Impact of India's Proposed Central Bank Digital Currency (CBDC)

Numerous signals have been emanating from the government and the RBI in the past several months to indicate the imminent launch of India’s Central Bank Digital Currency (CBDC). This includes the announcement last month that the Cryptocurrency and Official Digital Currency Bill, 2021 will be tabled for discussion in the ongoing session of the Indian parliament.

What is a CBDC?

In simple terms, it is the digital version of legal tender issued by a sovereign central bank. In terms of value, it is the same as the country’s fiat currency and is exchangeable with physical currency on demand. Thus, India’s CBDC will be denominated in Rupees. Like physical currency notes/coins, CBDC can be used by individuals and businesses as a store of value and to make payments for purchasing goods/services.

 

Why does India need a CBDC?

There are many reasons why countries will need their own CBDC systems. In India, interbank transactions and settlements already take place through the reserves individual banks maintain with the RBI, so there may not be much impact in this arena. However, in the retail segment, a bulk of the transactions still rely on physical cash and increasingly, on digital payment solutions. It is important to recognize that payment solutions such as those from Google, Amazon, Apple, or Paytm and Phonepe are all privately-owned and controlled; as such, their growing popularity does pose a risk to the country’s financial system.

For example, it is estimated that 94% of mobile payment transactions in China are processed on transactions owned by Alibaba or Tencent. As the companies behind these apps start to build “ecosystems”, more and more goods and services can be paid for through these apps. Such integration and breadth of usage can easily create a virtual stranglehold that has the potential to place at risk the entire financial system of a country; there could even be regional or global ripples. The launch of a CBDC is thus not just a digital payment system, but also a mechanism towards mitigation of major risks that are associated with an increasingly digital world.

Currently, all payment solutions in India, whether developed and deployed by fintech players, Big Tech or banks, run on the Unified Payments Interface (UPI) infrastructure built and managed by the National Payments Corporation of India (NPCI), which is jointly promoted by the RBI and the Indian Banks’ Association (IBA). That India’s payments backbone has never been in private hands reduces the level of risk to our financial system. Also, it must also be acknowledged that the NPCI has done a fabulous job so far. The month of October 2021 alone saw more than 4.2 billion transactions being processed through NPCI infrastructure. But it is important to keep in mind that the payment apps owned and managed by fintech and Big Tech companies are not under the direct regulatory supervision of the RBI because they are not licensed banks. A CBDC-based ecosystem will make the regulation of such apps and platforms easier and more effective- thus enabling a higher degree of consumer protection. 

There are other reasons too why an Indian CBDC will become a necessity sooner rather than later. Countries like China are already at an advanced stage of launching their versions of CBDC. Given global cross-border trade and investment flows and repatriation of funds by Indian diaspora overseas and tourist travel, it is only a matter of time before Chinese or other CBDC enter the Indian financial system. And as more countries launch their own CBDC, it is imperative that we have our own, so that we can negotiate from a position of experience (and strength) when it comes to agreeing on multilateral CBDC protocols.

A well-designed CBDC system reduces the threat of counterfeit currency- something that our adversaries have used over many decades to weaken our economy. Arguably, CBDC can also play an important role in the nation’s fight against corruption and black money- although much will depend on how it evolves and the operational rules and regulatory framework governing it.

 

CBDC: The Road Ahead

At this time, it is unclear when and how the government will choose to launch India’s CBDC. But it is fair to say that an entirely new digital currency ecosystem will be needed. It is likely that the RBI itself will cause to design, develop and run the CBDC infrastructure. There are also speculations that they would be regulated as financial assets by the Securities & Exchange Board of India (SEBI). Big Tech, fintech and banks will need to link their apps to this new infrastructure as well- assuming that over time, individuals will retain the option to pay via physical currency-backed UPI platforms or their CBDC cousins.

Since no regulator can compete with those it is tasked with regulating, the RBI may have to let financial intermediaries continue to take responsibility for the distribution of digital currency via e-wallets or other pre-paid digital instruments and similar solutions. This also means that fintech players, BigTech and retail banks will need to evolve their platforms and come up with innovative offerings to ride this new wave of opportunity. The road ahead will have its own challenges at both the policy and operational levels. The success of CBDC will also depend on how quickly internet access expands across the country and how resistant to hacking and breaches the underlying systems are.

