Introduction Fifth chapter of Economic Survey is about Financial intermediaries.

. You already know that financial intermediaries = banks, NBFC, pension-insurance-mutual funds etc. they acts middlemen between lenders (people) and borrowers (govt. and businessmen). for details given in earlier article, The fifth chapter, discusses various issues, reforms related to financial intermediaries in four sectors: 1) Banking, 2) Capital market, 3) Pension and 4) Insurance.

lets start with Economic Survey >> Chapter 5> Financial intermediaries> insurance sector. The chapter itself, barely contains 4-5 paragraphs on Insurance, but this article also covers budget-speech and various insurance schemes given in India Yearbook. Insurance: intro Insurance funds = important financial intermediaries for India. They help move peoples savings into Government and corporate securities. Insurance industry in India, can be classified into following Insurer Life Example LIC, ICICI prudential, ICICI Lombard, Oriental, New India, United India. Among them, three are standalone Health insurance companies Non-life/General insurance (e.g. health, travel, 1. Star health business, marine, fire) 2. Apollo Munich 3. Max BUPA Re-insurer GIC 1. Export credit guarantee corp. Specialized 2. Agriculture insurance Company of India ltd. (AICIL) The basics of IRDA, Insurance ombudsman functions, various types of policies etc. already explained in earlier article Insurance Penetration It is the ratio of premium underwritten in a given year vs. gross domestic product (GDP). It helps measuring growth in the insurance sector in a country. Insurance density ratio of premium underwritten in a given year to total population (measured in US dollars for convenience of comparison). Issue? In past, (before LPG reforms of 90s), Indias Insurance penetration and density were very low because insurance sector was monopolized by public sector companies. But Post liberalization, and with the entry of private sector companies, both insurance penetration and density have increased. However, Indias insurance penetration and density are still low as compared to other developing countries of the world. FDI in insurance Before 1999, Insurance sector in India was monopolized by public sector companies: LIC + GIC (and GICs subsidiaries). 1999 was the reform year insurance sector o Insurance Regulatory and Development Authority (IRDA) Bill passed o Private sector companies can enter insurance business (they started doing so from 2000) o 26% FDI allowed in Insurance sector. 2012: o As of 2012, there are 52 insurers in India. o Chindu gave 12 point revival package for insurance sector o Cabinet approved 49% FDI in insurance sector. o But insurance amendment bill is not yet passed in the parliament yet.

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FDI in insurance = will increase competition, = more efficiency, innovation, cheaper premiums for policy holders; Thus FDI ultimately benefit the customers, and help improving Indias insurance penetration and density. But some political parties oppose it saying, FDI in insurance = bad idea. Those unscrupulous private insurance companies will invest policy holders money into bad corporates and it will lead to something bad like sub-prime crisis. What they dont see is: Even China allows 50% FDI in Insurance, Malaysia 70%, and Mexico has 100% FDI in insurance sector. And all these countries are doing fine. Hence, the fears regarding foreign investment in insurance= misplaced. Insurance amendment bill 2008 Salient features are (list is definitely not exhaustive) Increases FDI from 26% to 49% health insurance policies would cover sickness benefits on account of domestic as well as international travel. Reduced capital requirement for new company wanting to enter health insurance. Policy can be repudiated on any ground, including misstatement of facts etc.within first three years of purchase. Public Sector General Insurance Companies and GIC will be permitted to raise capital from the market, as long as Governments shareholding doesnt fall down below 51%. Appointment of agents is to be done by insurance companies subject to the agents meeting the qualifications, passing of examinations etc. as per IRDAs guidelines. IRDA is empowered to take action against agents to protect the insurance customers. What is Bancassurance? Bancassurance = Arrangement through which banks sells insurance products. (and earns Commission) Bancassurance system appeared in France in the 80s. According to Insurance law: one bank can work as Bankassurance agent for only one insurance company. (one for life insurance and one for non-life insurance) Meaning one bank cannot sell policies of multiple insurance companies (unlike a stationary shop owner- who can sell pens from multiple brands such as Raynolds, Parker, Luxor, Cello etc.) But this one bank one insurance co. system was changed after Chindus revival package. Example of Bankcassurance Type of insurance Insurance co +bank Life ICICI prudential ICICI Bank SBI-life SBI Non-life ICICI Lombard ICICI bank TATA-AIG HSBC, IDBI etc. Bancassurance: pros and cons Pros Cons/Anti arguments LIC has a big network of agents and offices but private Banks have huge database of customer telephone Insurance companies dont. Hence Bancassurance system numbers. They annoy customers with stupid helps the private insurance companies to utilize the big telemarketing calls for selling insurance policies. network and manpower of a bank without much Bank employees donot have in-depth knowledge of investment. insurance products. It helps the reach of insurance products to the masses. They only care about meeting the sales-targets. Bancassurance increases Insurance density and insurance They sometimes misinform the customers about penetration. future benefits / returns to sell a particular insurance Increases the competition between public and private policy. (^although same criticism applies for insurance sector insurance companies = better prices, products and services for customers. agents also, they push for products that give more Account holder doesnt need to visit multiple offices Commission.) so ultimately youve to do bit of a research and comparison of various insurance policies one for banking and one for insurance. Now bank is a before investing into one. big mall where he can do shopping for both.

