Mortgage Guarantee Corporation to guarantee payment of principal and interest of

housing loan with a view to mitigate default risk. Like wise there is proposal to set up

Credit Guarantee fund for education loans so that bank can bank upon such funds in

case of defaults. Finally there is inherent emotional connect of home loan and gold

loan borrowers with the assets and they will not easily let their assets slip out of their

hands by willful defaults.

5. Retail loan and assets price risk- RBI has recently shown concern over fast

increase in prices of stocks and real estates. In fact such worries haunt the central

banks world over. However in built safe guards in financing against stocks or for real

estate if followed properly can surely mitigate such risk. For real estate lending if

backed by adequate and conservatively valued collateral will ensure that banks are

adequately protected if property prices fall. Indian banking has to learn a lesson from

recent sub-prime crises of US. These sub-prime crises have put loss in value of

American homes “between” 13% to 20% of USD 23 trillion. Sub-prime loans are those

which were pushed to people who can not afford to repay. Many loans were secured

by homes. Since home prices were steadily rising could take secured loan on the

same house and service the past debt. As long as prices rose, there was no default.

Based on good history, credit rating agencies gave good ratings to derivatives and

bonds issued by securitizing these loans. The banks that initially sanctioned these

loan did not carry it in their books and sold them to investors. When bubble burst,

default began and banks are forced to foreclose loans. Additional supply of houses

and resultant expectation that prices would come down further, together push down

prices further. This feeds into vicious circle of default.

6. Retail Loan and Concentration Risk- Retail loan as percentage of Gross Bank

Credit now constitutes about 21% and is largely concentrated in urban and metro

centers. As stated earlier that credit growth during 2004-05 has been significantly

higher at 26% (previous year 14.6%) and banks are aggressively seen increasing their

lending not only to corporate but also to other sectors like agriculture. Further, banks

particularly PSBs are taking steps to diversify retail loans in rural and semi urban

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areas to leverage their strength of Semi-urban and rural branches where opportunities

are more and competition is less. The increase in risk weight of retail loan and cap on

unsecured loan are other measures initiated by the regulator to counter exponential

retail credit growth.

7. Retail Loan and Interest rate risk- Interest Rate Risk is another area to address. In

the past two-three years banks have built up housing loan portfolio, which carries 7.5%

to 9.5% interest. Since 10% to 15% of these loans are on fixed rate basis, any

increase in interest rates may cause loss to banks. To mitigate interest rate risk, banks

are now putting ‘force majeure’ clause in the home loan agreement to reset interest

rate in case of extreme volatility in interest rates. Banks have also started offering

product with interest reset clause after every 5 years. Since housing loans are far large

tenure say 15 to 25 years and cause assets liability mismatch, interest rate risk

management is most important aspect of retail lending.

8. Retail Loan-Teasure rates:- In the recent past many banks offered housing loans

under fixed-cum-floating rate option under which banks fixed interest rates at 8% to

8.5% for one to five years and subsequently borrowers would shift to floating rate

under which interest would be aligned to market rate. The product has been

subsequently extended to car loans also. RBI has recently shown concern and

cautioned banks against risks in offering such loans as borrowers might experience

payment shocks when interest rates goes up as excessively low interest rates skew

the risk reward matrix by making projects that are actually not viable appears viable-till

interest rate reverse and the same project ceases to be viable. It is therefore

necessary that banks as risk mitigation should look into borrower’s capability of

servicing debt after interest rates aligned to normal rates. They should also keep

necessary cushions in margin and repayment conditions so that repayment capability

of the borrowers is not compromised. RBI to further show its concern on expected

rise in delinquency of such loan has raised standard provisioning from 0.4% to 2%

vide policy announcement of 2nd November, 2010.

9. Retain loan and pre-payment penalty- Penalty on mortgage prepayment has

become a contentious issue between banks and the customers who look out for ways

to bring their cost of borrowings by switching over to other banks. In last two year since

2008, when the central bank cut policy rates by more than five percentage points, most

banks did not pass on the reduction in interest rates to home loan customers but

reduced rates for new borrowers. RBI has recently directed the banks not to levy

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prepayment penalty on floating rate loans in larger interest of customers. With this

possibility of borrowers switching to other lenders have incrased exposing the banks to

both ALM risk and profitability.

10. Retail loan and operational risk- Operational risk is another area of concern as

fraud/forgery in retail loan is on rise. It is estimated that 28 PSBs have reported home

loan frauds of Rs. 600 crores between 2002 to 2006. Cases of multiple financing are

also reported. The competition in retail loan segment is very fierce and there is acute

pressure on the retail managers to perform. The retail is volume driven business and

while there can be genuine mistakes yet there are instances of acute negligence or

misuse of authority by the retail managers. To obviate these happenings, banks have

to put in place rigid due diligence standards on customer identification and acceptance

system .Recent announcement of budget 2010-11 to set up e-loan data registry will

also be helpful to banks to satisfy before sanctioning home loan that no other lender is

having claim over the property. It is also essential that only officers of proven

intelligence and integrity are selected/assigned handling of retail loans. The CIBIL,

which has developed database of credit history/report of the borrowers and also

mortgage default, will go a long way in mitigating operational risk/credit risk. Experian

Credit Information Company Indi launched a new product named ‘trigger’ which is by

way of daily alerts about a customer missing a repayment schedule, moving into

default, making application for the same loan with other lenders etc. which could

enable the bank to look into in its own portfolio and monitor the loan. Further in a bid

to overcome the menace of forged/fake title deeds, a central registry for registration of

equitable mortgage of houses has been set up. .

11. Monitoring of Retail Loans- Monitoring is essence of risk management. As earlier

stated, retail loans are

volume driven business

and requires close

monitoring/ follow-up. The

manager should take

timely steps for issuing

demand notice,

reminders,

Inspection/insurance of

assets etc. He should, as soon as first instance of default is noticed, contact the

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“99% of defaults happen in the first six months. Monitor the loan for first six months closely and you will know if the person is a fraud or not.”

- M. Anandan, Managing Director, Cholamandalam Investment and

Finance Company.

borrower (employer where salary tie up is held) to recover over due installment(s). He

should present post dated cheques (PDCs) on due date without fail and initiate legal

action immediately on dishnour of cheques as per provision of Negotiable Instruments

Act. In no case dishonored cheques should be represented and in case borrower

approach the bank for payment, he should be asked to deposit the installment in cash.

Further, where loans backed by assets turns NPA; immediate action for seizure and

sale of assets should be taken under provision of SARFESAI ACT, 2002.

Challenge ahead Emerging markets are following developed markets in consumer revolution. The

consumer is being leveraged through mortgages, auto loan, credit cards, personal loan

and other loans. This has become focus of all banks- both public and private sector.

The retail loan market in India is in early stage of evolution. The retail loan has

contributed significantly in credit growth of the banks in past few years. In fact retail

loan is considered as driver of economic growth. Assets impairment in retail loan in

India so far is much less than other sector and there is no systemic finance bubble as

such. Since retail loan is a different ball game and banks have no previous

experience, it is necessary that banks should have an effective risk management

system. While serious efforts should continue to develop healthy retail loan portfolio ,

the lending policies, product structure, loan appriasal, screening and documentation,

post sanction monitoring and follow-up, collection mechanism all should be geared up

simalteniously to continuously mange the risk.This also necessiciates risk awareness

among retail loan mangers. With setting up of CIBIL credit history of the borrowers will

come handy to manage operational risks. However overreaction to stop retail credit

will cause the banks as well as the economy dearly. Banks need to pull out weeds, not

dig up the garden. And managers should understand that credit quality should not be

compromised due to pressure of competition or pressure to outperform others.

-0-0-0-

Chapter-26

Risk Management

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“The down fall of Barings in February, 1995 revealed that the bank lacked ability to

monitor effectively the trading activities undertaken by Leeson. This was party due to

lack of proper risk management system and also partly due to disregard for proper risk

management procedure.”

1. Risk Management - Meaning and ConceptRisk is intrinsic to banking. It is as old as the banking is. What has changed is the

colour and contour of risk management, as approach has changed from defensive to

strategic. Banks have changed from simple organization to complex ones. Their

geographic reach has spread from local markets to regional, national, and global

markets. Their operations are increasingly automated and reliance on electronic delivery

system has increased. All this has altered the risk profile of banks significantly. These

changes have raised two interrelated challenges for bank management; how to stay

focused to markets and the customers while keeping overall risk exposures within

acceptable ranges. To meet these emerging challenges, Reserve Bank of India has

been preparing Indian Banking system for an integrated risk management framework

since 1999. Managing risk is now core of banking.

2. Sources of Risk-There are many sources from which risk may emanate like (a) Globalization of

business due to integration of Indian economy with the rest of the world, (b) Progressive

liberalization of economic policies leading to surge in new products , (c) Vicious

competitive business environment, (d) Promoters/borrowers, (e) Technology and (e)

Market dynamics.

3. Risk Management process- This encompasses (a) identification, (b)

quantification, (c) management, (d) monitoring and (e) control.

4. Type of risk-The banking risk spectrum cover the following main risks- (a) Credit

risk, (b) Market risk, (c) Liquidity risk, (d) Interest rate risk, (e) Basis risk, (f) Option

risk, (g) Industry risk, (h) Business risk, (i) Country risk, (j) Sovereign risk and (k)

Operational risk.

5. Credit Risk – Credit, for the purpose of risk analysis, not only involve actual outgo

of funds from the lenders to the borrowers but also covers: (a) investment in

securities (which is often named as quasi-credit) and (b) non funded exposures in

form of letter of credit, guarantee, options etc. Credit risk is also known as default

risk. It involves inability or unwillingness of a customer or counterpart to meet

commitments in relation to lending, trading, hedging, settlement and other financial

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transactions. The credit risk depends on both external and internal factors. (A) The

external factors are the state of the economy, wide swings in commodity/equity

prices, foreign exchange rates and interest rates, trade restrictions, economic

sanctions, Government policies etc. (B) The internal factors are deficiencies in loan

policies/administration, absence of prudential credit concentration limits,

inadequately defined lending powers for sanctioning of loan by officers/Credit

Committees, deficiencies in appraisal of borrowers’ financial position, excessive

dependence on collateral and inadequate risk pricing, absence loan review

mechanism and post sanction surveillance etc. New capital accord (BASEL II) has

set new approach for measurement of credit risk from regulatory perspective and

prescribed regulatory capital charge for credit risk, market risk and operational risk.

6. Dilution risk- The ‘word’ dilution with reference to any security implies reduction of

intensity and strength of the relative security. For a tradable/marketable security the

full in realizable value may be construed as dilution risk but Basel lI has described

dilution risk situation with respect to receivable (book debt financing) as security. As

per Basel II the dilution risk refers to the possibility that the receivable amount is

reduced through cash or non-cash credit to the receivables obligor (seller who has

sold goods on credit to a buyer). It is known that in case of financing against

receivable the probability of dilution of security compared to other financing is more.

7. Market RiskMarket risk is the risk arising out of unexpected change in market variables such

as interest rate, currency, commodity & equity prices both on and off balance sheets

item. As per RBI definition market risk covers both the banking book and the trading

book. Basel committee ‘s definition of market risk excludes banking book and include

only the trading book. Market risk in the banking book is referred to by the Basel II

as interest rate risk. Market risk thus include (a) Interest rate risk both Indian rupee

and other currencies in the banking book (b) Price risk in the trading book arising as

result of interest rate, currency, commodity and equity price movement, (c) Liquidity

risk of the institution whether it is funding or trading liquidity and (d) Credit spread

risk unrelated to downgrade.

8. Liquidity RiskThe liquidity risk of banks arises from funding of long term assets by short-term

liabilities, thereby making the liabilities subject to roll over or refinancing risk. The

liquidity risk in banks manifest in different dimensions:

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(a) Funding Risk:- need to replace net outflows due to unanticipated withdrawal/

non-renewal of deposits (wholesale and retail);

(b) Time Risk:- need to compensate for non-receipt of unexpected inflows of

funds, i.e. performing assets turning into non-performing assets; and

(c) Call Risk: - due to crystallization of contingent liabilities and failure of

borrowers to pay.

ALM system has been introduced to measure cash flow mismatches at different

time buckets. In addition to ALM system banks are required to fix prudential limits for (a)

cap on inter-bank borrowing, (b) cumulative mismatches across all time buckets, and (c)

duration of liabilities and investment portfolio.

9. Interest Rate RiskIt is the risk arising from the impact of the fluctuation of interest rates on the

profitability as well of the assets and liabilities structure of the balance sheet.

Deregulation of interest rates has exposed banks to the adverse impact of interest rate

risk. Interest rate risk (IRR) refers to potential impact on Net Interest Income (NII) or Net

interest Margin (NIM) or Market value of equity caused by unexpected changes in

interest rates. Different type of interest rate risk are-

A. Basis RiskMarket interest rates of various instruments seldom change by the same degree

during a given period of time. The risk that the interest rate of different assets,

liabilities and off-balance sheet items may change in different magnitude is termed

as basis risk. The degree of basis risk is fairly high in respect of banks that create

composite assets out of composite liabilities.

B. Option RiskSignificant changes in market interest rates create another source of risk to

bank’s profitability by encouraging prepayment of cash credit/term loan and exercise

of call/put options on bonds/debentures and /or premature withdrawal of term

deposits before their stated maturities. It is known that bank in India has traditionally

been selling in built option while accepting deposit and granting loan.

10. Industry RiskIndustry risk analysis is concerned with SWOT profile of the industry within the

economy vis-à-vis economic trends and the key success factors for the industry. The

Industry risk includes: -

(a) Business cyclicality, earnings stability and diversify of earnings base.

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(b) Economic parameters such as inflation, energy requirements.

(c) International competitive situation, demand projections and maturity of market

or life cycle of the product.

(d) Basic financial characteristics of the business.

(e) Cost structure in terms of raw materials, labour, and plant capacity.

(f) Competitive structure.

(g) Ease of entry/ exit.

11. Business RiskThis is defined as the inability of the business or project to service its debt in time.

This inability strikes about inadequate income generation capacity of the business,

which is affected by the following variables: -

(a) Nature of business or the product it sales

(b) External economic or market environment

(c) Internal manufacturing organization

(d) Products mix.

12. Country RiskIn broad terms, country risk is that uncertainty which is created when funds cross

international frontiers. Management of cross-border lending and international

investment risk calls for country risk analysis periodically as comprehensive as

possible. It is defined as risk of a foreign borrower failing to service his foreign

currency debt obligations for reasons beyond the usual risks that arise in relation to

lending. There are two basic differences between domestic and foreign loans. One is

that repayment of international loans must route through exchange markets and

therefore, lending banks should assess prospects for exchange rates and controls on

capital flows. Another difference is that unlike in domestic loans, there is no

established common legal system to act as an ultimate arbitrator to settle claims. It is

because of these factors that assessment of country risk is critical for banks to

safeguard their international exposures.

13. Sovereign RiskIf the borrower belongs to the public sector, the risk is usually referred to as

"Sovereign Risk". Public sector comprise of all state owned agencies and institutions.

While terming a borrower as public sector, there is an underlying assumption that the

state will, ultimately, take responsibility for the financial obligations of the borrower

concerned.

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14. Operational RiskManaging operational risk is becoming an important feature of sound risk

management practice in modern financial markets in the wake of phenomenal

increase in the volume of transactions, high degree of structural changes and

complex support systems. The most important type of operational risk involves

breakdowns in internal controls, corporate governance and legal risk. Such

breakdowns can lead to financial loss through error, fraud, or failure to perform in a

timely manner or cause the interest of the bank to be compromised. Generally,

operational risk is defined as any risk, which is not categorized as market or credit

risk, or the risk of loss arising from various types of human or technical error. It

includes legal risk but excludes strategic and reputation risk. The sources can be

fraud, incompetence, transaction mistake, execution error, people risk, exceeding

limit, security risk, technology risk, system failure, programming error,

telecommunication error, and product failure. In home loan alone public sectgor

banks have reported frauds amount to Rs. 599 croes ( BS 24.2.2009) between 2002

to 2006 mainly fake titled deeds, impersonation and inflated valuation reports.

Legal risks primarily arise either due to lack of clarity of the documentation of the

product or the act of the counterparty. Change in legal environment due to legislative

changes and court interpretations/proceedings also result in legal risk. Broadly legal

risks may result in (a) claim against institution, (b) fines, penalties and punitive

damages, (c) unenforceable contracts resulting from defective documentation and

(d) loss of institutional reputation. Another important area is legal risks arising out of

outsourcing of certain activities by banks. In case outsourced activities legal risks

may arise owing to breach of confidentiality or any fraud hat may be committed by

bank’s agent making the bank liable for his acts and omissions including

misrepresentation to the customers and breach of any law committed by the service

provider. Legal audit, internal controls and internal audit are used as the primary

means to mitigate operational risk. Banks could also set operational risk limits, based

on the measures of operational risk. Insurance is also an important mitigation of

some forms of operational risk. Risk educations for familiarizing the complex

operations at all levels of staff also reduce operational risk. Under Basel Committee

II guidelines, RBI has asked the bank to provide capital charge for operational risk

equivalent to 15% of their average gross income of previous three years.

Challenge ahead-

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The risk situation in Indian Banks is no different from the bank world over.

In fact, it is more complicated. The nationalized banks and SBI and its associates

contribute more than 80% of banking business. With adoption of Basle II from

March 2008, risk management and risk measurement has come into sharp focus.

Each bank is now required to educate and train all officers/employees so that they

are made to understand the process of generation of risk, its quantification,

mitigation and management. Risk management, cutting across all hierarchical levels

and activities in banks, has become part of every body job. While people at branch

level are required to take calculated risks, the top- management level the risk is

required to be monitored and managed. Further MIS is core of risk management and

has to be generated in timely and accurately. It is going to be a very big challenge

for public sector banks having far flung rural branches many of which are still not

under CBS. Thus, banks should attach considerable importance to improve the

competency of their work force to identify measure, monitor and control the overall

level of risks by proactive management.

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Chapter-27

Bank MarketingMaking of a Successful Sales Person

“People buy not because they understand your product or service but because

they feel that you understand them”.

Bank MarketingMarketing in most credit institutions including banks is new phenomenon. Before

that marketing was synonymous to advertising and public relation and role of

marketing was more tactical than strategic. However due to fierce competition

generated by entry of new generation private sector bank marketing has become a

strategic tool of product promotion and business development and all banks whether

in public sector or private sector have full fledged marketing department to effectively

put in place all the 7Ps’ of ‘marketing mix’ (a term coined by Kotler) - product, price,

place, promotion, people, process and physical evidence. To put in marketing terms,

it is not only necessary for a bank to have right product but also to have right price,

delivered by right people, using right processes, packaged in right manner and at a

right place. The sales person is a very crucial part of marketing mix.

Making of a sales person- sales skills‘People with right soft skill’ is the requirement of

marketing. A sales person should have pleasing

personality, attractive mannerism, positive attitude,

good communication and negotiation skill and genuine

concern of customers’ problem. He should be

attractive, smart, simple, serious, reliable, trust-worthy,

optimistic, positive, efficient, outgoing, aggressive, passionate and energetic. He

should have high level of energy and abounding self-confidence to win and hold

passionate desire to perform. In fact, marketing is for the fittest, fastest and smartest

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person. Fit and fast sale person must know and truly identify with his company and

know its product, customers, competitors, responsibilities and art of making sales

presentations. He should value relationship and follow ethical practices to offer value

for money to its customers. He should be fast enough to respond to customer’s

demand and satisfy his queries accurately and promptly. He should be smart

enough to greet the customer with smile, treat the customer with all the comfort he

expects and meet his product/service wants and needs. A smart salesperson is one

who checks and makes his selling style and language a perfect fit.

Making of Sales person- Kotler’s modelSelling is an art. It pre-supposes that sales person understands customer’s need

and is competent to offer effective solution. It is a customer problem solving

approach. This approach assumes that (a) customer have latent needs that provides

opportunity to the bank, (b) they like suggestions and (c) they will be loyal to the

sales persons if they satisfy their long-term interest. Kotler’s model consists of: -

(i) Prospecting the customerFirst step in selling is to identify a prospective customer. Current

customers are best source to develop a lead. Other sources like

associations of traders, pensioners’, and industries’, residents’ etc. can

assist the bank in identifying prospecting customers. Data sources like

newspaper; magazine, directories, bulletin etc are other important sources

to find out details of the prospective customers who can be approached. A

sales person should have ability to convert all these information into a data

warehouse to approach and market his products to the potential customers.

(ii) Learning and approaching a potential customer There is small piece of wisdom that I learnt from practical experience as

a sales man- and that is salesman never sales! Then what is he selling

about? In my experience, the best salesman is one who makes the buyer

buy. I used to tell my sales staff, “Don’t try to sell, but try to help your

prospective customer to buy”.1 A sales person must, therefore, learn as

much as possible about potential customers’ needs, habits, preferences,

personal characteristics, buying styles and buying decision process.

Approach is concerned with attitude, manners and appearance of the sales

person and relates to his ability to communicate with the prospective

1 My Master Pujaya Parthasarthi Rajagopalchari- page 78 Volume I Down Memory Lane

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customer. The sales person should decide best approach i.e. how

(personal visit, or telephone or letter), when (time of visit) and where (office

or residence) to contact the prospective customer.

(iii) Preparing for presentationFirst impression is the last impression. Success of a sales person lies in

opening lines and his follow up remarks. The spoken worlds are the most

powerful tool that creates sale. Sales person must prepare himself fully

before he actually meet the customer to make presentation.

(iv) PresentationPresentation signifies conveying product features, benefits and qualities

to the prospective customers to stimulate buying. Kotler suggested AIDA

approach i.e. getting attention, holding interest, arousing desire and

obtaining action. Sales presentation can be of three types - (a) Canned

approach based on memorized sales talk covering the points about product

features. It is based on stimulus response theory that suggests that by

proper use of words, pictures, action and terms, and sales person can

prompt customer to buy the product (b) Formatted approach is also based

on stimulus response thinking but lays emphasis on first identifying buyers

need and buying style and thereafter approaching him. For example, if the

customer is cost conscious, the sales person should offer him low cost

and no frill products. (c) Need satisfaction approach is based on search of

customer’s need. In this approach, the customer is encouraged to come out

with his requirement and based on his need, the product is tailor made.

Other way of identifying customer’s need is mapping his behavior and

identifying gap from which customer derives value. With introduction of

technology, sales presentation has become very scientific and focused,

which not only saves time and resources of the sales person but also

enable the target customer to understand the product better.

(v) Question and Answer session-A common complaint about sales person is that they talk too much. A

good sales person should, therefore encourage customer to raise questions

so that all the doubts/objections are cleared to his/her total satisfaction.

Customers may raise objections because he may find certain gaps either in

his understanding or in the adequacy of information or just the fact that he

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does not like the sales person. Sales person should know and appreciate

that objections are natural behavior from consumers and cannot be wished

away. These objections and doubts can be classified into two categories-

(a) psychological resistance that includes resistance to interference,

preference for existing brands, tendency to resist change, dislike to decide

new things, pre determined ideas and unpleasant past experience. (b)

Logical resistance that includes objection or doubt for price, quality, delivery

schedule, or product features. A successful sales person is one who

understands the objections clearly and addresses them to the best of

satisfaction of the customer. For this, it is important that the sales person

should have thorough product knowledge and should effectively and clearly

communicates its features/ benefits to the prospective customers. He

should answer all the objections in such a way that all doubts are

reasonably clarified and customer is prompted to buy the product. Handling

objections is a very tricky business and most difficult part of the

salesmanship. Negotiation skill plays a major part in handling objections

tactfully and firmly. Above all sales person should always be encouraged

and motivated to face challenges, as it will enable him to stay focused and

deliver result. The sales person must be a creative learner. He must be

willing to experiment and to learn from his mistakes.

(vi) Closing the dealOnce presentation is made and objections are satisfied, sales person

should fetch the orders. It is his ultimate object. It is his moment of truth.

Closing requires confidence, competence and capability to read closing

signals from the customers and decide right timing of obtaining order. Finer

details like terms and conditions, repayment period, interest-rate, option

fixed or floating etc. should be repeated once again so that there remains

no ambiguity. Most selling is persuasive today. In a demand led market

where the supply of goods and services is on over drive, persuasion is the

name of the game. When a sales person feel that the customer is avoiding

or postponing a buying decision, he should tactfully lure him by freebies,

discount etc. He can also tactfully say that offer will lapse if not availed or it

is lifetime opportunity, which the prospective customer should not miss. He

should say ‘thanks’ once the deal is over.

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(vii) Post sales follow-up A sale never really ends with the physical closure. The experience of the

product or service is therefore just as important if not more to the selling

process. Post sales follow-up is an exercise of establishing long-term

relationship with the customers so that sales man remains in touch with

post sales issues and get the repeat orders. For banks, follow-up also

means to look into cash-flow problem of the customer so that debt is

rescheduled or extension is allowed if it is so required. Follow up also

means to provide post credit counseling so that sales person remains in

touch with the customer and exploit the opportunity for cross selling or up

selling. It is the duty of sales person to check that customer is totally

satisfied with the product and in case he/she is having any problem that is

sorted out to his/her full satisfaction. A sales person should keep on

calling his customers to stay in touch, not necessarily to sell more.

Selling over Phone With mobile penetration on the rise, banks are opting to sell their

products over phone. Selling of credit card, life policies, mutual funds are very

common. The benefit of the selling over phone is that it allows the bank to sell

products at low cost where deputing the sales persons is cost prohibitive. As

general impression is not very good for this channel as selling over phone is

susceptible to misselling, bank has to be careful in recording such sales to

overcome the issues arising out of complaint of misselling or legal non

compliance. Sales persons while selling the products over phone must keep in

mind some basic principles namely:-

(a) Sales person should clearly tell her name, address and location from where

she is calling. This will add to the confidence of the buyer in the sales person.

(b) Sales person should specify the terms and conditions of the products

clearly. It is advisable to speak slowly so that customer understands the

things properly.

(c) Sales person should not give any false promise to induce sale. Benefits and

exclusions must be clearly spelt out.

(d) To meet regulatory requirements, banks are required to record conversation

that takes place through the call centre. Sales person should keep in mind

that he is morally as well as legally bound to be fair with the customer.

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No Kidding“Buying a car may be an adult decision but it’s the kids who decide models, variants, features and colours when a family goes vehicle shopping.”

- A study of Turner India ET 22.04.2006

(e) Typically the online sale is offered by a written confirmation offer where

customer is given choice to refuse to accept the product if he does not like it.

This cardinal principle must be complied in both letter and spirit so that

customer confidence in selling over phone is established.

(f) RBI has asked banks to disclose to their customers fees and other

commission earned by selling mutual funds/insurance policies etc. This has

been done to protect the customers from reckless selling of financial products

without protecting their interest.

Decision Influencing Although a consumer may get

information for a product or service through

multiple sources of communication

(including 1:1 with sales person), he/she

many times consults others before taking

the buying decision. These persons may

be housewives, kids, elders-in-family

(village elders in rural areas). (See Box) A

smart sales person always remains active and agile to watch such influence. The

sales person should study and analyze social and cultural habits that influence

the purchase decision and approach the marketing by addressing their priorities

and concerns. In Indian context, housewives play an important role in decision

making particularly in big-ticket loans like housing, car, insurance etc. Sales

person should be aware of their liking (including disliking) and so that their

concerns are addressed satisfactorily. Fair practices code

Many a time customers are complaining of too much intrusion in their

private life by the sales persons like unsolicited telephone call by Credit Card

Company or an insurance agent. With consumer awareness increasing for

privacy and RBI insisting for anti-tying measures, banks are putting in place fair

practices code for their salesperson. These practices include maintaining do not

call list, checking the calling per month, respecting privacy of the customer,

identifying hours and day of calling, putting complaint handling process and

response time in place. A sales person should be sensitive of these fair practices

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to avoid dislike of the customer. Ethics, caring and service are now foundation of

selling.

Selling to internal customers People create, deliver and sustain value for the organization.

Organizations that adopt a disciplined and integrated approach to the

management of people can harness their organizational intellect and transform it

into economic value. In order to leverage employee intellect towards value

creation, enterprises need to create a sales culture. Bank staff is bank’s ‘brand’

that greets the customers at the counter, entertain request for opening account or

processing a loan application, answers queries or solve problems etc. The

challenge before public sector banks is to make each and every employee a

sales person. This requires a whole lot of selling to internal customers to change

their mindset and ramping up belief that marketing is support function which

whole organization need in present day banking.

Behind every successful investor is a sound advisor The easy and passive products like fixed deposits are no longer attractive to

customers given the low rate of interest. Wealth management and private

banking is fast emerging as lucrative preposition for banks since customers are

now looking to invest in alternate products like insurance and mutual funds,

which gives higher yields with tax shield. Since these products comes with higher

risks, the bank need to educate customers so that potential investor understand

the inherent risk of these products fully. The IRDA and AMFI - who are

regulatory/advisory bodies for ensuring fair practices in marketing of these

products - has mandated that the value proposition and risks of insurance and

mutual funds products have to clearly explained by the sales person to

prospective investor and for that the sales person must be duly accredited for

selling such products after qualifying/passing the prescribed test. And with this

object banks have started recruiting people from finance and marketing

background to offer advisory services to customers in addition to customary

selling. These financial advisors are not merely the sales person but in true sense financial ‘guides’.

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Chapter-28

Customer Centric Banking Walking with the Customer

“Unless you have good idea that adds value to a customer, there is no point in

proceeding further. Your product or service must provide one of the following benefits -

reduce cost, reduce cycle time, improve productivity or improve free time of user of the

product. Most failures are due to negligence of this cardinal principle.”

- N. R. NARAYANA MURTHY

In sellers’ market businessmen were hardly bothered to keep the customers

happy. However, with change of sellers market to buyers market, whole approach to the

business (including banking) has changed. What is important is to recognize that

following the crowd will probably not enable an organization to outperform the crowd-if

one does what his competitors do, he can not be expected to perform better than others

do. That is why exceptional performers have always been willing to avoid following

conventional wisdom and attempts to do things differently. To walk with the customer is

a tool that enables an organization to explore better ideas to act. To know the concept,

let us first examine some applications: -

AN AUTOMOBILE COMPANY offering night servicing of car and two wheeler where

car or two wheeler is picked up in the night and delivered in the morning so that

vehicle owner does not face any inconvenience for going to office/business place.

