RESERVE BANK OF INDIA

Annual Policy Statement2009-10

April 21, 2009Mumbai

Dr. D. SubbaraoGovernor

CONTENTS

Page No.

Part A: Monetary Policy Statement 2009-10

I. Macroeconomic and Monetary Developments ........................................ 3

II. Stance of Monetary Policy ..................................................................... 21

III. Monetary Measures ................................................................................ 29

Part B: Developmental and Regulatory Policies 2009-10

I. Financial Stability ................................................................................... 30

II. Interest Rate Policy ................................................................................. 32

III. Financial Markets ................................................................................... 32

IV. Credit Delivery Mechanism and Other Banking Services .................... 38

V. Prudential Measures ............................................................................... 43

VI. Institutional Developments..................................................................... 47

Box: International Co-operation - Recent Initiatives ...................................... 31

Annex

I. Policy Measures by the Reserve Bank of India:September 2008 Onwards ...................................................................... 53

II. G-20 Working Group on Enhancing Sound Regulation andStrengthening Transparency: Current Status of theReserve Bank on the Recommendations ................................................ 58

ACRONYMS

ADRs - American Depository Receipts

ALM - Asset-Liability Management

AML - Anti-Money Laundering

AS - Accounting Standard

ASP - Application Service Provider

ATF - Accounting Task Force

ATM - Automated Teller Machine

BCs - Banking Correspondents

BCBS - Basel Committee on Banking Supervision

BCSBI - Banking Codes and Standards Board of India

BE - Budget Estimates

BF - Business Facilitators

BIS - Bank for International Settlements

BoP - Balance of Payments

BPL - Below Poverty Line

BPLRs - Benchmark Prime Lending Rates

bps - basis points

BSE - The Stock Exchange, Mumbai

CAD - Current Account Deficit

CBLO - Collateralised Borrowing and Lending Obligation

CBS - Core Banking Solutions

CCIL - Clearing Corporation of India Limited

CCP - Central Counterparty

CDs - Certificates of Deposit

CEO - Chief Executive Officer

CFMS - Centralised Funds Management System

CFSA - Committee on Financial Sector Assessment

CFT - Combating the Financing of Terrorism

CGFS - Committee on Global Financial System

CP - Commercial Paper

CPI - Consumer Price Index

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CPI-IW - Consumer Price Index - Industrial Workers

CPSS - Committee on Payment and Settlement Systems

CRR - Cash Reserve Ratio

CRAR - Capital to Risk-Weighted Assets Ratio

CSO - Central Statistical Organisation

CSOs - Civil Society Organisations

CTS - Cheque Truncation System

DR - Disaster Recovery

DSBs - Designated Settlement Banks

DvP - Delivery versus Payment

ECBs - External Commercial Borrowings

ECR - Export Credit Refinance

ECS - Electronic Clearing Services

EMEs - Emerging Market Economies

EU - European Union

EXIM Bank - Export-Import Bank of India

FATF - Financial Action Task Force

FC - Financial Conglomerate

FCCBs - Foreign Currency Convertible Bonds

FCNR(B) - Foreign Currency Non-Resident (Banks)

FDI - Foreign Direct Investment

FIs - Financial Institutions

FIIs - Foreign Institutional Investors

FITF - Financial Inclusion Technology Fund

FLCC - Financial Literacy and Credit Counselling Centre

FRBs - Floating Rate Bonds

FRBM - Fiscal Responsibility and Budget Management

FSAP - Financial Sector Assessment Programme

FSB - Financial Stability Board

FSF - Financial Stability Forum

G-20 - Group of Twenty

G-30 - Group of Thirty

GCC - General Credit Card

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GDP - Gross Domestic Product

GDRs - Global Depository Receipts

GSDP - Gross State Domestic Product

HFCs - Housing Finance Companies

HLCCFM - High Level Co-ordination Committee on Financial Markets

IAIS - International Association of Insurance Supervisors

IAS - International Accounting Standards

IASB - International Accounting Standards Board

IBA - Indian Banks’ Association

ICAI - Institute of Chartered Accountants of India

ICT - Information and Communication Technology

IDBI - Industrial Development Bank of India

IDRBT - Institute for Development and Research in Banking Technology

IFRS - International Financial Reporting Standards

IIP - Index of Industrial Production

IMF - International Monetary Fund

IOSCO - International Organisation of Securities Commissions

IRDA - Insurance Regulatory and Development Authority

IRFs - Interest Rate Futures

IT - Information Technology

KCC - Kisan Credit Card

KMs - Kilometres

KYC - Know Your Customer

LAF - Liquidity Adjustment Facility

LIBOR - London Inter-Bank Offered Rate

LIC - Life Insurance Corporation of India

M3

- Broad Money

MDBs - Multilateral Development Banks

MF - Mutual Fund

MFI - Micro-Finance Institution

MMMFs - Money Market Mutual Funds

MoUs - Memorandum of Understanding

MPLS - Multi-Protocol Label Switching

MSEs - Micro and Small Enterprises

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MSMEs - Micro, Small and Medium Enterprises

MSS - Market Stabilisation Scheme

NABARD - National Bank for Agriculture and Rural Development

NBFCs-ND-SI - Systemically Important Non-Deposit taking Non-Banking FinancialCompanies

NBFCs - Non-Banking Financial Companies

NDA - Net Domestic Assets

NDS - Negotiated Dealing System

NDTL - Net Demand and Time Liabilities

NECS - National Electronic Clearing Service

NEFT - National Electronic Funds Transfer

NER - North-Eastern Region

NFEA - Net Foreign Exchange Assets

NFS - National Financial Switch

NGO - Non-Government Organisations

NHB - National Housing Bank

NIMC - National Implementing and Monitoring Committee

NPAs - Non-Performing Assets

NR(E)RA - Non-Resident (External) Rupee Account

NRI - Non-Resident Indian

OECD - Organisation for Economic Co-operation and Development

OMO - Open Market Operation

OTC - Over-the-Counter

PACS - Primary Agricultural Credit Society

PDs - Primary Dealers

PDO - Public Debt Office

PDO-NDS - Public Debt Office – Negotiated Dealing System

PFRDA - Provident Fund Regulatory and Development Authority

PSBs - Public Sector Banks

PSUs - Public Sector Undertakings

Q - Quarter

RBI - Reserve Bank of India

RC - Reconstruction Companies

RE - Revised Estimates

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RIDF - Rural Infrastructure Development Fund

RM - Reserve Money

RRBs - Regional Rural Banks

RSETI - Rural Self Employment Training Institute

RTGS - Real Time Gross Settlement

SASF - Stressed Asset Stabilisation Fund

SC - Securitisation Companies

SCBs - Scheduled Commercial Banks

SDLs - State Development Loans

SEBI - Securities and Exchange Board of India

SFMS - Structured Financial Messaging System

SGL - Subsidiary General Ledger

SHG - Self-Help Group

SIDBI - Small Industries Development Bank of India

SLBC - State Level Bankers’ Committee

SLR - Statutory Liquidity Ratio

SMEs - Small and Medium Enterprises

SMO - Special Market Operations

SR - Security Receipt

SPV - Special Purpose Vehicle

STCRC - Short-Term Co-operative Rural Credit

STRIPS - Separate Trading of Registered Interest and Principal Securities

TAC - Technical Advisory Committee

TAFCUB - Task Force on Urban Co-operative Bank

TBs - Treasury Bills

UCBs - Urban Co-operative Banks

UK - United Kingdom

US - United States of America

WB - World Bank

WMA - Ways and Means Advance

WPI - Wholesale Price Index

WTO - World Trade Organisation

Y-o-Y - Year-on-Year

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Reserve Bank of IndiaAnnual Policy Statement 2009-10

ByDr. D. Subbarao

Governor

This annual policy statement for2009-10 is set in the context ofexceptionally challenging circumstances inthe global economy. The crisis has calledinto question several fundamentalassumptions and beliefs governingeconomic resilience and financial stability.What started off as turmoil in the financialsector of the advanced economies hassnowballed into the deepest and mostwidespread financial and economic crisisof the last 60 years. With all the advancedeconomies in a synchronised recession,global GDP is projected to contract for thefirst time since the World War II, anywherebetween 0.5 and 1.0 per cent, according tothe March 2009 forecast of the InternationalMonetary Fund (IMF). The World TradeOrganisation (WTO) has forecast thatglobal trade volume will contract by 9.0 percent in 2009.

2. Governments and central banksaround the world have responded to thecrisis through both conventional andunconventional fiscal and monetarymeasures. These measures have beencriticised for their size, timing, sequencingand design as also, more importantly, fortheir economic and ideologicalunderpinnings. The most voluble criticismhas been that ‘purely national responses’are inadequate to address a virulent global

crisis. In recognition of a pressing needfor global co-ordination and co-operation,particularly in order to inspire the trust andconfidence of economic agents around theworld, leaders of the G-20 group of nationsmet twice in the last six months. At theirrecent meeting in early April 2009, theG-20 leaders collectively committed to takedecisive, co-ordinated and comprehensiveactions to revive growth, restore stabilityof the financial system, restart the impairedcredit markets and rebuild confidence infinancial markets and institutions.

3. Despite some apprehensions priorto the meeting, the overall impact of theG-20 meeting in managing marketperceptions has been positive. Even so, theglobal financial situation remains uncertainand the global economy continues to causeanxiety for several reasons. There is as yetno clear estimate of the quantum of taintedassets, and doubts persist on whether theinitiatives underway are sufficient to restorethe stability of the financial system. Thereis continued debate on the adequacy of thefiscal stimulus packages across countries,and their effectiveness in arresting thedownturn, reversing job losses and revivingconsumer confidence. Many major centralbanks have nearly or totally exhausted theirconventional weaponry of calibratingpolicy interest rates and are now resorting

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to unconventional measures such asquantitative and credit easing. Given theerosion of the monetary policy transmissionmechanism, there are concerns about whenand to what extent monetary response,admittedly aggressive, will begin to havean impact on reviving credit flows andspurring aggregate demand.

4. Like all emerging economies,India too has been impacted by the crisis,and by much more than what wasexpected earlier. The extent of impact hascaused dismay, mainly on two grounds:first, because our financial sector remainshealthy, has had no direct exposure totainted assets and its off-balance sheetactivities have been limited; and second,because India’s merchandise exports, atless than 15 per cent of GDP, are relativelymodest. Despite these mitigating factors,the impact of the crisis on India evidencesthe force of globalisation as also India’sgrowing two-way trade in goods andservices and financial integration with therest of the world.

5. After clocking annual growth of 8.9per cent on an average over the last fiveyears (2003-08), India was headed for acyclical downturn in 2008-09. But thegrowth moderation has been much sharperbecause of the negative impact of the crisis.In fact, in the first two quarters of 2008-09,the growth slowdown was quite modest; thefull impact of the crisis began to be feltpost-Lehman in the third quarter, whichrecorded a sharp downturn in growth. Theservices sector, which has been our primegrowth engine for the last five years, isslowing, mainly in construction, transportand communication, trade, hotels and

restaurants sub-sectors. For the first timein seven years, exports have declined inabsolute terms for five months in a rowduring October 2008-February 2009.Recent data indicate that the demand forbank credit is slackening despitecomfortable liquidity in the system.Dampened demand has dented corporatemargins while the uncertainty surroundingthe crisis has affected business confidence.The index of industrial production (IIP) hasbeen nearly stagnant in the last five months(October 2008 to February 2009), of whichtwo months registered negative growth.Investment demand has also decelerated.All these indicators suggest that growth willmoderate more than what had beenexpected earlier.

6. Despite the adverse impact asnoted above, there are several comfortingfactors that have helped India weather thecrisis. First, our financial markets,particularly our banks, have continued tofunction normally. Second, India’scomfortable foreign exchange reservesprovide confidence in our ability to manageour balance of payments notwithstandinglower export demand and dampenedcapital flows. Third, headline inflation,as measured by the wholesale price index(WPI), has declined sharply. Consumerprice inflation too has begun to moderate.Fourth, because of mandated agriculturallending and social safety-net programmes,rural demand continues to be robust.

7. Both the Government and theReserve Bank responded to the challengeof minimising the impact of crisis on Indiain co-ordination and consultation. TheReserve Bank shifted its policy stance from

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monetary tightening in response to theelevated inflationary pressures in the firsthalf of 2008-09 to monetary easing inresponse to easing inflationary pressuresand moderation of growth engendered bythe crisis. The Reserve Bank’s policyresponse was aimed at containing thecontagion from the global financial crisiswhile maintaining comfortable domesticand forex liquidity. Taking a cue from theReserve Bank’s monetary easing, mostbanks have reduced their deposit andlending rates.

8. The Central Government launchedthree fiscal stimulus packages duringDecember 2008-February 2009. Thesestimulus packages came on top of analready announced expanded safety-netprogramme for the rural poor, the farm loanwaiver package and payout following the

Sixth Pay Commission report, all of whichtoo added to stimulating demand.

9. This annual policy statement for2009-10 is organised in two parts. Part Acovers Monetary Policy which provides anassessment of the Macroeconomic andMonetary Developments (Section I), theStance of Monetary Policy (Section II) andMonetary Measures (Section III). Part B onDevelopmental and Regulatory Policiescovers Financial Stability (Section I),Interest Rate Policy (Section II), FinancialMarkets (Section III), Credit DeliveryMechanism and other Banking Services(Section IV), Prudential Measures(Section V) and Institutional Developments(Section VI). This statement should be readand understood together with the analyticalreview of Macroeconomic and MonetaryDevelopments released yesterday.

Global Outlook

10. The global outlook has continuedto deteriorate in the last quarter withprojections for global growth in 2009undergoing rapid downward revision.According to the IMF’s March 2009forecast, global growth is projected toshrink by 0.5 to 1.0 per cent in 2009 incontrast to an expansion of 3.2 per cent in2008. Other projections are even more dire.The World Bank estimates global GDP tocontract by 1.7 per cent and the OECD byas much as 2.7 per cent. In the US,

Part A. Monetary Policy Statement 2009-10

economic activity has declined sharply,driven mainly by the decline in consumptionand exports. The Euro area too is in a severeand synchronised contraction. Reflectingsharp demand contraction, consumer priceinflation has reached near zero in severaladvanced countries, raising concerns aboutsustained deflation on the way forward. Theunemployment rate in the US has risen to8.5 per cent, the highest since 1983.Unemployment rates in the Euro area, theUK and Japan too increased significantly.The WTO projects that global trade willshrink by 9.0 per cent in volume terms in

I. Macroeconomic and Monetary Developments

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2009, down from an increase of 2.0 per centin 2008. Between 1990 and 2007, globaltrade grew twice as fast as global GDP; ina sharp reversal of this ‘trade as the engineof growth’ paradigm, in 2009 global tradeis projected to shrink twice as much asglobal GDP.

11. In advanced countries, substantialinjection of liquidity and successive cutsin the policy rates have resulted in thesoftening of short-term interest rates,particularly in the overnight segment.However, the transmission to the creditmarket has been impaired, suggesting thatthe process of deleveraging is incomplete,asset prices have yet to stabilise and thatcredit spreads need to narrow further. Banksand financial institutions are still in theprocess of recognising losses arising out ofoff-balance sheet exposures. This raisesconcerns about the extent of requiredrecapitalisation, and this uncertainty isinhibiting fresh lending. Most importantly,the global financial system is yet to recoverthe forfeited trust and confidence. Underthe G-20 initiative, efforts are underway tostrengthen the global financial architectureand restore the global growth momentumthrough co-ordinated actions.

Emerging Market Economies

12. The IMF projects that the GDPgrowth of EMEs will decelerate to a rangeof 1.5-2.5 per cent in 2009, down from 6.1per cent in 2008. This downturn is clearevidence that the forces of globalisation aretoo strong for the decoupling hypothesis towork. Even across EMEs, there are widevariations: several countries are likely topost negative growth, while significant

positive contributions are expected fromChina and India. The crisis spread fromadvanced countries to EMEs, as is nowclear, through both trade and financechannels. The slump in export demand andtighter trade credit caused deceleration inaggregate demand; reversal of capital flowsled to equity market losses and currencydepreciations; global liquidity tighteningresulted in lower external credit flows toEMEs; and market rigidities and erosion ofconfidence led to widening of creditspreads. Like advanced countries, EMEstoo responded to the challenge of managingthe crisis through fiscal and monetaryactions, but these measures will not havefull impact until the global situation stabilisesand trade and credit flows are restored. TheG-20 commitment to desist from all formsof protectionism and to maintain opentrade and investment regimes is a sourceof comfort to EMEs in an otherwisediscouraging external environment.

Domestic Outlook

13. Economic activity in India sloweddown in Q1 and Q2 of 2008-09 ascompared with over 9.0 per cent growthin the previous three years. However,growth decelerated sharply in Q3 followingthe failure of Lehman Brothers inmid-September 2008 and knock-on effectsof the global financial crisis on the Indianeconomy. Consequently, the growth rateduring the first three quarters (April-December) of 2008-09 slowed downsignificantly to 6.9 per cent from 9.0 percent in the corresponding period of theprevious year (Table 1). The advanceestimates of the Central StatisticalOrganisation (CSO) released in February

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Table 1: Real GDP Growth (%)

Q1 Q2 Q3 April-December

Sector (April-June) (July-September) (October-December)

2007-08 2008-09 2007-08 2008-09 2007-08 2008-09 2007-08 2008-09

Agriculture 4.4 3.0 4.4 2.7 6.9 -2.2 5.5 0.6Industry 8.5 5.2 7.5 4.7 7.6 0.8 7.9 3.5Services 10.7 10.2 10.7 9.6 10.1 9.5 10.5 9.7

Overall 9.1 7.9 9.1 7.6 8.9 5.3 9.0 6.9

Source: Central Statistical Organisation (CSO).

2009 have placed the real GDP growth for2008-09 at 7.1 per cent.

14. The last Annual Policy Statementof the Reserve Bank released in April 2008placed real GDP growth for 2008-09 in therange of 8.0-8.5 per cent. Around thattime, the IMF had projected the globalgrowth to be at 3.7 per cent in 2008. As theyear progressed and the crisis unfolded,economic prospects globally deterioratedrapidly and at home in India in Q32008-09. Beginning July 2008, the IMFmade frequent reductions in its growthforecasts for 2008. The Reserve Bank tooreflected the deteriorating outlook byrevising downward its growth projection forIndia for 2008-09 to 7.5-8.0 per cent in theMid-Term Review (October 2008) andfurther down to 7.0 per cent with adownward bias in the Third Quarter Review(January 2009). The downside risks havesince materialised and the GDP growth for2008-09 is now projected to turn out to bein the range of 6.5 to 6.7 per cent.

Agriculture

15. The second advance estimates ofthe Ministry of Agriculture released inFebruary 2009 have placed total foodgrainsproduction in 2008-09 at 227.9 million

tonnes, lower than the production of 230.8million tonnes in the previous year.Subsequent information on good sowing forrabi crops and the trend in procurementsuggests that agricultural production during2008-09 may turn out to be better thanearlier anticipated.

Industry

16. During 2008-09 so far (April-February), industrial growth based on theindex of industrial production (IIP),decelerated to 2.8 per cent, down by morethan two-third from 8.8 per cent in thecorresponding period of the previous year.While IIP growth was 5.0 per cent in thefirst half of 2008-09, the average growth inthe following five months was insignificant(0.2 per cent). There, however, have beensome incipient positive signs. Although theIIP contracted by 1.2 per cent in February2009, machinery and equipment (other thantransport equipment) exhibited double digitgrowth. In terms of use-based classification,capital goods production too registereddouble digit growth.

Demand Components of GDP

17. Private consumption andinvestment demand decelerated during

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Q3 of 2008-09. Government consumptiondemand, however, registered a sharpincrease, reflecting the partial payout ofthe Sixth Pay Commission Award andother fiscal stimulus measures. As aresult, the share of governmentconsumption demand in GDP increasedsignificantly. Deceleration in net exportsgrowth in the successive quarters of2008-09 had an adverse impact on theoverall GDP growth (Table 2).

Corporate Performance

18. After registering robust growthduring the five year period 2003-08, theperformance of the private non-financialcorporate sector deteriorated in the firstthree quarters of 2008-09. Sales growthof companies, which continued to bestrong in Q1 and Q2, decelerated sharplyin Q3 of 2008-09. Net profits, whichrecorded an average annual growth ofover 40 per cent during 2003-08, recordeda significantly lower growth in the first

quarter of 2008-09. In the second quarter,net profits declined, although grossprofits continued to increase, albeitmarginally. In the third quarter, evengross profits declined sharply (Table 3).Profit margins were eroded by higherinput costs, increased interest outgo,significant drop in non-sales income andlosses on foreign currency relatedtransactions. While moderation ininternal accruals has an adverse effect oncorporate investment, decline in inputprices and reduction in borrowing costsmay have a favourable impact onprofitability going forward.

