JAIIB IE and IFS Paper-1 Module-C Unit 9 : Reforms & Developments In The Banking Sector

21/07/2023

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JAIIB Paper 1 (IE and IFS) Module C Unit 9 : Reforms & Developments In The Banking Sector (New Syllabus)

IIBF has released the New Syllabus Exam Pattern for JAIIB Exam 2023. Following the format of the current exam, JAIIB 2023 will have now four papers. The JAIIB Paper 1 (Indian Economy & Indian Financial System) includes an important topic called “Reforms & Developments In The Banking Sector”. Every candidate who are appearing for the JAIIB Certification Examination 2023 must understand each unit included in the syllabus. In this article, we are going to cover all the necessary details of JAIIB Paper 1 (IE and IFS) Module C (INDIAN FINANCIAL ARCHITECTURE ) Unit 9 : Reforms & Developments In The Banking Sector, Aspirants must go through this article to better understand the topic, Reforms & Developments In The Banking Sector and practice using our Online Mock Test Series to strengthen their knowledge of Banker Customer Relationship. Unit 9: Reforms & Developments In The Banking Sector

Infrastructure Financing

Important Features of Infrastructure

Infrastructure is the backbone of any economy. It requires heavy financial investment and the benefits are, often, indirect. Thus, building of rural roads will benefit agriculture as the farmers are able to sell their products in towns where they can get remunerative prices. Besides, they can get some inputs such as fertilisers, pesticides and other industrial products, at relatively cheaper prices, as their transport costs decline due to improved transportation.

It is worthwhile to mention some distinctive features of infrastructure:

First, the building of infrastructure requires large investment and they contribute to output, after a long period of time that is their gestation period is quite long.
Second, due to large overhead capital and bulk investment, significant economies of scale are found in most of them.
The third important feature of infrastructure facilities is they create externalities.

Importance of Infrastructure

It needs to be emphasised that good quality infrastructure is important not only for faster economic growth but also to ensure inclusive growth.
By inclusive growth, it is meant that the benefits of growth are shared by the majority of the people of a country. Inclusive growth leads to alleviation of poverty and reduction in income inequality in the country.

Components of Infrastructure

According to Government classification, infrastructure comprises of the following sectors:

Construction
Electricity generation, transmission and distribution
Gas generation and distribution through pipes
Water works and supply
Non-conventional energy generation and distribution
Railway tracks, signalling system and stations
Roads and bridges, run-ways and other airport facilities
Telephone lines and telecommunications network
Pipelines for water, crude oil, slurry, etc.
Waterways
Port facilities
Canal networks for irrigation
Sanitation and sewerage

Channels for Financing Infrastructure in India

The channels through which the funds reach the infrastructure sector are:

Government,
Development Financial Institutions,
Commercial Banks,
Non-Banking Financial Companies,
Insurance Companies & Pension Funds,
External Commercial Borrowings, and
Foreign Direct Investment (FDI) from abroad.

Characteristics of Infrastructure Financing

Longer Maturity: Infrastructure finance tends to have maturities between 5 years to 40 years. This reflects both the length of the construction period and the life of the underlying asset that is created. A hydro-electric power project, for example, may take as long as 5 years to construct, but once constructed could have a life of as long as 100 years, or longer.
Larger Amounts: While there could be several exceptions to this rule, a meaningful sized infrastructure project could cost a great deal of money. For example, a kilometer of road or a mega-watt of power could cost as much as US$ 1.0 million and consequently, amounts of US$ 200.0 to US$ 250.0 million (Rs.1595 crores to Rs. 1,995 crores) could be required, per project. (1 US$=INR79.75)
Higher Risk: Since large amounts are typically invested for longer periods of time, it is not surprising that the underlying risks are also quite high. The risks arise from a variety of factors including demand uncertainty, environmental surprises, technological obsolescence (in some industries such as telecommunications) and very importantly, political and policy related uncertainties.
Fixed and Low (but positive) Real Returns: Given the importance of these investments and the cascading effect, higher pricing here could have on the rest of the economy, annual returns here are often near zero, in real terms.

National Bank for Infrastructure and Development (NaBFID)

A development finance institution is an agency that finances infrastructure projects that are of national importance but may or may not conform to commercial return standards.
Since few commercial lenders are willing to take on infrastructure risk, particularly after the experience of growing NPAs in the sector, a development finance institution has become necessary.
DFIs provide long-term credit for capital-intensive investments, spread over a long period and yielding low rates of return, such as urban infrastructure, mining and heavy industry, and irrigation systems.

DFIs in India

After independence, the institutional framework for development banking began with the setting up of the Industrial Finance Corporation of India (IFCI) (1948), Industrial Development Bank of India (IDBI) (1964), Industrial Investment Bank of India (IIBI) (1972), National Bank for Agriculture and Rural Development (NABARD), Export-Import Bank of India (EXIM Bank) (1982), and Small Industries Development Bank of India (SIDBI) (1990).
In the past, DFIs such as ICICI, IDBI and IDFC have transformed into universal banks, as they did not have the advantage of low-cost funding for long-term projects.
DFIs are sector-specific, such as Rural Electrification Corporation Ltd (REC) for the power sector, National Bank for Agriculture and Rural Development (NABARD) for the agriculture sector, and Indian Railway Finance Corporation (IRFC) to fund rail infrastructure among others.

