From UPSC perspective, the following things are important :
Prelims level : Not much
Mains level : Paper 3- Current account opening restriction to deal with the NPA issue
Some bank borrowers have gone to court demanding that it quash the Reserve Bank of India (RBI) circular dated August 6, 2020 on opening current accounts.
- Current accounts with non-lending banks are an important channel for diversion.
- Diversion of funds is a major reason for large non-performing assets (NPAs).
- Internal diversion is for non-priority purposes and funds can also be diverted to other firms, owned or controlled by the same group, friends or relatives.
- To prevent this, the RBI mandates a No-Objection Certificate (NOC) from lending banks before opening such accounts.
- Banks should verify with CRILC, the RBI credit database, and inform lenders. Banks should also obtain a NOC from the drawee bank when an account is opened through cheques.
- Widespread non-compliance with mandated safeguards forced the RBI to bar non-lending banks from opening current accounts for large borrowers.
- Thus, if borrowing is through a cash credit or overdraft account, no bank can open a current account.
What are the current regulations?
- If a borrower has no cash credit or overdraft account, a current account can be opened subject to restrictions.
- If the bank’s exposure is less than 10% of total borrowings, debits to the account can only be for transfers to accounts with a designated bank.
- If total borrowing is ₹50 crore or more, there should be an escrow mechanism managed by one bank which alone can open a current account.
- Other lending banks can open ‘collection accounts’ from which funds will be periodically transferred to the escrow account.
- If the borrowing is between ₹5 crore and ₹50 crore, lending banks can open current accounts.
- Non-lending banks can open collection accounts.
- If borrowing is below ₹5 crore, even non-lending banks can open current accounts.
- The working capital credit should be bifurcated into loan and cash credit components at individual bank levels.
Issues with regulations
- If a borrower has an overdraft, how can there not be a current account?
- An overdraft is the right to overdraw in a current account up to a limit.
- The second issue is that the circular forecloses such operational flexibility.
- Third, why should a bank with low exposure transfer funds to another bank when it can use it to adjust other dues with it?
- Fourth, share in borrowing is not static. Crossing the threshold both ways could happen often.
- Fifth, there is a mismatch between what a borrower needs and the regulations allow.
- Support of non-lending banks through current accounts in other banks is required for large accounts.
- Sixth, transactions in an active current account enables a bank to monitor a borrower’s account, however small.
- The lack of such control was why large development financial institutions of yesteryear built up huge NPAs.
- Seventh, the regulation mandates splitting working capital into loan and cash credit components across all banks.
- Such a one-size-fits-all regulation does not factor in the purpose of the different facilities.
- A large company might avail itself of loans in Mumbai, but require current accounts with another bank in Assam where it might have a factory.
- Lack of flexibility: Rules are not flexible, do not provide for unforeseen circumstances, and can be easily circumvented.
- Use more generic terms: Regulation needs to use more generic terms. Terms such as Working Capital Term Loan might mean different things in different banks.
- Diversion of fund is risk better dealt by banks: Is it not better to leave management of exceptional risks such as diversion of funds to the banks?
- The cost of regulation: the costs of regulation be justified by the benefits.
When regulation ignores market practices, it lacks legitimacy, a construct from neo-institutionalist literature. When legitimacy is wanting, compliance suffers.