Author: root

Loan guarantor? Know these risk factors

Personal Finance

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Standing guarantee for a loan is providing a helping hand to someone who is unable to get a loan on their own.

However, it comes with increased liability and financial risk for the guarantor.

Here are some crucial factors that a person should consider before agreeing to be a loan guarantor.

Why a guarantor

Co-borrower(s) of a loan shares the responsibility of making regular repayments with the primary borrower.

Co-borrowers can be usually selected from the list of close relations specified by the lender.

A loan guarantor comes to the scene only when the primary borrower and co-borrower(s), if any, fail to repay the loan.

The guarantor can be anyone beyond the specific relations listed by the lender.

Lenders can ask a prospective borrower to loop in a guarantor when they are unsure or not satisfied with the primary and co-borrower’s eligibility and repayment capacity.

High loan amount, poor credit scores of loan applicants, primary borrower nearing or beyond the cut-off age for applicants, risky job profile or employer profile of the applicants, etc, are some factors that prompt lenders to ask for someone to stand guarantee for loan.

Lenders can ask for guarantors in any type of unsecured and secured loans.

As in the case of primary borrower and co-applicants, the lenders will consider the credit score, income, job profile, repayment capacity, employer profile, etc, of the proposed guarantor while evaluating their eligibility.

Liabilities of guarantor

A loan guarantor is liable for the timely repayment of the guaranteed loan in case the primary borrower and co-borrower(s), if any, fail to do so.

Whenever the default happens, the lender can demand the loan guarantor to step in and repay the outstanding loan amount along with the penal rates and charges incurred due to the non-payment of loan dues.

Hence, those being roped in as guarantors should persuade the primary applicant and co-applicant, if any, to opt for a loan protection insurance plan. This will reduce the liability of the loan guarantors arising from loan default due to unfortunate demise or disability of the primary/co-borrowers.

Remember that these insurance plans do not cover loan default, they only cover the contingency arising out of demise or disability of the primary/co-borrower of the loan.

Credit score, loan eligibility

Any default or delay in the loan repayment by the primary borrower and co-borrower(s) will adversely impact the credit score of the loan guarantor as well. Hence, before accepting the role of a guarantor, one should always make sure that the primary and co-borrowers are financially stable and disciplined to make timely repayments.

Existing guarantors should keep a close tab on the repayment activities in the loans they guaranteed. Alternatively, guarantors can also fetch their credit reports at regular intervals as any delay or default in repayments will reflect in their credit reports as well.

Once a person stands guarantee for a loan, the loan amount they are eligible for gets reduced by the outstanding amount in the guaranteed loan. Lenders consider the outstanding loan amount in the guaranteed loan as contingent liability of the guarantors. Hence, one should always assess one’s probable financing requirements in the short and mid term before committing to standing guarantee for a loan.

The loan guarantor cannot withdraw from their responsibility till the lender and primary and co-borrower(s) find a mutually acceptable new replacement for the original loan guarantor. This is another reason why a loan guarantor should carefully assess their near- and mid-term financing requirements before agreeing to be a guarantor.

The writer is Director, Unsecured Loans, Paisabazaar.com

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Readers Say – The Hindu BusinessLine

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This is in the context of a story titled ‘Why you shouldn’t delay repaying loans anymore’ that appeared in BusinessLine on September 6. It says: “Can you pay the entire EMIs pertaining to the moratorium period at one go to lessen the pain? If you have ample funds, that would seem a prudent move but it is likely that your bank may not allow such repayments. According to HDFC Bank website, the unpaid EMIs cannot be paid in lump sum.” What could be the economic reasoning for such a restriction by the bank?

Anil K Sood

Our response: Even in the case of normal loans, one cannot make lump-sum partial payments. At best, loan can be foreclosed after paying certain charges. This is essential for ALM ,or asset-liability management, by banks — loans and deposits coming up for payment at a specific time. Too much uncertainty in loan repayments can be hard to manage.

This is in the context of the story titled ‘What makes Petronet LNG a good bet over the long term’ that appeared in BusinessLine on August 23. It is indeed an insightful analysis . The key to boost revenues and profitability is the Kochi-Manglore pipeline and the associated network. It has taken ages for its completion due to various factors.

Vishal Kelkar

I thank you for responding to my query ‘What is indexation? How is it calculated? What is its relevance for tax treatment of STCG/LTCG in mutual funds?’ that appeared in BusinessLine on August 30. For better understanding for investors, students and academicians, certain concepts, including financial modelling, rental discounting, short-term money market instruments, index funds and G-Sec yields, may be explained in the coming days, highlighting their application, present trends and the precautions to be adopted by investors.

