Prof. Suresh Aggarwal, Head of the
Department of Business Economics, University of Delhi, delegates to this
flagship 41st Annual Convention of the Department and students
participating in the convention - very good morning! It is an honour for
me to be here today to deliver the inaugural address of the
convention. The convention provides a valuable platform for interaction
between the industry and academia on various current issues relevant to
creating conducive business and growth environment. Banking is the
backbone to the development of trade, investments and business in any
country and provides crucial credit and payment infrastructure and
services to an economy. In this backdrop, I thought that it may be
appropriate for me to dwell on the main features of the Indian banking
regulatory firmament, specifically, on how the Reserve Bank has tailored
its regulatory stance and the banking regulation framework to suit the
evolving needs of the economy and disparate stages of economic
development. My address today, therefore, traces the evolution of
banking regulation in India since independence to highlight the main
thought process behind it as well as the challenges ahead in banking
policy formulation.
What and why of Banking Regulation
2. Banks are special and therefore, exposed to
special risks and challenges. In the course of fulfilling their
primary function of financial intermediation they are intricately
connected with various other drivers propelling growth and stability in
the real sector. Banks are conduits for monetary policy transmission
and serve as the backbone for credit creation and payments and
settlement systems. Also, banks are highly leveraged institutions and
function in fiduciary capacity. Therefore, the more immediate
motivations for banking regulation are the protection of the
depositors’ interest and maintaining public confidence in the banking
system. Banking regulations also aim at building efficiency and
resilience of the banking system on the one hand and address the
concerns that arise from the functioning of the financial system.
Financial risks are more dynamic than static and assume more intrepid
forms with the evolution of the banking functions, products and
financial innovation, increased functional integration and
decentralisation. Contagion and systemic risk, moral hazard, too big to
fail phenomenon, public bailouts of banks are some of the issues that
came under sharp scrutiny following the global financial crisis that
erupted in 2008. As such banking regulation assumes critical
significance to retain the resilience and soundness of the banking
entities on the one hand and the macro-prudential stability of the
financial system as a whole on the other and thereby also prevents
volatility and disruptions in the real sector and the overall economy.
Then, there are, of course, the structural and developmental issues
relevant to a particular economy and the financial system which, in a
large part, provide the backdrop for the regulatory measures.
3. Banking regulation can take the form of
formalised legislation and statutory provisions, regulatory directions
and guidelines, moral suasion, etc. Different times, evolutionary
stages in banking and the various financial and banking crisis have all
influenced the regulatory form and substance from time to time. World
over, regulation for the banking sector has gone through cycles which
range from prescriptive to principle based to a less pervasive format
allowing the market mechanism to take precedence (market oriented form
of regulation), from structural restrictions to micro and
macro-prudential regulation, etc. As the effectiveness of traditional
control based rules diminishes with increasing competition,
liberalization, globalization and innovation, ongoing regulatory reform
assumes great significance. The recent global financial crisis
demonstrated the overwhelming need for evolving commensurate banking
regulation as also the need for the regulatory reform process to remain
ahead of the developments in the banking functions, products and
services.
4. I intend to give you a peep into the
contextual circumstances that led to the regulatory measures in the
Indian banking sector, as also the rationale for considering these
important reforms and / or changes. While one of the prime thought in
this context has always been the need to align the Indian policy
measures and regulatory guidelines with the international best
practices, the different stages of economic growth in the country have
had an important bearing on the regulatory process in the banking
sector.
Banking Regulation in Emerging Market Economies (EMEs)
5. An emerging market economy (EME) is an
economy that has some characteristics of a developed economy but is not
yet a developed economy; it has aspirations to be a developed economy
one day; it has certain distinct characteristics and differs from
developed economies in multifarious ways. An EME is as an economy with
low to middle per capita income with dominance of the proportion of the
global population. EMEs are typically classified as emerging because of
the relatively recent initiatives at development and reforms and
beginning to open up their markets and "emerge" on to the global scene.
EMEs are expected to be fast-growing economies; the need for, as also
the level of savings, investments, both domestic and foreign,
consumptions and rate of growth are all expected to be higher and much
faster due to the smaller base effect.
