Current Affairs - Banking & Finance

• The Fifteenth Finance Commission, for the first time, will devote an entire chapter on health financing.
• The High Level Committee on Health sector constituted by Fifteenth Finance Commission and the World Bank will dove-tail their study and analysis to come up with suitable recommendations for health sector.
• The Government of India’s spending on health through centrally sponsored schemes will also be studied in detail by the Commission before it gave its recommendations to the Union government.

• The World Trade Organization (WTO) Dispute Settlement Body (DBS) has established a panel after the European Union (EU) has dragged India into the Dispute Settlement System of WTO for the second time against import duties on ICT (information and communication technology) products, including mobile phones, cameras, headphones and earphones, imposed by the country.
• India is levying a fee upto 20 % on them & these charges will affect the EU’s exports of 400 million euros annually.
  

• According to data from the Reserve Bank of India (RBI), Tamil Nadu has raised ₹30,500 crores in the fiscal 2020-21 and has topped market borrowings among States in the country.
• Tamil Nadu has been followed by Maharashtra ₹25,500 crores (14%), Andhra Pradesh ₹17,000 crores (9%) and Rajasthan ₹17,000 crores (9%).

• The merger of 10 public sector undertaking banks into four came into effect from 1^st April, 2020.

Background

• In the biggest consolidation exercise in the banking space, the government in August 2019 had announced mergers of public sector banks, a move aimed at making state-owned lenders global sized banks.
• The Cabinet Committee on Economic Affairs (CCEA) approved consolidation of 10 state-run banks into four on 4^th march, 2020.
• It is to be noted that in 2019, Dena Bank and Vijaya Bank were merged with Bank of Baroda.
• Prior to this, the government had merged five associate banks of SBI and Bharatiya Mahila Bank with the State Bank of India.

Key Points

• The banks are being amalgamated with a larger bank, referred to as the anchor bank.
• Account holders of merging banks will now be treated as customers of the anchor banks
• Oriental Bank of Commerce (OBC) and United Bank of India will be merged into Punjab National Bank (PNB). After the merger, these together will form the second-largest public sector bank (PSB) in the country, after State Bank of India (SBI).
• Syndicate Bank will be merged into Canara Bank, which will make it the fourth-largest public sector lender.
• Indian Bank will be merged with Allahabad Bank.
• Union Bank of India will be merged with Andhra Bank and Corporation Bank.
• Customers, including depositors of merging banks will be treated as customers of the banks in which these banks have been merged with effect from 1^st April, 2020.
• For multiple bank accounts with both merging as well as anchor banks, there might be a single customer ID now
• There will be no change in the existing interest rates and fixed deposits after the merger. It will just be transferred to the anchor bank.
• New cheque books will be issued by the anchor banks and the existing ones will no longer be effective.
• After the merger, there will be 12 PSUs - six merged banks and six independent public sector banks.

Six Merged Banks

• SBI, Bank of Baroda, Punjab National Bank, Canara Bank, Union Bank of India, Indian Bank.

Six Independent Banks

• Indian Overseas Bank, Uco Bank, Bank of Maharashtra, Punjab and Sind Bank, Bank of India, Central Bank of India.

Impact

Smooth Functioning & Better Delivery of Services

• The mega consolidation would help create banks with scale comparable to global banks and capable of competing effectively in India and globally.
• Greater scale and synergy through consolidation would lead to cost benefits which should enable the PSBs enhance their competitiveness and positively impact the Indian banking system.
• In addition, consolidation would also provide impetus to amalgamated entities by increasing their ability to support larger ticket-size lending and have competitive operations by virtue of greater financial capacity.

Boost to Financial Inclusion

• The adoption of best practices across amalgamating entities would enable the banks improve their cost efficiency and risk management, and also boost the goal of financial inclusion through wider reach.

Competitive Advantage

• Further, with the adoption of technologies across the amalgamating banks, access to a wider talent pool, and a larger database, PSBs would be in a position to gain competitive advantage by leveraging analytics in a rapidly digitalising banking landscape.

