Annual Report

COMMERCIAL BANKING

9.1 A number of policy measures were undertaken in the banking sector during 1999-2000 as a part of the ongoing financial sector reforms. These measures which were dealt with in Section I of Part One on the policy environment had the objectives of improving information flows, strengthening financial stability, enhancing the efficiency of systems and procedures in the use of financial instruments, and laying down guidelines for management of risks. The underlying medium-term objective of the reforms is to move towards internationally accepted best practices in prudential norms, accounting standards, disclosure norms, and the supervisory framework.

9.2 In October 1999, the Reserve Bank issued a self assessment of the compliance of the Indian banking system with the Core Principles for Effective Banking Supervision evolved by the Basel Committee on Banking Supervision (BCBS). This was done not only to achieve greater transparency in the operation of the supervisory system but also to inform the world at large of the framework in which the principles of regulation and supervision would operate in the country in the years to come. To entrench financial stability and to integrate into the international financial world in a systematic way the Reserve Bank had constituted a Standing Committee on International Financial Standards and Codes in December 1999. Being a Standing Committee, there will be a review after a year. The Reserve Bank also closely examined the ongoing efforts at the Bank for International Settlements (BIS) to review the Capital Adequacy Framework proposed through a consultative paper by the Basel Committee on Banking Supervision (BCBS) and forwarded its comments. These comments were also released in April 2000 by the Reserve Bank through its website and press releases to inform the public about its standpoint on the proposal and also to invite the reactions of the public.

9.3 The complexity of banking operations and the recurring incidence of financial crises necessitated sustained efforts towards upgradation of risk management practices and procedures for ensuring soundness of financial institutions. In October 1999, the Reserve Bank issued guidelines on Risk Management Systems to banks to put in place a system to take care of credit risk, market risk and operational risk. Together with the Asset-Liability Management (ALM) guidelines issued in April 1999 they would help to prepare banks for the changing dimensions of risk based supervision. The guidelines envisage setting up of credit policy committees (CPCs) and credit risk management departments (CRMDs) within the banks for evolving bank-specific loan policies, credit approving systems, benchmarks for credit risk rating and pricing, portfolio management techniques and loan review mechanism for management of credit risk. Market risk management is sought to be addressed by upgrading the existing institutional framework, adopting dynamic hedging techniques, setting up of Middle Offices to track the magnitude of market risk on a real time basis, estimating liquidity profiles under alternative scenarios, preparing contingency plans, moving over to alternative analytical tools for management of interest rate risk, i.e., gap analysis, value at risk (VaR) models, simulation etc. and funds transfer price mechanisms. In addition, in view of the phenomenal increase in the volume of transactions and complex technological support systems, banks are advised to put in place proper framework for management of operational risk. Banks across the world have adopted the Risk Adjusted Return on Capital (RAROC) framework for risk aggregation and allocation of economic capital to various product lines/operating units. Banks which have international presence have been advised to develop suitable methodologies for estimating and maintaining economic capital by March 31, 2001. As part of ALM support measures, banks were permitted to undertake Forward Rate Agreements (FRAs) and Interest Rate Swaps (IRSs) and price loans on a fixed rate or floating rate basis.

9.4 Take-out-finance is a new product emerging in the context of the funding of long-term infrastructure projects, with ramifications for asset-liability management as the financing of infrastructure is long-term in nature against their predominantly short-term resources. Under this arrangement, the institution or the bank financing infrastructure projects will have an arrangement with any financial institution for transferring to the latter the outstanding in respect of such financing in their books on a pre-determined basis. Take-out finance is either in the nature of unconditional take-out finance or conditional take-out finance with several variants. Take-out-finance products involve three parties viz., the project company, taking over institution and the lending banks/ financial institutions. Banks were advised to follow the guidelines pertaining to criteria for assigning risk weight for calculation of capital adequacy ratio and other prudential norms in respect of take-out-finance.

9.5 The Reserve Bank has been making continuous efforts towards strengthening financial soundness of banks by prescribing prudential norms that are comparable to international standards. Some of the steps which were taken during the year 1999-2000 include: (i) prescription of additional risk weight of 2.5 per cent for market risk for investments in securities outside the SLR from the year ending March 31,2001 in addition to the existing 100 per cent risk weight; (ii) in respect of agricultural advances and advances for other purposes granted by banks to Primary Agricultural Co-operative Credit Societies (PACS)/Farmers' Service Societies (FSS) under the on-lending system, only that particular credit facility granted to a PACSs/FSSs which is in default for a period of two harvest seasons (not exceeding two half years/two quarters as the case may be), after it has become past due (one month after due date), will be classified as NPA and not all the credit facilities sanctioned; and (iii) in respect of export project finance, in cases where the actual importer has paid the dues to the bank abroad but the bank in turn is unable to remit the amount due to political developments such as war, internal strife, UN embargo etc., the extant prudential norms relating to income recognition, asset classification and provisioning may be made applicable after a period of one year from the date the amount was deposited by the importer in the bank abroad.

9.6 The outstanding dues under foreign currency denominated loans (where actual disbursement was made in Indian rupee), which became past due, goes up correspondingly with the exchange rate movements of the Indian rupee with attendant implications for provisioning requirements, it was decided that such assets should not normally be revalued. In case such assets need to be revalued as per requirement of accounting practices or for any other requirement, the loss on account of revaluation has to be booked in the bank's Profit and Loss account. Besides the provisioning requirement as per asset classification, the banks should treat the full amount of the revaluation gain relating to the corresponding assets, if any, on account of foreign exchange fluctuation as provision against the particular assets.

