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Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
Banking developments&perspectives (2)
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Banking developments&perspectives (2)

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  • 1. Banking Developments and Perspectives Chapter I Banking Developments and PerspectivesOne of the major areas of the macro-economy 1999-2000 and a perspective towardsthat has been the subject of focused attention developing a more stable, efficient, resilientin recent years is the financial sector soundness and vibrant banking system.and efficiency. Within the broad ambit of thefinancial sector, a well-functioning banking 1. Policy Environmentsector is regarded as the bedrock of a stablefinancial system. The renewed focus on the Monetary and Credit Policiesbanking sector has been driven by two major 1.2 The annual Monetary and Credit Policyconsiderations. First, the growing Statements as well as Mid-term Reviews have,universalisation and internationalisation of in recent years, elaborated on a number ofbanking operations, driven by a combination medium to long-term structural reform measuresof factors, such as, the continuing deregulation, for providing stability to the financial system,heightened competition and technological besides undertaking short-term monetary policyadvancements, have altered the face of banks initiatives, when felt necessary, to stimulate thefrom one of mere intermediator to one of economy. The major short-term monetary andprovider of quick, efficient and consumer- credit policy measures announced duringcentric services. In the process, the potential 1999-2000 and 2000-01 (up to October) arefor risks has also increased. Secondly, the given in Appendix Table I.1. The table showswidespread banking problems that have that interest rates generally softened in 1999-plagued large areas of the globe have raised 2000 as cash reserve requirements werea gamut of questions relating to the linkages reduced and access to liquidity supportbetween banking reforms and reforms of other mechanisms was eased. In 2000-2001 (up tosegments of the financial sector, the extent October), after a brief continuation of theof exposures to sectors which are trends noticed in the previous year, the interestcharacterised by asymmetric information rates and cash reserve requirements wereproblems, and the ‘contagion’ effect. It has, moved up, and liquidity support was modulatedtherefore, become necessary to promote robust to suit the market conditions. The mainfinancial practices and policies, especially in objectives of structural measures have beenrespect of banks, in order to sustain financial five-fold, viz., (a) to increase operationalstability. This is all the more true in effectiveness of monetary policy by broadeningdeveloping economies where assets of the and deepening various segments of the market;banking system constitute a substantial (b) to redefine the regulatory role of theproportion of financial sector assets. In this Reserve Bank in order to make it morecontext, a number of policy measures have efficient and purposive; (c) to strengthen thebeen taken in recent years to improve the prudential and supervisory norms; (d) tohealth and efficiency of Indian commercial improve the credit delivery system; and (e) tobanks. This chapter provides an overall view develop the technological and institutionalof the policy initiatives undertaken since infrastructure of the financial sector.1999-2000, the financial performance ofscheduled commercial banks during 1.3 The important policy measures 1
  • 2. Report on Trend and Progress of Banking in India, 1999-2000pertaining to various segments of the money thrust essentially to improve the functioningmarket during 1999-2000 and 2000-01 (up of the market. The major monetary and creditto October 2000) are given in Appendix Policy measures announced in the Mid-termTable I.2. The table shows that liberalisation Review of October 10, 2000 are indicatedof money market has been given a major in Box I.1. Box I.1: Major Policy Measures Announced in the Mid-term Review of Monetary and Credit Policy for the year 2000-2001 (i) In the context of improving the efficacy of the secondary market, the restriction on Liquidity Adjustment Facility (LAF) and to transferability period for CDs issued by both make the money market more efficient and to banks and financial institutions, which was enable the development of a short-term rupee earlier fixed at 15/30 days from the date of yield curve, as recommended by the issue, is withdrawn. Narasimham Committee II, it is necessary to move towards the objective of pure inter-bank (iv) In order to improve the functional efficiency of call money market. However, considering the the market, the rating for the term deposits fact that the repo market is yet to be broad- accepted by select all-India financial institutions, based in terms of instruments and participants which are governed by the Reserve Bank and yet to acquire enough depth, it was decided guidelines, has been made mandatory, with to extend the permission granted to select effect from November 1, 2000. corporates, which have been given specific permission to route call money transactions (v) As a part of tightening the prudential norms, through Primary Dealers (PDs) which is banks were advised in October 1998 to make a available up to December 2000, for a further general provision on standard assets of a period of six months, i.e., up to June 2001. In minimum of 25 basis points from the year ended addition to select corporates which have been March 31, 2000. The guidelines were partially permitted to route call money transactions modified on April 24, 2000 stipulating that the through PDs, there are several non-bank provision should be made on a global portfolio institutions such as Financial Institutions and basis and not on domestic advances. The general Mutual Funds which are currently permitted to provision on standard assets woud be included lend directly in the call/notice money market. in Tier II Capital, in line with international best In order to make necessary transitional practices followed in this regard. provisions in respect of these institutions also, before the call money market is confined only (vi) The Reserve Bank issued final guidelines on to banks and PDs, it was decided to constitute categorisation and valuation of banks’ a Group to suggest a smooth phasing out by a investment portfolio. As per the new guidelines, planned reduction in their access to call/notice banks are required to classify the entire money market. The Group would also include investment portfolio (including SLR securities representatives of non-bank institutions. and non-SLR securities) under three categories, viz., ‘Held to Maturity’, ‘Available for Sale’ and (ii) The guidelines for issue of Commercial Paper ‘Held for Trading’. Out of these, the investment (CP) were finalised, after taking into account portfolio ‘Held to Maturity’ will not exceed 25 the views from the market participants on the per cent of the total investments, subject to draft guidelines and the Report of an Internal certain criteria. Group circulated in July 2000. The new guidelines are expected to provide considerable (vii) In order to bring more transparency to the flexibility to participants and add depth and balance sheets of public sector banks and as a vibrancy to the CP market while at the same further step towards consolidated supervision time ensuring prudential safeguards and and to provide additional disclosures, it has been transparency. decided that public sector banks should also annex the balance sheets of their subsidiaries to (iii) In order to provide flexibility and depth to the (Contd....) 2
  • 3. Banking Developments and Perspectives (....Concld.) their balance sheet beginning from the year Foreign Currency (EEFC) accounts of Export ending March 31, 2001. oriented units, units in Export Processing Zone, Software Technology Park or (viii) Owing to factors such as the improvements in Electronic Hardware technology Park, as the payment and settlement systems, recovery prevalent prior to August 14, 2000, i.e., 70 climate, and upgradation of technology in the per cent (from 35 per cent). Similarly, banking sector, the concept of “past due” (grace entitlement regarding inward remittances in period of 30 days) would be dispensed with, respect of others was restored to 50 per cent effective March 31, 2001. (from 25 per cent). It was also decided that EEFC accounts (including existing accounts) (ix) In order to facilitate quick export-related would henceforth be held in the form of payments and to reduce transaction costs, it chequeable, current deposit accounts and no was decided to restore fully the earlier credit facility would be provided by banks entitlements in respect of Exchange Earners against EEFC balances.Liquidity Adjustment Facility June 5, 2000. In the next stage, collateralised1.4 In line with the recommendations of the lending facility (CLF) for banks and level I liquidity support to PDs would also be replacedCommittee on Banking Sector Reforms(Chairman: Shri M. Narasimham), popularly by variable rate repo/reverse repo auctions. Some minimum liquidity support to PDs wouldknown as the Narasimham Committee II, theReserve Bank decided to introduce a Liquidity be continued but at an interest rate that would be linked to a variable rate in the daily repoAdjustment Facility (LAF) to set a corridorfor money market interest rates. LAF has auctions as obtained from time to time. With full computerisation of Public Debt Officereplaced the Interim Liquidity AdjustmentFacility (ILAF) which was introduced in April (PDO) and introduction of real time gross settlement (RTGS) system expected to be in1999, pending upgradation in technology andlegal/procedural changes to facilitate place by the end of 2000-01, in the subsequent stage, repo operations through electronicelectronic transfer and settlement. The ILAFoperated through a combination of repo, transfers would be introduced. In the final stage, it would be possible to operate LAF atexport credit refinance, collateralised lendingfacilities and open market operations (OMO) different timings of the same day. The quantum of adjustment as also the rates would beand provided a mechanism for injection aswell as absorption of liquidity to/from banks flexible, responding immediately to the needs of the system. The funds would meet primarilyand primary dealers (PDs) in order toovercome the liquidity mismatches in supply the day-to-day liquidity mismatches in the system and not the normal financingand demand. requirements of eligible institutions. Both the1.5 In the light of the experience gained time-table and the scope of proposed changesduring 1999-2000, the introduction of LAF by would, however, be subject to review in thethe Reserve Bank in June 2000 represented the light of actual experience.first stage of transition to a full-fledged LAF.In this stage, the additional collateralised 1.6 Effective June 5, 2000, the first stage oflending facility (ACLF) for banks and level II LAF was operationalised. Initially, repos/liquidity support to PDs were replaced by reverse repo auctions, conducted on a dailyreverse repo auctions, while the fixed rate repo basis (Monday through Friday) and with onewas replaced by variable rate repos, effective day maturity (except on Fridays/days preceding 3
  • 4. Report on Trend and Progress of Banking in India, 1999-2000holidays) were introduced. Subsequently, in number of PDs increased to 15 as at end-August 2000, multiple repo/reverse repo March 2000 from 13 as at end-March 1999.auctions with 3-7 day maturity periods were The system of underwriting by PDs in respectintroduced. Interest rates in respect of both of Treasury Bill auctions was changedrepos and reverse repos are the cut-off yields effective April 20, 1999. Presently, each PDemerging from auctions conducted on a is required to bid up to a fixed percentage ofuniform price basis. the notified amount and all PDs together have to bid for more than 100 per cent of the issue.Special Fund Facility for Security Settlement Consequently, PDs are not required to take devolvement and the commission payment to1.7 Pursuant to the announcement in the PDs for participation in the Treasury BillMonetary and Credit Policy for 2000-01, the auctions was withdrawn, effective June 5,Reserve Bank introduced a special fund 2000. As regards dated securities, it wasfacility, effective October 3, 2000, for decided to accept underwriting from PDs, upsettlement of transactions in Central/State to 100 per cent of the auction issue (as againstGovernments dated securities as well as 50 per cent earlier), effective April 27, 2000.Treasury Bills. The scheme would provide PDs were earlier permitted in 1999-2000 tocollateralised intra-day (not overnight) funds underwrite auction issues of State Governmentto banks and PDs to facilitate settlement of securities. The liquidity support to PDs wassecurities transactions in case of gridlock. based on their bidding commitments andGridlock occurs in the delivery versus payment secondary market operations during 1999-system on account of shortage of funds on a 2000. From the year 2000-01, biddinggross basis in the current account of SGL commitments and primary and secondaryaccount holder(s). Banks and PDs who are market performance are taken into account foreligible for CLF and Liquidity Support Facility fixing liquidity support under Level I which(LSF), respectively, from the Reserve Bank, is subject to a cap of three times their netare entitled to this facility. Credit would be owned funds. PDs were advised to evolveavailable at the Bank Rate on a collateralised reasonable leverage ratios with the consent ofbasis and would be extended against undrawn their boards of directors. Detailed guidelinesCLF/LSF. In addition, a flat fee of Rs.25 per on internal control systems relating totransaction would be charged from each of the securities transactions were issued onbeneficiary participants. All transferable December 31, 1999 on a uniform basis. FreshCentral Government dated securities and guidelines for capital adequacy standards forTreasury Bills (except 14-day Treasury Bills) PDs are being evolved to address marketwould be eligible collateral for this facility. risks.The drawal would be restricted to 95 per centof the face value of outstanding securities in 1.9 The Reserve Bank has been announcingreverse repo constituent SGL account of aparticipant after providing for successful bids an advance release calendar on issue of Treasury Bills on a half-yearly basis sincein reverse repo auctions. April 1999 to remove market uncertainties. Further, 182-day Treasury Bills wereGovernment Securities Market reintroduced on fortnightly basis, effective1.8 The Reserve Bank continued with the May 26, 1999 providing market players withprocess of further deepening and widening of an additional instrument. The Reserve Bankthe Government securities market. The also initiated the process of consolidation of 4
  • 5. Banking Developments and Perspectivesoutstanding loans since May 1999 to ensure towards international best practices in bankingsufficient volumes and liquidity in any supervision. The policy measures during 1999-particular issue which would also facilitate the 2000 and 2000-01 (up to October) concerningemergence of benchmarks and development of banking activities focus on various issues suchSeparate Trading of Registered Interest and as regulation and supervision, enhancedPrincipal Securities (STRIPS). Further, as competition, prudential norms, etc (Appendixannounced in the Monetary and Credit Policy Table I.3).for 2000-01, entities allotted securities inprimary auctions have been allowed to sell Strengthening the Banking Systemthem on the date of allotment itself, the Capital Adequacytransfer and settlement being effected in thenext working day. Technological upgradation 1.12 As a part of the follow-up of theof Government securities market by setting up recommendations of the Narasimham Committeean Electronic Screen-based Negotiated Dealing II, it was decided in October 1998 to raise theSystem and computerisation of the Public Debt stipulated minimum capital to risk-weightedOffice will facilitate electronic bidding in assets ratio (CRAR) of scheduled commercialauctions and dealing in Government securities banks by one percentage point to 9 per centand money market instruments including their from the year ended March 2000. Banks werederivatives. This would also facilitate smooth advised in October 1999 to assign a risk-weightsettlement through connectivity. of 2.5 per cent to cover market risk in respect of investments in securities outside the SLR by1.10 The amendment to Securities Contracts the year ending March 31, 2001 (over and(Regulation) Act, 1956, effective March 1, above the existing 100 per cent credit risk-2000, has vested the Reserve Bank with weight). A market risk-weight of 2.5 per centregulatory powers to regulate dealings in had been prescribed for Government and othergovernment securities, money market securities, approved securities from March 31, 2000.gold related securities as well as securities Further, banks were advised in April 2000 toderived from these securities and ready forward assign a risk-weight of 100 per cent only oncontracts in bonds, debentures, debenture stock, those State Government guaranteed securitiessecuritised and other debt securities. The issued by defaulting entities and not on all theReserve Bank permitted all entities having SGL securities issued or guaranteed by the concernedand current account with Mumbai office, to State Government. With regard to provisioningenter into repos in Treasury Bills and Central for standard assets, it was clarified that theand State Government dated securities. So far, general provision of 0.25 per cent on standard64 non-bank entities are eligible. assets should be made on global portfolio basis and not on domestic advances alone. It wasCommercial Banking System announced in October 2000 that the general provision on standard assets would be included1.11 In the wake of the recent financial in Tier II capital, together with other generalcrises, there has been a renewed focus world provisions/loss reserves, up to a maximum ofwide on containing risks. In this context, there 1.25 per cent of the total risk weighted assets.have been proposals for introduction of newcapital adequacy norms and development of Public Issue of Sharesinternational standards and codes with theobjective of achieving/maintaining stability. In 1.13 During 1999-2000, six old private sectorIndia too, efforts have been made to move banks – Ganesh Bank of Kurundwad Ltd. 5