6. Accordingly, the EMEs have their specific
economic and developmental needs and agenda. The global banking
regulatory standards, or for that matter, the regulatory framework for
any other financial sector segment is designed more to suit the needs
and the level of development in the advanced economies. The fundamental
reason for this is their dominant presence and role in the global
standard setting fora as also the more advanced stages of their
financial sector development including the higher level of complexity,
variety and sophistication of financial products and services innovated
/offered in these economies. However, the existing financial
intermediaries and the available financial products and services in the
EMEs often fall grossly short of meeting the requirements of higher
and faster growth, savings, investments etc. Moreover, the requirements
of funding infrastructure and social sectors, as also the real sector,
are unprecedented, particularly in view of the serious constraints on
funding, muted investor and international confidence, under developed
condition of the social and public institutions, lower levels of
appropriate skills, specialisation and expertise, etc. The risks and
volatility emerging from the foregoing are equally large and often
alien to the EME milieu. That is why the regulatory standards, often
designed keeping in view the ground realities in the advanced
economies, may not also always be a perfect fit for the emerging
economies and the EMEs use national discretion in this respect while at
the same time making sincere attempts at aligning their regulatory
framework with the global best practices.
Evolution of Banking Regulation in India
7. Reserve Bank of India was established on
April 1, 1935 in accordance with the provisions of the RBI Act, 1934
(the Act). This marked the culmination of the prolonged efforts, to set
up a central bank in the country. The principle of aligning the
regulatory structure to the specific needs of the country and for that
matter to even go beyond the prevalent wisdom and ethos were distinctly
visible at that time itself. Despite the Reserve Bank being
constituted as a central bank, it was thought fit to prescribe in the
statute itself a development role for the Reserve Bank. Accordingly,
the Act has a provision that the Reserve Bank will develop and maintain
expertise in agricultural development (later expanded as rural
development) and related subjects and thus began the role of the central
bank being sensitive to the need of the economy.
8. Private banks were then on the scene, though
the money lenders were the major source of funding. A usurious and
exploitative system prevailed. As such, after independence in the year
1947, the Indian banking industry was brought under the regulatory
ambit of the Reserve Bank of India with the passing of the Banking
Companies Act in the year 1949. Later, in March 1966, certain
co-operative societies were brought within its fold and this act was
renamed as the Banking Regulation Act, 1949 (BR Act). This enactment
brought significant powers to the Reserve Bank of India (RBI) over the
banks. Though anointed as the regulator, the Reserve Bank was, is and
will be conscious of its responsibility to be alive to the aspirations
of the economy.
Promotional and Developmental role of the Central Bank in India
9.The basic function of the Reserve Bank,
according to the preamble of the Reserve Bank of India Act, is to
regulate the issue of Bank notes and the keeping of the reserves with a
view to maintaining monetary stability in India and generally to
operate the currency and credit system of the country to its advantage.
This function imposes on the Reserve Bank the responsibility for:
-
Operating the monetary policy for maintaining price
stability and ensuring adequate financial resources for developmental
purposes;
-
Promotion of the efficient financial system; and
-
Meeting the currency requirement of the public.
10. In the process of discharging these
responsibilities, the Reserve Bank over the years acquired a wide range
of promotional and developmental roles. The Government’s efforts to
accelerate and sustain growth of the economy through planned development
process and to realize its socio-economic goals also warranted a
complimentary role from the Reserve Bank. The First Five Year Plan
emphatically stated, that “central banking in a planned economy can
hardly be confined to the regulation of the overall supply of credit or
to a somewhat negative regulation of the flow of bank credit. It would
have to take on a direct active role of, firstly, in creating or
helping to create the machinery needed for financing developmental
activities all over the country and secondly, ensuring that the finance
available flows in the directions intended”.
Establishment of Specialized Institutions
11. In order to meet this mandate that
devolved outside the objectives defined in the RBI Act, 1934, in the
years of the Five Year plans beginning from 1950-51, the Reserve Bank
embarked upon a number of specialized initiatives. These included
establishment of a well defined structure of credit institutions to
promote savings and capital formation and to widen and deepen flow of
agricultural and industrial credit.