9.7 As per the extant instructions banks are required to provide 100 per cent provision for the net debit position arising out of the unreconciled entries (both debit and credit) outstanding for more than three years as on 31st March every year in their inter-branch accounts. On prudential considerations, the time lag has been reduced from three to two years with effect from the accounting year ending 31st March, 2001.

9.8 The credit entries in each nostro account pertaining to the period up to March 31, 1996 and remaining unreconciled as on March 31, 2000 were allowed to be netted against the debit entries in the respective mirror accounts. Likewise, the debit entries in each nostro account could be netted against credit entries in the respective mirror accounts. The accounts showing net debit position and the accounts showing the net credit position may be aggregated separately while ensuring that the net debit position in an account is not set off against net credit position in another account or vice versa. The net debit and net credit positions were required to be reflected in the bank's accounts for the year 1999-2000 by transferring the aggregate net debit to profit and loss account and the aggregate net credit to Sundry Creditor Account. However, the unreconciled debits which were already transferred to profit and loss account were not to be written back to the respective accounts in order to carry out the netting exercise as indicated above. For the unreconciled debit entries in the nostro and mirror accounts for the subsequent periods outstanding for more than three years, the banks were required to make 100 per cent provision in the relevant accounting year while the unreconciled credit entries in the nostro and mirror accounts outstanding for more than three years were to be segregated and kept in an account like Unclaimed Deposit Account.

9.9 With the passage of the Insurance Regulatory and Development Authority (IRDA) Act, 1999, banks have been permitted to enter into insurance business. The Reserve Bank of India has issued guidelines in this regard. Banks having minimum net worth of Rs.500 crore and satisfying other criteria in respect of capital adequacy, profitability, NPA level and track record of existing subsidiaries can undertake insurance business through joint venture with risk participation, subject to certain safeguards. Though maximum equity holding by banks will normally be 50 per cent in such joint ventures, the Reserve Bank could, on a highly selective basis, permit a higher equity contribution by a promoter bank initially, pending divestment of equity within the period prescribed under the amended insurance statutes. Banks which are not eligible as joint venture participants can participate without risk participation basis up to 10 per cent of their net worth or Rs.50 crore, whichever is lower, in an insurance company for providing infrastructure and services support, without taking on any contingent liability. Any scheduled commercial bank or its subsidiary can distribute insurance products as agent of an insurance company. Banks are required to obtain prior approval of the Reserve Bank to undertake any form of insurance business.

9.10 In order to improve the recovery of debts due to banks and financial institutions, the 'Recovery of Debts due to Banks and Financial Institutions (Amendment) Ordinance, 2000' was promulgated on January 17, 2000. Some of the existing provisions of the 'Recovery of Debts due to Banks and Financial Institutions Act, 1993' have been amended and certain new provisions have been incorporated in the Act for strengthening DRTs viz., provision for the appointment of more than one recovery officer for a DRT, power to attach defendant's property/assets before judgement, power to appoint receiver of any property of the defendant before or after grant of recovery certificate, power to appoint Commissioner for preparing an inventory of the properties of the defendant or for sale thereof, and penal provisions for disobedience of Tribunal's Order or for breach of any terms of the Order. Banks were also advised that in cases where loss assets are more than two years old on the books of the bank without legal action being initiated, they may be reviewed at different levels of management depending on the quantum of dues.

9.11 The Reserve Bank issued guidelines to public sector banks for the constitution of Settlement Advisory Committees (SAC) for compromise settlement of chronic NPAs of small sector in May 1999. A review of the compromise settlements of NPAs through SACs made by the Reserve Bank revealed that the progress of recovery of NPAs through this mechanism has not been satisfactory. The recovery position in respect of categories of borrowers other than small sector has also not been satisfactory. The Reserve Bank recognised that banks should take effective measures to strengthen the credit appraisal and post-credit monitoring to arrest incidence of fresh NPAs and adopt a realistic approach to reduce the stock of existing and chronic NPAs in all categories. Therefore, the Reserve Bank issued revised guidelines covering all sectors including the small sector in July 2000 which would provide a simplified, non-discretionary and non-discriminatory mechanism for recovery of the stock of NPAs. The Reserve Bank advised that all public sector banks should implement these guidelines in order to realize the maximum dues from the stock of NPAs within the stipulated time i.e., March 31, 2001.

9.12 Following dematerialisation of shares of banking companies, banks are not in a position to have prior knowledge of transfer of their shares to any particular category of investors in the dematerialisation segment. As a consequence, they are unable to comply with the requirement of obtaining prior approval of Reserve Bank when the shareholding reaches the prescribed level. A working group was set up consisting of representatives from Securities Exchange Board of India (SEBI), National Securities Depository Ltd. (NSDL), Deutsche Bank and the Reserve Bank in order to evolve a framework by which acknowledgement of shares in the demat segment would be within the purview of the instructions. The working group submitted its report in March 2000. The various recommendations made by the working group are being examined. As an immediate measure all the Indian private sector commercial banks have been advised to promote an amendment to their Articles of Association to the effect that acquisition of shares by a person/group which would take his/its holding to a level of 5 per cent or more of the total paid up capital of the bank (or such other percentage as may be prescribed by the Reserve Bank from time to time) should be with the prior approval of the Reserve Bank. Suitable proposals are being initiated for promoting necessary amendments to the Banking Regulation Act, 1949, for the purpose.