Table 2: Demand Components of GDP

2008-09 2008-09Item Advance

Estimates Q1 Q2 Q3

y-o-y Growth Rate (%)

Private Final Consumption Expenditure 6.8 7.7 6.9 5.4

Government Final Consumption Expenditure 16.8 7.1 7.9 24.6

Gross Fixed Capital Formation 8.9 10.1 15.1 5.3

Net Exports -60.5 -231.5 -63.8 -54.2

Share in GDP (%)

Private Final Consumption Expenditure 57.0 59.8 58.0 59.5

Government Final Consumption Expenditure 10.6 10.3 8.7 10.0

Gross Fixed Capital Formation 32.1 32.3 35.3 31.0

Net Exports -6.5 -2.5 -10.7 -7.5

Source: Central Statistical Organisation (CSO).

Table 3: Private Corporate Sector –Growth Rates (%)

Item2006-07 2007-08 2008-09

Q1 Q2 Q3

Sales 26.5 18.3 29.3 31.8 9.5

Expenditure 24.7 18.4 33.5 37.5 12.6

Gross Profits 44.7 22.8 11.9 8.7 -26.7

Net Profits 44.0 26.2 6.9 -2.6 -53.4

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Business Confidence

19. The Industrial Outlook Survey ofthe Reserve Bank for January-March 2009indicates a further worsening of perceptionfor the Indian manufacturing sector. Theoverall business and financial sentiment,which touched a seven-year low in thepreceding quarter, slid below the neutral 100mark, for the first time since the compilationof the index began in 2002. According tothe survey, the demand for working capitalfinance during January-March 2009 fromexternal sources dropped due to slowdownin business, even as the availability offinance eased. The business confidencesurveys conducted by other agencies arealso consistent with these findings.

Lead Indicators

20. In terms of lead indicators of theeconomy, economic activity in severalservices sectors has been moderating. Cargohandled at major ports, passengers handledat airports, railway freight traffic andarrival of foreign tourists registered lower/negative growth. Strong rural demand,lagged impact of monetary and fiscalstimuli, softening of domestic input prices,investment demand from brown-fieldprojects and some restructuring initiativesare expected to have a positive impact onindustrial production in the months ahead.

Inflation

21. Headline inflation, as measured byyear-on-year variations in the wholesaleprice index (WPI), decelerated sharply fromits intra-year peak of 12.91 per cent onAugust 2, 2008 to 0.26 per cent by March28, 2009. In terms of relative contribution

to the fall in WPI inflation since August2008, mineral oils and basic metals(combined weight 15.3 per cent in WPI)together accounted for over 83 per cent ofthe decline reflecting global trend incommodity prices. The prices of foodarticles, however, are still ruling high. Theinflation based on various consumer priceindices (CPIs) continues to be near double-digit level mainly reflecting a firm trendin prices of food articles (Table 4). WPIinflation declined further to 0.18 per centas on April 4, 2009.

22. The analysis of the last four yearssuggests that WPI inflation and CPIinflation moved, by and large, in tandemtill April 2007. Thereafter, inflationmeasured in WPI and CPI tended todiverge. However, the divergence in therecent period has been unusually highreflecting the volatilities in commodityprices which have a higher weight in WPI(Chart 1). With the decline in WPI inflation,CPI inflation is expected to moderate in thecoming months. For its overall assessmentof inflation outlook for policy purposes, theReserve Bank continuously monitors thefull array of price indicators.

Fiscal Scenario

23. The finances of the CentralGovernment in 2008-09 deviatedsignificantly from the Budget Estimates(BE). Higher revenue expenditure togetherwith lower revenue receipts led to a sharpincrease in the revenue and fiscal deficits.The deviation of deficit indicators from thetargets stipulated under the FiscalResponsibility and Budget Management(FRBM) Rules was on account of several

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fiscal stimulus measures undertaken bythe Government to boost aggregatedemand. The financing gap was met byenhancement of market borrowings(Table 5).

24. Because of the fiscal stimuluspackages as also additional post-budgetitems of expenditure, Central Government’sborrowing during 2008-09 wassubstantially above the initial budget

estimates. In fact, the actual net borrowingwas more than two and half times the initialbudget estimate (Table 6).

25. The net amount raised by thegovernment by way of dated securities,additional Treasury Bills and MSSde-sequestering aggregated Rs.2,98,536 croreduring 2008-09. In addition, specialsecurities (oil and fertiliser bonds) issuedby the Central Government outside the

Table 4: Annual Inflation Rate (%)

Wholesale Price Index (WPI)March 29, 2008 March 28, 2009

(y-o-y) (y-o-y)

WPI - All Commodities 7.75 0.26WPI - Primary Articles 9.68 3.46WPI - Food Articles 6.54 6.31WPI - Fuel Group 6.78 -6.11WPI - Manufactured Products 7.34 1.42WPI - Manufactured Food Products 9.40 7.51WPI - Excluding Fuel 8.01 2.01WPI - Excluding Food Articles and Fuel 8.38 0.95

Consumer Price Index (CPI) February 2008 February 2009(y-o-y) (y-o-y)

CPI - Industrial Workers 5.47 9.63CPI - Agricultural Labourers 6.38 10.79CPI - Rural Labourers 6.11 10.79CPI - Urban Non-manual Employees # 4.84 10.38

# Pertains to January.

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Table 5: Fiscal Position of the Central Government: 2008-09

ItemAmount Difference

(Rs. crore) (per cent)

Budget Estimates Revised Estimates

1. Revenue Receipts 6,02,935 5,62,173 -6.8

2. Capital Receipts 1,47,949 3,38,780 129.0of which: Market Loans 1,00,571 2,61,972 160.5

3. Non-Plan Expenditure 5,07,498 6,17,996 21.8

4. Plan Expenditure 2,43,386 2,82,957 16.3

5. Revenue Expenditure 6,58,119 8,03,446 22.1

6. Capital Expenditure 92,765 97,507 5.1

7. Revenue Deficit 55,184 2,41,273 337.2(1.0) (4.4)

8. Fiscal Deficit 1,33,287 3,26,515 145.0(2.5) (6.0)

Notes : (i) The receipts are net of repayments.(ii) Figures in parentheses are percentages to GDP.

Source: Interim Budget 2009-10 of the Central Government.

market borrowing programme amounted toRs.95,942 crore in 2008-09. As against theinitial estimate of Rs.47,044 crore, the StateGovernments raised a net amount ofRs.1,03,766 crore during 2008-09 (Table 7).The combined market borrowings of theCentral and State Governments in 2008-09were nearly two and half times their netborrowings in 2007-08. Even as theincrease in borrowing was large and abrupt,it was managed in a non-disruptive mannerthrough a combination of measures such as

unwinding under the market stabilisationscheme (MSS), open market operations andeasing of monetary conditions. Theweighted average yield of CentralGovernment dated securities issued during2008-09 was lower at 7.69 per cent ascompared with 8.12 per cent in the precedingyear. The weighted average maturity ofthese securities was 13.80 years, whichwas lower than 14.90 years in 2007-08.

26. Reflecting the continued need forfiscal stimulus in 2009-10, the borrowingrequirements of both the Central and StateGovernments are estimated to be higher ascompared with 2008-09 (Table 8).

27. According to the borrowingcalendar released for the first half (April-September) of 2009-10, net marketborrowings of the Central Government arelikely to be of the order of Rs.2,07,364crore. However, after adjusting for MSSunwinding and the Reserve Bank’s support

Table 6: Central GovernmentBorrowings: 2008-09

(Rs. crore)

BE RE ActualItem (February (March

2008) 2009)

Gross Borrowing * 1,76,453 3,42,769 3,18,550

Net Borrowing 1,13,000 3,29,649 2,98,536

* Pertains to dated securities and 364-day TreasuryBills.

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by way of open market operations, netsupply of fresh securities is expected to beof the order of Rs.85,364 crore. Althoughthe fresh supply of securities will be higherthan the first half of the last year, it will beof much lower order as compared with thefirst half of 2007-08 (Table 9).

28. Keeping in view the large budgetedgovernment market borrowing in 2009-10coming on top of a substantial expansionin market borrowing in 2008-09, it wasimportant for the Reserve Bank to providecomfort to the market so that the borrowingprogramme is conducted in a non-disruptive

manner. Accordingly, the Reserve Banksimultaneously indicated its intention topurchase government securities under openmarket operations (OMO) for an indicativeamount of Rs.80,000 crore during the firsthalf of 2009-10.

29. To contain the growth slowdownduring 2008-09, the Central Governmentannounced three fiscal stimulus measuresduring December 2008-February 2009.The Government had also providedadditional expenditure of Rs.1,48,093crore (2.7 per cent of GDP) through twosupplementary demands for grants during

Table 7: Net Market Borrowings of the Central and State Governments (Rs.crore)

Item 2007-08 2008-09

A. Central Government 1,08,998 2,98,536i. Dated Securities 1,10,671 2,16,972ii. Additional 364-day T-Bills - 1,167 13,345iii. Additional 182-day T-Bills - 76 10,995iv. Additional 91-Day T-Bills - 431 45,224v. MSS De-sequestering 0 12,000

B. State Governments 56,224 1,03,766

Total (A+B) 1,66,895 4,02,302

Memo Items:

i. Special Securities Issued outside the Market Borrowing Programme 38,050 95,942ii. Net Issuances under MSS 1,05,691 -81,781

Table 8: Borrowings of the Central and State Governments: 2009-10 (Rs. crore)

Item 2008-09 2009-10

Central GovernmentGross Market Borrowings 3,18,550 3,98,552Net Market Borrowings 2,98,536 3,08,647 *

State GovernmentsNet Market Borrowings 1,03,766 1,26,000 **

Total Net Market Borrowings 4,02,302 4,34,647

* Interim Budget Estimates.** Estimated. The State Governments have been allowed an additional 0.5 per cent of Gross State Domestic

Product (GSDP) as a part of the fiscal stimulus package.

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Table 9: Central Government Borrowings: First Half of the Fiscal Year(Dated Securities)

(Rs. crore)

ItemFirst Half (April-September) Borrowings

2007-08 2008-09 2009-10

Gross Market Borrowings 97,000 1,06,000 2,41,000

Less: Repayments 30,554 44,028 33,636

Net Market Borrowings 66,446 61,972 2,07,364

Less: OMO Purchases 0 0 80,000

Less: MSS Unwinding* 0 0 42,000

Add: MSS Issuances (net)* 69,077 5,263 0

Net Supply of Fresh Securities 1,35,523 67,235 85,364

* Includes dated securities and Treasury Bills.

October-December 2008. The total revenueloss due to tax reductions amounted toRs.8,700 crore (0.2 per cent of GDP) in2008-09 and Rs.28,100 crore (0.5 per centof GDP) in 2009-10. The additionalstimulus measures during 2008-09 work outto about 2.9 per cent of GDP. Furthermore,the revenue collection was adverselyimpacted by the economic slowdown.Consequently, the Interim Budget for2009-10 revised the estimates for 2008-09– revenue deficit to 4.4 per cent and thefiscal deficit to 6.0 per cent of GDP asagainst the budget estimates of 1.0 per centand 2.5 per cent respectively. In addition,special bonds amounting to 1.8 per cent ofGDP were issued to oil marketing companiesand fertiliser companies during 2008-09.

30. As per the Interim Budget 2009-10,the revenue deficit and the fiscal deficit areprojected to decline only moderately to 4.0per cent and 5.5 per cent respectively during2009-10. The Government in itsmacroeconomic framework statement,indicated that in view of the compelling

need to adjust the fiscal policy to take careof exceptional circumstances throughwhich the economy is passing, the fiscalconsolidation process has to be put on holdtemporarily. The process of fiscalconsolidation should resume once there isan improvement in economic conditions.

31. Currently available informationindicates that the consolidated budgetedrevenue surplus of the States in 2008-09may not materialise. Consequently, theconsolidated fiscal deficit of the States isexpected to rise to around 3.0 per cent ofGDP. The combined fiscal deficit of theCentral and State Governments during2008-09 would be about 9.0 per cent ofGDP. Accounting for special securitiesissued by the Central Government outsidethe market borrowing programme, thecombined fiscal deficit works out to about10.8 per cent of GDP. While some of theincrease in the revenue and fiscal deficitsis on account of post-budget expenditurecommitments such as payment of arrearsresulting from the Sixth Pay Commission

12

Award, a substantial increase is also due tothe economic downturn arising from theimpact of the global financial crisis.Although the fiscal stimulus packages havemeant deviation from the roadmap laid outby the FRBM Act, reversing theconsolidation process of the last severalyears, they were warranted under theprevailing circumstances. It is criticallyimportant, however, that the Centre andStates re-anchor to a revised FRBMmandate once the immediacy of the crisisis behind us.

Monetary Conditions

32. Growth in key monetary aggregates– reserve money (RM) and money supply(M

3) – in 2008-09 reflected the changing

liquidity positions arising from domesticand global financial conditions and themonetary policy response. Reserve moneyvariations during 2008-09 largely reflectedthe increase in the currency in circulationand reduction in the cash reserve ratio(CRR) of banks.

33. As indicated in the Third QuarterReview, reduction in the CRR has three

inter-related effects on reserve money.First, it reduces reserve money as bankers’required cash deposits with the ReserveBank fall. Second, the money multiplierrises. Third, with the increase in the moneymultiplier, M3 expands with a lag. Whilethe initial expansionary effect is strong,the full effect is felt in 4-6 months.Reflecting these changes, the year-on-yearincrease in reserve money in 2008-09 wasmuch lower than in the previous year.However, adjusted for the first round effectof CRR reduction, deceleration in reservemoney growth was less pronounced. Theannual M3 growth in 2008-09, thoughlower compared with the previous year,was also below the trajectory projectedin the Third Quarter Review of January2009 (Table 10).

34. Monetary management during2008-09 was dominated by the response tothe spillover effects of global financialcrisis and the need to address slackeningof domestic demand conditions, especiallyduring the third quarter. As the ReserveBank had to provide foreign exchangeliquidity to meet the demand from

Table 10: Annual Variations in Monetary Aggregates (Per cent)

ItemAnnual Variations

2007-08 2008-09

Reserve Money 31.0 6.4

Reserve Money (adjusted for CRR changes) 25.3 19.0

Currency in Circulation 17.2 17.0

Money Supply (M3) 21.2 18.4

M3 (Policy Projection) 17.0-17.5 * 19.0**

Money Multiplier 4.33 4.82

* Policy projection for the financial year as indicated in the Annual Policy Statement 2008-09 (April 2008).** Policy projection for the financial year as indicated in the Third Quarter Review of Monetary Policy

2008-09 (January 2009).

13

importers and contain volatility in theforeign exchange market arising out ofcapital outflows by foreign institutionalinvestors (FIIs), its net foreign exchangeassets (NFEA) declined. This had an overallcontractionary effect on rupee liquidity. TheReserve Bank addressed this issue byproviding rupee liquidity throughexpansion of net domestic assets (NDA) by(i) conventional open market operations;(ii) special 14-day term repo facility forbanks; (iii) buy-back of securities heldunder the market stabilisation scheme;(iv) special market operations, including thepurchase of oil bonds; (v) enlargement ofexport credit refinance window; (vi) specialrefinance facility for banks for addressingthe liquidity concerns of NBFCs, mutualfunds and housing finance companies;(vii) special refinance facility for financialinstitutions (SIDBI, NHB and Exim Bank);and (viii) funding to NBFCs through aspecial purpose vehicle (SPV). Thus, anotable feature of monetary operationsduring the second half of 2008-09 was thesubstitution of foreign assets by domesticassets. Consequently, liquidity conditionshave remained comfortable sincemid-November 2008 as reflected in theLAF window being generally in theabsorption mode and the call/notice rateremaining near or below the lower boundof the LAF corridor consistent with thestance of monetary policy.

Credit Conditions

35. During 2008-09, the growth innon-food bank credit (year-on-year basis)decelerated from a peak of 29.4 per cent inOctober 2008 to 17.5 per cent by March2009. At this rate, non-food credit

expansion was lower than that of 23.0per cent in 2007-08 as also the indicativeprojection of 24.0 per cent set in the ThirdQuarter Review of January 2009. Theintra-year changes in credit flow could beattributed to several factors. First, thedemand for bank credit increased sharplyduring April-October 2008 as corporatesfound that their external sources of credithad dried up, and shifted that demand todomestic credit. Second, there was a sharpincrease in credit to oil marketingcompanies by Rs.36,208 crore during April-October 2008 as compared with a declineof Rs.1,146 crore in the correspondingperiod of the previous year. In thesubsequent period, however, the demandfor credit moderated reflecting theslowdown of the economy in general andthe industrial sector in particular. Workingcapital requirements had also come downbecause of decline in commodity prices anddrawdown of inventories by the corporates.The demand for credit by oil marketingcompanies also moderated. In addition,substantially lower credit expansion byprivate and foreign banks also muted theoverall flow of bank credit during the year(Table 11).

36. Commercial banks’ investmentin SLR securities, adjusted for LAF,declined marginally from 28.4 per cent ofNDTL in March 2008 to 26.7 per cent inMarch 2009.

37. According to the data at adisaggregated level drawn from 49 banksaccounting for 95.0 per cent of total bankcredit, the year-on-year growth in bankcredit to industry as of February 2009 wasbroadly similar to that in the previous year.While credit flow to agriculture and real

14

estate was significantly higher, it was lowerfor housing. As a result, industry’s sharein total credit flow increased significantlyin 2008-09 (Table 12).

38. Significant variations have alsobeen observed in the flow of credit todifferent sectors by the three broad bankgroups during 2008-09. Credit growth bypublic sector banks to industry acceleratedin 2008-09. However, credit growth topersonal loans and services decelerated.

Credit by all the three bank groups to realestate accelerated significantly, while thatto small enterprises decelerated (Table 13).

Total Flow of Resources to the CommercialSector

39. The flow of resources from non-bank sources to the commercial sectorthroughout 2008-09 was lower than that inthe previous year, reflecting depresseddomestic and international capital market

Table 11: Bank Group-wise Growth in Deposits and Credit (Per cent)

Bank GroupAs on March 28, 2008 As on March 27, 2009

(y-o-y) (y-o-y)

Deposits

Public Sector Banks 22.9 24.1Foreign Banks 29.1 7.8Private Sector Banks 19.9 8.0Scheduled Commercial Banks* 22.4 19.8

Credit

Public Sector Banks 22.5 20.4Foreign Banks 28.5 4.0Private Sector Banks 19.9 10.9Scheduled Commercial Banks* 22.3 17.3

* Including RRBs.

Table 12: Annual Sectoral Flow of Credit

Sector

As on February 15, 2008 As on February 27, 2009(y-o-y) (y-o-y)

Amount % share Variations Amount % share Variations(Rs. crore) in total (per cent) (Rs. crore) in total (per cent)

Agriculture 34,013 9.2 16.4 52,742 13.0 21.5

Industry 1,67,819 45.2 25.9 2,13,261 52.5 25.8

Real Estate 11,361 3.1 26.7 34,533 8.5 61.4

Housing 26,930 7.3 12.0 19,012 4.7 7.5

NBFCs 20,979 5.7 48.6 26,651 6.6 41.7

Overall Credit 3,71,053 100.0 22.0 4,06,304 100.0 19.5

Notes: 1. Credit growth for February 2008 is calculated with outstanding as on February 15, 2008 to obtainvariation over comparable 26-week data.

2. Data are provisional.

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Table 13: Sectoral Deployment of Credit: Bank Group-wise

Item

Variation (y-o-y) (%)

Public Sector Private Sector Foreign Banks* Banks Banks*

As on As on As on As on As on As onFebruary February February February February February15, 2008 27, 2009 15, 2008 27, 2009 15, 2008 27, 2009

Non-food Gross Bank Credit (1 to 4) 22.3 23.9 19.0 9.1 28.8 1.61. Agriculture and Allied Activities 19.3 19.2 - 1.3 39.0 NA NA2. Industry 23.2 31.0 35.2 7.4 35.0 6.53. Personal Loans 15.6 11.6 8.5 7.4 14.5 -8.1 of which:

Housing 13.2 10.0 13.5 4.9 - 2.1 -4.44. Services 28.6 24.4 28.5 4.5 41.2 6.9 of which:

Real Estate Loans 47.9 79.1 6.9 13.9 - 36.0 40.5 Non-Banking Financial Companies 53.0 44.8 14.0 38.1 64.0 20.8

Memo Item

Small Enterprises** 49.0 36.7 209.5 23.2 190.4 59.5

* The share of some private sector banks and foreign banks in total bank credit to agriculture andsmall scale enterprises is small.

