Differential Banking, Payment Banks, Small Finance Banks

 

CONCEPT OF DIFFERENTIAL BANKING:

• These Banks are said to be differential as they differ with common Parlance "Universal Bank".
• Differentiation could be on account of capital requirement, target audience, scope of activities or area of operations. 
• These banks offer a limited range of services / products under a different regulatory dispensation.
• In pre-LPG periods, UCBs, the PACS, the RRBs and LABs could be considered as Differentiated Banks as they operate in localized areas. 

Post LPG Differential Banking:

• In 2013, RBI invited private entities for issuance of new banking licenses. 
• There were 26 applicants including Tata Sons, India Post and IFCI. Out of these, India Post and  Bandhan bank and IDFC Bank were given licenses for private banking. 
• Apart from Private bank licenses, RBI on November 27, 2014 granted in-principle approvals to set up 10 small finance banks and to 11 Payments Banks.  

Pre-Paid Instrument Providers (PPI): 

• PPI are payment instruments that facilitate purchase of goods and services against the value stored on such instruments. 
• The value stored on such instruments represent the value paid for by the holder, by cash, by debit to a bank account, or by credit card. 
• The Prepaid instruments can be in the form of smart cards, magnetic stripe cards, internet accounts, internet wallets, mobile accounts, mobile wallets, paper vouchers.

For eg in case of Paytm —

Pre-Paid Instrument model working:

Individual deposit  money in PPI wallet from your regular bank account

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 PPI provides for a “digital wallet” tied with your mobile 

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Digital wallet can be used to pay bills, shopping, movie tickets etc.

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PPI are regulated by RBI under Payment and Settlements Act of 2007

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PPI’s don’t give interest on your money and You cant withdraw the deposited  money.

• Nachiket Mor Committee find this helpful for financial inclusion but observed that PPI doesn’t offer interest rate on the wallet deposits.
• From financial inclusion point of view, PPI model is good, if they gave interest on your money. 
• Nachiket More recommended for a new type of banks called “payment banks” under the banking regulation Act.

The guidelines for payment banks:

(i) eligible promoters can be non-bank Pre-paid Payment Instrument (PPI) issuers; and other entities like mobile telephone companies etc. 

(ii) shall primarily accept demand deposits upto maximum balance of Rs. 1,00,000 per individual customer. 

(iii) Issue ATM/debit cards, payments and remittance services but can not issue credit cards  

(iv) maintain CRR with the Reserve Bank on its outside demand and time liabilities and invest at least 75 per cent of its “demand deposit balances” in SLR eligible Government securities/treasury bills.  

They will not lend to customers and will have to deploy their funds in government papers and bank deposits.

Small Finance Banks (SFBs):

These banks serve the needs of a certain demographic segment of the population. 

The objectives of setting up of small finance banks :

(1) the provision of savings vehicles 

(2) supply of credit to small business units; small and marginal farmers; micro and small industries; and other unorganised sector entities, through high technology-low cost operations.

The guidelines for small finance banks :

(i) eligible promoters could be resident individuals/professionals with 10 years of banking and finance experience including companies controlled by them etc. 

(ii) shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections 

(iii) The minimum paid-up equity capital for small finance banks shall be Rs. 100 crore and

 (iv) all prudential norms and regulations of RBI as applicable to existing commercial banks including requirement of maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).  

SFB can not extend large loans and can not float subsidiaries and deal in sophisticated products.

Now both SFB and Payment bank are scheduled bank .

Phases in the Evolution of Indian Banking

 

PHASES IN THE EVOLUTION OF BANKING:

The banking sector development can be divided into three phases:

·         Phase I: The Early Phase which lasted from 1770 to 1969

·         Phase II: The Nationalisation Phase which lasted from 1969 to 1991

·     Phase III: The Liberalisation or the Banking Sector Reforms Phase which began in 1991 and continues to flourish till date

UNDERSTANDING THE EVOLUTION:

Pre-Independence Era:

The East India Company established the Presidential Banks ie. Bank of Bengal, Bank of Bombay and Bank of Madras. 

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1921: These three banks were merged as “Imperial Bank of India.”

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1949: RBI was  nationalised under the Banking Regulation Act, 1949.

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1955: The Imperial Bank of India nationalized as The State Bank of India.