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Chindus revival package for insurance sector He released this in late 2012. Total 12 points, important ones are New products

Janshree Bima Yojana (JBY)

Started in 2000 and merged with Aam Admi Bima Yojana in 2012, for better convergence.

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An insurance company has to seek approval from IRDA, before launching a new product. According to this plan, IRDA must give that clearance within 30 days. Life insurance companies can introduce a product even without getting formal approval from the IRDA. (in some specific conditions). Bank brokers Banks can work as brokers of Insurance products. (earlier they could work only as agents: meaning as an agent, one bank could tie up with only one insurance co.) But now as a broker One Bank can sell insurance products of multiple insurance companies. Banking Correspondence agents can sell micro-insurance products. KYC IRDA will accept Know Your Customer (KYC) check done by banks. Taxation Service tax to be cut on single premium policies and 1st year premium Government is thinking about offering some more income tax exemption, for investing in insurance products. Investment Investment norms for Insurance companies=relaxed. Life insurers can invest in infrastructure SPV (special purpose vehicles) of any firm (earlier they could only invest in public sector undertakings SPV only). Chindus Budget speech: Insurance Reforms We need to increase insurance penetration in India. Ive a number of proposals that have been finalized in consultation with the regulator, IRDA. New branches Insurance companies will be empowered to open branches in Tier II cities and below without prior approval of IRDA. All towns of India with a population of 10,000 or more will have an office of LIC and an office of at least one public sector general insurance company. I propose to achieve this goal by 31.3.2014. Banks as insurance brokers KYC of banks will be sufficient to acquire insurance policies. Banks will be permitted to act as insurance brokers so that the entire network of bank branches will be utilized to increase penetration. Banking correspondents will be allowed to sell micro-insurance products. Group insurance products will now be offered to homogenous groups such as SHGs, domestic workers associations, anganwadi workers, teachers in schools, nurses in hospitals etc. Claims There are about 10,00,000 motor third party claims that are pending before Tribunals/Courts. Public sector general insurance companies will organise adalats to settle the claims and give relief to the affected persons/families. RSBY extended The Rashtriya Swasthiya Bima Yojana already covers BPL families. Now, Itll cover rickshaw, auto-rickshaw and taxi drivers, sanitation workers, rag pickers and mine workers as well. Integrated social security package We need a comprehensive and integrated social security package for the unorganised sector The package should include life-cum-disability cover, health cover, maternity assistance and pension benefits. At present schemes like AABY, JSBY, RSBY, JSY and IGMSY are run by different ministries and departments. I propose a convergence among these schemes so we can evolve a comprehensive social security package. Itll benefit the poorest and most vulnerable sections of society. Government Schemes: Insurance From, INDIA Yearboook Rural landless households For the death / disability of Head of family / one earning member of the family. Aam Admi Bima Yojana(AABY) +scholarship for kids implemented via LIC

Provided Life insurance protection to the rural and urban poor persons below poverty line and marginally above the poverty line. Insurance cover 30k (natural death) Rs.75k (accidental death/disability) implemented via LIC Started in 2003 Healthcare for BPL Medical expenses upto Rs.25k Maternity benefit given Pre-existing diseases also covered. Started in 2007 Smart card based cashless health insurance. BPL family (upto 5 members) in unorganized sector. In Budget 2013, Chindu extended this scheme to rickshaw, auto-rickshaw and taxi drivers, sanitation workers, rag pickers and mine workers. For medical expenses upto Rs.30k per year. Premium sharing: centre vs State=75:25, incase of North east, 90:10 For emigrant workers Minimum Rs.10 lakh insurance cover Applicable during employment contract period abroad. For sickness, accidental death, disability while being abroad. Also cover expenses for transporting dead Also for legal expenses related to employment contract dispute abroad. body/sick/disabled person back home. Two schemes: 1) NAIS (National agriculture insurance scheme): available to all farmers, irrespective of their farm size. Protects them against crop losses due to natural calamity. 2) Weather based crop insurance scheme Both are run by Agricultural insurance company (AIC) Provides health insurance to handicraft artisans family. (man, wife and two children only).

Universal Health Insurance Scheme (UHIS)

Rashtriya Swasthya Bima Yojana (RSBY)

Pravasi Bharatiya Bima Yojana

Agro Insurance

Rajiv Gandhi Shilpi Swasthya

&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&& How does an Indian company arrange for money to start new business / expand existing business? Ans. Via debt or equity. From Where can Indian company arrange for money? Ans. Within India Outside India 1. Short term funds= ADR, GDR, External commercial borrowing Money market (ECB), foreign currency convertible bonds 2. Long term funds= (FCCB) etc. Capital market For the moment, lets concentrate within India.

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 Primary market helps businessmen (and Government) arrange money for their projects. Financial It market also helps investors earn profit on it via interest / dividend. Financial intermediaries come into picture here: they act as middlemen and help investor lend money to borrower (and earn Commission in between). If lot of money in invested in primary market (especially for corporate sector), that means economy is booming. But as per the Economic Survey, Compared to 2011, companies raised less money from primary market via debt and equity in 2012. It means companies are not doing as many new projects / business expansion like they did in 2011. Why? 1) policy paralyses, 2) inflation =less demand of products within India 3) Slowdown in US, EU = less demand of products abroad Now lets take a look at the reforms taken. From abroad Within India IDR fungibility FII, FDI, QFI External commercial borrowing (ECB) Financial literacy, REGSS Misc.