** Includes small manufacturing and service enterprises.NA: Not Available.Note: See also footnotes to Table 12.

conditions. However, till mid-January 2009,higher bank credit growth compensated forthe decline in resources from non-banks.Beginning from the fortnight ended January16, 2009, non-food bank credit growthturned lower than the previous year.

Reflecting moderation in both bank creditand funds from other sources, the total flowof resources to the commercial sector frombanks and other sources during 2008-09was significantly lower than that in theprevious year (Table 14).

Table 14: Flow of Financial Resources to the Commercial Sector

(Rs. crore)

Item 2007-08 2008-09

From Banks 4,44,807 4,14,902

From Other Sources* 3,35,698 2,64,138

Total Resources 7,80,505 6,79,040

* Includes borrowings from financial institutions and NBFCs as well as resources mobilised from the capitalmarket and by way of ECBs, FCCBs, ADRs/GDRs, FDI and short-term credit as per the latest availabledata, adjusted for double counting.

Note: Data in this table also include gross investments by LIC in corporate debt and infrastructure andsocial sector, which were not included in the corresponding table presented in Third Quarter Review,January 2009.

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Table 16: Reduction in Deposit and Lending Rates(October 2008 - April 2009*)

(Basis points)

Bank Group Deposit Rates Lending Rates (BPLR)

Public Sector Banks 125-250 125-225

Private Sector Banks 75-200 100-125

Five Major Foreign Banks 100-200 0-100

* As on April 18, 2009.

Interest Rates

40. Since mid-September 2008, theReserve Bank has cut the repo rate by 400basis points and the reverse repo rate by250 basis points. The CRR was alsoreduced by 400 basis points of NDTL ofbanks (Table 15).

41. Taking cues from the reduction inthe Reserve Bank’s policy rates and easyliquidity conditions, all public sector banks,most private sector banks and some foreignbanks have reduced their deposit andlending rates. The reduction in the range ofterm deposit rates between October 2008 -April 18, 2009 has been 125-250 basispoints by public sector banks, 75-200 basispoints by private sector banks and 100-200basis points by five major foreign banks.The reduction in the range of BPLRs was125-225 basis points by public sector

banks, followed by 100-125 basis pointsby private sector banks and 100 basis pointsby five major foreign banks (Table 16).

42. The reduction in deposit rates wasmore pronounced in respect of deposits ofup to three year maturity. The range ofBPLRs of public sector banks, privatesector and five major foreign banksdeclined between October 2008 and April18, 2009 (Table 17).

43. The reduction in BPLRs by mostpublic sector banks was in the range of125-200 basis points, followed by 50-150basis points reduction by most privatesector banks and 50 basis points reductionby foreign banks (Table 18).

44. The efficacy of the monetarytransmission mechanism hinges on theextent and the speed with which changesin the central bank’s policy rate are

Table 15: Monetary Easing by the Reserve Bank since mid-September 2008

(Per cent)

InstrumentAs at Extent of Reduction

Mid-September 2008 Early March 2009 (basis points)

Repo Rate 9.00 5.00 400

Reverse Repo 6.00 3.50 250

Cash Reserve Ratio @ 9.00 5.00 400

@ Percentage of NDTL.

17

Table 18: Reduction in BPLR by SCBs – Frequency Distribution(April 18, 2009 over October 2008)

(Number of banks)

Bank Group25 50 75 100 125 150 175 200 225 250 Total

bps bps bps bps bps bps bps bps bps bps

Public Sector Banks – – 1 – 8 8 2 7 – 1 27(27)

Private Sector Banks 1 7 3 2 1 2 – – 1 – 17(22)

Foreign Banks – 4 1 1 – – – 2 – – 8(28)

Note: Figures in parentheses indicate total number of banks operating in India.

transmitted through the term-structure ofinterest rates across markets. While theresponse to policy changes by the ReserveBank has been faster in the money andgovernment securities markets, there has

been concern that the large and quickchanges effected in the policy rates by theReserve Bank have not fully transmittedto banks’ lending rates. During the secondhalf of 2008-09, while the Reserve Bank

Table 17: Movements in Deposit and Lending Rates (Per cent)

Interest RatesOctober March April* Variation**

2008 2009 2009 (basis points)

Term Deposit Rates

Public Sector Banksa) Up to 1 year 2.75-10.25 2.75-8.25 2.75-8.00 0-225b) 1 year up to 3 years 9.50-10.75 8.00-9.25 7.00-8.75 200-250c) Over 3 years 8.50-9.75 7.50-9.00 7.25-8.50 125-125

Private Sector Banksa) Up to 1 year 3.00-10.50 3.00-8.75 3.00-8.50 0-200b) 1 year up to 3 years 9.00-11.00 7.50-10.25 7.50-9.50 150-150c) Over 3 years 8.25-11.00 7.50-9.75 7.50-9.25 75-175

Five Major Foreign Banksa) Up to 1 year 3.50-9.50 2.50-8.00 2.50-8.00 100-150b) 1 year up to 3 years 3.60-10.00 2.50-8.00 2.50-8.00 110-200c) Over 3 years 3.60-10.00 2.50-8.00 2.50-8.00 110-200

BPLRPublic Sector Banks 13.75-14.75 11.50-14.00 11.50-13.50 125-225Private Sector Banks 13.75-17.75 12.75-16.75 12.50-16.75 100-125Five Major Foreign Banks 14.25-16.75 14.25-15.75 14.25-15.75 0-100

* As on April 18, 2009.** Variation of April 18, 2009 over October 2008.

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has reduced its lending rate (repo rate) by400 basis points, most banks have loweredtheir lending rate in the range of 50-150basis points.

45. The adjustment in market interestrates in response to changes in policyrates gets reflected with some lag.However, the transmission to the creditmarket is somewhat slow on account ofseveral structural rigidities. In thiscontext, banks have brought out thefollowing constraints in their discussionswith the Reserve Bank. First, theadministered interest rate structure ofsmall savings acts as a floor to depositinterest rates. Without reduction indeposit rates, banks find it difficult toreduce lending rates exclusively on policycues. Second, while banks are allowed tooffer ‘variable’ interest rates on longer-term deposits, depositors have a distinctpreference for fixed interest rates on suchdeposits which results in an asymmetriccontractual relationship. In a risinginterest rate scenario, while depositorsretain the flexibility to prematurelywithdraw their existing deposits andre-deploy the same at higher interestrates, banks have to necessarily carrythese high cost deposits till their maturityin the downturn of the interest rate cycle.Third, during periods of credit boom asin 2004-07, competition among banks forwholesale deposits often hardens depositinterest rates, thereby further increasingthe cost of funds. Fourth, the linkage ofconcessional administered lending rates,such as for agriculture and exports, tobanks’ BPLRs makes overall lendingrates less flexible. Fifth, the persistenceof large volumes of market borrowing by

the government hardens interest rateexpectations. From the real economyperspective, however, for monetarypolicy to have demand-inducing effects,lending rates will have to come down.

46. The changes in BPLR do notfully reflect the changes in the effectivelending rates. During the pre-policyconsultations with the Reserve Bank,banks pointed out that lending ratesshould not be assessed only in terms ofreduction in BPLRs since as much asthree-quarters of lending is at rates belowBPLR which includes lending toagriculture, export sector, and well-ratedcompanies, including PSUs. Theweighted average lending rate, which was11.9 per cent in 2006-07, increased to12.3 per cent (provisional) in 2007-08.According to the information collectedfrom select banks, the average yield onadvances, a proxy measure of effectivelending rate, in 2008-09 was around 10.9per cent. As most of the commercialbanks have cut their BPLRs in the secondhalf of 2008-09, the effective lending ratetowards the end of 2008-09 could beeven lower than 10.9 per cent .Nevertheless, i t may be noted thatcurrent deposit and lending rates arenow higher than in 2004-2007, althoughthe policy rates are now lower than in thatperiod. This is reflective of the hysteresisin the system. Reduction in public sectorbanks deposit rates in 1-3 year maturityfrom 9.50-10.75 per cent in October 2008to 7.00-8.75 per cent by April 2009 hasnot been commensurate with themoderation in inflation. Judging fromthe experience of 2004-07, deposit ratescan be lower and should come down.

19

47. Notwithstanding the abovefactors, there is still a scope for banks toreduce their lending rates. Pointing to thecurrent WPI inflation rate near zero, somehave argued that real lending rates are veryhigh. The point-to-point variations in WPIexaggerate the level of real interest ratedue to divergence between various priceindices as also the inflation expectations.Notwithstanding computational challenges,even when inflation is taken as 4.0-4.5per cent based on the underlying trend, reallending rates would still appear to be high.Banks, therefore, must strive to reducetheir lending rates further.

Financial Markets

48. Since October 2008, interest rateshave declined across the term structure inthe money and government securitiesmarkets (Table 19). The call/notice rateshave remained near or below the lowerbound of the LAF corridor from November2008. While the secondary market yieldon the 10-year government securitytouched an intra-year low of 5.11 per cent

on December 30, 2008, it then generallyincreased in the wake of the large marketborrowing programme of the Government,reaching 7.08 per cent on March 30, 2009.The yield has subsequently declined onaccount of substantial easing of liquidityand reduction in inflation.

49. During 2008-09, the rupee, withsignificant intra-year variation, generallydepreciated against major currenciesexcept pound sterling on account ofwidening of trade and current accountdeficits as well as capital outflows. Duringthe current fiscal year (up to April 17,2009), the rupee has generally remainedsteady (Chart 2).

50. During 2008-09, equity marketsweakened in tandem with global stockmarkets, reflecting general deterioration insentiment, FII outflows, slowdown inindustrial growth and lower corporateprofits. The BSE Sensex declined to 8160on March 9, 2009 from a peak of 20873recorded on January 8, 2008; it closedhigher at 11023 on April 17, 2009.

Table 19: Interest Rates - Monthly Average (Per cent)

Segment/InstrumentMarch October January March April 17,2008 2008 2009 2009 2009

Call Money 7.37 9.90 4.18 4.17 3.47

CBLO 6.37 7.73 3.77 3.60 2.60

Market Repo 6.72 8.40 4.27 3.90 2.86

Commercial Paper 10.38 14.17 9.48 9.79 7.00

Certificates of Deposit 10.00 10.00 7.33 6.73# 4.00

91-day Treasury Bills 7.33 7.44 4.69 4.77 4.09

10-year Government Security 7.69 7.80 5.82 6.57 6.41

# Pertains to mid-March 2009.

20

External Sector

51. India’s current account deficit(CAD) widened during 2008-09 (April-December) in comparison with thecorresponding period of the previous year.As net capital inflows declined sharply,the overall balance of payments (BoP)position turned negative resulting indrawdown of reserves (Table 20).

52. The overall approach to themanagement of India’s foreign exchangereserves takes into account the changing

composition of the balance of paymentsand endeavours to reflect the ‘liquidityrisks’ associated with different types offlows and other requirements. As capitalinflows during 2007-08 were far inexcess of the normal absorptive capacityof the economy, there was substantialaccretion to foreign exchange reserves byUS$ 110.5 billion. As capital inflowsreduced sharply, the foreign exchangereserves declined by US$ 53.7 billionfrom US$ 309.7 billion as at end-March2008 to US$ 256.0 billion by

Table 20: India’s Balance of Payments(US $ billion)

ItemApril-December

2007-08 2008-09

Exports 113.6 133.5

Imports 182.9 238.9

Trade Balance -69.3 -105.3

Invisibles, net 53.8 68.9

Current Account Balance -15.5 -36.5

Capital Account* 82.7 16.1

Change in Reserves# -67.2 20.4

* Including errors and omissions.# On a BoP basis (i.e., excluding valuation): (-) indicates increase; (+) indicates decrease.

21

end-December 2008, including valuationlosses. Excluding valuation effects, thedecline was US$ 20.4 billion duringApril-December 2008. India’s foreign

exchange reserves were US$ 252.0billion as at end-March 2009 whichincreased to US$ 253.0 billion by April10, 2009.

53. The policy responses in Indiasince September 2008 have been designedlargely to mitigate the adverse impact ofthe global financial crisis on the Indianeconomy. The conduct of monetary policyhad to contend with the high speed andmagnitude of the external shock and itsspill-over effects through the real,financial and confidence channels. Theevolving stance of policy has beenincreasingly conditioned by the need topreserve financial stability while arrestingthe moderation in the growth momentum.

54. The thrust of the various policyinitiatives by the Reserve Bank has been onproviding ample rupee liquidity, ensuringcomfortable dollar liquidity and maintaininga market environment conducive for thecontinued flow of credit to productivesectors. The key policy initiatives taken bythe Reserve Bank since September 2008 areset out below:

Policy Rates

• The policy repo rate under theliquidity adjustment facility (LAF)was reduced by 400 basis points from9.0 per cent to 5.0 per cent.

• The policy reverse repo rate underthe LAF was reduced by 250 basispoints from 6.0 per cent to 3.5per cent.

II. Stance of Monetary Policy

Rupee Liquidity

• The cash reserve ratio (CRR) wasreduced by 400 basis points from 9.0per cent of net demand and timeliabilities (NDTL) of banks to 5.0 percent.

• The statutory liquidity ratio (SLR) wasreduced from 25.0 per cent of NDTLto 24.0 per cent.

• The export credit refinance limit forcommercial banks was enhanced to50.0 per cent from 15.0 per cent ofoutstanding export credit.

• A special 14-day term repo facilitywas instituted for commercial banksup to 1.5 per cent of NDTL.

• A special refinance facility wasinstituted for scheduled commercialbanks (excluding RRBs) up to 1.0 percent of each bank’s NDTL as onOctober 24, 2008.

• Special refinance facilities wereinstituted for financial institutions(SIDBI, NHB and Exim Bank).

Forex Liquidity

• The Reserve Bank sold foreignexchange (US dollars) and madeavailable a forex swap facility tobanks.

22

• The interest rate ceilings on non-resident Indian (NRI) deposits wereraised.

• The all-in-cost ceiling for the externalcommercial borrowings (ECBs) wasraised. The all-in-cost ceiling forECBs through the approval routehas been dispensed with up to June30, 2009.

• The sys temical ly importantnon-deposit taking non-bankingfinancial companies (NBFCs-ND-SI)were permitted to raise short-termforeign currency borrowings.

Regulatory Forbearance

• The risk-weights and provisioningrequirements were relaxed andrestructuring of stressed assets wasinitiated.

55. A detailed listing of various policymeasures undertaken by the Reserve Bank

since September 2008 is set out inAnnex I.

Liquidity Impact

56. The actions of the Reserve Banksince mid-September 2008 have resultedin augmentation of actual/potentialliquidity of over Rs.4,22,000 crore. Inaddition, the permanent reduction in theSLR by 1.0 per cent of NDTL has madeavailable liquid funds of the order ofRs.40,000 crore for the purpose of creditexpansion (Table 21).

57. The liquidity situation hasimproved significantly following themeasures taken by the Reserve Bank. Theovernight money market rates, whichgenerally hovered above the repo rateduring September-October 2008, havesoftened considerably and have generallybeen close to or near the lower bound ofthe LAF corridor since early November2008. Other money market rates such as

Table 21: Actual/Potential Release of Primary Liquidity –since Mid-September 2008

Measure/FacilityAmount

(Rs. crore)

1. CRR Reduction 1,60,000

2. Unwinding/Buyback/De-sequestering of MSS Securities 97,781

3. Term Repo Facility 60,000

4. Increase in Export Credit Refinance 25,512

5. Special Refinance Facility for SCBs (Non-RRBs) 38,500

6. Refinance Facility for SIDBI/NHB/EXIM Bank 16,000

7. Liquidity Facility for NBFCs through SPV 25,000*

Total (1 to 7) 4,22,793

Memo: Statutory Liquidity Ratio (SLR) Reduction 40,000

* Includes an option of Rs.5,000 crore.

23

discount rates of CDs, CPs and CBLOsoftened in tandem with the overnightmoney market rates. The LAF windowhas been in a net absorption mode sincemid-November 2008. The liquidityproblem faced by mutual funds has easedconsiderably. Most commercial bankshave reduced their benchmark primelending rates. The total utilisation underthe recent refinance/liquidity facilitiesintroduced by the Reserve Bank has beenlow as the overall liquidity conditionsremain comfortable (Table 22). However,their availability has provided comfort to

the banks/FIs, which can fall back onthem in case of need.

58. The Reserve Bank has multipleinstruments at its command such as repoand reverse repo rates, cash reserve ratio(CRR), statutory liquidity ratio (SLR),open market operations, including themarket stabilisation scheme (MSS) and theLAF, special market operations, andsector-specific liquidity facilities. Inaddition, the Reserve Bank also usesprudential tools to modulate flow of creditto certain sectors consistent with financial

Table 22: Utilisation of Various Liquidity Facilities Available from the Reserve Bank –As on April 16, 2009

Refinance FacilityAvailability of Outstanding

Facility: as per centTerminal Dates Limit Outstanding of Limit

i) Export Credit Refinance Facility Standing Facility 36,446 590 1.6

ii) Special Refinance Facility forScheduled Commercial Banks(excluding RRBs) 30.09.2009 38,429 1,380 3.6

iii) Special Term Repo Facilityto Banks (for funding to MFs,NBFCs and HFCs) 30.09.2009 60,000 90 0.2

iv) Refinance Facility to SIDBI 31.03.2010 7,000 5,819 83.1

v) Refinance Facility to NHB 31.03.2010 4,000 3,220 80.5

vi) Refinance Facility toEXIM Bank 31.03.2010 5,000 2,800 56.0

vii) Liquidity Facility for NBFCs through SPV Route 30.06.2009 25,000* 750 3.0

Total (i to vii) 1,75,875 14,649 8.3

Memo Item:

Forex Swap Facility to Banks 31.03.2010 For tenor up to 1,030 –three months

* The total support from the Reserve Bank is limited to Rs.20,000 crore with an option to raise it by a furtherRs.5,000 crore.

Amount(Rs. crore)

24

stability. The availability of multipleinstruments and flexible use of theseinstruments in the implementation ofmonetary policy has enabled the ReserveBank to modulate the liquidity and interestrate conditions amidst uncertain globalmacroeconomic conditions.

Growth Projection

59. The India MeteorologicalDepartment in its forecast of South-Westmonsoon expects a normal rainfall at 96per cent of its long period average for thecurrent year. The fiscal and monetaryst imulus measures ini t iated during2008-09 coupled with lower commodityprices could cushion the downturn in thegrowth momentum during 2009-10 bystabilising domestic economic activity tosome extent. However, any upturn in thegrowth momentum is unlikely in view ofthe projected contraction in globaldemand during 2009, particularly declinein trade. While domestic financingconditions have improved, externalfinancing conditions are expected toremain tight. Private investment demandis, therefore, expected to remain subdued.On balance, with the assumption ofnormal monsoon, for policy purpose, realGDP growth for 2009-10 is placed ataround 6.0 per cent.

Inflation Projection

60. On account of slump in globaldemand, pressures on global commodityprices have abated markedly around theworld. The sharp decline in prices of crudeoil, metals, foodgrains, cotton and cementhas influenced inflation expectations in

most parts of the world. This is alsoreflected in the domestic WPI inflationreaching close to zero. Prices ofmanufactured products have deceleratedsharply, while that of the fuel group havecontracted, though inflation on account offood articles still remains high. Keepingin view the global trend in commodityprices and domestic demand-supplybalance, WPI inflation is projected ataround 4.0 per cent by end-March 2010.

61. The WPI inflation, however, isexpected to be in the negative territory inthe early part of 2009-10. However, thisshould not be interpreted as deflation forpolicy purposes. This expected negativeinflation in India has only statisticalsignificance and is not a reflection ofdemand contraction as is the case inadvanced economies. This transitory WPIinflation in negative zone may not persistbeyond the middle of 2009-10. Theconsumer price inflation as reflected invarious indices is expected to moderatefrom its present high level but wouldcontinue to remain in positive territorythrough 2009-10 unlike WPI inflation.Moreover, it may also be noted that thesharp decline in WPI inflation has not beencommensurately matched by a similardecline in inflation expectations.

62. It would be the endeavour of theReserve Bank to ensure price stabilityand anchor inflation expectations.Towards this objective, the Reserve Bankwill, as always, continue to take intoaccount the behaviour of all the priceindices and their components. Theconduct of monetary policy wouldcontinue to condit ion and contain

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perception of inflation in the range of4.0-4.5 per cent so that an inflation rateof around 3.0 per cent becomes themedium-term objective, consistent withIndia’s broader integration into the globaleconomy and with the goal ofmaintaining self-accelerating growthover the medium-term.

