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The Financial Sector Reforms in India
 

The Financial Sector Reforms in India

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    The Financial Sector Reforms in India The Financial Sector Reforms in India Presentation Transcript

    • Presentation Economic Environment of Business The Financial Sector Reforms Slow but steady …not to forget the socio economic needs … 1 The financial Sector Reforms September 9, 2009
    • GROUP • AJAY K. DHAMIJA N-1 • SNEHAL SONI N-47 2 The financial Sector Reforms September 9, 2009
    • Coverage •Introduction •Major Contours of Reforms •Banking sector Reforms •Monitory Policy Reforms •Financial Markets Reforms •Forex Market Reforms •Assesment •Conclusions 3 The financial Sector Reforms September 9, 2009
    • Introduction • FIVE Principle – Measured, gradual, cautious and steady sequencing of reforms – Introduction of mutually reinforcing norms – Development of an Efficient, Competitive and Stable financial sector – Development of Financial Institutions – Introduction of complementary reforms across Monetary, Fiscal and external sector • Broad based reforms touching every sector – Financial Sector – Monetary and Fiscal Policy – Capital Market – Foreign Exchange Market – Money and Government Securities Market 4 The financial Sector Reforms September 9, 2009
    • In early 1990s Lion in jungle • Financial Repression vs lion in cage – Extensive Regulations – Administered Interest rates – Directed Credit Programmes – Weak Banking Structure – Lack of Proper Accounting & Risk management systems – Lack of transparency in operations 5 The financial Sector Reforms September 9, 2009
    • In early 1990s… – Pre-emption of resources from the banking system by the Pre- government to finance its fiscal deficit – Excessive structural and micro regulation that inhibited financial innovation and increased transaction costs – Relatively inadequate level of prudential regulation in the financial sector – Poorly developed debt and money markets – Outdated (often primitive) technological and institutional structures that made the capital markets and the rest of the financial system highly inefficient. 6 The financial Sector Reforms September 9, 2009
    • Resulting into … • Government regulated the price at which firms could issue equity, the rate of interest which they could offer on their bonds, and the debt equity ratio that was permissible in different Industries • Working capital management was even more constrained with detailed regulations on how much inventory the firms could carry or how much credit they could give to their customers. • Working capital was financed almost entirely by banks at interest rates laid down by the central bank • Working capital finance was related more to the credit need of the borrower than to creditworthiness 7 The financial Sector Reforms September 9, 2009
    • … and … • Volatility was not something that most finance managers worried about or needed to. – The exchange rate of the rupee changed predictably and almost imperceptibly – Administered interest rates were changed infrequently and the changes too were usually quite small • Financial genius consisted largely of finding one’s way through the regulatory maze, exploiting loopholes wherever they existed and above all cultivating relationships with those officials in the banks and institutions who had some discretionary powers. • Even an overnight cash surplus could be parked in the overdraft account where it could earn (or rather save) interest at the firm’s borrowing rate. 8 The financial Sector Reforms September 9, 2009
    • At larger level … • The balance of payments crisis that threatened the international credibility of the country and pushed it to the brink of default • The grave threat of insolvency confronting the banking system which had for years concealed its problems with the help of defective accounting policies. • Hindered efficient allocation of resources 9 The financial Sector Reforms September 9, 2009
    • Major Contours of Reforms • Removal of existing financial repression • Creation of an efficient, productive and profitable financial sector • Enabling the process of price discovery by the market determination of interest rates that improves allocative efficiency of resources • Providing operational and functional autonomy to institutions • Preparing the financial system for increasing international competition • Opening the external sector in a a calibrated manner • Promoting financial stability in the wake of domestic and external shocks 10 The financial Sector Reforms September 9, 2009
    • Two phased Reforms • First Generation (Early 1990):- Ist Phase: 1990):- – Creating an efficient, productive and profitable financial sector to function with operational flexibility and functional autonomy • Second Generation (Mid 1990 …) :- IInd phase :- – Strengthening the financial system and introducing structural improvements 11 The financial Sector Reforms September 9, 2009