9.13 Broad guidelines were issued to banks regarding safeguards to be observed in respect of smart/debit cards introduced by banks. Banks can introduce smart/debit cards with the approval of their Boards without the prior approval of the Reserve Bank; however they should not issue smart/debit cards in tie-up with a non-bank entity. The guidelines cover aspects such as eligibility of customers, treatment of the liability, payment of interest, security and terms and conditions for issue of smart/debit cards etc.

9.14 The Union Government has delegated powers to the Reserve Bank under Section 16 of the Securities Contracts (Regulation) Act for regulating contracts in government securities, money market securities, gold related securities and derivatives based on these securities, as also ready forward contracts in all debt securities. In exercise of these powers the Reserve Bank notified that Ready Forward (RF) contracts could be undertaken in Treasury bills and dated securities of all maturities issued by the Government of India and State governments and that the RF contracts in the above-mentioned securities should be settled through the Subsidiary General Ledger Account of the participants with the Reserve Bank at Mumbai. Banks were advised that RF deals could be entered into by a banking company with another banking company, a co-operative bank or entities maintaining SGL Account and current account with the Reserve Bank, Mumbai, subject to the condition that they should comply with all instructions on securities transactions in force and issued from time to time.

9.15 'Cheque Writing' facility which scheduled commercial banks were initially permitted to offer to Money Market Mutual Funds (MMMFs) was extended to Gilt Funds and to those Liquid Income Schemes of mutual funds which predominantly (not less than 80 per cent of the corpus) invest in money market instruments, subject to the same safeguards prescribed for MMMFs except that the prescription of lock-in period in such cases will be governed by SEBI regulations.

9.16 On a review of the assured return schemes floated by bank-sponsored mutual funds, banks whose mutual funds have offered assured return schemes were required to assess the shortfall arising on such schemes with reference to the Net Asset Value (NAV) as on the date of the balance sheet and disclose the same as a contingent liability in their published accounts. The banks were also advised to make provisions for the shortfall for the residual maturity period of the schemes year-wise from profits or by creating a Special Reserve Account by appropriating General Reserve. The amount appropriated out of general reserve would also be deducted from Tier-I capital for the purpose of determining the capital adequacy ratio of the bank.

9.17 The interest rate chargeable on advances granted to depositors against their domestic/NRE term deposits was to be equal to bank's Prime Lending Rate (PLR) or less, except in cases where deposit rates were equal to or more than PLR or less than one percentage point below PLR. In the latter case, the banks had freedom to charge suitable rates of interest without reference to the ceiling of PLR. Advances against NRE term deposits to the depositors, when repaid in rupees, were subject to PLR. Further, advances against FCNR (B) deposits were also subject to PLR. In October 1999, banks were given freedom to charge interest rates on advances against domestic/NRE (irrespective of repayment in foreign currency or rupees)/FCNR (B) term deposits to the depositors without reference to their own PLR. Interest rates chargeable on advances against third party domestic/NRE/ FCNR(B) term deposits were at the rates prescribed in the Reserve Bank's directive on interest rates on advances. In March 2000, banks were given freedom to charge interest rates on such advances without reference to their PLR, if the amount of advance is up to Rs.2 lakh. Such advances above Rs.2 lakh would continue to be governed by the Reserve Bank's directive on interest rates on advances as hitherto.

9.18 Banks have been given the freedom to operate different PLRs for different maturities. Some banks are declaring a stand alone PLR in addition to tenor linked PLRs. Banks which have moved over to declaration of tenor-linked PLRs should always indicate the specific tenor for which the declared PLRs is applicable.

9.19 Till October 1999, loans up to Rs.2 lakh attracted interest rates not exceeding the PLR and on the loans above Rs.2 lakh, PLR was the minimum lending rate. In the light of the suggestions received from the banks and other market participants, effective October 29, 1999, banks were given freedom to charge interest rates without reference to their own PLR in certain categories viz., loans covered by refinance scheme of term lending institutions, interest rates on bank lending to intermediary agencies including housing finance intermediary agencies, bill discounting by banks and advances/overdrafts against domestic/NRE/FCNR (B) deposits.

9.20 The Reserve Bank has given 'in-principle' approval for setting up of nine Local Area Banks in the private sector. Of these, licenses were issued to two Local Area Banks viz., 1) Coastal Local Area Bank Limited., Vijayawada in the districts of West Godavari, Krishna and Guntur in Andhra Pradesh and 2) Capital Local Area Bank Limited., Phagwara in the districts of Kapurthala, Jalandhar and Hoshiarpur in Punjab to commence banking business. These banks have started functioning with effect from December 27, 1999 and January 14, 2000, respectively. The application of one of the remaining proposed LABs is at an advanced stage of issuance of license.

