Cut in most administered interest rates by 0.5% (by 50 basis points) from March 1, 2002. Administered interest rates will now be benchmarked to the average annual yields of government securities of equivalent maturities in the secondary market.
RBI Relief bonds not only faced a 50 basis points reduction in interest rates but also a ceiling of Rs 200,000 per year has been put on investment in these bonds.
Setting up of Asset Reconstruction Company by June 2002.
Banks are now allowed to deduct 7.5% of their total income against provisions made by them for bad and doubtful debts.
Banks are given option to deduct up to 10% of their non-performing assets (NPAs) falling in the category of loss or doubtful assets from total income. This is double compared to 5% given in the previous year.
The RBI will announce an issuance calendar for dated government securities. It will also introduce a new Government Securities Bill to replace the old Public Debt Act 1949 within this Parliament Session.
The RBI will announce an issuance calendar for dated government securities. It will also introduce a new Government Securities Bill to replace the old Public Debt Act 1949 within this Parliament Session.
A new Bill on the banking sector reforms is to be introduced in Parliament.
Foreign banks are permitted to operate in India with fully owned branches after the specific permission of RBI.
Budget Impact
Reduction in small savings rates: Inflation rate, which was averaging near 5% at the beginning of this fiscal year, has declined to less than 2%. Even after a 0.5% cut in small saving rates, it gives investors a better rate of return than nominal rate of return (summation of real rate of return and inflation) which stands at about 7%. It would be positive for banks, as now they will be able to reduce bank deposits rates, which could lead to some improvement in their interest spread. Also, with a cut in small saving rates, the government's interest liability would be reduced, as fresh liability would be calculated on the lower rates. The government would be able to reduce its interest payments, which constitutes about 48% of the revenue receipts.
Alignment of interest rates on administrative instruments: This is a step in the right direction for deregulating the interest rates in the economy that has been carried out in phases over the last 10 years. This would also help in reducing the interest burden on the government.
ARC: A pilot Asset Reconstruction Company (ARC) will be set up by June 30, 2002 with the participation of public and private sector banks, financial institutions and multilateral agencies. This company will initiate measures for taking over non-performing assets (NPAs) in the banking sector and also develop a market for securitised loans. Creation of Asset Reconstruction Company would aid banks in faster recovery of non-performing assets. It is a step in the right direction considering gross NPAs of Rs 608 bn in FY01 for the entire banking sector. This accounted for about 2.8% of GDP. ARC would also help banks in reducing their average cost of funds, as securitization of banks' loans would provide them with more liquidity.
Increase in provision limit: Currently banks are allowed to reduce 5% of their total income against provisions made by them for bad and doubtful debts. Increasing the limit to 7.5% would help banks (specially state run banks) in cleaning up their accounts. Gross NPAs of state run banks increased by 3.2% in FY01 to Rs 548 bn, accounting for 86% of total NPAs of the banking sector. Although higher provisions would reduce their earnings in the initial years, it would help them to report better earnings quality in the coming years and increase the provision coverage.
G-Secs: Issuance of calendar for dated government securities will help investors to plan their investment better. This would also add transparency and stability in the market.
New Bill on banking sector reforms: This is to strengthen creditor rights through foreclosure and enforcement of securities by banks and financial institutions. The Bill will also enable securitisation for money locked up in the long-term loans. Banks would be able to recover their dues at a faster clip once the foreclosure law comes into effect.
Permission to foreign banks: Foreign banks are given an option to either operate as branches of their parent banks or to set up subsidiaries. Such subsidiaries will have to adhere to all banking regulations, including priority sector lending norms, applicable to other domestic banks. Also, there will be a ceiling of 10% on voting rights for such subsidiaries. The RBI has already increased foreign direct investment limit for private banks to 49% (from the earlier 20%). Entry of foreign banks in the sector would increase the competition further. Public sector banks may have to face challenging business conditions considering their lower adoption to technology.
FII and FDI limit:The government had increased the FDI limit to 49% in private banks. However, it is not yet clear that whether FDI limit includes FII limit also.
Industry wish list
Banks are demanding abolition of tax deducted at source on bank fixed deposits. This is to enhance the deposit growth. However, given the declining tax revenues of the government, it is unlikely that TDS on bank deposits would be eliminated.
Banks are proposing to raise the foreign investment limit in the banking sector. Private sector banks are demanding for increase in limit to 74% and state run banks expects the limit to go up to 49%.
State Bank of India (SBI) is asking for excluding the GDR holding in the bank from the 20% cap on foreign holding.
Like financial institutions, banks should also be allowed to raise funds for infrastructure projects.
The Finance Minister is planning a 50-100 basis point interest rate cut on all administered instruments (post office recurring deposits, NSC Series VII and PPF). A cut in small savings instruments signals softening of interest rates for the system as a whole. It would enable banks to reduce their deposit rates to lower their cost of funds. The government has already lowered the interest rates ceiling on company fixed deposits to 12.5% from 14%.
The industry has proposed to increase section 80L limit for deduction of bank interest, to Rs 25,000 from the current Rs 12,000. This is to offer some relief from the recent interest rate cut to retired persons who depend on fixed income as their main revenue source.
The Indian Banking Association (IBA) has demanded relaxation for listed banks and financial institutions from adhering to accounting standards not synchronous with banking operations. (Globally there is separate set of accounting standards for banks under IAS - 42).
Key Positives
The government has already indicated its plans to bring down its stake to 33% in public sector banks (PSBs) from the current level of 51%.
The last few months saw a beginning of the consolidation process in the banking industry.
RBI has recently given approval to an NBFC to convert into a bank. The central bank has however, stated that it would not issue new licences in the next two-three years.
The RBI has increased FDI limit in private sector banks to 49% from the earlier 20%. This will allow foreign banks to acquire strategic stake in banks having better asset quality and IT systems.
The RBI has increased the limit of banks' exposure to capital markets to 5% of outstanding advances (from the earlier 5% of incremental deposits). Banks are also allowed to finance margin trading in equities, 5% of net outstanding advances.
Key Negatives
The government is however not willing to give away management control in these banks. Consequently, PSBs may find it difficult to attract strategic investors. Also, the bill, which has been introduced in the parliament in December 2000, is yet to be passed.
Although a merger helps banks in increasing the size and fuel future profits growth, integration of two different cultures and technology is a challenge for any bank.
Entry of NBFCs into the sector would intensify the competition further. Given the subdued credit growth, pressure on interest spread is likely to increase.
Although the government has increased the FDI limit to 49%, it is not yet clear that whether FDI limit includes FII limit also. Also the limit for state run banks still stands at 20%.
