4- basel iii, rbi, priority sector

8/3/2019 4- Basel III, Rbi, Priority Sector

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Academic Year 2010-11

RMB

Some recent happenings


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Some recent happenings

Banks given time until 2019 to complywith Basel III

IRDA may cap LIC's infra bond issuesize

RBI permits corporations to work asrural agents of banks

Credit growth still sluggish


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Banks given until 2019 to comply with Basel III

New rules will force the banks to hold more capital to

prevent another financial crisis The regulators have given banks longer than expected to

comply with tough new rules on capital requirements.

Under the new Basel III rules, banks will be forced to

more than triple the amount of top-quality capital theymust hold in reserve to prevent a repeat of the financialcrisis, following a deal hammered out in Switzerland.

Banks will have to increase their core tier-one capitalratio to 4.5% under the plan. In addition, they will have tocarry a further "counter-cyclical" capital conservationbuffer of 2.5%.

Any bank that fails to meet the new requirements isexpected to be banned from paying dividends to

shareholders until it has improved its balance sheet.


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Basel III continued

To ease the burden arising out of BASEL III, the

regulators have given the banks transition periods tocomply. These periods, extending in some cases toJanuary 2019 or later, are longer than many analystshad expected.

Global banks have liked the news that they have beengiven an extended period and the fact that they're notgoing to have to rush to raise capital.

Gary Jenkins at Evolution Securities said: "The newregulations will be phased in over quite a long period oftime and indeed will not be fully implemented until thestart of 2019." He added: "Banks will be allowed to usethe buffer during periods of stress but the more it is usedthe greater the constraints will be on earnings

distributions."


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IRDA may cap LIC's infra bond issue size

The insurance regulator, IRDA, has indicated that it may

restrict the size of the proposed retail infrastructure bondto be issued by the Life Insurance Corporation of India.

The regulator is concerned about investments byinsurance companies in the infrastructure space.

We have certain regulatory concerns and we will putstrict limits. We will put restrictions on the size of theoffer, said Mr J. Hari Narayan, Chairman, IRDA.

The Government, in the Union Budget, had allowed

financial institutions such as IFCI, IDFC, PFC and LIC toissue tax-free infrastructure bonds. Investment in thesebonds is exempt from tax up to a limit of Rs 20,000.


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LICs Infra bond continued LIC has the mandate to raise up to Rs 5,000 crore

through infrastructure bonds, which is 25 per cent of itsRs 20,000 crore incremental investment in infrastructurein the previous financial year.

LIC is expected to issue the infrastructure bonds withinsurance cover as an additional feature to attractinvestors.

Among other financial institutions which have beenpermitted to issue long-term retail infrastructure bonds,IFCI has raised Rs 100 crore.

IDFC has said that it was proposing to raise up to Rs3,400 crore.

Others are likely to follow suit in the coming months.


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RBI permits corporations to work as rural agents of banks

RBI has in a recent move allowed firms to play the role of an

intermediary to spread banking in rural areas, in a move aimedat making banking services available to the unbanked.

RBI, in its guidelines for business correspondents (BCs), has

allowed individuals, non-governmental organizations,cooperative societies, post offices and companies withlarge and widespread retail outlets to become BCs, buthas kept NBFCs out of it.

One reason behind the move, according to people familiarwith how NBFCs work, could be that these firms, includingmicrofinance institutions, lend money in rural India. If theyare allowed to mobilize deposits on behalf of banks and atthe same time continue with their business of lending

money, there could be a conflict of interest.


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Opportunities for corporates present in rural markets

Telecom companies, fertilizers and oil marketing companies,

and FMCG companies with exposure to rural markets arelikely to take the plunge following RBI's move.

According to the guidelines, BCs will raise deposits; disbursetiny loans; recover bad loans; sell micro insurance, mutual

funds, pension products and other third-party products; andreceive and deliver small value remittances.

Their activities will be within the normal course of banking

business, but conducted at places other than the bank

premises and ATMs. The distance between the BC and the base bank branch

should not exceed 30km in rural, semi urban and urbanareas, and 5km in metropolitan areas, RBI has said.


