Financial Sector Refoms

Presentation
Economic Environment of Business

The Financial Sector Reforms
Slow but steady
not to forget the socio economic needs
The financial Sector Reforms
1
September 9, 2009
GROUP
AJAY K. DHAMIJA
SNEHAL SONI
N-1
N-47
2
September 9, 2009
Coverage
Introduction
Major Contours of Reforms
Banking sector Reforms
Monitory Policy Reforms
Financial Markets Reforms
Forex Market Reforms
Assesment
Conclusions
3
September 9, 2009
Introduction
FIVE Principle
Measured, gradual, cautious and steady sequencing of reforms
Introduction of mutually reinforcing norms
Development of an Efficient, Competitive and Stable financial
sector
Development of Financial Institutions
Introduction of complementary reforms across Monetary, Fiscal and
external sector
Broad based reforms touching every sector
Financial Sector
Monetary and Fiscal Policy
Capital Market
Foreign Exchange Market
Money and Government Securities Market
4
September 9, 2009
In early 1990s
Lion in jungle
Financial Repression
vs
lion in cage
Extensive Regulations
Administered Interest rates
Directed Credit Programmes
Weak Banking Structure
Lack of Proper Accounting & Risk management systems
Lack of transparency in operations
5
September 9, 2009
In early 1990s
PrePre-emption of resources from the banking system by the
government to finance its fiscal deficit
Excessive structural and micro regulation that inhibited financial
innovation and increased transaction costs
Relatively inadequate level of prudential regulation in the
financial sector
Poorly developed debt and money markets
Outdated (often primitive) technological and institutional
structures that made the capital markets and the rest of the
financial system highly inefficient.
6
September 9, 2009
Resulting into
Government regulated the price at which firms could issue equity,
the rate of interest which they could offer on their bonds, and the
debt equity ratio that was permissible in different Industries
Working capital management was even more constrained with

detailed regulations on how much inventory the firms could carry
or how much credit they could give to their customers.
Working capital was financed almost entirely by banks at interest

rates laid down by the central bank
Working capital finance was related more to the credit need of the
borrower than to creditworthiness
7
September 9, 2009
and
Volatility was not something that most finance managers worried
about or needed to.
The exchange rate of the rupee changed predictably and almost

imperceptibly
Administered interest rates were changed infrequently and the
changes too were usually quite small
Financial genius consisted largely of finding ones way through the
regulatory maze, exploiting loopholes wherever they existed and above

all cultivating relationships with those officials in the banks and
institutions who had some discretionary powers.
Even an overnight cash surplus could be parked in the overdraft
account where it could earn (or rather save) interest at the firms
borrowing rate.
8
September 9, 2009
At larger level
The balance of payments crisis that threatened the international
credibility of the country and pushed it to the brink of default
The grave threat of insolvency confronting the banking system which

had for years concealed its problems with the help of defective
accounting policies.
Hindered efficient allocation of resources
9
September 9, 2009
Major Contours of Reforms

Removal of existing financial repression
Creation of an efficient, productive and profitable financial sector
Enabling the process of price discovery by the market determination of
interest rates that improves allocative efficiency of resources
Providing operational and functional autonomy to institutions

Preparing the financial system for increasing international competition
Opening the external sector in a a calibrated manner
Promoting financial stability in the wake of domestic and external
shocks
10
September 9, 2009
Two phased Reforms

First Generation (Early 1990):1990):- Ist Phase:
Creating an efficient, productive and profitable financial
sector to function with operational flexibility and
functional autonomy
Second Generation (Mid 1990 ) ::- IInd phase

Strengthening the financial system and introducing
structural improvements
11
September 9, 2009
Major Sectors of Reforms

Banking Sector
Monetary Policy
Financial Markets
Forex Market
12
September 9, 2009
Banking Sector Reforms

Competition Enhancing Measures
Measures Enhancing Role of Market Forces
Prudential Measures
Institutional and Legal Measures
Supervisory Measures
Technology Related Measures
13
September 9, 2009
Banking Sector Reforms :

Competition Enhancing Measures
Operational autonomy to Public Sector banks
Reduction in public ownership of public sector banks
Can raise capital from equity market up to 49% of paid up capital
Transparent Norms related to entry, mergers /amalgamation and
governance issues for Indian private sector, foreign and jointjoint-venture

banks, NBFCs and insurance companies
Permission for foreign investment in the financial sector in the form of

