BANK SYNERGY AND SCENARIO

History:

The amalgamation of all presidency banks started the emergence of modern banking in India (Bank of Calcutta, Bank of Bombay, and Bank of Madras) in 1921 to form the Imperial Bank of India, which was run by European Shareholders. They set reserve Bank of India up in 1935 to address the irregularities in the Joint Stock Company. Post-independence, they nationalized the RBI in 1949 as per the Transfer to Public Ownership Act. In 1955, State Bank was nationalized under the State Bank of India Act in Parliament. In 1959, seven subsidiaries of State Bank were nationalized.

In 1969, Indira Gandhi presented a paper entitled “Stray Thoughts on Bank Nationalization” at the annual conference meeting of the Government of India. The paper emphasized on nationalization of Banks. 

There were factors that led to the nationalization of banks. It was told that banks must play a social role in the economy and maintain social balance. They assumed capitalists to be imperialists. Indian freedom battles were against imperialism. Hence, people and government were conservative and influenced by the alternative to socialism. East India Company was a product of monopoly. There were few business people and rich authorities who used to dominate the banking sector and make a profit. The government of India wanted to stop this practice. Banks were set up in cities and also targeted the urban people who were very few at that time. It did not provide people living in rural areas with banking facilities. The banks before nationalization were focusing to perform transactions in the Corporate and Business sectors. They gave not much emphasis on infrastructure sectors. Despite being a country dependent on agriculture for its income and livelihood, they did not give farmers loans because of their poor economic condition.

In response to these factors, the major nationalization of Indian Banks was implemented within a month of the proposal. After this acquisition, the government-controlled around 91% of banking business in India.  

Post Nationalization Reforms:

Indian Banking System experienced a good turn after nationalization. With nationalization, the government focused on components that led to this event. In 1975, the first regional rural bank was set up. Branches of banks were set up in the rural areas of the country. In 2013, the number of branches reached 109,811. Loans to farmers were granted. People, according to their economic status, were given subsidies. In 1975, the first regional rural bank was set up. 

Nariman Committee:

In 1969, under the chairmanship of Shri F.K.F Nariman, new objectives were put forward to discharge social responsibilities and to implement Lead Bank Scheme (At least one bank should have a lead branch in one district).

Narasimhan Committee:

In 1975 and 1991, the Narshimha Committee (also known as Committee on Financial System) brought reforms in the banking sector by introducing the concept of big banks, three-tier system of banks, mega-banks, and more control.

In 1980, six more banks were nationalized. In 1993, Punjab National Bank was merged with the New Bank of India, which reduced the numbers of nationalized banks from 20 to 19. In 2018, Bank of Baroda was merged with Vijaya Bank and Dena Bank. In 2019, 10 more banks were merged into 4 major banks.

Need and Advantages of Mergers (Implementation of 4Rs: Regulate, Recapitalise, Resolution and Reform)

The number of PSBs is high. 27 Public sector banks in India were targeting the same potential customers. It made little sense for the government to compete to gain the same customers. Recapitalization will reduce if the mergers become successful. The government is facing fiscal constraints. Hence, a reduction in recapitalization is needed. The non-performing assets are very high in some banks. A proper check is required to reduce it. By merging, the regulatory burden on banks will reduce. Except for SBI, there is no big bank in India to compete on International Level. Merging banks will cause the formation of big banks with more total business and deposits.

Issues of Mergers

It is difficult for one bank to sync with a bank with higher NPAs. This might create complexities further and can have side effects. Different banks have their unique mission and visions. Merging the two different banks will need time to settle with the new system. If banks after merging are not assessed and controlled well can result in higher NPAs.

Why back to privatization?

