Part B: Mid-term Monetary policy review statement for the Year 2008-09

122. The Annual Policy Statement of April 2008 set developmental and regulatory policies for the year 2008-09 with a focus on developing a sound, efficient and vibrant financial system that ensures the efficient provision of financial services to the widest sections of society. Against the backdrop of the international financial turmoil, the securing and maintenance of financial stability was accorded priority from a policy perspective with a readiness for swift responses, both conventional and unconventional, to any threats to financial stability from adverse international developments. Credit quality, credit delivery and financial inclusion alongside credible communication, adequate and timely availability of information and a broad-based, participative and consultative approach with involvement of all stakeholders were emphasised in the stance of developmental and regulatory policies for the year.

123. As stated in the Annual Policy Statement and reiterated in the First Quarter Review of July 2008, the recent global financial developments may carry profound implications for the health of the financial sector, business strategies, capital requirements, risk pricing and management tools, transparency, and starkly in the recent period, the blurring of the boundaries between liquidity and solvency stress in situations of generalised uncertainty and loss of confidence among financial entities. In this environment, banks in India were enjoined to monitor their credit portfolios closely in the context of the persisting high growth in bank credit at the systems level and to take corrective action as appropriate in order to prevent undue asset-liability mismatches or deterioration in the quality of credit, recognising the reality of business cycles and counter-cyclical monetary policy responses. ��The Reserve Bank���s response to global developments has also been swift, pre-emptive and even unconventional, especially in the context of assuaging the liquidity pressures impacting domestic financial markets, as demonstrated in the policy measures taken in September and October 2008 and referred to in Part A of this Review.

124. During 2008-09 so far, the Reserve Bank has put in place several measures for the development of financial markets and instruments, credit delivery mechanisms, in particular, for weaker sections, the priority sector and potentially viable sick, small and medium enterprises (SME) units and financial inclusion. Alongside, initiatives have been taken for strengthening of prudential norms and entrenching the three-track approach for Basel II with due emphasis on country-specific requirements in the convergence with international best practices.

125. In the period ahead, the developmental and regulatory policies of the Reserve Bank would continue to adopt a holistic approach to the responsibility for price and financial stability. The Reserve Bank is committed to deepening and expanding reforms in the financial sector so that efficient and competitive financial intermediation evolves in tune with real sector objectives so as to secure sustained growth with stability. The process of participation of and consultation with all stakeholders would be further intensified for the promotion of inclusive growth through provision of prompt and accessible financial services and the spread of financial education so as to develop a system that is attentive to the needs of the common person.

126. The Mid-Term Review of Annual Statement on Developmental and Regulatory Policies focuses on certain key areas: carrying forward development of various segments of financial markets and strengthening the financial market infrastructure; further liberalisation of foreign exchange transactions; relaxation in the interest rate ceilings on non-resident Indian (NRI) deposits; strengthening the supervisory framework in terms of cross-border supervision, risk-based supervision and bank-led conglomerates; enhancement in the off-site monitoring system and surveillance over banks��� credit portfolios; development of instruments and infrastructure relating to payment and settlement systems in response to financial innovations; strengthening urban cooperative banks (UCBs) and regional rural banks (RRBs) for improved credit delivery mechanisms and financial inclusion.

127. This part is divided into five sections: I. Interest Rate Policy; II. Financial Markets; III. Credit Delivery Mechanisms and Other Banking Services; IV. Prudential Measures; and V. Institutional Developments.

Interest Rates on FCNR(B) and NR(E)RA Deposits

128. Recent global developments brought some pressure to bear on the domestic money and foreign exchange markets in conjunction with temporary local factors. In response, the Reserve Bank increased the interest rate ceiling on FCNR(B) deposits by 50 basis points, i.e., to Libor/Swap rates minus 25 basis points and the interest rate ceiling on NR(E)RA deposits by 50 basis points, i.e., to Libor/Swap rates plus 50 basis points effective from the close of business on September 16, 2008. These ceilings were increased further by 50 basis point each, i.e., Libor/Swap rates plus 25 basis points and Libor/Swap rates plus 100 basis points, respectively, with effect from the close of business on October 15, 2008.

Money Market

(a) Special Market Operations

129. The Reserve Bank announced Special Market Operations (SMO) on May 30, 2008 on an ad hoc and temporary basis to minimise potential adverse consequences for financial markets and for overall financial stability in view of liquidity and other related issues arising from the unprecedented escalation in international crude prices. Under the SMO, the Reserve Bank conducted open market operations in the secondary market through designated banks in oil bonds held by public sector oil marketing companies in their own accounts subject to an overall ceiling of Rs.1,500 crore on any single day and provided equivalent foreign exchange through designated banks at market exchange rates to the oil companies. The SMO was terminated effective from August 8, 2008. Taking into account the continuing uncertain global situation and the potentially adverse implications for domestic financial markets, the Reserve Bank announced on October 15, 2008 that it has decided to reinstitute a similar facility when oil bonds become available.

(b) Second Liquidity Adjustment Facility

130. The Reserve Bank operates a liquidity adjustment facility (LAF) to inject/absorb liquidity through daily repo/reverse repo auctions. These operations are conducted in the forenoon between 9.30 A.M. and 10.30 A.M. In response to suggestions from market participants for fine-tuning the management of bank reserves on the last day of the maintenance period, a second LAF (SLAF) on reporting Fridays was introduced with effect from August 1, 2008 which is conducted between 4.00 P.M. and 4.30 P.M. In view of the recent extraordinary global developments, the SLAF is conducted on a daily basis beginning September 17, 2008.

