Article 9: Banking – Part II

Article 8: Banking – Part I
December 11, 2018
Article 10: Inclusive growth and NITI Aayog
December 18, 2018

Current Affairs for Engineering Service Exam

Article 9: Banking – Part II

Video Lectures and Test Series for ESE 2019

Contents:

  1. Basel Norms
    1. Pillars of the Basel Norms
    2. Major Changes in Basel Norms
  2. Priority Sector Lending
  3. Non-Performing Asset
    1. Categories
    2. Recovery of NPA’s
  4. Quiz

BASEL NORMS

Concept of Basel Norms:

  • Basel is a city in Switzerland.
  • It is the headquarters of Bureau of International Settlement (BIS)
  • BIS fosters cooperation among central banks with a common goal of financial stability and common standards of banking regulations.
  • Basel guidelines refer to broad supervisory standards formulated by these groups of central banks – called the Basel Committee on Banking Supervision (BCBS).
  • The set of the agreement by the BCBS, which mainly focuses on risks to banks and the financial system is called Basel accords/Basel Norms.
  • The purpose of the accord is to ensure that financial institutions have enough capital on account to meet obligations and absorbs unexpected losses.
  • India has accepted Basel Norms for Banking.

A.Basel I:

  • In 1988, BCBS introduced capital measurement system called Basel capital accord, also called Basel 1. It focused almost entirely on credit risk.
  • Assets were classified under different risk profiles. Example: An asset backed by collateral would carry lesser risks as compared to personal loans, which have no collateral.

  • Assets of banks were classified and grouped into five categories according to credit risk, carrying risk weights of:
  1. 0% (for example cash, home country debt like Treasuries),
  2. 20% (securitizations such as MBS rated AAA)
  3. 50%,
  4. 100% (for example, most corporate debt), and
  5. Some assets are given no rating
  • The minimum capital requirement was fixed at 8% of risk-weighted assets (RWA).

B.Basel II:

In 2004, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of Basel I accord.

The guidelines were based on three parameters:

  1. Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.
  2. Banks were needed to develop and use better risk management techniques in monitoring and managing all the three types of risks
  3. Banks need to mandatorily disclose their risk exposure, etc. to the central bank.

C.Basel III:

  • Basel III or Basel 3 released in December 2010 is the third in the series of Basel Accords.
  • These guidelines were introduced in response to the financial crisis of 2008.
  • These accords deal with risk management aspects for the banking sector.
  • In a nutshell, we can say that Basel III is the global regulatory standard on bank capital adequacy, stress testing, and market liquidity risk.

Objectives of the Basel III

  • Improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source
  • Improve risk management and governance
  • Strengthen banks’ transparency and disclosures

Pillars of the Basel Norms for Banking:

  1. Pillar 1- Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs): Maintaining capital calculated through credit, market and operational risk areas.
  2. Pillar 2- Supervisory Review Process: Regulating tools and frameworks for dealing with peripheral risks that banks face.
  3. Pillar 3- Market Discipline: Increasing the disclosures that banks must provide to increase the transparency of banks

Major Changes in Basel Norms for Banking

The Major Changes Proposed in Basel III over earlier Accords i.e. Basel I and Basel II or the Major Features of Basel III:

  1. Better Capital Quality:
    1. One of the key elements of Basel 3 is the introduction of a much stricter definition of capital.
    2. Better quality capital means the higher loss-absorbing capacity.
  2. Capital Conservation Buffer
    1. Under Basel III  banks will be required to hold a capital conservation buffer of 2.5%.
    2. The aim of asking to build conservation buffer is to ensure that banks maintain a cushion of capital that can be used to absorb losses during periods of financial and economic stress.
  3. Countercyclical Buffer:
    1. The countercyclical buffer has been introduced with the objective to increase capital requirements in good times and decrease the same in bad times.  
    2. The buffer will slow banking activity when it overheats and will encourage lending when times are tough i.e. in bad times. 
  4. Minimum Common Equity and Tier 1 Capital Requirements:
    1. Tier 1 capital is a bank’s core capital.
    2. Tier 1 capital consists of common equity and also other qualifying financial instruments.
    3. Common equity is the amount that all common shareholders have invested in a company.
    4. The common equity is the highest form of loss-absorbing capital.
    5. Under Basel III, common equity requirement is raised from 2% to 4.5% of total risk-weighted assets.
    6. The overall Tier 1 capital requirement also increased from the current minimum of 4% to 6%.  
  5. Leverage Ratio:  
    1. A leverage ratio is a relative amount of capital to total assets (not risk-weighted).
    2. Basel III rules include a leverage ratio to serve as a safety net.
  6. Liquidity Ratios:
    1. Under Basel III, a framework for liquidity risk management will be created. 
  7. Systemically Important Financial Institutions (SIFI):
    1. As part of the macro-prudential framework, systemically important banks will be expected to have loss-absorbing capability beyond the Basel III requirements.

