Banking: NBFCs, PSL and NPAs

Statements 1 and 2 are correct. Under the RBI's income recognition and asset classification norms, a term loan turns into an NPA when interest or principal stays overdue for more than 90 days. NPAs are then graded by age. A substandard asset is one that has been an NPA for up to 12 months. Statement 3 is wrong: an asset becomes doubtful only after it has stayed in the substandard category for 12 months, not six. A loss asset is one where the loss has been identified by the bank, its auditors or the RBI but the amount has not yet been written off. Provisioning rises at each stage, so the grade directly affects a bank's profits.

Statements 1 and 2 are correct. Net interest income is what a bank earns on loans and investments minus what it pays on deposits and borrowings; the NIM expresses this as a percentage of average earning assets and is the core measure of a bank's lending profitability. Income from fees and commissions, such as remittance charges, locker rent or the sale of insurance, is 'other income', not interest income, so statement 2 is correct. Statement 3 is wrong: how a repo rate cut affects NIM depends on how quickly a bank's loan rates and deposit rates reprice. Banks with many loans linked to an external benchmark often see loan yields fall faster than deposit costs, which can squeeze their NIM for a while.

NARCL, often called India's 'bad bank', was set up by banks to aggregate and resolve large legacy NPAs, with public sector banks holding a 51% stake. It acquires a stressed loan by paying 15% in cash and 85% in security receipts (SRs). In September 2021 the Union Cabinet approved a Government guarantee of up to ₹30,600 crore for these SRs, valid for five years, to cover any shortfall between their face value and the actual amount recovered on resolution or liquidation. A separate company, the India Debt Resolution Company Ltd (IDRCL), in which private lenders hold the majority, manages and resolves the assets. The guarantee adds credibility and makes the SRs tradable without a large upfront cash cost to the Government.

Statements 1 and 2 are correct. An ARC buys bad loans from banks and financial institutions and tries to recover value through restructuring, sale of assets or a change of management. Section 3 of the SARFAESI Act requires every ARC to register with the RBI, which regulates it. In its review of 11 October 2022, the RBI raised the minimum net owned fund from ₹100 crore to ₹300 crore for new ARCs, gave existing ARCs a glide path up to March 2026, and allowed ARCs with a net owned fund of ₹1,000 crore or more to act as resolution applicants under the IBC. Statement 3 is wrong: issuing security receipts to qualified buyers does not make ARCs SEBI-regulated entities. The RBI remains their regulator.

Under section 21 of the IBC, the Committee of Creditors (CoC) is made up of the financial creditors of the corporate debtor, those who lent money against the time value of money, such as banks and bondholders. A financial creditor that is a related party of the debtor, for example a promoter-group company, is kept out so that the people who ran the firm into trouble cannot steer its rescue. Voting share is in proportion to the debt owed, and a resolution plan needs approval by at least 66% of the voting share under section 30(4). Operational creditors, such as suppliers and employees, may attend CoC meetings if their dues are large enough, but they have no vote. In Essar Steel (November 2019) the Supreme Court upheld the 'commercial wisdom' of the CoC, while requiring that operational creditors be treated fairly in the plan. Only where a debtor has no financial creditors does the Code allow a committee of operational creditors.

The 4R strategy has four parts. Recognition means making banks declare NPAs openly; the RBI's Asset Quality Review of 2015–16 ended the practice of hiding stress through 'evergreening'. Resolution means recovering value through the IBC, SARFAESI and other tools. Recapitalisation means the Government putting capital into public sector banks, including through recapitalisation bonds from 2017. Reforms include the EASE agenda, better governance and bank mergers. 'Rescheduling' of loans is not one of the Rs. In fact, repeatedly rescheduling and restructuring loans to avoid recognising them as NPAs was part of the problem the strategy set out to end.

Statements 1 and 2 are correct. PSLCs, introduced in 2016, let banks trade their priority sector achievement. A bank that has lent more than its target, often an RRB or SFB with strong rural reach, can sell certificates to a bank that is short of its target. Only the obligation is transferred; the underlying loans, their cash flows and their credit risk stay with the original lender. Trading takes place on the RBI's e-Kuber platform, in four types: PSLC-Agriculture, PSLC-Small and Marginal Farmers, PSLC-Micro Enterprises and PSLC-General. Statement 3 is wrong: only banks can participate, namely scheduled commercial banks, RRBs, UCBs, SFBs and Local Area Banks. NBFCs and mutual funds have no priority sector targets to meet.

