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Banks disciplined by new RBI norms - Views on News from Equitymaster
 
 
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  • Apr 6, 2000

    Banks disciplined by new RBI norms

    The Reserve Bank of India (RBI) has recently issued guidelines stating that any investments in privately placed debts such as debentures by commercial banks shall be treated as advances.

    These guidelines will be applicable to investment in debentures with a maturity period of more than five years.

    The immediate fallout of the decision is that banks will have to classify these investments as non-performing assets in the event of non-payment of interest and principal.

    More and more banks, especially the private sector banks had been increasingly resorting to lending by way of investments in debentures, ever since the ceiling of five per cent on incremental deposits for investments was removed. They have been making high risk high return investments, because of pressures to earn more profits. The other advantage of resorting to this measure was that in case of default in the payment of interest or principal on these investments there was no need to treat it as non-performing assets and hence no need to make provisions.

    Following is the comparison of NPA’s for private and public sector banks which reveals significantly higher NPA’s for public sector banks.

    Table showing comparison of Investments in Debentures to Total Investments.

    From the above table it is clearly evident that private sector banks have significantly higher exposure to debentures and bonds as compared to public sector banks. The higher investments in bonds and debentures could also be a reason for their low level of non performing assets.

    If any of these investments have been made in high-risk sectors, it could lead to a substantial increase in the non-performing assets for banks that have made such investments.

    The immediate fall out of the announcement is that banks shall henceforth be far more conservative and prudent in their lending policies, because of the new disclosure norms. This could reduce their spreads as they might not invest in such high yielding debentures and only resort to lending by way of term loans and working capital loans where returns are much lower.

     

     

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