Reform: ECB What is ECB? External commercial borrowing As the name suggest: ECB= when Indian company borrows money from external (non-Indian / foreign) sources. Money is borrowed from non-resident lenders. Via bank loans, fixed rate bonds, non-convertible shares, optionally convertible or partially convertible preference shares etc. For minimum average 3 years. Who can borrow? Hotel, infra, IT, hospital sector. (But company must have registered itself under Companies Act 1956, in India). Micro Finance Institutions (MFI) can borrow via ECB NGOs, NBFCs, Companies can borrow via ECB, if theyre involved in Microfinance activity. SEZ units ECB money cannot be used for? share market or real-estate speculation. Acquiring another company ECB: Pros and Cons Pro Anti Today, American and European economy In ECB, the borrower has to repay in foreign currency (usually is not performing well, their banks and dollar). lenders are not finding local borrowers So If Rupee sharply weakens dollar (e.g. from 1$=Rs.50 to even at dirt cheap interest rate. 1$=Rs.60), then Indian borrower will have to more amount of rupees So in this scenario, If an Indian company to repay the same amount of loan he previously took. (because first can borrow money from abroad, at a lower hell need to convert his Indian rupee income/profit into dollar then interest rate than in India, then whats the repay the loan). harm? Let them do it. Reforms in ECB? Government has liberalization in External Commercial Borrowings Policy during 2012-13 Main Beneficiaries of this liberalization = infra companies, SIDBI and NHB. Infrastructure companies

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Infrastructure companies can borrow in Chinese currency (Renminbi/RMB) Infrastructure companies can use 25% of the money borrowed via ECB for repaying their previous rupee debts IF they invest 75% of the ECB borrowed money to start new infrastructure projects.

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Banks as such, are not allowed to borrow via ECB route. But Small Industries Development Bank (SIDBI) can borrow via ECB route and lend that money to micro, small, and medium enterprises (MSME) sector subject to certain conditions. National Housing Bank (NHB)/ Housing Finance Companies can also borrow via ECB and use National housing bank that money on low cost / affordable housing units. This list of ECB reform is not exhaustive but for exam oriented preparation- youve to draw a line somewhere hahaha. Reform: IDR fungibility Before going into that, lets look at: What is ADR? American Depository receipt. Already explained, just copy pasting from my old article Suppose, Indian Co. wants to raise money from America, by issuing shares in American stock exchange. But then Indian co. will have to maintain accounts according to American standards. To prevent this problem, Indian company gives its shares to American bank. American bank gives that Indian company receipts (called ADR) in return of those shares. Then Indian Co. can trade those ADR receipts in American share market, to raise money. Sound good? Yes, but then Indian company will have to pay dividends to those investors in Dollar currency. Similarly GDR= Global depository receipt What is IDR? ADR= American depository receipt = from Americas point of view, it allows a foreign company (e.g. Indian) to raise money from American financial market. Similarly, IDR= Indian depository receipt= from Indias point of view, it allows a foreign company (e.g. American, British) to raise money from Indian financial market. IDR: Two way fungibility? First what is fungibility?= ability for mutual substitution. For example, if you borrow Rs.1000 rupee note from someone, you can repay it using two Rs.500 notes or 10 notes of Rs.100. because currency notes are fungible. Similarly, One gold bar weighing 100 gms. Vs. 10 gold bars weighing 10 gms. = easily fungible IF all of them are 24carat gold, because weight and price wise both sides are same. But gold bars of 22 carat vs 24 carat = not easily fungible because theyll have different price. ADR is two way fungible. Meaning, (from American investors point of view) if youve ADR, you can convert it into the underlying shares of that (foreign/Indian) company. As part of financial reforms, Now IDR (Indian depository receipts) are also made Two way fungible. Reform: FDI vs FII definition Chindu proposed in Budget speech that We need to remove the ambiguity on what is FDI and what is FII, I propose to follow the international practice: o if an investor has a stake of 10 per cent or less in a company, it will be treated as FII and, o if more than 10%= FDI. Later Chindu formed a panel under Arvind Mayaram for giving clear definitions to FDI and FII. FII inflow increased FIIs invest in Indian securities markets based on their perception how much money will I mae? Their perception is influenced by o prevailing macroeconomic environment of India o The growth potential of the Indian economy o Performance of corporate sector in competing countries (such as Brazil, South Africa.) In 2012, FII inflows were around 30 billion dollar. Much of these FII inflows went into equity segment. The increase in FII inflow indicates their confidence in the performance of the Indian economy and Indian market. Compared to previous years, the turnover in share market has increased and volatility has decreased. The economic and political developments in the Euro zone area and United States had their impact on markets around the world including India. fiscal cliff in the US had been resolved, and had a positive impact on the market worldwide including in India. Further, the reform measures recently initiated by the government have been well received by the markets. SIDBI

