UNIT 5 – REGULATORY

FRAMEWORK
The principal governmental and
regulatory policies that govern
the banking sector

– The Indian banking sector is regulated by

the Reserve Bank of India Act 1934 (RBI
Act)
– and the Banking Regulation Act 1949 (BR
Act).
– In addition, the Foreign Exchange
Management Act 1999 (FEMA) regulates
cross-border exchange transactions by
Indian entities, including banks.
KEY REGULATORY FOR THE BANKING SYSTEM
IN INDIA
– RBI
• THE RESERVE BANK OF INDIA (RBI), INDIA’S CENTRAL BANK, ISSUES VARIOUS GUIDELINES,
NOTIFICATIONS AND POLICIES FROM TIME TO TIME TO REGULATE THE BANKING SECTOR
• RBI – CENTRAL BANK OF INDIA, PRIMARY REGULATORY FOR BANKING
• AN ENTITY – CARRY OUT BANKING BUSINESS IN INDIA – OBTAIN A LICENSE FROM THE RBI
• RBI –POWERS TO REGULATE THE FINANCIAL SECTOR
• PRESCRIBING NORMS FOR SETTING UP AND LICENSING BANKS
• CORPORATE GOVERNANCE
• PRUDENTIAL NORMS,
• CONDITIONS FOR STRUCTURING PRODUCTS AND SERVICES
• OTHER FINANCIAL SECTOR REGULATORS,
• NHB – HFC’S
• SEBI – SECURITIES MARKET
• IRDAI – INSURANCE SECTOR
– RBI Act
– to establish and set out the functions of the RBI
– Empowers the RBI to issue rules, regulations, directions & guidelines
– BR act
– Provides a framework for supervision and regulation
– Gives the RBI the power to grant licenses to banks and regulate their
business operation
– FEMA
– Primary legislation in India which regulates cross border transactions and
related activities
– FEMA and the rules made – administered by the RBI
 Objective of Regulatory
Framework
• Government regulations strive to protect bank depositors and
other stakeholders from bank failures and to encourage banks to
become a stabilizing force in the economy.
• This regulatory structure creates transparency between banking
institutions and the individuals & corporations with whom they conduct
business.
1. Liquidity and
Capital Adequacy
• The Basel III capital regulations are being
implemented in India (to be fully implemented by
31st March 2019).
• Banks are required to comply with the
requirements as per Basel III norms.
• The Basel III frameworks main thrust has been
enhancing the banking sector’s safety and stability
emphasizes on the need to improve the quality and
quantity of capital components, leverage ratio,
liquidity standards, and enhance disclosures.
• Capital Needs
• Leverage risk
• Liquidity
2. Exposure limits :

Lending to a single borrower is limited to 15% of

the bank’s capital funds ,which may be extended
to 20% in the case of infrastructure projects.
For group borrowers, lending is limited to 30% of
the bank’s capital funds, with an option to extend
it to 40% for infrastructure projects.
 3. Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR):

Banks in India are required to keep

a minimum of 4% of their net demand and time
liabilities (NDTL) in the form of cash with the
RBI. (Earn No Interest)
Bank should maintain 22% in the form of
SLR(Cash, gold, securities)
1. Liquidity and
Capital Adequacy
• The Basel III capital regulations are being
implemented in India (to be fully implemented by
31st March 2019).
• Banks are required to comply with the
requirements as per Basel III norms.
• The Basel III frameworks main thrust has been
enhancing the banking sector’s safety and stability
emphasizes on the need to improve the quality and
quantity of capital components, leverage ratio,
liquidity standards, and enhance disclosures.
• Capital Needs
• Leverage risk
• Liquidity
2. Exposure limits :

Lending to a single borrower is limited to 15% of

the bank’s capital funds ,which may be extended
to 20% in the case of infrastructure projects.
For group borrowers, lending is limited to 30% of
the bank’s capital funds, with an option to extend
it to 40% for infrastructure projects.
 3. Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR):

Banks in India are required to keep

a minimum of 4% of their net demand and time
liabilities (NDTL) in the form of cash with the
RBI. (Earn No Interest)
Bank should maintain 22% in the form of
SLR(Cash, gold, securities)
 Introduction

