CONSOLIDATION OF BANKS – Part 2

With recent government announcement of merging 10 public sector banks into 4 banks in order to foster further banking reforms, total number of  state run banks  have been brought down from 27 (2017) to 12. Government clarified that this process will rationalize the demand on government finances for capital infusion.

An analysis of the data provided in the finance ministry’s presentation shows that the larger banks stand to benefit more in terms of capital adequacy than the smaller lenders, a sharp departure from the past, wherein the government infused capital in their balance sheets year after year.

Way back in 2016, through my blog “Consolidation of Banks- a noval suggestion”  (published in my  blogspot www.itstrgulati.blogspot.com  &  in my website www.bankingquest.com) which was also published in “Business Standard” dated 09.03.2016 under the heading “Bifurcating Capital”;  I advised the Expert Committee on consolidation of public sector banks to ponder over the innovative structure of banks.

I cautioned the government that having 20, or in  its place, five nationalized banks would not serve the purpose if they do the same type of business, selling similar products and competing among themselves.

I advised that let there be specialized banks:-

a)      Large Banks for projects and infrastructure financing and having overseas presence;

b)      Small and medium enterprises (SME) Banks to meet the needs of the SME sector, thus aiding Make in India;

c)      Retail Banks that concentrate on the retail and priority sectors, tax collection and miscellaneous functions such as financial inclusion and subsidy distribution.

My suggestion was – let the consolidation be based upon the core strength of banks, existing and proposed, and their jurisdiction be clearly demarcated.

The government move is clearly in tune with my suggestion. Finance Minster Mrs Nirmala Sitharaman, in her presentation, has bifurcated the PSBs in three categories:-

1.      Banks with strong national & global reach;

a.      Punjab National Bank (+Oriental Bank of Commerce + United Bank of India)

b.      Canara Bank (+Syndicate Bank)

c.       Union Bank of India (+Andhra Bank + Corporation Bank)

d.      Indian Bank (+Allahabad Bank)

e.      State Bank of India (amalgamated earlier)

f.        Bank of Baroda (amalgamated earlier)

2.      Banks with national presence;

a.      Bank of India

b.      Central Bank of India

3.      Banks with regional focus;

a.      Indian Overseas Bank

b.      UCO Bank

c.       Bank of Maharashtra

d.      Punjab and Sind Bank

Exactly on the lines of my advice, government has divided the banks into  three categories  based upon   their core strength,  and   their jurisdiction is also clearly demarcated. Though in each category, number of banks are many, but with the passage of time, each category will have only one bank. Government should be one player in the market competing with the private sector. Public Sector Bank should be so strong as to compete with private banks. It’s not rational that PSBs keep on competing among themselves.

Regarding the clarification of the government that this process of consolidation will rationalize the demand on government finances for capital infusion, I had suggested in my said article (Business Standard dated 09.03.2016) as below:-

“The capital requirement of these banks should be stipulated. As the Large Banks would be competing with those around the world, their capital requirement should be according to Basel norms. SME Banks would mainly work within India, so their capital requirement could be less than that of the large banks. Retail Banks’ capital requirement would be the least, as their operations would be local, and they would have government guarantee.

“Instead of giving capital proportionately, let it be bifurcated into developmental capital and survival capital. The bigger chunk should be allotted as developmental capital and given to large banks and SME banks. Retail banks should be given only survival capital. This way the government would not have to shell out a large amount of funds and yet the social responsibility of public sector banks would be met”

TILAK GULATI

CEO

Banking Quest

Asset Resolution through Insolvency and Bankruptcy Code (IBC), 2016

Ever since the financial market  has come into existence, the problem of loan default is  haunting the banking sector. Since 1990s, under BASEL norms, NPA concept has been  implemented to assess the real health of the credit portfolio of  banks. Many a laws have been enacted to have effective and timely recovery in the loan accounts. BIFR proceedings under Sick Industries  Companies Act, Debt Recovery Tribunal,  SARFAESI Act, Lok Adalat, civil courts, all have been performing their roles to help banks make effective recovery. Inspite of all these institutions and the laws, NPAs of the banking sector are mounting up.

It is not that all loans go bad due  to malicious intention of the debtors. The problem is when a loan starts showing the symptoms of sickness or it goes bad, the banker become interested in recovery whereas the borrower is more  interested in rehabilitation. There arises  the conflict of interest between the debtor and the creditor.

The reasons of this conflict may be many; the most important was the absence regulations, which  could define the common guidelines, standard procedure and fixed time line to  achieve the desired goal. Due to lack of common regulations, if a banker goes for SARFAESI action, the borrower appeals to DRT;  if the banker approaches  High Court for  liquidation of a company, the company goes to BIFR for rehabilitation. In a nutshell, all these previous laws have not come up to the  expectations of the bankers.