131. Taking in to account the continuing uncertainty and its indirect impact on our financial markets, the Reserve Bank decided to conduct a special 14-day repo for a notified amount of Rs.20,000 crore on October 14, 2008 with a view to enabling banks to meet the liquidity requirements of mutual funds. As only Rs.3,500 crore was utilised on October 14, 2008, this 14-day repo facility was further extended to be conducted every day up to the cumulative amount of Rs.20,000 crore. It was further decided that purely as a temporary measure, banks may avail of additional liquidity support exclusively for the purpose of meeting the liquidity requirements of mutual funds to the extent of up to 0.5 per cent of their NDTL. This accommodation was extended in addition to the temporary measures announced on September 16, 2008 permitting banks to avail of additional liquidity support to the extent of up to 1 per cent of their NDTL. Furthermore, the Reserve Bank relaxed the restrictions on lending and buy-back only in respect of the certificates of deposit (CDs) held by mutual funds effective from October 14, 2008.

Government Securities Market

(a)�� Central Government Securities

(i) Floating Rate Bonds: Development of NDS Auction Format

132. The Annual Policy Statement of April 2008 had indicated that the Clearing Corporation of India Limited (CCIL) is developing a primary auction module for dated Government securities which would cover all types of instruments, including floating rate bonds (FRBs). Necessary software modifications are being incorporated for issuance of FRBs. The new structure of issuance incorporated in the Negotiated Dealing System (NDS) auction module (Version��2) is being developed by the CCIL. The FRBs will be issued at an appropriate time taking into account the prevailing market conditions.

(ii) Auction Process of Government of India Securities

133. As announced in the Annual Policy Statement for the year 2008-09, the recommendations of the Internal Working Group on the Auction Process (Chairman: Shri H. R. Khan) are in the process of implementation. The major recommendations of the Working Group include reduction in the time gap between bid submission and declaration of auction results, withdrawal of the facility of bidding in physical form and submission of competitive bids only through the NDS. In the first phase, the recommendations relating to the reduction in the time gap and withdrawal of physical bids are being implemented. Some of the recommendations like facilitating direct participation of non-NDS members in auctions through a secured web-based system are under examination.

(iii) Collateral Facility Extended for Savings Bonds

134. On August 19, 2008 the Government of India amended the notifications relating to the 7 per cent Savings Bonds, 2002, the 6.5 per cent Savings Bonds, 2003 (non-taxable), and the 8 per��cent Savings Bonds, 2003 (taxable) schemes and allowed for pledge or hypothecation or lien of these bonds as collateral for obtaining loans from scheduled banks in accordance with the provisions of Section 28 of the Government Securities Act, 2006 and Regulations 21 and 22 of the Government Securities Regulations, 2007. These amendments would enable pledge of these instruments for raising of loans by the holders, thereby imparting liquidity to these instruments.

(b) Debt Management for State Governments

Non-Competitive Bidding Scheme in the Auctions of the State�� Development Loans

135. With a view to widening the investor base and enhancing the liquidity of State Development Loans (SDLs), a scheme for Non-Competitive Bidding Facility has been approved by the State Governments. Accordingly, the General Notifications on issue of SDLs have been amended by the State Governments. The NDS Auction Module (Version 2), which would facilitate introduction of the scheme, is under development by the CCIL. The parallel run of the new Version 2 will commence shortly and the scheme will be operationalised by end-December 2008.

(c) Development of Market Infrastructure

(i) Introduction of Interest Rate Futures

136. A Working Group on Interest Rate Futures (Chairman: Shri V. K. Sharma) was constituted to review the experience gained with interest rate futures since its introduction in India in June 2003, with particular reference to product design issues. The recommendations of the Group were placed before the Technical Advisory Committee (TAC) for Money, Foreign Exchange and Government Securities Markets. Taking into consideration the feedback and comments received from the public, experts, banks, market participants and the Government of India, the report was finalised and has been placed on the Reserve Bank���s website on August 8, 2008. The RBI-Securities and Exchange Board of India (SEBI) Standing Technical Committee has been entrusted with the work relating to the operationalisation of these recommendations.�� Accordingly, the Committee has initiated��work on various issues which��broadly fall into three categories: product design and specification issues;��exchange related issues and specifications like margins; and��regulatory issues for banks. On October 13, 2008 banks were permitted to take trading positions in interest rate futures (IRFs), as��recommended by the working group. This will add depth and liquidity to the market. It is expected that IRF contracts as recommended by the Working Group would be launched in early 2009 along with the supporting changes in the regulatory regime.

(ii)�� Multi-modal Settlement

137. The Annual Policy Statement of April 2008 proposed a new settlement mechanism in Government securities through settlement banks in order to facilitate direct access to NDS and NDS Order Matching (NDS-OM) by participants who do not maintain current accounts but maintain Subsidiary General Ledger (SGL) accounts with the Reserve Bank. Accordingly, guidelines were issued on June 2, 2008 to operationalise the mechanism. Secondary market transactions in Government securities are being settled only through the designated settlement banks (DSBs) with effect from June 30, 2008. Arrangements for settlement of primary auction bidding under the new mechanism are being worked out.

(iii) Access to NDS-OM Through CSGL Route

138. Access to the NDS-OM segment, which was launched in August 2005, was initially allowed to commercial banks and primary dealers (PDs) and later to other NDS members such as insurance companies, mutual funds and large provident funds for their proprietary deals. To widen its reach, access to NDS-OM was extended to certain entities maintaining gilt accounts with the NDS members (i.e., banks and PDs) through the Constituent SGL (CSGL) route in a phased manner and is now available to deposit-taking non-bank financial companies (NBFCs), provident funds, pension funds, mutual funds, insurance companies, cooperative banks, RRBs, trusts and systemically important non-deposit taking NBFCs (NBFCs-ND-SI). As proposed in the Annual Policy Statement of April 2008, access to NDS-OM through the CSGL route was further extended to investors such as other non-deposit taking NBFCs, corporates and FIIs. These entities can place orders on NDS-OM directly through NDS-OM members using the CSGL route. Such trades will settle through the CSGL accounts and current accounts of the NDS-OM members.