  • 6. Report on Trend and Progress of Banking in India, 1999-2000(Rs.0.54 crore), Ratnakar Bank Ltd. (Rs.5.89 2000. During 1999-2000, the Governmentcrore), Nainital Bank Ltd. (Rs.2.50 crore), provided a sum of Rs.297.07 crore towardsBharat Overseas Bank Ltd. (Rs.10.50 crore), writing down of the investments (capital base)Bank of Rajasthan Ltd. (Rs.67.24 crore) and of Vijaya Bank for adjustment of its losses.Sangli Bank Ltd. (Rs.15.77 crore) were granted With this, the losses of nationalised bankspermission to issue shares on rights basis for written off against capital amounted toaugmenting their capital. While five banks Rs.6,334.44 crore.have collected the full amounts of the issue,Sangli Bank Ltd. has collected Rs.3.15 crore. Recovery Management 1.16 The relatively high level of non-Ownership Pattern of Nationalised Banks performing assets (NPAs) of public sector1.14 Recognising that the nationalised banks banks (PSBs) has been a matter of concern.need to augment their capital base to cope Its reduction is closely linked to recoveries.up with the changing operational However, the recovery management has beenenvironment, the Government has permitted impeded by the fact that laws have not beenbanks to access capital market, both at home robust enough to provide comfort to banks’and abroad. However, as the amount of efforts in reducing the level of NPAs. Variouscapital which can be raised by th e measures have been taken recently to addressnationalised banks from the capital market this issue which include: announcement in thehas been constrained by the minimum Union Budget 2000-01 for setting up of sevenshareholding of 51 per cent by the Central more debt recovery tribunals (DRTs),Government, the Union Budget for 2000- strengthening the infrastructure of DRTs and2001 has envisaged a reduction in the amendment to the Recovery of Debts Due tominimum Government shareholding in Banks and Financial Institutions Act. The Act,nationalised banks to 33 per cent. It was also inter alia, has sought to empower the DRT tostated in the Budget that in the process of straightaway issue certificate for recovery onreduction of Government shareholding limit, the basis of decree or order of Civil courts.the public sector character of these bankswould remain unchanged and that the fresh 1.17 The Reserve Bank had issued guidelinesissue of shares would need to be widely held to PSBs for the constitution of Settlementby the public. The Government also proposed Advisory Committees (SACs) for compromiseto bring about necessary changes in the settlement of chronic NPAs of small scalelegislative provisions to accord flexibility sector in May 1999. A review of theand autonomy to the Boards of the banks. performance of SACs revealed that progress of recovery of NPAs through this mechanismRecapitalisation and Write-offs of Losses was not satisfactory. Consequently, the Reserveagainst Capital of Nationalised Banks Bank issued revised guidelines in July 20001.15 The Government had contributed an covering all sectors, including the small scaleaggregate amount of Rs.20,446.12 crore sector, to provide a simplified, non-towards recapitalisation of nationalised banks discretionary and non-discriminatoryby end-March 1999. The Government did not mechanism for recovery of NPAs withprovide any amount on this account in 1999- outstanding balance of up to Rs.5 crore as at 6
  • 7. Banking Developments and Perspectivesend-March 1997. The scheme would be addressed. It may be recalled that draftoperative up to end-March 2001. guidelines on asset-liability management (ALM) were issued in September 1998 and onRestructuring of Weak Public Sector Banks the basis of the feedback received from banks on the draft guidelines, the final guidelines1.18 The Working Group on Restructuring were issued in February 1999 forWeak PSBs (Chairman: Shri M.S. Verma), had implementation by banks from April 1, 1999.concluded that a comprehensive restructuringstrategy dealing with operational, 1.20 Asset-Liability Management Committeesorganisational, financial and systemic aspects, (ALCOs) have been set up in all banks and arewould be the most appropriate for the three headed by Chairman and Managing Director/identified weak banks. Subsequently, the Union Executive Director to manage various risks fromBudget for 2000-2001 announced that weak risk-return perspective. Besides, Managementbank-specific Financial Restructuring Authority Committee or a specific Committee of the Board(FRA) would be constituted, not an authority has been formed in each bank to overseeto deal with all weak banks put together as implementation of the ALM system and reviewrecommended by the Working Group. Under its functions periodically.the proposed framework, the statutes governingPSBs would be amended to provide for 1.21 The guidelines introduced two returns,supersession of the Board of Directors on the viz., Statement of Structural Liquidity andbasis of recommendations of the Reserve Bank Statement of Interest Rate Sensitivity coveringand constitution of a FRA for such a bank, liquidity risk management and interest rate riskcomprising experts and professionals. The management in respect of banks’ dealings inamendments would also enable the FRA to rupee. As regards foreign currency risk, banksexercise special powers, including all powers were advised to follow the instructions issuedof the Board of the bank. The Government by the Exchange Control Department inwould consider recapitalisation of the weak December 1997 that introduced two returns,banks to achieve the prescribed capital viz., Statement of Maturity and Position (MAP)adequacy norms, provided a viable and Statement of Interest Rate Sensitivityrestructuring programme acceptable to the (SIR).Government as the owner and the ReserveBank as a regulator is made available by the 1.22 In July 1999, the Reserve Bank advisedconcerned banks. The restructuring plans banks to submit four returns with effect fromsubmitted by the three identified weak banks the quarter ended June 1999. The two returnsare being finalised by the Government/Reserve on foreign currencies, viz., MAP and SIR haveBank. been aligned in periodicity and time–buckets with the Rupee statements on StructuralAsset-Liability Management Liquidity and Interest Rate Sensitivity for the1.19 Given the increasing internationalisation purpose of supervisory returns. Banks haveof banking operations, commercial banking been provided with structured formats foroperations are subject to significant mismatch compiling these returns. Banks have startedbetween assets and liabilities with implications submitting the returns since the quarter endedfor several types of risks, such as, the interest June 1999.rate risk, liquidity risk and foreign exchangerisk which are likely to arise and need to be 1.23 Keeping in view the prevailing 7
  • 8. Report on Trend and Progress of Banking in India, 1999-2000Management Information System (MIS) in of this, guidelines on Risk Managementbanks and in the absence of high level of Systems were issued in October 1999,computerisation, banks were advised to ensure providing essential details to enable the bankscoverage of at least 60 per cent of their assets to put in place a comprehensive riskand liabilities from April 1, 1999 and 100 per management system to take care of credit risk,cent by April 1, 2000. In view of genuine market risk and operational risk. Thedifficulties expressed by a few banks, it was guidelines show that risk management is adecided to grant extension to some of the necessary condition for maintaining, preservingbanks, subject to their covering at least 80 per and enhancing financial stability in the contextcent of business by April 1, 2000 and 100 per of the financial and structural reforms that arecent by April 1, 2001. being undertaken. An important means for positioning appropriate risk management1.24 The Reserve Bank embarked on a techniques is the MIS. Development andproject to upgrade the off-site data base strengthening of MIS would require in the firstsupervisory statistics with enhanced place a strong data base, and other informationcapabilities of processing of reports on risk sets, and secondly, application of data miningexposures based on submission of returns on techniques and behavioural and technicalALM, introduced for banks and all-India term relationships among different variables.lending and refinancing institutions. Exposure Norms1.25 Considering the existing MIS and 1.27 Effective April 1, 2000, the exposuretechnical expertise, banks have been advised ceiling in respect of an individual borrowerto adopt the Traditional Gap analysis as a was reduced from 25 per cent to 20 per centsuitable method for measuring interest rate of the bank’s capital funds. Where the existingrisk. It is, however, the intention of the level of exposure as on October 31, 1999, wasReserve Bank to move over to the modern more than 20 per cent, banks were expectedtechniques like Duration Gap analysis, to reduce the exposure to 20 per cent of capitalSimulation and Value at Risk over time when funds over a two-year period (i.e., by end-banks acquire sufficient expertise and October 2001). The Rupee sub-ordinated debtimprovement in acquiring and handling of raised by banks as Tier-II capital would notMIS. Banks are, therefore, required to be included in the capital funds for the purposestipulate a time frame for switching over to of determining the exposure ceiling tothe new techniques. The switchover is for individual group borrowers.prescribing explicit capital charge for interestrate risk in the trading book. 1.28 A review of current practices regarding credit exposure limits vis-à-vis internationalRisk Management best practices shows that there are certain1.26 The increased complexity in banking issues which require further consideration. Theoperations, and the need to prevent financial first relates to the concept of ‘capital funds’;crises of the type witnessed in East Asia, have second relates to the scope of the measurementnecessitated continuous efforts towards of credit exposure, in particular, the coveragestrengthening the soundness of financial of non-fund and other off-balance sheetentities, and in particular, upgradation of risk exposures; and the third relates to the level ofmanagement practices and procedures. As part exposure limit itself. Taking into account the 8
  • 9. Banking Developments and Perspectivescomplexities involved, it has been decided to PSBs and as a further step towardsprepare a detailed Discussion Paper on the consolidated supervision and to providesubject which would inter alia address issues additional disclosures.relating to current practices in India vis-à-visinternational best practices and the possible Supervisory Initiatives relating to Foreignalternative approaches with pros and cons and Branches of Indian Banksother relevant aspects. The Discussion Paper 1.30 A Working Group was set up in thewhich is expected to be finalised by December Reserve Bank to go into the entire gamut of2000, would be circulated among banks. Based the management of overseas operations ofon the comments and suggestions on the issues, Indian banks. Officials from major banksand followed by an interaction with banks, the having overseas operations, apart from officialsReserve Bank would take a final view on the from the Reserve Bank were represented in theapproach that should be adopted with a view Working Group. Some of the importantto making it effective from end-March 2002. recommendations of the Group are:Consolidated Supervision of Banks and theirSubsidiaries • Introduction of a new supervisory reporting system called the DSB-O returns1.29 The Reserve Bank initiated steps to to replace the existing RALOO (Returnsmove towards consolidated supervision on Assets and Liabilities of Overseaswhereby banks would voluntarily build in the Offices) statements. The existing systemrisk-weighted components of their subsidiaries is to be rationalised with focus on marketinto their own balance sheet on notional basis risks which were not adequately capturedby applying risk-weights to subsidiaries’ assets in the present set up.identical to those applied to banks’ own assets.Banks would also be required to earmark • Introduction of comprehensive policies inadditional capital in their books in a phased respect of credit and investmentmanner beginning from the year ending March management at the overseas branches2001 to obviate the possible impairment to taking into account the host countrytheir net worth during the period of switching regulation/legislation. The objective is toover to a unified balance sheet for the group improve the asset quality by takingas a whole. The principal bank in the group advantage of the emerging opportunities inwould be responsible for monitoring the group the overseas markets.operations from prudential perspective andprovide data/information to the Reserve Bank • Formulation of appropriate riskincluding filing of returns regarding management policies taking into accountsubsidiaries. The returns in respect of each of the scale and complexity of operations,the subsidiaries would cover capital adequacy, risk philosophy and risk taking capacitylarge credit exposures, asset quality, ownership of banks. Such policies should aim atand control, profitability and contingent identification of risks, their quantification,liabilities and credit exposure to each of the monitoring and control.subsidiaries. Further, PSBs would also berequired to annex the balance sheets of their • Banks to put in place strong managementsubsidiaries to their balance sheet beginning information system which would providefrom the year ending March 2001, to bring comprehensive/valuable feed back to themore transparency to the balance sheets of top management on a timely basis to 9
  • 10. Report on Trend and Progress of Banking in India, 1999-2000 enable the top management to initiate recommendations and furnish to the Reserve appropriate action. Bank the progress reports in this regard on a quarterly basis, which are being monitored in• Periodicity of inspection of foreign the Cell. branches to be decided by banks taking into account the instructions of the host 1.32 The Cell has started analysing the country regulator in this regard, if any, and portfolio appraisal reports of the overseas status of the branch. In addition, banks to operations. The supervisory action being introduce a system of quick assessment/ undertaken includes discussion with the top review of the larger foreign branches at management on the identified supervisory more frequent intervals. concerns and follow-up action on the assurances given by the bank. Other activities• As regards supervision by the Reserve of the Cell include analysis of returns from Bank, apart from the DSB-O returns, the overseas offices and undertaking country quarterly DO letters from the Head analysis on a periodical basis. Offices, copies of the head office inspection reports of the foreign branches 1.33 The most recent initiative undertaken by and inspection reports of the host country the Cell is the preparation of market regulator to be used as supplementary off- intelligence reports on overseas markets. Such site tools. The Reserve Bank is required reports are being prepared and circulated in the to undertake on-site supervision of department on a fortnightly basis. These foreign branches, the frequency of which reports are expected to act as an important depends on its perception of supervisory input for initiating supervisory action. concerns. Technological Developments• Banks to initiate action on reviewing their Information Technology personnel policies consisting of placement policy, succession policy, and retention 1.34 During 1999-2000, the Reserve Bank policy for smooth functioning of overseas focussed on two major areas in the field of branches. computers and information technology (IT). One of the issues of concern related to smooth1.31 In view of these recommendations, the year 2000 transition which entailed a thoroughReserve Bank set up a new cell named examination of the hardware, software,‘Foreign Branches Cell’ in the Department of operating system and networking systems inBanking Supervision to oversee the vogue in the entire financial sector and inimplementation of these recommendations and particular, in the banking sector so as to ensurealso to provide sharper focus on the that there would be business continuity. Thesupervision of overseas operations. The efforts made by the Reserve Bank to encourageReserve Bank has introduced DSB-O and to foster implementation of necessary actionquarterly reporting system consisting of seven in this regard by commercial banks helped toreturns in place of RALOO statements from further improve IT infrastructure with latestthe quarter ended June 2000. Further, the equipments and solutions and integratedbanks were advised to review their policies networks. The second area of focus was onrelating to credit, investment, risk overall technological upgradation in banks,management, etc. in the light of the Group’s essentially to facilitate smooth and efficient 10
