Banking Sector Reforms – Basel Norms, Risk Management, Non-Performing Assets Commerce YouTube Lecture Handouts Part 2

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Committee Formation

Importance of Banking Sector Reforms and Acts

  • These banking reforms aim to remove the external restriction on banks like high-interest rates, reserve requirements (CRR and SLR) , and frequent change in interest rates. They want to make the banking system more adaptive and flexible.
  • They are to smoothen the process of bank formation in India.
  • It is to promote healthy competition for better productivity.
  • Foreign direct investment is another area they focus on to improve the economy.
  • The merging of banks across India is their focus again. It is done to improve efficiency and productivity.
  • The reforms have improved the overall functioning of the banking system in the country.
  • The main focus of reforms was in three areas:
    • Non-Performing Assets (NPAs)
    • Capital Adequacy Norms
    • Diversification of operations
  • NPA՚s – A non-performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
  • Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.
  • The gross NPA of scheduled commercial banks (SCBs) increased over the period March s 31,1998 to March 31,2002 from ₹ 50,815 crores to ₹ 70,904 crores. Gross NPA of public sector banks (PSBs) were also correspondingly higher.
  • However, the share of PSBs in total NPAs declined from 90 % to 80 % during the period (1998 - 2002)
  • Furthermore, there was a decline in the ratio of gross NPAs and net NPAs, measured as percentage of advances as well as assets.
  • These ratios represent the quality of banks assets and are thus taken as measures of soundness of the banking system.
  • Gross and net NPAs as a proportion of gross advances and total assets of Scheduled Commercial Banks declined substantially during this period.
  • The Basel Accords refer to the banking supervision Accords (recommendations on banking regulations) —
    • Basel I, Basel II and Basel III — issued by the Basel Committee on Banking Supervision (BCBS) .
  • They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland.
  • The committee normally meets there.
  • The Basel Accords is a set of recommendations for regulations in the banking industry.
  • The Basel IV standards are changes to global bank capital requirements that were agreed in 2017 and are due for implementation in January 2023 due to COVID-19 Pandemic.
  • Basel IV introduces changes that limit the reduction in capital that can result from banks՚ use of internal models under the Internal Ratings-Based approach.
  • This includes:
    • A standardized floor, so that the capital requirement will always be at least 72.5 % of the requirement under the Standardized approach;
    • A simultaneous reduction in standardized risk weights for low-risk mortgage loans;
    • A higher leverage ratio for Global Systemically Important Banks (G-SIBs) , with the increase equal to 50 % of the risk adjusted capital ratio.
  • More detailed disclosure of reserves and other financial statistics.

Capital Adequacy Ratio (CAR)

  • Higher Capital Adequacy will improve the efficiency of banks in two ways:
    • By forcing banks to reduce operating costs,
    • By improving long-term viability through risk reduction.
  • In 1988 the Basel Committee for international banking supervision made an attempt worldwide to reduce the number of bank failures by tying a bank՚s CAR to the riskiness of the loans it makes.
  • CAR is a measure of the amount of a bank՚s capital expressed as a percentage of its risk weighted credit exposures.
  • Capital adequacy enables banks to mobilize more capital at reasonable cost.
  • On the basis of the Basel Committee proposals (1988) , two tiers of capital have been prescribed for Indian SCBs:
    • Tier I — capital which can absorb losses without forcing a bank to stop trading,
    • Tier II — capital which can absorb losses only in the event of a winding up.

Following the recommendations of the first Narasimhan Committee (1991)

  • the RBI directed the banks to maintain a minimum capital of 8 % as the risk-weighted assets;
  • the second Narasimhan Committee (1998) suggested raising the ratio further.
  • At the end of March 2002, all SCBs (except five) had CRARs in excess of the stipulated 9 % .
  • The capital of PSBs has increased through government capital infusion, equity issues to public, and retained earnings.

Diversification in Bank Operations

  • During the period of economic Liberalization, PSBs have diversified their activities considerably.
  • They have moved in new areas such as
    • mutual funds,
    • merchant banking,
    • venture capital funding and
    • other para-banking activities such as leasing (lease financing) ,
    • hire-purchase, factoring and so on.
  • The main objective has been -to make profits by deriving maximum economies of scale and scope, enlarging customer base and providing various types of banking services under one umbrella (both directly as also through subsidiaries) .
  • Many banks such as the SBI have become a one-stop financial services center.

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