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Click here to return to main page of Annual Policy Statement 2006-07
Part II. Annual Statement on Developmental and Regulatory Policies for the Year 2006-07
Prudential Measures
169. The Reserve Bank has focused continuously on regulatory and supervisory aspects of the financial sector in order to improve efficiency, stability and soundness of regulated entities and markets. As has been stated in earlier policy Statements, the Reserve Bank is committed to continuing the process of adopting international best practices with appropriate flexibility in view of the differences in the existing institutional framework and capacity. In this direction, the following further measures are proposed:
(a) Capital Adequacy Requirements: New Option for Raising Capital
170. The Reserve Bank issued guidelines to banks in January 2006 for raising capital funds through the issue of innovative perpetual debt instruments (IPDI) (Tier I capital) and debt capital instruments (upper Tier II capital) to meet business as well as the Basel II requirements. In terms of these guidelines, IPDI should not exceed 15 per cent of total Tier I capital of the issuing bank and investment in these instruments by FIIs and NRIs should be within an overall limit of 49 per cent and 24 per cent of the issue, respectively, subject to the investment by each FII not exceeding 10 per cent of the issue and investment by each NRI not exceeding 5 per cent of the issue. A few banks had expressed some difficulties in complying with some of these limits on individual issuance basis and requested that these limits could be operated on an overall basis. Accordingly, necessary clarifications have been issued.
(b) Preference Shares
171. The Basel I framework recognises issue of preference shares as an eligible instrument of capital. Although nationalised banks are able to raise capital through public issue of preference shares, there are restrictions on other banks. The Reserve Bank has, therefore, proposed necessary legal amendments in this regard to enable all banks in India to avail of this option for raising capital.
(c) Protected Disclosure Scheme for Private Sector and Foreign Banks
172. Disclosure of information in the public interest by the employees of an organisation is increasingly gaining acceptance by public bodies for ensuring better governance standards and probity/transparency in the conduct of affairs of public institutions. In this regard, on April 21, 2004 the Government had authorised the Central Vigilance Commission (CVC) as the ‘Designated Agency’ to receive written complaints or disclosure of any allegation of corruption or of misuse of office and recommend appropriate action. The jurisdiction of the CVC is restricted to employees of the Government or of any corporation established by it or under any Central Act, Government companies, societies or local authorities owned or controlled by the Government.
173. As private sector and foreign banks are outside the purview of the CVC, the Reserve Bank has formulated a scheme called "Protected Disclosures Scheme for Private Sector and Foreign Banks". The draft of the proposed scheme has been placed on the Reserve Bank’s website on January 25, 2006 soliciting comments/suggestions from the public. The scheme is being finalised on the basis of the feedback received.
(d) Prudential Norms for Restructuring of Advances (Other than under CDR Mechanism)
174. The Reserve Bank had issued guidelines in March 2001 allowing banks/financial institutions to restructure/reschedule credit facilities extended to industrial units which are fully secured by tangible assets. In August 2001, an institutional mechanism was put in place for restructuring of corporate debt in the form of the Corporate Debt Restructuring (CDR) system. The CDR mechanism, which was reviewed twice in 2003 and 2005, covers multiple banking accounts/syndication/consortium accounts with outstanding exposure of Rs.10 crore and above by banks and institutions. In addition, in September 2005, the Reserve Bank issued guidelines for restructuring of debt of all eligible small and medium enterprises (SME) which cover SME accounts with outstandings up to Rs.10 crore. As banks would need to restructure credit facilities pertaining to borrowers who are not covered by any of the above guidelines issued so far, it is proposed:
• to constitute a Working Group to review and align the existing guidelines on restructuring of advances (other than under CDR mechanism) on the lines of provisions under the revised CDR mechanism.
(e) Draft Guidelines Relating to Classification and Valuation of Investments in Alignment with International Standards
175. The Reserve Bank has been continuously working towards aligning the accounting standards for banks with the best international standards. The Institute of Chartered Accountants of India (ICAI) proposes to issue an accounting standard on ‘Financial Instruments: Recognition and Measurement’ which would be the Indian parallel of IAS 39. The proposed accounting standard will be of considerable significance for financial entities and, therefore, has implications for the financial sector. In this context, an Internal Group was constituted to review the existing guidelines on classification and valuation of investments by banks and to align them with the accounting standard proposed by ICAI, consistent with international standards. The Group, taking into account the unique country-specific circumstances, has focused on dovetailing the provisions of IAS 39 with the existing prudential guidelines relating to classification and valuation of investments. The report of the Group has been referred to experts for their comments. On the basis of the feedback received, draft guidelines would be prepared and placed on the Reserve Bank’s website for wider dissemination and comments.
