Part II. Annual Statement on Developmental and
Regulatory Policies for the Year 2007-08
IV. Prudential Measures
171.The Reserve Bank continues to sharpen its regulatory and supervisory roles for ensuring the smooth and effective functioning of the financial system thereby contributing to public confidence and accelerated economic growth. The approach also seeks convergence between Indian standards and international best practices with regard to prudential norms, accounting standards, transparency and disclosure, asset-liability management and risk management systems. Keeping in view the pace and pattern of developments in the financial sector, the Reserve Bank has intensified its consultative process and provided stakeholders with the flexibility to absorb changes in a non-disruptive manner.
(a)Extension of Credit Facilities to Overseas Step-down Subsidiaries of Indian Corporate
172.The Mid-Term Review of October 2006 enhanced the prudential limit on credit and non-credit facilities extended by banks to Indian Joint Ventures (JV)/Wholly Owned Subsidiaries (WOS) abroad from the existing limit of 10 per cent to 20 per cent of their unimpaired capital funds (Tier I and Tier II capital) with a view to facilitating the expansion of Indian corporates’ business abroad.
173.Over the years, Indian industry has been successfully building up its presence abroad with increasing overseas acquisitions and as a consequence, the exposure of banks to such financing is rising. As overseas markets are expected to offer better opportunities for growth and bring in higher revenue and volumes, it is proposed:
•to permit Indian banks to extend credit and non-credit facilities to step-down subsidiaries which are wholly owned by the overseas subsidiaries of the Indian corporates, within the existing prudential limits and some additional safeguards.
(b)Comprehensive Guidelines on Derivatives: Status
174.The Reserve Bank had constituted an Internal Group to review the existing guidelines on derivatives and formulate comprehensive guidelines on derivatives for banks in view of the growing complexity, diversity and volume of derivatives used by banks. Based on the Group’s report, draft comprehensive guidelines on derivatives were placed on the Reserve Bank’s website and final guidelines have been issued on April 20, 2007 in the light of the feedback received. These guidelines relate to rupee derivatives and cover operational issues relating to interest rate derivatives and broad generic principles for undertaking derivatives transactions, management of risk and sound corporate governance requirements as also adoption of suitability and appropriateness policy, while undertaking derivatives transactions.
(c)Introduction of Credit Default Swaps
175.As part of the gradual process of financial sector liberalisation in India, it is considered appropriate to introduce credit derivatives in a calibrated manner at this juncture. The risk management architecture of banks has strengthened and banks are on the way to becoming Basel II compliant, providing adequate comfort level for the introduction of such products. Furthermore, the recent amendment to the Reserve Bank of India Act, 1934 has provided legality of OTC derivative instruments, including credit derivatives. Accordingly, to begin with, it is proposed:
•to permit banks and primary dealers to begin transacting in single-entity credit default swaps (CDS). Detailed guidelines in this regard will be issued by May 15, 2007.
(d)New Capital Adequacy Framework (Basel II):
Status and Plans
176.Taking into account the size, complexity of operations, relevance in the financial sector, the need for greater financial inclusion and the necessity of an efficient delivery mechanism for directed credit, capital adequacy norms applicable to banking entities in India have been maintained at varying levels of stringency. On the first track, commercial banks are required to maintain capital for both credit and market risks as per the Basel I framework; on the second track, co-operative banks are required to maintain capital for credit risk as per the Basel I framework and surrogates for market risk; on the third track, the RRBs have a minimum capital requirement which is, however, not on par with the Basel I framework. Consequently, the Indian banking system has a major segment of systemically important banks on a full Basel I framework, a portion of the minor segment partly on Basel I framework and an insignificant segment on a non-Basel I framework. Against this backdrop, at least initially, a similar diversity would be visible in the Indian banking segment even after the commercial banks begin implementing New Capital Adequacy Framework (Basel II) in March 2008.
177.The Reserve Bank had issued draft guidelines for implementation of the Basel II framework in February 2005 inviting feedback from banks. On the basis of the feedback received from a wide spectrum of banks and other stakeholders, the draft guidelines were revised and issued to banks on March 20, 2007 for a second round of consultation. On the basis of the feedback received, the final guidelines are being issued separately.