GILLETTE GII PLUS TWIN BLADE SAVING system introduced new lubrastrip to

lubricate the face while one shave.

TTK Prestige introduced two innovations in its product range of pressure cookers- a

visual pressure indicator that indicates when pressure has been released within the

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cooker and a silicon gasket that need not be replaced during the life time of a cooker

–about 11 years. By this innovation, TTK steamed ahead in the cooker segment by

35% during 2003-04.

INDIAN POST offer of Business Post as complete solution for bulk mailing of

invitation cards, share holders notices, bills, etc. by offering services like pick up,

insertion, gumming, addressing, franking and mailing the letters.

BRITAN’S FINANCIAL SERVICE AUTHORITY (FSA) go-ahead to first Islamic bank

in Britain to open its first branch in London and work as per Islamic Sheriat Law i.e.

not to pay interest and Tobacco and Alcohol sector will be out of bound. The bank

will allow 1.89 million British Muslims access to banking strictly as per sheriat law.

MARTIN LOTTERY AGENCY Ltd. rolled out a scheme in which company will

mobilize small savings from its on-line lottery sale. The company would have

investment advisory staff at each out-let with separate counter and each winner will

be given investment counseling.

WALKING WITH THE CUSTOMER- A STRATEGIC TOOL The objective of the walking with the customer approach is to have competitive

advantage –the ability to earn above normal economic returns over a sustained period of time- by offering products, which add value to the customer in terms of

Convenience, Cost and or Quality.

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As one walk with the customer from very beginning of identification of his need

and is with him right through while selecting, buying, using and disposing the product,

one can identify great deal of happening that can be used for creating value for the

customer and can lead to competitive advantage for the organization. The walking with

the customer is however, different to what a customer feels about the product, its

intrinsic value or price but it is about understanding the whole process of behaving and

feeling exactly like what customer would do. It is thus a process of mapping the customer’s behavior by analyzing various activities that he performs while selecting, purchasing, using and disposing a product and then to locate gaps from where he derives value. The next strategy is to close the gap by introducing product innovation or renovation. The concept is simple yet a powerful strategy for a

customer centric approach. In service industry like banking walk becomes a strategic

tool for growth and survival.

Application in Banking Industry A question is often raised: - Is banking today is different from any other

consumer goods business? In addition to accepting deposit and lending, the banks

are offering various products/facility like collection of telephone/electricity/insurance bills,

selling insurance policies/bonds/mutual funds, collecting income tax, disbursing salaries,

home delivery of cash/draft and home/office pick up of cash/cheque etc. All this

multifarious banking is targeted to customer acquisition either by developing a new

product or by value addition in the existing product. Thus, increasing focus on customer

acquisition has made the banking similar to that of consumer goods business.

Let us see application of this concept in Indian banking and financial sector: -

(a) Having realized that for opening new accounts prospective customers have to

face lot of inconvenience both in terms of time and dislocation of work for

visiting a photographer, a bank provided digital Camera to its staff to take

photographs of the persons intending to open account.

(b) Home delivery and pick up facility of cash/cheque/draft recently introduced by

few banks.

(c) Following innovations and renovations in Home-loan products have been

introduced-

Get loan approved first and select the property later to enable the

customer to select the property as per his financial resources,

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Short-term bridge loan –against mortgage of existing house to enable the

borrower to buy a bigger house and loan will be repaid from sale proceed

of old house.

Top up offer of consumer loan up to 10% of housing loan to its existing

borrowers at same rate of interest and at same security.

Over-draft facility against security of house to provide liquidity against

assets which customer till now felt as an unproductive.

New home loan product in which excess funds in borrower’s saving

bank or current accounts is automatically swapped in Home loan account

to reduce the interest burden. In case of need funds will get reverse

swapped to savings /current account so that customer can withdraw the

money.

(c) Cash back offer of credit card companies- ICICI Bank has taken lead in credit

card number through this offer.

(d) Money transfer facility from card to card- from debit card to credit card or

vice versa. An innovative C2C product.

SYNERGISTIC BANKINGWith customers loyalty shifting to cheaper loans, flexible repayment plans, better

terms and freebies, it is duty of each and every employee of the organization to make

collective efforts to identify new opportunities to increase business through walking with

the customer strategy..

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Chapter-29

Selling of third party productsEmerging opportunities for banks

“ Banking is laid back whereas third party products like insurance and mutual funds are

sold aggressively. Bank people do not sell their own credit cards. The skill development

requires lot of orientation, attitudinal change and training of the employees.”

1. Welcome to the world of selling of third party product- This bit of information is real. In days of Raj, scotch was stored in the vaults of

some foreign banks. Warehousing was an issue and by agreeing to keep in their

vaults these banks earned the fee income. Scotch has not returned to bank vaults for

sure, but something on those lines is happening. Now walk into any supermarket,

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bank, post office, ATM, Internet kiosk, Credit Card Company or departmental store to

pick up an insurance product virtually off the shelf. As competition is hotting up, the

alternate delivery channel is developing on win-win concept. The barrier between

product and service is also disappearing. One can now buy toothpaste and have

dental insurance and buy a home loan and have life insurance cover too. Banks are

not staying behind and now across the board selling products ranging from mutual

funds (MFs) to insurance to equity to government securities on another party’s

behalf.

2. Selling of third party products- A new business model for banks There are many reasons for this venture by banks. The race for becoming a

one-stop financial supermarket is hotting up like never before and even smaller

banks are now talking about becoming the destination for all kinds of financial

products. Another reason is that developing own products is an expensive

proposition and is a time consuming process. Through this process, banks get the

benefit of associating with another recognized brand in segments where the bank

itself possesses no experience. Another reason is that with spread under pressure,

banks are looking for alternative income. Fee based income by selling third party

product is an answer to the problem. Selling of third party products also help the

bank to cross sell its own products to its customer thus utilizing surplus staff in

productive purpose. This can also helps the bank in improving market share by

retaining the existing customers and by providing those right options as knowing

what a customer requires is more important than what the bank is having. This also

helps bank in developing customer’s loyalty. Vast net work of the branches is bank’s

real strength, which adds tremendous value to this sort of business.

3. Bank as Super MarketIn many countries, banks have virtually become super markets selling

chocolates, coffee and pharma products. In India also, a bank has tied up with

BARISTA to promote concept known as BANKCAFE-where customers can refresh

them-selves with coffee & snacks while doing the banking business.

4. LimitationsThe marketing of third party products like insurance is push business whereas

traditionally banking is laid back business. This is due to cultural differences of banks

and insurance. This takes us to marketing that occupies center stage in undertaking

this business. Banks are required to develop marketing skills in the employees

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selected for the job. The training has a crucial role. In competitive environment,

selling of third party products presupposes certain service standard, particularly

selling to up market customers. The ambience of branches will have to be upgraded

and will have to be manned by forward looking and committed employees.

5. Skills required to sell third party productsHowever to offer correct product to the customers, bankers need to have skill in

knowing the products, to have speed in marketing the products, and to have pool of

well defined attractive products. They must also understand customer’s investment

need so that he can offer him best product available and not the one, which he is

having. It is also important that while selling third party products, bankers must

convey unconditionally to the customers that they are only selling some thing for

which responsibility to service and performance lies with the third party. But since

banks own credibility is at stake, they should do proper check up about service

standard of alliance partner. It should also be remembered that new age customer’s

look for convenience and informed advice from branch officials and they prefer banks

that display this attitude at the front desk. This requires lot of orientation, attitudinal

change and training of the employees. Banks in all countries that have ventured in

selling third party products like insurance have faced the task of transforming their

staff into effective salesman through systematic training and attitude orientation.

Banks in India have excellent training facilities that can be geared up to meet the

requirement.

6. Regulatory complianceIn a move to curb mis-selling of financial products and ensure transparency, the

RBI has mandated that banks should disclose to their customers details of the

commission and other fees received by them while selling mutual funds and

insurance policies. This has been done to ensure that bank should not recklessly

push products which earn them higher commission without bothering whether the

product is beneficial to the customer or not.

7. Emerging Opportunities in IndiaWith liberalisation of financial sector, many new opportunities are emerging in

India for selling third party products - mainly financial products. This are :-

(a) Bancassurance is globally a big business. According to a report of IRDA,

premium collected through banc assurance was Rs. 21947 croes in 2009-10

which is 7.31% of the total premium income of life and non-life insurance

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companies. Further 28% of new premium income insurers got through bank

assurance channel. India’s insurance sector is likely to touch about $400

billion in premium income by 2020 making the country of the top-three life

insurance and top 15 non-life insurance markets by 2020 as per survey of

FICCI and Boston Consulting Group. In last few years many public sector

banks in India have ventured into both life and non life segment. Bank

assurance model is low cost model and helps the bank in capturing business

leveraging on its own distribution capacity. As per survey conducted by

Watson Wyatt World Wide private insurer’s premium income will rise to 40%

by March 2010 from Bankassurnce business. Private insurers paid Rs.205

crores as commission for banc assurance during 2008-09. Of late taking

advantage of regulatory permission, banks are taking equity stake in

insurance company and entering into bankassurnce model to sell their

products which in turn help insurance companies to reduce their operational

cost. It ultimately works as WIN WIN model for both of them.

(b) Credit protection insurance is a big business worldwide which provide

protection to loan liabilities. After home loan, it is insurance market for home

loan repayment that is booming in India. Borrowers are scurrying for home

loan covers, where the life insurer repays the entire loan amount in event of

the death of the borrower and prevent the bank from taking away the

financed property. Education loans are also covered under credit protection

plan.

(c) Credit insurance is other segment which is catching fast. Under credit

insurance seller of goods/services are offered protection against any default

of payment by buyer. Where sellers are not insisting for letter of credit or

bank guarantee, credit insurance helps to overcome crisis when buyer

defaults. Many non-life insurance companies are offering this product which

can be marketed by banks under bankassurance.

(d) Assets under the management of mutual funds on October 2007 end have

crossed the Rs. 5 lakhs crores mark. Funds industry estimates indicate that

banks now brings in about 40% of retail mutual funds investments up from

20% a couple of years ago. Funds are entering into distribution pacts with

public sector banks to reach out small investors who are already availing

traditional banking services from banks.

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GOLD COINS & BARS SOLD

2010-11

In Kg.

SBI 2610IOB 1392Indian Bank 1150Andhra Bank 305Source: Business Line 14.5.2011

(e) Selling of Gilt also offers good business opportunity which many banks have

already started enchasing. Banks are also selling RBI Relief Bonds.

(f) Selling credit cards, debit cards and e-card is another area where banks are

utilising synergy of their existing customers to build business.

(g) After fake stamp paper scam, new business opportunity of stamp franking

has emerged as numbers of state governments are now selling stamp paper

through banks.

(h) Finance Ministry has mandated rural and urban branches of the public sector

banks to generate minimum 150 and 50 subscription under new pension

scheme every year. This has been done to ensure that all citizen in

unorganised sector and underprivileged are given opportunity to get pension.

Although mandated yet it is an opportunity for banks to promote the scheme

and earn extra money.

(i) Banks now see opportunity in selling gold coins and bars. According to

World Gold Council consumption of gold for

jewellery plunged 20%, while investor

demand for gold increased 51% in second

quarter of 2009. India is now largest

consumer of yellow metal and imported 944

tonnes of gold worth $59 billion in 2011-12.

A good number of banks have started

selling this product to earn extra fee based

income. Buyers find investment in gold as attractive option since interest

income in fixed deposit is comparative low to increase in the price of gold in

the recent past. Since gold coins and bars are hallmarked, buyers feel

secured.

(j) Banks are now offering new channel that is being developed by share

brokers in alliance with the bank where three in one services of saving bank

account, depository services and internet based trading account are offered.

8. Market Size(a) HDFC mutual fund has tied up with ICICI Bank, HDFC Bank, Canara Bank,

Citibank and Standard Chartered Bank to sell its mutual funds products. As

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per press release of HDFC, as much as 27% of the mobilisation of business

is now coming through this channel.

(b) LIC expects that sales of its products through banks will touch Rs. 600 clrores

by end of March 2006. LIC has signed MOU with 34 banks for sale of its

products through bancassurance.

(c) In Q3 of 2004-05 SBI Life total premium collection was Rs. 360 crores. SBI

Life is looking for No. 2 slot in life insurance business. It is at present selling

its product through 5000 branches.

(d) Bajaj Alliance Life, which has tied up with Standard Chartered Bank,

Syndicate Bank, Indusind bank and Centurion Bank, mobilised about 26% of

premium income through bancassurance mode.

(e) Aviva bancassurance success is stupendous as it earns 68% income through

this mode.

(f) Export Credit Guarantee Corporation of India Ltd. (ECGC) has signed

corporate agency agreements with 11 leading banks in the country to sell

export credit guarantee cover.

(g) The Bank of Rajasthan has reportedly surpassed the Rs. 100 crores mark in

its stamp franking business by end March, 2005.

(h) Birla Sun life offered advance commission of Rs. 600 crores to Syndicate

Bank which in turn will buy 6% in the company.

(i) Metlife has sold 30% stake to Punjab National Bank for life insurance.

-0-0-0-

Chapter-30

"Know Your Customer"-Guidelines

“There is need to sensitizing front office staff so as not to antagonize customers.”-DR A. K. Khandelwal- CMD, Bank of Baroda

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Key elements of Policy and procedure to open new accounts

1. Formalities preferably completed in bank premises.

2. Ascertain purpose of account and likely amount and kind of transaction intended. Banks may fix thresh hold limit for likely transaction in the account to monitor turnover.

3. Account holder with account of minimum 6 months must introduce an account.

4. Introducer to confirm that he knows the account holder for a reasonable time and also to confirm his/her occupation and address.

5. Obtain photograph of all account holders/partners/directors. In case of legal person, verify relevant documents and verify status of the persons acting on its behalf.

6. Obtain copy of PAN, Driving license, Voter Identity card etc.

7. Corroborate information from independent sources to check authenticity.

8. Send letter of thanks to account holder and introducer.

9. Don’t issue cheque book unless address is confirmed.

10. Keep tab on the account of politically exposed persons.

11. Banking facility on Internet will be subject to existing regulatory framework. Only banks physically present in India can offer internet facility to resident Indian only.

1. KYC- Concept and Coverage‘Know Your Customer’ (KYC) principle, has

been laid down by RBI to put in place systems and

procedures (a) to control financial frauds, (b) to

identify money laundering and suspicious activities,

and (c) to do scrutiny/monitoring of large value

cash transactions. Customer means any person

availing any type of banking facility who may not

necessarily maintain a bank account. This includes

foreign-exchange transactions and accounts as

well. The key elements of KYC policy are (a)

Customer identification policy, (b) Customer

acceptance policy, (c) Policy of monitoring of high

value cash transaction and (d) Risk management.

2 . “ Know Your Customer" (KYC) -guidelines

2.1 KYC Policy for opening accounts

(a) "Know Your Customer” (KYC) procedure is

the key principle for identification of an

individual/corporate opening an account.

The customer identification entails

verification through an introductory

reference from an existing account holder or

a person known to the bank or on the basis

of documents provided by the customer. No

banking relationship should be accepted

until and unless the customers’ identity is

established to full satisfaction of the bank.

(b) The prescribed procedure (see box) for opening and operation of new accounts

include verification of bonafide and identification of individual/ corporate

opening new deposit accounts. These guidelines contains procedure of

verification on the basis of documents like passport, driving license etc. and

system of corroboration of information from independent sources.

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(c) Unique Identification Authority of India (UIDAI) is likely to commence eKYC

authentication service for opening of account which will pave the way of identity

of account holder and his address proof and RBI as well as GOI is likely to

approve AADHAAR as valid ID proof for opening accounts. Facility is likely to

minimize operational problem in opening accounts and is also likely to bio-metric

identification of the account holder.

(d) Looking to the problem of low-income group customers, RBI has permitted

banks to open accounts of those customers, who are not in a position to submit

address or identity proof, on the basis of introduction of an existing customer

having minimum six months old account with satisfactory turnover, provided

introducer has been subjected to KYC procedure and subject to annual deposit

limit of Rs. 1 lakh, monthly withdrawal can not exceed Rs. 10000 and balance

does not cross Rs. 50,000/- . RBI has also advised that individuals who do not

have an individual proof of residence can now open an account by producing

utility bill of close relative as a proof of residence along with a declaration of

close relative that prospective customer is living with him. It has been clarified

that the customer acceptance policy procedure should not lead to denial of

banking services to the general public.

(e) RBI has also advised banks not to open accounts or close an existing account

where bank is unable to apply appropriate customer due diligence standard i.e.

bank is unable to verify customer’s identity or documents required. Further to

build safeguard decision to close account or not to open account must be taken at

higher level after giving due notice to the customer indicating reason.

(f) RBI has advised banks to identify politically exposed persons who are resident

outside India and verify their source of funds before accepting deposits.

Politically exposed persons are individuals who are or have been entrusted with

prominent public functions in foreign countries such as head of states, senior

politicians, senior government, judicial or military officers, important political

party officials and senior executives of state owned companies. It is may be

recalled that globally politically exposed persons are seen as high risk category

particularly if they originates from countries having high level of corruption. RBI

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has further advised that decision to open the account of politically exposed person

should be taken at senior level.

(g) The RBI has advised banks to conduct extra due diligence of accounts operated

by NGOs to monitor and reduce risks of money laundering. Further through an

amendment in PMLA 2002, charitable trusts, non-government organizations,

educational institutions or societies have been mandated to disclose the source of

their funds and has also been mandated that large monetary transactions may be

scrutinized.

(h) RBI has advised banks to obtain a declaration from the account-holder to the

effect that he is not enjoying any credit facility with any other bank or obtain a

declaration giving particulars of credit facility enjoyed by the intending customer

with any other bank(s). Besides, in the latter case, the concerned lending bank(s)

were required to be duly informed so that suitable precautionary measures, where

necessary could be taken by them.

(i) Banking facility on Internet is subject to the existing regulatory framework. Banks

having physical presence in India only are allowed to offer banking service over

Internet to residents in India and any cross border transactions are subject to

existing exchange control regulations. Banks to establish identity and also make

enquiry about integrity and reputation of the prospective customer. Internet

account should be opened only after proper introduction and physical verification

of the identity of the customer. Similarly Credit/Debit/Smart/Gifts cards should

also be issued on compliance of KYC guidelines.

(j) RBI has also advised banks to subject locker hirer to KYC norms and where it is

found that locker remain inoperative for more than one year in medium risk

category or more than three year in high risk category, bank should break open

the locker after serving notice to the customer. These guidelines have been issued

on the background of instances that not only arms and ammunition but also

bombs were found in the lockers.

(k) RBI is also working on brining prepaid cards, gift vouchers travel, expenses cards

and food coupons under KYC and AML guidelines. Institutions issuing these

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Suspicious transactionsRed-alert signals

1. A customer submitting unusual or suspicious identification documents that cannot be readily verified.

1. A customer’s home or business phone disconnected or letter of thanks returned back with vague remarks.

2. Watch cash transactions which are out of business or income profile of the account holder.

3. Watch if customer is found splitting transactions to avoid filing of mandatory reports. Bank to check series of transaction with aggregate below cut off date.

4. Watch charity or relief organization linked transactions. Also accounts operated through power of attorney and accounts of politically exposed persons.

5. Reasonable ground to suspect that proceeds of crime money is deposited even if below cut off limit.

instruments would also be required to file STR with Financial Intelligence Unit of

India.

(l) Banks have been advised to prescribe thresh hold limit for particular type of

accounts and to pay attention to the transactions which exceed these limits.

Transactions that require large amount of

cash inconsistent with the normal and

expected activity of the customer should

particularly attract the attention of the

bank. Very high account turnover

inconsistent with the size of the balance

maintained may indicate that funds are

being ‘washed’ through the account.

(m) RBI has advised banks to revisit (a time

frame has been prescribed) all the

existing accounts where summation of

credit/debit transaction is more than Rs.

10 lakhs or accounts of trusts,

intermediaries or account operated

through mandate to recheck that KYC

guidelines so framed have been followed

and where-ever there is any discrepancy

the same should be got rectified at the

earliest.

2.2 KYC Policy for issuance of TT/DD/MT etc.

(a) KYC policy stipulates that branches

should issue travelers cheques,

demand drafts, mail transfers, and

telegraphic transfers for Rs.50, 000

and above only by debit to customers’

accounts or against cheques and not against cash.

(b) Further, the applicants (whether customers or not) for TT/MT/DD/Traveler

Cheque etc for amount exceeding Rs.50,000 should affix permanent (Income

tax) account number on the applications.

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(c) Some time to bye pass the requirement, customers resorts to splitting of the

transaction, which send warning signals to the bank. The branch officials

should be vigilant to check such transactions where they find that

transactions are splitted up to avoid compliance.

2.3 KYC policy for monitoring high value transactions

(a) The branches are also under obligation to monitor transactions of a

suspicious nature (See Box) and to report such transactions to law

enforcement agencies and to freeze such accounts as per their direction and

also report to their corporate office within seven days of arriving at the

conclusion that that a transactions or series of transaction including

attempted transaction are of suspicious nature.

(b) The branches are required to keep a close watch of cash withdrawals and

deposits for Rs.10 lakhs and above in deposit, cash credit or overdraft

accounts and record details of these large cash transactions in a separate

register.

2.4 KYC policy for terrorism finance and money laundering

(a) It is estimated that the size of money laundering worldwide through the

banking sector, is more than US $ 500 bn to US $1 tn annually. Given the

staggering volume of this crime, broad international cooperation between

regulatory and law enforcement agencies is important to identify source of

illegal money, trace the funds to specific criminal activities and confiscate

such assets. Post September 11, the issue that bank supervisors the world

over a grappling with is “How to root out the menace of money laundering?”

The law being enacted typically require a bank to “know the customer” to be

confident that his money is obtained by legitimate means and to report any

suspicious activity. This means bank must know their customers’ customer as

well. RBI has reemphasized that banks can effectively control and reduce

their risks only if they have an understanding of the normal and reasonable

activity of the customer so that they have means of identifying transactions

that fell outside the regular pattern of activity. However the extent of

monitoring will depend on risk sensitivity of the account. Bank should pay

special attention to all complex unusually large transactions and all unusual

patterns, which have no apparent economic or visible lawful purpose.

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(b) Where banks become aware of facts which lead to the reasonable

presumption that money held on deposit drives from criminal activity or that

transactions entered into are themselves criminal in purpose, appropriate

measures, consistent with law, should be taken, for example, to report the

matter to law enforcement agencies, deny assistance, severe relations with

customers and close or freeze accounts.

(c) A FIU (Financial Intelligence Unit) has been set up under Prevention of

Money Laundering Act, 2002 and Banks /FIs are required to keep record of

the dealings above thresh-hold (excepting dealing with corporate clients, PSU

etc. specifically exempted by the government) and to report such transactions

to FIU. Reporting threshold has been fixed at Rs. 10 lakh for cash transaction

and Rs 100 lakhs for non-cash transactions which cover payment through

cheque, demand draft etc. FIU has been entrusted with the responsibility to

track suspicious transactions that involve potential money-laundering or

violation of the Banking secrecy act, Indian Penal Code, Narcotic Drugs &

Psychotropic Substance Act 1985 and Arms Act 1959 etc.

(d) RBI is circulating list of terrorist entities notified by GOI to banks from time to

time. Branches should consult such list before opening new accounts.

However as and when the list is received the existing accounts should also to

be checked and if any account is found existing appropriate measure for

seizure and reporting should immediately be undertaken.

(e) Indian Banks’ Association has listed 23 countries in the high-risk category for

implementation of KYC and AML norms by the banks. These high risk

countries are- Myanmar, Nigeria, Turkmenistan, Ukraine, Guatemala, Cook

islands, St Vincent & the Grenadines, Russia, Angola, Zimbabwe,

Afghanistan, Cuba, Iraq, Libya, Azerbaijan, Moldova, Kazakhstan, Georgia,

Uzbekistan, Belarus, Armenia, Kyrgyz Stan and Tajikistan. Customer living in

these countries will be classified in high risk irrespective of their nationality

and opening their account will need specific approval from higher authorities.

(f) IntegraScreen Group, a Singapore based company has compiled global anti-

money laundering (AML) database having list of high-risk individuals. About

121,000 individuals have been categorized as high risk in this database. Most

foreign banks and few private banks in India have started using this database

to check profile of individuals while opening new accounts.

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(g) IN CBS environment banks can automatically monitor/detect money

laundering, fraud and out-of-profile behavior of the customers and accounts

through software. The software enables the bank to put every transaction

through validation check and helps to detect any abnormal transfer of funds

into undesirable hands. It is estimated that AML software market is about 2

US billion in India.

(h) RBI has asked Indian banks to put in place AML system and submit their

action plan with regard to deployment of AML system by June 2006 and final

report on the solutions and infrastructure installed by December 2006.

3. KYC-Compliance of FCRA 1976(a) Branches should adhere to the instructions on the provisions of the Foreign

Contribution Regulation Act, 1976 regarding opening of accounts or collection

of cheques only in favour of association, which are registered under the Act

with Government of India. A certificate to the effect that the association is

registered with the Government of India should be obtained from the

concerned associations at the time of opening of the account or collection of

cheques.

(b) Branches should exercise due care to ensure compliance and desist from

opening accounts in the name of banned organizations and those without

requisite registration.

(c) Under FCRA 1976 only designated branches of banks are allowed to accept

deposit whose name is given in the application form to government. The act

also make it mandatory for the banks to submit half-yearly statement to

government giving details of the contribution received by associations and

organizations. 4. Risk management and monitoring procedures

(a) Non Compliance of KYC norms may put the bank to various risks such as

reputation (loss of reputation in case of fraud), Operational (loss due to

fraud), legal (legal action against the bank due to fraud) and concentration

(group of borrowal accounts turning bad or chain of deposit accounts found

involved in fraud) risks. KYC policies are essentially measures of preventive

vigilance and are framed to mitigate aforesaid risks.

(b) In order to check possible abuse of banking channels for illegal and anti-

national activities, the internal control system laid down by the bank should

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be strictly followed. Duties and responsibilities allocated at various levels

should be explicit and policies and procedures are managed effectively to

ensure full compliance of KYC programme in respect of both existing and

prospective deposit/borrowal accounts.

(c) An independent evaluation of the controls for identifying high value

transactions should be carried out on a regular basis by the inspection team

of the bank.

(d) Concurrent/internal auditors must specifically scrutinize and comment on the

effectiveness of the measures taken by branches in adoption of KYC norms

and steps towards prevention of money laundering. Such compliance report

should be placed before the Audit Committee of the Board of banks at

quarterly intervals.

(e) RBI decision to put penalty in public domain is a measure, which may trigger

reputation risk.

5. Record Keeping Bank should prepare and maintain documentation on their customer relationships

and transactions to meet the requirements of relevant laws and regulations, to enable

any transaction effected through them to be reconstructed. In the case of

electronic/telegraphic transfer transactions, the records of electronic payments and

messages must be treated in the same way as other records in support of entries in the

account. All financial transactions records should be retained for at least five years after

the transaction has taken place and should be available for perusal and scrutiny of audit

functionaries as well as regulators as and when required.

6. Training of staff It is crucial that all the operating and management staff fully understand the need for

strict adherence to KYC norms. The regular input on KYC should be given to staff

through training as per for their roles so that they understand their responsibility of

implementing KYC policies clearly.

7. Penalties and Restrictions(a) KYC guidelines are issued under Section 35 (A) of the Banking Regulation

Act, 1949 and any contravention of the same attracts penalties under the

relevant provisions of the Act.

(b) Office of the Comptroller of the Currency which regulates and examines

approximately 2,000 national banks and 51 federal branches of foreign bank

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in the US announced on May 13, 2004 that, it has assessed a $ 25 mn civil

money penalty against Riggs bank N.A. for violation of the Bank Secrecy Act

as it has failed to implement an effective anti-money laundering programme

and it did not detect and investigate suspicious transaction and had not filed

suspicious activity report as required under the law.

(c) A prove by US senate’s permanent committee found that HSBC used its US

bank as gateway into the US financial system to provide US dollar services to

clients while playing fast and loose with US banking rules and charges it

giving terrorist, drug cartels and criminals access to the US financial system.

( TOI 19.07.12)

(d) RBI has recently hauled up / fined cross Citi Bnk rs. 25 lakhs for failure to

follow KYC and anti-money laundering rules which led to Rs. 400 crores fraud

in Citi’s Gurgaon branch. (ET 6.7.2011)

(e) Another reported violation is by a south based private- bank in a case of two

FCNR (B) deposits amount to $ 200,000 held by an NRI. RBI as per reports

has proved the negligence and is contemplating imposing fine.

(f) Following IPO scam of IDFC and Yes bank where RBI identified certain

weaknesses on the part of banks in customer identification and acceptance

system. It has decided to impose financial penalties as well as decided to

“indefinitely” put on hold all applications from concerned banks seeking

clearance for various businesses, including opening of new branches.

(g) RBI has advised banks to ensure that information called from the customer is

relevant to the perceived risk, is not intrusive and is conformity with

guidelines issued by RBI. Any other information from the customer should be

sought separately with his or her consent and after opening the account.

Banks should not misuse personal information given to them while opening of

accounts for cross-selling or passing on to subsidiary/business associates. If

obtained specific disclosure should be made to customer that information so

obtained would be used for this purpose.

8. Summing UpKYC is a tool of customer due diligence and preventive vigilance. RBI directive is

mandatory in nature. It creates responsibility on officials to follow laid-down measures in

both letter and spirit before opening of the accounts and also to monitor high

value/sensitive transactions. Looking to the problems of small depositors and micro

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finance institutions, RBI has relaxed KYC norms for opening accounts of small

depositors provided introducer has been subjected KYC norm.

Chapter- 31

Risk Based Supervision“I believe that banking institutions are more dangerous to our liberties than standing armies in the field.”

- Thomes Jefferson

1. Introduction1.1 The prime concern of central banks across the globe is to ensure safety and

soundness of the banking system and for this they are vested with supervisory

powers that include conducting inspection, issuing direction, levying penalties and

putting bank to rehabilitation, moratorium and liquidation. Post 1992 banking in India

is witnessing strong deregulation, tightening of prudential norms, and enhancement

of disclosure standards and adoption of internationally accepted best accounting

practices, consolidation and globalization and increasing use of technology. This has

on the one hand provided massive opportunity of growth to banks but at the same

time enhanced risk which otherwise is essence of banking. This has also thrown

challenge on regulator i.e. Reserve Bank to make the supervisory policies and

process more efficient and sophisticated.