12. Apart from furthering the development of
cooperatives to provide short-term credit to agriculture, the Reserve
Bank established a separate institution, viz., the National Bank for
Agriculture and Rural Development (NABARD) for provision of medium-term
and long-term refinance for agriculture and rural development as also
for providing consultative service to the Government and banks and
generally coordinate its activities in area of agricultural credit with
those of the agencies engaged in purveying such credit. Further, in
the absence of an active capital market, the Reserve Bank actively
assisted in setting up of several specialized financial institutions at
all India and also regional level, to widen the facilities for
term-finance to industry and for institutionalization of savings. This
included establishment of Industrial Finance Corporation of India
(IFCI), State Financial Corporations, Industrial Development Bank of
India (IDBI) and Unit Trust of India (UTI). In order to provide a
safety net for the small depositors and to encourage commercial banks
and other financial institutions to grant loans to various categories
for small borrowers, the Reserve Bank promoted the Deposit Insurance
and Credit Guarantee Corporation of India Limited (DICGC) for providing
insurance and guarantees against the risk of default in payment by the
banks or to the banks.
13. Further, the Reserve Bank also helped
establish specialized institutions for specific type of financing, like
National Housing Bank (NHB) and Export Import Bank of India (EXIM
Bank). For ushering in market making in government securities and
treasury bills, the Reserve Bank established the Discount Finance House
of India (DFHI) and the Securities Trading Corporation of India
(STCI). The Reserve Bank also helped promote market infrastructure
institutions like the Clearing Corporation of India Ltd (CCIL) and the
National Payment Corporation of India Ltd (NPCI).
Expansion of the scope and reach of the Indian banking system
14. Even though, up to the late 1960’s the
Indian banking system made reasonable progress, there were still many
rural and semi-urban areas which were not served by banks. The large
industries and the big and established business houses tended to enjoy a
major portion of the credit facilities, to the detriment of the
priority sectors such as agriculture, small-scale industries and
exports. Thus, with the primary objective of achieving efficient
distribution of resources in conformity with the requirements of the
economy and in order to meet the needs of the priority sectors, the
Government decided to introduce social control over banks by amending
the banking laws. Accordingly, on July 19, 1969 and April 15, 1980
respectively, 14 and six major Indian scheduled commercial banks in the
private sector were nationalised. Social control marked a transitory
stage in the evolution of banking policy and in this process; a system
of credit planning and the Lead Bank Scheme were operationalized by the
Reserve Bank to make the banking system function as an instrument of
economic and social development.
15. In conformity with these desired objectives
of social control, the banking policy was reoriented in the seventies
for securing a progressive reduction in poverty, concentration of
economic power and regional disparities in the banking facilities. The
promotional aspects of the banking policy came into greater prominence.
In this direction, the branch expansion policy was designed, among
other things, as a tool for reducing inter-regional disparities in
banking development, deployment of credit and urban-rural pattern of
credit distribution. Administered interest rate policy emerged as an
important instrument for directing the flow of funds and for augmenting
the pace of deposit mobilisation. The Reserve Bank opted for selective
extension of credit under the Selective Credit Control scheme to those
sectors that were accorded priority in conformity with the national
objectives. The objective was to correct undue price fluctuations in
respect of certain commodities such as food grains and agricultural raw
materials arising from speculative activities. The main instruments of
Selective Credit Control were a) minimum margins for lending and b)
ceilings on the level of credit against stocks of selected commodities
to control the quantum of credit given.
16. The period since 1985 was a process of
consolidation which involved, i) comprehensive action plans by banks
covering organization, structure, training, house-keeping, customer
service, credit management and recovery of bank dues, productivity and
profitability, ii) phased introduction of modern technology in banking
operations with emphasis on financial viability by easing some of the
policy related constraints on profitability, iii) strengthening capital
base of banks and iv) allowing them flexibility in several areas.
17. By the end of eighties, the Indian economy
had developed an extensive financial superstructure consisting of a
vast network of institutions, deploying varied instruments and
facilitating the mobilisation and channelling of funds for working
capital and production credit purposes as well and for long term
investment. The Reserve Bank thus helped promote and nurture a
functionally varied and spatially diversified financial system.
Financial Sector reforms of 1990s - new Economic Policy Regime
18. In the economic planning phase initiated
in April 1951, which postulated financial and physical controls for
rapid economic and social developments, the financial system was
increasingly called on to meet the financial needs of the economy.
