Monetary Policy Update

The Monetary Policy Committee of the Reserve Bank of India (RBI) has decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points, from 6.5% to 6.25%, with immediate effect. Consequently, the Bank Rate has been adjusted to 6.5%.

The MPC has also shifted the monetary policy stance from "calibrated tightening" to "neutral."

These decisions are aimed at achieving the medium-term target for consumer price index (CPI) inflation of 4% (with a band of +/- 2%) while supporting growth.

Growth Outlook

The MPC noted that the growth outlook will be influenced by aggregate bank credit and overall financial flows to the commercial sector. Although these are strong, they have not yet become broad-based. Despite soft crude oil prices and the lagged effect of the recent depreciation of the Indian rupee on net exports, slowing global demand could pose a challenge. As a result, GDP growth for 2019-2020 is projected at 7.4%, assuming normal monsoons and steady oil prices. The impact of several budget proposals is expected to boost aggregate demand by raising disposable incomes, but their full effect will likely be experienced over time.

Private Investment and Consumption

The MPC highlighted the need to strengthen private investment and consumption. Investment activity is recovering, mainly due to public spending on infrastructure.

Boost to Agricultural Sector

As a measure to support the agricultural sector, RBI has raised the limit for collateral-free agricultural loans from ₹1 lakh to ₹1.6 lakh. According to the RBI's circular dated 7 February, banks may now waive margin requirements for agricultural loans up to ₹1.6 lakh.

Foreign Portfolio Investment Changes

Previously, no Foreign Portfolio Investor (FPI) could have exposure of more than 20% of its corporate bond portfolio to a single corporate entity. This restriction has now been withdrawn with immediate effect.

Credit Growth Analysis

According to the latest analysis, credit to industry has gained momentum after a prolonged contraction. Although retail lending has seen modest growth, credit growth to industry is recovering. In particular, credit to medium and large industries has turned positive, while credit flow to micro and small industries remains limited.

Monetary Policy Update

The Monetary Policy Committee of Reserve Bank of India decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 6.5 per cent to 6.25 per cent with immediate effect and consequently, the Bank Rate stands adjusted to 6.5 per cent.

The MPC also decided to change the monetary policy stance from calibrated tightening to neutral.

These decisions have been taken with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent (within a band of +/- 2 per cent), while supporting growth.

Growth Outlook

The MPC also noted that the growth outlook is likely to be influenced by aggregate bank credit and overall financial flows to the commercial sector which while continuing to be strong, are yet to get broad-based. Also, in spite of soft crude oil prices and the lagged impact of the recent depreciation of the Indian rupee on net exports, slowing global demand could prove a deterrent.. Considering the above factors, GDP growth for 2019-20 has been projected at 7.4 per cent. Assumptions include monsoon to be near normal and oil price to be steady. It is hoped, several proposals made in the union budget for 2019-20 would boost aggregate demand by raising disposable incomes, the full effect of some of the measures is likely to experienced over a period of time.

Private Investment and Consumption

The MPC highlighted the need to strengthen private investment and consumption. Investment activity is recovering, mainly due to public spending on infrastructure.

Boost to Agricultural Sector

As a measure to give a push to agricultural sector, RBI decided to raise the limit for collateral free agricultural loans. In its circular dated 7Februay, it says:”Keeping in view the overall inflation and rise in agriculture input cost over the years since 2010, it has been decided to raise the limit for collateral free agricultural loans from the existing level of ₹1 lakh to ₹1.6 lakh. Accordingly, banks may waive margin requirements for agricultural loans upto ₹1.6 lakh.”

Foreign Portfolio Investment Changes

Till recently, no Foreign Portfolio Investor could have an exposure of more than 20% of its corporate bond portfolio to a single corporate (including exposure to entities related to the corporate). This restriction has been withdrawn with immediate effect.

Credit Growth Analysis

An analysis of credit offtake by the regulator reveals that the credit to industry has gradually gained momentum in 2018-19 after a prolonged contraction. While the surge in retail lending appears modest at present the credit growth to industry has turned and a recovery is gaining traction. Within industries, credit offtake by the medium and large segments has returned to positive territory while credit flow to micro and small industries continues to be negligible

Monetary Policy Update

The Monetary Policy Committee of RBI noted that the benign outlook for headline inflation is driven mainly by the unexpected softening of food inflation and a substantial fall in oil prices. However, escalating trade tensions, tightening of global financial conditions, and slowing global demand pose downside risks to the domestic economy. The recent decline in oil prices, if sustained, is expected to provide stability. The acceleration in investment activity is seen as a positive sign for medium-term growth potential. Given this backdrop, the MPC decided to keep the policy repo rate on hold and maintain the stance of calibrated tightening.

Floating Rate Loans Benchmarking

Starting April 1, 2019, all new floating-rate personal loans (such as housing and auto loans) and loans to Micro and Small Enterprises extended by banks will be benchmarked to one of the following:

• Reserve Bank of India policy repo rate,
• Government of India 91 days Treasury Bill yield (produced by Financial Benchmarks India Pvt. Ltd.),
• Government of India 182 days Treasury Bill yield (produced by FBIL), or
• Any other benchmark market interest rate produced by FBIL.

The spread over the benchmark rate will be decided by banks at their discretion and will remain fixed throughout the loan term unless there is a fall in ratings.

Working Capital Finance Discipline

To promote greater credit discipline among working capital borrowers, a minimum level of the 'loan component' in fund-based working capital finance for larger borrowers will be stipulated.

SLR and LCR Alignment

To align the Statutory Liquidity Ratio (SLR) with the Liquidity Coverage Ratio (LCR) requirement, it is proposed to reduce the SLR by 25 basis points every calendar quarter until it reaches 18% of Net Demand and Time Liabilities (NDTL). The first reduction will take effect from January 2019.

Expert Committee for MSME Sector

An Expert Committee will be constituted by the Reserve Bank of India to identify the causes and propose long-term solutions for the economic and financial sustainability of the MSME sector.

Threat of Big Data Giants to Traditional Banks

Internet and big data giants like Amazon and China's Alipay could pose a serious threat to traditional banks. According to Agustin Carstens, head of the Bank for International Settlements, these entities have an advantage due to their ability to collect vast amounts of customer data. By leveraging this data, they can offer better products and services, potentially disrupting the banking sector. However, this also raises concerns over risky lending practices and financial instability.

Moody's Outlook on Indian Banks

Moody's outlook for Indian banks in the next 12-15 months is stable. The pace of bad asset accumulation has slowed significantly, and with healthy economic growth and stable asset quality, the outlook remains positive. Public sector banks' funding and liquidity profiles remain resilient.

Public Credit Registry (PCR) Setup

The Reserve Bank of India (RBI) is in the process of setting up a Public Credit Registry (PCR), an information repository that will collate all loan information of individuals and corporate borrowers.

The PCR aims to help banks and financial institutions distinguish between good and bad borrowers, allowing them to better price their products.