Monetary Projection

63. Monetary and credit aggregateshave witnessed deceleration since theirpeak levels in October 2008. The liquidityoverhang emanating from the earliersurge in capital inflows has substantiallymoderated in 2008-09. The Reserve Bankis committed to providing ample liquidityfor all productive activities on acontinuous basis. As the upside risks toinflation have declined, monetary policyhas been responding to slackeningeconomic growth in the context ofsignificant global stress. Accordingly, forpolicy purposes, money supply (M

3)

growth for 2009-10 is placed at 17.0per cent. Consistent with this, aggregatedeposits of scheduled commercial banksare projected to grow by 18.0 per cent.The growth in adjusted non-food credit,including investment in bonds/debentures/shares of public sectorundertakings and private corporate sectorand CPs, is placed at 20.0 per cent. Giventhe wide dispersion in credit growthnoticed across bank groups during2008-09, banks with strong deposit baseshould endeavour to expand credit beyond20.0 per cent. As always, these numbersare provided as indicative projections andnot as targets.

Overall Assessment

64. The global financial and economicoutlook continues to be unsettled anduncertain. The latest assessment by majorinternational agencies projecting sharpcontraction in global trade volumes in2009 has exacerbated the uncertainty. Thecurrent assessments project little chanceof global economic recovery in 2009.Despite large scale recapitalisation,write-offs and asset substitutions, sizeablechunks of assets of systemically importantbanks and financial institutions remainimpaired. It is also not clear if thedeleveraging process is complete. In sucha scenario, external financing conditionsfor emerging market economies maycontinue to remain tight and constrain theirgrowth prospects.

65. Governments and central banksall over the world have responded tothe ongoing global financial crisis byinitiating several large, aggressive andunconventional measures. There is,however, a contentious debate on whetherthese measures are adequate andappropriate and when, if at all, they willstart showing the desired results. There isa separate debate on whether the measurestaken so far, responding as they are toshort-term compulsions, are erodinglong-term sustainability. Many difficultissues will need to be addressed goingforward. There is unprecedentedco-ordinated policy action on monetary,fiscal, regulatory and institutional reformsto address the ongoing financial andeconomic crisis and strengthen theinternational financial architecture. In thiscontext, the initiatives by the leaders of

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the G-20 announced in April 2009 to:(i) restore confidence, growth, and jobs;(ii) repair the financial system to restorelending; (iii) strengthen financialregulation to rebuild trust; (iv) fund andreform the international financialinstitutions to overcome the crisis andprevent future ones; (v) promote globaltrade and investment and rejectprotectionism to underpin prosperity; and(vi) build an inclusive, green andsustainable recovery, should helpovercome the uncertainty surrounding thefinancial and economic outlook.

66. Here in India, there are severalimmediate challenges facing the economywhich would need to be addressed goingforward. First, after five years of highgrowth, the Indian economy was headed fora moderation in the first half of 2008-09.However, the growth slowdownaccentuated in the third quarter of 2008-09on account of spillover effects ofinternational developments. While themoderation in growth seems to havecontinued through the fourth quarter of2008-09, it has been cushioned by quickand aggressive policy responses both by theReserve Bank and the Government.Notwithstanding the contraction of globaldemand, growth prospects in India continueto remain favourable compared to mostother countries. While public investmentcan play a critical role in the short-termduring a downturn, private investment hasto increase as the recovery process sets in.A major macroeconomic challenge at thisjuncture is to support the drivers ofaggregate demand to enable the economyto return to its high growth path.

67. The second challenge goingforward is meeting the credit needs of thenon-food sector. Although, for the year2008-09 as a whole, credit by the bankingsector expanded, the pace of credit flowdecelerated rapidly from its peak in October2008. This deceleration has occurredalongside a significant decline in the flowof resources from non-bank domestic andexternal sources. The deceleration in totalresource flow partly reflects slowdown indemand, drawdown of inventories by thecorporates and decline in commodityprices. The expansion in credit, however,has been uneven across sectors. There is,therefore, an urgent need to boost the flowof credit to all productive sectors of theeconomy, particularly to MSMEs, to aidthe process of economic recovery. TheReserve Bank continues to maintain andwill maintain ample liquidity in thesystem. It should be the endeavour ofcommercial banks to ensure that everycreditworthy borrower is financed at areasonable cost while, at the same time,ensuring that credit quality is maintained.

68. It may be noted that bank credithad accelerated during 2004-07. This,combined with significant slowdown of theeconomy in 2008-09, may result in someincrease in NPAs. While it is not unusualfor NPAs to increase during periods of highcredit growth and downturn in the economy,the challenge is to maintain asset qualitythrough early actions. This calls for afocused approach, due diligence andbalanced judgment by banks.

69. Third, the Reserve Bank was ableto manage the large borrowing programmeof the Central and State Governments in

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2008-09 in an orderly manner. The marketborrowings of the Central and StateGovernments are expected to be higher in2009-10. Thus, a major challenge is tomanage the large government borrowingprogramme in 2009-10 in a non-disruptivemanner. Large borrowings also militateagainst the low interest rate environmentthat the Reserve Bank is trying to maintainto spur investment demand in keeping withthe stance of monetary policy. The ReserveBank, therefore, would continue to use acombination of monetary and debtmanagement tools to manage governmentborrowing programme to ensure successfulcompletion of government borrowings in asmooth manner. The Reserve Bank hasalready announced an OMO calendar tosupport government market borrowingprogramme through secondary marketpurchase of government securities. Duringthe first half of 2009-10, planned OMOpurchases and MSS unwinding will addprimary liquidity of about Rs.1,20,000crore which, by way of monetary impact,is equivalent to CRR reduction of 3.0percentage points. This should leave adequateresources with banks to expand credit.

70. Fourth, another challenge facingthe Indian economy is to restore the fiscalconsolidation process. The fiscalstimulus packages by the Governmentand some other measures have led tosharp increase in the revenue and fiscaldeficits which, in the face of slowingprivate investment, have cushioned thepace of economic activity. However, itwould be a challenge to unwind fiscalstimulus in an orderly manner and returnto a path of credible fiscal consolidation.

In this context, close monitoring of theperformance of the economy and theproper sequencing of the unwindingprocess would have to be ensured.

71. Fifth, a continued challenge is topreserve our financial stability. TheReserve Bank would continue to maintainconditions which are conducive forfinancial stability in the face of globalcrisis. A sound banking sector, well-functioning financial markets and robustpayment and settlement infrastructureare the pre-requisi tes for f inancialstability. The banking sector in Indiais sound, adequately capitalised andwell-regulated. By all counts, Indianfinancial and economic conditions aremuch better than in many other countriesof the world. The single factor stress testscarried out as part of the report of theCommittee on Financial Sector Assessment(CFSA) (Chairman: Dr. Rakesh Mohan andCo-Chairman: Shri Ashok Chawla) haverevealed that the banking system in Indiacan withstand significant shocks arisingfrom large potential changes in creditquality, interest rate and liquidityconditions. These stress tests for credit,market and liquidity risk show that Indianbanks are generally resilient.

72. Sixth, the Reserve Bank hasinjected large liquidity in the system sincemid-September 2008. It has reduced theCRR significantly and instituted somesector-specific facilities to improve theflow of credit to certain sectors. The tenureof some of these facilities has beenextended to provide comfort to the market.While the Reserve Bank will continue tosupport all the productive requirements of

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the economy, it will have to ensure that aseconomic growth regains momentum, thelarge liquidity injected in the system iswithdrawn in an orderly manner. It isworth noting that even as the monetaryeasing by the Reserve Bank has potentiallymade available a large amount of liquidityto the system, at the aggregate level thishas not been out of line with our monetaryaggregates unlike in many advancedcountries. As such, the challenge ofunwinding will be less daunting for Indiathan for other countries.

73. Finally, we will have to addressthe key challenge of ensuring an interestrate environment that supports revival ofinvestment demand. Since October 2008,as the inflation rate has decelerated andthe policy rates have been reduced, marketinterest rates have also come down.However, the reduction in interest ratesacross the term structure and acrossmarkets has not been uniform. Given thecost plus pricing structure, banks havebeen slow in reducing their lending ratesciting high cost of deposits. In this context,it may be noted that the current depositand lending rates are higher than in2004-07, although the policy rates are nowlower. Reduction in deposit rates affectsthe cost only at the margin since existingterm deposits continue at the originallycontracted cost. So lending rates take longerto adjust. Judging from the experience of2004-07, there is room for downwardadjustment of deposit rates. With WPIinflation falling to near zero, possibly likelyto get into a negative territory, albeit for ashort period, and CPI inflation expected tomoderate, inflationary risks have clearly

abated. The Reserve Bank’s currentassessment is that WPI inflation could bearound 4.0 per cent by end-March 2010.Banks have indicated that small savingsrate acts as a floor to banks’ depositinterest rate. It may, however, be noted thatsmall savings and bank deposits are notperfect substitutes. Banks should not,therefore, be overly apprehensive aboutreducing deposit interest rates for fear ofcompetition from small savings, especiallyas the overall systemic liquidity remainshighly comfortable. There is scope for theoverall interest rate structure to movedown within the policy rate easing alreadyeffected by the Reserve Bank. Furtheraction on policy rates is now being takento reinforce this process.

Policy Stance

74. On the basis of the above overallassessment, the stance of monetary policyin 2009-10 will broadly be as follows:

• Ensure a policy regime that will enablecredit expansion at viable rates whilepreserving credit quality so as tosupport the return of the economy to ahigh growth path.

• Continuously monitor the global anddomestic conditions and respondswiftly and effectively through policyadjustments as warranted so as tominimise the impact of adversedevelopments and reinforce the impactof positive developments.

• Maintain a monetary and interest rateregime supportive of price stability andfinancial stability taking into accountthe emerging lessons of the globalfinancial crisis.

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Bank Rate

76. The Bank Rate has been retainedunchanged at 6.0 per cent.

Repo Rate

77. It is proposed:

• to reduce the repo rate under theLiquidity Adjustment Facility (LAF)by 25 basis points from 5.0 per centto 4.75 per cent with immediate effect.

Reverse Repo Rate

78. It is proposed:

• to reduce the reverse repo rate underthe LAF by 25 basis points from 3.5per cent to 3.25 per cent withimmediate effect.

79. The Reserve Bank has theflexibility to conduct repo/reverse repoauctions at a fixed rate or at variable ratesas circumstances warrant.

80. The Reserve Bank retains theoption to conduct overnight or longer termrepo/reverse repo under the LAF dependingon market conditions and other relevantfactors. The Reserve Bank will continue touse this flexibly including the right toaccept or reject tender(s) under the LAF,wholly or partially, if deemed fit, so as tomake efficient use of the LAF in dailyliquidity management.

Cash Reserve Ratio

81. The cash reserve ratio (CRR) ofscheduled banks has been retainedunchanged at 5.0 per cent of net demandand time liabilities (NDTL).

First Quarter Review

82. The First Quarter Review ofMonetary Policy for 2009-10 will beundertaken on July 28, 2009.

III. Monetary Measures

75. Over the last several months, theReserve Bank has been actively engaged inpolicy action to minimise the impact of theglobal crisis on India. The policy responseof the Reserve Bank has helped in keepingour financial markets functioning in anormal manner and in arresting the growth

moderation. The Reserve Bank willcontinue to maintain vigil, monitordomestic and global developments, andtake swift and effective action to minimisethe impact of the crisis and restore theeconomy to a high growth path consistentwith price and financial stability.

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83. The key objective of financialsector policies is to aid the process ofeconomic growth consistent with price andfinancial stability. In this context, theReserve Bank has been focusing onimproving credit delivery, developingfinancial markets and promoting financialinclusion. Internationally, the financialintermediation process has gotsignificantly affected by the ongoingfinancial crisis. Consequently, variousinternational bodies and financialintermediaries have been contemplatingchanges in the financial regulatoryarchitecture to restore normalcy in thefunctioning of global financial markets

Part B. Developmental and Regulatory Policies 2009-10

and strengthen financial stability. Thereis a great deal of thinking going on aboutthe appropriate design of the regulatoryframework that encourages credit flowwhile mitigating risks. Domestically,although there has been some slowdownin credit growth, particularly in the secondhalf of 2008-09, the banking systemremains inherently sound and the financialmarkets including inter-bank markets arefunctioning normally. Nevertheless, theunfolding of the global financial crisisunderscores the need for furtherstrengthening of regulation andsupervision even as India remains outsidethe epicentre of the global crisis.

84. The current crisis has triggeredseveral initiatives in an unprecedented co-ordinated manner at the global level with aview to resolving the crisis andstrengthening the international financialarchitecture (Box).

85. While India has been a part of theglobal initiative, recently a comprehensiveassessment of the Indian financial sectorhas been conducted by the Committee onFinancial Sector Assessment (CFSA)(Chairman: Dr. Rakesh Mohan andCo-Chairman: Shri Ashok Chawla)constituted by the Government of India, inconsultation with the Reserve Bank. TheCommittee submitted its report to theFinance Minister on March 25, 2009 at NewDelhi. The Report was also released to the

I. Financial Stability

public on March 30, 2009 and placed onthe Reserve Bank’s website. While theCommittee found India’s financial sectorto be broadly sound and resilient, it alsoidentified specific concerns. The Committeehas made several recommendations towardsfurthering financial sector developmentover the medium term.

86. Keeping in view both internationaland domestic initiatives in the financialsector, it is proposed:

• to constitute a Task Force to look intoall the issues that have arisen withregard to the G-20 Working Groups andthe report of the CFSA and suggestfollow-up actions relevant for theReserve Bank in the domestic contexton an on-going basis, for every quarter;

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Several international initiatives have beentaken in the recent period for formulatingproposals for strengthening the financialsystem. The major initiatives in this regardinclude the following:

• Several reports have been released recentlysuch as the Financial Stability Forum’s (nowFinancial Stability Board) Report on‘Enhancing Market and InstitutionalResilience’, the Geneva Report on ‘TheFundamental Principles of FinancialRegulation’, Larosiere Report on ‘The HighLevel Group on Financial Supervision in theEU’ and the Turner Review on ‘RegulatoryResponse to the Global Banking Crisis’.

• The G-20 countries have also taken severalinitiatives. In the summit held inWashington in November 2008, the G-20countries laid down an action plan andconstituted four Working Groups, viz.,(i) Enhancing Sound Regulation andStrengthening Transparency; (ii) ReinforcingInternational Co-operation and PromotingIntegrity in Financial Markets; (iii) Reformof the IMF; and (iv) The World Bank andother Multilateral Development Banks(MDBs). The first group on EnhancingSound Regulation and StrengtheningTransparency was co-chaired by Dr. RakeshMohan, Deputy Governor, Reserve Bank ofIndia along with Mr. Tiff Macklem ofCanada. The status for India with regard tothe recommendations of this group in setout in Annex II.

• The leaders of the G-20 again met inLondon on April 2, 2009 and laid downthe ‘Global Plan for Recovery and Reform’.

Box: International Co-operation - Recent Initiatives

• Drawing mainly from the recommendationsof the group on Enhancing Sound Regulationand Strengthening Transparency, the G-20also made a declaration for strengtheningthe financial system. The declarationagreed to make far reaching reforms in theareas of expanding the membership ofinternational bodies, internationalco-operation, prudential regulations, scopeof regulations, compensation, tax havens andnon-co-operative jurisdictions, accountingstandards and credit rating agencies.

• With a view to increasing internationalco-operation, the Financial Stability Forum(FSF), rechristened as Financial StabilityBoard (FSB), has been expanded to includemore emerging market economies and itsmandate has been broadened. India has beeninvited to join the FSB as a member.Alongside the current mandate of the FSF– to assess vulnerabilities affecting thefinancial system and identify and overseeaction needed to address them – the FSBwill advise on market developments andmonitor best practices in meeting regulatorystandards, among others.

• The Basel Committee on BankingSupervision (BCBS) has also beenexpanded and India has been invited tonominate a member to the Committee.Accordingly, Smt. Usha Thorat, DeputyGovernor, Reserve Bank of India has beennominated as a member of the BCBS.

• A Group of 30 (G-30) released the reporton ‘Financial Reform – A Framework forFinancial Stability’ on January 15, 2009 tostrengthen prudential regulations andsupervision.

• in consultation with all regulators andthe Government to consider the settingup of a Working Group to implementthe recommendations of the CFSA;

• to set up a Financial Stability Unit inthe Reserve Bank drawing upon inter-

disciplinary expertise from supervisory,regulatory, statistics, economics andfinancial markets departments forcarrying out periodic stress testing andfor preparing financial stabilityreports.

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Money Market

(a) Special Refinance Facility:Extension

89. A special refinance facility wasintroduced on November 1, 2008 underSection 17(3B) of the Reserve Bank ofIndia Act, 1934 to provide funding to

scheduled commercial banks (excludingregional rural banks) up to 1.0 per cent oftheir net demand and time liabilities (NDTL)as on October 24, 2008 at the repo rate. Itis proposed:

• to extend this special refinance facilityup to March 31, 2010.

III. Financial Markets

(a) BPLR System: Review

87. Consequent to the Mid-TermReview of October 2005, the Indian Banks’Association (IBA) issued guidelines fordetermination of benchmark prime lendingrate (BPLR) by banks for appropriatepricing of credit. Over time, however, thesystem of BPLR has evolved in such amanner that it has lost its relevance as ameaningful reference rate as bulk of loansis advanced below BPLR. Furthermore,this impedes the smooth transmission ofmonetary signals and makes the loanpricing system non-transparent. It has,therefore, become necessary to review thecurrent procedures and processes ofpricing of credit. Accordingly, it isproposed:

• to constitute a Working Group toreview the present BPLR system andsuggest changes to make creditpricing more transparent. TheWorking Group would consult all thestakeholders and submit its report byend-August 2009.

(b) Payment of Interest on Savings BankAccount on a Daily Product Basis

88. At present, interest on savings bankaccounts is calculated on the minimumbalances held in the accounts during theperiod from the 10th day to the last day ofeach calendar month. Several banks havesuggested that interest on savings bankaccounts may be calculated either on theminimum balances in the deposit accountsduring the period from the first to the lastday of each calendar month or on a dailyproduct basis. The matter was referred to theIBA, which was of the view that payment ofinterest on a daily product basis would befeasible only when computerisation in banksis completed. In view of the presentsatisfactory level of computerisation incommercial bank branches, it is proposed that:

• payment of interest on savings bankaccounts by scheduled commercialbanks (SCBs) would be calculated ona daily product basis with effect fromApril 1, 2010.

Modalities in this regard will beworked out in consultation with banks.

II. Interest Rate Policy

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(b) Special Term Repo Facility: Extension

90. The Reserve Bank introduced aspecial 14-day term repo facility for banksin September 2008 through relaxation in themaintenance of SLR up to 1.5 per cent oftheir NDTL, to enable them to meet theliquidity requirements of mutual funds(MFs), non-banking financial companies(NBFCs) and housing finance companies(HFCs). The auctions for the special 14-day term repo are conducted on a dailybasis. On a review, it is proposed:

• to extend the time for availability ofthis special term repo facility to banksup to March 31, 2010;

• to conduct these 14-day term repoauctions on a weekly basis.

(c) Export Credit Refinance: Review

91. With a view to providing flexibilityin the liquidity management of banks, thelimit of the standing liquidity facility tobanks in terms of export credit refinance(ECR) under Section 17(3A) of the RBI Actwas raised from 15.0 per cent of the eligibleoutstanding rupee export credit as on thepreceding fortnight to 50.0 per cent inNovember 2008. It is proposed:

• to review the ECR limit in March 2010.

(d) Money Market Mutual Funds

92. The liquidity stress recently facedby mutual funds, particularly the moneymarket mutual funds (MMMFs), wascaused primarily on account ofmobilisation of significant resources fromlarge corporates and banks with redemptionfacilities on par with current accounts ofbanks. In this regard, the Securities and

Exchange Board of India (SEBI) has takenseveral measures to mitigate the liquidityrisks. In view of the systemic implicationsof the activities of such funds, it is proposed:

• to identify and address the macro-prudential concerns arising from thecurrent framework in consultationwith SEBI.

(e) Interest Rate Futures

93. The Technical AdvisoryCommittee (TAC) for Money, ForeignExchange and Government SecuritiesMarkets had released the report of theWorking Group on Interest Rate Futures(Chairman: Shri V. K. Sharma) in August2008. The Working Group hadrecommended, inter alia, the introductionof a physically settled contract based on a10-year notional coupon bearinggovernment bond. The Reserve Bank hasalready permitted banks to take tradingpositions in interest rate futures (IRFs). TheRBI-SEBI Standing Technical Committeehas completed the preparatory work and anexchange traded IRFs contract on the 10-year notional coupon bearing governmentbond is expected to be launched shortly.