Present scenario in India:

  • New Basel-III norms, will kick in from March 2019
  • Indian banks need to maintain a minimum capital adequacy ratio (CAR) of nine percent, in addition to a capital conservation buffer, which would be in the form of common equity at 2.5 percent of the risk-weighted assets

Priority Sector Lending

Objective:

To ensure that adequate institutional credit flows into some of the vulnerable sectors of the economy, which may not be attractive for the banks from the point of view of profitability.

Categories under priority sector:

(i) Agriculture

(ii) Micro, Small and Medium Enterprises

(iii) Export Credit

(iv) Education

(v) Housing

(vi) Social Infrastructure

(vii) Renewable Energy

(viii) Others

Priority Sector Targets:

Categories Domestic scheduled commercial banks (excluding Regional Rural Banks and Small Finance Banks) and Foreign banks with 20 branches and above Foreign banks with less than 20 branches
Total Priority Sector 40%* 40%, to be achieved in a phased manner by 2020.
Agriculture  18%

Within the 18 percent target for agriculture, a target of 8% is prescribed for Small and Marginal Farmers.

Not applicable
Micro Enterprises 7.5% Not applicable
Advances to Weaker Sections 10% Not applicable
of Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.

Priority Sector Lending Certificates (PSLCs):

  • Priority Sector Lending Certificates (PSLCs) are a mechanism to enable banks to achieve the priority sector lending target and sub-targets by purchase of these instruments in the event of shortfall.
  • This also incentivizes surplus banks as it allows them to sell their excess achievement over targets.
  • Under the PSLC mechanism, the seller sells fulfilment of priority sector obligation and the buyer buys the obligation with no transfer of risk or loan assets.

NON PERFORMING ASSETS

What is NPA?

  • An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.
  • A ‘non-performing asset’ (NPA) was defined as a credit facility in respect of which the interest and/ or instalment of principal has remained ‘past due’ for a specified period of time.
    • According to RBI, terms loans on which interest or instalment of principal remain overdue for a period of more than 90 days from the end of a particular quarter is called a Non-performing Asset.
    • Terms of Agriculture / Farm Loans-
      • For short duration crop agriculture loans such as paddy, Jowar, Bajra etc. if the loan (installment / interest) is not paid for 2 crop seasons, it would be termed as a NPA.
      • For Long Duration Crops, the above would be 1 Crop season from the due date.

Causes

Categories of NPAs:

Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained non-performing and the realisability of the dues:

1.Sub Standard Assets:

  • A sub-standard asset is one, which has remained NPA for a period less than or equal to 18 months.

2.Doubtful Assets:

  • An asset is to be classified as doubtful, if it has remained NPA for a period exceeding 18 months.

3.Loss Assets:

  • A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly.
  • In other words, such an asset is considered uncollectible.

Recovery of NPA’s

  1. SARFAESI Act 2002

  • Banks utilizes Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. an effective tool for bad loans (NPA) recovery.
  • It is possible where non-performing assets are backed by securities charged to the Bank.
  • Upon loan default, banks can seize the securities (except agricultural land) without intervention of the court.
  • However, if the asset in question is an unsecured asset, the bank would have to move the court to file civil case against the defaulters.
  1. Debt Recovery Tribunals:

  • DRTs were first set up under Recovery of Debts Due to Banks and Financial Institutions Act 1993, also known as DRT Act.
  • Under existing norms, DRT is supposed to dispose of matter referred to it within 180 days of receipt of application
  • An appeal can be filed against DRT order with Debt Recovery Appellate Tribunals (DRATs).
  1. Bad Bank:
  • A bank that is set up with the sole purpose of buying the bad loans of other banks along with other NPAs at market prices.
  • By transferring the bad loans to the bad bank, a bank will be able to clear its balance sheet.
  • This concept was first introduced in 1988 when the Grant Street National bank that was set up to house the NPAs of the Pittsburgh-headquartered Mellon Bank.

Quiz

Hi there.. We know, you just need single reading to grasp the concepts…Please prove us right.

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