Reserve Bank of India Monetary Policy Statement 2010-11 By Dr. D. Subbarao Governor The Monetary Policy for 2010-11 is set against a rather complex economic backdrop. Although the situation is more reassuring than it was a quarter ago, uncertainty about the shape and pace of global recovery persists. Private spending in advanced economies continues to be constrained and inflation remains generally subdued making it likely that fiscal and monetary stimuli in these economies will continue for an extended period. Emerging market economies (EMEs) are significantly ahead on the recovery curve, but some of them are also facing inflationary pressures. 2. India’s growth-inflation dynamics are in contrast to the overall global scenario. The economy is recovering rapidly from the growth slowdown but inflationary pressures, which were triggered by supply side factors, are now developing into a wider inflationary process. As the domestic balance of risks shifts from growth slowdown to inflation, our policy stance must recognise and respond to this transition. While global policy co-ordination was critical in dealing with a worldwide crisis, the exit process will necessarily be differentiated on the basis of the macroeconomic condition in each country. India’s rapid turnaround after the crisis induced slowdown evidences the resilience of our economy and our financial sector. However, this should not divert us from the need to bring back into focus the twin challenges of macroeconomic stability and financial sector development. 3. This statement is organised in two parts. Part A covers Monetary Policy and is divided into four Sections: Section I provides an overview of global and domestic macroeconomic developments; Section II sets out the outlook and projections for growth, inflation and monetary aggregates; Section III explains the stance of monetary policy; and Section IV specifies the monetary measures. Part B covers Developmental and Regulatory Policies and is organised into six sections: Financial Stability (Section I) , Interest Rate Policy (Section II) , Financial Markets (Section III) , Credit Delivery and Financial Inclusion (Section IV), Regulatory and Supervisory Measures for Commercial Banks (Section V ) and Institutional Developments (Section VI). 4. Part A of this Statement should be read and understood together with the detailed review in Macroeconomic and Monetary Developments released yesterday by the Reserve Bank.
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Reserve Bank of India
Monetary Policy Statement 2010-11
By
Dr. D. Subbarao
Governor
The Monetary Policy for 2010-11is set against a rather complex economicbackdrop. Although the situation is morereassuring than it was a quarter ago,uncertainty about the shape and pace ofglobal recovery pers is ts . Pr ivatespending in advanced economiescontinues to be constrained and inflationremains generally subdued making itlikely that fiscal and monetary stimuliin these economies will continue for anextended period. Emerging marketeconomies (EMEs) are significantlyahead on the recovery curve, but someof them are also facing inflationarypressures.
2. India’s growth-inflation dynamicsare in contrast to the overall globalscenario. The economy is recoveringrapidly from the growth slowdown butinflationary pressures, which weretriggered by supply side factors, are nowdeveloping into a wider inflationaryprocess. As the domestic balance of risksshifts from growth slowdown to inflation,our policy stance must recognise andrespond to this transition. While globalpolicy co-ordination was critical indealing with a worldwide crisis, the exitprocess will necessarily be differentiatedon the basis of the macroeconomiccondition in each country. India’s rapid
turnaround after the crisis inducedslowdown evidences the resilience of oureconomy and our financial sector.However, this should not divert us fromthe need to bring back into focus the twinchallenges of macroeconomic stabilityand financial sector development.
3. This statement is organised in twoparts. Part A covers Monetary Policy andis divided into four Sections: Section Iprovides an overview of global anddomestic macroeconomic developments;Section II sets out the outlook andprojections for growth, inflation andmonetary aggregates; Section III explainsthe stance of monetary policy; and SectionIV specifies the monetary measures.Part B covers Developmental andRegulatory Policies and is organised intosix sections: Financial Stability (SectionI), Interest Rate Policy (Section II),Financial Markets (Section III), CreditDelivery and Financial Inclusion (SectionIV), Regulatory and SupervisoryMeasures for Commercial Banks (SectionV) and Institutional Developments(Section VI).
4. Part A of this Statement should beread and understood together with thedetailed review in Macroeconomic andMonetary Developments releasedyesterday by the Reserve Bank.
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Global Economy
5. The global economy continues torecover amidst ongoing policy support andimproving financial market conditions.The recovery process is led by EMEs,especially those in Asia, as growthremains weak in advanced economies.The global economy continues to faceseveral challenges such as high levelsof unemployment, which are close to10 per cent in the US and the Euro area.Despite signs of renewed activity inmanufacturing and initial improvement inretail sales, the prospects of economicrecovery in Europe are clouded by theacute fiscal strains in some countries.
6. Core measures of inflation inmajor advanced economies are stillmoderating as the output gap persists andunemployment remains high. Inflationexpectations also remain well-anchored.In contrast, core measures of inflation inEMEs, especially in Asia, have beenrising. This has prompted central banksin some EMEs to begin phasing out theiraccommodative monetary policies.
Domestic Economy
7. The Reserve Bank had projectedthe real GDP growth for 2009-10 at 7.5per cent. The advance estimates releasedby the Central Statistical Organisation(CSO) in early February 2010 placedthe real GDP growth during 2009-10 at7.2 per cent. The final real GDP growthfor 2009-10 may settle between 7.2 and7.5 per cent.
8. The uptrend in industrial activitycontinues. The index of industrial
production (IIP) recorded a growth of 17.6per cent in December 2009, 16.7 per centin January 2010 and 15.1 per cent inFebruary 2010. The recovery has alsobecome more broad-based with 14 out of17 industry groups recording acceleratedgrowth during April 2009-February 2010.The sharp pick-up in the growth of thecapital goods sector, in double digits sinceSeptember 2009, points to the revival ofinvestment activity. After a continuousdecline for eleven months, importsexpanded by 2.6 per cent in November2009, 32.4 per cent in December 2009,35.5 per cent in January 2010 and66.4 per cent in February 2010. Theacceleration in non-oil imports sinceNovember 2009 further evidencesrecovery in domestic demand. Aftercontracting for twelve straight months,exports have turned around since October2009 reflecting revival of externaldemand. Various lead indicators of servicesector activity also suggest increasedeconomic activity. On the whole, theeconomic recovery, which began aroundthe second quarter of 2009-10, has sinceshown sustained improvement.
9. A sharp recovery of growth during2009-10 despite the worst south-westmonsoon since 1972 attests to theresilience of the Indian economy. Onthe demand side, the contribution ofvarious components to growth in 2009-10was as follows: private consumption(36 per cent), government consumption(14 per cent), fixed investments(26 per cent) and net exports (20 per cent).The monetary and fiscal stimulusmeasures initiated in the wake of the
Part A. Monetary Policy
I. The State of the Economy
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global financial crisis played an importantrole, first in mitigating the adverse impactfrom contagion and then in ensuring thatthe economy recovered quickly.
10. However, the developments onthe inflation front are worrisome.The headline inflation, as measured byyear-on-year variation in Wholesale PriceIndex (WPI), accelerated from 0.5 per centin September 2009 to 9.9 per cent inMarch 2010, exceeding the ReserveBank’s baseline projection of8.5 per cent for March 2010 set out in theThird Quarter Review. Year-on-year WPInon-food manufactured products (weight:52.2 per cent) inflation, which was (-) 0.4per cent in November 2009, turnedmarginally positive to 0.7 per cent inDecember 2009 and rose sharplythereafter to 3.3 per cent in January 2010and further to 4.7 per cent in March 2010.Year-on-year fuel price inflation alsosurged from (-) 0.7 per cent in November2009 to 5.9 per cent in December 2009,to 8.1 per cent in January 2010 and furtherto 12.7 per cent in March 2010. Despitesome seasonal moderation, food priceinflation remains elevated.
11. Clearly, WPI inflation is no longerdriven by supply side factors alone. Thecontribution of non-food items to overallWPI inflation, which was negativeat (-) 0.4 per cent in November 2009 rosesharply to 53.3 per cent by March 2010.Consumer price index (CPI) basedmeasures of inflation were in the range of14.9-16.9 per cent in January/February2010. Thus, inflationary pressures haveaccentuated since the Third QuarterReview in January 2010. What wasinitially a process driven by food priceshas now become more generalised.
12. Growth in monetary and creditaggregates during 2009-10 remainedbroadly in line with the projections set outin the Third Quarter Review in January2010. Non-food bank credit expandedsteadily during the second half of the year.Consequently, the year-on-year non-foodcredit growth recovered from its intra-yearlow of 10.3 per cent in October 2009 to16.9 per cent by March 2010. The increasein bank credit was also supplemented byhigher flow of financial resources fromother sources. Reserve Bank’s estimatesshow that the total flow of financialresources from banks, domestic non-bankand external sources to the commercialsector during 2009-10 at Rs.9,71,000crore, was higher than the amount ofRs.8,34,000 crore in the previous year.
13. Scheduled commercial banks(SCBs) raised their deposit rates by25-50 basis points between February andApril 2010 so far, signalling a reversal inthe trend of reduction in deposit rates. Onthe lending side, the benchmark primelending rates (BPLRs) of SCBs haveremained unchanged since July 2009following reductions in the range of25-100 basis points between March andJune 2009. However, data from selectbanks suggest that the weighted averageyield on advances, which is a proxymeasure for effective lending rates, isprojected to decline from 10.8 per cent inMarch 2009 to 10.1 per cent by March2010. The Base Rate system of loanpricing, which will replace the BPLRsystem with effect from July 1, 2010, isexpected to facilitate better pricing ofloans, enhance transparency in lendingrates and improve the assessment ofmonetary policy transmission.