1.2 The traditional system of bank’s supervision of one size fits all approach is

largely based on assessing the accuracy of balance sheet and profit and loss

account and adequacy of internal control measures and is done to fulfill the

obligation of section 22 of BR Act 1949. The current system puts reliance on

transaction testing like adequacy of appraisal, assessing the quality of credit and

adequacy of the provisioning. It is largely done through on site inspection. The

system has merit for determining the current conditions of the operations of the bank

but has limitation that it can not throw light on problem areas that may have adverse

bearing on future performance of the bank.

1.3 The risk based supervision (RBS) has evolved as a more dynamic approach to

bank supervision. It attempts to overcome the aforesaid deficiency. It also attempts

to address the competencies of the bank to identify, measure, monitor and control

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risk arising out of various business activities. Risk management is crucial element of

banking and hence of banking supervision. The RBS can not only promote safety

and soundness of banks but it can also mitigate and offset risks inherent in traditional

form of supervision.

2. RBS- Objectives2.1 The RBS aims to enhance the effectiveness and efficiency of supervisory

capabilities of the central bank. It also aims to direct central banks resources towards

the areas of greater risk to enable it to meet its supervisory objectives in a more

meaningful and effective manner.

2.2 The RBS entails paying supervisory attention in accordance with the risk profile of

the bank. The approach is expected to optimize utilization of supervisory resources

and minimize the impact of crisis situation in the financial system. The RBS is based

on CAMELS approach on on-site examination and off-site monitoring and is forward

looking beyond focusing attention on the rectification of deficiency with reference to

on site inspection.

3 RBS approach-3.1 RBI introduced the concept of RBS in Credit and

Monetary policy of April 01. In August 01, it brought out a

discussion paper entitled ‘Move towards RBS’. Based on the

feed back, RBI has started supervision on pilot basis from

last quarter of 2002-03.

3.2 RBS framework starts from preparation of risk profile of

the bank on 12 identified areas of business and control risks

and then proceeds to (a) determining supervisory cycle, (b) determining supervisory

programme, (c) conducting inspection, (d) reviewing evaluation and (e) follow up

through MAP. The risk profiling is essence of RBS and all supervisory action are

required to be based on risk profile as assessed by the regulator.

4 RBS Pre- approach 4.1 The RBI over a period of time has advised bank to initiate certain measures so

as to prepare for smooth implementation of the RBS.

4.2 The preparations are (a) Setting up of Risk Management Architecture, (b)

Adoption of risk focussed internal audit, (c) Strengthening of management

information system, (d) Selection, training, education and deployment of the staff and

(e) Setting up of the compliance unit and nomination of the compliance officer.

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5 RBS- Risk Profiling5.1 The risk profiling is based on assessment of (a) business risks and (b) control

risks in 12 critical areas of banks functioning. Business risk assessment would

cover (a) capital risk, (b) Credit risk, (c) market risk, (d) Earnings risk, (e)

Liquidity risk, (f) Business strategy and environment risk, (g) operational risk and

(h) group risk. The control risk would cover (i) internal control risk (j)

organization risk (k) management risk and (l) compliance risk. There could be

more than one type of risk under the same assessment.

5.2 Nature of risk relevant to various areas is as under: -

No. Risk category Assessment area Nature of risk

1. Business risk Capital adequacy

(Soundness of

bank)

Adequacy of capital

Composition and quality of

capital

Access to capital market

Shareholders assessment

Economic capital

2. Business risk Credit Risk

(Risk of default or

NPA)

Credit concentrations

Credit quality

Adequacy of provisions

Composition of credit portfolio

Other credit risk like trading

book, off balance sheet items,

country risk etc.

3. Business risk Market risk

(Change of interest

or exchange rate or

price of investment)

Quality of investments

Interest rate risk

Composition of trading book.

Forex risk

Equity price risk

4. Business risk Earnings Risk

(profitability)

Earnings and expenses

Spread and burden

Earnings quality and stability

Budget and profit planning

Fund cost and return

5. Business risk Liquidity Risk Liquidity risk

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(risk of liquidity) Composition of liabilities

Liquidity profile

6. Business risk Business strategy

and environment

risk.

Business strategy

Strategic business initiatives

External environment and macro

indicators

7. Business risk Operational risk People risk

Process risk

Technology risk

Legal risk and Reputation risk

External events

Operating environment

8. Business risk Group Risk Capital and investment

Operations and performance

9. Control Risk Internal Control Risk Risk management system

Internal controls and

housekeeping

Risk based internal audit

Anti money laundering controls

10. Control Risk Organizational Risk External and internal

relationships

Legal structure and ownership

11. Control Risk Management Risk Board of directors-composition

and competencies

Senior management profile

Corporate governance

12. Control Risk Compliance Risk Statutory and regulatory

compliance

Monitoring action plan

compliance

5.3 RBI has developed the risk profile templates to standardize the risk profiling

system. The guidance sheet prepared by RBI facilitates assessment of these

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risks. Through this process, the level of risk – low, moderate and high and

direction of risk - increasing, decreasing and stable is determined.

5.4 The review and updating of the risk profile will have to be done on quarterly

basis.

5.5 Since risk profiling is essence of RBS, it is necessary that in house quality

assessment be done from time to time so that the bank may do independent

evaluation of risk assessment.

6 RBS- Supervisory Cycle- 6.1 The supervisory cycle depends upon the risk profile of each bank. The principle

being higher the risk shorter is the cycle and vice versa.

6.2 The cycle will generally remain at 12 months but can be extended beyond 12

months for low risk banks. In cases of high-risk banks, cycle can be lower than

12 months.

6.3 RBI will prepare a customized cycle programme for each bank after completing

the risk profiling.

7 Supervisory Programme7.1 The objective of this steps is to prepare RBI supervisory programme to set out

the work which bank as well as RBI will undertake during supervisory period. The

work will relate to areas of concern identified through risk profiling.

7.2 While drawing the supervisory programme, RBI will prepare risk matrix based on

business risk and control risk to decide level of monitoring and remedial action. A

typical supervisory risk matrix will be as follows-

7.3 It will also decide tool of supervision that RBI will employ. RBI will suggest action

plan which bank will undertake to rectify the situation during a given period. The

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High Monitoring but little remedial action unless the risk is found excessive.

High Monitoring . Need for immediate remedial action to improve the risk profile.

Low monitoring, little remedial action is necessary.

Moderate monitoring. Need for remedial programme to improve control.

BUSINESSRISK C O N T R O L R I S K S

programme will set out specific linkage to the area of risks so that bank

management can understand and appreciate why particular action has been

recommended.

7.4 The programme will be first discussed with the bank at draft stage and thereafter

listening to the management side, it will be finalized.

7.5 The supervisory tools to be deployed under the programme shall vary from

targeted on-site inspection, commissioned external audit, structured meeting with

the bank and specific supervisory direction etc.

8. Inspection Process8.1 The inspection under the new approach will largely be system based rather than

laying emphasis on underlying transaction and asset valuation.

8.2 The inspection will target high-risk areas from RBI perspective and would focus

on effectiveness of mechanism in capturing, measuring, monitoring and

controlling various risks.

8.3 The inspection process will continue to test transaction and evaluation the extent

of which will depend upon materiality of the activity, integrity of the risk

management system and control process.

9. Monitorable Action Plan (MAP) - 9.1 The follow-up will aim to evaluate progress in corrective action taken by bank.

The major devise in this regard will be MAP.

9.2 The MAP- Monitorable Action Plan- will decide time frame within which specific

action will be taken by bank to remedy a situation. It will also clearly spell out

the key persons responsible for the same. It action and timetable decided by the

RBI is not complied with, RBI would examine further course of action. If satisfied

with the progress, may give further time to improve or make compliance. RBI

may also decided restrictions in branch expansion, new business line, or new

products or may levy penalties.

9.3 Over all objective of the MAP is risk mitigation. It would suggest action from the

regulator if time bound actions be not taken.

9.4 Enforcement process and incentive framework is centre-stage of MAP. If the risk

profile is low or compliance is as per MAP besides longer inspection cycle,

incentive will be by way of less intervention or more autonomy. PCA- Prompt

Corrective Action will be part of MAP.

10. Moving to risk based internal audit (RBIA) —

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10.1 RBS will leverage on the work of internal auditor. So bank will be required to

move to risk based internal audit of their branches where greater emphasis will

be on identifying risk and drawing action plan in mitigating these risks. Internal

auditor will not only offer suggestions to mitigating the current identified risks but

will also anticipate areas of potential risk and will play a key role from protecting

the bank from these possible risks.

10.2Every care has to be taken that the work of risk management department and

risk based internal audit is not over lapping. RBS is expected to be an aid to the

ongoing risk management in bank by providing necessary check and balances in

the system. In other word there should not be duplication of work process. RBS

will look into effectiveness of Risk Management System of the bank and draw

action plan if any deficiency is observed.

10.3RBIA will give insight to RBI for conducting RBS in general and preparing risk

profile in particular.

11. Other issues-11.1 External Auditors are very important part of audit chain. RBI will discuss

and percolate the basis and objective of RBS with them so that they may also

understand underlying process and supplement the RBS.

11.2 RBS is supplementary to the existing system and is not a substitute. The

process requires elaborate discussion and training to change the mindset of

employees.

11.3 HRD issues like training, education, placement and posting are important

for successful implementation of RBS. This will also help in developing

coordinated effort of regulator and bank for smooth transition.

11.4 Good corporate governance and documented policies for accountability

and responsibility are pillar of RBS.

11.5 The setting up of insurance, merchant banking, mutual funds and housing

finance and investment companies as joint venture or subsidiaries has brought

into focus need of consolidated supervision by various regulator like RBI, SEBI

and IRDA.

-0-0-0-

275

Chapter- 32

Risk Based Internal Audit- An Outline

Introduction

RBIA is part of bank level preparedness to implement RBS (Move Towards Risk

Based Supervision of Banks – RBI discussion paper, August 3, 2002).

RBI circular of December 27, 2002 provides an outline of RBIA.

Gradual switch over from transaction based branch internal inspection to RBIA.

But internal control/audit through concurrent auditor should continue and become

stronger.

Banks to report to the RBI on quarterly basis regarding the progress on RBIA.

Features of RBIA

Risk Management Committee (RMC)/Department (RMD) and the role of RBIA need to

be distinguished. RBIA is an independent risk assessment at branch level solely for

formulating the risk based audit plan. But the RMD/RMC focusses on areas such as

identification, measurement and monitoring of risks at bank level. Broad policy

guidelines of RMC/RMD on risk management, risk profile of the bank, etc. are examined

for developing RBIA policy.The focus of RBIA is to provide reasonable assurance to the

Board and the top management about the adequacy and effectiveness of the risk

management and control framework in the operations. Also, to indicate potential risk

which a branch is exposed to. The conduct of RBIA will shift emphasis from the present

system of full scale transaction testing to risk identification, prioritization of audit areas

and allocation of audit resources in accordance with the risk assessment.For RBIA,

limited period is allotted which should be utilized mainly for high risk areas. If time

permits, low risk areas may also be covered.Until the switch-over takes place, internal

inspection will continue. In that case, the branch should be inspected first by a team of

internal inspectors and thereafter, the same team should conduct the RBIA. Limited

transaction testing is advised. If major deviations are observed in respect of audit of

sample cases, all transactions will be considered for verification after consulting the

276

higher authorities.Switch-over to RBIA is expected in the next 2-3 years. Initially, ELBs

and VLBs may be covered and all other branches thereafter within 2-3 years.

Risk Assessment

Risk assessment is undertaken as part of RBIA solely for the purpose of

formulating the risk based audit plan. Risk assessment may be done at

corporate, branch, portfolio and individual levels, which involves the process to

identify, measure, monitor and control the risks. At present, the RBIA is

proposed at branch level only.

The risk assessment involves;

Identification of both inherent business risks and control risks.

Drawing up a risk–matrix for taking into account both business risk

and control risk. (Risk matrix is shown subsequently)

Risk to be assessed in terms of Level (High, Medium, and Low) and

Direction (increasing, stable and decreasing). The basis of

assessment of risk in terms of Level and Direction should be spelt-out.

Methodology – On site audit – deviations – magnitude – frequency.

Risk Assessment framework in one bank is suggested as under:

Marks

I Business Risk 500

1. Credit Risk 200

2. Earning Risk 80

3. Liquidity Risk 40

4. Business Strategy Risk 80

5. Operational Risk 100

II Control Risk 500

6. Internal Control Risk 400

7. Compliance Risk 100

Total Marks 1000

Level of Risk for Business and Control separately

(In percentage)

Low - Over 80

Medium - 65 – 79

High 64 and Below

Direction : Increasing, stable and decreasing

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Composite (Business as well as Control) Risk Matrix

Inherent Busines

s Risk

HighA

High Risk

B

Very High Risk

C

Extremely Risk

MediumD

Medium Risk

E

High Risk

F

Very High Risk

LowG

Low Risk

H

Medium Risk

I

High RiskLow Medium High

Control Risk It would be possible to identify 5 levels of risk from the above matrix – low,

medium, high, very high and extremely high.

Magnitude and frequency of risk.

While the quantum of credit, market and operational risks could be largely

determined by quantitative assessment, the qualitative approach may be adopted

for assessing the quality of controls in various business activities. Identification of

risk may be done activitywise (business segmentwise) or locationwise

(branchwise). In the initial stage, banks may confine to branchwise risk

assessment.

The risk assessment methodology includes the following parameters:

Previous internal audit report and compliance

Proposed change in business lines or change in focus

Change in management/key personnel

Results of the latest regulatory examination report

Report of external auditors

Business trends and other environmental factors

Time lapsed since last audit

Volume of business and complexity of business activities

Performance variations from the budget

For accurate risk assessment, MIS and data integrity is essential. Hence, the

audit department should be informed by all other departments about introduction of

new product, changes in reporting lines, changes in accounting policies and

practices, etc.

The risk assessment should be done on yearly basis which may updated

periodically in the light of changes in business environment, work process etc.

278

Audit PlanBanks have to prepare the annual audit plan. The areas (branches) or activities

identified as high, very high or extremely high risk (based on risk matrix) may be audited

at shorter intervals and at longer intervals for medium or low risk areas/activities.

In one bank, the audit plan is suggested as under:Level of Risk Periodicity of RBIA

Very High Within 6 months

High Within 12 months

Medium 12-15 months

Low 15-18 months

Transaction testing depends upon the risk assessment.

In one bank, the extent by transaction testing is suggested as under:% Testing Level of Risk/Direction

100 High and increasing

50 Medium and stable

10-20 Low and decreasing

RBIA Audit Report FormatRBIA auditor at the minimum must report the following points in his report:- Process by which risks are identified and managed in various areas

- The control environment in various areas

- Gaps, if any, in control mechanism which might lead to frauds, identification of

fraud prone areas

- Data integrity, reliability and integrity of MIS

- Internal, regulatory and statutory compliance

- Budgetary control and performance review

- Transactions testing/verification of assets to the extent considered necessary

- Monitoring compliance with risk based internal audit report

- Variations, if any, in the assessment of risks under the pre-audit plan vis-à-vis

RBIA.

The scope of RBIA should also include review of the systems to ensure compliance with

money laundering controls, identifying potential inherent business risks and control risks

and suggesting steps to mitigate risks.

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Exit meetingThe audit report should be prepared after holding discussion with the Branch

Manager/Management regarding audit findings relating to risk assessment, risk matrix,

positive and negative factors and steps to mitigate risks, as also identify the areas of

potential risks. Banks are expected to develop RBIA report format. Special letter stating

serious irregularities, if noticed during the RBIA, should be sent to the management

immediately and seek instructions therefrom.

Rating of BranchesAs part of RBIA report, branches may be rated in different categories on the basis of

level and direction of risk. In one bank, branches are rated in nine categories - Levels 3

X Directions 3 (1) High increasing (2) High stable (3) High decreasing (4) Medium

increasing (5) Medium stable (6) Medium decreasing (7) Low increasing (8) Low stable

(9) Low decreasing. For each category, reasons should be stated and steps should be

suggested to mitigate risk by branches.

RBIA – OutsourcingWith the permission of the Board, outsourcing can be done for RBIA. But enough care is

needed to ensure that internal control is not weakened due to outsourcing.

RBIA Process1. Pre-audit: - Study of RBIA policy guidelines

- Study of Branch Profile to get an idea about nature of risk i.e.

level and direction.

- Preparation of pre-audit plan.

2. On-site audit: - Assessment of risk based on deviations observed during the

course of audit; Development of Risk Matrix.

3. Post audit: - Implementation of the RBIA report by a branch within the

specified

time. (Monitorable Action Plan – MAP)

- Follow-up of the implementation of the report by the RO/ZO

- Closure of the report by the regional inspectorate on the recommendations of

the RO/ZO

- Audit Committee of the Board to be informed about the gist of the RBIA report.

Organisational Aspects of RBIA- A Task Force of senior executives to be formed to prepare a plan for switch-over

to RBIA during the next 2-3 years.

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- The Task Force to develop RBIA policy guidelines, branch profile format, risk

assessment framework, risk matrix, RBIA report format, Monitorable Action Plan

(MAP) format, etc.

- Regional Inspectorate/Regional Office to develop Branch profile data annually

- Inspectors to be identified to conduct RBIA and necessary training to be imparted

- A Pilot RBIA should be introduced to test the audit tools. Thereafter, the RBIA

should be conducted on full scale.

- Internal audit inspection shall be conducted

alongwith RBIA until the total switch-over is

done.

- The success of RBIA depends upon MIS,

efficiency of internal control/concurrent

audit/IT audit machinery, competence of

inspectors

- As far as possible, RBIA should be

conducted by internal staff only.

- The Task Force is expected to prepare an

annual plan for conducting RBIA. A road-

map has to be prepared for switch-over to RBIA during the next 2-3 years.

-000

Chapter-33

Preventive Vigilance in Banks “Truth has a bad habit. It surfaces and emerges and reemerges like that of Siberian bird

Phoenix who rises from its own ashes.” - Anon

1. Introduction- Banks in India lost about Rs. 1883 crores due to frauds during 2008-

09. Of late, frauds in banking industry are showing unabated spurt year after year.

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2004-05 779

2005-06 1381

2006-07 1194

2007-08 1059

2008-09 1883

Frauds in Banking Sector (Amount

in croes )

ET 31st January 2010

The magnitude is also increasing on account of financial sector reforms and

globalization. e-Banking has added a new dimension of frauds as necessary security

awareness, knowledge and expertise are not available with staff in operation.

Fierce competitions amongst the banks to excel performance and to grab more and

more business from others have made the banks to let loose internal control system,

norms and procedures. Further with the opening up of the financial sector, a desire

for earning quick money has cropped up amongst a section of people who

increasingly design new ways and means to commit frauds. All this has made the

Vigilance an important aspect of banking business management and responsibility of

the apex management to strengthen the fraud management practices.

2. Vigilance a mental state- Vigilance is a mental state and in general parlance refers

to awareness, alertness, watchfulness, fore-sightedness, exercising caution and

prudence on the part of the employees to save the property of the banks from

unscrupulous elements. It is a fight for uprooting corruption and malpractice, which

are harmful to the organization as well as to society. The vigilance protects the

honest persons to stimulate operational efficiency and punishes dishonest persons

as a deterrent measure.

3. Three O’s of Vigilance-3.1 Offenders-Offenders who perpetrate the frauds can be both insiders and

outsiders. The experience has shown that majority of frauds are committed by the

insiders either singly or jointly with outsiders. A recent incident at French Bank,

Societe General S.A. which was defrauded by US $ 3.2 billion by its trader has

exposed vulnerability of bank by insider. Hence strict vigil has to be exercised on

activities of the insiders to check frauds. Further, the bank has to closely observe the

principle of “know your customers” to check perpetration of fraud by the outsiders.

3.2 Objects-Object means target of fraud. Offenders commit frauds by targeting

branches where the system and procedures are not meticulously complied with or

targeting loophole in the system and procedure. The RBI has the identified following

areas as fraud prone: -

Deposit Accounts- opening of fictitious deposits accounts by persons not

properly identified/introduced to the bank followed by deposit of

fake/stolen/forged instruments in such accounts and withdrawals of the

proceeds and fraudulent operations in Impersonal accounts.

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Payment of Demand Drafts and other Transfer Instruments-payment of

altered/forged drafts & Forged inter-branch transfer advice.

Letters of Credit/Guarantees and Co-acceptances- Opening / issue of Letter

of credit and bank guarantees, co-acceptance of bills without proper

authority and consideration, issue of letter of Credit/ bank guarantees without

recording in the branch books,

Foreign Exchange- Frauds in foreign exchange transactions through non-

adherence of RBI’s prescribed norms and procedures like acceptance of non

resident deposits through middlemen and thereafter allowing/availing of

overdraft against fraudulent discharge of these deposits receipts by forgoing

power of attorney and loan documents of third parties without proper

identification/introduction,

Credit Portfolio- Misutilisation/overstepping of lending/discretionary powers

and non observance of prescribed norms/ procedures in credit dispensation,

submission of false stock/ financial statements to avail of finance,

clandestine removal of goods hypothecated and siphoning of sale proceeds,

manipulation of stock and financial statements and financing against

accommodation bills,

Clearing operations-Collection of an instrument in the accounts of a party

other than its payee, Withdrawal of full amount before realisation of proceeds

and subsequent failure of the party to make good the amount of the

instrument is received back dishonoured, Failure to send the instrument to

the drawee branch, Destruction of the instrument while in transit or at the

drawee branch, Availing the ‘withdrawal against clearing’ facility against

instruments known to have been drawn without funds, One party and its

associate or two different parties having accounts in two branches indulging

in kite flying operations.

Others -Raising unauthorised debits on nominal heads of account,

manipulating and tampering with the books of accounts by passing

unauthorised entries, issue of pay orders/demand drafts without

consideration, fake documentation, Unlimited computer access provided to

vendors and staff not related to the computer operation etc.

3.3 Opportunity-Lack of job knowledge, Non-compliance of system and procedures,

Non-balancing of books, Non-reconciliation of clearing and inter-branch accounts,

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Good model,Bad people

Good model,Good people

Bad model,Bad people.

Bad model, Good people.

Lack of safe keeping of critical stationery items, Casual approach to security alertness

and Poor monitoring of branches by controlling offices provide opportunity to

unscrupulous elements to commit fraud. 4. Quality of management- Every organization has business model, which guides its

business policies. These models are not

fortuitous, but are often chosen by design

and predilection of the person behind the

project. There can be good business

model run by good people; bad model run

by bad people; bad model by good people

and good model by good people. The

quality of model and people running it is

function of quality of management and

ethics and integrity of the people

managing it. While we have business model run with greed, fear, lust and selfishness

like Ramalingraju’s of Satyam, Kenneth Lay’s of Enron, Robert Maxwell’s of Maxwell

communication Corporation and Harshad Mehta of broking firm , we have business

model run by visionaries, patriots and great entrepreneurs.

5. Objective of the Vigilance- The broadly the vigilance aims to achieve the following

objectives-

(a) Checking/preventing fraud and forgery,

(b) Protecting honest employees,

(c) Punishing dishonest employees,

(d) Simplification of the system and procedures,

(e) Review of system and procedures to plug loopholes,

(f) Bringing about fairness and purity in service,

(g) Bringing awareness among employees to create a corruption free

organisation /society.

6.Vigilance Management- Vigilance activities can be grouped under following heads

from management perspectives-6.1.Educative Vigilance – Educative Vigilance aims to achieve awareness of

rules and regulation, system and procedures etc. among employees. This is

done by conducting training and seminar on vigilance management and by

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highlighting importance of vigilance through articles in house-magazine on

various aspects of vigilance management.

6.2 Preventive Vigilance- It is better to prevent and prepare than to repent and

repair. The objective is achieved by creating alertness and foresightedness

among employees to prevent fraud and forgeries and by creating a sense of

responsibility among employees to observe system and procedures. It is a most

important approach of the Vigilance Management as it treats the cause of

disease rather than to treat the disease.

6.3 Detective Vigilance-This refers to detection of fraud and forgery through

investigation. The objective is to ascertain the causative factors, which facilitated

perpetration of fraud and to identify the persons responsible for the same. It aims

to fix accountability and to initiate measures to recover the involved amount.

6.4 Punitive Vigilance-This refers to process of initiating disciplinary action by

issuing show cause notice & charge sheet, conducting enquiry and awarding

punishment as per disciplinary and appeal regulation of the bank.

7. Preventive Vigilance Action Plan- “ Prevention is better than cure” is an old saying.

Hence, all out efforts should be made to create vigilance awareness among employees

to prevent occurrence of fraud and forgeries. The action plan for preventive vigilance

comprises of the following-

7.1 At corporate level-(a) Recruitment of officers/employees should be carefully verified;

(b) All employees handling various duties should be made aware of the essential

safeguards, which should be observed in the discharge of those duties;

(c) The duties and responsibilities of employees should be clearly laid down

through job cards, instruction manual, computer security policy etc.

(d) The principles of dual custody and concept of checker and maker should be

observed at all times.

(e) All the officers/employees should be transferred at prescribed intervals and

bank must insist on their going on leave periodically.

(f) Monitoring and scrutiny of control returns to find out deviation/non-

compliance/over-stepping of lending /non-lending authority, checking of

unusual variation in deposit/advances & non personal/revenue heads in

weekly, monitoring position of balancing of books, reconciliation of inter-

branch /inter-bank accounts/cash movement etc.

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(g) Posting officers of suspected integrity at non-sensitive assignments.

(h) Scrutiny of Assets and Liability Statement of officer employees.

(i) Causing Surprise Vigilance Inspection at Fraud Prone branches.

(j) Surprise visit of branches by Controlling Authority.

(k) Review of System and Procedure in the light of fraud cases and modification

of the system and procedure to contain frauds.

(l) Conducting regular inspection/concurrent audit/revenue audit/ statutory

audit/system audit/computer audit etc. at branches and following up

rectification of irregularities.

(m) Encouraging and praising performance of individual/branches when frauds

are prevented.

7.2 At branch level-(a) To ensure meticulous compliance and observance of systems and

procedures.

(b) Regular and timely submissions of control returns/ inter branch schedules.

(c) Reporting irregularity in borrower accounts including excess drawings,

drawings against uncleared effects etc. to controlling authority regularly.

(d) Compliance/rectification of Inspection and Audit reports.

(e) Implement job rotation policy of both officers/employees.

(f) Regular reconciliation of inter bank accounts, clearing accounts and doing

regular balancing of books and not allowing any voucher, register, ledger to

remain unchecked by officials/Special Assistant.

(g) Doing rotation of balancing work among employees.

(h) Keeping an eye on life- styles of subordinates. The cases of living beyond

known sources of income must be closely examined and reported to higher

authorities confidentially.

8. Preventive vigilance in computerized branches: - e-Security has become a

center-stage of concern for bankers due to various reasons such as lack of

knowledge of IT security, fear of loss of public faith in case of system break- down,

fear of financial loss due to IT related frauds etc. According to India Fraud Survey

report 2006 brought out by KPMG, financial sector susceptibility to fraud risk and

Indian corporate preparedness to address fraud is very low. It, therefore, calls for an

286

Fraud in Home LoanYear A/C Amou

nt @2002-03 236 282003-04 456 702004-05 H1

380 50

@ Amount in crores

effective preventive action to avoid fraud and forgeries in computerized set up.

Suggestive steps can be as under: -

(a) To ensure compliance of IT security measures in computerized and network

branches as per IT security policy of bank.

(b) To observe principle of ‘least privilege’ and that of ‘maker and checker’.

(c) To do job /duty allocation by proper office-order/memorandum.

(d) To observe proper physical security control such as to keep computer screen

out of sight of visitors, to keep server locked with minimum access, do not

allow visitors into work station area and do not leave computer without

logging out.

(e) Educate people about physical security and tell them that they are part of

security chain.

(f) To check active user list and check that there is no unauthorized user.

(g) To ensure that no single user is allotted more than one password.

(h) To educate employees to keep the password secret and change it

periodically as per norms.

(i) To allow access to the system to soft ward and hardware vendor through

authorised ID/Password and keep an eye on their work.

(j) To follow disaster management and business continuity plan.

(k) To check that time off mechanism is active.

(l) To do data consistency check periodically.

(m) To create e-security consciousness among employees.

9. Retail Loan and Preventive Vigilance- Of late fraud and forgeries in retail loan are

on rise. (See box) Even in housing segment

where banks draw comfort by way of security,

there are instances of multiple financing against

fake title deeds and impersonation. The

fabrication of income documents, balance sheets

etc. are common modus operandi to defraud

banks. Other common modus operandi is misuse

of loan in connivance of builder/dealers. The preventive vigilance is an important tool

to check such fraud and forgeries. This helps the banks in creating alertness,

foresightedness and a sense of responsibility among employees.

287

10. KYC- as a tool of Preventive Vigilance- RBI has been reiterating the extant

guidelines and instructions on KYC from time to time to prevent frauds. These

guidelines pertain to identification of new customers- both individual/corporate,

establishing identity of the customers by obtaining PAN, driving license voter identity

card etc., implementing process and procedure to monitor transactions of suspicious

nature in accounts, conducting due diligence and reporting of such transactions,

obtaining credit report of borrowers dealing with other banks before making

advance/taking over accounts, obtaining report of overseas exporters/sellers in

respects of high value imports, etc. The RBI has recently reiterated following

guidelines for strict compliance by the banks -

(a) To do customer identification before opening account either through

introductory reference or through documents such as voter identity card,

PAN, passport, driving license etc.

(b) To obtain photograph of the customers both in deposit and loan accounts.

(c) To record cash transactions –both deposit and withdrawal -of Rs. 10 lakhs

and above in a separate register and to report such transactions including

any other suspicious transaction to controlling office.

(d) To obtain PAN for issuance of travellers cheques, demand drafts, mail

transfers and telegraphic transfer above Rs. 50,000/-.

