With the economic growth picking up pace and the investment cycle on the way to recovery, the banking sector has witnessed a transformation in its vital role of intermediating between the demand and supply of funds.

The revived credit offtake (both from the food and non food segments) and technological reforms have paved the way for a change in the dynamics of the sector itself. Besides gearing up for the compliance with Basel accord, the sector is also looking forward to consolidation and investments on the FDI front.

Budget Measures Autonomy to RBI to implement reforms in banking sector. Amendment of the Banking Regulation Act. Allow banking companies to issue preference shares to boost their Tier-I capital. Introduce provisions to enable the consolidated supervision of banks and their subsidiaries by RBI. Increase bank lending to agricultural sector by 30% and PSU banks to increase number of agricultural borrowers by 5 m. Remove the lower and upper bounds to the statutory liquidity ratio (SLR) and removal of the limits on the cash reserve ratio (CRR) to provide flexibility to RBI to prescribe prudential norms Enable RBI to lend or borrow securities by way of repo, reverse repo or otherwise. 0.1% banking transaction tax to be imposed on cash withdrawals above Rs 10,000 on a single day. Removal of benefits available to depositors (Section 80-L)  Budget Impact Higher autonomy to RBI will enable the apex bank to vary the CRR and SLR limits as per the liquidity requirements of banks (in consonance with the credit growth) and this in turn, will facilitate more flexible conduct of monetary policy. Also, enabling RBI to lend or borrow securities by way of repo or reverse repo will enhance trading of government securities. The proposal to amend the Banking Regulation Act does not specify the intended modifications to be brought in the act. However, the same may consider the enhancement of FDI limits and higher voting rights cap. Allowing banking companies to issue preference shares will enable them to infuse more Tier I capital and thereby help them comply with Basel requirements Mandation on PSU banks to hike their agricultural lending may resurface the problem of NPAs for these banks. Banks are also likely to be the beneficiaries of higher infrastructure lending by way of routing their funds through the 'Infrastructure financing SPV' for eligible and appraised projects. While this would provide an impetus to core advances of banks, the quality of such advances is likely to be better. In this light, there is relatively less NPA risk. The 0.1% banking transaction tax will discourage cash transactions. The removal of benefits to individuals with respect to Section 80-L i.e. deduction to a limit on interest on bank deposits could impact deposit growth.  Sector Outlook The budget has been a mixed one for the banking sector. While there is increased flexibility, the move to boost agriculture advances is likely to have a much larger impact on PSU majors. While we expect the credit growth to remain robust (though slower than 21% in the recent past), not all banks will be able to reap the benefit from such sector trends. Enhanced lending to agriculture and priority sectors (including infrastructure lending) will require banks to exercise more caution on the NPA front. Amendments to Banking Regulation Act may however, fulfill the key objectives of competition, consolidation and convergence as highlighted in the Budget speech.  Industry Wish List Anuj Kumar (Head - Strategic Planning, Centurion Bank) Clarity on FDI in private banks Clarity on voting rights in private banks Risk weightages for Capital Adequacy purposes should be moved closer to Basel II norms Rationalisation of tax structures - simplify direct taxation and push implementation of VAT Reduction of subsidies and non infrastructure spending to bring the fiscal deficit under control CII and FICCI Voting rights should be made pari-passu with the shareholding in private sector banks Encourage consolidation, allow private banks the benefit of carry forward and set off of accumulated losses Permit banks to raise long-term funds and exempt these from SLR and CRR Allow deduction for initial contribution of capital by banks in asset reconstruction companies (ARCs) and exempt ARCs from tax Reactivate project financing by strengthening development financial institutions so that long-term funds are available for 10-15 year duration to the corporate sector at a lower 5-6% interest rate  Budget over the years Budget 2002-03 Budget 2003-04 Budget 2004-05 Cut in most administered interest rates by 0.5% (by 50 basis points) from March 1, 2002. Setting up of Asset Reconstruction Company by June 2002. Banks are now allowed to deduct 7.5% of their total income against provisions made by them for bad and doubtful debts. Banks are given option to deduct up to 10% of their non-performing assets (NPAs) falling