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14. Financial markets functionednormally through the year. Surplusliquidity that prevailed throughout theyear declined towards the end of the yearconsistent with the monetary policystance. The Reserve Bank absorbed aboutRs.1,00,000 crore on a daily average basisunder the liquidity adjustment facility(LAF) during the current financial year upto February 12, 2010, i.e., before the firststage of increase in the cash reserve ratio(CRR) came into effect. During February27- March 31, 2010, the average dailyabsorption of surplus liquidity declined toaround Rs. 38,200 crore reflecting theincrease in the CRR, year-end advance taxoutflows and higher credit demand fromthe private sector. However, as the overallliquidity remained in surplus, overnightinterest rates generally stayed close to thelower bound of the LAF rate corridor.
15. The large market borrowing by theGovernment put upward pressure on theyields on government securities during2009-10. However, this was contained byactive liquidity management by theReserve Bank. Lower credit demand bythe private sector also cushioned the yield.Equity markets generally remained firmduring the year with intermittentcorrections in line with the global pattern.Resource mobilisation through publicissues increased sharply. Housing pricesrebounded during 2009-10. According tothe Reserve Bank’s survey, they surpassedtheir pre-crisis peak levels in Mumbai.
16. During 2009-10, the CentralGovernment raised Rs.3,98,411 crore (net)through the market borrowing programmewhile the state governments mobilisedRs.1,14,883 crore (net). This largeborrowing was managed in a non-disruptive manner through a combination
of active liquidity management measuressuch as front-loading of the borrowingcalendar, unwinding of securities underthe market stabilisation scheme (MSS)and open market operation (OMO)purchases.
17. The Union Budget for 2010-11has begun the process of fiscalconsolidation by budgeting lower fiscaldeficit (5.5 per cent of GDP in 2010-11 ascompared with 6.7 per cent in 2009-10)and revenue deficit (4.0 per cent of GDPin 2010-11 as compared with 5.3 per centin 2009-10). As a result, the net marketborrowing requirement of the CentralGovernment in 2010-11 is budgeted lowerat Rs.3,45,010 crore as compared with thatin the previous year.
18. Historically, fiscal deficits havebeen financed by a combination ofmarket borrowings and other sources.However, in 2009-10 and 2010-11,reliance on market borrowings forfinancing the fiscal deficit increased inrelative terms. The large marketborrowing in 2009-10 was facilitated bythe unwinding of MSS securities andOMO purchases, as a result of which freshissuance of securities constituted 63.0 percent of the total budgeted marketborrowings. However in 2010-11, almostthe entire budgeted borrowings will befunded by fresh issuance of securities.Therefore, notwithstanding the lowerbudgeted net borrowings, fresh issuanceof securities in 2010-11 will beRs.3,42,300 crore, higher than thecorresponding figure of Rs.2,51,000 crorelast year. The large government borrowingin 2009-10 was also facilitated by sluggishprivate credit demand and comfortableliquidity conditions. However, going
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forward, private credit demand is expectedto pick up further. Meanwhile, inflationarypressures have also made it imperative forthe Reserve Bank to absorb surplusliquidity from the system. Thus, managingthe borrowings of the Government during2010-11 will be a bigger challenge than itwas last year.
19. The current account deficit duringApril-December 2009 was US$ 30 billionas compared with US$ 28 billion for thecorresponding period of 2008. Net capitalinflows at US$ 42 billion were alsosubstantially higher than US$ 7 billion in
the corresponding period last year.Consequently, on a balance of paymentsbasis (i.e., excluding valuation effects),foreign exchange reserves increased byUS$ 11 billion as against a decline of US$20 billion during the corresponding perioda year ago. Foreign exchange reservesstood at US$ 279 billion ason March 31, 2010. The six-currencytrade-based real effective exchange rate(REER) (1993-94=100) appreciated by15.5 per cent during 2009-10 up toFebruary as against 10.4 per centdepreciation in the corresponding periodof the previous year.
II. Outlook and Projections
Global Outlook
Growth
20. In its World Economic OutlookUpdate for January 2010, the InternationalMonetary Fund (IMF) projectedthat global growth will recover from (-) 0.8per cent in 2009 to 3.9 per cent in 2010and further to 4.3 per cent in 2011.Organisation for Economic Co-operationand Development’s (OECD) compositeleading indicators (CLIs) in February2010 continued to signal an improvementin economic activity for the advancedeconomies. Three major factors that havecontributed to the improved globaloutlook are the massive monetary andfiscal support, improvement in confidenceand a strong recovery in EMEs.
21. US GDP rose by 5.6 per cent onan annualised basis during Q4 of 2009.However, household spending remainsconstrained by high unemployment at9.7 per cent. Though business fixedinvestment is turning around and housingstarts are picking up, investment in
commercial real estate is declining.Growth in the euro area, on a quarter-on-quarter basis, was 0.1 per cent in Q4 of2009. It may remain moderate in 2010because of the ongoing process of balancesheet adjustment in various sectors,dampened investment, low capacityutilisation and low consumption. Thoughexports are improving and the decline inbusiness fixed investment is moderating,several euro-zone governments are facedwith high and unsustainable fiscalimbalances which could have implicationsfor medium and long-term interest rates.In Japan, improved prospects on accountof exports have been offset by thelevelling off of public investment and risein unemployment.
22. Amongst EMEs, China continuesto grow at a rapid pace, led mainly bydomestic demand. Malaysia and Thailandhave recovered to register positive growthin the second half of 2009. Indonesiarecorded positive growth throughout2009.
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Inflation
23. Globally, headline inflation ratesrose between November 2009 and January2010, softened in February 2010 onaccount of moderation of food, metal andcrude prices and again rose marginally insome major economies in March 2010.Core inflation continued to decline in theUS on account of substantial resourceslack. Inflation expectations in advancedcountries also remain stable. Thoughinflation has started rising in severalEMEs, India is a significant outlier withinflation rates much higher than in otherEMEs.
Domestic Outlook
Growth
24. The Indian economy is firmly onthe recovery path. Exports have beenexpanding since October 2009, a trendthat is expected to continue. The industrialsector recovery is increasingly becomingbroad-based and is expected to take firmerhold going forward on the back of risingdomestic and external demand.
25. Surveys generally support theperception of a consolidating recovery.According to the Reserve Bank’s quarterlyindustrial outlook survey, although the
business expectation index (BEI) showedseasonal moderation from 120.6 in Q4 of2009-10 to 119.8 in Q1 of 2010-11, it wasmuch higher in comparison with the levelof 96.4 a year ago. The improvedperformance of the industrial sector is alsoreflected in the improved profitability inthe corporate sector. Service sectoractivities have shown buoyancy,especially during the latter half of2009-10. The leading indicators of varioussectors such as tourist arrivals,commercial vehicles production andtraffic at major ports show significantimprovement. A sustained increase in bankcredit and in the financial resources raisedby the commercial sector from non-banksources also suggest that the recovery isgaining momentum.
26. On balance, under the assumptionof a normal monsoon and sustenance ofgood performance of the industrial andservices sectors on the back of risingdomestic and external demand, for policypurposes the baseline projection of realGDP growth for 2010-11 is placed at 8.0per cent with an upside bias (Chart 1).
Inflation
27. Headline WPI inflation, whichmoderated in the first half of 2009-10,
Chart 1: Projection of GDP Growth for 2010-11
GD
PG
row
th(%
)
50 Per cent CI 90 Per cent CI70 Per cent CIBaseline Projection CI - confidence interval
6
7
8
9
10
2005-0
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2006-0
7
2007-0
8
2008-0
9
2009-1
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firmed up in the second half of the year. Itaccelerated from 1.5 per cent in October2009 to 9.9 per cent by March 2010. Thedeficient south-west monsoon rainfallaccentuated the pressure on food prices.This, combined with the firming up ofglobal commodity prices from their lowlevels in early 2009 and incipient demandside pressures, led to acceleration in theoverall inflation rate – both of the WPIand the CPIs.
28. The Reserve Bank’s baselineprojection of WPI inflation for March2010 was 8.5 per cent. However, somesubsequent developments on both supplyand demand sides pushed up inflation.Enhancement of excise duty andrestoration of the basic customs duty oncrude petroleum and petroleum productsand the increase in prices of iron ore andcoal had a significant impact on WPIinflation. In addition, demand sidepressures also re-emerged as reflected inthe sharp increase in non-foodmanufactured products inflation from 0.7per cent to 4.7 per cent between December2009 and March 2010.
29. There have been significantchanges in the drivers of inflation in recentmonths. First, while there are some signs
of seasonal moderation in food prices,overall food inflation continues at anelevated level. It is likely that structuralshortage of certain agriculturalcommodities such as pulses, edible oilsand milk could reduce the pace of foodprice moderation. Second, the firming upof global commodity prices poses upsiderisks to inflation. Third, the ReserveBank’s industrial outlook survey showsthat corporates are increasingly regainingtheir pricing power in many sectors. Asthe recovery gains further momentum,the demand pressures are expected toaccentuate. Fourth, the Reserve Bank’squarterly inflation expectations survey forhouseholds indicates that householdinflation expectations have remained at anelevated level.