  • 11. Banking Developments and Perspectivespayment and settlement, improved customer developing an integrated payment andservice and the resultant increase in profitability. settlement system. The council has a broad representation from commercial banks and1.35 It was in this direction that the other financial sectors (Box I.2).Committee on Technology Upgradation in theBanking Sector set up by the Reserve Bank 1.37 The ultimate goal is to design andmade wide-ranging recommendations based on develop a settlement system which will bewhich the Reserve Bank drew up an Action based on multiplicity of deferred/discrete netPlan for implementation of the settlement systems and RTGS, and facilitaterecommendations. Besides, three sub-groups efficient funds management, house-keeping andhave also been constituted to (i) review customer service. Both domestic and cross-periodically security policies, message formats, border payment transactions as well as equitysoftware, etc.; (ii) examine legal issues of and other securities settlements would be partelectronic banking; and (iii) monitor progress of such a system. The infrastructure that willof computerisation of branches of banks help to make it a reality will be large, andhandling Government transactions. will include networking of computerised bank branches, with their controlling offices, central1.36 Furthermore, an institutional mechanism treasury cells and head offices with the provisoin the form of National Payments Council has for introducing standardisation of operatingbeen constituted in May 1999, with Deputy systems and networking platforms within theGovernor Shri S.P. Talwar as the Chairman, bank and a bank-level standardised gateway toto focus and recommend broad policy Indian Financial Network (INFINET). Aparameters that provide basis for designing and consultant has been appointed to assist the Box I.2: National Payments Council - Policy Decisions The National Payments Council was constituted in e) Systems and Procedures - related issues. May 1999 with the objective of providing perspectives and recommendations on broad policy issues to help (iv) Provision of Collateralised credit and/or Repo design, develop and maintain an integrated, robust based intra-day liquidity by the Reserve Bank payment and settlement system for the country. with terms and conditions providing due Several important policy decisions were taken by the recognition to risk management. National Payments Council in its meetings held (v) Recommendation of standards for smart cards for between July 1999 and June 2000. These are detailed financial transactions and thereafter as under: operationalisation of these standards in the context of the guidelines given for the (i) Introduction of Real Time Gross Settlement introduction of debit/smart cards. (RTGS) System. (vi) Adoption of Generic Architecture Model for (ii) Adoption of the ‘Y’ topology for the RTGS payment systems which provides for a ‘tree’ involving a service provider between the structure (for older banks) and a ‘star’ topology originator and beneficiary of the transaction and (for newer banks) for inter branch networking its settlement in the books of the Reserve Bank of individual banks with the proviso for a bank- (Chart I.1). level standardised gateway to the Indian Financial Network (INFINET). (iii) Constitution of five permanent Task Forces on a) Monetary Policy and related issues, b) (vii) Strategies for computerisation and networking of Payment and Settlement Systems Oversight, c) bank branches, to ensure that most of the major Legal Issues, d) Technology Related Issues, and centres are covered by the INFINET. 11
  • 12. Report on Trend and Progress of Banking in India, 1999-2000implementation of the RTGS. Rationalisation of Procedures Regulations Review Authority 1.39 The Reserve Bank had set up a Regulations Review Authority (RRA) (with Deputy Governor Dr. Y.V. Reddy as RRA) on April 1, 1999 for one year for reviewing the Reserve Bank’s rules, regulations, reporting systems, etc., in the light of suggestions received from general public, market participants and users of services of the Reserve Bank. However, as the scope of the work for RRA has been found to be large, the term of RRA has been extended by one more year from April 1, 2000. During 1999-2000 and the first half of 2000-01, the Authority received 235 applications, which contained more than 400 suggestions, pertainingSmart Card based Payment System to various functional areas of the Reserve Bank. Implementation of the accepted suggestions has1.38 Progress is being made towards paved way for streamlining several existingdeveloping standards for newer payments procedures in the Reserve Bank, particularly ininstruments such as SMART cards. A pilot its departments which deal with the public. Theproject on SMART Card technology in India suggestions also compelled a review of thetitled ‘SMART Rupees System (SMARS)’ was Reserve Bank’s reporting systems and contributedundertaken by the Indian Institute of to rationalisation of a number of statistical returnsTechnology, Mumbai to examine the viability and reports. The RRA initiated the work relatingand use of SMART cards as retail payment to compilation of subject-wise master circularsinstruments within the country. It came out by merging circulars issued over the years onwith a set of recommendations on SMART select subjects. One circular on Exposure Normscards standards. With a view to examining has already been issued and others are at variousthese recommendations and for determining the stages of finalisation. Further, it is proposed tostandards for the Indian banking industry, the issue an updated Master Circular on selectReserve Bank set up a ‘Working Group to subjects at the beginning of each year.study the recommendations for SMART cardbased Payment System Standards’ in 1.40 With a view to having a consistent policySeptember 1999. The Working Group with regard to investor protection, MMMFssubmitted its Report to the Reserve Bank in were brought under the regulatory purview ofJanuary 2000 and the recommendations were Securities and Exchange Board of India (SEBI)accepted by the Reserve Bank. These have which regulate mutual funds in general. Mutualbeen forwarded to the Bureau of Indian Funds have been permitted to issue units toStandards for adoption as National Standards. foreign institutional investors (FIIs). 12
  • 13. Banking Developments and Perspectives1.41 The Reserve Bank has permitted banks Transparency and Disclosureto fix service charges which would generally 1.44 In February 1999, the Reserve Bankbe based on the cost of providing services. issued guidelines for improving transparencyBanks have also been urged to pay interest at in the financial statements of banks.the rate applicable for appropriate tenor of Accordingly, banks were required to disclosefixed deposit for the period of delay beyond the following information as ‘Notes on10/14 days in collection of outstation Accounts’ to their balance sheets from the yearinstruments and pay penal interest at the rate ended March 31, 2000: (i) maturity pattern ofof 2 per cent above the fixed deposit rate loans and advances, investments in securities,applicable for any abnormal delay that might deposits and borrowings, (ii) foreign currencybe caused by bank branches in collection of assets and liabilities, (iii) movements in NPAs,outstation instruments. and (iv) lending to sensitive sectors as defined by the Reserve Bank from time to time. It was1.42 The Reserve Bank also did away with decided that the sensitive sectors in respect ofsample test checking of newly printed MICR which information was to be disclosed for theinstruments at MICR cheque processing centres year 1999-2000 would include (i) capitalbefore putting them into use and withdrew the market, (ii) real estate and (iii) commodities.requirement of obtaining succession certificate Considering, however, the difficultiesfrom the legal heirs, irrespective of the amount expressed by certain banks in disclosing theinvolved in the account of a deceased maturity pattern of Indian Rupee assets andcustomer. liabilities, in the ‘Notes on Accounts’ as they have not covered 100 per cent of their business1.43 A few important developments during under ALM system, banks were allowed tothe first half of the current year (April- disclose, if need be, this information in theSeptember, 2000) as a result of implementation Director’s Report. Banks were, however,of the suggestions were : (a) putting in place advised in May 2000 to disclose the abovein the Reserve Bank, a comprehensive information in the ‘Notes on Accounts’ to theirinformation transmittal system in electronic balance sheets from the year ending March 31,form for the benefit of seekers of information 2001. Such disclosures and transparencyfrom the Bank, (b) revision in the Bank’s practices would help improve the process ofinstructions relating to nomination facility for expectation formation by market players andthe benefit of investors in Relief Bonds, (c) eventually lead to effective decision-making byincrease in the limit of same day credit of banks.local/outstation instruments sent for collectionby banks from Rs.5,000 to Rs.7,500 per Institutional Reforms for Capacity Buildinginstrument, (d) streamlining the procedure forprompt payment of interest to scheduled Credit Information Bureaucommercial banks on the eligible CRR 1.45 There has been a widely felt need tobalances, and (e) relaxation in the prescribed establish a Credit Information Bureau (CIB)eligibility criteria for opening and maintaining designed to obtain and share data on borrowersNon-Resident External Rupee Accounts by the in a systematic manner for sound creditcentral co-operative banks. decisions, thereby helping to facilitate 13
  • 14. Report on Trend and Progress of Banking in India, 1999-2000 Box I.3: Working Group to Explore the Possibilities of Setting up a Credit Information Bureau in India – Major Recommendations The Working Group constituted by the Reserve Bank framework and share such information among its to explore the possibilities of setting up a Credit members. Information Bureau in India submitted its Report in November 1999. The major recommendations of the The proposed Credit Information Bureau could be Working Group are indicated below. set up as a separate company jointly owned by banks and FIs under the regulatory purview of the The existing legal framework does not permit Reserve Bank. Co-option of a foreign technology disclosure of information except in cases where there partner/ collaborator would also provide the is explicit consent of the constituent or where suits necessary expertise. have been filed. Amendments to existing Acts relating to banking sector or enactment of a master legislation The Bureau should inherit the best international would be necessary to form a full-fledged Credit practices with regard to collection of information, Information Bureau. processing of data and sharing of information and it should build up effective systems to ensure the Pending legislative changes, to begin with, a Credit security of data maintained by it and restrict access Information Bureau can be set up to pool the limited to its data base to institutions accredited by it and information as is possible under the existing legal evolve an appropriate code of access.avoidance of adverse selection. This would Inc. as foreign partners, to set up a CIBalso facilitate reduction in NPAs. In June 1999, within the confines of the existinga Working Group was constituted to explore legislation. The work of preparing a masterthe possibilities of setting up a CIB in India. legislation to establish a full-fledged BureauThe Group, in its Report submitted to the is underway.Reserve Bank, recommended the setting up ofa CIB in India (Box I.3). Deposit Insurance Reform 1.47 Reforming the deposit insurance system1.46 Based on the recommendations of the is a crucial component of the present phase ofWorking Group and realising the importance financial sector reforms in India. Accordingly,of developing better institutional mechanisms a Working Group was constituted by thefor sharing of credit-related information, the Reserve Bank on Reforms in Deposit InsuranceUnion Budget 2000-01 announced the in India (Chairman: Shri Jagdish Capoor). Theestablishment of a Credit Information Group submitted its Report in October 1999.Bureau. Subsequently, in the Monetary and The major recommendations of the GroupCredit Policy of April 2000, the Reserve include: (i) fixing the capital of DepositBank advised banks and financial institutions Insurance and Credit Guarantee Corporationto make the necessary in-house arrangement (DICGC) at Rs.500 crore, to be contributedfor transmittal of the appropriate information fully by the Reserve Bank; (ii) withdrawingto the Bureau. The State Bank of India (SBI) the function of credit guarantee on loans fromhas entered into a Memorandum of DICGC; and (iii) risk-based pricing of theUnderstanding (MOU) with the Housing deposit-insurance premium in lieu of theDevelopment Finance Corporation (HDFC), present flat rate system. The task of preparationwith Dun and Bradstreet Information of the new draft law has been taken up inServices Ltd. and Trans Union International supersession of the existing law. 14
  • 15. Banking Developments and PerspectivesDiversification in Banking Operations company will normally be 50 per cent of the paid-up capital of the insuranceInsurance company. On a selective basis, the1.48 The Insurance Regulatory and Reserve Bank may permit a higherDevelopment Authority (IRDA) Act, 1999 was equity contribution by a promoter bankpassed by the Parliament. The Act is a major initially, pending divestment of equitymilestone in liberalisation as it opens the way within the prescribed period. Thefor private sector entry into the insurance eligibility criteria for joint venturebusiness. It also provides statutory backing to participant as on March 31, 2000 willthe IRDA. Under this Act, foreign equity will be as under: (i) the net worth of thebe restricted to 26 per cent of the total paid- bank should not be less than Rs.500up capital. crore; (ii) the CRAR of the bank should not be less than 10 per cent; (iii) the1.49 With a view to assessing the scope, level of NPAs should be reasonable;desirability and eligibility of institutions to (iv) the bank should have net profit fortake up insurance business, draft guidelines the last three continuous years; and (v)were initially framed for banks entering into the track record of the performance ofinsurance business with risk participation as the subsidiaries, if any, of thealso for permitting banks to undertake fee- concerned bank should be satisfactory.based business as insurance agents. On thebasis of feedback received from banks and 3. In cases where a foreign partnerfinancial insitutions (FIs), the Reserve Bank contributes 26 per cent of the equityissued final guidelines for banks’ entry into with the approval of IRDA/Foreigninsurance business along with the Investment Promotion Board, more thanannouncements in the Monetary and Credit one public sector bank or private sectorPolicy for the year 2000-2001. The guidelines bank may be allowed to participate inare as under: the equity of the insurance joint venture. 1. Any scheduled commercial bank would be permitted to undertake insurance 4. A subsidiary of a bank or of another business as an agent of insurance bank will not normally be allowed to companies on fee basis, without any join the insurance company on risk risk participation. The subsidiaries of participation basis. Subsidiaries would banks would also be allowed to include bank subsidiaries undertaking undertake distribution of insurance merchant banking, securities product on agency basis. transactions, mutual fund, leasing finance, housing finance, etc. 2. Banks which satisfy the eligibility criteria would be permitted to set up a 5. Banks which are not eligible as joint joint venture company for undertaking venture participant, as above, can make insurance business with risk investments up to 10 per cent of the participation, subject to safeguards. The net worth of the bank or Rs.50 crore, maximum equity contribution such a whichever is lower, in the insurance bank can hold in the joint venture company for providing infrastructure 15
  • 16. Report on Trend and Progress of Banking in India, 1999-2000 and services support. Such participation The SBI’s share in equity would be 51 per shall be treated as an investment and cent in the joint venture. The other equity should be without any contingent participants in the venture are Allahabad Bank liability for the bank. (8.5 per cent), Corporation Bank (8.5 per cent) and Canara Bank (6 per cent). Credit Suisse1.50 Prior approval of the Reserve Bank is Financial Products, London (as the foreignrequired for banks to enter into insurance partner) would be holding 26 per cent equitybusiness. The Reserve Bank would give in the joint venture.permission to banks on a case-by-case basis,keeping in view all relevant factors including Banks’ Investmentsthe position in regard to the level of NPAs of Investment in Shares and Debenturesthe applicant bank so as to ensure that NPAsdo not pose any future threat to the bank in 1.52 Effective April 24, 1999, the overallits present or in the proposed line of activity, ceiling of investment by banks in ordinaryviz., insurance business. With a view to shares, convertible debentures of corporatesensuring insulation of banking business from and units of mutual funds (other than debtany risks which may arise from insurance funds), which was at 5 per cent of theirbusiness, there should be ‘arms length’ incremental deposits of the previous year, wasrelationship between the bank and the enhanced to the extent of banks’ investmentsinsurance outfit. With the issuance of in venture capital. Such investments in ventureNotification by the Government, specifying capital were also included under the purview“Insurance” as a permissible form of business of priority sector lending.that could be undertaken by banks underSection 6(1)(o) of the Banking Regulation Valuation of Banks’ InvestmentsAct, 1949, applications were invited from 1.53 The Reserve Bank had advised the banksbanks with supporting documents for their in April 1992 to bifurcate their investments inentry into insurance business. While 12 banks approved securities into ‘permanent’ andhad expressed their intention to enter into ‘current’ categories, and to keep not less thaninsurance business either by way of joint 30 per cent of their investments in the currentventure, strategic investments or agency category from the accounting year 1992-93.arrangements, applications to enter into The ratio of current investments was graduallyinsurance business on risk participation basis, increased to a minimum of 70 per cent of thesupported by required documents have been approved securities for 1998-99 and further toreceived from three banks. Of these, “in a minimum of 75 per cent for 1999-2000.principle” approval has been given to twobanks, viz., SBI and Vysya Bank Ltd. 1.54 Under the Mid-term Review of Monetary and Credit Policy of October 10, 2000, theSubsidiary for Assaying and Hallmarking of Reserve Bank finalised the guidelines onGold categorisation and valuation of banks’1.51 The Reserve Bank granted ‘in principle’ investment portfolio. The guidelines would beapproval to the SBI for setting up the effective from the half-year ended Septembersubsidiary SBI Gold and Precious Metals 2000. First, the banks are required to classifyPrivate Ltd. (SBIGPMPL) with an authorised the entire investment portfolio (including SLRand paid up capital of Rs.15 crore for securities and non-SLR securities) under threeundertaking assaying and hall marking of gold. categories, viz., ‘Held to Maturity’, ‘Available 16