in the category of loss or doubtful assets from total income. Bill on the banking sector reforms is to be introduced in Parliament. Foreign banks permitted to operate in India with fully owned branches after the specific permission of RBI. The FDI limit in private sector banks has been raised to 74% from the existing 49%. The SBI [Get Quote] will have to lend at lower rates to the agricultural sector as well as SSIs. SBI will now offer loans in the range 2% above its Prime Lending Rate (PLR) or 2% below its PLR. Tax exemption on interest on housing loans maintained at Rs 150,000 per year. The government has agreed to buy back older government borrowing with high interest rates from banks. Reduction in the interest rates on all small savings schemes by 1%. The government proposed to double credit to the agriculture sector in the next three years. Significant emphasis on making credit available towards infrastructure development. Inter-institutional group comprising select banks and financial institutions incorporated to ensure speedy conclusion of loan agreements for infrastructure projects. Nearly Rs 400 bn will be kept aside by this consortium for infrastructure support. Task force to be set up to explore reforms in the cooperative banking sector. Securitisation Act to be amended. FDI in the insurance sector to be hiked from 26% to 49%. [Read more on Budget 2004-05]
Key Positives Amendment to Securitisation Act: The amendment proposed to make it mandatory for borrowers who prefer an appeal to the Debt Recovery Appellate Tribunal (DRAT), to deposit upfront 50 % of the amount decreed by the DRT (Debt Recovery Tribunal). However, the DRT can reduce the upfront payment to 25 per cent. The said amendment reduced the possibility of defaulters delaying the recovery process through frivolous appeals. One time transfer of assets from AFS to HTM: The RBI initiated one time transfer of investments from AFS to HTM category safeguarded the banks' investment portfolio to the vagaries of the interest rate movements. Tax breaks for consolidation: The finance ministry proposed amendments in the tax laws to offer tax breaks under section 72A in all involuntary amalgamations of banking companies- that are initiated through the action of RBI. Tax breaks will also be offered to FIs merging with banks. Higher margin on advances against shares: To reiterate its concern over the huge FII inflows and hinting at its possible "temporary" nature, RBI has increased the margins on all advances against shares from 40% to 50%. The regulator has also advised banks to raise the minimum cash margin of 20% to 25%. The move is aimed to protect banks that fund investments, against a sharp drop in share prices. FII limit from 20% to 49% in PSU banks: MoF is considering raising the FII limit from 20% to 49% - the maximum possible in PSU banks, so as to allow PSU banks to issue ADRs and GDRs while keeping the overall government equity limit of 51%. Overseas listing will not only bring better transparency and efficiency in the banks' operations but also enable the banks access global capital markets at competitive rates. Clarity on the risk evaluation front: RBI's draft guidelines for implementation of Basel II in India clarified the ambiguity that was persisting on the 'approach' to be adopted for risk evaluation. Keeping in view the goal to have consistency and harmony with international standards, the RBI decided that all banks in India should adopt ' standardized approach' for credit risk and 'basic indicator approach' for operational risk.		Key Negatives Liquidity crunch: The SEBI dictate that Mutual funds will not to be allowed to invest in bank deposits might create liquidity crunch for the banks in the short term, forcing them to accept deposits at higher rates and paring their interest margins. Hike in wages: The 8th bipartite wage settlement that paved the way for 13.25% hike in wages has caused accumulation of huge arrears to the tune of Rs 66 bn to be paid to the bank employees across the industry. The hike in wages was more than what the banks had expected and provisioned for and therefore the entities will have to provide for them in the coming quarters. Interest rate dampener: The interest rate movement in the short term is likely to be with an upward bias. Although a marginal hike will not trigger any sensitivity, an upward movement in inflation, leading to a parallel rise in interest rates may put the current credit growth on hold. Impediments in sectoral reforms: The hike in the FDI cap in private banking sector to 74% and a revision in the voting rights to make it commensurate with equity holding were expected to bring sea changes in the Indian banking scenario. However, opposition from Left and resultant cautious approach from the North Block may hamper the reforms to materializing in the near term.

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