9.21 In order to improve further the customer service in the banks, based on the suggestions received by the Regulation Review Authority, some of the areas of customer service have been reviewed and instructions were issued to commercial banks. All commercial banks were advised by the Reserve Bank that they should pay interest at a rate as applicable for appropriate tenor of fixed deposit for the period of delay beyond 10/14 days in collection of outstation instruments. Besides, banks should also pay to the customers automatically, penal interest at the rate of 2 per cent above the fixed deposit rate applicable for abnormal delay caused by the branch in collection of outstation instruments. For the issue of duplicate demand draft on the basis of adequate indemnity and without obtaining non-payment advice from the drawee branch, the Reserve Bank advised banks that the present limit at Rs.2,500 may be enhanced to Rs.5,000, in view of the considerable delay in issue of non-payment advice by the drawee branch. It was also decided that a duplicate demand draft be issued to the customer within a fortnight from the receipt of such a request. In case of delay in issuing duplicate draft beyond the stated stipulated period, banks should pay interest at rates applicable for fixed deposit of corresponding maturity in order to compensate the customer.

9.22 Nine Indian banks (8 in the public sector and 1 in the private sector) operate branches abroad. During the year 1999-2000, the number of Indian branches abroad remained at 95. The number of representative offices of Indian banks abroad remained at 14. The number of wholly owned subsidiaries of Indian banks abroad and joint ventures of Indian banks abroad stood at 13 and 7, respectively.

9.23 During the year 1999-2000 no new foreign bank opened its branch in India. However, the Commercial Bank of Korea and Hanil Bank closed their operations in India. The British Bank of the Middle East ceased its operations consequent to its amalgamation with Hong Kong Shanghai Banking Corporation (HSBC). As a result, the number of foreign banks operating in India was reduced to 42. The existing foreign banks opened nine new branches. With this the total number of branches of foreign banks increased to 183 as at the end of June 2000.

9.24 As on December 31, 1999, 78 banks were in liquidation. Early completion of the liquidation proceedings continues to be pursued with the concerned Officials/Court Liquidators. The Bareilly Corporation Bank Ltd. was amalgamated with Bank of Baroda with effect from June 3, 1999 while the Sikkim Bank Ltd. was amalgamated with Union Bank of India with effect from December 22, 1999. The Times Bank Ltd. was amalgamated voluntarily with HDFC Bank Ltd. with effect from February 26, 2000. The branches of the British Bank of the Middle East in India were amalgamated with HSBC with effect from September 25, 1999.

9.25 The progressive liberalisation of the financial sector and the establishment of international standards, codes and best practices by international agencies to promote financial stability have been two areas where supervisors of financial systems have focussed attention. A self-assessment of the Indian banking system vis-a-vis the Core Principles for Effective Banking Supervision as enunciated by the Basel Committee on Banking Supervision, was conducted by an internal group in 1998 and was followed up by a second detailed self-assessment using the revised methodology set out by the BCBS in October 1999. It concluded that systems in India are largely in compliance with the core principles notwithstanding the need to close gaps in respect of risk management, consolidated supervision and inter-agency cooperation. In order to rectify these gaps, ALM and Risk Management guidelines were issued to banks. A system of consolidated supervision of banking groups (i.e. banks and their subsidiaries) is gradually being introduced. In keeping with the commitment to increased transparency, the Reserve Bank placed its self-assessment in the public domain in October 1999. An external assessment of the compliance position in India was conducted in November 1999 by the International Monetary Fund. It stated that, ';with the exception of a few areas viz., consolidated supervision, country risk, market risk and other risks, there already exist adequately detailed and comprehensive regulations on all significant aspects of banking. These regulations generally comply with international best practices, with minor exceptions.'; In recognition of the role played by the Reserve Bank in the implementation of the Basel Core Principles, the BCBS invited the Reserve Bank in August 1999 to be a member of the Core Principles Liaison Group (CPLG), which has been set up by the BCBS to promote and monitor the implementation of these principles worldwide. The Reserve Bank participates actively in the deliberations of the Group and is also represented on the Working Group on Capital, which is currently discussing the proposals of the revised capital adequacy framework. In April 2000, the Reserve Bank released its view on the proposals under the new capital adequacy framework with a view to generating a debate at the national and international levels.

9.26 Work was initiated on OSMOS-IT database upgradation project during the year. The systems requirement study for the project was completed in the first half of 1999. Based on this, the Reserve Bank took up the implementation of the project in view of increased data processing requirements necessitated by the second tranche of off-site returns which were introduced in 1999-2000 as well as to enable more sophisticated analysis of supervisory data captured by the returns. The project would facilitate distributed analysis of off-site returns as a precursor to the central point of contact (CPOC) of the risk-based supervision and also substantially enhance the research capabilities built around this supervisory data. The project would be implemented using Relational Data Base Management System (RDBMS) with a data-warehousing component.

9.27 During the period from July 1999 to March 2000, the Board for Financial Supervision considered various memoranda placed by the Department of Banking Supervision. The Board reviewed the performance of banks, financial institutions and subsidiaries of banks for the periods ended March 31, 1998 and 1999 and in some cases up to a later period ended September 30, 1999. It reviewed 13 inspection reports of public sector banks, 3 reports of Local Head Offices (LHOs) of State Bank of India, 24 reports on private sector banks, 32 reports on foreign banks, 5 reports on financial institutions, and 4 reports on subsidiaries of public sector banks. The responsibility of on-site inspection of overseas branches of Indian banks has been left to the parent banks and RBI will confine itself to quick scrutiny of all the foreign branches once in three years. The Board gave its directions on several regulatory and supervisory issues thrown up in the course of deliberations on the performance of banks and financial institutions as revealed in the inspection reports.

9.28 During the year 1999-2000, annual financial inspection was completed in respect of 27 public sector banks, 33 private sector banks and 39 foreign banks.