AS Venkata Rao

The BusinessLine Star Track MF Rating of MF is really good. It is unique as the star rating comprises rolling returns, downside risk and also one-year performance. It would be more helpful if the data was downloadable in excel format. Request you to rate overnight funds and liquid funds as well.

Raghavendra

Readers can share their views in the comments section on our website (thehindubusinessline.com/portfolio/). You can also send your feedback and suggestions to blportfolio@thehindu.co.in, or tweet at us @Blportfolio

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Why you shouldn’t delay repaying loans anymore

Personal Finance

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For many of us, the outbreak of Covid-19 pandemic has been quite a drain on our finances.The six-month moratorium on loan repayments provided by banks eased the pain of those who opted for the relief.

The moratorium on loan EMIs expired on August 31. The Supreme Court is currently hearing a matter regarding waiver of interest on loan moratorium. Hence more clarity on the moratorium and interest that banks have been charging on your loan under moratorium is awaited. However, it is advisable that you prepare yourself to resume your loan repayments and know your options. If you have given an auto debit mandate, then your bank will start debiting your EMIs from your account on the same day of the month as agreed upon earlier.

Will your EMIs remain the same as it was before opting for the moratorium? Can you pay a lump sum amount to clear your dues post moratorium period? Will the bank grant any additional relief if you are still unable to meet loan commitments ?

Here, we attempt to answer these queries based on our interactions with banks and FAQs put out on certain websites. These may of course change, post the SC’s final order.

No change in EMI amount

If you availed of the moratorium relief, you must remember that your bank would have continued to charge you interest on the outstanding loan amount at the rate applicable for the respective loan during the moratorium period (this is currently under review by the SC). This interest has been added to your principal amount–essentially the unpaid EMIs along with the accrued interest have been added to your loan outstanding.

This will result in the increase in the tenure (residual) of your loan and not your EMIs. Hence your EMI would remain the same but the tenure of your loan would have increased. For instance, if you had taken a home loan from SBI of ₹30 lakh with a remaining tenure of 15 years, the additional interest payable would be about ₹4.54 lakhin case you availed moratorium for six months. This would lead to increase in tenure of your loan by 16 months (additional 16 EMIs). The revised repayment schedule will be mailed to your registered email ID. You can also login to NetBanking and download the repayment schedule.

As has been communicated by various banks before and advised earlier (https://www.thehindubusinessline.com/portfolio/personal-finance/go-for-emi-moratorium-only-if-you-are-cash-crunched/article31235150.ece), deferment of big-ticket loan payments can pinch you quite a bit, given the substantial increase in the overall interest and loan tenure. But if you have still opted for the moratorium, owing to your financial situation, start making payments right away.

Can you pay the entire EMIs pertaining to the moratorium period at one go to lessen the pain? If you have ample funds, that would seem a prudent move but it is likely that your bank may not allow such repayments. According to HDFC Bank website, the unpaid EMIs cannot be paid in lump sum. But you can contact your bank to see if any option is available for you to settle payments in lump sum. Also, you can foreclose your loan if you have sufficient funds. Do check for foreclosure charges though.

Track your credit score

If you opted for the moratorium, remember that it would not have qualified as a default and hence your credit score should not have been affected. But it is advisable that you run a check on your credit score to ensure that there has not been any adverse impact on it because of opting for the the moratorium. Credit scores are given by credit bureaus such as CIBIL and Experian. You can approach them if you notice any change in your credit score during the moratorium period.

But note that any delay in payment of dues after the expiry of the moratorium could qualify as default and impact your credit score. Hence, if you have the necessary funds, clear your dues on time now onwards to avoid a negative impact on your credit score which can affect your loan-taking ability in future (may also lead to higher loan rates in future).

Restructuring is an option

All of the above mentioned points apply only if you are comfortable paying your EMIs. What if you are still cash-crunched and are unable to resume EMI payments ?

In a bid to provide some relief to borrowers amid the pandemic-induced crisis, the Reserve Bank of India (RBI) had allowed banks to restructure loans across the board — auto, credit card, housing, personal loans, education and loans given for investment in financial assets such as shares, debentures etc.

Restructuring normally involves rescheduling of EMIs (maybe lower outgo), grant of additional moratorium or extension of loan tenure to allow borrowers some breathing space. However, individual banks may or may not grant such relief based on their assessment of the borrower’s income stream, past record or other parameters. Hence, check with your bank on what they can offer you.

In any case, the maximum period by which the loan can be extended (if restructured) is two years, according to the RBI regulations. Also, you are eligible for a loan restructuring only if your account was ‘standard’— not in default for more than 30 days as on March 1, 2020.

Above all if you are able to source additional funds and repay your EMIs that would always be a better option than going in for restructuring, which can increase your burden over a period of time and may impact your credit score too.