Government Securities Market

(a) Central Government Securities

(i) Floating Rate Bonds

94. The floating rate bonds (FRBs)issued by the Government of India tillSeptember 2004 were linked to the cut-off yields of the 364-day Treasury Bills(TBs), which led to certain issues relatingto the pricing of FRBs in the secondarymarket. Reflecting this experience andin consultation with market participants

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and the Technical Advisory Committee onMoney, Foreign Exchange andGovernment Securities Markets, thestructure has been revised. The revisedstructure contemplates that: (i) the auctionwill be conducted through the ‘price based’process as against the ‘spread based’process earlier; and (ii) the base yield forFRBs will be linked to the primary marketcut-off yield of the 182-day TBs. Therevised structure is expected to simplifythe methodology for pricing of FRBs inthe secondary market. The revised issuancestructure for FRBs has been built into thenegotiated dealing system (NDS) auctionformat being developed by the ClearingCorporation of India Limited (CCIL).

95. The indicative calendar for theissuance of Central Government securitiesprovides for the issuance of FRBs.Accordingly:

• any new issuance of floating ratebonds would be in terms of the revisedissuance structure.

(ii) Auction Process of Government ofIndia Securities

96. As indicated in the Mid-TermReview of October 2008, therecommendations of the Internal WorkingGroup (Chairman: H.R. Khan) involvingthe Reserve Bank such as reduction of thetime gap between bid submission anddeclaration of auction results have alreadybeen implemented. The otherrecommendations of the Working Groupsuch as: (i) withdrawal of the facility ofbidding in physical form and submission ofcompetitive bids only through the NDS;and (ii) submission of a single

consolidated bid on behalf of all itsconstituents by the bank/primary dealer(PD) in respect of non-competitive bidswill be implemented after the amendmentsin the specific notification and in thescheme for non-competitive biddingfacility by the Government of India.

(iii) Ways and Means Advances to theGovernment of India: Status

97. The Reserve Bank, in consultationwith the Government of India, has revisedthe extant limits for the Ways and MeansAdvances (WMA) for the financial year2009-10. As per the revised arrangements,the WMA limits will continue to be fixedon a half-yearly basis, and are placed atRs.20,000 crore for the first half andRs.10,000 crore for the second half of2009-10. The applicable interest rate onWMAs and overdrafts will, as it is thepractice now, continue to be linked to therepo rate. The Reserve Bank of India,however, retains the flexibility to revisethe limits in consultation with theGovernment of India, taking intoconsideration the prevailing circumstances.

(b) Debt Management for StateGovernments

(i) Non-Competitive Bidding in theAuction of State Development Loans(SDLs): Status

98. In order to widen the investor baseand enhance the liquidity for SDLs, ascheme for non-competitive bidding in theauction of SDLs was notified by all theState Governments on July 20, 2007.Subsequent to the announcement in theMid-Term Review of October 2008, the

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necessary system changes required to handlenon-competitive bidding in the auction ofSDLs have been carried out in the NDSauction platform developed by the CCIL.

99. The scheme for non-competitivebidding in SDLs will be operationalisedduring the current financial year.

(ii) Ways and Means Advances Limits forthe State Governments: Status

100. The State-wise limits of normalWMA for the year 2009-10 have been keptunchanged at the limits set for the year2008-09. Accordingly, the aggregatenormal WMA limit for State Governmentsis placed at Rs.9,925 crore, including theWMA limit of Rs.50 crore for theGovernment of the Union Territory ofPuducherry. All other terms and conditionsof the scheme remain unchanged.

(c) Development of Market Infrastructure

(i) Separate Trading for RegisteredInterest and Principal of Securities(STRIPS)

101. Stripping is the process ofconverting periodic coupon payments andthe principal of an existing Governmentsecurity into tradable zero-couponsecurities, i.e., separate trading forregistered interest and principal ofsecurities (STRIPS). The availability ofSTRIPS across the term structure will aidthe development of a sovereign zero-coupon yield curve. As indicated in theAnnual Policy Statement of April 2008, alloperational arrangements for theintroduction of STRIPS are ready. Therequired software development, critical for

the introduction of STRIPS, has beencarried out as part of the public debt office– NDS (PDO-NDS) platform maintained bythe Reserve Bank. Furthermore, in order toensure sufficient volume/liquidity inSTRIPS and considering the fungibility ofcoupon STRIPS, securities have beenidentified that will be eligible for stripping/reconstitution by the market participants.Accordingly:

• draft guidelines prepared inconsultation with the marketparticipants are being placed on theReserve Bank’s website for commentsand feedback by end-May 2009. Withthe finalisation of the guidelines,STRIPS will be launched during thecurrent financial year.

(ii) Revision of Repo Accounting

102. The accounting norms on repotransactions prescribed by the ReserveBank in 2003, treated repo as a set of twoindependent outright transactions.Consequent upon the amendment in 2006to the Reserve Bank of India Act, 1934, repohas been defined as an instrument forborrowing funds by selling securities.Accordingly, it was proposed to revise theaccounting guidelines to capture theeconomic essence of repo as a collateralisedlending and borrowing instrument and notas outright sale and purchase. Accordingly,it is proposed:

• to issue revised guidelines on repoaccounting, taking into accountcomments on the draft guidelinesearlier placed on the Reserve Bank’swebsite, by end-June 2009 forimplementation from April 1, 2010.

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(iii) Multi-modal Settlements inGovernment Securities: Status

103. As indicated in the Annual PolicyStatement of April 2008, a new settlementmechanism (Multi-modal Settlement)through commercial banks has been putin place to facilitate entities such as mutualfunds (MFs), which do not hold a currentaccount with the Reserve Bank, to directlyparticipate in the government securitiesmarket. Under the new mechanism, whilesettlement of the securities leg continuesto take place in the SGL account maintainedwith the Reserve Bank, the funds leg willsettle through the ‘designated settlementbanks’ (DSBs) appointed by the CCIL. Theguidelines in the matter were issued on June2, 2008. From June 30, 2008 onwards,secondary market transactions ingovernment securities undertaken by MFsare being settled only through thismechanism.

104. The facility of multi-modalsettlements can also be availed of by othernon-bank entities such as insurancecompanies, pension funds and co-operativebanks which do not maintain a currentaccount with the Reserve Bank.

(iv) Clearing and Settlement of OTCRupee Interest Rate Derivatives:Status

105. As indicated in the Mid-TermReview of October 2008, the CCIL hasoperationalised a clearing and settlementarrangement for over-the-counter (OTC)rupee interest rate derivatives on a non-guaranteed basis since November 27, 2008.As at end-March 2009, 13 members havedecided to participate in the non-guaranteed

settlement of OTC rupee interest ratederivatives. The trade reporting platformfor OTC rupee interest rate derivatives isalready functional.

(v) Settlement of OTC Trades inCorporate Bonds

106. For facilitating settlement of OTCcorporate bond transactions in real-timegross settlement (RTGS) system on a DvP-I basis (i.e., on a trade-by-trade basis), ithas been decided, in consultation with theSEBI, to allow the clearing houses of theexchanges to have a transitory poolingaccount facility with the Reserve Bank.Under the proposed settlementmechanism, the buyer of securities willtransfer the funds through his bank to thistransitory account through RTGS. Theclearing house will thereafter transfer thesecurities from the seller’s account to thebuyer’s account and effect the release offunds from the transitory account to theseller’s account.

Foreign Exchange Market

(a) ECBs: Extension of Relaxation ofall-in-cost Ceilings

107. As per extant ECB policy, the all-in-cost ceilings for ECBs are: LIBOR plus300 bps for ECBs with average maturityperiod of three years and up to five years;and LIBOR plus 500 bps for ECBs withaverage maturity of more than five years.However, these all-in-cost ceilings havebeen dispensed with up to June 30, 2009subject to the condition that ECB proposalsabove the prescribed all-in-cost ceilings,irrespective of the amount of the borrowing,will come under the approval route.

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Considering the continuing tightness ofcredit spreads in the international markets,it is proposed:

• to extend the relaxation in all-in-costceilings until December 31, 2009.

(b) Liberalisation of the Policy onBuyback of FCCBs

108. Recognising the benefits accruingto the Indian companies as well as to theeconomy, the policy on the prematurebuyback of FCCBs was liberalised inDecember 2008. The proposals for buybackof FCCBs by Indian companies are beingconsidered both under the approval andautomatic routes, provided buyback isfinanced out of their foreign currencyresources held in India or abroad and/or outof fresh ECBs raised in conformity with thecurrent ECB norms and out of internalaccruals up to US $ 50 million of theredemption value per company. The entireprocedure for buyback of FCCBs isrequired to be completed by December 31,2009 and details of the buyback are alsorequired to be reported to the Reserve Bank.

109. In terms of the extant norms, theReserve Bank has been considering, underthe approval route, proposals from Indiancompanies for buyback of FCCBs, out ofinternal accruals, up to US $ 50 millionredemption value per company, at aminimum discount of 25 per cent on thebook value. Up to April 15, 2009, theReserve Bank has approved 18 proposalsfor buyback of FCCBs involving US $ 765million with the discount ranging from 25per cent to 50 per cent.

110. The current policy has beenreviewed. Keeping in view the benefits

accruing to Indian companies, it is proposedto increase the total amount of permissiblebuyback, out of internal accruals, from US$50 million of the redemption value percompany to US $ 100 million, by linkingthe higher amount of buyback to largerdiscounts. Accordingly:

• Indian companies may, henceforth, bepermitted, under the approval route,to buy back FCCBs out of internalaccruals with a minimum discount of25 per cent of book value forredemption amount of up to US $ 50million, 35 per cent of book value forredemption amount more than US $50 million and up to 75 million; and50 per cent of book value forredemption amount more than US $75 million and up to US $ 100million.

(c) Loans against Non-resident Deposits

111. As per the extant norms,Authorised Dealer Category–I andauthorised banks are permitted to grantloans up to Rs.20 lakh against the securityof funds held in NR(E)RA and FCNR(B)deposits. On a review, it is proposed:

• to enhance the cap of Rs.20 lakh toRs.1 crore with immediate effect.

(d) Currency Futures

112. Since the launch of the firstcurrency futures exchange in September2008, currency futures contracts are beingtraded in three recognised exchanges. Theaverage daily volume of currency futurescontracts traded on all the exchangesincreased from Rs.260 crore in September2008 to Rs.2,181 crore in December 2008and further to Rs.5,235 crore in March

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2009. The functioning of the exchangescontinues to be reviewed by the RBI-SEBIStanding Technical Committee. On therecommendation of the Committee, theposition limits on the clients and tradingmembers have been doubled from US $ 5million and US $ 25 million respectively to

US $ 10 million and US $ 50 million. However,the upper limits of 6 per cent and 15 percent of the total open interest on the clientsand trading members remain unchanged.The position limit for banks continues at15 per cent of total open interest or US $100 million, whichever is higher.

(a) Credit Flow to the MSE Sector

113. As indicated in the Mid-TermReview of October 2008, the ReserveBank appointed a Working Group onRehabilitation of Sick SMEs (Chairman:Dr. K.C. Chakrabarty). The WorkingGroup made several significantrecommendations pertaining not only tothe issue of rehabilitation of sick SMEsbut also to the larger issues of credit flowto the SME sector and other developmentalissues. While the recommendations onwhich action is to be initiated by theGovernment of India, State Governmentsand SIDBI are being forwarded to them,it is proposed:

• to issue guidelines to banks based onthe recommendations of the Group,by April 30, 2009.

114. Having regard to the need toaccelerate the credit flow to the micro andsmall enterprises (MSEs) sector so criticalfor employment, output and exports, it isproposed:

• to ask the Standing AdvisoryCommittee on MSEs to review theCredit Guarantee Scheme so as tomake it more effective.

(b) Rural Co-operative Banks

(i) Licensing of Co-operatives

115. The Committee on FinancialSector Assessment (Chairman: Dr. RakeshMohan and Co-Chairman: Shri AshokChawla) has observed that there is a needto draw up a roadmap for ensuring that onlylicensed banks operate in the co-operativespace. The Committee further suggested theneed for a roadmap to ensure that bankswhich fail to obtain a licence by 2012should not be allowed to operate. This willexpedite the process of consolidation andweeding out of non-viable entities from theco-operative space. Accordingly, it isproposed:

• to work out a roadmap for achievingthis objective in a non-disruptivemanner in consultation withNABARD.

(ii) Revival of Rural Co-operative CreditStructure: Status

116. As indicated in the Annual PolicyStatement of April 2008, the Governmentof India approved a package for revival ofthe short term rural co-operative creditstructure based on the recommendations ofthe Task Force on Revival of Rural

IV. Credit Delivery Mechanism and Other Banking Services

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Co-operative Credit Institutions (Chairman:Prof. A. Vaidyanathan). So far, 25 Stateshave executed Memoranda ofUnderstanding (MoUs) with theGovernment of India and the NABARD, asenvisaged in the package. Eight States havemade necessary amendments in their Co-operative Societies Acts. An aggregateamount of Rs. 4,740 crore has beenreleased by the NABARD as theGovernment of India’s share forrecapitalisation of primary agriculturalcredit societies (PACS) in eight States ason February 28, 2009. Eight StateGovernments have released their shares ofRs.459 crore for recapitalisation of PACS.The National Implementing andMonitoring Committee (NIMC), set up bythe Government of India, is guiding andmonitoring the implementation of therevival package on an all-India basis.

(c) Regional Rural Banks

(i) Capital to Risk-weighted Assets Ratiofor RRBs

117. The Committee on Financial SectorAssessment (Chairman: Dr. Rakesh Mohanand Co-Chairman: Shri Ashok Chawla) hassuggested a phased introduction of capitalto risk-weighted assets ratio (CRAR) in thecase of RRBs, along with the recapitalisationof RRBs after consolidation of these entities.It is, therefore, proposed:

• to introduce CRAR for RRBs in aphased manner, taking into account thestatus of recapitalisation andamalgamation. A time-table for thispurpose would be announced inconsultation with NABARD.

(ii) Assistance to RRBs for Adoption ofICT Solutions for Financial Inclusion:Status

118. The Report of the Working Groupon Defraying Costs of ICT Solutions forRegional Rural Banks (Chairman: Shri G.Padmanabhan) was placed on the ReserveBank’s website in August 2008 forcomments from public. The Group has,inter alia, noted that apart from the North-Eastern region and Jammu and Kashmir,there are 204 districts in several Stateswhich have been identified by theCommittee on Financial Inclusion(Chairman: Dr. C. Rangarajan) as areaswhere there is a high level of financialexclusion. It is, therefore, suggested thatthese areas could also be considered forspecial treatment. With a view to enablingRRBs to adopt IT based solutions forfinancial inclusion, it is proposed:

• to work out, in consultation withNABARD, the manner of providingassistance to RRBs adopting ICTsolutions for financial inclusion indistricts identified as having high levelof exclusion by the Committee onFinancial Inclusion.

(iii) Amalgamation of RRBs

119. Consequent upon theamalgamation of 156 RRBs into 45 newRRBs sponsored by 20 banks in 17 States,the total number of RRBs declined from196 to 86 as at end-March 2009 (whichincludes a new RRB set up in the UnionTerritory of Puducherry). The amalgamationprocess is almost complete.

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(iv) Recapitalisation of RRBs

120. The Union Budget 2007-08announced that RRBs, which have a negativenet worth, would be recapitalised in a phasedmanner. As on March 31, 2009, 26 RRBshave been fully recapitalised with an amountof Rs. 1,783 crore and one RRB has beenpartially recapitalised with an amount ofRs.13 crore. The process of recapitalisationhas been completed except in respect of oneRRB in the State of Uttar Pradesh.

(v) Scheduling of Amalgamated RRBs

121. Out of 45 amalgamated RRBs, 25RRBs have been included in the SecondSchedule to the RBI Act, 1934 while 76erstwhile RRBs have been excluded fromthe Second Schedule in terms of thenotification dated September 22, 2008published in the Gazette of India datedNovember 15, 2008.

(vi) Branch Licensing: FurtherLiberalisation

122. The Mid-Term Review of October2008 proposed to allow RRBs greaterflexibility in opening new branches as longas they made profits and their financialsimproved. The RRBs have obtained 345licenses for opening branches in thefinancial year 2008-09 and have opened316 branches in the same period.

(vii) Technology Upgradation of RRBs

123. As indicated in the Mid-TermReview of October 2008, therecommendation of the Working Group(Chairman: Shri G. Srinivasan) to preparea roadmap for migration to core bankingsolutions (CBS) by RRBs, was forwarded

to all sponsor banks in October 2008 forimplementation. The Report has, amongothers, set September 2011 as the target datefor all RRBs to move towards CBS. Also,all RRB branches opened after September2009 are required to be CBS compliantfrom day one. In March 2009, sponsorbanks were advised to give their feedback/status on implementation of therecommendations of the report in respectof RRBs sponsored by them.

(d) Delivery of Credit to Agriculture andother Segments of the Priority Sector

(i) Kisan Credit Card Scheme

124. The Kisan Credit Card (KCC)scheme, introduced in 1998-99 to enablefarmers to purchase agricultural inputs anddraw cash for their production needs, wasrevised to provide adequate and timelyfinance for meeting the comprehensivecredit requirements of farmers under asingle window, with flexible and simplifiedprocedure, adopting a whole farm approach.During 2008-09 (up to December 2008),public sector banks (PSBs) issued 3.9million KCCs with sanctioned limitsaggregating Rs.23,366 crore. Since theinception of the scheme, PSBs have issued35.08 million KCCs with sanctioned limitsaggregating Rs.1,77,607 crore.

(ii) Rural Infrastructure DevelopmentFund

125. The Interim Budget 2009-10announced the continuation of financing ofrural infrastructure projects for 2009-10 byway of RIDF XV which would be set upwith NABARD with a corpus of Rs.14,000crore, and a separate window under RIDF

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XV for rural roads component of BharatNirman Programme with a corpus ofRs.4,000 crore.

126. Consequent upon theannouncement made in the Union Budget2008-09, several funds were set up such as:(i) Short-Term Co-operative Rural Credit(STCRC) (Refinance) Fund with theNABARD with a corpus of Rs.5,000 crore;(ii) MSME (Refinance) Fund and MSME(Risk Capital) Fund with the SmallIndustries Development Bank of India(SIDBI) with corpus of Rs.1,600 crore andRs.1,000 crore; and (iii) Rural HousingFund with the National Housing Bank(NHB) with corpus of Rs.1,000 crore. TheAnnual Policy Statement of April 2008announced that the shortfall in achievementof 10 per cent sub-target for lending toweaker sections by domestic scheduledcommercial banks will also be taken intoaccount for the purpose of allocatingamounts for contribution to the RuralInfrastructure Development Fund (RIDF)maintained with the NABARD or fundswith other financial institutions, asspecified by the Reserve Bank, with effectfrom April 2009.

127. Consequent upon the announcementof measures by the Reserve Bank onNovember 15, 2008 to sustain the growthmomentum in the employment-intensivesectors of micro and small enterprises andhousing, the corpus of MSME (Refinance)Fund and Rural Housing Fund was enhancedby Rs.2,000 crore (to Rs.3,600 crore) andby Rs.1,000 crore (to Rs.2,000 crore)respectively. As on March 31, 2009 variousscheduled commercial banks have placeddeposits of Rs.4,622 crore in STCRC

(Refinance) Fund, Rs.3,326 crore in MSME(Refinance) Fund, Rs.250 crore in MSME(Risk Capital) Fund and Rs.1,760 crore inRural Housing Fund.

(e) Interest Subvention Relief to Farmers

128. The Union Budget 2008-09announced continuation of the interestsubvention scheme for short-term crop loans,introduced in 2006-07. The rate ofsubvention was increased from 2 per cent to3 per cent for 2008-09. The Interim Budget2009-10 announced that the Government ofIndia would also continue to provideinterest subvention in 2009-10 to ensure thatfarmers get short-term crop loans up to Rs.3lakh at 7.0 per cent per annum.

(f) Micro-finance

129. The self-help group (SHG)-banklinkage programme has emerged as the majormicro-finance programme in the countryand is being implemented by commercialbanks, RRBs and co-operative banks. As onMarch 31, 2008 3.6 million SHGs hadoutstanding bank loans of Rs.17,000 crore,an increase of 25 per cent over March 31,2007 in respect of number of SHGs creditlinked. During 2007-08, banks financed 1.2million SHGs for Rs.8,849 crore. As atend-March 2008, SHGs had 5 million savingsaccounts with banks for Rs.3,785 crore.