30. Going forward, three majoruncertainties cloud the outlook forinflation. First, the prospects of themonsoon in 2010-11 are not yet clear.Second, crude prices continue to bevolatile. Third, there is evidence ofdemand side pressures building up. Onbalance, keeping in view domesticdemand-supply balance and the globaltrend in commodity prices, the baselineprojection for WPI inflation for March2011 is placed at 5.5 per cent (Chart 2).
Chart 2: Projected Path of Y-o-Y WPI Inflation
CI - confidence interval
Infl
ati
on
Rate
(%)
50 Per cent CI 90 Per cent CI70 Per cent CIBaseline Projection
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
Mar-
08
Jun-0
8
Sep-0
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Mar-
09
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0
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31. It would be the endeavour of theReserve Bank to ensure price stability andanchor inflation expectations. In pursuitof these objectives, the Reserve Bankwill continue to monitor an array ofmeasures of inflation, both overall anddisaggregated components, in the contextof the evolving macroeconomic situationto assess the underlying inflationarypressures.
32. Notwithstanding the currentinflation scenario, it is important torecognise that in the last decade, theaverage inflation rate, measured both interms of WPI and CPI, had moderated toabout 5 per cent from the historical trendrate of about 7.5 per cent. Against thisbackground, the conduct of monetarypolicy will continue to condition andcontain perception of inflation in the rangeof 4.0-4.5 per cent. This will be in linewith the medium-term objective of 3.0per cent inflation consistent with India’sbroader integration into the globaleconomy.
Monetary Aggregates
33. During 2009-10, money supply(M3) growth decelerated from over 20.0per cent at the beginning of the financialyear to 16.4 per cent in February 2010before increasing to 16.8 per cent byMarch 2010, slightly above the ReserveBank’s indicative projection of 16.5per cent. This was reflected in non-foodcredit growth of 16.9 per cent, above theindicative projection of 16.0 per cent.
34. Keeping in view the need tobalance the resource demand to meetcredit offtake by the private sector andgovernment borrowings, monetaryprojections have been made consistentwith the growth and inflation outlook. For
policy purposes, M3 growth for 2010-11is placed at 17.0 per cent. Consistent withthis, aggregate deposits of SCBs areprojected to grow by 18.0 per cent. Thegrowth in non-food credit of SCBs isplaced at 20.0 per cent. As always, thesenumbers are provided as indicativeprojections and not as targets.
Risk Factors
35. While the indicative projections ofgrowth and inflation for 2010-11 mayappear reassuring, the following majordownside risks to growth and upside risksto inflation need to be recognised:
First, uncertainty persists about the paceand shape of global recovery. Fiscalstimulus measures played a major role inthe recovery process in many countries bycompensating for the fall in privatedemand. Private demand in majoradvanced economies continues to be weakdue to high unemployment rates, weakincome growth and tight credit conditions.There is a risk that once the impact ofpublic spending wanes, the recoveryprocess will be stalled. Therefore, theprospects of sustaining the recovery hingestrongly on the revival of privateconsumption and investment. Whilerecovery in India is expected to be drivenpredominantly by domestic demand,significant trade, financial and sentimentlinkages indicate that a sluggish anduncertain global environment canadversely impact the Indian economy.
Second, if the global recovery does gainmomentum, commodity and energy prices,which have been on the rise during the lastone year, may harden further. Increase inglobal commodity prices could, therefore,add to inflationary pressures.
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Third, from the perspective of bothdomestic demand and inflationmanagement, the 2010 south-westmonsoon is a critical factor. The currentassessment of softening of domesticinflation around mid-2010 is contingenton a normal monsoon and moderation infood prices. Any unfavourable pattern inspatial and temporal distribution ofrainfall could exacerbate food inflation.In the current context, an unfavourablemonsoon could also impose a fiscalburden and dampen rural consumer andinvestment demand.
Fourth, it is unlikely that the largemonetary expansion in advancedeconomies will be unwound in the nearfuture. Accommodative monetary policiesin the advanced economies, coupled withbetter growth prospects in EMEsincluding India, are expected to triggerlarge capital flows into the EMEs. Whilethe absorptive capacity of the Indianeconomy has been increasing, excessiveflows pose a challenge for exchange rateand monetary management. The rupee hasappreciated sharply in real terms over thepast one year. Pressures from highercapital flows combined with the prevailingrate of inflation will only reinforce thattendency. Both exporters, whose prospectsare just beginning to turn, and producers,who compete with imports in domestic
markets, are getting increasinglyconcerned about the external sectordynamics.
36. Our exchange rate policy is notguided by a fixed or pre-announced targetor band. Our policy has been to retain theflexibility to intervene in the market tomanage excessive volatili ty anddisruptions to the macroeconomicsituation. Recent experience hasunderscored the issue of large and oftenvolatile capital flows influencingexchange rate movements against thegrain of economic fundamentals andcurrent account balances. There is,therefore, a need to be vigilant against thebuild-up of sharp and volatile exchangerate movements and its potentiallyharmful impact on the real economy.
37. The resumption of the process offiscal consolidation has been a significantpositive development. This will help avoidcrowding out of private sector creditdemand and facilitate better monetarymanagement. However, the overall size ofthe government borrowing programme isstill very large and can exert pressure oninterest rates. Going forward, fiscalconsolidation has to shift from one-offgains to structural improvements on bothtax and expenditure sides, and focusincreasingly on the quality of fiscalconsolidation.
III. The Policy Stance
38. In the wake of the global economiccrisis, the Reserve Bank pursuedan accommodative monetary policybeginning mid-September 2008. Thispolicy instilled confidence in marketparticipants, mitigated the adverse impactof the global financial crisis on the
economy and ensured that the economystarted recovering ahead of most othereconomies. However, in view of the risingfood inflation and the risk of it impingingon inflationary expectations, the ReserveBank embarked on the first phase of exitfrom the expansionary monetary policy by
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terminating some sector-specific liquidityfacilities and restoring the statutoryliquidity ratio (SLR) of scheduledcommercial banks to its pre-crisis level inthe Second Quarter Review of October2009.
39. The process was carried forwardby the second phase of exit when theReserve Bank announced a 75 basis pointsincrease in the CRR in the Third QuarterReview of January 2010. As inflationcontinued to increase, driven significantlyby the prices of non-food manufacturedgoods, and exceeded the Reserve Bank’sbaseline projection of 8.5 per cent forMarch 2010 (made in the Third QuarterReview), the Reserve Bank respondedexpeditiously with a mid-cycle increaseof 25 basis points each in the policy reporate and the reverse repo rate under theLAF on March 19, 2010.
40. The monetary policy responsein India since October 2009 hasbeen calibrated to India’s specificmacroeconomic conditions. Accordingly,our policy stance for 2010-11 has beenguided by the following three majorconsiderations:
First, recovery is consolidating. The quickrebound of growth during 2009-10 despitefailure of monsoon rainfall suggests thatthe Indian economy has become resilient.Growth in 2010-11 is projected to behigher and more broad-based than in2009-10. In its Third Quarter Review inJanuary 2010, the Reserve Bank hadindicated that our main monetary policyinstruments are at levels that are moreconsistent with a crisis situation than witha fast recovering economy. In theemerging scenario, lower policy rates
can complicate the inflation outlookand impair inflationary expectations,particularly given the recent escalation inthe prices of non-food manufactureditems. Despite the increase of 25 basispoints each in the repo rate and the reverserepo rate, our real policy rates are stillnegative. With the recovery now firmly inplace, we need to move in a calibratedmanner in the direction of normalising ourpolicy instruments.
Second, inflationary pressures haveaccentuated in the recent period. Moreimportantly, inflation, which was earlierdriven entirely by supply side factors, isnow getting increasingly generalised.There is already some evidence that thepricing power of corporates has returned.With the growth expected to acceleratefurther in the next year, capacityconstraints will re-emerge, which areexpected to exert further pressure onprices. Inflation expectations also remainat an elevated level. There is, therefore, aneed to ensure that demand side inflationdoes not become entrenched.
Third, notwithstanding lower budgetedgovernment borrowings in 2010-11 thanin the year before, fresh issuance ofsecurities will be 36.3 per cent higher thanin the previous year. This presents adilemma for the Reserve Bank. Whilemonetary policy considerations demandthat surplus liquidity should be absorbed,debt management considerations warrantsupportive liquidity conditions. TheReserve Bank, therefore, has to do afine balancing act and ensure that whileabsorbing excess liquidity, thegovernment borrowing programme is nothampered.
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41. Against this backdrop, the stanceof monetary policy of the Reserve Bankis intended to:
∑ Anchor inflation expectations,while being prepared to respondappropriately, swiftly and effectivelyto further build-up of inflationarypressures.
∑ Actively manage liquidity to ensurethat the growth in demand for creditby both the private and publicsectors is satisfied in a non-disruptiveway.
∑ Maintain an interest rate regimeconsistent with price, output andfinancial stability.
IV. Monetary Measures
42. On the basis of the currentassessment and in line with the policystance as outlined in Section III, theReserve Bank announces the followingpolicy measures:
Bank Rate
43. The Bank Rate has been retainedat 6.0 per cent.
Repo Rate
44. It has been decided to:
∑ increase the repo rate under theLiquidity Adjustment Facility (LAF)by 25 basis points from 5.0 per centto 5.25 per cent with immediateeffect.
Reverse Repo Rate
45. It has been decided to:
∑ increase the reverse repo rate underthe LAF by 25 basis points from 3.5per cent to 3.75 per cent withimmediate effect.
