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Annual Policy Statement for the Year 2011-12 click here

Annual Monetary Policy Statement for the Year 2011-12- 3rd May 2011

Part B. Development and Regulatory Policies

V. Regulatory and Supervisory Measures for Commercial Banks

Strengthening the Resilience of the Banking Sector

107. After the financial crisis, the BCBS has taken a number of initiatives with a view to improving the banking sector’s ability to absorb shocks arising from financial and economic stress and to reduce the risk of spillover from the financial sector to the real economy. It may be recalled that the BCBS had issued certain enhancements to Basel II Framework, including amendments to the market risk framework in July 2009, which were implemented by the Reserve Bank with effect from March 31, 2010. In December 2010, the BCBS released a comprehensive package of further reforms which, together with the July 2009 enhancements, is known as the Basel III framework. This reform package aims at (i) increasing the quality and quantity of the capital with greater emphasis on common equity; (ii) increasing the risk coverage; (iii) introducing a leverage ratio as a back stop to the risk-based capital ratio; and (iv) introducing capital conservation and counter-cyclical capital buffers to ensure build up of additional capital in good times, thereby protecting banks from the dangers of excessive credit growth. Besides, the Committee has also introduced liquidity ratios with a view to ensuring that banks maintain adequate liquidity buffers and reduce maturity mismatches.

108. 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 studying the Basel III reform measures for preparing appropriate guidelines for implementation. It is taking steps to disseminate information on Basel III and help banks prepare for smooth implementation of the framework.

Implementation of Advanced Approaches under Basel II Framework

109. The Reserve Bank had announced timeline for implementation of advanced approaches for computation of regulatory capital under the Basel II framework in India in July 2009. The guidelines for 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 in April 2010. Draft guidelines for advanced measurement approach (AMA) for operational risk were issued in January 2011 for public comments/feedback, and final guidelines were issued in April 2011. Guidelines for internal rating based (IRB) approach for credit risk are under preparation.

Enhancement of Rates of Provisioning for Non-Performing Assets

110. In pursuance of the announcement made in the Second Quarter Review of October 2009, banks were advised in December 2009 to achieve a provisioning coverage ratio (PCR) of 70 per cent for their non-performing advances by end-September 2010. This coverage ratio was intended to achieve a counter-cyclical objective by ensuring that banks build up a good cushion of provisions to protect them from any macroeconomic shock in future. In April 2011, banks were advised to segregate the surplus of provisions under the PCR vis-a-vis as required as per prudential norms as on September 30, 2010, into an account styled as “counter-cyclical buffer”. While the “counter-cyclical buffer” so created would be available to banks for making specific provisions during economic downturns, there is a need for banks to make higher specific provisions also as part of the prudential provisioning framework. Accordingly, It is proposed to enhance the provisioning requirements on certain categories of non-performing advances and restructured advances as under:

advances classified as “sub-standard” will attract a provision of 15 per cent as against the existing 10 per cent (the “unsecured exposures” classified as sub-standard assets will attract an additional provision of 10 per cent, i.e., a total of 25 per cent as against the existing 20 per cent);

the secured portion of advances which have remained in “doubtful” category up to one year will attract a provision of 25 per cent (as against the existing 20 per cent);

the secured portion of advances which have remained in “doubtful” category for more than one year but upto 3 years will attract a provision of 40 per cent (as against the existing 30 per cent);

restructured accounts classified as standard advances will attract a provision of 2 per cent in the first 2 years from the date of restructuring, or in cases of moratorium on payment of interest/principal after restructuring, for the period covering moratorium and 2 years thereafter (as against existing provision of 0.25-1.00 per cent, depending upon the category of advances); and

restructured accounts classified as non-performing advances, when upgraded to standard category will attract a provision of 2 per cent in the first year from the date of upgradation (as against existing provision of 0.25-1.00 per cent, depending upon the category of advances).