Earlier, RBI had set up a committee under the leadership of Mr. Y.M. Deosthalee to examine the possibility of establishing such a registry. The committee has submitted its report, and RBI is now moving forward with setting up the Registry.

Benefits of PCR

This credit repository is expected to address information asymmetry, improve access to credit, and strengthen the credit culture among consumers. The Registry will bridge information gaps exploited by some borrowers who accessed additional credit from multiple banks without disclosing their existing debt.

It is anticipated that PCR will enhance the ease of doing business and improve India's global rankings.

Implementation and Coverage

The registry will be implemented in a “modular and phased manner.” Initially, it will be operated by the RBI, but in the future, the central bank may consider transferring the registry to a separate non-profit entity. The PCR will cover all credit contracts verified by reporting institutions, including all loans in India and any lending by Indian financial institutions to Indian natural or legal persons.

Scope of Data

There is no monetary threshold for inclusion, meaning the registry will capture all loan data, including external commercial borrowings, market borrowings, and contingent liabilities, to provide a holistic view of the borrower's indebtedness. Both positive and negative loan features will be recorded, and borrowers will likely be able to access their own history.

Data Privacy and Access

Regarding privacy concerns, data will be accessible only on a need-to-know basis to stakeholders like banks and financial institutions. The privacy of data will be protected, and the reporting entities will be held responsible for maintaining data quality. The registry will operate within an appropriate legal framework.

Collaboration with Other Institutions

The Registry will also include data from market regulators like SEBI, Ministry of Corporate Affairs, Goods and Service Tax Network, and the Insolvency and Bankruptcy Board of India (IBBI). This collaboration will enable banks and financial institutions to access a complete and real-time profile of borrowers.

Existing Borrower-Level Dataset

Currently, RBI's CRILC dataset supervises borrower-level data for exposures of Rs 5 crore and above, supported by four privately sponsored Credit Information Companies.

Central Registries and Fraud Prevention

In April 2011, the Central Registry of Securitisation Asset Reconstruction and Security Interest (CERSAI) was established to prevent fraud in lending against equitable mortgages, where multiple loans were taken against the same asset from different banks. This initiative was followed by the establishment of a Central Fraud Registry to help lenders identify and avoid fraudulent activities.

Impact of PCR

The introduction of the Public Credit Registry is expected to significantly increase the flow of information, which will reduce the number of willful defaulters and, consequently, help reduce bad loans.

On Stressed Assets:

The underlying theme of the revised framework on stressed assets is to provide as much flexibility as possible to the lenders and the stressed borrowers while ensuring that the resolution plan is implemented within a timeframe and is credible. If lenders and large stressed borrowers are unable to put in place a credible resolution plan within the timelines, they will be required to go through the structured insolvency resolution process under the IBC.

The revised framework also attempts to instil the requisite discipline mechanism for a one-day default in the context of bank loans, akin to the market discipline to which borrowers raising money through debt markets are subject. With defaults being reported to a central database accessible to all banks, the credit discipline is expected to improve significantly.

However, default in payment is a lagging indicator of financial stress, and therefore lenders need to be proactive in credit monitoring to identify financial stress at an early stage, rather than waiting for a borrower to default. Early identification of stress would provide sufficient time for lenders to put in place the required resolution plan.

Another significant change is that resolution plans can now be implemented either individually or jointly by lenders. Banks have been given complete discretion to formulate their own ground rules for dealing with borrowers who have exposures with multiple banks. The lenders can implement differential resolution plans tailored to their internal policies and risk appetite. To ensure only credible plans are implemented, independent credit opinions from empaneled credit rating agencies are required.

Taken together, the revised framework aims to improve the credit culture in the country and the trust between counterparties in transactions. This will be critical for ensuring sufficient incentives for banks to effectively carry out their role as delegated monitors of loans.

On Prompt Corrective Action (PCA):

RBI has initiated Prompt Corrective Action (PCA) for 12 banks (11 of which are in the public sector) to restore their financial health, limit deterioration, and preserve capital levels. Under PCA, certain restrictions are imposed to prevent excessive risks on their balance sheets.

The key areas monitored under PCA are capital, asset quality, and profitability. A new trigger, the Common Equity Tier-1 (CET1) ratio, has been added alongside the monitoring of leverage.

Mandatory actions under PCA include:

• Restriction on dividend distribution/remittance of profits;
• Requirement for promoters/owners to inject more capital;
• Restrictions on branch expansion;
• Higher provisioning requirements;
• Restrictions on management compensation.

While no restrictions have been placed on the retail deposit-taking activity of any bank, these banks have been advised to avoid high-cost bulk deposits and focus on improving Current Account and Savings Account (CASA) deposit levels.

Merging weak banks with stronger ones has also been considered as a method to strengthen such weak banks.

RBI Annual Report - Fiscal Year 2017-18

RBI, in its Annual Report for the fiscal year 2017-18, highlighted various audits undertaken in banks. The report stated:

“Major fraud incidents reported by banks in the recent past have highlighted the need for improvement in the audit function and its governance. In addition, an increase in divergence in asset classification and provisioning as assessed by the Reserve Bank vis-à-vis the audited financial statements of SCBs has been seen as a concern.”

On Concurrent Audits:

The regulator expects exception reports, even of a routine nature, to be reviewed in detail on an ongoing basis. Additionally, the RBI expects audit trails to be checked for diversion of funds, including round tripping and other means. Furthermore, the regulator stresses that FEMA guidelines must be complied with, and KYC / AML directions should be implemented properly.

The report noted that the quality of audits suffers due to inadequate human resources, lack of desired skill sets (particularly for specialized branches), non-adherence to timelines for compliance with audit findings, and non-inclusion of critical areas. This indicates insufficient attention to sustainable compliance with earlier reports. The report also highlighted that repetitive and similar audit findings remain unaddressed, and internal audits failed to detect many frauds that came to light after accounts became NPAs.

The RBI stresses the need for fraud detection and reporting to be more risk-focused to identify red flags at an incipient stage.

Income Recognition and Asset Classification (IRAC) Norms:

The report flagged non-adherence to Income Recognition and Asset Classification (IRAC) norms as a major concern. The audit function has yet to provide the desired level of assurance to all stakeholders, including the Reserve Bank. While some information asymmetry may exist between the supervisor and stakeholders, the RBI pointed out that NPA divergence should not arise from failure to adhere to regulatory guidelines.

Actions for Statutory Auditors (SAs):

RBI has called for statutory auditors to undertake root cause analysis to identify deficiencies exposed by incidents of fraud and divergences in asset classification and provisioning. The report highlights that statutory auditors could better identify issues banks face in implementing system-based identification of NPAs and more effectively utilize the central database in banks for their audits.

To improve audit quality and introduce a transparent mechanism for the accountability of statutory auditors, the RBI has decided to implement a graded enforcement action framework. This will allow appropriate actions for lapses observed in statutory audits, particularly for instances of divergence in asset classification and provisioning during RBI inspections, relative to the audited financial statements of banks above the specified threshold.