Cash Reserve Ratio
46. It has been decided to:
∑ increase the cash reserve ratio (CRR)of scheduled banks by 25 basis pointsfrom 5.75 per cent to 6.0 per cent oftheir net demand and time liabilities
(NDTL) effective the fortnightbeginning April 24, 2010.
47. As a result of the increase in theCRR, about Rs. 12,500 crore of excessliquidity will be absorbed from the system.
48. The Reserve Bank will continue tomonitor macroeconomic conditions,particularly the price situation, closely andtake further action as warranted.
Expected Outcomes
49. The expected outcomes of theactions are:
(i) Inflation will be contained andinflationary expectations will beanchored.
(ii) The recovery process will besustained.
(iii) Government borrowing requirementsand the private credit demand will bemet.
(iv) Policy instruments will be furtheraligned in a manner consistent withthe evolving state of the economy.
First Quarter Review of MonetaryPolicy 2010-11
50. The First Quarter Review ofMonetary Policy for 2010-11 will beannounced on July 27, 2010.
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51. The global financial crisis hasunderscored the importance of pursuingfinancial sector policies in the broadercontext of financial stability and to servethe interests of the real economy. A majorlesson is that no indicator or action isfoolproof, which points to the need forcontinuous monitoring, regular review ofprocesses, proactive oversight andpre-emptive actions. Thus, periodicassessment of regulatory comforts andeffective supervision are critical elementsfor developing the financial sector on asound footing.
52. Over the last several years, theReserve Bank has undertakenwide-ranging financial sector reforms toimprove financial intermediation and
Part B. Developmental and Regulatory Policies
maintain financial stability. This processhas now become more intensive with afocus on drawing appropriate lessons fromthe global financial crisis and putting inplace a regulatory regime that is alert topossible build-up of financial imbalances.The focus of the Reserve Bank’sregulation will continue to be to improvethe efficiency of the banking sectorwhile maintaining financial stability.Simultaneously, it will vigorously pursuethe financial inclusion agenda to makefinancial sector development moreinclusive.
53. A synopsis of the action taken onthe past policy announcements togetherwith a list of fresh policy measures is setout below.
I. Financial Stability
Financial Stability Report
54. As announced in the Annual PolicyStatement of April 2009, the Reserve Bankestablished a Financial Stability Unit inAugust 2009 for carrying out periodicstress testing and for preparing financialstability reports.
55. The first Financial Stability Report(FSR) was released on March 25,2010. This Report is an attempt atinstitutionalising the focus on financialstability and making it an integral part ofthe policy framework. The first FSRmakes an assessment of the strength of thefinancial sector, with particular focus onbanks, and has raised some concerns,including rising inflation, highgovernment borrowings and likely surgein capital flows, from the financial
stability standpoint. The FSR observedthat the banks remained well-capitalisedwith higher core capital and sustainablefinancial leverage. Further, stress tests forcredit and market risk confirmed banks’resilience to withstand high stress. TheFSR also emphasised the need forevolving a stronger supervisory regime forsystemically important non-deposit takingnon-banking financial companies(NBFCs-ND-SI) and strengthening themonitoring and oversight framework forsystemically important financialconglomerates. Overall risk to financialstability was found to be limited.However, the recent financial turmoil hasclearly demonstrated that financialstability cannot be taken for granted, andthat the maintenance of financial stabilityrequires constant vigilance, especially
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during normal times to detect and mitigateany incipient signs of instability. Going
forward, the Financial Stability Reportswill be published half-yearly.
II. Interest Rate Policy
Base Rate: Introduction
56. As indicated in the Annual PolicyStatement of April 2009, the Reserve Bankconstituted a Working Group onBenchmark Prime Lending Rate(Chairman: Shri Deepak Mohanty) toreview the present benchmark primelending rate (BPLR) system and suggestchanges to make credit pricing moretransparent. The Working Groupsubmitted its report in October 2009 andthe same was placed on the ReserveBank’s website for public comments.Based on the recommendations of the
Group and the suggestions from variousstakeholders, the draft guidelines on BaseRate were placed on the Reserve Bank’swebsite in February 2010.
57. In the light of the comments/suggestions received, it has been decidedto mandate banks to switch over to thesystem of Base Rate from July 1, 2010.Guidelines on the Base Rate system wereissued on April 9, 2010. It is expected thatthe Base Rate system will facilitate betterpricing of loans, enhance transparency inlending rates and improve the assessmentof transmission of monetary policy.
III. Financial Markets
Financial Market Products
Interest Rate Futures
58. The Interest Rate Futures contracton 10-year notional coupon bearingGovernment of India security wasintroduced on August 31, 2009. Basedon the market feedback and therecommendations of the TechnicalAdvisory Committee (TAC) on the Money,Foreign Exchange and GovernmentSecurities Markets, it is proposed:
∑ to introduce Interest Rate Futures on5-year and 2-year notional couponbearing securities and 91-dayTreasury Bills. The RBI-SEBIStanding Technical Committeewill finalise the product designand operational modalities forintroduction of these products on theexchanges.
Regulation of Non-ConvertibleDebentures (NCDs) of Maturity of Lessthan One Year
59. As indicated in the Second QuarterReview of October 2009, the draftguidelines on the regulation ofnon-convertible debentures (NCDs)of maturity of less than one yearwere placed on the Reserve Bank’swebsite on November 3, 2009 forcomments/feedback. The comments/feedback received were examined and alsodeliberated by the TAC on the Money,Foreign Exchange and GovernmentSecurities Markets. Accordingly, it isproposed:
∑ to issue the final guidelines onthe issuance of NCDs of maturity lessthan one year by end-June 2010.
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Introduction of Credit Default Swaps(CDS)
60. As indicated in the Second QuarterReview of October 2009, the ReserveBank constituted an internal WorkingGroup to finalise the operationalframework for introduction of plainvanilla over-the-counter (OTC) single-name CDS for corporate bonds forresident entities subject to appropriatesafeguards. The Group is in the processof finalising a framework suitable for theIndian market, based on consultations withmarket participants/experts and study ofinternational experience. Accordingly, itis proposed:
∑ to place the draft report of the internalWorking Group on the ReserveBank’s website by end-July 2010.
Guidelines on Forex Derivatives
61. As indicated in the Second QuarterReview of October 2009, the draftguidelines on OTC foreign exchangederivatives were placed on the ReserveBank’s website on November 12, 2009 forpublic comments. The feedback receivedfrom stakeholders and industryassociations was discussed in the meetingof the TAC on the Money, ForeignExchange and Government SecuritiesMarkets. On the basis of the discussions,it is proposed:
∑ to issue final guidelines by end-June2010.
Introduction of Exchange-TradedCurrency Option Contracts
62. Currently, residents in India arepermitted to trade in futures contracts infour currency pairs on two recognisedstock exchanges. In order to expand themenu of tools for hedging currency risk,it has been decided:
∑ to permit the recognised stockexchanges to introduce plain vanillacurrency options on spot US Dollar/Rupee exchange rate for residents.
63. The risk management andoperational guidelines will be finalised bythe RBI-SEBI Standing TechnicalCommittee.
Separate Trading for Registered Interestand Principal of Securities (STRIPS):Status
64. As indicated in the Annual PolicyStatement for 2009-10, the draftguidelines on stripping/reconstitution ofgovernment securities prepared inconsultation with market participants wereplaced on the Reserve Bank’s website onMay 14, 2009 for comments and feedback.Taking into consideration the feedbackreceived on the draft guidelines, the finalguidelines on stripping/reconstitution ofgovernment securities were issued onMarch 25, 2010. The guidelines, whichcame into effect from April 1, 2010, willenable market participants to strip/reconstitute eligible Government of Indiadated securities through the negotiateddealing system (NDS) subject to certainterms and conditions.
Corporate Bond Market
65. In the recent period, the ReserveBank initiated several measures to developthe corporate bond market as detailedbelow:
(i) To facilitate settlement of secondarymarket trades in corporate bondson a delivery versus payment-1(DVP-1) basis on the Real Time GrossSettlement (RTGS) system,the National Securities ClearingCorporation Limited (NSCCL) andthe Indian Clearing Corporation
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Limited (ICCL) have been permittedto maintain transitory poolingaccounts with the Reserve Bank.Further, guidelines have been issuedto all Reserve Bank regulated entitiesto mandatorily clear and settle allOTC trades in corporate bonds usingthe above arrangement with effectfrom December 1, 2009.
(ii) To facilitate the development of anactive repo market in corporate bonds,the guidelines for repo transactions incorporate debt securities were issuedon January 8, 2010. The guidelines,which came into force with effectfrom March 1, 2010, will enable repoin listed corporate debt securitiesrated ‘AA’ or above. Fixed IncomeMoney Market and DerivativesAssociation of India (FIMMDA) isworking on the development ofreporting platform and also on theGlobal Master Repo Agreement tooperationalise the repo in corporatebonds.
Non-SLR Bonds of companies engaged ininfrastructure: Valuation
66. At present, banks’ investments innon-SLR bonds are classified either underheld for trading (HFT) or available for sale(AFS) category and subjected to ‘mark tomarket’ requirements. Considering thatthe long-term bonds issued by companiesengaged in infrastructure activities aregenerally held by banks for a long periodand not traded and also with a view toincentivising banks to invest in suchbonds, it is proposed:
∑ to allow banks to classify theirinvestments in non-SLR bondsissued by companies engaged ininfrastructure activities and having aminimum residual maturity of seven
years under the held to maturity(HTM) category.