9.29 During the year, quick scrutiny of operations of Indian banks in Hong Kong and Singapore was undertaken. Supervisory meetings with the Financial Services Authority (FSA) of UK were held in London and later in Mumbai regarding the operations of Indian banks in UK.

9.30 During the year 1999-2000 (July-March), commercial banks reported 2,899 cases of frauds involving an amount of Rs.303.74 crore and 16 cases involving Rs.101.89 crore in the overseas branches of Indian banks. During the year 1998-99 (July-June), commercial banks reported 2,456 cases of frauds involving an amount of Rs.585.91 crore and 12 cases involving an amount of Rs.35.18 crore in the overseas branches of Indian banks. These cases have been followed up with the banks for necessary remedial measures and fixing staff accountability. During the year 1999-2000 (July-June), 92 cases of robberies/dacoities involving an amount of Rs.4.13 crore have been reported by public sector banks. During the year 1998-99 (July-June), 92 cases involving an amount of Rs.6.02 crore were reported by public sector banks.

9.31 The existing licensing policy in respect of new primary co-operative banks is based on the need and potential for mobilisation of deposits and absorption of credit at a centre. During 1999-2000, 172 proposals were cleared for registration, and 58 proposals were rejected. During 1999-2000, licences were issued to 89 new primary (urban) co-operative banks for commencement of banking business. The number of unlicensed primary cooperative banks issued licences during the year were 12.

9.32 In regard to valuation of investments for the year ending March 31, 2000, PCBs were required to mark-to-market a minimum of 75 per cent of their investments in approved securities. The PCBs were advised to adopt the procedure for valuation of investments as applicable to commercial banks.

9.33 Primary (urban) co-operative banks were allowed to invest their surplus funds in unsecured redeemable bonds floated by nationalised banks within the stipulated limit of 10 per cent of their deposits, subject to the conditions/safety measures as stipulated by the Reserve Bank.

9.34 The credit for food and agro-processing industries extended by PCBs was included within the ambit of priority sector lending. To increase the outreach of banks, lending by Scheduled PCBs to NBFCs or other financial intermediaries for on-lending to the tiny sector were also included as priority sector lending. Further, bank finance to HUDCO as a line of credit for on-lending to artisans, handloom weavers etc. under tiny sector was classified as indirect lending to small scale industries (tiny) sector.

9.35 The total number of primary (urban) cooperative banks including salary earners' type of banks increased to 2,064 as on June 30, 2000 from 1,936 as at end-March 1999. The number of offices increased to 7,084 as on June 30, 2000 from 6,066 as on March 31, 1999.

9.36 The Reserve Bank has been following a liberal policy regarding the extension of area of operation and opening of branches by PCBs, pursuant to the Marathe Committee recommendations. As a result, 3,938 centres were allotted for branch expansion since 1993, of which 3,407 branches have been opened till June 2000. During 1999-2000 (July-June), 463 centres were allotted for opening branches and 455 licences were issued. Besides, a salary earners' bank was granted permission for opening branch at one centre. PCBs having deposits of more than Rs.50 crore are allowed to extend their area of operation to more than one State, provided they satisfy prescribed norms. As on June 30, 2000, 21 PCBs have presence in more than one State.

9.37 As on March 31, 1999 there were 29 scheduled PCBs. Twenty two PCBs were scheduled during the year ended June 30, 2000 raising the total number of scheduled PCBs to 51. Of these, 34 were located in Maharashtra, 11 in Gujarat, 3 in Andhra Pradesh, 2 in Goa and 1 in Karnataka.

9.38 During the year, policy changes were made with regard to prudential norms on income recognition, asset classification and provisioning for PCBs. An asset should be classified as doubtful if it has remained in substandard category for 18 months instead of 24 months as at present, by March 31, 2001. Primary (urban) co-operative banks should make a general provision on standard assets of a minimum of 0.25 per cent from the year ending March 31, 2000. With regard to the provisioning requirement for advances guaranteed by State governments, which stood invoked as on March 31, 2000, necessary provision should be made during the financial years ending March 31, 2000 to March 31, 2003 with a minimum of 25 per cent each year. When natural calamities occur, PCBs may decide to convert the short term production loan into a term loan or re-schedule the repayment period. The asset classification of these loans would be governed by the revised terms and conditions and would be treated as NPAs, if interest and/or instalment of principal remains unpaid, after it has become past due, for two harvest seasons but for a period not exceeding two half years.

9.39 The non-performing assets (NPAs) of 1,748 reporting PCBs stood at Rs.4,534.60 crore constituting 12.2 per cent of their aggregate advances (Rs.37,036.50 crore) as on March 31, 1999.

9.40 On-site financial inspection is carried out at annual intervals in respect of Scheduled PCBs and weak banks and once in two years in respect of all other PCBs. During 1999-2000 (July-June), 828 banks were inspected.

9.41 The total number of PCBs which were classified as 'weak' banks as on June 30, 2000 increased to 262 from 249 at end-March 1999.

9.42 The licences of 17 banks were cancelled due to bad financial positions and licence applications from nine unlicensed banks were rejected during the year 1999-2000 (July-June). In all these cases, the Registrar of Cooperative Societies of the States concerned were advised to initiate liquidation proceedings. Further in respect of Ferozabad Urban Cooperative Bank Ltd., Uttar Pradesh, necessary permission was granted to take the bank into liquidation. One weak bank viz., The Daxini Brahman Co-perative Bank Ltd., Mumbai has been amalgamated with Pen Co-operative Urban Bank Ltd., Pen, Maharashtra.

