GS-3, Indian Economy, Uncategorized

All you wanted to know about PARA

What is it?

The Public Sector Asset Rehabilitation Agency or PARA will be an independent entity that will identify the largest and most vexatious NPA accounts held by banks, and then buy these out from them. By consolidating problem accounts across banks, the PARA is expected to solve two problems.

One, it can effect speedier settlements with borrowers by cutting out individual banks. Two, as a single large lender, it can drive a better bargain with borrowers and take more stringent enforcement action against them.

PARA is expected to raise capital for its buyouts by issuing government securities, tapping the capital markets or receiving a capital infusion from the RBI.

In short, PARA is just a new version of the ‘bad bank’ idea that has been doing the rounds for some time now.

Why is it important?

The stockpile of bad loans has had several ill-effects on the economy at large.

One, with 16.6 per cent of their loan book tied up in stressed assets (bad and doubtful loans), banks have been fighting shy of new lending. This is constraining new investments in projects that can power the economy. Even if the Government were to infuse fresh capital into public sector banks, (Rs 1.8 Lakh cr are required) there’s worry that this may go to write off older bad loans rather than kick-start lending.

Two, public sector banks, which hold over 70 per cent of all deposits, are the worst hit by the bad loan problem. For some of these banks, the provisions for bad loans have already overtaken operating profits, leaving them short of capital to sustain operations.

Three, high NPAs force banks to keep their lending rates high to boost their profits.

Finally, with 40 per cent of the loans stuck with companies who simply do not earn enough profits to service them, simply waiting for the problem to solve itself will not work. This is already telling on private sector investments and GDP growth.

PARA is expected solve all these problems at one stroke, by relieving the banks of their NPAs and expediting ways for the corporate borrowers to settle their debts.

Why should I care?

As a depositor, PARA will mean greater safety of your deposits with the tottering public sector banks. As a taxpayer, it is your money that the Centre uses to recapitalise public sector banks when they indulge in big ticket write-offs. By moving large problem accounts to PARA, the government can separate the capital infusion exercise from the clean-up exercise. PARA can raise money from institutional investors rather than looking only to the Government.

As an honest borrower, bad loans weighing on bank balance sheets mean higher interest costs and slower transmission of RBI rate cuts. Once stressed assets are sold to PARA, the RBI can lean harder on banks to pass on its rate cuts.

What other steps RBI has taken before PARA to take care of bad loan problem?

1- 5/25 Scheme

2- S4A scheme

3- Banks Board Bureau

 

Big Picture, GS-3, Indian Economy, Uncategorized

Merger of Associate Banks with SBI

Introduction

The five banks set to merge with SBI are State Bank of Bikaner and Jaipur, State Bank of Travancore,State Bank of Mysore, State Bank of Hyderabad and State Bank of Patiala. SBI will also absorbBharatiya Mahila Bank.

This is a bigger merger. 6 banks will be merging at the same time. This has never happened in the country earlier.

What has strengthened the case for such mergers at this stage is the need to infuse capital in state-owned banks that are burdened by a large pile of non-performing assets