111. Detailed guidelines in this regard will be issued separately.

Investments in Debt Oriented Mutual Funds

112. It has been observed that banks’ investments in liquid schemes of debt oriented mutual funds (DoMFs) have grown manifold. The liquid schemes continue to rely heavily on institutional investors such as commercial banks whose redemption requirements are likely to be large and simultaneous. DoMFs, on the other hand, are large lenders in the over-night markets such as collateralised borrowing and lending obligation (CBLO) and market repo, where banks are large borrowers. DoMFs invest heavily in certificates of deposit (CDs) of banks. Such circular flow of funds between banks and DoMFs could lead to systemic risk in times of stress/liquidity crunch. Thus, banks could potentially face a large liquidity risk. It is, therefore, felt prudent to place certain limits on banks’ investments in DoMFs. Accordingly, it is proposed:

that the investment in liquid schemes of DoMFs by banks will be subject to a prudential cap of 10 per cent of their net worth as on March 31 of the previous year. However, with a view to ensuring a smooth transition, banks which are already having investments in DoMFs in excess of the 10 per cent limit, will be allowed to comply with this requirement in six months’ time.

Presence of Foreign Banks in India

113. It was indicated in the Monetary Policy Statement of April 2010 that drawing lessons from the crisis, a discussion paper on the mode of presence of foreign banks through branch or wholly owned subsidiary (WOS) would be prepared by September 2010. Accordingly, a discussion paper on 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 by March 7, 2011. The comprehensive guidelines on the mode of presence of foreign banks in India are being formulated, keeping in view the suggestions/comments on the discussion paper, received from all concerned.

Licensing of New Banks in the Private Sector

114. 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, NBFCs, industrial houses, other institutions, and the public at large. The discussion paper reviewed the international and Indian experience on various issues and also indicated possible approaches with the pros and cons of each of the approaches. Detailed discussions were held with various associations of stakeholders from the industry, banks, NBFCs, and MFIs and some consultants in October, 2010. In addition, diverse comments, including relating to granting of banking license to industrial houses/business houses have been received from a large number of respondents, which include parties interested in setting up new banks, industry associations, banks, academia, eminent personalities associated with banking and finance, and the members of the general public. Certain issues, which would require amendments to the Banking Regulation Act, 1949, have also been brought to the notice of the Government of India. A gist of comments on various issues received from important stakeholders and eminent people on the discussion paper was placed on the Reserve Bank’s website in December 2010. All these comments have been examined and the draft guidelines on the entry of new banks are being finalised in consultation with the Government of India.

Compensation Practices

115. It was indicated in the Second Quarter Review of October 2009 that in line with the steps taken by the global community, particularly the initiatives taken by G-20 nations, the Reserve Bank would issue guidelines to private sector banks and foreign banks with regard to sound compensation policy. It was proposed to issue comprehensive guidelines based on the FSB principles on sound compensation practices, which would cover, among others, effective governance of compensation, alignment of compensation with prudent risk-taking and disclosures for whole time directors/chief executive officers as well as risk takers of banks. Accordingly, draft guidelines on sound compensation policy were framed and placed on the Reserve Bank’s website in July 2010 for public comments. A large number of comments/suggestions were received on the draft guidelines and it was proposed in the Second Quarter Review of Monetary Policy for 2010-11 to issue final guidelines on compensation practices by end-December 2010. However, in October 2010, the BCBS brought out a consultative paper titled ‘Range of Methodologies for Risk and Performance Alignment of Remuneration’, for public comments. As the paper provides guidance on important methodological issues, it has been decided to await the final version of this paper for formulating our guidelines. Accordingly, the implementation of the Reserve Bank guidelines on compensation policy has been deferred till 2012-13. This will also give sufficient time to banks to formulate their policies. Banks, in the meantime, should refer to the BCBS consultative paper on ‘Range of Methodologies for Risk and Performance Alignment of Remuneration’ of October 2010, and begin the preparatory work.

