The Financial Sector Reforms in India

PresentationPresentation

Economic Environment of BusinessEconomic Environment of Business

The Financial Sector ReformsThe Financial Sector Reforms

September 9, 2009The financial Sector Reforms

1

Slow but steady …not to forget the socio economic needs …

GROUPGROUP

•• AJAY K. DHAMIJAAJAY K. DHAMIJA NN--11•• SNEHAL SONISNEHAL SONI NN--4747


2

•Introduction

•Major Contours of Reforms

•Banking sector Reforms

•Monitory Policy Reforms

•Financial Markets Reforms

•Forex Market Reforms

•Assesment

•Conclusions

CoverageCoverage


3

•Introduction

•Major Contours of Reforms

•Banking sector Reforms

•Monitory Policy Reforms

•Financial Markets Reforms

•Forex Market Reforms

•Assesment

•Conclusions

IntroductionIntroduction•• FIVE PrincipleFIVE Principle

–– Measured, gradual, cautious and steady sequencing of reformsMeasured, gradual, cautious and steady sequencing of reforms–– Introduction of mutually reinforcing normsIntroduction of mutually reinforcing norms–– Development of an Efficient, Competitive and Stable financialDevelopment of an Efficient, Competitive and Stable financial

sectorsector–– Development of Financial InstitutionsDevelopment of Financial Institutions–– Introduction of complementary reforms across Monetary, Fiscal andIntroduction of complementary reforms across Monetary, Fiscal and

external sectorexternal sector

•• Broad based reforms touching every sectorBroad based reforms touching every sector

–– Financial SectorFinancial Sector–– Monetary and Fiscal PolicyMonetary and Fiscal Policy–– Capital MarketCapital Market–– Foreign Exchange MarketForeign Exchange Market–– Money and Government Securities MarketMoney and Government Securities Market


4

•• FIVE PrincipleFIVE Principle

–– Measured, gradual, cautious and steady sequencing of reformsMeasured, gradual, cautious and steady sequencing of reforms–– Introduction of mutually reinforcing normsIntroduction of mutually reinforcing norms–– Development of an Efficient, Competitive and Stable financialDevelopment of an Efficient, Competitive and Stable financial

sectorsector–– Development of Financial InstitutionsDevelopment of Financial Institutions–– Introduction of complementary reforms across Monetary, Fiscal andIntroduction of complementary reforms across Monetary, Fiscal and

external sectorexternal sector

•• Broad based reforms touching every sectorBroad based reforms touching every sector

–– Financial SectorFinancial Sector–– Monetary and Fiscal PolicyMonetary and Fiscal Policy–– Capital MarketCapital Market–– Foreign Exchange MarketForeign Exchange Market–– Money and Government Securities MarketMoney and Government Securities Market

In early 1990sIn early 1990s•• Financial RepressionFinancial Repression

–– Extensive RegulationsExtensive Regulations

–– Administered Interest ratesAdministered Interest rates

–– Directed Credit ProgrammesDirected Credit Programmes

–– Weak Banking StructureWeak Banking Structure

–– Lack of Proper Accounting & Risk management systemsLack of Proper Accounting & Risk management systems

–– Lack of transparency in operationsLack of transparency in operations

Lion in jungle

vs

lion in cage


5

•• Financial RepressionFinancial Repression

–– Extensive RegulationsExtensive Regulations

–– Administered Interest ratesAdministered Interest rates

–– Directed Credit ProgrammesDirected Credit Programmes

–– Weak Banking StructureWeak Banking Structure

–– Lack of Proper Accounting & Risk management systemsLack of Proper Accounting & Risk management systems

–– Lack of transparency in operationsLack of transparency in operations

In early 1990s…In early 1990s…

–– PrePre--emption of resources from the banking system by theemption of resources from the banking system by thegovernment to finance its fiscal deficitgovernment to finance its fiscal deficit

–– Excessive structural and micro regulation that inhibited financialExcessive structural and micro regulation that inhibited financialinnovation and increased transaction costsinnovation and increased transaction costs

–– Relatively inadequate level of prudential regulation in theRelatively inadequate level of prudential regulation in thefinancial sectorfinancial sector

–– Poorly developed debt and money marketsPoorly developed debt and money markets

–– Outdated (often primitive) technological and institutionalOutdated (often primitive) technological and institutionalstructures that made the capital markets and the rest of thestructures that made the capital markets and the rest of thefinancial system highly inefficient.financial system highly inefficient.


6

–– PrePre--emption of resources from the banking system by theemption of resources from the banking system by thegovernment to finance its fiscal deficitgovernment to finance its fiscal deficit

–– Excessive structural and micro regulation that inhibited financialExcessive structural and micro regulation that inhibited financialinnovation and increased transaction costsinnovation and increased transaction costs

–– Relatively inadequate level of prudential regulation in theRelatively inadequate level of prudential regulation in thefinancial sectorfinancial sector

–– Poorly developed debt and money marketsPoorly developed debt and money markets

–– Outdated (often primitive) technological and institutionalOutdated (often primitive) technological and institutionalstructures that made the capital markets and the rest of thestructures that made the capital markets and the rest of thefinancial system highly inefficient.financial system highly inefficient.

Resulting into …Resulting into …•• Government regulated the price at which firms could issue equity,Government regulated the price at which firms could issue equity,

the rate of interest which they could offer on their bonds, and thethe rate of interest which they could offer on their bonds, and thedebt equity ratio that was permissible in different Industriesdebt equity ratio that was permissible in different Industries

•• Working capital management was even more constrained withWorking capital management was even more constrained withdetailed regulations on how much inventory the firms could carrydetailed regulations on how much inventory the firms could carryor how much credit they could give to their customers.or how much credit they could give to their customers.