Monetary Policy Committee (MPC) Decision:

The recently convened Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) decided to increase the repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.5%. Consequently, the reverse repo rate under the LAF stands adjusted to 6.25%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75%.

The decision was consistent with the MPC's objective of achieving the medium-term target for the Consumer Price Index (CPI) inflation of 4%, within a band of +/- 2%, while also supporting growth. The decision was based on the following economic assessments:

• The US economy rebounded strongly in Q2, while the Euro area reported sluggish growth, and major emerging market economies slowed down considerably.
• The Chinese economy faced challenges due to efforts to contain debt, and most countries, except Russia, dealt with weak exports, high unemployment, muted industrial production, and uncertainty regarding Brexit.
• Trade wars and geopolitical tensions continued to impact global growth.

Domestic Outlook:

On the domestic front, the south-west monsoon has been quite active, leading to better reservoir levels, which bode well for agriculture. However, flooding, inundation, and unrelenting rains have caused significant destruction and impacted large areas of cultivable land.

Industrial growth strengthened in April-May 2018, largely driven by a significant turnaround in the production of capital goods and consumer durables. Growth in the infrastructure/construction sector accelerated sharply, though growth in consumer non-durables decelerated. The output of eight core industries accelerated in June, and capacity utilization in the manufacturing sector remained robust.

An uptick in fuel prices and inflationary pressures in items other than food have impacted retail inflation. RBI's survey of households indicates further uptick in inflation, both in the near term and over the one-year horizon. While export growth picked up, double-digit import growth pushed up the trade deficit. Various factors, including MSP for Kharif crops, monsoon conditions, crude oil prices, and reduced GST rates on several products, are likely to influence retail inflation in the coming months.

Global and Banking Sector Outlook:

While robust corporate earnings indicate continued strong economic activity, rising trade protectionism poses a significant risk to both near-term and long-term global growth. The banking sector, still burdened by stressed assets, is looking for accelerated economic growth to improve performance.

Enforcement Action Framework for Statutory Auditors:

The Reserve Bank of India (RBI) has recently introduced an Enforcement Action Framework targeting Statutory Auditors for lapses in the statutory audit of banks. The framework aims to establish a transparent mechanism to examine auditors' accountability in a consistent manner, ultimately improving audit quality.

The types of lapses that will be scrutinized under this framework include:

• Misstatements in financial statements
• Incorrect certifications
• Incorrect information in the Long Form Audit Report
• Lapses in adhering to RBI's directions/guidelines
• Misconduct during the audit process

The framework will assess lapses based on non-adherence to statutory provisions or directives, as well as discrepancies between the reported and RBI-determined figures after annual inspections. Materiality will be determined based on the extent, frequency, and impact of the violation, with repeated violations being considered seriously.

RBI will provide auditors with a reasonable opportunity to present their views, and any enforcement action taken will be communicated through a speaking order.

If violations are deemed non-material, auditors will receive a cautionary advice. In the case of material violations, enforcement actions may include suspension from conducting statutory audits for a specified period or debarment if the auditors have been debarred by other regulatory, government, or law-enforcement agencies. Public interest cases of serious nature may result in the debarment of audit firms by RBI.

All enforcement actions, including cautionary notices, will be publicly disclosed and communicated to the Institute of Chartered Accountants of India (ICAI).

Financial Stability Report - June 2018:

The RBI released its Financial Stability Report in June 2018, which highlighted some key observations:

• The stress in the banking sector is expected to increase as the gross non-performing advances (GNPA) ratio rises further.
• In 2017-18, the profitability of Scheduled Commercial Banks (SCBs) declined, primarily due to increased provisioning, which has put pressure on SCBs' regulatory capital ratios. However, the provision coverage ratio has increased.
• Despite sluggish deposit growth, credit growth of SCBs picked up in 2017-18.

Macro-stress tests conducted by RBI predict that the overall GNPA ratio may rise from 11.6% in March 2018 to 12.2% by March 2019. The system-level capital to risk-weighted assets ratio (CRAR) is expected to decrease from 13.5% to 12.8% during the same period. Banks under the Prompt Corrective Action (PCA) framework are likely to see their GNPA ratio worsen from 21.0% in March 2018 to 22.3%, and six of these banks may face a capital shortfall relative to the required CRAR of 9%.

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Power Sector Dues and Allahabad High Court Ruling:

In June, the Allahabad High Court made a significant move concerning the dues of the Power Sector to banks. As of April 2018, outstanding dues from the Power Sector to banks amount to Rs 5.18 lakh crores. Of this, Rs 70,000 crores have turned into NPAs, with Rs 34,600 crores already before the NCLTs.

The Court, echoing the sentiments of a Parliamentary panel, acknowledged that the stress in the power sector is driven by factors such as fuel shortage, sub-optimal loading, lack of fuel supply agreements, and the absence of power purchase agreements—issues beyond the control of these companies. The Court noted that requiring banks to apply RBI guidelines mechanically would worsen the situation, pushing plants into further trouble without any chance of recovery.

The Power Ministry expressed concern about the RBI's mandate for a quick resolution plan, seeking at least a year to resolve these issues. The Court has instructed the Finance Ministry to convene a meeting with all stakeholders by the end of June to find a consensus.

Relaxation for MSME Sector:

Units in the MSME sector received some relief from prudential norms last fiscal. The Ministry has now extended these relaxations, particularly in meeting their dues to the banking sector. The new guidelines for the past due criterion for these units are as follows:

RBI's Proposal on Loan System for Large Borrowers:

The RBI has proposed a new loan system aimed at enhancing credit discipline among large borrowers. This would include a minimum 'loan component' in fund-based working capital finance and a mandatory Credit Conversion Factor (CCF) for the undrawn portion of cash credit/overdraft limits.

Cash Credit, a popular working capital financing mode, presents regulatory challenges such as perpetual rollovers and difficulty in smooth monetary policy transmission. This proposed system is designed to address these issues effectively.

Mark-to-Market Loss Provisioning Relaxation:

Given the rising yields, the RBI has decided to allow banks to spread provisioning for their mark-to-market (MTM) losses on all investments held in AFS and HFT for the quarter ending June 30, 2018. The required provisioning can be spread equally over up to four quarters, starting from the quarter ending June 30, 2018.

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Overview of RBI's Recent Restructuring Circular:

The RBI's circular dated 12 February 2018 on restructuring created substantial buzz in the banking sector. The Deputy Governor of the Reserve Bank of India recently offered a detailed explanation regarding the logic behind the RBI's decision.

Asset classification was initially based on the recovery record in the books of individual banks. When banks reported the asset classification of borrowers under CRILC, the regulator noticed a significant divergence, leading to the RBI's Asset Quality Review (AQR) in 2015-16. This exercise resulted in a substantial increase in NPAs.

Initially, the Corporate Debt Restructuring (CDR) scheme worked well, but over time, banks began using it to delay identifying non-performing assets.

