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Daily News RBI Credit Policies (1999-2005)
Part II. Review of Annual Statement on Developmental and Regulatory Policies for the Year 2005-06
Prudential Measures
(a) Capital Market Exposure Limits: Rationalisation
79. As per the current norms, a bank’s aggregate exposure in all forms to the capital market should not exceed five per cent of its total outstanding advances (including commercial paper) as on March 31 of the previous year. Within this overall ceiling, the bank’s investment in shares, convertible bonds and debentures and units of equity-oriented mutual funds should not exceed 20 per cent of its net worth. On a consolidated basis, the bank’s aggregate exposure to capital markets should not exceed two per cent of its total on-balance-sheet assets (excluding intangible assets and accumulated losses) as on March 31 of the previous year. Within the total limit, investment in shares, convertible bonds and debentures and units of equity-oriented mutual funds should not exceed 10 per cent of the bank’s consolidated net worth.
80. The Reserve Bank has undertaken a review of the prudential limits on the capital market exposure with a view to rationalising them in terms of base and coverage. Accordingly, it is proposed:
• to restrict a bank’s aggregate capital market exposure to 40 per cent of the net worth of the bank on a solo and consolidated basis.
• to modify a bank’s consolidated direct capital market exposure to 20 per cent of the bank’s consolidated net worth.
• to simplify and rationalise the exemptions in regard to the coverage.
81. Banks exceeding these limits either on solo or consolidated basis should approach the Reserve Bank with a plan for bringing down the exposure within the permissible limits. Banks having sound internal controls and robust risk management systems can approach the Reserve Bank for higher limits. Guidelines in this regard would be issued separately.
(b) Prudential Provisioning Requirements: Review
82. In terms of the prudential guidelines, banks are required to assess their entire loans and advances portfolio on an account-by-account basis with regard to the degree of delinquency and classify them into four broad asset classification categories, viz., standard, sub-standard, doubtful and loss. The standard assets attract a uniform provisioning requirement of 0.25 per cent of the funded outstanding on a portfolio basis. Banks are required to make specific provisions in respect of sub-standard assets at a uniform rate of 10 per cent of the funded outstanding and for doubtful accounts at rates ranging from 20 to 100 per cent, taking into account the period for which the account has remained non-performing and the realisable value of security charged to the bank.
83. Traditionally, banks’ loans and advances portfolio is pro-cyclical and tends to grow faster during an expansionary phase and grows slowly during a recessionary phase. During times of expansion and accelerated credit growth, there is a tendency to underestimate the level of inherent risk and the converse holds good during times of recession. This tendency is not effectively addressed by the above mentioned prudential specific provisioning requirements since they capture risk ex post but not ex ante.
84. The various options available for reducing the element of pro-cyclicality include, among others, adoption of objective methodologies for dynamic provisioning requirements, as is being done by a few countries, by estimating the requirements over a business cycle rather than a year on the basis of the riskiness of the assets, establishment of a linkage between the prudential capital requirements and through-the-cycle ratings instead of point-in-time ratings and establishment of a flexible loan-to-value (LTV) ratio requirements where the LTV ratio would be directly related to the movement of asset values.
85. Taking into account the recent trends in credit growth, it is proposed:
• to increase the general provisioning requirement for ‘standard advances’ from the present level of 0.25 per cent to 0.40 per cent. Banks’ direct advances to agricultural and SME sectors would be exempted from the additional provisioning requirement. As hitherto, these provisions would be eligible for inclusion in Tier II capital for capital adequacy purposes up to the permitted extent. Operational guidelines in this regard would be issued separately.
(c) New Capital Adequacy Framework: Status
86. Draft guidelines for implementation of the New Capital Adequacy Framework have been formulated and placed on the Reserve Bank’s website. In line with international standards, banks were advised to adopt the Standardised Approach for credit risk with effect from March 31, 2007. Banks adopting the Standardised Approach would use the rating assigned by only those credit rating agencies which are identified by the Reserve Bank. Accordingly, an in-house Group has been constituted in the Reserve Bank for identifying the external rating agencies. Final guidelines would be issued on the basis of the recommendations of the Group and the feedback received thereon.
87. Under the New Framework, banks are required to adopt the Basic Indicator Approach (BIA) for computing capital requirement for operational risk. The Reserve Bank has issued a ‘Guidance Note on Management of Operational Risk’ in
October 2005 to facilitate a smooth transition to the New Framework. Banks using BIA are encouraged to comply with ‘Sound Practices for the Management and Supervision of Operational Risk’ issued by the Basel Committee on Banking Supervision (BCBS) in February 2003.
88. The BCBS has undertaken the Fifth Quantitative Impact Study (QIS-5) to assess the impact of adoption of New Capital Adequacy Framework. Twelve banks identified to participate in the QIS-5 were advised to familiarise themselves with the requirements of QIS-5 for effective participation.
(d) Capital Adequacy Requirements
89. Banks which have maintained regulatory capital of at least nine per cent of the risk weighted assets for both credit risk as well as market risk in respect of ‘held for trading’ (HFT) and ‘available for sale’ (AFS) categories as on March 31, 2006 would be permitted to treat the entire balance in the investment fluctuation reserve (IFR) as Tier I capital. Once the amount of IFR is so transferred towards Tier I capital, a headroom for raising an equal amount of Tier II capital would become available to the eligible banks, up to half of which could be raised through issuance of subordinated debt.