Commercial banks were subjected to interest rate controls and
regulations such as the pre-emptions in forms of cash reserves ratio
(CRR) and statutory liquidity ratio (SLR), directed lending,
prescription of norms governing credit dispensation. The CRR and SLR
that together imposed a marginal pre-emption of around 28% of bank
deposits in 1951, increased to 63.5% in 1991. In addition, credit
allocation at concessional rates at designated priority sectors
constituted a major portion of bank credit and over time, this rose upto
40%.
19. Though the steps initiated post 1951
propelled development of resource mobilisation and deployment relative
to the pre 1951 period, several distortions, rigidities and weaknesses
crept into the financial system which hindered it from playing its role
in ushering in a more efficient and competitive economy. The
efficiency, productivity and profitability of the banking system were
severely challenged. Banks became saddled with a large volume of
non-performing assets. The acceleration in economic growth witnessed in
the eighties was also associated with macro - economic imbalances and
persistence of structural rigidities. By 1990, against the background
of the weak macro-economic situation with rising inflation, high fiscal
deficit, low economic growth and unsustainable current account
deficit, the Gulf war precipitated the balance of payments crisis. This
led to loss of international confidence and as a consequence
international commercial borrowing dried up and non-resident Indian
deposits recorded net capital outflows. The foreign exchange reserves
touched a low of US $1 billion (roughly equal to two week’s imports) in
June 1991. Besides, by August 1991, inflation had reached a peak of
17% on annualised basis. These factors coupled together put pressure on
India in meeting its international commitments.
20. The situation called for strong measures
towards macro-economic stabilization and removal of structural
rigidities. As a response, an intensive reform programme for developing
a competitive environment as a means of improving productivity and
efficiency of both the economic and financial system was initiated.
Deregulation of the real sector and removal of the license and permit
system that was prevalent in and constrained almost all spheres of
production and domestic trade were a part of these initiatives. It was,
however, recognized that the financial sector reform was a necessary
concomitant to the trade and industrial policy liberalization.
21. An overhaul of the Indian financial system
was initiated as part of the structural reforms. In August 1991, the
GOI set up a high-powered Committee on the Financial System (CFS) under
the Chairmanship of Shri M. Narasimham, to examine all aspects relating
to the structure, organization, functions and procedures of the
financial system and made wide- ranging recommendations which formed
the basis of financial sector reforms relating to banks, development
financial institutions (DFIs) and the capital market in the years to
come. The Committee’s recommendations aimed at improving the allocative
and functional efficiency of the banking sector while putting in place
a vibrant, diversified, competitive and efficient system.
22. During the first phase (1991-92 to
1997-98) of reforms, several mutually reinforcing measures were
initiated with focus on strengthening the commercial banking sector by
applying prudential norms, providing operational flexibility and
functional autonomy as also strengthening of the supervisory practices.
The important measures undertaken during this period covered adoption
of capital adequacy norms to strengthen the capital base of the banks,
strengthening the IRAC (Income Recognition and Asset Classification)
norms to enable realistic assessment of the asset quality of banks;
phased reduction in the SLR and CRR to augment the lendable resources
of banks; rationalization and gradual deregulation of interest rates
for inducing competitiveness; permitting new players in the banking
sector to enhance competition and granting greater flexibility in
branch expansion. Another important aspect of the reforms in this phase
was new institutional arrangements like setting up of the Board for
Financial Supervision (BFS) within the Reserve Bank in 1994 for
strengthening the arrangements for monitoring and supervision of banks,
especially in view of the increased risks faced by banks in the
liberalized environment; instituting a state of-the-art Off-site
Monitoring and Surveillance (OSMOS) system for banks in 1995 as part of
crisis management framework for Early Warning System (EWS) and as a
trigger for on-site inspections of vulnerable institutions;
operationalisation of the Banking Ombudsman Scheme for expeditious and
inexpensive resolution of customer complaints against deficiency in
banking services and compilation and dissemination of credit
information so as to contain incidence of fresh NPAs. Several other
channels of NPA management were also instituted including Lok Adalats,
Debt Recovery Tribunals (DRTs), Corporate Debt Restructuring Mechanism
and Asset Reconstruction Companies (ARCs) for strengthening credit
appraisal and recovery framework.