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What should home buyers know about stamp duty and registration charges?

Personal Finance

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Since the outbreak of the Covid-19 pandemic, demand for house property has slowed, with many postponing big-ticket purchases. In a bid to attract home buyers, the Maharashtra Government recently announced reduction in stamp duty rates on property purchases. It has lowered the stamp duty rate to 2 per cent (from 5 per cent) of the property value; this is applicable across Maharashtra from September 1 to December 31, 2020. The State has kept the stamp duty rate at 3 per cent from January 2021 to March 31. This reduction in stamp duty rates is expected to boost residential demand, and help developers bring down the level of unsold inventories in the market.

With demand slowdown in the property market and economic uncertainty, property prices too have remained stagnant, and in some regions it has declined. As stamp duty rates (and registration charges) add to the total cost of the property, any increase or decrease in these rates influences demand to some extent. So, if you are looking to buy a property, it would be good to have a fair idea about these charges.

Basics

In addition to the property price, a home buyer has to incur other charges as well, most of which are mandatory. Among such unavoidable expenses are stamp duty and registration charges that are payable to the respective state Governments.

Stamp duty is the tax levied when a property is transferred from the seller to the buyer.

The receipt or acknowledgement of payment of stamp duty is a crucial, legally recognised document that acts as proof of ownership in court, in case of any dispute. So you are considered an owner of a house property when your sale agreement is registered and signed, and the stamp duty and registration charges are paid. Stamp duty is applicable on conveyance deeds, sale deeds and power of attorney papers and this rate varies with each State (2-8 per cent). For instance, stamp duty in Maharashtra is currently around 2 per cent of the value of the property, while in Tamil Nadu, it is around 7 per cent.

Registration fee, on the other hand, is charged to record the execution of transaction between the buyer and the seller. This, too, varies with each State. For instance, in Maharashtra, registration charges are around ₹30,000 (flat fee), while in Karnataka, it is 1 per cent of the value of the property.

The amount paid as stamp duty and registration charges depends on the value of the property and the circle rate (price of the residential or commercial property or land for a given area, published and regulated by the state government), whichever is higher.

Aarthi Lakshminarayanan, Partner, Shardul Amarchand Mangaldas & Co, says “The value of any house or building, in Tamil Nadu, is arrived at based on a common schedule of plinth area rates prepared by the PWD department and published by the Government of Tamil Nadu every year”.

Do keep in mind that, both stamp duty and registration charges, are over and above the purchase value of the property. So, if you are a buyer, plan for such outgo as well at the time of buying a property.

Say, the house property you plan to buy is a resale property and costs ₹1 crore. While this is the price you pay to the seller, you will have to pay stamp duty of, say, 7 per cent and registration of, say, 4 per cent, (on ₹1 crore), in addition to the purchase price. In total, you will pay ₹1.11 crore (₹1 crore plus 11 per cent on ₹1 crore).

In case of under-construction property, the payment varies with each state. In Tamil Nadu, for instance, you will pay stamp duty on the guideline value or market value of undivided share (land), whichever is higher. Say, the cost of property is ₹60 lakh, of which the undivided share of land accounts for ₹20 lakh, then the stamp duty (7 per cent) and registration charges (4 per cent) are levied on this amount. On the balance ₹40 lakh, registration charges of 1 per cent (in Tamil Nadu) on the cost of construction or the amount mentioned in the construction agreement, whichever is higher, will apply. The Government of Tamil Nadu also charges 1 per cent stamp duty on the same. You will also have to pay Goods and Services Tax (GST) (around 5 per cent or 1 per cent in case of affordable housing) on the total consideration of the property. GST is not applicable on completed properties.

Payment

Usually, it is the buyer who pays the stamp duty at the time of registration of property. There are two popular ways to make this payment: e-stamping and through non-judicial stamp paper.

When it comes to e-stamping, a buyer has to visit the website of Stock Holding Corporation of India, the central record keeping agency for all e-stamps in the country. It has authorised collection centres (ACC) that issue such e-stamps. You can go to schilestamp.com and check if your State government provides for such facility.

So, if your State allows e-stamping, first you will have to fill an application by providing details of the transaction, name of the parties involved (buyer and seller) and PAN number of the parties, value of the property (for which stamp paper is required), and mode of payment (NEFT/cheque/DD). If you are making payment via NEFT, then the website will generate an acknowledgement for the payment. Next, at the ACC, buyers/payers have to submit the filled up form along with the amount to be paid as stamp duty or submit acknowledgement. The e-stamp certificate will be generated immediately after realisation of the funds.

The advantages of using e-stamps are that it can be generated within minutes and is tamper proof. But on the downside, once an e-stamp is generated, it is a difficult process to modify or cancel the e-stamp; so, fill the details with care.