Associated Challenges

Integration Challenge

• The main hurdle will be to the smooth process of integration. All banks have their own importance in terms of origin, growth, expansion and geographical , and have been contributing to economic development in their own way.
• Merger of banks will take away their identity and customers will find it difficult to deal with the new bank.
• It might create a lot of problems for employees in inter-se seniority, transfers to their place of choice, etc. This will pose a challenge to the unions dealing with these problems.

Loss of Job

• Branch rationalisation and branch closures are bound to happen on account of mergers, which would lead to job losses and back room operations may reduce face to face interaction of the service providers with the customers.

Better Service Delivery Challenge

• By merging branches in a certain locality, the number of customers to be taken care of by the merged branch will double or treble. Hence, customer attention and quality of customer service are bound to be affected adversely. When every customer wants better service, the branch will face a big hurdle in this regard.
• Further, there are many welfare schemes, fringe benefits and other schemes that vary from bank to bank. Mergers will impact these benefits and schemes and unionists have to address these issues to harmonise these benefits.
• Mergers will totally divert the attention of the banks from loan recovery and it is bound to take a back sea

High-Cost Model

• The merged entity would not get any benefit of efficiencies. The PSBs have a very high-cost structure. The biggest challenge in PSB merger is to cut costs, bring efficiencies, improve profit per branch and profit per employee.

High Cost of Funds

• The cost of funds plays a very important role in the competitive banking landscape. The weak entities that are merging tend to have a higher cost of funds.
• While the private banks are using the digitisation and also digital modes to raise deposits and target new customers, the PSBs have this challenge of reducing the cost of the deposit.
• At the same time, they have to deploy their resources to high yielding assets to earn high interest.

Way Forward

• With the introduction of financial service convergence and competitions from outside and within, it is quite justifiable that to bring a sound transparent, efficient, and effective and culture friendly banking practices should be on the anvil of the government as well as policy makers.
• The legal implications combined with the ethical and governance issues need to be redefined very soon so that the positive impact of mergers may be ensured.
• Mergers strategies should be designed to improve the financial and operational soundness of existing small and capital needy banks and these should not be focused merely to gut the beautiful entities.

• Recently, the private lender YES Bank additional tier 1 (AT1) bonds worth Rs. 8,415 crore have been written down to zero by the Reserve Bank of India(RBI) under the scheme of reconstruction of Yes Bank.

About AT-1 Bonds

• AT-1 bonds are unsecured perpetual bonds — with no maturity — issued by banks to shore up their capital base to meet Basel III requirements.The RBI is the regulator for these bonds.
• The concept of Additional Tier-1 (AT1) Bonds was introduced by Basel III post the 2008 financial crisis, to protect depositors of a bank on a going concern basis. These bonds are also commonly known as Contingent convertible capital instruments (CoCos).
• Under the Based III framework, bank’s regulatory capital is divided into Tier 1 and Tier 2 capital. Tier 1 capital is subdivided into Common Equity (CET) and Additional Capital (AT1).
• In simple terms, equity and preference capital is classified as CET and perpetual bonds are classified as AT1. Together, CET and AT1 are called Common Equity.

Features of AT-1 Bonds

• AT1 are a special category of debt designed to absorb losses in case the bank’s equity capital dips below a certain threshold.
• These are quasi-equity instruments. These are meant to be like equity, but are structured as bonds.
• These bonds are listed and traded on the exchanges.So, if an AT1 bondholder needs money, he can sell it in the market.
• Banks cannot use conversion or write down of AT1 instruments to support expansion of balance sheet.

Risk Involved

• As these bonds are perpetual and carry no maturity date, they carry call options that allow banks to redeem them after five or 10 years.
• Banks can stop paying interest on them and also write off their value.
• In case, if the RBI feels that a bank is tottering on the brink and needs a rescue, it can simply ask the bank to cancel its outstanding AT-1 bonds without consulting its investors. This is what has happened to YES Bank’s AT-1 bond-holders.

