Indian Financial System

The financial institutions in India are broadly divided into two categories viz. Banks and Non-Banking Financial Institutions (NBFIs).

Banks

The main business of a bank is accepting deposits for the sake of lending. They are classified into commercial banks and cooperative banks. Commercial banks operate on the commercial (profit) principles while the basis of operation for cooperative banks is on cooperative lines i.e. service to its members and the society. Cooperative banks provide higher rates of interest on deposits as compared to commercial banks.

Commercial Bank

It is a financial intermediary because it mediates between the saver and borrowers. It does so by accepting deposits from the public and lending money to businesses and consumers. Its primary liabilities are deposits and primary assets are loans.

The commercial banking system in India consists of public sector banks, private sector banks and foreign banks, RRBs (Regional Rural Banks), SFBs (Small Finance Banks), Payment Banks and LABs (Local Area Banks).

Currently, India has 12 public sector banks, 22private banks & 45 foreign banks.

In the year 2019, our finance minister announced the merger of ten banks into four and this has come in effect from 1st April 2020. Now, there are 12 public sector banks, which are managed and controlled by the Reserve Bank of India.

Commercial banks are of two type’s viz. scheduled commercial banks and non-scheduled commercial banks.

Scheduled Commercial Banks

They have been included in the second schedule of the RBI Act 1934.The other conditions for a scheduled commercial bank are that it must be a corporation and the paid up share capital should be at least 5 lakh rupees. It must satisfy RBI that its affairs are not conducted in a manner detrimental to the depositors.

The scheduled banks enjoy certain privileges like approaching RBI for financial assistance; refinance etc and correspondingly they have certain obligations like maintaining certain cash reserves as prescribed by the RBI etc. The Scheduled Banks in India comprise of nationalized banks (PSBs), foreign banks, private sector banks, co-operative banks, regional rural banks, SFBs (Small Finance Banks) and Payment Banks.

 TYPES:

1. Public Sector Banks: They are the banks in which the government holds more than 50% shares. There are 12 PSBs in India.
2. Private sector banks are owned by private individuals eg. Kotak Mahindra, ICICI Bank
3. Foreign banks are established in India by foreign entities eg. Citi bank. They are basically private banks which are owned by foreign entities.
4. Regional Rural Banks (RRBs) are established under the RRB Act 1976 with a view of developing the rural economy which could be done by providing credit to agriculture, trade, commerce, handicraft, industry etc in the rural areas. The first RRB was established in 1975 even before the act was brought.

Universal Banking refers to those banks that offer a wide range of financial services (beyond the commercial banking functions) like mutual funds, merchant banking, credit cards, retail loans, housing finance, auto loans, investment banking, insurance etc. This is most common in European countries.

Core Banking Solutions (CBS) – It can be defined as a solution that enables banks to offer a multitude of customer-centric services on a 24×7 basis from a single location, supporting retail as well as corporate banking activities.

Systemically Important Banks (SIBs)

The Basel Committee on Banking Supervision (BCBS) came out with a framework in 2011 for identifying the Global Systemically Important Banks (G-SIBs) and the magnitude of additional loss absorbency capital requirements applicable to these G-SIBs.

Domestic Systematically Important Banks (D-SIB)

• According to the RBI, some banks become systemically important due to their size, cross-jurisdictional activities, complexity and lack of substitute and interconnection. 
• Identification of D-SIB’s is based on Basel Committee recommendations. Banks whose assets exceed 2% of GDP are considered part of this group.
• The RBI stated that should such a bank fail, there would be significant disruption to the essential services they provide to the banking system and the overall economy.
• The too-big-to-fail tag also indicates that in case of distress, the government is expected to support these banks.
• D-SIBs are closely monitored by the central bank to ensure their better functioning and prevent the indulgence of such banks in any grey areas such as money laundering etc.
• They are domestically identified by Central Banks of a country and globally by BASEL committee on banking supervision.
• Currently, State Bank of India, ICICI Bank, and HDFC are in the list released by RBI.

Criteria for DSIBs

Qualifying Criteria: To identify the D-SIBs, the RBI considers only those banks whose size is equal to or more than 2% of GDP.

Criteria used for Identification of D-SIBs:

• Size: Failure of Bank with higher Balance sheet can cause greater damage to Economy.
• Interconnectedness: Extent of linkages with other Banks and financial institutions. Failure of Bank with higher interconnectedness can cause greater damage to Economy.
• Substitutability: Lack of readily available substitutes. Failure of a large bank would inflict greater damage if certain critical services provided by the bank cannot be easily substituted by other banks.
• Complexity: The more complex a bank is, the greater are the costs and time needed to resolve its problems. Computation of Score: The systemic importance of a bank is computed as weighted average scores of all 4 indicators. Thus, the systemic importance score of a bank would represent its relative importance with respect to the other banks. Banks that have scores above a threshold score are classified as D-SIBs.

Additional Policy Measures for SIBs:

1. Capital requirement: These banks will be required to have additional Common Equity Tier 1 capital requirements ranging from 0.20% to 0.80% of risk weighted assets, depending upon the bucket they are plotted into. The additional CET1 core capital requirement in case of the State Bank of India applicable from 1st April 2019 has been prescribed at 0.6% of Risk Weighted Assets (RWAs) while for the other two banks it is 0.2%.
2. Supervision: More intensive supervision in the form of higher frequency and higher intensity of on and off-site monitoring.
3. Governance: It is also important that these banks should adopt sound corporate governance of risk and risk management culture.

Financial Stability Board (FSB)

• Financial Stability Board (FSB) is a global organization that regulates and makes recommendations regarding the global financial system.
• It is hosted and funded by Bank for International Settlements (BIS) and is located in Basel, Switzerland. Membership.
• The FSB is not a treaty-based organization and therefore policies agreed by the FSB are not legally binding.
• The FSB regularly reports to the G20 which supports implementation of agreed international standards.
• Members – 24 member countries (G20 + 4 Key Financial Centres Hongkong, Singapore, Spain and Switzerland); International organisations (such as IMF, World Bank, Bank for International Settlements, OECD etc); Standard Setting Bodies such as Basel Committee on Banking Supervision India is one of the members.