9.43 During the year 1999-2000 (July-June), 1,255 complaints relating to irregularities in the functioning of the Board of Directors, unsatisfactory customer service, non-payment of DDs, non-payment of matured deposits, fraudulent encashment of payment instruments, non-sanctioning of loan etc. were received and 219 cases of frauds were reported.

9.44 The Reserve Bank put in place a comprehensive regulatory framework in January 1998 to ensure that the NBFCs function on sound and healthy lines and that only financially sound and well run NBFCs are allowed to access public deposits. For the purpose of regulation, NBFCs were stratified into three categories viz., those accepting/ holding public deposits, those which do not accept public deposits and are engaged in financial business and, core investment companies which hold at least 90 per cent of their assets as investments in their group/ subsidiary companies.

9.45 The total number of NBFCs which submitted applications for certificate of registration (CoR) till June 30, 2000 were 37,256. However, a large number of these companies were found to be not satisfying the basic condition of having minimum level of Net Owned Fund (NOF), which was enhanced from Rs.25 lakh till April 20, 1999 to Rs.200 lakh with effect from April 21, 1999. As on June 30, 2000, the Reserve Bank approved applications of 9,130 companies, of which 679 are deposit holding/accepting companies, and rejected applications of 14,986 companies. As many as 5,992 companies whose NOF is below the prescribed minimum level of Rs.200 lakh are pending with the Reserve Bank and the remaining 7,148 applications are at various stages of processing.

9.46 Action was initiated against errant NBFCs for violations of the Reserve Bank of India Act and the directions issued there-under. 107 companies were issued orders prohibiting them from accepting fresh deposits for not complying with the directions issued by the Reserve Bank. Prosecution proceedings were launched in respect of 24 companies and winding up petitions were filed in 16 cases. Show-cause notices were issued in respect of 9,435 companies for rejection of application for certificate of registration/non-submission of various prescribed returns. The Reserve Bank continued to coordinate with various State governments for enacting State legislation on the lines of the Tamil Nadu Protection of Interest of Depositors (in Establishments) Act, 1997. Maharashtra and Andhra Pradesh have passed Acts on the lines of Tamil Nadu Act, while State governments of Gujarat and Tripura have issued ordinances. Governments of Haryana and Himachal Pradesh have framed Bills on similar lines.

9.47 Considerable effort has been undertaken to inform depositors regarding do's and don'ts for placement of deposits with NBFCs, educating the registered NBFCs about the regulatory framework and the role of the Reserve Bank in regulating the registered NBFCs. The information campaign included issue of press releases, advertisements in print media, seminars, use of the Reserve Bank website and printing and distribution of a booklet containing the names of NBFCs approved for issue of certificate of registration and allowed to accept public deposits and those rejected by the Reserve Bank.

9.48 A number of measures were undertaken during 1999-2000 to further liberalise the foreign exchange market in terms of delegation of more powers to authorised dealers, relaxation of investment limits/simplification of procedures, both direct and portfolio investment, for NRIs/OCBs and FIIs (for details please see also Section I).

9.49 The following measures were undertaken towards liberalisation of capital transactions which broadly cover foreign direct investment and portfolio investment.

9.50 Foreign Direct Investment: (i) permission was granted to, (a) Indian companies to issue rights/bonus shares to non-residents and to send such shares out of India, (b) nonresidents to acquire such shares subject to reporting to the Reserve Bank; (ii) a person resident outside India or a company incorporated outside India which has been permitted to set up 100 per cent owned subsidiary, to acquire shares from the shareholders who had acquired such shares as signatories to the Memorandum and Articles of Association subject to certain conditions; (iii)a) non-residents to acquire shares of companies incorporated in India from other non-residents (other than NRIs/OCBs) by way of sale/transfer provided the transferor/seller had acquired the shares under general/specific permission of the Reserve Bank, b) nonresident Indians (NRIs) and Persons of Indian Origin (PIOs) and Overseas Corporate Bodies (OCBs) to acquire shares of companies incorporated in India from other NRIs/PIOs/ OCBs by way of sale/transfer provided the transferor had acquired the shares under general or special permission of the Reserve Bank; (iv) Indian companies for issuing non-convertible debentures to NRIs/OCBs on repatriation/non-repatriation basis subject to certain conditions; and (v) eligible Indian companies to issue shares to non-residents and submit the prescribed documents to the Reserve Bank.

9.51 Portfolio Investment: (i) the aggregate ceiling of 30 per cent on FII investment in the paid-up equity capital was enhanced up to 40 per cent. The ceilings of 30 per cent/40 per cent are applicable exclusively to FII investment and do not include NRI/OCB investment under Portfolio Investment Scheme; (ii) the existing overall ceiling of (a) 5 per cent of the total paid-up equity capital of the company concerned and (b) 5 per cent of the total paid-up value of each series of convertible debentures issued by the company to all NRIs/ OCBs taken together both on repatriation and on non-repatriation basis was raised to 10 per cent. The individual ceiling (applicable to NRIs/ OCBs) of 1 per cent of the total paid-up equity capital or preference capital or total paid-up value of each series of convertible debentures of Indian company was raised to 5 per cent. The overall ceiling of 10 per cent for NRIs/ OCBs can be raised up to 24 per cent by the company by passing a General Body Resolution to that effect; and (iii) the Reserve Bank empowered designated branches of authorised dealers to grant permission on repatriation/ non-repatriation to NRIs/OCBs under all portfolio investment schemes to acquire shares/debentures of Indian companies and other securities. NRIs/OCBs were also granted permission to acquire such shares/debentures of Indian companies and other securities.