Convergence of Indian Accounting Standards with International Financial Reporting Standards

116. As indicated in the Second Quarter Review of November 2010, a Working Group (Chairman: Shri P. R. Ravi Mohan) was constituted in July 2010 to address the implementation issues and facilitate formulation of operational guidelines in the context of convergence of Indian Accounting Standards with the International Financial Reporting Standards (IFRSs). Six sub-groups, constituted under the aegis of this Working Group, are closely monitoring the developments at the international level, especially the progress made by the International Accounting Standard Board (IASB) in finalising the accounting standards relating to financial instruments, and fair value accounting, among others, and attempting to prepare operational guidelines within the framework of IFRS for the Indian banking sector. The Ministry of Corporate Affairs placed on its website 35 Indian Accounting Standards (IND AS), converged with IFRS in February 2011. It also stated that it would implement them in a phased manner after various issues, including tax related issues, were resolved with the concerned departments. The Reserve Bank is also endeavouring towards skill development at the level of banks and supervisors with a view to ensuring smooth and non-disruptive migration to the IFRS.

Amendments to the Banking Regulation Act, 1949

117. A comprehensive legislation for the amendment of the Banking Regulation Act, 1949 and the Banking Companies (Acquisition & Transfer of Undertakings) Act, 1970 & 1980 was introduced in the Parliament in March 2011. The important amendments relating to the Banking Regulation Act include insertion of a new section to override the provisions of the Competition Act, 2002 and exempt the applicability of such provisions to amalgamations/reconstitutions/mergers/acquisitions, etc. of different categories of banks; removal of the restrictions on voting rights; enabling banking companies to issue preference shares subject to regulatory guidelines by the Reserve Bank; formation of a depositor education and awareness fund; facilitating consolidated supervision; and a provision for supersession of boards of directors by the Reserve Bank; and increase in the quantum of penalties. The proposals relating to the amendment of the Banking Companies (Acquisition & Transfer of Undertakings) Act, 1970 & 1980 include raising the authorised capital of nationalised banks; enabling them to raise capital through “rights issue” or by issue of bonus shares; and raising the restrictions on voting rights. These amendments will have implications for the regulation and supervision of various types of banks by the Reserve Bank.

Introduction of Bank Holding Company/Financial Holding Company Structure in India

118. In pursuance of the announcement made in the Monetary Policy Statement of April 2010, 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 is expected to submit its report by end-May 2011.

Information Technology and Related Issues: Enhancement to the Guidelines

119. A Working Group on Information Security, Electronic Banking Technology Risk Management and Cyber Frauds (Chairman: Shri G. Gopalakrishna) was set up by the Reserve Bank to strengthen the Reserve Bank’s guidelines relating to the governance of IT information security measures, apart from enhancing independent assurance about the effectiveness of IT controls. The report, which was submitted by the Group in January 2011, covers various areas such as IT governance, information security (including electronic banking channels like internet banking, ATMs, cards), IT operations, IT services outsourcing, information system audit, cyber frauds, business continuity planning, customer education and legal issues. The report was placed on the Reserve Bank’s website for public comments/feedback. Keeping in view the feedback/comments received, detailed guidelines are being issued to banks. While major recommendations of the Group are to be implemented by banks within a period of six months, other recommendations/guidelines are required to be implemented within a period of one year from the date of issue of the circular.

Supervisory Policies, Procedures and Processes: A Comprehensive Review

120. The operating environment with regard to supervision of banks has undergone significant changes with considerable increase in size, number and complexities of banks’ businesses over the last decade. There have been extensive innovations in financial products, processes, strategies and risk management techniques at the institutional level. In the recent period, banks have also emerged as financial conglomerates in order to exploit economies of scale and scope. In view of the widening gap between growing supervisory responsibilities and available supervisory resources, it was considered expedient to conduct a review of the supervisory processes followed by the Reserve Bank. 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 Committee, among others, will include a leading industry expert, one sitting and one retired chairman and managing director (CMD) of public sector banks as members. The Committee will lay down the terms of reference for review of the supervisory processes in the Reserve Bank and select one domestic or international agency for reviewing the supervisory processes and giving its recommendations for implementation.

Click Here For Highlights of Annual Policy Statement for the Year 2011-12

Click Here For Macro economic and Monetary Developments : 2010-11

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