  • 17. Banking Developments and Perspectivesfor Sale’ and ‘Held for Trading’. The the capital market returns without exposinginvestments in the ‘Held to Maturity’ category them to undue risks arising from marketshould not exceed 25 per cent of the total volatility. The Reserve Bank circulated theinvestments. The banks have been given the draft guidelines in September 2000. The finalfreedom to decide on the extent of holdings guidelines were announced in October 2000,under ‘Available for Sale’ and ‘Held for after taking into account the views expressedTrading’ categories. Secondly, investments by the banks and other market participants.classified under ‘Held to Maturity’ category As per the final guidelines, the terms andneed not be ‘marked to market’ and will be conditions for financing of initial publiccarried at acquisition cost, unless it is more offerings (IPOs) should be the same as thosethan the face value, in which case the premium applicable to advances against shares toshould be amortised over the period of individuals. As recommended by theremaining maturity. The individual scrips in the Committee, within the overall exposure to‘Available for Sale’ category will be marked sensitive sectors, the bank’s total exposure toto market at the year-end or at more frequent the capital market by way of investments inintervals. The individual scrips in the ‘Held ordinary shares, convertible debentures andfor Trading’ category will be marked to market units of mutual funds (other than debt funds)at monthly or at more frequent intervals. should not exceed ‘5 per cent of totalThirdly, the Reserve Bank will not announce outstanding advances as on March 31 of thethe Yield to Maturity (YTM) rates for previous year’ as against the earlier ceilingunquoted Government securities, as hitherto, of ‘5 per cent of incremental deposits of thefor the purpose of valuation of investments by previous year’. The Board of Directors ofbanks. The banks are required to value the banks shall formulate their policy on totalunquoted SLR securities on the basis of the exposure to capital market, keeping in viewYTM rates to be put out by the Primary its overall risk profile. In respect of thoseDealers Association of India (PDAI) jointly banks where the present outstandingwith the Fixed Income Money Market and investments in equities are relatively smallDerivatives Association (FIMMDA) at and well below the 5 per cent overall ceiling,periodical intervals. The valuation of the other as a prudential measure, the Board should alsounquoted non-SLR securities, wherever linked lay down an annual ceiling for freshto the YTM rates, will be with reference to investments in equities so that any increasethe YTM rates as put out by the PDAI/ in fresh investments in equities takes placeFIMMDA. in a phased, gradual and cautious manner, within the absolute ceiling fixed by the BoardBanks’ Investments in Capital Market for each year. The RBI-SEBI Technical1.55 In pursuance of the Monetary and Credit Committee will review the actual working ofPolicy for 2000-01, a Standing Technical the new guidelines in consultation with selectCommittee of the Reserve Bank and SEBI on banks.Bank Financing of Equities was constituted todevelop operative guidelines for a transparent Rural Credit, Housing Finance and Creditand stable system of banks’ financing of to Small Scale Industriesequities and investments in shares. TheCommittee submitted its report to the Reserve Rural CreditBank on August 30, 2000. The guidelines 1.56 In order to strengthen the capital basereflected the Committee’s approach to optimise of the rural institutions, a sum of 17
  • 18. Report on Trend and Progress of Banking in India, 1999-2000Rs.152.65 crore was expended by the Central for being considered for FDI/OCB/NRIGovernment during 1998-99 to strengthen the investment. This would cover extension ofcapital base of Regional Rural Banks (RRBs). credit facilities at the micro level to smallBesides, a budgeted sum of Rs.168 crore was producers and small enterprises in the rural andreleased for restructuring the capital base of urban areas.select RRBs during 1999-2000. The ReserveBank has been providing to National Bank for 1.58 The total ground level credit forAgriculture and Rural Development agriculture and allied activities disbursed by(NABARD), a General Line of Credit (GLC) co-operative banks and commercial banksto enable it to meet the short-term credit (including RRBs) increased by 13.2 per centrequirements of co-operative banks and RRBs. to Rs.41,764 crore during 1999-2000 fromFor the year 1999-2000 (July–June), the Reserve Rs.36,897 crore during 1998-99. TheBank renewed a credit limit of Rs.5,700 crore, NABARD has been playing a significant rolesanctioned in the previous year, to NABARD in providing and facilitating adequate creditconsisting of Rs.4,850 crore under GLC I (for support to agriculture and other rural activities.seasonal agricultural operations) and Rs.850 The amount of funds sanctioned and disbursedcrore under GLC II (for various other approved by NABARD under Rural Infrastructureshort-term purposes). In view of the increase Development Fund (RIDF) amounted toin sanction of credit limit by NABARD to co- Rs.14,923 crore and Rs.6,680 crore,operatives and RRBs in general, and for meeting respectively, as at end-August 2000. Kisanthe additional requirements of funds on account Credit Cards (KCC) numbering 57.41 lakhof cyclone /floods in Orissa in particular, an were issued by PSBs, RRBs and co-operativeadditional limit of Rs.400 crore under GLC I banks; the amount sanctioned under thiswas sanctioned in December 1999, on request scheme amounted to Rs.9,632 crore as at end-by NABARD. March 2000. All PSBs have been advised to set monthly targets within the yearly target1.57 Provision of micro-credit by banks has fixed for the bank and draw action plan foremerged as an important instrument for achieving the overall target. The role playedalleviating poverty, particularly in rural areas, by NABARD and co-operative banks inas this raises the productive capacity of the augmenting the flow of credit to the ruralbeneficiaries. Banks were accordingly advised sector is detailed in Chapter III, while that ofin February 2000 to make micro-credit an commercial banks (including RRBs) is detailedintegral part of their corporate credit plan. in Chapter II of this Report.Micro-credit is reckoned as part of banks’priority sector lending since February 2000. Housing FinanceFurther, with a view to providing an additional 1.59 Commercial banks were advised toavenue for bank’s lending to agriculture and compute their minimum share of housingincreasing the outreach of banks in rural areas, finance allocation for 1999-2000 and 2000-01lending by banks to non-banking financial at 3 per cent of their incremental deposits ofcompanies (NBFCs) for on-lending to the previous year or the amount of housingagriculture is reckoned for the purpose of finance allocation fixed for the previous year,priority sector lending as indirect finance to whichever was higher. Prior to October 1999,agriculture since April 2000. In a significant indirect housing loans sanctioned by banks tomove, micro-credit/ rural credit has been intermediary housing agencies against theincluded in the list of eligible NBFC activity direct loan sanctioned/proposed to be 18
  • 19. Banking Developments and Perspectivessanctioned by the latter were reckoned as part by accepting bills drawn on corporates by theirof their housing finance allocation, provided the suppliers, particularly those belonging to theloan per borrower by such intermediary SSI sector. This was aimed at development ofagencies did not exceed Rs.5 lakh and Rs.10 a bills culture. Effective October 29, 1999,lakh in rural/semi-urban and urban/ banks were given freedom to charge interestmetropolitan areas, respectively. In order to rates on discounting of bills without referenceenhance the flow of credit to housing sector, to PLR, thereby enabling banks to offereffective October 29, 1999, banks were advised competitive rates of interest. This measurethat housing finance sanctioned by them to would motivate corporates to make use of thehousing finance intermediary agencies would bill route for receiving/paying their credithenceforth be reckoned for the purpose of sales/credit purchases. In view of the aboveachievement of their housing finance and considering the operational problems facedallocations, irrespective of the per borrower by banks in implementing the bills discipline,size of the loans extended by these agencies. the mandatory minimum 25 per cent for acceptance of bills was withdrawn, effectiveCredit to Small Scale Industries November 2, 1999.1.60 Total credit provided by PSBs to small-scale industries (SSIs) as at end-March 2000 1.62 As a part of follow up of the Unionconstituted 15.6 percent of net bank credit and Budget 2000-01 proposals, the Reserve Bank35.8 per cent of total priority sector advances increased the limit for collateral requirementof these banks. Out of the advances to SSI on loans from Rs.1 lakh to Rs.5 lakh in respectsector, the advances to tiny sector (i.e. to units of the tiny sector. To promote credit flow towhere investment in plant and machinery does small borrowers, the composite loan limit (fornot exceed Rs.25 lakh) constituted 54.0 per providing working capital and term loanscent of advances to SSI sector. Those banks through a single window) was increased fromwhich have not achieved the priority sector- Rs.5 lakh to Rs.10 lakh. PSBs were requestedlending target of 40 per cent even after to accelerate their programme of SSI brancheseffecting their contribution to the RIDF, have, to ensure that every district and SSI clustershowever, been included in the consortium for within districts are well served by at least oneproviding finance to the Khadi and Village specialised SSI bank branch. The GovernmentIndustries Commission (KVIC). Such credit is decided that SSI branches would need to obtainreckoned as their indirect lending to SSIs under ISO certification to improve the quality of theirthe priority sector. These loans are provided banking services. A new central creditat 1.5 percentage points below the average guarantee scheme for SSI is proposed to beprime lending rates (PLRs) of five major banks implemented through Small Industriesin the consortium. As at the end of June 2000, Development Bank of India (SIDBI), whichan amount of Rs.518.18 crore was outstanding would cover loans up to Rs.10 lakh for theout of an amount of Rs.704.00 crore disbursed banking sector. The guaranteed loans would beby the consortium under the scheme. securitised and tradable in the secondary debt market. Further, PSBs have been advised to1.61 Banks were advised in January 1998 to complete the process of opening/ensure that their corporate borrowers financed operationalising SSI branches by Decemberat least 25 per cent of their credit purchases 2000. 19
  • 20. Report on Trend and Progress of Banking in India, 1999-20002. Financial Performance of in operating profits of foreign banks too Scheduled Commercial Banks turned out to be high at around 51.5 per cent as against a decline of 30.3 per cent during during 1999-2000 1998-99.1.63 This Section presents highlights of thefinancial performance of scheduled commercial 1.66 PSBs exhibited an operating profitbanks during the year 1999-2000 on the basis growth of 23.7 per cent during 1999-2000 asof the balance sheets of these banks. The compared with a marginal increase of 2.8 peranalysis is in terms of both the aggregate and cent during 1998-99. Even more spectaculargroup-wise position of scheduled commercial was the increase in net profits (57.2 per cent)banks. as against a decline of 35.3 per cent in 1998- 99. The improved financial performance ofProfitability PSBs, despite a sharper increase in interest expenditure (15.8 per cent) than that in interest1.64 The operating profits of scheduled income (14.5 per cent), was attributable to thecommercial banks increased by Rs.4,613 crore spurt in other income and deceleration inin 1999-2000 (33.4 per cent) to Rs.18,423 operating expenses. Booking of capital gainscrore as against a decline of Rs.830 crore (5.7 by PSBs in their treasury operations in theper cent) in 1998-99. Net profits increased by context of the downward movement of interestRs.2,816 crore (62.7 per cent) to Rs.7,306 rates, inter alia, boosted their other income.crore during 1999-2000 as against a declineof Rs.2,012 crore (30.9 per cent) during 1998- 1.67 As a proportion of total assets,99. As a share of total assets, operating and provisions and contingencies of schedulednet profits increased by 21 and 19 basis points commercial banks increased by 2 basis pointsto 1.66 per cent and 0.66 per cent, respectively, to 1.00 per cent during 1999-2000. Theduring 1999-2000 as against a decline of 39 aggregate figure, however, hides the vastand 35 basis points, respectively, during differences in bank-group-wise position in1998-99. The improvement in financial respect of provisions. On the one hand,performance reflected (i) higher rate of growth provisions by both foreign and new privatein interest income than interest expenditure sector banks increased sharply by 44 basisduring 1999-2000, ii) a lower rate of growth points and 40 basis points, respectively, to 2.07in operating expenses during 1999-2000 as per cent and 1.15 per cent, respectively, duringcompared with that in the preceding year, and 1999-2000 while provision of old privateiii) a higher rate of growth in other income sector banks increased by 27 basis points tothan that in 1998-99. 1.00 per cent. On the other hand, provisions by PSBs declined by 6 basis points to 0.891.65 Operating and net profits across all per cent, mainly due to the sharp decline inbank groups exhibited a substantial increase the provisions of 17 basis points by the SBIduring 1999-2000 as against a decline across Group. Provisions by nationalised banksall bank groups (barring nationalised banks increased marginally by one basis point.in operating profits) during 1998-99. Inparticular, new and old private sector banks Spreadregistered operating profit growth of 81.8 and80.4 per cent respectively, during 1999-2000, 1.68 The movements in the interest incomeas against a decline of 7.5 and 26.8 per cent, and interest expenditure were influenced byrespectively, in the preceding year. The rise liquidity conditions and the varying response 20
  • 21. Banking Developments and Perspectivesof major bank groups to the monetary policy per cent. The share of loans and advancessignals of the Reserve Bank. The spread of and investments in the total assets increasedPSBs declined by 10 basis points to 2.70 per to 39.9 per cent and 37.3 per cent,cent during 1999-2000, due to a 9 basis points respectively, as at end-March 2000.fall in interest income. The spread of SBI andnationalised banks group declined by 9 and 10 Off-Balance Sheet Activitiesbasis points, respectively. The spread of 1.71 Reflecting the growing importance offoreign banks improved sharply by 38 basis non-fund based activities of the banking sector,points owing to a sharper fall in interest the off-balance sheet exposures (contingentexpenditure compared with that of interest liabilities) of all SCBs recorded an increaseincome. While the spread of old private sector of 27.6 per cent to Rs. 5,84,441 crore in 1999-banks improved by 18 basis points, that of new 2000, led by a sharp increase of 31.4 per centprivate banks declined by 11 basis points. The in forward exchange contracts. The off-balanceinterest rate spread varied markedly across sheet exposures as a proportion to the totalmajor bank groups – from 1.87 per cent for liabilities of all SCBs increased by 4.4new private sector banks to 3.85 per cent for percentage points from 48.2 per cent in 1998-foreign banks. For the SCBs, the spread 99 to 52.6 per cent in 1999-2000.continued to exhibit a declining trend and wasat 2.72 per cent during 1999-2000 as against Non-Performing Assets2.78 per cent during 1998-99. 1.72 During 1999-2000, there was a markedIntermediation Cost improvement in the proportion of net NPAs to net advances with the number of PSBs with1.69 An indicator of competitiveness in net NPAs up to 10 per cent increasing frombanking is the intermediation cost (i.e. 18 to 22. Similarly, the number of old privateoperating expenses as a proportion of total sector banks and foreign banks with net NPAsassets). There was a sizeable decline in the of less than 10 per cent went up from 17 tointermediation cost of SCBs to 2.49 per cent 18 and from 27 to 31, respectively. Newduring 1999-2000 from 2.67 per cent in 1998- private banks continued to have net NPAs99, with wage bill declining from 1.75 per cent below 10 per cent during 1999-2000.to 1.66 per cent. Among the bank groups, thehighest order of decline in intermediation cost Capital to Risk-Weighted Assets Ratioduring 1999-2000 was recorded by the foreignbanks (38 basis points). New private sector 1.73 As against the stipulated minimumbanks recorded the lowest intermediation cost CRAR of 9 per cent of scheduled commercial(1.42 per cent). PSBs recorded a decline of 14 banks, all but one PSB attained the normbasis points in intermediation cost to 2.52 per during 1999-2000. This achievement needs tocent during 1999-2000. be viewed against the fact that no public sector bank was recapitalised during 1999-2000. Of the 24 old private sector banks, 21 banks metSize of Balance Sheet the 9 per cent norm. All the 8 new private1.70 The share of capital in total liabilities sector banks and 42 foreign banks had CRARdeclined to 1.66 per cent as at end-March 2000 in excess of 9 per cent. It may be recalled thatfrom 1.92 per cent as at end-March 1999. With the Narasimham Committee II had emphasisedregard to assets, scheduled commercial banks the raising of CRAR to 10 per cent by end-were able to increase their total assets by 16.8 March 2002. 22 PSBs, 19 old private sector 21