Statements 1 and 2 are correct. Section 29A, added in 2017 and amended in 2018, stops defaulting promoters from buying back their own companies cheaply through the insolvency process. Among those barred are an undischarged insolvent, a wilful defaulter under RBI guidelines, and a person whose account has been an NPA for at least a year (clause (c)), along with persons connected to them. Statement 3 is wrong: the proviso to clause (c) lets such a person become eligible by paying all overdue amounts with interest and charges on the NPA account before submitting the resolution plan. This makes sense: the purpose is to keep out those who refuse to settle, not to punish forever those who clear their dues. Separate relief exists for financial entities that hold such accounts only because of debt conversion, and for MSME promoters. The Supreme Court upheld section 29A in Swiss Ribbons (2019) as a reasonable classification.

Statements 1 and 4 are correct (a). The RBI lists how an NBFC differs from a bank. Statement 1 is right: NBFCs cannot accept demand deposits. Statement 4 is right: depositors of NBFCs get no DICGC insurance cover. Statement 3 is wrong: NBFCs are not part of the payment and settlement system and cannot issue cheques drawn on themselves. Statement 2 is wrong: not every NBFC registers with the RBI; insurers report to IRDAI, merchant bankers and brokers to SEBI, and chit funds to State governments. So options (b), (c) and (d) fail.

Notice the current rules: since 2021, the RBI regulates NBFCs through a Scale-Based Regulation in four layers: Base, Middle, Upper and Top. DICGC covers bank deposits up to ₹5 lakh.

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The sub-indices are Access, Usage and Quality (c). The RBI launched the FI-Index in August 2021. It covers banking, investments, insurance, postal services and pension, and gives one value between 0 and 100. Its three parameters are Access (35%), Usage (45%) and Quality (20%). Options (a), (b) and (d) list areas or ideas that are not its sub-indices; GDP contribution and affordability are not parameters.

Notice the logic: usage has the most weight, because an account that is never used does not mean real inclusion. Quality includes financial literacy and consumer protection. The index is published every July, and it has risen steadily, helped by Jan Dhan (2014) and UPI.

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All three statements are correct (c). Statement 1 is right: the Liquidity Adjustment Facility (repo and reverse repo) is open to banks and to standalone primary dealers, which are themselves NBFCs registered with the RBI. Statement 2 is right: foreign portfolio investors may hold G-Secs within limits, and some bonds are fully open to them under the Fully Accessible Route (FAR). Statement 3 is right: NSE and BSE run separate debt segments for trading bonds.

Notice the big change: from 2024, Indian government bonds entered global indices such as JP Morgan's, bringing in large foreign money. The FAR, introduced in 2020, made this possible. Primary dealers help the RBI sell government bonds.

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Neither statement is correct (d). Statement 1 is wrong: under the RBI's 2013 scheme, a foreign bank's wholly owned subsidiary needs a minimum paid-up capital of ₹500 crore. Statement 2 is wrong as worded: on the board, at least 50% must be Indian nationals, NRIs or PIOs, and at least one-third must be Indian nationals resident in India. Statement 2 narrows the rule to Indian nationals alone, so UPSC treated it as wrong.

Notice why the RBI prefers subsidiaries to branches: a subsidiary is a separate Indian company with its own capital, so it is easier to control in a crisis. Subsidiaries also get near national treatment. SBM Bank and DBS Bank India were among the first to take this route.

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Open Market Operations are used for sterilisation (a). When the RBI buys dollars to stop the rupee rising too fast, it pays in rupees, which adds money to the system and can push up inflation. To soak up that extra money, it sells government securities through open market operations. Cancelling the effect of forex operations on money supply this way is called sterilisation. Option (b) is wrong: overseeing payment systems is a separate RBI role. Option (c) is wrong: debt and cash management for governments is its banker role. Option (d) is wrong: regulating NBFCs is supervision.

Notice other sterilisation tools: the Market Stabilisation Scheme (2004), the Standing Deposit Facility (2022) and forex swaps, which avoid selling bonds.

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Statements 2 and 3 are correct (b). Statement 1 is wrong: no local boards regulate Urban Cooperative Banks. They have dual control: the State Registrar of Cooperative Societies handles registration and management, and the RBI regulates their banking business. Statement 2 is right: the 2020 amendment to the Banking Regulation Act allowed UCBs to raise capital through equity shares, preference shares and bonds, with RBI approval. Statement 3 is right: cooperative banks came under the Banking Regulation Act through an amendment in 1966.

Notice the PMC Bank crisis of 2019, which pushed the 2020 amendment giving the RBI more power over cooperative banks. Multi-State cooperative banks are registered under the Central Registrar instead.

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