• Basel is a city in Switzerland which is also the

headquarters of Bureau of International Settlement
(BIS).
• BIS fosters co-operation among central banks with a
common goal of financial stability and common
standards of banking regulations.
• The Bank for International Settlements (BIS) established
on 17 May 1930, is the world's oldest international
financial organisation. There are two representative
offices in the Hong Kong and in Mexico City. In total BIS
has 60 member countries from all over the world and
covers approx. 95% of the world GDP.
Current secretary general -William
Coen

PRESENT CHAIRMAN OF THE COMMITTEE- Governor of Bank of Sweden

 Objectiv
e
•The set of the agreement by the BCBS (BASEL COMMITTEE ON BANKING
SUPERVISION), which mainly focuses on risks to banks and the financial system
are called Basel accord.
• The purpose of the accord is to ensure that financial institutions have enough
capital on account to meet the obligations and absorb unexpected losses.
• India has accepted Basel accords for the banking system.
• BASEL ACCORD has given us three BASEL NORMS which are BASEL 1,2 and 3.
BASE
LI
 In 1988, The Basel Committee on Banking Supervision (BCBS) introduced capital
measurement system called Basel capital accord, also called as Basel 1.
 It focused almost entirely on credit risk, It defined capital and structure of risk weights
for banks.
 The minimum capital requirement was fixed at 8% of risk-weighted assets (RWA).
 India adopted Basel 1 guidelines in 1999.
  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 which are as follows
 Banks should maintain a minimum capital adequacy requirement of 8%
of risk assets.
 Banks were needed to develop and use better risk management
techniques in monitoring and managing all the three types of risks that
is credit and increased disclosure requirements.
 The three types of risk are- operational risk, market risk, capital risk.
 Banks need to mandatory disclose their risk exposure, etc to the central
BASEL II 
bank.
Basel II norms in India and overseas are yet to be fully implemented.
BASEL
III
• In 2010, Basel III guidelines were released. These guidelines were
introduced in response to the financial crisis of 2008.
• In 2008, Lehman Brothers collapsed in September 2008, the need for
a fundamental strengthening of the Basel II framework had become
apparent.
• Basel III norms aim at making most banking activities such as their
trading book activities more capital-intensive.
• The guidelines aim to promote a more resilient banking system by
focusing on four vital banking parameters viz. capital, leverage,
funding and liquidity.
• Presently Indian banking system follows Basel II norms.
• The Reserve Bank of India has extended the timeline for full
implementation of the Basel III capital regulations by a year to March
31, 2019.
 • These are the guidelines and general norms
issued by the regulatory bank (RBI) of the
Prudential country for the proper and accountable
norms functioning of banks.
• In other words, these are the practices that
all banks are expected to follow.
Banker’s
Compliance
• Many banks differ in how they operate, but
one thing they have in common is a
compliance department.
• It describes the compliance department as a
bank's internal police force.
• It is the unit that ensures that a financial
institution complies with applicable laws,
regulations and rules,
• It plays an essential role in helping to preserve
the integrity(Honest and Moral principles)
and reputation of the bank.
Responsibilitie
s

Common tasks The compliance

Since banks'
The compliance include team may also
activities vary,
department's • monitoring the bank's design and
duties also vary, but
ultimate goal is to activities implement solutions
each bank should
ensure that a bank • controls to address any
clearly and • identifying
does not cross the identified risks,
specifically have the • analyzing risk areas.
lines drawn by develop compliance
responsibilities for • assessing and testing the
legislators, programs for new
its compliance adequacy of the bank's
regulators or its policies regulations, and
department
board of directors. • security and risk oversee employee
outlined. assessment training programs.
Responsibility for
Clients

• A compliance department must extend its focus

beyond the bank, its policies and its employees.
This unit also bears the responsibility for
ensuring that the bank's clients act within the
law and don't use the bank for illegal activities,
such as money laundering, evading taxes or
funding terrorism.
Compliance Department Structure

There isn't a prescribed structure

for a compliance department.

Each is designed to meet the

needs of the bank it serves.
Operating the Compliance Department

A compliance department can be an expensive unit to operate, but

non-compliance can be more costly.

Although it is the bank's internal enforcement unit, it should not be

above scrutiny and therefore should be subject to periodic,
independent review.
 FEM
A
• The Government of India formulated FEMA or Foreign Exchange Management Act to encourage the external
payments and across the border trades in India.
• It was formulated in the year 1999 while it replaced FERA (Foreign Exchange Regulation Act).