(f) Working Group to Review Asset-Liability Management Guidelines
176. Asset-Liability Management (ALM) guidelines were issued to banks in February 1999, based on maturity gap analysis for management of risks. As the ALM systems in banks have stabilised, it is appropriate to move towards the modified duration gap approach to interest rate risk management, as envisaged in the guidelines. Accordingly, a Working Group was constituted to suggest a framework to enable banks to implement the modified duration gap approach for management of interest rate risk. The Group has submitted its report. Draft guidelines, based on the recommendations of the Group, have been placed on the Reserve Bank’s website for comments.
(g) New Capital Adequacy Framework: Status
177. Banks in India were advised to adopt the Standardised Approach for credit risk and Basic Indicator Approach for operational risk under the New Capital Adequacy Framework with effect from March 31, 2007. Under the Standardised Approach, banks are required to compute capital requirements for credit risk exposures on the basis of ratings assigned to these exposures by external credit assessment institutions (ECAI). National supervisors are responsible for determining whether the ECAIs meet the eligibility criteria stipulated by Basel Committee on Banking Supervision (BCBS) before allowing banks to use the ratings awarded by these agencies. Accordingly, an in-house Group has been constituted by the Reserve Bank for identifying the ECAIs whose ratings may be relied upon by banks. The Group’s recommendations are being finalised.
178. Draft guidelines for implementation of the New Capital Adequacy Framework were formulated and placed on the Reserve Bank’s website on February 15, 2005 for wider dissemination and comments. The feedback received in this regard is being examined by the Reserve Bank. Final guidelines on implementation of the New Capital Adequacy Framework would be issued after taking into account the recommendations of the in-house Group.
179. The BCBS has undertaken the Fifth Quantitative Impact Study (QIS-5) to assess the impact of adoption of the New Capital Adequacy Framework. Eleven Indian banks, accounting for about 50 per cent of market share (by assets), participated in the QIS-5 exercise. Preliminary analysis indicates that the combined capital adequacy ratio of these banks is expected to come down by about 1 percentage point when these banks apply Basel II norms for Standardised Approach for credit risk and Basic Indicator Approach for operational risk. Although none of these banks would be breaching the minimum capital adequacy ratio under the new framework, the net impact reflects a wide range and as such, the results are being further examined.
(h) Credit Information Companies (Regulation) Act, 2005
180. In pursuance of powers conferred under the Credit Information Companies (Regulation) Act, 2005 (CIC Act) the Government requested the Reserve Bank to frame rules and regulations for implementation of the Act. Accordingly, a Working Group (Chairman: Shri P. Saran) was constituted by the Reserve Bank to frame draft rules and regulations for implementation of the Act. The draft rules and regulations were placed on the Reserve Bank’s website for wider dissemination and were open for comments up to April 15, 2006. The draft rules and regulations will be reviewed in the light of the feedback received and forwarded to the Government for consideration.
181. The Credit Information Bureau (India) Ltd. (CIBIL), established in 2001, has been collecting data on suit-filed accounts and the accounts in respect of which the borrowers have given consent for sharing information with CIBIL. After the CIC Act is operationalised, banks/FIs would be able to submit data to credit information companies without obtaining consent of the borrowers. Pending the operationalisation of the CIC Act and in order to build up the credit database, banks were advised by the Reserve Bank to obtain consent from all existing borrowers at the time of renewal of loans for sharing the credit information with the CIBIL. The Reserve Bank proposes to call for credit information on customers from CIBIL in order to ensure that the process of obtaining consent has been completed.
(i) Working Group on Conflict of Interest in the Indian Financial Services Sector
182. As indicated in the Annual Policy Statement of April 2005, the Reserve Bank constituted a Working Group on Conflict of Interest in the Indian Financial Services Sector (Chairman: Shri D. M. Satwalekar) which submitted its report in December 2005. The Group examined various conflict of interest situations, both nationally and internationally, and provided an integrated framework of forward-looking measures to mitigate/prevent such situations. The report of the Group has been placed on the Reserve Bank’s website for wider dissemination.