(iv) Clearing and Settlement of OTC Rupee Interest Rate Derivatives

139. The CCIL has operationalised a trade reporting platform for over-the-counter (OTC) rupee interest rate derivatives which has been functioning satisfactorily. The average daily turnover is currently about Rs.14,000 crore. It was announced in the Annual Policy of April 2008 that a clearing and settlement arrangement for OTC rupee interest rate derivatives would be put in place. Accordingly, permission has been given to the CCIL to operationalise a clearing and settlement arrangement for OTC rupee interest rate derivatives on a non-guaranteed basis and this is expected to commence within a month. Once the software systems are in place and the issues relating to counter-party exposure and risk weights as applicable to the CCIL are advised, the CCIL would operationalise settlement of these products on a guaranteed basis within three months.

Foreign Exchange Market

(a) Liberalisation of Foreign Exchange Transactions

140. Measures taken during 2008-09 towards further liberalisation of foreign exchange transactions and improvement of foreign exchange facilities are set out below:

(i) Overseas Investment

��� Registered trusts and societies engaged in manufacturing/ education/hospitals were allowed to make investment in the same sector(s) in a joint venture (JV) or wholly owned subsidiary (WOS) outside India with the prior approval of the Reserve Bank, subject to compliance with the prescribed eligibility criteria.

��� Indian entities were allowed to invest in overseas unincorporated entities in the oil sector up to 400 per cent of their net worth as on the date of the last audited balance sheet.

��� Based on a review, the external commercial borrowings (ECBs) policy was modified and accordingly, effective October 22, 2008 ECBs up to US $ 500 million per borrower per financial year are permitted for rupee expenditure and/or foreign currency expenditure for permissible end-uses under the automatic route.

��� Payment for obtaining licence/permit for 3G Spectrum is considered an eligible end-use for the purpose of ECBs.

��� The ECBs borrowers have been extended the flexibility to either keep the proceeds off-shore or to remit to India for credit to their rupee accounts with AD Category I banks in India, pending utilisation for permissible end-uses.

��� In view of the tight liquidity conditions in the international financial markets, all-in-cost ceilings were rationalised and enhanced and accordingly, the ceiling for ECBs of average maturity period of three years and up to five years was enhanced to 300 basis points and the ceiling for ECBs over five years was enhanced to 500 basis points.

��� Keeping in view the risks associated with unhedged foreign exchange exposures of SMEs, a system of monitoring such unhedged exposures by the banks on a regular basis is being put in place.

��� The definition of infrastructure for the purpose of availing of ECBs has been expanded to include mining, exploration and refining.

��� Entities in the services sector, viz., hotels, hospitals and software companies were permitted to avail ECBs up to US $ 100 million in a financial year under the approval route for the purpose of import of capital goods.

��� The Foreign Currency Exchangeable Bonds (FCEB) Scheme, 2008 notified by the Government of India on February 15, 2008 was operationalised by the Reserve Bank.

��� AD Category ��� I banks were allowed to convey ���no objection��� under the Foreign Exchange Management Act (FEMA), 1999 for the creation of charge over immoveable assets and financial securities and issue of corporate or personal guarantees on behalf of the borrower in favour of the overseas lender to secure ECBs under automatic/approval route, subject to certain conditions.

��� Banks were allowed to borrow funds from their overseas branches and correspondent banks up to a limit of 50��per��cent of their unimpaired Tier I capital as at the close of the previous quarter or US $ 10 million, whichever is higher, as against the existing limit of 25��per��cent.

��� The limit of US $ 100,000 was enhanced to US $ 300,000 for making remittances for imports where the import bills/documents were received directly by the importer from the overseas supplier.

��� The limit for advance remittance for import of goods without bank guarantee/stand-by letter of credit was increased from US $ 1 million or its equivalent to US $ 5 million or its equivalent.

��� The limit for advance remittance for import of services without bank guarantee was enhanced from US $ 100,000 to US $ 500,000 or its equivalent.��

��� The usance period of letters of credit opened for import of platinum, palladium, rhodium and silver has been limited to 90 days from the date of shipment.

(b)���� Introduction of Currency Futures

141. The final report of the Internal Working Group on Introduction of Currency Futures in India (Chairman: Shri Salim Gangadharan) was placed on the Reserve Bank���s website on April 28, 2008.�� The report of the RBI-SEBI Standing Technical Committee on Exchange Traded Currency Futures, constituted to suggest a suitable framework to operationalise currency futures, was also placed on��the Reserve Bank���s website on June 13, 2008. The recommendations of the Working Group were examined and accepted by the Reserve Bank. Directions were issued under provisions of theReserve Bank of India Act, 1934 and the necessary Notification was issued under FEMA on August 5, 2008 for the introduction of exchange traded currency futures.�� The directions permit scheduled commercial banks (AD Category���I) to become trading/clearing members of the�� currency derivatives segment set up by recognised stock exchanges, subject to their fulfilling certain prudential requirements.�� Banks which do not meet the minimum prudential requirements are permitted to participate in the currency futures market only as clients, after obtaining approval from the Reserve Bank.

142. The exchange traded currency futures started trading first on the National Stock Exchange on August 29, 2008, followed by the Bombay Stock Exchange and the Multi Commodity Exchange ��� Stock Exchange (MCX-SX) on October 1, 2008 and October 7, 2008, respectively.

(c)�� Branch/Liaison Offices in India by Foreign Entities

143. Under the current provisions of the FEMA, a person resident outside India requires prior approval of the Reserve Bank for establishing branch/liaison offices in India. The Reserve Bank has placed on its website for public comments��the draft circulars regarding delegation of powers for extension of the validity period or closure of liaison offices of foreign entities in India and the eligibility criteria and procedural guidelines for branch/liaison offices of foreign entities in India with a view to further liberalising the procedure and achieving greater transparency.�� Final guidelines will be issued by end-December 2008.

(d) Clearing and Settlement of Forex Forwards

144. The CCIL provides a platform for guaranteed settlement of inter-bank foreign exchange trades to banks in India. Settlement is on a multilateral net basis, with the CCIL becoming the central counter-party to the trades through the process of novation. The guaranteed settlement of foreign exchange trades mitigates risks and also allows banks to use their capital in an optimal manner. Currently, 72 banks as members for foreign exchange settlement operations settle, on an average, 8,500 deals daily with a gross volume of US��$ 17 billion. Forward trades are accepted for guaranteed settlement only when they enter the spot window.