RBI Guidelines Regarding AT-1 Bonds

• According to the RBI’s Basel III capital regulations, if the relevant authorities decide to reconstitute a bank or amalgamate it with any other lender under Section 45 of Banking Regulation Act, 1949, the bank will be deemed as non-viable or approaching approaching non-viability.
• The RBI has also added an additional trigger in Indian regulations, called the ‘Point of Non-Viability Trigger’ (PONV), which gives power to the RBI to decide if the bank has reached a situation wherein it is no longer viable.
• The RBI can then activate a PONV trigger and assume executive powers and can do whatever is required to get the bank on track, including superseding the existing management, forcing the bank to raise additional capital and so on.
• The PoNV condition requires all AT1 and Tier 2 instruments to be capable of being converted into common equity or written off.

Impact of Write Down

Impact on Investors

• RBI’s write-down of Yes Bank AT1 bonds will not only be detrimental to the financial interests and may cause panic redemptions in situations where it is not warranted, it will severely affect investor’s confidence in debt markets and financial institutions.
• This could also result in the contraction of the investor base in these bonds, as many would seek to avoid these bonds in future.

Impact on Banking and Financial System

• Any write-down on existing AT1 bonds will set a wrong precedence as it may lead to drying up of the AT-1 market in India completely for all issuers, especially in light of the fact that the banking system seems to be under stress.
• Any negative impact on these bonds could also increase the credit spreads across the assets classes and would have a detrimental impact on RBI’s objective of transmission of rate cuts to the larger economy.

• In a significant judgment, the Supreme Court on 4^th March, 2020, lifted the curbs imposed by the Reserve Bank of India(RBI) on regulated entities such as banks and NBFCs from dealing with virtual currencies (VC) and from providing services to crypto businesses.
• The court held that the ban did not pass the “proportionality” test.
• The test of proportionality of any action by the government must pass the test of Article 19(1)(g), which states that all citizens of the country will have the right to practise any profession, or carry on any occupation or trade and business.

Background

• The circular issued on April 6, 2018 directed the entities regulated by RBI:

1. Not to deal in virtual currencies nor to provide services for facilitating any person or entity in dealing with or settling virtual currencies.
2. To exit the relationship with such persons or entities, if they were already providing such services to them.

While striking down the circular, the Court took note of three factors:

• RBI, in the past 5 years or more, has not found any of the activities of Virtual Currency exchanges to have actually impacted adversely, the way the entities regulated by RBI function.
• In its reply, dated 04-09-2019, RBI said that it has not prohibited Virtual Currencies in the country.
• Even the Inter-Ministerial Committee constituted on 02-11-2017 was of the opinion that a ban might be an extreme tool and that the same objectives can be achieved through regulatory measures.

Reasons to Ban Virtual Currencies

• Owing to the lack of any underlying fiat, episodes of excessive volatility in their value, and their anonymous nature which goes against global money-laundering rules, the RBI initially flagged its concerns on trade and use of the currency.
• Risks and concerns about data security and consumer protection on the one hand, and far-reaching potential impact on the effectiveness of monetary policy itself on the other hand, forced RBI to impose the ban on trading of virtual currencies.
• Further, owing to a significant spurt in the valuation of many virtual currencies and rapid growth in initial coin offerings, virtual currencies were not safe for use.

Petitioner’s Argument

• The petitioner, Internet and Mobile Association of India (IMAI), had argued in the top court that the RBI had banned cryptocurrencies on "moral grounds" as no prior studies were conducted to analyse their effect on the economy.
• It was also argued that cryptocurrencies were not "currency" in the strict sense, and that they could be termed as a medium of exchange or a store of value.
• The RBI should have adopted a wait-and-watch approach, as taken by other regulators such as the Directorate of Enforcement or the Securities and Exchange Board of India.

Impact of SC Judgment

• The order is likely to come as a big relief to VC proponents in the country.
• It could lead RBI to reconsider its approach to cryptocurrency and come up with a new calibrated framework or regulation that deals with the reality of these technological advancements.

Digital Currencies

• Digital currency is the blanket term used to describe all electronic money; that includes both virtual currency and cryptocurrency. It can be regulated or unregulated.
• Digital currencies, which can only be owned and spent using electronic wallets or designated connected networks, are also commonly called digital money, or cyber cash.