With restrictions of movement due to the coronavirus, home buyers can pay stamp duty online and print e-stamp certificate from home. But this facility is provided only by a few states such as New Delhi, Karnataka and Chandigarh. You can also use the e-payment facility, if provided, by your State government for making payment of both stamp duty and registration charges.

Another and the most common method of paying stamp duty is by purchasing non-judicial stamp paper from a licensed vendor. Under this, the stamp paper — either purchased for the value of the stamp duty or a lesser amount (rest can be remitted as cheque or DD to the designated banks), will contain the agreement details and should be signed by the parties involved.

Note that once the payment of stamp duty is made and signed by the parties, registration of the property can be done immediately or within a certain time period, say three to six months. The applicable registration charges will be paid at the time of registration of property.

Payment modes:

e-stamping

e-payment

Non-judicial stamp paper

Additional cost to buyer

Stamp duty and registration charges are costs over and above the cost of a house property

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What’s better – Investing in equity mutual funds or investing directly in stocks?

Personal Finance

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Amit has been investing in mutual funds for the last seven years. He is not happy with the returns, as they have been much below his expectations. He invested in a few small-cap stocks in March 2020. Some of those stocks have given more than 100 per cent returns in the last three-four months.

However, Amit did not really invest big amounts in those stocks. Hence, those investments have not made a meaningful difference to his portfolio.

Now, he wants to revisit his entire equity strategy. There is a sense of disillusionment with mutual funds and he is unsure if the mutual funds are worth investing in.

He wonders whether investing directly in stocks is a better approach than investing in mutual funds.

Flavour of the season approach

Amit has not focussed on allocation within various equity categories and has gone with the flavour of the season approach. He invested a lot of money in small-cap funds in 2017 when small-cap stocks were doing well. But the small-cap stocks have been under pressure since the beginning of 2018. While the broader equity markets have done not too well over the last couple of years, Amit’s portfolio has struggled even more due to higher allocation to small-cap funds.

Whether he invests directly in stocks or through mutual funds, the underlying exposure is to a volatile asset. Both the approaches have merits and demerits. If he gets his direct equity picks right, he can earn above-normal returns. However, if his bets go wrong, there can be serious wealth destruction. Mutual fund schemes have diversified equity portfolios and help hedge bets. While this reduces return potential, this also reduces risk.

Amit’s stock picks did very well over the past few months, and he deserves credit for his choices. However, he must not mistake luck for skill. Stock research requires time and skill. Four or five months of investing or getting two or three stock calls right does not establish skill. If he is very keen on investing a significant portion of equity portfolio in direct stocks, he must test his stock-picking skill and market judgement for a few years. Only then, should he allocate greater capital to direct stocks.

By the way, over the past four-five months, even some small-cap funds have returned more than 50 per cent. A rising tide lifts all the boats. Amit must remember that something similar happened in 2017 and he has experienced the subsequent pain. While no one can say with certainty whether the performance of the past few months will sustain or there will be a reversal, he must remain cautious.

At the same time, this does not imply that direct equity investing must be shunned completely. There is a middle ground. If Amit wants to take exposure to direct stocks, he must first set up a threshold for the direct equity exposure. For instance, he can limit direct equity exposure to say 20 per cent of the equity portfolio. Therefore, if his equity portfolio is ₹10 lakh, not more than ₹2 lakh should be in direct equity. This way, he can strike a balance between the two modes of equity investments.

Amit can set aside money for stocks that he has researched well and thinks offer potential for good returns. Mutual fund investments, if selected well, will diversify equity exposure. Therefore, this internal limit helps him retain upside potential of his stock picks. In addition, this helps him maintain discipline and not get carried away and take unnecessary risks.

If he is satisfied with the results of direct equity investments, he can increase the threshold after a few years.

Within the mutual fund portfolio, Amit can split investments across two-three funds. He can invest in a large-cap and a mid-cap fund. Or he can pick up a multi-cap fund. Remember four small-cap funds do not build a diversified equity portfolio. If he does not trust active fund management, he can simply invest in index funds or exchange-traded funds (ETFs). There are now passive options across the market spectrum.

The word “diversify” has been used loosely when referring to equity mutual funds. Note that true diversification does not happen when you add different types of equity products to the portfolio. You diversify the portfolio by adding assets with low correlation. For instance, adding a fixed income product to an equity portfolio diversifies the portfolio.

Asset allocation is of vital importance. Sub-allocation within the equity portfolio is secondary.

(The writer is a SEBI-registered investment advisor at personalfinanceplan.in)

True diversification

Having assets with low correlation helps in true portfolio diversification

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Will employees gain if gratuity rules are tweaked?