Establishment of NaBFID

NaBFID will be set up as a corporate body with authorised share capital of Rs 1 lakh crore. Shares of NaBFID may be held by:

Central government,
Multilateral institutions,
Sovereign wealth funds,
Pension funds,
Insurers,
Financial institutions,
Banks, and
Any other institution prescribed by the central government. Initially, the central government will own 100% shares of the institution which may subsequently be reduced up to 26%.

Functions of NaBFID

NaBFID will have both financial as well as developmental objectives. Financial objectives will be to directly or indirectly lend, invest, or attract investments for infrastructure projects located entirely or partly in India.
Central government will prescribe the sectors to be covered under the infrastructure domain. Developmental objectives include facilitating the development of the market for bonds, loans, and derivatives for infrastructure financing.

The functions of NaBFID include:

Extending loans and advances for infrastructure projects,
Taking over or refinancing such existing loans,
Attracting investment from private sector investors and institutional investors for infrastructure projects,
Organising and facilitating foreign participation in infrastructure projects,
Facilitating negotiations with various government authorities for dispute resolution in the field of infrastructure financing, and providing consultancy services in infrastructure financing.

Sources of fund

NaBFID may raise money in the form of loans or otherwise, both in Indian Rupees and foreign currencies, or secure money, by the issue and sale of various financial instruments including bonds and debentures.

NaBFID may also borrow money from:

Central government,
Reserve Bank of India (RBI),
Scheduled commercial banks,
Mutual funds, and
Multilateral institutions such as World Bank and Asian Development Bank.

Management of NaBFID

NaBFID will be governed by a Board of Directors. The members of the Board include:

The Chairperson appointed by the central government, in consultation with RBI,
Managing Director
Up to three Deputy Managing Directors,
Two directors nominated by the central government,
Up to three directors elected by shareholders, and
A few independent directors (as specified).

Support from the central government

Grants worth Rs 5,000 crores to NaBFID by the end of the first FY
Provide guarantee, at a concessional rate of up to 0.1%, for borrowing from multilateral institutions, sovereign wealth funds, and other foreign funds.
Costs towards insulation from fluctuations in foreign exchange (in connection with borrowing in foreign currency), may be reimbursed by the government, in part or full.
Upon request by NaBFID, the government may guarantee the bonds, debentures, and loans issued by NaBFID.

National Asset Reconstruction Bank (NARCL – BAD BANK)

Indian banks have reported over Rs 8.3 lakh crore worth of gross non-performing assets as on March 2021.
This is expected to go up to Rs. 10 -11 lakh crores by end March, 2022, owing to the decline in manufacturing and production activities on account of the pandemic.
The RBI’s Financial Stability Report has also reflected that the gross NPA ratio may increase to 13.59% by September 2021.
The Indian Bank Association (IBA) also submitted a proposal to the government for setting up a Bad Bank, with contribution from the government and banks.
Objective: it would take over NPAs from banks so that it could, then focus on recovery of the said loans.
Benefits: Transfer of the NPAs from the banks to the Bad Bank would also free up the balance sheets of the bank and enable them to concentrate on business development and raising capital from the market.

The concept of the Bad Bank :

National Asset Reconstruction Company (NARCL)
Coupled with a debt resolution company (India Debt Resolution Co. Ltd – IDRCL).

While NARCL has been set up by banks to aggregate and consolidate stressed assets for their subsequent resolution,
IDRCL is a service company/operational entity which will manage the asset and engage market professionals and turnaround experts.
While for NARCL, public sector banks will hold 51% of the equity capital
IDRCL, public sector banks will hold 49% of the capital, the rest will be with private sector lenders
7th July, 2021: NARCL was incorporated as a Company.
While it is expected that banks will transfer NPAs to the extent of Rs 2 lakh crores (which comprises of 1.8% of total loans) to NARCL, Rs 90,000 crores will transferred in the first phase.
The minimum cut off amount for transfer of loans to NARCL is Rs 500 crores.
While the initial tranche of Rs 90,000 crores will comprise of fully provided loans, the balance amount would comprise of loans with lower provisioning as well.
It is expected that sale of the bad loans to NARCL will be against 15% cash and balance 85% being in the form of Security Receipts (SRs).
Initially, the Central government is expected to guarantee the SRs, to the extent of Rs 30,600 crores.
The Government guarantee will be valid for 5 years.
The limited period of Government guarantee is expected to incentivise NARCL, to speed up resolution of the loans transferred to it.
The NARCL will acquire assets by making an offer to the lead bank. Once NARCL’s offer is accepted, then, IDRCL will be engaged for management and value addition.