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Individual BCs have been around

Currently, about 36,000 BCs are being employed bybanks, besides less than a dozen institutions such EkoIndia and Financial Inclusion Network and OperationsLtd (Fino).

Banks manage the individual BCs on their own. Once

corporations are allowed to enter this space, they will beable to organize them better and take care of thesecurity aspects as the job involves collection anddisbursement of money.

The banks will, however, continue to be fullyresponsible for the actions of the BCs and their retailoutlets/sub agents, the RBI guidelines have said.


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Most No-frills accounts not operational!

About 50% of India's population does not have bankaccounts. In rural India, the coverage among the adult

population is 39% against 60% in urban India. This doesn'tnecessarily mean that 60 out of every 100 Indian adults incities have bank accounts as many people operate multipleaccounts.

Only 34% of people with annual earnings less than 50,000 inurban India had a bank account in 2007. The comparativefigure in rural India is even lower, 26.8%.

To handle this, banks have been aggressively opening no-

frill accounts, that require zero minimum balance. However, a 2009 study by Skoch Development Foundation,

a strategy and management consultancy, says that only 11%of 25.1 million such basic banking accounts, opened

between April 2007 and May 2009, are actually operational.


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Credit Growth still sluggish RBI in its annual credit & monetary policy has projected a credit growth of

20% for the current fiscal.

Non-food credit or the amount of money that banks lend to corporatesand individuals, grew at a slower pace of 19.06% y-on-y to Rs 33,72,059crore during the fortnight ended September 24, 2010; FPOs, ECBs,CORP. BONDS other sources

Meanwhile, deposits grew at 14.29% to Rs 4707293 crore; CDs finding

their way at higher rates

Bankers see raising of lending rates across the industry as the reasonbehind such sluggish credit growth.

However, they still exude confidence to reach growth targets.

The expected boom in infrastructure sector, manufacturing sector andretail sector are fuelling optimism among the bankers.

Ramnath Pradeep, CMD, Corporation Bank, told Indian Express, "Asmost banks raised their base rates above 8%, some corporates haveshifted their focus to raise funds from the commercial paper market at7.50%. Now, commercial papers rates, too have moved up and after

September 24, banks are seeing credit off-take.


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Lecture IV Part II

Overview of Banking in IndiaRole and Functions of the

Regulator and certain otheraspects


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Main Functions of RBI

Monetary Authority Regulator and supervisor of the financial system:

Prescribes broad parameters of bankingoperations within which the country's bankingand financial system functions

Manager of Foreign Exchange Issuer of currency Developmental role Related to the abovementioned functions, RBI

also performs the functions of being theBanker/Merchant Banker to the central and stateGovernments. It also acts as the Banker tobanks.


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Legal Framework Umbrella Acts Reserve Bank of India Act 1934: governs the Reserve Bank functions

Banking Regulation Act, 1949: governs the financial sector Acts governing specific functions Public Debt Act governing government debt market, Securities Contract (Regulation) Act, regulating government securities

market, Indian Coinage Act,

Foreign Exchange Management Act Acts governing Banking Operations Companies Act: governs banks as companies Banking Companies (Acquisition and Transfer of Undertakings) Act,

1970/1980: relates to nationalization of banks Bankers' Books Evidence Act Banking Secrecy Act Negotiable Instruments Act Acts governing Individual Institutions Specific acts governing State Bank of India, Industrial Development Bank

of India, Industrial Finance Corporation of India, National Bank forAgriculture and Rural Development, National Housing Bank and DepositInsurance and Credit Guarantee Corporation


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India: Too big to fail

Financial Conglomerates

More than 5 years ago, the Reserve Bank had set upa Working Group on Monitoring of Systemically

Important Financial Intermediaries (FinancialConglomerates); govt planning to give RBI the

powers to regulate banks with presence acrossother financial sectors as well like MF, insurance,etc.

Various steps were taken by the RBI and the twoother key regulators, IRDA & SEBI, working together,to take care of the risks emerging on account ofmany of these Financial Conglomerates becomingtoo big to fail


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Financial Conglomerates: Background The financial sector in India had undergone significant

liberalisation in all the four segments - banking, non-banking finance, securities and insurance and each ofthese sectors has grown significantly accompanied by aprocess of restructuring among the marketintermediaries.