•• Working capital was financed almost entirely by banks at interestWorking capital was financed almost entirely by banks at interestrates laid down by the central bankrates laid down by the central bank

•• Working capital finance was related more to the credit need of theWorking capital finance was related more to the credit need of theborrower than to creditworthinessborrower than to creditworthiness


7

•• Government regulated the price at which firms could issue equity,Government regulated the price at which firms could issue equity,the rate of interest which they could offer on their bonds, and thethe rate of interest which they could offer on their bonds, and thedebt equity ratio that was permissible in different Industriesdebt equity ratio that was permissible in different Industries

•• Working capital management was even more constrained withWorking capital management was even more constrained withdetailed regulations on how much inventory the firms could carrydetailed regulations on how much inventory the firms could carryor how much credit they could give to their customers.or how much credit they could give to their customers.

•• Working capital was financed almost entirely by banks at interestWorking capital was financed almost entirely by banks at interestrates laid down by the central bankrates laid down by the central bank

•• Working capital finance was related more to the credit need of theWorking capital finance was related more to the credit need of theborrower than to creditworthinessborrower than to creditworthiness

… and …… and …•• Volatility was not something that most finance managers worriedVolatility was not something that most finance managers worried

about or needed to.about or needed to.

–– The exchange rate of the rupee changed predictably and almostThe exchange rate of the rupee changed predictably and almostimperceptiblyimperceptibly

–– Administered interest rates were changed infrequently and theAdministered interest rates were changed infrequently and thechanges too were usually quite smallchanges too were usually quite small

•• Financial genius consisted largely of finding one’s way through theFinancial genius consisted largely of finding one’s way through theregulatory maze, exploiting loopholes wherever they existed and aboveregulatory maze, exploiting loopholes wherever they existed and aboveall cultivating relationships with those officials in the banks andall cultivating relationships with those officials in the banks andinstitutions who had some discretionary powers.institutions who had some discretionary powers.

•• Even an overnight cash surplus could be parked in the overdraftEven an overnight cash surplus could be parked in the overdraftaccount where it could earn (or rather save) interest at the firm’saccount where it could earn (or rather save) interest at the firm’sborrowing rate.borrowing rate.


8

•• Volatility was not something that most finance managers worriedVolatility was not something that most finance managers worriedabout or needed to.about or needed to.

–– The exchange rate of the rupee changed predictably and almostThe exchange rate of the rupee changed predictably and almostimperceptiblyimperceptibly

–– Administered interest rates were changed infrequently and theAdministered interest rates were changed infrequently and thechanges too were usually quite smallchanges too were usually quite small

•• Financial genius consisted largely of finding one’s way through theFinancial genius consisted largely of finding one’s way through theregulatory maze, exploiting loopholes wherever they existed and aboveregulatory maze, exploiting loopholes wherever they existed and aboveall cultivating relationships with those officials in the banks andall cultivating relationships with those officials in the banks andinstitutions who had some discretionary powers.institutions who had some discretionary powers.

•• Even an overnight cash surplus could be parked in the overdraftEven an overnight cash surplus could be parked in the overdraftaccount where it could earn (or rather save) interest at the firm’saccount where it could earn (or rather save) interest at the firm’sborrowing rate.borrowing rate.

At larger level …At larger level …•• The balance of payments crisis that threatened the internationalThe balance of payments crisis that threatened the international

credibility of the country and pushed it to the brink of defaultcredibility of the country and pushed it to the brink of default

• The grave threat of insolvency confronting the banking system whichThe grave threat of insolvency confronting the banking system whichhad for years concealed its problems with the help of defectivehad for years concealed its problems with the help of defectiveaccounting policies.accounting policies.

•• Hindered efficient allocation of resourcesHindered efficient allocation of resources


9

Major Contours of ReformsMajor Contours of Reforms•• Removal of existing financial repressionRemoval of existing financial repression

•• Creation of an efficient, productive and profitable financial sectorCreation of an efficient, productive and profitable financial sector

•• Enabling the process of price discovery by the market determination ofEnabling the process of price discovery by the market determination ofinterest rates that improves allocative efficiency of resourcesinterest rates that improves allocative efficiency of resources

•• Providing operational and functional autonomy to institutionsProviding operational and functional autonomy to institutions

•• Preparing the financial system for increasing international competitionPreparing the financial system for increasing international competition

•• Opening the external sector in a a calibrated mannerOpening the external sector in a a calibrated manner

•• Promoting financial stability in the wake of domestic and externalPromoting financial stability in the wake of domestic and externalshocksshocks


10

•• Removal of existing financial repressionRemoval of existing financial repression

•• Creation of an efficient, productive and profitable financial sectorCreation of an efficient, productive and profitable financial sector

•• Enabling the process of price discovery by the market determination ofEnabling the process of price discovery by the market determination ofinterest rates that improves allocative efficiency of resourcesinterest rates that improves allocative efficiency of resources

•• Providing operational and functional autonomy to institutionsProviding operational and functional autonomy to institutions

•• Preparing the financial system for increasing international competitionPreparing the financial system for increasing international competition

•• Opening the external sector in a a calibrated mannerOpening the external sector in a a calibrated manner

•• Promoting financial stability in the wake of domestic and externalPromoting financial stability in the wake of domestic and externalshocksshocks

Two phased ReformsTwo phased Reforms•• First Generation (Early 1990):First Generation (Early 1990):-- IIstst Phase:Phase:

–– Creating an efficient, productive and profitable financialCreating an efficient, productive and profitable financialsector to function with operational flexibility andsector to function with operational flexibility andfunctional autonomyfunctional autonomy

•• Second Generation (Mid 1990 …) :Second Generation (Mid 1990 …) :-- IIIIndnd phasephase

–– Strengthening the financial system and introducingStrengthening the financial system and introducingstructural improvementsstructural improvements


11

•• First Generation (Early 1990):First Generation (Early 1990):-- IIstst Phase:Phase:

–– Creating an efficient, productive and profitable financialCreating an efficient, productive and profitable financialsector to function with operational flexibility andsector to function with operational flexibility andfunctional autonomyfunctional autonomy

•• Second Generation (Mid 1990 …) :Second Generation (Mid 1990 …) :-- IIIIndnd phasephase

–– Strengthening the financial system and introducingStrengthening the financial system and introducingstructural improvementsstructural improvements

Major Sectors of ReformsMajor Sectors of Reforms•• Banking SectorBanking Sector

•• Monetary PolicyMonetary Policy

•• Financial MarketsFinancial Markets

•• Forex MarketForex Market


12

•• Banking SectorBanking Sector

•• Monetary PolicyMonetary Policy

•• Financial MarketsFinancial Markets

•• Forex MarketForex Market

Banking Sector ReformsBanking Sector Reforms•• CompetitionCompetition EnhancingEnhancing MeasuresMeasures

•• Measures Enhancing Role of Market ForcesMeasures Enhancing Role of Market Forces

•• Prudential MeasuresPrudential Measures

•• Institutional and Legal MeasuresInstitutional and Legal Measures

•• Supervisory MeasuresSupervisory Measures

•• Technology Related MeasuresTechnology Related Measures


13

•• CompetitionCompetition EnhancingEnhancing MeasuresMeasures

•• Measures Enhancing Role of Market ForcesMeasures Enhancing Role of Market Forces

•• Prudential MeasuresPrudential Measures

•• Institutional and Legal MeasuresInstitutional and Legal Measures

•• Supervisory MeasuresSupervisory Measures

•• Technology Related MeasuresTechnology Related Measures

Banking Sector Reforms :Banking Sector Reforms :Competition Enhancing MeasuresCompetition Enhancing Measures

•• Operational autonomy to Public Sector banksOperational autonomy to Public Sector banks

•• Reduction in public ownership of public sector banksReduction in public ownership of public sector banks–– Can raise capital from equity market up to 49% of paid up capitalCan raise capital from equity market up to 49% of paid up capital

•• Transparent Norms related to entry, mergers /amalgamation andTransparent Norms related to entry, mergers /amalgamation andgovernance issues for Indian private sector, foreign and jointgovernance issues for Indian private sector, foreign and joint--ventureventurebanks, NBFC’s and insurance companiesbanks, NBFC’s and insurance companies

•• Permission for foreign investment in the financial sector in the form ofPermission for foreign investment in the financial sector in the form ofForeign Direct Investment (FDI) as well as portfolio investmentForeign Direct Investment (FDI) as well as portfolio investment

•• Permission to banks to diversify product portfolio and businessPermission to banks to diversify product portfolio and businessactivitiesactivities


14

•• Operational autonomy to Public Sector banksOperational autonomy to Public Sector banks

•• Reduction in public ownership of public sector banksReduction in public ownership of public sector banks–– Can raise capital from equity market up to 49% of paid up capitalCan raise capital from equity market up to 49% of paid up capital

•• Transparent Norms related to entry, mergers /amalgamation andTransparent Norms related to entry, mergers /amalgamation andgovernance issues for Indian private sector, foreign and jointgovernance issues for Indian private sector, foreign and joint--ventureventurebanks, NBFC’s and insurance companiesbanks, NBFC’s and insurance companies

•• Permission for foreign investment in the financial sector in the form ofPermission for foreign investment in the financial sector in the form ofForeign Direct Investment (FDI) as well as portfolio investmentForeign Direct Investment (FDI) as well as portfolio investment

•• Permission to banks to diversify product portfolio and businessPermission to banks to diversify product portfolio and businessactivitiesactivities

Banking Sector Reforms :Banking Sector Reforms :Measures Enhancing Role of Market ForcesMeasures Enhancing Role of Market Forces

•• Sharp reduction in preSharp reduction in pre--emption through reserve requirementemption through reserve requirement

•• Market determined pricing for government securitiesMarket determined pricing for government securities

•• Disbanding of administered interest ratesDisbanding of administered interest rates

•• Enhanced transparency and disclosure norms to facilitate marketEnhanced transparency and disclosure norms to facilitate marketdisciplinediscipline

•• Introduction of pure interIntroduction of pure inter--bank call money market and developingbank call money market and developingmarkets for securitized assetsmarkets for securitized assets

•• AuctionAuction--based reposbased repos--reverse repos for shortreverse repos for short--term liquidityterm liquiditymanagement and Improved payments and settlementmanagement and Improved payments and settlementmechanismmechanism


15

•• Sharp reduction in preSharp reduction in pre--emption through reserve requirementemption through reserve requirement

•• Market determined pricing for government securitiesMarket determined pricing for government securities

•• Disbanding of administered interest ratesDisbanding of administered interest rates

•• Enhanced transparency and disclosure norms to facilitate marketEnhanced transparency and disclosure norms to facilitate marketdisciplinediscipline

•• Introduction of pure interIntroduction of pure inter--bank call money market and developingbank call money market and developingmarkets for securitized assetsmarkets for securitized assets

•• AuctionAuction--based reposbased repos--reverse repos for shortreverse repos for short--term liquidityterm liquiditymanagement and Improved payments and settlementmanagement and Improved payments and settlementmechanismmechanism

Banking Sector Reforms :Banking Sector Reforms :Prudential MeasuresPrudential Measures

• Introduction and phased implementation of international best practicesand norms related to:- CRAR, Income recognition, Provisioning andExposure

• Strengthen risk management :-– Assignment of risk-weights to various asset classes– Norms on connected lending, risk concentration– Application of marked-to-market principle for investment portfolio and

limits on deployment of fund in sensitive activities– 'Know Your Customer‘ norms– 'Anti Money Laundering' guidelines– Graded provisioning for NPA’s– Capital charge for market risk