The Insolvency and Bankruptcy Code, 2016 has tried to address all these issues.  Insolvency is the stage when a borrower is unable to pay his dues in time. And the bankruptcy is the legal status when a court declares a borrower  bankrupt since he is not able to pay his liabilities out of his total assets. The bankruptcy  laws in India are very old,  made under the British Raj. However, with some modifications, the bankruptcy laws have also found places in its own ways under the SICA, DRT and SARFAESI Act. The Insolvency and Bankruptcy Code (IBC), 2016 has been enacted to merge all these existing laws related to insolvency and bankruptcy. Though it  is a new tool for recovery for the bankers, but it  is viewed positively by both the lenders as well the borrowers. How far it will succeed and how effective it will be, we have tried to address in our one day workshop on “Asset Resolution through Insolvency and Bankruptcy Code (IBC), 2016”.

For workshop or webinar on different areas of banking, please visit my website www.bankingquest.com . At Banking Quest, we endeavor to   spread awareness about the basic banking guidelines among the public, in general and the youngsters joining the banking industry, in particular. Banking industry is fast changing and also passing through turbulent phase of rising NPAs and the financial frauds. The present situation has endangered the career of the young bankers and also the deposits of the general public.

Banking Quest aims to support the present and the aspiring bankers by updating their knowledge through the platform of this website (www.bankingquest.com) ,  online coaching and by conducting the off-site workshops

Tilak Gulati

Executive Trainer

Anti-Money Laundering/Combating the Financing of Terrorism

The motive of AML/CFT are:-

1.   To protect the integrity and stability of the  financial system

2.   To cut off the resources available to terrorists

3.   To make it more difficult for those engaged in crime to profit from their criminal activities

What is Money Laundering

Criminal activities, such as drug trafficking, smuggling, human trafficking, corruption and others, tend to generate large amounts of profits for the persons carrying out the criminal act.

 However, by using funds from such illicit sources, criminals risk drawing the authorities' attention to the underlying criminal activity and exposing themselves to criminal prosecution. In order to benefit freely from the proceeds of their crime, they must therefore conceal the illicit origin of these funds.

Money laundering" is the process by which proceeds from a criminal activity are disguised to conceal their illicit origin. Terrorist financing is the collection of funds for terrorist purposes. In the case of money laundering, the funds are always of illicit origin, whereas in the case of terrorist financing, funds can stem from both legal and illicit sources.

In both cases, the perpetrators of crime  make an illegitimate use of the financial sector.

Methodology of Money Laundering

Criminals are very creative in developing methods to launder money.

·         Structuring: Often known as smurfing, this is a method of placement whereby cash is broken into smaller deposits of money, used to defeat suspicion of money laundering and to avoid anti-money laundering reporting requirements.

·         Bulk cash smuggling: This involves physically smuggling cash to another country and depositing it in a financial institution with greater bank secrecy or less rigorous money laundering enforcement.

·         Cash-intensive businesses: In this method, a business typically expected to receive a large proportion of its revenue as cash uses its accounts to deposit criminally derived cash. Examples are parking structures, strip clubs, tanning salons, car washes, arcades, bars, restaurants, and casinos.

·         Trade-based laundering: This involves under- or over-valuing invoices to disguise the movement of money.

·         Shell companies : Money is routed through the bank accounts of companies which are only on papers and doing no business.

·         Round-tripping: The money is routed through different countries to be received back as Foreign Direct Investment.

·         Bank capture: In this case, money launderers or criminals buy a controlling interest in a bank, preferably in a jurisdiction with weak money laundering controls, and then move money through the bank without scrutiny.

·         Casinos:  in casinos, winners are paid through cheques. The illicit money is converted and shown as proceeds of win.

·         Real estate: Someone purchases real estate with illegal proceeds and then sells the property. To outsiders, the proceeds from the sale look like legitimate income.

·         Black salaries: A company may have unregistered employees without written contracts and pay them cash salaries. Dirty money might be used to pay them.

How, banks are used by money launderers

Money Launderers generally use three stages  to clean their dirty money through banking channel:-

Placement is the first stage in money laundering where the cash proceeds of criminal activity enter into the financial system.

This is most critical stage for any money launderer as the criminal can effectively mask his ‘dirty’ funds by  mixing with  his ‘clean’ funds and create an impression of legitimacy.

Examples of Placement include:

·         Depositing cash  below threshold reporting limits for AML purposes into multiple bank accounts

·         Purchasing demand drafts for cash and depositing the same into bank account.

Layering is the second stage in money laundering where attempts are made to distance the money from its illegal source through layers of financial transactions.