The financial landscape was increasingly witnessing(i) entry of some of the bigger banks into other financialsegments like merchant banking, insurance, etc. whichhas made them financial 'conglomerates';

(ii) emergence of several new players with diversifiedpresence across major segments, and(iii) possibility of some of the non-banking institutions inthe financial sector acquiring large enough proportions tohave a systemic impact.


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Financial Conglomerates contd

As a proactive stance to address theseissues so that the gains on financial stabilityare further strengthened, the Governor hadannounced in the Mid-term Review of

Monetary and Credit Policy for the year 2003-04 about the decision taken in consultationwith the Chairman, Securities and ExchangeBoard of India (SEBI) and Chairman,Insurance Regulatory and Development

Authority (IRDA) for establishment of aspecial monitoring system for SystemicallyImportant Financial Intermediaries (SIFI).


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The identified FCs Of the 12 identified FCs, the principal

regulator in eight cases is the Reserve Bank,IRDA in three cases and Sebi in one case.Financial groups like ICICI, SBI and HDFC

are among the FCs The financial system in India is largely bank

dominated and the banks are the parents of

most of the large financial conglomerates. None of these FCs are not owned by any

Holding companies.


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Financial Conglomerates-Regulatory Framework A new framework was proposed as a complementary

strand to the already existing regulatory structure -supervision of individual entities by respectiveregulators and the system of Consolidated PrudentialReporting already introduced in regard to banks.

The basic building blocks of the new framework were:(i) identification of Financial Conglomerates that would

be subjected to focused regulatory oversight;(ii) capturing intra-group transactions and exposures(which were not being captured at that point in time)amongst group entities within the identified financialconglomerate and large exposures of the group(s) tooutside counterparties;

(iii) identifying a designated entity within each groupthat would collate data in respect of all other groupentities and furnish the same to its regulator (principalregulator for the group); and(iv) formalising a mechanism for inter-regulatory

exchange of information.


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Financial Conglomerates-Reporting Framework

The new reporting framework was developed for

tracking the following :1. Any unusual trend in respect of intra-grouptransactions manifest in major markets2. Build up of any disproportionate exposure (both fundbased as well as non-fund based) of any entity to other

group entities;3. Any group-level concentration of exposure tovarious financial market segments and outsidecounterparties;4. Direct/indirect cross-linkages amongst group entities

Crossholdings; Intra-group advisory and service arrangements; and Commonality of directors and senior executives


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Financial Conglomerates-Operational Framework

In the past, there was no legislative framework in place for inter-regulatory coordination.

The Group recommended that one of the existing TechnicalCommittees consisting of all the three regulators may function as astanding inter-regulatory forum to address all issues arising outthe proposed framework.

The framework envisaged furnishing of the required data by thedesignated entity in respect of each identified financial

conglomerate to its own regulator (the principal regulator) atmonthly/quarterly intervals. The primary responsibility of analysingthe Return and initiating any action thereon, if required, would liewith the Principal Regulator.

Post-analysis, the principal regulator would share with the otherregulators the analysis of the data submitted.

The salient features of the analysis and any unusual trend wouldbe discussed by the Technical Committee which could recommendfurther course of action. A quarterly review report would beprepared on the functioning of the entire mechanism and put up tothe top management of all the three regulators which would beplaced before the Standing Committee referred to above.


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RBI Departments concerned with banks

Out of its 30 odd departments, there are 5departments of RBI which focus on the banksand the Non Banking Finance Companies(NBFC). These are:

Urban Banks Department (UBD)

Rural Planning and Credit Department (RPCD)

Department of Banking Supervision (DBS)

Department of Non-Banking Supervision (DNBS)

Department of Banking Operations andDevelopment (DBOD)


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RBIs Department of Banking Supervision

The Reserve Bank of India has been entrusted

with the responsibility of supervising the Indianbanking system under various provisions of theBanking Regulation Act, 1949 and RBI Act, 1934.As regards commercial banks and FIs, thisresponsibility is discharged through theDepartment of Banking Supervision (DBS), whichsupervises 92 commercial banks and 9 select

financial institutions (FIs), through its 16 RegionalOffices.