Consequences of the merging

  • The merger will result in a “win-win situation”for the bank and its associates. It will be good for the staff because they will be getting good facility almost at par with SBI.
  • It has been assured by SBI management and Government that there will be no retrenchment and all staff will be absorbed, like the earlier mergers of State Bank of Saurashtra and State Bank of Indore where that staff dint have any problem.
  • It will be a big bank with around 23700 branches. It will be in the top 50 banks of the world. SBI was at rank 52 in the world in terms of assets in 2015, the combined entity would be ranked at 45th position. It will be 5 times to the asset size of ICICI bank.
  • Our country doesn’t have any bank in top 10 or top 50. It will be good for the bank also as it will be big in size. They can lend more, the amount of the loan will be high, their risk operations could be better, their treasury will be united, and lot of economy will be there in the operation.
  • The associate banks can avail the facility of Risk Management. Risk Management means, when a bank lends, it assess the repaying capacity of the borrower, assess the project viability and the risk the bank takes in lending.
  • This Risk Management is done by the experts with scientific and computerised models and assesses the Risk of the project
  • The net profit of SBI is Rs 9950cr, as against Rs 1600cr for associate banks. The NPAs of associate banks are 7-9 %, while that of SBI is 6.8%. After merging the total NPAs will be around 7-8 %. This quantum of NPA for the whole of State Bank group would not be high.
  • SBI has better advanced system of recovery and management. These benefits will now percolate down to the associate banks.
  • SBI’s reach and network will multiply, efficiency will likely increase with the rationalisation of branches, there will be a common treasury pooling and there will be proper deployment of skilled resources. Overlapping of business will be reduced.
  • An enhanced scale of operations and the rationalisation of common costs will result in big savings.
  • It will benefit the customers in terms of pricing of loans and deposits. The pricing which was offered by the SBI to its customers, the same will be offered by the associate banks.
  • The state Bank’s Base rate and MCLR are the lowest in the industry. Base rate is the minimum rate set by the Reserve Bank of India below which banks are not allowed to lend to its customers. In MCLR, interest rate for different types of customers should be fixed in accordance with their riskiness. The base rate will be now determined on the basis of the MCLR calculation. With the merging, the Base rate and MCLR rate will not be affected.
  • The associate banks will follow the policies of SBI. The policies of SBI are better in comparison to associate banks. Merging might reduce the lending rates of the banks.
  • SBI offers more Innovative products in terms of technology, like SBI Intouch Earlier these were not available with associate banks. Now they become part of associate banks. These bring more facilities to the customers of associate banks.
  • Regarding ownership of shares, there is a swap ration which has been decided through a formula approved by RBI and the Government. The share holders will be benefitted by this. SBI shares are one of the highest traded shares in the stock market.
  • As the health of SBI is relatively better amongst other banks, the benefit of this will be available to the investors.
  • SBI recently brought out wealth management which is a new product. It is for the High Net worth Individuals, who have disposable funds for the investment in stock market, but don’t have enough expertise. The benefits of expertise of SBI would be available to these customers.
  • Employees of the associate banks would benefit by the merging. They will have opportunities for promotion. SBI is a well organised professional bank.

Government share holding will change from 60.3% to 59.7%. SBI has got good opportunity to raise capital from the market when the need arises. SBI has more than 100 branches globally. They could offer more innovative products internationally as SBI would be under top 50 after the merger. SBI’s innovation and pioneering should be followed by other PSB’s also.

Editorials, Uncategorized

Payments banks aren’t looking that lucrative anymore

Article Link

Summary:

Three firms—Tech Mahindra; Sun Pharma promoter Dilip Shanghvi and his partners IDFC Bank Ltd and Telenor Financial Services; and Cholamandalam Investment and Finance Co- have withdrawn their applications to start payment banks. These firms, along with eight other firms, had obtained in-principle approvals from the RBI in August 2015 to start payment banks. They have now started to realize that the business may not be easy to crack.

What are payment banks?

Payment banks are non-full service banks, whose main objective is to accelerate financial inclusion. These banks have to use the word ‘Payment Bank’ in its name which will differentiate it from other banks.

Key facts:

  • Capital requirement: The minimum paid-up equity capital for payments banks is Rs. 100 crore.
  • The payments bank should have a leverage ratio of not less than 3%, i.e., its outside liabilities should not exceed 33.33 times its net worth (paid-up capital and reserves).
  • Promoter’s contribution: The promoter’s minimum initial contribution to the paid-up equity capital of such payments bank shall at least be 40% for the first five years from the commencement of its business.
  • Foreign shareholding: The foreign shareholding in the payments bank would be as per the Foreign Direct Investment (FDI) policy for private sector banks as amended from time to time.
  • Apart from amounts maintained as Cash Reserve Ratio (CRR) with the Reserve Bank on its outside demand and time liabilities, it will be required to invest minimum 75% of its “demand deposit balances” in Statutory Liquidity Ratio(SLR) eligible Government securities/treasury bills with maturity up to one year and hold maximum 25% in current and time/fixed deposits with other scheduled commercial banks for operational purposes and liquidity management.