The RBI subsequently introduced measures such as the Strategic Debt Restructuring (SDR) and Sustainable Structuring of Stressed Assets (S4A), allowing banks to implement deep structural changes, including management changes and significant haircuts, to revive industrial units.

However, in many SDR cases, the change in management was not implemented, and the S4A scheme was rarely used, prompting the RBI to move towards the Insolvency and Bankruptcy Code (IBC) for resolving borrower defaults through a collective decision-making process among creditors.

The RBI now advocates a framework that begins with out-of-court workouts, and if these fail, a statutory process under IBC would take over, offering a structured resolution within a specified timeframe.

Importance of Timely Resolution Plans:

The RBI has stressed the need for banks to have a resolution plan ready even for a day's delay in repayment. In contrast to the bond market, where borrowers face immediate consequences for even slight delays, bank debt contracts often suffer from a lack of enforcement of debt covenants. This discrepancy undermines the financial discipline required from borrowers. To address this, the RBI has introduced a one-day default clause to instill discipline in the banking sector.

Changes in the Joint Lender's Forum and Credit Rating Agencies:

A significant change has been made regarding the Joint Lender's Forum (JLF). Under the new framework, resolution plans can now be implemented individually or jointly by lenders. Previously, the decision of the JLF was binding on all members, leaving smaller players sidelined. Now, even smaller lenders have a say in the decision-making process.

The new framework also places increased responsibility on credit rating agencies. Their reputation would be at stake if they provide erroneous or questionable opinions regarding borrowers' creditworthiness.

Other Regulatory Changes:

In response to increasing yields, the RBI has allowed banks to stagger provisioning for mark-to-market (MTM) depreciation. Additionally, banks have been seen providing for enhanced gratuity and dividend payments as per the provisions of Section 15 of the Banking Regulations Act, 1949, ensuring compliance with regulatory requirements by the end of the March quarter.

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Overview of Recent Regulatory Developments:

Banks are now required to review their bond portfolios every quarter. If the value of securities is lower than the market price, banks must provide for depreciation. Bond valuation is the process of determining its fair value by discounting the cash flows emanating from the bonds until their maturity to their present value. The appropriate discount factor is largely determined by similar instruments in the market. Bond prices and yields move in opposite directions.

Change in the Role of FIMMDA:

The Fixed Income Money Market and Derivatives Association (FIMMDA), which was formed by a consortium of banks, public financial institutions, insurance companies, and primary dealers, ceased to publish price/yield data for government securities from 31 March 2018.

The responsibility for the valuation of Government Securities and State Development Loans (SDLs) has now been transferred to Financial Benchmark India Private Limited (FBIL). FBIL will also compute and disseminate daily reference rates for the US Dollar and other major currencies against the rupee, a function previously handled by the Reserve Bank of India (RBI).

For now, FBIL will adopt the same valuation methodology previously used by FIMMDA, but in due course, it is expected to develop its own technology and methodology for valuations.

Impact of Depreciation in Bond Valuations:

FIMMDA had lowered the price valuation of government bonds in December, and banks were estimated to provide around Rs 15,500 crore towards depreciation for that quarter. The situation for the March quarter was similar. In response to the systemic impact of sharp increases in yields, the RBI has given banks the option to spread the provisioning losses over four quarters, starting with the quarter in which the loss was incurred.

Banks that opt to spread the depreciation are required to make suitable disclosures in their quarterly results, providing details of:

Creation of Investment Fluctuation Reserve (IFR):

To help banks build adequate reserves to protect themselves against future increases in yields, the RBI has advised them to create an Investment Fluctuation Reserve (IFR) starting from the financial year 2018-19. The IFR must be the lower of:

The IFR will be held until it reaches a cap of at least 2% of the Held For Trading (HFT) and Available For Sale (AFS) portfolio, with a suggested timeline of three years.

The RBI may allow banks to draw down from the IFR if it exceeds 2% of the HFT and AFS portfolio. However, any drawdown must meet certain conditions, such as being used only for meeting the minimum Common Equity Tier 1 (CET1) / Tier 1 capital requirements or reducing the balance of loss.

Regarding accounts referred to the National Company Law Tribunal (NCLT) under the Insolvency and Bankruptcy Code (IBC), banks are expected to provide 40% of the provisioning by March, with the remaining 10% to be provided in the June quarter.

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Challenges Faced by Exporters under GST:

The implementation and refund delays under the new tax regime of GST have created working capital constraints, especially for exporters. Under GST, exporters are required to pay taxes upfront and later claim refunds. Delays in these refunds have had a significant impact on their working capital needs. A study by the regulator revealed this issue, which may have prompted the circular dated 7th February extending the 90-day prudential norm to 180 days.

Regulatory Measures Post LOU Scam:

In response to the recent LOU (Letter of Undertaking) scam, the regulator has directed banks not to extend Letters of Undertaking or Letters of Comfort for trade credits for imports into India. However, Letters of Credit and guarantees for trade credit for imports will continue. Additionally, banks are required to provide details of LOUs issued in recent years, including the outstanding amounts, margin held, and whether they fall under pre-approved credit limits.

SWIFT Integration and Fraud Prevention:

Banks have been asked to complete the linking of the SWIFT interbank messaging system to Core Banking Solutions by April 30. In recent times, frauds have been mainly associated with trade credit, particularly involving forex transactions and advance remittances. To address these concerns, banks must ensure tighter monitoring of such transactions. Passport details of borrowers taking loans of Rs 50 crores and above will now be mandatory to prevent economic offenders from fleeing the country.

Fugitive Economic Offenders Bill:

The Cabinet has approved the Fugitive Economic Offenders Bill, which aims to seize and sell assets of economic offenders to recover their dues. This bill will apply to defaulters who have an outstanding of Rs 100 crore and more. The regulator has also instructed banks to flag loans of Rs 250 crore and more where loan covenants have not been complied with.

Resolution of NCLT Cases:

Out of the twelve major cases referred to NCLT, two resolution plans are almost complete, and six are in the final stages. The remaining four cases are still in their initial stages.

Finance Ministry's Directive on Defaulters:

The Finance Ministry has instructed state-run banks to take Board approvals for publishing the photographs of willful defaulters, as part of efforts to “name and shame” defaulters.

Insurance Sector - Delhi High Court Ruling on Genetic Disorders:

In an important ruling, the Delhi High Court criticized health insurers for excluding genetic disorders from coverage. The Court found that the general exclusion of genetic disorders was illegal and unconstitutional. The judgment argued that insurance contracts should be based on empirical data and testing, not on subjective or vague criteria. The Insurance Regulatory and Development Authority (IRDA) has yet to define what constitutes genetic disorders, but this ruling marks a significant shift in how such exclusions are viewed under insurance law.

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RBI's Relief for MSME Borrowers:

The RBI has announced a relief for MSME borrowers by extending the 90-day delinquency norm to 180 days, under specific conditions. These borrowers must be registered under GST and have been classified as standard assets as of 31st August 2017. Amounts overdue as of 1st September 2017, as well as those falling due between 1st September 2017 and 31st January 2018, will benefit from the 180-day period under IRAC norms before their status is downgraded. However, this relief is limited to asset classification, and income recognition will only occur upon realization of interest debited.