Examples of Layering include:

·         Sending funds to different onshore and offshore bank accounts

·         Creating complex financial transactions

·         Loans and borrowing against financial and non-financial assets

Integration is the third stage of money laundering. This stage involves the re-introduction of the illegal proceeds into legitimate commerce by providing a legitimate-appearing explanation for the funds.

Examples of Integration include:

·         Buying businesses

·         Investing in luxury goods

·         Buying commercial property

·         Buying residential property

It is clear from above that banking institutions are required by money launderers to conceal their illegal funds and that is why it is important that Know-Your-Customer (KYC) checks are done on customers. In certain cases there may be a need for Enhanced Due Diligence (EDD) on clients.

Money laundering can’t happen without banks being involved somewhere within the three stages. Since they are our first line of defence against criminals, by having robust controls and access to accurate KYC data, banks will prevent many money laundering attempts. 

Tilak Gulati

Executive Trainer & Blogger

Author: www.itstrgulati.blogspot.in     

Arbitrage on Bitcoin – legal issues

Preface

Finance Minister Arun Jaitley says government do not recognize crypto-currency as legal tender, but he has not categorically declared crypto as illegal. However, there are many laws and regulations in India which may make life miserable of the persons dealing in Bitcoin. This article is an attempt to explain these laws which the persons dealing in crypto-currency must be aware of. 

Mains

Crypto-currency, especially, Bitcoin has become controversial. A few countries, like US and Japan have  allowed crypto exchanges, whereas  China and South Korea have banned dealing in Bitcoin. India is in a fix- neither giving it a legal status nor declaring it illegal. Ministry of Finance formed a committee in April 2017 to submit its report within three months whether to allow crypto-currencies to be traded in India. If yes,  how to deal with it- as a legal tender or as an asset; who would be the regulator;  and the  safe guards to be adopted to protect  interest of the nation.

Union finance minister Arun Jaitley, in his Budget 2018 speech said that government  does not recognize  crypto-currencies such as Bitcoin, Ripple and Etherium as "legal tender" and as such will discourage their use. Mr Jaitley further  said that his government "will take all measures to eliminate the use of crypto in financing illegitimate operations".

The statement of Finance Minister has further confused the nation. Of course, no government will recognize crypto-currency as legal tender. FM has kept mum as to (a) whether he will treat crypto as an asset or an investment opportunity (b)  whether unregulated crypto exchanges will be  allowed to operate in India, and (c) what is the stand of the government if legitimate operations are conducted through the medium of crypto-currencies.

Due to this confused state  investors are put to high risk area- if they don’t invest, they may lose a golden opportunity to earn handsome profit (people have become multi-millionaire over  a short span by investing in Bitcoin) – and if they invest and lose their money, there is no authority to help them. Government has spared itself from  responsibility by a simple statement that it considers Bitcoin equivalent to Ponzi Scheme. Similarly, Reserve Bank also keeps on issuing advisories periodically to desist investors dealing in crypto. Billion of rupees in the shape of Bitcoin are being traded through unregulated exchanges;  government and the RBI are simply issuing advisories without taking any concrete steps to safe guard the innocent investors.

Let’s first analyze why the governments of nations are confused about  the Bitcoin. After the US sub prime crises in 2008 and the fall of Lehman Bros; the trust on banking industry was shaken. Satoshi Nakamoto, an unknown entity, published a paper on peer to peer money transfer through the medium  of Bitcoin, a virtual currency, using block-chain technology wherein the control of a single agency or the government or the nation  was wished out. Under the new scheme, the transaction control was diversified in the hands of numerous participants spread over different  corners of the world. Blockchain technology augmented  peer-to-peer transactions eliminating the role of intermediate banking industry.

The concept of virtual currency was welcomed on many counts:-

One: The fiat currencies of nations are of national character whereas its citizens are becoming global in stature. Instead of exchanging currencies every now and then while travelling to different countries; these global characters were long wishing a global currency. Bitcoin fulfilled their wish being global in nature.

Two: In a family of four persons, if all are staying in different countries and  one member wants to send some money to the other, one has to go through the banking channel paying their hefty charges. In international transactions, banks conduit a trust between two unknown entities and charge for this trust. But what trust banks give in a transaction between father and his son living in different countries. Why do they require a bank in between.  Bitcoin facilitates peer-to-peer transaction.

Three:  The circulation of Bitcoin are fixed in numbers, ie, maximum 21 million will come into circulation. It cannot be misused by the governments for meeting their deficit financing or populist election expenditure as is done in fiat currencies wherein governments print ‘n’ number of currency notes thus devaluing their own currency. Whereas the value of Bitcoin will always be increasing since its supply is fixed and demand will keep on increasing. Thus investing in Bitcoin is beneficial in the long run than investing in fiat currency.

