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Second Quarter Review of Monetary Policy click here

Second Quarter Review of Monetary Policy 2009-2010
-Announced on the 27th October 2009

Part B. Developmental and Regulatory Policies

VI. Regulatory Measures for Commercial Banks

Relaxations in Branch Authorisation Policy

152. As announced in the Annual Policy Statement of April 2009, a Working Group (Chairman: Shri P. Vijaya Bhaskar) was constituted to review the extant branch authorisation policy with a view to providing greater flexibility to banks for opening branches to enhance banking penetration and promote financial inclusion. The Group has since submitted its report. Taking into consideration the Group’s recommendations, it is proposed to liberalise the extant branch authorisation policy for domestic scheduled commercial banks (other than RRBs) as under:

• Domestic scheduled commercial banks (other than RRBs) will now be free to open branches in Tier 3 to Tier 6 centres as identified in the Census 2001 (with population up to 50,000) under general permission.

• Opening of branches by domestic scheduled commercial banks (other than RRBs) in Tier 1 and Tier 2 centres (with population over 50,000) will continue to require prior authorisation.

• Banks may plan their branch expansion in Tier 3 to Tier 6 centres in such a manner that at least one-third of such branches are in the underbanked districts of underbanked States as will be notified separately by the Reserve Bank. This would be one of the criteria in the Reserve Bank’s consideration of proposals by domestic scheduled commercial banks (other than RRBs) to open branches in Tier 1 and Tier 2 centres. In considering such proposals, the Reserve Bank would, in addition, take into account banks’ performance in financial inclusion, priority sector lending and level of customer service, among others.

Enhancements to the Basel II Framework

153. In July 2009, the Basel Committee on Banking Supervision (BCBS) had finalised enhancements and revisions in certain areas of the Basel II framework. The enhanced/revised guidance of BCBS is contained in their three documents, viz., Enhancements to the Basel II Framework; Revisions to the Basel II Market Risk Framework; and Guidelines for Computing Capital Charge for Incremental Risk in the Trading Book. These enhancements and revisions are intended to strengthen the framework and respond to lessons learnt from the financial crisis.

154. The enhancements and revisions now stipulated by BCBS are, however, mostly applicable to advanced approaches of the Basel II framework. Banks in India have implemented standardised/basic approaches contained in the framework. However, wherever those enhancements and revisions are applicable to standardised/basic approaches, it is proposed:

• to issue detailed guidelines as appropriate for implementation by banks operating in India by end-November 2009.

Introduction of Duration Gap Analysis for Asset Liability Management

155. The Reserve Bank had issued guidelines on asset liability management in February 1999, which, inter alia, covered aspects relating to interest rate risk measurement. These guidelines to banks approached interest rate risk measurement from the ‘earnings perspective’ using the traditional gap analysis (TGA). To begin with, the TGA was considered as a suitable method to measure interest rate risk. The Reserve Bank had, however, indicated its intention to shift to modern techniques of interest rate risk measurement such as duration gap analysis (DGA), simulation and value-at-risk over a period of time, when banks acquire sufficient expertise and sophistication in this regard. Since banks have gained considerable experience in implementation of the TGA and have become familiar with the application of the concept of duration/modified duration while applying standardised duration method for measurement of interest rate risk in the trading book, this is an opportune time for banks to adopt the DGA for management of their interest rate risk. With this move, banks would migrate to the application of the ‘economic value perspective’ to interest rate risk management. Accordingly, it is proposed:

• to issue detailed guidelines on the use of DGA for management of interest rate risk by end-November 2009 .

Review of Capital Adequacy Norms for Take-out Financing

156. At present, the credit conversion factor (CCF) for off-balance sheet exposure of the take-out financing institution, which captures that institution’s unconditional commitment during the period up to the take-out event, is 100 per cent. The CCF for conditional take-out has been fixed at a lower level of 50 per cent reflecting the uncertainty regarding the take-out event due to the conditional nature of the agreement. The existing capital adequacy treatment of take-out financing is in conformity with the capital adequacy treatment of forward asset purchases under both Basel I and Basel II. The issue has been reconsidered and it is proposed:

• to allow banks to build up capital for take-out exposures in a phased manner.

157. Detailed guidelines in this regard are being issued separately.

Commercial Real Estate Exposures

158. In view of large increase in credit to the commercial real estate sector over the last one year and the extent of restructured advances in this sector, it would be prudent to build cushion against likely non-performing assets (NPAs). Accordingly, it is proposed:

• to increase the provisioning requirement for advances to the commercial real estate sector classified as ‘standard assets’ from the present level of 0.40 per cent to 1 per cent.