What are the scopes of activities of Payment Banks?

  • Payments banks will mainly deal in remittance services and accept deposits of up to Rs 1 lakh.
  • They will not lend to customers and will have to deploy their funds in government papers and bank deposits.
  • The promoter’s minimum initial contribution to equity capital will have to be at least 40% for the first five years.
  • They can accept demand deposits.
  • Payments bank will initially be restricted to holding a maximum balance of Rs. 100,000 per individual customer.
  • They can issue ATM/debit cards but not credit cards.
  • They can carry out payments and remittance services through various channels.
  • Distribution of non-risk sharing simple financial products like mutual fund units and insurance products, etc. is allowed.

Why this is not an easy business?

  • First, these entities can’t undertake any lending businesses and the income stream is initially restricted to remittances. Eventually, they can cross-sell banking products through their reach and earn a fee. But neither of these two streams of revenue are high-margin businesses.
  • RBI has put in place strict rules on how these banks can deploy the deposits they garner. 75% has to go into government securities. This limits their ability to earn from the deposit base as well. Garnering a strong deposit base in the first place will be a challenge as well. Besides, if these banks want to steal customers away from banks, they may have to offer more than the 4% interest rate that banks do. But to do that, payment banks need to be able to earn enough on deposits as well.
  • Over the last few years, large banks, including private lenders, have significantly expanded their networks in rural areas. This means that these markets are no longer wide open for new business with limited competition. Banks are offering most services that payments banks can and hence, for payments banks to offer a new and differentiated proposition will not be easy.

Conclusion:

For the regulator, the payments banking model was an experiment. RBI said as much when it first issued the guidelines. The experiment is still underway and it may be too early for the regulator to be “aggrieved” at the decision of three applicants to withdraw their plans.

Editorials, GS-3, Indian Economy, Uncategorized

The risks of creating giant banks

Summary:

The government has decided to push for the creation of a new banking giant by merging the State Bank of India with its associate banks. The quest to create an Indian bank that will be in the league of global giants is an old one. It has been talked about since the 1991 economic reforms. However, not many are happy with this move. Large banks have lost their charm in recent years, especially since the global financial crisis.

  • The merger move comes at a time when the most important issue facing Indian banks—and the Indian economy—is the growing pile of bad loans with the baking system.
  • If the merger of the five associate banks with the SBI goes through, the latter’s assets will jump from about 21.50 lakh crore to 28.25 lakh crore. The number of branches will increase from 16,500 to over 21,500.

Why merger is good?

  • The merger benefits include getting economies of scale and reduction in the cost of doing business.
  • Technical inefficiency is one of the main factors responsible for banking crisis. The scale of inefficiency is more in case of small banks. Hence, merger would be good.
  • Mergers help small banks to gear up to international standards with innovative products and services with the accepted level of efficiency.
  • Mergers help many PSBs, which are geographically concentrated, to expand their coverage beyond their outreach.
  • A better and optimum size of the organization would help PSBs offer more and more products and services and help in integrated growth of the sector.
  • Consolidation also helps in improving the professional standards.
  • The size of each business entity after merger is expected to add strength to the Indian Banking System in general and Public Sector Banks in particular.
  • After merger, Indian Banks can manage their liquidity – short term as well as long term – position comfortably. Thus, they will not be compelled to resort to overnight borrowings in call money market and from RBI under Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF).
  • This will also end the unhealthy and intense competition going on even among public sector banks as of now. In the global market, the Indian banks will gain greater recognition and higher rating.
  • The volume of inter-bank transactions will come down, resulting in saving of considerable time in clearing and reconciliation of accounts.
  • The burden on the central government to recapitalize the public sector banks again and again will come down substantially.
  • This will also help in meeting more stringent norms under BASEL III, especially capital adequacy ratio.
  • Synergy of operations and scale of economy in the new entity will result in savings and higher profits.
  • A great number of posts of CMD, ED, GM and Zonal Managers will be abolished, resulting in savings of crores of Rupee.
  • This will also reduce unnecessary interference by board members in day to day affairs of the banks.
  • After mergers, bargaining strength of bank staff will become more and visible. Bank staff may look forward to better wages and service conditions in future. The wide disparities between the staff of various banks in their service conditions and monetary benefits will narrow down.
  • Customers will have access to fewer banks offering them wider range of products at a lower cost.
  • From regulatory perspective, monitoring and control of less number of banks will be easier after mergers. This is at the macro level.
  • Mergers can diversify risk management.