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DBS - Supervisory Strategy

While on-site inspections has been themain plank of banking supervision, it alsofocuses on three other areas:

off-site monitoring through introduction of a set ofreturns;

strengthening of the internal control systems inbanks and

increased use of external auditors in bankingsupervision


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RBIs Department of Non-Banking Supervision

The mission of RBI includes Developing NBFC sector as an integrated and healthy part of

the Financial System; and thereby Affording indirect protection to the interests of their depositors

RBI provides for, among other things Entry norms for NBFCs Compulsory registration, maintenance of liquid assets and

reserve fund Directions on acceptance of deposits and prudential regulation Comprehensive regulation of deposit taking NBFCs

RBI has evolved a supervisory framework for NBFCscomprising (a) on-site inspection (CAMELS pattern) (b) off-sitemonitoring through returns (c) market intelligence, (d) auditors'exception reports


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RBIs Department of Banking

Operations and Development The Department is entrusted with the responsibility of

regulation of commercial banks. This includes monitoringof banks maintaining the prescribed cash and statutoryliquidity reserves, appointment of CEOs, etc.

The Department lays down prudential regulations

relating to capital adequacy, income recognition, assetclassification, provisioning for loan and other losses,investment valuation, accounting and disclosurestandards, asset-liability management and riskmanagement systems.

The other important activities of the Department includelicensing of new banks, expansion of foreign anddomestic banks, approval for setting up of subsidiariesand undertaking new activities by commercial banks andfollow-up for rehabilitation of weak banks.


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RBIs Urban Banks Department Urban Cooperative Banks (UCBs) are registered as

cooperative societies under the provisions of, either the

State Cooperative Societies Act of the State concerned orthe Multi State Cooperative Societies Act, 2002. They are regulated and supervised by the Registrar of

Cooperative Societies (RCS) of State concerned or by theCentral Registrar of Cooperative Societies (CRCS), as the

case may be. The applicability of banking laws to cooperatives societiessince March 1, 1966 led to duality of control over UCBsbetween the Registrar of Cooperative Societies/CentralRegistrar of Cooperative Societies and the RBI.

RBI regulates and supervises the banking functions of UCBsunder the provisions of Banking regulation Act, 1949. RBI has been vested powers to issue licences to UCBs to

carry on banking and to open new branches. The ReserveBank has prescribed prudential norms in various areas.


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RBIs Rural Planning and Credit Department The Rural Planning and Credit Department formulates policies relating

to rural credit and monitors timely and adequate flow of credit to therural population for agricultural activities and rural employment

programmes.

It also formulates policies relating to the priority sector which includesagriculture, small-scale industries, tiny and village industries, artisansand retail traders, professional and self-employed persons, statesponsored organisations for Scheduled Castes and Scheduled Tribes

and Government Sponsored credit-linked programmes likeSwarnjayanti Gram Swarojgar Yojana, Prime Ministers Rojgar Yojana,etc.

It implements and monitors the Lead Bank Scheme which is aimed atforging a coordinated approach for providing bank credit to achieve

overall development of rural areas in the country.

The department also oversees implementation of the BankingOmbudsman Scheme.

Its current thrust areas include credit delivery innovations, like Micro

Finance Initiatives & Kisan Credit Cards, Restructuring Co-operativesand Framing guidelines for rehabilitation of sick SSIs

C


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RBIs Rural Planning and Credit Dept.Targets/Sub-targets under priority sector lending


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Priority Sector advancesBroadly the following activities are included in priority sector:

Agriculture

Small scale industry Small road and water transport operators Retail traders and small business operators Professional and self-employed persons State-sponsored organisations for Scheduled Caste/Scheduled

Tribe, Educational loans, up to Rs. 0.75 million for studies within thecountry and Rs. 1.5 million for studies abroad.