FII reform? In 2012, FII limit for investment in G-Secs (government securities) and corporate bonds =was increased. FII limit (US Billion dollars) G-Sec 25 Corporate bonds 51 FDI reform? Cabinet has approved increase in FDI for Multibrand retail, pension, insurance, aviation, power and broadcasting. QFI To put this in crude terms: QFI is a guy who Doesnt live in India Is not an FII Doesnt have a sub-account under FII Is not a Foreign Venture Capital Investor. Year Reforms taken Initially this QFI guy was allowed to invest in Indian mutual funds, IF he met the Know your customers norm 2011 (KYC). QFI was allowed to directly invest in Indian equity market. (provided theyre from member countries of Financial Action Task Force (FATF).) 2012 QFIs from Gulf Cooperation Council (GCC) and European Commission were also allowed to Invest. QFIs have been permitted to invest in debt market, with a total overall ceiling of US$ 1 billion. PAN card is mandatory for QFIs. What is Alternative Investment fund (AIF)? An entity that collects money from people, and invests it. But unlike the regular mutual funds, they donot usually involve in the conventional debt-equity share market type investment. And Theyre not covered under SEBIs regulations for mutual funds and collective investment schemes. Such funds / entities are called Alternative Investment fund.

3 types of AIF SEBI has notified new regulations covering alternate investment funds (AIFs) under three broad categories Category Note These funds have positive spillover effects on the economy. E.g. venture capital funds, small and medium 1 enterprises (SME) funds, social venture funds, and infrastructure funds SEBI and Government might give them incentives or concessions. 2

Funds that dont fall under category 1 or 3. They can invest anywhere in any combination but are prohibited from raising debt, except for meeting their day-to-day SEBI/Government will not give any specific incentive or concession to them. Funds that have negative externality. They only work to get short-term benefits/speculation. E.g Hedge funds.

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All the alternative investment funds have to register with SEBI. Why Fin literacy and RGESS? Government wants to make people buy less gold. Because when Indians buy a lot of gold, it increases our current account deficit> our rupee weakens against dollar >weve to pay more for importing crude oil =petro-diesel price increase= inflation (+bad election publicity for Government). Therefore, Government wants to increase financial literacy among (particularly) middle class and lower middle class folks, make them invest in share market, mutual funds etc. and move away from gold-purchase.

So Government needs to generate awareness that investment in capital market is safe and gives you good returns. => Financial literacy / awareness needed. For this, CBSE already included financial literacy related courses in the syllabus. Financial Stability and Development Council (FSDC) also working on forming national policy for financial literacy. But just by making people aware, wont make them invest in capital market. Government needs to offer some carrot to lure them. Thats why Government introduced Rajiv Gandhi Equity Savings scheme- it provides tax benefits and assured returns to FIRST TIME INVESTORS in the equities. Rajiv Gandhi Equity Savings Scheme (RGESS) It is a new tax saving scheme. This was announced in Budget 2012. Main purpose of this scheme: attract more (middle class and lower middle class) people to invest in securities market. (and divert them from investing money in gold, which increases current account deficit and creates more problems for Indian economy). Your annual income must be below 12 lakh. (original figure was Rs.10 lakh, but Chindu raised it in budget 2013). This must be your first investment in securities market. E.g. if youve been already investing purchased Conditions some IPOs, shares or invested in mutual funds, then you dont get tax benefit in this scheme. Lock in period of three years. (meaning you cannot take out your money before that). You must purchase approved shares/mutual funds only. Benefit?

For investment upto Rs.50000, you get 50% deduction in income tax. You can invest money in installments. No need to invest Rs.50000 in on go. You dont have to pay tax on dividends paid by the company.

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issue/problem in RGESS? To invest in any type of securities (debt or equity), you first need two things 1) PAN card and 2) DEMAT account. Most of the Indians dont have either PAN card or DEMAT account. FSDC Government has set up Financial Stability and Development Council (FSDC) in 2010. Org of FSCD FM = chairman Heads of financial-sector regulatory authorities (RBI, SEBI etc), Finance Secretary and a few other departments Chief Economic Adviser What does FSCD Do? Promote financial literacy (their sub Committee has made draft National Strategy on Financial Education). Promote financial inclusion (get people in banking, pension, insurance net) Increase financial stability Increase inter-regulatory coordination (between RBI, SEBI, IRDA etc) Promoting financial-sector development Misc. Reforms MCX-SX SEBI permitted MCX-SX to operate as a full-fledged stock exchange (just like BSE/NSE). Now MCX-SX will directly compete with BSE and NSE, and itll lead to better services, lesser costs for the investors. CDS Credit default swap (more explained earlier ) Mutual funds and Insurance companies can now participate in CDS as users. This will increase liquidity in the corporate bond markets. IRDA-repo Insurance Regulatory and Development Authority (IRDA) has permitted insurance companies to participate in the repo market. Electronic voting A public limited company has shareholders. And the company needs to take votes of the shareholders before mergeracquisition, election of new board of directors etc. Earlier this was done through postal ballot.