23. The focus in the second phase (1998-99 and
beyond) was on further strengthening of the prudential norms in line
with the international best practices, improving credit delivery,
strengthening corporate governance practices, promoting financial
inclusion, strengthening the urban co-operative banking sector and
improving the customer service. The experience of banks facing
asset-liability mismatches in the South East Asian countries during
1997, underlined the need for putting in place sound asset liability
management (ALM) practices. The ALM framework was, therefore,
complemented with guidelines on risk management. One of the significant
achievement of this phase was the introduction of comprehensive policy
framework of ownership and governance in private sector banks in
February 2005 to ensure that (i) ultimate ownership and control was well
diversified; (ii) directors and CEO and the important shareholders
were ‘fit and proper’ and observed sound corporate governance
principles; (iii) private sector banks maintained minimum net worth of
Rs.300 crore for optimal operations and for systemic stability; and
(iv) policy and processes were transparent and fair.
Impact of the Financial Sector Reforms
24. The reforms had the desired outcome of
strengthening the banking sector; providing more operational
flexibility to banks, enhancing the competitive efficiency, and
strengthening the legal framework governing operations of banks. In
addition, the reform measures had a major impact on the overall
efficiency and stability of the banking system in India. The outreach
of the banks increased in terms of branch / ATM presence. The balance
sheets and overall banking business also grew in size. The financial
performance of Indian banks improved, as reflected in their
profitability. Following the 1st phase of reforms, the performance of
nationalised banks particularly, showed significant improvement. In the
second phase, the capital position improved significantly and banks
were able to bring down their non-performing assets sharply. As the
asset quality began to improve, banks also started expanding their
credit portfolio which included increase in the flow of credit to the
agriculture and SME sectors. Intensified competition however, narrowed
down the margins. But despite this, banks improved their profitability
among others, due to increased volumes and improvement in asset
quality. Return on assets improved from 0.39 at the beginning of
reforms in 1991-92 to 0.50 in 2001 -2002. The reform phase also
witnessed increased use of technology which in turn, helped improve the
customer service in banks.
25. During the period of reforms, conforming
to international standards and best practices was the primary driver.
It is equally true that the economy's difficult situation in the
beginning and the liberalizing, globalising and growing economy also
dictated such an approach.
Shift towards Macro prudential Regulation
26. The reform process did not cease with the
second phase of reforms but remained a progressive ongoing practice in
the Indian banking system. The most significant among these and much
applauded in the aftermath of the financial crisis have been the macro
prudential policies. Globally, the financial crisis brought to the fore,
only recently, the concept of macro prudential regulation of the
financial system. However, in India along with the measures detailed in
the foregoing paras, there was a gradual shift towards macro
prudential financial regulation as early as 2004 itself. The Reserve
Bank made use of the countercyclical policies since 2004 as a toolkit
for addressing systemic risk and ensuring financial stability though it
had used them sporadically even earlier.
27. The instruments used to address the time
dimension of the systemic risk have been time varying risk weights and
provisioning norms on standard assets for certain specific sectors
wherein excessive credit growth, in conjunction with sharp rise in asset
prices, has caused apprehension of potential build-up of systemic risk
and asset bubbles. In the process, the policies have “leaned” against
the wind and have had the desired effect of moderating the credit boom
in the specified sectors both through signaling effect and affecting
the cost of credit.
28. As regards the cross sectional dimension
of the systemic risk which deals with the interconnectedness issues,
various measures have been undertaken such as, prudential limits on
aggregate interbank liabilities; restricting the access of
uncollateralized funding markets only to banks and PDs and stipulating
caps on lending and borrowing; restricting the banks’ investments in
the capital instruments of other banks; stipulation on banks’ exposure
to NBFCs and MFs and close monitoring of systemically important NBFCs
and financial conglomerates; restrictions on unbridled innovation in
financial products; enhancing transparency and addressing risks in OTC
transactions by operationalizing reporting platforms and CCP
arrangements.
Current Approach to Banking Regulation and Reforms and the Challenges involved
29. Given these realities, the needs for the
financial sector reforms and regulatory development in India do not
necessarily converge with those felt in the developed nations. Risks
emanating from the EME financial sector are also diametrically different
from those emerging from those in the advanced economies. In the
emerging economies, it is the limited spread of the financial sector as
well as the constrained and or underdeveloped / lower capacity in
terms of the products, services and institutions that subject these
economies to various financial risks, as against the advanced economies
where the risks emanate from the sheer scale and volumes of financial
transactions, size, connectivity and systemic importance of the
financial institutions, sophistication and complexity of the financial
products and services etc.