Foreign Direct Investment (FDI) as well as portfolio investment
Permission to banks to diversify product portfolio and business

activities
14
September 9, 2009

Measures Enhancing Role of Market Forces
Sharp reduction in prepre-emption through reserve requirement
Market determined pricing for government securities
Disbanding of administered interest rates
Enhanced transparency and disclosure norms to facilitate market
discipline
Introduction of pure interinter-bank call money market and developing

markets for securitized assets
Auction
Auction--based reposrepos-reverse repos for shortshort-term liquidity
management and Improved payments and settlement
mechanism
15
September 9, 2009

Prudential Measures
Introduction and phased implementation of international best practices
and norms related to:- CRAR, Income recognition, Provisioning and
Exposure
Strengthen risk management : Assignment of risk-weights to various asset classes

Norms on connected lending, risk concentration
Application of marked-to-market principle for investment portfolio and
limits on deployment of fund in sensitive activities
'Know Your Customer norms
'Anti Money Laundering' guidelines
Graded provisioning for NPAs
Capital charge for market risk
Guidelines for ownership and governance, securitization and debt

restructuring mechanisms norms, etc
16
September 9, 2009

Prudential Measures:Measures:- Roadmap for Basel II
Implementing Basel II with effect from March 31, 2007
Standardized Approach for credit risk and Basic Indicator
Approach for operational risk (First Phase)

Migrate to the Internal Rating Based (IRB) Approach after
adequate skills are developed (Second Phase)
Basel II will require more capital for banks in India
Presently CRAR is over 12 per cent
New and Innovative Funding options

Perpetual debt instruments and nonnoncumulative preference shares
Redeemable cumulative preference shares
and hybrid debt instruments
17
September 9, 2009

Institutional and Legal Measures
Setting up of Lok Adalats (peoples courts), debt recovery tribunals,
asset reconstruction companies, settlement advisory committees,
corporate debt restructuring mechanism, etc.
Promulgation of Securitization and Reconstruction of Financial Assets

and Enforcement of Securities Interest (SARFAESI) Act, 2002 and its
subsequent amendment to ensure creditor rights
Setting up of Credit Information Bureau of India Limited (CIBIL) for

information sharing on defaulters as also other borrowers
Setting up of Clearing Corporation of India Limited (CCIL) to act as
central counter party for facilitating payments and settlement system

relating to fixed income securities and money market instruments
18
September 9, 2009

Supervisory Measures
Board for Financial Supervision as the apex supervisory authority for
Risk based supervision
Introduction of CAMELS supervisory rating system

(i.e., capital adequacy, asset quality, management, earning,
liquidity and system and control).
Consolidated supervision of financial conglomerates

Recasting of the role of statutory auditors with increased internal
control through strengthening of internal audit
Strengthening corporate governance

Fit and proper tests for directors along-with enhanced due diligence on
important shareholders
19
September 9, 2009

Technology Related Measures
INFINET as the communication backbone for the financial
sector
Negotiated Dealing System (NDS) for screen-based trading in

government securities
Real Time Gross Settlement (RTGS) System
True test of the success of the banking

reforms would be the extent of NPAs
20
September 9, 2009
Monitory Policy Reforms

Objectives
Instruments
Developmental Measures
Institutional Measures
21
September 9, 2009
Monitory Policy Reforms :

Objectives
Twin objectives of Maintaining price stability and Ensuring
availability of adequate credit to productive sectors
Use of broad money (M2) as an intermediate target has been deemphasized and a multiple indicator approach has been adopted
Development of multiple instruments to transmit liquidity and interest

rate signals in the short-term in a flexible and bi-directional manner
Increase of the inter-linkage between various segments of the financial

market including money, government security and forex markets
22
September 9, 2009

Instruments:
Strategic Shift: From Direct to Indirect
Open market operations (OMO) to deal with overall market liquidity

situation especially those emanating from capital flows
Introduction of Market Stabilization Scheme (MSS) as an additional

instrument to deal with enduring capital inflows without affecting
short-term liquidity management role of LAF
Introduction of Liquidity Adjustment Facility (LAF), which operates

through repo and reverse repo auctions Liquidity Adjustment Facility
( LAF )
To nudge overnight interest rates within a specified corridor.
TO de-emphasize targeting of bank reserves and focus increasingly on
interest rates.
reducing the cash reserve ratio (CRR) without loss of monetary control.
23
September 9, 2009
LAF + OMO + MSS => Flexibility

Transition from direct instruments of monetary control
such as administered interest rate, reserve requirement,
selective capital control) to indirect instruments like open
market operations, purchase and repurchase of
government securities
Advantages
Certain dead weight loss for the system was saved.