  • 22. Report on Trend and Progress of Banking in India, 1999-2000banks, 7 new private sector banks and 37 new framework on emerging market economiesforeign banks had CRAR in excess of 10 per like India, the Reserve Bank constituted ancent as at end-March 2000. internal Working Group to examine the impact, applicability, scope, problems and the time span3. Perspectives of its implementation in India. The Reserve Bank has finalised its views on the basis of1.74 As the present phase of reforms the recommendations of the Group, andgathers momentum and competitive pressures subsequently forwarded its comments to thebecome strong, more focussed attention would Basle Committee. The main thrust of theneed to be paid to inter-related sets of issues comments is to ensure sufficient flexibility inregarding (a) strengthening the foundation of the framework to fully reflect the macro-the banking system; (b) streamlining banking economic environment, structural rigidities andprocedures including upgrading of concerns of emerging markets. The Reservetechnologies and networking; and (c) effecting Bank felt that where banks are of simplestructural changes in the system. structure and have subsidiaries, the framework1.75 It needs to be recognised that given the could be adopted on stand-alone basis with thesize of the financial system, broadly defined, full deduction of equity contribution made tothe question of banking soundness cannot be subsidiaries from the total capital. Besides,analysed in isolation from the broader system. national supervisors should have discretion toThis is because financial disturbances, wherever prescribe a material limit up to which cross-they originate, can have serious consequences holdings could be permitted. Moreover, thefor the rest of the economy. In view of the Reserve Bank felt that assigning greater roleuniversalisation of banking operations, the walls to external rating agencies in regulatorybetween banks and non-bank entities are getting process would not be desirable. Instead,gradually blurred. However, banks in their domestic credit rating agencies, which arepresent structural form continue to have more adequately informed, would be morestrategic importance, notwithstanding the effective, subject to adequate safeguards.importance of other major entities of the Further, the Reserve Bank viewed that riskfinancial system, viz., development financial weights of banks ought to be de-linked frominstitutions (DFIs) and NBFCs. that of the sovereign. Instead, preferential risk weights in the range of 20-50 per cent, on aStrengthening the Commercial Banking graded scale may have to be assigned on theSystem basis of risk assessments by domestic rating agencies. Furthermore, the proposal forCapital Adequacy Measures assigning favourable risk weight to short-term1.76 Capital constitutes the basic cushion as claims would jeopardise the stability of thea rescue for contingencies. The Basle international financial architecture. Again, theCommittee on Banking Supervision (BCBS) proposal to link the banking supervisorhad released a Consultative Paper on New implementing/endorsing the Core PrinciplesCapital Adequacy Framework in June 1999 for Effective Banking Supervision was notto further strengthen the soundness of the considered desirable. Finally, while thefinancial system and better align regulatory Committee’s views on increased disclosurescapital with the underlying risks faced by and enhanced transparency are reasonable,banks. Recognising the implications of the national supervisors should consider the ability 22
  • 23. Banking Developments and Perspectivesof the market to logically interpret the with its explicit emphasis on ratings, internalinformation. and external, are likely to have implications for the required levels of capital (Box I.4).1.77 The new capital adequacy normsproposed by the BCBS in June 1999, if These issues gain in importance in view ofimplemented, are likely to be stricter than Government ownership of banks and thethose prevailing at present. The new norms ability of the PSBs to raise capital either Box I.4: Ratings of Banks The Basle Committee on Banking Supervision (BCBS) The Reserve Bank, however, favoured greater has proposed a revised Capital Adequacy Framework reliance on internal ratings-based approach for banks, in 1999, which uses a three-pillar approach consisting which could be structured under an acceptable of (a) a minimum capital requirements pillar, (b) a framework so that a standardised approach to internal supervisory review pillar to ensure that the bank’s rating could be adopted. The internal ratings-based capital is aligned to its actual risk profile, and (c) a approach could incorporate supplementary customer market discipline pillar to enhance the role of the information, which is typically not available to credit other market participants in ensuring that appropriate assessment institutions. It could also extend to a capital is held by prescribing greater disclosure. The greater number of counter-parties, such as, unrated revised framework is presently being discussed by borrowers in the small/retail sector. This would supervisory authorities all over the world. encourage banks to refine their risk assessment and monitoring process, which would facilitate better The revised framework places an explicit emphasis management of their loan books. The regulators on ratings. Risk differentiation between counterparties, should, however, evolve suitable process and criteria be they sovereign governments, banks, corporates, for approving the rating framework so as to ensure public sector enterprises or securities firms is sought the integrity of different banks’ systems and that the to be done either on the basis of external or internal parameters are consistent across various institutions. ratings. In broad summary, the weights based on While encouraging banks to use their own internal external risk assessment proposed for claims on rating systems for distinguishing better the credit sovereign governments, banks and corporates are quality, the issues that need to be addressed relate presented in Table 1. to: (i) mapping of bank grades into a series of Table 1: Proposed Risk Weights based on External Risk Assessment Assessment Claim on Sovereign Banks Corporates Governments Option 1 Option 2 1 2 3 4 5 AAA to AA- 0 20 20 20 A+ to A- 20 50 50 * 100 BBB+ to BBB- 50 100 50 * 100 BB+ to B- 100 100 100 * 100 Below B- 150 150 150 150 Unrated 100 100 50 * 100 * Claims on banks of short-term maturity, e.g., less than 6 months would receive a weighting that is one category more favourable than the usual risk weight on the bank’s claim. Option 1 : Based on risk weight of sovereign where bank is incorporated. (Contd....) Option 2 : Based on assessment of the individual bank. 23
  • 24. Report on Trend and Progress of Banking in India, 1999-2000 (...Concld.) regulatory risk-weight baskets; (ii) development of upper limit on corporate credit ratings, irrespective capital charge on the basis of rating grades; (iii) of their individual creditworthiness and past debt ensuring consistency between the standardised service record. approach and an internal ratings-based approach; and (iv) minimum standards and sound practical Yet another type of rating that can be expected to guidelines for key elements of rating process and play a significant role is supervisory rating. The supervisory process. Besides, a common standards second pillar of the new framework expects review mechanism would need to be put in place. supervisors to specify bank-specific capital add-ons based on the risk profile of individual banks, thereby Secondly, with regard to the new framework, the effectively raising the Basle minima for riskier banks. Reserve Bank has preferred that assessments be made Although supervisors would use different methods to by the domestic rating agencies for assigning diagnose the risk profile of their banks, it can be preferential risk weights for banking book assets expected that some would use the component or (excluding claims on sovereign), subject to adequate composite ratings of supervisory rating models (such safeguards. In its view, domestic rating agencies that as CAMELS) which can provide useful indicators of have up-to-date and ongoing access to information on risk profile. Whatever be the manner of determining domestic macro-economic conditions, legal and risk profile, what is evident is that several banks in regulatory framework, etc. would be better placed to the Indian context could be expected to have higher rate domestic entities vis-à-vis external rating than system capital charge required of them, which agencies. This would also facilitate the national would eventually raise the capital requirements for supervisory authorities to have greater access to the the system as a whole. quality of assessment sources and methodologies used by various rating agencies and also facilitate evolving References country-specific parameters for rating of various counter-parties. In general, the skepticism about the Karacadag, C. and M.W.Taylor (2000), ‘The New role of external rating agencies arises because different Capital Adequacy Framework: Institutional external rating agencies resort to different parameters Constraints and Incentive Structures’, IMF for risk evaluation, which are often not transparent. Working Paper No. 93, IMF: Washington. Apart from the lack of uniformity in selection of parameters, the mix and weightage of objective and Monfort, B. and C.Mulder (2000), ‘Using Credit subjective factors also vary across agencies, which, Ratings for Capital Requirements on Lending to in the Reserve Bank’s view, may lead to incorrect Emerging Market Economies: Possible Impact of assessments. Due to enormous subjective element a New Basle Accord’, IMF Working Paper No. involved in the rating process and the lack of 69, IMF: Washington. transparency in risk assessment, and other reasons, the role proposed to be assigned to the external rating Reserve Bank of India (2000), ‘Comments of the agencies is a matter of supervisory concern. This is Reserve Bank of India on A New Capital particularly so in emerging market economies which Adequacy Framework’, Reserve Bank of India: are assigned sovereign credit ratings which put an Mumbai.internally or from the market. It appears that by contribution from the owners/shareholderseven after allowing for additional infusion of or whether legislative ceiling for capital tocapital through internal generation and access to be subscribed by the public should be raised.subordinated debt, the gap between the additional Provision of banks’ capital by the Reservecapital requirement and the leeway available to Bank would tantamount to monetisation withraise capital from the market is likely to remain inflationary implications, while contributionquite sizeable. In this situation, an issue that would to additional capital by the Government willrequire critical attention and would need to be adversely impact the fiscal situation.resolved is whether this gap should be filled Therefore, there seems on balance, to be a 24
  • 25. Banking Developments and Perspectivesstrong case for raising the legislative ceiling doing so, banks would need to criticallyfor market participation in equity capital of evaluate their risk management systems in thePSBs. In this context, the pronouncement in light of the guidelines issued by the Reservethe Union Budget 2000-01 that the Bank and evolve an appropriate system toGovernment would reduce its holdings in overcome the existing deficiencies and institutePSBs to 33 per cent while ensuring that the requisite improvements.banks retain their public sector character,assumes importance. 1.80 The need for putting in place ALM and risk management systems in banks hasAsset-Liability Management underscored the imperative of building internal1.78 The increasing internationalisation of capacities to make appropriate analysis of thebanking operations engenders the possibility of evolving domestic and international businessa significant mismatch between assets and and economic circumstances. These includeliabilities, which have adverse implications for both market conditions and the issues arisingliquidity and solvency of the banking sector. out of financial market integration. In thisIn this context, pro-active ALM assumes context, the role of bank economists assumesimportance. Broadly, the objectives of ALM crucial importance. Bank managements willare to contain the volatility of net interest have to reorient and restructure their statisticalincome and net economic value of a bank. The and economics wings in a way that economistssupplementary objectives would be to reduce in Indian banks have an important role to playvariability in all target accounts including as much as in most international banks.control of liquidity risk, and to ensure balancebetween profitability and asset growth. To Risk Based Supervisionrealise these objectives, asset-liability managers 1.81 Considering the complexities of bankingmust be guided by policies that specifically business and emerging product innovationsaddress the bank’s overall ALM goals and risk with complex risk profiles, there is a growinglimits, and also by information that relates acceptance that a Risk Based Supervisiondirectly to its asset-liability positions. Such risk (RBS) approach would be more efficient thanmanagement strategies would help to reduce the traditional transaction based approach.the adverse effects of macro-economic shocks RBS entails monitoring of banks by allocatingon the soundness of the financial system. supervisory resources and focusing supervisory attention according to the riskRisk Management profile of each institution. The instruments of1.79 Given the diversity and varying size of RBS are off-site monitoring and on-sitebalance sheet items among banks as well as inspection supplemented by marketacross the bank-groups, the design of risk intelligence mechanism. However, off-sitemanagement framework would need to be surveillance has gained primacygeared to meet bank-specific requirements, internationally in recent times, given the easecovering the size and complexity of their and promptness of monitoring (Box I.5).business, risk philosophy, market perception Therefore, the Reserve Bank has decided toand the existing level of their capital. In other gradually move towards a risk based approachwords, banks would need to evolve their own to inspection. Apart from strengthening thesystems compatible with the type and size of risk modelling capabilities based on off-siteoperations as well as risk perception. While data and associated research for ‘predictive 25