Review of Adequacy of Loan Loss Provisions

159. At present, the provisioning requirements for NPAs range between 10 per cent and 100 per cent of the outstanding amount, depending on the age of the NPAs, the security available and the internal policy of the bank. Since the rates of provisioning stipulated by the Reserve Bank for NPAs are the minimum and banks can make additional provisions subject to a consistent policy based on riskiness of their credit portfolios, it has been observed that there is a wide heterogeneity and variance in the level of provisioning coverage ratio across different banks. With a view to improving the provisioning cover and enhancing the soundness of individual banks, it is proposed:

• to advise banks to augment their provisioning cushions consisting of specific provisions against NPAs as well as floating provisions, and ensure that their total provisioning coverage ratio, including floating provisions, is not less than 70 per cent. Banks should achieve this norm not later than end-September 2010.

Banks’ Exposure to NBFCs Engaged in Infrastructure Financing: Review of Risk Weights

160. At present, the risk weight for banks’ exposure to systemically important non-deposit taking NBFCs (NBFCs-ND-SI) is 100 per cent. However, asset finance companies (AFCs) within the NBFCs-ND-SI category carry a risk weight based on credit ratings. As indicated in para 178 in Section VII of this part, NBFCs engaged in financing of infrastructure would henceforth be classified in a new category called infrastructure NBFCs. Since financing by such NBFCs would essentially result in the creation of physical infrastructure, it is proposed:

• to link the risk weights of banks’ exposure to such NBFCs to the credit rating assigned to the NBFC by external credit assessment institutions (ECAIs).

Lock-in Period and Minimum Retention for Securitisation Exposures

161. To ensure that the originators do not compromise on due diligence of assets generated for the purpose of securitisation, it was proposed in the Annual Policy Statement of April 2009 to stipulate a minimum lock-in period for bank loans before these were securitised. It was also proposed to lay down minimum retention criteria for the originators as another measure to achieve the same objective. Accordingly, it is proposed:

• that the minimum lock-in period for all types of loans would be one year before these can be securitised; and

• that the minimum retention by the originators will be 10 per cent of the pool of assets being securitised.

162. The international work, especially in the European Union and the US regarding the minimum retention criteria, is still underway. The Reserve Bank will issue detailed guidelines on the manner of computation of the one year lock-in period and other operational details keeping in view the international norms being developed.

Compensation Practices

163. Compensation practices, especially of large financial institutions, were one of the factors which contributed to the recent global financial crisis. The FSB has brought out certain principles for sound compensation practices. The principles call for effective governance of compensation, and for compensation to be adjusted for all types of risk, to be symmetric with risk outcomes, and to be sensitive to the time horizon of risks. These principles, which have been endorsed by the G-20, should be the guiding tenets for devising compensation schemes for all employees in a financial institution. The Reserve Bank is working on the FSB principles for sound compensation and it is proposed:

• to issue suitable guidelines to private sector and foreign banks with regard to sound compensation policies.

Liquidity Risk

164. The Annual Policy Statement of April 2009 proposed to place the draft circular on liquidity risk management, as also the guidance note on “Liquidity Risk Management” on the Reserve Bank’s website by mid-June 2009. This was deferred. Keeping in view active discussions underway at the global level on liquidity risk management as the BCBS is also in the process of enhancing the modalities for adopting the integrating risk management system, it is now proposed:

• to issue a draft circular reflecting these changes by end-December 2009.

Stress Testing

165. The Annual Policy Statement of April 2009 proposed upgradation of the stress testing guidelines once BCBS finalises the paper on ‘Principles for Sound Stress Testing Practices and Supervision’. In this context, the guidelines issued to banks in June 2007 are required to be enhanced in the light of the final paper issued by BCBS and taking into account international work/initiatives in the area of stress testing, particularly that being done by the IMF and the FSB. It is proposed:

• to issue guidelines to banks on stress testing by end-January 2010.

Credit Rating Agencies: Status

166. It was indicated in the Annual Policy Statement of April 2009 that the Reserve Bank will liaise with the SEBI on the issue of rating agencies’ adherence to Code of Conduct Fundamentals of the International Organisation of Securities Commissions (IOSCO). Accordingly, in order to review rating agencies’ continued accreditation under Basel II, the Reserve Bank conducted meetings with Credit Rating Information Services of India Ltd. (CRISIL), ICRA Ltd., Credit Analysis and Research Ltd. (CARE) and Fitch. The Reserve Bank has also initiated discussions with the SEBI to assess the rating agencies’ compliance with the enhanced Code of Conduct Fundamentals of the IOSCO.

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