30. The need for the financial development and
regulatory reform remains as strong as ever in emerging markets.
Instead of innovating complex and sophisticated products and
instruments or setting up financial behemoths, the EMEs require to focus
more on the fundamental financial sector elements such as financial
stability, strengthening and creating sound banking systems, widening
the scope and reach of the formal financial system and services,
expanding financial inclusion and enhancing financial literacy,
improving monetary policy transmission as also developing and deepening
the financial markets (such as corporate bond markets and basic
currency derivatives) and making them more liquid, etc. As such the
financial development and regulation has to be aligned to these specific
needs of the emerging market economy financial system.
31. One of the most critical aspects of
reforms in the Indian financial sector, was the deliberate strategy of
‘cautious gradualism’ so that the pace of reforms remained specific to
the nature of the Indian financial system in terms of its maturity,
absorptive capacity and the stage of development and was neither too
fast or abrupt to disrupt the very structure of the financial system
nor too slow as not to have a meaningful impact This approach
encompassed small and steady doses of reform push, coupled with a close
and continuous monitoring of impact and preparedness for taking
mid-course correction, if required. The reform measures in the banking
sector were coordinated with those in other areas and even within the
banking sector, the measures were well sequenced, with an unwavering
focus on stability.
32. On the one hand, while, since the early
years of 2000, the Reserve Bank has embarked on a dedicated effort at
reconciling its guidelines with the Basel Accords and chosen to be more
conservative on many of the prudential norms in comparison to the
global standards, it has also retained its national discretion on some
of the regulatory aspects so as not to disrupt and instead encourage
the flow of credit to sectors crucial for growth. Some such
divergences, whether sub-equivalent or super-equivalent, are discussed
below:
Capital requirement and Leverage Ratio
33. RBI implemented Basel III requirements
w.e.f. April 1, 2013. Under Basel III too in India, the minimum capital
requirements has been retained at 9% of Risk Weighted Assets as
against Basel III requirements of 8%. Leverage Ratio requirement is
proposed to be at 4.5 % as against Basel III proposal of 3%. In India,
the real sector is predominantly dependent on the banking sector for
credit needs. Any disruption in provision of credit supply from banks
may be catastrophic for the economy. Further, the extant external
credit ratings provided by the credit rating agencies to bank loans
which determine the risk weight and capital for those exposures under
the Basel II Standardised Approach for credit risk, suffer from various
gaps and weaknesses. In view of the forgoing, it is desirable to
reduce probability of bank failures by having additional capital. The
Basel Committee for Banking Supervision (BCBS) provides flexibility to
national regulators to prescribe higher minimum capital requirements.
Several other jurisdictions (e.g. Singapore, China, South Africa,
Brazil, Australia etc.) have also prescribed higher capital
requirements than 8% of the risk weighted assets. Incidentally, the
Reserve Bank has prescribed higher capital requirements even under
Basle II.
34. However, capital and leverage ratio
prescriptions at levels higher than the global standards can have
constraining effect on the supply of adequate credit from banks to the
productive sectors which in turn, can adversely impact growth to some
extent raising questions of trade-off between growth and banking
stability. Further, questions have been raised about requiring banks to
mobilise additional capital, given the huge capital needs and a
lackluster capital market. This compels us to take a balanced view
about continuing with the additional requirements to ensure banking
resilience by having adequate cushion towards identified weaknesses and
the practical difficulties the banks face.
Exposure Norms - the Group borrower limits
35. Exposure norms for banks in India are as
follows: for a single borrower, it is 15 per cent of the bank's capital
funds and for borrowers belonging to a group, 40 per cent of the
bank's capital funds. The present guidelines also allow banks to exceed
the norm with respect to a single borrower and group borrower by an
additional 10 per cent and 15 per cent respectively, for extension of
credit to infrastructure projects and in exceptional circumstances.