Why merger is not so good?

  • Merger will affect regional flavour and end regional focus.
  • The argument that size is going to determine the future of the bank in a globalised scenario is facile. Remember the fate of large global banks, which collapsed during the global financial crisis? On the contrary, small banks have survived the crisis due to their nimbleness and the niche areas they operate in.
  • Immediate negative impact would be from pension liability provisions (due to different employee benefit structures) and harmonisation of accounting policies for bad loans recognition.
  • There are many problems to adjust top leadership in institutions and the unions.
  • Mergers will result in shifting/closure of many ATMs, Branches and controlling offices, as it is not prudent and economical to keep so many banks concentrated in several pockets, notably in urban and metropolitan centres.
  • Mergers will result in immediate job losses on account of large number of people taking VRS on one side and slow down or stoppage of further recruitment on the other. This will worsen the unemployment situation further and may create law and order problems and social disturbances.
  • The weaknesses of the small banks may get transferred to the bigger bank also.
  • New power centres will emerge in the changed environment. Mergers will result in clash of different organizational cultures. Conflicts will arise in the area of systems and processes too.
  • When a big bank books huge loss or crumbles, there will be a big jolt in the entire banking industry. Its repercussions will be felt everywhere.
  • Also, India right now needs more banking competition rather than more banking consolidation. In other words, it needs more banks rather than fewer banks. This does not mean that there should be a fetish about small-scale lending operations, but to know that large banks are not necessarily better banks.

What should be ensured by the government?

  • The government shall not have any hidden political agenda, in bank mergers.
  • All stakeholders are taken into confidence, before the merger exercise is started.
  • After mergers, shares of public sector banks shall not be sold to foreign banks, foreign institutions and Indian corporate entities, beyond certain limit.
  • Whenever further divestment (dilution of government holdings) takes place, the government share holdings shall not fall below 51% under any circumstances. This will ensure that the ownership and control of public sector banks remain with the government.
  • The central government shall not rush through the process of bank mergers.
  • The decision with regard to selection of smaller/weaker banks for merger with larger/stronger banks is to be taken carefully and grouping of various banks for this purpose is the key issue involved. The government shall not yield to pressure from any political or social groups.
  • The acquiring bank shall not attempt to dominate or subsume the acquired bank. Good aspects of both the banks before merger shall be combined, in order to instil confidence in all stakeholders and to produce better results.
  • Personnel absorbed from the smaller bank shall undergo brief, intermittent training programs to get acquainted with the philosophies, processes and technology in the new environment. The management must be ready with a good roadmap for this and allot considerable budgetary resources for this purpose.
  • There shall be conscious and organized efforts to synthesize the differing organizational cultures, for the mergers to yield the desired results.

Various committees in this regard:

Various committees appointed by the government and RBI have studied in detail the aspects of consolidation through the process of mergers.

  • Narasimham committee (1991 and 1998) suggested merger of strong banks both in public sector and even with the developmental financial institutions and NBFCs.
  • Even the Khan committee in 1997 stressed the need for harmonization of roles of commercial banks and the financial institutions.
  • Verma committee pointed out that consolidation will lead to pooling of strengths and lead to overall reduction in cost of operations.