Housing up to Rs. 1.5 million in all areas for acquisition byindividual. Rs. 0.1 million in rural/semi urban areas and Rs. 0.2million in urban/metropolitan areas for repairing of existing unit)

Consumption loans for weaker sections, Self Help Groups/ Non Governmental Organisations, Software industry (having credit limits up to Rs 10 million from the

banking system) Food and agro based processing sector


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Categories of borrowers included in Weaker Sections

Small and marginal farmers with land holdings offive acres and less, landless labourers, tenant

farmers and sharecroppers; Artisans, village and cottage industries where

individual credit requirements do not exceed Rs.50,000;

Beneficiaries of Swarnjayanti Gram SwarozgarYojana, Swarna Jayanti Shahari Rozgar Yojanaand Scheme for Liberation and Rehabilitation ofScavangers;

Scheduled castes and scheduled tribes; Beneficiaries under the Differential Rate of

Interest (DRI) scheme; and Self Help Groups.


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RBI Policy Rates & Reserve Ratios

Policy Rates Bank Rate 6.00%

Repo Rate 6.25%

Reverse Repo Rate 5.25%

(During 2010 the differential between the Repo and theReverse Repo rates (interest rate corridor) has beenreduced from 150 to 100 basis points)

Reserve Ratios

CRR 6.00% (up from 5% at thebeginning of the year)

SLR 25.00%


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Lecture IV Part III

MONETARY POLICY IMPLICATIONSFOR BANK MANAGEMENT


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MACROECONOMIC POLICIES The Governments primary objective is to achieve

economic stability and growth

Three indicators are targeted and monitored to achievethis objective:

Prices,

Employment and

Balance of payments

The two pillars of macroeconomic policy Fiscal and Monetary policies

The monetary policy is in the domain of the central

bank

G l T t & I t t f M t P li


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Goals, Targets & Instruments of Monetary Policy

Strategic Goals: Strategic Intermediate Targets: price stability

Money supply,economic growth inflation rate and

exchange rate

Operating Targets:

Reserve money, interest rates,

exchange rates and

volume of credit

Instruments: Reserve requirements( impact through themoney multiplier), bank/ discount rate and open marketoperations (OMS impact through the monetary base e.g.when the central bank absorbs liquidity, it reduces the

monetary base)


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MONEY, MONEY SUPPLY AND MONETARY POLICY

Money is something that people are universally willing toaccept in payment for goods and services or to pay off debts

Monetary Policy marks the management of money supplyand its links to prices, interest rates and other economicvariables

Money supply = total quantity of money in the economy

The definition of money supply in India was altered a

few years back to adhere to Residency concept(exclude FCNR(B) deposits and RIBS) and is also inaccordance with the norms of progressive liquidity, inaccordance with international best practices


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MONEY SUPPLY MEASURES IN INDIA

Monetary Base M0 = Currency in circulation + bankers deposits

with RBI + Other deposits with RBI NARROW MONEY [M1] = narrow measure of moneys functionas a medium of exchange Currency with the public + transactionaccounts (current deposits held with banks + demand liabilitiesportion of saving deposits with banks) + other deposits with RBI

BROAD MONEY [M2] = M1 +: a broader measure to reflectmoneys function as a store of value, which includes besides M1,time liabilities portions of savings deposits with banks + CDsissued by banks, term deposits excluding FCNR(B) depositswith maturity up to 1 year with banks

BROAD MONEY [M3] = M2 +: a still broader measure to alsocover items regarded as close substitutes of money, whichincludes besides M2, term deposits excluding FCNR(B) deposits with maturity over 1 year with banks + call borrowings from nondepository financial corporations by banks


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LIQUIDITY AGGREGATESIN INDIA

Apart from monetary aggregates, in conformitywith the progressive norms, liquidity aggregatesare also computed

L1 = M3 + all deposits with Post office savingsbanks, excluding NSCs

L2 = L1 + term deposits with term lendinginstitutions + term borrowings by institutions +CDs issued by institutions

L3 = L2 + public deposits of non bankingfinancial companies


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How banks create credit-THE MONEY MULTIPLIER

Banks, as financial intermediaries, cannot createcurrency.