In spite of so many benefits, no government would like to declare it a legal tender, because then it will lose its status of monetary authority. Bitcoin is posing a big threat to the monetary system of the nations. A day may come when all the governments the world over  may join hands to combat this big demon but may not succeed.

Recently, Income Tax Department  raided crypto-currency exchanges in India with the sole objective to know whether investors have paid taxes on profits out of sale of Bitcoin. Income Tax Department is not concerned about the legality of the transaction. As per income tax rules, “Income is income, though tainted. For purpose of Income-tax, there is no difference between legal and tainted income. Even illegal income is taxed just like any legal income. By taxing such income, the state is not taking part in the crime or condoning it, nor would become a principal or a sharer in the illegality. The revenue merely looks at an accomplished fact, viz, on profits having earned and assess the same”.

Hence by paying tax over the profit earned on a transaction  will not make it legal if otherwise it is not- the same is the case with crypto-currencies.

Naïve investors are attracted towards the price difference of Bitcoin in US and Indian exchanges;  and resort to Arbitrage of crypto-currency.  Let’s illustrate with example:-

A Non-Resident Indian staying in US comes across an arbitrage opportunity (on 02nd February, 2018) wherein he can buy a Bitcoin in US exchange Coinbase for USD 10085 and to sell in Indian exchange Koinex for         INR  725000 (which is equivalent to USD  11382). He has two options available to complete this arbitrage:-

1.      Buy in US exchange for USD 10085; transfer to Indian exchange in his own account; sells it for  INR 725000; transfer rupee funds to his NRO account; finally remit these funds (USD 11382) to US  from his NRO account. If he has to pay USD 500 for exchanges/banks’ charges and currency conversion cost etc, still he can pocket USD 797 as arbitrage profit.  As a law-abiding citizen, he also pays income-tax on this profit, still a handsome gain.

Looks lucrative.  But FEMA comes into picture. As per FEMA, permissible credits in NRO account are:-

a.      Proceeds of remittances received in any permitted currency from outside India through normal banking channels.

b.      Legitimate dues in India of  the account holder like rent, dividend, interest, pension etc.

Now question arises whether (a) sale proceeds of Bitcoin in India is considered as remittance from outside India  or (b)  is it  a legitimate dues in India. No bank will allow to  deposit  such funds in NRO accounts without clarification from RBI;  and RBI will never permit. Hence this rout of arbitrage is partially blocked.

Even if RBI permits to deposit the sale proceeds in NRO account; whether the account holder can repatriate the funds abroad. As per FEMA, permissible debits in NRO accounts are:-

a.      All local payments in rupee.

b.      Remittance outside India of current income in India of the account holder like rent, dividend, pension, interest etc.

c.       Remittance up to USD one million per financial year, for all bona fide purposes, to the satisfaction of Authorized Dealer Bank.

Again a question; whether AD Bank will consider this as remittance for bona fide purpose in the light of fact that government of India and RBI are against the crypto-currency.

2.      The second option to complete this arbitrage is : NRI purchases Bitcoin from US exchange;  gifts this to his blood relation in India; the relative sells Bitcoin in India; pays short term capital gain tax on the profits earned.  As per US laws, gift tax is levied on the donor. A US resident is exempt from gift tax if he gifts maximum of USD 14000 to one recipient in a year. As per Indian laws, gift tax is applicable in the hands of recipient and any gift from  blood relation is totally exempt. However, on the sale of gifted assets, while calculating  capital gain, cost of the asset is taken as was incurred by the previous owner.

Here Foreign Contribution (Regulation) Act, 2011 poses hurdles. As per website of Ministry of Home Affairs , purpose of FCRA is to facilitate receipt of foreign contribution for genuine purposes, without compromising national security.  Though foreign contribution received from a relative is exempt, intimation is required to be submitted to the Ministry of Home Affairs in form FC-1 if foreign contribution received in a financial year exceeds rupee one lakh.

In the light of aversion towards crypto-currency by the government, how many question will be asked to recipient of Bitcoin. Since Bitcoin was purchased in dollar from US exchange and sold in India, government may consider it foreign remittance in India.

Recently, Bank of International Settlement has exhorted the member Central Banks to deal strictly with crypto-currencies as these pose danger to the basic foundation of monetary system of the world.

Bitcoin will stay or not, only time will tell. For the time being, governments are confused how to regulate it.

Epilogue

I put this article for general debate seeking suggestions – for and against crypto-currencies; and possible safeguards to be taken – which can be escalated at the appropriate forum making it easy for the government to enact regulations. 

Tilak Gulati,
Executive Trainer & Blogger.
Principal (Retd), Staff Training College, UCO Bank
 

Author:  www.itstrgulati.blogspot.in

Resume: https://in.linkedin.com/in/tilakgulati