 To solve these issues, a new agenda is required. With Globalization and competencies in the Economy, the Government of India is gradually shifting to the Libertarian side of the economy. The business of government is not to run a business. As per the RBI Financial Stability Report, the Gross NPA ratio is likely to increase. Also, because of financial limits, it is proposing private players come forward and invest in banking. Market capitalization in Public Sector Banks is less than the private sector banks. The money used to recapitalize the banks to recover the stressed assets should be used in development projects and the improvement of infrastructure. The budget presented in 2021 states Rs. 1.75 Lakh Crore worth revenue will be generated by Private Sector. There was much emphasis on disinvestment, too. The budget also says two banks will be privatized in this financial year. The government will have a bare minimum presence in running them. 

Privatisation is expected to decrease the recapitalization burden on government as India is already a capital starved country. Considering the business angle of the banking industry, PSBs are more leveraged than PVBs, making the former one risky. On the business expansion front, they have fallen way behind: their (y-o-y) CASA growth in September 2021 was 11.6 percent compared to 22.8 percent for PVBs and 17.2 percent for FBs.

Conclusion

Although much has been talked about privatization, the proper implementation and regulation is demanded so that banking reforms do not shift back to square one. In a country like where people expect populist reforms, we might not well appreciate this move. Also, bitter memories of private imperialism still haunt people. People can easily lose money in private banks if the employees of banks indulge them in malpractices. There is equal risk in public sector banks and the value of frauds in these banks is much higher than in private banks. The solution to every problem is better asset liability management and efficient use of capital, as well as policies. 

Country post-pandemic is facing issues of rising inequality and inflation. Privatisation at this point in time would be very stricter move as people are unsure about the policy changes. How these banks will try to cater to people from different income group and different sectors, is still a question?

REFERENCES

  1. Banking In India –Wikipedia (https://en.wikipedia.org/wiki/Banking_in_India)
  2. Data and image- Bloomberg Quint(https://www.bloombergquint.com/opinion/the-origins-of-the-great-indian-bank-merger)
  3. Draft Reports- RBI (https://m.rbi.org.in/scripts/PublicationDraftReports.aspx?ID=552)

FRAUDS IN BANKING SECTOR

Banking post-nationalization has progressed unexpectedly. With new reforms in the banking sector, more emphasis was given on lending so that economy of the nation can be improved.   But it also exposed banking to risks and frauds. Banks are the backbone of the economy. Any disruption in banking poses threat to the economy and therefore citizens.

“Reserve Bank of India defines banking fraud as an act of commission /abatement, which is intended to cause illicit gain to one person(s), entity and wrongful loss to the other, either by way of concealment of facts by deceit or by playing a confidence risk.”

The numbers and values of frauds keep on accelerating with every financial year. In the financial year 2019-20, the bank frauds (value Rs. 1.85 trillion) were more than double of the bank frauds that were reported in 2018-2019. The number of frauds was increased by 28%. The top 50 credit-related frauds constituted 76% of the total amount reported as frauds during 2019-20. Public sector banks accounted for 80% of the total value of frauds in this fiscal year. The private bank followed it by 18% and foreign banks with 2%. Although the total frauds reduced in the financial year 2020-21, frauds in private banks increased up to 21%. (Refer Table)

These frauds are spread over several years and are accounted for in the financial year they are reported. On average, banks took two years to detect fraud after it had occurred. The delay was even greater for frauds greater than Rs. 100 Crore with a time of 5 years. There have been instances in the past where banks were found not following the protocols needed while sanctioning any kind of loan. Harshad Mehta Scam was one where he got hand-in-glove with bank employees to get fake bank receipts. Satyam companies manipulated the financial statements and issued fake bank statements to purchase more land for their projects. Vijay Mallya borrowed money from 13 banks and did not pay in time. The discrepancy happened due to a lack of diligence in the process of consortium lending. The recent one is Nirav Modi PNB Scam. The bank manager sanctioned the loan without following the process.