(j) Know Your Customer Guidelines
183. In November 2004, guidelines on Know Your Customer (KYC) and Anti Money Laundering (AML) standards were issued by the Reserve Bank and banks were advised to put in place a policy framework to ensure that they are fully compliant with the provisions.
184. The Government of India, notified on July 1, 2005 the Rules under the Prevention of Money Laundering Act (PMLA), 2002. Accordingly, the provisions of PMLA, 2002 came into effect from July 1, 2005. In terms of the Rules, the Financial Intelligence Unit – India (FIU-IND) was set up to collect, compile, collate and analyse the cash and suspicious transactions reported by banks and financial institutions. Reporting formats for suspicious transactions and currency transactions were finalised in consultation with the FIU-IND and, accordingly, banks were advised to report cash and suspicious transactions as prescribed under PMLA, 2002 to FIU-IND.
(k) Prudential Provisioning Requirements
185. The Committee on Banking Sector Reforms (Chairman: Shri M. Narasimham) had recommended that, as a prudential measure, a general provision of about one per cent of standard assets of banks would be appropriate and should be implemented in a phased manner. The Mid-term Review of October 2005 increased the provisioning requirement on standard assets, with the exception of direct advances to agricultural and SME sectors, from 0.25 per cent to 0.40 per cent of the funded outstanding on portfolio basis. To ensure that asset quality is maintained in the light of high credit growth, it is proposed:
• to increase the general provisioning requirement on standard advances in specific sectors, i.e., personal loans, loans and advances qualifying as capital market exposures, residential housing loans beyond Rs.20 lakh and commercial real estate loans from the present level of 0.40 per cent to 1.0 per cent. 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.
(l) Risk Weight on Exposures to Commercial Real Estate
186. In July 2005, the Reserve Bank had increased the risk weight on exposures to commercial real estate from 100 per cent to 125 per cent. Given the continued rapid expansion in credit to this sensitive sector, it is proposed:
• to increase the risk weight to 150 per cent.
(m) Exposure to Venture Capital Funds Included for Capital Market
187. Venture capital funds (VCFs) play an important role in encouraging entrepreneurship. In the absence of adequate public disclosures with regard to performance/asset quality of VCFs, prudence would demand treatment of exposures to VCFs as ‘high risk’. Therefore, in terms of risk, all exposures to VCFs would have to be deemed to be on par with ‘equity’. While significance of venture capital activities and need for banks’ involvement in financing venture capital funds is well recognised, there is also a need to address the relatively higher risks inherent in such exposures. Accordingly, it is proposed that:
• a bank’s total exposure to venture capital funds will form a part of its capital market exposure and banks should, henceforth, assign a higher risk weight of 150 per cent to these exposures.
Operational guidelines in this regard would be issued separately.
(n) Stress Testing of Asset Portfolio by Banks
188. In the present liberalised environment, banks need to have a robust and sound stress testing process for assessment of capital adequacy. The stress testing involves identifying possible events, future economic conditions that could unfavourably impact bank’s credit exposures and making an assessment of the ability of banks to withstand the loss arising out of such events. There is also a need for carrying out stress tests on the asset portfolio incorporating various scenarios, like economic downturns, industrial downturns, market risk events and sudden shifts in liquidity conditions. Furthermore, exposures to sensitive sectors and high risk category of assets would have to be subjected to more frequent stress tests based on realistic assumptions for asset price movements. Stress tests would enable banks to assess the risk more accurately and, thereby, facilitate planning for appropriate capital requirements. This stress testing would also form a part of preparedness for Pillar 2 of the Basel II framework. Against this backdrop, it is proposed:
• to advise banks to undertake sound stress testing practices.
(o) Internal Group on Regulatory Convergence and Regulatory Arbitrage in the Financial Sector
189. The Reserve Bank constituted a Group to study the issues of regulatory convergence, regulatory arbitrage and to recommend a policy framework for a level playing field in the financial sector. The report of the Group has been placed on the Reserve Bank’s website for wider dissemination and comments.
(p) Rationalisation of Calendar of Reviews
190. In an effort to reduce the burden on boards of banks and with a view to ensuring that boards deal with important issues in a focused manner, the calendar items were reviewed in June 2005. Accordingly, the total number of reviews were reduced by leveraging the work of several committees of the boards. The Reserve Bank requested the IBA to offer its views on the structure of calendar of reviews with a view to further rationalising the structure. The IBA has since forwarded its views which are under consideration for implementation.
Click Here For Highlights of Annual Policy Statement for the Year 2006-07
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