The wording of the circular seems to focus primarily on term loans (“repayment obligations”), leaving operative accounts such as Cash Credit and Overdraft in a somewhat unclear position. Since the benefit is being extended due to adverse impacts on cash flows, it would seem reasonable to assume that the relief should apply to these accounts as well.

RBI's New Circular on Big Ticket Loans:

The RBI issued a surprise circular addressing big-ticket loans, effectively eliminating Resolution Plans (RP) such as Corporate Debt Restructuring (CDR), Strategic Debt Restructuring (SDR), and the Scheme for Sustainable Structuring of Stressed Assets (S4A). Under the new framework, RP approval will require consent from all banks involved, and may include regularization or restructuring of accounts. If the loan is above Rs. 100 crore, the borrower must obtain an investment grade rating from a rating agency (two agencies required for loans above Rs. 500 crore). After restructuring, the loan will be classified as NPA and can only return to a standard status if the borrower demonstrates satisfactory performance during the specified period and repays 20% of the restructured amount. Loans of Rs 2,000 crore or more, currently under SDR, CDR, or S4A schemes, must be resolved within six months, or they will be referred to bankruptcy courts.

Weekly Default Reporting and Stress Indicators:

Banks are now required to report defaults exceeding Rs 5 crore on a weekly basis to the centralized database of the Reserve Bank of India.

The regulator has also outlined several signs of financial stress that banks should be vigilant for. These include the non-maintenance of stipulated margins, delays in meeting commitments, excessive leverage, failure to meet statutory obligations, delays in project implementation, elongation of the working capital cycle, falling credit ratings, and the inability to meet financial covenants.

Short and Long-term Outlook:

In the short term, slippages are expected to increase, provisioning requirements will rise, and top-line growth may remain muted. However, in the long term, the banking system is expected to become stronger. These new norms are anticipated to prompt both borrowers and lenders to act within 30 days of default to prevent the escalation of problems.

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Basel Committee's Consultation on Technology Use in the Financial Sector:

The Basel Committee on Banking Supervision released a consultative document in August 2017 examining the implications of technological advancements in the financial sector and their potential impact on the supervisory system.

In their analysis, the Committee considered three broad scenarios focusing on technology developments such as big data, distributed ledger technology, and cloud computing, while also evaluating three emerging business models: innovative payment services, lending platforms, and neo-banks.

The rapid growth of technology in banking has created new business models, presenting a significant challenge for traditional banks across all the scenarios considered by the Committee. Regulators recognize the need to adapt banking standards and supervisory expectations to these innovations while maintaining essential prudential standards.

The Basel Committee has identified 10 key observations and recommendations for banks and bank supervisors regarding the following issues:

India's Draft Financial Resolution and Deposit Insurance Bill 2017:

The Government of India, which had previously been discussing recapitalizing public sector banks through budget allocations or bond issues, has proposed a new draft Financial Resolution and Deposit Insurance Bill 2017. This bill introduces the concept of "bail-ins" for the first time, which would allow for the conversion of existing liabilities into securities (e.g., converting a bank deposit into preference shares) or even the cancellation of liabilities.

While the government had initially been considering "bail-outs" for troubled banks, the introduction of "bail-ins" has raised concerns among depositors, especially those without a stake in the banks. The Finance Minister has downplayed the matter, stating that the bill is designed to gather public feedback and explore options for strengthening the banking system. Many depositors believe the bill could lead to negative consequences, and some have argued that the deposit insurance cover should be increased instead. The Finance Minister has assured that the government's objective is to protect both financial institutions and depositors.

As of now, the bill has been deferred until the budget session.

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Study Group on Marginal Cost of Funds Based Lending Rate (MCLR):

A study group constituted by the Reserve Bank of India examined various aspects of the Marginal Cost of Funds Based Lending Rate (MCLR) and explored the possibility of identifying a market-related benchmark for bank lending rates.

The group noted significant delays in the transmission of changes in the Base Rate regime and MCLR, which was reflected in the ultimate lending rates. Interestingly, this transmission seemed asymmetric—higher during the tightening phase of the monetary cycle and lower during the easing phase, affecting both the Base Rate and MCLR.

The group observed that banks had deviated from the prescribed methodologies for calculating the Base Rate and MCLR, aiming to maintain the Base Rate and prevent it from falling in line with the drop in the cost of funds. Some deviations included:

• Inappropriate calculation of cost of funds;
• Not adjusting the Base Rate even when the cost of funds sharply declined;
• Reporting a sharp increase in the return on net worth that was inconsistent with past records or future prospects;
• Introducing new components into the formula to achieve desired outcomes.

The delay in transmission was exacerbated by long reset periods, which further slowed down the process.

The study group identified four factors impeding monetary transmission:

1. Deterioration in the overall health of the banking sector;
2. Fixed rates for deposits vs. floating rates for advances, with fixed deposits of one year and above constituting more than 53% of total deposits;
3. Rigid interest rates on savings bank deposits;
4. Other financial saving instruments, which banks saw as a threat, fearing deposit outflows if deposit rates were reduced.

Additionally, increasing stressed assets meant that banks had to maintain Net Interest Margins (NIM) to cover loan losses, making it difficult to lower NIM. This forced higher pricing on advances.

While private sector banks took approximately six months for the changes in MCLR to reflect in lending rates, Public Sector Banks (PSBs) took even longer. Many banks arbitrarily added a "Business Risk Premium," often with little to no documentation, in an effort to keep their lending rates high.

Recommendations from the Group:

• Calculation of the Base Rate should not be compromised under any circumstances;
• A sunset clause is necessary for transitioning away from the Base Rate;
• There should be widespread dissemination of information regarding how the rate is determined.

To identify a market rate that could serve as a benchmark, the group examined 13 different market rates and identified three as more suitable: the Treasury Bill (T Bill) rate, the Certificate of Deposit (CD) rate, and the Reserve Bank's Policy Repo Rate.

The group also recommended that once the spread is fixed, it should remain constant throughout the loan's term. Furthermore, the reset clause should apply quarterly, instead of annually, as is the current practice.

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Banking and Insurance

Starting from October 14, 2017, every commercial bank is expected to maintain assets, referred to as ‘SLR assets’, in India, which shall not be less than 19.5% of their total net demand and time liabilities (NDTL) in India as of the last Friday of the second preceding fortnight. The valuation basis will follow the method specified by the Reserve Bank of India (RBI).

This requirement marks a reduction from the earlier SLR requirement of 20.0% of NDTL.

In the words of the Regulator: "Currently, the banks are permitted to exceed the limit of 25% of the total investments under the HTM category, provided the excess comprises SLR securities, and total SLR securities held under HTM category do not exceed 20.5% of NDTL. In order to align this ceiling with the mandatory SLR, it has been decided to reduce the ceiling from 20.5% to 19.5% in a phased manner, i.e., 20% by December 31, 2017, and 19.5% by March 31, 2018."

