First Bi-monthly Monetary Policy Statement, 2014-15 By Dr. Raghuram G. Rajan, Governor, RBI - 1st April 2014

Part B: Developmental and Regulatory Policies

This part of the Statement reviews the progress on various developmental and regulatory policy measures announced by the Reserve Bank in recent policy statements and also sets out new measures.

In the Second Quarter Review of Monetary Policy 2013-14 announced in October 2013, the Reserve Bank set out a five-pillar framework to guide its developmental and regulatory measures. Noteworthy progress has since been made in implementing measures within this framework. Read more

Some of the recommendations of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (Chairman: Dr. Urjit R. Patel) have been implemented including adoption of the new CPI (combined) as the key measure of inflation, explicit recognition of the glide path for disinflation, transition to a bi-monthly monetary policy cycle, progressive reduction in access to overnight liquidity under the LAF at the fixed repo rate and corresponding increase in access to liquidity through term repos, and introduction of longer tenor term repos.

On strengthening banking structure, which is the second pillar, the High Level Advisory Committee (Chairman: Dr. Bimal Jalan) has recently submitted its recommendations to the Reserve Bank on the licensing of new banks. The Reserve Bank will announce in-­principle approval for new licences after consulting with the Election Commission. Immediately afterwards, the Reserve Bank will start working on the framework for on-tap licensing as well as differentiated bank licences, building on the Discussion Paper on “Banking Structure in India – The Way Forward” placed on the Reserve Bank’s website in August 2013 and using the learning from the recent licensing process. The intent is to expand the variety and efficiency of players in the banking system while maintaining financial stability. The Reserve Bank will also be open to banking mergers, provided competition and stability are not compromised.

Progress has been made on a number of regulatory and supervisory measures. Based on the comments/feedback received on the draft framework for dealing with domestic systemically important banks (D-SIBs), the final framework is proposed to be issued by end­-May 2014. As the liquidity coverage ratio (LCR) stipulated by the Basel Committee becomes a standard with effect from January 1, 2015 it is proposed to issue guidelines relating to Basel III LCR and Liquidity Risk Monitoring tools by end-May 2014. Updated guidelines on stress testing, drawing from Basel Committee on Banking Supervision (BCBS) principles and subsequent global developments, were issued in December 2013. Capital and provisioning requirements on banks' advances to corporates with unhedged foreign currency exposures were specified in January 2014. The draft report of the Internal Working Group (Chairman: Shri B. Mahapatra), which was constituted to operationalise the countercyclical capital buffer framework in India, was placed on the Reserve Bank's website for comments in December 2013. On the basis of the recommendations of the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (Chairman: Dr. Nachiket Mor) to encourage banks to actively manage their exposures to various sectors, including priority sectors, it is proposed to prescribe certain additional disclosure requirements in the financial statements by end-June 2014.

Following industry-wide concerns about asset quality and the consequential impact on the performance/profitability of banks, the Reserve Bank has extended the transitional period for full implementation of Basel III Capital Regulations in India up to March 31, 2019, instead of as on March 31, 2018. This will also align full implementation of Basel III in India closer to the internationally agreed date of January 1, 2019.

The Reserve Bank has moved over to risk-based supervision (RBS) for scheduled commercial banks (SCBs), starting with banks that were more prepared. Based on the experience gained from the completion of Phase I and the feedback received on the RBS framework from banks, the framework is being fine-tuned. Banks are also being advised to assess their risk management architecture, practices, related processes and management information systems (MIS) to facilitate their switch over to RBS in Phase II.

As regards the third pillar on the broadening and deepening of financial markets, Inflation Indexed National Saving Securities (IINSSs) for retail investors were issued in December 2013. To expand investor demand, certain design changes are required. Some such as an increase in the limit for individual investors and trusts have been implemented. Others such as tradability (and consequently, the benefit of indexation for capital gains tax) and issuance of securities with regular coupon flows are being contemplated. Cash settled single bond 10 year Interest Rate Futures (IRFs) were introduced by stock exchanges in January 2014. The Reserve Bank will shortly issue guidelines that would allow banks to offer partial credit enhancements to corporate bonds. As recommended by the Working Group on Enhancing Liquidity in the Government Securities and Interest Rate Derivatives Markets (Chairman: Shri R. Gandhi), the Reserve Bank proposes to introduce a market making scheme for primary dealers (PDs) by allocating specific securities to PDs and ensuring continuous availability of prices, with a suitable framework for assessing the performance of PDs. It will also examine the possibility of limited re-repo/re-hypothecation of "repoed" government securities, subject to appropriate risk control measures.

The Committee on Financial Benchmarks (Chairman: Shri P. Vijaya Bhaskar) submitted its report in February 2014. The Committee has recommended several measures/principles to be adopted in respect of major Indian rupee interest rate and foreign exchange benchmarks to strengthen their quality, the methodology by which they are set and the governance framework. Banks and PDs are being advised to strengthen their governance frameworks on benchmark submissions, subject to the supervisory review of the Reserve Bank. Other recommendations will be implemented in consultation with the Fixed Income, Money Market and Derivatives Association (FIMMDA) and Foreign Exchange Dealers Association of India (FEDAI).

The Reserve Bank will continue to work to ease entry while reducing risk to foreign investors from the volatility of flows. The modalities for allowing FIIs to hedge their currency risk by using exchange traded currency futures in the domestic exchanges are being finalised in consultation with the Securities and Exchange Board of India (SEBI). In order to enhance hedging facilities for foreign investors in debt instruments, it is proposed to allow them to hedge the coupon receipts falling due during the next 12 months. Rebooking of cancelled contracts in case of contracted exposures has been fully restored. It is further proposed to allow all resident individuals, firms and companies with actual foreign exchange exposures to book foreign exchange derivative contracts up to US$ 250,000 on declaration, subject to certain conditions.


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