Forms of Digital Currencies

Virtual Currencies

• Virtual currencies are a type of digital currency, typically controlled by its creators and used and accepted among the members of a specific virtual community.
• Cryptocurrencies such as Bitcoin and Ethereum are considered to be virtual currencies.
• Satoshi Nakamoto, widely regarded as the founder of the modern virtual currency -Bitcoin

Cryptocurrencies

• Cryptocurrencies are digital currencies because they exist online, but they are also virtual currencies created with cryptographic algorithms.
• Most cryptocurrencies now operate on the blockchain or distributed ledger technology, which allows everyone on the network to keep track of the transactions occurring globally.

Risks Associated with Cryptocurrencies

Business Risk

• Cryptocurrencies are not backed by a central bank, a national or international organization, or assets or other credit, and their value is strictly determined by the value that market participants place on them through their transactions, which means that loss of confidence may bring about a collapse of trading activities and an abrupt drop in value.

Cyber/Fraud Risk

• Even with encryption to protect cryptocurrency transactions, there have been hacks resulting in substantial losses.
• Passwords can be stolen or hacked. Hardware can be corrupted or taken.

Regulatory/Compliance Risk

• Some countries may prevent the use of the currency or may state that transactions break anti-money laundering(AML) regulations, notwithstanding the global implications.
• Due to the complexity and decentralized nature of the Bitcoin and the significant number of participants — senders, receivers (possibly launderers), processors (mining and trading platforms), currency exchanges, a single AML approach does not exist.

Market Risks

• The market risks are idiosyncratic as the currency trades only on demand. There is a finite amount of the currency which means that it can suffer from liquidity concerns and limited ownership may make it susceptible to market manipulation.
• Further more, given its limited acceptance and lack of alternatives, the currency can appear more volatile than other physical currencies, fueled by speculative demand and exacerbated by hoarding.

• Recently, seven of the 10 public sector banks slated for merger have invited independent experts to determine their share swap ratios.
• The valuer will adopt all market prevalent practices/principles for arriving at the valuation (including principles specified by the Reserve Bank of India and the Ministry of Finance).

Seven Banks

• Allahabad Bank, United Bank of India, Oriental Bank of Commerce, Punjab National Bank, Union Bank of India, Canara Bank and Syndicate Bank.

Objective

• Improving Investor Sentiment: The share swap ratio that the government would hammer out for the merger of the three public sector banks would go a long way in improving investor sentiment.

Share Swap Ratio

• When a company pays for an acquisition by issuing its own shares to the shareholders of the target company, this is known as a share Swap.
• The number of shares to be issued in lieu of their existing holdings in the target company is known as Swap Ratio.

Basis of Calculation

• To calculate the swap ratio, companies analyze financial ratios such as book value, earnings per share, profits after tax as well as other factors, such as size of company, long-term debts and strategic reasons for the merger or acquisition.
• If the target company is listed, the market value of its shares is often a key consideration to arrive at the right price to be paid.

How it Works?

• Suppose, if company A is acquiring company B and offers a swap ratio of 1:5, it will issue one share of its own company (company A) for every 5 shares of the company B being acquired.
• In other words, if company B has 10 crore outstanding equity shares and 100% of it is being acquired by company A, then company A will issue 2 crore new equity shares of company A to the shareholders of company B, proportionately.

Benefits of Share Swap

Risk Sharing Benefit:

• As shareholders of the target company will also be shareholders of the merged entity, the risks and benefits of the expected synergy from the merger will be shared by both the parties.
• In a cash deal, if the acquirer has paid a premium and the synergies don’t materialise, shareholders of the acquiring company alone bear the fallout.
• Benefits would also flow as a result of wider reach and distribution network, and reduction in distribution costs for the products and services through sub-sidiaries.

Saving of Borrowing Costs:

• In a share swap, there is no cash outgo involved for the acquirer, saving the acquirer borrowing costs.
• The acquirer companies, in turn, can put their cash to use for investments in the business or for other buyouts.

No Capital Gains Tax:

• In case of a share swap, when shareholders of the acquired company are given shares of the acquirer company as part of the deal, this is not considered a transfer of shares.
• Hence, capital gains tax will not arise in the hands of the shareholders (including minority shareholders) of the acquired company. The tax liability will arise only when the shares of the merged entity are sold.