The fraud reasons are not limited. Any mishandling of data and manipulation in process at any step can lead to the formation of higher Non-Performing Assets. Many of those take place due to the interference of corrupted third parties like auditors, controllers, and chartered accountants. Poor Internal Management also factors these frauds. When banks and employees do not follow the proper identification method and regulated assessment, it results in fraud. Due to a weaker selection process in banks, employees are not well qualified for loan assessment. RBI recently has given detailed guidelines for recruitment of employees for recovery of loans. The recruited ones will be given 100-hours training to deal with these going to be “bad debt”. Such initiatives are needed even while recruiting employees who are responsible to process the loan. In many cases, the purpose of the loan is manipulated. The loan amount received by the borrowers was not utilized for the approved project. In cases like Nirav Modi and Harshad Mehta Scam, collusion with bank officials resulted in big frauds. Weakened Business Model: Sometimes banks lend money for a project without calculating the potential of the project. Bank’s official lack in their analysis of the project. Due to this, an enterprise might go into losses and would not be in a position to pay to back its creditors. Banks at times, do not make these frauds public to prevent their goodwill in the market. In those circumstances, the amount of loan increases with negligence. When added up to a huge amount, the case is held over to Apex Court which further increases the cost on banks. With the emergence of digital banking, banks as well as the public are more at risk. RBI regularly updates customers with advertisements and guidelines to avoid these crimes. Banks have also switched to online sanctioning of the loan, so they are required to verify every document closely.

The impact of these frauds hits the financial statement of the bank first and then the economy as a whole. When an account is declared fraud, banks need to provision 100% of the outstanding loans. The provisioning is generally done in one time or four quarters. The profitability and credibility of a bank are impacted adversely. When banks face the issue of liquidity, a limit is imposed on the withdrawal of depositors. As frauds are not new in the banking context, RBI and the government has formulated many laws and acts to avoid fraud. Banks have an option to securitize the assets of the company that committed the fraud. The Debt Recovery Tribunal (DRT) was formed under “The Recovery of Debts and Bankruptcy Act,1993 to deal with loans related to the agriculture sector if the loan amount is 10 Lakhs. Banks also have Corporate Debt Restructuring framework in place to ensure a timely and transparent mechanism for restructuring the corporate debts above 20 Crore. Some of the laws against fraud are mentioned below.

  1. The Indian penal code,1860
  2. The Negotiable Instruments Act,1881
  3. The Reserve Bank of India Act,1934
  4. The Banking Regulation Act,1949
  5. Criminal procedure code,1973
  6. SARFESI Act,2002
  7. Insolvency and Bankrupt Code,2016
  8. Fugitive Economic Offenders Act,2018

RBI has taken several measures to avoid fraud and deal with fraud. Banks are required to categorize accounts for better risk assessment and to implement provisioning norms. Accounts can be classified as Special Mention Accounts (SMA), standard Accounts, substandard Accounts, doubtful accounts, and Non-Performing Accounts. Constant review of the transactions, identifying and tracking the patterns of transactions should be constantly done. RBI regularly comes up with updated frameworks that are to be followed to prevent, detect and mitigate frauds gravity.

As per RBI’s latest report, there is a list of 42 early warning signals. The presence of any of these, in any case, will mark that account as a Red Flag account. This will trigger the detailed investigation of an account which can save the bank from fraud.RBI has also put in place the three stages of the loan life cycle which should be followed for early detection. The three stages are pre-sanction Order, disbursement, and annual review

  • Pre-sanction Order  
  • – Banks should follow and track Anti Money Laundering Norms, accurate CIBIL Credit Scores, involvement in a legal dispute, due diligence on the borrower’s antecedents, set margins as per MCLR, and check whether the loan is recoverable.
  • Disbursement: While disbursement of the loan amount, banks are required to mention terms and conditions to the borrower. Borrowers and Banks should adhere to these norms so that the core purpose of the loan could not be diluted.
  • Annual Review: Monitoring EWS and reassessing the value of prime and collateral underlying.