Personal Finance

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The Centre is said to be mulling a key change in the rules pertaining to gratuity payment by employers.

So, for an employee to be eligible for gratuity benefit, the minimum period of service could be reduced from the current five years to one-three years, say reports.

This is in keeping with the changing dynamics of the job market where many employers and employees prefer shorter-term engagements, rather than the practice of decades-long service.

If the threshold for getting gratuity benefit is reduced, it could act as a boost for many, including short-tenure and contract workers — especially in the present times when many employees are being laid off due to the coronavirus impact.

A lower period of service will be another major relaxation after the doubling in the maximum limit on gratuity payment, from ₹10 lakh to ₹20 lakh, a few years ago. As it stands, here’s how the gratuity benefit works and the tax benefits associated with it.

Reward for loyalty

Gratuity is like a retention bonus — a reward for employee loyalty given by the employer. Just that this reward is mandated by law and not at the discretion of the employer.

So, if you stay on with your employer for five years or more, you are entitled to receive gratuity when you retire, resign or are retrenched. Note that the service has to be continuous in nature, that is, at one stretch.

So, if you work with an employer for three years, resign, but later rejoin and work another thee years before leaving again, you will not be entitled to gratuity despite a service record of more than five years. That’s because the period of service was broken and not continuous.

The monetary reward to be paid by an employer in recognition of an employee’s years of service is laid down by the Payment of Gratuity Act, 1972. Most establishments employing 10 or more workers come under the Act. Once an organisation comes under the Act, it will remain so, even if the number of employees falls below 10.

Roughly said, you get half a month’s Basic and Dearness Allowance (DA) for every completed year of service as gratuity. Here’s how it is calculated: (Number of years of service) x (Last drawn monthly Basic and DA) x 15/26.

So, if you have served 25 years and draw a monthly Basic and DA of ₹30,000 when you leave the job, you get gratuity of ₹4,32,692, calculated as 25 x 30,000 x 15/26. If you serve more than six months in the last year of employment, it is considered as a full year of service.

For instance, service of 24 years, eight months will be considered as 25 years.

Your employer can choose to pay you more, but the maximum amount of gratuity according to the Act cannot exceed ₹20 lakh. Amounts paid above this will be in the nature of ex gratia.

There are exceptions and legal rulings that relax the five-year continuous service rule. One, the rule is waived if an employee dies or is disabled.

Next, the Madras High Court in the Mettur Beardsell case had ruled that if an employee completes four years and 240 days in service, he will be eligible for gratuity.

Tax break

You get a favourable tax treatment under Section 10(10) of the Income Tax Act on the gratuity amount you receive.

If you are a government employee, the entire amount you get is exempt from tax. If you are not a government employee, but are covered under the Act, the tax exempt amount is the lower of the following: a) Actual gratuity received; b) 15 days Basic and DA for each completed year of service or part thereof in excess of six months (as per calculations in the above example); c) ₹20 lakh.

Say, in the example above, your employer paid you gratuity of ₹5,00,000, which is more than the ₹4,32,692 actually payable under the law. You will enjoy tax exemption on ₹4,32,692 and the balance ₹67,308 will be subject to tax.

Consider another example in which the gratuity payable to you as per the formula comes to ₹25 lakh and the employer pays you the amount.

But the current cap on gratuity payable and tax exemption is ₹20 lakh. So, ₹20 lakh will be tax exempt and the balance ₹5 lakh will be taxed. Note that the total tax exemption on gratuity amount received, including those from previous employers in earlier years, cannot exceed ₹20 lakh.

Employees not covered under the Payment of Gratuity Act also get tax benefit if their employers give them gratuity.

But in such cases, the tax exempt amount is the lower of the following: a) Actual gratuity received b) 15 days Basic and DA for each completed year of service calculated as (number of years of service) x (average monthly salary in the last 10 months of employment) x (15/30). c) ₹ 20 lakh.

Note that in such cases, the number of years of service will be only the full years in service; part-year service will not be considered even if it exceeds six months in a year.

For instance, service of 24 years, eight months will be considered as 24 years.

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Readers say – The Hindu BusinessLine

Personal Finance

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This is in the context of the Big Story titled ‘Unlock your investment plans from home’ dated August 15, 2020. Would like to say that the article had an excellent coverage.

Girraj Sharan

This is in the context of the Big Story titled ‘What lies ahead for the rupee?’ that appeared in BusinessLine on August 10. I am willing to bet against the rupee. The fundamentals of the Indian economy are weak. In the equity market, it is one stock that has pulled the index up; domestic institutions, led by government desire, have driven the rally. Barring the monsoon, I don’t see any positive. Most States still have lockdowns in force in some form or other. Dollar weakness is partly due to approaching US polls. It is difficult to share your optimism.