Greater flexibility in determining both the quantum of adjustment
as well as the rates by responding to the needs of the system on
a daily basis.
Modulation of the supply of funds on a daily basis to meet dayto-day liquidity mismatches.
demand for funds are affected through policy rate changes.
Stabilization of short-term money market rates.
24
September 9, 2009

Developmental Measures
Discontinuation of automatic monetization through an agreement

between the Government and the Reserve Bank
Amendment of Securities Contracts Regulation Act (SCRA), to create

the regulatory framework
Introduction of automated screen-based trading in government

securities through Negotiated Dealing System (NDS).
Setting up of risk-free payments and system in government securities

through Clearing Corporation of India Limited (CCIL).
Phased introduction of Real Time Gross Settlement (RTGS) System

Deepening of inter-bank Repo market Deepening of government
securities market by making the interest rates on such securities
market related
25
September 9, 2009

Setting up of Technical Advisory Committee on Monetary
Policy with outside experts to review macroeconomic and

monetary developments and advise the Reserve Bank on
the stance of monetary policy
Creation of a separate Financial Market Department within

the RBI
Development of appropriate trading, payments and
settlement systems along with technological infrastructure.
Success of monetary management such as interest rates, is contingent

upon the extent and speed with which changes in the central bank's
policy rate are transmitted to the spectrum of market interest rates
and exchange rate in the economy and onward to the real sector.
26
September 9, 2009
Capital Market Reforms :

Abolition of capital issues control and the introduction of free pricing of
equity issues (CCI)
Securities and Exchange Board of India (SEBI) was set up as the apex
regulator of the Indian capital markets.
Primary market regulations:
Entry norms for capital issues were tightened
Disclosure requirements were improved
Regulations were framed and code of conduct laid down for
merchant bankers
Underwriters, mutual funds, bankers to the issue and other
intermediaries
Corporate governance regulations:
Regulations were framed for insider trading
Regulatory framework for take overs was revamped
27
September 9, 2009
Capital Market Reforms

Secondary market regulations:
Capital adequacy and prudential regulations were introduced for brokers,
and other intermediaries
Dematerialization of scrips was initiated with the creation of a legislative
framework and the setting up of the first depository
Settlement period was reduced to one week
Carry forward trading was banned
Tentative moves were made towards a rolling settlement system.
28
September 9, 2009
Reforms in Government Securities

Market
Increase in Instruments in the Government Securities
Market
Enabling Measures
29
September 9, 2009
Government Securities Market :

Administered interest rates on government securities were replaced
by an auction system for price discovery
Banks have been permitted to undertake primary dealer business while

primary dealers are being allowed to diversify their business
Central Government would cease to raise resources on behalf of State

Governments . State Governments' capability in raising resources will
be market determined and based on their own financial health
Effective April 1, 2006, RBI has withdrawn from participating in

primary market auctions of Government paper
fully market based system in the G-sec market.
30
September 9, 2009

Increase in Instruments
Market Stabilization Scheme (MSS) has been introduced, which has
expanded the instruments available to the Reserve Bank for managing

the enduring surplus liquidity in the system
91-day Treasury bill was introduced for benchmarking
Zero Coupon Bonds, Floating Rate Bonds, Capital Indexed Bonds were
issued
Exchange traded interest rate futures were introduced
OTC interest rate derivatives like IRS/ FRAs were introduced
Repo status has been granted to State Government securities in order

to improve secondary market
31
September 9, 2009

Enabling Measures
Foreign Institutional Investors (FIIs) were allowed to invest in
government securities subject to certain limits with non-banks allowed

to participate in repo market
Introduction of automated screen-based trading in government

securities through Negotiated Dealing System (NDS)
Setting up of risk-free payments and settlement system in government

securities through Clearing Corporation of India Limited (CCIL)
Phased introduction of Real Time Gross Settlement System (RTGS).