• Guidelines for ownership and governance, securitization and debtrestructuring mechanisms norms, etc


16

• Introduction and phased implementation of international best practicesand norms related to:- CRAR, Income recognition, Provisioning andExposure

• Strengthen risk management :-– Assignment of risk-weights to various asset classes– Norms on connected lending, risk concentration– Application of marked-to-market principle for investment portfolio and

limits on deployment of fund in sensitive activities– 'Know Your Customer‘ norms– 'Anti Money Laundering' guidelines– Graded provisioning for NPA’s– Capital charge for market risk

• Guidelines for ownership and governance, securitization and debtrestructuring mechanisms norms, etc

Banking Sector Reforms :Banking Sector Reforms :Prudential Measures:Prudential Measures:-- Roadmap for Basel IIRoadmap for Basel II

•• Implementing Basel II with effect from March 31, 2007Implementing Basel II with effect from March 31, 2007•• Standardized Approach for credit risk and Basic IndicatorStandardized Approach for credit risk and Basic Indicator

Approach for operational risk (First Phase)Approach for operational risk (First Phase)•• Migrate to the Internal Rating Based (IRB) Approach afterMigrate to the Internal Rating Based (IRB) Approach after

adequate skills are developed (Second Phase)adequate skills are developed (Second Phase)•• Basel II will require more capital for banks in IndiaBasel II will require more capital for banks in India

–– Presently CRAR is over 12 per centPresently CRAR is over 12 per cent

–– New and Innovative Funding optionsNew and Innovative Funding options Perpetual debt instruments and nonPerpetual debt instruments and non--

cumulative preference sharescumulative preference shares Redeemable cumulative preference sharesRedeemable cumulative preference shares

and hybrid debt instrumentsand hybrid debt instruments


17

•• Implementing Basel II with effect from March 31, 2007Implementing Basel II with effect from March 31, 2007•• Standardized Approach for credit risk and Basic IndicatorStandardized Approach for credit risk and Basic Indicator

Approach for operational risk (First Phase)Approach for operational risk (First Phase)•• Migrate to the Internal Rating Based (IRB) Approach afterMigrate to the Internal Rating Based (IRB) Approach after

adequate skills are developed (Second Phase)adequate skills are developed (Second Phase)•• Basel II will require more capital for banks in IndiaBasel II will require more capital for banks in India

–– Presently CRAR is over 12 per centPresently CRAR is over 12 per cent

–– New and Innovative Funding optionsNew and Innovative Funding options Perpetual debt instruments and nonPerpetual debt instruments and non--

cumulative preference sharescumulative preference shares Redeemable cumulative preference sharesRedeemable cumulative preference shares

and hybrid debt instrumentsand hybrid debt instruments

Banking Sector Reforms :Banking Sector Reforms :Institutional and Legal MeasuresInstitutional and Legal Measures

• Setting up of Lok Adalats (people’s courts), debt recovery tribunals,asset reconstruction companies, settlement advisory committees,corporate debt restructuring mechanism, etc.

• Promulgation of Securitization and Reconstruction of Financial Assetsand Enforcement of Securities Interest (SARFAESI) Act, 2002 and itssubsequent amendment to ensure creditor rights

• Setting up of Credit Information Bureau of India Limited (CIBIL) forinformation sharing on defaulters as also other borrowers

• Setting up of Clearing Corporation of India Limited (CCIL) to act ascentral counter party for facilitating payments and settlement systemrelating to fixed income securities and money market instruments


18

• Setting up of Lok Adalats (people’s courts), debt recovery tribunals,asset reconstruction companies, settlement advisory committees,corporate debt restructuring mechanism, etc.

• Promulgation of Securitization and Reconstruction of Financial Assetsand Enforcement of Securities Interest (SARFAESI) Act, 2002 and itssubsequent amendment to ensure creditor rights

• Setting up of Credit Information Bureau of India Limited (CIBIL) forinformation sharing on defaulters as also other borrowers

• Setting up of Clearing Corporation of India Limited (CCIL) to act ascentral counter party for facilitating payments and settlement systemrelating to fixed income securities and money market instruments

Banking Sector Reforms :Banking Sector Reforms :Supervisory MeasuresSupervisory Measures

• Board for Financial Supervision as the apex supervisory authority forRisk based supervision

• Introduction of CAMELS supervisory rating system(i.e., capital adequacy, asset quality, management, earning,

liquidity and system and control).

• Consolidated supervision of financial conglomerates

• Recasting of the role of statutory auditors with increased internalcontrol through strengthening of internal audit

• Strengthening corporate governance

• Fit and proper tests for directors along-with enhanced due diligence onimportant shareholders


19

• Board for Financial Supervision as the apex supervisory authority forRisk based supervision

• Introduction of CAMELS supervisory rating system(i.e., capital adequacy, asset quality, management, earning,

liquidity and system and control).

• Consolidated supervision of financial conglomerates

• Recasting of the role of statutory auditors with increased internalcontrol through strengthening of internal audit

• Strengthening corporate governance

• Fit and proper tests for directors along-with enhanced due diligence onimportant shareholders

Banking Sector Reforms :Banking Sector Reforms :Technology Related MeasuresTechnology Related Measures

• INFINET as the communication backbone for the financialsector

• Negotiated Dealing System (NDS) for screen-based trading ingovernment securities

• Real Time Gross Settlement (RTGS) System

True test of the success of the bankingreforms would be the extent of NPA’s


20

• INFINET as the communication backbone for the financialsector

• Negotiated Dealing System (NDS) for screen-based trading ingovernment securities

• Real Time Gross Settlement (RTGS) System

True test of the success of the bankingreforms would be the extent of NPA’s

Monitory Policy ReformsMonitory Policy Reforms• Objectives

• Instruments

• Developmental Measures

• Institutional Measures


21

• Objectives

• Instruments

• Developmental Measures


Monitory Policy Reforms :Monitory Policy Reforms :ObjectivesObjectives

• Twin objectives of “Maintaining price stability” and “Ensuringavailability of adequate credit to productive sectors