(e)Establishment of Credit Information Companies: Status
178.With a view to strengthening the legal mechanism and facilitating credit information bureaus to collect, process and share credit information pertaining to borrowers of banks/financial institutions (FIs), the Credit Information Companies (Regulation) Act, 2005 was passed in the Parliament in May 2005 and notified in the Gazette of India on June 23, 2005. Collection and dissemination of credit information will help the banks and FIs in strengthening their credit risk management systems.
179.The Rules and Regulations for implementation of the Credit Information Companies (Regulation) Act, 2005 were notified by the Government of India on December 14, 2006 and the Act has become operational. A press release has since been issued inviting applications for establishment of Credit Information Companies.A High Level Advisory Committee has been set up to screen the applications and recommend the names of credit information companies to whom certificate of registration for commencement/continuing business of credit information could be granted.
(f)Introduction of KYC Norms/AML Standards:
Procedure for Wire Transfer
180.The Financial Action Task Force (FATF) has made forty recommendations and nine special recommendations to address the concerns relating to money laundering and terrorism financing. The Reserve Bank had earlier issued detailed guidelines to banks based on the FATF recommendations to ensure that a proper policy framework on ‘Know Your Customer’ and Anti-Money Laundering measures is put in place. Special Recommendation VII (SR VII) aims at preventing terrorists and other criminals from having unfettered access to wire transfers for moving their funds. Accordingly, banks were advised in April 2007 that all cross-border wire transfers and related messages that are sent by them should be accompanied by accurate and meaningful originator information (name, address and account number) and the information should remain with the transfer or related message throughout the payment chain. Furthermore, the record of originator information accompanying a wire transfer should be kept for ten years. In case any overseas ordering bank/financial institution fails to furnish information on the remitter, the receiving bank should restrict or even terminate its business relationship with the ordering bank.
(g)Bank Finance to Factoring Companies:
Review of Existing Guidelines
181.The extant guidelines of the Reserve Bank enable banks to freely extend financial assistance to non-banking financial companies (NBFCs) except for certain activities. A Working Group has been constituted with representatives from banks, factoring companies and the Reserve Bank to review the existing guidelines regarding financing of factoring companies in view of difficulties expressed by some banks.
(h)Segment Reporting under Accounting Standard 17:
Enhancement of Disclosure
182.In March 2003, banks were advised to adopt three business segments, viz., ‘Treasury’, ‘Other Banking Business’ and ‘Residual’ as the uniform business segments and ‘Domestic’ and ‘International’ as the uniform geographic segments for the purpose of segment reporting under Accounting Standard - 17 (AS-17). The reporting segment under the ‘Other Banking Business’ category is fairly broad covering large part of the ‘banking book’. This segment is further divided into three categories, viz., ‘Corporate/Wholesale Banking’, ‘Retail Banking’ and ‘Other Banking Business’ in order to impart greater transparency in disclosures. ‘Retail Banking’ would include exposures which fulfil the four criteria of orientation, product, granularity and low value of individual exposures for retail exposures as laid down in the Basel Committee on Banking Supervision (BCBS) document entitled "International Convergence of Capital Measurement and Capital Standards: A Revised Framework". In addition, individual housing loans will also be included in the retail banking segment. Wholesale banking would include all advances to trusts, partnership firms, companies and statutory bodies, which are not included under ‘Retail Banking’. ‘Others Banking Business’ would include all other banking operations not covered under ‘Treasury’, ‘Wholesale Banking’ and ‘Retail Banking’ segments. It will also include all other residual operations such as para-banking transactions/activities. Banks will also be required to report any additional segments, which fulfill the criteria laid down under AS-17. The disclosure requirement will come into force from the reporting period ending March 31, 2008.