(g) Financial Inclusion

(i) Pilot Project of State Level Bankers’Committee (SLBCs) for 100 per centFinancial Inclusion

130. So far, 344 districts have beenidentified by SLBCs for 100 per centfinancial inclusion. Of these, 175 districts

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in 21 States and 7 Union Territories havereported having achieved the target. Alldistricts of Haryana, Himachal Pradesh,Karnataka, Kerala, Uttarakhand, Goa,Chandigarh, Puducherry, Daman & Diu,Dadra & Nagar Haveli and Lakshadweephave reported having achieved the targetof 100 per cent financial inclusion.

131. As indicated in the Mid-TermReview of October 2008, the findings ofthe external agencies entrusted withconducting evaluation studies in achievingthe target of 100 per cent financial inclusionin 26 districts were placed on the ReserveBank’s website for wider dissemination.Based on the findings, banks were advisedin January 2009, among other things, to(i) ensure provision of banking servicesnearer to the location of the no-frillsaccount holders through a variety ofchannels; (ii) provide General Credit Card(GCC)/small overdrafts along with no-frillsaccounts to encourage the account holdersto actively operate the accounts; (iii) conductawareness drives so that the no-frills accountholders were made aware of the facilitiesoffered; (iv) review the extent of coveragein districts declared as 100 per centfinancially included; and (v) efficientlyleverage on the technology enabled financialinclusion solutions currently available.

(ii) Special Task Force in North-EasternRegion

132. As indicated in the Mid-TermReview of October 2008, a scheme ofproviding financial support to banks by theReserve Bank for setting up bankingfacilities (currency chests, extension offoreign exchange and Government businessfacilities) at centres, in the North-Eastern

region (NER), which are not found to becommercially viable by banks, wasformulated, provided the State Governmentsmade available necessary premises and otherinfrastructural support. The Government ofMeghalaya has agreed to the proposal ofproviding premises and security, and bidshave been received by PSBs and RRBs forsetting up branches at centres identified bythe State Government and are beingprocessed. Action is being intitiated inrespect of other States in NER whererequests have been received.

(iii) Setting up of Credit CounsellingCentres on a Pilot Basis

133. So far, banks have reported settingup or proposing to set up 123 creditcounselling centres in various States of thecountry. The feedback received in this regardindicated that most of these centres were ineffect set up as extensions of the bankbranches and engaged in promotion of bankspecific products. Accordingly, a modelscheme on financial literacy and creditcounselling centres (FLCCs) was formulatedand communicated to all scheduledcommercial banks and RRBs with the adviceto set up the centres as distinct entitiesmaintaining an arm’s length from the bankso that the FLCC’s services are available toeven other banks’ customers in the district.

(iv) Setting up of Rural Self EmploymentTraining Institutes

134. The Reserve Bank has issuedguidelines, framed by the Government ofIndia, to the SLBC convenor banks to setup at least one Rural Self EmploymentTraining Institute (RSETI) in each districtby 2010. These institutions will train at least

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one youth in a family below poverty line(BPL) in various fields and enhancecapacity building. In all, 134 RSETIs havebeen set up as on December 31, 2008. Atarget for opening of 100 RSETIs by bankswas set for the year 2008-09 and a grant ofRs. one crore per RSETI has beenearmarked by the Planning Commission forsetting up the institutes. The RegionalOffices of the Reserve Bank have beenadvised to monitor the progress of settingup of RSETIs under their jurisdiction on aquarterly basis.

(h) High Level Committee on Lead BankScheme

135. As announced in the Mid-TermReview of the Annual Policy Statement forthe year 2007-08, a High Level Committee(Chairperson: Smt. Usha Thorat) withmembers drawn from various financialinstitutions, banks and Chief Secretaries of

select States was constituted to review theLead Bank Scheme. The Committee hadseveral rounds of discussions with differentState Governments, banks and otherstakeholders, including academicians,micro-finance institutions (MFIs) and non-governmental organisations (NGOs). TheCommittee’s draft report will be placed onthe Reserve Bank’s website by May 15, 2009.

(i) Amendment to Banking OmbudsmanScheme 2006

136. The scope of the BankingOmbudsman Scheme, 2006 was widenedto include, inter alia, deficiencies arisingout of internet banking. Under the amendedScheme, customers can lodge complaintsagainst banks for non-adherence to theprovisions of the fair practices code forlenders or the code of bank’s commitmentto customers issued by the Banking Codesand Standards Board of India (BCSBI).

(a) Further Relaxations in the BranchAuthorisation Policy

137. The current branch authorisationpolicy requires banks to have a mediumterm plan in respect of branch expansion.The request for opening of off-site ATMswas also required to be a part of such plans.On a review, it is proposed:

• to allow scheduled commercial banks(SCBs) to set up offsite ATMs withoutprior approval subject to reporting.

138. With respect to branchauthorisation policy, it is proposed:

• to constitute a Group to review theextant framework of branchauthorisation policy with a view toproviding greater flexibility, enhancedpenetration and competitive efficiencyconsistent with financial stability.

(b) Presence of Foreign Banks in India:Review

139. In February 2005, the Governmentof India and the Reserve Bank released the‘Roadmap for Presence of Foreign Banksin India’ laying out a two-track andgradualist approach aimed at increasing the

V. Prudential Measures

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efficiency and stability of the bankingsector in India. One track was theconsolidation of the domestic bankingsystem, both in private and public sectors,and the second track was the gradualenhancement of the presence of foreignbanks in a synchronised manner. Theroadmap was divided into two phases, thefirst phase spanning the period March 2005- March 2009, and the second phasebeginning April 2009 after a review of theexperience gained in the first phase.

140. In view of the current globalfinancial market turmoil, there areuncertainties surrounding the financialstrength of banks around the world. Further,the regulatory and supervisory policies atnational and international levels are underreview. In view of this, it is consideredadvisable, for the time being, to continuewith the current policy and proceduresgoverning the presence of foreign banks inIndia. The proposed review will be taken upafter due consultation with the stakeholdersonce there is greater clarity regardingstability, recovery of the global financialsystem, and a shared understanding on theregulatory and supervisory architecturearound the world.

(c) Mitigating Procyclicality: Use ofFloating Provisions

141. The G-20 Working Group onEnhancing Sound Regulation andStrengthening Transparency hasrecommended, as a part of measures tomitigate procyclicality, that capital buffersabove minimum requirements and loan lossprovisions should be built up in good timesin order to enhance the ability of the

regulated financial institutions to withstandlarge shocks. This would requiremodification in the Reserve Bank’s circularof June 22, 2006. The Reserve Bank has beenencouraging banks to build floatingprovisions as a buffer for the possible stresson asset quality later. It is proposed:

• to issue further detailed guidelines onmitigating procyclicality later thisyear after FSB, BCBS and Committeeon Global Financial System (CGFS)finalise their recommendations in thisregard.

(d) Credit Rating Agencies

142. In India, all credit rating agenciesare registered with the SEBI. The ReserveBank has accorded accreditation to fourSEBI registered credit rating agencies for thelimited purpose of using their ratings forassigning risk weights within the frameworkof the Basel II Accord. Since the Indianbanking system has migrated to the Basel IIframework, there is a need to review theperformance of the credit rating agencies forcontinuation of the accreditation, especiallyby looking at the latest data relating tocumulative default rate and transition matrixof the rating agencies. Accordingly:

• the Reserve Bank will liaise with SEBIon the issue of rating agencies’ adherenceto Code of Conduct Fundamentals of theInternational Organisation SecuritiesCommissions (IOSCO).

(e) Liquidity Risk

143. In terms of the asset liabilitymanagement, liquidity of banks in Indiais tracked through traditional maturity or

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cash flow mismatches. The Reserve Bankhas examined the issue of banksestablishing a more robust liquidity riskmanagement framework that is wellintegrated into the bank-wide riskmanagement process by adopting globalliquidity planning. In this context, bankswill be required to integrate their variousforeign currency assets and liabilitiespositions from their branch operations inIndia with the rupee asset liability position.Accordingly, it is proposed:

• to prepare a draft circular detailingthe modalities for adopting theintegrated liquidity risk managementsystem as also the guidance note on‘Liquidity Risk Management’ basedon Basel Committee’s ‘Principles forSound Liquidity Risk Managementand Supervision’ brought out inSeptember 2008 as well as otherinternational best practices whichwould be placed on the ReserveBank’s website by June 15, 2009.

(f) Financial Inclusion: RelaxingEligibility Criteria for BankingCorrespondents

144. With the objective of achievinggreater financial inclusion and increasing theoutreach of the banking sector, banks werepermitted, to use the services of NGOs/MFIsset up as societies, trusts, Section 25companies, post offices, co-operativesocieties and more recently retired bankemployees, ex-servicemen and retiredgovernment employees as bankingcorrespondents (BCs). Scaling up the BCmodel is a challenge. It is, therefore, proposed:

• to constitute a Working Group toexamine the experience to date of the

business correspondent (BC) modeland suggest measures, to enlarge thecategory of persons that can act asBCs, keeping in view the regulatoryand supervisory framework andconsumer protection issues.

• to increase the maximum distancecriterion for the operation of the BCfor rural, semi-urban and urban areasfrom the existing 15 kms. to 30 kms.

(g) Risk Weights for Exposure to CentralCounterparties

145. A central counterparty (CCP) is anentity that interposes itself betweencounterparties to contracts traded withinone or more financial markets, becomingthe legal counterparty such that it is thebuyer to every seller and the seller to everybuyer. The CCIL has been acting as a CCPfor banks in various segments of thefinancial market. Similarly, contracts likeinterest rate futures and currency futures,which are traded on the stock exchanges,are also settled through the clearing housesattached to these exchanges.

146. Banks settling trades throughCCIL/stock exchanges have two types ofexposures to these CCPs. First, on accountof the on-balance sheet and off-balancesheet transactions undertaken through theCCP; and second, the exposure on accountof deposits/collateral kept with the CCPsto meet the margin requirements. It hasbeen decided to lay down the norms forcapital adequacy treatment of suchexposures. Accordingly:

• the exposures on account of derivatives/securities financing transactions tradesoutstanding against all the CCPs, will

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be assigned zero exposure value, as itis presumed that the CCPs’ exposuresto their counterparties are fullycollateralised on a daily basis, therebyproviding protection for the centralcounterparty’s credit risk exposures;

• the margin amounts/collateralsmaintained with the CCPs will attractrisk weights appropriate to the natureof the CCP. For CCIL, the risk weightwill be 20 per cent and for other CCPs,it will be according to the ratingsassigned to these entities as per theNew Capital Adequacy Framework.

• the above prescription will be subjectto review on an on-going basis by theReserve Bank about the adequacy ofmargin, quality of collateral and riskmanagement systems of the clearinghouse/CCP.

(h) Private Pool of Capital

147. It has been observed that Indianbanks have recently been engaged insponsoring and managing private pools ofcapital such as venture capital funds andinfrastructure funds. The G-30 Report on‘Financial Reform – A Framework forFinancial Stability’ released on January 15,2009, observed that large, systemicallyimportant banking institutions should berestricted in undertaking proprietaryactivities that present particularly high risksand serious conflicts of interest.Sponsorship and management ofcommingled private pools of capital (thatis, hedge and private equity funds in whichthe banking institutions own capital iscommingled with client funds) shouldordinarily be prohibited and largeproprietary trading should be limited by

strict capital and liquidity requirements.Therefore, there is need for banks to havegreater awareness of the risks inherent insuch activities and limit such exposurescommensurate with their risk managementand available capital. Keeping in view thereputational risk involved in such activities,the Reserve Bank had mandatedmaintenance of certain level of economiccapital in some of the cases approved inthe recent past. It is now proposed:

• to issue a paper on prudentialissues in banks’ floating andmanaging private pools of capitalfor eliciting public commentswhich will form the basis forfinalising regulatory guidelines bySeptember 30, 2009.

(i) Stress Testing

148. In the Mid-Term Review of October2008, it was indicated that the Reserve Bankwould be upgrading the stress testingguidelines. Subsequently, the BCBS hasissued a paper on ‘Principles for SoundStress Testing Practices and Supervision’ inJanuary 2009 for comments. The paperdraws lessons for banks and supervisorsemerging from the financial crisis andaddresses weaknesses in stress testing,including the specific areas of risk mitigationand risk transfer. In this context, the CFSAhas recommended that there is a need forthe banks themselves to carry out suchperiodic stress testing. It is proposed toupgrade the stress testing guidelines onceBCBS finalises the paper based oncomments received.

(j) Securitisation of Bank Loans

149. The securitisation framework inIndia is considered to be reasonably

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prudent and has been able to minimise theincentives that have led to the problemswhich surfaced in the current crisis. It hascome to the Reserve Bank’s notice thatsome banks have securitised loansimmediately after originating or purchasingthese from other banks. Banks are alsodividing the total loan for one project intodifferent tranches and securitising a fewtranches even before the total disbursementis complete, thus passing on the projectimplementation risk also to the investors.It is, therefore, proposed:

• to prescribe a minimum lock-in-period and minimum retentioncriteria for securitising the loansoriginated and purchased by banks.

(k) Certificate of Registration to CreditInformation Companies

150. In response to the Reserve Bank’spress release of April 18, 2007 invitingapplications for grant of Certificate ofRegistration from companies desirous ofentering into the business of creditinformation under the Credit InformationCompanies (Regulation) Act, 2005, 13applications were received. A High LevelAdvisory Committee (Chairman: Dr. R.H.Patil) set up by the Reserve Bank screenedthe applications and recommended thenames of four applicants for issue ofCertificate of Registration. Accordingly, ‘inprinciple’ approvals have been issued tothese four applicants.

VI. Institutional Developments

Payment and Settlement Systems

(a) Final Guidelines for PrepaidPayment Instruments in India

151. The enactment of the Payment andSettlement Systems Act, 2007 has broughtthe payment systems involved in theissuance of prepaid payment instrumentsunder the regulatory jurisdiction of theReserve Bank. The Reserve Bank had earlierplaced the draft guidelines for issuance/operation of such instruments in publicdomain for wider dissemination andfeedback. Taking into account the commentsreceived from various entities within andoutside the country, it is now proposed:

• to permit SCBs which comply with theeligibility criteria to issue allcategories of prepaid paymentinstruments;

• eligible non-bank entities, includingNBFCs, will be permitted to issuesemi-closed instruments, which can beused to purchase all types of goods andservices at an identified network ofestablishments.

The operating guidelines in thisregard are being issued separately.

(b) Consolidation of InformationTechnology Systems: Data Centres

152. The Reserve Bank has set up datacentres which were made operational inthe second half of 2008. The state-of-the-art data centres provide for a high levelof availability of information technology(IT) systems and ensure optimumbusiness continuity management. Thecritical payment and settlement systems

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of the Reserve Bank are now operatedusing the systems at the data centres.Adequate disaster recovery drills areconducted at periodic intervals. While allparticipating member banks have been ableto ensure full participation in these drillsby operating from their disaster recovery(DR) sites, there are a few banks whichhave not been able to meet this objective.In view of the critical importance of suchdrills and in order to achieve overallsystemic efficiency:

• banks are urged to ensure fullcompliance of these requirements.

(c) Adequacy of the FallbackArrangements for Managed ITSystems

153. Currently, a number of banks haveresorted to the retention of service providersto manage their IT-based operationalrequirements. It has, therefore, becomeimperative that banks have adequate plans/systems in place so as to manage risksarising out of such outsourcingarrangements. These risks arise on accountof excessive dependence by the system ona single entity (concentration risk),inadequate systems (operational risks) asalso on account of failure of these serviceproviders. The Reserve Bank has alreadyissued comprehensive outsourcingguidelines in November 2006. The riskmanagement aspects detailed therein are ofparticular relevance to a technology serviceprovider. Hence, it is proposed that:

• banks should undertake acomprehensive review of all suchoutsourced arrangements includingon-site inspections of critical service

providers and ensure that adequatefallback arrangements are put in place.

(d) Network Based Operations: RBISupported Systems

154. The Reserve Bank has taken stepsto make the application systems [NDS, realtime gross settlement (RTGS), centralisedfunds management system (CFMS) andstructured financial messaging solution(SFMS)] provided by it to operate in annetwork based environment using the MultiProtocol Label Switching (MPLS). TheMPLS approach by using a meshed networktopology provides increased redundanciesvis-a-vis a point to point connectivity atcheaper costs without impacting thesecurity aspects. Accordingly:

• banks are advised to migrate to theMPLS system on a time bound basis.

(e) Recent Developments

(i) Electronic Payment Systems

155. The coverage of bank branchesunder the electronic payment network, viz.,the RTGS and the National ElectronicFunds Transfer (NEFT) has increasedsignificantly. While the NEFT network hasincreased to 54,200 branches at end-March2009, the RTGS network has increased to55,000 branches. The RTGS handles, onan average, 80,000 transactions per day,with a peak of 1,28,295 transactionsprocessed as on March 30, 2009.

(ii) National Electronic Clearing Service

156. The volume of transactions throughnational electronic clearing service(NECS), introduced in September 2008, isalso increasing. With a view to moving

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towards the centralised NECS system, theelectronic clearing service (ECS) (credit)in Mumbai has been merged with theNECS. As such no separate local ECSclearing is operative in Mumbai.

(iii) National Financial Switch

157. The national financial switch(NFS) membership/volume is steadily onthe increase. As on March 31, 2009 the NFSnetwork covered a total of 38,714automated teller machines (ATMs) of 34banks. On an average, a daily volume of8,90,180 transactions (of which 2,56,156transactions pertained to balance enquiryand 6,34,024 pertained to cash withdrawal)were routed through the NFS in March 2009as against a daily volume of 2,67,598transactions in March 2008. Furthermore,on an average, the daily value settledthrough the NFS was around Rs.45 crorein March 2009 as against Rs.26 crore inMarch 2008. Since April 1, 2009customers have the facility of using ATMof any bank for cash withdrawal, free ofcost, thereby making ATMs nationalpayment outlets rather than bank-specificoutlets. This measure has seen a surge intransactions in the NFS network with apeak of 1.1 million transactions on a singleday on April 11, 2009.

(iv) Mobile Payments

158. As indicated in the Mid-TermReview of October 2008, the operativeguidelines for mobile payments were issuedon October 8, 2008. So far, 19 banks haveobtained permission from the Reserve Bankto provide mobile payment facilities to theircustomers.

(v) Rationalisation of Charges forPayment Systems

159. The Reserve Bank has rationalisedvarious charges for payment systems.Accordingly, service charges levied fortransfer of funds under outward RTGStransactions shall not exceed Rs.25 fortransactions of Rs.1 lakh and up to Rs.5lakh, and Rs.50 for transactions of Rs.5 lakhand above. Similarly, for outward NEFTtransactions, service charges levied shallnot exceed Rs.5 for transfer of funds up toRs.1 lakh and Rs.25 for transactions of Rs.1lakh and above.

160. The Reserve Bank has alsoprescribed maximum charges which couldbe levied for collection of outstationcheques under which the service chargeswould not exceed Rs.50 for cheque valueup to Rs.10,000. A maximum charge ofRs.100 would be levied for cheque valueof Rs.10,000 – Rs.100,000. The servicecharge would not exceed Rs.150 of chequevalue Rs.100,001 and above.

(vi) Cheque Truncation System

161. The cheque truncation system(CTS) pilot project was operationalised inDelhi in February 2008 and more than 90per cent of the cheque volume of Delhiclearing house is now processed throughthe CTS. The Reserve Bank continues totake steps towards extending the CTSacross the country and accordingly, it hasbeen decided to set up the CTS in Chennai.

(f) The Payment and SettlementSystems Act, 2007

162. As indicated in the Mid-TermReview of October 2008, the process of

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issuing authorisation to persons to operatevarious payment systems has commencedfollowing the notification of the Paymentand Settlement Systems Act, 2007 inAugust 2008. In terms of the Act, allpayment system providers/operatorsincluding credit card issuing companies andentities engaged in money transfer activitywould require authorisation.

Urban Co-operative Banks

(a) Area of Operations of UCBs

163. In order to facilitate the growth ofwell-functioning urban co-operative banks(UCBs) in States, which enter intoMemorandum of Understanding (MoU), itis proposed:

• to permit extension of area ofoperation of Tier II UCBs in Grade Ito the entire State of registration withthe prior approval of the ReserveBank.