  • 26. Report on Trend and Progress of Banking in India, 1999-2000 Box I.5: Off-site Monitoring and Surveillance Systems in Select Countries The growing complexity of financial institutions received from banks include prudential ratios, balance coupled with the need for frequent and continuous sheet and off-balance sheet exposures, and profit and monitoring has made off-site monitoring an important loss accounts. While prudential ratios and balance instrument of supervision. Countries all over the world sheet are received on quarterly basis (some of the have embraced off-site surveillance mechanisms in institutions submit them on monthly basis), profit and varying degrees. The Monetary and Credit Policy of loss account and prudential ratios like capital April 2000 has observed that the Reserve Bank would adequacy and solvency ratios are required to be draw on other countries’ experiences in moving submitted on half-yearly basis. In addition to the towards RBS and it would be instructive, in this above off-site returns received from the supervised context, to examine the off-site monitoring procedures institutions, the Commission also receives two reports adopted in different countries. relating to internal controls containing details of internal control policies every year. The off-site United Kingdom: In the UK, integrated supervision information is supplemented by on-site inspection over the financial system is carried out by the reports. Actions under off-site surveillance are Financial Services Authority (FSA). The FSA system preventive measures like advising bank management, of bank supervision is predominantly off-site with resorting to on-site inspection and other measures and most of the on-site work being done by accountancy disciplinary sanctions. firms called ‘reporting accountants’ specialising in bank audit. The off-site database of FSA includes Singapore: Bank supervision in Singapore is the statistical returns submitted by banks to the Bank of responsibility of the Monetary Authority of Singapore England and information available within FSA files (MAS). The authority’s off-site monitoring system about the banks. Banks are required to submit returns complements and provides the basis for continuous covering aspects of capital adequacy, balance sheet, supervision of banks. Under the off-site system, the profit and loss account, liquidity and large exposures, MAS has prescribed a set of returns of varying large deposits, foreign exchange exposures and periodicity (monthly, quarterly and annual). The country exposures. Risk assessment of banks is carried returns cover the capital adequacy, asset quality, out on the basis of CAMELB factors (capital, assets, statutory liquidity, connected lendings, call money market risk, earnings, liabilities and business) covering borrowings, negotiable certificates of deposit, balance business risk and COM factors (internal controls, sheet, large borrowers, profit and loss account, foreign organisation and management). The supervisory exchange business transacted and loan syndication. process is divided into three phases, viz., risk The returns are analysed by a team of off-site analysts, assessment phase, tools of supervision and risk each analyst being responsible for a portfolio of banks. evaluation phase. The concerns identified by off-site The results of the off-site analysis are conveyed to analysis are supplemented by one or all of the tools the on-site examination division. Specific concerns of supervision, i.e., accountants reports, traded markets arising out of the off-site analysis are also investigated team visit, risk review team visit, liaison with overseas through targeted appraisals carried out by on-site regulators, prudential and ad-hoc meetings with the examination teams. banks. The risk-based supervisory process is dynamic, in that the analyst receives new information Hong Kong: The Hong Kong Monetary Authority throughout the process. This may cause the analyst (HKMA) is entrusted with the responsibility of to adapt or revise supervisory actions and initiatives promoting general stability and effective working of throughout the supervisory period. the banking system under the Banking Ordinance. A member of off-site team is assigned to supervise a France: Supervision over the banking system is portfolio of banks as a Case Officer and to do all carried out by the French Banking Commission known related off-site supervisory work. The HKMA’s as Commission Bancaire. The off-site monitoring approach is that of continuous supervision through a system involves prudential regulation of banks on five combination of on-site inspection, off-site reviews and parameters, viz., minimum capital and reserves, prudential meetings. HKMA collects monthly/quarterly liquidity, large exposures ratio, solvency ratio and prudential off-site returns covering assets and capital adequacy ratio. Quarterly monitoring of bank’s liabilities, profit and loss, capital adequacy, liquidity, compliance with the prescribed guidelines is done and large exposures, loan classification, maturity profile any violations are taken up with the bank. The returns (Contd....) 26
  • 27. Banking Developments and Perspectives (...Concld.) of assets and liabilities, foreign exchange position, report covers all the important supervisory indicators. interest rate risk, country risk, market risks and a Comparisons with the peer group are also provided. certificate of compliance with various requirements Peer group is arrived at on the basis of asset size of under the law. These returns are called either on an the existing banks and newly established banks are individual basis, or combined or in the case of capital grouped separately. adequacy, liquidity and large exposures, on a consolidated basis. The accuracy of submitted returns India: In India, as part of the new supervisory strategy and the quality of systems are regularly scrutinised piloted by the Board for Financial Supervision (BFS), by external auditors, besides by the HKMA’s on-site the Reserve Bank set up an Off-Site Monitoring and supervisors. There is a CAMEL rating system in place Surveillance system (OSMOS) in 1995 in order to to trigger discriminatory supervision. Off-site supplement the existing system of on-site inspections examiners use the data to make regular (at least and to provide a means of closer and continuous annual) off-site reviews, which result in a CAMEL monitoring of bank performance. Under OSMOS, type rating and they also set the triggers for each bank banks are required to submit quarterly and half-yearly or bank group. Where there are causes for concern, returns on several aspects of financial performance, the reviews are more frequent. The off-site examiners including asset quality, capital adequacy, large also run regular reports mirroring bank performance exposures, connected lending, ownership patterns, etc. on the bank data. As a move towards further strengthening the off-site monitoring process, a second tranche of four returns United States: In the US, the Board of Governors of covering liquidity and interest rate risk in local and Federal Reserve (FED) is responsible for supervising foreign currencies has recently been introduced. A national banks. The Federal Deposit Insurance return covering critical information about the Corporation (FDIC) and the Office of the Comptroller operations of Indian subsidiaries of banks has been of Currency (OCC) are responsible for supervision of introduced, effective quarter ended September 2000 other types of banks. The supervision is basically as a move towards consolidated supervision of banking conducted by a very strong on-site examination. This groups. Standard reports and detailed individual and is supplemented by the off-site surveillance process systemic analyses are carried out and shared with the called the Financial Institutions Monitoring Systems Bank Monitoring Divisions of respective banks to (FIMS), which is used to track the financial condition initiate timely supervisory intervention. of individual banks and banking organizations between on-site examinations. Based on the call reports, which Off-site surveillance in different economies has cover the entire gamut of banking operations including evolved over a period of time, depending on the Capital Adequacy, Asset Quality, Earnings and Large country’s financial system and their level of exposures, received from the bank, the FED prepares development. As the supervisory framework acquires a Uniform Bank Performance Report (UBPR) bank- greater sophistication, it is expected that the off-site wise or bank-holding company (BHC)-wise. UBPR surveillance will acquire greater prominence for covers five quarter’ data. This report is generated at developing policy positions that are both relevant and quarterly intervals and forwarded to banks/ BHCs. The beneficial.supervision’, the overall compliance burden tools, techniques, systems, available ITunder the RBS framework is likely to be infrastructure and various internal and externallargely rationalised. linkages. The thrust of the Phase 1 recommendations is on enhancements to the1.82 To develop an overall plan for moving regulation and supervision framework leadingtowards RBS, international consultants were to increased effectiveness of overallappointed. They completed Phase 1 of the supervision through greater focus on risk asproject by conducting a review and evaluation well as a realignment of the inspection processof the current supervisory and regulatory to fall in line with a more risk-based approach.framework, policies, guidelines, instructions, Their recommendations cover vital areas, such 27
  • 28. Report on Trend and Progress of Banking in India, 1999-2000as, data management, supervisory process, Advisory Group on Transparency in Monetaryinspections, feedback to banks, external audit, and Financial Policies (Chairman: Shrietc. During Phase 2 of the project, the M.Narasimham) has submitted its report to theConsultants are expected to work out the Chairman of Standing Committee on Septemberpractical and operational aspects of the above 13, 2000. The Group has examined in detailrecommendations and suggest a new RBS issues related to the clarity of roles andframework including the sequencing of responsibilities including transparency indifferent stages and a time frame for monetary policy formulation andimplementation. implementation. Further, the Advisory Groups on Banking Supervision (Chairman: ShriInternational Financial Standards and Codes M.S.Verma), Insurance Regulation (Chairman: Shri R.Ramakrishnan) and Payment and1.83 Against the background of financial and Settlement System (Chairman: Shri M.G.Bhide)currency crises in some parts of South-East submitted the first part of their Reports inAsia, Mexico, Brazil and Russia, the systemic September 2000. The Report on “Bankingstability issues have come under a sharp focus. Supervision” has taken an exhaustive accountBest market practices, transparency and data and given recommendations pertaining to fourdissemination have been increasingly viewed as major areas in banking regulation, viz., corporateimportant areas where standards, codes, and governance in banks, transparency practices incore principles need to be evolved and Indian banking, supervision of cross-borderinternationally accepted for adoption. India has banking and internal rating practices adopted byrecognized that fostering the implementation of banks. The Report on “Insurance Regulation”standards is a means through which financial mainly deals with the various provisions relatingstability could be secured and maintained. In to licensing of insurance companies in the lightthe context of the ongoing financial reforms and of standards set by the International Associationin the light of the country’s economic of Insurance Supervisors (IAIS) and the Twentycircumstances and institutional and legal Insurance Guidelines issued by OECD. Theinfrastructure, a Standing Committee on Report on “Payment and Settlement System”International Financial Standards and Codes has dealt with issues pertaining to the inter-bank(Chairman: Dr.Y.V.Reddy) was set up in payment and settlement system covering CoreDecember 1999 with the objective of laying Principle and Central Bank responsibilities. Thedown a road-map for aligning India’s standards reports have been placed on the Bank’s web-and practices with international best practices. site for wider public information and debate.The Standing Committee identified ten coreareas and set up Advisory Groups for each of Prompt Corrective Actionthe areas, viz., international accounting andauditing, monetary and financial policies, 1.84 Worldwide, there is an increasingbanking supervision, fiscal transparency, movement towards building a safe and soundsecurities regulation, insurance regulation, data banking system, backed by a strongdissemination, payment and settlement system, supervisory regime. This is in accordance withcorporate governance and bankruptcy laws. The one of the Core Principles for EffectiveGroups are undertaking a review of standards, Banking Supervision, which mandates thatwith reference to the Indian circumstances and banking supervisors must have at their disposalthe feasibility of implementation of international adequate supervisory measures, backed bystandards within a time frame, given the legal legal provisions, to bring about timelyand institutional practices in India. The corrective action. Such a phenomenon has 28
  • 29. Banking Developments and Perspectivesprompted the supervisory authorities to potential for return to profitability, withoutconsider the possibility of introducing a system substantial restructuring, is doubtful. Theof Prompt Corrective Action (PCA) in India. resolution of the NPA problem requires greaterThe response has been dictated by two major accountability on the part of corporates,considerations. The first is the responsibility greater disclosures in the case of defaults, andof bank supervisors to identify problem banks an efficient credit information system. Actionat an early stage. The other is to monitor the has been initiated in all these areas, and it isbehaviour of troubled banks in an attempt to expected that, with the help of stricterprevent failure or to limit losses or contagion. accounting and prudential standards and appropriate legal support, NPAs will be1.85 In view of the above considerations, a effectively contained.system of PCA with various trigger points andmandatory and discretionary responses by the 1.87 The problem of NPAs is closely tied tosupervisors is envisaged for the banking system the issue of legal reforms. Recognizing thatin India. In addition to CRAR, two additional the legal framework pertaining to the bankingindicators, viz., ‘Net NPA’ and ‘Return on system might act as an impediment to itsAssets’, reflecting asset quality and efficient functioning, initiatives have beenprofitability, respectively, have been included taken to align the legal setup with theunder the broader PCA regime. Trigger points requirements of the banking system. The legalhave been proposed under each of the three framework is a key ingredient for limitingparameters, taking into account the practicality moral hazard. Given the high transactionsof implementation of certain measures in the costs of finality of settlement, including legalIndian context. For CRAR, three trigger points costs, there is an urgent need for developinghave been proposed - CRAR of greater than workable laws on contract, collateral andor equal to 6 per cent, but less than 9 per cent; bankruptcy proceedings and to implement andgreater than or equal to 3 per cent but less streamline court procedures for seekingthan 6 per cent; and less than 3 per cent. For effective and rapid remedies under these laws.Net NPAs, two trigger points have been The issue would assume greater importance asproposed - greater than 10 per cent but less economic liberalization gathers momentum.than 15 per cent; and 15 per cent and above. Otherwise, the continual state of innovationFor ROA, the trigger point has been set at less and evolution of new financial products in thethan 0.25 per cent. A discussion paper on PCA liberalization process would outpace thehas been put on the Reserve Banks web-site existing legislation and raise the need forfor wider circulation, inviting suggestions and implementing fine and sharper points of law.comments from banks and others. It is, therefore, essential that the requisite legal framework is quickly put in place.Non-Performing Assets1.86 The level of NPAs of the banking system 1.88 In India, the issues pertaining to legalin India has shown an improvement in recent framework have been examined by the Expertyears, but it still remains high. A significant Group under the Chairmanship of Shripart of the problem arises on account of the T.R.Andhyarujina, former Solicitor General ofcarry-over of old NPAs in certain sun set India. The Group, in its Report submitted inindustries. The problem is often complicated February 2000 to the Governmentby the fact that there are a few banks which recommended, among other things, the creationare fundamentally weak and where the of a new law granting statutory power of 29
  • 30. Report on Trend and Progress of Banking in India, 1999-2000possession and sale of security directly to achieving the best internationalbanks and FIs and adoption of the draft standards within a reasonableSecuritisation Bill. It has also suggested the timeframe.provision of additional avenues of recovery ofdues to banks and FIs by empowering them to (ii) The unions and the managementtake possession of securities and sell them for should achieve a consensus onrecovery of loans. The Report is under converting the present performance-consideration of the Government. unrelated uniform remuneration structure fixed for all PSBs and at allCorporate Governance levels of management into1.89 Experience of various countries with performance-related remunerationregard to bank failures has clearly identified structure.inadequate/inefficient management as one ofthe principal factors. Banking supervisors (iii) A comprehensive risk managementtherefore seek, as one of their key tasks, to system should be put in place in allenhance the quality of corporate governance banks within two to three years. Sincein bank management. The corporate banks are in different stages ofgovernance structure of the bank needs to be implementation of risk managementtransparent and consistent, striking a balance systems, small banks, in particular,between promoting safe and sound banking, on would require encouragement andthe one hand, and the flexibility required for technical support to undertake riskeffective competition, on the other. The Basle management practices.Committee has also mentioned in one of itsCore Principles that supervisors should (iv) The statutory provision (Section 20encourage and pursue market discipline by of the B.R. Act, 1949) prohibitingencouraging good corporate governance connected lending to directors and(through an appropriate structure and set of their connected parties needs to beresponsibilities for a bank’s Board of Directors extended to include largeand senior management), and enhancing market shareholders.transparency and surveillance. (v) Banks need to develop mechanisms1.90 The Advisory Group on Banking for ensuring percolation of corporateSupervision (Chairman: Shri M.S.Verma) strategic objectives and set valuesobserved that while ownership of banks is not throughout the organisation.an important issue in establishing corporategovernance practices, the extent of compliance (vi) Since Boards of very few banks areof the standards of corporate governance varies known to enforce clear lines offrom bank to bank. The salient responsibility and accountability forrecommendations of the Group are given below. themselves, there is an urgent need to follow the best practices in the banks (i) All banks should attain an acceptable in respect of constitution and minimum level of corporate functioning of the Boards. While governance. Subsequently, banks may nominating individuals on banks’ make a sustained progress towards Boards, the practice of pre-induction 30