Introduction of trading in government securities on stock exchanges
for promoting retailing and Non-banks participation
32
September 9, 2009
Reforms in Foreign Exchange Market

Exchange Rate Regime
Finance Mobilization
Institutional Framework
Increase in Instruments in the Foreign Exchange Market
Liberalization Measures
33
September 9, 2009
Reforms in Foreign Exchange Market :

Exchange Rate Regime
Evolution of exchange rate regime from a single-currency fixed-
exchange rate system to fixing the value of rupee against a basket of

currencies and further to market-determined floating exchange rate
regime
Adoption of convertibility of rupee for current account transactions
with acceptance of Article VIII of the Articles of Agreement of the IMF
De facto full capital account convertibility for non residents

Calibrated liberalization of transactions undertaken for capital account
purposes in the case of residents
34
September 9, 2009

Finance Mobilization
Indian companies were allowed to raise equity in international markets
subject to various restrictions.
Indian companies were allowed to borrow in international markets
subject to a minimum maturity, a ceiling on the maximum interest

rate, and annual caps on aggregate external commercial borrowings
by all entities put together.
Indian mutual funds were allowed to invest a small portion of their

assets abroad.
Indian companies were given access to long dated forward contracts

and to cross currency options.
35
September 9, 2009

Institutional Framework
Replacement of the earlier Foreign Exchange Regulation Act (FERA),
1973 by the market friendly Foreign Exchange Management Act, 1999

(FEMA)
Delegation of considerable powers by RBI to Authorized Dealers to

release foreign exchange for a variety of purposes
36
September 9, 2009

Increase in Instruments
Development of rupee-foreign currency swap market
Introduction of additional hedging instruments, such as, foreign
currency-rupee options
Permission to use innovative products like cross-currency options,
interest rate swaps (IRS) and currency swaps, caps/collars and forward
rate agreements (FRAs) in the international forex market.
37
September 9, 2009

Authorized dealers permitted to initiate trading positions, borrow and

invest in overseas market subject to certain specifications and
ratification by respective Banks Boards
Banks are also permitted to fix interest rates on non-resident deposits,

subject to certain specifications
Use of derivative products for asset-liability management and fix
overnight open position limits and gap limits in the foreign exchange
market, subject to ratification by RBI
Permission to various participants in the foreign exchange market,
including exporters, Indians investing abroad, FIIs, to avail forward

cover and enter into swap transactions without any limit subject to
genuine underlying exposure
38
September 9, 2009

FIIs and NRIs permitted to trade in exchange-traded derivative
contracts subject to certain conditions
Foreign exchange earners permitted to maintain foreign currency

accounts
Residents are permitted to open such accounts within the general limit
of US $ 200,000 per year
39
September 9, 2009
Financial Sector and Monetary

Policy Reforms : An assessment
Progress of Commercial Banking in India
1
1 Commercial Banks
2 No. of Bank Offices
Rural and semi
-urban bank offices
3 Population per
Office (000s)
4 Per capita
Deposit (Rs.)
5 Per capita Credit
(Rs.)
6 Priority Sector
Advances@ (%)
7 Deposits (% of
National Income)
1969
1980
3
1991
4
1995
2000
6
2005
7
73
8,262
154
34,594
272
60,570
284
64,234
298
67,868
288
68,339
5,172
23,227
46,550
46,602
47,693
47491
64
16
14
15
15
16
88
738
2,368
4,242
8,542
16,699
68
457
1,434
2,320
4,555
10,135
15
37
39
34
35
40
16
36
48
48
54
65
40
September 9, 2009

Policy Reforms : An Assessment
Distribution of Commercial Banks According to Risk-weighted
Capital Adequacy
Year
1
1995-96
2000-01
2004-05
<4%
4-9 % 9-10 %
>10 %
Total
2
8
3
1
3
9
2
1
5
42
84
78
6
92
100
88
4
33
11
8
41
September 9, 2009

Non-Performing Loans (NPL) of Scheduled Commercial Banks(%)
1
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
Gross NPL/
advances
2
Gross NPL/
Assets
3
Net NPL/
advances
4
Net NPL/
Assets
5
15.7
14.4
14.7
12.7
11.4
10.4
8.8
7.2
5.2
7
6.4
6.2
5.5
4.9
4.6
4
3.3
2.6
8.1
7.3
7.6
6.8
6.2
5.5
4.4
2.9
2
3.3
3.0
2.9
2.7
2.5
2.3
1.9
1.2
0.9
42
September 9, 2009