• During British Era, there were 3 types of banks: Imperial Bank of India, Joint stock banks and Foreign owned Exchange Banks (To facilitate trade).
• At independence, there were 97 scheduled private banks and 557 Non Scheduled (small ) private banks organized as joint stock companies and 395 cooperative banks.
• At the time of independence, all the major banks were owned by  private sector and there was almost negligible access to finance for rural areas.

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   1950-60: Large no of banking failures (Out of 566 commercial banks operating in 1951, only 89 survived by 1969)

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1969:     Nationalisation of 14 private banks  in 1969 

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1974: Narasimham Committee recommended for Regional Rural Banks (RRB) to promote Financial Inclusion, accordingly RRBs were established in 1975.

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  1980 : Nationalisation of 6 more banks in taking the Nationalised banks number to 20. 

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Liberalisation Period (1991-Till Date):

In 1991, Narasimham committee recommended certain reforms like entry of private sector and foreign banks in banking sector. 

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In 1993,  RBI gave license to 10 Private sector banks to establish themselves in the country. These were Global Trust Bank, ICICI Bank, HDFC Bank, Axis Bank, Bank of Punjab, IndusInd Bank, Centurion Bank, IDBI Bank, Times Bank and Development Credit Bank. 

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Kotak Mahindra Bank & Yes Bank got banking license from RBI in the year 2003 and 2004.

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2014, RBI grants in-principle approval to IDFC and Bandhan Financial Services to set up banks.

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Apart from this 11 licenses for Payment banks and 10 for Small Finance banks were also given under differential banking. 

Wholesale Banking

 

WHOLESALE BANKING: 

• Banks which provide banking services to larger customers like Mortgage banks, Commercial Banks, Large Corporations, Mid-sized Companies, Real Estate Developers and Investors, Institutional Customers and Government agencies. 
• It is in contrast to Retail banking as it does not deal with individual clients and small business entities.

Wholesale Long Term finance banks (WLTF):

• RBI is contemplating to bring Wholesale Long Term finance banks (WLTF) to fund the large infrastructure projects.
• These banks will focus on lending to the corporate sector, small and medium businesses, and the infrastructure sector. 
• They may also offer services in the area of Foreign Exchange and Trade Finance. 
• Further, they can act as market makers in instruments like corporate bonds and credit derivatives. 
• WLTF banks can raise funds through issuance of debt and equity. 

Relevance of Wholesale Long Term finance banks (WLTF):

• Companies struggle to get long-term financing because of the underdeveloped corporate bond market. WLTF banks will promote Bond market.
• Being specialized institutions, they will be in a much better position compared with commercial banks in evaluating and funding long-term projects.  
• Arrival of WLTF banks will reduce NPA risks for the Commercial Banks. 
• Establishment of WLTF banks will also enhance competition, which will lead to more efficient allocation of financial resources.

Universal Banking-Too Big to Fail

 

UNIVERSAL BANKING---

• Single bank entity is carrying out multiple banking activities as that of a commercial bank as well as of an investment Banking  and other financial related services as insurance etc.
• All these services are provided under one roof and handled by financial experts who can deal with different products. 
• Universal Banking is usually undertaken by large banks that can manage the cost of such widespread operations.  
• The concept of Universal Banking was culmination of Narasimham Committee and S.H. Khan Committee Reports which recommended for consolidation of the financial industry of India. 
• The practice of universal banking  is common in European countries .

Benefits of Universal Banking :

• Economies of Scale leading to  greater economic efficiency in the form of lower cost, higher output ,increased profitability, Better Resource Utilization and better products.
• Services under one roof will save a lot of transaction costs resulting.
• Brand name leverage, 
• Existing clientele leverage, 
• Value added services and 
• ‘One-stop shopping’ 

Issues in Universal Banking:

• Number of financial services are there and each have to satisfy a unique set of regulations which often makes the operations complex. 
• Universal banking being exclusive affairs of the big players in banking, so it will be open to the fears of monopolising the markets. 
• Too Big to Fail -These banks so big that the failure of the bank will shatter the economy of country .

The commercial banks are moving towards the concept of Universal banking as single bank is providing all types of services to the customers.

RESERVE BANK OF INDIA

 

RESERVE BANK OF INDIA (RBI ):

• Reserve Bank of India (RBI) is the supreme monetary authority responsible for controlling the banking system in the country. 
• It was established on April 1, 1935, in accordance with the provisions of the Reserve Bank of India Act, 1934.
• Originally privately owned, RBI is fully owned by the Government of India since its nationalization in 1949.
• It was nationalized on the basis of the RBI (Transfer to Public Ownership) Act, 1948. 
• The Banking Regulation Act, 1949, provides the legal framework for regulation of the banking sector by the Reserve Bank of India. 