Way Forward

• Share Swap is not always beneficial to shareholders. For ex- In the recently concluded merger of Bank of Baroda (BoB) with Dena Bank and Vijaya Bank, shareholders of Vijaya Bank and Dena Bank got 402 and 110 equity shares, respectively, of BoB for every 1,000 shares they held, hurting both the shareholders of Vijaya and Dena bank.
• The share swap regime also entails certain practical challenges involving shareholders’ rights and governance issues concerning the incoming shareholders. Since both acquirer and target tend to have investors at different stages of lifecycle, friction may arise if incoming shareholders secure the same terms as are available to existing shareholders. Thus, balancing rights of various investors and finding the right leverage becomes crucial.
• However, the share swap framework is becoming common as it facilitates acquisitions even when the transaction is unviable due to cash crunch.
• A swap ratio also brings to lights many aspects of the Merger and Acquisition (M&A) transaction between two companies. Firstly, it shows the relative size and strength of both companies. In general, if more shares of the target company are exchanged for one share in the acquiring company, then the latter is likely to be bigger and stronger.
• Secondly, it determines the control that each set of shareholders has on the combined company. For example, the acquiring company may have greater control over the firm if the swap ratio is high and, therefore, its Board of Directors could have a larger share in the new Board.

Why is it in News?

Sashakt committee has praised the mandatory norm of Inter Creditor Agreement (ICA) for its effectiveness in tackling bad loans.

Relevance of the News: It highlights the committee formed for addressing bad loans crisis and its observations.

More about the News:

• Sashakt Committee has observed that the mandatory norm of ICA allows banks to decide resolution strategy outside the Insolvency and Bankruptcy Code (IBC) which will accelerate the resolution process.
• The committee has recommended that the existing ICA, which is executed by 35 banks/ FI’s, must be adopted to incorporate the revised voting threshold and other changes in decision making that are stipulated by the RBI recently.
• RBI has recently changed norms which state that if 75% of lenders by value of the loans or 60% by number agree to a resolution plan then the plan can be adopted.

Sashakt Committee:

Sashakt committee is a group consisting of chiefs of 5 Indian public sector banks pioneered by PNB chairman Sunil Mehta. This committee had forwarded ‘Project Sashakt’ last year, a five-pronged strategy to resolve bad loans, which has been accepted by the government, which aims at

Project Sashakt:

• The five-pronged resolution route includes:
• oOutlining an SME resolution approach
• oBank-led resolution approach
  AMC/AIF led resolution approach
• oNCLT/IBC approach
• oAsset-trading platform
• This 5 pronged approach will be applicable to smaller assets with exposure up to Rs 50 crore, mid-size assets between Rs. 50 crore and Rs. 500 crore, and large assets with exposure of Rs 500 crore and more which have a potential for turnaround.
• Bad loans of up to Rs. 50 crore will be managed at the bank level, with a deadline of 90 days.
• For bad loans of Rs. 50-500 crore, banks will enter an inter-creditor agreement, authorizing the lead bank to implement a resolution plan in 180 days, or refer the asset to National Company Law Tribunal.
• For loans above Rs. 500 crore, the panel recom­mended an independent asset management company (AMC), supported by institutional funding through the alternative investment fund (AIF). The idea is to help consolidate stressed assets.

Inter Creditor Agreement (ICA):

• ICA is an agreement hashed out by public and private banks in July 2018 to deal with the bad loans crisis in Indian banking sector. It is a part of Project Sashakt.
• ICA framework envisages effective communication among lenders and lays down some ground rules for multiple-banking arrangements and consortium lending.
• Some large borrowers often take loans from multiple banks for a single project and in case of failure of the project all creditors face loss from that one common project’s failure. ICA allows all creditor banks to communicate with each other and commonly arrive at a resolution plan for the project.
• ICA makes sure that there is effective, good communication amongst banks and if any bank has a difference with another bank, then they will resolve it among themselves.
• ICA was earlier voluntary for banks but recent RBI guidelines have made ICA mandatory for banks.

Why is it in News?