Select Productivity Indicators of Scheduled Commercial Banks
(Rs. million at 1993-94 prices)
Year
Business
per employee
Profit per
Employee
Business
per branch
1992
1996
2000
2005
5.4
6.0
9.7
17.3
0.02
0.01
0.05
0.13
109.9
119.6
179.4
267.0
43
September 9, 2009

Despite record high international crude oil prices, inflation remains low
and inflation expectations also remain stable.
44
September 9, 2009

Fresh issuances under the MSS were suspended between November 2005 and April 2006
due to tight liquidity. Redemptions of securities/Treasury Bills issued earlier along with
active management of liquidity through repo/reverse repo operations under Liquidity
Adjustment Facility - provided liquidity to the market and imparted stability to financial
markets. With liquidity conditions improving, it was decided to again start issuing
securities under the MSS from May 2006 onwards.
45
September 9, 2009
Forex Reforms : An Assessment
Exchange rate exhibiting reasonable two-way movement
46
September 9, 2009

Credit Delivery increased from 30 per cent during 1999-00 to 41 per cent
during 2004-05 and further to 48 per cent during 2005-06.
47
September 9, 2009
Conclusion
Financial system in India, through a measured,
gradual, cautious, and steady process, has
undergone substantial transformation
Reasonably sophisticated, diverse and resilient
system through well-sequenced and coordinated

policy measures aimed at making the Indian financial
sector more competitive, efficient, and stable
Effective monetary management has enabled price

stability while ensuring availability of credit to
support investment demand and growth in the
economy.
48
September 9, 2009
Conclusion
The multi-pronged approach towards managing
capital account in conjunction with prudential and

cautious approach to financial liberalisation has
ensured financial stability in contrast to the
experience of many developing and emerging
economies
Monetary policy and financial sector reforms in India

had to be fine tuned to meet the challenges
emanating from all global and domestic shocks.
Viewed in this light, the success in maintaining price

and financial stability is all the more creditworthy.
The overall objective of maintaining price stability in
the context of economic growth and financial stability

will remain
49
September 9, 2009
Thank You
50
September 9, 2009

Financial Sector Refoms

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Presentation

Economic Environment of Business

Slow but steady

not to forget the socio economic needs

The financial Sector Reforms

The financial Sector Reforms

The financial Sector Reforms

Broad based reforms touching every sector

The financial Sector Reforms

The financial Sector Reforms

The financial Sector Reforms

Working capital management was even more constrained with

Working capital was financed almost entirely by banks at interest

The financial Sector Reforms

The exchange rate of the rupee changed predictably and almost

Financial genius consisted largely of finding ones way through the

regulatory maze, exploiting loopholes wherever they existed and above

Even an overnight cash surplus could be parked in the overdraft

The financial Sector Reforms

The grave threat of insolvency confronting the banking system which

Hindered efficient allocation of resources

The financial Sector Reforms

Major Contours of Reforms

Providing operational and functional autonomy to institutions

The financial Sector Reforms

Two phased Reforms

Second Generation (Mid 1990 ) ::- IInd phase

The financial Sector Reforms

Major Sectors of Reforms

The financial Sector Reforms

Banking Sector Reforms

Banking Sector Reforms :

Transparent Norms related to entry, mergers /amalgamation and

governance issues for Indian private sector, foreign and jointjoint-venture

Permission for foreign investment in the financial sector in the form of

Permission to banks to diversify product portfolio and business

The financial Sector Reforms

Banking Sector Reforms :

Introduction of pure interinter-bank call money market and developing

Banking Sector Reforms :

Strengthen risk management : Assignment of risk-weights to various asset classes

Guidelines for ownership and governance, securitization and debt

The financial Sector Reforms

Banking Sector Reforms :

Approach for operational risk (First Phase)

New and Innovative Funding options

The financial Sector Reforms

Banking Sector Reforms :

Promulgation of Securitization and Reconstruction of Financial Assets

Setting up of Credit Information Bureau of India Limited (CIBIL) for

Setting up of Clearing Corporation of India Limited (CCIL) to act as

central counter party for facilitating payments and settlement system

The financial Sector Reforms

Banking Sector Reforms :

Introduction of CAMELS supervisory rating system

Consolidated supervision of financial conglomerates

Strengthening corporate governance

The financial Sector Reforms

Banking Sector Reforms :

Negotiated Dealing System (NDS) for screen-based trading in

Real Time Gross Settlement (RTGS) System

True test of the success of the banking

The financial Sector Reforms