Apart from this, there are specific prudential norms for bank finance
to NBFCs, call money / notice money borrowing and lending and
inter-bank liabilities, etc. BCBS in the Standards published on
Supervisory framework for measuring and controlling large exposures’
(the BCBS Standards) in April 2014 have stipulated that the sum of all
the exposure values of a bank to a single counterparty or to a group of
connected counterparties must, at all times, not be higher than 25% of
the bank’s available eligible capital base. As per the Standards, the
eligible capital base is also revised to the effective amount of Tier 1
capital only.
36. In India, our effort has been to harmonise
our guidelines with the international best practices and converge the
same with the global prudential norms/standards. However, India, being
an emerging economy with limited sources of funds to finance the growth
process, relatively smaller capital base of the Indian banks as also
fewer number of corporate groups which can take up big ticket
infrastructure and manufacturing projects and sudden growth in their
size, has certain typical compulsions to meet. Funding requirement for
development of the infrastructure sector in India is huge. During the
12th five year plan, starting in the current year, this requirement is
estimated to be approximately $1 trillion or Rs 61 lakh crore.
Currently, a huge chunk of this financing responsibility is borne by
the banks. The banking sector exposure to the infrastructure sector has
grown from 3.61% of total bank credit as on March 2003 to approx 15.09
percent of the total bank advances as on March 2014 1.
The group borrower limit in India is substantially larger in our
country than the international norms due to the developmental needs of
the country. Keeping the group borrower limit at the level of single
borrower limit, that too related to Tier I than the total capital will
severely constrain the availability of bank finance (which is the major
source of finance in India) to these corporate groups and the
infrastructure sector and thus hamper the growth of the economy.
Stricter group exposure limits would also leave surplus lendable
resources with banks which may result in adverse selection. At the same
time, high exposures to specific businesses or business groups impairs
stability and results in excessive concentration of credit. Thus, while
we are aware of the need to reduce the group borrower limit, we have
to take a considered view as to what extent and how smoothly this can
be brought down going forward without adversely impacting the growth
prospects of the economy.
Liquidity Standards – treatment of the SLR holdings
37. During the early “liquidity phase” of the
financial crisis that began in 2007, globally many banks faced
unprecedented difficulties despite adequate capital levels. The Basel
Committee on Banking Supervision (BCBS) recognized that such
difficulties were due to lapses in basic principles of liquidity risk
management. In response, as the foundation of its liquidity framework,
the BCBS in 2008 published Principles for Sound Liquidity Risk
Management and Supervision (“Sound Principles”), which provide detailed
guidance on the risk management and supervision of funding liquidity
risk. To complement these principles, the BCBS further strengthened its
liquidity framework by developing two minimum standards for funding
liquidity, viz., the Liquidity Coverage Ratio (LCR) and Net Stable
Funding Ratio (NSFR) to achieve two separate but complementary
objectives. While the LCR’s objective is to promote short-term
resilience of a bank’s liquidity risk profile by ensuring that it has
sufficient high-quality liquid assets to survive a significant stress
scenario lasting for one month, the NSFR is aimed at promoting
resilience over a relatively longer time horizon (one year) by creating
additional incentives for banks to fund their activities with more
stable sources of funding on an ongoing basis.
38. Following the issue of final standards by
BCBS, the Reserve Bank of India issued its final guidelines on
‘Liquidity Coverage Ratio (LCR), Liquidity Risk Monitoring Tools and
LCR Disclosure Standards’ on June 9, 2014. The RBI’s guidelines have
taken into account the range of HQLAs available in Indian financial
markets and their liquidity vis-Ã -vis the liquidity instruments
prescribed in the BCBS standard. The balance sheets of Indian banks
have adequate liquid assets due to the CRR and SLR requirements of 4%
and 22% respectively of a bank’s NDTL. Any additional HQLA requirement
on banks over and above CRR and SLR may reduce banks’ capacity to meet
the growing credit needs of the economy. It also reduces
competitiveness of banks in India vis-a-vis their international
counterparts. Keeping this aspect in view, Government securities to the
extent of 2 per cent of NDTL i.e. those currently allowed under
marginal standing facility (MSF), have been allowed to be included as
Level 1 HQLAs in India. Further, eligible common equity shares with 50%
haircut have been allowed to be included as a Level 2B HQLAs in RBI
guidelines.