(i)Guidelines on Restructuring of Advances
183.As indicated in the Annual Policy Statement of April 2006, a Working Group comprising members from commercial banks, the Indian Banks’ Association (IBA), and the Reserve Bank was constituted to review and align the existing guidelines on restructuring of advances (other than under the corporate debt resctructuring (CDR) mechanism) on the lines of provisions under the revised CDR mechanism. The recommendations of the Group envisage rationalisation of the guidelines that are applicable to restructured/rescheduled accounts under the CDR mechanism as also outside its purview. The Group’s recommendations are under examination. The copy of the report of the Working Group has been placed on the Reserve Bank’s website and based on the comments/feedback received, the Reserve Bank would issue operational guidelines by May 31, 2007.
(j)Residential Housing Loans: Reduction of Risk Weight
184.Under the standardised approach for credit risk under Basel II which is being implemented as per the schedule already indicated, the risk weight on residential property fully secured by mortgages is prescribed at 35 per cent, subject to fulfillment of strict prudential criteria. Keeping this in view and the fact that banks have been advised to tighten their credit administration in this area in particular, from time to time, it is proposed:
•to reduce the risk weight on the residential housing loans to individuals from the existing 75 per cent to 50 per cent as a temporary measure. This dispensation will be applicable for loans up to Rs.20 lakh and will be reviewed after one year, keeping in view the default experience and other relevant factors.
(k)Differentiated Bank Licenses
185.A differentiated licensing procedure for banks is an accepted practice internationally. While in some countries there is no discrimination between domestic and foreign banks in regard to licensing policy, in other countries separate norms exist. In India, there is no differentiated licensing policy between domestic and foreign banks as the regulatory regime for domestic and foreign banks is non-discriminatory. With a view to directing the resources of banks to their niche areas and to sustain efficiency in the banking system, a graded approach of licensing may be appropriate which can be equally applicable to both domestic and foreign banks. A technical paper on this subject will be placed on the website by May 31, 2007 inviting comments/suggestions from the public.
(l)Restructuring of Advances to SMEs
186.There is a set of guidelines covering restructuring of exposures to SMEs by banks. These guidelines will also be reviewed and modified, if necessary, in the light of the recommendations of the Working Group constituted to review and align the existing guidelines on restructuring of advances by May 31, 2007.
(m)Strengthening of the Financial Sector Regulated by the Reserve Bank
187.In line with the recommendations of the Committee on Banking Sector Reforms (Narasimham Committee II), the Reserve Bank has been undertaking a series of steps aimed at progressively strengthening the institutions regulated by it. The Committee had inter alia recommended strengthening of the capital adequacy of banks and conversion of Development Financial Institutions (DFIs) into banks or NBFCs in view of the convergence of activities between banks and DFIs. The progress made in this regard is set out as under:
(i)Banks in the Private Sector
188.As on March 31, 2005, three banks that had CRAR below 9 per cent have since been amalgamated with other banks and currently there is no bank whose capital adequacy ratio does not meet the minimum requirement of 9 per cent.
189.As on March 31, 2005, there were 15 banks not having the minimum requirement of net worth of Rs.300 crore. With the amalgamation of seven banks with other banks and three banks having raised capital to meet the net worth criteria, only five banks remain whose net worth is below the minimum of Rs.300 crore. The matter has been taken up with the remaining individual banks for compliance with the requirements relating to net worth in a time-bound manner.
(ii)Public Financial Institutions
190.At present, there are 49 Public Financial Institutions (PFIs) which are notified under section 4(A) of Companies Act, 1956 by the Ministry of Company Affairs, Government of India. Earlier, one institution each had been converted into a bank (IDBI) and an NBFC (IDFC). Of the 49 PFIs, 12 are regulated by the Reserve Bank, four are Refinancing Institutions (RFIs) and the remaining eight are NBFCs. One of the Reserve Bank regulated RFIs, viz., Small Industries Development Bank of India (SIDBI), in turn, supervises 28 PFIs, namely, 18 State Financial Corporations (SFCs) and 10 State Industrial Development Corporations (SIDCs). SIDCs are registered as NBFCs. The Reserve Bank is in the process of strengthening the prudential, regulatory and supervisory norms in respect of the SIDBI with a view to bringing about convergence in the regulatory framework vis-a-vis banks. Of the remaining nine entities, the IRDA regulates five while four are unregulated.
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