But in 2012, SEBI made rule: voting must be done through electronic means. (this reduces any mischief or foul play and brings more transparency). At the moment, SEBI has made electronic voting is made Compulsory for the top 500 listed companies and more companies will be included soon. SCOREs SEBI complaints redress system It is a web portal, where you can file online-complaints to SEBI. &&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&& Prologue In the earlier articles, we saw What is financial intermediaries? Why are they important for Economy? Then in part 1 of 3, we saw insurance sector In part 2 of 3, capital market In this third and final part, well see the banks and NBFCs. Banks What do banks do? They collect deposits from savers and lend it as loan to the borrowers, and earn Commission in between. Hence theyre one type of financial intermediaries. We already know that banks have to invest some of their deposit money in govt. securities (and high rated corporate bonds) under the statutory liquidity ratio (SLR). For past few years, this SLR rate has remained steady 23-24%. Yet banks have invested more than 30% of their deposits in Government securities. Recall that Government securities are safe investments and if an investment is safe then it wont give much profit. So why are the bank investing more money in Government securities, even above the SLR requirement? 1. because they think it is safer investment (compared to lending it to the likes of Kingfisher) and or 2. because businessmen are not coming forward to take loans and or 3. Consumers are also not coming forward for getting loans for bike, car, or home loans (due to inflation). Interest rate There are mainly three type of bank account: Current Account Savings account Term deposits/Fixed Deposit Interest paid by bank 0% 4-6*% Depends on how long you keep the money. 6-8*% These rates change from bank to bank, ^these are just approximate numbers for illustration. For banks Current account and savings account (CASA) are most important. Why? Because on these deposits, bank has to pay very low interest. So if bank gets lot money from CASA source, and lends it as car/bike/home/business/personal loans @12-18% =there is big profit margin. Interest rate change Deposit rates (bank pays to accounts holders) Lending rate (bank charging to loan takers) RBI controls the interest rates on foreign currency 2012: RBI deregulated the interest rate on loans given non-resident account (FCNR). to exporters (in foreign currency). This was done to In 2011, RBI deregulated the interest rates on savings improve the exports. deposits. In 2012-13 period, RBI started reducing the repo rate Still no public sector bank has increased its savings and consequently banks too lowered their loan interest deposit rate. (they just offer 4%). Although private rates a bit. sector banks offer higher. Rural Banking: Background During the British raj and the initial years after independence, the banks (and insurance companies) only operated in the urban areas. Why? 1. Staff/Manpower: easy availability of educated youth in cities. 2. Urban areas had better availability of electricity, telephone, telegram, railways, office supplies etc. 3. Customers: Main Target audience of banks and insurance companies= educated middle class, rich people and businessmen. They live in cities. 4. At that time, Banks and insurance companies were controlled by private players: they had only one motive=Profit. And city folks have more surplus income compared to villagers.

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Result: Villagers did not get facility of banking / insurance, and they had to rely on the (evil) money lender who charged whatever interest rate he wanted to. Sometimes they paid more money in interest, than the actual principle they had borrowed. And thus villagers remained in debt and poverty forever. Governments action Over the years, Government certain things to achieve following objectives: 1. To help the villagers get easy loans for buying cows, buffalos, diesel pump sets, seeds, fertilizers, digging wells and bores in their farms etc. 2. increase the penetration of banking services in rural areas 3. To achieve financial inclusion in rural areas Timeline: Banking in rural areas 50s Cooperative banks / societies 55 Birth of SBI and ICICI (although not related with rural banking directly) 60s Bank nationalization (first round) 75 Regional rural banks were setup 80s NABAD was setup.+ Bank nationalization (second round) Early 90s Self Help groups (SHG) and bank linking Late 90s Kisan Credit Card 1. No-frills account Mid-2000s 2. Banking Business correspondence Agents (BCA) 3. Interest subvention scheme on crop loans 2011 Swabhiman scheme Now lets fill in the details After independence The structure looked like this (for rural banking) 1. RBI 2. State cooperative banks 3. Central cooperative banks (@District level.) || Urban cooperative banks (in cities and small towns) 4. Primary Agriculture Credit societies (PCAS) (@village level) Then came RRB and NABARD. Why RRB? 1975: Government appointed MM Narsimhan Committee to look into rural banking. Narsimhan observed that Commercial banks (such as SBI, BoB) have high cost structure (building, staff etc.) so they prefer to open branches in cities rather than villages- Because city branches make more profit. The staff of commercial banks= expert in banking and financial matters but not aware of the problems of rural people. On the other hand, the Primary agriculture Cooperative societies have members from the villagers themselves, so they are more aware of the needs and problems of the villagers. Therefore, we need to create a hybrid institution that has positive characters of both 1. Financial strength and expertise of commercial banks) + 2. Grassroot problem awareness of cooperative society). Thus, Regional rural banks were born. RRB provides loan and savings facilities to villagers. These villagers include 1. farmers (small and marginal) 2. agri laborers 3. rural artisans 4. rural entrepreneurs 5. cooperative societies 6. primary agriculture credit societies RRBs are sponsored by Commercial banks. The Sponsor bank provides training to the staff of Regional rural bank. The sponsor bank also provides initial capital to setup the regional rural bank. According to the RRB Act, the paid up capital is Central Government : State Government : Sponsor bank = 50 : 15 : 35 How is RRB different from commercial banks?

Area of operation Source of finance

Commercial Bank Huge.