Fasten your seatbelts and prepare for an interesting ride at the end of which, digital currency could be the crowned king. 

 

Image Credits:  Photo by Alesia Kozik from Pexels

At this time, it is unclear when and how the RBI will choose to launch India’s CBDC. But it is fair to say that an entirely new digital currency ecosystem will be needed. It is likely that the RBI itself will cause to design, develop and run the CBDC infrastructure

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Bad Bank in India: A Concept Note

The Indian banking system has been grappling with the ballooning Non-Performing Assets (NPAs) crisis on its balance sheets for decades now. The pandemic marked a further downward spiral for the Indian economy; proving specifically detrimental to individual borrowers and large corporates across sectors, who were adversely affected by the cash flow in businesses which led to defaults in outstanding obligations. The consequential increase in the NPAs revived the discussions for institutionalizing an independent entity that would exclusively deal with the bad loans and help in cleaning up the NPAs off the balance sheets. As of March 2021, the total NPAs in the banking system amounted to Rs 8.35 lakh crore (approx). According to the Reserve Bank of India’s (RBI) financial stability report, the gross NPAs ratio for the banking sector could rise to 9.8% by March 2022.

Following India’s first-ever Bad Bank announcement in the 2021-22 Union Budget by the Finance Minister; India, Debt Resolution Company Ltd (“IDRCL”), an Asset Management Company (“AMC”) has been set up that shall work in tandem with the National Asset Reconstruction Company Ltd (“NARCL”) to streamline and square away bad loans as per the documents and data available with the Registrar of Companies (“RoC”).

Proposed Mechanism of Bad Bank in India

  • The Government of India (“GOI”) has primarily set up two entities to acquire stressed assets from banks and then sell them in the market.
  • The NARCL has been incorporated under the Companies Act, 2013. NARCL will buy stressed assets worth INR 2 lakh crore from banks in phases and sell them to buyers of distressed debt. NARCL shall also be responsible for the valuation of bad loans to determine the price at which they will be sold. Public Sector Banks (PSBs) will jointly own 51% in NARCL.
  • The IDRCL will be an operational entity wherein 51% ownership will be of private-sector lenders / commercial banks, while the PSBs shall own a maximum of 49%.

NARCL will purchase bad loans from banks and shall pay 15% of the agreed price in cash, and the remaining 85% in the form of Security Receipts. If the bad loans remain unsold, the government guarantee shall be invoked; a provision worth INR 30,600 crore has been structured for the same.

Benefits of Bad Bank in India

Since non-performing assets have majorly impacted Public Sector Banks, the institutionalization of a Bad Bank shall equip PSBs in selling / transferring the NPAs, while simultaneously improving and promoting credit quality, strategically minimizing efforts in loan recovery and enhancing the macroeconomy.

Additionally, the profits of the banks were mostly utilized to cut losses. With the NPAs off their balance sheets, the banks will have more capital to lend to retail borrowers and large corporates.

The issues faced by Asset Reconstruction Companies (ARCs) relating to the governance, acceptance of deep discount on loans, and valuation may not concern the Bad Bank, owing to the government’s initiative and support that engages appropriate expertise.

 

Challenges of Bad Bank

As per the operational structure, bad banks shall buy bad loans, that have been recorded in the books of the PSB’s or private lenders. If the institution fails to secure buyers and record appropriate prices for the assets, the entire exercise shall prove to be futile.

In India, 75% of the bad loans are defaulted corporate loans, including a consortium of banks that had loaned corporations to finance major infrastructure and industrial projects. Countries such as Mexico, Greece, South Korea, Argentina, and Italy have portrayed that bad banks rarely yield positive outcomes in settings dominated by industrial, corporate, and conglomerate-level bad loans. Hence, structural and governance issues at various levels with state governments, judiciary, and political interests shall have to be streamlined and implemented efficiently to steer away from making them a repository of bad loans and for cleaning up the books of the PSBs.

Bad Bank: A One-Time Exercise?

The Government of India will have to undertake appropriate reforms/lending norms to reduce the number of NPAs. Setting up Bad Bank is most likely to tackle only the existing NPAs problem and should be a one-time exercise.

The concept of Bad Bank has been a success in certain European countries and the United States of America, however, it is pertinent to understand that they were structured to tackle home loans and toxic mortgages, unlike in India. Hence, in-depth analysis of the experiences of these countries should be utilized and intricately be revamped in alignment with key differences to ascertain the role of Bad Bank in the near future in the country.