At present, banks can shift investments to/from HTM (Held-to-Maturity) with the approval of the Board of Directors once a year, usually at the start of the accounting year. To comply with the Regulator's instructions, the RBI has decided to allow additional shifting of excess SLR securities from HTM to the AFS (Available for Sale) or HFT (Held for Trading) categories. This will be allowed in addition to the shift permitted at the beginning of the accounting year, i.e., in the month of April. Such transfers to AFS/HFT, along with sales of securities from HTM, will be excluded from the 5% cap on the value of sales and transfers to/from HTM category, as per the Master Circular on Prudential Norms for Classification, Valuation, and Operation of Investment Portfolio by Banks.

The RBI has recently issued a Master Direction on Financial Services provided by Banks. According to the new regulation:

• No bank can hold more than 10% in the equity of a deposit-taking Non-Banking Financial Company (NBFC), excluding housing finance companies.
• Banks cannot make an investment of more than 10% of the unit capital of a Real Estate Investment Trust (REIT) or Infrastructure Investment Trust (InvIT), subject to an overall ceiling of 20% of the bank’s net worth for direct investments in shares, convertible bonds/debentures, units of equity-oriented mutual funds, and exposures to Alternative Investment Funds (AIFs).
• No bank can hold more than the lower of 10% of its paid-up capital and reserves, or 10% of the paid-up capital of a company engaged in non-financial services, provided investments in excess of 10% but not exceeding 30% of the paid-up share capital of such companies may be permitted under select circumstances.

Insurance

Insurance companies are offering special insurance coverage to meet medical expenses incurred in tackling the dreaded dengue disease.

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Banking and Insurance

One of the measures contemplated to counter the menace of mounting NPAs (Non-Performing Assets) is the setting up of a Public Credit Registry (PCR). A suggestion to this effect has come from Dr. Viral V. Acharya, Deputy Governor of RBI. A Public Credit Registry (PCR) is an extensive database of credit information that would be accessible to all stakeholders and managed by a public authority, like the central bank. The idea is to capture all relevant information in one large database on the borrower. At present, several Indian banks burdened with NPAs are looking for a service provider who can give them objective data for making credit decisions and enable them to defend their actions with market evidence when subjected to scrutiny.

A PCR is expected to help in:

• Credit assessment and pricing by banks;
• Risk-based, dynamic, and countercyclical provisioning at banks;
• Supervision and early intervention by regulators;
• Effective transmission of monetary policy;
• Strategic restructuring of stressed bank credits.

A central repository would capture details of collaterals and prevent over-pledging of collateral by borrowers. In the absence of such information, the lender might charge a high cost on the loan or ask for more collateral than necessary to prevent being diluted by other lenders. Moreover, in the absence of a PCR, 'good' borrowers are disadvantaged as they are unable to demonstrate their creditworthiness.

Currently, the private Credit Bureaus (CBs) operating in India are regulated by the RBI, and each one focuses on data analytics to provide credit scores and allied reports. These analytics are useful for member banks for issuing credit cards and for making decisions, primarily on retail loans.

The RBI's CRILC (Central Repository of Information on Large Credits), set up in 2014-15, is now one of the most important databases for offsite supervision. Scheduled Commercial Banks (SCBs) report credit information of their large borrowers, i.e., those with an aggregate fund-based and non-fund-based exposure of INR 50 million and above. It covers around 60% of the loan portfolio and about 80% of the non-performing loans of SCBs. However, it only captures limited details shared with the reporting banks and is not open to Credit Bureaus or the larger lender community. Additionally, it does not provide real-time data for making credit decisions at the micro level and does not fully capture all credit data.

Small and marginal borrowers are disadvantaged against larger borrowers as they lack many of the qualifications necessary for credit. Transparency in credit information would serve as a "reputational collateral" for such borrowers. Even transactional data, including payments to utilities like power and telecom, would help small players. Regularity in making payments to utilities and trade creditors provides an indication of credit quality. In turn, credit from the formal sector can flow to these small players, boosting financial inclusion. As a side benefit, the extent of financial inclusion can become more precisely measurable for policymakers.

PCRs can help enhance the efficiency of the credit market, increase financial inclusion, improve ease of doing business, and control delinquencies. By incorporating unique linkages (such as Aadhar for individuals and CIN for companies), the RBI's datasets can quickly be converted into a useful PCR covering customers of SCBs to start with. It can then be expanded to cover other financial institutions in India. A comprehensive PCR down the road will be even more effective. It's time for India to make the establishment of a PCR a reality!

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Banking and Insurance

The Regulator has come out with guidelines for Small Finance Banks (SFBs). These banks are intended to serve the unserved and underserved sections of the population. They would extend credit to small business units, small and marginal farmers, micro and small industries, and to the organized sector. These banks in the private sector are expected to be high on technology and low on operational costs. SFBs would have 25% of their branches in unbanked rural centres.

These banks are expected to lend 75% of their Adjusted Net Bank Credit (ANBC) to the Priority Sector. Of this 75%, the allocation is as follows:

• 18% to agriculture (of which 8% will be for Small and Marginal Farmers),
• 7.5% to Micro Enterprises,
• 10% to weaker sections of society.

Agricultural Credit

Credit to Agriculture would cover Farm Credit, which includes lending for long, medium, and short-term loans for cultivation, agricultural infrastructure, and ancillary activities. Farm Credit also includes allied activities such as dairy, fishery, animal husbandry, poultry, and sericulture. Purchases of agricultural machinery, implements, and activities like spraying, weeding, and transportation are also covered under this category. Borrowers could include corporates, with an aggregate limit of Rs 2 crore.

Agricultural Infrastructure

Agricultural infrastructure would include market yards, warehouses, godowns, silos, soil conservation, watershed development, tissue culture, agri-biotechnology, seed production, bio-pesticides, and more. Corporates can also be borrowers in this category, with the upper limit going up to Rs 100 crore.

Ancillary Activities

Ancillary activities would cover agri-clinics, agro-business centers, food agro-processing, and maintenance of equipment like tractors, bulldozers, well-boring equipment, and threshers.

Definitions of Farmers and Enterprises

Marginal farmers are those with holdings of less than 1 hectare, while small farmers are those with 1 to 2 hectares. Similar limits have been prescribed to identify Micro, Small, and Medium Enterprises (MSMEs) as well. Services sector businesses are defined based on the cost of equipment they hold. These banks will also cater to sectors like housing, renewable energy, education, and social infrastructure for their lending. The rate of interest charged will be in line with the DBR Master Directions.

Bankruptcy Code for Small Enterprises

It is learnt that the government is working on a simpler bankruptcy code to cover defaulters in the non-corporate world, which includes small and medium enterprises managed by partnership firms and proprietary units. These organizations, which have unlimited liability, currently lack protection for their personal assets. Once a unit enters the Bankruptcy code, the stake sale often falls short of the market value. These issues will need to be addressed before the code is implemented. The Code is expected to cover personal bankruptcy of individuals who hold business interests.