Main Functions of RBI:

Custodian of Monetary Policy:

• It implements the Monetary Policy and ensures price stability while keeping in mind the objective of growth.

Bankers’ Bank:

• The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities by rediscounting bills of exchange.

Controller of Credit:

• The Reserve Bank of India has the power to influence the volume of credit created by banks in India.
• It issues and exchanges / destroys currency and coins not fit for circulation.

The Reserve Bank has the obligation to transact Government business.

Mangement of Banks:

• Every bank has to get a license from the Reserve Bank of India to do banking business within India.
• It Prescribes broad parameters of banking operations such as issuing licenses, branch expansion, liquidity of assets, amalgamation of banks etc.
• Reserve Bank has selected a Bank Led Model for financial inclusion in India.
• The Reserve Bank has also the power to inspect the accounts of any commercial bank.
• The Reserve Bank of India is armed with many more powers to control the Indian money market.
• RBI Manages the Foreign Exchange reserves of India. 
• It facilitates external trade and payment and promotes orderly development and maintenance of foreign exchange market in India.

Public Sector Banks, Nationalised Banks, State Bank of India

 

Public Sector Banks:

• Banks where a majority stake (i.e. more than 50%) is held by the Government. 
• All the Public sector banks (PSB) except SBI are nationalized banks. 
• At present, there are 12 Public Sector Banks in India including SBI and 11 Nationalized Banks. 
• IDBI now comes under Private Bank as GOI shareholding has reduced below 50 % and the maximum shareholding is with LIC.

NATIONALIZED BANK:

• Banks which have been taken over by a national or State government by an Act or ordinance or some other kind of orders.  
• This strategy has been frequently adopted by socialist governments for transition from Capitalism to Socialism.  
• GoI did nationalisation of Banks twice. For the first time, 14 commercial banks were nationalized through an Ordinance (Banking Companies (Acquisition and Transfer of Undertakings) in 1969 Similarly in 1980, GoI again nationalised 6 more banks.   Thus, in total 20 banks were nationalized.

Status of State Bank of India: 

• At the time of independence, this bank was known as Imperial Bank of India and was a Joint Stock Company.
• In 1955, Reserve Bank of India acquired a controlling interest in the Imperial Bank of India under the provisions of the State Bank of India Act 1955.   
• On 30th April 1955, the Imperial Bank of India became State Bank of India.  
• RBI continued to have controlling interest in SBI till recently when Government of India decided to acquire RBI's stake in SBI (59.7 % ) in 2008 so as to remove any conflict of interest .

Why SBI was not nationalized during the waves of Nationalization of Banks :

• SBI was already under State control in 1969/1980, vide SBI Act, 1955. 
• So, there was no need of Nationalization of State Bank of India. 
• Banks which were nationalized in 1969/1980 were either owned by private business groups or individual investors.
• Hence SBI has special status as it is Public sector bank but not the nationalised bank.

Schedule Commercial Banks , Non Scheduled Commercial Banks

 

Classification of Banks: 

Broadly banks can be classified as:

• Schedule Commercial Banks and 
• Non Scheduled Commercial Banks. 

Schedule Commercial Banks: 

• A Schedule Commercial Banks is so called because it has been included in the second schedule of the Reserve Bank of India Act,1934. 
• These banks comprise Scheduled Commercial Banks and Scheduled Co-operative Banks.

To be eligible for Schedule Commercial Bank, a bank must satisfy the following three condition:      

• It must have a Paid Up Capital and reserves for an aggregate value of at least Rs. 5 Lacs
• It must satisfy the RBI, that its affairs are not conducted in a manner detrimental to the interest of its depositors; 
• It must be a corporation and not a partnership or a single owner firm.

In 2001, RBI came up with new guidelines for giving license to the private bank.

Following are the preconditions to qualify as a Schedule Commercial Banks:

• The initial minimum paid-up capital for a new bank shall be Rs.200 crore. The initial capital will be raised to Rs.300 crore within three years of commencement of business.
• The promoters’ contribution shall be a minimum of 40 per cent of the paid-up capital of the bank at any point of time.
•  NRI participation in the primary equity of a new bank shall be to the maximum extent of 40 per cent. 
• The new bank should not be promoted by a large industrial house
•  The proposed bank shall maintain an Arm's Length relationship with business entities in the promoter group

At present Scheduled banks can be categorized as:

1. State Bank of India and its Associates

2. Nationalised Banks

3. Foreign Banks

4. Regional Rural Banks

5. Payment bank

6.Small Finance bank

7.Other scheduled commercial banks /Private Sector Banks.