Investment in Unlisted Non-SLRSecurities
67. In terms of extant instructions,banks’ investments in unlisted non-SLRsecurities should not exceed 10 per centof their total investments in non-SLRsecurities as on March 31 of the previousyear. Since there is a time lag betweenissuance and listing of security, banks maynot be able to participate in primary issuesof non-SLR securities, which are proposedto be listed but not listed at the time ofsubscription. In view of the above, it isproposed that:
∑ investment in non-SLR debt securities(both primary and secondary market)by banks where the security isproposed to be listed on theExchange(s) may be considered asinvestment in listed security at thetime of making investment.
68. If such security, however, is notlisted within the period specified, the samewill be reckoned for the 10 per cent limitspecified for unlisted non-SLR securities.In case such investment included underunlisted non-SLR securities lead to abreach of the 10 per cent limit, the bankwould not be allowed to make furtherinvestment in non-SLR securities (bothprimary and secondary market, includingunrated bonds issued for financinginfrastructure activities) till such time thelimit is reached.
Financial Market Infrastructure
Reporting Platform for Certificates ofDeposit (CDs) and Commercial Papers(CPs)
69. Although there is a large CD andCP market, there is currently li t t le
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transparency in the secondary markettrades. In order to promote transparencyin the secondary market transactions forCDs and CPs, it is proposed:
∑ to introduce a reporting platform forall secondary market transactions inCDs and CPs.
70. FIMMDA has been requested tostart work on developing a platformsimilar to its existing platform forcorporate bonds. Eventually, once thereporting system stabilises, a settlementmechanism similar to the one introducedfor the OTC corporate bonds may be putin place.
Reporting of OTC DerivativeTransactions
71. The issue of transparency and theneed for information repositories fortransactions in OTC derivatives haveassumed sharper focus in the post-crisisscenario. In India, centralised reporting ofOTC trades in interest rate derivatives[interest rate swap (IRS)/forward rateagreements (FRAs)] commenced inAugust 2007 on the Clearing Corporationof India Limited (CCIL) platform. Tocapture the trade data pertaining to allOTC derivative transactions for
regulation, surveillance and transparencypurposes, it is necessary to extend theexisting reporting arrangement in respectof IRS to all OTC interest rate and forexderivatives. Accordingly, it is proposed:
∑ to set up a Working Group consistingof members of the Reserve Bank, theCCIL and market participants to workout the modalities for an efficient,single point reporting mechanism forall OTC interest rate and forexderivative transactions.
Revision of Repo Accounting: Status
72. As indicated in the Annual PolicyStatement of April 2009, the revisedguidelines for accounting of repo/reverserepo transactions were issued by theReserve Bank on March 23, 2010. Therevised accounting guidelines capturethe economic essence of repo as acollateralised lending and borrowinginstrument and not as outright sale andpurchase. The revised accountingguidelines have been made applicable tomarket repo transactions with effect fromApril 1, 2010. These accounting normswill, however, not apply to repo/reverserepo transactions conducted under theLiquidity Adjustment Facility (LAF) withthe Reserve Bank.
IV. Credit Delivery and Financial Inclusion
Credit Flow to the MSE Sector
Credit Guarantee Scheme for MSEs
73. Following the recommendations ofthe Working Group (Chairman: Shri V. K.Sharma) on credit guarantee scheme of theCredit Guarantee Fund Trust for Microand Small Enterprises (CGFTMSE), it isproposed:
∑ to mandate banks not to insist oncollateral security in case of loans upto Rs.10 lakh as against the presentlimit of Rs.5 lakh extended to all unitsof the micro and small enterprises(MSEs) sector.
High Level Task Force on MSMEs
74. A High Level Task Force wasconstituted by the Government of India
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(Chairman: Shri T.K.A. Nair) to considervarious issues raised by micro, smalland medium enterprises (MSMEs) anddraw up an agenda for action. The TaskForce submitted its Report on January 30,2010 to the Government of India. The TaskForce recommended several measureshaving a bearing on the functioning ofMSMEs, viz., credit, marketing, labour,exit policy, infrastructure/technology/skilldevelopment and taxation. In particular,it recommended that: (i) all scheduledcommercial banks should achieve a 20 percent year-on-year growth in credit tomicro and small enterprises to ensureenhanced credit flow; (ii) any shortfall inthe achievement of sub-target of 60 percent for lending to micro enterprises ofthe total advances granted to the micro andsmall enterprises, would also be taken intoaccount for the purpose of allocatingamounts for contribution to ruralinfrastructure development fund (RIDF)or any other Fund with other financialinstitutions as specified by the ReserveBank, with effect from April 1, 2010; and(iii) all scheduled commercial banksshould achieve a 15 per cent annualgrowth in the number of micro enterpriseaccounts.
75. Banks are urged to keep inview the recommendations made by theTask Force and take effective steps toincrease the flow of credit to the MSEsector, particularly to micro enterprises.The Reserve Bank will monitor theperformance of banks in this regard.
Rural Co-operative Banks
Revival of Rural Co-operative CreditStructure
76. Based on the recommendationsof the Task Force on Revival of Rural
Co-operative Credit Institutions(Chairman: Prof.A.Vaidyanathan) and inconsultation with the state governments,the Government of India had approved apackage for revival of the short-termrural co-operative credit structure. Asenvisaged in the package, so far 25 Stateshave entered into Memorandaof Understanding (MoU) with theGovernment of India and the NationalBank for Agriculture and RuralDevelopment (NABARD). FourteenStates have made necessary amendmentsto their respective Co-operative SocietiesActs. As on December 31, 2009, anaggregate amount of about Rs.7,000 crorewas released by the NABARD asGovernment of India’s share under thepackage to primary agricultural creditsocieties (PACS) in 11 States.
Financial Inclusion through Grass-rootCo-operatives
77. There is a need for bet terunderstanding of the grass-root levelrural co-operatives, which can play amore effect ive role as vehicles offinancial inclusion. Besides, a largenumber of PACS, large adivasi multi-purpose co-operative societies (LAMPS)and farmers’ service societies (FSS), anumber of thrift and credit co-operativesocieties have been set up under theparal lel Self-Reliant Co-operat iveSocieties Acts in some States. There is aneed to understand the operations ofthese co-operat ive societ ies withreference to their membership profile,management structure, range of servicesbeing offered by them, savings mobilisedfrom members/non-members, percentageof non-borrower members, creditextended to tenant farmers, oral lesseesand agricultural labourers to appreciate
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the strengths of the well-functioningsociet ies and their potential as aneffective vehicle of financial inclusion.It is, therefore, proposed:
∑ to const i tute a Committeecomprising representatives from theReserve Bank, the NABARD and afew State Governments to study thefunctioning of well-run PACS,LAMPS, FSS and thrift and credit co-operative societies set up under theparallel Self-Reliant Co-operativeSocieties Acts to gather informationon their working and assess theirpotential to contribute to financialinclusion.
Financial Inclusion Plan for Banks
78. With a view to increasing bankingpenetration and promoting financialinclusion, domestic commercial banks,both in the public and private sectors, wereadvised to take some specific actions.First, banks were required to put in placea Board-approved Financial InclusionPlan (FIP) in order to roll them out overthe next three years and submit the sameto the Reserve Bank by March 2010.Banks were advised to devise FIPscongruent with their business strategy andto make it an integral part of theircorporate plans. The Reserve Bank hasdeliberately not imposed a uniform modelso that each bank is able to build its ownstrategy in line with its business modeland comparative advantage. Second,banks were required to include criteria onfinancial inclusion in the performanceevaluation of their field staff. Third, bankswere advised to draw up a roadmap byMarch 2010 to provide banking servicesin every village having a population of
over 2,000. The Reserve Bank will discussFIPs with individual banks and monitortheir implementation.
Business Correspondents: Relaxations
79. Under the extant guidelines on thebusiness correspondent (BC) model, onlycertain select categories of individuals arepermitted to be engaged as BCs. With aview to providing more flexibility tobanks, it is proposed:
∑ to permit banks to engage anyindividual, including those operatingCommon Service Centres (CSCs), asBC, subject to banks’ comfort leveland their carrying out suitable duediligence.
80. Operational guidelines to banks inthis regard will be issued separately.
81. Furthermore, a suggestion hasbeen received from various quarters toconsider ‘for profit’ companies (other thanNBFCs) as BCs of banks. Keeping in viewthe ramifications of the suggestion, it isproposed:
∑ to prepare a discussion paper on thesubject which will be placed on theReserve Bank’s website. Based on thefeedback, a final view will be takenin the matter.
High Level Committee on Lead BankScheme
82. On the basis of therecommendations of the High LevelCommittee on Lead Bank Scheme(Chairperson: Smt. Usha Thorat), the StateLevel Bankers’ Committee (SLBC)convenor banks were advised onNovember 27, 2009 that the lead banksshould constitute a sub-committee of the
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District Consultative Committees (DCCs)to draw up a roadmap by March 2010 toprovide banking services through abanking outlet in every village having apopulation of over 2,000. Such bankingservices need not necessarily be extendedthrough a brick and mortar branch butthrough any of the various forms ofinformation and communicationtechnology (ICT)-based models, includingthrough business correspondents (BCs).Based on the other recommendations ofthe Committee, the lead banks/scheduledcommercial banks were advised onMarch 2, 2010 to (i) strengthen variousfora under the Lead Bank Scheme;(ii) discuss specific issues enabling andinhibiting financial inclusion in the SLBC/DCC machinery; (iii) set up separatesub-committees to work intensively onspecific issues; and (iv) prepare districtcredit plans/annual credit plans linkedwith the business plans of the banks. Forthis purpose, it is proposed:
∑ to put in place an appropriatemonitoring mechanism of the workingof the SLBCs/DCCs.