RBI has also imposed penal measures on Fraudulent Borrowers-. In case of willful default that accounts for the high value of Frauds, RBI with CBI and Supreme Court can impose these penal provisions. Under Securitization, Banks can acquire the assets borrowers want to securitize. Banks can trade on that asset (via pass-through certificate) and recover the loan amount. Banks have also an option to repossess the asset. Banks can take control over the prime and collateral for the recovery of loans. Banks can give time to borrowers for repayment of loans. If it is not done in time, Banks can auction it to recover the loan and repay the excess amount from the auction sale to the borrower.

Although RBI updates frameworks as per the demand in banking loopholes, it has still not served the purpose to solve cases of fraud due to lack of diligence in bank employees, less transparency, less accountability, and ineffective implementation of this framework. The proof of this is the increase in the percentage of frauds associated with private sector banks. The repo rate (4 % currently) for the bank and the interest rate for the loan takers are comparatively low. This makes it attractive for people to borrow money. Banks should be cautious enough in these circumstances because some people or entities can manipulate their documents to get a loan at a cheaper rate. 

Despite the annual review, the banks should collect interim reports of the financial status of high credited accounts to get a clear picture. Credit scores need to be considered while giving any loan. Actions against Early Warning Signals should be taken strictly. The reporting of fraud cases should be done proactively so that it does not accumulate to huge losses for banks as well as the economy. Most importantly, RBI has to ensure that the guidelines issues are implemented and followed. That is where the complete banking system is lagging. Those rules and regulations have to come out from documents in action in reality.

Editor
Swati Shubham

The Last Phase of Bank Recapitalization

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Source: www.financialexpress.com

By S.Seemanthini

Recapitalization is the infusion of fresh capital in the banks by the government. As the major owner of PSUs, on October 24, 2017, the government announced Rs2.11 lakh crore to be infused in the banks. This was done for two purposes, i.e. to help them recover from the NPAs that has been saddling the banks for a long time and also to support the banks in meeting their capital requirements. The recapitalization was meant to be done in a phased manner by the government.

As a part of the recapitalization plan, Rs1.53 lakh crore was to be infused by the government and the rest was to be raised from the market. However, the last phase of capital infusion of Rs65000 crore is dependent upon the performance of the banks. IBA had invited bids in May 2018 and the lowest cost for the project was proposed by BCG. The IBA (Indian Banks Association) in association with BCG (Boston Consultancy Group) has been tasked to do a qualitative and quantitative assessment of the banks based on certain defined themes. The themes are basically a set of reforms agenda called EASE (Enhanced Access and Services Excellence). All PSBs have secured the approvals from their respective boards to implement the EASE plan.

In this, banks have a 50-point action plan that includes customer responsiveness, credit offtake, UdyamiMitra for MSMEs, deepening financial inclusion and digitisation. BCG has to validate the functioning of the banks measuring the reforms plan, data collection and do an analysis of the outcomes. Depending on the outcomes BCG is supposed to submit the compliance report by end of 2018, based on which the centre will take a call on the quantum of funds to be infused in the banks. Under the reforms agenda, PSBs are required to maintain a separate vertical for stressed assets management and perform their due diligence for sanctioning of the loans. Apart from this PSBs have to tie up with agencies for specialised monitoring of loans above Rs2.5 billion. Few more reforms suggested are

  • Reduce the size of the consortium with a minimum 10% exposure for each participating bank
  • Corporate exposure of any bank should not be more than 40%
  • Fast paced loan processing for MSMEs
  • Improve digitisation (smart banking) by making branch visits redundant
  • Strict surveillance of the loan defaulters
  • Strict segregation of post and pre-sanction of roles and responsibilities
  • Appoint a whole-time director to monitor the reforms every year

All the 21 PSBs are supposed to implement the reforms as a part of EASE agenda. Since NPAs were mainly attributed to “aggressive lending” and hence, reforms are the banks’ strategy to fast-track the recovery of non-performing assets. As the RBI has mandated the banks to comply with BASEL III norms by 31st March, 2019, that includes additional capital conversion buffer, the recapitalization has sought to be a right move by the government. Indian banks’ ability to maintain capital more than the stipulated Basel norms is the reason why Indian banks were not majorly affected by the 2008 financial crisis. The decision to maintain a cushion capital was based on shrewd and better understanding of banking and its problems by RBI. In order to help the emerging economy of India and banks being the major provider of credit, the EASE reforms plan can be considered a great move by the government before the general elections in 2019.