(e) To ensure compliance of Foreign Contribution Regulation Act 1976 while

opening accounts or collecting cheques by insisting to account holder to

furnish certificate of registration with the GOI.

(f) To train/educate staff for anti money laundering guidelines and implementing

KYC policies consistently.

(g) To ask concurrent auditors/internal inspector to check and report compliance

of KYC norms.

11. Role of Ethics and Value. Ethics and values play a major role in preventive

vigilance. Ethics is framework of values for moral behaviour. It is a code of conduct

for individuals which prescribes do and don’t of doing business. In business of

banking, the essence of ethics lies in integrity and honesty. The current debate on

“Corporate Governance of banks “ is based on growing realization that bank must

not do any illegal or unethical things. The age-old concept of “Honesty is the best

policy” is still a useful and practical guide for survival in this material word. Following

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versus from the Kural, Tiru Valluvar translated in English by Dr. C Rajagopalachari

are relevant :-

(a) Avoid at all times action that is not in accordance with the moral law;

(b) Those who seek to be great should refrain from

everything that might tarnish their good name,

(c) Do not do that which good men would condemn;

even if it means helplessly looking on without

finding food for your starving mother;

(d) Success achieved without minding the

prohibitions of the moral law brings grief in the

wake of achievement;

(e) To seek to further the welfare of the state by

enriching it through fraud and falsehood is like

storing water in an unburnt mud pot and hoping

that it can be preserved.

12. Preventive Vigilance Actions Points- Preventive vigilance action points in fraud

prone areas in credit as well as in operation are given below-

(a) PREVENTIVE VIGILANCE IN LOANS- IMPORTANT ACTION POINTS

Retail Loan Type – Committed by

Nature of Frauds Preventive Vigilance Measures

1) Housing

Loan -

Committe

d by direct

selling

agents /

real estate

Fabrication of income

documents like salary slip,

balance sheet, income tax

return etc.

Verification of salary slip with the

employer.

Salary slip should be crosschecked with

bank statement.

Cross Verification of Balance sheet with

bank statement.

Interview of the borrower to cross check

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‘Do not do that

which your better

sense tells you that

you will afterwards

regret. But if you

have done such a

thing it is well you

at least decide to

refrain from such

folly again.’

agents

/builders

details.

2) Housing

Loan –

Committe

d by

direct

selling

agents/

real estate

agent

/builders /

borrowers

Including income by way of

agriculture, tuition,

coaching, etc to inflate loan

amount .

Agricultural income can only be

considered if it is supported by land

record and income is reported in

income tax return though not taxed.

In case agricultural income is

considered, installment should coincide

with harvesting of crop.

Other income like coaching, tuition etc.

should reflect in income tax return.

3) Housing

Loan –

Involveme

nt of

middle-

men

Disbursed cheques/ drafts

were collected by third party

through fictitious accounts.

Money is withdrawn later

Cheque should be issued in the name

of the banker to builder with bank

account no.

Cheque should not be handed over to

the borrower or to the middlemen. It

should be delivered by hand to builder

at the address recorded in the sale

deed. 4) Housing

Loan -

Stamped

document

s forged

by

customes/

builders.

Coloured Xerox of all

documents with fake

stamps submitted- difficult

to identify/distinguish with

genuine one.

Tracking and sharing of information

among banks about black listed

builders.

The title deeds to be handed over to

advocate by bank only and all his

queries should be routed through bank

only. The fee will also be paid through

bank.

Bank officers should verify genuineness

of the documents independently

through their own advocates/solicitors.

In case of large value loans, bank can

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approach sub-registrar to verify the

genuineness of title deeds/other

documents.

5) Housing

Loan-

Over

valuation

of

property

by

builders /

valuers

To draw higher loans in

connivance with builders.

The value is inflated by

including value of additional

amenities, fixtures, legal

charges, society advance,

maintenance charge etc.

For valuation report over Rs. 25 lacs,

two independent valuers should do it.

Government should introduce certificate

course for approved valuer.

Banks should develop in house

expertise for valuation of properties.

Bank to obtain indemnity from valuer

while approving them so that

unscrupulous valuer can also be made

liable of losses of banks.

6) Housing

Loan-

Multiple

Financing

Fabrication (fake) of

documents that are

produced to different bank

and financial institution to

commit fraud.

Tracking and sharing of information

among banks and housing finance

companies about black listed builders.

Agreement to sale and documents of

title should be in demat form.

(PROPOSED)

Bank/ FI should insist on original

documents of title deed on which

structure is built.

7) Housing

Loan -

Cancellati

on of

booking of

flat/apartm

ent in

collusion

between

customer

and

After availing loan the

booking is cancelled and

loan is refunded to the

borrower directly.

Credit Rating of Builders by CRISIL

should be made mandatory

Bank should check past track record,

financial viability, project execution

capacity, clear titles, customer

satisfaction of previous projects and

technical competence of the builders.

Registration receipt issued by Registrar

of assurance should bear hypothecation

clause. (PROSPOSED)

Bank should obtain tripartite agreement

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builder. with builder bank and borrower stating

that if booking is cancelled, the money

will be refunded to bank only.

8) Housing

Loan -

Sale of

property

by loanee

without

clearing

existing

loan.

Property sold through

duplicate or fake title deed

even though the original

legal title deed is with the

bank.

Banks to represent to RBI and GOI to

enact legislation for creation of

Equitable Mortgage in the office of

registrar of assurances.

Credit Rating of the Builders/realtors

should be stipulated as terms of

sanction.

Internal due diligence like inspection of

property plays crucial role in preventing

such frauds.

9) Housing

Loan -

Misrepres

entation of

end use of

loan

Loan taken for residential

house but commercial

property is constructed.

Banks officer to verify end use of loan in

addition to verification by

architect/engineer as per system.

10) Housing

Loan -

Sale of

property

by builder

without

clearing

dues of

financing

bank/FI.

Builders sold

constructed/semi-

constructed houses but did

not pay the dues of

banks/FI raised for

constructions of the

building.

Construction/ funding of loan should be

closely supervised.

Original title documents should be

called for appraisal at the time of

sanction of loan.

Bank to keep eyes on builder and seek

information for sale of flat/houses on

regular basis.

11) Car Loan-

The

middlema

n, car

Misrepresentation of end

use of loan

Follow KYC for identification and

verification of customer’s profile and

ascertain genuineness of

paper/documents tendered.

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dealer and

proponent

s

connived

in

misutilizati

o-n of the

loan.

Margin money should be realized

through account or by cheque.

Car financing should be through

approved dealers only.

12) NRI

Deposits -

frauds

NRI cheated by

unscrupulous brokers who

gave them forged/altered

FDR, availed loan through

power of attorney without

borrower’s consent.

Publicity voucher- no agent can solicit

deposit.

Follow KYC guidelines.

Follow procedure for opening and

operation of the account-verify

signatures with care & verify the

genuineness of the loan application.

Hand over FDR to depositor only or

send a registered AD letter to depositor

having handed over FDR to authorized

person. Do not hand over FDR to third

party without authority.

Follow prescribed procedure for

sanction and disbursement of the loan.

PA-Operations can be permitted to

resident on the basis of PA for

withdrawals for local payments. Also

subject to RBI permission local resident

can make payment for investment on

the basis of PA. Loan through PA -

Satisfy fully about genuineness of the

documents.

No third party advance against NRE

deposit on the basis of P. A. can be

allowed.

13) Opening LC opened against 100% KYC- knows your customer’s need

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Letter of

credit-

Imports

cash margin for the

customer keeping current

account only. Bank felt no

need to look into borrower’s

need, reliability and why

customer has not

approached his banker from

whom he was availing

regular credit facilities.

100% cash margin was

taken as comfort for not

appraising the proposal

properly.

reliability and ability- check that he is

engaged in the same trade.

Do not normally open LC for customer

who are not availing credit facilities and

only maintaining current account. In

case customer is availing facilities with

other bank, ascertain reason of not

availing facility with that bank before

opening letter of credit.

Make thorough scrutiny of the LC

proposal like a credit proposal.

Satisfy that importer will be able to retire

bills including payment of custom

duties.

Validity of import license, identity etc. to

be proved reasonably.

Large value imports- obtain credit report

of overseas seller from overseas banker

or reputed credit agency that exporter is

engaged in purchase/sale of goods

sought to be exported to India and is

good for ordinary business

engagements.

14) Negotiatio

n of bills

under

Inland

letter of

credit

Branch negotiated bill

drawn against letter of credit

without confirming

genuineness of the letter

of credit.

Branch should seek confirmation of the

authorized signatory on the letter of

credit from or nearest source of issuing

bank before negotiating bills.

Confirmation must be obtained through

bank’s own accredited official and not

through the beneficiary or any other

third party.

Follow KYC -verify antecedents,

business records, financial health and

reputation of the party.

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15) Imports

Bills –fake

Bank made FX remittance

against forged import

documents-documents

included import license,

EXIM scrip, EC copy of bill

of entry, Airway bill,

Certificate of origin etc.

Same custom and clearing

agent in all bills-bank raised

no query. Partial remittance

was made against each

license and small balance

remained undrawn- License

was returned to importer –

hence none of the original

license reaches RBI with R

returns.

Risk of fake bill is higher in import bills

received on collection basis. Hence

follow KYC rigidly.

Check business bonafides of your

importer customers.

Direct bills received by importer from

overseas sellers- exercise caution.

Importer bills by buyer banker through

seller banker only- exception upto US$

25000 provided BM is fully satisfied by

financial standing and past track record.

Non-existing imports – Manager to

exercise caution through various means

such as (a) Indian customer banking for

a reasonable long time. (b)Customer

has availed credit facilities from the

bank. (c) Bank has any time in the past-

examined balance sheet of the

customer. (d) Customer is an

established dealer/trader/user of the

imported goods. (e) Place of the

business, godown etc. has been visited

by bank’s officials (f) Sales are routed

through account.

In case of doubt, bank should ask for

detailed verification importer’s book of

accounts, inspection of place of work,

enquiry with business customers to

check business bonafides, and

comprehensive opinion report from

bankers of overseas seller.

Proof of imports-obtain bill of entry-

counterfeit bill of entry in case of fake

import- do careful scrutiny- Check

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inconsistency/inaccuracy to verify

genuineness-send few bills of entry to

custom and seek confirmation- keep

correspondence on record for

verification by RBI/auditors.

16) Fraud

through

exports

bills

Export bills supported by

fictitious materially altered

documents- availed packing

credit by inflating stocks-

availed advances against

false/altered cash incentive

claims-availed large credit

without valid documents-

Borrower dealing with the

bank for over seven years-

earned confidence of the

staff- he was himself taking

the documents to FX branch

and than taking back

documents to be sent by

their courier.

Verify that documents represents

genuine transactions- carefully verifies

RR/MTR/BL to check that it is genuine.

Verify standing and creditworthiness of

the borrower and his prospective buyer.

In case of Pre-accepted bills –

confirmation should be obtained from

the drawee (buyer).

See that bill facility is not

disproportionate to the business need of

the borrower.

Observe usual safeguards such as

verifying documents, see approval of

the carrier, follow up remittance of the

overdue bill.

17) Fake

guarantee

The guarantees were

issued (a) by misusing the

round seal and letterhead of

the bank (b) by forging the

signature of the bank’s

officials and (c) by bank

officials without recording in

book of accounts. The firm

met it obligation, hence

there was no question of

invocation of the guarantee.

After fulfillment of the

contract, the guarantees

Conduct proper pre credit appraisal to

ensure that the customer is in a position

to discharge guarantee in case it is

invoked. Bank should refrain in issuing

guarantee for those who are enjoying

credit facilities with other bank.

All guarantees must carry branch code,

date and serial number of the

guarantee.

Proper recording in books of account

should be done including passing of the

liability voucher.

Guarantee should be issued only under

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were returned to

beneficiary. The

government department did

not verify the genuineness

of the guarantees from the

bank.

signature of two officials.

Paragraph for seeking confirmation

from controlling office should be added

in guarantee bond or otherwise

guarantee should accompany a letter

from bank advising the beneficiary to

seek confirmation from controlling office

of the issuing bank.

(b) PREVENTIVE VIGILANCE IN BANKING OPERATIONS-IMPORTANT

MEASURES-

Sl.no

Fraud prone areas Preventive vigilance measures

18) Fake entries in GL to adjust

unauthorized clean advances

by using others passwords.

Password should not be shared.

No one should be given more than one password

and ID.

Maker and checker concept should be

implemented.

Manager should check audit trail of transactions

daily.

19) Alteration in sanctioned limit

by using some one else

password.

Keep the password secret.

Follow maker and checker norm.

Manager or DBA should check active ID list

periodically.

Manager should check non-financial audit trail.

20) Transfer of balance to other

account by using staff

password by the software

vendor.

Software vendor should be allotted separate

password and in no case manager or DBA

should allow him to use his/her password to

access the system.

Proper record of long in and log out should be

maintained.

As soon as vendor finishes his/her work, his/ her

ID should be disabled. In case of need in future,

ID can be restored.

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Data if required by the vendor should be sent to

company’s head office directly by branch through

floppy mailer.

21) Misappropriations of cash

showing it in transit or

keeping fewer notes in

packets.

Manager should observe dual custody norm

carefully. They should not share their keys with

others.

Manager should verify cash each day and do

sample checking of cash packets before cash is

finally closed.

Duplicate set of keys must be properly lodged

with the other branch/bank.

Officers unconnected with its custody should

periodically verify cash.

22) Parallel banking-

misappropriation of cash

deposited by the customers

by the cashier.

Pre scrolling norms must be followed

meticulously. Cash department should not accept

cash unless pre scrolling is done.

A notice should be displayed in the branch

prominently in cash counter stating that (a) cash

should be deposited at the cash counter only and

during business hours and (b) customer should

ensure that counterfoil of the pay in slip is

countersigned by the Head Cashier/Officer above

thresh hold limit say Rs.3, 000/- in addition to the

signature of the receiving cashier.

Do job rotation of cashier as per extant rules.

23) Forged withdrawal in

inoperative and dormant

Accounts- Instances of

replacing signature cards by

forged card also reported.

Signature cards of all inoperative accounts

should be kept separately in joint custody.

Withdrawal in dormant/inoperative accounts will

not be allowed without permission of branch

manager, who will satisfy that transaction is

genuine and is in order before granting

permission.

In case of doubt the account holder should be

contacted over phone or in person before a

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withdrawal is passed.

24) Fraud through forged or

chemically altered drafts and

mail transfer.

1. Follow normal precautions for opening and

operation of the account in which draft is

collected. Also follow KYC norm of issuing draft

above Rs. 50,000/- either through account or by

cheque (NOT AGAINST CASH) and to obtain

PAN.

2. Draft issuing branch should follow following

precautions-

(a) Exercise care by issuance of draft on

proper series and Issuance of Non-MICR

drafts on MICR centers properly.

(b) Observe system of using reverse carbon

paper on back of draft

(c) Observe procedure of putting slash

(transverse line) marked after each word

while writing amount in words.

(d) Observe system of writing the words

under rupees.

(e) All cuttings or over-writings should be

authenticated without fail.

(f) Do punching of cages in draft and affix

transparent adhesive sticker on amount in

figure.

(g) Officers should to take care to put stamp

of authorized signature number below

signature of authorized officials in draft or

advice.

(h) Affix account payee crossing

(unless otherwise requested by the

customer).

(i) Dispatch draft advice to paying branch on

the date of issue it self.

(j) Small value drafts of Rs. 100 or below –

299

fully satisfy about identity of the purchaser

and genuineness of the purpose.

3. Paying branches should follow following

precautions-

(a) Check that draft is complete in all respect

with regards to its contents and text. High

value draft should be subject to closer

scrutiny and passing by at least two

officials.

(b) Overwriting and cutting must receive due

attention. In case of doubt, issuing branch

must be contacted.

(c) Authorized signatures must be

checked/verified very carefully. In case of

doubt, issuing branch must be contacted

before draft is paid.

(d) Check reported loss series without fail

before a draft is passed.

(e) In case of large cash payment, exercise

due care and diligence.

25) Opening of new accounts in

fictitious name and then

withdrawing therefrom the

proceeds of cheques, drafts,

dividend warrants etc.

deposited (which may be

forged or materially altered).

Prospective account holder should visit

personally for opening the account (where ever

possible) and where there is no face to face

contact proper care to be taken while dealing with

such customers so that identity is verified to the

satisfaction of the bank. Account opening

formalities should be completed in bank’s

premises and the documents should not normally

be taken out for execution.

Where it is absolutely necessary to make

exemption of the above rules, banks may take

precaution such as deputing an officer to verify

the particulars, obtaining signed photograph on

suitably formatted verification sheet, forwarding

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by registered acknowledgement due mail a copy

of account opening form and accompanying

instructions to the client for necessary verification

before any operation are conducted in the

account.

Customers should establish identity through

Electoral card, Identity card, Passport, Driving

license, Credit card, Sales Tax No., PAN no, and

information should be corroborated from

independent sources. Also Obtain recent

photograph (no photograph is required for term

deposit up to Rs. 10,000/- . Obtain and record

PAN number.

Account holder having satisfactory SB/CT

account for at least 6 months can introduce new

accounts. The introducer, except under

unavoidable circumstances, should sign the

account opening form in presence of the bank

officials. Introduction should not be treated as

formality but as a measure of preventing opening

of fictitious accounts.

Complete mailing address of the account holder

should be obtained. Obtain confirmation of

address of account holder and introducer by

sending letter of thanks under Registered

acknowledgement due post. Do not issue

checkbook unless address of account holder and

introducer is confirmed. Only cash transactions

should be permitted till address of introducer or

account holder is confirmed.

Obtain information regarding purpose of opening

of account and likely amount and kind of

transactions intended. Prepare a risk profile of

customer as per KYC norm.

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Follow “Care new Accounts” for cash

deposit/transfer / Withdrawal etc.

26) Collection of cheque, drafts,

and dividend warrants etc. in

accounts of the party other

than its actual payee. Also

indulging in kite flying by

granting accommodation

against uncleared cheques.

If the account is opened after the date of

instrument intended to be deposited in the

account, address indicated on the dividend

/interest warrant/refund orders must be

independently verified with that recorded with the

branch to ensure genuineness of the instruments

and person depositing it. In case address is

mentioned the depositor should be asked to

tender its counterfoil to verify the address.

Account payee cheques should be collected only

for the named payee and not in third party

account.

Internal inspector should specifically be asked to

look into advances allowed by the manager

against uncleared effects and furnish comment in

their inspection reports.

Computer operations should be checked to

ensure that effects are cleared only as per

clearing cycle in consistent with time prescribed

by the clearing house.

27) Fraudulent withdrawal by

obtaining new cheque book

on false ground through

forged requisition slip or letter

forging the signature of the

account holder.

Request of fresh cheque book should be

examined carefully. It should be checked that

requisition slip is genuine and belongs to the

cheque book issued to the account holder earlier.

In case of delivery of chequebook to a third

person, the signature of the person authorised to

collect chequebook should be confirmed on

requisition slip. An intimation cum

acknowledgment letter should be sent to the

account holder at the recorded address if the

chequebook is delivered to third party.

In case chequebook is sent at new address by

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post at the request of the account holder, the

intimation of having sen5t the chequebook at new

address should also be sent at old address.

Proper care about custody of passbook should

be taken. In branch undelivered passbook should

be kept in a box under lock and key.

Banks may fix internally some limit of cash

payment and in case cash payment exceeds

these limits, due precautions should be taken

before cash payment

-0-0-0-

Chapter-34

Security Issues in Computerized Environment“The cyber crime world is thriving and is among the largest illegal revenue

earning industry today.”- Vallier Mc Niven- US Treasury Advisor

-1. Introduction1.1 Paradigm shift in Banking: Computerization has brought in advantages in terms of

reach, efficiency, convenience, speed and economy in banking through host of e-

banking solutions like ATM, Mobile banking, Internet banking, Tele-banking, Electronic

Clearing System, Electronic Fund Transfer, Payment of Utility Bills etc. This has made

any time anywhere and anyhow banking possible. About 95.1% of business of Public

Sector Banks is now computerized.

1.2 Information Technology Act, 2000: India has already been ushered into the IT

revolution by enacting the Information Technology Act, 2000. The Act has put in place

law for electronic contract made on electronic medium, addressed the legal requirement

of electronic record keeping and has clearly defined rights and obligation of all the three

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CII-PWC Information System Security Survey

Who determines security policy?

India Global

CIO 43% 57%IT Manager 30% 52%President 33% 41%Security Management

10% 41%

CFO 10% 15%Security Administration

10% 41%

Information Security Officer

13% 35%

Consultant 5% 17%Others 5% 30%

important parties of eContract viz. the originator, the addressee and the intermediary.

The act has created Certifying Authorities (CA) and new arena of public key and private

key. This has paved way for growth of eBanking in India by addressing to various

security and legal issues. The Act has also laid down laws for cyber-policing for safety

of netizen such as it empowers police officers to enter and search public places, like

cyber-cafes without a warrant and arrest suspects when they believe that a cyber crime

is being committed.

1.3 e-Record Management- Recording the business transaction in the electronic form is

fast emerging as an alternative to physical records due to its advantages in terms of

convenience and functionality over paper based record and its legal recognition by IT

Act 2000. To facilitate legal acceptance of electronic records of banks, Negotiable

Instrument Act 1881, Indian Evidence Act, 1872 and Bankers Book Evidence Act, 1891

have also been amended. Amendment in NI Act has included electronic cheque in the

definition of cheque and defined ‘truncated cheque’ for electronic clearing. Amendment

in Indian Evidence Act, 1872 has enabled production of electronic record such as

computer output, whether paper print or information stored, recorded or copied in optical

or magnetic media produced by a computer as evidence in court of law. Further as per

amendment in Bankers Book Evidence Act, 1891 all bankers book like ledger, long-book

and day book now include both physical as well as electronic record.

2. e-Security 2.1 Cause of security concern: Any time anywhere banking has opened risk of any

time anywhere fraud. Boundary less banking has

no law to deal with cyber criminals. e-Security has

now become a centre-stage of concern for

bankers due to various reasons such as lack of

knowledge of IT security, fear of loss of public faith

in case of system breakdown, fear of financial loss

due to IT related frauds etc. Ernst & Young’s

Global Information Security Survey 2002

conducted across 17 countries says that 70% of

Indian Chief Information Officers (CIOs), IT

Directors and Business Executives surveyed

indicated that they expect to experience greater

vulnerability as connectivity increases. It is

304

therefore necessary to put in place an effective IT Security Management Policy (Who

determines security policy?- (see box) so that bank employee can better accept, under

stand, monitor and manage IT related risks. This also means more investment in

employee’s education through training.

2.2 Computer Frauds-Defined: Fraud is defined as an intentional or deliberate

perversion of truth in order to gain an unfair advantage. Financial fraud is intentional or

deliberate act to deceive other persons who suffer a financial loss. Computer frauds are

committed by an unauthorized user (whether insider or outsider) to the computer

networks for causing economic or financial gains to the user or for an economic or

financial loss to the information system (i.e. hardware, software and data) owner (i.e.

bank).

2.3 Types of fraud: The most important types of computer fraud are through

manipulation of input, manipulation of output, or throughput of a computer system. While

in input manipulation, input data such as deposit amounts in ledgers, limits in accounts

are changed; output manipulation is achieved by affecting the output of the system, such

as use of stolen or falsified cards in ATM machines. Throughput manipulation could be

by way of rounding off sums credited to different accounts and siphoning of the rounded

digits to another account. Other types of computer frauds could be by way of

unauthorized access to computers by hacking into systems or stealing passwords,

deliberate damage caused to computer data or programs through Trojan Horse or Logic

Bomb, computer forgery (changing of data or images stored in computers) and

unauthorized reproduction / modification of computer programs. Recently, customers of

a bank received email asking them to provide required data for verifying account

information and many of the customers who responded by giving their PIN number and

password realized later that it was a Spam mail from unknown fraudsters. In another

reported case a Chinese national hacked into 21 online accounts at Singapore Bank

DBS, transferred $ 35,000 into his account, withdrew the money at a bank branch and

then fled to neighboring country Malaysia. It is believed

that hacker might have used a Trojan horse

programme to capture user keystrokes to learn

identification codes and pass words.

2.4 Role of Insiders: As per study conducted by

STANDARD RESEARCH INSTITUTE (1991-97) the

outsiders committed only 13% frauds whereas internal

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STANDARD RESEARCH INSTITUTE (1991-97) SURVEY1. The outsiders committed

only 13% frauds.2. Internal people like users

Committed 37% and system people committed 26% of the frauds.

people like users committed 37% and system people committed 26% of the frauds. This

indicates that disgruntled employees like operators and system administrators commit

most of the frauds. The reason is that these insiders have a good understanding of the

systems and weaknesses in controls and hence are in an advantageous position to

exploit the loopholes easily. Other important reasons of computer frauds are lack of

knowledge, alertness and awareness among employees, laxity in implementation of

security policies, non-compliance of system and procedures, improper allocation of

duties, weak security features of the software and negligence on the part of users

(employees) in password management and in conducting data consistency checks.

2.5 Risk management and IT: -The operational risk is generally associated with failure

of man, machine or the system. With more and more reliance on computer in banking

operation, IT related operational risks have increased. The operational risks are (a)

Error Risk (error made during development/modification of computer program, simple

error in data entry and misuse of tool/facilities resulting into inaccuracy of data, (b)

Computer fraud risk (such risks are more when security and control system is not

properly implemented), (c) Disclosure Risk (accidental or intentional disclosure of

customer’s information is possible, and (d) Interruption Risk (due to failure of the

computer system). With this background, the Basel Committee II has advised banks that

all risks arising out of electronic banking should be recognized, addressed and managed

by banks in a prudent manner.

3. Implementation of IT Security Management: -3.1 IT Security Management –Best Practices: - Best practices are set of

commercially proven approaches to IT security

management that, when used together, strike

at root cause of security problems. The

application of these best practices in a unified

manner helps the banks in designing its

security policy in effective and integrated

manner. 3.2 IT Security Management-Principles:- IT

security management in bank has been

established on the two basic principles, the

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TIPS ON LOGICAL ACCESS CONTROL

1. Check active user ID to ensure that all users ID are authorized one.

2. Do not allot more than one ID to one user.

3. Educate employees to keep the password secret and to change the password periodically.

4. Assign ID & password to hardware and software vendors and keep a close watch on their activities.

5. Do data consistency check periodically.

6. Inspector/Auditors to check compliance IT security measures.

9. Job rotation, delegation of job, checking of reports, assignments of level etc. must be done as per laid down system and procedures.

10. Follow disaster management system.

TIPS ON PHYSICAL ACCESS CONTROL

1. Do not allow visitors into workstation area.

2. Keep computer screen out of sight of visitors.

3. Keep server locked with minimum access. It should be vacuum cleaned and mopped with wet cloth.

4. Do not leave computer without logging out.

5. No smoking in computer/server room. Install Halon based fire extinguishers

principle of ‘least privilege’ and that of ‘maker and checker’. The principle of least

privilege means that user is given access to the

system strictly on the ‘need to know’ basis and

is given only those rights to access data and

programs, which are in line with his duties (job

allocation) and responsibilities. While giving

lesser rights than required may decrease the

efficiency of working, giving more rights has

associated risks of misuse or possible frauds.

Here underlined objective is to keep the

knowledge of the officials handling the computer

transactions limited to their functional

responsibility so that possibility of such officials

causing the security risk is minimized. The job /duty allocation should be done by proper

office-order/memorandum so that there is clarity in responsibility on one hand and

proper record is kept on the other hand for future reference. The principle of ‘maker and

checker’ means that for each transaction, there must be at least two employees

necessary for its creation and validation. While one may create a transaction, the other

should be involved in confirmation or authorization of the same. In this way, the system

exercises dual control in recording / committing transactions.

3.3 Physical Access Control and the Hardware management - The first step in

prevention of frauds in computerized systems involves setting up of proper physical

access control on the hardware. The physical access control means physical protection

and access control of computer and network systems and the devices. Physical controls

are further divided into preventive and detective physical control. Preventive physical

control shall include access control through security guards, installation of code locks,

smart card driven door opening devices or modern biometrics devices (which control the

access on the basis of certain individual characteristics such as finger-prints). Protection

to peripheral units (terminals, printers, and modems) can be provided by keeping them in

room and allowing/restricting physical access only to authorized persons. Detective

physical controls include smoke and fire detectors, closed circuit television, sensor and

alarms. No smoking in computer/server room should be permitted and appropriate type

of fire extinguishers should be installed to have protection from accidental fire. Control/

supervision is also exercised on taking out computer devices or tape/diskette by the

307

vendor for maintenance as it may carry important/sensitive data, which may be misused.

Lastly all employees should be educated about physical access control as they are

important element of security chain.

3.4 Logical Access Control and the Software management –If software is

outsourced, it is first customized after due requirement analysis and design control. A

quality audit is also conducted by a reliable software-testing agency. To put in place

logical access control system (i.e. controls over operating systems, database systems

as well as application systems) each user is allotted an USER ID and a PASSWORD as

per his job hierarchy (such as branch manager, DBA, officer, operator, auditor etc.) to

limit his access to the system as per his powers (authority). DBA / branch manager must

periodically check from active user ID list that no unauthorized ID is existing in the

system and IDs of retired employees / transferred employees /deceased employees /

employees on deputation to other branches / employees on long leave have been

disabled. He should also ensure that not more than one ID is allotted to a single user.

Vendors should be allowed access to the system (where hardware and software has

been outsource) subject to proper log in and log out by allotting temporary user ID which

must be suspended/deleted immediately on completion of the job by the vendor. System

Auditors / Internal Inspectors should also do necessary checking while conducting

computer audit to ensure compliance of IT security guidelines.