Priority Sector Lending Certificates:Working Group
83. In pursuance of the announcementmade in the Second Quarter Review ofOctober 2009, a Working Group onIntroduction of Priority Sector LendingCertificates (PSLCs) (Chairman:Shri V. K. Sharma) was constituted by theReserve Bank in November 2009 toexamine the pros and cons of therecommendation made by the Committeeon Financial Sector Reforms (Chairman:Dr. Raghuram G. Rajan) relating to PSLCsand make suitable recommendations on itsintroduction and their trading in the openmarket. In this context, it is proposed:
∑ to expand the terms of reference ofthe Working Group to also review thepros and cons of inclusion of banklending to micro-finance institutions(MFIs) under priority sector lending.The Group is expected to submit itsReport by end-June 2010.
Urban Co-operative Banks
Establishment of New UrbanCo-operative Banks
84. Taking into account the systemicfinancial health of urbanco-operative banks (UCBs), it wasdecided in 2004 not to set up any newUCBs. With a view to improving thefinancial soundness of the UCB sector,memoranda of understanding (MoU) weresigned with all State Governments.Following the consolidation, the financialcondition of the UCB sector has improvedconsiderably and UCBs have also beenallowed to enter into new areas ofbusiness. With a view to increasing thecoverage of banking services amongstlocal communities, it is proposed:
∑ to set up a Committee comprisingall stakeholders for studyingthe advisability of granting newurban co-operative banking licencesunder Section 22 of the BankingRegulation Act, 1949 [as applicableto co-operative societies (AACS)].
Liberalisation of Off-site ATMs byUCBs
85. Under the extant policy of branchauthorisation, UCBs, which arewell-managed and meet the regulatorycriteria, are required to submit annualbusiness plans, based on which centres areallotted to them according to their choicefor opening of branches. Centres whereUCBs desire to open off-site ATMs are
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also required to be included in their annualbusiness plan. In order to further improvethe banking infrastructure, it has beendecided to liberalise the approach tosetting up of off-site ATMs by UCBs.Accordingly, it is proposed:
∑ to allow well-managed UCBs to setup off-site ATMs without seekingapproval through the annual businessplans.
86. Detailed guidelines in this regardwill be issued by mid-May 2010.
Customer Service
87. The issue of ‘treating customersfairly’ is assuming critical importance asthe experience shows that consumer’sinterests are often not accorded fullprotection and properly attended to.Customer service in the banking industryis increasingly becoming important asbanks are privileged institutions andbanking is a special public utility service.The Reserve Bank and the BankingOmbudsman’s offices have been receivingseveral complaints regarding levying ofexcessive interest rates and charges oncertain loans and advances.
88. The Reserve Bank has, over theyears, undertaken a number of initiativesfor ensuring fair treatment to customers.This has taken the form of both regulatoryfiats (such as reining in of recovery agents,introduction of comprehensive displayboard, banking facilities for the visuallychallenged, rationalisation of servicecharges on collection of outstationcheques and free use of ATMs) as alsomoral suasion and class action. The Codeof Bank’s Commitment to Customers wasintroduced in July 2006 to set a minimumstandard of banking practices for banks
to follow for their dealing with individualcustomers.
89. However, within the domain ofnecessary freedom to banks to choosethe types of services to be offered to thecustomers and related costs, concertedefforts need to be made to furtherdevelop a credible and effec t ivefunct ional sys tem of a t tending tocustomer complaints. In particular,banks’ internal structure needs to bemade functionally effective and scaledup to attend to not only basic customerneeds , but the specia l needs ofdisadvantaged groups such aspensioners and smal l borrowers ,including farmers. Though there existsa t ie red mechanism for cus tomergrievance redressal in the banks, itseff icacy in terms of a t tending tocustomer complaints i s far f romsatisfactory. Taking into account allthese considerations, it is proposed:
∑ to set up a Committee to look intobanking services rendered to retailand small customers, includingpensioners. The Committee will alsolook into the system of grievanceredressal mechanism prevalent inbanks, its structure and efficacy, andsuggest measures for expeditiousresolution of complaints. TheCommittee will also examine theinternational experiences in thisregard.
∑ to further strengthen the mechanism,for implementing the Reserve Bank’sguidelines on customer service,through on-site and off-siteinspections.
∑ to require banks to devote exclusivetime in a Board meeting once everysix months to review and deliberateon customer service.
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Strengthening the Resilience of theBanking Sector
90. In December 2009, the BaselCommittee on Banking Supervision(BCBS) had issued two consultativedocuments for public comments. Thedocument on ‘Strengthening theResilience of the Banking Sector’ containsproposals for raising the quality,consistency and transparency of thecapital base, enhancing risk coverage,prescribing leverage ratio and containingpro-cyclicality. The second document on‘International Framework for LiquidityRisk Measurement Standards andMonitoring’ focuses on measures forfurther elevating the resilience ofinternationally active banks to liquiditystress across the globe as well asincreasing international harmonisation ofliquidity risk supervision. The BaselCommittee is presently undertaking aQuantitative Impact Study (QIS) of theseproposals. The QIS will form the basis forcalibrating reforms proposed in the abovetwo documents to arrive at an appropriatelevel and quality of capital and liquidity.The fully calibrated set of standards isexpected to be developed by end-2010with the aim of implementation byend of 2012. Ten large Indian banks areparticipating in the QIS.
Working Group on ValuationAdjustment and Treatment of IlliquidPositions
91. In the Second Quarter Review ofOctober 2009, it was proposed to issueappropriate guidelines to banks for
implementation of enhancements andrevisions to Basel-II framework finalisedby the Basel Committee in July 2009.Accordingly, the Reserve Bank issuedguidelines to banks in February 2010.These guidelines require banks to makespecified valuation adjustments forvarious risks/costs in their portfoliosincluding derivatives, which are subjectto ‘mark to market’ requirement and alsofor illiquidity of these positions. Theseguidelines also permit banks to follow anyrecognised models/methods for computingthe amount of valuation adjustment. Inorder to ensure that a consistentmethodology is adopted by banks for thepurpose, it is proposed:
∑ to constitute a Working Group withmembers from the Reserve Bank,FIMMDA, the IBA and a few banksto recommend an appropriateframework in this regard.
Convergence of Indian AccountingStandards with International FinancialReporting Standards
92. As part of the efforts to ensureconvergence of the Indian AccountingStandards (IASs) with the InternationalFinancial Reporting Standards (IFRSs),the roadmap for banking companies andnon-banking financial companies(NBFCs) has been finalised by theMinistry of Corporate Affairs inconsultation with the Reserve Bank. Asper the roadmap, all scheduledcommercial banks will convert theiropening balance sheet as at April 1, 2013in compliance with the IFRS convergedIASs.
V. Regulatory and Supervisory Measures forCommercial Banks
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93. However, with regard to UCBs andNBFCs, a gradualist approach isconsidered appropriate. The roadmapenvisages UCBs having net worth inexcess of Rs. 300 crore and NBFCs whichare part of NSE-Nifty 50 and BSE-Sensex30 as well as those NBFCs having networth in excess of Rs.1,000 crore toconverge with IFRSs in tandem with thetime schedule given for scheduledcommercial banks. UCBs having networth in excess of Rs. 200 crore but notexceeding Rs. 300 crore and other listedNBFCs as well as unlisted NBFCs havinga net worth in excess of Rs. 500 crore shallconvert their opening balance sheets as onApril 1, 2014 in compliance with the IFRSconverged IASs. Remaining UCBs,unlisted NBFCs not falling in the abovecategories and regional rural banks(RRBs) need to follow only the notifiedIASs which are not converged with IFRSs.
94. Considering the amount of workinvolved in the convergence process, it isexpected that banks and other entitiesconcurrently initiate appropriate measuresto upgrade their skills, managementinformation system (MIS) and informationtechnology (IT) capabilities to manage thecomplexities and challenges of IFRSs. Theimplementation poses additionalchallenge as certain aspects of IFRSs,especially the standards on financialinstruments, are under review and wouldtake some time before they are finalised.In order to facilitate smooth migration toIFRSs, it is proposed:
∑ to undertake a study of theimplications of the IFRSsconvergence process and also to issueoperational guidelines as appropriate.
∑ to disseminate information throughlearning programmes with a view to
preparing banks and other entities toadhere to the roadmap.
Infrastructure Financing
95. With a view to meeting theincreasing financing needs ofinfrastructure development, the ReserveBank has taken a number of measures tofacilitate adequate flow of bank credit tothis sector. In order to give a further thrustto infrastructure financing by banks, somefurther measures are felt necessary.
96. In terms of extant instructions,rights, licenses and authorisations ofborrowers, charged to banks as collateralin respect of project loans (includinginfrastructure projects) are not eligible forbeing reckoned as tangible security for thepurpose of classifying an advance assecured loan. As toll collection rights andannuities in the case of road/highwayprojects confer certain material benefitsto lenders, it is proposed:
∑ to treat annuities under build-operate-transfer (BOT) model in respect ofroad/highway projects and tollcollection rights, where there areprovisions to compensate the projectsponsor if a certain level of traffic isnot achieved, as tangible securitiessubject to the condition that banks’right to receive annuities and tollcollection rights is legally enforceableand irrevocable.
