Mid-Term Review of the Annual Policy Statement for 2006-07, RBI Credit Policy: Banknet India

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Part II. Mid-term Review of Annual Statement on Developmental and Regulatory Policies for the Year 2006-07

III. Prudential Measures

134. The Reserve Bank has been continuously sharpening its regulatory and supervisory roles in order to establish a stable financial system which contributes to public confidence and accelerated economic growth. Furthermore, the Reserve Bank is committed to continuing the process of adopting international best practices with regard to prudential norms and standards of transparency and disclosure.

(a) New Capital Adequacy Framework: Status

135. Commercial banks (excluding RRBs) had been advised that they will be required to adopt the standardised approach for credit risk and basic indicator approach for operational risk with effect from March 31, 2007. Under the standardised approach, banks are required to use risk weights which are dependent on credit ratings. These credit ratings are to be assigned by External Credit Assessment Institutions (ECAIs) which have been found eligible by the Reserve Bank. An internal Working Group constituted by the Reserve Bank for identifying eligible domestic ECAIs has submitted its report and its recommendations are being incorporated into the final guidelines.

(b) Basel II: Schedule for Compliance

136. The Reserve Bank is committed to the adoption of Basel II by the banks and had indicated March 31, 2007 as the intended date for adoption by all. Taking into account the state of preparedness of the banking system, however, it has been decided to provide banks some more time to put in place appropriate systems so as to ensure full compliance with Basel II. Foreign banks operating in India and Indian banks having presence outside India are to migrate to the standardised approach for credit risk and the basic indicator approach for operational risk under Basel II with effect from March 31, 2008. All other scheduled commercial banks are encouraged to migrate to these approaches under Basel II in alignment with them but in any case not later than March 31, 2009. The Steering Committee of banks will continue to interact with banks and the Reserve Bank, and guide the smooth implementation of Basel II.

(c) Comprehensive Guidelines on Derivatives

137. Derivatives play a critical role in shaping the overall risk profile of banks. Over the years, banks have been increasingly using derivatives for managing risks and have also been offering these products to corporates. The Reserve Bank has issued several guidelines to banks from time to time on various derivative instruments. In view of the growing complexity, diversity and volume of derivatives used by banks, an Internal Group has been constituted by the Reserve Bank to review the existing guidelines on derivatives and formulate comprehensive guidelines on derivatives for banks. These guidelines are intended to cover broad generic principles for undertaking derivative transactions, management of risk and sound corporate governance requirements. The draft guidelines would be placed on the Reserve Bank’s website by end-November, 2006.

138. On the basis of the recommendations of an earlier Internal Group, a ‘Discussion Paper on Derivative and Hedge Accounting by Banks’ was prepared and placed on the Reserve Bank’s website for wider dissemination. The feedback received from market participants on the Discussion Paper is under examination.

(d) Credit Information Companies (Regulation) Act, 2005: Status

139. Consequent upon the enactment of the Credit Information Companies (Regulation) Act, 2005 the Reserve Bank constituted a Working Group (Chairman: Shri Prashant Saran) to frame draft rules and regulations for implementation of the Act. The draft rules and regulations were prepared and placed on the Reserve Bank’s website for wider dissemination and comments. On the basis of the responses received, the draft rules and regulations have been prepared and would be notified shortly in consultation with the Government of India.

(e) Funded and Non-funded Limits by Indian Banks to Joint Ventures/Wholly Owned Subsidiaries of Indian Corporates: Enhancement

140. In April, 2003 Indian banks were permitted to extend credit/non-credit facilities to Indian Joint Ventures (JVs)/Wholly Owned Subsidiaries (WOS) abroad up to the extent of 10 per cent of their unimpaired capital funds (Tier I and Tier II), subject to certain conditions. In order to facilitate the expansion of Indian corporates’ business abroad, it is proposed:

• to enhance the prudential limit on credit and non-credit facilities extended by banks from the existing 10 per cent to 20 per cent of unimpaired capital funds (Tier I and Tier II capital) of the bank.

(f) Banks’ Exposures to Systemically Important NBFCs

141. An Internal Group was constituted by the Reserve Bank to study the issues of regulatory convergence, regulatory arbitrage and to recommend a policy framework for level-playing field in the financial sector. The report of the Group was placed on the Reserve Bank’s website for wider dissemination and comments. In the light of the recommendations of the Group and the feedback received, and in view of the importance of this segment of the financial sector, a draft circular will be put in the public domain to invite further feedback by November 3, 2006. After providing two weeks for comments, the final circular will be issued before November 30, 2006.