• This was meant to close all the loopholes and drawback of FERA and hence major economic reforms were
introduced under this act.
• It was primarily formulated to de-regularize and have liberal Indian economy.
• FEMA is applicable to all parts of India and was primarily formulated to utilize the foreign exchange resources in
efficient manner.
• It is also equally applicable to the offices and agencies which are located outside India however is managed or owned
by an Indian Citizen.
• FEMA head office is known as Enforcement Directorate and is situated in Delhi
Objectives of
FEMA:
• The main objective of FEMA was to help facilitate
external trade and payments in India.

• It was also meant to help orderly development and

maintenance of foreign exchange market in India.

• It defines the procedures, formalities,

dealings of all foreign exchange transactions in
India.

• These transactions are mainly classified under two

categories -- Current Account Transactions and
Capital Account Transactions.
KE
DIFFERENCE
Y Foreign Exchange Regulation Act (FERA)

Parliament of India passed the

Foreign Exchange Management Act (FEMA)

Parliament of India enacted Foreign Exchange

S Foreign Exchange Regulation Act in 1973 Management Act (FEMA) on 29 December 1999
replacing FERA.

FERA came into force from January 1, 1974. FEMA came into force from June 2000.

FERA was repealed in 1998 by FEMA succeeded FERA

Vajpayee Government

FERA has 81 sections FEMA has 49 sections

FERA was conceived with the notion that FEMA was conceived with the notion that Foreign
Foreign Exchange is a scarce resource. Exchange is an asset.

FERA rules regulated foreign payments. FEMA focused on increasing the foreign exchange
reserves of India, focused on promoting foreign
payments and forein trade.

The objective of FERA was conservation of The objective of FEMA is Management of Foreign
Foreign Exchange Exchange
The definition of “Authorized Person” was narrow. The definition of “Authorized Person” was widened

Banking units did not come under the definition of Banking units came under the definition of Authorized
Authorized Person. Person.

If there was a violation of FERA rules, then it was If there was a violation of FEMA rules, then it is
considered as Criminal offence. considered as civil offence

A person accused of FERA violation was not provided A person accused of FEMA violation will be provided
legal help. legal help.

There was no provision for Tribunal, the appeals were There is provision for Special Director (Appeals) and
sent to High Courts Special Tribunal

For those guilty of violating FERA rules, there was For those guilty of violating FEMA rules, they have to
provision for direct punishment. pay a fine, starting from the date of conviction, if the
penalty is not paid within 90 days, then the guilty will be
imprisoned.

If there was a need for transferring of funds for For External trade and remittances, there is no need for
external operations, then prior approval of the prior approval from the Reserve Bank of India (RBI).
Reserve Bank of India (RBI) is required.

There was no provision for IT There is provision for IT

SARFAESI ACT
2002
Securitization
and
Reconstruction of
Financial
Assets and
Enforcement of
Security
Interest Act,
SARFAESI
Act,2002

• The SARFAESI Act,2002 - removes unnecessary litigation (It is the

process of taking legal action) from the courts.
• Beneficiary - Bank
• Recovery of debts due to Banks and Financial Institutions act 1993-
Replaced .
• The Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, of 2002, allows banks and
financial institutions to auction properties (residential and
commercial) when borrowers fail to repay their loans.
• Methods
• Auction method
• Take over Method
• Change Management
Objectives of SARFAESI Act,
2002
• Efficient or rapid recovery of non-performing assets (NPAs) of
the banks
• Allows banks and financial institutions to auction properties
(say, commercial/residential) when borrower fail to repay their
loans.
• It enables banks to reduce their non-performing assets (NPAs)
by adopting measures for recovery or reconstruction.
• Upon loan default, banks can seize the securities (except
• agricultural land) without intervention of the court.
SARFAESI is effective only for secured loans where bank can
enforce the underlying security
• In such cases, court intervention is not necessary, unless the
security is invalid or fraudulent.
• 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.
Preconditions for the recovery of debt

1. SARFAESI applies only to loans above

Rs.10 lakhs.
2. By the way SARFAESI applies only to
those assets “mortgaged/secured” to get
the loan.
3. Hence Bank can SEIZE only those
assets
4. But Bank cannot take away personal
home-furniture, expensive items in the
name of SARFAESI.
5. Similarly, Agricultural land is exempted
from SARFAESI attachment
6. The debt is secured
7. The debt has been classified as an NPA
by the banks
Methods of
Recovery

• This act makes provisions for two main

methods of recovery of the NPAs as
follows:
• Securitization and Asset
Reconstruction
• Enforcement of securities Interest
without the intervention of court
 SECURITIZATION IS THE IN OTHER WORDS, MR X – GOLD
PROCESS OF CONVERSION OF SECURITIZATION DEALS WITH
EXISTING ASSETS OR FUTURE THE CONVERSION OF ASSETS

SECURITIZATI
CASH FLOWS INTO WHICH ARE NOT MARKETABLE
MARKETABLE SECURITIES. INTO MARKETABLE ONES.