97. Till June 2004, the Reserve Bankhad prescribed a limit on banks’ unsecuredexposures. As a step towards deregulation,the above limit was withdrawn to enablebanks’ Boards to formulate their ownpolicies on unsecured exposures. Theprovisioning requirement for unsecuredsub-standard exposures, however, wasincreased to 20 per cent consequent to the
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withdrawal of limits on banks’ unsecuredexposures (the provisioning requirementfor secured sub-standard exposures standsat 10 per cent). In view of certainsafeguards such as escrow accountsavailable in respect of infrastructurelending, it is proposed that:
∑ infrastructure loan accounts classifiedas sub-standard will attract aprovisioning of 15 per cent instead ofthe current prescription of 20 per cent.To avail of this benefit of lowerprovisioning, banks should have inplace an appropriate mechanism toescrow the cash flows and also havea clear and legal first claim on suchcash flows.
Presence of Foreign Banks
98. In February 2005, the ReserveBank had released the ‘roadmap forpresence of foreign banks in India’ layingout a two-track and gradualist approachaimed at increasing the efficiency andstability of the banking sector in India. Thefirst track was the consolidation of thedomestic banking system, both in theprivate and public sectors, and the secondtrack was the gradual enhancement offoreign banks in a synchronised manner.The roadmap was divided into two phases,the first phase spanning the period March2005 – March 2009, and the second phasebeginning after a review of the experiencegained in the first phase. In the first phase,foreign banks wishing to establishpresence in India for the first time couldeither choose to operate through branchpresence or set up a 100 per centwholly-owned subsidiary (WOS),following the one-mode presencecriterion. Foreign banks already operatingin India were also allowed to convert theirexisting branches to WOS while following
the one-mode presence criterion. TheWOS was to be treated on par with theexisting branches of foreign banks forbranch expansion in India. No foreignbank, however, applied to establish itselfas a WOS or to convert to a WOS duringthe first phase.
99. When the revision of presence offoreign banks in India was due in April2009, the global financial markets werein turmoil and there were uncertaintiessurrounding the financial strength ofbanks around the world. Accordingly, theAnnual Policy Statement of April 2009indicated the intent to continue with thecurrent policy and procedures governingthe presence of foreign banks in India andto review its roadmap after dueconsultation with the stakeholders oncethere was greater clarity regardingstability and recovery of the globalfinancial system.
100. While global financial marketshave been improving, variousinternational fora have been engaged insetting out policy frameworksincorporating the lessons learnt from thecrisis. Some of the lessons from crisis areto avoid organisational structures whichbecome (i) too big to fail and (ii) toocomplex to fail. Furthermore, while thereis a realisation that as internationalagreement on cross-border resolutionmechanism for internationally activebanks is not likely to be reached in thenear future, there is considerable meritin subsidiarisation of significantcross-border presence. Apart from easingthe resolution process, this will alsoprovide greater regulatory control andcomfort to the host jurisdictions. Drawinglessons from the crisis, it is proposed:
∑ to prepare a discussion paper on themode of presence of foreign banks
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through branch or WOS by September2010.
Licensing of New Banks
101. The Finance Minister, in hisbudget speech on February 26, 2010announced that the Reserve Bankwas considering giving some additionalbanking licenses to private sector players.NBFCs could also be considered,if they meet the Reserve Bank’seligibility criteria. In line with the aboveannouncement, it is proposed:
∑ to prepare a discussion papermarshalling the internationalpractices, the Indian experience asalso the extant ownership andgovernance (O&G) guidelines andplace it on the Reserve Bank’swebsite by end-July 2010 for widercomments and feedback.
102. Thereafter, detailed discussionswill be held with all stakeholders on thediscussion paper and guidelines will befinalised based on the feedback. Allapplications received in this regard wouldbe referred to an external expert group forexamination and recommendations to theReserve Bank for granting licenses.
Introduction of Bank HoldingCompany (BHC)/Financial HoldingCompany (FHC) in India
103. The Reserve Bank placed aDiscussion Paper on Holding Companiesin Banking Groups on its website inAugust 2007 for public comments. Thefeedback received on the Discussion Paperunderscored the need for introduction ofbank holding companies (BHCs)/financialholding companies (FHCs) in India toensure an orderly growth of financial
conglomerates and better insulation of abank from the reputational and other risksof the subsidiaries/affiliates within thegroup. The Committee on Financial SectorAssessment (CFSA), in its report issuedin March 2009, observed that given thelack of clarity in the existing statutesrelating to the regulation and supervisionof financial holding companies, theholding company structure as prevalent inthe US for financial conglomerates is notcurrently in use in India. The Committeenoted that the absence of the holdingcompany structure in financialconglomerates exposes investors,depositors and the parent company torisks, strains the parent company’s abilityto fund its own core business and couldrestrict the growth of the subsidiarybusiness. Considering the complexity ofthe issues involved and implications of theBHC/FHC model for the financial systemin general and banking system inparticular, it is proposed:
∑ to constitute a Working Group withthe representatives from theGovernment, the Reserve Bank, theSEBI, the IRDA and the IBA torecommend a roadmap for theintroduction of a holding companystructure together with the requiredlegislative amendment/framework.
Conversion of Term Deposits, DailyDeposits or Recurring Deposits forReinvestment in Term Deposits
104. As per extant guidelines, banksshould allow conversion of term deposits,daily deposits or recurring deposits toenable depositors to immediately reinvestthe amount lying in the aforesaid depositswith the same bank in another termdeposit. Banks are required to pay interestin respect of such term deposits without
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reducing the interest by way of penalty,provided that the deposit remains with thebank after reinvestment for a period longerthan the remaining period of the originalcontract. On a review of the extantregulatory norms and in order to facilitatebetter asset-liability management (ALM),it is proposed:
∑ to permit banks to formulate their ownpolicies towards conversion ofdeposits.
Compensation Practices
105. It was indicated in the SecondQuarter Review of October 2009 that inline with the steps taken by globalcommunity, particularly the initiativestaken by G-20 nations, the Reserve Bankwould issue guidelines to private sectorbanks and foreign banks with regard tosound compensation policy. Accordingly,it is proposed:
∑ to issue comprehensive guidelinesbased on Financial Stability Board(FSB) principles on soundcompensation practices by end-June2010.
106. The guidelines will cover effectivegovernance of compensation, alignment ofcompensation with prudent risk-takingand disclosures for whole time directors(WTDs)/chief executive officers (CEOs)as well as risk takers of banks.
Implementation of Pillar 2 of Basel II
107. All commercial banks, includingforeign banks in India, migrated tothe Basel II framework by March 31,2009. The Reserve Bank has developeda framework to conduct the SupervisoryReview and Evaluation Process (SREP)in banks under Pillar 2 of Basel II. One
of the major objectives of SREP isto evaluate whether the capital maintainedby the bank is adequate keeping inview its risk profile and to determine thesupervisory capital ratio (SCR). TheSCR would be determined for each bankseparately. Under this framework,the adequacy of the risk managementand internal control frameworkof banks would be subjected toin-depth assessment. In order tostrengthen the supervisory process, it isproposed:
∑ to implement the SREP frameworkfor banks from the inspection cycle2010-11 as an integral part of theAnnual Financial Inspection (AFI) ofbanks.
Cross-border Supervision
108. As indicated in the Mid-TermReview of October 2008, an InternalWorking Group (Chairman: Shri S.Karuppasamy) examined the legalposition on cross-border supervisionarrangements and also explored thefeasibility of executing memoranda ofunderstanding with overseas supervisors.Subsequent to the submission of therecommendations of the Group, theReserve Bank has comprehensivelyreviewed its existing practices forcross-border supervisory co-operation.With a view to ensuring effectivecross-border supervision and supervisoryco-operation, it is proposed:
∑ to enter into bilateral MoU withoverseas supervisory authoritieswithin the existing legal provisions,consistent with the Basel Committeeon Banking Supervision (BCBS)principles.
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Information Technology and RelatedIssues: Enhancement to the Guidelines
109. Information technology (IT) riskassessment and management are requiredto be made a part of the risk managementframework of a bank, while internal audit/information system audit needs toindependently provide assurance that theIT-related processes and controls areworking as intended. Given the increasedincidents of cyber frauds in banks in therecent period, it is necessary to improvecontrols and examine the need for apro-active fraud risk assessment andmanagement processes in commercialbanks. With the increase in transactionsin electronic mode, it is also critical toexamine the legal implications for banksarising out of IT-related legislations andother legislations such as IT Act 2000,IT Amendment Act 2008 and Preventionof Money Laundering Act, 2002 and alsosteps that are required to be taken tosuitably mitigate the legal risks arising
from such transactions. Accordingly, it isproposed:
∑ to set up a Working Group oninformation security, electronicbanking, technology risk management,and tackling cyber frauds.
Credit Information Companies:Grant of Certificate of Registration
110. In April 2009, the Reserve Bankhad issued in-principle approvalto four entities to set up creditinformation companies. Out ofthe four companies, Experian CreditInformation Company of India PrivateLtd. and Equifax Credit InformationServices Private Ltd. have been grantedCertificate of Registration (CoR) tocommence the business of creditinformation on February 17, 2010 andMarch 26, 2010, respectively. Theapplications of the remaining twocompanies for grant of CoR are underconsideration.