RRB

Small. One or a few districts. (rural)

Whole India (although mainly concentrated in urban areas and small towns) Savings accounts, fixed deposit etc. Borrowing from RBI and other sources

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Borrowing from NABARD, SIDBI. They also have savings account of villagers, but it is not sufficient to cover the loan demands. Apart from RRBs, villagers also get services from cooperative credit societies, Microfinance institutions; Even commercial banks such as SBI also serve the villagers via BCA (Banking correspondence agents). And the urban-rural geographical breakup has changed a lot since the birth of RRBs. (Many places that were villages in 70s have now become small towns). In this context, it was necessary to consolidate/merge various RRBs- to reduce their overhead expenses and make them more competitive Therefore in 2005: Government of India started amalgamation of RRB. So now the number of RRBs have decreased. Till 1 January 2013, 22 RRBs had already been amalgamated into 9 RRBs. Rural Infrastructure Development Fund (RIFD) Started in mid 90s. NABARD operates the Rural Infrastructure Development Fund (RIDF). This fund provides cheap loans to states and state-owned corporations So they can quickly complete projects related to 1. medium and minor irrigation, 2. soil conservation, 3. watershed management 4. Flood Protection; 5. Forest Development; 6. Cold storage 7. Community Irrigation wells for the village as a whole; 8. Village Knowledge Centres; 9. Desalination plants in coastal areas; 10. Building schools, Anganwadi Centres etc. 11. Building toilet blocks in existing schools, specially for girls 12. Rural Roads, Bridges 13. and other forms of rural infrastructure. Banks who do not meet their Priority sector lending requirements, provide money to this rural infrastructure development fund. Financial Inclusion Financial inclusion = getting all poor people in the banking, insurance, pension net. So they dont become victims of evil money lenders who charge 36% compound interest rates (or even more). Swabhimaan scheme Weve already discussed this scheme and Banking business correspondents (BCs) in earlier article. Budget 2012, Chindu Pranab had announced that Swabhimaan would be extended to habitations with population more than 1,000 in the north-eastern and hilly states and population more than 1,600 in the plains areas as per Census 2001. Ultra Small Branches Ultra small branches (USBs) are being set up in all villages covered through Banking Correspondence Agents. (Weve already discussed Banking business correspondents in earlier article. ) These Ultra small branches (USBs) will have a small area of 100-200 sq. feet. A bank officer will be available here with a laptop on pre-determined days. The Banking Correspondence agents will offer cash service to villagers (e.g. depositing or taking out money), This bank officer (in Ultra small branch) will offer other services, undertake field verification (for loan applications), and follow up banking transactions. A total of over 40,000 Ultra small branches (USBs) have so far been set up in the country. SHG Bank linkage program Self-Help Group (SHG)-Bank Linkage Programme started in early 90s. Under this programs, self-help group open savings account in the bank. They get loans for their projects, deposit money from members (and NGOs earn commission in between).

It is being implemented by 1. commercial banks, 2. regional rural banks (RRBs) 3. Cooperative banks. Development Banks/AIFI They can be further classified based on their target audience Agro Housing Industry Import-export 1. SIDBI 2. IDBI NABARD National Housing Bank 3. ICICI EXIM bank 4. IFCI 5. IIBI Out of ^them, names highlighted in bold (NABARD, NHB, SIDBI, EXIM) = All Indian financial institutions (AIFI). Rest are development banks. Industrial Development Bank? First question: How is industrial development bank different from regular (commercial) banks such as SBI, PNB etc.? Industrial development bank Commercial Bank Public Sector 1. ICICI* 1. SBI 2. IDBI 2. PNB Examples 3. SIDBI (AIFI) 3. BoB 4. IFCI Pvt.Sector 5. IIBI 1. ICICI* 2. HDFC Accept deposit No Yes from public? Provide medium/long term finance Provide short/medium/long term finance to both common men Job? to ONLY industries. (car/bike/home/education/personal loans) + to industries. *The ICICI started in 1955 to provide finance to industries. In 1994 they also started ICICI Bank. And in 2002, the original parent (ICICI) was merged with ICICI Bank Ltd. how do Industrial development banks provide finance to industries? 1. By directly giving loans to a company. 2. By buying shares and bonds of a company. 3. By underwriting new IPOs. In the beginning, these organizations started as All India financial institutions, their job was to provide medium / long term finance to companies. But after the LPG reforms in the 90s, capital market become popular. Now businessmen had more options to arrange for finance (via IPOs, bonds). So these All India financial institutions (AIFI) lost their original glamour and government converted them into Development banks (as per Narsimhan Committees recommendation). Now only four AIFI left: NABARD, SIDBI, EXIM and NHB. They are regulated by RBI. In the (part 2 of 3), we had seen that now SIDBI and NHB are allowed to borrow via external commercial borrowing (ECB) route. Full name: Industrial Credit and Investment Corporation of India. Private sector development bank 1.ICICI Setup in 55. (same year SBI was also born). 2002: Merged it with ICICI Bank ltd.