But they can create deposits, which in turn can be lent The operation of the Money multiplier makes Money

creation by banks an ongoing process The key variables determining money supply are the

monetary base and level of leakage The monetary base is represented by the financial

liabilities of the central bank

Central bank can control monetary base and stronglyinfluences leakage Central bank sets reserve requirements [= leakage],

which places a limit on banks ability to create credit


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Other factors which impact monetary base/bank reserves

Refinance windows the central bank

does take additional steps to encourage ordiscourage refinancing at times

Securitization by banks additional

liquidity gets created Foreign exchange transactions by the

central bank


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MONETARY POLICIES IN INDIA

Emphasize co-ordination between monetary and fiscalpolicies

Have, as their main objectives,

price stability and

ensuring availability of adequate credit to productive sectors ofthe economy

They also increasingly emphasize Financial Stability


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RBIs reserve requirements

All banks in India are required to maintain aspecified amount of reserves as cash / bankbalances with the RBI and as investment inapproved securities.

All such reserves that are to be maintained as alegal requirement are termed PrimaryReserves.

These reserve requirements are categorized as[a] Cash Reserve Ratio [CRR] and [b] StatutoryLiquidity Ratio [SLR]


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The CRR and SLR

CRR is maintained as cash balances withRBI and cash balances in the currencychest (deemed to be a part of RBI)

The SLR is maintained to Facilitate government borrowings through

bank investment in approved securities

Provide additional liquidity to banking system

Developmental financial institutions notrequired to maintain reserves

M i f


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Maintenance of reserverequirements

CRR and SLR are prescribed as a minimum percentageof Net Demand and time Liabilities [NDTL] of eachbank operating in India

Conceptually, NDTL is the aggregate of liabilities toothers and net inter bank liabilities [NIBL], where Net

Inter bank liabilities = liabilities of the banking systemLESS assets with the banking system.

NDTL is measured on every alternate Friday by banksthese Fridays are termed Reporting Fridays.

Maintenance of CRR and SLR are computed based on

the NDTL as on the Reporting Friday. There are penal provisions for non compliance with the

reserve requirements


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Reserve requirements vs OMO

RBI is increasingly resorting to Open Market Operations(OMO) to regulate money supply in the economy

When OMOs are used as the primary policy instrument,the use of other tools such as reserves and bank rate

becomes selective and restricted.


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OMO and the Repo

Use of OMO has given rise to active repomarkets in many countries

REPURCHASE AGREEMENT [REPO] IS

An agreement

Between 2 parties

Where one party SELLS securities [for raising short term funds]

At a specified price

With commitment to BUY BACK At another date

At another predetermined price

WHY ARE REPOS


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WHY ARE REPOSIMPORTANT?

Repos used as the policy rate to signify the centralbanks monetary policy stance

They can influence interest rates by controlling liquidityand signifying desired interest rate levels

They can be used to offset short term fluctuations inbank reserves


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REVERSE REPOS

For the buyer of these securities, it is a reverse repotransaction- a contract to buy and resell the securities ata predetermined date and price.

To adjust short term surpluses.

The economic effect of repos and reverse reposamounts to a secured loan


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Open Market Operations in India

The Liquidity Adjustment Facility (LAF)introduced in 2000,operates through repos andreverse repos to set the corridor for moneymarket interest rates

In addition the RBI also aims at developing arepo market outside the LAF for both bank andnon-bank participants

LAF has settled into predominantly an overnightauction


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Repo Market Instruments outside the LAF Collateralized borrowing and lending obligations: Under

CBLO, participants i.e. banks, FIs, Insurance companies,

MFs, PDs, NBFCs, non-govt. pension funds and corporatescan lend and borrow funds, against security of govt.securities, for short term

Market Repo: From 2003, NBFCs, Insurance companies,

HFCs and MFs could access the repo markets and later onnon-scheduled urban co-op banks, listed companies with giltaccounts with SCBs were also permitted to transact in thismarket

Both CBLOs and market repos have helped in aligning shortterm money market rates to the repo and the reverse reporates in the LAF. Also, repo markets outside the LAF havebanks, PDs and corporates as major borrowers of fundssupplied typically by MFs and insurance companies

4- basel iii, rbi, priority sector

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