    • Major Sectors of Reforms • Banking Sector • Monetary Policy • Financial Markets • Forex Market 12 The financial Sector Reforms September 9, 2009
    • Banking Sector Reforms • Competition Enhancing Measures • Measures Enhancing Role of Market Forces • Prudential Measures • Institutional and Legal Measures • Supervisory Measures • Technology Related Measures 13 The financial Sector Reforms September 9, 2009
    • Banking Sector Reforms : Competition Enhancing Measures • Operational autonomy to Public Sector banks • Reduction in public ownership of public sector banks – Can raise capital from equity market up to 49% of paid up capital • Transparent Norms related to entry, mergers /amalgamation and governance issues for Indian private sector, foreign and joint-venture joint- banks, NBFC’s and insurance companies • Permission for foreign investment in the financial sector in the form of Foreign Direct Investment (FDI) as well as portfolio investment • Permission to banks to diversify product portfolio and business activities 14 The financial Sector Reforms September 9, 2009
    • Banking Sector Reforms : Measures Enhancing Role of Market Forces • Sharp reduction in pre-emption through reserve requirement pre- • Market determined pricing for government securities • Disbanding of administered interest rates • Enhanced transparency and disclosure norms to facilitate market discipline • Introduction of pure inter-bank call money market and developing inter- markets for securitized assets • Auction-based repos-reverse repos for short-term liquidity Auction- repos- short- management and Improved payments and settlement mechanism 15 The financial Sector Reforms September 9, 2009
    • Banking Sector Reforms : Prudential Measures • Introduction and phased implementation of international best practices and norms related to:- CRAR, Income recognition, Provisioning and Exposure • Strengthen risk management :- – Assignment of risk-weights to various asset classes – Norms on connected lending, risk concentration – Application of marked-to-market principle for investment portfolio and limits on deployment of fund in sensitive activities – 'Know Your Customer‘ norms – 'Anti Money Laundering' guidelines – Graded provisioning for NPA’s – Capital charge for market risk • Guidelines for ownership and governance, securitization and debt restructuring mechanisms norms, etc 16 The financial Sector Reforms September 9, 2009
    • Banking Sector Reforms : Prudential Measures:- Roadmap for Basel II Measures:- • Implementing Basel II with effect from March 31, 2007 • Standardized Approach for credit risk and Basic Indicator Approach for operational risk (First Phase) • Migrate to the Internal Rating Based (IRB) Approach after adequate skills are developed (Second Phase) • Basel II will require more capital for banks in India – Presently CRAR is over 12 per cent – New and Innovative Funding options Perpetual debt instruments and non- non- cumulative preference shares Redeemable cumulative preference shares and hybrid debt instruments 17 The financial Sector Reforms September 9, 2009
    • Banking Sector Reforms : Institutional and Legal Measures • Setting up of Lok Adalats (people’s courts), debt recovery tribunals, asset reconstruction companies, settlement advisory committees, corporate debt restructuring mechanism, etc. • Promulgation of Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002 and its subsequent amendment to ensure creditor rights • Setting up of Credit Information Bureau of India Limited (CIBIL) for information sharing on defaulters as also other borrowers • Setting up of Clearing Corporation of India Limited (CCIL) to act as central counter party for facilitating payments and settlement system relating to fixed income securities and money market instruments 18 The financial Sector Reforms September 9, 2009
    • Banking Sector Reforms : Supervisory Measures • Board for Financial Supervision as the apex supervisory authority for Risk based supervision • Introduction of CAMELS supervisory rating system (i.e., capital adequacy, asset quality, management, earning, liquidity and system and control). • Consolidated supervision of financial conglomerates • Recasting of the role of statutory auditors with increased internal control through strengthening of internal audit • Strengthening corporate governance • Fit and proper tests for directors along-with enhanced due diligence on important shareholders 19 The financial Sector Reforms September 9, 2009
    • Banking Sector Reforms : Technology Related Measures • INFINET as the communication backbone for the financial sector • Negotiated Dealing System (NDS) for screen-based trading in government securities • Real Time Gross Settlement (RTGS) System True test of the success of the banking reforms would be the extent of NPA’s 20 The financial Sector Reforms September 9, 2009
    • Monitory Policy Reforms • Objectives • Instruments • Developmental Measures • Institutional Measures 21 The financial Sector Reforms September 9, 2009