#Fincabulary 37 – Letter of Undertaking

depositphotos_46003477-stock-illustration-banking-agreement-icon

Source: https://depositphotos.com/

The term LoU or Letter of Undertaking has recently been in news in wake of the banking fraud concerning Punjab National Bank and Nirav Modi. A LoU is a provision of bank guarantees under which a bank can allow its customer to raise money from another Indian bank’s foreign branch in the form of a short-term credit. The LOU serves the purpose of a bank guarantee for a bank’s customer for making payment to its offshore suppliers in the foreign currency.

For raising the LOU, the customer is supposed to pay margin money to the bank that issues the LOU and accordingly, they are granted a credit limit. Once the letter of credit is acknowledged and accepted, the lender (the foreign branch of Indian bank) transfers money to the nostro account of the bank that has issued the LoU.

Indian Banks going long on Data Analytics

By Manisha Sharma

Big data in banking

Source: https://i.pinimg.com/

Today companies like Paytm extensively use data analytics to provide an unparalleled experience to customers by extending faster and better services. If Indian banks don’t retaliate there are many other companies waiting in the wings to take away their businesses. Today, the need to build better data-centric products is driving the Banking Industry in India. Customer-centricity, combating cyber threat, compliance and risk management and cost containment are some of the key areas where data analytics is applied.

The first instance of usage of data analytics can be traced back to 2000s when HDFC Bank invested heavily in data warehouses and used descriptive and predictive analytics to track customer’s financial habits. This move created opportunities in the area of cross-selling which is currently one of the biggest tools to retain and attract customers in the Indian banking industry. Complex neural network scoring engine is used to assign a credit score to customers and thus help in reducing money laundering. Another bank that uses Business Intelligence (BI) and analytics to identify serious delinquencies (high risk) and early delinquencies (low risk) loans is ICICI Bank. The bank is using a ‘centralized debtors’ allocation model’ to allocate the right set of delinquent cases to the most appropriate collection channel. ING Vysya Bank created a central data repository via SAP BO in order to provide accurate reports to customers. India’s biggest public sector bank, SBI, is not behind in this quest. The bank uses Social Media Analytics to identify prospective customers and to analyse high delinquencies in loans.

But all that glitters is not gold. According to a latest McKinsey survey, most banks have invested significantly in data infrastructure and advanced analytics but are yet to derive expected results from it. Few common mistakes are not asking the right questions to the algorithms, lack of planning, using analytics on a project by project basis and not deriving the full potential of the tools at a detailed level.

In order to utilize technology for their benefits, banks need to develop two assets: a transformation strategy and a vigorous analytics organization to support the usage of analytics in their day to day activities. Different departments in banks contain a huge amount of data. Complete potential can be realized if small samples of information are brought together. Creating interactive dashboards by making the technology simpler to understand can attract more people to use the tools. Usage of feedback loops can help to market faster than competitors. A deep pipeline of analytics talent should be the top priority of banks.

According to a McKinsey survey, more than 90 percent of the top 50 banks around the world are using advanced analytics. Among other things, a combination of  talented pool of graduates, innovation labs, clear governance plan and robust data quality controls should be some of the significant tools that will help shape a bank’s future in the competitive banking and financial services industry of India.

References:

  • Gupta, B. (2015, February). Analytics in Indian Banking Sector – On A Right Track. Retrieved from: https://analyticsindiamag.com/analytics-in-indian-banking-sector-on-a-right-track/