3.5 Password Management:- The password is a key to commit a transaction in the

system and is a tool of access control. In prevention of frauds, proper password

management by the users is very important. The password management includes

password validation (a user is disabled after say three unsuccessful log in),

password aging (user is obliged to change password periodically say within 30 days)

and password qualification (password is made by mix of alpha, numeric and special (like

+, -, $) characters which can not be anticipated and deciphered by unauthorized

persons). Passwords are kept one way encrypted in the system, so that even a user

with higher rights does not know the passwords of other users. With an average

employee having 12 passwords every year, remembering them has become a difficult

job. The problem gets compounded when the same employee has to access multiple

systems and multiple servers for which he need to have number of passwords. No

doubt, if an employee forgets his password, he can approach the DBA/BM for another

password, but precious time is wasted in doing this exercise in which cost too is

involved. Hence software solution has been developed for an automatic password

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management system. The employee, who has forgotten his password, can log into the

system and can answer the question, which the system will ask If he identifies him-self

right, the system allots him a new password without any human intervention. The user

must be educated to keep his password strictly secret and in that process take all

possible precaution so that his password is not misused. In case it is felt that password

has been compromised, it should be changed immediately. In one reported case, the

perpetrator was able to change the borrower's limits by sharing the password of the

authorized personnel. This suggests that the password cannot just be treated as a

friendly word. This aspect in the Indian work culture needs to be closely looked into and

the system of password management has to be made foolproof. All staff/officers should

be advised that in case of misuse of the password they would be held accountable.

3.6 Data Consistency Checks- Software is designed to keep a chronological record of

the events occurring in the system (i.e. commands executed by the users, actions on

files, messages displayed by the system, resources consumption by the users,

transaction entry and security violations) in the form of audit trails. These can be

retrieved as and when required to know the details of the users. Hard copies of these

trails are also periodically taken, checked and filed for reference. The branch officials /

DBA has to carry out data consistency check as also other checks such as BALANCE

CHECK THROUGH SQL on regular intervals and any discrepancy, even if minor, should

immediately be documented for logical analysis and rectification. The branch in-

charge/DBA/ must ensure that access to SQL modules are made strictly as per office

order; audit trails of SQL access are printed and safely filed.

3.7 IC Check, Check Sum and Hash Total Check- Software solution usually contains

some simple but effective processes like IC check, check sum or hash totals to ensure

protection and integrity of data. DBA/ manager must check periodically that IC check /

check sum / hash total check is not disabled and is effectively used to check data

integrity and consistency.

3.9 Compliance of System and Procedures- The system and procedures as

prescribed by the bank such as assignment of duty through office order, job rotation,

passing of transaction singly /jointly as per delegated authority, recording of entry

number on the voucher, checking of financial and non financial audit trails, checking of

financial audit trails with vouchers, printing of month/quarter end reports etc, should be

meticulously observed. Branch manager must supervise compliance of these

instructions as is done in the manual system. The old disk/tapes should be erased /

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formatted and useless printed reports should be shredded as it may contain

sensitive/important information.

3.10 Additional Security Tools--In net-work environment the following additional

security tools are used- (a) Data Encryption-It scrambles the data before and during transmission and is used

as a tool for data protection. In case encryption is not done it is possible for the other

people to view the page when it is transmitted.

(b) Fire Wall-It is first line of defense from the outside. Firewall acts as security guard for

bank’s internal network, filtering all incoming traffic from the Internet or networking.

© Intrusion Detection System- (IDS)- It scans the net-work for abnormal activity,

unauthorized resource access and security breaches. It protects network from both

inside and outside access (d) Key Management-It acts like “key” to access encrypted data and affords maximum

protection to protect data from unauthorized parties. It is used in conjunction with

encryption to limit the number of eyes reading encrypted file.

(e) Digital Certificates:-It is an electronic identification card that establishes user

credential while doing Internet banking. It verifies the author of the message or if the

message has been tampered in transit.

(f) Virus Detection- It scans the network for virus-both prevention and cure.

(g) Security Solution- Security solutions are also available to zero in more effectively

on indicators with massive amount of data to alert them on potential or ongoing

problems. These solutions provide for analysis and documentation capabilities for

discovering, preventing, remedying and prosecuting inappropriate or malicious behavior.

(h) Zero Interactive Authentication (ZIA) – In order to obviate situations when laptop

or desktop falling into wrong hands either due to theft or remaining unattended, ZIA

manages the authentication process using “authentication token” which user has to

wear (e.g. like a wrist watch) to remain in constant touch with the PC. As long as

laptop/desktop is able to contact the token the computer functions normally and once the

contact is broken all the data inside is automatically encrypted.

(i) Two factor authentication-The two factor authentication requires a customer to go

through a two-step authorization process. After a customer keys in his username and

internet banking password to access to his account, another security screening is

scheduled if the customer wants to carry out a transaction. The second stage of security

screening involves the mobile phone. When a customer clicks on the transaction menus,

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the system generates a one-time use transaction password and sends it to mobile hand

set with the customer using the short messaging service.

3.11 Putting System to Independent Audit- The working group to review the Internal

Control and Inspection /Audit Systems in banks (Jilani Committee) recommended for

EDP audit in checking data integrity, security and control measures such as system

development, system maintenance, application control, data security, data access and

contingency planning. To conduct such test, EDP auditor should frame logical questions

such as –

(a) Is it possible to earn higher rate of interest on a deposit account than authorized?

(b) Is it possible to pre-close a fixed deposit and still earn full interest?

(c) Is it possible to make back dated correction /modification after day end process?

(d) Is it possible to make correction / modification by a user singly?

(e) Is it possible to access program / files / setting meant for higher level by a lower

user?

(f) Is it possible to make changes in parameter setting, master data, transaction data

etc. without reflecting in audit trail?

(g) Is it possible to bypass printing of mandatory audit trails?

(h) Is there any transaction, which is not associated with any ID?

(i) Is there any transaction not associated with any authorized ID?

The EDP audit should cover compliance check on all technology and process related

security aspects to detect violation/ breaches if any. Problem detected should be

appropriately documented to support remedial action. Banks own inspectors / auditors

should also be educated and trained in conducting such audits.

3.12 Business Continuity Plan (BCP) and Disaster Recovery Plan (DRP): - A crucial

element in IT security management is BCP- the ubiquitous terms covering events

ranging from any disastrous event through to

assessment, mitigation and continual readiness to

future disasters and DRP - to adequate duplication of

important files and applications and storing them off-

site for recovery of data either due to sabotage or due

to natural calamity such as flood, fire, earthquake etc.

The event like 9/11 has re-established the need of

proper BCP and DRP policies. KPMG survey of

banks/FIs observed that only 31% of banks/FIs have

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KPMG SURVEYRESPONDENT FROM

BANKING AND F I 1. 31% have documented

and tested BCP.2. 9% did not have any

BCP.3. 30% are developing

plan.4. 17% have local or

partial plan.5. 13% documented but

untested plan.Best BCP is one, which is never implemented.

documented and tested BCP. (See box) The methods commonly used for data

protection are - (I) Tape or floppy back up, (ii) Mirroring, (iii) Data Guarding, (iv)

Duplexing, (v) Partitioning, (vi) Clustering and (vii) Replication. In ALPM and TBM

environment floppy / diskette back up system is generally adopted where two sets of

back up are generally taken each day, while one set is stored in fire proof cabinet at the

branch it-self other is stored off site. The month end, quarter end and half year end back

up is also taken and kept off site as well as on site in the same manner. The back up

floppies / tape should be properly leveled and a record is maintained in back up register

mentioning location where these are kept. The periodical testing of the back up media

should be done to check their correctness and reliability. The floppies / tape should also

be changed periodically to take care of wear and tear. The banks with core banking

solution keep back up by mirroring database off-site.

4.Role of Vigilance: -4.1 No System is 100% Secure- No system is considered 100% foolproof as fraudulent

money transfers has occurred even in a highly automated and secure funds transfer

systems. As technology is taking rapid strides (for fraudsters as well as organizations),

banks are discovering that they have to constantly upgrade and improve their

technological tools. However, these tools can only reduce the possibility of fraud and not

totally rule it out.

4.2.Low Risk and High Profit Business- Computers crimes are considered as low risk

and high profit business as these can be committed by comparatively with much less

investment and high gains (recovery in many cases is an endless and fruitless exercise)

with lower possibility of conviction as courts in India takes years to decide cases

(average time is 15 to 20 years) with very low conviction rate (average 6 %). It is,

therefore, prudent to follow preventive measures to avert potential frauds than to face a

complex process of punitive action.

4.3 Prevention is better than cure- The security built around technology always comes

at a cost. Hence, while finding technological solutions to security or fraud control, bank

cannot ignore the cost of technology and some trade off is always made. Such trade off

is tackled in conjunction with normal vigilance mechanism particularly through preventive

vigilance. The computer preventive vigilance shall include measures such as-

(a) Improving employee’s knowledge through job card, computer manual etc. and

develop innate habit of meticulous observance of system and procedures,

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(b) Conducting system-audit of computer operations at branches to detect cases of

non -compliance and taking corrective measures,

(c) Engaging ethical hackers to check possible security breaches in net work

environment and to plug the loop holes,

(d) Doing job rotation of computer operators/officers as per extant rules to check

growing vested interest,

(e) Circulating case study of computer frauds among branches/ employees to build

foresightedness among employees for close observance of suspicious behavior/

movement of colleagues / outsiders and reporting the same to higher authority

confidentially, and

(f) Conducting seminar / workshop/ training programs in the area of password

management, software and hardware management, physical and logical access

control, disaster management etc.

4.4 Educate Your Customers-Effective security management is done through

combination of measures and educating customer is one of the key components of e-

security. A bank should advise its customer to (a) keep PIN or password of ATM/internet

account safe/confidential, (b) Be wary of unsolicited email or telephone calls asking them

for any personal detail like card number or PIN, (c) Access internet banking account by

typing bank address instead through hyper link and never go to a web site from link in

email and enter personal details and (d) Advise customers to use up to date anti virus

software, security patches and personal fire wall.

4.5 Preventive vigilance- Monitoring of transactions- Monitoring is essential part of

preventive vigilance. It is essential to do day to day monitoring of (a) new accounts (b)

large value transactions especially in new accounts, (c) large value collection especially

in new accounts, (d) transaction in inoperative account, (e) transaction above cut off limit

in staff or staff related account, (f) expenditure variation and (g0 concession in interest,

commission etc. In CBS environment bank can automatically monitor out of profile

transactions through specially designed software.

4.6 Detective and Punitive Vigilance - In a computerized environment, banks are

increasingly exposed to operational-risk as scoundrel believe that their action is near

impossible to detect, if detected near impossible to prove, if proved nearly impossible to

convict and if convicted, amounts nearly impossible to recover. The problem is

compounded in networked banks operating in different nations with different laws.

Despite these limitations, frauds perpetrated from across the globe have been detected

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and amounts recovered by proper combination of technology and vigilance skills. Hence,

while inspectors/auditors continually must carefully watch incidences and plug the holes,

vigilance people should improve their skills and actively follow up cases- both internal

departmental enquiry and court cases- for punitive action.

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Chapter-35

Short Notes on important topicsAgriculture Kisan Credit

Card The Kisan credit Card (KCC) scheme was

introduced in 1998-99 to enable farmers to

purchase agriculture input and draw cash for

their production needs. Till December end

2008 banks have issued 35.08 million kisaan

credit cards (KCC) with sanctioned limit

aggregating to Rs.177607 crore.

All farmers having agricultural land whether

irrigated or un-irrigated are eligible. Fixation of

loan is done on the basis of operational land

holding, cropping pattern and scale of finance.

The validity period of KCC is three years

subject to annual review.

In a study, the RBI has discovered that

farmers are not too keen to have KCC, as

some of them are well to do, some held job,

some are cultivating land under oral lease or

under contract basis, some are not having

land holding certificates and some are share

cropper. The lack of upgradation of land

record, small land holding and illiteracy of

borrowers has been some of the other

problems hindering KCC.

The Vyas Committee has recommended ATM

enabled cards.

Agriculture Rural housing scheme

Golden Jubilee Rural Housing Finance Scheme

(GLRHFS) has been designed to address the problem

of rural housing-Villages/town/cantonment/notified

area upto population of 50000 as per 1991 census is

covered. Loan for construction up to 5,00,000 and

repair /renovation upto 50,000 can be considered.

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Schoolteacher, service holders, progressive farmers

and businessmen can be target group. Loan period is

15 year and margin is 33%, which can be relaxed by

bank.

Agriculture Service area approach

Service area approach (SAA) was introduced in April

1989 to bring about an orderly and planned

development of rural and semi-urban areas of the

country. Under the scheme all rural and semi-urban

branches of the banks in the country were allocated

specific villages for over all development and credit

needs. With a view to provide opportunity to rural

borrower to have wider choice and easy access of

credit facilities, RBI has now decided that allocation of

villages among the rural and semi-urban branches of

banks shall not be applicable for lending excepting

under government sponsored scheme. Further the

requirement of no dues certificate from service area

branches of allocated bank will also stand dispensed

with.

CAPITAL MARKET

INTEREST RATE SWAPS

It is a financial instrument of risk hedging. Depending

upon risk perception of interest rates, a person having

fixed interest loan may swap with floating interest loan

through a financial intermediary say a bank.

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Capital Market Credit Derivatives Market - CDS

A financial derivative is an instrument that allows risk

to be transferred from one party to the other. A credit

derivative is a contract that allows the credit risk (or

the risk of default) of a loan or bond to be separated

and transferred to another entity, independent of the

assets. A simplest form of credit derivative is CDS-

Credit Default Swap in which credit protection buyer

pays to credit protection seller a periodic fixed

payment of fee in return of protection of default.

Reserve Bank has issued draft guidelines for CDS

whereby RBI regulated gentilities may buy credit

protection on bonds they hold. The credit protection

can be sold by banks and finance companies with net

worth of over Rs.500 crores and non performing loans

less than 3% with capital adequacy of 12% for banks

and 15% for non banking companies. Biggest gainers

will be large corporate particularly infrastructure

companies as bank after credit protection cover can

go on making advance as exposure will be taken

against seller of protection and not against the

borrower.

While the proposal in general has met with positive

response, but expert say that inclusion of FIIs will

provide the depth to the market and two way interest

both to sell and buy protection. Another suggestion is

that investor in certificate of deposit and commercial

paper should be allowed by buy protection.

Capital Market Negotiated Dealing Settlement System

Negotiated Dealing System (NDS) is an electronic

platform for facilitating dealing in Government

Securities and Money Market Instruments. NDS

facilitates electronic submission of bids/application by

members for primary issuance of Government

Securities by RBI through auction and floatation. The

system of submission of physical SGL transfer form

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for deals done between members will, on

implementation of NDS, be discontinued. NDS will

also provide interface to Securities Settlement System

(SSS) of Public Debt Office, RBI, and thereby

facilitating settlement of transactions in Government

Securities including treasury bills, both outright and

repo.

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CAPITAL MARKET

OPTIONInstrument of hedging of interest rate risk.

Buyer of option is given option to buy assets while

seller of option is given option to sell assets.

CALL OPTION

When option holder can exercise his right to buy

assets at pre determined price and period after paying

option fee. It is profitable in bullish market.

PUT OPTION

When option holder can exercise his right to sell

assets at pre determined price and period after paying

option fee. It is profitable in bearish market.

LIQUIDITY ADJUSTMENT FACILITY OF RBI

REPO & REVER REPO

RBI conduct REPO to suck liquidity by buying security

with option to seller to buy them back at pre

determined price and date. RBI also conducts

REVERSE REPO infuse liquidity by selling security

with option to buyer to sell back the security at pre

determined price and date. Repo and Reverse repo

are considered as benchmark rate for short-term

deposit.

CAPITAL MARKET

INVERSE FLOATER

It is an innovative instrument. Coupon rate is

inversely related to the direction of interest rate.

Grasim has issued Rs 50 crores inverse floater

carrying yield between 14% and 1 year gilt yield.

Instrument gives investor 40 bps marker over gilt

yield.

Credit Capital Market -Exposure Norms

1. Exposure norms for capital market has been

fixed at 5% of outstanding advances with a

rider that banks having better risk

management practices can be permitted on

case to case basis to have more exposure.

2. RBI has recently permitted HDFC bank to

have capital market exposure up to 10%.

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Credit Credit counselling

3. A credit counselor helps the borrower to:-

(a) To evaluate his/her current financial status,

(b) To make a detailed review of his/her income,

assets and expenses,

(c) To find out personalized outcome to get over the

his/her problem,

(d) To draw detailed debt management plan,

(e) To work with lending bank on voluntary basis to

waive or reduce financial charges such as late

fees, penal interest , finance charges etc,

(f) To formulate a debt restructuring plan mutually

acceptable to borrower as well as the bank.

The objective is to make the borrower feel that in his

hour of crisis there is someone to help him out of the

situation.

Credit Factoring Facility in the area of credit collection and invoice

management.

Discounting of bills.

Credit screening and collection of bills.

Invoice management.

With recourse and without recourse –both.

Export factoring also by ECGC - Special

emphasis for SSI.

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Credit Regulating the warehousing sector

Salient features of Warehousing (Development and

Regulation) Act, 2007:-

Object of the act is to make provisions for the

development and regulation of warehouses,

negotiability of warehousing receipts and

establishment of a warehousing development

and regulatory authority. Act will facilitate the

warehouse receipt as document to title of

goods and raising finance there against would

be easy as it would be tantamount to implied

pledge.

Negotiability of warehouse receipt is

established by law.

Law recognizes the warehouse receipt in

electronic form.

Registration of warehouse is now mandatory.

Existing warehouse will have to obtain

registration within 30 days of the act.

The concept of accreditation agencies for

issuance of certificate of accreditation to

warehouses issuing negotiable warehouse

receipt has been introduced.

Any existing or future warehouse not intending

to issue negotiable warehouse receipt will not

be governed by the law.

Credit FORFAITING Non-recourse discount of export receivable.

EXIM bank offers this facility.

Is done for discount of capital goods or contract of

long-term liability.

Backed by guarantee of importer bank for

payment.

ECGC has offered non-recourse forfaiting product

through banks where ECGC will bear the credit risk

for exporters.

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Credit Teaser Rates These are loans where the interest rate is fixed at

an attractive rate for an initial pre determined

period after which it ceases to be fixed and

becomes floating rate of interest. Banks’ recently

launched special schemes for home loan offering

teaser rates inviting criticism from different

quarters. It is being argued that banks are not

taking care of serviceability of these loans and

there is likely hood of default when the pre

determined period will be over and rate will be

linked to market rates.

The teaser rates have also raised voice of

discrimination from existing borrowers of the bank

who is crying foul as they are paying at least 100

bps more than the new borrowers. Banks

argument is that offering same rates to old

borrowers would crate assets-liability mismatch

and therefore their inability to agree.

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Credit Infrastructure financing

To achieve sustained GDP growth of 9%, GOI has

envisaged investment of around $500 billion in

infrastructure sector in 11th Five year plan (2007-

12). It is believed that infrastructure will be the

next driver of growth and the companies in

infrastructure could grow the same way the

software companies grew in the last decade.

Roads, Transport, Communication, Ports, Energy,

Hospital, Telecom, Healthcare, Educational

Institutional and storage facility for farm sector

including cold storage form infrastructure.

In the past, the government did infrastructure

financing but limited budget resources have

opened option for private sector and hence

financing by banks.

GOI is providing incentive by extending tax

concessions and tax holiday.

Infrastructure Development Finance Company-set

up in 1997- to do infrastructure financing in big

way.

SEZ financing has also come up as opportunity for

banks and financial institutions as many as 154

special economic zones have been approved

which provide opportunity to fiancé captive power

generation, roads, waste disposal and township

development.

Issues-- Infrastructure is capital intensive and high cost

oriented. Working capital requirements are

relatively less. Repayment period is long including

gestation period, which creates problem in Asset Liability mismatch for the banks. RBI vide credit

policy of May 2004 has permitted banks to raise

long terms funds ( not less than 5 years) for

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infrastructure financing through bonds ( not in the

nature of subordinated debts)

Securitisation and take out finance are deemed as

most suitable to bank for infrastructure financing

from ALM angle.

Funds requirements are huge and small and

medium banks find it difficult to meet the

requirement within EXPOSURE NORMS. (15% of

net owned funds of banks for individuals and 40%

of net owned funds of banks and extra 10% for

infrastructure for group). RBI vide credit policy of

May 04 has empowered bank’s board to exceed

limit by 5% of individual/group exposure.

Power sector problem:

Outstanding debt of state power utilities have grown to a staggering R6 lakh crore or 6% of the GDP. Roughly a third of these are loans taken to fund past losses which cannot be serviced through tariff hikes and, hence, are being considered for a benign restructuring by the Centre.

Needless to say, the extreme indebtedness of these utilities is attributable to state governments that don't let regulators increase tariffs in tandem with rising costs, leading to a constantly widening revenue-expenditure gap at the utilities.

This undermines their ability to invest and thwarts India's ambitious plan to multiply its power generation capacity and create a competitive power market.

According to Reserve Bank of India data, outstanding debt of power utilities to banks has grown by 56% in the two years to June 2012 — from R2.1 lakh crore to R3.3 lakh crore.

Over the last one year, the increase in this debt burden was 40%, suggesting an acceleration in the addition to the liabilities, owing mainly to the relentless rise in fuel costs.

Governments pandering to the electorate have either

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stymied or staggered the pass-through of fuel price-driven cost increase, stifling the utilities in the process.

While these are the loans taken from banks, the utilities also owe big amounts to specialised agencies for power sector financing - the Power Finance Corporation (R1.3 lakh crore) and Rural Electrification Corporation (R81,725 crore). That adds up to some R5.4 lakh crore. If liabilities to other institutions like LIC and IDFC and the external commercial borrowings too are included, the total burden would easily be above R6 lakh crore.

According to Crisil, unless big reforms are undertaken to stem losses and spur revenue streams, these liabilities would grow further to R7.3 lakh crore by March 2013. This looks like a reasonable estimate, given that annual losses (after receipt of subsidy) of discoms in the country were R42,415 crore in 2009-10, up 18% over the previous year.

Analysts say many states continue to follow a cautious and staggered approach on tariff hikes despite the hefty increase in electricity purchase costs in recent years. According to Icra, Rajasthan needs to hike tariff by 80%, Madhya Pradesh 65%, Tamil Nadu 55% and Punjab 24% to bridge their discoms' revenue gaps. Such tariff shocks are, of course, not politically feasible, and carefully calibrated tariff hikes are unavoidable, analysts say.

Of course, some states have of late started assessing their discoms' annual revenue requirements (ARR) and followed these with some tariff hikes, which are, again, far below what is required. Though some states have adopted provisions for automatic recovery of increase in fuel costs, implementation remains patchy. Subsidies (meant to facilitate cheaper power to farmers and domestic consumers) account for 20% of discoms' total revenue and delays in their payment are also a stress on their finances. There is the facility of regulatory assets - uncovered revenue deficit proposed to be covered through future tariff hikes — which are aimed at preventing tariff shocks, but this is not fully functional in most cases.

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A recent Crisil report said that the share of bank loans in the total capital employed by state power utilities rose from 60% at the end of 2007-2008 to 72% in 2009-10. This shows the state governments' share in capital employed has shrunk to abysmally low levels. The agency has recommended automatic pass-through of fuel price-driven cost increases and said that all unpaid utility subsidies and regulatory assets should be charged to the state government's account by the RBI beyond a period of six months. Crisil also said that state governments could take over the portion of liabilities incurred to fund losses under a specific arrangement supervised by the RBI.

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Credit Mortgage Guarantee

Company

RBI in its recent credit policy announced

setting up of Mortgage Guarantee Corporation

to guarantee housing loan granted by banks

and financial institutions.

National Housing Bank (NHB) is in discussion

with Canada Housing and Mortgage

Corporation for sharing knowledge in the area

of mortgage guarantee. This concept is in

departure with earlier guarantee scheme of the

government, which could not find favour with

the bank and also with the borrowers.

The funding of India Mortgage Guarantee

Corporation (IMGC) was completed on June

29, 2012 with all four major shareholder

contributing their share viz Genworth (36%),

ADB (13%), IFC (13) and NHB (36%). NHB

has now approached RBI for granting

certificate of registration.

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Credit SOFTWARE The major driver of world economic growth today

is IT. IT enabled service such as Call Centers,

BPO (Business Process Outsourcing) are new

growth areas. India has a good start in software

and has assumed a leadership role.

Presently IT services and product contribute 1.7%

of GDP which is likely to grow upto 7.7% by 2008.

At present IT exports contribute 14% of India’s

export which is likely to increase to 35% by 2008.

NASSCCOM has projected US$ 23 billion by

2008.

India spends 1.1% of GDP on IT whereas USA

spends 5% of GDP on IT. Even domestic market

has good scope.

IT/ITES (IT enabled services) emerging growth

areas are-

(a) Packaged software support and installation,

(b) IT consulting, net work infrastructure

management,

(c) Hardware support,

(d) Network consulting,

(e) Integration

Software exporters can acquire stake in Foreign

company they deal with to the extent of 25% of

the export. They have to seek RBI approval

through AD.

SEZ has provided new growth opportunity to the

industry.

Merger, alliances and takeover have become key

driver of growth in software sector.

Financing software issues-1. Software and IT is classified in four categories (1)

Software services –Staffing services and

programme services at customers location, (2)

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Project Services such as customized software

development, systems solution and integration

and maintenance of the software, (3) Software

projects and packages as standard products, and

(4) IT related services such as call centers,

mentoring, Tele-conferencing etc.

2. MPBF- Cash budget system is ideal but working

capital assessment upto Rs 2 crores can be done

on turnover system i.e. 20% of projected turnover

and for above 2 crores cash budget system will be

adopted and MPBF will be determined based on

peak deficit in cash budget.

3. For working capital limits above Rs. 10 crores,

Cash credit component will be 20% of the MPBF

after excluding export credit and balance as

demand loan.

4. The bank has to fix reasonable margin excluding

export where margin will be NIL.

5. Banks can also provide Equity, Seed money and

Venture capital on case to case basis with

prudential limit of 5% of incremental deposit of the

previous year.

6. Promoter’s background, his qualification and

experience in developing software products is a

crucial factor in appraisal. Other professional

manpower associated with full commitment is also

to be considered seriously. The success of the

project depends upon skills of the professionals.

Hence, bank should critically examine this aspect,

also to examine marketing abilities.

7. Monitoring- to obtain quarterly actual cash flow

statement and compare it with projected

statement, submit GR forms and Softtex forms as

appropriate.

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8. Risk factors are- absence of tangible current

assets, high obsolescence, fixed assets

depreciates rapidly, rate of failure is high, high

manpower turnover, product may turnout non

marketable or overtaken by the same product of

the competitors.

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Credit Medium Scale Enterprise

GOI has approved definition of Medium Scale

enterprises to cover investments in plant and

machinery in an industrial undertaking upto Rs.

10 crores.

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Credit Base Rate RBI has decided effective 1July l 2010 to replace

the BPLR system with base rate and hence the

rate of interest of borrowers will now be linked to

base rate.

Criteria for determination of base rate as

illustrated is cost of funds, cost of compliance of

CRR and SLR, profit margin and mark up for cost

of operation for particular product and premium

for credit risk and tenor of loans.

Banks will not be permitted to lend below base

rate exception being lending against bank’s own

fixed deposit, lending under differential rate of

interest and staff loans.

Stipulation of BPLR as the ceiling rate for loans up

to Rs. 2 lakh stands withdrawn.

Base rate will be revised by banks every three

months.

Existing loans based on the BPLR system may

run till their maturity. In case existing borrowers

want to switch to the new system, before expiry of

the existing contracts, an option may be given to

them, on mutually agreed terms. Banks, however,

should not charge any fee for such switch-over.

Introduction of base rate is likely to change the

entire dynamics of credit, as short term loans

which are presently be sanctioned by banks at

substantial discount to PLR will vanish. It is

expected that PSU like oil companies, fertilizer

companies etc. were raising short term loans at

5% to 6% will have to factor in up to 5% rise in

interest rates.

It is argued that banks are presently mispricing

loan and base rate system would put a stop to

such system. Undercutting of rates to compete

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other banks will not be possible.

Presently when interest rate increases banks

increases the PLR thereby increase the cost of

borrowing but when interest rates falls banks do

not reduce the PLR and due to this benefit of cost

of reduction is not passed to the borrowers. Base

rate system will remove this anomaly.

It is also expected that interest yield of banks

would rise as base rate would end cross

subsidization of interest rates.

Banks are in a fix to decide parameters. For

example to arrive at cost of deposit, bank can use

overnight cost of fund, average cost of funds,

average cost of deposits or marginal cost.

Likewise for profit bank can use net profit or

operating profit. RBI has clarified that banks are

free to decide methodology say cost of funds but

would not be allowed to change. They free till

December 2010 to change the methodology.

Commercial paper all of a sudden is in demand

from corporate who are seeing opportunity to

raise money at much cheaper rate than the

borrowing at base rate.

From Monetary Policy perspective it was

experienced that BPLR system was rigid and

change in policy rates was not reflected in the

change in interest rates.

RBI is likely to introduce sun set clause so that all

borrowers moves to base rate system in the

given time frame.

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Deposit Insurance

Deposit Insurance

Deposit insurance scheme is under review by RBI. It

may be recalled that the Jagdish Capoor committee

recommended to charge premium from banks as per

risk grade i.e. low risk bank should pay less premium

and high risk bank to pay high premium. Until March,

04 banks pay uniform premium of 5 paisa % on total

deposit that was raised to 08 paisa from April, 04 and

will again be raised to 10 paisa from April, 05. The

stronger banks are raising objection to pay equal

premium as it amounts to cross subsidization. IBA

also feels that instead of one size fit all approach the

premium should be risk related. Committee has

recommended having separate fund for cooperative

and commercial banks and higher capitalization of

DICGC at Rs. 500 croroes to be funded by RBI, its

promoter.

Credit Negative amortisation

In rising interest scenario, when EMI is only able to

cover payment of interest, the situation is known as

negative amortization. In such situation borrower is

left with only option of raising the EMI otherwise the

debt can not be repaid.

e-banking Cheque

Truncation

System

Cheque truncation system is being started in the

country with a pilot project in the national capital

region. Banks globally are looking to ways and means

of reducing cost in processing the cheques which

paper based processing system has. Cheque

truncation system is electronic based cheque

presentment through mirror based approach and it

facilitates speedy cheque collection specially

outstation cheques. It may be recalled that

Information Technology Act 2002 couple with

amendment in NI Act has facilitates image based

processing of cheques through cheque truncation

system.

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Foreign Exchange

EXTERNAL COMMERCIAL BORROWING(ECB)

Source of finance of corporate from banks,

insurance fund, foreign equity holder and

international capital market from abroad.