(b) Review of Regulatory and SupervisoryFramework: UCBs

164. UCBs are presently on Basel Icapital framework with surrogate (additionalrisk-weight) capital charge on market risks.The Advisory Panel on Financial Regulationand Supervision to the Committee onFinancial Sector Assessment (Chairman:Dr. Rakesh Mohan and Co-Chairman:Shri Ashok Chawla), which looked into thepresent regulatory and supervisoryframework for UCBs, has observed that itwould be premature for full migration ofUCBs to Basel II at this juncture. However,it recommended assigning duration basedcapital charge for market risk for scheduledUCBs that are systemically important and

comparable in size to medium-sizedcommercial banks. Furthermore, the Panelrecommended: (i) a review of the existinginternal control systems, risk managementsystems, asset liability management (ALM)and disclosure norms for UCBs; and (ii) theissue of appropriate guidelines.Accordingly, it is proposed:

• to review the existing instructionsand issue appropriate guidelines toUCBs on internal controls, riskmanagement systems, ALM anddisclosure norms;

• to apply capital charge for market risksin respect of large-sized andsystemically important UCBs witheffect from April 1, 2010.

(c) Vision Document for UCBs

165. The Vision Document for UCBsenvisaged signing of MoU with the Stateand Central Governments forharmonisation of dual regulation andsupervision of UCBs and setting up of TaskForce on Urban Co-operative Banks(TAFCUB) for identification of viableUCBs for their rehabilitation and non-viable UCBs for their non-disruptive exit.Subsequent to the release of the VisionDocument in public domain in March 2005,the Reserve Bank has entered into MoUswith 25 State Governments (nine enteredduring April 2008 to March 2009). As ofdate, 99 per cent of UCBs and 99 per centof deposits of the UCB sector are coveredunder MoU arrangements. The number ofUCBs in Grade III and IV, signifyingvarious degrees of sickness, has sincedeclined to 496 as on March 31, 2008 from725 as on March 31, 2005. Till March 31,

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2009 licences had been cancelled orrejected in respect of 85 banks and 31unlicensed banks in MoU States have beenissued banking licences. Since therecommencement of new branchauthorisation, 232 licences have beenissued for opening of branches by UCBsin MoU States. The initiatives forvoluntary mergers and amalgamations ofweak UCBs for bringing consolidation inthe sector were also carried forward andnew policy guidelines on mergers wereannounced. Sixty-eight mergers betweenhealthy and weak banks have been effectedso far. In view of the improved financialcondition and enhanced regulatory andsupervisory jurisdiction of the ReserveBank, additional business opportunitieswere opened up for well-functioningmulti-state UCBs and UCBs in MoU States.

(d) Information Technology Support toUCBs

166. Based on the recommendations ofthe Working Group which looked into waysof supporting IT initiatives of the UCBs,IDRBT is being asked to facilitate UCBsavailing of Core Banking Platform on anApplication Service Provider (ASP) model.With this, the UCBs will be able to put inplace cost-effective, modern technology soas to render better customer service andsound regulatory compliance.

Non-Banking Financial Companies

(a) CRAR for NBFCs-ND-SI

167. The Mid-Term Review of October2008 had indicated that the CRAR forNBFCs-ND-SI would be raised from 10 percent to 12 per cent by March 31, 2009 and

further to 15 per cent by March 31, 2010.Taking into account the difficulty in raisingequity capital in the current economicenvironment, it has been decided:

• to defer the implementation of CRARof 12 per cent to March 31, 2010 andof 15 per cent to March 31, 2011.

(b) Time-frame for Realisation of Assetsby Securitisation Companies/Reconstruction Companies

168. In terms of the extant guidelines,securitisation companies (SCs)/reconstruction companies (RCs) arerequired to realise the financial assetswithin a specified time-frame, which shallnot in any case exceed five years from thedate of acquisition of financial assets.Requests for extending the time frame inthis regard are being examined. As aninterim measure, it is proposed:

• to give an extension of two moreyears for realisation of the assets inrespect of the security receipts(SRs) issued by SCs/RCs whichhave completed five years.

(c) Repossession of Vehicles by NBFCs

169. The issue of repossession ofvehicles in the event of non-payment ofinterest and/or principal of loans given byNBFCs has recently come into focus, andsome courts have also ruled in this regard.The Reserve Bank has already advisedNBFCs to put in place a Fair Practices Codewith the approval of their boards which,inter alia, covers recovery of loans. Theissue has been discussed with the industryparticipants and in view of certain queriesraised, it is further clarified that:

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• NBFCs must have a built-inre-possession clause in the contract/loan agreement with the borrowerwhich must be legally enforceable. Toensure transparency, the terms andconditions of the contract/loanagreement should contain detailedprovisions in this regard.

A circular to NBFCs to this effectis being issued separately.

(d) Special Liquidity Facility for EligibleNBFCs-ND-SI

170. The Central Government hadannounced an arrangement for providingliquidity support to eligible NBFCs-ND-SIfor meeting the temporary liquiditymismatches through the IndustrialDevelopment Bank of India Stressed AssetStabilisation Fund (IDBI SASF) Trust,

which has been notified as special purposevehicle for undertaking this operation. Thefacility is meant exclusively for meeting thetemporary liquidity mismatches of theNBFCs and not for asset growth.

171. The facility was available foreligible paper issued by NBFCs up toMarch 31, 2009 with an overall ceiling ofRs.20,000 crore, which was subsequentlyextended for eligible paper for a furtherperiod of three months till June 30, 2009.The facility has been availed to the extentof Rs.750 crore till date.

Second Quarter Review

172. The next review of the AnnualStatement on Developmental andRegulatory Policies will be undertaken aspart of the second quarter review ofmonetary policy on October 27, 2009.

Mumbai

April 21, 2009

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September 2008

• A firm assurance to meet any demand-supply gaps of foreign exchange in thedomestic foreign exchange market.

• A second LAF was re-introduced on adaily basis.

• Interest rate ceilings on FCNR(B) andNR(E)RA deposits were increased by50 basis points each to LIBOR/swaprates minus 25 basis points andLIBOR/swap rates plus 50 basispoints respectively.

• As a temporary measure, scheduledbanks were allowed to avail ofadditional liquidity support under theLAF to the extent of up to one per centof their net demand and time liabilitiesfrom their SLR portfolio and seekwaiver of penal interest.

October 2008

• The CRR was reduced by 250 basispoints from 9.0 per cent to 6.5 per centeffective from the fortnight beginningOctober 11, 2008.

• A 14-day special repo facility for anotified amount of Rs.20,000 crorewas instituted to alleviate liquiditystress faced by mutual funds, andbanks were allowed temporary use ofSLR securities for collateral purposesby an additional 0.5 per cent of NDTLexclusively for this purpose.

Annex I

Policy Measures by the Reserve Bank of India:September 2008 Onwards

• Commercial banks and all-India termlending and refinancing institutionswere allowed to lend against and buyback certificates of deposit (CDs) heldby mutual funds.

• The Reserve Bank temporarilyprovided a sum of Rs.25,000 crore asthe first instalment under theAgricultural Debt Waiver and DebtRelief Scheme to scheduled banks andNABARD immediately, pendingParliamentary sanction andconsequent release of funds by theCentral Government.

• Interest rate ceilings on FCNR(B) andNR(E)RA deposits were increasedfurther by 50 basis points each toLIBOR/swap rates plus 25 basispoints and LIBOR/swap rates plus 100basis points respectively.

• Banks were permitted to borrow fundsfrom their overseas branches andcorrespondent banks to the extent of50 per cent of their unimpaired Tier-Icapital or US $ 10 million, whicheveris higher.

• The Reserve Bank announced that itwould institute special marketoperations to meet the foreignexchange requirements of publicsector oil marketing companiesagainst oil bonds when they becomeavailable.

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• On October 20, 2008 the repo rateunder the LAF was reduced by 100basis points to 8.0 per cent.

• The systemically important non-deposit taking non-banking financialcompanies (NBFCs-ND-SI) werepermitted to raise short-term foreigncurrency borrowings.

• External commercial borrowings(ECBs) up to US $ 500 million perborrower per financial year werepermitted for rupee expenditure and/or foreign currency expenditure forpermissible end-uses under theautomatic route. Further, the all-in-cost ceiling for ECBs of averagematurity period of three years and upto five years was raised to 300 basispoints, and over five years, to 500basis points above 6-month LIBOR.

November 2008

• The repo rate under the LAF wasreduced by 50 basis points to 7.5 percent with effect from November 3,2008.

• The CRR was reduced by 100 basispoints from 6.5 per cent to 5.5 per centof NDTL.

• The statutory liquidity ratio (SLR),which was relaxed on a temporarybasis earlier, was made permanent andreduced to 24 per cent of NDTLeffective November 8, 2008.

• In order to provide further liquiditycomfort, a special refinance facility forscheduled commercial banks(excluding RRBs) up to 1.0 per centof each bank’s NDTL as on October

24, 2008 was introduced under Section17(3B) of the Reserve Bank of IndiaAct, 1934 up to a maximum period of90 days.

• On October 15, 2008 the ReserveBank introduced a 14-day special repofacility allowing banks to availadditional liquidity supportexclusively for the purpose of meetingthe liquidity requirements of mutualfunds to the extent of 0.5 per cent oftheir NDTL. Subsequently, thisfacility was extended for NBFCs andthe relaxation in the maintenance ofthe SLR was enhanced to the extentof up to 1.5 per cent of their NDTL.

• Buy-back of MSS dated securities wasannounced to provide another avenuefor injecting liquidity to be calibratedwith the market borrowingprogramme of the Government ofIndia.

• The special term repo facilityintroduced for the purpose of meetingthe liquidity requirements of MFs andNBFCs, was extended till end-March2009. Banks can avail of this facilityeither on an incremental basis or on arollover basis within the entitlementof up to 1.5 per cent of their NDTL.

• Interest rate ceilings on FCNR(B) andNR(E)RA deposits were further raisedby 75 basis points each to LIBOR/swap rates plus 100 basis points andLIBOR/swap rates plus 175 basispoints respectively.

• Housing finance companies (HFCs)registered with the National HousingBank (NHB) were permitted to raise

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short-term foreign currencyborrowings under the approval route.

• The Reserve Bank permitted Indiancorporates to prematurely buy backtheir FCCBs at prevailing discountedrates.

• The period of entitlement of the firstslab of pre-shipment rupee exportcredit was extended from 180 days to270 days.

• The aggregate limit of export creditrefinance (ECR) facility for scheduledbanks (excluding RRBs) wasenhanced from 15 per cent to 50 percent of the outstanding export crediteligible for refinance.

• SIDBI and the NHB were allocatedRs. 2000 crore and Rs.1000 crorerespectively against banks’ estimatedshortfall in priority sector lending inMarch 2009.

• Banks were encouraged to use thespecial refinance facility underSection 17(3B) of the Reserve Bankof India Act, 1934 for the purpose oflending to micro and small enterprises.

• The provisioning requirements for alltypes of standard assets were reducedto a uniform level of 0.40 per cent,except in the case of direct advancesto the agricultural and SME sectorswhich continue to attract provisioningof 0.25 per cent, as hitherto.

• Risk weights on banks’ exposures toall unrated claims on corporates,claims secured by commercial realestate and claims on NBFCs-ND-SIwere reduced to 100 per cent from 150per cent.

• The special refinance facility underSection 17(3B) of the Reserve Bankof India Act, 1934 introduced onNovember 1, 2008 was extended upto June 30, 2009.

• The special term repo facility wasexpanded to enable banks toaccommodate the funding needs ofHFCs. The facility was extended upto June 30, 2009.

• On November 7, 2008 Indian publicand private sector banks that haveforeign branches or subsidiaries wereprovided a forex swap facility of tenorup to three months with the ReserveBank. Further, for funding the swap,banks were allowed to borrow underthe LAF for the corresponding tenorat the prevailing repo rate. This facilitywas subsequently extended up to June30, 2009.

• The period of entitlement of the firstslab of post-shipment rupee exportcredit was extended from 90 days to180 days.

December 2008

• The repo rate under the LAF wasreduced by 100 basis points from 7.5per cent to 6.5 per cent and the reverserepo rate by 100 basis points from 6.0per cent to 5.0 per cent, effectiveDecember 8, 2008.

• A refinance facility was introduced forSIDBI, NHB and EXIM Bank for Rs.7,000 crore, Rs.4,000 crore andRs.5,000 crore respectively. Thisfacility will be available up to March31, 2010.

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• Authorised Dealers Category-I bankswere permitted to considerapplications for premature buy-backof FCCBs from their customers.

• Loans granted by banks to HFCs foron-lending for housing up to Rs.20lakh per dwelling unit were classifiedunder priority sector.

• Commercial real estate exposuresrestructured up to June 30, 2009 wereallowed to be treated as standardassets. As a one-time measure, thesecond restructuring done by banks ofexposures (other than exposures tocommercial real estate, capital marketexposures and personal/consumerloans) up to June 30, 2009 was alsomade eligible for concessionalregulatory treatment.

• The prescribed interest rate asapplicable to post-shipment rupeeexport credit (not exceeding BPLRminus 2.5 percentage points) wasextended to overdue bills up to 180days.

January 2009

• The repo rate under the LAF wasreduced by 100 basis points from 6.5per cent to 5.5 per cent with effectfrom January 5, 2009.

• The reverse repo rate under the LAFwas reduced by 100 basis points from5.0 per cent to 4.0 per cent with effectfrom January 5, 2009.

• The CRR was reduced from 5.5 percent to 5.0 per cent of NDTL effectivefrom the fortnight beginning January17, 2009.

• In order to address the temporaryliquidity constraints of systemicallyimportant non-deposit taking non-banking financial companies (NBFCs-ND-SI), the Government announcedthe setting up of a special purposevehicle (SPV). According to thescheme announced, the SPV wasallowed to mobilise resources throughissuance of government guaranteedsecurities for investment in CPs andNCDs of NBFCs-ND-SI. Governmentguaranteed securities were required tobe purchased by the Reserve Bank.The SPV was to ensure that theNBFCs used the money only foraddressing liquidity constraints andnot for business expansion. The totalsupport from the Reserve Bank waslimited to Rs.20,000 crore with anoption to raise it by a further Rs.5,000crore.

• The special term repo facility underLAF for the purpose of meeting thefunding requirements of MFs, NBFCsand HFCs was extended up toSeptember 30, 2009.

• The special refinance facility forscheduled commercial banks underSection 17 (3B) of the RBI Act, 1934was extended up to September 30,2009.

• The all-in-cost ceiling for ECBsthrough the approval route has beendispensed with up to June 30, 2009.

February 2009

• The Forex Swap facility was extendedtill March 31, 2010.

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• Banks were allowed to apply specialregulatory treatment for accountswhich were standard on September 1,2008 and taken up for restructuring upto January 31, 2009 even if these hadturned non-performing along thisperiod. Subsequently, the timeschedule for taking up restructuringwas extended up to March 31, 2009.

• The ceiling rate on export credit inforeign currency was raised fromLIBOR + 100 basis points to LIBOR+ 350 basis points on February 5, 2009subject to the condition that the bankswould not levy any other charges.

• Correspondingly, the ceiling interestrate on the lines of credit with overseasbanks was also increased from 6months LIBOR/ EURO LIBOR/EURIBOR + 75 basis points to sixmonths LIBOR/ EURO LIBOR/EURIBOR + 150 basis points.

March 2009

• The repo rate under the LAF wasreduced by 50 basis points from 5.5per cent to 5.0 per cent with effectfrom March 5, 2009.

• The reverse repo rate under the LAFwas reduced by 50 basis points from4.0 per cent to 3.5 per cent with effectfrom March 5, 2009.

• The MoU signed by the RBI with theGovernment on March 25, 2004 on theMSS was amended on February 26,2009 to enable the transfer of a partof the amount in the MSS cash account

to the normal cash account as part ofthe Government’s market borrowingprogramme for meeting Government’sapproved expenditure. An amount ofRs.12,000 crore was transferred fromthe MSS account to the normal cashaccount of the Government of Indiaon March 4, 2009 and an equivalentamount of Government securitiesissued under the MSS formed a partof the normal market borrowing of theGovernment of India. Based on theemerging fund requirements of theGovernment, Rs.33,000 crore of MSSwould be de-sequestered against theapproved market borrowingprogramme or bought back in thefiscal year 2009-10.

• The Reserve Bank announced OMOpurchase of government securities ofthe order of Rs.80,000 crore in the firsthalf of 2009-10, of which Rs.40,000crore is envisaged for the first quarterof 2009-10.

• The facility of providing liquiditysupport to meet the temporaryliquidity mismatches for eligible non-banking non-deposit takingsystematically important financialcompanies (NBFCs-ND-SI), whichwas initially available for any paperissued up to March 31, 2009 wasextended for any paper issued up toJune 30, 2009. Accordingly, the SPVwould cease to make fresh purchasesafter September 30, 2009 and wouldrecover all dues by December 31,2009.

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Measures for strengthening theregulation of the financial system wereconsidered by the G-20 Working Group onEnhancing Sound Regulation andStrengthening Transparency. Therecommendations of the Group and thestatus with regard to the relevant items forIndia are set out below.

System-wide Approach to FinancialRegulation

Recommendation 1

As a supplement to their coremandate, the mandates of all nationalfinancial regulators, central banks, andoversight authorities, and of all internationalfinancial bodies and standard setters (IASB,BCBS, IAIS and IOSCO) should takeaccount of financial system stability.

• Over the last few years, financialstability has emerged as a keyobjective of the Reserve Bank’s policy.Accordingly, several measures havebeen taken in recent years to promotefinancial stability. As recommendedby the Committee on FinancialSector Assessment (CFSA), aFinancial Stability Unit is being set up.

Recommendation 2

Within each country, there shouldbe an effective mechanism for appropriate

Annex II

G-20 Working Group on Enhancing Sound Regulationand Strengthening Transparency: Current Status of the

Reserve Bank on the Recommendations

domestic financial sector authorities tojointly assess the systemic risks across thefinancial system and to co-ordinate thedomestic policy response to limit the build-up in systemic risk. The structure of thiscoordinating mechanism should betransparent, with clear assignments ofroles, responsibilities and accountabilityfor each authority.

• In India, the High LevelCo-ordination Committee on FinancialMarkets (HLCCFM) provides a co-ordination mechanism among financialsector regulators, viz., Reserve Bank ofIndia (RBI), Securities and ExchangeBoard of India (SEBI), InsuranceRegulatory and DevelopmentAuthority (IRDA) and Provident FundRegulatory and DevelopmentAuthority (PFRDA). It is supported byother technical committees/sub-committees, which examine issuesrelating to entities under variousregulators that have cross-sectorimplications.

• There are separate technicalcommittees for RBI regulated entities,SEBI regulated entities and IRDAregulated entities. These committeesreview capital market relateddevelopments and based on an earlywarning system attempt to identifyany unusual developments that may

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require co-ordinated action.Exchange-traded currency futures andinterest rate futures, financialconglomerate monitoring framework,crisis management group and acorporate bond and securitisationadvisory committee have beenintroduced through co-ordination ofinter-regulatory agencies.

Recommendation 3

Financial sector authorities shouldhave suitable macroprudential tools toaddress systemic vulnerabilities.

• The Reserve Bank has been usingvarious macro-prudential tools toaddress banking system risks. Forinstance, during the expansionaryphase of 2004-07, the Reserve Banktook various measures to restrictunbridled growth of credit. Theseincluded increased provisioning forstandard advances and increased riskweights in respect of certain assetclasses. However, subsequently, duringslow credit growth phase beginningNovember 2008, those counter-cyclicalmeasures were reversed. The ReserveBank will continue to make efforts todevelop and use further macro-prudential tools and would alsoconsider using any tools that may bedeveloped or recommended byinternational standard setting bodies.

Recommendation 4

The expanded FSF, together with theIMF, should create an effective mechanismfor key financial authorities in each countryto regularly come together around an

international table to jointly assess thesystemic risks across the global financialsystem and to coordinate policy responses.

• The G-20 has redesignated theFinancial Stability Forum (FSF) toFinancial Stability Board (FSB) and itsmembership has, inter alia, beenenlarged to include, all G-20 membercountries, including India. The ReserveBank, the Government of India and theSEBI look forward to contributingactively and effectively to the work andinitiatives of the FSB and the BCBS.

Scope of Regulation

Recommendation 5

All systemically importantfinancial institutions, markets andinstruments should be subject to anappropriate degree of regulation andoversight, consistently applied andproportionate to their local and globalsystemic importance. Non-systemicallyimportant financial institutions, marketsand instruments could also be subject tosome form of registration requirement oroversight, depending on the type and degreeof risk posed, for example for the integrityor efficiency of markets.

National authorities should havethe authority to expand the perimeter ofregulation in a timely way, recognizingthat it may vary across countries andthrough time.

• Banks, which form the largest segmentof the Indian financial system, areclosely regulated by the Reserve Bank.In recent years, the Reserve Bank hasextended its detailed prudential

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regulation to systemically importantnon-deposit taking NBFCs (NBFCs-ND-SI) also. The Reserve Bankoversees the payment and settlementsystems, regulates money markets,foreign exchange market andgovernment securities market.