    • Monitory Policy Reforms : Objectives • Twin objectives of “Maintaining price stability” and “Ensuring availability of adequate credit to productive sectors • Use of broad money (M2) as an intermediate target has been de- emphasized and a multiple indicator approach has been adopted • Development of multiple instruments to transmit liquidity and interest rate signals in the short-term in a flexible and bi-directional manner • Increase of the inter-linkage between various segments of the financial market including money, government security and forex markets 22 The financial Sector Reforms September 9, 2009
    • Monitory Policy Reforms : Instruments: Strategic Shift: From Direct to Indirect • Open market operations (OMO) to deal with overall market liquidity situation especially those emanating from capital flows • Introduction of Market Stabilization Scheme (MSS) as an additional instrument to deal with enduring capital inflows without affecting short-term liquidity management role of LAF • Introduction of Liquidity Adjustment Facility (LAF), which operates through repo and reverse repo auctions Liquidity Adjustment Facility ( LAF ) – To nudge overnight interest rates within a specified corridor. – TO de-emphasize targeting of bank reserves and focus increasingly on interest rates. – reducing the cash reserve ratio (CRR) without loss of monetary control. 23 The financial Sector Reforms September 9, 2009
    • LAF + OMO + MSS => Flexibility Transition from direct instruments of monetary control such as administered interest rate, reserve requirement, selective capital control) to indirect instruments like open market operations, purchase and repurchase of government securities • Advantages – Certain dead weight loss for the system was saved. – Greater flexibility in determining both the quantum of adjustment as well as the rates by responding to the needs of the system on a daily basis. – Modulation of the supply of funds on a daily basis to meet day- to-day liquidity mismatches. – demand for funds are affected through policy rate changes. – Stabilization of short-term money market rates. 24 The financial Sector Reforms September 9, 2009
    • Monitory Policy Reforms : Developmental Measures • Discontinuation of automatic monetization through an agreement between the Government and the Reserve Bank • Amendment of Securities Contracts Regulation Act (SCRA), to create the regulatory framework • Introduction of automated screen-based trading in government securities through Negotiated Dealing System (NDS). • Setting up of risk-free payments and system in government securities through Clearing Corporation of India Limited (CCIL). • Phased introduction of Real Time Gross Settlement (RTGS) System • Deepening of inter-bank Repo market Deepening of government securities market by making the interest rates on such securities market related 25 The financial Sector Reforms September 9, 2009
    • Monitory Policy Reforms : Institutional Measures • Setting up of Technical Advisory Committee on Monetary Policy with outside experts to review macroeconomic and monetary developments and advise the Reserve Bank on the stance of monetary policy • Creation of a separate Financial Market Department within the RBI • Development of appropriate trading, payments and settlement systems along with technological infrastructure. Success of monetary management such as interest rates, is contingent upon the extent and speed with which changes in the central bank's policy rate are transmitted to the spectrum of market interest rates and exchange rate in the economy and onward to the real sector. 26 The financial Sector Reforms September 9, 2009
    • Capital Market Reforms : • Abolition of capital issues control and the introduction of free pricing of equity issues (CCI) • Securities and Exchange Board of India (SEBI) was set up as the apex regulator of the Indian capital markets. • Primary market regulations: – Entry norms for capital issues were tightened – Disclosure requirements were improved – Regulations were framed and code of conduct laid down for merchant bankers – Underwriters, mutual funds, bankers to the issue and other intermediaries • Corporate governance regulations: – Regulations were framed for insider trading – Regulatory framework for take overs was revamped 27 The financial Sector Reforms September 9, 2009
    • Capital Market Reforms • Secondary market regulations: – Capital adequacy and prudential regulations were introduced for brokers, and other intermediaries – Dematerialization of scrips was initiated with the creation of a legislative framework and the setting up of the first depository – Settlement period was reduced to one week – Carry forward trading was banned – Tentative moves were made towards a rolling settlement system. 28 The financial Sector Reforms September 9, 2009
    • Reforms in Government Securities Market • Institutional Measures • Increase in Instruments in the Government Securities Market • Enabling Measures 29 The financial Sector Reforms September 9, 2009