Free to raise from any internationally recognized

source such as bank, export credit agencies,

supply of equipment, foreign collaborators, foreign

equity holders, international capital market etc.

with average maturity 3 to 7 years.

ECB are subject to specific maximum spreads

over six months LIBOR, for the respective

currency.

ECB prepayment is permitted up to US $ 200

million, subject to minimum average maturity of

five years.

ECB can be assessed under two routes:

automatic and approval route.

ECB limit under automatic route is 500 $ million

with average maturity of 5 years.

ECB limit for infrastructure companies is $ 500

million a year with average maturity up to 7 years

for rupee expenditure under the approval rule.

ECB loans are utilised for import capital goods

and services. End use for ECBs was enlarged to

include overseas direct investment in Joint

Ventures (JVs)/Wholly Owned Subsidiaries

(WOS) in order to facilitate corporate to become

global players.

Risk management is done by currency swap and

interest rate swap

Exporter can raise ECBs for tenure of less than

three years in special economic zones. This will

provide opportunities for accessing working capital

loan for these units at internationally competitive

rates.

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Corporates have estimated to raise more than US

$ 11.7 billion through ECB during 2004-05 (ET

22.4.05).

With international interest rates on rise, the

interest of corporate to raise ECB is gradually

waning. The anticipation that cost will further rise

is also hurting ECB.

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Government Business

Turnover commission

A distinctly unglamorous but very lucrative area that

has been opened for banks is government business.

This range from collection of direct taxes at branches

to disbursing government funds and salaries to

handling the account of the railway. The business is

huge and banking industry put the total at around Rs.

15,00,000 crores annually on which the government

pays 1.11 paisa per Rs. 1000 . That work out to Rs.

1700 crores annually out of which half goes to SBI

alone. Quite naturally other banks also want to grab a

bigger pie of this business. With competition coming

from private sector bank, nationalised banks too have

started offering OLTAS.

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Miscellaneous REAL TIME

GROSS

SETTLEMENT

SYSTEM

RTGS started since 26.03.2004 and India crossed a

major milestone in development of systemically

important payment system. Salient features of RTGS

are-

(a) Payments are settled transaction by

transaction for high value and retail

payment.

(b) Settlement of funds is final and

irrevocable.

(c) Settlement is done on real time basis and

the funds remitted can be further used

immediately.

(d) It is fully secure system which uses digital

signatures, public key infrastructure based

encryption for safe and secure

transmission.

(e) It provide for transfer of funds for inter-

bank settlements and customer related

funds transfer.

Present RTGS net work is of 55000 branches

and it handles on an average 80000

transaction per day with a peak of 128295

transactions processed as on March 30, 2009.

Miscellaneous Green Shoots Green shoots is used to refer to signs which indicate

recovery of the economy. It draws the facts that green

shoots which appears above the earth are first visible

sign of growth of plants. Particularly after a recession,

green shoots are welcome as symbols of economy

taking treading path upward. Improvement of

industrial production figure, rise in car sales,

development in infrastructure sector including

steadying of prices of cement and steel have been

seen as green shoots in India.

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Miscellaneous Fake notes The RBI detected counterfeit notes worth Rs.10.54

crores during 2006-07 against Rs. 8.39 crores 2005-

06. Further counterfeit notes worth Rs. 25.79 crores

were recovered till September 2009. Looking to

danger being posed to our economy, it is decided that

outsourcing of printing of notes will be stopped

forthwith. It is has also been suggested that RBI

should introduce easily recognizable

anti[counterfeiting security features in the designs.

Miscellaneous Doorstep Banking

Individual customers can now have cash and other

bank instruments picked up from their home or office

with banking services now available at door steps.

Corporate customers can additionally have cash

delivered against cheque received at the bank’s

counter.

Miscellaneous Quantitative easing

Central bank usually stimulates an economy by

reducing interest rates so that there is less incentive

to save and people borrow and spend more. But in

developed word where interest rates are already near

zero this option is not available. In such a situation,

central bank resorts to pumping money directly into

the economy which process is known as quantitative

easing. It is done by buying bonds – usually

government paper but can also be private bonds-

from banks and financial institutions. The idea is get

more money into the system chasing the same

amount of commodities to drive up the prices. The

flood of money may cause assets prices to rise i.e.

prices of shares, real estate etc. Quantitative easing

may potentially ward off deflation and kick start the

economy.

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Miscellaneous Head line and core inflation

Headline is about estimate total inflation in an

economy where as core inflation measures exclude

food and energy prices. As policy some central banks

follows headline inflation both for framing policy

objectives and also for operational guidance while

other central banks follows core inflation only.

Economist feels that process of stabilising core

inflation is seen as more optimal policy.

Miscellaneous

TIPS

(Treasury inflation protected securities)

First issued in United States, TIPS are special type of

government securities that offers investors protection

from inflation. This is how TIPS works: The principal

increases in line with inflation or decreases with fall in

prices. When instruments mature investor is paid

original principal or inflation adjusted principal which

ever is higher. This under TIPS original principal

amount remains protected.

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Miscellaneous

Mobile Banking

With rapid growth of mobile phone subscribers in

India, banks have been exploring the feasibility of

using mobile phones as an alternative channel for

delivering banking services. Some banks have started

offering information based services like balance

enquiry, transactions enquiry, location of the nearest

ATM/branch, acceptance of transfer of funds

instructions etc. Looking to the fact the technology is

new , RBI has issued following set of guidelines :-

(a) Only banks which are licensed and supervised

in India and have a physical presence in India

will be permitted to offer these services.

(b) The services shall be restricted to customers

only.

(c) Only Indian rupee based domestic services

shall be provided. Mobile service for cross

border transfer of funds is prohibited.

(d) Banks may use the services of business

correspondents to extending this facility

provided BC guidelines are followed.

(e) Guidelines of RBI for Risks and Controls in

computers and telecommunications will be

followed.

(f) KYC and AML guidelines will be followed.

(g) Banks will have to put in place a system of

document based registration with mandatory

physical presence of the customers.

(h) Information security aspects have to be put in

place.

(i) Transfer of funds are subject to cap of

Rs. 5000 per day and Rs. 10000 for

transactions involving purchase of

goods/services.

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NPA Management

NPA Buyout norms

Foreign investors have been showing keen interest to

buy NPA, which has opened market, valued about $

22 billion. Overseas investors are currently limited to

purchase of Indian stock and bonds. RBI in

consultation with SEBI and finance ministry has put

public domain draft rules of NPA securtisation. It is

believed that NPAs are backed by as much as 140 %

collateral in many cases and units are operating that

provide immense business opportunity.

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NPA Management

Recovery Management Policy

Each bank is expected to have a recovery

management policy duly approved by the board

including policy for compromise settlement.

RBI GUDELINES- Past due concept deleted from 31.03.2001.

NPA classification shall be based on actual

recovery as on balance sheet date subject to

following:-

(a) Interest / installment for term loan

remaining over due for more than 90 days

(b) Cash credit / over draft account remaining

out of order for more than 90 days.

(c) Bill purchased or discounted remaining

over due and not paid more than 90 days

(d) Accounts due for review or renewal for

more than 90 days from due date.

However account will be upgraded

immediately after review/renewal if it is

otherwise in order.

(e) Non submission of stock statement for

more than 90 days from due date will

make the drawings irregular and such

irregular drawings for period more than 90

days. However, account will be upgraded

immediately after receipt of stock

statement if the account is otherwise in

order.

NPA identification norms for agricultural advances-(a) Short duration crop will be treated as NPA

if installments of principal or interest

remains unpaid for two crop season

beyond the due dates for example Kharif

crop loan sanctioned in June 2005 will due

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for repayment in March, 2006 and if

remains unpaid two crop seasons beyond

the due dates i.e. 2007 and 2008, it will be

NPA as on March 2008.

(b) Long duration crops where the harvesting

of the crops are made after a period more

than 12 months. In case of sugarcane the

crop season is more than 12 months. The

crop loan for sugar cane given in

November 2005 will fall due on March

2007 and will become NPA on March

2008.

(c) Term loan same norms for short and long

duration crops will apply.

Off balance sheet exposure deemed as credit – Interest rate, forex deals and future

credit exposure come within the single

borrower limit of 15 per cent of capital owned

funds. Further any restructuring of derivative

deals shall be carried out only on cash

settlement basis. Overdue receivables representing positive mark to market ( MTM) value of a derivatives contract will be treated as non performing asset, if these remain unpaid for 90- days or more. In case where a derivative contract is restructured, the MTM value of the contract on the date of restructuring will be cash settled. For this purpose, any change in any of the parameters of the original contract would be treated as restructuring.

Provision w.e.f. 30.6.11 (a) Sub- standard 15%,

Unsecured substandard 25% (b) Unsecured

portion of doubtful advance 100% , Secured

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portion of doubtful up to one year 25%, above one

year to 3 year 40% (c) Restructured Standard 2%

for first two year from the date of restructuring (e)

Loss assets 100%. (d) General provision of 0.40%

on outstanding standard assets, 1% for

residential housing loan of Rs. 20 lakhs and

above, commercial real estate, capital market

exposure exposure and personal loan and 0.25%

for direct financing to agriculture and SME.

Asset Classification under doubtful category –

12 months from the date advance turned sub-

standard.

Restructured accounts

(a) Standard Assets where Principal and

interest (excepting where commercial

production has started and advance has

become sub standard) will continue to be

standard provided interest element in

terms of present value terms has been

provided for (written off).

(b) Sub-standard restructured account will

be upgraded only after one year or when

principal or interest has fallen due which

ever is earlier after satisfactory

performance.

Interest application on monthly basis w.e.f 01.04.02.

State government guaranteed advances would be classified as NPA if interest and

installment remain unpaid for 90 days

irrespective whether the guarantee is invoked

or not.

Central government guaranteed advances

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would be classified NPA only after 90 days of

repudiation of the guarantee by the

government, when the same is invoked.

RBI has advised bank that while selling or

making compromise in NPA banks should

work out net present value of future cash flows

arising from security being sold. The sale price

or compromise should not be below NPV.

Prompt Corrective Action-One of the trigger

points in Prompt Corrective Action mechanism is

level of net NPA. When the trigger point under the

mechanism is activated by the performance of the

bank, the mandatory actions would follow by way

of restriction on expansion of risk weighted assets,

submission and implementation of capital

restoration plan, prior approval of RBI for opening

new branches/new line of business, paying off

costly deposits and special drive for NPA

recovery.

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NPA Provision Coverage Ratio

PCR is the ratio of provision to gross non performing

advances and indicates the extent of funds a lender

(bank) keeps aside to cover loan losses. RBI has

stipulated that minimum PCR of banks should be

70%. RBI has clarified that technical write offs would

be taken into calculation while calculating PCR.

Technical write off or prudential write off are the

amount of non performing loans in the books of the

branches and yet to be written off at head offices.

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NPA Management

Wilful defaulters –redefined

Wilful default would be said to have happened if

the borrowing unit fails to meet repayment

obligations to its lenders even when it has the

capacity to honour it commitments to lender or

diverts funds for the purpose other than they were

availed of. Diversion of funds would be when short

term working capital funds would be for long term

purpose, loan funds are deployed for purpose

other than intended for, or transferring money to

subsidiary or group company.

RBI will share the information with SEBI to prevent

them assessing capital market.

Where banks have identified diversion of funds,

misrepresentation, falsification of accounts and

fraudulent transactions, promoters will be

debarred from accessing finance from all legal

entities and also in floating new entities (including

issue of share capital) for 5 years from the date

their name appear in RBI list.

No additional finance will be granted to the

borrower and bank will initiate criminal action

whereever possible.

Bank will have to give adequate opportunity to

borrowers before declaring them wilful defaulters. As

per RBI directives bank has to form two committees

(I) Committee headed by ED and two senior

executives to approve the borrower as wilful defaulter

(ii) Committee headed by CMD to consider objection if

any raised by the borrower and then taking final

decision to declare him wilful defaulter.

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NPA Management

Credit Information companies

(A) Credit Information Companies (regulation) Act

2005 stipulates that -

Every existing credit institution shall be a member

of at least one credit information company within

three months of the commencement of the act.

Credit information bureaus formed under the act

and duly registered with the RBI can requisition

credit information from their members.

The share of such information by a credit

institution with a duly constituted bureau of which

it is a member is mandatory.

(B) CIBIL( Credit information Bureau of India Ltd)is

first company which has got mandate to act as credit

information company.

CIBIL now has a database of over 90 million

individual borrowers taken from various

banks, financial institution and non-banking

finance companies.

CIBIL has also launched the data base of

mortgaged properties containing the details

of properties against which owners have

availed loan so as to help the lenders share

and access information so as to avoid

fraudulent mortgage of same property to

multiple banks.

CIBIL is sharing more than 2 million credit

information’s each month.

FI/Banks/NBFC/SEBI/IRDA / broker

registered with SEBI/IRDA who is members

of CIBIL can determine on line whether a

prospective borrower is a disciplined

borrower or a serial defaulter on payment of

fee of Rs 10 per borrower.

CIBIL has also put in place data base of

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mortgage default.

CIBIL has also been authorized to maintain

credit history of telecom, insurance

customers, NBFC and micro finance

institutions .

CIBIL has close to 164 members which use

its database.

© RBI has given approval to three more credit

information companies namely Equifax Credit

Information Service, Experian Credit Information

Company and High Mark Credit Information Services.

(a) RBI has issued registration certificate to

Experian credit information company as a

credit information company.

Regulatory Requirement

PROMPT CORRECTIVE ACTION (PCA)

In the backdrop of large-scale crises in banks

resulting into closure, insolvency and losses, RBI has

proposed PCA. It is in the form of trigger points as

under:-

Capital to risk adjusted assets ratio (CRAR) -three

trigger points are proposed (a) CRAR less than

9% but equal or more than 6%, (b) CRAR less

than 6% but equal or more than 3% and (c) CRAR

less than 3%.

NPA-two trigger points have been proposed (a)

Net NPA over 10% but less than 15% and (b) Net

NPA15% and above.

Return on assets (ROA) -single trigger point i.e.

ROA below 0.25%

Compliance of PCA may result into following action:-

Trigger point Net NPA:- Mandatory action(a) Special drive to reduce the NPA and

contain generation of fresh NPA

(b) Review of loan policy

(c) Upgrade credit appraisal skills and

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systems

(d) Strengthen follow-up of suit field and

decreed debts

(e) Putting in place proper credit risk

management policies ,process, procedure,

prudential limit

(f) Reduce loan concentration-individual,

group, sector, industry etc.

Trigger point Net NPA:- Discretionary action(a) Restriction of entry into new lines of

business

(b) Reduce/suspension of dividend payments

(c) Reduce stake in subsidiaries

Trigger point ROA-Mandatory action:-(a) Pay off costly deposits and CDs

(b) Increasing fee based income

(c) Containing administrative expenses

(d) Special drive to reduce the stock of NPAs

and contain generation of new NPA

(e) Restriction on entry into new lines of

business

(f) Reduction/suspension of dividend

payments

(g) Restriction on borrowing from the inter

bank market

Trigger point ROA-Discretionary action:-(a) Capital expenditure only for technological

up gradation and for day to day operations

within board approved limits

Staff expansion or filling up of vacancies only

with prior approval of RBI except recruitment of

specialists

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REGULATORY REQUIREMENT

BANK RATE

(BR)

6 % w.e.f. 29.04.03

In 2004 the RBI completely delinked the standing

liquidity facilities to bank from the BR and repo

rate emerged as the lending rate of the RBI for all

practical purposes. As a result, the importance of

the BR as the monetary policy instrument waned.

A working group headed by Mr. Deepak Mohanty,

Executive Director, RBI has recommended for

reactivating BR by providing bank liquidity under a

new collateralized Exceptional Standing Facility (ESF) at this rate.

Group also recommended that BR be pegged at

50bps above the repo-rate which will also be

upper band to the policy rate corridor.

REGULATORY REQUIREMENT

DO NOT CALL REGISTRRY

The Indian Bank Association and Indian Card

Council have joined hand to set up a data of

telephone numbers whose owners do not wish to

receive telephone call for banking telemarketing.

This will be one stop center for ‘do-not call

registry’ for customers of all the banks.

REGULATORY AUTONOMY

AUTONOMY Financial market regulators like the Reserve Bank

of India, SEBI, and IRDA etc. have their

jurisdiction over different segment of the market.

Their activities are overseen by the government,

though they are suppose to be autonomous –

meaning that government will not interfere with

their day to day functioning or in the rule and

guidelines they make for market participants.

However they are suppose to interact with the

government regularly such as RBI is regularly

intereact with the government in three areas –

matters of appointment, matters of monetary

policy making and matter of finance of public debt.

There have been instances of between the RBI

352

and government for example during five year

plans in 1950 RBI did not approve financial

planning substituted by physical planning and this

led to resignation of then RBI Governor Rama

Rau.

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REGULATORY REQUIREMENT

CAPITAL ADEQUACY RATIO

As bank expands its business it needs more

capital to account far additional risk.

MINIMUM 8 % RAISED TO 9% w.e.f. 31.3.2000

Bench mark of evaluation of soundness and

stability of bank

Capital to Risk Weighted Assets Ratio =Capital

funds *100/Risk Weighted Assets

Tier I Capital to include (a) paid up capital less

investment in subsidiary, intangible assets and

losses (b) reserve and surplus (c) capital reserves

regarding sale proceeds of assets.

Tier II Capital to include (a) Revaluation Reserve

(at discount of 55%), (b) Undisclosed Reserve

(c) General Provision and Loss Reserve including

IFR (d) subordinated debt.

Tier I can not be less than 4. 5% or 50% of

required ratio

Risk Weighted Assets -

(a) Cash/Balance with RBI / advance to government

and banks own staff covered by superanuation

benefits and mortgage of house and Investment

in Government guaranteed security- 0%

(b) Claims with banks 20%

(c) Other investments 100%

(d) Loan and advances including bill purchased /

discounted and other credit facilities 100%

(e) Fixed and other assets 100%

Note: -

1. Advances collateralized by cash margin and

provisions, bank deposits, gold and loans

granted to staff up to 80% are excluded while

computing the total advances.

2. Housing loan collateralized by commercial

properties, exposure to capital market,

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personal loan, capital market exposure etc.

risk weight is 150%.

3. An additional risk weight of 2.5% on the total

investment is also provided.

Credit Conversion Factor

(a) Financial Guarantee 100%

(b) Performance Guarantee

50%

(c) Letter of Credit (documentary) 20%

(d) Counter party Government 0%

(e) Counter party Bank 20%

(f) Counter party others 100%

(g) Forward exchange contracts for less than one

year 2%

(h) Forward exchange contracts for each

additional year 3%

(i) Forex-open position – Uncovered

overnight position

100%

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REGULATORY REQUIREMENT

Basel III Rule written by the Bank of international

settlement’s committee on Banking supervision

whose mandate is to define agenda for global

banking community as a whole.

Main component is capital is common equity and

retained earnings. The new restricts inclusion of

items such as deferred tax assets, mortgage

servicing rights and investment in financial

institutions to no more than 15% of the common

equity components.

While the key capital ratio has been raised to 7%

risky assets, accordingly to the new norms. Tier I

capital that includes common equity and perpetual

deferred stock will be raised from 2% to 4.5%

starting in phases from January 2013 to be

completed by January 2015. In addition bank will

be required to set aside 2.5% as contingency for

future stress bringing the common equity to 7%.

According to RBI, banks in India are not like to be

much impacted by Basel III. As at the end of June

2010, Indian banks are already reached capital

adequacy of 13.4% of which the tier I is 9.3%. As

such Indian banks would not be considerably

stretched by new norms. A further counter

cyclical buffer in the range of 0% to 2.5% of

common equity is to be imposed (depending

upon national circumstances) to protect banking

sector from periods of excess aggregate credit

growth. These capital requirements will be

supplemented by a non-risk based leverage ratio

that will serve to backstop the risk based

measures and higher capital norms for

systemically important banks.

Europe will be most likely region for banks to need

356

to raise funds notably in Germany, France and

Spain.

It is argued that whatever capital adequacy

measures are taken, banking system will only

remain foolproof if banking supervision is

proactive and competent. Unfortunately it has not

been so in US and UK in particular.

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REGULATORY REQUIREMENT

CRR Section 42 (1) of Reserve Bank of India Act provide

for maintenance of CRR.

Parliament has passed the bill on 17th May 2006 to

remove the legislative cap of minimum CRR. Now

there is no minimum mandatory limit and RBI is free to

fix limit is wants.

4.50% of NDTL from 22.09.12

Inter bank term liability as term borrowing for period

15 days to 1 year is exempted from CRR requirement.

Following removal of minimum cap of 3%, RBI has

decided not to pay interest on CRR balance kept by

banks with it. RBI earlier used to pay interest @3.5%

over and above the minimum 3% mandatory CRR.

CRR is used by RBI (a) investment with RBI is risk free

(b) RBI controls the liquidity and (c) restricts capacity

of the bank to lend.

REGULATORY REQUIREMENT

SLR Section 24 (a) of Banking Regulation Act

provide for maintenance of SLR by every

banking company.

23% of NDTL vide 1st quarterly review of

monetary policy effective August 11, 2012.

Parliament has passed the bill on 17th May

2006 to remove the legislative cap of

minimum/ maximum SLR.

Restrict the capacity of bank of credit

expansion. It is tool of liquidity management in

the hand of RBI.

RISK MANAGEMENT

Assets and Liability Management(ALM)

ALM is systematic approach that attempt to provide

degree of protection to the bank by measuring,

managing, monitoring and modifying interest rest rate

risk.

GAP MODEL-Difference between risk sensitive

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assets and risk sensitive liability (RSA-RSL) -risk

is managed by keeping gap to zero or near zero-

RSL and RSA are put to time bucket based on

residual maturity.

SIMULATION MODEL-What if analysis of impact

of interest rate changes-forecasting different

scenario-depends on accuracy of forecast.

DURATION MODEL-Duration is calculated at

weighted average maturity of resultant cash flows-

expressed as less or equal to maturity period of

bonds-greater the gap higher is risk.

EaR (Earning at risk) Approved - based on bank’s

perception of movement of interest rate.

Prudential limit is decided by ALCO OR BOARD

based on GAP model (RBI advised bank’s to

maintain on the basis of Simple Gap Statement

and switch over to more technical model in due

course when banks develop expertise.)

Also a tool of Pricing of Loan, decide NIM, fix PLR

etc.

INTRODUCED w.e.f. 1.4.99

Main challenge is non-computerized environment,

which create problem in data creation.

Bank has to cover 100% business.

Prudential norms prescribed only for 1-14 days

and 15-29 days bucket as 20% of mismatch.

RBI in report of Trend & Progress of Banking 2004

has reported that PSBs are having assets liability

mismatch as majority of banks are having

investment in the maturity bracket of 5 years and

above.

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RISK MANAGEMENT

Stress Testing It is a risk measurement tool. It measures the key

movement in market variables that lie beyond the day

to day monitoring but that could potentially occur.

Stress testing evaluates the short-term impact on a

given portfolio of a series of predefined moves, in

particular market variables. It is also known as

creation of ‘worst case scenario’.

In present scenario of financial instability, stress

testing is one tool which can give insight to the bank

to know its vulnerable areas and address the issues

proactively.

A stress test of U S financial industry found that 10

out of 19 largest banks need a combined $75 billion to

weather the continuing recession. ( BS 9.5.2009)

RISK MANAGEMENT

Credit Rating Agencies

(CRAs)

CRISIL -Promoted by ICICI, UTI, HDFC and

number of banks. Number one in rating business.

Other in the line are ICRA –Investment

Information and Credit Rating Agency (1992),

CARE-Credit Analysis and Research Ltd. (1994)

There are three segments which use credit rating.

These are retail investors, financial institutions

and regulators.

Regulatory support like credit rating of CP (RBI) or

Bonds (SEBI) made rating mandatory.

New Basel II guidelines require mandated rating

(IRB) of borrowers for risk-based assessment for

capital adequacy.

CRAs have been extensively used by the

investing community in their investment

decisions. But truth is that these agencies could

never predict a financial crisis may be Mexican

crisis, South East Asian crisis, or Sub-prime crisis.

This has put a question mark on their credibility.

360

SEBI has directed that all CRAs (credit rating

agencies) will have to maintain records of the

important factors underlying the credit rating, a

summary of discussions with all stake holders

involved as well as decisions of the rating

committee, including voting details and notes of

dissent, and also if there was any divergence

between the rating assigned by the analytical

model and the actual rating assigned to the

company. The move is expected to bring more

transparency and accountability through uniform

disclosure.

Concerned over companies keeping under wraps

their bad credit ratings and publishing only

favorable ones, SEBI is mulling ways to prevent

rating shopping system. It is considering making it

mandatory to publish even those rating which are

not acceptable to companies and rating agencies

will be responsible to put in place clear and

effective ‘Chinese walls’ between their analytical

and business development teams.

In insurance and banks internal model are gaining

prominence and emerging view is that banks

should rely more on their internal models than to

external ratings.

Regulators’ are using the ratings for prescribing

prudential requirements for the FI and also for

prudential investments prescriptions. The

suggestions for improving effectiveness for this

purpose are:

a. Enhance the transparency of the rating process.

b. Rating decisions should be based on professional

standards.

c. Improve accountability so that CRAs suitably

361

rewarded and punished for their decisions.

d. CRAs should also be rated and those who have

poor capabilities be weeded out.

e. Regulators to prescribe standards for the CRAs.

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Chapter –36

Short Notes on Committees/Study groups

Agricultural Financing

R V GUPTA Committee –on

agriculture

Recommendations-

Adequate powers to branch managers.

Chairman and Managing Director to visit rural

branches.

To have flexibility in unit cost and scale of

finance.

Agricultural loan on cash basis only.

Obtaining no dues certificates to be left at

discretion of the bank.

Introduce passbook with authentic record of

land holding –accepted as title deed for

equitable mortgage.

Guarantee where land is available as collateral

is discouraged.

Compulsory rural posting should be done away

with.

Financing through self-help group (SHG).

Interest to be deregulated for small loans.

Rationalise returns – management information

system to be computer based.

Insurance is burden-allow discretion to banks.

To open high-tech agriculture branches.

Modification in Service Area Approach -

borrower should be free to approach any bank.

SLBC to think on greater agenda than distribution

of APP target like area development,

Implementation of new schemes, Impact of

technology absorption, Identification of fresh

schemes.

Agriculture RBI panel for RBI has sent up a sub-committee of Central Board

364

MFI of directors to address :-

Issue and concerns of MFI and

To decide ways and means to make

interest rate reasonable.

It may be noted that RBI regulate only those MFI

which are registered with it as NBFC. It however

does not prescribe any lending rates for these

institutions.

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Agriculture Sarangi CommitteeU C Sarangi Chairman NABARD

How small and marginal farmers, tenant

farmers, share croppers etc. can be brought

within the ambit of institutional finance.

Recommendations: Government to give joint and individual loan

to small farmers including tenant farmers,

share croppers currently outside the ambit

of institutional finance via jointly liability

group and thrift and cooperative society.

Intervention solely on farmer’s debts may

not be adequate. GOI need to incentives to

those choosing to engage in more

sustainable farming.

State ineffective money lending act to be

overhauled.

Identified weakness in newer model of

credit delivery like KCC, micro-finance.

Rigid system of commercial banks caused

prevention of small and marginal farmers

from bank credit.

Agriculture V. S. Vyas Committee

An Advisory Committee on Flow of Credit to

Agriculture and Related Activities from the Banking

System (Chairman: Prof.V.S. Vyas) was

constituted by RBI.

Recommendations- Fixation of target to Priority Sector including

Agriculture needs comprehensive review. Until

review is done present target of 18% for

agriculture may continue. Committee has also

identified demand side constraints and cap on

indirect agriculture to achieve agriculture target.

Securitiised agricultural loan should be treated

as direct agricultural loan.

Expanding outreach of banks in rural areas

366

need change in mind set of bankers as all over

the world retail lending is treated as most

lucrative. In Indian context, hardly there is a

better avenue other than agriculture.

Franchising village post office for dispensation

of credit in rural areas is also an innovative idea

mooted in budget of 2003-04, commercial

banks should explore this model.

Reducing cost of credit to agricultural

borrowers- KCC should be made ATM enabled.

Non-performing asset (NPA) norms in

agricultural finance be revised as default of two

crop season and setting up of an Agri -risk fund

to mitigate risk of lending in case of genuine

default.

Pilot project of multi-commodity exchange-

bank be exempted from sections 6 and 8 of BR

Act.

Micro-finance institutions (MFIs) would not be

permitted to accept public deposits unless they

comply with the extant regulatory framework of

the Reserve Bank.

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Agriculture Rao Committee on RRB

Recommendations- Possible reorganization of Regional Rural

Banks (RRBs).

Centre to bring its stake to 33% from 50%.

Amalgamation of contiguous RRBs.

Vesting more supervising and regulatory

powers to NABARD.

RRB staff can pick up State Government stake

if they are interested and after that it should be

divested to private sector.

Capital Market BHAGWATI COMMITTEE ON TAKE OVER

SEBI Committee on takeover under chairmanship

of Shri P.N.Bhagwati

Recommendations- Banks should finance take over.

RBI and SEBI to set terms to finance such

take-over.

The acquirer should not strip substantial assets

of the acquired company without permission of

shareholders. (The issue involved in case of

VSNL where TATAs are in dispute with the

government).

Open offer should always be 20% and above

but may be subject to acceptance level of less

than 20%.

Corporate Governance

RBI Consultative Group on Bank Boards

(Ganguli Committee)

Recommendations- Appointment of one more whole-time director

on the boards of large-sized nationalised

banks.

Establishment of appropriate due diligence

procedures for appointment of directors on the

boards of private sector banks.

Setting up of nomination committees of boards

of banks to recommend appointment of

independent/non-executive directors.

368

Building and creation of a pool of professional

and talented people for board level

appointments in banks and also maintenance

of the data for the purpose by the Reserve

Bank of India, etc.

369

Credit CHORE COMMITTEE

Shri K.B Chore

of DBOD of RBI

Recommendations-- Annual review for limit of Rs 2 crores and

above.

QIS I to III.

1% penal interest for default.

Fix operating limit on the basis of QIS I .

Peak and non-peak limit.

Adhoc-sanction extra interest 1%.

2nd method only.