2.SIDBI

3.IDBI

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Small industries development bank of India Started in 1990. SIDBI helps the micro, small and medium enterprises (MSME). It provides finance to State Industrial Development Corporation (SIDC), State finance corporations, Commercial banks, cooperative banks and regional rural banks. And then those organizations deliver loans/finance to the ultimate target group (MSME industries). Industrial development bank of India

UTI is a subsidiary of IDBI It borrows money by issuing bonds (and then lends that money to industries at a higher interest rate.) Industrial finance corp. of India Setup in 1948: that makes it the first industrial financial institution in India. Industrial investment Bank of India. NABARD = National bank for Agriculture and rural development It was setup in early 80s. (Regional rural banks (RRB) were started in 75, that means first RRB came and then NABARD came). It acts as the regulatory authority for cooperative banks and regional rural banks NABARD lends it downwards to State cooperative banks (SCB), Regional Rural banks (RRBs), Microfinance institutions, cooperative credit societies etc. Thats how farmers, villagers, cottage/handicraft, self help group (SHG) get loans at reasonable interest rate. NABARD operates the Rural Infrastructure Development Fund (RIFD) National Housing Bank (NHB) Started in late 80s As the subsidiary of RBI It is the apex institution for housing finance in India (just like how NABARD is for rural / agri).

4.IFCI 5.IIBI

6.NABARD

7.NHB

Reverse Mortgage product Launched by National Housing bank. For senior citizen The senior citizen can mortgage his house and hell be given monthly income. He doesnt need to repay loan or pay any EMIs, but when he dies, bank will take over his house and auction it to recover the loan money. (and if house fetches more than loan dues, then bank will give that extra money to heirs of the dead person.) Punjab National bank also has a scheme like that, called PNB Baghban. FINANCIAL PERFORMANCE OF BANKS NPA = Non performing asset, in crude term, bank gave loan to someone but he is not repaying it back on time. Reasons for rising NPAs 1. current macroeconomic situation in the country; 2. increased interest rates in the recent past; 3. lower economic growth; 4. aggressive lending by banks in earlier good economic times (i.e. prior to 2007). And now some of those businessmen / salaried individuals are not earning enough due to slow down, hence unable to repay the loans. 5. Our banks had also loaned to some State electricity boards and airline companies (but they are not paying back on time) so the banks NPA increased. 6. switchover to system-based identification of NPAs by Public Sector Banks Capital Adequacy Ratio A measure of a banks ability to absorb losses. Formula: value of its capital divided by the value of risk-weighted assets. To put this crudely : CAR= banks capital / banks risky assets. A low capital adequacy ratio (CAR) = bank has a limited ability to absorb losses (meaning bank is more likely to collapse if people start defaulting on their loans.) High CAR= bank has good ability to absorb losses. In public sector banks, government of India (GoI) has regularly infused capital to keep the CAR high. But over the years, GoI too is running low on cash (thanks to fiscal deficit), so government had formed a committee, and committee recommended that Government should create a new financial holding company. This company will raise money from domestic and international sources and then infuse it as equity in public sector banks. NPA: steps taken to reduce it 1. SARFAESI act and asset reconstruction companies (ARCs) (already discussed, ) 2. nodal officers in banks for each Debts Recovery Tribunal (DRT); 3. close watch on NPAs RBI has also announced the following remedial measures:

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1. sanction of fresh loans/ad-hoc loans from 1st Jan 2013 will be made on the basis of sharing of information among banks; 2. banks will conduct sector- /activity-wise analysis of NPAs; 3. banks will put in place a robust mechanism for early detection of sign of distress, amendments in recovery laws, and strengthening of loan appraisal and post credit monitoring. Chindus Budget speech Interest subvention scheme It was started in 2006 Govt. will continue this scheme for 2013-14 also. Given for short term crop loans For loan Upto Rs.3 lakh Time period: 1 year. Under this scheme, farmer can get loan @7% interest rate. But if he repays the loan on time, then he will get additional 4% interest subvention. (meaning loan would cost him 74=3% interest rate only.) So far, the scheme has been applied to loans taken from public sector banks, RRBs and cooperative banks. Chindu proposed to extend this scheme to crop loans borrowed from private sector scheduled commercial banks as well. In case you wonder WHY? Why is govt. giving 3% interest subversion to farmer who repay the loans on time? Earlier the interest subvention was 1% (2009), It was increased to 2% (2010) and 3%(2011). Because, in 2009, govt. had launched debt waiver scheme. (Meaning farmers didnt have to repay the loans they had taken earlier.) Govt. say they are doing it to prevent farmers suicides, but experts believe it was more of an election gimmick. It hurt the economy in two ways 1. It increased fiscal deficit of the government. 2. The farmers who had been regularly repaying loan, felt cheated. Now they also dont repay the loans on time, thinking sooner or later govt. would announce another debt-waiver. Thus, banks, particularly regional rural banks (RRBs) are facing really hard time recovering the loan money. Thats why Chindu is doing two things 1. On one hand, he offers additional interest subersion to farmers who repay loans on time. 2. On the other hand, he is also working for amalgation of RRBs. More cash to NABARD Govt. will provide Rs. 5000 crore to NABARD NABARD will give it as loan for construction of warehouses, godowns, silos and cold storage units both in the public and the private sectors. Panchayats can also use this money for construction of godowns to help farmers to store their produce. Multilateral Development banks: Roads in NE These banks operate at international level. They are formed by group of countries. Examples of MDB= Word Bank, Asian Development Bank (ADB), African development bank. Chindu wants to get loan from both World Bank and the Asian Development Bank to build roads connecting North East India with Myanmar. This will help in our look east policy and improve the economic prosperity of north eastern States of India. Bank for Women? At present, there is no bank that exclusively serves women. Chindu porposed that we should have have a bank that 1. lends mostly to women and women-run businesses, 2. supports women SHGs and womens livelihood, 3. employs predominantly women, 4. addresses gender related aspects of empowerment and financial inclusion for this, MBN Rao committee = theyll prepare the blueprint for the countrys first womens bank. Govt. shall provide Rs 1,000 crore as initial capital to start this bank. Chindu hopes RBI will give banking license to this by October, 2013. Urban housing fund There is already Rural Housing Fund set up through the National Housing Bank.