    • Government Securities Market : Institutional Measures • Administered interest rates on government securities were replaced by an auction system for price discovery • Banks have been permitted to undertake primary dealer business while primary dealers are being allowed to diversify their business • Central Government would cease to raise resources on behalf of State Governments . State Governments' capability in raising resources will be market determined and based on their own financial health • Effective April 1, 2006, RBI has withdrawn from participating in primary market auctions of Government paper – fully market based system in the G-sec market. 30 The financial Sector Reforms September 9, 2009
    • Government Securities Market : Increase in Instruments • Market Stabilization Scheme (MSS) has been introduced, which has expanded the instruments available to the Reserve Bank for managing the enduring surplus liquidity in the system – 91-day Treasury bill was introduced for benchmarking – Zero Coupon Bonds, Floating Rate Bonds, Capital Indexed Bonds were issued – Exchange traded interest rate futures were introduced – OTC interest rate derivatives like IRS/ FRAs were introduced • Repo status has been granted to State Government securities in order to improve secondary market 31 The financial Sector Reforms September 9, 2009
    • Government Securities Market : Enabling Measures • Foreign Institutional Investors (FIIs) were allowed to invest in government securities subject to certain limits with non-banks allowed to participate in repo market • Introduction of automated screen-based trading in government securities through Negotiated Dealing System (NDS) • Setting up of risk-free payments and settlement system in government securities through Clearing Corporation of India Limited (CCIL) • Phased introduction of Real Time Gross Settlement System (RTGS). • Introduction of trading in government securities on stock exchanges for promoting retailing and Non-banks participation 32 The financial Sector Reforms September 9, 2009
    • Reforms in Foreign Exchange Market • Exchange Rate Regime • Finance Mobilization • Institutional Framework • Increase in Instruments in the Foreign Exchange Market • Liberalization Measures 33 The financial Sector Reforms September 9, 2009
    • Reforms in Foreign Exchange Market : Exchange Rate Regime • Evolution of exchange rate regime from a single-currency fixed- exchange rate system to fixing the value of rupee against a basket of currencies and further to market-determined floating exchange rate regime • Adoption of convertibility of rupee for current account transactions with acceptance of Article VIII of the Articles of Agreement of the IMF • De facto full capital account convertibility for non residents • Calibrated liberalization of transactions undertaken for capital account purposes in the case of residents 34 The financial Sector Reforms September 9, 2009
    • Reforms in Foreign Exchange Market : Finance Mobilization • Indian companies were allowed to raise equity in international markets subject to various restrictions. • Indian companies were allowed to borrow in international markets subject to a minimum maturity, a ceiling on the maximum interest rate, and annual caps on aggregate external commercial borrowings by all entities put together. • Indian mutual funds were allowed to invest a small portion of their assets abroad. • Indian companies were given access to long dated forward contracts and to cross currency options. 35 The financial Sector Reforms September 9, 2009
    • Reforms in Foreign Exchange Market : Institutional Framework • Replacement of the earlier Foreign Exchange Regulation Act (FERA), 1973 by the market friendly Foreign Exchange Management Act, 1999 (FEMA) • Delegation of considerable powers by RBI to Authorized Dealers to release foreign exchange for a variety of purposes 36 The financial Sector Reforms September 9, 2009
    • Reforms in Foreign Exchange Market : Increase in Instruments • Development of rupee-foreign currency swap market • Introduction of additional hedging instruments, such as, foreign currency-rupee options • Permission to use innovative products like cross-currency options, interest rate swaps (IRS) and currency swaps, caps/collars and forward rate agreements (FRAs) in the international forex market. 37 The financial Sector Reforms September 9, 2009
    • Reforms in Foreign Exchange Market : Liberalization Measures • Authorized dealers permitted to initiate trading positions, borrow and invest in overseas market subject to certain specifications and ratification by respective Banks’ Boards • Banks are also permitted to fix interest rates on non-resident deposits, subject to certain specifications • Use of derivative products for asset-liability management and fix overnight open position limits and gap limits in the foreign exchange market, subject to ratification by RBI • Permission to various participants in the foreign exchange market, including exporters, Indians investing abroad, FIIs, to avail forward cover and enter into swap transactions without any limit subject to genuine underlying exposure 38 The financial Sector Reforms September 9, 2009
