Annex II.1
Initiatives by the Board for Financial Supervision –
2007-08 During 2007-08, the Board for Financial Supervision (BFS)
continued to exercise its supervisory role over those segments of the financial
institutions that are under the regulatory purview of the Reserve Bank. The BFS
met ten times during 2007-08 (July-June) and the major initiatives taken are set
out below.
(i) The BFS deliberated upon the unprecedented growth in the
exposure of banks to the real estate sector and related issues like improper documentation,
frauds, incidence of NPAs and lack of registration system for equitable mortgages,
among others. The Reserve Bank has been sensitising the banks in this regard and
stressing the need for quality, due diligence and proper documentation, among
others. At the instance of the BFS, the NHB has been advised to carry out a study
on the arrangements in place for housing loans in order to get a better picture
of the matter.
(ii) Keeping in view the irregularities observed in the
functioning of an Indian bank abroad, a system for monthly reporting of incidents
of overseas regulatory violations/breaches and related issues by banks, in any
of the countries where they have a presence, to their boards of directors and
the Reserve Bank was put in place. This prescription is in addition to the existing
reporting requirements in this regard and the compliance officer of the bank shall
be responsible for this reporting.
(iii) Against the backdrop of the
steady improvement in the asset quality of the Indian banking system over the
years, the BFS desired that this achievement be taken up as a case study by documenting
the history of evolution of the current NPA scenario in India and highlighting
the regulatory and institutional efforts made to bring down the NPAs. Accordingly,
a comprehensive study on NPA management was carried out covering the position
in the pre- and post-reform period and legislative,
regulatory and institutional
changes in the area.
(iv) The BFS felt that the incidences of common
and recurring deficiencies pointed out in successive Annual Financial Inspection
reports had a bearing on the level of corporate governance in banks and directed
that the position of discomfort/governance issues may be examined bank-wise.
Accordingly, separate formats were devised for public sector and private
sector banks for evaluation of their performance in the area of corporate governance,
touching upon the issues covered under the Banking Regulation Act, 1949; Clause
49 of the Listing Agreement as prescribed by SEBI; recommendations of the Ganguly
committee and guidelines issued from time to time.
(v) The issue of sale
of NPAs by banks was deliberated upon by the BFS, which directed that banks should
clearly indicate the realisation cost and establish that the amount of settlement
is larger than the NPV of the net realisable value of the securities, when taking
decisions for sale of NPAs.
(vi) On the matter of outsourcing of services
by banks, the BFS directed that the guidelines on the issue should clearly emphasise
the enforceability requirement in the outsourcing contracts. All documents pertaining
to the outsourcing contract should be made available for inspection. It would
be obligatory on the part of banks to cover the outsourcing agencies under their
internal audit and submit a confirmation report and compliance certificate in
this regard to the Reserve Bank.
(vii) Two rounds of the SRP with regard
to exposure of banks to sensitive sectors were undertaken. In regard to the exposure
to real estate sector, banks were advised to put in place board approved policy
specifying, inter alia, internal limits for such exposures, minimum rating for
builders, minimum share of the promoters’ contribution, requisite security
cover, panel of approved valuers for giving valuation reports, and procedure for
registration of documents and verification of the registration with the authorities. (viii)
After detailed deliberations on the efficacy of issuing instructions on matters
such as the method of valuation to be adopted for property/land taken as security
by banks, the BFS advised banks to go by the current market value of the land
for valuation purpose. Accordingly, the Reserve Bank issued a mail-box clarification
to all banks. (ix) The BFS took note of the press reports on the substantial
losses suffered by certain corporates on the cross-currency derivatives undertaken
by them. The losses were on account of the continued fall in the value of the
dollar vis-à-vis other European currencies and yen. On the directions of
the BFS, banks with high off-balance sheet exposure were identified and a study
was carried out on the nature of exposures and overall implications in the current
scenario.
