Second Quarter Review of the Monetary Policy for 2011-12
-Announced on the 25th October 2011
Part B. Developmental and Regulatory Policies
V. Regulatory and Supervisory Measures for Commercial Banks
Strengthening the Resilience of the Banking Sector
95. It was announced in the Monetary Policy Statement of May 2011 that the Reserve Bank would adhere to internationally agreed phase-in period (beginning January 1, 2013) for implementation of the Basel III framework. The Reserve Bank is finalising the draft guidelines for implementing Basel III framework for the scheduled commercial banks operating in India. It is proposed:
to issue the draft guidelines for implementing the Basel III framework by end-December 2011.
96. While at present, at the system level, banks in India are adequately capitalised, and transition to Basel III is expected to be smooth, careful capital planning would be required by banks in view of substantially higher equity requirement in capital. The draft guidelines would form the basis for preliminary estimation of capital requirements over the implementation phase of Basel III.
Implementation of Advanced Approaches under Basel II Framework
97. Guidelines on computation of capital requirements under the standardised approach (TSA)/alternate standardised approach (ASA) for operational risk were issued in March 2010 and those for internal models approach (IMA) for market risk were issued in April 2010. Final guidelines for advanced measurement approach (AMA) for operational risk were issued in April 2011. Draft guidelines on internal rating based (IRB) approach for credit risk were issued in August 2011. Comments/suggestions received from various stakeholders are under examination. It is proposed:
to issue the final guidelines on IRB approach for credit risk by end-December 2011.
98. After the financial crisis, the inherent pro-cyclicality of regulatory capital and provisioning requirement have attracted considerable attention. Consequently, work has been taken up at international level by the Basel Committee on Banking Supervision (BCBS) to introduce countercyclical capital and provisioning buffers. Essentially, these approaches require build-up of capital and provision in good times, which can be drawn down in bad times to enable banks to absorb the losses and continue lending. While BCBS has finalised a framework for countercyclical capital buffer, the work on devising a framework for countercyclical provisioning norm is still underway. Therefore, as an interim measure, a provisioning coverage ratio (PCR) was introduced by the Reserve Bank in December 2009 as a countercyclical measure to ensure build-up of provisioning buffer when banks in general were making good profits. This measure was aimed at achieving a PCR of 70 per cent with reference to the position as on September 30, 2010. Since work is still in progress by BCBS for devising a methodology for countercyclical provisioning, the Reserve Bank has, as a further interim measure, initiated work for devising a forward looking provisioning framework reflecting the credit history of Indian banks, based on data collected from select banks and data already available with the Reserve Bank. Accordingly, it is proposed:
to issue a discussion paper by end-March 2012, on the proposed provisioning approach for comments.
Working Group on Pricing of Loans and Advances
99. As part of financial sector reform, interest rates on loans and advances have been deregulated in a phased manner since 1997 and banks have been given freedom to fix the rates. The Base Rate system was introduced with effect from July 1, 2010, under which all categories of loans and advances are priced with reference to the Base Rate and banks are not permitted to lend below the Base Rate. Banks are required to determine interest rates on advances with reference to the Base Rate by adding a spread reflecting product specific charges together with term premium and risk premium. While the Base Rate can change depending on the cost of funds, the spread over the Base Rate should undergo change only when components of the spread undergo changes.
100. In a deregulated environment, transparency in pricing assumes greater significance in ensuring that the risk is priced adequately and borrowers are charged interest in a fair manner. It has, however, been observed that in the case of floating rate loans, there is lack of transparency in loan pricing and banks are also mispricing risk. Instances where the spread charged to a customer has been revised upward frequently during the tenure of the floating rate loan, have also come to the notice of the Reserve Bank. These have also resulted in a situation where existing customers are at a disadvantage, as compared with new customers with the same credit rating, leading to customers complaining about discrimination. In view of the above, it is proposed:
to set up a Working Group to look into principles governing proper, transparent and non-discriminatory pricing of credit.
Prudential Norms for Restructuring of Advances by Banks
101. An account, if restructured due to borrowers’ financial difficulties, is treated as being in default and accordingly considered impaired as per international prudential and accounting norms. Accordingly, as per extant guidelines issued by the Reserve Bank, accounts classified as 'standard assets' should be immediately re-classified as 'sub-standard assets' upon restructuring. However, if the restructuring is done as per a specified framework prescribed by the Reserve Bank, certain asset classification benefits are extended. These guidelines have evolved over a period of time. The current restructuring guidelines were formulated based on the recommendations of the Special Group (Chairperson: Smt. S. Gopinath), which had representations from the IBA, among others. The restructuring guidelines, last revised in August 2008, have generally helped both the lenders and borrowers, especially during economic downturns. However, the Reserve Bank has been receiving requests from stakeholders to review the restructuring guidelines in the light of experience gained. In view of the above, it is proposed:
to constitute a Working Group to review the existing prudential guidelines on restructuring of advances by banks/financial institutions and suggest revisions taking into account the best international practices and accounting standards.