• Issues relating to expansion of theperimeter of regulation to thoseinstitutions which are not prudentiallyregulated and are systemicallyimportant could be deliberated in theHLCCFM.

Recommendation 6

The systemic importance offinancial institutions, markets andinstruments depends on a wide range offactors, including their size, leverage,interconnectedness, as well as fundingmismatches. The IMF, in consultation withthe BIS and the expanded FSF and otherbodies, should jointly develop a commoninternational framework and guidelines tohelp national authorities assess whether afinancial institution, market or an instrumentis systemically important as consistently aspossible across jurisdictions.

• The Reserve Bank is committed tofollow sound international practicesand standards. When a commoninternational framework is availableto help national authorities to assesswhether a financial institution, marketor an instrument is systemicallyimportant, the Reserve Bank will usethe framework to further sharpen itsfocus with regard to the supervisionof those institutions consideredsystemically important in consultation

with the Government and otherregulatory authorities, as necessary,consistent with the legal framework.

Recommendation 7

Large complex financialinstitutions require particularly robustoversight given their systemic importance,which arises in part from their size andinterconnectedness (or correlation) withother institutions, and from their influenceon markets.

• Following the report on financialconglomerates (FCs), a monitoringmechanism for the identified FCs hasbeen in place since 2004 in co-operation with other regulators. SinceApril 2005, the FC monitoringmechanism has been furtherstrengthened with the introduction ofhalf-yearly discussion with theCEOs of the major group entitieswithin the FC.

• As indicated in the Mid-term Reviewof October 2008, an ‘approach paper’on the supervision of financialconglomerates has since beenprepared by an Internal Group. Therecommendations of the Group arebeing examined from the regulatoryand supervisory perspectives forinitiating appropriate action.

• As part of its endeavour tostrengthen the supervision of bankinggroups, the Reserve Bank extendedthe major elements of prudentialregulations, viz., capital adequacy andexposure norms to all the subsidiariesof commercial banks in 2003.

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Recommendation 8

The boundaries of the regulatoryframework should be reviewed periodicallywithin national jurisdictions, in light offinancial innovation and broader trends inthe financial system. International bodieswill promote good practice and consistentapproaches in this area.

• The Reserve Bank regularly interactswith other regulators of the financialsystem within the national jurisdiction,viz., SEBI, the securities regulator,IRDA, the insurance regulator andPFRDA, the regulator of pension funds.The Reserve Bank has also beenassociated with various internationalbodies such as G-20 and the BIS, andnow also with the FSB and the BCBS.

• The issue of review of the boundariesof the regulatory framework will bekept in focus, both in the interactionwith sectoral regulators within thenational jurisdiction and withinternational bodies.

Oversight of Credit Rating Agencies

Recommendation 9

All credit rating agencies whoseratings are used for regulatory purposesshould be subject to a regulatory oversightregime that includes registration and thatrequires compliance with the substance ofthe IOSCO Code of Conduct Fundamentals.National authorities should obtain theauthority to enforce compliance and requirechanges to a rating agency’s practices andprocedures for managing conflicts ofinterest and for assuring the transparencyand quality of the rating process.

• In India, all credit rating agencies areregistered with the SEBI. The ReserveBank has accorded accreditation to fourcredit rating agencies registered withthe SEBI for the limited purpose ofusing their ratings for assigning riskweights within the framework of theBasel II Accord which has beenimplemented by all banks as at the endof March 2009. Prior to theaccreditation, the Reserve Bank hadundertaken a review of the ratingagencies’ practices and procedures toensure that they comply with thecriteria prescribed for accreditation inthe Basel II framework.

• Since the Indian banking system hasmigrated to the Basel II framework,there is a need to review theperformance of the credit ratingagencies for continuation of theaccreditation, especially by looking atthe latest data relating to cumulativedefault rate and transition matrix of therating agencies. The Reserve Bankwill liaise with the SEBI on the issueof rating agencies’ adherence to theIOSCO Code of ConductFundamentals.

Private Pools of Capital

Recommendation 10

Private pools of capital, includinghedge funds, can be a source of risk owingto their combined size in the market, theiruse of leverage and maturity mismatches,and their connectedness with other partsof the financial system. They or theirmanagers should therefore be required toregister with financial authorities and

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disclose appropriate information to assessthe risks they pose.

• In India, venture capital funds andmutual funds are registered andregulated by the SEBI. Hedge fundsdo not operate in India at present. TheReserve Bank proposes to issue apaper on prudential issues in banks’floating and managing private poolsof capital to finalise the regulatoryguidelines.

Transparent Assessment of RegulatoryRegimes

Recommendation 11

All G-20 members should committo undertake a Financial Sector AssessmentProgram (FSAP) report and to publish itsconclusions. National authorities may alsoperiodically undertake a self-assessmentof their regulatory frameworks based oninternationally agreed methodologiesand tools.

• India first participated in an FSAP in2001 conducted by the IMF and theWorld Bank and also associated withthe independent assessment ofstandards and codes by the Fund/Bank.It also conducted a self-assessment ofcompliance with internationalstandards and codes in 2002 and itsreview in 2004 and put these reports inpublic domain. Since the last FSAP in2001, India has undertaken a series ofongoing reforms in the financial sectoraimed at improving its soundness,resilience and depth. India hascompleted a comprehensive self-assessment of the financial sector in

2009 under a Committee on FinancialSector Assessment (Chairman: Dr.Rakesh Mohan and Co-Chairman: ShriAshok Chawla) based on the IMF-WBmethodology. The assessment,comprising six volumes, has beenpublished and put in the public domainalong with the comments of theinternationally acclaimed PeerReviewers on March 30, 2009. TheReserve Bank will set up a Task Forceto take steps for implementation of therecommendations of the two G-20Working Groups viz., Enhancing SoundRegulations and StrengtheningTransparency, and ReinforcingInternational Co-operation andPromoting Integrity in FinancialMarkets and will also continuouslymonitor the implementation. The TaskForce will also look into all the issuesthat have arisen and what follow-upactions relevant to the Reserve Bankneed to be taken regarding the recentlyreleased report of the Committee onFinancial Sector Assessment(Chairman: Dr. Rakesh Mohan andCo-Chairman: Shri Ashok Chawla).The Task Force would suggest animplementation schedule for everyquarter on a rolling basis.

Procyclicality

Recommendation 12

The FSF and other bodies,particularly the BCBS, should develop andimplement supervisory and regulatoryapproaches to mitigate procyclicality in thefinancial system by promoting the build-upof capital buffers during the economic

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expansion and by dampening the adverseinteraction between fair valuation, leverageand maturity mismatches in times of stress.

• As against the Basel norm for minimumCRAR of 8 per cent, in India, banksare required to maintain a minimumCRAR of 9 per cent. The overallCRAR of all scheduled commercialbanks continued to be strong and it wasat 13 per cent at the end-March 2008and 13.1 per cent at end-December2008. The Reserve Bank recognisesthe need for mitigating the element ofprocyclicality embedded in theregulatory norms as it may exacerbatecyclical trends. With this objective inview, the Reserve Bank has beenemploying a menu of macroprudentialtools to mitigate the impact ofprocyclicality.

• FSB and member bodies, BCBS andCGFS have been entrusted with thework of developing regulatory andsupervisory approaches to mitigateprocyclicality. They are expected todevelop a strategic plan by Fall 2009.India will take further action in thisregard as per global consensusemerging from the work ofinternational bodies.

Recommendation 13

Accounting standard setters shouldstrengthen accounting recognition of loanloss provisions by considering alternativeapproaches for recognizing and measuringloan losses that incorporate a broaderrange of available credit information. Theyshould also examine changes to relevantstandards to dampen adverse dynamics

associated with fair value accounting,including improvements to valuations whendata or modelling is weak. Accountingstandards setters and prudentialsupervisors should work together to identifysolutions that are consistent with thecomplementary objectives of promoting thestability of the financial sector and ofproviding transparency of economic resultsin financial reports.

• The Reserve Bank introduced the assetclassification and loan provisioningnorms in the year 1991-92 whichprescribe the minimum provisioningbased on classification of assets.Certain areas of difference existbetween the requirements ofaccounting standards in respect of loanloss provisioning (accountingperspective) and the Reserve Bank’spresent regulatory approach and theBasel II approach of calculatingexpected loan losses (regulatoryperspective). Internationally, there areattempts for a convergence in thisregard between the Accounting TaskForce (ATF) of the BCBS and theIASB. The Reserve Bank will finetune its policies in tandem withdevelopments at international level inthis regard.

• The Reserve Bank has, over the years,issued guidelines on valuation ofvarious instruments/assets inconformity with the international bestpractices while keeping India-specificconditions in view. In order toencourage market discipline, theReserve Bank has developed a set ofdisclosure requirements which allow

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the market participants to assess keypieces of information on capitaladequacy, risk exposure, riskassessment processes and key businessparameters which provide a consistentand understandable disclosureframework that enhancescomparability. Banks are also requiredto comply with the AccountingStandard (AS) on disclosure ofaccounting policies issued by theInstitute of Chartered Accountants ofIndia (ICAI).

Capital

Recommendation 14

Capital should serve as an effectivebuffer to absorb losses over the cycle, soas to protect both the solvency of financialinstitutions in the event of losses, and theirability to lend.

In the near term, capital buffersabove required minimums should beallowed to decline in response todeteriorating economic conditions andcredit quality, and urgent considerationshould be given to measures that wouldfacilitate access to additional private sectorcapital in the downturn.

Once conditions in the financialsystem have recovered, the adequacy ofthe international standard for theminimum level of capital for banks shouldbe reviewed and the quality and globalconsistency of capital should be enhanced.In addition, capital buffers aboveminimum requirements and loan-lossprovisions should be built up in goodtimes in order to enhance the ability of

regulated financial institutions towithstand large shocks.

• Once conditions in the global financialsystem recover, the Reserve Bankwould consider enhancing theminimum capital standards in tandemwith the proposals at the internationallevel. The build-up of capital andprovisioning buffers in good times willbe encouraged by the Reserve Bankso that capital can absorb unexpectedlosses and be drawn down duringdifficult times.

Recommendation 15

G-20 leaders should support theprogressive adoption of the Basel II capitalframework, which will continue to be improvedon an ongoing basis, across the G-20.

• All commercial banks in India wereBasel II compliant as on March 31,2009. Initially the base approach of theBasel II framework have beenadopted. The Reserve Bank hasplaced on its website a draft circulargiving an indicative timeframe forimplementation of the advancedapproach of the Basel II framework.The enhancement to current Basel IIframework by the internationalstandard setting bodies will beconsidered for implementation asappropriate.

Liquidity

Recommendation 16

Prudential supervisors and centralbanks should deliver a global framework forpromoting stronger liquidity buffers at

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banks, including cross-border institutions, toensure that they can withstand prolongedperiods of market and funding liquidity stress.

• Indian banks have a significantholding of liquid instruments as theyare required to maintain cash reserveratio and statutory liquidity ratio (5 percent and 24 per cent of their netdemand and time liabilities, as atpresent). The substantial CRR/SLRholding offers, in effect, a goodliquidity buffer. There are prudentialnorms governing unsecured overnightborrowings by banks and inter-bankliabilities.

• The Reserve Bank has examined theissue of banks establishing a morerobust liquidity risk managementframework that is well integrated intothe bank-wide risk managementprocess by adopting global liquidityplanning. In this context, banks will berequired to integrate their variousforeign currency assets and liabilitiespositions from their branch operationsin India with the rupee asset liabilityposition.

Infrastructure for OTC Derivatives

Recommendation 17

Financial institutions shouldcontinue to strengthen the infrastructuresupporting OTC derivatives markets. In thecase of credit derivatives, this includesstandardizing contracts to facilitate theirclearing through a central counterparty.National authorities should enhanceincentives as needed for the use of centralcounterparties to clear OTC creditderivatives.

Recommendation 18

Central counterparties should besubject to transparent and effectiveoversight by prudential supervisors andother relevant authorities, includingcentral banks, and meet high standards interms of risk management, operationalarrangements, default procedures, fairaccess and transparency. The CPSS andIOSCO should review their experiences inapplying their recommendations forcentral counterparties to derivatives.

• The CCIL provides an institutionalstructure for the clearing and settlementof transactions undertaken ingovernment securities, money marketinstruments and foreign exchangeproducts and has adopted the coreprinciples set by the CPSS and IOSCO.In October 2007, CCIL has joined as amember of the CCP 12, an internationalorganisation of central counterparty(CCP) clearing organisations.

• CCIL’s role is being graduallyextended to the OTC derivativessegment, initially as a reportingplatform and thereafter, covering thesettlement aspect.

• The Payment and Settlement SystemsAct, 2007 has designated the ReserveBank as the authority to regulate andsupervise the payment and settlementsystems in the country.

• The netting procedure and settlementfinality, earlier governed bycontractual agreement/s, have beenaccorded legal recognition under theAct. The Reserve Bank is empoweredto issue directions and guidelines to

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the system providers, prescribe theduties to be performed by them andaudit and inspect their systems/premises.

• The recommendations of the CPSSand the IOSCO when available will beapplied as appropriate to CCIL.

Compensation Schemes and RiskManagement

Recommendation 19

Large financial institutions shouldensure that their compensation frameworksare consistent with their long-term goalsand with prudent risk-taking. As such, theBoards of Directors of financial institutionsshould set clear lines of responsibility andaccountability throughout theirorganizations to ensure that the design andoperation of its remuneration systemsupports the firm’s goals, including itsoverall risk tolerance. Shareholders mayhave a role in this process. Boards shouldalso ensure there are appropriatemechanisms for monitoring remunerationschemes.

Recommendation 20

In order to promote incentives forprudent risk taking, each financialinstitution must review its compensationframework to ensure it follows soundpractice principles developed by the FSF.These include the need for remunerationsystems to provide incentives consistentwith the firm’s long-term goals, to beadjusted for the risk taken by employees, andfor the variable components of compensationto vary symmetrically according toperformance.

Recommendation 21

Prudential supervisors shouldenhance their oversight of compensationschemes by taking the design ofremuneration systems into account whenassessing risk management practices. TheBCBS should more explicitly integrate thisdimension in its guidance for theassessment of risk management practicesby national prudential supervisors.

• In terms of Section 35 B of theBanking Regulation Act, 1949banks in the private sector andforeign banks in India are requiredto obtain the approval of theReserve Bank for remunerationpayable to their CEOs (theremuneration of public sector bankCEOs is fixed by the Governmentof India).

• While devising the totalremuneration package (including allperquisites and bonus) of CEOs andwhole-time directors, Boards ofprivate banks are required to ensurethat the total package is reasonablein the light of industry normsincluding size of the business inIndia. The CompensationCommittee which looks into theremuneration issue is required tohave adequate representation ofindependent directors and directors,if any, representing majorinstitutional shareholders in India.Remuneration of foreign banks’CEOs is mainly driven by thepolicies of their head offices.

• The Reserve Bank wouldrecommend the implementation of

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the sound procedures/principlesdeveloped by the FSB for financialinstitutions regarding thecompensation packages.

Transparency

Recommendation 22

Accounting standard setters shouldaccelerate efforts to reduce the complexityof accounting standards for financialinstruments and enhance presentationstandards to allow the users of financialstatements to better assess the uncertaintysurrounding the valuation of financialinstruments.

• International Accounting Standards/International Financial ReportingStandards (IAS/IFRS) are adopted asa basis for formulation of Indianstandards and due consideration isgiven to local customs, usage,practices, legal and regulatoryenvironment. The Reserve Bank hastaken a proactive role in the area ofadherence by banks to the AccountingStandards. The Reserve Bank alsoactually participates in the standardsetting process through its nomineesin the Accounting Standards Boardand the National Advisory Committeeon Accounting Standards.

• IASB is in the process of issuing a newglobally accepted standard in placeof the existing financial instrumentsstandard (IAS 39 FinancialInstruments: Recognition andMeasurement) that would addressissues arising from the financial crisisin a comprehensive manner.Implementation of the standard in the

Indian context will arise after it isfinalised by IASB and adopted byICAI as a part of its convergenceprogramme.

• The Reserve Bank has, over the years,issued guidelines on valuation ofvarious instruments/assets inconformity with the international bestpractices while keeping India-specificconditions in view.

• The securitisation framework in Indiais considered to be reasonably prudentand has been able to minimise theincentives that have led to theproblems which surfaced in thecurrent crisis.

Recommendation 23

The IASB should enhance its effortsto facilitate the global convergence towardsa single set of high-quality accountingstandards by sharing the experience ofcountries that have completed this processand by providing technical assistance.

• The recently published report of theCFSA on India’s financial sectorassessment has stated that the Indianaccounting standards are generally inalignment with international accountingstandards, except for somemodifications to suit local customs,usages and level of development in thecountry. There has been significantprogress in the area of convergence ofaccounting standards. The Indianaccounting standards are expected to befully convergent with IFRSs with effectfrom April 1, 2011 when IFRSs arelikely to be adopted in India for listedand other public interest entities.

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Enforcement

Recommendation 24

The effective enforcement ofregulation should be a priority of allfinancial regulators. As such, nationalfinancial regulators and oversightauthorities should ensure the effectivenessof their enforcement activities and thatappropriate resources are available formonitoring the application of regulationand for prosecuting offenders. Theenforcement function should beindependent from other activities or fromexternal influences.

• Regulations issued by the ReserveBank are monitored by its supervisorydepartment. The Banking RegulationAct, 1949 has prescribed extensivepenalties for non submission or willfulomission of information, for makingfalse statements, and for not followingdirections issued by the Reserve Bank.Apart from this, the Reserve Bank canimpose penalties under specificpowers granted to it under the Act.Similar provisions exist in the CreditInformation Companies (Regulation)Act, 2005 and the Payment andSettlement Systems Act, 2007. Thepenalties imposed by the ReserveBank under the BR Act are placed inpublic domain.

Technical Assistance and CapacityBuilding in Emerging Market Economies

Recommendation 25

Recognizing that the degree ofdevelopment of financial systems variesconsiderably across the G20, nationalauthorities should commit to assist each

other in enhancing their capacity tostrengthen regulatory frameworks. Inaddition, IOSCO, the IAIS and the BCBSshould have the appropriate capacity toprovide technical assistance. The needs ofemerging market economies deserveparticular consideration.

• India has been striving for adoptingthe international best practices,tailored to country-specific conditions.Accordingly, the capacity building ofall stakeholders has been progressivelyupgraded. The Reserve Bank has alsoconducted several internationalseminars often in collaboration withinternational bodies, to upgrade theskill levels in various developingeconomies. The Reserve Bank willcontinue such efforts.

G-20 Leaders’ Declaration

The other important elements forstrengthening the financial system ascontained in the G-20 Leaders’declaration are:

International Cooperation

To establish the remainingsupervisory colleges for significant crossborder firms by June 2009 building on 28already in place.

• India has been actively participatingin supervisory colleges conducted byoverseas home regulators of foreignbanks operating in India. No Indianbank has significant presence inforeign jurisdictions so as to renderthem systemically important there.As and when Indian banks attaincritical level of operations, theReserve Bank will considerconvening supervisory colleges.

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To implement the FSF principlesfor cross-border crisis managementimmediately, and that home authorities ofeach major international financialinstitutions should ensure that the groupof authorities with a common interest inthat financial institution meet at leastannually;

To support continued efforts by theIMF, FSB, World Bank, and BCBS todevelop an international framework forcross-border bank resolutionarrangements;

• An Internal Working Groupconstituted to lay down the road mapfor adoption of a suitable frameworkfor cross-border supervision andsupervisory co-operation withoverseas regulators has submitted itsreport in January 2009. Therecommendations of the Group arebeing examined for initiating furtheraction.

• Further, an Inter-departmental Groupis examining additional areas/issueswhich need to be brought undersupervisory focus, including modalitiesfor on-site supervision of overseasbranches and subsidiaries of Indian

banks. The group is expected to submitits report by end May, 2009.

• As and when international frameworkis developed by internationalagencies/standard setters, India willadopt the same in line with countryspecific needs.

Tax havens and non-cooperativejurisdictions

Increased disclosure requirementson the part of taxpayers and financialinstitutions to report transactions involvingnon-cooperative jurisdictions.

• In India, banks have been advised tobe extremely cautious while continuingrelationships with respondent bankslocated in countries with poor know-your-customer (KYC) standards andcountries identified as ‘non-co-operative’ in the fight against moneylaundering and terrorist financing.

• The AML/CFT guidelines issued bythe Reserve Bank are in consonancewith the FATF recommendations andthe Reserve Bank would continue toincorporate in its regulations latestinternational best practices.