(x) The rising trend of banks accepting bulk deposits at higher
interest rates attracted the attention of the BFS which querried the Reserve Bank
about its comfort level regarding these kinds of deposits. A study was undertaken
which revealed that the risk of concentration of deposits sourced from a few large
depositors was high in the case of foreign banks, particularly those with a limited
retail deposit base. Some private sector banks also had a significant degree of
concentration risk, while for public sector banks, this risk was found to be low.
The level of concentration risk had not changed significantly over the past three
years. In comparison to other bank groups, new private sector banks paid higher
rates of interest irrespective of the size of the deposits. Though the foreign
banks paid the lowest rates of interest, they had a significant proportion of
current deposits in the bulk deposits. This reliance on bulk deposits, including
bulk current deposits, and short-term money market exposed the foreign banks to
significant liquidity and earnings risk. (xi) While deliberating on the
review of the Indian banking system for the half-year ended September 2007, the
BFS directed that a special study be carried out to examine: (a) centre-wise,
sector-wise data on advances and deposits that would indicate the sectors which
were experiencing strong growth; (b) whether the credit growth in the retail sector
had slowed down; (c) whether NPAs in that area were growing; and (d) whether the
data squared with the data compiled through other sources such as the Basic Statistical
Returns data. The study has been undertaken and the report is awaited. Annex
VII.1 Financial Stability Forum (FSF) Report: Status
In the wake of the turmoil in global financial markets, the FSF
brought out a report in April 2008 identifying the underlying causes and weaknesses
in the international financial markets. The proposals made by the FSF and status
in regard to each in India are narrated below:
Proposal 1.
Strengthened Prudential Oversight of Capital, Liquidity and Risk Management
(i) Capital requirements: - Raise Basel II capital requirements for
certain complex structured credit products;
- Introduce additional capital
charges for default and event risk in the trading books of banks and securities
firms;
- Strengthen the capital treatment of liquidity facilities to off-balance
sheet conduits.
Changes will be implemented over time to avoid exacerbating
short-term stress
(ii) Liquidity:
Supervisory guidance to be
issued for the supervision and management of liquidity risks.
(iii) Oversight
of risk management:
Guidance for supervisory reviews under Basel II will
be developed that will:
- Strengthen oversight of banks’
identification and management of firm-wide risks;
- Strengthen oversight
of banks’ stress testing practices for risk management and capital planning
purposes;
- Require banks to soundly manage and report off-balance
sheet exposures;
Supervisors will use Basel II to ensure banks’
risk management, capital buffers and estimates of potential credit losses are
appropriately forward looking.
(iv) Over-the-counter derivatives:
Authorities will encourage market participants to act promptly to ensure
that the settlement, legal and operational infrastructure for over-the-counter
derivatives is sound.
Status
The road-map for
the implementation of Basel II in India has been designed to suit the country-specific
conditions. The phased implementation process got underway with the Basel II Accord
being made applicable to foreign banks operating in India and Indian banks having
operational presence outside India with effect from March 31, 2008. All other
commercial banks (except Local Area Banks and RRBs) are encouraged to migrate
to Basel II in alignment with them but in any case not later than March 31, 2009.
The process of implementation is being monitored on an on-going basis for calibration
and fine-tuning.
The minimum capital to risk-weighted asset ratio (CRAR)
in India is placed at 9 per cent, one percentage point above the Basel II requirement.
Further, regular monitoring of banks’ exposure to sensitive sectors and
their liquidity position is also undertaken. In India, off-balance sheet vehicles
in the form of SPVs for the purpose of securitisation are in existence for which
extensive guidelines, in line with the international best practices, have already
been issued. Liquidity facilities to such SPVs are subject to capital charge.
Banks were required to put in place appropriate stress test policies and relevant
stress test frameworks for various risk factors by March 31, 2008.
In
order to further strengthen capital requirements, the credit conversion factors,
risk weights and provisioning requirements for specific off-balance sheet items
including derivatives have been reviewed. Further, in India, complex structures
like synthetic securitisation have not been permitted so far. Introduction of
such products, when found appropriate, would be guided by the risk management
capabilities of the system.