Credit JILANI COMMITTEE II

Mr. Rashid

Gillani Chairman

PNB

Recommendations- Shift from cash credit to demand loan.

Bifurcation of cash credit into cash credit and

demand loan.

Borrowers of Rs. 10 crores and above -80%

WCDL and no slip back permitted.

Bank can fix separate rate of interest for

demand loan.

Credit RBI Committee

to Review the

System of

Lending Under

Consortium

Arrangements

J.V. Shetty, EX-CMD, Canara Bank

Purpose to review the system of Lending Under

consortium arrangements and to suggest

improvement therein.

Recommendations- Recommended various alternatives including

inter bank participation certificates, commercial

papers, debentures, securitisation of loans and

syndication of credit.

Suggested substantial modifications in the

system of consortium lending to make it simpler

and more flexible to meet credit needs of trade

and industry quickly.

Recommended enhancement of the threshold

limit for mandatory formation of consortium

from Rs. 5 crores to Rs. 20 crores with

immediate effect and to Rs. 25 crores or above

by March 1996.

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Introduction of syndication for borrowers

enjoying fund based working capital limits of

Rs. 25 crores or above from the banking

system.

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Credit Shanker Acharya Committee

Based on the recommendations made by this

committee on Primary Market, RBI issued

guidelines under which banks can provide funds to

meet genuine requirement of approved market

makers. Advances shall be purely commercial

terms and banks will have to lay down norms for

financing them including exposure limits and

method of valuation. These advances are freed

from the Rs. 10-20-lakh ceiling applicable to

individuals against shares/debentures.

Credit TANDON COMMITTEEJuly 74 Sri PL Tandon Chairman of PNB

Recommendations- Inventory norm for 15 industries

Approach to lending –1st and 2nd method of

lending

No slip back of current ratio

Classification guidelines for current assets and

current liabilities

Bifurcation of demand and loan component

Credit Working Group on Flow of Credit to SSI Sector (Chairman: Dr. A.S. Ganguly

Following the announcement in the mid-term

Review of November 2003, a Working Group on

Flow of Credit to SSI Sector (Chairman: Dr.A.S.

Ganguly) was constituted. .

In order to enable the banks to determine

appropriate pricing of loans to small and medium

enterprises, development of a system of proper

credit records is useful. For this purpose, Credit

Information Bureau of India Ltd. (CIBIL) would work

out a mechanism, in consultation with RBI, SIDBI

and IBA. Further, a mechanism for debt

restructuring on the lines of the Corporate Debt

Restructuring (CDR) has been proposed for

medium enterprises.

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Credit VAGHUL COMMITTEE-Factoring

Recommendations- To solve problem of SSI by discounting invoice

/bills

To offer

(a) Sales Ledger Management services.

(b) Purchase and collection of debt and

credit protection services.

(c) Advisory services.

Customer Service

GOIPORIA COMMITTEE

Recommendations- Opening of branch before 15 minutes.

May I help you counter to be opened.

Change of soiled and mutilated notes-binding

of note packet by rubber band.

Nomination facility.

Issue of fixed deposit (FD) pass book and

obtaining renewal instructions while accepting

fixed deposit or issue reminder for over due

fixed deposit.

Notification re. Interest change in news paper.

Issuance of draft at one counter –pre signed

draft up to Rs.5000/- .

Return dishonored chequed within 24 hours.

Remittance beyond two days-remitting bank to

compensate.

Instant credit upto Rs. 5000/-(Since raised to

Rs.15,000/-) .

Interest on delayed collection at SB rate plus

2%.

Extended non-cash business hours by 2 hours.

Use of cash counting machine.

Opening of special branches for customer

service.

Customer Service

Procedure and performance

Recommendations- To help small depositors, the RBI has asked all

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audit of public services: Banking Operations- S.S. Tarapore

the banks to put in place policy on depositor’s

right.

The policy will encompass all aspects of

deposit operation of all accounts, charges that

can be levied and other related issues.

IBA has been asked to prepare a model code

to help the bank to adopt their own policy.

RBI has also put in place system of imposing

penalty on banks for infringement of customer

right.

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Financial Sector Reforms

NARSIMHAN COMMITTEE – I

Recommendations- No further nationalisation of banks. No bar on private sector banks.

Enhancement of share capital of PSB, by

offering to Mutual Funds, General public and

government undertaking.

Liberal policy for foreign bank and opening of

branches

4 tier banking (a) 3 to 4 large banks (b) 8 to 10

national banks (c) local banks (d) rural banks

Abolition of dual control of government and RBI

Lowering of SLR to 25%

Phasing out commercial interest rate.

Special Tribunal for recovery

Transparency of balance sheet of banks –

disclosure mandatory

Financial Sector Reforms

NARSIMHAN

COMMITTEE –II

Recommendations- Entire portfolio of government security to

marked to market. Government security to

carry 5% risk weight (present 2.5%).

CAR – reach to 8% by 2000 and 9% by 2002.

Recapitalisation is not sustainable option --no

further recapitalisation from government

budget.

Object to reduce net NPA to 5% by 2000 and

3% by 2002.for large NPA accounts- constitute

AMC.

NPA-now move to 90 days default

General provision on standard assets- 1%.

10% PS to weaker section, interest subsidy

element in directed credit be eliminated.

Greater attention to AL management

Weak Bank- where accumulated losses and net

NPA exceeds it net worth or where operating

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profit less income on recapitalisation bond is

negative in consecutive 3 years. –Do study of

weak banks, which are potentially viable, by

financial and operational restructuring.

Greater autonomy to banks by amending RBI

Act, BR Act, Nationalisation Act etc.

Also suggested measures for legal and

legislative frame work like amendment of

transfer of Property act 1882, extension of

special statue like SFC for recovery ,

rationalisation of stamps duty etc.

376

Foreign Exchange

Capital Accounts Convertibility –TARAPORE COMMITTEE

India adopted current account convertibility in

1994.

CAC recommended a time bound programme

to make Indian Rupee Fully Convertible by

March 2000.

CAC already done for foreign Institutional

Investors both direct and portfolio

Control still exists for Individual and corporate

to remit capital abroad and inflow and outflow

of capital through bank and NBFC

Pre-condition for CAC(a) Fiscal deficit as % of GDP from 4.5% to

3.5% by 2000.

(b) Mandated inflation rate –3 to 5%.

(c) CRR- reduced to 3%.

(d) NPA- reduced to 5%.

(e) Deregulation of interest rates (still

Saving Bank deposit rate is regulated).

(f) Exchange rate movement –REER (Real

Effective Exchange Rates) to be

declared, published and made public-

band of (+)/ ( -) 5% of REER , RBI

intervention if REER is outside band.

(g) FX Reserve should not be less than 6

months of imports.

(h) FX reserves should be at least 70% of

the currency and in no case less than

40% of the currency in circulation.

Implications (a) Time is too short- high risk of out flow of

capital –pre conditions could not be

achieved within target date i.e. March,

2000

(b) Need of expertise for banks due to

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market risk exposure

(c) With FX above 131 BN USD and Net

NPA around 5% pre conditions are met

partially. Limiting factors are high Fiscal

Deficit. Government is cautiously

moving towards CAC.

(d) Recently individual persons allowed

investing upto USD 25,000.

(e) As per latest credit policy banks can

borrow overseas up to 25% of their Tier

I Capital.

(f) .Residents have been allowed to invest

overseas up to $ 25,000. RBI panel has

recommended allowing resident Indians

to open account overseas and remit $

25,000 annually. RBI has permitted to

remit other amount like $10,000 for

private visit, $5,000 for gift, $5,000 for

donation etc. through the same account.

(g) RBI has announced on 20.3.06 for

setting up of Tarapore Committee II to

suggest comprehensive medium term

frame work with sequencing and timing

to move to capital account

convertibility.

378

Foreign Exchange

Capital Accounts Convertibility –TARAPORE COMMITTEE II

2nd Tarapore Committee was appointed in

March 2006 at the behest of the Prime Minister

Dr. Man Mohan Singh to draw a road map of

full convertibility, as conditions now are more

benign.

2nd Tarapore Committee has submitted its

report to the Reserve Bank of India.

It is expected that full convertibility will be a

boon for companies looking for acquisitions

overseas.

The committee is expected to look into the

issues of fiscal deficit, impact of immediately

and sudden convertibility of forex reserves etc.

Foreign Exchange

SODHANI COMMITTEE –LIBERALISE FX RULES

Recommendations- Bank to fix of its own open position of FX

Interest rate of FCNR to be decided by bank

Customers to have option/hedge facility

Bank to have their own gap limit based on

risk/exposure

Human Resource Management

Kanan Committee

on Banking

Education

Chairman

Kannan, CMD,

Bank of Baroda

To look into revision of the examination system for

the banks which is administered by the Indian

Institute Bankers’ (IIB), Mumbai.

Recommendations - The present system of conduction

examinations by the Indian Institute of

Bankers’, (IIB) for banking professionals needs

some changes.

The suggested changes include (a) introduction

of Junior Associate Diploma examinations and

Certificate Associate Examination would; (b)

the committee highlighted the need for

increasing level of specialization at senior level.

It has suggested a Specialised MBA course in

Banking and Finance; (c) the committee also

379

suggested that employees of finance

companies should also be covered by the IIB

examinations.

380

Human Resource Management

KOHLI COMMITTEE

ON HRM

Sri SS Kohili,

CMD PNB

Recommendations- Recommended downsizing of manpower in

PSBs.

To draw manpower plan before implementing

VRS.

Suggested norms for compensation.

Removal of Centralized Recruitment System.

Introduction of ESOP in banks.

Reorienting the transfer placement policy.

Changing performance appraisal norms.

Alterations in the norms of work allocation.

Improving the job profile of employees.

Human Resource Management

Khandelwal committee

The Khandelwal committee has proposed changes

in the way PSBs recruits, compensate, provide

incentives and plan for succession of employees

under their fold.

Recommendations: Bank should do away with the system of

industry wise settlement of wage revision

instead it should be at bank level depending

upon its capacity and profitability.

It observed that salary level up to Scale II is

competitive but senior level salary is not at

per market rates.

Bank can have either variable pay or

incentive scheme to compensate the senior

level executive.

Recruitment, promotion and training are

other issues that need to be addressed.

Bank are likely to face a severe crisis with

almost all senior level executive retiring in

next couple of years with no alternative plan

at place.

381

Awarding ESOP up to 15% to top performer

is other key recommendation of the

committee.

382

Inspection JILANI COMMITTEE ON INTERNAL CONTROL SYSTEM IN BANKS –RASHID JILANI

CMD PNB

To examine the efficacy and adequacy of the

internal control systems in banks and to suggest

improvements in them.

Recommendations- To beef-up Internal Inspection and audit

system.

Computer audit-reliable software, confidentiality

of data is maintained.

Rating of branches –inspection of poor rated

branches within 12 months.

Inspector to check NPA.

Accountability of auditors also.

Efficiency ratio of branches – on floppy to

ascertain risks and updated.

Audit committee of board - scope to be

increased to include fraud, RBI inspection etc.

Inspection PADMANABHAN WORKING GROUP ON BANK SUPERVISION (PWG) 1991

Recommendations- Shift from current system of periodical

inspection to ongoing supervision.

On site Monitoring-target specific critical areas

Supervision based on CAMELS

(a) Capital Adequacy

(b) Assets Quality

(c) Managerial

(d) Earning

(e) Liquidity

(f) System and Control

Focus on (a) Financial Conditions (b)

Operating Conditions and (c) Regulatory

Compliance.

Money Market L.C. Gupta Committee on

Derivatives

Derivatives are financial instruments that derive

their value from the underlying financial assets.

Recommendations:

383

Mutual funds should be allowed to trade in

derivatives for hedging but not for speculation.

Stock exchanges should inspect the books of

all its members participating in the derivative

segment at least once a year.

Existing stock exchanges should be allowed to

set up a derivative segment.

384

NPA Management

Pannir Selvam Committee on

NPA

1997

Recommendations- Enlarge the definition of debts to include debt

due to banks and mortgage debt. This will

help avoiding reference to High Court when

the mortgage suits come up before the DRT.

DRTs should have power to appoint

receivers and issue attachments during the

pendency of suits. Government should

specify remedies for contempt of DRTs in

case of disobedience or breach of orders of

the DRTs.

NPA Management

S R IVYER GROUP ON CREDIT INFORMATION BUREAU OF INDIA

Recommendations- Dissemination of information relating to suit

filed accounts regardless of the amount

claimed or such other accounts where borrower

has given consent for disclosure.

Prevent taking advantage of lack of information

by unscrupulous borrower.

NPA Management

SS KOHLI REPORT on willful defaulters.

Recommendations- Suggested amendment in banking law to

enable banks to make public the name of willful

defaulters.

As various acts forbids bankers to disclose

identity of the customers unless it is suit filed

hence suggested amendment in various act

such as SBI Act /BR Act / IDBI act.

Panel has defined willful defaulter as one who

Does not repay despite cash.

Does not purchase assets for which it has

borrowed.

Misrepresents or falsifies records.

Disposes of secured assets without

informing the bank.

Operates an account outside the

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consortium of lenders.

Name of willful defaulters including full time

executive should be circulated among banks /

public and SEBI.

386

Regulatory Requirement

Ganguly Committee

Report of the Consultative Group of Directors of

Banks / Financial Institutions (Dr. Ganguly

Group).

Recommendations-(a) Responsibilities of the Board of

Directors.

(b) Role and responsibility of independent

and non-executive directors.

(c) Training facilities for directors.

(d) Agenda and minutes of the board

meeting.

(e) Committees of the Board

(a) Shareholders' Redressal Committee

(b) Risk Management Committee

(c) Supervisory Committee,

(f) Disclosure and transparency.

Regulatory Issues

Malegam committee

Sub-committee will review the definition of

‘microfinance’ and ‘microfinance institutions’ for

the purpose of regulation , examine conditions

under which loan to MFI can be classified as

priority sector, recommend for money lending

legislation of the states for MFI, recommend for

MFI association and their role in increasing

transparency of operation, and grievance

handling mechanism for adherence to

regulations.

Recommendations Creation of separate category of NBFC- MFIs

A cap on 12% and 24% on margin and interest,

separately.

Creation of one or more social capital funds.

Lending by not more than two MFIs to

individual borrowers.

Creation of one or more credit bureaus

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Reaffirmed priority sector status

Total permitted outstanding to Rs. 50,000 and

increase in annual income limit to Rs. 60000 for

rural and Rs. 120000 for other areas.

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REGULATORY REQUIREMENTS

BASEL II Increased transparency re. Bank’s actual risk

Better monitoring by private investors

Better risk management and capital allocation

Three pillars of accord are -

FIRST PILLAR-Minimum capital required

(a) Minimum 8% requirement.

(b) Measure operational and credit risk.

(c) Inclusion of capital for operational risk

also.

(d) Two approach-Standardized and

Internal Rating Based.

(e) IRB based on internal estimate of

borrowers credit worthiness to assess

credit risk by rating agency.

SECOND PILLAR –Role of regulator

(a) Approval of IRB by regulator

(b) Bank management to bear responsibility

to for keeping adequate capital in

support of risk beyond core capital

THIRD PILLAR – Market Discipline

(a) New disclosure requirement in several

cases

(b) Quantitative/qualitative dimension of

capital structure

Three layered structures have become matter

of debate. IRB approach require several core

input such as PD (Probability of default), LGD

(expected loss rate given a default) and EAD

(expected amount of exposure at default). Such

sophisticated process requires lot of expertise,

technology and resources for banks and

regulators. It is argued that basing capital

requirement on very fine discrimination of credit

risk is not practical.

389

In line with Basel Pact, the RBI has asked all

banks to draw a road map to comply BASEL II.

To begin with all banks in India will adopt

Standardized approach for credit risk and Basic

Indicator Approach for operational risk. Once

basic skill is developed and RBI is satisfied

bank can l switch over to Internal Rating Model.

All scheduled commercial banks will be

required to follow BASEL II w.e.f. March 08.

RBI after conducting a simulation study on 50

public and private sector bank has assessment

additional capital requirement of tier I capital of

Rs. 51, 255 crore within March 2009.

As on 30th June 2010, CRAR of commercial

bank was 13.4% of which tier I was 9.3%.

Although Basel III norms are yet to be

calibrated yet RBI is confident that they will not

impact the Indian banking system significantly.

390

Credit Report of the

Committee on

comprehensive

Regulation of

Credit rating

agencies Dr.

K.P. Krishnan)

The Committee was constituted by the Ministry of Finance at the instance of the High Level Coordination Committee on Financial Markets (HLCCFM) to revisit the legal and policy framework for regulating the activities of Credit Rating Agencies (CRAs) in order to take a larger view of the entire policy with respect to banking, insurance and securities market. The Committee submitted its report to the HLCCFM on December 21, 2009.

The Committee has observed that although, prima facie there is no immediate concern about the operations and activities of CRAs in India even in the context of the recent financial crisis, there is a need to strengthen the existing regulations by learning the appropriate lessons from the current crisis. The Committee has taken note of international action in this regard and, inter alia, has recommended that there is a need for enhanced disclosure, continuation of the issuer-pays model, strengthened process and compliance audit, reporting of ownership changes, disclosure of default and transition statistics and strengthening of the regulation of the CRAs in tune with these suggestions.

Priority sector M V Nair

Committee

To re-examine the existing classification and suggest revised guidelines with regard to priority sector lending and related issues.

Major Recommendations of the Committee are:

1. The target of domestic scheduled commer-cial banks for lending to priority sector may be retained at 40 per cent of adjusted net bank credit (ANBC) or credit equivalent of off-balance sheet exposure (CEOBE), whichever is higher.

2. The sector ‘agriculture and allied activities’ may be a composite sector within priority sector, by doing away with distinction be-tween direct and indirect agriculture. The targets for agriculture and allied activities may be 18 per cent of ANBC or CEOBE, whichever is higher.

3. A sub target for small and marginal farmers within agriculture and allied activities is rec-ommended, equivalent to 9 per cent of ANBC or CEOBE, whichever is higher to

391

be achieved in stages by 2015-16. 4. The MSE sector may continue to be under

priority sector. Within MSE sector, a sub target for micro enterprises is recommended equivalent to 7 per cent of ANBC or CEOBE, whichever is higher, to be achieved in stages by 2013-14.

5. Banks may be encouraged to ensure that the number of outstanding beneficiary accounts under ‘small and marginal farmers’ and mi-cro enterprises’ each register a minimum an-nual growth rate of 15 per cent.

6. The loans to housing and education may continue to be under priority sector. Loans for construction/purchase of one dwelling unit per individual up to Rs.25 lakh; loans up to Rs.2 lakh in rural and semi urban areas and up to Rs.5 lakh in other centres for re-pair of damaged dwelling units may be granted under priority sector.

7. In order to encourage construction of dwelling units for Economically Weaker Sections (EWS) and Low Income Groups (LIG), housing loans granted to these indi-viduals may be included in Weaker Sections Category.

8. All loans to women under priority sector may also be counted under loans to weaker sections.

9. Limit under priority sector for loans for studies in India may be increased to Rs. 15 lakh and Rs. 25 lakh in case of studies abroad, from existing limit of Rs 10 lakh and Rs 20 lakh, respectively.

10. The priority sector target for foreign banks may be increased to 40 per cent of ANBC or CEOBE, whichever is higher with sub-tar-gets of 15 per cent for exports and 15 per cent for MSE sector, within which 7 per cent may be earmarked for micro enter-prises.

11. The committee recommends allowing non-tradable priority sector lending certificates (PSLCs) on pilot basis with domestic sched-uled commercial banks, foreign banks and regional rural banks as market players.

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12. Bank loans to non-bank financial intermedi-aries for on-lending to specified segments may be allowed to be reckoned for classifi-cation under priority sector, up to a maxi-mum of 5 per cent of ANBC or CEOBE, whichever is higher, subject to certain due diligence and documentation standards.

13. The present system of report-based report-ing has certain limitations and it may be im-proved through data-based reporting. There is a need to address the issues in data report-ing like pre-defined parameters, reference date, periodicity, unit of reporting, etc.

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Customer service

RBI panel on

customer

service

Chairman Mr.

Damodaran Ex

Chief of SEBI

Recommendations: Deposit insurance cover to increase to Rs. 5

lakhs No exorbitant rate for foreclosure of housing

loans Prescription on service charges for basic ser-

vices like remittances Compensation on delayed returns of instru-

ments and loss of title deeds Increasing cap of pre-paid instrument to Rs.

50,000 Intimating customer for breaching minimum

balance and charges for the same

In case of failure of ATM or net customer will not be required to bear loss.

Replacement of ATM card or debit card with Chip based card with a photograph of card holder

Small Scale Industries

KAPUR COMMITTEE-SSI

LOAN-Composite Loan up to Rs. 5 lacs, Loan

by SFC/Banks up to Rs. 25 lacs and above 25

lacs by SFC/BANKS any one

Sectoral allocation- 40% up to Rs.5 lacs, 20%

from Rs.5 to 25 lacs and 40% above Rs. 25

lacs.

Interest Rate –PLR or cost of funds

DICGC-scrap and banks to set up their own

sinking funds.

Adhoc upto 20% by BM.

Phasing out collateral security.

Change in definition of Sick unit.

Committee approach for appraisal.

MOU with SFC in each state by lending by

bank to sanction joint loan-WC by banks only.

PS funds should not be diverted for NABARD,

SIDBI, SFC, SIDC, NSIC, NBH, and HUDCO

BONDS.

Small Scale Industries

NAYAK COMMITTEE –

Recommendations- MPBF 20% of sales-maximum Rs. 5 crores

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P R NAYAKDY GOVERNOR RBI

Both term loan and cash credit loan up to

project of Rs. 20 lacs (working capital Rs. 10

lacs )

Preference to village, tiny and other small

industries

1st method of lending for institution marketing

goods of village, tiny and other small industries.

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MSME Working group to review the working of CGSTMSME

Having regard to the imperative of accelerating the flow of credit to the Micro and Small Enterprises (MSEs) sector, which is very critical for inclusive and equitable growth and larger economic empowerment, it was announced in the (paragraph 114) Annual Policy statement for 2009-10 "to ask the Standing Advisory Committee on MSEs to review the Credit Guarantee Scheme so as to make it more effective.” Following this announcement, a working group was constituted under the Chairmanship of Shri V.K. Sharma, Executive Director, Reserve Bank of India. The terms of reference of the Group were: i) to review the working of the Credit Guarantee Scheme and to suggest measures to enhance its usage and facilitate increased flow of collateral free loans to MSEs; ii) to make suggestions to simplify the existing procedures and requirements for obtaining cover and invoking guarantee claims under CGTMSE Scheme; iii) to examine the feasibility of a whole turnover guarantee for the MSE portfolio; and iv) any other issues. The group has recommended:

The main recommendations of the Group are:

1. Collateral free loans

The limit for collateral free loans to the MSE sector to be increased from the present level of Rs. 5 lakh to Rs.10 lakh and it be made mandatory for banks.

2. Guarantee Fee

a) The guarantee fee for collateral free loans upto Rs.10 lakh to Micro Enterprises to be borne/ ab-sorbed by the CGTMSE subject to the proviso that the Trust be free to adjust the guarantee fee both downwards and upwards based on the modelling of the dynamically evolving distribution of claims. This will ensure that the CGTMSE remains self-fi-nancing and self-sustaining in the long-term.

b) CGTMSE may charge composite, all-in guaran-tee fee of 1% p.a. and appropriately realign down-wards the guarantee fees chargeable to women entrepreneurs, Micro enterprises and units located in North-Eastern Region including Sikkim. The

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Trust may also annually review the Guarantee Fee to be charged on the basis of the pricing/valuation model suggested by the Group.

c) The Government of India to consider exempting both guarantee fee and the income on investments of the Trust from Income Tax, as is the practice in-ternationally for such non-profit credit guarantee or-ganisations.

3. Extent of the Guarantee Cover

Consistent with the recommendation for enhance-ment of the collateral free loan limit from Rs. 5 lakh to Rs. 10 lakh, the guarantee cover upto 85% of the amount in default to be made applicable to credit facilities to Micro Enterprises upto Rs 10 lakh.  However, the extent of guarantee cover for credit facilities above Rs.10 lakh upto Rs.50 lakh will be 75% and for credit facilities in excess of Rs.50 lakh upto Rs.1 crore will be 75% upto Rs. 50 lakh and 50% of the amount in excess of Rs. 50 lakh, as per the extant provisions of the Scheme.

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Technology Committee On Technological Issues – W S Saraf - Dec 1994

Recommendations- An electronic funds transfer system is set up –

BANKNET communication network may be

used for the purpose.

Steps are taken by RBI to enact a suitable

legislation on the lines of Electronic Funds

Transfer Act 1978 in USA and Data Protection

Act 1984 in UK.

RBI may explore the feasibility of using

NICNET for electronic reporting of currency

chest transactions

Funds settlement in respect of Govt.

transactions may be delinked from submission

of scrolls and documents to PAO of Govt. dept.

Funds settlement to take place in a prescribed

frame ensuring at T + system

Electronic clearing service is introduced to

effect repetitive low value transactions like

interest, dividend, refund orders, salary,

pension etc.

Bills payment system to introduce to enable

customers of utility services to pay bills by debt

to their accounts in banks.

Cheque transaction system should introduced

initially for Intra-bank cheques of value up to

Rs. 5000. In due course, it may be extended to

Inter-bank instruments. Suitable changes to be

initiated in NI Act.

Universal Banking

KHAN COMMITTEE (Harmonizing the role of DFI and banks for moving

Universal banking –doing all banking activity

both commercial and developmental under one

roof.

CRR to be reduced to 3% and SLR to be

phased out

FII to be allowed to accept short-term deposit.

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towards universal banking)

DFI has no future –allow converting to bank or

NBFC.

Transfer of RBI holding of equity in DFI to

Government-RBI can not be owner as well as

supervisor at the same time.

Doing away with concessional lending.

RBI approach – allow 5 years to DFI to convert into

banks.

Vigilance Expert Committee on Bank Frauds -Chairman:

N. L. Mitra

Recommendations- Suggested both - preventive and curative

aspects of bank frauds.

Recommended for including financial fraud as a

criminal offence.

Suggested for amendments to the (A) Indian

Penal Code by including a new chapter on

financial fraud; (B) Indian Evidence Act to shift

the burden of proof on the accused person and

(C) special provision in the Code of Criminal

Procedure for transferring the properties

involved in the financial fraud and confiscating

unlawful gains.

Preventive measures including the

development of Best Code Procedures by

banks.

Vigilance GHOSE COMMITTEE -High level committee on fraud and malpractice

Recommendations- Introduce Concurrent Audit -substantive

checking-special report to bank.

Photograph of the depositors.

Desk card to employees.

Cash and valuable in joint custody.

Cash should not be deposited other than cash

department.

Advance not to exceed delegated authority.

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Chapter- 37

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Becoming an effective trainer

….true illiterates of the future will be those who do not relearn and retrain. ………Anon

1. Trainer as a sales person1.1There is a little bit of selling that each one of us does all the time. The

priest at the temple is selling the service he knows best. The young man appearing for the interview is selling his candidature to the board. A policeman is selling his skill to control law and order. The teacher sells his wisdom and knowledge to students. The trainer is to do the same job. The selling is, therefore, essential of life.

1.2The trainer as a sales person has to understand his customers (trainees), their wants (training needs), how to map these wants (training need analysis), how to satisfy these needs (training effectiveness), how to measure needs satisfaction (training evaluation) and to take feed back to ensure that training serve its purpose (return on training investment).

1.3The key to the success of any organization lies in how efficiently the organization manages its human resources. The principle applies more aptly to service institutions like banks. The issue is still more relevant to public sector banks as they are striving hard to keep pace with the technological changes and challenges of competition. All this requires creation of new competencies and capabilities in officers/employees on an on-going basis for which a good training system is a must. Training is not one-off ‘repair’ to meet an immediate need but a tool of continuous development. Training not only makes the mangers’ efficient but also makes them effective.

2. Making of a trainer2.1 One may become a trainer by choice (a core faculty or faculty selected

through interview process) or by default (picked up by the management and posted). But once he is in the system, he must consciously try to develop him-self. He has to be a friend, philosopher and guide of trainees. He has to be Fit, Fast and Smart like a sales-man.

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2.2 A trainer should not only be fit to be a teacher but also continue to be fit for teaching. He should have pleasing personality, attractive mannerism, positive attitude and good communication skill. He should develop trust, closeness and rapport with his trainees. He should speak convincingly and listen non-defensively. He should express clearly and logically. He should be ready to guide, help and direct. He should be hugely communicative and maintain a personal touch with trainees while giving them enough space to communicate with him. He should know art of answering questions of the trainees logically and convincingly. He should be conversant with all training methodologies and techniques to deliver what trainee needs and not what trainer has. He should be computer savvy. He should also be a good learner. Above all he should make continuous efforts to keep himself up to date so that he continues to be a fit teacher.

2.3 It is said that reading makes a ready man. Reading is basic requirement of a trainer. In fact trainer must develop habit of rapid reading. As per survey, average reading speed of executives in India is 250 words per minute when in fact it should be 500. President Kennedy is believed to have had a phenomenal speed of 1500 words per minute. He was not born with this capacity; he cultivated this. Poor reading erodes 50% of one’s time. Fastness is thus a special virtue of a trainer.

2.4 Fastness requires setting the priorities right. He should introduce trainees with faculties as well as within group as early as possible. Small anecdotes, jokes, stories etc. create humor and improve involvement. He should be articulate enough to use these tools to break the ice. He should have ability to place first things first such as class- room setting, address system, multi-media, air-conditioning and lighting. He should be fast to pick- signals of passive listening like no questions, blank faces etc. and should encourage them to come out of the shell by putting questions and stimulating interaction. He should be sensitive enough to observe happenings both inside and outside the class and promptly take proactive measures to keep the learning atmosphere in its right earnestness.

2.5 Smartness demands that trainer is not only smartly dressed but also passionate about his profession. A smart trainer is one who checks and makes his training style and language a perfect fit. He should have high

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level of energy and abounding self-confidence to command respect from the trainees. He should dress appropriately. The dress makes a statement about trainer’s personality.

2.6 Effectiveness of the trainer is like developing a brand. Like a successful brand, a trainer should be customer (trainee) driven. He has to deliver what trainee needs. He has to deliver what can be put into practice.