In this system, govt. gives cash to NHB. And NHB lends it to other banks operating in rural areas >> finally those bank lend it to villagers to construct houses. Chindu has proposed to start similar fund for Urban housing under National housing bank. Banking 1. Govt. will provide capital infusion to public sector banks and make sure they meet BASEL III norms. 2. All scheduled commercial banks and all RRBs are on core banking solution (CBS) and on the electronic payment systems (NEFT and RTGS). 3. Public sector banks have assured Chindu that well set up ATM in all our branches by the end of March 2014 4. We are working with RBI and NABARD to bring all other banks, including some cooperative banks, on CBS and epayment systems by the end of December 2013. What is Core Banking Solution (CBS)? Core banking solution= Bank integrates all of its branches in a single IT network. Whenever you take out money or deposit money from your account, the database is updated in the central server directly. Any branch of the bank, can access this date from the central server. Thus Core banking solution helps customers to operate their accounts, and avail banking services from any branch of the Bank on CBS network, regardless of which branch he had opened the account. The customer is no more the customer of a Branch. He becomes the Banks Customer. Thus CBS = Anywhere and Anytime Banking. You can deposit money in any branch-office, you can give cheque, you can take out money, you can get your account statement, etc...as long as that branch is part of the core banking solution. CBS branch is like a Sales & Service Delivery Center. Internet banking, mobile banking, ATM are all interconnected in Core banking solution. Why is CBS in news? Because of two reasons #1: Chindus budget speech All scheduled commercial banks and all RRBs are on core banking solution (CBS) and on the electronic payment systems (NEFT and RTGS). We are working with RBI and NABARD to bring all other banks, including some cooperative banks, on CBS and epayment systems by the end of December 2013. #2: RBIs notice to UCB in March 2013, RBI issued a notice that Many Urban Co-operative Banks (UCBs) havent implemented the core banking solutions (CBS) yet. Were giving them deadline: Dec 2013. If they do not implement core-banking solutions by that time, then we (RBI) could deny them various approvals (e.g. permission to open new branch etc.) Why UCBs havent implemented CBS? All the state-owned commercial banks have implemented CBS system already. But other Urban cooperative banks at district level are unable do it due Lack of funds (takes lot of money to setup server, buy licensed softwares, intenet bill etc). Although RBI maintains that in long term, use of Information technology and CBS will reduce the cost of operation so its a win-win situation if UCBs implemented the CBS. Finally, conclusion, summary, what do we get from fifth chapter? Conclusion Indian Government started reforming the financial markets under LPG reforms in 90s. The results of these reforms have been encouraging. Today, India has one of the most vibrant and transparent capital markets in the world. But still there are certain challenges before Indian capital market becomes an important avenue for investors both foreign and domestic. 1) Our corporate sector requires long term funds (@low cost), and 2) we need lot of money for infrastructure project. To help ^these two, we need three things 1. Well developed Banking systemalready present 2. Well developed equity market.already present. 3. Well developed corporate bond marketyet to develop. So, Government needs to take policy initiatives for developing a robust corporate bond market. These policy initiatives include:

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1. Need to strengthen the legal, regulatory framework for corporate debt market. 2. Legal regulatory framework for financial products which is new or still in nascent stage e.g. municipal bonds, credit default swaps. 3. At present our public sector organizations related to pension-insurance sector (LIC, EPFO) cannot invest lot money in corporate debts. Government needs to relax their investment guidelines. Infrastructure development funds (IDF) IDF are already discussed in earlier article Infrastructure Development funds will financing the long term infrastructure projects @cheaper cost. However, for the IDF to become effective, Government needs to take policy initiatives. (allowing public sector insurance and pension funds to invest in them). Financial literacy Investment will not come just by relaxing the legal/regulatory framework. You need to encourage people to invest in capital market. (and to prevent them from investing all their money in goldbecause gold purchase increases current account deficit and creates more problems for Indian economy). Govt also tried to give the carrot of RGESS. But challenge : much of the target audience doesnt have PAN card and DEMAT account. Banks Banking Laws (Amendment) Act 2012 already discussed o This will give more regulatory and supervisory to RBI and o help banks in raising funds from the capital market for expanding their banking business. SARFAESI act amendment help banks reduce their NPAs. Other issues related to RRBs, NABARD etc given in this article itself. Pension Pension reforms in India 1. Will facilitate the flow of long-term savings for development 2. Will help establish a credible and sustainable social security system in the country But challenge: NPS is not popular due to low commission, bill pending in parliament. More explained earlier, Insurance Chindu gave revival package. Challenge: Less insurance penetration, FDI Bill pending in parliament

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