The Reserve Bank had issued broad guidelines
for asset-liability management and banks have flexibility in devising their own
risk management strategies as per board-approved policies. However, in regard
to liquidity risks at the very short end, the Reserve Bank has taken steps to
mitigate risks at the systemic level and at the institution level as well. The
Reserve Bank has introduced greater granularity to measurement of liquidity risk
by splitting the first time bucket (1-14 days, at present) into three time buckets,
viz., next day, 2-7 days and 8-14 days. The net cumulative negative mismatches
in the three time buckets have been capped at 5 per cent, 10 per cent, and 15
per cent of the cumulative cash outflows.
The Reserve Bank had recognised
the risks of allowing access to unsecured overnight market funds to all entities
and, therefore, restricted the overnight unsecured market for funds only to banks
and primary dealers (PD). Since August 2005, the overnight call market is a pure
inter-bank market. Accordingly, trading volumes have shifted from the overnight
unsecured market to the collateralised market.
Greater inter-linkages
and excessive reliance on call money borrowings by banks could cause systemic
problems. The Reserve Bank has, therefore, introduced prudential measures to address
the extent to which banks can borrow and lend in the call money market. On a fortnightly
average basis, call market borrowings outstanding should not exceed 100 per cent
of capital funds (i.e., sum of Tier I and Tier II capital) in the latest audited
balance sheet.
Recognising the potential of ‘purchased inter-bank
liabilities’ (IBL) to create systemic problems, the Reserve Bank had issued
guidelines in March 2007 prescribing that IBL of a bank should not exceed 200
per cent of its net worth (300 per cent for banks with a CRAR more than 11.25
per cent).
Proposal 2. Enhancing Transparency and Valuation
(i) Robust risk disclosures:
- The FSF strongly encourages
financial institutions to make robust risk disclosures using leading disclosure
practices at the time of their mid-year 2008 reports.
- Further guidance
to strengthen disclosure requirements under Pillar 3 of Basel II will be issued
by 2009.
(ii) Standards for off-balance sheet vehicles and valuations:
Standard setters will take urgent action to:
- Improve and converge
financial reporting standards for off-balance sheet vehicles;
Develop
guidance on valuations when markets are no longer active, establishing an expert
advisory panel in 2008. (iii) Transparency in structured products:
Market participants and securities regulators will expand the information provided
about securitised products and their underlying assets.
Status
The Reserve Bank has, over the years, issued guidelines on valuation of various
instruments/ assets in conformity with the international best practices while
keeping India-specific conditions in view. In order to encourage market discipline,
the Reserve Bank has developed a set of disclosure requirements which allow the
market participants to assess key pieces of information on capital adequacy, risk
exposure, risk assessment processes and key business parameters which provide
a consistent and understandable disclosure framework that enhances comparability.
Banks are also required to comply with the Accounting Standard (AS) on Disclosure
of Accounting Policies issued by the Institute of Chartered Accountants of India
(ICAI).
In recognition of the fact that market discipline can contribute
to a safe and sound banking environment and as part of the ongoing efforts to
implement the Basel II Accord, the Reserve Bank issued guidelines on minimum capital
ratio (Pillar 1) and market discipline (Pillar 3) in April 2007 and guidelines
for Pillar 2 (supervisory review process) were issued in March 2008. Under these
guidelines, non-compliance with the prescribed disclosure requirements would attract
a penalty, including financial penalty.
Proposal 3. Changes in
the Role and Uses of Credit Ratings
Credit rating agencies should:
- Implement the revised IOSCO Code of Conduct Fundamentals for Credit
Rating Agencies to manage conflicts of interest in rating structured products
and improve the quality of the rating process;
- Differentiate ratings
on structured credit products from those on bonds and expand the information they
provide.