Of course, the problem of chronic NPAs (Non-Performing Assets) will not be solved overnight, but the process is underway.

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Banking and Insurance

The stressed asset pile in the Indian banking system is estimated to be around Rs 10 trillion. Of this, assets labeled Non-Performing (NPAs) account for about Rs 7.7 trillion, and the balance is held under the restructured category. The RBI's internal panel identified accounts with outstandings in excess of Rs 5000 crore (60% of which were already classified as Non-Performing) for bankruptcy proceedings. In May this year, through an Ordinance amending the Banking Regulation Act, the RBI was empowered to ask banks to initiate proceedings against defaulters.

The Internal Advisory Committee (IAC) of the Regulator, which consists of independent board members of the Central Bank, identified accounts to be referred for resolution under the Insolvency and Bankruptcy Code, 2016 (IBC). The panel has examined the top 500 stressed accounts for referral.

RBI has, for a start, zeroed in on 12 accounts representing about 25% of the gross NPAs in the banking system, and these accounts will be referred for bankruptcy proceedings.

The National Company Law Tribunal (NCLT), which is the arbitration authority under the Bankruptcy Law, will take up these cases on priority. Banks have been asked to file for insolvency proceedings under the IBC with NCLT. Currently, NCLT already handles 81 cases of NPAs, and creditors have initiated insolvency proceedings in 18 of them.

For those accounts that do not immediately meet the criteria for reference, the advisory panel has suggested that the concerned banks come up with a resolution plan within six months. If no viable plan emerges, these cases are likely to be taken up under the IBC as well.

The relevant press release reads as follows:

"As regards the other non-performing accounts which do not qualify under the above criteria, the IAC recommended that banks should finalize a resolution plan within six months. In cases where a viable resolution plan is not agreed upon within six months, banks should be required to file for insolvency proceedings under the IBC. The Reserve Bank, based on the recommendations of the IAC, will accordingly issue directions to banks to file for insolvency proceedings under the IBC in respect of the identified accounts. Such cases will be accorded priority by the National Company Law Tribunal (NCLT). The details of the resolution framework in regard to the other non-performing accounts will be released in the coming days. The circular on revised provisioning norms for cases accepted for resolution under the IBC is being issued separately."

On the provisioning front, for accounts that have not yet suffered loan loss provisioning, bankers seem to prefer spreading the provisioning over a few quarters to soften the impact on their financials.

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Banking and Insurance

In a recent circular, the Regulator stressed the need for the participants of a Joint Lenders Forum (JLF) to conform to the timelines set under a Corrective Action Plan (CAP). In its circular dated 5th May, the Regulator stated:

“In order to ensure that the CAP is finalised and formulated in an expeditious manner, the Framework specifies various timelines within which lenders have to decide and implement the CAP. The Framework also contains disincentives, in the form of asset classification and accelerated provisioning where lenders fail to adhere to the provisions of the Framework. Despite this, delays have been observed in finalising and implementing the CAP, leading to delays in the resolution of stressed assets in the banking system.”

It is clarified that the CAP can also include resolution by way of Flexible Structuring of Project Loans, Change in Ownership under Strategic Debt Restructuring, Scheme for Sustainable Structuring of Stressed Assets (S4A), etc.

In this context, it is reiterated that lenders must scrupulously adhere to the timelines prescribed in the Framework for finalising and implementing the CAP. To facilitate timely decision-making, it has been decided that, henceforth, the decisions agreed upon by a minimum of 60 percent of creditors by value and 50 percent of creditors by number in the JLF would be considered as the basis for deciding the CAP and will be binding on all lenders, subject to the exit (by substitution) option available in the Framework. Lenders shall ensure that their representatives in the JLF are equipped with appropriate mandates and that decisions taken at the JLF are implemented by the lenders within the timelines. It shall be noted that:

Any non-adherence to these instructions and timelines specified under the Framework shall attract monetary penalties on the concerned banks under the provisions of the Banking Regulation Act 1949.

The urgency that comes out is very palpable.

The Global Financial Stability Report of the International Monetary Fund (IMF) points out two important aspects:

• The Indian industrial sector is now among the most heavily indebted in the world in terms of the ability of its cash flows to meet its bank loan repayments; and
• The Indian banking sector has set aside very little bank capital to cover provisions for loan losses on loans made essentially to the industrial sector.

Dr. Viral V. Acharya, Deputy Governor, suggests a five-pronged remedy, which includes:

• Private capital raising;
• Asset sales, including disposal of non-core assets and healthy loan portfolios;
• Mergers;
• Divestment by Government, increasing direct public participation; and
• Tough corrective action.

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Banking and Insurance

UPDATES ON THE BANKING FRONT - MAY 2017

The Central Government is in the process of setting up an Information Utility (IU), known as the Credit Registry, which will provide data on borrowing, defaults, and security cover available on the lending and borrowing transactions extended by banks and financial institutions, especially those advances which have ended up as stressed assets. Authorized users would be able to know the current status of such borrowers.

The Regulator is concerned that some Overseas Direct Investments under FDI schemes are posing significant problems, such as round-tripping, tax evasion, and money laundering. The RBI is exploring ways to curb these issues.

March 17th was set as the date for the share swap related to the merger of five associate banks with the State Bank of India, which came into effect on April 1st. Minority shareholders, identified on March 17th in the case of SBBJ, SBM, and SBT, are entitled to receive Equity Shares in SBI of a face value of Re 1 each at the agreed swap ratio.

Credit growth has fallen below 5%, bellying expectations of a quicker recovery in factory output. The data released by the Regulator shows that bank loans grew by 4.88% year-on-year, compared to 11.2% a year ago. This is the slowest growth rate since 2006. Low consumer spending, which has led to lower capacity utilization, is cited as the primary reason for the sluggish credit growth.

All Savings Bank accounts may soon become internet-enabled. Increased digital banking is expected to lead more and more account holders to operate their accounts online. Internet users in India are expected to cross 450 to 465 million by June this year, up from 432 million in December. Of these, 269 million are in urban areas.

Credit Information Company TransUnion CIBIL has launched a credit risk ranking for MSME units. The exposure of the banking industry to this sector is around Rs 12 lakh crore. Using algorithms based on credit history data, the CIBIL MSME Rank (CMR) is expected to forecast default probability in the next 12 months.

S&P Global Ratings has opined that the profitability of banks in India will improve next fiscal year but has warned that unless large-scale capital infusion is made, banks will continue to remain vulnerable. In a bid to align with the emerging financial ecosystem, banks are looking to adopt alternative financing methods such as aggregation financing, supply-chain financing, and internet-based financing, which are seen as the latest corporate trends.

Players in the virtual currency market, such as Zebpay, Unocoin, Coinsecure, and Searchtrade, have formed the Digital Asset and Blockchain Foundation of India (DABFI), which aims to provide orderly and transparent growth for the virtual currency market. This body is expected to function as a self-regulatory organization (SRO), with an international law firm tasked with framing self-regulation norms.