Banks in the groups (1) & (2) above are known as Public Sector Banks whereas, other Scheduled commercial banks mentioned at group (7) above are known as private sector banks.

Non-scheduled Commercial banks: 

•  Banks which are not the part of the 2nd schedule of the RBI Act. 
•  Unlike Schedule Commercial Banks, these are not entitled to borrow from the RBI for normal banking purposes, though they may  approach the RBI  under abnormal circumstances. 
•  These banks are also subject to the statutory Cash Reserve Requirement But they may keep these balances with themselves rather than keeping with RBI.
• Non-Scheduled banks are also called Local Area Banks (LAB). 
• There are only four Local Area Banks in India, which exist eg. Subhadra LAB.

Financial Intermediaries,All India Financial Institutions

 

Financial Intermediaries:

Financial Intermediaries are the middlemen between these two types of people and channelize fund from households to the businessman /Government.

How Financial Intermediary works:

In an economy:

Common men (households)--------spend money and save money. 

Households have “surplus” money in the economy

                                On the other hand, 

Businessmen (industries) and even Government need money for functioning

These Financial intermediaries can be All India Financial Institutions (AIFI), Scheduled Commercial ,Non Scheduled Commercial banks, Cooperative banks,RRB ,Post offices

All India Financial Institutions (AIFI) :AIFI is group of financial institution engaged in developmental functions of the nation. As per RBI ,AIFI constitutes of:

• All India Development Banks 
• Specialised Financial Institutions
• Investment Institutions
• Refinance Institutions 

All India Development Banks comprises of IDBI,IFCI,SIDBI.

Specialised Financial Institutions comprises of  EXIM Bank.

Investment Bank comprises of LIC & GIC

Refinance Institutions comprises of NABARD & NHB.

Internationalization of Currency, Issues in Internationalization, Liberalized Remittance Scheme

Internationalization of Currency:

• Currency that is freely available to Non-Residents, to settle cross-border transactions in international markets. 
• Internationalization of a currency is an expression of credibility by the countries in the currency as well as in the economy.
• Use of Indian currency to make payments and buy things in a foreign country, merely does not signify Internationalization.

Issues in Internationalization:

Trade Invoicing: 

• Over 90% of India’s Exports and Imports are invoiced in Dollars and Euros while the use of the INR is negligible.
• US dollar is the most widely traded currency, representing 45 % of total global transactions, followed by the Euro(16 % ), the Yen(8%) the pound sterling (6%) the remaining percentage is accounted for by other currencies.

FOREX RESERVES :

• Dollar continues to be kept as 60 % of the world FOREX Reserves by countries  followed by Euros(20%), Renminbi 3 % and Currencies other than the Pound Sterling and Japanese Yen, constitute less than 10%. 
• The Indian currency is held in the reserves only by approximately  six out of 130 countries.

World Trade Participation :

India’s share in major exporters is merely 1.8 %  and in imports is 2.8 % and the average daily share of the rupee in foreign exchange market turnover is only 1.6 %.

Exchange Rate Volatility :

• Increased volatility in Rupee & Exchange Rate with other currencies is a big hurdle in the Internationalisation of the currency. 
• During announcement of Fed Tapering, Rupee depreciated 19.4% in period from may 2013 to August 2013, because of loss of Foreign Reserve. 
• This create Current Account Deficit (CAD) which in turn produces bad macroeconomic conditions and negative investors sentiments.

Liberalized Remittance Scheme (LRS):

In 2004, RBI implemented Liberalized Remittance Scheme which provides for Limit of total investment/usage of $2.5 Lakh dollars per year, out of which Limit of investment into foreign stock markets is up to the extent of $25,000 in a year. 

Potential disadvantages:

• Internationalisation of a currency increases the  vulnerability of currency to the  external shocks. 
• If large amounts of domestic currency are held by non-residents, particularly at offshore locations, any expectation that the currency is vulnerable due to weak fundamentals, may lead to a sell-off resulting in depreciation of the currency.