9.52 During the year under review, further relaxations were made in the existing guidelines for Indian direct investment in joint ventures/subsidiaries (JVs/WOS) abroad. In order to promote Indian investment in SAARC countries and Myanmar, the ceiling for clearance of proposals of investment under the Fast Track Route of the Reserve Bank was raised from US $ 15 million to US $ 30 million in respect of investments in these countries. The Fast Track Route for Indian rupee investment in Nepal and Bhutan was raised from Rs.60 crore to Rs.120 crore in May 1999. The existing ceiling of U.S. $ 15 million will continue to remain applicable for investment in other countries. With a view to facilitating direct investment in JVs/WOS abroad by Indian companies, the condition that the amount of investment should be repatriated in full by way of dividend, royalty, fees etc. within a period of five years was dispensed with. A new scheme of overseas investment was introduced under which Indian companies engaged in knowledge-based sectors like information technology, pharmaceuticals, biotechnology and entertainment software were permitted to acquire overseas companies engaged in the same line of activity, as that of the Indian company, through stock swap options up to US $ 100 million or 10 times the export earnings during the preceding financial year on an automatic basis. Acquisitions under the automatic route should, however, conform to the extant FDI policy. Where the investing company does not qualify to avail of such automatic route or where the value of acquisition exceeds the limit indicated above, applications for overseas acquisition through ADR/GDR stock swaps will be considered by a Special Composite Committee (SCC) constituted by the Government of India.

9.53 As a sequel to the announcements made by the Finance Minister in his budget speech for the year 2000-01, the extant guidelines for overseas investments were considerably liberalised and rationalised. Besides the ADR/GDR stock swap route available to knowledge-based Indian companies, three routes/schemes are available to Indian corporates for overseas investment: (i) automatic route under which Indian companies can freely invest up to US $ 50 million provided that they have earned net profit in the last three years and the overseas investment is core activity of the Indian company. Funding of such investments can be out of balances held in EEFC accounts or proceeds of ADR/GDR issues (up to 50 per cent of such issues) and market purchase of foreign exchange plus capitalisation of exports up to 25 per cent of the net worth of the Indian company; (ii) ADR/GDR automatic route under which Indian Companies can freely utilise the proceeds of ADR/GDR issues (up to 50 per cent of such proceeds) for overseas investments without prior approval of the Reserve Bank or Government of India; and (iii) the Special Committee which will be headed by Deputy Governor, Reserve Bank of India and will comprise representatives from Ministries of Finance, Commerce, External Affairs and the Reserve Bank to deal with proposals not coming under the automatic route.

9.54 At the end of March 2000, there were 968 active JVs abroad, out of which 375 were in operation and 593 were under various stages of implementation. As on March 31, 2000, the approved equity with these JVs amounted to US $ 1,226.16 million. The total investment approved during the financial year 1999-2000 in respect of 95 new and 27 existing JVs amounted to US $ 472.49 million as equity, US $ 6.26 million as loan and US $ 31.92 million as guarantees as against equity, loan and guarantees amounting to US $ 61.95 million, US $ 7.87 million and US $ 33.45 million, respectively, approved in respect of 89 new and 25 existing JVs in 1998-99. The actual investment outflows during the financial year 1999-2000 were to the tune of US $ 24.18 million (provisional) which included cash remittance of US $ 22.49 million. As per the provisional information, the total inflows of foreign exchange to the country up to March 31, 2000 in the form of dividend and other entitlements repatriated were Rs.189.85 crore and Rs.381.24 crore, respectively. The additional/non-equity exports realised through the JVs were approximately Rs.1,348.10 crore up to March 31, 2000.

9.55 At the end of March 2000, there were 938 active WOS abroad, out of which 347 were in operation and 591 were under various stages of implementation. As on March 31, 2000, the approved equity with these subsidiaries amounted to US $ 1,627.64 million. The total investment approved during the financial year 1999-2000 in respect of 205 new and 68 existing subsidiaries amounted to US $ 826.43 million as equity, US $ 44.18 million as loan and US $ 375.72 million as guarantees as against US $ 85.30 million, US $ 10.61 million and US $ 52.76 million towards equity, loan and guarantees, respectively, approved in respect of 117 new and 44 existing WOS in 1998-99. The actual investment outflows during the financial year were to the tune of US $ 36.19 million (provisional) which included cash remittance of US $ 34.83 million. As per the provisional information, the total inflows of foreign exchange up to end-March 2000 in the form of dividend and other entitlements repatriated were Rs.106.74 crore and Rs.401.10 crore, respectively. The additional/non-equity exports realised through the subsidiaries were approximately Rs.1,103.94 crore up to end-March 2000.