  • 31. Banking Developments and Perspectives briefing or post-induction orientation (viii) The legal processes also need to be can be put in place forthwith to strengthened to facilitate corrective develop a proper appreciation of their action like removal of the incompetent role in the banks’ corporate management. governance. A ceiling needs to be imposed on the number of Boards and 1.91 The Group, however, noted that the the number of Committees a Director guidelines and norms for good corporate can work at a time, since members of governance in banks and overall responsible Board of Directors are required to give corporate governance are still in formative their valuable time to the governance stages and healthy conventions do not exist. of banks. Laws which can be seen as supporting or facilitating corporate governance are also yet (vii) With a view to conducting corporate to be framed. It will, therefore, take time to governance in a transparent manner, enact tenets of good governance in a piece of public disclosure in respect of details legislation. of qualifications of the Directors needs to be revealed in the balance sheet. 1.92 Compliance with regulatory Banks also need to be encouraged to prescriptions is a minimal requirement of disclose the senior management good corporate governance and what is structure, basic organisational structure, required are internal pressures, peer pressures information about incentive structure, and market pressures to reach standards far and nature and extent of transactions higher than those prescribed by regulatory with affiliated and related parties. agencies (Box I.6). Box I.6: Corporate Governance in the Banking SectorUnder corporate governance, banks articulate corporate hand, shareholdings have until recently been heldvalues, codes of conduct and standards of appropriate mainly by individuals. In Japan, the groupings canbehaviour etc, and have systems and controls to ensure be classified into former zaibatsus, new bank-centredcompliance with them. The Board sets the strategic groups and manufacture-centred groups. In Germany,objectives and corporate values of banks and specify most groupings are industry-based but there are alsotransparent lines of responsibility and accountability, bank and insurance-based groupings. In Sweden,which are communicated throughout the organisation. groupings are predominantly family-controlled. WithThe Board and the top management meet at specified regard to structure of corporate Boards, several authorsintervals for timely exchange of information on the have observed that carefully designed Board structuresbank’s financial condition and management practices. prevent hostile takeovers from taking place.It is, therefore, possible to identify different sets of Since banks are important players in financial systemplayers in the corporate governance system. There is in India, special focus on the corporate governancea dynamic balance among them that determines the in the banking sector becomes critical. Secondly, theprevailing corporate governance system depending on Reserve Bank, as regulator, has responsibility on thethe stage of institutional development and the nature of corporate governance in the banking sector.historical development. Two aspects of financial Thirdly, to the extent that banks have systemicsystems in other countries emerge as particularly implications, corporate governance in the banks is ofimportant in determining the operation of corporate critical importance. Fourth, given the dominance ofgovernance, viz., ownership of the corporate sector public ownership in the banking system in India,and the structure of corporate Boards. In UK, more corporate practices in the banking sector would alsothan 60 per cent of issued equity is held by financial set the standards for corporate governance in privateand non-financial corporations. In US, on the other (Contd....) 31
  • 32. Report on Trend and Progress of Banking in India, 1999-2000 (...Concld.) sector. Finally, with a view to reducing the possible advisory committees. fiscal burden of recapitalising the PSBs, attention towards corporate governance in the banking sector Thirdly, there is an issue of institutional structure for assumes added importance since PSBs must be in a regulation. The basis of the institutional approach is position to assure the market that their system of to cover institutions, irrespective of business, which corporate governance is such that they can be trusted is convenient from the prudential angle. This contrasts with shareholders’ money. with the functional approach to regulation which seeks to control business activity, irrespective of institutions. It is important in this context to examine the In reality, there is an overlap and over time, such regulatory issues under Government ownership that overlap between institutions and business are bound interact with the corporate governance practices in to become increasingly complex. In view of the above, India. The first issue is that of enhancing corporate it is deemed essential to review and identify a model governance in banks. However, the usefulness of the that is suitable in the Indian conditions and is common supervisory mechanism would require consistent with future needs. strengthening internal controls and facilitate monitoring by focusing on a few identifiable References parameters. Bank for International Settlements (1999), ‘Enhancing Corporate Governance in Banking Organisations’, Secondly, the approach of the Reserve Bank to Basle, Switzerland. regulation has some features that would enhance the need for and usefulness of good corporate governance Jenkinson, T and C.Mayer (1992), ‘The Assessment: in the banking sector. The transparency aspect has Corporate Governance and Corporate Control’, been emphasised by expanding the coverage of Oxford Review of Economic Policy, 8, pp.1-10. information, timeliness of such information and the analytical content in various publications. Further, Reddy, Y. V. (1999), ‘Corporate Governance in interaction with market participants has been Financial Sector’, RBI Bulletin, August, pp.993- intensified both at informal level and formal fora, like 1004.Streamlining the Banking Procedures Transparency and DisclosureImportance of Audit Procedures 1.94 One of the characteristic features of a perfectly competitive market model is the free1.93 The system of audit plays an important flow of information or the transparency ofrole in ensuring a proper functioning of the business operations. Transparency not onlybanking system. The need for external audit helps the creditors to make optimal decisionsin maintaining the soundness of the banking regarding their investment portfolio, but alsosystem is being increasingly felt, particularly imposes market discipline on banks toafter the recent experience of many East Asian perform well in a competitive mannercountries. In India, auditors nominated by the (Box I.7).Reserve Bank have been playing a crucial rolein ensuring the overall soundness of thebanking system. However, the system of audit Internal Controlsneeds to be made more extensive, accountable 1.95 Cumbersome loan and documentationand brought in line with the internationally procedures in banks impinge on the efficientaccepted standards. functioning of the banking sector. It is, 32
  • 33. Banking Developments and Perspectivestherefore, vital that internal controls, which level offices, visits by controlling officials toconsist of a wide spectrum of internal the field level offices, simplification ofinspection and audit, observance of manuals documentation procedures and efficient inter-and procedures, submission of control returns office communication channels, areby branches/controlling offices to higher substantially strengthened. The Reserve Bank Box I.7: Transparency Practices in Commercial Banks Transparency of banking operations plays an important immunity to contagion. However, while piecemeal role in ensuring effective market discipline, a implementation does not ward off the threat of the potentially crucial mechanism for keeping banks ‘contagion effect’, systemic stability would be prudent. This particularly helps investors and impaired if adverse information about weak banks depositors to ascertain the true health of financial becomes public knowledge all of a sudden. Hence, entities and assist policy makers to initiate timely and complete transparency would need to be gradually put adequate remedial action when required. Transparency, in place. Further, operational risks associated with in the context of the banking operations, may be certain activities cannot be unambiguously quantified, defined as public disclosure of reliable and timely so that disclosures in this respect may not always give information that enables the users of that information a clear picture to the market. Riskiness of a bank’s to make an accurate assessment of a bank’s financial portfolio must also be viewed in the context of its condition and performance, business activities, risk risk appetite and its risk management skills. These profile and risk management practices. again tend to be somewhat subjective in nature so that an exact quantification is not possible. In such In a liberalised economic framework, market discipline cases disclosure alone would not lead to transparency. constitutes a critical pillar of supervision of commercial banks, together with minimum capital The Transparency Sub-group of the Basle Committee requirements and supervisory review of capital on Banking Supervision (BCBS) identified six adequacy. Under certain circumstances, market qualitative characteristics of the information disclosed mechanisms complement supervisory efforts by by banks that are critical for ensuring that such rewarding banks that adopt prudent business strategies disclosure leads to transparency regarding the and penalising those that do not. Public disclosure operation of banks. These characteristics include encourages safe and sound banking practices and acts comprehensiveness, relevance, timeliness, reliability, as a deterrent to imprudent risk taking while providing comparability and materiality. Comprehensiveness of incentive for effective risk management. Market information relates to the scope or span of activities discipline, however, can be effective only if market covered by such information. The supervisor should participants have access to timely and reliable seek information about the different activities information which enables them to assess correctly a undertaken by banks by themselves or through bank’s activities and the risks inherent in those subsidiaries and the risks associated with these activities. activities. Relevance is the characteristic that distinguishes facts, qualitative or quantitative, from Systematic transparency in the working of the banking information and in order to be relevant, information sector enhances the stability of a financial system. A must be timely. Reliability of information depends regular flow of information keeps market agents aware on its factual accuracy and freedom from bias in of the situation and prevents sudden unpredictable presentation. As regards comparability, information reactions. Public disclosure also helps limit the disclosed must be comparable on two fronts. First, it contagion of a run on a bank by allowing the market must be comparable for the reporting entities, to to distinguish between banks that are genuinely enable the market mechanism to distinguish between vulnerable from those that are not. If disclosure norms ‘good’ and ‘bad’ banks. Second, it must be are universally implemented, whereby banks provide comparable across time for the supervisor to be able comprehensive, accurate, and timely information on to gauge the trends in the performance of banks. The their financial conditions, performance, risk exposure, onus for ensuring comparability, therefore, rests to a etc., a sound and well managed bank stands to benefit, large extent with the supervisor. Finally, information e.g. in accessing the capital market and in developing (Contd....) 33
  • 34. Report on Trend and Progress of Banking in India, 1999-2000 (...Concld.) is material if its omission or misstatement could any falsification should invite criminal procedures. change the assessment or decision of a user relying The Reserve Bank agreed with these recommendations on that information. in principle and referred them to the Audit Committee of the Board of Financial Supervision. With a view The goal of achieving transparency has become more to discouraging false/inaccurate disclosures by banks, challenging in recent years as banks’ activities have the Reserve Bank can impose a penalty, as come to include many new areas of financial recommended by the Committee. The banks had operations and become more complex and dynamic. earlier been advised to disclose CRAR, the level of The Narasimham Committee II, recognising the net NPAs, the ratio of net NPAs to net advances, importance of adequate disclosure norms for the break-up of the provisions made towards NPAs and Indian banking sector, noted that there is a need for depreciation on investments. disclosure, in a phased manner, of the maturity pattern of assets and liabilities, foreign currency assets and Consequent to the implementation of the liabilities, movements in provision account and NPAs. recommendations of the Narasimham Committee II, The Reserve Bank accordingly, instructed banks to the standards of disclosure of Indian commercial banks provide information regarding these items, except have moved closer to the international best practices movements in provisions, in their ‘Notes on Accounts’ including the standards set by the BCBS. The process to their balance sheets with effect from March 31, of expansion of the ambit of statutory disclosure 2000. The Committee also suggested that full continues. disclosure would also be required of connected lending, lending to sensitive sectors and loans given References to related companies in the banks’ balance sheets. Banks would be required to publish half-yearly Bank for International Settlements (1999), ‘Report of disclosure statements. There should be a general the Transparency Sub-group of the Basle disclosure, providing a summary of performance over Committee on Banking Supervision’, Basle, a period of time, say 3 years, including the overall Switzerland. performance, capital adequacy, information on the bank’s risk management systems, the credit rating and Government of India (1998), ‘Report of the Committee any action by the regulator/supervisor. The disclosure on Banking Sector Reforms’, (Chairman: Shri. M. statement should be subject to full external audit and Narasimham), New Delhi.issued guidelines in June 1999 to banks to Information Technologystrengthen the internal control system bysetting up Electronic Data Processing audit 1.96 Information technology (IT) has widecell in computerised branches/offices. ramifications for an entire gamut of issuesBesides, banks have been advised to concerning the banking sector. The growingconstitute Audit Committees of the Boards internationalisation of banking operationsto enable focussed attention by the Boards necessitates flexibility in financial policies toon internal control systems. It is now time raise and sustain economic growth. In thisthat such a control system is implemented, context, the switchover from manual operationseven though they necessitate revisions in the to reliable and time-saving operations has to‘Operational Manuals’, audit procedures and be rendered possible through appropriatebetter evaluation of clients. A few banks application of IT. Secondly, seamlessseem to have already initiated steps in this integration of applications and systems isdirection but these efforts need to be crucial to ensure smooth passage of inter-enhanced throughout the banking system. related transactions over the electronic medium 34
  • 35. Banking Developments and Perspectivesfor facilitating greater integration of various applications, banks would need to proactivelymarkets. Thirdly, developments in IT have address issues that help set up an efficient MIScontributed to devising complex financial through adoption of modern IT methods. Toproducts, such as, derivatives which in turn, ensure sustained use of IT, institution ofhas expanded the options for both savers and appropriate systems and procedures ininvestors, in terms of asset preferences and risk commercial banks, and effecting requisite shiftsprofiles. Coupled with improvements in from the written manuals to manuals incommunications infrastructure, this is expected electronic form would be imperative.to give rise to efficiency advantage over aperiod of time and to act as a driving force Entry of Banks into Insurance Businessfor gradually reducing the digital divide 1.98 The IRDA Act, 1999, has been enactedbetween the rural and urban segments of the against the background of the widelysociety. recognised need for opening up of the insurance sector. Banks, with their wide branch1.97 However, several areas would need to be network, particularly in the rural areas, andaddressed before IT can act as a catalyst for with available manpower, would like to utilizeenhancing financial development. In the highly this opportunity in mobilising sizeable fundsindustrialised countries, access to financial of long-term nature, which could financeentities is increasingly on an on-line basis with infrastructure projects having long gestationvirtual banking gaining in prominence. In periods. However, international experienceIndia, while the pace of technological clearly reveals that insurance business may notupgradation would need to be accelerated to break-even during the initial years ofattain international standards, large investment operations. It would, therefore, be necessaryrequirements of the IT sector, particularly in for banks to have adequate financial strengthbanking, often acts as an impediment towards to commence this activity. Insurance businessundertaking full-fledged computerisation of also requires product designing skills andbranches. It would be useful if banks devise a actuarial expertise, and banks may be requiredroadmap for networking ‘critical offices’, to enter into joint ventures with foreigndefined in terms of their volume, diversity and insurance partners. The entry of banks intoscope of work, so as to ensure coverage of a insurance would, however, raise a number ofcertain minimum quantum of business, with other issues of overlap between banking andcustomer service as the main focus in the insurance business which have been recognizedmedium-term. Secondly, under the payment in India as very critical. These would need tosystem, claims to various parties are interlinked be addressed as experience is gathered and aswhich create potential risk problems, especially situations develop in this overlapping businessif the systems are too ‘open’. As a result, activity (Box I.8).smooth functioning of the payments systemrequires the integration of work processes, Financial Innovationscommunication linkages and integrateddelivery systems with focus on stability, 1.99 The financial services industry in Indiaefficiency and security. While adopting the has witnessed a phenomenal growth,relevant security standards for India, the diversification, transformation andspecific requirements of the Indian banking specialisation since the initiation of financialsystem would need to be kept in view. Finally, sector reforms. The industry has gained into enhance further appreciation of IT depth and sophistication following the entry 35