ON

MR Y- RUNNING A CONCERN MR Z – LAND PROPERTY MAKE INVESTMENT BOND –

RBI/FI

3
ASSET
RECONSTRUCTION

• An Asset Reconstruction Company is a

specialized financial institution that
buys the NPAs or bad assets from banks
and financial institutions so that the
latter can clean up their balance sheets.
Examples:
• ARCIL (India’s first and largest asset
reconstruction company (ARC))
• Reliance Asset
Reconstruction Company
Limited
4
 ASSET RECONSTRUCTION
• Example
• Bank has NPA worth Rs.40 crores.
• ARC will buy the NPA file from Bank at a lower rate say 35 crores.
• Besides, banks have hundreds of bad loan cases, they do not have time or manpower to pursue individual
case, sometimes no bidders are interested in auction.
• In such cases, it’s better for bank to transfer NPA to ARC.
• But that doesn’t mean ARC will give 35 crores to the Bank from its own pocket!
• In above example, ARC needs Rs.35 crores to buy a Non performing asset from Bank.
• So ARC will issue “security receipts (SR)” worth Rs.35 crores.
• Only Qualified Institutional buyers (QIB) can buy these security receipts (SR).
• SR are not “bonds”, they do not carry fixed interest rate.
• ARC will promise to pay money on SR, when it gets money the bad loan
• Although, ARC usually promise 9% profit on “security receipts (SR)”
Qualified
Institutional Buyer
(QIB)
• Scheduled Commercial Banks
• Foreign Institutional Investor
• Mutual Funds
• Venture Capital Investors
• Insurance Companies
• Pension/ Provident Funds
 Steps in the recovery of
Debt 1. Contact with a 2. Contact with an
Debt recovery
friendly overdue payment
procedure :
payment reminder
reminder

3. Contact your 4. Try to make direct

5. Send a formal
customer with a final contact with your
letter of demand
notice customer

6. Repossession of 7. Valuation & Sale of

Security Property Defaulter
 Income Recognition and Assets
Classification Norms
• IRAC NORMS
Basic Concepts-IRAC Norms

•  Prior to 1992 Banks used to recognize Interest on Entire Portion of Loans and
Advances, irrespective of the fact that whether each of the Loan advanced is good or
bad. This has resulted into following Draw Backs;
•  The Banks used to recognize Interest on Bad Loans.

•  Due to recognition of Interest on Income on entire loans and advances

it was
• difficult for the reader of Balance Sheet the actual financial health of the Bank.
•  Bank used to pay Income Tax even on the portion of the Interest pertaining to Bad
Loans.
•  It was difficult to fix the accountability on Bank Staff in respect of Bad Loans
advanced.
Basic Concepts-IRAC Norms

•  In 1992, M.Narismhan Committee set up by

Reserve Bank of India to report on Financial
System of the Banks made certain
recommendations. One of the
recommendation was that a Policy of Income
Recognition should be Objective and based
on record of recovery rather than on any
subjective considerations.
•  Consequent to report from M.Narasimhan
committee Reserve Bank started issuing
guidelines on the concept of Income
Recognition, Asset Classification and
Provisioning pertaining to Advances. These
provisions amended from time to time are
being popularly called as IRAC norms.
 Criteria of Classification in respect of each
class of Advances

•  Term Loans: A Term Loan is treated as a Non Performing Asset if interest and/or
installment of principal remain overdue for a period 90 days.
•  Cash Credits and Overdrafts: A cash credit or overdraft account is treated as Non
Performing Assets if it remains Out of Order for a continuous period of 90 days.
•  Bills Purchased and Discounted: Bills Purchased and Discounted are treated as
Non Performing Asset if they remain overdue and unpaid for a period of more than
90 days.
•  Securitization: The Asset to be treated as Non performing if the amount of
liquidity facility remains outstanding for more than 90 days, in respect of
securitization transactions.
 Type of Agriculture Example of Criteria for Recognition of
Advance Crops NPA
Agriculture Loans granted Paddy, Jawar, If the Principal or Interest
towards short duration crops Pulses thereon remains overdue for
etc., two crop seasons
Agriculture Loans granted Sugar Cane, If the Principal or Interest
towards Long Duration Crops Banana thereon remains overdue for
Plantation one crop seasons
etc.,

Criteria of Classification in respect of

each class of Advances-”Agriculture
Advances”
 ”Credit
Cards”
•  A Credit Card Account will be treated as
non performing asset if the minimum
amount due, as mentioned in the
statement, is not fully paid within 90
days from the next statement date.