145. The Reserve Bank has accorded its approval to the CCIL for commencement of guaranteed settlement of inter-bank foreign exchange forward trades from the trade date. The CCIL has notified to banks its readiness to start operations of the foreign exchange forward segment and the software has been fully tested. The CCIL would operationalise the settlement system within a month, once the issues relating to counter-party exposure and risk weights are advised.

(e) Liberalisation of Hedging Facilities

Expansion of Hedging Facilities to Domestic Crude Oil Refining Companies

146. Major domestic crude oil refining companies are permitted to hedge their commodity price risks on overseas exchanges/markets.�� Major oil refining and shipping companies have been representing to the Reserve Bank for extending the hedging facilities further in view of the volatility of freight rates. With a view to facilitating better management of freight risk, it is proposed:

���� to permit domestic oil and shipping companies to hedge their freight risk with overseas exchanges/ OTC markets.
In respect of other customers who are exposed to freight risk,AD banks may approach the Reserve Bank for permission on behalf of customers.

(f) Trade Credit: Enhancement of All-in-cost Ceilings

147. In view of the tight liquidity conditions in the global credit markets, domestic importers are experiencing difficulties in raising trade credits within the existing all-in-cost ceilings. Considering the international developments, it is proposed:

���� to enhance the all-in-cost ceiling for trade credits less than 3 years to 6 months LIBOR plus 200 basis points.

III.��Credit Delivery Mechanisms and
Other Banking Services

(a) Priority Sector Lending

(i) Weaker Sections��� Lending Targets: Status

148. As indicated in the Annual Policy Statement of April 2008, domestic SCBs were advised that the shortfall in achievement of the sub-target of lending to weaker sections will also be taken into account for the purpose of allocating amounts for contribution to the Rural Infrastructure Development Fund (RIDF) maintained with the National Bank for Agriculture and Rural Development (NABARD) or funds with other financial institutions as specified by the Reserve Bank, with effect from April 2009.

(ii) General Purpose Credit Cards and Overdrafts Against ���No-frills��� Accounts as Indirect Finance to Agriculture Under Priority Sector: Status

149. Consequent upon the announcement made in the Annual Policy Statement of April 2008, banks were allowed to classify 100 per cent of the credit outstanding under General Credit Cards (GCC) and overdrafts up to Rs.25,000 (per account) granted against ���no-frills��� accounts in rural and semi-urban areas as indirect finance to agriculture under the priority sector.

(iii)�� Increasing Opportunities for RRBs for Lending to Priority Sector: Status

150.�� With a view to augmenting RRBs��� funds/resource base, commercial banks/sponsor banks were allowed to classify in their books loans granted to RRBs for on-lending to agriculture and allied activities as indirect finance to agriculture. Furthermore, RRBs were permitted to sell loan assets held by them under priority sector categories in excess of the prescribed priority sector lending target of 60 per cent.

(b) �� Delivery of Credit to Agriculture and Other Segments of the Priority Sector

151. Under the Special Agricultural Credit Plan (SACP), disbursements by public and private sector banks to agriculture aggregated Rs.1,25,758 crore (provisional) and Rs.47,862 crore, respectively, during 2007-08 as against the target of Rs.1,52,133 crore and Rs.41,427 crore. Under the kisan credit card (KCC) scheme, public sector banks have issued 4.6 million KCCs covering limits aggregating Rs.59,582 crore during 2007-08. Since the inception of the scheme, public sector banks have issued 31.22��million KCCs covering an amount of Rs.1,54,294 crore.

152. The Union Budget for 2008-09 had announced establishment of the Rural Infrastructure Development Fund (RIDF XIV) with the NABARD with a corpus of Rs.14,000 crore, and a separate window under RIDF (XIV) for rural roads programme under the Bharat Nirman Programme with a corpus of Rs.4,000 crore. The Union Finance Minister had also announced setting up of specific funds with the NABARD/Small Industries Development Bank of India (SIDBI)/National Housing Bank (NHB) with contributions by SCBs��which failed to achieve their obligations to lend to the priority sector.

153. Since the inception of the RIDF (I to XIV), including separate windows under RIDF for rural roads under the Bharat Nirman Programme, the total allocation was of the order of Rs.86,000 crore. While cumulative sanctions to State Governments and the National Rural Roads Development Agency (NRRDA) under various tranches of RIDF (I to XIV) stood at Rs.79,920 crore and Rs.12,000 crore, respectively, as on August 31, 2008 the cumulative disbursements stood at Rs.48,615 crore and Rs.4,889 crore, respectively. During 2008-09 (up to August 31), various State Governments were sanctioned loans aggregating Rs.5,864 crore, which included Rs.522 crore sanctioned to the distressed districts of four States, viz., Andhra Pradesh, Kerala, Karnataka and Maharashtra. The disbursements under various tranches of RIDF��during the year 2008-09 (up to August 31) amounted to Rs.3,021 crore.

154. Pursuant to the announcement made in the Union Budget for 2006-07, commercial banks were advised to grant interest relief of two percentage points in the interest rate on the principal amount on each crop loan up to Rupees one lakh granted by banks during Kharif and Rabi seasons of 2005-06. Furthermore, consequent upon announcements made in the Union Budgets for the years 2007-08 and 2008-09, public sector banks, RRBs and rural co-operative banks were advised to grant interest rate subvention of 2 per cent per annum to farmers in respect of short-term production credit up to Rupees three lakh provided to them.

155. As announced in the Annual Policy Statement of April 2008, banks were advised to accept affidavits submitted by landless labourers, share croppers and oral lessees giving occupational status(i.e., details of land tilled/crops grown) for loans up to Rs.50,000, where there are difficulties in getting certification from local administration/panchayati raj institutions regarding the cultivation of crops. Furthermore, banks were advised to select one rain-fed district for introduction of a cyclical credit product for financing crop production on pilot basis, where 20 per cent of the limit would be continuously available to farmers as a core component.

