Report of the Committee on Financial Sector Assessment (CFSA) 2009

REPORT FINDINGS

Financial Markets

The equity, government securities, foreign exchange and money markets along with their corresponding derivatives segments have developed into reasonably deep and liquid markets and there has been significant increase in domestic market integration over the years. However, the credit derivatives market is yet to take off in any significant manner. Though the primary market in corporate bonds has seen an increase in issuance, the secondary market has not yet developed commensurately.

Equity Market

The equity market has witnessed wide-spread development in infrastructure and its functioning is comparable to that in advanced markets. It has seen significant increase in growth and diversity in composition in the past two decades. Certain areas, however, could be further developed. Among the major steps to be considered are:

According Self-regulatory Organisation (SRO) status to certain trade and industry associations to enhance regulatory efficiency, subject to appropriate safeguards;

Further improvements in infrastructure and risk management systems;

More focussed monitoring of market intermediaries; and

Streamlining of issuance procedures by setting up of a central integrated platform.

Foreign Exchange Market

With the economy moving towards fuller capital account convertibility in a calibrated manner, focussed regulation and monitoring of the foreign exchange market assumes added importance. There is though a need to strengthen infrastructure, transparency and disclosure, and product range in the forex derivatives segment. Strengthening the trading infrastructure, market conduct, transparency of Over-the-counter (OTC) derivatives in the forex market, accounting and disclosures in line with international practices, including disclosures by non-bank corporates, needs to be done on a priority basis. The recent introduction of currency futures is a step in this direction.

Government Securities Market

The government securities market has witnessed significant transformation in its various facets: market-based price discovery, widening of the investor base, introduction of new instruments, establishment of primary dealers and electronic trading and settlement infrastructure. This is the outcome of persistent and high-quality reforms in developing the government securities market. Increased transparency and disclosures, gradual scaling down of mandated investments and development of newer instruments are some major areas which could be considered for further development. Regulatory incentives to increase the size of trading book could also be considered as a measure to further develop the government securities market.

Money Market

The money market is an important channel for monetary policy transmission and India has generally conformed to being a liquid market. In the ongoing global financial crisis, the Indian money market has continued to function normally. The gradual shift towards a collateralised inter-bank market, phasing out of non-bank participants from the call and notice money market, policy direction towards reductions in cash reserve requirements, the introduction of new instruments, such as, Collateralised Borrowing and Lending Obligation (CBLO), implementation of Real Time Gross Settlement (RTGS), significant transformation of monetary operations framework towards market-based arrangements and facilitating trading through Negotiated Dealing System – Call Money (NDS-CALL) are some of the reform measures that have contributed to the development of a relatively vibrant and liquid money market. However, the limitations of market participants in taking a medium- term perspective on interest rates and liquidity, coupled with the absence of a credible long-term benchmark, constraining further market development that needs to be addressed.

Corporate Bond Market

The development of the corporate bond market could be a source of long-term finance for corporates. The development of this market currently suffers from lack of buying interest, absence of pricing of spreads against the benchmark and a flat yield curve. It requires further regulatory and legislative reforms for its development and reforms in the pension and insurance sectors to aid in the emergence of large institutional investors.

Credit Derivatives

The unbridled proliferation of complex credit derivatives and excessive risk transfer by adoption of the originate-to-distribute model is recognised as one of the root causes of the current financial crisis. The recent credit turmoil has also underscored the importance of liquidity risk arising from off-balance sheet commitments, implicit or explicit, of the credit intermediaries. The Reserve Bank had put in place regulatory guidelines that were aligned with global best practices while tailoring them to meet country-specific requirements. While the development of markets for credit derivatives and asset securitisation products could play a critical role in furthering economic growth, this requires to be pursued in a gradual manner by sequencing reforms and putting in place appropriate safeguards before introduction of such products.

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