  • 36. Report on Trend and Progress of Banking in India, 1999-2000of new products, including, among others, take- requirements of infrastructure projects, FIs/out finance and securitisation. banks have been taking recourse to new products and in this context, take-out financeTake out Finance is one of the emerging products. The1.100. In order to meet long term financing Reserve Bank has issued guidelines to banks Box I.8: Insurance and Banking – Issues of Overlap Insurance may be defined as a ‘social device whereby Banks are the chief purveyors of financial services to a large group of individuals, through a system of a very large number of individuals and small contributions, may reduce or eliminate certain borrowers. On account of their geographical reach and measurable risks of economic loss common to all access to customers, banks could be used as channels members of the group’. Insurance involves the transfer for the distribution of insurance products. Since of potential losses to an insurance pool. The pool banking services, insurance selling and fund combines all the potential losses and then transfers management are all interrelated activities and have the cost of the predicted losses back to the exposures. inherent synergies, selling of insurance by banks Thus, insurance involves the transfer of loss exposures would be mutually beneficial for banks and insurance of several entities into a common pool, and the companies. In Europe this synergy between banking redistribution of the cost of actual losses among the and insurance has given rise to a novel concept called members of the pool. The intermediary in the process, ‘bankassurance’. Also known as ‘Alfinanz’, which collects premia (payment for the purchase of bankassurance can be defined as a package of insurance) from individual entities with risk exposures financial services that can fulfil both banking and and pays compensation to the ones that actually suffer insurance needs at the same time. For instance, the loss insured against, is the insurer. The insurer financial services companies offer a whole gamut of is a risk taker who accepts the risks of others and financial products that include banking services, motor earns a profit given by the difference between the total insurance, home finance, life insurance and pensions. premium collected from the buyers of insurance and the total payment made on account of compensation Many European markets have put bankassurance into for losses. practice. In France more than 50 per cent of life insurance is sold through banks. In the United Whenever the contract period of an insurance contract Kingdom a large number of banks deal with insurers covers a long time, as is the case with life insurance, as providers of products. In the USA, banks lease premium payments have two components. The first is space to insurers and retail products of multiple the payment for risk coverage and the second goes insurers. In India too, banks have been offering towards savings. The saving component of life personal accident and baggage insurance directly to insurance results in enhanced competition between the their credit card holders as value addition to their insurer and other financial intermediaries like banks products. offering different savings instruments. It may be noted here that the combination of risk coverage and savings In developed economies, the collaboration between is peculiar to life insurance, especially in developing banking and insurance is brought about by several countries. means. Banks like the Deutsche Bank and the Credit Agricole have entered the insurance market by starting The progressive expansion of the insurance sector in their own insurance companies. Others like SE Banken India has certain implications for the banking industry. (Sweden) and Lloyds Bank have chosen to buy stakes The overlaps between banking and insurance business in already existing insurance companies. A third group implies that, on the one hand, the two can be of banks have chosen to swap shares with insurance competitors and hence substitutes of each other, and companies, while some banks have resorted to mergers on the other hand, they can complement each other as means of making inroads into the insurance sector. as well. (Contd....) 36
  • 37. Banking Developments and Perspectives (...Concld.)Initiatives in this direction have not been one sided balance sheet. Second, the guidelines have made aeither. Insurance companies have also sought to distinction between the banks which, by setting upacquire stakes in some banks. joint venture companies, can ‘underwrite’ or perform the principal function and those banks which couldIn India the concept of bankassurance has been only distribute insurance products, i.e., the agencyrecognised with its inclusion in the broader ambit of function. Third, insurance companies will benefit fromuniversal banking. The Discussion Paper (RBI, 1999) the wide net work of rural branches of commercialstates that in a very broad sense, ‘Universal Banking’ banks in India through the agency route while enablingrefers to the combination of commercial banking and banks to earn fee income.investment banking. In other words, universal banksrefer to those banks that offer a wide range of The issue of regulatory overlap also comes to the forefinancial services, beyond commercial banking and when banks enter insurance business through settinginvestment banking, such as insurance. up of joint venture companies. The guidelines, however, seek to eliminate any concern on thisThe guidelines issued by the Reserve Bank in April account. Whereas the holding of equity by a promoter2000 permitting banks to enter the insurance market bank in an insurance company or participation in anyemphasise the symbiotic aspect in the relationship form in the insurance business is subject tobetween commercial banks and insurance companies. compliance with the Government/IRDA regulations,As per the guidelines, commercial banks, depending the authority to grant case-by-case permission to bankson their satisfying specified eligibility criteria, can to enter insurance business is vested with the Reservetake any of the three routes: i) undertake distribution Bank.of insurance product as an agent of insurancecompanies on fee basis, ii) make investments in an Referencesinsurance company for providing infrastructure and Canals, Jordi (1997), ‘Universal Banking,services support, or iii) set up a joint venture company International Comparisons and Theoreticalfor undertaking insurance business with risk Perspectives’, Oxford University Press, Newparticipation. The Advisory Group on Insurance York.Regulation (Chairman: Shri R.Ramakrishnan), in itsReport submitted to the Chairman of the Standing Dorfman, Mark S. (1994), ‘Risk Management andCommittee on International Financial Standards and Insurance’, Prentice Hall, New Jersey.Codes in September 2000, noted the possible future Ranade A. and R. Ahuja (1999), Insurance in Indiarole of co-operative credit institutions in spreading Development Report: 1999-2000, Indira Gandhiinsurance business in rural areas. Similarly, the Institute of Development Research, Mumbai.distribution of insurance products was one of the areasthat co-operative banks could undertake to diversify Reddy, Y.V. (1999), ‘Universal Banking and Beyond’,their portfolios as per the recommendations of the in Monetary and Financial Sector Reforms inTask Force to Study the Co-operative Credit System India: A Central Banker’s Perspective, UBSPD,and Suggest Measures for its Strengthening New Delhi.(Chairman: Shri J.Capoor). Reserve Bank of India (2000), ‘Monetary and Credit Policy for the Year 2000-2001’, Reserve Bank ofAs per the Reserve Bank guidelines, banks are not India, Mumbai.allowed to conduct insurance business departmentally.Nor can they set up a separately capitalised subsidiary. Reserve Bank of India (1999), ‘Harmonising the RoleThere has to be an ‘arms length’ relationship between and Operations of Development Financialthe bank and the insurance entity, so that risks inherent Institutions and Banks’, A Discussion Paper,in insurance business do not contaminate the bank’s Reserve Bank of India, Mumbai. 37
  • 38. Report on Trend and Progress of Banking in India, 1999-2000and FIs on take-out finance. The FI/bank and their related cash flows. In effect,that finances infrastructure projects could securitisation is a combination of traditionalhave an arrangement with any FI for secured financing and securities offering,transferring to the latter the outstandings in involving the issuance of asset-backedrespect of such financing in their books on securities. Virtually every asset that has aa pre-determined basis. Take-out finance predictable stream of cash payments could bewould be of help to banks in ALM, since securitised (Box I.9).the financing of infrastructure is long-termin nature against their predominantly short- 1.102 The Reserve Bank, considering theterm resource base. Take-out finance could evolving situation in this area and the needbe either unconditional of conditional. The for reducing risks for the banks, appointed antake-out-finance products involve three in-house Working Group on Assetparties viz., the project company, taking over Securitisation (Chairman: Shri V.S.N. Murty)institution and the lending banks/FIs. Banks, in June 1999 to examine the applicability ofhowever, would have to assign the risk securitisation to the Indian financial system.weights for calculation of CRAR and The Group, in its Report submitted inapplication of other prudential norms, as December 1999, categorised theadvised by the Reserve Bank. recommendations into short-term, medium-term and long-term, with a definite time frame forSecuritisation implementation in each category. It suggested that securitisation should be appropriately1.101. A prominent development in defined to lend uniformity of approach andinternational finance in recent years has been restrict the benefits provided by law/regulationthe growing importance of securitisation. for genuine securitisation transactions. TheSecuritisation can be best described as recommendations also include rationalisation/structured financing in which assets, having a reduction of stamp duties, inclusion ofstable and predictable stream of cash payments, securitised instruments in Securities Contractscan be monetised through a public offering or (Regulation) Act, 1956, removal of prohibitionprivate placement of securities in the capital on investment in mortgage-backed securities bymarkets and which are secured by, and mutual fund schemes, tax neutrality of SPV,dependent in part upon, the assets securitised etc. As medium-term measures, the Working Box I.9: Securitisation Securitisation involves the process of pooling and re- countries, asset securitisation as a structured financing packaging of homogeneous illiquid loans into technique had its genesis in the US in the late marketable securities and distributing to a broad range ’seventies. Securitisation evolved rapidly throughout of investors through capital markets. In the process, the ’eighties and ’nineties to become one of the the lending institution’s assets are removed from its dominant means of capital formation. As of 1995, balance sheet and are instead funded by investors securitisation accounted for more than US $ 450 through a negotiable financial instrument. Increased billion of financing per year and more than US $ 2 pressure on operating efficiency, market niches, trillion in financing outstandings in the US. competitive advantages and capital strength provide impetus for change. Securitisation has emerged as one The core concept of securitisation pertains to the of the solutions to these challenges. segregation of the assets to be securitised from the credit risk of entities involved in financing, except, Although relatively new in European and other (Contd....) 38
  • 39. Banking Developments and Perspectives (...Concld.)in some instances, for FIs, which provide credit towards housing receivables. In India, securitisationenhancement for the securitised assets. Assets to be dates back to 1991 when Citibank securitised auto loanssecuritised are transferred by the asset owner (the and placed a paper with GIC Mutual Fund. Since then,originator or transferor) to a special purpose vehicle a variety of deals have been undertaken. According to(SPV) as the asset purchaser. The SPV may be a some estimates, 35 per cent of all securitisation dealscorporation, trust or other independent legal entity. between 1992 and 1998 were related to hire purchaseThe SPV issues securities to public or private receivables of trucks and the rest towards other auto/investors in the capital markets, which are backed (i.e. transport segment receivables. These apart, SBI Capssecured) by the cash payment streams generated by structured an innovative deal in 1994-95, where a poolthe assets securitised and by the assets themselves. of future cash flows of high value customers ofThe net proceeds received from the issuance of the Rajasthan State Industrial and Development Corporationsecurities are used to pay the transferor for the assets was securitised. The recent securitisation deal of Larsenacquired by the SPV. and Toubro has opened a new vista for financing power projects. National Housing Bank (NHB) has also beenThe principal advantage of securitisation is the making efforts to structure the pilot issue of mortgageseparation of the transferor’s credit risk from that of backed securities (MBS) within the existing legal, fiscalthe SPV. By segregating its credit risk in and regulatory framework.securitisation, a transferor can access the capitalmarket at a lower cost of financing because (a) In October 1999, the Parliament was presented withsignificant differential exists between the stream of amendment to the Securities Contracts (Regulation)cash payments that can be generated by the assets Act that seeks to redefine ‘securities’. The amendedsegregated and the cost of securitisation, and (b) the definition is broad and covers securitisationcredit of securitisation is based primarily on the credit instruments also. The results of the amendment, whenof the source of the cash payment streams generated finally adopted, is expected to bring securitisationby the assets segregated and on credit enhancement, public offers under the regulation of the securitiesif any. In securitisation, investors focus mainly on the regulatory body.credit and liquidity of the assets securitised and onthe structure of the financing - not on the transferor’s In future, financial entities will be judged more bycredit risk. the informal strength and capital base rather than by the external support from the central bank or theAssets that have been securitised in structured government. Market penetration of financialfinancings in the US include, among others, institutions in the area of loan origination in futuremortgages, automobiles, aircraft, equipment and will be determined more by the volume of loansmunicipal leases, credit card receivables, hospital, originated during a period than by the amount of loansretail and trade receivables, real estate, purchase owned at a particular point of time. As the structurecontract for natural resource assets such as oil, gas of the financial system evolves over time, it isand timber, student and home equity loans. expected that securitisation will play a much more important role in the future.The principal disadvantage of securitisation is itscomplexity. Securitisation, typically being References‘transaction-specific’, is more costly to structure andimplement than other more traditional forms of Glennie. D.G., E.C.de Bouter and R.D.Luke (1998),secured financing. Therefore, securitisation is an ‘Securitisation’, Kluwer Law International,appropriate alternative to traditional secured financings London.only if the securitisation costs are lower than the costof funds accessed in the public or private capital Kothari, V. (1999), ‘Securitisation: The Financialmarkets or if other material benefits are realised from Instrument of the New Millennium’, Academy ofthe securitisation deal. Financial Services, Calcutta.Most securitisation deals in India have been related to Reddy, Y.V. (1999), ‘Securitisation in India: Nexttransport sector financing, while there have been some Steps’, RBI Bulletin, pp.693-701. 39
  • 40. Report on Trend and Progress of Banking in India, 1999-2000Group suggested the increased flow of mortgage sectors. Adequate disclosure normsinformation through credit bureaus, have also been suggested to facilitate informedstandardisation of documents, improvement in decision-making by investors. The Report alsothe quality of assets, upgradation of computer suggested that the Government might considerskills and exploring the possibilities of bringing out an umbrella legislation coveringsecuritising NPAs. As a long-term measure, the all aspects of securitisation. The Reserve BankGroup underscored the need to develop has set up an Implementation Committee forinsurance/guarantee institutions to give comfort suggesting the framework for giving effect toto investors, especially in infrastructure/ the above recommendations. 40

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