Counter Cyclical Capital Buffer
39. In the aftermath of the financial crisis in 2008, BCBS published Guidance for national authorities operating countercyclical capital buffer
(CCCB) to propose a framework for dampening excess cyclicality of
minimum regulatory capital requirements with the aim of maintaining the
flow of credit from banks to the real sector in economic downturns with
the capital accumulated in good times. Moreover, in good times, while
the banks will be required to shore up capital, they may be restrained
from extending indiscriminate credit. In Indian context, its
implementation may have to be well calibrated by recognising structural
changes in banking system due to financial deepening and the need for
separating the structural factors from cyclical factors. Accordingly,
it has been envisaged that while the credit-to-GDP gap shall be used
for empirical analysis to facilitate CCCB decision, other indicators
like Gross Non-Performing Assets’ (GNPA) growth, Industrial Outlook
Survey, Credit to Deposit Ratio, etc., will also be considered in
India.
Accounting Norms and IFRS implementation
40. Some of our prudential guidelines on key
areas such as investment classification and valuation norms, impairment
recognition and loan loss provisioning as well as securitisation are
indeed at variance with international accounting norms. However, these
guidelines were framed keeping the Indian financial system in
perspective. Some of them are more conservative than international
practices. For instance, we do not allow the recognition of unrealized
gains in investment portfolios while requiring that unrealized losses
be provided for. Similarly, we require banks to provide for standard
assets even where there are no signs of impairment. While these have
served us well, as our financial system develops we may have to
harmonise our guidelines with international requirements.
41. At their summit in London in 2009, the G 20
leaders called on “the accounting standard setters to work urgently
with supervisors and regulators to improve standards on valuation and
provisioning and achieve a single set of high-quality global accounting
standards”. The International Accounting Standards Board (IASB) has
now replaced IAS 39 with IFRS 9 with a view to reduce complexity and
improve convergence.
42. With India having made a commitment to
converge to IFRS and the Finance Minister’s Budget announcement of the
mandatory preparation of financial statements by companies (other than
banks, insurance and NBFCs) on the basis of IFRS converged Indian
Accounting Standards (Ind AS) from FY 2016-17 onwards, the RBI is in
advanced stages of finalization of a roadmap for banks and NBFCs in
consultation with various stakeholders. The main challenges for Indian
banks would be system changes, implementation of an expected loss
impairment model and skilling human resources. Issues also arise on
account of the interaction of the regulatory and accounting frameworks.
For instance, apart from the complexities of an expected loss model,
transitioning from an incurred loss to an expected loss model may also
potentially adversely affect capital adequacy. Similarly, the
introduction of a fair value through other comprehensive income (FVOCI)
category coupled with the removal of the regulatory filters under
Basel III may also potentially introduce volatility in the capital. In
order to address implementation issues and facilitate a smoother
transition, the RBI has set up a Working Group comprising professionals
with experience in IFRS implementation, bankers and RBI staff engaged
in regulation and supervision.”
KYC and AML Standards
43. The international standards for
KYC/AML/CFT are set by the Financial Action Task Force (FATF) and the
Reserve Bank issues KYC/AML/CFT guidelines mainly on the lines of FATF
recommendations. However, irrespective of the FATF recommendations
covering many areas, the Reserve Bank issues instructions to banks only
if there are enabling provisions in Prevention of Money Laundering
Act/Rules 2002. Thus, for example, Recommendation 17 of FATF provides
for third party verification of KYC, subject to certain conditions. In
India, we had not allowed it until enabling provisions were brought in
the PML Rules by the Government in August 2013. Similarly, in terms of
Recommendation 12 of FATF, banks/FIs are required to take reasonable
measures to determine whether a customer or beneficial owner is a
domestic Politically Exposed Person (PEP) and if so are required to take
certain enhanced customer due diligence procedures, etc. Since the
Government has not taken a decision in this regard/incorporated this in
PML/Rules, RBI has not instructed banks/FIs to follow the FATF
recommendation.
Conclusion
44. To conclude, designing banking regulations
for an aspiring economy has to carefully factor difficult realities
and calibrate its policies. While on some the regulations have to
conform to international standards, norms and best practices, on certain
other issues the regulations will have to be designed using national
discretion and consciously be different from such standards and norms.
Enlightened self interest will have to be the guide post. In the Indian
context, our past experience of and learnings from such deviations are
our additional guide posts. Reserve Bank is ever conscious of this
position.
45. Thank you.
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