Positives :

• It will lead to Lower cost of capital due to better access to International financial markets . 
• It will open the gates for domestic companies to raise funds from overseas markets through ECB ( external commercial borrowings ) and FCCB ( foreign currency convertible bonds ) modes, if interest rates look attracting. 
• It will result in increase in demand of the currency and will result in High income through Seigniorage.
• Internationalisation will result in Reduced requirement of FOREX reserves as internationalised currency will provide Immunity from BoP crisis .
• Foreign exchange reserves lead to high sterilisation costs and lower the forex ,lower will be the sterlisation cost.USA has forex of only 243 bln $ out of which 200 bln are in the form of SDR and Reserve Tranche.
• It will Mitigate currency risk for Indian businesses and bargaining power of Indian businesses will improve.
• The other benefits of currency internationalisation include an increase in growth by facilitating greater degree of integration both in terms of foreign trade and international capital flows, savings on foreign exchange transactions, reduced foreign exchange exposure, and economies of scale.

OPPORTUNITY FOR INDIA :

• Countries like Bangladesh and S.lanka are running out of dollar so it is an opportunity for India  
• Major exporters like Russia ,China ,Middle East -Iran are under US sanction so they cant use dollar for buying so countries use any other currencies .
• India has target of  transforming from 5^th economic power to 3 global power not depending upon any foreign currency .

Steps taken :

• US used 2 World War, Britain used Colonization ,Euro used institutions for Internationalising their currency and China post global recession of 2008 look towards making it a global currency. Now the Global realities provide opportunity for India to internationalise Rupee.
• In Jul 2023- The Reserve Bank of India Inter-departmental group said that the Indian rupee has the potential to become an  internationalised currency.
• The Reserve Bank of India (RBI) has allowed banks from 18 countries to settle payments in the rupee. This includes names like Sri Lanka, Israel, Russia, Germany, Singapore and the United Kingdom. 
• Apart from this, 64 other countries have expressed their intent to trade with India in rupee. 
• In Jan 2024-Recently India has made its first-ever payment in rupees to the United Arab Emirates (UAE) for crude oil acquisition. 
• The new Foreign Trade Policy (FTP) 2023 seeks to promote exports with the implementation of a mechanism for invoicing and settlement of transactions in Rupees on a bilateral basis. 
• Sri Lanka settled its debt in Rupee to tide over its precarious economic predicament. 
• Initiation of bilateral trade in rupees between India and Bangladesh, was also an attempt to  internationalise the rupee.

What can be done : 

• Financial stability : Fiscal Deficit  should be less than 3.5 while CPI should be  below 5 %.
• Capital Account Convertibility should be there as there are restrictions on free flow under the limits defined under  LRMS .
• RBI intervenes when rupee depreciates which investors don’t like RBI intervention should be minimised.
• India could learn from China’s strategy . Even though the yuan is not fully convertible, China  produces goods that the world wants to buy can enhance the acceptance of a partially convertible currency. So the key is increase exports.
• One of the key recommendations of IDG is to include the rupee in the IMF SDR basket.
• Capital account convertibility and development of offshore centres are other enabling conditions for internationalisation.
• The depth and liquidity of financial market is a very important element in internationalisation.

EVERGREENING IN BANKING & PHARMA

 EVERGREENING:

“Evergreening” refers to the practice whereby pharmaceutical  firms extend the patent life of a drug for next 20 years only by minor reformulations or other iterations  without necessarily increasing the therapeutic efficacy. 

• Evergreening allows a prolonged monopoly that unfairly denies the public access to medicines at equitable prices. 
• In 2013, Supreme Court refused to grant a new patent to Swiss Company Novartis  for its Leukaemia drug Glivec as the drug was not substantially different from original one.
• It was case of Evergreening.

INDIAN PATENT ACT AND EVERGREENING: 

• As per Section 2(1) (ja) of the Patents Act, the product in question must feature a technical advance over what came before. 
• Section 3(d) necessitates a demonstration of improvement in its therapeutic efficacy.
• Section 3(e) ensures that patents for combinations of known substances are allowed only if there is synergistic effect.
• So, Indian Patent Act after 2005 amendments under TRIPS regime does not allow Evergreening.

EVERGREENING IN BANKING:

• Financial practice of extending additional loans to borrower who is unable to repay the existing loans.
• The main objective of Evergreening is to hide the status of Non Performing Asset (NPA).
• Evergreening creates false impression of quality of the assets and the profitability of the banks which delays the identification and hence resolution of the stressed assets.
• Loan evergreening may provide temporary relief, but it can negatively impact banks’ performance and the entire economy over some time.