Ramanujam P B

I read the article titled ‘Gold ETFs eye futures for that extra edge’ dated August 3, 2020. It deserves praise for adding a cautionary takeaway. The article could have added more value if it had mentioned the face value and the present NAV in the table carried in the story.

N Mukunda Kumar

Readers can share their views and suggestions in the comments section on our website (thehindubusinessline.com/portfolio/), mail them to blportfolio@thehindu.co.in or tweet at us @Blportfolio

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Reserve Bank of India – Speeches

Speeches

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1. The COVID-19 pandemic still continues to keep the world on the edge. The pandemic has so far infected more than 2.3 crore people and has claimed more than 8 lakh lives worldwide. The world is struggling to find a vaccine and/or a cure to the deadly virus. In India also the spread of pandemic continues unabated, though the fatality rate is much lower.

2. As the pandemic ravages on, the economic impact is hard to measure. While there are green shoots and some businesses are getting back to pre-pandemic levels, the uncertainty over the length and intensity of the pandemic and its impact on the economy continue to cause concern. In the wake of the pandemic, RBI has stepped forward and has so far announced various liquidity, monetary, regulatory and supervisory measures in the form of interest rate cuts, higher structural and durable liquidity, moratorium on debt servicing, asset classification standstill and recently a special resolution window within our Prudential Framework for Resolution of Stressed Assets.

3. This framework is a well thought out decision taken in consultation with stakeholders and is aimed at striking a balance between protecting the interest of depositors and maintaining financial stability on one hand, and preserving the economic value of viable businesses by providing durable relief to businesses as well as individuals affected by the Covid-19 pandemic, on the other. We expect efficient and diligent implementation of the resolution plans by the banks, keeping the above objectives in mind. While the moratorium on loans was a temporary solution in the context of the lockdown; the resolution framework is expected to give durable relief to borrowers facing Covid related stress.

4. RBI’s response to the situation arising out of Covid has been unprecedented. The measures taken by the RBI are intended to deal with the specific situation of Covid and can not be permanent. Post containment of COVID-19, I repeat, post containment of Covid, a very careful trajectory needs to be followed for orderly unwinding of the various counter-cyclical measures taken by the RBI and the financial sector should return to normal functioning without relying on the regulatory relaxations and other measures as the new norm.

5. In my address today, I would like to dwell upon the following theme: It is Time for Banks to Look Deeply Within: Reorienting Banking Post-Covid. Just like boosting immunity of the population is the key to tackle pandemics, the key to long term financial stability would be to foster tangible improvement in the inherent ability of the banks to withstand the exogenous shocks like the current pandemic. As I have stated elsewhere, the causes of weak banks can usually be traced to one or more of the following conditions: an inappropriate business model given the business environment; quality or the lack of governance and decision making; misalignment of internal incentive structures with external shareholder/stakeholder interests1 and other factors. Accordingly, the core of resilient banks is made up of good governance, effective risk management and robust internal controls. This is not to say that Indian banks do not have sound governance and risk management systems in place. There is always scope for improvement and these are the areas which need greater attention going forward.

6. In recent years, the business landscape of banks has undergone significant change. Today the banks need to look out for ‘sunrise’ sectors while supporting those which have the potential to bounce back. For instance, Banks need to look at prospective business opportunities in the rural sector which remain unexplored despite efforts to support it. They need to look at start-ups, renewables, logistics, value chains and other such potential areas. The banking sector has a responsible role to play not only as a facilitator of growth of the economy but also to earn its own bread. Thus, a complete relook at the business strategy and orientation is the immediate need of the hour.

7. Scale ignites the volume effect in business turnover; but that presupposes bigger size of the banks. Despite several reforms in the banking sector since its nationalisation, lot more needs to be done. With change in time, the nature of reforms needs to be reconfigured. The current steps towards consolidation of public sector banks in line with the Narasimham Committee recommendation is a step in the right direction. Indian banks this way can reap the benefits of scale, and become partners in the newer business opportunities across the globe. Larger and more efficient banks, both in public and private sector, can compete shoulder to shoulder with the global banks to get a decent space in the global value chains.

8. Size is essential, but efficiency is even more important. Efficiency, however, is a much broader concept and requires several other factors to evolve and act along its side. The prerequisite will be use of technology. The quality and ingenuity of technology should match our aspirations of acquiring scale and diversion of business across the globe. The focus of use of technology should shift from ‘transactions-based’ to ‘business-oriented’. We have a pocket full of technological tools like big-data, artificial intelligence, machine learning to leverage upon , in order to be able to compete with the global players in reaping the benefits of ‘creativity’ looming large all over.