90. In terms of the prudential guidelines on capital adequacy, banks are required to maintain capital charge for market risk in respect of their trading book exposures (including derivatives) and securities included under the AFS category with effect from March 31, 2005 and March 31, 2006, respectively. Furthermore, banks are required to migrate to the New Capital Adequacy Framework with effect from March 31, 2007. These developments would result in additional capital requirements for banks. Internationally, banks raise capital through equity shares and instruments such as subordinated debt and preference shares which are eligible for inclusion in Tier I/Tier II/Tier III capital. Banks in India, however, do not currently have such options available except for raising Tier II capital through subordinated debt to a limited extent. The Reserve Bank is examining various types of capital instruments that can be permitted under the New Capital Adequacy Framework.
(e) Corporate Debt Restructuring Mechanism
91. As mentioned in the annual policy Statement of April 2005, the performance of the corporate debt restructuring (CDR) mechanism was reviewed and draft guidelines on CDR mechanism were placed on the Reserve Bank’s website in May 2005 for wider dissemination. The changes to the existing CDR scheme have been finalised taking into account the feedback received. Operational guidelines in this regard would be issued separately.
(f) Supervisory Review Process
92. Having regard to the recent trends in the credit markets it is proposed:
• to initiate a supervisory review process with select banks having significant exposure to some sectors, namely, real estate, highly leveraged NBFCs, venture capital funds and capital markets, in order to ensure that effective risk mitigants and sound internal controls are in place for managing such exposures.
(g) Financing of NBFCs
93. As indicated in the annual policy Statement of April 2005, an Informal Working Group (Chairperson: Smt. Usha Thorat) was constituted to examine the issues involved in financing of NBFCs by banks and suggest ways to use the core competencies of NBFCs in extending credit to small borrowers. The recommendations of the Group include: (i) extending bank finance to NBFCs for permissible activities; (ii) using NBFCs as business correspondents or agents; (iii) permitting banks to rediscount the bills discounted by NBFCs pertaining to the transport sector; (iv) using NBFCs as a conduit for providing long-term funds to the SME sector; and (v) extending training facilities to NBFCs engaged in financing the SSI and agriculture sectors. The recommendations are under examination.
(h) Credit Information Companies (Regulation) Act, 2005: Status
94. The Credit Information Companies (Regulation) Act, 2005 was notified in the Gazette of India on June 23, 2005 and the Government requested the Reserve Bank to frame rules and regulations for implementation of the Act. Accordingly, a Working Group (Chairman: Shri Prashant Saran) was constituted with representatives from the Reserve Bank, the IBA, the Credit Information Bureau of India Ltd. (CIBIL) and select banks. The Group, in consultation with the Ministry of Law, prepared the draft rules and regulations for implementation of the Act with specific provisions for protecting individual borrower’s rights and obligations. The draft rules and regulations are being examined by the Reserve Bank.
(i) Setting up of Banking Codes and Standards Board of India: Status
95. Modalities regarding setting up of an independent Banking Codes and Standards Board of India (BCSBI) on the model of the mechanism in the UK are being worked out in pursuance of the annual policy Statement of April 2005 in order to ensure that a comprehensive code of conduct for fair treatment of customers is established.
(j) Financial Inclusion
96. The annual policy Statement of April 2005, while recognising the concerns in regard to the banking practices that tend to exclude rather than attract vast sections of population, urged banks to review their existing practices to align them with the objective of financial inclusion. In many banks, the requirement of minimum balance and charges levied, although accompanied by a number of free facilities, deter a sizeable section of population from opening/maintaining bank accounts. With a view to achieving greater financial inclusion, all banks need to make available a basic banking ‘no frills’ account either with ‘nil’ or very low minimum balances as well as charges that would make such accounts accessible to vast sections of population. The nature and number of transactions in such accounts could be restricted, but made known to the customer in advance in a transparent manner. All banks are urged to give wide publicity to the facility of such a ‘no-frills’ account so as to ensure greater financial inclusion.
(k) Issue of Co-branded Debit Cards by Banks
97. At present, banks are required to obtain the Reserve Bank’s approval for issue of debit cards in tie-up with other non-bank entities for marketing and distribution purposes. In order to further liberalise the procedure, it is proposed:
• to accord general permission to banks to issue debit cards in tie-up with non-bank entities subject to certain conditions. Detailed instructions would be issued separately.
(l) Anti-Money Laundering Guidelines: Status
98. In recent years, prevention of money laundering has assumed importance in international financial relationships. In this context, in November, 2004 the Reserve Bank revised the guidelines on ‘Know Your Customer’ (KYC) principles in line with the recommendations made by the Financial Action Task Force (FATF) on standards for Anti-Money Laundering (AML) and Combating Financing of Terrorism (CFT). Banks were advised to frame their KYC policies with the approval of their boards and ensure that they are compliant with its provisions by December 31, 2005. The salient features of the policy relate to the procedure prescribed in regard to customer acceptance, customer identification, risk management and monitoring of transactions. The revised guidelines envisage verification of the identity and address of the customer through independent source documents as mandatory and banks are required to classify the accounts according to their risk perceptions. In order to ensure that the inability of persons belonging to low income groups to produce documents to establish their identity and address does not lead to their financial exclusion and denial of banking services, a simplified procedure has been provided for opening of account in respect of those persons who do not intend to keep balances above Rs.50,000 and whose total credit in one year is not expected to exceed Rs.1,00,000.
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