Regulators will review the roles given to ratings in regulations
and prudential framework
Status
The Reserve Bank
has undertaken a detailed process of identifying the eligible credit rating agencies
whose ratings may be used by banks for assigning risk weights for credit risk.
Banks should use the chosen credit rating agencies and their ratings consistently
for each type of claim, for both risk weighting and risk management purposes.
Banks are not allowed to ‘cherry pick’ the assessments provided by
different credit rating agencies. If a bank has decided to use the ratings of
some of the chosen credit rating agencies for a given type of claim, it can use
only the ratings of those credit rating agencies, despite the fact that some of
these claims may be rated by other chosen credit rating agencies whose ratings
the bank has decided not to use. External assessments for one entity
within
a corporate group cannot be used to risk weight other entities within the same
group.
Banks must disclose the names of the credit rating agencies that
they use for the risk weighting of their assets, the risk weights associated with
the particular rating grades as determined by the Reserve Bank through the mapping
process for each eligible credit rating agency as well as the aggregated risk
weighted assets as required.
In India, complex structures like synthetic
securitisations have not been permitted so far. As and when such products are
to be introduced, the Reserve Bank would put in place the necessary enabling regulatory
framework, including calibrating the role and capacity building of the rating
agencies.
Proposal
4. Strengthening the Authorities’
Responsiveness to Risks
- A college of supervisors will
be put in place by end-2008 for each of the largest global financial institutions.
Status
In the Indian context, there has been exchange of supervisory information
on specific issues between the Reserve Bank and few other overseas banking supervisors/regulators.
Supervisory cooperation has been working smoothly and efficiently.
The
Mid-Term Review of October 2007 had announced the constitution of a Working Group
to lay down a road-map for adoption of a suitable framework for cross-border supervision
and supervisory cooperation with overseas regulators, consistent with the framework
envisaged in the Basel Committee on Banking Supervision (BCBS). A Working Group
was constituted in March 2008 and is in the process of finalising its Report.
A number of overseas regulators of countries such as the USA, the UK, Canada,
Hong Kong, Australia and Singapore have been formally approached to share systems
and practices, including legal positions, in the matter of supervisory cooperation
and sharing of information with overseas regulators. The response from a few countries
has been received and is being examined. The ‘Supervisory College’
arrangement for this purpose is also being examined by the Group.
Proposal 5. Robust Arrangements for Dealing with Stress in the Financial System
- Central banks will enhance their operational frameworks and authorities
will strengthen their cooperation for dealing with stress.
Status
In the Reserve Bank, there is an institutional arrangement
in place to oversee the functioning of the financial markets on a daily basis.
There is a Financial Market Committee monitoring and assessing the functioning
of different financial markets. Based on such an oversight, appropriate and prompt
action is taken, whenever necessary.
The Reserve Bank has the necessary
framework for provision of liquidity to the banking system, in terms of Sections
17 and 18 of the Reserve Bank of India Act, 1934. The regular liquidity management
facilities of the Reserve Bank include the LAF, OMO and MSS besides standing facilities
such as export credit refinance (ECR) and the liquidity facility for standalone
PDs. The Reserve Bank can undertake purchase/sale of securities of the Central
or State Governments and can purchase, sell and rediscount bills of exchange and
promissory notes drawn on and payable in India and arising out of bona fide commercial
or trade transactions for provision/absorption of liquidity for normal day-to-day
liquidity management operations as also for provision of emergency liquidity assistance
to the banks under the lender of last resort function.
The Reserve Bank
is empowered under the existing legal framework to deal with the resolution of
weak and failing banks. The Deposit Insurance and Credit Guarantee Corporation
(DICGC) offers deposit insurance cover in India. The Banking Regulation Act provides
the legal framework for voluntary amalgamation and compulsory merger of banks
under Sections 44 (A) and 45, respectively. The mergers of many weak private sector
banks with healthy banks have improved overall stability of the system.
Source: Annual Policy Statement for the Year 2008-09, Reserve
Bank of India. |