9. While introspecting on newer ideas to improve the health of banks and quality of banking, it is fundamental to reform the culture of governance and risk management systems. These two areas lend inherent strength to the business of banking and good amount of work has been done in this direction over the years. The RBI has issued a discussion paper on ‘Governance in Commercial Banks’, for comments from various stakeholders. Ideally, efficiency should be ownership-neutral. While it is natural that the capital-providers or investors would like to remain alive to the aspects of how exactly a bank is run, it is worthwhile to allow sufficient leeway to the Board and management of a bank to run the affairs of a bank in a professional and autonomous manner. A decent distance between the owner and the professionally sound management and Board would promote robustness of banking institutions.

10. There will be newer risks with newer business models. More so, when banks get bigger and more connected across diverse jurisdictions. High growth by virtue of newer business models can be achieved with clear understanding of one’s own strengths and weakness. Remaining overly risk-averse may seem to be a measure of self-immunisation; but will be self-defeating as it would affect the bottom lines adversely. Risk propensity should be in alignment with the individual bank’s measured risk-appetite. The risk management system should be sophisticated enough to smell vulnerabilities brewing within the various businesses well in advance and should be dynamic enough to capture looming risks in sync with the changes in external environment and best practices.

11. One visible area of concern in the arena of risk management is the inability to manage the operational risk/s, more particularly controlling the incidence of frauds, both cyber-related and otherwise. The higher incidence of frauds which have come to light in the recent times have their origins in not so efficient risk management capacity of the banks, both at the time of sanctioning of loans as well as in post sanction credit monitoring. It is observed that it takes many months after a fraud is committed before it comes to light. Banks need to tighten their underwriting and credit monitoring standards and ensure that incidences of frauds are reduced by early detection and are followed up by initiating appropriate legal action against the fraudsters. Here too, the need is to leverage on technology, namely, artificial intelligence, to study the patterns of such incidences and the root cause behind their recurrence.

12. An effective early warning system and forward-looking stress testing framework should be an integral part of the risk management framework of the banks. Banks should be able to pick-up incipient signals of stress faced by their borrowers, and take proactive remedial action, which may include a viable resolution of the credit facilities aimed at preserving the value of the assets and not just aimed at reducing the short term burden on the balance sheet of the banks.

13. In addition to a strong risk culture, banks should also have appropriate compliance culture. Cost of compliance should be perceived as an investment, as inadequacy of the same will prove to be very costly. The compliance culture of banks should ensure adherence to laws, rules, regulations and various codes of conduct. Compliance should go beyond what is legally binding and attempt to embrace broader standards of integrity and ethical conduct2. The essential features of the compliance culture are broadly similar to the essential features of risk culture. All these will also help to maintain a high degree of market reputation which is imperative for retaining customers and commanding a higher valuation amongst the investors.

14. A good governance framework and effective risk and compliance culture should be complemented by a robust assurance mechanism by way of internal audit function. This is an integral part of sound corporate governance which should provide an independent assurance to the Board of the bank as well as to external stakeholders that the operations of the entity are performed in accordance with the set policies and procedures.

15. The competition in the Indian banking system has been increasing over the years and unless banks meet the expectations of their target customers, even a well thought out business model may not succeed. In this context, quality of customer service and redress of customer grievances assume high importance. We have to recognize that banks exist for customers viz. both depositors and borrowers.

16. India’s banking and financial system has displayed tremendous operational resilience in the face of Covid and lockdowns. Going ahead, financial institutions in India have to walk a tightrope of nurturing the recovery within the overarching objective of preserving long-term stability of the financial system. The current pandemic related shock is likely to place greater pressure on the balance sheets of banks leading to erosion of their capital. Proactive building of buffers and raising capital will be crucial not only to ensure credit flow but also to build resilience in the financial system – resilience of individual banks and financial entities as well as resilience of the financial sector as a whole. We have already advised all banks, large non-deposit taking NBFCs and all deposit-taking NBFCs to assess the impact of COVID-19 on their balance sheet, asset quality, liquidity, profitability and capital adequacy. Based on the outcome of such stress testing, banks and NBFCs should work out possible mitigation measures including capital planning, capital raising, and contingency liquidity planning, among others. Upfront capital infusion would also improve the sentiment of investors and other stakeholders alike for the sector to continue remaining attractive for investors, both domestic and foreign, over the medium to long-term. Some of the banks have already either raised or announced capital raising. This process needs to be carried forward vigorously by Banks and NBFCs, both in the public and private sector.

17. In conclusion, I would like to say that Covid-19 poses several challenges for banks and the financial sector. Proactive action on various fronts – some of which I have highlighted – will enable us to deal with these challenges effectively and maintain the soundness of Indian banking system. I am reminded here of a quote from Leo Tolstoy in War and Peace: “a battle is won by those who firmly resolve to win it!”