Meanwhile, the Deputy Governor of RBI has raised concerns over virtual currencies, as they pose potential financial, legal, customer protection, and security-related risks, according to the Regulator.

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Banking and Insurance

The Central Government is in the process of setting up an Information Utility (IU) known as the Credit Registry, which will provide data on borrowing, defaults, and security cover available on the lending and borrowing transactions extended by banks and financial institutions, particularly on advances that have ended up as stressed assets. Authorized users would be able to know the current status of such borrowers.

The Regulator is concerned that some Overseas Direct Investments under FDI schemes are posing significant problems, such as round-tripping, tax evasion, and money laundering. The RBI is exploring ways to curb these issues.

March 17th has been fixed as the date for the share swap regarding the merger of five associates with the State Bank of India, which is expected to come into effect on April 1st. Minority shareholders identified on March 17th (in the case of SBBJ, SBM, and SBT) would be entitled to receive Equity Shares in SBI of a face value of Re 1 each at the agreed swap ratio.

World Bank's Chief Executive, Kristalina Georgieva, advocated for a ban on high-value bank notes, stating that the move would have a profound and positive impact on the economy. OECD Secretary-General Angel Gurria also supported this, saying that a ban would help move the nation toward a less-cash society, leading to greater financial penetration and better consumer protection.

Credit growth has fallen below 5%, defying expectations of a quicker recovery in factory output. Data released by the Regulator showed that bank loans grew by 4.88% year-on-year, compared to 11.2% a year ago. This is the slowest growth rate since 2006. Low consumer spending, which has led to lower capacity utilization, is said to be the primary reason for the sluggish credit growth.

All Savings Bank accounts may soon become internet-enabled. Increased digital banking is expected to encourage more account holders to operate their accounts online. Internet users in India are expected to cross 450 to 465 million by June this year, up from 432 million in December. Of these, 269 million are in urban areas.

Banks, in an effort to keep pace with the emerging financial ecosystem, are looking to adopt different financing methods, such as aggregation financing, supply-chain financing, and internet-based financing, which are seen as the latest corporate trends.

Credit Information Company TransUnion CIBIL has launched a credit risk ranking for MSME units. The exposure of the banking industry to this sector is around Rs 12 lakh crore. Using algorithms based on credit history data, the CIBIL MSME Rank (CMR) is expected to forecast default probability in the next 12 months.

S&P Global Ratings has opined that the profitability of banks in India will improve next fiscal year but has warned that unless large-scale capital infusion is made, banks will continue to be vulnerable.

Players in the virtual currency market, such as Zebpay, Unocoin, Coinsecure, and Searchtrade, have formed the Digital Asset and Blockchain Foundation of India (DABFI), which aims to provide orderly and transparent growth for the virtual currency market. This body is expected to function as a self-regulatory organization (SRO), with an international law firm tasked with framing self-regulation norms.

Meanwhile, the Deputy Governor of RBI raised concerns over virtual currencies, as they pose potential financial, legal, customer protection, and security-related risks, according to the Regulator.

RBI has provided its preliminary views on demonetization, opining that its impact on the real economy will be transient. The banking sector benefited from an increase in CASA (which surged by 4.1%). The increase in Net Interest Income is expected to absorb the cost of managing the currency exchange process. The impact of demonetization on certain segments, like exports of readymade garments, gems, and jewelry, was noted to be significant.

On resolving the problem of stressed assets, Sri Viral V. Acharya, Deputy Governor of RBI, suggests two models: one through Private Asset Management Companies and the other through National Asset Management Companies. However, he stresses that these entities should focus solely on resolving stressed asset issues and not engage in regular banking activities. In his words, “It would be better to limit the objective of these asset management companies to orderly resolution of stressed assets with a graceful exit thereafter; in other words, no mission creep over time to do anything else, such as raising deposits, starting a new lending portfolio, or helping deliver social programs. It is essential to keep the business model of these entities simple to make them attractive to private investors with expertise in asset restructuring.”

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Banking and Insurance

Can banks effect payments out of Statutory Reserves without the Regulator's nod? Normally, it is never done, but in the case of those banks trying to meet the Coupons issued towards Perpetual Debt Instruments (for mobilizing Additional Tier I capital under Basel III), RBI has clarified certain conditions. Banks that plan to issue such PDIs should ensure they have full discretion at all times to cancel distributions/payments to be eligible for such issues.

Secondly, before making payments towards such coupons out of reserves, banks must ensure they meet the minimum regulatory requirements for CET1, Tier 1, and Total Capital ratios, including the additional capital requirements for Domestic Systemically Important Banks, subject to the capital buffer frameworks.

Thirdly, banks should, out of current year's profits, profits brought forward, and revenue reserves (excluding reserves such as Statutory Reserves, Share Premium, revaluation reserve, foreign currency translation reserve, and Investment Reserve), net off losses and Deferred Revenue Expenditure. If the balance is inadequate to meet bond payments, banks can use the Statutory Reserve. In such cases, they need not seek prior permission from the regulator but must keep the regulator informed after meeting the obligations within the specified time.

On the aspect of cyber security, the Regulator intends to form a cross-functional Standing Committee, including industry experts and government representatives, to address concerns and issues.

Regarding asset quality in the banking system, based on the Q3 results and provisional data, the Regulator observes an elevation in the gross NPA ratio across categories. However, for the first time in a few quarters, some banks have reported a decrease in the NPA ratio compared to the preceding quarter. There is also a dip in the net NPA ratio, indicating that provisioning levels are adequate. The percentage of restructured assets has also reduced. Overall, the system shows improvement in operating profit, although provisioning pressures on net profit are likely to continue. The Regulator advises considering the beneficial circular issued on asset classification and income recognition, which was necessitated by the re-monetization of certain currencies. On capital adequacy, most banks are well-placed to meet regulatory norms, but some will need to raise additional capital to meet requirements. By March 2019, banks will require Rs 91,000 crore in additional capital funds, assuming 8-9% growth. Of this, Rs 50,000 crore would be Tier I capital. SBI, among other banks, has requested a longer-term amortization of loan losses due to deep restructuring.

Professional forecasters on macroeconomic indicators project that bank credit will grow by 11.9% in 2017-18. The Consumer Confidence Survey indicates lower optimism regarding economic conditions, income, spending, employment, and price levels over the next year.

The Government of India plans to inject Rs 500 crore into India Post Payments Bank to set up 650 branches by September 2017. Of this, Rs 123 crore would be capital infusion, and Rs 375 crore would be through grants-in-aid.

The much-awaited merger of Subsidiaries with SBI has been deferred to a date post-March.

Banks registered a sharp decline in FCNR-B deposits in the quarter ending December 2016, from USD 44.11 billion in September to USD 20.85 billion in December.

Banks have been instructed by RBI to create a pool of forensic audit firms due to the rising number of advance-related frauds, which accounted for 92% of all frauds in 2016.

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