Conclusion:

Merger is a good idea. However, this should be carried out with right banks for the right reasons. Underperforming shall not be the only reason for merger. Now that the move has been initiated, the bigger challenge is consolidation in the rest of the banking system. This is tricky given the huge challenges banks face, including the bad loan problem that has plunged many public sector banks in an unprecedented crisis. Also, since mergers are also about people, a huge amount of planning would be required to make the consolidation process smoother. Piecemeal consolidation will not provide a lasting solution and what is required is an integrated approach from all stakeholders including the government.

Editorials, GS-3, Indian Economy, Uncategorized

On-tap bank licences: 5 questions that linger

The Hindu

Issue

Questions being asked related to ‘on-tap’ bank licenses.

Q.1) External committee needed?

  • The RBI had said it would form a standing external advisory committee (SEAC) that will vet the applications after the initial screening is done by central bank staffers.
  • The committee is to have a three-year term and will comprise eminent personalities from the banking, financial and other relevant sectors.
  • The RBI grants licences to primary dealers, non-banking finance companies and even to foreign banks to operate in India, without any external help. So why do they need a committee only for domestic bank licences?
  • Now that on-tap licensing has been proposed, the RBI should set up a separate department to look into only licensing issues

Q.2) No timeframe?

  • The central bank has tried to make the process on-tap licensing process transparent.
  • For example, for the first time, it has allowed unsuccessful candidates to appeal to the central board of the RBI.
  • Unsuccessful candidates can also apply again, after three years from the date of rejection.
  • While the RBI has said it will communicate its decision to the unsuccessful candidates as well, it has not specified any timeframe by which a licence will be awarded or declined.

Q.3) Reasons for rejection?

  • Applicants from past rounds feel that the central bank, known to be a conservative regulator, seldom communicates the cause for rejection.
  • There is a demand from bank aspirants, in order to ensure transparency, that the central bank should make public reasons for rejecting bank licence applications.

Q.4) Not to all eligible?

  • In the draft norms, the RBI had said entities or individual promoters would be found be fit and proper if they had 10 years of banking experience or running their respective businesses, sound credentials and integrity, sound financials, and diversified shareholding pattern among promoting entities.
  • Prospective applicants said if the objective is to allow financial services to reach the remotest part of the country, adding only a few banks will not solve the problem.

Q.5) Why not business houses?

  • It is clear from the guidelines that the central bank wants entities that are predominantly in financial services.
  • The big change in guidelines comes in the form of excluding large industrial houses from being promoters, and cap their shareholding to 10 per cent
GS-3, Indian Economy, Uncategorized

RBI for easier bank permits

As part of its plan to put universal bank licences ‘on tap’, the Reserve Bank of India has unveiled draft guidelines that could encourage big non-banking financial players to throw their hats in the banking ring.

What is ‘on tap mechanism?

The central bank has been opening the bank licence window only periodically. Under the ‘on tap’ mechanism, however, an application can be made at any time subject to certain conditions.

Who is eligible?

According to the draft RBI guidelines, non-banking finance companies and resident individuals or professionals with 10 years of experience in banking and finance will be eligible to apply.

  • Also eligible are private sector entities and groups owned and controlled by residents, provided they have total assets worth at least 5,000 crore, with the non-financial group business not accounting for more than 40% of the total assets or the gross income.
  • Individuals and companies directly or indirectly connected with large industrial houses may also take equity in a new private bank but only up to 10%. Such shareholders will not get any representation on the board.

Capital requirements:

  • The initial minimum paid-up voting equity capital for a bank has been left unchanged at 500 crore. But the bank has to have a minimum net worth of Rs. 500 crore at all times.
  • The promoters need to hold a minimum 40% of the paid-up voting equity capital, which will be locked-in for five years from the date of commencement of business. The RBI has allowed banks to get their shares listed within six years (three years earlier) of commencement of business.
  • In the case of an NBFC applying for a licence, if the entity has diluted the promoter shareholding to below 40% but above 26%, the RBI may not insist on the promoters’ minimum initial contribution. However, the lock-in period of five years will apply to the 26% promoter shareholding.