(e) Agricultural Debt Waiver and Debt Relief Scheme, 2008

156. A scheme of agricultural debt waiver and debt relief for farmers was announced in the Union Budget for 2008-09 for implementation by all SCBs, RRBs and cooperative credit institutions. The modalities of the scheme were finalised and notified by the Government of India on May 23, 2008. The scheme covers direct agricultural loans extended to marginal and small farmers and other farmers by SCBs, RRBs, cooperative credit institutions (including urban cooperative banks) and local area banks (LABs). Accordingly, the Reserve Bank advised all SCBs, including LABs, to take necessary action towards expeditious implementation of the scheme. The NABARD issued similar guidelines to RRBs and cooperatives. The Reserve Bank also advised all SCBs, including LABs, to utilise at their discretion the floating provisions held for advances portfolio to the extent of meeting the interest/charges (i.e., interest in excess of the principal amount, unapplied interest, penal interest, legal charges, inspection charges, miscellaneous charges and the like). The floating provisions should not, however, be utilised for meeting any other provisioning requirements without the Reserve Bank���s prior approval, as hitherto.

157. Under the scheme, the Government had agreed to provide to commercial banks, RRBs and co-operative credit institutions a sum of Rs.25,000 crore as the first instalment. At the request of the Government, the Reserve Bank has agreed to provide the sum to the lending institutions immediately. This temporary liquidity support provided by the Reserve Bank of India under Section 17(3-B) and Section 17(4-E) of the RBI Act to scheduled banks and the NABARD, respectively, is available till November 3, 2008.

(f)�� Promotion of Livelihood in the Unorganised Sector: Role of Financial System

158. As indicated in the Annual Policy Statement of April 2008, the report of the Internal Working Group constituted within the Reserve Bank to study the recommendations of the National Commission for Enterprises in the Unorganised Sector (Chairman: Dr. Arjun K. Sengupta) in its report on ���Conditions of Work and Promotion of Livelihood in the Unorganised Sector��� was placed on the Reserve Bank���s website for wider dissemination.

(g) Working Group on Rehabilitation/Nursing of Potentially Viable Sick SME Units

159. As indicated in the Annual Policy Statement of April 2007, the report of the Working Group (Chairman: Dr. K. C. Chakraborty), constituted to look into the issues and suggest remedial measures so that potentially viable sick units can be rehabilitated at the earliest, was placed on the Reserve Bank���s website in April 2008. Based on the comments received, it is proposed:

���� to issue detailed guidelines to banks on rehabilitation of potentially viable sick SME units by end-November 2008.

160. The self help group (SHG)-Bank Linkage programme has emerged as the major micro-finance programme in the country and is being implemented by commercial banks, RRBs and cooperative banks. As on March 31, 2008, 3.48 million SHGs had outstanding bank loans of Rs.22,227 crore. During 2007-08, banks financed 0.74million SHGs, including repeat loans to existing SHGs to the tune of Rs. 4,228 crore.

161. In the Union Budget for 2007-08, constitution of the Financial Inclusion Fund (FIF) and the Financial Inclusion Technology Fund (FITF) were announced with an overall corpus of Rs.500 crore each with the NABARD. The Government of India also advised that for the year 2007-08, the initial contribution of Rs.25 crore each in these two Funds would be shared by the Central Government, the Reserve Bank and the NABARD in the ratio of 40:40:20. The Reserve Bank���s contribution to these funds would accordingly be Rs.10 crore each.

162. In order to give further impetus to branch expansion programmes of RRBs, existing branch licensing criteria have been further liberalised. Accordingly, it is proposed:

���� to allow RRBs greater flexibility in opening new branches as long as they are making operational profits and their financials are improving.

163. As indicated in the Annual Policy Statement of April 2008, the report of the Working Group (Chairman: Shri G. Srinivasan), constituted for preparing a road map for RRBs to adopt appropriate technology and migrate to core banking solutions (CBS), was placed on the Reserve Bank���s website. The Report has set September 2011 as the target for all RRBs to move towards CBS and all RRB branches opened after September 2009 are to be CBS-compliant. The report has been forwarded to all sponsor banks for necessary action.

(iii) Assistance to RRBs for Adoption of ICT solutions for Financial Inclusion: Status

164. The report of the Working Group (Chairman: Shri G. Padmanabhan), constituted to examine provision of financial assistance to RRBs for defraying a part of their initial cost in implementing information and communication technology (ICT)-based solutions for financial inclusion, was placed on the Reserve Bank���s website in August 2008. The Group has inter alia recommended that the funding of ICT solutions for financial inclusion may be done through interest-free loans to be routed through the Institute for Development and Research in Banking Technology (IDRBT). The recommendations are under examination.

(i)�� Pilot Project of State Level Bankers��� Committee (SLBCs) for 100 per cent Financial Inclusion

165. So far, 342 districts were identified by SLBCs for 100 per��cent financial inclusion. Of these, 155 districts have reported having achieved the target of 100 per cent financial inclusion. The Reserve Bank had undertaken evaluation studies of the progress made in achieving this target in 26 districts through external agencies to draw lessons for further action in this regard. Based on the findings of the studies, it is proposed to:

���� provide feedback to banks to make the process of financial inclusion more effective.

166. Consequent to the meeting that the former Governor of the Reserve Bank had with the Chief Ministers of a few States in the North-Eastern Region in May 2008, a Special Task Force (Chairperson: Smt. Usha Thorat) was constituted in order to give a fresh impetus for setting up of banking facilities at additional centres in the region perceived as essential for public policy. A scheme of providing financial support to banks by the Reserve Bank for setting up banking facilities (currency chests, extension of foreign exchange and Government business facilities) at such centres, provided that the State Governments make available necessary premises and other infrastructural support, has been formulated. The Government of Meghalaya has agreed to the proposal of providing premises and necessary security arrangements for the new branches. Similar mechanisms for other States in the North-Eastern region where requests have been received are under consideration.