    • Reforms in Foreign Exchange Market : Liberalization Measures • FII’s and NRI’s permitted to trade in exchange-traded derivative contracts subject to certain conditions • Foreign exchange earners permitted to maintain foreign currency accounts • Residents are permitted to open such accounts within the general limit of US $ 200,000 per year 39 The financial Sector Reforms September 9, 2009
    • Financial Sector and Monetary Policy Reforms : An assessment Progress of Commercial Banking in India 1969 1980 1991 1995 2000 2005 1 2 3 4 5 6 7 1 Commercial Banks 73 154 272 284 298 288 2 No. of Bank Offices 8,262 34,594 60,570 64,234 67,868 68,339 Rural and semi -urban bank offices 5,172 23,227 46,550 46,602 47,693 47491 3 Population per Office (’000s) 64 16 14 15 15 16 4 Per capita Deposit (Rs.) 88 738 2,368 4,242 8,542 16,699 5 Per capita Credit (Rs.) 68 457 1,434 2,320 4,555 10,135 6 Priority Sector Advances@ (%) 15 37 39 34 35 40 7 Deposits (% of National Income) 16 36 48 48 54 65 40 The financial Sector Reforms September 9, 2009
    • Financial Sector and Monetary Policy Reforms : An Assessment Distribution of Commercial Banks According to Risk-weighted Capital Adequacy Year <4% 4-9 % 9-10 % >10 % Total 1 2 3 4 5 6 1995-96 8 9 33 42 92 2000-01 3 2 11 84 100 2004-05 1 1 8 78 88 41 The financial Sector Reforms September 9, 2009
    • Financial Sector and Monetary Policy Reforms : An Assessment Non-Performing Loans (NPL) of Scheduled Commercial Banks(%) Gross NPL/ Gross NPL/ Net NPL/ Net NPL/ advances Assets advances Assets 1 2 3 4 5 1996-97 15.7 7 8.1 3.3 1997-98 14.4 6.4 7.3 3.0 1998-99 14.7 6.2 7.6 2.9 1999-00 12.7 5.5 6.8 2.7 2000-01 11.4 4.9 6.2 2.5 2001-02 10.4 4.6 5.5 2.3 2002-03 8.8 4 4.4 1.9 2003-04 7.2 3.3 2.9 1.2 2004-05 5.2 2.6 2 0.9 42 The financial Sector Reforms September 9, 2009
    • Financial Sector and Monetary Policy Reforms : An Assessment Select Productivity Indicators of Scheduled Commercial Banks (Rs. million at 1993-94 prices) Year Business Profit per Business per employee Employee per branch 1992 5.4 0.02 109.9 1996 6.0 0.01 119.6 2000 9.7 0.05 179.4 2005 17.3 0.13 267.0 43 The financial Sector Reforms September 9, 2009
    • Financial Sector and Monetary Policy Reforms : An Assessment Despite record high international crude oil prices, inflation remains low and inflation expectations also remain stable. 44 The financial Sector Reforms September 9, 2009
    • Financial Sector and Monetary Policy Reforms : An Assessment Fresh issuances under the MSS were suspended between November 2005 and April 2006 due to tight liquidity. Redemptions of securities/Treasury Bills issued earlier – along with active management of liquidity through repo/reverse repo operations under Liquidity Adjustment Facility - provided liquidity to the market and imparted stability to financial markets. With liquidity conditions improving, it was decided to again start issuing securities under the MSS from May 2006 onwards. 45 The financial Sector Reforms September 9, 2009
    • Forex Reforms : An Assessment Exchange rate exhibiting reasonable two-way movement 46 The financial Sector Reforms September 9, 2009
    • Financial Sector and Monetary Policy Reforms : An Assessment Credit Delivery increased from 30 per cent during 1999-00 to 41 per cent during 2004-05 and further to 48 per cent during 2005-06. 47 The financial Sector Reforms September 9, 2009
    • Conclusion • Financial system in India, through a measured, gradual, cautious, and steady process, has undergone substantial transformation • Reasonably sophisticated, diverse and resilient system through well-sequenced and coordinated policy measures aimed at making the Indian financial sector more competitive, efficient, and stable • Effective monetary management has enabled price stability while ensuring availability of credit to support investment demand and growth in the economy. 48 The financial Sector Reforms September 9, 2009
    • Conclusion • The multi-pronged approach towards managing capital account in conjunction with prudential and cautious approach to financial liberalisation has ensured financial stability in contrast to the experience of many developing and emerging economies • Monetary policy and financial sector reforms in India had to be fine tuned to meet the challenges emanating from all global and domestic shocks. • Viewed in this light, the success in maintaining price and financial stability is all the more creditworthy. • The overall objective of maintaining price stability in the context of economic growth and financial stability will remain 49 The financial Sector Reforms September 9, 2009
    • Thank You 50 The financial Sector Reforms September 9, 2009