• Use of broad money (M2) as an intermediate target has been de-emphasized and a multiple indicator approach has been adopted

• Development of multiple instruments to transmit liquidity and interestrate signals in the short-term in a flexible and bi-directional manner

• Increase of the inter-linkage between various segments of the financialmarket including money, government security and forex markets


22

• Twin objectives of “Maintaining price stability” and “Ensuringavailability of adequate credit to productive sectors

• Use of broad money (M2) as an intermediate target has been de-emphasized and a multiple indicator approach has been adopted

• Development of multiple instruments to transmit liquidity and interestrate signals in the short-term in a flexible and bi-directional manner

• Increase of the inter-linkage between various segments of the financialmarket including money, government security and forex markets

Monitory Policy Reforms :Monitory Policy Reforms :Instruments:Instruments: Strategic Shift: From Direct to IndirectStrategic Shift: From Direct to Indirect

• Open market operations (OMO) to deal with overall market liquiditysituation especially those emanating from capital flows

• Introduction of Market Stabilization Scheme (MSS) as an additionalinstrument to deal with enduring capital inflows without affectingshort-term liquidity management role of LAF

• Introduction of Liquidity Adjustment Facility (LAF), which operatesthrough repo and reverse repo auctions Liquidity Adjustment Facility( LAF )

– To nudge overnight interest rates within a specified corridor.– TO de-emphasize targeting of bank reserves and focus increasingly on

interest rates.– reducing the cash reserve ratio (CRR) without loss of monetary control.


23

• Open market operations (OMO) to deal with overall market liquiditysituation especially those emanating from capital flows

• Introduction of Market Stabilization Scheme (MSS) as an additionalinstrument to deal with enduring capital inflows without affectingshort-term liquidity management role of LAF

• Introduction of Liquidity Adjustment Facility (LAF), which operatesthrough repo and reverse repo auctions Liquidity Adjustment Facility( LAF )

– To nudge overnight interest rates within a specified corridor.– TO de-emphasize targeting of bank reserves and focus increasingly on

interest rates.– reducing the cash reserve ratio (CRR) without loss of monetary control.

LAF + OMO + MSS => FlexibilityLAF + OMO + MSS => Flexibility

Transition from direct instruments of monetary controlsuch as administered interest rate, reserve requirement,selective capital control) to indirect instruments like openmarket operations, purchase and repurchase ofgovernment securities

• Advantages– Certain dead weight loss for the system was saved.– Greater flexibility in determining both the quantum of adjustment

as well as the rates by responding to the needs of the system ona daily basis.

– Modulation of the supply of funds on a daily basis to meet day-to-day liquidity mismatches.

– demand for funds are affected through policy rate changes.– Stabilization of short-term money market rates.


24

Transition from direct instruments of monetary controlsuch as administered interest rate, reserve requirement,selective capital control) to indirect instruments like openmarket operations, purchase and repurchase ofgovernment securities

• Advantages– Certain dead weight loss for the system was saved.– Greater flexibility in determining both the quantum of adjustment

as well as the rates by responding to the needs of the system ona daily basis.

– Modulation of the supply of funds on a daily basis to meet day-to-day liquidity mismatches.

– demand for funds are affected through policy rate changes.– Stabilization of short-term money market rates.

Monitory Policy Reforms :Monitory Policy Reforms :Developmental MeasuresDevelopmental Measures

• Discontinuation of automatic monetization through an agreementbetween the Government and the Reserve Bank

• Amendment of Securities Contracts Regulation Act (SCRA), to createthe regulatory framework

• Introduction of automated screen-based trading in governmentsecurities through Negotiated Dealing System (NDS).

• Setting up of risk-free payments and system in government securitiesthrough Clearing Corporation of India Limited (CCIL).

• Phased introduction of Real Time Gross Settlement (RTGS) System

• Deepening of inter-bank Repo market Deepening of governmentsecurities market by making the interest rates on such securitiesmarket related


25

• Discontinuation of automatic monetization through an agreementbetween the Government and the Reserve Bank

• Amendment of Securities Contracts Regulation Act (SCRA), to createthe regulatory framework

• Introduction of automated screen-based trading in governmentsecurities through Negotiated Dealing System (NDS).

• Setting up of risk-free payments and system in government securitiesthrough Clearing Corporation of India Limited (CCIL).

• Phased introduction of Real Time Gross Settlement (RTGS) System

• Deepening of inter-bank Repo market Deepening of governmentsecurities market by making the interest rates on such securitiesmarket related

Monitory Policy Reforms :Monitory Policy Reforms :Institutional MeasuresInstitutional Measures

•• Setting up of Technical Advisory Committee on MonetarySetting up of Technical Advisory Committee on MonetaryPolicy with outside experts to review macroeconomic andPolicy with outside experts to review macroeconomic andmonetary developments and advise the Reserve Bank onmonetary developments and advise the Reserve Bank onthe stance of monetary policythe stance of monetary policy

•• Creation of a separate Financial Market Department withinCreation of a separate Financial Market Department withinthe RBIthe RBI

•• Development of appropriate trading, payments andDevelopment of appropriate trading, payments andsettlement systems along with technological infrastructure.settlement systems along with technological infrastructure.

Success of monetary management such as interest rates, is contingentupon the extent and speed with which changes in the central bank'spolicy rate are transmitted to the spectrum of market interest ratesand exchange rate in the economy and onward to the real sector.