VI. Institutional Developments
Non-Banking Financial Companies
Core Investment Companies (CICs):Regulatory Framework
111. The regulatory framework forNBFCs has evolved in the recent past withparticular focus on inter-connectednessand systemic risk. Under this approach,access to public funds has been perceivedas a systemic issue necessitating closeregulation and monitoring of NBFCs,including systemically important non-deposit taking NBFCs (NBFCs-ND-SI).However, companies which have theirassets predominantly as investments inshares not for trading but for holding
stakes in group companies and also do notcarry on any other financial activity [i.e.,Core Investment Companies (CICs)]justifiably deserve a differential treatmentin the regulatory prescription applicableto NBFCs-ND-SI. In order to rationalisethe policy approach for CICs, and basedon feedback received from suchcompanies, it is proposed to:
∑ treat CICs having an asset size ofRs.100 crore and above assystemically important coreinvestment companies. Suchcompanies will be required to registerwith the Reserve Bank.
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112. The CICs fulfilling minimumcapital and leverage criteria will be givenexemption from maintenance of net ownedfund and exposure norms applicable toNBFCs-ND-SI. They would be requiredto submit annual certificate from theirstatutory auditors regarding compliancewith the prescribed norms. Draftguidelines will be placed on the ReserveBank's website by April 30, 2010 forpublic comments.
Securitisation Companies/ReconstructionCompanies set up under the SARFAESIAct, 2002: Changes in Regulations
113. The guidelines and instructionsissued to the Securitisation Companies/Reconstruction Companies (SCs/RCs)have been reviewed by the Reserve Bankin consultation with these companies.Accordingly, it is proposed to makethe following modifications to theguidelines:
∑ SCs/RCs can acquire the assets eitherin their own books or directly in thebooks of the trusts set up by them.
∑ The period for realisation of assetsacquired by SCs/RCs can be extendedfrom five years to eight years by theirBoards of Directors, subject to certainconditions. Asset/Security Receipts(SRs), which remain unresolved/notredeemed as at the end of five yearsor eight years, as the case may be, willhenceforth be treated as loss assets.
∑ It will be mandatory for SCs/RCsto invest an amount not less than5 per cent of each class of SRs issuedunder a particular scheme andcontinue to hold the investments tillthe time all the SRs issued under thatclass are redeemed completely.
∑ With a view to bringing transparencyand market discipline in the
functioning of SCs/RCs, additionaldisclosures relating to assets realisedduring the year, value of financialassets unresolved as at the end ofthe year, value of SRs pendingredemption, among others, are beingprescribed.
114. Detailed guidelines will be issuedby April 30, 2010.
Guidelines on Change in or Takeover ofthe Management of the Business of theBorrower by the SCs/RCs
115. The draft guidelines on change inor takeover of the management of thebusiness of the borrower by the SCs/RCswere placed on the Reserve Bank’swebsite for public comments. Theguidelines define the eligibility conditionsand the grounds based on which SCs/RCsmay exercise the powers. The guidelinesprovide for setting up of an IndependentAdvisory Committee (IAC) to evaluatethe proposals of the SCs/RCs regardingthe change in or taking over of themanagement of the business of theborrowers. Based on the feedbackreceived and recommendations of theExternal Advisory Committee, it isproposed:
∑ to issue the final guidelines by April30, 2010.
Payment and Settlement Systems
Payment System Vision Document2009-12
116. Keeping in view the significantdevelopments in payment systems and theReserve Bank’s responsibility with regardto regulation and supervision of paymentsystems, the ‘Vision Document’ for theperiod 2009-12 was released on February16, 2010. The scope of the ‘VisionDocument’ has been enhanced to ensure
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that all the payment and settlementsystems operating in the country are safe,secure, sound, efficient, accessible andauthorised.
Membership to the Committee on Paymentand Settlement Systems
117. The Committee on Payment andSettlement Systems (CPSS), constitutedunder the aegis of the Bank forInternational Settlements (BIS), wasrecently broadened to include India andalso nine other countries as members. TheReserve Bank is also represented on threeWorking Groups of the CPSS set up fordrawing up standards/guidelines towardsefficient functioning of the payment andsettlement systems and supporting marketinfrastructure across the world.
Standardisation of Security Features onCheque Forms
118. Cheques continue to be apredominant instrument for retailpayments. To act as a deterrent to chequefrauds and to bring about uniformityacross cheques issued/used by the bankingindustry, it was decided to examine theneed for standardisation of securityfeatures on cheque forms. A WorkingGroup was accordingly constituted andbased on its recommendations and theindustry’s feedback, cheque truncationsystem (CTS)–2010 Standardwith benchmark specifications forsecurity features on cheques and fieldplacements on cheque forms has beenprescribed.
Operationalisation of National PaymentsCorporation of India
119. The National PaymentsCorporation of India (NPCI), set up inDecember 2008 as an umbrella
organisation for operating and managingretail payment systems, has the envisionedrole to look at future innovations in theretail payment space in the country.Effective December 14, 2009, NPCI hastaken over operations of the NationalFinancial Switch (NFS) from Institute forDevelopment and Research in B a n k i n gTechnology (IDRBT). NPCI is alsoexpected to take the lead role in rollingout the proposed CTS project at Chennai.
Phased Discontinuation of High ValueClearing
120. It has been the endeavour of theReserve Bank to migrate from paper-basedpayments to electronic payment systemsby creating the appropriate technologicalinfrastructure. As a step towardsencouraging migration of paper-basedhigh value payments to more secureelectronic modes, i t was decidedto discontinue high value clearing (HVC)in a phased and non-disruptive manner byMarch 31, 2010. This process has beencompleted as per schedule.
Enhancements in National ElectronicFunds Transfer System
121. To further strengthen the NationalElectronic Funds Transfer (NEFT) systemin terms of availability, convenience,efficiency and speed, significantenhancements were introduced in theoperational procedures and process flow,effective March 1, 2010. These included:(i) increasing the operating window bytwo hours on weekdays and one hour onSaturdays; (ii) introducing the concept ofhourly settlements; (iii) shortening thetime window for return of uncreditedtransactions; and (iv) enabling positiveconfirmation to the remitter through SMS
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or e-mail about the time and date of actualcredit of funds to the beneficiary’s accountwith the destination bank. The concept ofpositive confirmation to the remitter isperhaps unique across all retail electronicpayment systems world-wide.
122. As at end-March 2010, over66,500 branches of 95 banks hadparticipated in NEFT and the volume oftransactions processed increased with arecord volume of 8.3 million transactionsin March 2010.
Directions to Intermediaries and PaymentAggregators
123. The use of electronic/onlinemodes of payments for purchase of goodsand services and also for making paymentsfor other utilities is increasingly gainingpopularity in the country. The increase inthe electronic/online mode of paymentinvolves the use of intermediaries such asaggregators and payment gateway serviceproviders. In order to ensure the safety ofsuch transactions, detailed guidelines wereissued in November 2009.
Mobile Banking in India
124. The use of mobile phone channelsfor initiation and execution of bankingtransactions has been gaining significancethe world over. The significance of thischannel has been recognised by theReserve Bank. Accordingly, regulatoryguidelines for enabling mobile bankingwere notified in October 2008. Thetransaction limits were further relaxed inDecember 2009. Banks were alsopermitted to enable small valuetransactions up to Rs.1,000 withoutend-to-end encryption. Currently, thischannel is used to settle on an average 1.9lakh transactions of average value 12 crorein a month.
125. To further encourage thedevelopment of other mobile-basedproducts, non-bank entities were alsopermitted in August 2009 to issuemobile-based, semi-closed prepaidpayment instruments, up to Rs.5,000.Non-bank entities can issue suchinstruments for facilitating payment forgoods/services and m-commercetransactions.
126. The Reserve Bank believes thatgiven the penetration levels of mobiletelephony in India, this could become animportant medium for achieving financialinclusion in the country. However, thiscalls for focused efforts by the banks topartner with mobile service providers.Co-operation rather than competitionbetween these two important stakeholdersis the critical need of the hour. Recently,an Inter-Ministerial Group constituted bythe Government of India, has madeimportant recommendations for financialinclusion through a bank-led model usingthe infrastructure already set up by mobileservice providers. The Reserve Bank isexamining the recommendations of theGroup.
Automated Data Flow from Banks
127. As the policy and decision-makingprocesses are becoming more informationintensive, it is imperative to ensure qualityof data and their timely submission.With a view to ensuring accuracy andintegrity of data flow from the bankingsystem to the Reserve Bank, a Core Groupconsisting of experts from banks, theReserve Bank, IDRBT and the IBA hasbeen constituted for preparing an ApproachPaper on Automated Data Flow (a straight-through-process) from the core bankingsolution (CBS) or other IT systems of
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commercial banks to the Reserve Bank. Itis expected that the Approach Paper wouldbe ready for circulation among banks byend-August 2010.
RTGS Upgradation
128. The current RTGS systemhas been in operation for nearly sixyears and there is a need to initiatesteps for replacing i t with a newsystem having improved functionalitiesin view of advancement intechnology. Accordingly, a WorkingGroup comprising representat ives
from the Reserve Bank and majorcommercial banks has been constitutedfor preparing the basic approach towardsa next generat ion RTGS system,both from the business and ITperspective.
Second Quarter Review
129. The next review of theDevelopmental and Regulatory Policieswill be undertaken as part of the SecondQuarter Review of Monetary Policy onNovember 2, 2010.
Mumbai
April 20, 2010