3 Effectiveness ladder3.1 Like advertising, a trainer will fail to deliver if he lacks to connect with the

people (trainees). As learning process of adults is entirely different from that of schoolchildren, a trainer has to be conscious of connecting with trainees to make them active learner.

3.2 The training is known as long-term intangible investment. An effective trainer has to tangibilise the intangibles. He has to make the results visible by change of attitude, improvement of skill and betterment of knowledge of the trainees. He has to quantify the improvement by measuring results.

3.3 Effectiveness ladder starts with identification of training needs. Inspection reports, annual performance appraisal of employees, customer complaints, review meetings, interview for promotions, new product/business line, new recruits, new promotion etc. are events that trigger training needs. Structured pre training survey is the other tool to identify changing training needs of the employees. In addition, there are skill-oriented jobs like computer operations that require regular skill up gradation.

3.4 Once training needs are identified, next step is to analyze these needs and translate into specific topics and modules. In order to evaluate the results, training objectives are simultaneously determined so that aggregate learning outcome is quantified through evaluation process. It is essential that programme objectives are set out from learner’s perspective and should also quantify benefits that are expected of the trainees.

3.5 Next step is to identify programme contents. This is also known as topic planning. A trainer should remember that programme contents are contained in the objectives and conversely programme contents dovetail

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into programme objectives. Hence contents should match training needs. Flexibility is a key to this process. At the start of the progrmme, the contents should be reviewed with the target trainees and depending upon their feedback, a quick adjustment should be done so as to meet expressed need. If necessary, additional sessions can be planned. This process of consultation has one more advantage. It creates commitment and ownership of the participants.

3.6 The subject sequencing, time allocation, training methodology etc. are very crucial for implementation perspective. All these have to be planned in logical and integrated manner. Programme should start from simple, easy to understand and uncomplicated subjects and gradually rise to difficult, hard and complicated subjects. The efforts should be to develop confidence and create interest of trainees and maintain momentum of the programme. Support material like handout, case studies, exercises etc. should be provided to supplement the training efforts or to give group/team assignments.

3.7 The trainer should in between the programme do recap of the training events and should also do mid-term review with a view to do mid-term correction. Experience shows that trainees very often are not able to express their requirement in early stage of the programme and it is only when they are exposed to the subject, they are able to give meaningful suggestions.

3.8 The trainees are other important element of this value chain. A trainer should constantly strive to empower his trainees. He should

Promote self-awareness and self-effectiveness among trainees. Initiate the process to bring down barriers between the participants

and remove inhibitions. Facilitates the process of exploring, knowing and developing

healthy relationship among participants. Motivate the participants for meaningful and productive

participation. Promote free and open exchange of experiences and ideas. Acquaint them with the dynamics of a training group and group

process. Develop respect for group procedures and norms.

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3.9 Training effectiveness can be better measured through standards of performance that participants are required to attain during the process of training. These performances can be measured through entry and exit test. The test process will not only speak about knowledge addition of the participants in general but will also help the trainer to identify the knowledge gaps that he has to fill up. Incentive/prizes are other means to improve enhancement of performance for high flyers. To encourage participation, the trainer should always give appreciation and acknowledgement of good work to trainees.

3.10 Effectiveness ladder requires strategic integration of training system, trainers and the trainees. Trainer’s commitment and passion smoothen the integration process.

4. Develop your brand- standard setting 4.1Setting standards are like building the brands. And like a brand, a trainer

must be value driven. Firstly he should have faith in training as a tool for growth and development. He should have firm belief in humanistic approach in training. He should have commitment to the programme and its objectives. He should have professional commitment to excel. And above all, he should have faith in participatory training.

4.3Session feed back is an important tool that enables the trainer to evaluate his performance. A trainer should not be hesitant to use this tool. He should use this as often as necessary. In order to encourage honest feedback, a trainer should not only guarantee anonymity but also take the feed back in sporting sprit. He should evaluate him-self over a time span. He should constantly aim at improving his performance. He should consult his peers and selected trainees to identify his weaknesses and make conscious efforts to improve upon them.

5. Handling problem situations5.1A trainer may come across a situation when trainees differ from his point

of view. They may also express their dissent vocally. Whatever be the reasons, such situations require high degree of patience and competency from the trainer to handle such awkward situations. He should be tactful as well as strategist.

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5.2A trainer my come across a situation when a participant put repeated questions or make unnecessary/unwarranted suggestions. A trainer should never get provoked on such events. He may tactfully ask the participant to briefly indicate in what ways his contribution is helping the discussion and may involve other participants to bring home the point that questions are unnecessary and are not relevant.

5.3 A situation may arise when participants may involves themselves in counter arguments. Such situations may create unhealthy environment in the classroom and may ultimately affect learning atmosphere. A trainer should tactfully intervene on behalf of the group and state that such discussion is not contributing to the knowledge of the group without ascribing motive even if he is sure what lies behind the confrontation.

5.4A participant may be found unable to make a substantive point due to communication problem or lack of understanding of the subject. In such a situation the trainer should give patient and genuine listening and understand the problem. In case it is observed that problem is due to comprehension of the subject, then the trainer should again explain the subject. If problem is in communication, the trainer should paraphrase the subject to clarify the doubts. The participants can also be encouraged to speak in their regional language so as to enable them to communicate clearly/freely.

5.5Private or cross conversation is a problem very often faced by the trainers. Trainer should draw the attention of the whole group and encourage participants to share their views with the group so that every body is benefited. Or, he can use non-verbal communication to show that behavior has been noticed. He may ignore the behavior as tactical measure also.

5.6A participant may go to an extent where he challenges the trainer. Notwithstanding the motive of the participant, a trainer should not lose his composure. He should not get provoked. He may state is disagreement but acknowledge the contribution of the trainee.

5.7Lack of participation or response is other common problem. This can be overcome by encouraging participation through questions and answers. Teaching through a case study can be of great help in such situations.

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5.8Distraction through movement of the participants or late arrival of participants is other major problem, which is often confronted by the trainer. A trainer should tell to participants about the expected behavior at the start of the course. If body language of the participants says that they are not interested in the session, then the trainer has to change his training style as well as methodology. He may in exceptional cases use administrative measures to check delinquency.

5.9Occasionally one or two participants may try to monopolize the discussion. One reason may be that the trainees have very high level of self-esteem and feel that they are entitled for such domination in the group. The other reason may be to secure leadership among the group. A trainer should keep his cool and should never behave out of emotion. His strategy should be to handle the situation without getting into a direct confrontation with the participants.

5.10 A trainer has cited an incident when he find that his ex-boss is his trainee in a training programme. There may not be any problem with the boss but the trainer may be worried how to teach him. Such a psychological barrier may come very often. Here he is facing the boss; others may have a senior colleague. A trainer should understand that he is not teaching to a boss or subordinate. He is not teaching to a junior or senior. As one can learn from his subordinate, he can learn from his seniors also. A trainer should have confidence (and not fear) to handle such situations in a stress-free manner.

5.11 A trainer was once asked by one of his trainees about mistake he himself committed when he was in field. He could sense that purpose was to distract the trainees from learning path and to embarrass the trainer. A trainer must be ready to face such peculiar situations without losing heart. He should be brave to acknowledge his shortcomings. He should tell the trainees that this is what the training is meant to be where shortcoming of not only his but of others also will be discussed so that mistakes are not repeated.

5.12 A trainer may confront with employees who are not really interested to learn. He may also find employees not interested in training at all. A trainer is like a gardener. He plants the flowers, create a context, provide

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support, and is there to help the trainee in his development. However having done that he does not always expect every effort to bear fruit. He should accept that some peopled do not want to be trained and he may not be able to make a difference in his development. An effective trainer should show empathy in dealing with such people and instead of judging the individual by surface behaviour; the trainer should seriously create conditions, which motivate the people to work. They should be open to personal learning, to receive feedback and ready to learn even from the employees.

5.13 A trainer may confront a situation when he does not know the answer to a problem. In such situation, he may commit to his trainees to come back afterwards. He should honestly honour this commitment. This is his professional obligation.

6. Summing up- playing the value game6.1 If you scan the career history of most admired bankers, you will find that

most of them were trainer at least once in their service career. And, they became successful banker, great speaker and visionary leader because of this. So if you have opted yourself as trainer by choice, you perhaps know the value of this opportunity, or if you are in the training system by chance, it is a Godsend opportunity for you. It is a very good break in your service career. You will not only get love, respect and regard but also experience deep sense of satisfaction by contributing some thing of great value to you and to your organization. In selling perspective, this can be termed as value addition in your personality and value creation in developing human resource.

6.2 It is said that any body can be student but a few can be teacher. “Budding trainers,” it is a lifetime opportunity for you. You have great career ahead. You are in value creation mode. You are in the profession of rendering the greatest service of mankind. Develop your self-fulfilling prophecy and enjoy.

“There are no boring subjects and there are no boring trainees.”

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“Only there are boring trainers.”

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Chapter - 38

Trainers’- as change Managers

“ It is not the strongest of the species that survive, nor the most intelligent but the one most responsive to change.”

-Charles DarwinIntroduction-Paradigm shift in Indian Banking

The changes after liberalisation, privatisation and globalisation in India since l991 has a significant impact on the banking system that has exposed the public sector banks (PSBs) to de-regulated and competitive environment. These changes have brought pressure on business share, pressure on interest spread (NIM) and pressure on financial health of PSBs. The customers expectations and demands have also under gone radical change due to entry of private banks who have started offering variety of value added services with focus on door step delivery and that too round the clock. The challenge and pressure of this new environment has resulted into a sea change in banking business process. Bank’s are innovating new products, offering 7days a week to 24 HRS banking, introducing new delivery channels

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and devising new ways and means to cut cost, to overcome delays, and to offer services at competitive rates. They are becoming more and more professional in their approach by complying with international banking standards in the area of risk management, capital adequacy, loan loss-provisioning, assets quality and corporate governance. The merger, acquisition and business alliances have become new mantra of survival and business growth for banks. Intensive use of information technology is another consequence of this business process re-engineering which has opened new delivery channels through ATM, Tele-banking, e-banking etc. where a customer can do banking to his convenience any time any where and that too without physically visiting the bank. The pressure to cut cost and over come delays in decision making has given way to structural changes as banks have started transforming them-selves into a lean and thin organisation by moving to three tier structure from four tier and right sizing manpower through Voluntary Retirement Scheme and Sabbatical leave scheme and taking measures for improving productivity by re-deploying and re-locating manpower as per business need from surplus to deficit pockets and from controlling offices to branches. In preparing for these changes focus is now on adopting a holistic approach to Human Resource Development by training and retraining existing workforce to enable them to cope with the new environment more efficiently and more effectively.TRAINING –as Human Resource Development process

This paradigm shift is all pervasive and has necessitated for the banks to respond fast, firmly, decisively and innovatively. In order to enable the employees to cope with these changes more efficiently and professionally, banks have to devise appropriate Human Resource Measures to develop ATTITUDE, SKILL and KNOWLEDGE of their employees through appropriate training input with focus on: -

1. To change Attitude (mindset) of the employees in tune with changing times and requirements.

2. To develop Skills in the employees in operational areas such as Product development and marketing skill. Credit management including credit monitoring. Forex management and international trade.

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NPA management including recovery of problem loan. Marketing fee based product and services. New risk management practices. Skill to operate electronic environment/technology driven banking. New internal control and audit skill in the area of e- banking. New focus in customer’s delight.

3. To have faster dissemination of Knowledge among the employees in the area of New concepts like risk management, derivative trading, ALM etc. New products like insurance, cash management, e-loan etc.

4. To identify hidden talents who can be better utilized in the area of their competence for the growth of the organisation.

However to make the training result oriented, it is required to effectively address certain misconception of training such as training is a paid holiday for the employees or a waste of scarce organisational resources by creating necessary awareness about its usefulness as a tool of organisational and individual growth. Training needs and employees -

One parameter by which employees rate their organization is training. As per BES 04, about 40% respondents’ felt that training is one need, which is not being adequately addressed. They felt that organization that is giving training is enhancing their skills and productivity. And most importantly they believe that raining will help them grow- either within the organization or outside- both in terms of job role as well as salary. Naturally, all these things will make the employee to respect the employer they work for more. Preparing for the changes-Convergence of training with Human Resource Development Plan

In order to have convergence of training strategies with Human Resources Development Plan, the trainer has to address the following issues:

To develop an integrated approach to learning -participants explores in training situation what interests them most and the job of the trainer is to provide that opportunity.

To develop an appropriate training method and technique as effective delivery mechanism.

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To act as facilitator -to serve as resource for guidance and information and converting participants from passive listener to active learner.

To give strategic thrust to new dimension of banking business in order to make the training system relevant and participant oriented.

To measure effectiveness of the training. This can be measured by greater organisational effectiveness and improved participants behavior through a well-designed and tested feedback cum evaluation system.

To do training audit- are we doing it right? – To establish standards for training and evaluating it continuously to check if the objectives are achieved. As the training programmme by nature are short-term where impact is invisible, evaluation is difficult and results are intangible, role of the trainer is not only to understand these limitations but also to make continuous and concerted efforts to effectively focus to improve training delivery mechanism based on feedback from training audit.

Training effectiveness –Key drivers The Trainers, the Participants and the Organization are all partners in training efforts. This

requires collaboration at all levels starting from identifying training needs, designing courses, and

nominating trainees and up to follow-up for post training support/placement for measuring results.

The objective is achieved if the training is viewed in the organization on continuous basis as a change

agent of employee’s development and organizational growth. The key drivers to these changes are: -

Key Drivers Measured by Attitudinal change Greater acceptance of the role and

responsibility, willingness to accept change by way of promotion/ job-rotation/transfers, removal of fear syndrome etc. all reflected by change in work culture.

Job Satisfaction By increased involvement of employees and orderly compliance of system and procedure.

Job Enrichment By higher output, improved skill in technology, marketing, and recovery and in functional areas such as credit appraisal, risk management etc.

Boosting employee moral and building commitment.

By improved productivity and confidence in decision-making.

Motivation To get the best out of every individual in the organization measured by improved business per employee/profit per employee/higher

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business share, and improvement in customer base etc.

Unqualified support to business goal

To have a passion for excellence –reflected by business results.

POST VRS-Challenges and Opportunity The post VRS situation in the banking industry has brought both

challenges and opportunities to the trainers. The branch where manpower is in short supply has to be provided manpower by redeployment. Attitudinal shift is required in the mindset of employees to accept this change, which can be done through HR intervention via training. Similarly, vacuum caused by exit of senior level officials has created shortage of skilled officials in the area of treasury management, forex management, credit management, marketing of retail products etc. This requires training of the officers, both existing and promoted, to sharpen their skill in the area where these officers are proposed to be engaged. To tap new business in the area of retail banking, housing finance, cash management, insurance and other value added products, there is need to train the identified officers so that they are well equipped both in knowledge and skill to sell these products by proactively contacting the existing and potential customers. In customer centric environment, the attitude and approach of the employees have to be changed through training so that there is new organization work culture of customer’s concern and organizational prosperity. With increased focus on e banking and other e-based value added products like EFT, ECS etc. There is need to develop skill of the employees to make them fully conversant with its application. Over all in the competitive scenario where there is continuous pressure on spread and profitability, each training programme should focus on the employees to build a new work culture of unqualified support to business goal and employees’ excellence. Summing up

As stated earlier the trainer is a facilitator of the learning process in this value chain and his effectiveness is measured by harnessing of untapped potential of its employees. He has to identify training needs and plan the programme. He is a subject specialist so that he can respond to the doubt and queries of the participants in clear and convincing manner. He is a role model of experienced banker to offer relevance of theory with practice. He is

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a counselor, a friend, a philosopher and a guide to the participants. He is a leader having responsibility to effectively conduct the programme, achieve its objectives, and give direction and support and to bring required changes in Attitude, Skill and Knowledge of the participants. Such a learning process can truly transform an organization into a learning organization i.e. an organization, which can actually develop employee’s commitment for organizational growth.

Trainer is thus a change Manager. To make these changes happen is his job.

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Chapter - 39Innovate or Die

New Mantra of modern day banking

“Knowledge innovation has come to mean the systematic application of new ideas into the marketable goods and services, for the

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success of enterprise, economic vitality and the speedy advancement of society.”

1. ‘Innovate or Die” - New mantra of modern day banking -

1.1 Innovation is application of ideas – new or existing - in new ways or in

new fields or in new products. It helps an organization to cut cost, to

improve profit and also to improve market share.

1.2 Organizations often associate innovation with a product or process. In

fast moving time that we live in, this is not enough. Today innovation

means change in business model it-self.

1.3 Innovation happened when TCS began to offshore information

technology, or when Dhirubhai Ambani told his son , Mukesh, that only

if he can price a call less than the cost of post card will his mobile

business has future, or when Jack Welch set up a call centre at

Gurgaon to answer queries raised by General electric customers in US,

or when Lalit Modi introduced T 20 format in Indian Premier League.

1.4 Winning companies recognize the need of ‘out of box thinking’ and are,

therefore, creating culture where ideas keep flowing continuously.

Those who do not innovate, join the list organizations that drive

themselves to oblivion. ‘Innovation’ is ‘in’ word in corporate

philosophy now.

1.5 Competition, convergence and consolidation are key drivers of banking

these days. Competition breeds innovation and innovation breed’s

competitive advantage. To stay ahead of their competitors, banks are

trying new ideas (innovations) and reinventing existing products

(renovations). ‘Innovate or die’ is new mantra of modern day

banking.

2. Customer is driving innovation – 2.1 Customers buy not because they understand the product or service

but because they feel that the bank understand their needs and wants.

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“High healed shoes were developed for short women who were tired of being kissed on fore-head.”

Customer centric innovation flips traditional ‘design – produce - sell’

model into ‘design – redesign – innovate – produce - market ” model.

In fact it is the changing needs of the customers that drive innovation.

2.2. Innovations come in two forms - the quantum leap type innovation

and incremental innovation. Quantum

leap type innovation in the financial

services industry may not come very

often but incremental innovation is now

order of the day. Engaging with the

customer is first step in the innovation

process, which provides strong insights for value addition (see box).

2.3 ‘Walking with the customer’ is a strategic tool of innovation as

strategically companies are now not generating ideas internally or having

R & D departments to innovate but are open to ideas from customers and

alliance partners. As one walk with the customer and is with him right

through while selecting, buying and using a product, one can identify great

deal of happening that can be used for creating (innovation) new products

or modifying the existing products (renovation). Walking with the

customer is a strategic tool of (a) mapping the customer’s need by

analyzing activities that customer performs while selecting,

purchasing or using a product, (b) locating the gap based on unfulfilled

or expected needs and wants and (c) closing the gap by introducing new

products (innovation) or modifying existing products (renovation) as

per identified needs and wants. Customer thus teaches everything

including what you should innovate.

3. Innovate to stay ahead – A new banking paradigm - Since

each product has its life cycle, banks are required to continuously innovate and

renovate products so that new/renovated product can replace the existing product by

the time its life cycle is over or new product is launched by its competitors. Creation/

modification of products are done either through value creation (new products) or

value addition (new features) or value affordability (less price or no frill products).

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After liberalization, privatization and globalization of banking in India, there is a

paradigm shift in product development with regards to process, pricing, place

(delivery channel), packaging, people and partnering. (Following paragraph will

enlighten the readers with paradigm shift taking place in product development. List is

only illustrative not exhaustive).

4.1 Deposit products – Accepting deposit is basic function of banks. From

core deposit products like savings account, current account and fixed deposit, banks

have gone a long way in offering augmented deposit products like monthly income

plan, reinvestment plan etc. Some emerging innovations are: -

3.1.1. Opening of no-frill savings accounts with zero balance is recent

innovation, which has been introduced at the instance of Reserve Bank of

India for financial inclusion of poorer section of the society. It is built on the

concept of value affordability so that customer can enter the market with

cheap entry-level product and thereafter use the product as per his capacity.

3.1.2. Tax-incentive on term deposit is another recent development. Banks will

have to structure deposit products of specified maturity to attract investors

who were hitherto parking their funds in small savings schemes of post

office, life insurance etc. for tax savings.

3.1.3. Floating rate of deposit products where interest rate is linked to some

benchmark rates like inter-bank call money rate are also entering in the

market. These products assure market related return to depositors. They

also help the bank in mitigating interest rate risk and overcoming ALM

problem.

3.1.4. Flexi-fix deposit with sweep and reverse sweep facility to a deposit

account (Savings/Current) has also become very popular where sum

exceeding minimum balance is auto-sweep to fixed deposit account. To

facilitate withdrawal money is reverse-sweep to savings/current deposit

account as and when required. The balance lying in the flex-fix deposit earns

interest as per fixed deposit rate.

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3.1.5. New deposit products with auto investment facility in mutual funds (debt

funds or equity funds) are also evolving with objective of maximizing return

to the depositors. Since dividend income (in the hand of investors) and

capital gain (long term) is exempted from tax, these products have become

very attractive.

3.1.6. Opening of accounts with zero balance for NRI and salaried class is other

innovation, which the banks have successfully used in mobilizing account of

salaried and NRI customers.

4.2 Retail Credit Products- Given the microeconomic scenario, it is expected that retail

loan segment will grow at 35% CAGR. Seeing big opportunity ahead, banks have

become aggressive in retail loans and attracting customers with innovative offerings.

Some emerging innovations in retail credit products are-

4.2.1 Pre approved housing loan so that customer can select the property of

his/her choice as per his/her financial resources.

4.2.2 Pre approved personal loan so that customer can draw the amount as per his

convenience as and when he needs money.

4.2.3 Pre approved housing properties that save the borrowers from hassles of

going through formalities of title examination and valuation.

4.2.4 Bridge loan against mortgage of existing house to enable the borrower to

buy a bigger house and loan will be repaid from sale proceeds of old house.

4.2.5 Overdrafts against security of house property, which house owner generally,

feel as unproductive.

4.2.6 Variants of personal loan like loan for purchase of jewellery, loan to meet

tax liability, loan to meet festival expenses, loan to meet critical sickness etc.

4.2.7 Home loan with ‘repayment holiday’- to enable the borrower to tide over

unexpected financial needs like tax liability, educational expenses of children or

expenses of critical illness.

4.2.8 New home loan product launched is 110% home loan requirement. Extra

10% is for furnishing the house, which comes along with the home loan.

4.2.9 Overdraft through ATM to privilege customers to meet emergency

requirements is other innovation.

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4.3 Financial Services 4.3.1 e-Commerce is opening up opportunities for bank to act as intermediaries

for authenticating transaction between retailer and consumer through digital

signatures. So far banks are issuing guarantee and letter of credit by giving

assurance to seller that he will get the payment of goods/services sold and

authentication of e-transaction is a logical extension of bank guarantee and letter

of credit business.

4.3.2. Integrated financial services provided by financial advisers who assist

customer in executing long term saving and investment plan to achieve individual

financial goals.

4.3.3 Mobile banking is other innovation which is breaking the barrier of branch

banking, PC based banking and ATM.

4.4 Risk free income- Banks are innovating by leveraging on their credit

dispensation strength to augment risk free income through variety of ways like-

4.4.1 Originator of loan- Banks will mobilize loan but will not carry in their

books. Earn income as originator. LIC has huge corpus of funds but cannot

directly lend. Here originator has opportunity.

4.4.2 Monitoring fee- Transfer loan to SPV or other banks through

securitization process but continue to earn fee-based income for monitoring of

loan. Even in case of sale of distressed assets to ARC, bank has opportunity

to earn monitoring fee, as they know the assets better than the buyer.

4.4.3 Take out finance- Largely resorted to for infrastructure projects where

the loan is taken up by other institution after a specified period to overcome

problem of assets liability mismatch.

4.4.4. Money transfer business- Money transfer is business is growing with

the growth of remittance in India which is estimated at $22 billion annually.

And banks are tying up with money transfer companies like Western Union

Money Transfer to offer this service to their customers.

4.4.5. Financial advisors- from relationship manager to financial advisor to

private banker- all services are for fee. Banks are now offering discretionary

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portfolio management services- investment in art, philanthropy, real estate,

funds within country and in offshore funds - for its affluent customers all

under one roof. Property advisors guide customers about entire process of

selecting and buying a house and handle the cumbersome documentation

formalities and the registration on his behalf.

4.4.6 Gold hedging services- Most Indian gold jewellery manufacturers are

now hedging their gold purchases in Dubai Commodity exchange in absence

of such facilities in India. A few private sector banks have seen business

opportunity here and are offering gold-hedging products. The gold traders and

jewellery exporters are expected to avail gold hedging service, which has very

lucrative market.

4.5. Selling of third party products-4.5.1 Starting from selling free personal accident to holders of credit card,

ATM card and Kisaan Credit cards, banks have gone a long way of cross

selling various insurance products like life insurance to savings banks

account holder, credit protection bundled with education loan, housing

loan and other loan, loss of baggage and other insurance bundled with NRI

accounts. These innovations are offering business avenues of earning fee

based income by selling products on behalf of third party where banks

have no expertise or product offering is not possible due to regulatory

constraints.

4.5.2 Apart from selling insurance and mutual funds, banks now see

opportunity in selling gold coins and bars to earn extra fee based income.

Buyers find investment in gold as attractive option since interest income in

fixed deposit is comparatively low to increase in the price of gold in the

recent past. Since gold coins and bars are hallmarked, buyers feel secured.

4.5.3 Selling of stamp papers, collection of utility bills like electricity,

telephone and school fees, collection of taxes for the state and central

government, payment of pension of government, railway and defense

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pensioners, safe keeping of examination papers, credit/debit cards in

alliance with other banks etc., are fast expanding fee based services.

4.5.4. Prepaid gift card is recent innovation, which is substitution of gift

voucher/ gift cheques. These cards act like a debit card, which can be used

by the recipient of the gift for purchasing any article/good from approved

merchants up to the value of the card. Bank can earn extra fee based

income by selling such cards by way of upfront fee, reload or reassurance

charge, refund charge etc.

4.6 Secondary market for bad loans

RBI has made the beginning by putting in place the policy of buying and selling

distressed assets in policy announcement of 2005.Indian bad loan market is sizeable

and provides immense business opportunity. And the driver of the market is potential

profit.

4.7 New credit products

4.7.1 Commodity Finance Business- Commodity financing business has

brought new revolution in credit business. Banks are innovating products to lend

to farmers and traders in collaboration with commodity exchanges against demat

warehouse receipts of gold, silver and other commodities. Collateral managers are

also designing new products to assist banks in undertaking due diligence (credit

risk), guaranteeing quality and safety of the commodity (operational and

performance risk), documentation (legal risk) and insurance (default risk). India’s

commodity trading is estimated to Rs. 400,000 crores annually and offers good

business opportunity.

4.7.2 Asset based financing (ABF) - Asset base financing started from

transportation segment (preferably truck financing) and is gradually spreading

into financing of bulk machinery like printing machinery, road building

equipments, medical equipments etc. To mobilize business banks are entering into

business alliances with the manufacturers and offering credit to buyers backed by

security of assets crated out of the bank loan.

4.7.3 Channel financing - Channel financing is an innovative finance mechanism

by which banks meets the various funds requirements along with supply chain at

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the supplier’s ends itself, thus helping him in seamless cash flow along the

arteries of the enterprise. Channel finance ensures the immediate realization of

sales proceeds for the client’s supplier, making practically a cash sale. Under

channel financing, the dealer can leverage on the relationship with reputed

companies in sourcing low cost credit with support from their counterparts. Under

channel financing following credit facilities are available-

o Discounting of trade bills accepted by the dealer/distributor.

o Limited overdraft facility to dealer/distributor for his business dealing

with large corporates.

4.7.4 Micro-credit through on line route- Inspired by global efforts, some

websites are providing platform to HNIs and professionals who want to extend

credit to rural entrepreneurs and wants to make difference in the life of rural poor.

These websites employ crowd-funding techniques, informing and encourage

common people online to act as investors in microfinance space aimed at the small

borrowers and tries to seek investment from them where business plan inspire and

suits them. For example Chennai based Rangde lends mainly to women and

Bangalore based Dhanax reaches out to self help group in urban area. They also

encourage people to contribute beyond investing, volunteering time and efforts

with them for the social development.

4.8. Delivery channels

Banks now have multi channel approach, which add convenience to

customers on one hand and cost effectiveness to banks on the other hand. ATMs

are now gradually becoming more popular and offering 24X7 facilities to

customers. While mobile ATMs are bringing service to customer doorstep, there

are specialized ATM for blind, solar powered ATMs for rural areas, Barcode

enabled ATM for payment of bills and so on. Sunday banking and 8 AM to 8

PM banking is other innovation, which has totally transformed the delivery

channel.

5. Captivating the customer through innovation – A new learning curve

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Walk in business is the thing of past. The customers are now not only demanding

on price (interest rates, service charges etc.), they are also demanding on product

(quality), place (home delivery, internet banking), packaging (brand affinity), people

(customer service), partnering (business alliances, direct selling agents), and

promotion (discount, freebies etc.). Due to this old business model of ‘capturing

customer through aggressive selling’ has given way to new business model of

‘captivating the customer through innovation’.

New learning curve is-

Shift focus from product to customer – You need to appreciate that

the Customer is King.

Anticipate and adapt as per customer’s changing need and demand –

You need to continuously innovate or renovate your product to

stay ahead of your competitors.

Take speedy action and decision to have first mover advantage.

Make effective implementation- Idea alone cannot deliver.

5. Looking ahead -

Indians are known to have good culture of innovation but bad for execution.

Hence, bank people should learn not only to innovate but also to implement

innovative ideas into practice. Next big thing is learning to accept change. The

person with the best idea may not win but a person who learns the fastest win. The

lesson is learning the change is as essential as innovation. Next important thing for

innovation is speed. The success of innovation lies in speedy implementation of the

new ideas before the competitors are able to copy them. Lastly deregulation and

liberalization plays a major role in inducing banks to innovate as it increases

competition and allows necessary freedom to practice new ideas. Although

significant progress has been made in India in past 10 years in this regard, yet there is

good scope of further liberalization and deregulation so that banks have full liberty to

offer products and services at par with international standards. The Indian banking

industry is hugely under-penetrated industry and it is expected that with innovation,

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banks will be able to make inroads in the new markets by putting the customers at the

centre of everything they do.

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