26

•• Setting up of Technical Advisory Committee on MonetarySetting up of Technical Advisory Committee on MonetaryPolicy with outside experts to review macroeconomic andPolicy with outside experts to review macroeconomic andmonetary developments and advise the Reserve Bank onmonetary developments and advise the Reserve Bank onthe stance of monetary policythe stance of monetary policy

•• Creation of a separate Financial Market Department withinCreation of a separate Financial Market Department withinthe RBIthe RBI

•• Development of appropriate trading, payments andDevelopment of appropriate trading, payments andsettlement systems along with technological infrastructure.settlement systems along with technological infrastructure.

Success of monetary management such as interest rates, is contingentupon the extent and speed with which changes in the central bank'spolicy rate are transmitted to the spectrum of market interest ratesand exchange rate in the economy and onward to the real sector.

Capital Market Reforms :• Abolition of capital issues control and the introduction of free pricing of

equity issues (CCI)

• Securities and Exchange Board of India (SEBI) was set up as the apexregulator of the Indian capital markets.

• Primary market regulations:– Entry norms for capital issues were tightened– Disclosure requirements were improved– Regulations were framed and code of conduct laid down for

merchant bankers– Underwriters, mutual funds, bankers to the issue and other

intermediaries• Corporate governance regulations:

– Regulations were framed for insider trading– Regulatory framework for take overs was revamped


27

• Abolition of capital issues control and the introduction of free pricing ofequity issues (CCI)

• Securities and Exchange Board of India (SEBI) was set up as the apexregulator of the Indian capital markets.

• Primary market regulations:– Entry norms for capital issues were tightened– Disclosure requirements were improved– Regulations were framed and code of conduct laid down for

merchant bankers– Underwriters, mutual funds, bankers to the issue and other

intermediaries• Corporate governance regulations:

– Regulations were framed for insider trading– Regulatory framework for take overs was revamped

Capital Market Reforms

• Secondary market regulations:– Capital adequacy and prudential regulations were introduced for brokers,

and other intermediaries

– Dematerialization of scrips was initiated with the creation of a legislativeframework and the setting up of the first depository

– Settlement period was reduced to one week

– Carry forward trading was banned

– Tentative moves were made towards a rolling settlement system.


28

• Secondary market regulations:– Capital adequacy and prudential regulations were introduced for brokers,

and other intermediaries

– Dematerialization of scrips was initiated with the creation of a legislativeframework and the setting up of the first depository

– Settlement period was reduced to one week

– Carry forward trading was banned

– Tentative moves were made towards a rolling settlement system.

Reforms in Government SecuritiesMarket


• Increase in Instruments in the Government SecuritiesMarket

• Enabling Measures


29


• Increase in Instruments in the Government SecuritiesMarket

• Enabling Measures

Government Securities Market :Institutional Measures

• Administered interest rates on government securities were replacedby an auction system for price discovery

• Banks have been permitted to undertake primary dealer business whileprimary dealers are being allowed to diversify their business

• Central Government would cease to raise resources on behalf of StateGovernments . State Governments' capability in raising resources willbe market determined and based on their own financial health

• Effective April 1, 2006, RBI has withdrawn from participating inprimary market auctions of Government paper– fully market based system in the G-sec market.


30

• Administered interest rates on government securities were replacedby an auction system for price discovery

• Banks have been permitted to undertake primary dealer business whileprimary dealers are being allowed to diversify their business

• Central Government would cease to raise resources on behalf of StateGovernments . State Governments' capability in raising resources willbe market determined and based on their own financial health

• Effective April 1, 2006, RBI has withdrawn from participating inprimary market auctions of Government paper– fully market based system in the G-sec market.

Government Securities Market :Increase in Instruments

• Market Stabilization Scheme (MSS) has been introduced, which hasexpanded the instruments available to the Reserve Bank for managingthe enduring surplus liquidity in the system

– 91-day Treasury bill was introduced for benchmarking– Zero Coupon Bonds, Floating Rate Bonds, Capital Indexed Bonds were

issued– Exchange traded interest rate futures were introduced– OTC interest rate derivatives like IRS/ FRAs were introduced

• Repo status has been granted to State Government securities in orderto improve secondary market


31

• Market Stabilization Scheme (MSS) has been introduced, which hasexpanded the instruments available to the Reserve Bank for managingthe enduring surplus liquidity in the system

– 91-day Treasury bill was introduced for benchmarking– Zero Coupon Bonds, Floating Rate Bonds, Capital Indexed Bonds were

issued– Exchange traded interest rate futures were introduced– OTC interest rate derivatives like IRS/ FRAs were introduced

• Repo status has been granted to State Government securities in orderto improve secondary market

Government Securities Market :Enabling Measures

• Foreign Institutional Investors (FIIs) were allowed to invest ingovernment securities subject to certain limits with non-banks allowedto participate in repo market

• Introduction of automated screen-based trading in governmentsecurities through Negotiated Dealing System (NDS)

• Setting up of risk-free payments and settlement system in governmentsecurities through Clearing Corporation of India Limited (CCIL)

• Phased introduction of Real Time Gross Settlement System (RTGS).

• Introduction of trading in government securities on stock exchangesfor promoting retailing and Non-banks participation


32

• Foreign Institutional Investors (FIIs) were allowed to invest ingovernment securities subject to certain limits with non-banks allowedto participate in repo market

• Introduction of automated screen-based trading in governmentsecurities through Negotiated Dealing System (NDS)

• Setting up of risk-free payments and settlement system in governmentsecurities through Clearing Corporation of India Limited (CCIL)

• Phased introduction of Real Time Gross Settlement System (RTGS).