Banks will get a huge financial boost with the transfer of the NPAs off their books and help in credit growth in the country. The success of Bad Bank is also crucial in restoring the faith of the taxpayer in the banking system. With the existence of the Insolvency and Bankruptcy Code, 2016 and Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, it remains to be seen how a Bad Bank will be a complement in the resolution of the bad loans.

 

Image Credits: Photo by Visual Stories || Micheile on Unsplash

The concept of Bad Bank has been a success in certain European countries and the United States of America, however, it is pertinent to understand that they were structured to tackle home loans and toxic mortgages, unlike in India. Hence, in-depth analysis of the experiences of these countries should be utilized and intricately be revamped in alignment with key differences to ascertain the role of Bad Bank in near future in the country.

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Budget Proposal to Boost Non-Banking Financial Companies

  • August 7, 2019
  • Swati Hegde

The looming crisis concerning Non-Banking Financial Companies (NBFC) necessitated some quick action on the part of the government to stabilize the shaking consumer confidence on the shadow banking sector. Although scholars are still confident of the sector’s performance as a whole but delayed disbursement caused by a liquidity crunch was seen as a cause of concern that required quick redressal to attain balance.

The liquidity crunch is not a recent development, it started affecting NBFCs, especially micro-finance institutions, in the aftermath of demonetization as these institutions basically catered to the financial needs of the lower section of the society which had to bear the major brunt of the currency deficit. The situation further worsened with increasing bank NPAs and the recent payment defaults by leading infrastructure finance companies. Non-Banking Finance Company-Microfinance Institutions (NBFC-MFIs) hold the largest share of the portfolio in micro-credit with the total loan outstanding of ₹68,868 crore, which is 36.8 percent of the total micro-credit universe.[i]

In a bid to lower the NBFC liquidity crisis, the Central Government in its Budget 2019-20 announced that, “NBFCs are playing an extremely important role in sustaining consumption demand as well as capital formation in small and medium industrial segment. NBFCs that are fundamentally sound should continue to get funding from banks and mutual funds without being unduly risk averse. For purchase of high-rated pooled assets of financially sound NBFCs, amounting to a total of Rupees one lakh crore during the current financial year, Government will provide one time six months’ partial credit guarantee to Public Sector Banks for first loss of up to 10%.[ii]” Thereby the Union Budget has enhanced the liquidity to financially sound NBFCs.

The NBFC situation had worsened because of increased dependence on easy money by the banks which declined after the Infrastructure Leasing and Financial Services Ltd debacle and the fact that these entities are loosely regulated. The Central Government, therefore, proposed to increase RBI’s oversight on these entities through the following changes to the ‘NBFCs’s regulations in its Finance (No.2) Bill, 2019(“Bill 2019”)[iii].

 

Net Owned Fund:

At present no NBFC can commence or carry on the business of a non-banking financial institution without obtaining a certificate of registration and having the net owned fund of twenty-five lakh rupees or such other amount, not exceeding two hundred lakh rupees, as the RBI may, by notification in the Official Gazette, specify.

The Bill 2019 proposed to increase the upper limit to a hundred crore rupees. Further, the RBI may notify different amounts of net-owned funds for certain categories of NBFCs. This change will enable RBI to notify a higher minimum net-owned fund requirement for an NBFC.

Debenture Redemption Reserve:

Ms. Nirmala Sitharaman, the Finance Minister, in her budget speech mentioned that NBFCs that do the public placement of debt have to maintain a Debenture Redemption Reserve (DRR) and in addition, a special reserve is also required to be maintained as per the RBI. The Budget 2019-20 relaxed the mandate of having DRR by NBFCs for raising the funds in public issues. However, the reference of the same is not provided in Bill 2019.

Change in Board of Directors:

Further, the Bill, 2019 has granted the power to RBI to remove the directors of NBFCs where it is satisfied that the affairs of the NBFCs are in a manner detrimental to the public interest. However, the RBI is required to grant an opportunity to the director to represent himself before an order is passed against him. Further, the RBI has the power to appoint a new director in the place of the director removed.