•The Gap between two statements

should not be more than one month.

•All Banks should uniformly follow the

uniform system of overdue recognition
including intimation to be given to Credit
Information companies.
INCOME
RECOGNITION
Income Recognition as per IRAC Norms

• Income from NPA assets is to be recognized only when it is actually received by the banks.
• To ensure that the policy is objective and based on record of recovery rather than on any
subjective considerations so as to ensure a uniform and consistent application of these norms.
• Further, the provisioning should be made on the basis of the classification of assets, based on
I. The period for which the asset has remained non-performing
II. The availability of security and
III. The realizable value thereof.

• When a Credit Facility is classified as Non-performing for the first time, interest accrued and
credited to the Income account in the corresponding previous year which has not been realized
should be reversed or provided for.
• In respect of NPAs, fees commission and similar income that have accrued should cease to accrue
in the current period and should be reversed or provided for with respect to past periods, if
uncollected.
 Income Recognition as per IRAC
Norms
• However, interest on advances against term deposits, NSC(National saving
deposit), IVPs(Indira Vikas Patra), KVPs(Kisan Vikas Patra), and Life policies
may be taken into income account on the due date provided adequate margin
is available in these accounts.
• Banks should reverse the interest already charged to NPA accounts but not
collected, by debiting Profit and Loss account.
• Further they should stop further application of interest to these accounts.
• Likewise fees, commission and similar income in respect of past periods, if
uncollected, need to be reversed.
• This would go a long way to facilitate prompt repayment by the borrowers
and thus improve the record of recovery in advances.
ASSET
CLASSIFICATION
 Categories of
NPAs

• Banks are required to classify nonperforming assets further into the following three
categories based on the period for which the asset has remained nonperforming and the
realizability of the dues:
• I. Substandard Assets
• II. Doubtful Assets
• iii. Loss Assets
 Substandard Assets

• With effect from 31 March 2005, a substandard

asset would be one, which has remained NPA
for a period less than or equal to 12 months. In
such cases, the current net worth of the
borrower/ guarantor or the current market
value of the security charged is not enough to
ensure recovery of the dues to the banks in full.
 Doubtful
Assets

• With effect from March 31, 2005, an

asset would be classified as doubtful if it
has remained in the substandard
category for a period of 12 months.
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.
Classification of Sl. No Type of Asset Period/Remarks
Advances
1 Standard Asset Recoveries are fine and account is nor mal

2 Sub Standard Less than 12 Months

Asset

3 Doubtful Assets More than 12 Months

4 Loss Assets Loss has to be identified by the bank

itself or internal or
external auditors or RBI
Inspection
 Type of Standard Provisioning
Asset
Direct Advance to Agricultural and : 0.25%
Small and Micro Enterprises
(SMES)
Advance to Commercial Real Estate : 1.00%
Provisionin
Advance to Commercial Real Estate- : 0.75%
g Norms- Residential Housing
”Standar d Sector
Assets” Housing Loans during the period of Teaser : 2.00%
Rates
Housing Loans after period of Teaser Rates : 0.40%

Restructured Advances : 3.50%

All Other Loans not covered above : 0.40%
 Provisioning Norms-
”Doubtful Assets”
Type of Asset Provisioning Percentage

1.Loss Assets : 100%

2.Unsecured Portion of Doubtful Assets : 100% of Unsecured Portion

3.Doubtful for a period less than 1 : 25%

Year*

4.Doubtful for a period more than 1 : 40%

Year and upto 3 Years*

5.More than 3 Years* : 100%

* Secured portion of Assets

 Provisioning Norms-”Sub
Standard Assets”
Type of Asset Provision Percentage

Sub Standard Asset : 15% on Total Outstanding

Unsecured Exposure-Non : An additional Provision of 10%

Infrastructure Advances

Unsecured Exposure Infrastructure : An additional Provision of 5%

Advance where safeguards like Escrow
Accounts are available