• Introduction of trading in government securities on stock exchangesfor promoting retailing and Non-banks participation

Reforms in Foreign Exchange MarketReforms in Foreign Exchange Market• Exchange Rate Regime

• Finance Mobilization

• Institutional Framework

• Increase in Instruments in the Foreign Exchange Market

• Liberalization Measures


33

• Exchange Rate Regime

• Finance Mobilization

• Institutional Framework

• Increase in Instruments in the Foreign Exchange Market

• Liberalization Measures

Reforms in Foreign Exchange Market :Reforms in Foreign Exchange Market :Exchange Rate RegimeExchange Rate Regime• Evolution of exchange rate regime from a single-currency fixed-

exchange rate system to fixing the value of rupee against a basket ofcurrencies and further to market-determined floating exchange rateregime

• Adoption of convertibility of rupee for current account transactionswith acceptance of Article VIII of the Articles of Agreement of the IMF

• De facto full capital account convertibility for non residents

• Calibrated liberalization of transactions undertaken for capital accountpurposes in the case of residents


34

• Evolution of exchange rate regime from a single-currency fixed-exchange rate system to fixing the value of rupee against a basket ofcurrencies and further to market-determined floating exchange rateregime

• Adoption of convertibility of rupee for current account transactionswith acceptance of Article VIII of the Articles of Agreement of the IMF

• De facto full capital account convertibility for non residents

• Calibrated liberalization of transactions undertaken for capital accountpurposes in the case of residents

Reforms in Foreign Exchange Market :Reforms in Foreign Exchange Market :Finance MobilizationFinance Mobilization• Indian companies were allowed to raise equity in international markets

subject to various restrictions.

• Indian companies were allowed to borrow in international marketssubject to a minimum maturity, a ceiling on the maximum interestrate, and annual caps on aggregate external commercial borrowingsby all entities put together.

• Indian mutual funds were allowed to invest a small portion of theirassets abroad.

• Indian companies were given access to long dated forward contractsand to cross currency options.


35

• Indian companies were allowed to raise equity in international marketssubject to various restrictions.

• Indian companies were allowed to borrow in international marketssubject to a minimum maturity, a ceiling on the maximum interestrate, and annual caps on aggregate external commercial borrowingsby all entities put together.

• Indian mutual funds were allowed to invest a small portion of theirassets abroad.

• Indian companies were given access to long dated forward contractsand to cross currency options.

Reforms in Foreign Exchange Market :Reforms in Foreign Exchange Market :Institutional FrameworkInstitutional Framework• Replacement of the earlier Foreign Exchange Regulation Act (FERA),

1973 by the market friendly Foreign Exchange Management Act, 1999(FEMA)

• Delegation of considerable powers by RBI to Authorized Dealers torelease foreign exchange for a variety of purposes


36

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

• Delegation of considerable powers by RBI to Authorized Dealers torelease foreign exchange for a variety of purposes

Reforms in Foreign Exchange Market :Reforms in Foreign Exchange Market :Increase in InstrumentsIncrease in Instruments

• Development of rupee-foreign currency swap market

• Introduction of additional hedging instruments, such as, foreigncurrency-rupee options

• Permission to use innovative products like cross-currency options,interest rate swaps (IRS) and currency swaps, caps/collars and forwardrate agreements (FRAs) in the international forex market.


37

• Development of rupee-foreign currency swap market

• Introduction of additional hedging instruments, such as, foreigncurrency-rupee options

• Permission to use innovative products like cross-currency options,interest rate swaps (IRS) and currency swaps, caps/collars and forwardrate agreements (FRAs) in the international forex market.

Reforms in Foreign Exchange Market :Reforms in Foreign Exchange Market :Liberalization MeasuresLiberalization Measures• Authorized dealers permitted to initiate trading positions, borrow and

invest in overseas market subject to certain specifications andratification by respective Banks’ Boards

• Banks are also permitted to fix interest rates on non-resident deposits,subject to certain specifications

• Use of derivative products for asset-liability management and fixovernight open position limits and gap limits in the foreign exchangemarket, subject to ratification by RBI

• Permission to various participants in the foreign exchange market,including exporters, Indians investing abroad, FIIs, to avail forwardcover and enter into swap transactions without any limit subject togenuine underlying exposure


38

• Authorized dealers permitted to initiate trading positions, borrow andinvest in overseas market subject to certain specifications andratification by respective Banks’ Boards

• Banks are also permitted to fix interest rates on non-resident deposits,subject to certain specifications

• Use of derivative products for asset-liability management and fixovernight open position limits and gap limits in the foreign exchangemarket, subject to ratification by RBI

• Permission to various participants in the foreign exchange market,including exporters, Indians investing abroad, FIIs, to avail forwardcover and enter into swap transactions without any limit subject togenuine underlying exposure

Reforms in Foreign Exchange Market :Reforms in Foreign Exchange Market :Liberalization MeasuresLiberalization Measures• FII’s and NRI’s permitted to trade in exchange-traded derivative

contracts subject to certain conditions

• Foreign exchange earners permitted to maintain foreign currencyaccounts

• Residents are permitted to open such accounts within the general limitof US $ 200,000 per year


39

• FII’s and NRI’s permitted to trade in exchange-traded derivativecontracts subject to certain conditions

• Foreign exchange earners permitted to maintain foreign currencyaccounts

• Residents are permitted to open such accounts within the general limitof US $ 200,000 per year

Financial Sector and MonetaryFinancial Sector and MonetaryPolicy Reforms : An assessmentPolicy Reforms : An assessment