9.56 Some of the important measures undertaken by the Reserve Bank in the exchange management during the first quarter of 2000-2001 were: (i) the firms/companies having trading offices abroad, operating on 'no remittance' basis or maintained out of funds in EEFC accounts need not apply for renewal of permission for continuation of their offices abroad; (ii) authorised dealers are permitted to grant, through their overseas branches and correspondents, loans and overdrafts against the security of fixed deposits or other assets in India, to Indian nationals or persons of Indian origin and to Overseas Corporate Bodies (OCBs) established in business or trade, provided they are satisfied that such assets represent funds which had previously been remitted to India in an approved manner; (iii) authorised dealers are permitted to grant, to the EEFC account holders, credit facilities (fund based as well as non-fund based) according to their commercial judgement against the security of balances held in their EEFC accounts. The credit facilities against the security of balances in EEFC accounts may be granted in foreign exchange also. The repayments of such credit facilities should, however, be made out of balances in EEFC accounts of the depositors concerned. The facilities should be utilised for normal business purposes only and not for any on-lending or for investment in shares, securities, etc.; (iv) exporters after award of contracts abroad for supply contracts on deferred payments/terms, turnkey projects or construction contracts are required to submit applications in form DPX3 or PEX 4, as the case may be to the authorised dealer for post award clearances, if the value of contract is up to Rs.25 crore and to Exim Bank through an authorised dealer if the value of contract exceeds Rs.25 crore but is within Rs.100 crore, for clearance. The above value limit for clearance of post award proposals for authorised dealers has been raised from Rs.25 core to Rs.50 crore and that for Exim Bank from Rs.100 crore to Rs.200 crore; (v) authorised dealers/Exim Bank have been permitted to clear project export proposals (including service contract proposals) involving bridge finance up to 25 per cent of the contract value; (vi) the Foreign Exchange Management Act, 1999 (42 of 1999) came into force from June 1, 2000. The Reserve Bank has made Regulations/issued Notifications under various provisions of the Act. All the foreign exchange transactions taking place with effect from June 1, 2000, will be governed by the provisions of the Foreign Exchange Management Act, 1999, Rules, Regulations, Notifications/directions or orders made or issued thereunder; and (vii) all authorised dealers and money changers who have been issued licences by the Reserve Bank and functioning as on May 31, 2000 shall be deemed as authorised persons, authorised by the Reserve Bank to deal in foreign exchange as authorised dealers or as authorised money-changers, for the purpose of Section 10 (1) of the Foreign Exchange Management Act. The directions issued in this regard will be applicable, mutatis-mutandis to money changers and they shall continue to be governed by the provisions of Memorandum FLM/RLM, as amended from time to time.

9.57 Some of the important policy measures initiated by the Reserve Bank with reference to internal debt management during 1999-2000 (April-March) and up to end-June 2000 are presented in Box IX.1

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Date : Aug 28, 2000

IX Banking, Internal Debt and Exchange Management Developments

Part Two : The Working and Operations of The Reserve Bank of India

9.58 During 1999-2000, the Central Government's market borrowings amounted to Rs.99,630 crore (gross) and Rs.73,077 crore (net), exceeding the budgeted amount by about Rs.15,000 crore. Dated securities aggregating Rs.86,630 crore were issued during fiscal 1999-2000 as against Rs.83,753 crore in 1998-99. The Central Government entered the market on 22 occasions (14 auctions, seven private placements with the Reserve Bank and one on-tap issues) in 1999-2000 as against 24 occasions (with private placements on eight occasions) in 1998-99. Out of 30 loans floated by the Government, only four were fresh issues whereas others were reissues. The Reserve Bank's subscription to total primary issues (including private placement) amounted to Rs.27,000 crore (31 per cent) as against Rs.38,205 crore (46 per cent) during 1998-99. The details of market borrowing have been discussed in Section V of this Report.

9.59 The system of Primary Dealers (PDs) has been operating in India since 1996 with the objectives of strengthening the market infrastructure, enhancing liquidity and widening the market, ensuring and developing the underwriting and market making capabilities for government securities, improving trading in the secondary market, widening the investor base and developing PDs as effective conduits for open market operations. The obligations upon PDs include an annual minimum bidding commitment for dated securities and Treasury Bills with a minimum success ratio and commitment to underwrite the gap between the subscribed/accepted amount and the notified amount where there is a short-fall. The PDs are allowed to access call money as well as repos/reverse repo markets and to trade in all money market instruments. They have access to SGL account and current account facility with the Reserve Bank. The number of PDs increased to 15 as on March 31, 2000 as against 13 as on March 31, 1999.

9.60 The conference of State finance secretaries was held twice during 1999-2000 (April-March) and once during the first quarter of the financial year 2000-01. The discussions were on issues relating to market borrowings, Y2K related problems, the auction system for market borrowings, State government guarantees and fiscal transparency. The status reports on the Government Securities Act, the Committee on Voluntary Disclosure Norms and the Consolidated Sinking Fund were presented in the conference. A working group of State finance secretaries was constituted to explore the scope for reducing the interest burden of States, including measures such as debt prepayment and recourse to floating rate debt instruments. Another significant decision was the constitution of a task force on similar lines to analyse and report on the extent of maneuverability available in budget making at the State level as also on the scope for increasing budget flexibility. The Reserve Bank provides technical and secretarial support to both the groups. As a follow up to the recommendations of the Committee of State finance secretaries, the Governments of Karnataka, Gujarat and Assam have introduced legislative ceilings on guarantees. The Government of Tamil Nadu has decided to charge guarantee commission on the outstanding guaranteed amount. The meeting of the State finance secretaries of North-Eastern States was held on May 17, 2000 to discuss problems particularly relating to the region.