(iii)�� Setting up of Credit Counseling Centres on Pilot Basis167. A concept paper on Financial Literacy and Counselling Centres was prepared and placed on the Reserve Bank���s website on April 3, 2008 for public feedback in order to take this initiative forward. Based on the feedback, it is proposed:

���� to notify a Model Scheme for Financial Literacy and Credit Counselling Centres.

(l)�� High Level Committee on Lead Bank Scheme

168. As announced in the Mid-Term Review of October 2007, a High Level Committee (Chairperson: Smt. Usha Thorat) was constituted to review the Lead Bank Scheme and improve its effectiveness in the light of the recent developments in the banking sector. The Committee had several rounds of discussions with different State Governments, banks and other stakeholders, including academicians, micro-finance institutions and NGOs, and is in the process of consolidating its findings and crystallising its recommendations. The broad view that is emerging is that while greater banking and credit penetration by the formal financial institutions for facilitating inclusive growth should��be the primary objective of the scheme, it would also be necessary to strengthen the institution and processes through which the scheme is implemented.�� The Committee is expected to submit its report by December 2008.

(m) Relief Measures by Banks in Flood affected areas in Assam, Bihar and Orissa

169. The Reserve Bank has issued comprehensive standing instructions to banks for ensuring continuity of banking operations and providing relief and rehabilitation to persons affected by natural calamities. Consequent to the unprecedented rains and floods resulting in heavy losses of life and property in the States of Assam, Bihar and Orissa, special committees/meetings of banks and State Governments at district/State level, as appropriate, were held to trigger the implementation of these standing instructions which include re-scheduling of existing loans, grant of fresh credit and consumption loans, making available currency in adequate measures and ensuring continuance of normal banking services

(n) Study on Courier/Postage Charges of Banks

170. The Annual Policy Statement of April 2008 indicated that the Reserve Bank is in the process of collecting details of various charges levied by banks for public dissemination with a view to bringing about greater transparency in banks��� services to the common person. Accordingly, information in respect of courier/postage charges levied for collection of outstation cheques and for sending statements/cheque books to the customer was collected, compiled and placed on the Reserve Bank���s website. The Reserve Bank would conduct such studies from time to time in respect of other charges and will place the results on its website.

(a) Cross-border Supervision

171. An Internal Working Group (Chairman: Shri S. Karuppasamy) was constituted to lay down the roadmap for adoption of a suitable framework for cross-border supervision and supervisory cooperation with overseas regulators, consistent with the framework envisaged by the Basel Committee on Banking Supervision (BCBS). The Working Group consulted both Indian banks with overseas branches and foreign banks with Indian operations to elicit the practices followed relating to cross-border activities, inspection methodology and frequency adopted by overseas supervisors, systems followed for securing of supervisory rating and progress made in implementation of Basel II. The Group sought information from various overseas regulators/supervisors on the practices adopted by them on information sharing/policies on cross-border supervisory cooperation and the existing legal framework in those jurisdictions. The Group examined the legal position on cross-border supervision arrangements and also explored the feasibility of executing memoranda of understanding (MoUs) with overseas supervisors. The Group is expected to submit its report by mid-November 2008.

(b)�� Consolidated Supervision and Financial Conglomerates

172. The Annual Policy Statement of April 2008 had proposed realignment of various internal supervisory processes for implementing an improved consolidated supervision process in order to enhance the effectiveness of the banking supervisory system for bank-led conglomerates. Accordingly, an ���approach paper��� on the supervision of financial conglomerates is expected to be finalised by end-November 2008.

(c) Supervisory Review Process on Activities of the Trusts/SPVs Set up by Banks

173. Special purpose vehicles (SPVs) and trusts set up by banks are generally unregulated and are subject to inadequate independent board oversight. As the activities of these entities could be a potential risk to the parent bank and could also pose systemic risk, the Annual Policy Statement of April 2008 proposed to study and recommend a suitable supervisory framework for activities of SPVs/trusts set up by banks. Accordingly, a Working Group (Chairman: Shri S. Sen) has been constituted in October 2008 with representatives from the Reserve Bank, banks and credit rating agencies which is expected to submit its report within three months. The Group would study various types of trusts/SPVs set up by banks, management control by parent banks, related regulatory/supervisory issues and recommend a suitable supervisory framework.

(d) New Model of Risk-Based Supervision: Evolution

174. With a view to evolving an appropriate model of risk-based supervision (RBS), a departmental Group was set up to study international practices on such systems. The Group studied the RBS mechanism adopted by various supervisory authorities across certain jurisdictions (the US, the UK, Australia, France, Hong Kong, Singapore, Thailand and Malaysia) with a view to evolving a suitable RBS framework without diluting the intensity of the existing supervisory framework. An approach paper in this regard is under preparation and is expected to be finalised by mid-December 2008.

(e)�� Overseas Operations of Indian Banks: Review of Existing Off-Site Monitoring Framework

175. The Inter-departmental Group constituted to review the existing regulatory and supervisory framework for overseas operations of Indian banks held consultations with Indian banks having large overseas presence. An appropriate supervisory framework, including a revised off-site surveillance system for overseas operations of Indian banks, is expected to be finalised by end-November 2008.

(f) Supervisory Review Process Related to Banks��� Credit Portfolio

176. The First Quarter Review of July 2008 had indicated that the Reserve Bank would consider undertaking a supervisory review of select banks which are over-extended in terms of their credit portfolios relative to their sources of funds. Accordingly, banks were identified based on their off-site returns and detailed information from these banks was sought regarding the sources and deployment of their funds. Detailed discussions with the top management of banks were held and concerns were conveyed to them for taking appropriate action.