 Supersede the Board:

RBI is authorized to supersede the Board of Directors of an NBFC, not exceeding five years, to prevent the affairs of an NBFC from being conducted in a manner detrimental to the public interest or the interest of the depositors or creditors or interest of the NBFC (other than Government Company) or for securing the proper management of such NBFC or for financial stability, if it is necessary so to do.

 Removal of Auditor:

RBI is empowered to remove or debar an auditor from exercising the duties as auditor of any of the RBI regulated entities for a maximum period of three years, at a time,  in case the auditor fails to comply with any direction given or order made by the RBI.

Currently, ICAI Council has the power to debar its members from audits with or without directions from any authority. However, with this change, RBI is also vested with the power to debar auditors.

Scheme for Amalgamation and/or Reconstruction:

 RBI may frame a scheme for amalgamation and/or reconstruction of NBFCs with any other NBFCs and/or splitting of the NBFCs into different units or institutions and vesting viable and non-viable businesses in separate units or institutions to establish Bridge Institutions.

“Bridge Institutions” mean temporary institutional arrangement made under the scheme, to preserve the continuity of the activities of NBFCs that are critical to the functioning of the financial system.

Once RBI frames the scheme it is understood that the Companies will have to adopt the NCLT Process to obtain necessary orders.

 

Information of Group Companies:

RBI is empowered to seek statements and information relating to the business or affairs of any group company of NBFCs where it considers necessary or expedient to obtain. Further, the bank may cause an inspection or audit of any Group Company.

“Group Company” shall mean an arrangement involving two or more entities related to each other through any of the following relationships, namely: –

(i) subsidiary- parent (as may be notified by the RBI in accordance with Accounting Standards);

(ii) joint venture (as may be notified by the RBI in accordance with Accounting Standards);

(iii) associate (as may be notified by the RBI in accordance with Accounting Standards);

(iv) promoter-promotee (under the Securities and Exchange Board of India Act, 1992 or the rules or regulations made thereunder for listed companies);

(v) related party;

(vi) common brand name (that is usage of a registered brand name of an entity by another entity for business purposes); and

(vii) investment in equity shares of twenty percent. and above in the entity.

Penalties/Fine:

The penalties/fine for non-compliance under various provisions has also been increased as follows:

Sl. No.

Description of the Penalties

Existing Amount of Penalty/Fine

Proposed revision of the Penalty/Fine amount

1.       

If any person fails to produce any documents or any books.

Fine of Rs. 2000/- for each offence and Rs. 100/- per day where failure is continuous.

Fine of Rs. 100000/- for each offence and Rs. 5000/- per day where failure is continuous.

2.       

Non-Compliance of Section 45IA (1) of the RBI Act, 1934.

Maximum fine of Rs. 500000/- along with imprisonment.

Maximum fine of Rs. 2500000/- along with imprisonment.

3.       

Failure by the Auditor to comply with any direction given or order made by the RBI.

Maximum Fine of Rs. 5000/-

Maximum Fine of Rs. 1000000/-

4.       

Person who fails to comply with any direction given or order made by the RBI.

Fine of Rs. 50/- per day during which non-compliance continues.

Fine of Rs. 5000/- per day during which non-compliance continues.

5.       

Any person guilty of non-compliance with the provisions of NBFCs.

Fine upto Rs. 2000/- and Rs. 100/- per day during which non-compliance continues.

Fine upto Rs. 100000/- and Rs. 10000/- per day during which non-compliance continues.

Conclusion:

With high-risk entities such as small and medium enterprises (SMEs), real estate developers, and auto manufacturers majorly relying on NBFCs for their funding requirements, it is crucial that they are effectively managed to reduce the chances of them slipping into a major crisis. The proposed changes to the NBFC’s regulations are endeavoured to provide liquidity as well as increasing their commitment as reliable lenders. Sound implementation of these measures is vital to bring back the NBFC sector to a solid ground

References 

[i] https://www.livemint.com/

[ii] https://www.indiabudget.gov.in/budgetspeech.php

[iii] https://www.indiabudget.gov.in/finance_bill.php

 

 

 

Image Credits: Photo by Ishant Mishra on Unsplash 

With high risk entities such as small and medium enterprises (SMEs), real estate developers and auto manufacturers majorly relying on NBFCs for their funding requirements, it is crucial that they are effectively managed to reduce the chances of them slipping into a major crisis. The proposed changes to the NBFC’s regulations are endeavoured to provide liquidity as well as increasing their commitment as reliable lenders. 

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