Progress of Commercial Banking in India

1969 1980 1991 1995 2000 20051 2 3 4 5 6 7

1 Commercial Banks 73 154 272 284 298 2882 No. of Bank Offices 8,262 34,594 60,570 64,234 67,868 68,339

Rural and semi-urban bank offices 5,172 23,227 46,550 46,602 47,693 47491

3 Population perOffice (’000s) 64 16 14 15 15 16

4 Per capitaDeposit (Rs.) 88 738 2,368 4,242 8,542 16,699

5 Per capita Credit(Rs.) 68 457 1,434 2,320 4,555 10,135

6 Priority SectorAdvances@ (%) 15 37 39 34 35 40

7 Deposits (% ofNational Income) 16 36 48 48 54 65


40

Progress of Commercial Banking in India

1969 1980 1991 1995 2000 20051 2 3 4 5 6 7

1 Commercial Banks 73 154 272 284 298 2882 No. of Bank Offices 8,262 34,594 60,570 64,234 67,868 68,339

Rural and semi-urban bank offices 5,172 23,227 46,550 46,602 47,693 47491

3 Population perOffice (’000s) 64 16 14 15 15 16

4 Per capitaDeposit (Rs.) 88 738 2,368 4,242 8,542 16,699

5 Per capita Credit(Rs.) 68 457 1,434 2,320 4,555 10,135

6 Priority SectorAdvances@ (%) 15 37 39 34 35 40

7 Deposits (% ofNational Income) 16 36 48 48 54 65

Financial Sector and MonetaryFinancial Sector and MonetaryPolicy Reforms :Policy Reforms : An AssessmentAn Assessment

Distribution of Commercial Banks According to Risk-weightedCapital Adequacy

Year <4% 4-9 % 9-10 % >10 % Total

1 2 3 4 5 61995-96 8 9 33 42 922000-01 3 2 11 84 1002004-05 1 1 8 78 88


41

Distribution of Commercial Banks According to Risk-weightedCapital Adequacy

Year <4% 4-9 % 9-10 % >10 % Total

1 2 3 4 5 61995-96 8 9 33 42 922000-01 3 2 11 84 1002004-05 1 1 8 78 88


Non-Performing Loans (NPL) of Scheduled Commercial Banks(%)

Gross NPL/ Gross NPL/ Net NPL/ Net NPL/advances Assets advances Assets

1 2 3 4 5

1996-97 15.7 7 8.1 3.31997-98 14.4 6.4 7.3 3.01998-99 14.7 6.2 7.6 2.91999-00 12.7 5.5 6.8 2.72000-01 11.4 4.9 6.2 2.52001-02 10.4 4.6 5.5 2.32002-03 8.8 4 4.4 1.92003-04 7.2 3.3 2.9 1.22004-05 5.2 2.6 2 0.9


42

Non-Performing Loans (NPL) of Scheduled Commercial Banks(%)

Gross NPL/ Gross NPL/ Net NPL/ Net NPL/advances Assets advances Assets

1 2 3 4 5

1996-97 15.7 7 8.1 3.31997-98 14.4 6.4 7.3 3.01998-99 14.7 6.2 7.6 2.91999-00 12.7 5.5 6.8 2.72000-01 11.4 4.9 6.2 2.52001-02 10.4 4.6 5.5 2.32002-03 8.8 4 4.4 1.92003-04 7.2 3.3 2.9 1.22004-05 5.2 2.6 2 0.9


Select Productivity Indicators of Scheduled Commercial Banks(Rs. million at 1993-94 prices)

Year Business Profit per Businessper employee Employee per branch

1992 5.4 0.02 109.91996 6.0 0.01 119.62000 9.7 0.05 179.42005 17.3 0.13 267.0


43

Select Productivity Indicators of Scheduled Commercial Banks(Rs. million at 1993-94 prices)

Year Business Profit per Businessper employee Employee per branch

1992 5.4 0.02 109.91996 6.0 0.01 119.62000 9.7 0.05 179.42005 17.3 0.13 267.0



44

Despite record high international crude oil prices, inflation remains lowand inflation expectations also remain stable.



45

Fresh issuances under the MSS were suspended between November 2005 and April 2006due to tight liquidity. Redemptions of securities/Treasury Bills issued earlier – along withactive management of liquidity through repo/reverse repo operations under LiquidityAdjustment Facility - provided liquidity to the market and imparted stability to financialmarkets. With liquidity conditions improving, it was decided to again start issuingsecurities under the MSS from May 2006 onwards.

Forex Reforms :Forex Reforms : An AssessmentAn Assessment


46

Exchange rate exhibiting reasonable two-way movement



47

Credit Delivery increased from 30 per cent during 1999-00 to 41 per centduring 2004-05 and further to 48 per cent during 2005-06.

ConclusionConclusion• Financial system in India, through a measured,

gradual, cautious, and steady process, hasundergone substantial transformation

• Reasonably sophisticated, diverse and resilientsystem through well-sequenced and coordinatedpolicy measures aimed at making the Indian financialsector more competitive, efficient, and stable

• Effective monetary management has enabled pricestability while ensuring availability of credit tosupport investment demand and growth in theeconomy.


48

• Financial system in India, through a measured,gradual, cautious, and steady process, hasundergone substantial transformation

• Reasonably sophisticated, diverse and resilientsystem through well-sequenced and coordinatedpolicy measures aimed at making the Indian financialsector more competitive, efficient, and stable

• Effective monetary management has enabled pricestability while ensuring availability of credit tosupport investment demand and growth in theeconomy.

ConclusionConclusion• The multi-pronged approach towards managing

capital account in conjunction with prudential andcautious approach to financial liberalisation hasensured financial stability in contrast to theexperience of many developing and emergingeconomies

• Monetary policy and financial sector reforms in Indiahad to be fine tuned to meet the challengesemanating from all global and domestic shocks.

• Viewed in this light, the success in maintaining priceand financial stability is all the more creditworthy.

• The overall objective of maintaining price stability inthe context of economic growth and financial stabilitywill remain


49

• The multi-pronged approach towards managingcapital account in conjunction with prudential andcautious approach to financial liberalisation hasensured financial stability in contrast to theexperience of many developing and emergingeconomies

• Monetary policy and financial sector reforms in Indiahad to be fine tuned to meet the challengesemanating from all global and domestic shocks.

• Viewed in this light, the success in maintaining priceand financial stability is all the more creditworthy.

• The overall objective of maintaining price stability inthe context of economic growth and financial stabilitywill remain


50

Thank You

Economy & Finance

The Financial Sector Reforms in India