RBI released new norms on NPA management for banks on 7 June 2019.

Relevance of the News: It lists the changes made in the NPA norms by the RBI which would help in curbing the menace of bad loans in Indian banking sector.

Some Changes made by the RBI include:

• Balanced between tight timelines and extreme delays:
• oIn the earlier circular even a single day's default in debt servicing would have required reporting to the RBI and implementation of Resolution Plan (RP). If RP is not completed in 180 days the company would be subject to IBC mandatorily.
• oIn the changed rules lenders have been given 30 days (in place of one day earlier) to decide upon a strategy. If RP is not implemented in 180 days banks will have to pay penalty rather than mandatory IBC referral.
• Improved realizations to banks:
• oDoing away with the mandatory referral to the IBC after 180 days can lead to improved realizations as intrinsic value of assets can be preserved.
• oIn case of mandatory referral RBI has placed penalties on banks if they fail to deliver within 180 days.
• oIf RP is not implemented in 180 days from the start of the review period, banks will have to make additional provision of 20% and another 15% if the plan is not implemented within 365 days.
• Accelerated provisioning by RBI: The central bank would issue directions to banks for initiation of insolvency proceedings against borrowers for specific defaults. This will force lenders to refer some specific cases to IBC.
• ICA has been made more practical: The Inter Creditor Agreement has been made more practical as approval percentage has been reduced from 100% to 75% by value of total outstanding credit facilities and 60% of lenders by number which is mandatory now.

Why is it in News?

FIU-IND is in news due to recent arrest and auction of the properties of fugitive jeweler Nirav Modi.

Why was FIU-IND set up?

• Financial Intelligence Unit – India (FIU-IND) was set by the Government of India in 2004 as the central national agency responsible for receiving, processing, analyzing and disseminating information relating to suspect financial transactions.
• FIU-IND is also responsible for coordinating and strengthening efforts of national and international intelligence, investigation and enforcement agencies in pursuing the global efforts against money laundering and related crimes.

What are the Functions of FIU-IND?

The primary responsibility of FIU-IND is to collect the data, analyse the data and disseminate that data to the regulators like RBI, SEBI, IRDAI etc. The functions of FIU-IND are:

• Collection of Information: Acts as the central reception point for receiving Cash Transaction Reports (CTRs), Cross Border Wire Transfer Reports (CBWTRs), Reports on Purchase or Sale of Immovable Property (IPRs) and Suspicious Transaction Reports (STRs) from various reporting entities.
• Analysis of Information: Analyze received information in order to uncover patterns of transactions suggesting suspicion of money laundering and related crimes.
• Sharing of Information: Share information with national intelligence/ law enforcement agencies, national regulatory authorities and foreign financial intelligence units.
• Act as Central Repository: Establish and maintain national data base on cash transactions and suspicious transactions on the basis of reports received from reporting entities.
• Coordination: Coordinate and strengthen collection and sharing of financial intelligence through an effective national, regional and global network to combat money laundering and related crimes.
• Research and Analysis: Monitor and identify strategic key areas on money laundering trends, typologies and developments.

Composition of FIU-IND:

• The FIU-IND is a multidisciplinary body with members from various government departments. The members are inducted from organizations including Central Board of Direct Taxes (CBDT), Central Board of Excise and Customs (CBEC), Reserve Bank of India (RBI), Securities Exchange Board of India (SEBI), Department of Legal Affairs and Intelligence agencies of the Government.

Whom does this Organization report to?

• FIU-IND is an independent body reporting directly to the Economic Intelligence Council (EIC) headed by the Finance Minister.

Economic Intelligence Council (EIC):

• EIC was formed in 1990 and is the apex forum overseeing government agencies responsible for economic intelligence and combating economic offences in India.
• EIC is responsible for coordination, strategy and information-sharing amongst the government agencies responsible for intelligence and control of economic offences such as smuggling, money laundering tax evasion and fraud. The Council also advises the Finance Minister and the Union Council of Ministers on laws regulating the financial sector and fighting economic crimes.
• EIC is headed by the Union Finance Minister.

Source: www.fiuindia.gov.in, TH, IE