(g) Review of Banks��� Exposures to Agricultural Commodities

177.��In view of the current public policy concerns in regard to trading in food items, the Annual Policy Statement of April 2008 had urged banks to review their advances to traders of agricultural commodities including rice, wheat, oilseeds and pulses as also advances against warehouse receipts. Banks were advised to forward the first such review to the Reserve Bank for carrying out supervisory review of banks��� exposures to the commodity sector. A supervisory review of banks��� exposures to agricultural commodities as on March 31, 2008 was carried out on the basis of data submitted by banks. The review revealed that banks��� advances to traders in agricultural commodities and advances against warehouse receipts constituted less than one per cent of their gross advances. Banks also confirmed that they are exercising due caution while extending advances to agricultural commodities so as to ensure that bank finance is not used for hoarding. A further review of the position as on June 30, 2008 was also made and no significant change was observed in such exposure of banks.

(h) Implementation of Basel II Framework in India: Status

178. Indian banks with overseas presence and branches of foreign banks functioning in India have migrated to Basel II Framework with effect from March 31, 2008. Considering the level of sophistication of risk management techniques and availability of data, these banks have been advised to follow the Standardised Approach for credit risk and the Basic Indicator Approach for operational risk. All banks in India follow the Standardised Measurement method for computation of capital charge for market risk since June 2004. With the issuance of guidelines on Pillar II in March 2008, banks are also required to have an Internal Capital Adequacy Assessment Process (ICAAP) to ensure that they have adequate capital to support all risks in their business and are encouraged to develop and use better risk management techniques in monitoring and managing risks. The evaluation of the ICAAP of individual banks is being taken up by the Reserve Bank in conjunction with the annual financial inspection of banks. As planned, the remaining banks are required to migrate to the Basel II framework with effect from March 31, 2009.

(i) Introduction of Credit Derivatives in India: Review of Status

179. The Reserve Bank had issued draft guidelines on credit default swaps (CDS) in May 2007, followed by a revised version in October 2007 for another round of consultation. However, in view of certain adverse developments in international financial markets, particularly credit markets, resulting in considerable volatility, it was not considered opportune to introduce the credit derivatives. Accordingly, the issuance of final guidelines on the introduction of credit derivatives was kept in abeyance. This decision was taken so as to be able to draw upon the experience of the financial sector of some of the developed countries, particularly in the current circumstances in which the entire dimensions of the credit market crisis have not yet been gauged. The Reserve Bank would draw from lessons from the recent turmoil and review the proposal to introduce the CDS at an appropriate time.

(j)�� Strengthening of Risk Management in Banks: Liquidity Risk

180. The on-going turmoil in international financial markets has brought the management of liquidity risk in banks to the fore front. It is clear that even the most sophisticated banks had not considered the amount of liquidity they might need to satisfy contingent obligations, either contractual or non-contractual, as they viewed funding of these obligations to be highly unlikely or regarded the availability of resources to meet such funding requirements as stable over future periods. Many international banks had envisaged severe and prolonged liquidity disruptions as highly unlikely and did not conduct stress tests that factored in the possibility of market-wide strain or the severity and duration of disruption. The Reserve Bank had issued guidelines on asset-liability management in February 1999 which created a sound framework for liquidity risk and interest rate risk management in banks. These guidelines were modified in October 2007 to bring about granularity of time buckets and recognised the impact of cumulative outflows on liquidity across time buckets. The Reserve Bank is in the process of significantly revising these guidelines, especially in the light of a paper entitled ���Principles for Sound Liquidity Risk Management and Supervision��� published by the Basel Committee on Banking Supervision in September 2008, to ensure that banks��� liquidity risk measurement and management capabilities are in tune with the level of complexity of their operations.

(k)�� Stress Testing

181. Stress testing has evolved as a practical risk management tool and its applications are expanding. As observed in the Committee on Global Financial System (CGFS) Report, 2005 stress testing works as a complement rather than as a supplement to major risk management tools such as value-at-risk. It is, therefore, becoming an integral part of the risk management frameworks of banks and securities firms. In an increasingly complex financial environment where banks are facing new risks and markets are becoming more global, stress testing benefits from its flexibility, comprehensibility and the responsibility that it puts on managements to evaluate the risks that a bank is currently running. The stress tests are increasingly being integrated into risk management frameworks of financial institutions.

182. The Reserve Bank had issued guidelines to banks on stress testing in June 2007 which require banks to have a sound stress testing policy which will determine the liquidity risk, interest rate risk, credit risk and foreign exchange risk under stressed scenarios. It is proposed to upgrade these guidelines appropriately to provide further guidance to banks in the matter. Banks are also encouraged to improve their management information systems (MIS) and risk management skills for conducting stress tests and make full use of the insights gained from such tests.

(l)�� Financial Stability Forum Report: Status

183. The Annual Policy Statement of April 2008, while presenting the status on the implementation of the proposals of Financial Stability Forum (FSF), indicated that the Reserve Bank has put in place regulatory guidelines covering many of these proposals and in other cases, actions are being initiated. In the ensuing period, the Reserve Bank has issued guidelines on prudential norms for off-balance sheet exposures of banks which are set out below:

(i) Exposure Norms: Method of Computation

184. Banks shall compute their credit exposures arising on account of their interest rate and foreign exchange derivative transactions and gold using the ���Current Exposure Method���. Banks may exclude ���sold options��� provided thatthe entire premium/fee or any other form of income is received/realised while computing the credit exposure.

(ii) Capital Adequacy: Computation of the Credit Equivalent Amount

185. For the purpose of capital adequacy, all banks, both under Basel I and under Basel II frameworks, shall use the ���Current Exposure Method��� to compute the credit equivalent amount of the interest rate and foreign exchange derivative transactions and gold.

(iii)�� Provisioning Requirements for Derivative Exposures

186. Credit exposures computed as per the current marked-to-market value of the contract arising on account of the interest rate and foreign exchange derivative transactions and gold shall also attract provisioning requirements as applicable to the loan assets in the ���standard��� category of the counterparties concerned. All conditions applicable for treatment of provisions for standard assets would also apply to the provisions for derivatives and gold exposures.

