Understanding Indian Banking Sector
Understanding Indian Banking Sector
Why in news ?
RBI might limit size of lender consortiums
- The Reserve Bank of India (RBI) is considering a proposal that would limit the number of participants in a single lenders’ consortium, in a bid to encourage banks to carry out better independent credit checks and do more to chase rogue borrowers.
- It is said that banks with very meagre share neither have the incentive nor the information to independently assess a proposal. They typically go by one who has the bigger share.
- The suggestion is to have a regulatory limit on the number of members in a consortium, so that every member will have a serious independent credit appraisal and credit mindset. Though the proposal could also have drawbacks, as it effectively restricts a bank’s freedom.
What is a lender consortium?
- In a very general sense, a consortium is any group of individuals or entities that decides to pool resources toward a given objective.
- A consortium is usually governed by a legal contract that delegates responsibilities among its members.
- In the financial world, a consortium refers to several lending institutions that group together to jointly finance a single borrower.
- These multiple banking arrangements are very similar to a loan syndication, although there are structural and operational differences between the two.
- Like a loan syndication, consortium financing occurs for transactions that might not take place with a single lender. Several banks may agree to jointly supervise a single borrower with a common appraisal, documentation and follow-up but consortiums are not built to handle international transactions such as a syndication loan; instead, a consortium may arise because the size of the project at hand is simply too large or too risky for any single lender to assume. Sometimes the participating banks form a new consortium bank that functions by leveraging assets from each institution and disbands after the project is complete.
The following are some of the challenges faced by the Indian banking sector :
- Increase penetration of banking in India- tackle demand supply mismatch
- A large proportion of the population in India, largely concentrated in rural areas is believed to be financially excluded from formalized credit markets (implies having access to bank credit) and payments systems (implies not having access to bank accounts).
- Inaccessible institutional credit drives these people to use the services of unorganized credit markets which charge interest at rates in the range of 35-60%.
- According to the Report of the Committee on Financial Inclusion (NABARD, 2008) and NSSO, 45.9 million farmer households in India do not have access to credit, even from non-institutional sources.
- Credit disbursement to the priority sector:
- One of the major challenges faced by the banking system in India is to provide timely and cost effective credit to the priority sectors especially the agriculture and Small scale industries, which are critical in generating employment and support the growth momentum of the economy.
- After witnessing robust growth between FY05-FY07, the growth in agriculture credit witnessed some moderation in FY08.
- Thus banks are required to ensure availability of credit to the agriculture sector, which forms the backbone of the Indian economy.
- With significant slowdown in economic activity and exports during the latter part of FY09, the credit growth to the micro and small experienced some moderation. While it is important for the banks to maintain the asset quality, they also need to direct the credit flow towards small and medium enterprises which play a critical role in India’s economic development.
- Maintain asset quality:
- The secured advances made by banks have shown a mild decline in FY09.
- The unsecured advances of banks particularly of credit card receivables have increased substantially.
Thus a major challenge in the current economic scenario for the Indian banks is to maintain the gains made with respect to asset quality over the past few years.
- Improve risk management mechanism:
- Strategies to combat the problem of high risk perception must be taken up by banks on priority basis.
- Increased usage of rating services must be employed to reduce risk.
- Besides, SME specific risk management procedures must be setup to make the business more viable, as the risk perception associated with lending to small enterprises is generally very high.
- Further, the banks would also be required to acquire skill for managing emerging risks resulting from innovations in financial products as well as technological advancements.
- Technology adoption:
- The problem of resistance from workforce has largely been neutralized over the years, but the primary issue involved with the adoption and rapid integration of technological processes within banks still related to human resources- the availability of technically skilled resources is scarce.
- Technology is not among the core competencies of financial institutions, which necessitates outsourcing.
- Banks in India are different from banks in many other countries, in ways that they have a very large branch network and varied needs specific to regions and customers.
- Besides, a serious concern in implementing complex technologies is protection against frauds and hacking. Security concern slows down technology adoption significantly for the banking industry. A fast pace of development of security systems is imperative to the adoption of large scale innovations in the industry.
STRUCTURE OF INDIAN BANKING INDUSTRY
Increasing Non Performing Assets
NPAs reflect the performance of banks. A high level of NPAs suggests high probability of a large number of credit defaults that affect the profitability and net-worth of banks and also erodes the value of the asset. The NPA growth involves the necessity of provisioning, which reduces the over all profits and shareholders value.
Granting of credit for economic activities is the prime duty of banking. However lending also carries a risk called credit risk, which arises from the failure of borrower to repay. Non-recovery of loans along with interest forms a major hurdle in the process of credit cycle. Thus, these loan losses affect the banks profitability on a large scale. Though complete elimination of such losses is not possible, but banks can always aim to keep the losses at a low level.
Meaning of NPAs
An asset is classified as Non-performing Asset (NPA) if due in the form of principal and interest are not paid by the borrower for a period of 180 days. However with effect from March 2004, default status would be given to a borrower if dues are not paid for 90 days. If any advance or credit facilities granted by banks to a borrower becomes non-performing, then the bank will have to treat all the advances/credit facilities granted to that borrower as non-performing without having any regard to the fact that there may still exist certain advances / credit facilities having performing status.
Causes of NPAs
Here are several reasons for an account becoming NPA :
* Internal factors
* External factors
- Funds borrowed for a particular purpose but not use for the said purpose.
- Project not completed in time.
- Poor recovery of receivables.
- Excess capacities created on non-economic costs.
- Inability of the corporate to raise capital through the issue of equity or other debt instrument from capital markets.
- Business failures.
- Diversion of funds for expansion\modernization\setting up new projects helping or promoting sister concerns.
- Willful defaults, siphoning of funds, fraud, disputes, management disputes, misappropriation etc.,
- Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups, delay in settlement of payments\ subsidiaries by government bodies etc.,
- Sluggish legal system –
- Long legal tangles
- Changes that had taken place in labour laws
- Lack of sincere effort.
- Scarcity of raw material, power and other resources.
- Industrial recession.
- Shortage of raw material, raw material/input price escalation, excess capacity, natural calamities like floods, accidents.
- Failures, non payment over dues in other countries, recession in other countries, externalization problems, adverse exchange rates etc.
- Government policies like excise duty changes, Import duty changes etc.