Monitoring of Unhedged Foreign Currency Exposure of Corporates by Banks
102. Unhedged forex exposure of corporates is a source of risk to corporates and a source of credit risk to financing banks. If the unhedged position is large, it can have serious consequences for the solvency of corporates in the event of large depreciation of the home currency and can result in large credit losses to the financing banks. Considering that a significant part of corporates’ foreign currency commitments tended to remain unhedged, banks were mandated in October 2001 to monitor and review on a monthly basis the unhedged portion of the foreign currency exposures of large corporates whose total foreign currency exposure was relatively large (say, above US $25 million or its equivalent). Banks were further advised in December 2003 to put in place a policy that explicitly recognised and took into account risks arising on account of unhedged foreign exchange exposures of their clients. Banks were also advised that foreign currency loans above US $10 million, or such lower limits as may be deemed appropriate vis-a-vis the banks' portfolios of such exposures, could be extended by banks only on the basis of a well laid out policy of their Boards with regard to hedging of such foreign currency loans. These instructions to banks were reiterated in December 2008. Further, banks were advised in December 2008 to exchange information among themselves in respect of borrowers enjoying credit facilities from more than one bank, which should, inter alia, cover information relating to derivative transactions and unhedged foreign currency exposures of the borrowers.
103. Recent events relating to derivative trades showed that excessive risk taking by corporates could lead to severe distress to them and large potential credit loss to their bankers in the event of sharp adverse movements in currencies. The recent episode of volatility in rupee exchange rate when the rupee depreciated by more than 10 per cent in a short period of 6 weeks has sharply underlined the importance of prudent management of foreign exchange risk. It is, therefore, proposed that:
while extending fund based and non-fund based credit facilities to corporates, banks should rigorously evaluate the risks arising out of unhedged foreign currency exposure of the corporates and price them in the credit risk premium. Banks may also consider stipulating a limit on unhedged position of corporates on the basis of their Board’s approved policy.
Licensing of New Banks in the Private Sector
104. Following the announcement made by the Hon’ble Finance Minister in the Union Budget 2010-11 and as indicated in the Monetary Policy Statement of April 2010, the Reserve Bank released a discussion paper on licensing of new banks on its website in August 2010, seeking views/comments of banks, non-banking financial companies (NBFCs), industrial houses, other institutions, and the public at large. Detailed discussions were also held with various stakeholders. All these comments were examined and the draft guidelines on licensing of new banks in the private sector were placed on the Reserve Bank’s website in August 2011, inviting comments from all the stakeholders up to October 31, 2011. It was indicated in the draft guidelines that certain amendments to the Banking Regulation Act, 1949 are under consideration of the Government of India, including a few which are vital for finalisation and implementation of the policy for licensing of new banks in the private sector. Once the amendments are in place, and after examining the feedback on the draft guidelines, the final guidelines will be issued and the process of inviting applications for setting up of new banks in the private sector will be initiated.
Presence of Foreign Banks in India
105. Pursuant to the announcement in the Monetary Policy Statement of April 2010, a discussion paper on the presence of foreign banks in India was placed on the Reserve Bank’s website in January 2011 soliciting views/comments from all stakeholders, including banks, non-banking financial institutions, and the public at large. Feedback/comments received from foreign banks and other stakeholders have been consolidated and are under examination. The comprehensive guidelines on the mode of presence of foreign banks in India would be formulated after factoring in the views/comments on the discussion paper received from all concerned.
106. Pursuant to the announcement made in the Monetary Policy Statement of May 2011, the Reserve Bank is in the process of issuing the final guidelines on compensation based on the Financial Stability Board (FSB) principles on sound compensation practices as well as taking into account the guidelines issued by the BCBS in May 2011 on Range of Methodologies for Risk and Performance Alignment of Remuneration.
Introduction of Bank Holding Company/Financial Holding Company Structure in India
107. A Working Group (Chairperson: Smt. Shyamala Gopinath) was constituted to examine the introduction of a holding company structure for banks and other financial entities together with the required legislative and regulatory framework. The Group submitted its report, and the same was placed on the Reserve Bank’s website, inviting comments/feedback from all the stakeholders. Comments received are under examination.
Supervisory Policies, Procedures and Processes: Comprehensive Review
108. A High Level Steering Committee (Chairman: Dr. K. C. Chakrabarty) was set up by the Reserve Bank to review the existing supervisory processes in respect of commercial banks in India. The terms of reference of the Committee, include (i) review of the approach to supervision; (ii) review of the extant onsite supervisory examination and offsite supervisory methods; (iii) review of the adequacy of prudential supervisory guidelines and supervisory review process; (iv) examination of the extant methods for consolidated supervision; (v) recommendation of the measures for strengthening the extant cross-border supervisory cooperation processes; (vi) assessment of the adequacy of the institutional structure for carrying out supervisory function; and (vii) suggestion for a framework for feedback mechanism. A Technical Committee, comprising officers from the Reserve Bank and representatives from a few banks, has also been constituted to aid and assist the Steering Committee. The Steering Committee will submit its report by end-July 2012.
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