(iv) Asset Classification of the Receivables Under�� the Derivatives Transactions

187. In respect of derivative transactions, any amount due to the bank which remains unpaid in cash for a period of 90 days from the specified due date for payment will be classified as non-performing assets as per the prudential norms on income recognition, asset classification and provisioning pertaining to the advances portfolio.

188. These modifications would come into effect from the financial year 2008-09. Banks would, however, have the option of complying with the additional capital and provisioning requirements arising from these modifications in a phased manner over a period of four quarters ending March 31, 2009.

V.��Institutional Developments

Payment and Settlement Systems

(a) Payment and Settlement Systems Act, 2007

189. The Payment and Settlement Systems Act, 2007 (51 of 2007) and the Payment and Settlement Systems Regulations, 2008 were notified and have come into effect from August 12, 2008. The Payment and Settlement Systems Act stipulates that no person other than the Reserve Bank shall commence or operate a payment system except under and in accordance with an authorisation issued by the Reserve Bank under the provisions of the Act. Accordingly, all persons currently operating a payment system or desirous of setting up a payment system as defined in the Act need to apply for authorisation to the Reserve Bank unless specifically exempted in terms of the Act. All existing payment systems will cease to have the right to carry on their operations unless they obtain an authorisation within six months from the commencement of the Act (i.e., August 12, 2008). The Payment and Settlement Systems Regulations, 2008 detail the form and manner in which the application is to be made to the Reserve Bank for grant of authorisation.

(b) Regulatory Guidelines: Mobile Payments

190. As indicated in the Annual Policy Statement of April 2008, the Reserve Bank had placed on its website ���Draft Operating Guidelines for Mobile Payments in India��� in consultation with banks and a few industry bodies for public comments. Following a wide-ranging consultative process, operative guidelines were issued for adoption by banks under Section 18 of the Payment and Settlement Systems Act, 2007 (Act 51 of 2007) with effect from October 8, 2008.

Urban Cooperative Banks

(a) Creation of Umbrella Organisation and Revival Fund for Urban Cooperative Banks

191. As indicated in the Annual Policy of April 2008, the Reserve Bank constituted a Working Group (Chairman: Shri V.S Das) to suggest measures, including the appropriate regulatory and supervisory framework, to facilitate emergence of umbrella organisation(s) for the UCB sector. The Group would also look into the issues concerning creation of a Revival Fund for the sector. The Group���s report is expected to be submitted by end-December 2008.

(b)�� Information Technology Support to UCBs

192. As indicated in the Annual Policy of April 2008, the report of the Working Group (Chairman: Shri R. Gandhi), constituted to examine various areas where IT support could be provided to UCBs by the Reserve Bank, was submitted on April 17, 2008. The report has been placed on the Reserve Bank���s website on August 13, 2008 for comments. Appropriate action would be initiated on the recommendations of the Group based on the comments received.

(c) Investment in Government Securities for SLR Purposes by Non-scheduled UCBs

193.Non-scheduled UCBs in Tier I were exempted from maintaining SLR in Government and other approved securities up to 15 per cent of their NDTL provided the amount is held in interest-bearing deposits with the State Bank of India and its subsidiary banks and the public sector banks, including Industrial Development Bank of India Ltd. It has been decided:

��� to continue the exemption provided that with effect from October 1, 2009 such exemption shall not exceed 7.5 per cent of NDTL. The exemption will stand withdrawn effective from April 1, 2010.

���

���

In view of the exemption, it has also been decided that:

��� Non-scheduled UCBs in Tier I shall maintain SLR in the form of Government and other approved securities not less than 7.5 per cent of their NDTL by September 30, 2009 and 15 per cent of their NDTL by March 31, 2010.

��� The current prescription of holding SLR in Government and other approved securities not less than 15 per cent of their NDTL in respect of non-scheduled UCBs in Tier-II shall continue up to March 31, 2010.

��� From March 31, 2011 onwards all UCBs (non-scheduled and scheduled) shall be required to maintain SLR in Government and other approved securities up to 25 per cent of their NDTL.

Non-Banking Financial Companies

Financial Regulation of Systemically Important NBFCs: Review of Prudential Regulations

194. In 2006, regulatory guidelines covering the prudential norms for systemically important NBFCs and banks��� relationship with them were put in place. The Reserve Bank has been monitoring the functioning of systemically important NBFCs and banks��� exposure to them. In the light of international developments and increasing bank exposure to these systemically important NBFCs, the Annual Policy Statement of April 2008 proposed to review the regulations in respect of capital adequacy, liquidity and disclosure norms of these entities. Accordingly, draft guidelines on systemically important non-deposit taking non-banking financial companies (NBFCs-ND-SI) regarding prudential norms have been placed on the Reserve Bank���s website for public comments. Taking into consideration the comments received from the public, the final guidelines dated August 1, 2008 were issued.

Committee on Financial Sector Assessment: Developments

195. The Annual Policy Statement of April 2008 had outlined the progress made by the Committee on Financial Sector Assessment (CFSA), constituted by the Government of India, in consultation with the Reserve Bank, to undertake a comprehensive assessment of the financial sector. Since then, the reports of four Advisory Panels constituted by the Committee covering assessment of Financial Stability Assessment and Stress Testing, assessment of relevant international standards and codes as applicable to Financial Regulation and Supervision, Institutions and Market Structure and Transparency Standards were peer-reviewed by external experts in each relevant area identified for the purpose. The CFSA also held a two-day seminar in June and a one-day conference in July 2008 with the peer reviewers and Advisory Panel members to discuss the major issues/recommendations of the various Panel reports. The Panels have finalised their reports by appropriately incorporating the comments of the peer reviewers. Simultaneously, the overview report of the CFSA is also under preparation. It is expected that the four Advisory Panel Reports and the overview report of the CFSA will be released by December 2008.
��
��(Courtesy: http://rbi.org.in/)