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How ‘restoration benefit’ in health insurance works

Personal Finance

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Most health insurance policies in the market offer built-in back-up plans for policyholders in the form of ‘restoration’ benefit. In this feature, the insurer fully reinstates the original sum insured (SI) once it is exhausted. This means, in a floater policy, if any other family member gets hospitalised even after the entire sum insured (SI) is used up in a policy year, there will still be a cover available to the extent of the full SI. This reinstatement of health cover is welcome, especially if your original cover is small. Restoration feature is also termed as refill, reset or reload depending on the insurer.

However, restoration benefits come with caveats and limitations. Here is what you should know.

The basics

While health insurers offer to reinstate your original SI, the restoration process varies with insurers. Some policies such as Manipal Cigna’s ProHealth policy, Activ Assure Diamond policy from Aditya Birla Health, ICICI Lombard’s iHealth Plus restore your original SI only after the existing cover is exhausted.

Let’s understand this concept with an example. Joe has ₹5 lakh as health cover and, on his first claim, this amount gets utilised. A few months later, he gets hospitalised for another illness, and his second claim is for ₹2 lakh. Given that his original SI is exhausted, his restored SI will be ₹5 lakh and the insurer will settle his claim (of ₹2 lakh).

Now, let’s take another case. Joe’s first claim is for ₹4 lakh; the balance SI will be ₹1 lakh. He makes a second claim for ₹2 lakh. The insurer will cover only ₹1 lakh and Joe will have to settle the balance from his pocket. The ‘restore’ benefit will not be triggered as Joe has not exhausted his SI completely. However, if Joe makes a third claim in a year, he will have ₹5 lakh as his SI.

There are health covers in the market such as Optima Restore from HDFC Ergo Health, Max Bupa’s Go Active policy and Lifeline by Royal Sundaram General Insurance that offer to reinstate the original SI even when the SI is partially exhausted.

For instance, let’s assume Joe has a health policy of ₹5 lakh and he makes a claim for ₹3 lakh (first claim). The insurer settles the claim and Joe’s SI balance is ₹2 lakh. His ‘restore’ benefit is triggered (available only for subsequent claims) and his SI balance for the year will be ₹7 lakh (existing balance of ₹2 lakh and SI restored is ₹5 lakh). What must be kept in mind is that a single claim in a policy year cannot exceed base SI. Which means, if Joe makes a second claim for ₹6 lakh, the insurer will pay ₹5 lakh only and the balance ₹2 lakh SI will be available for subsequent claims.

Note that, while most policies come with ‘restore’ benefit, it may be not available across all variants of a particular policy. For instance, in ICICI Lombard’s iHealth Plus, the ‘reset’ benefit is available from SI of ₹3 lakh and above only. Similarly, in Digit Insurance’s health plan, the ‘restore’ benefit is available for comfort variant of the plan only.

What’s the catch?

Since most insurers offer ‘restore’ or ‘refill’ benefit as an in-built feature in the policies, there are certain points that you as a policyholder should keep in mind.

One, ‘restore’ benefit is usually available only once during a policy year when insurers refill 100 per cent of the base SI. But there are policies in the market such as Pro Health policy (Manipal Cigna), Max Bupa’s ReAssure plan and Star Health’s Family Health Optima plan (SI is restored three times a year), that offer ‘restore’ benefit multiple times. Insurers also offer unlimited ‘restore’ benefits as a rider, like in Religare Health insurance’s Care plan and Activ Assure Diamond plan (Aditya Birla Health).

Two, as a norm, the ‘restored’ SI will be available only for subsequent claims made by the policyholder. That is, the ‘restore’ benefit will not be applicable on the first claim in the policy year. Also, most policies do not offer the ‘reinstated’ SI for the same illness for which you had made the claim in a policy year. However, some policies in the market such as ReAssure (Max Bupa) do cover for the same illness subsequently.

Three, your ‘restoration’ SI will not be considered for no claim bonus (a reward that policyholders receive from the insurer for staying healthy and not making any claim on the policy in a year) calculation.

Lastly, the SI reinstated during the policy year, if unutilised, will expire and cannot be carried forward to next year or at the time of renewal of policy.

Remember that your reinstated SI can be utilised only sequentially, that is, after exhausting the original SI, accumulated no-claim bonus (NCB) SI, additional or super NCB (if any opted), and additional SI through booster benefit (if any opted).

Our take

SI restoration benefit is offered by most health insurers as part of the basic cover. While this benefit can compensate if you are under-insured, relying on reinstated SI to make up for the gap is not advisable. Also, you need to understand the workings and applicability of this feature and choose a SI, accordingly, based on your need.

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